MERCHANDISINGMERCHANDISING rService Businesses - Make money by providing a service - Services can’t be created and stockpiled for later sale. - An advantage is usually less Rs. needed to start and operate business. - A disadvantage relates to staffing employees during erratic demand periods. rService Businesses - Make money by providing a service - Services can’t be created and stockpiled for later sale. - An advantage is usually less Rs. needed to start and operate business. - A disadvantage relates to staffing employees during erratic demand periods. 3 BASIC TYPES OF COMPANIES

MERCHANDISINGMERCHANDISING pMerchandiser - Make money by selling a product. - Usually more Rs. needed to start and operate business because inventory must be available for sale. - Bigger risk also due to obsolescence, theft, competition on price. - Inventory is purchased from a supplier. Merchandiser doesn’t “add value” to product. pMerchandiser - Make money by selling a product. - Usually more Rs. needed to start and operate business because inventory must be available for sale. - Bigger risk also due to obsolescence, theft, competition on price. - Inventory is purchased from a supplier. Merchandiser doesn’t “add value” to product. 3 BASIC TYPES OF COMPANIES

MERCHANDISINGMERCHANDISING pManufacturer - Convert a raw material to a finished good. - Direct labor and manufacturing processes used in conversion. - 3 types of inventories: Raw materials Work in process Finished goods pManufacturer - Convert a raw material to a finished good. - Direct labor and manufacturing processes used in conversion. - 3 types of inventories: Raw materials Work in process Finished goods 3 BASIC TYPES OF COMPANIES

INCOME STATEMENT SERVICE Revenues - Expenses Net Income =========== MERCHANDISING Sales - Contra Sales Net Sales - Cost of Goods Sold (CGS or COGS) Gross Profit - Operating Expenses Income from operations + or - other income or expense Net Income ==================================

Inventory Methods Inventory Methods - 2 GAAP options: EXAMPLE Perpetual : Inventory C G S EXAMPLE Perpetual : Inventory C G S PERPETUAL1 - PERPETUAL records CGS for each sale. Start 10 units, cost = Rs.1 each 10 Sell 2 units 2 2 Sell 5 units 5 5 Purchase 10 units 10 Sell 8 units 8 8. Balances 5 15

PERIODIC2 - PERIODIC doesn’t record CGS at all! EXAMPLE Periodic : Inventory CGS EXAMPLE Periodic : InventoryPurchases CGS Start 10 units 10 Sell some No recording Inv/CGS (record revenue but not CGS) Sell some more No recording Inv/CGS Purchase 10 units 10 (must record purchase) Sell some more No recording Inv/CGS What is needed to compute amount CGS?

COMPARISON OF SYSTEMS PERPETUAL - On-Line Inventory Info - Control over theft amount, errors. - Lots of inventory record keeping. PERIODIC - Ease of use. Much less records. Count inventory once per year and Record inventory purchases only. - No ongoing record of inventory amounts. - No direct calculation of theft

Computers and electronic scanning equipment make perpetual inventory cost effective! Scans be used to create automated journal entries with no human accounting.

SALES & Cost of Goods Sold (CGS) Revenue Recognition Principle requires revenue be recorded at point of sale. - When “legal ownership” changes from seller to buyer. - Goods must be transferred to buyer (shipped). Matching Principle also requires the expense of the sale be recorded at the same time as revenue.

Recording a Sale Two things need to be recorded for each sale: 1. Revenue Dr. Cash (or A/R) xxxx Cr. Sales xxxx 2. Expense (Perpetual method only) Dr. Cost of Goods Sold (or CGS) xxxx Cr. Inventory xxxx

Inventory cost Components of Full inventory cost: Purchase price from vendor plus Freight cost if paid separately by purchasing company less Discounts allowed by vendor (Generally based on credit terms)

Example: Recording a sale Konk Co. Sold 10 units of inventory for Rs.100 each. The units were purchased last month for Rs.60 each. - Freight charges on the purchase were Rs.5 each. - Discounts granted on the purchase were Rs.2 each. Journal entry to record the sale? Cash (or A/R) 1000 Sales 1000 For perpetual method also: Cost of Goods Sold 630 Inventory 630 To record sale (10 x 100) and cost [10 x (60+5-2)] Cash (or A/R) 1000 Sales 1000 For perpetual method also: Cost of Goods Sold 630 Inventory 630 To record sale (10 x 100) and cost [10 x (60+5-2)]

Sales & Sales Discounts text p. 227, also see purchase discounts on p 223 Most business to business sales are on account. (competition, business practice, etc) - Credit terms are listed on invoice. Seller’s often provide an incentive for buyers to pay before the normal due date. - Called a cash discount - Usually a % reduction in payment - Why would they do this? - What is the cost to do this?

