5-1 ©2006 Prentice Hall, Inc.

5-2 ©2006 Prentice Hall, Inc. ACCOUNTING FOR MERCHANDISING OPS (1 of 2)  Learning objectives Learning objectives  Merchandising firms Merchandising firms  Acquiring merchandise for sale Acquiring merchandise for sale  Sale of merchandise Sale of merchandise

5-3 ©2006 Prentice Hall, Inc. ACCOUNTING FOR MERCHANDISING OPS (2 of 2)  Recording inventory Recording inventory  Multiple-step income statement Multiple-step income statement  Financial statement analysis Financial statement analysis  Business risk, controls, and ethics Business risk, controls, and ethics

5-4 ©2006 Prentice Hall, Inc. Learning Objectives (1 of 2) 1. Describe the differences between service and merchandising firms 2. Explain how merchandise in acquired and perform the related record-keeping 3. Explain how sales are made and perform the related record-keeping 4. Explain the differences between a periodic and perpetual inventory system

5-5 ©2006 Prentice Hall, Inc. Learning Objectives (2 of 2) 5. Explain the difference between a single- step income statement and a multiple- step income statement 6. Compute the gross profit ratio and profit margin ratio to evaluate a firm’s profitability 7. Recognize the special risks and controls related to inventory

5-6 ©2006 Prentice Hall, Inc. Merchandising Firms (1 of 3)  Two types of merchandising firms  Retailers sell products to the final consumer  Wholesalers sell products to retailers or other wholesalers  Cost of Goods Sold (CoGS)  Cost of merchandise sold during the period

5-7 ©2006 Prentice Hall, Inc. Merchandising Firms (2 of 2)  Gross profit (also called gross margin)  Sales Revenue – CoGS  Operating cycle for merchandising firm  Purchase inventory  Sell inventory, creating accounts receivable (AR)  Collect cash from customers, reducing AR

5-8 ©2006 Prentice Hall, Inc. Acquiring Merchandise For Sale (1 of 2)  What is merchandise inventory?  Where on the balance sheet is it?  Acquisition process for inventory Acquisition process for inventory  Periodic & perpetual inventory Periodic & perpetual inventory

5-9 ©2006 Prentice Hall, Inc. Acquiring Merchandise For Sale (2 of 2)  Recording purchases: perpetual Recording purchases: perpetual  Freight costs Freight costs  Purchase Returns and Allowances Purchase Returns and Allowances  Purchase Discounts Purchase Discounts  Goods available for sale Goods available for sale

5-10 ©2006 Prentice Hall, Inc. Acquisition Process for Inventory (1 of 3)  Inventory manager sends purchase requisition to purchase agent  Purchase agent sends purchase order (PO) to chosen vendor  Copies to accounts payable (AP) and receiving departments  No quantity on receiving dept’s copy

5-11 ©2006 Prentice Hall, Inc. Acquisition Process for Inventory (2 of 3)  Objectives of purchase process  Quality  Purchase from reliable vendors  Timeliness  Vendors must have an adequate supply of merchandise to avoid stock-outs  Accuracy  Receive only items ordered

5-12 ©2006 Prentice Hall, Inc. Acquisition Process for Inventory (3 of 3)  Receiving dept notifies AP dept when goods arrive  AP pays for goods when it receives invoice from vendor  Invoice matched with purchase order  How does a computer change this process?

5-13 ©2006 Prentice Hall, Inc. Periodic and Perpetual Inventory  Perpetual inventory system  Every purchase of inventory is recorded directly to inventory account  Periodic inventory system  Inventory account only updated at the end of the accounting period

5-14 ©2006 Prentice Hall, Inc. Recording Purchases: Perpetual Transaction 1  Gravity Power Sports (GPS) Purchase 20 skateboards on account for $150 each  Increase inventory $3,000  Increase AP $3,000  Record the journal entry Dr. Cr.

5-15 ©2006 Prentice Hall, Inc. Freight Costs Transaction 2 (1 of 3)  FOB (free on board) shipping point  Shipping is free until it leaves the seller’s loading dock  Buying firm pays freight  Recorded as freight-in  Included in cost of inventory  Who owns the goods while they are in transit? Where does title pass?

5-16 ©2006 Prentice Hall, Inc. Freight Costs Transaction 2 (2 of 3)  FOB destination  Shipping is free until it arrives at the buyer’s place of business  Selling firm pays the freight  No freight-in charge  Not included in cost of inventory  Who owns the goods while they are in transit? Where does title pass?

5-17 ©2006 Prentice Hall, Inc. Freight Costs Transaction 2 (3 of 3)  Shipping charges to GPS on skateboards were $100 with terms FOB shipping point  What accounts are affected?  Do they increase or decrease? Dr. Cr.

5-18 ©2006 Prentice Hall, Inc. Purchase Returns and Allowances Transaction 3 (1 of 3)  Amounts that reduce $$ of inventory purchases due to returned or damaged inventory  Also reduce accounts payable for inventory purchased on account  Which account is affected if the inventory was purchased for cash?

