Inventories

Learning Objectives 1. Identify the differences between a service business and a merchandising business. 2. Explain the recording of purchases under a perpetual inventory system. 3. Explain the recording of sales revenues under a perpetual inventory system. 4. Prepare a fully classified statement of financial position.

Merchandising Operations Merchandising businesses buy and resell inventory. Revenues are referred to as sales revenue. Expenses are divided into two categories: Cost of goods sold Operating expenses

Profit Measurement Process for a Merchandising Business

Operating Cycles

Operating Cycles (cont’d)

Recording Purchases of Inventories Example: Purchase of inventory on credit from PW Audio Supply Ltd. May 5 Inventory3 800 Accounts Payable (To record goods purchased on account from PW Audio Supply Ltd)

Purchases Returns and Allowances A purchase return is the return of goods by the customer. The customer will receive a refund in the form of either credit or cash. A purchase allowance occurs where the customer keeps the goods and a reduction in price is granted.

Purchases Returns and Allowances (cont’d) Example: Goods costing $300 are returned to PW Audio Supply Ltd. May 8 Accounts Payable 300 Inventory 300 (To record return of goods received from PW Audio Supply Ltd)

Freight Costs Cost of freight is added to the cost of inventory where cost is charged to buyer. Cost is allocated to Freight-in account. Example: Sauk Stereo pays We Deliver Freight Co. $150 for freight charges. May 6 Freight-in 150 Cash 150 (To record payment of freight on goods purchased)

Freight Costs (cont’d) Freight costs incurred by the seller are an operating expense to the seller. These costs are included as part of delivery or freight-out expenses. Example: PW Audio paid freight charges $150 for goods sold May 5 Freight-out 150 Cash 150 (To record payment of freight on goods sold)

Purchase Discounts Settlement discounts are discounts given for prompt payment of account. Example: Sauk Stereo settles account outstanding of $3500 and receives discount of $70 May 5 Accounts Payable Cash Discount Received 70 (To record payment within the discount period)

Purchase Discounts (cont’d) Trade discounts are a % reduction in the list price of inventory sold. Example: List price quoted is $5000 and trade discount given of 10% May 5 Inventory Accounts Payable (To record purchase of inventory on account with a trade discount of $500)

Recording Sales of Inventory Two entries are required: 1. To record the sale of goods 2. To record the cost of goods sold Example 1: PW Audio Supply Ltd made cash sales of $2200. Cost of goods sold was $1400. Example 2: PW Audio Supply Ltd sold $3800 to Sauk Stereo on credit. Cost of goods sold was $2400.

Recording Sales of Inventory (cont’d) Example 1 Sale of the goods for $2200 cash Cost of goods sold was $1400 reducing inventory on hand May 5 Cash Sales (To record daily cash sales) May 5 Cost of Goods Sold Inventory (To record cost of inventories sold for cash)

Recording Sales of Inventory (cont’d) Example 2 Sale of the goods on credit for $3800 Cost of goods sold was $2400 May 5 Cost of Goods Sold Inventory (To record cost of inventories sold to Sauk Stereo) May 5 Accounts Receivable Sales (To record credit sale to Sauk Stereo per invoice no. 731)

Sales Returns and Allowances Return of goods by a customer Two entries are required: 1. To record sales return at selling price 2. To record return to inventory at cost price Example 1: PW Audio Supply Ltd records credit for goods returned by customer. Example 2: Goods returned by customer are faulty.

Sales Returns and Allowances (cont’d) Example 1 Sales return at selling price of $300 Return (increase) to inventory at cost price of $140 May 5 Inventory 140 Cost of Goods Sold 140 (To record cost of goods returned) May 5 Sales Returns and Allowances 300 Accounts Receivable 300 (To record credit granted to Sauk Stereo for returned goods)

Sales Returns and Allowances (cont’d) Example 2 Sales return at selling price of $300 Increase in expense account of $140 May 5 Inventory Write-down 140 Cost of Goods Sold 140 (To record cost of faulty goods returned) May 5 Sales Returns and Allowances 300 Accounts Receivable 300 (To record credit granted to Sauk Stereo for returned goods)

Sales Discounts Invoice amount less a discount for prompt payment given to customer Example: Sauk Stereo pays PW Audio Supply and receives a discount May 12 Cash Discount Allowed 70 Accounts Receivable (To record collection within 2/7 n/30 discount period)

Income Statement Presentation Sales Revenue Gross Profit Other Revenue Net sales$ Less: Cost of goods sold Gross Profit$ Rent revenue$ Interest revenue Discount received Sales revenue Sales $ Less: Sales returns and allowances Net sales $

Income Statement Presentation (cont’d) Operating Expenses Selling expenses cost of making the sale e.g. advertising, delivery expenses Administration expenses cost of operating activities of the general, accounting and personnel offices e.g. salaries, rent Financial expenses costs of financing the business e.g. interest expense, discounts allowed

PW AUDIO SUPPLY LTD Income Statement for the year ended 30 June 2008 (partial) Operating expenses Selling expenses Sales salaries & commission expense $ Advertising expense Freight-out Rent expense – store space Depn expense – store equipment $ Administration expenses Office salaries expense Electricity expense Rent expense – office space Depn expense – office equipment Insurance expense Financial expenses Interest expense Discount allowed $