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Learning Objectives 1. Identify the components in measuring net income in a merchandising company. 2. Explain the entries for sales revenues. 3. State the steps in determining cost of good sold. 4. Explain the computation and importance of gross profit. 5. Identify the unique features of the income statement for a merchandising company. 6. Explain the steps in the accounting cycle for a merchandising company. 7. Distinguish between a multiple-step and a single step income statement. 2

3 Accounting for Merchandising Operation Measuring Net Income Completing the Accounting Cycle 1.Sales Revenue 2.Cost of Good Sold 3.Gross Profit 4.Operating Expenses 5.Income Statement / Net Income 1.Using a work sheet 2.Preparing FS 3.Adjusting and closing Entries 4.Post-closing Trial Balance 5.Summary of entries 6.Form of income statements

4 Income Measurement Process Sales Revenue Cost of Good Sold Gross Profit Operating Expenses Net Income

5 Time Line of Business Issues Involved With Inventory COMPUTE BUY Raw Materials or Goods for Resale Value ADD SELL Finished Inventory Ending Inventory Cost of Goods Sold

6 What Is Inventory? Inventory designates goods held for sale in the normal course of business and, in the case of a manufacturer, goods in production or to be placed in production.

7 Raw Materials Raw Materials are goods acquired for use in the production process. Materials that are used directly in the production of goods are frequently referred to as direct materials. Materials that are necessary in the production process but are not directly incorporated into the product are referred to as indirect materials.

8 Work in Process Work in process consists of materials partly processed and requiring further work before they can be sold. This inventory includes three cost elements. 1.Direct materials 2.Direct labor 3.Manufacturing overhead

9 Finished Goods Finished goods are the manufactured products awaiting sale. Raw Materials Finished Goods Cost of Goods Sold Balance SheetIncome Statement Direct Labor Work in Process Manufacturing Overhead

Summary 10 MerchandiseMerchandise Balance Sheet Items Income Statement Items Retailer Cost of Goods Sold Sale Manufacturer Raw Materials Cost of Goods Sold Sale Finished Goods Work in Process Overhead Direct Labor

Periodic Inventory Systems Cost of Goods Sold is determined and Inventory is adjusted to proper balance at period end. All purchases of inventoriable merchandise are recorded in the Purchases account. Ending inventory is determined by physical count of merchandise on hand. 11

12 Perpetual Inventory Systems Cost of Goods Sold is determined and Inventory is adjusted to proper balance each time inventory is purchased or sold. All purchases of inventoriable goods are recorded in the Inventory account.

13 Purchases of Inventory Periodic Method Purchases3,000 Accounts Payable3,000 Perpetual Method Inventory3,000 Accounts Payable3,000 Inventory Systems

14 Sales During the Period Periodic Method Accounts Receivable4,125 Sales4,125 Perpetual Method Accounts Receivable4,125 Sales4,125 Cost of Goods Sold2,750 Inventory2,750 Inventory Systems

15 Sales During the Period Accounts Receivable3,800 Sales3,800 OR Cash 4,125 Sales 4,125

16 Sales Return and Allowance Sales Return and Allowance 300 Accounts Receivable 300 Sales Discounts Cash 3,430 Sales Discounts 70 Accounts Receivable 3,500

17 Cost of Goods Sold Recording Purchases of Merchandise Purchases 3,800 Accounts Payable3,800 Purchase Returns and Allowances Accounts Payable 300 Purchase Return and Allowances300

18 Cost of Goods Sold Purchase Discounts Accounts Payable3,500 Purchase Discounts 70 Cash3,430 Accounts Payable 3,500 Cash3,500

Whose Inventory Is It? Goods in Inventory. Goods in Transit. – FOB Shipping Point: buyer’s inventory from time of shipment. – FOB Destination: seller’s inventory until receipt by buyer. Goods on Consignment: inventory of the consignor, not the consignee. 19

20 Goods in Transit Quality Produce Goods being shipped are included in inventory of buyer while in transit. FOB Shipping Point Seller Buyer

21 FOB Destination Quality Produce Goods being shipped are included in inventory of seller until received by buyer. Seller Buyer Goods in Transit

22 Goods on Consignment Title to goods sold on consignment remains with the shipper until their sale or use by the dealer or customer.