5-19 ©2006 Prentice Hall, Inc. Purchase Returns and Allowances Transaction 3a (2 of 3)  Purchase return  Three skateboards were defective and returned to the vendor Dr. Cr.

5-20 ©2006 Prentice Hall, Inc. Purchase Returns and Allowances Transaction 3b (3 of 3)  Purchase allowance  The decks had graphics for Bores of Hogtown movie instead of Lords of Dogtown movie  GPS received a $250 purchase allowance Dr. Cr.

5-21 ©2006 Prentice Hall, Inc. Purchase Discounts Transaction 4 (1 of 4) 3/10, n/45 3% discount If received w/in 10 days Or full amount Due w/in 45 days

5-22 ©2006 Prentice Hall, Inc. Purchase Discounts Transaction 4 (2 of 4)  Annual rate of return if taking advantage of discount Discount # of days paid early Annual rate of return ÷x 360 (or 365) =  Calculate the annual rate of return if you pay early with terms 3/10, n/45

5-23 ©2006 Prentice Hall, Inc. Purchase Discounts Transaction 4a (3 of 4)  GPS pays the balance due within the discount period with terms 3/10, n/45  Discount calculated on balance due InventoryAccts. Payable Dr. Cr.  3,000  100  3,000  450  250  450  250

5-24 ©2006 Prentice Hall, Inc. Purchase Discounts Transaction 4b (4 of 4)  How would the transaction change if GPS paid outside of the discount period? InventoryAccts. Payable Dr. Cr.  3,000  100  3,000  450  250  450  250

5-25 ©2006 Prentice Hall, Inc. Goods Available for Sale Beginning inventory +Net purchases (total purchases less returns and allowances and discounts) + Shipping costs (freight in) _ Goods available for sale

5-26 ©2006 Prentice Hall, Inc. Sale of Merchandise  Sales are the mirror image of purchases  What the vendor records when you make an inventory purchase  Sales process for merchandise inventory Sales process for merchandise inventory  Recording sales Recording sales  Sales Returns and Allowances Sales Returns and Allowances  Sales Discounts Sales Discounts  Net sales Net sales  Credit card sales and sales taxes Credit card sales and sales taxes

5-27 ©2006 Prentice Hall, Inc. Sales Process for Merchandise Inventory  Steps in the sales process 1. Customer places an order 2. Company approves the order 3. Warehouse selects goods for shipment 4. Company ships goods 5. Company bills customer for goods 6. Company receives payment for the goods

5-28 ©2006 Prentice Hall, Inc. Recording Sales Transaction 5: Revenue (1 of 3)  GPS sells 11 skateboards on account for $250 each  Increase Sales $2,750  Increase AR $2,750 Dr. Cr.

5-29 ©2006 Prentice Hall, Inc. Recording Sales Transaction 5: Expense (2 of 3)  How much did GPS pay for the 17 (20 – 3 returned) skateboards assuming they paid w/in the discount period? $3,000 purchase price freight-in purchase return purchase allowance $2,400 for 17 skateboards  How much did each skateboard cost?

5-30 ©2006 Prentice Hall, Inc. Recording Sales Transaction 5: Expense (3 of 3)  GPS sells 11 skateboards on account for $250 each 1/15, n/30  Increase or decrease merchandise inventory?  Increase CoGS $2,750  On which fin. stmt. will you find CoGS? Dr. Cr.

5-31 ©2006 Prentice Hall, Inc. Sales Returns and Allowances Transaction 6 (1 of 5)  Contra-revenue account  Used to reduces a firm’s revenue  Net revenue  Revenue less contra-revenue  Sales Returns and Allowances  Decrease revenue because you reduce a customer’s AR account or give a cash refund (if the customer paid cash)

5-32 ©2006 Prentice Hall, Inc. Sales Returns and Allowances Transaction 6 (2 of 5)  Customer returned one skateboard because it was defective  First, undo the revenue side of the transaction  What was the sale price of the merchandise?  Second, undo the expense side of the transaction  How much did the merchandise sold cost?

5-33 ©2006 Prentice Hall, Inc. Sales Returns and Allowances Transaction 6: Reverse Revenue (3 of 5)  The sales price was $250  Increase Sales Returns and Allowances  If revenues increase with credits, how would you increase a contra-revenue?  Decrease AR Dr. Cr.

5-34 ©2006 Prentice Hall, Inc. Sales Returns and Allowances Transaction 6: Reverse Expense (4 of 5)  Cost of the merchandise sold was $150  Reduce CoGS by $150  What happens to the inventory account? Dr. Cr.

5-35 ©2006 Prentice Hall, Inc. Sales Returns and Allowances Transaction 6: Reverse Expense (5 of 5)  How would the transaction change if GPS granted a Sales Allowance?  Would the revenue side of the sale need to be reversed?  Would the expense side of the sale need to be reversed?  Why would a business record SR&A in a separate account?