Example: Sales Discounts Konk Co. had a sale of Rs.1000, terms 2 / 10, n / 30. This means : Buyer gets 2 % price reduction IF buyer pays within 10 days of the sale, OTHERWISE the entire net (full price) is due within 30 days of the sale. Record sale as before. See previous example. Record cash received if within 10 days of sale? Cash 980 Sales Discounts 20 Accounts Receivable 1000 Record sale as before. See previous example. Record cash received if within 10 days of sale? Cash 980 Sales Discounts 20 Accounts Receivable 1000

SALES RETURNS & ALLOWANCES text p226 Use to record returns of merchandise from buyer, or a special allowance. Dr. Sales R & A xxxx Cr. A/R (or Cash) xxxx Note: If inventory is returned (not just an allowance), also record (perpetual only): Dr. Inventory xxxx Cr. Cost of Goods Sold xxxx

INCOME STATEMENT PRESENTATION SALES Less: Sales Discounts 20. Sales Returns & Allowances 100. (120.) Net Sales 880. Less: Cost of Goods Sold (630.) Gross Profit 250. These sales accounts are called CONTRA-REVENUE accounts (not EXPENSES).

Other issues for Purchaser Purchase Discounts - Buying company that pays early records discount effect in inventory. Example: Buy Rs.1000 of inventory on terms 2/10, n/30 On date of purchase: Inventory (perpetual method only) 1000 Accounts Payable1000 If paid within 10 days of purchase Accounts Payable 1000 Inventory (perpetual method only) 20 Cash 980 On date of purchase: Inventory (perpetual method only) 1000 Accounts Payable1000 If paid within 10 days of purchase Accounts Payable 1000 Inventory (perpetual method only) 20 Cash 980

Other issues for Purchaser Purchase Returns & Allowances - Company that returns or gets allowance reduces inventory. Dr. A/P (or Cash) xxxx Cr. Inventory (perpetual method only) xxxx

Other issues for Purchaser Freight on purchases - Buying company adds freight they pay to inventory cost. Dr. Inventory (perpetual method only) xxxx Cr. A/P (or Cash) xxxx Note: If seller agrees to pay freight, record operating expense called freight out on seller’s books: Dr. Freight- out expense xxxx Cr. A/P (or Cash) xxxx

Inventory Account (Perpetual) Beginning Balance Purchase Inventory Freight on purchase Purchase Discounts Purchase R & A Cost of Inventory sold Cost of Sale Returns Ending Balance

Data needed for PERIODIC method 1 Start with beginning inventory amount – Count it! 2Keep track of full costs of inventory bought during the year. Don’t record in inventory, but use the following periodic accounts: Purchases Freight-In Purchase discounts Purchase returns & allowances 3Subtract inventory left over at year end – Count it! Note an AJE will be needed at period end to update the inventory account to reflect the ending physical count balance! (We won’t worry about in this class.)

Inventory Account (Periodic) Beginning Balance Additional periodic accounts for: - Purchases - Freight in on purchase - Purchase R & A - Purchase discounts Year end adjustment (debit or credit) to physical count Ending Balance

CGS on PERIODIC Income Statement COST OF GOODS SOLD : Beginning Inventory 100. Purchases 700. Less: Purchase Discounts -50. Purchase R & A -10. Add: Freight In 30. Cost of goods purchased 670. Cost of Goods Available for Sale 770. Less: Ending Inventory Cost of Goods Sold 620.

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

Merchandising Company Operating Cycle Cash Accounts Receivable Merchandise Inventory Buy InventorySell Inventory Receive Cash

Gross Profit Rate= Gross Profit Net Sales Company’s gross profit expressed as a percentage x (100)

Reasons Gross Profits Rates Change Selling products with a lower “mark-up”Selling products with a lower “mark-up” Increased competition can lower sale prices Increased competition can lower sale prices Paying higher prices to suppliersPaying higher prices to suppliers Sales MixSales Mix

Profitability - Profit Margin Ratio Measures the percentage of each dollar of sales that results in net income Profit Margin Ratio = Net Income Net Sales Similar to gross profit ratio except it considers ALL costs, including operating expenses (not just CGS).

General Journal- Perpetual 7/1Inventory (70 Rs.30 each)2100 A/P2100 7/3A/R (40 Rs.50 each) 2000 Sales2000 CGS (40 x Rs.30) 1200 Inventory1200 P5-2B text p First 2 transactions only, Perpetual, then periodic On 7/1, buy 70 suitcases for Rs.30 each. On 7/3 sell 40 cases for Rs.2,000. On income statement: Sales CGS Gross profit800 On balance sheet: Inventory balance = 900 (2100 dr and 1200 cr)

General Journal – P E R I O D I C 7/1Purchases2100 A/P2100 7/3A/R2000 Sales2000 NOTE: To prepare statements, inventory must be counted and cost calculated (30 Rs.30 = Rs.900). On income statement: Sales CGS: BI 0 Purchases 2100 Cost Available EI Gross profit 800 On balance sheet: Inventory = 900 (adj made to physical count)