What Is Inventory Cost? Inventory Cost is all expenditures related to inventory acquisition, preparation, and placement for sale. Trade Discounts – Convert the catalog price to the actual price. – Record inventory at discounted price. Cash Discounts – Granted for payment of invoices within a limited time period. – Record inventory using the net method or gross method. 23

24 Purchase Date End of Discount Period $9,800 Owed $10,000 Owed Final Payment Date 10 Days20 Days Supplier “Loan” Period Cash Discounts

Determining Cost of Goods on Hand Computing the units on hand for each item of inventory. Applying unit costs to the total units on hand for each item of inventory. Aggregating the costs for each item of inventory to determine the total cost of goods on hand. 25

Computing Cost of Goods Sold Add the cost of goods purchased to the cost of goods on hand at the beginning of the period (beginning inventory) to obtain the cost of goods available for sale. Subtract the cost of goods on hand at the end of the period (ending inventory) from the cost of goods available for sale to arrive at the cost of goods sold. 26

27 Revenue$xxx Costs and expenses: Costs of salesxxx Selling and administrativexxx Interest expensexxx Other income/expense, netxxx Restructuring chargexxx Total costs and expensesxxx Income before income taxesxx Income taxes xx Net income $ xx Single-Step Income Statement Form of the Income Statement

28 Revenue$xxx Costs of goods sold: Beginning inventoryxxx Net purchasesxxx Cost of goods available for salexxx Less ending inventoryxxxxxx Gross profit on salesxxx Operating expenses: Selling expensesxxx General expensesxxxxxx Other incomexxx Multiple-Step Income Statement Form of the Income StatementContinuedContinued

29 Other income (from previous page)$xxx Other revenue and gainsxxx Other expenses and losses(xxx) Income from continuing operations before income taxesxxx Income taxes on continuing operations(xxx) Discontinued operations: Loss from operations of discontinued business segment (net of tax)$xxx Loss on disposal of segment (net of tax)xxx(xxx) Extraordinary gain (net of tax)xxx Net income$xxx Form of the Income Statement

30 Components of the Income Statement Income from Continuing Operations 1.Revenue 2.Cost of goods sold 3.Operating expenses 4.Other revenues and gains 5.Other expenses and losses 6.Income taxes on continuing operations

31 Components of the Income Statement Income from Continuing Operations Determining Subtotals Gross profit: Revenue – Cost of goods sold Operating income: Gross profit – Operating expenses ContinuedContinued

32 Components of the Income Statement Income from Continuing Operations Determining Subtotals Income from continuing operations before income taxes: Operating income + Other revenues and gain – Other expenses and losses Income from continuing operations: Income from continuing operations before income taxes – Income taxes on continuing operations

33 Components of the Income Statement Revenue Revenue reports the total sales to customers for the period less any sales returns and allowances or discounts.

34 Components of the Income Statement Cost of Goods Sold Beginning inventory +Net purchases +Freight-in +Other inventory acquisition costs =Cost of goods available for sale –Ending inventory =Cost of goods sold

35 Components of the Income Statement Cost of Goods Sold Cost of goods sold is a significant item on merchandising and manufacturing companies’ income statement.

36 Components of the Income Statement Gross Profit Net sales –Cost of goods sold =Gross profit Gross profit ÷ Net sales = Gross profit percentage

37 Components of the Income Statement Operating Expenses Operating expenses may be reported in two parts: 1)Selling expenses 2)General and administrative expenses

38 Components of the Income Statement Operating Income Operating income measures the performance of the fundamental business operations conducted by a company. Gross profit –Operating expenses =Operating income

39 Components of the Income Statement Other Revenues and Gains This section usually includes items identified with the peripheral activities of the company. 1)Rent revenue 2)Interest revenue 3)Dividend revenue 4)Gains from the sale of assets

40 Components of the Income Statement Other Expenses and Losses This section parallels “Other Revenues and Gains” except the items result in deductions from operating income. 1)Interest expense 2)Losses from the sale of assets

41 Discontinued Operations Why would management decide to dispose of a component of a business?  The component may be unprofitable.  The component may not fit into the long- range plans for the company.  Management may need funds to reduce long-term debit or to expand into other areas.  Management may be fearful of a corporate takeover.

42 Discontinued Operations Income statement section consists of two parts: – Income (loss) from operations--disclosed only if decision to discontinue operations is made after beginning of the year. – Gain (loss) on disposal of operations-- consisting of income (loss) during phase out and gain (loss) from disposal of segment assets.

43 Discontinued Operations According to FASB Statement No. 144, if on the balance sheet date assets and liabilities associated with discontinued components have not been completely disposed, they are to be listed separately in the asset and liability sections of the balance sheet.

44 Discontinued Operations In addition to the summary income or loss number reported in the income statement, the total revenue associated with the discontinued operations should be disclosed in the financial statement notes.

45 Extraordinary Items Extraordinary items must be both unusual and infrequent.

46 Never Extraordinary  Write-down or write-off of receivables, inventory, etc.  Gains or losses from exchange or remeasurement of foreign currencies.  Gains or losses on disposal of business segment.  Gains or losses from sale or abandonment of productive assets.  Effects of a strike.  Adjustment of accruals on long-term contracts.

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