Unit 2: Chapter 5: Accounting for Merchandising Operations Unit 2 Quiz (chapter 5 quest) will be Thursday October 9

Operating Cycle: Service Company Cash Accounts Receivable Receive Cash Perform Services Accounts Receivable

Merchandising Company (whole sale) Operating Cycle: Cash Merchandising Company (whole sale) Accounts Receivable Receive Cash Buy Inventory Merchandise Inventory Sell Inventory

Merchandising Company Enterprise that buys and sells goods to earn a profit E.g. clothing stores, convenience stores, restaurants, etc. Wholesalers sell to retailers, retailers sell to consumers Primary source of revenue for Merchandising Company = Sales Service company primary source of revenue = Service revenue or Fees earned 4

Merchandising Company 2 types of Expenses in Income Statement: Cost of goods sold Total cost of merchandise you sold during the period. For manufacturer: How much you paid for the raw materials or For retailer: How much you paid for the finished goods Operating expenses Advertising expense Salary expense Rent expense Utility expense 5

Merchandising Company Gross Profit = Sales Revenue – COGS For example, if Walmart buys 100 calculator for $15 from Texas instruement on September 1. Then WMT sells them for $25 to customers during September. What is their Gross Profit for September? (assuming that this is the only item they sold during September) GP = (25 * 100) – (15* 100) = 1000 6

To calculate the cost of goods sold in Periodic Inventory system, three figures are needed: The beginning inventory figure (last year’s ending inventory figure) The cost of goods purchased figure (accumulated throughout the year in an account known as ‘Purchases’) The ending inventory figure – obtained by taking a physical inventory (counting and valuing the entire inventory) *****The expenses section is now headed Operating Expenses

Periodic Inventory Method: The cost of the inventory sold is calculated at the end of the fiscal period using the formula below: Cost of Beg. + Cost of goods - Cost of goods= Cost of Ending Inventory Purchased Sold Inventory CGS and CGP will appear in Income Statement whereas CEI will appear in Balance sheet under “current asset” right after accounts receivable. Many companies use Periodic Inventory method because this is relatively easy and inexpensive. Companies, which use periodic inventory method, will typically calculate CGS only once a year at year end.

Periodic Inventory Method: At the fiscal year-end, a physical inventory must be taken to: Update the current asset on the balance sheet just like office supplies account Calculate the cost of goods sold for the income statement To be used as the beginning inventory for the next accounting period Merchandise Inventory is a Current Asset on the balance sheet as it will be sold within a year.

Example – Use the formula! Units Dollars Beginning Inventory 1700 $42,500 Merchandise Purchased 5500 143,000 Total Goods Available for Sale ? ? Merchandise Sold 5800 149,100 Ending Inventory ? ? Use the equation to calculate the total number of units and dollar value for ending inventory, as well as Total Goods Available for Sale

Example – Use the formula! Units Dollars Beginning Inventory 1700 $42,500 Merchandise Purchased 5500 143,000 Total Goods Available for Sale ? ? Merchandise Sold 5800 149,100 Ending Inventory ? ? Use the equation to calculate the total number of units and dollar value for ending inventory, as well as Total Goods Available for Sale Answers: Total Goods Available for Sale = Units: 7200 Dollars: $185,500 Ending Inventory = Units: 1400 Dollars: $36,400

Cost of Goods Sold on the Income Statement The inventory that was NOT sold belongs on the balance sheet – appears as “Ending Inventory or Inventory” in Balance Sheet. The cost of the inventory that WAS sold – is known as Cost of Goods Sold – which belongs to the income statement Ie: an item that cost $75.00 to produce was sold for $100.00. The profit is $25.00

Cost of Goods Sold on the Income Statement The total cost of goods sold is usually the biggest expense figure for a merchandising business “Purchase” account is in expense category of the ledger.

Eastern Trading Company Income Statement Year Ended Dec 31 2014 Revenue Sales 231 967 Cost of Goods Sold Inventory, January 1 $55 325 Purchases 120 402 Cost of Goods Available for Sale 175 727 Less Inventory, December 31 57 350 Cost of Goods Sold 118 377 Gross Profit 113 590

Gross Profit Percentage In this example, Gross Profit or Margin is 49% of sales. 113590 / 231967 = 0.49 This means that for every dollar of revenue, 49 cents are available to cover operating expenses and to achieve a net income. Most companies try to reach a specific gross profit percentage.

Drawbacks of Periodic Inventory System When the periodic inventory system is used, financial statements cannot be obtained unless a physical inventory is taken - very time consuming. However, it is also very easy to manage (especially for small businesses such as a convenience store or pharmacy store) We can calculate cost of goods sold only once a year when we do the physical inventory.

PERPETUAL INVENTORY Typically small businesses would use periodic inventory system, which we have learned so far. But many big corporaions would use perpetual inventory system. Under perpetual inventory system, you do not have to wait until Dec 31 to find out how many units are ”goods available for sale” in your storage. You can easily find out how many inventory you have at any moment. A detailed record of items in stock is up to date on an ongoing basis.

PERPETUAL INVENTORY For example, at wal-mart, each cash register is a point of sale terminal connected to the store’s main computer. As items are sold, the cashier scans the items, which captures the code numbers and the quantities sold via the scanner. This information is transfered directly to the store’s central computer, which is programmed to make the appropriate deductions from the inventory and to make the accounting entries as shown below:

PERPETUAL INVENTORY For example, at wal-mart, customer bought and paid $150 for a printer today. WMT paid $ 100 last month for this printer to Samsung. What kind of accounting transaction should occur under periodic inventory system? Bank $150 Sales $150 What kind of accounting transaction should occur under perpetual inventory system?

PERPETUAL INVENTORY The entriy would be: Dr. Cr. Bank 150 Sales 150.00 (selling price) Cost of goods sold 100 (cost price) Merchandise Inventory 100

PERPETUAL INVENTORY Every sale under perpedutal system has two parts: Revenue portion of the sale: Receipt of cash or AR and recording sales account Cost portion of the sale: Reduction of inventory (by crediting merchandize inventory account) and recording COGS (by debiting COGS account) This means that we do not need to use COGS formula under this system, which is COGS = BI + purchase - EI

PERPETUAL INVENTORY Apple sold 5085 + HST worth of Ipads to Bestbuy. This is the seller’s (Apple) perspective: Dr. Cr. AR 5085 Sales 4500(selling price) HST Payable 585 Cost of goods sold 2250 (cost price) Merchandise Inventory 2250

Classwork / Homework Page 258 BE5-1, BE5-8, BE5-10, BE5-11, BE5-12, BE5-15 Page 260 E5-1 (1, 2, 3, 7, 12, 14)