5-36 ©2006 Prentice Hall, Inc. Sales Discounts Transaction 7 (1 of 4)  Sales discount  Reduction in sales price offered for prompt payment  Contra-revenue  Reduces net sales  Based on customer’s outstanding balance from sales  Sales price less SR&A

5-37 ©2006 Prentice Hall, Inc. Sales Discounts Transaction 7 (2 of 4)  Amount to be received if payment is received w/in discount period  Cash collected  ($2,750 – $250) x (1 – 1%)  Sales discount – increases contra revenue  ($2,750 – $250) x 1%  Accounts receivable decreases by full amount owed  Customers balance completely satisfied for 99% of the amount due

5-38 ©2006 Prentice Hall, Inc. Sales Discounts Transaction 7 (3 of 4)  Make the journal entry if payment received w/in discount period  Increase Cash  Increase Sales Discounts  Decrease AR Accts. Rec. Dr. Cr.  250  2,750

5-39 ©2006 Prentice Hall, Inc. Sales Discounts Transaction 7 (4 of 4)  How would the journal entry change if the customer paid outside the discount period?  How much cash is received? Accts. Rec. Dr. Cr.  250  2,750

5-40 ©2006 Prentice Hall, Inc. Net Sales Sales -Allowances given - Sales Discounts _ Net sales

5-41 ©2006 Prentice Hall, Inc. Credit Card Sales and Sales Taxes (1 of 4)  Bank cards  Cash sale  Credit card company pays seller full amount less a service fee (2% - 4%)  Service fee is an expense  E.g, Visa, MasterCard, American Express

5-42 ©2006 Prentice Hall, Inc. Credit Card Sales and Sales Taxes (2 of 4)  Sales tax  Seller collects sales tax from customer and remits to state/local government  Liability  Sales tax payable

5-43 ©2006 Prentice Hall, Inc. Credit Card Sales and Sales Taxes (3 of 4)  Sell $100 of merchandise to customer  Sales tax rate is 5%  Customer pays with bank card with a 3% service fee  Cash collected  $100 – (3% x $100) + (5% x $100)  Service Revenue = $100

5-44 ©2006 Prentice Hall, Inc. Credit Card Sales and Sales Taxes (4 of 4)  Journal entry  Increase Cash  Increase Service Fee (expense)  Increase Sales  Increase Sales Tax Payable Dr. Cr.

5-45 ©2006 Prentice Hall, Inc. Recording Inventory (1 of 2)  Perpetual inventory system  Inventory records updated every time a purchase, sale, or return is made  Periodic inventory system  Inventory records only updated at end of accounting period  Both systems require an actual inventory count at end of period

5-46 ©2006 Prentice Hall, Inc. Recording Inventory (2 of 2)  Perpetual inventory system can detect shrinkage  Shrinkage = Inventory account balance less actual inventory $$ amount based on physical count of merchandise

5-47 ©2006 Prentice Hall, Inc. Multistep Income Statement (1 of 2)  Single-step income statement  All revenues presented first  All expense subtracted to arrive at net income

5-48 ©2006 Prentice Hall, Inc. Multistep Income Statement (2 of 2)  Multiple-step income statement  Gross profit  Sales – CoGS  Operating income  Gross profit – operating expenses  Other revenues and expenses not directly related to firm’s day-to-day operations

5-49 ©2006 Prentice Hall, Inc. Financial Statement Analysis Profitability Measures (1 of 4)  Gross profit ratio  Gross Profit ÷ Sales  Portion of each sales $ a company has left after paying for goods it sold  Amount left over to cover operating and non-operating expenses and generate a profit

5-50 ©2006 Prentice Hall, Inc. Financial Statement Analysis Profitability Measures (2 of 4)  Profit margin ratio  Net Income ÷ Sales  Measures % of each sales $ that results in net income  A measure of how well a company is controlling its operating expenses

5-51 ©2006 Prentice Hall, Inc. Financial Statement Analysis Profitability Measures (3 of 4)  Example: GPS’s results for 2008 & 2009 Year Sales$500,000$600,000 CoGS$300,000$400,000 Net Income$ 50,000$ 80,000 Gross Profit Ratio$200K/$500K=40%$200K/$600K=33% Profit Margin Ratio$50K/$500K=10%$80K/$600K=13%

5-52 ©2006 Prentice Hall, Inc. Financial Statement Analysis Profitability Measures (4 of 4)  Explain the trend in GPS’s gross profit ratio  Explain the trend in GPS’s profit margin ratio  What can you say about GPS’s profitability based on these ratios?

5-53 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics  Segregation of duties  Person with physical control over merchandise should NOT also do the record-keeping on the merchandise under her control  However, this control can be defeated if both people get together to commit fraud  See In the News—Risks and Controls

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 5-54 ©2006 Prentice Hall, Inc.