©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Five Accounting for Merchandising Businesses

Merchandising Businesses Sale Merchandising businesses generate revenue by selling goods. The goods purchased for resale are called merchandise inventory.

Product Costs Versus Selling and Administrative Costs Product Costs Costs that are included in inventory. Selling & Admin. Costs Costs that are not included in inventory. They are sometimes called period costs.

Allocation of Inventory Cost Between Asset and Expense Accounts Cost of Goods Available for Sale Merchandise Inventory (Balance Sheet) Cost of Goods Sold (Income Statement)

Gross Margin (or Gross Profit)

Perpetual Inventory System Inventory account is adjusted perpetually (continually) throughout the accounting period.

Perpetual Inventory System Let’s see how a perpetual inventory system works by looking at transactions for June’s Plant Shop (JPS).

Event 1: JPS acquired $15,000 by issuing common stock. 1.Increase assets (cash). 2.Increase equity (common stock). Asset Source Transaction

Event 2: JPS purchased merchandise inventory for $14,000 cash. 1.Decrease assets (cash). 2.Increase assets (merchandise inventory). Asset Exchange Transaction

Event 3a: JPS recognized sales revenue from selling inventory for $12, Increase assets (cash). 2.Increase equity (sales revenue). Asset Source Transaction

Event 3b: JPS recognized $8,000 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

Event 4: JPS paid $1,000 cash for selling expenses. 1.Decrease assets (cash). 2.Decrease equity (selling expenses). Asset Use Transaction

Purchasing inventory often involves: Transportation costs Inventory returns Purchase allowances Cash discounts Other Topics Let’s look at these transactions for JPS.

Event 1: JPS purchased merchandise inventory on account with a list price of $8,000. The payment terms are 2/10 n/30. Before analyzing this transaction, let’s learn a little about cash discounts.

A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Full amount less discount Credit Period Full amount due Purchase or Sale Cash Discounts

2/10, n/30 Percentage of Discount # of Days Discount Is Available Otherwise, the Full Amount Is Due # of Days when Full Amount Is Due Cash Discounts

Event 1: JPS purchased merchandise inventory on account with a list price of $8,000. The payment terms are 2/10 n/30. 1.Increase assets (merchandise inventory). 2.Increase liabilities (accounts payable). Asset Source Transaction

Event 2: JPS returned some of the inventory purchased in Event 1. The list price of the returned merchandise was $1, Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

Event 3: JPS paid cash to settle the account payable due on the inventory purchased in Event 1. The payment was made after the end of the discount period. 1.Decrease assets (cash). 2.Decrease liabilities (accounts payable). 3.Decrease equity (interest expense). Asset Use Transaction

Event 4: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise. Before analyzing this transaction, let’s learn a little about transportation costs.

Transportation Costs FOB shipping point (buyer pays) FOB destination (seller pays) Merchandise Seller Buyer FOB = Free on Board

Event 4: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise. 1.Decrease assets (cash). 2.Increase assets (merchandise inventory). Asset Exchange Transaction

Event 5a: JPS recognized $24,750 of revenue on the cash sale of merchandise that cost $11, Increase assets (cash). 2.Increase equity (sales revenue). Asset Source Transaction

Event 5b: JPS recognized $11,500 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

Event 6: JPS incurred $450 of freight costs on inventory delivered to customers. 1.Decrease assets (cash). 2.Decrease equity (transportation-out). Asset Use Transaction

Event 7: JPS purchased $14,000 of merchandise inventory on account with credit terms of 1/10 n/30. The inventory was delivered FOB destination. The freight costs were $ Increase assets (merchandise inventory). 2.Increase liabilities (accounts payable). Asset Source Transaction

Event 8a: JPS recognized $16,800 of revenue from the sale on account of merchandise that cost $8,660. The freight terms were FOB shipping point. The party responsible paid freight costs of $275 in cash. JPS does not offer a cash discount to purchasers. 1.Increase assets (accounts receivable). 2.Increase equity (sales revenue). Asset Source Transaction

Event 8b: JPS recognized $8,660 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

Event 9: JPS paid $9,900 cash in partial settlement of the account payable that arose from purchasing inventory on account in Event 7. The partial payment was made within the discount period for merchandise with a list price of $10, Decrease assets (cash). 2.Decrease liabilities (accounts payable). Asset Use Transaction

Event 10: JPS paid $8,000 cash for selling and administrative expenses. 1.Decrease assets (cash). 2.Decrease equity (selling and admin. expense). Asset Use Transaction

Sales of inventory often involves: Inventory returns Purchase allowances Cash discounts Events Affecting Sales Let’s look at these transactions for JPS.

Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/20 n/30. The merchandise had cost JPS $5, Increase assets (accounts receivable). 2.Increase equity (sales revenue). Asset Source Transaction

Event 1b: JPS recognized $5,100 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

Event 2a: The customer in Event 1a returned inventory with a $1,000 list price that JPS had sold with 1/10 n/30 payment terms. The merchandise had originally cost JPS $ Decrease assets (accounts receivable). 2.Decrease equity (retained earnings). Asset Use Transaction

Event 2b: The cost of the goods ($600) is returned to the inventory account. 1.Increase assets (merchandise inventory). 2.Increase equity (cost of goods sold). Asset Source Transaction

Event 3: JPS collected the balance of the account receivable from the customer that purchased the goods in Event 1a. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). Asset Exchange Transaction Let’s assume the customer paid within the discount period.

Event 3: JPS collected the balance of the account receivable from the customer that purchased the goods in Event 1a. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). 3.Increase equity (interest revenue). Asset Exchange & Source Now, let’s assume the customer did not pay within the discount period.

Lost, Damaged, or Stolen Inventory Most merchandise companies experience some level of inventory shrinkage, a term that reflects decreases in inventory for reasons other than sales to customers.

Lost, Damaged, or Stolen Inventory Assume a company determined that $500 of inventory was lost through shrinkage. Here is how it would effect the statements: In general journal form, the entry is as follows:

Gross Margin Percentage Gross Margin Net Sales This measure indicates how much of each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit. Other things being equal, the company with the higher gross margin percentage is pricing its products higher.

Return on Sales Net Income Net Sales Net income expressed as a percentage of sales provides insight as to how much of each sales dollar is left as net income after all expenses are paid. Other things being equal, the company with the higher return on sales percentage is doing a better job of controlling costs.

Financing Merchandise Inventory Borrow Money from Bank Interest Expense Use Cash Opportunity Cost Purchase on Account Higher Prices and/or Interest

End of Chapter Five