Chapter 5

Service enterprises perform services as their primary source of revenue. Merchandising companies buy and sell merchandise.

Differences Between a Service Business and a Merchandising Company PowerPoint Slides In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales. Unlike expenses for a service company, expenses for a merchandising company are divided into two categories: Cost of goods sold - the total cost of merchandise sold during the period. Operating expenses - selling and administrative expenses. 2

Calculating Net Income Net Income--A measure of the overall performance of a business entity.

Calculating Net Income Net Income--A measure of the overall performance of a business entity. Service Company Revenues - Operating Expenses Net Income

Calculating Net Income Net Income--A measure of the overall performance of a business entity. Service Company Revenues - Operating Expenses Net Income Product Company Revenues - Cost of Goods Sold Gross Margin - Operating Expenses Net Income

Terms Sales revenue or sales = sale of merchandise Cost of goods sold = total cost of merchandise sold

Operating cycle of any company is... the average time it takes to go from cash to cash in producing revenues. TO

merchandising company is... Operating cycle of a merchandising company is... Ordinarily longer than that of a service company; Purchase of merchandise and its sale lengthens the cycle.

Merchandising Company Receive Cash Perform Services Buy Inventory Sell Inventory Service Company Merchandising Company Cash Accounts Receivable Merchandise Inventory

Inventory The Inventory account is one of the largest assets for any company. The determination of which goods should be included in inventory at the end of a period is “Inventory Cutoff.” Inventory errors will affect the financial statements for 2 years.

Merchandise Inventory? What Is Charged to Merchandise Inventory? All costs needed to get inventory to a company and ready to sell +Freight-In +Special Permits Only costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies

Transportation Costs The cost of inbound transportation is added to the cost of inventory. For the perpetual method, the cost must be added to the Inventory account to reflect actual cost of acquiring inventory. For the periodic method, a Freight-In account is used.

Inventory Control Methods Perpetual Inventory Method--A system of accounting in which cost of goods sold and inventory are adjusted when the merchandise is purchased or sold. Periodic Inventory Method--A system of accounting in which the cost of goods sold and inventory are adjusted at the end of the accounting period.

First: Let’s look at the whole process assuming Perpetual Inventory

Perpetual Inventory Transaction records of every sale or purchase are required to account for inventory. The perpetual method is similar to how you would account for cash. The Inventory account should represent the amount of inventory on hand at any time.

Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. Task: Record the purchase by getting information from the Purchase Invoice. The Purchase Invoice is the buyer’s copy of the sales invoice.

Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. GENERAL JOURNAL Debit Credit May 4 Merchandise Inventory 3,800 Accounts Payable 3,800 To record goods purchased on account.

Merchandise Purchases On May 5 the company received an invoice from a freight company for $ 120 for delivery of the merchandise from PW Audio GENERAL JOURNAL Debit Credit May 5 Merchandise Inventory 120 Accounts Payable 120 To record in-coming freight on account.

Purchase Returns On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Merchandise Inventory 300 Record goods returned on account.

Purchase Discounts A purchase discount is a reduction in the purchase price, usually when payment is made within a specified period. Purchase discounts reduce the net cost of the purchases account. For perpetual inventory, a purchase discount reduces inventory by the same amount.

Purchase Discount Example: On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.

Purchase Discount Example: On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier. 3/1 Inventory ………….................... 1,000 Accounts Payable ...........… 1,000 Received books from Wiley, purchase order #M1234 with terms of 2/10, n/30.

Purchase Discount Example: On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier. 3/10 Accounts Payable..................... 1,000 Inventory…………...........… 20 Cash................................... 980 Paid Wiley’s invoice 1234 for purchase of books with 2% discount.

Purchase Discount Example: On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made for the payment to the supplier, but assume the payment was Apr 1 4/1 Accounts Payable..................... 1,000 Cash................................... 1000 Paid Wiley’s invoice 1234 for purchase of books. No discount taken.

Sales Revenues: are recorded when earned-revenue recognition principle must be supported by a business document-written evidence 2 entries are made for each sale one to record sale one to record cost of merchandise sold

Sales Revenue Example: On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900. 3/1 Accounts Receivable.......... 5,000 Sales………….............… 5,000 Record sale to Acme Inc. 3/1 Cost of Goods Sold............ 2,900 Merchandise Inventory.. 2,900 Record Cost of Goods

Merchandise Inventory Sales Returns & Allowances Sales Revenue Example: Cash Accounts Receivable Merchandise Inventory Mar 1 5,000 2,900 Mar 1 Cost of Goods Sold Sales Returns & Allowances Sales 5,000 Mar 1 Mar 1 2,900

Periodic Inventory Inventory levels on the general ledger are not affected by purchases or sales. Might be used in a juice bar or a small clothing store. The Inventory and Cost of Goods Sold accounts are only correct at the end of the fiscal period, when a physical inventory is taken.

Cost of Goods Sold -Periodic Method A running account of changes in inventory is not maintained. Separate accounts are used to record Purchases Freight in, Purchase returns Discounts Cost of goods sold is calculated at end of period.

