© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Five Accounting for Merchandising Businesses

5-2 Merchandising Businesses Sale Merchandising businesses generate revenue by selling goods. The goods purchased for resale are called merchandise inventory.

5-3 LO 1 Identify and explain the primary features of the perpetual inventory system.

5-4 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.

5-5 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)

5-6 Gross Margin (or Gross Profit)

5-7 Gross Profit – Op Exp. = Op. Income Op. Inc + Other Inc. – Exp = Inc. Before taxes Inc. before taxes – taxes = Net Income

5-8

5-9 Perpetual Inventory System Inventory account is adjusted perpetually (continually) throughout the accounting period.

5-10 LO 2 Record and report inventory transactions in the double-entry accounting system.

5-11 Perpetual Inventory System Let’s see how a perpetual inventory system works by looking at transactions for June’s Plant Shop (JPS).

5-12 Event 1: JPS acquired $15,000 by issuing common stock. 1.Increase assets (cash). 2.Increase equity (common stock). Asset Source Transaction

Cash $15,000 Common Stock $15,000 Journal Entry

5-14 Event 2: JPS purchased merchandise inventory for $14,000 cash. 1.Decrease assets (cash). 2.Increase assets (merchandise inventory). Asset Exchange Transaction

Journal Entry Inventory$14,000 Cash$14,000

5-16 Event 3a: JPS recognized sales revenue from selling inventory for $12, Increase assets (cash). 2.Increase equity (sales revenue). Asset Source Transaction

Journal Entry Cash$12,000 Sales$12,000

5-18 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

Journal Entry Costof Goods Sold $8,000 Inventory $8,000

5-20 Event 4: JPS paid $1,000 cash for selling expenses. 1.Decrease assets (cash). 2.Decrease equity (selling expenses). Asset Use Transaction

Journal Entry Selling Expense $1,000 Cash$1,000

5-22 Event 5: JPS paid $5,500 cash to purchase land for a place to locate a future store. 1.Decrease assets (cash). 2.Increase assets (land). Asset Exchange Transaction

Journal Entry Land$5,500 Cash$5,500

5-24

5-25

5-26 LO 3 Explain the meaning of terms used to describe transportation costs, cash discounts, returns or allowances, and financing costs.

5-27 Purchasing inventory often involves: Transportation costs Inventory returns Purchase allowances Cash discounts Other Topics Let’s look at these transactions for JPS.

5-28 Event 1: JPS borrowed $4,000 cash by issuing a note payable. 1.Increase assets (cash). 2.Increase liabilities (notes payable). Asset Source Transaction

Journal Entry Cash$4,000 Note Payable$4,000

5-30 Event 2: JPS purchased on account merchandise inventory with a list price of $11, Increase assets (merchandise inventory). 2.Increase liabilities (accounts payable). Asset Source Transaction

Journal Entry Inventory$11,000 Accounts Payable$11,000

5-32 Event 3: JPS returned some of the inventory purchased in Event 2. The list price of the returned merchandise was $1, Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

Journal Entry Accounts Payable $1,000 Inventory$1,000

5-34 Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms are 2/10 n/30. Before analyzing this transaction, let’s learn a little about cash discounts.

5-35 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

5-36 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

5-37 Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms were 2/10, n/30. 1.Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

Journal Entry Accounts Payable$200 Inventory$200

5-39 Event 5: JPS paid the $9,800 balance due on the account payable. 1.Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

Journal Entry Accounts Payable$9,800 Cash$9,800

5-41 Event 6: The shipping terms for the inventory purchased in Event 2 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.

5-42 Transportation Costs FOB shipping point (buyer pays) FOB destination (seller pays ) Merchandise Seller Buyer FOB = Free on Board

5-43 Event 6: 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

Journal Entry Inventory$300 Cash$300

5-45 Event 7a: 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

Journal Entry Cash$24,750 Sales$24,750 Cost of Goods Sold$11,500 Inventory$11,500

5-47 Event 7b: JPS recognized $11,500 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

5-48 Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers. 1.Decrease assets (cash). 2.Decrease equity (transportation-out). Asset Use Transaction

Journal Entry Transportation Out $450 Cash$450

5-50 Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers. 1.Decrease assets (cash). 2.Decrease equity (transportation-out). Asset Use Transaction

5-51 Event 9: JPS paid $5,000 cash for selling and administrative expenses. 1.Decrease assets (cash). 2.Decrease equity (selling and admin. expense). Asset Use Transaction

Journal Entry Selling & Admin. Expense$5,000 Cash$5,000

5-53 Event 10: JPS paid $360 cash for interest expense on the note described in Event 1. 1.Decrease assets (cash). 2.Decrease equity (interest expense). Asset Use Transaction

Journal Entry Interest Expense$360 Cash$360

5-55 Event 11: JPS sold the land that had cost $5,500 for $6,200 cash. Before analyzing this transaction, let’s learn a little about gains and losses.

5-56 Gains and Losses Sales Price of Land - Cost of Land Gain or Loss Gross margin Sales Revenue -Cost of Goods Sold Gross Margin

5-57 Event 11: JPS sold the land that had cost $5,500 for $6,200 cash. 1.Increase assets (cash). 2.Decrease assets (land). 3.Increase equity (gain on sale of land). Asset Source Transaction

Journal Entry Cash$6,200 Land$5,500 Gain on Sale –Land$700

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5-60 LO 5 Compare and contrast single and multi-step income statements.

5-61

5-62

5-63 LO 6 Show the effect of lost, damaged, or stolen inventory on financial statements.

5-64 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.

5-65 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:

5-66 Sales of inventory often involves: Inventory returns Purchase allowances Cash discounts Events Affecting Sales Let’s look at these transactions for JPS.

5-67 Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/10 n/30. The merchandise had cost JPS $4, Increase assets (accounts receivable). 2.Increase equity (sales revenue). Asset Source Transaction

Journal Entry Accounts Receivable$8,500 Sales$8,500

5-69 Event 1b: JPS recognized $4,000 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

Journal Entry Cost of Goods Sold$4,000 Inventory$4,000

5-71 Event 2a: A customer from Event 1a returned inventory with a $1,000 list price. The merchandise had cost JPS $ Decrease assets (accounts receivable). 2.Decrease equity (retained earnings). Asset Use Transaction

5-72 Event 2b: The cost of the goods ($450) is returned to the inventory account. 1.Increase assets (merchandise inventory). 2.Increase equity (reduce cost of goods sold). Asset Source Transaction

5-73 Event 3a (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired. 1.Decrease assets (accounts receivable). 2.Decrease equity (sales). Asset Use & Exchange Let’s assume the customer paid within the discount period.

5-74 Event 3b (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). Asset Use & Exchange Let’s assume the customer paid within the discount period.

5-75 Event 3 (Alternative 2): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred after the discount period had expired. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). Asset Exchange Transaction Now, let’s assume the customer did not pay within the discount period.

5-76 LO 7 Use common size financial statements and ratio analysis to evaluate managerial performance.

5-77

5-78 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.

5-79 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.

5-80 Financing Merchandise Inventory Borrow Money from Bank Interest Expense Use Cash Opportunity Cost Purchase on Account Higher Prices and/or Interest

Periodic Inventory System (Appendix) A practical alternative for recording inventory in a low-technology, high-volume environment Cost of inventory is recorded in a Purchases account Ending inventory and cost of goods sold are determined by year-end physical count 5-81

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Periodic Inventory System (Appendix) 5-83

5-84 End of Chapter Five