Periodic Inventory MERCHANDISE INVENTORY BEG. BALANCE $25,000

Periodic Inventory This account is NOT changed during the MERCHANDISE INVENTORY $25,000 This account is NOT changed during the accounting period

Periodic Inventory $25,000 Merchandise bought during MERCHANDISE INVENTORY PURCHASES $25,000 XXX Merchandise bought during the year is debited to Purchases instead of Merchandise Inventory

Periodic Inventory MERCHANDISE INVENTORY PURCHASES $25,000 XXX SALES XXX The COST of merchandise sold is NOT recorded. The selling price is credited to the Sales account

Sales Revenue Periodic On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900. 3/1 Accounts Receivable.......... 5,000 Sales………….............… 5,000 Record sale to Acme Inc. 3/1 Cost of Goods Sold............ 2,900 Merchandise Inventory.. 2,900 Record Cost of Goods Periodic

Periodic Inventory $25,000 After a year of purchasing MERCHANDISE INVENTORY $25,000 After a year of purchasing and selling merchandise, the balance is no longer accurate!

Periodic Inventory $25,000 An adjustment is needed to update the MERCHANDISE INVENTORY $25,000 An adjustment is needed to update the balance of the Merchandise Inventory account. That takes a physical count.

Periodic Inventory The calculation to determine Cost of Goods Sold using the periodic method is as follows: Beginning Inventory, Jan 1 + Purchases for the year = Cost of goods available for sale - Ending Inventory, Dec. 31 = Cost of Goods Sold

What Is the Sales Returns and Allowances Account? Contra Revenue Account to sales Used to show how much came back in returns and allowances Excessive returns and allowances suggest: inferior merchandise inefficiencies in filing orders errors in billing customers mistakes in delivery or shipment of goods

Sales Returns and Allowances Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL Debit Credit Mar 1 Accounts Payable 300 Merchandise Inventory 300 To record goods returned to Sauk. On seller’s books GENERAL JOURNAL Debit Credit Mar 1 Sales Returns and Allowance 300 Accounts Receivable 300 To record return of goods sold to Sauk Stereo. Mar 1 Merchandise Inventory 170 Cost of Goods Sold 170 To record cost of goods returned from Sauk Stereo.

What Is the Sales Discount Account? Contra Revenue Account to sales Used to disclose amount of cash discounts given to customers

Flip side of purchase discounts Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period On seller’s books GENERAL JOURNAL Debit Credit May 14 Cash 3,430 Sales Discounts 70 Accounts Receivable 3500 To record collection within discount period.

LOOK OUT !!! Transportation Costs It’s not part of inventory! For the Outbound freight

Merchandise Inventory Freight Costs-on outgoing inventory On May 6 we paid $150 to have merchandise inventory delivered to the buyer. Merchandise Inventory Freight-Out Expense Cash May 6 150 May 6 150 GENERAL JOURNAL Debit Credit May 6 Freight-Out Expense 150 Cash 150 To record payment of freight on goods sold.

Two Forms Of Income Statements Single-step income statement Multiple-step income statement

Single-Step Income Statement One step… subtract total expenses from total revenues Revenues $10,000 Expenses 3,000 Net income $ 7,000

PW AUDIO, Inc. Single-step Income Statement For the Year Ended December 31, 20xx Sales $460,000 Interest Revenue 3,000 Gain on Sale of equipment 600 Total Revenues $463,600 Expenses Cost of goods sold $316,000 Selling expenses 76,000 Administrative expenses 38,000 Interest expense 1,800 Casualty Loss from vandalism 200 Income tax expense 10,100 Total expenses 442,100 Net income $ 21,500

PW AUDIO SUPPLY, INC. Multi-step Income Statement For the Year Ended December 31, 20xx Sales revenues Sales $ 480,000 Less: Sales returns and allowance $12,000 Sales discounts 8,000 20,000 Net sales 460,000 Cost of goods sold 316,000 Gross profit $ 144,000 Operating expenses Selling expenses: Store salaries expense $45,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Total selling expenses $76,000 Administrative expenses Salaries expense $19,000 Utilities expense 17,000 Insurance Expense 2,000 Total administrative expenses 38,000 Total operating expenses 114,000 Income from operations $ 30,000

PW AUDIO SUPPLY, INC. Multi-step Income Statement For the Year Ended December 31, 20xx Income from operations (continued) $ 30,000 Other revenues and gains Interest revenue $ 3,000 Gain on sale of equipment 600 $ 3,600 Other expenses and losses Interest expense $ 1,800 Casualty loss from vandalism 200 2,000 1,600 Income before income taxes 31,600 Income tax expense 10,100 Net income $21,500

PW AUDIO SUPPLY, INC. Cost of Goods Sold For the Year Ended December 31, 2005 Cost of goods sold Inventory, January 1 $ 36,000 Purchases $325,000 Less Purchase returns and allowances $10,400 Purchase discounts 6,800 17,200 Net purchases 307,800 Add: Freight-in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 356,000 Inventory, December 31 40,000 Cost of goods sold 316,000

Gross Profit Rate= Gross Profit Net Sales Company’s gross profit expressed as a percentage of revenue

Profit Margin Ratio Measures the percentage of each dollar of sales that results in net income Profit Margin Ratio = Net Income Net Sales Higher value suggests favorable return on each dollar of sales. 19

Now, that wasn’t so bad! Was it?