1 Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso ELS

Chapter 5

3 Chapter 5 Merchandising Operations After studying Chapter 5, you should be able to : zIdentify the differences between a service enterprise and a merchandising company. zExplain the recording of purchases under a perpetual inventory system. zExplain the recording of sales revenues under a perpetual inventory system. zIdentify the unique features of the financial statements for a merchandising company. zExplain the factors affecting the profitability.

Merchandising companies buy and sell merchandise Service enterprises perform services as their primary source of revenue

5 Differences Between a Service Enterprise and a Merchandising Company zIn a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales. zUnlike expenses for a service company, expenses for a merchandising company are divided into two categories: yCost of goods sold - the total cost of merchandise sold during the period. yOperating expenses - selling and administrative expenses.

6 Terms zSales revenue or sales = sale of merchandise zCost of goods sold = total cost of merchandise sold

7 Page 202 in book Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Net Income (Loss) Less Equals How Income is Measured in a Merchandising Company Page 202 in book

Sales revenues Sales$ 480,000 Less: Sales returns and allowance$12,000 Sales discounts 8,000 20,000 Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000Operating expenses Store salaries expense45,000 Rent expense19,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000 Total operating expenses114,000 Net Income $ 30,000 PW AUDIO SUPPLY, INC. Income Statement (Partial) For the Year Ended December 31, 1998 Page 213 in book

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

10 Operating cycle of a merchandising company is... zordinarily longer than than that of a service company; zpurchase of merchandise and its sale lengthens the cycle.

11 Receive Cash Perform Services Buy Inventory Sell Inventory Service Company Merchandising Company Cash Accounts Receivable Accounts Receivable Merchandise Inventory Page 203 in book

12 Inventory Systems zPerpetual - detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand zPeriodic -inventory system in which detailed records are not maintained and the cost is goods sold is determined only at end of accounting period Page 203 in book

13 Cost of Goods Sold Computed Perpetual Periodic Perpetual Point of SaleItem Sold Inventory Purchased Item SoldPoint of Sale End of Period Comparing Periodic and Perpetual Inventory Systems Inventory Purchased End of Period Page 204 in the book

14 Computers

and electronic scanners have enabled many companies to install perpetual inventory systems

16 What Is Charged to Merchandise Inventory? zAll Costs of getting the inventory to company and ready to sell y+Freight-In y+Special Permits zOnly costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies

17 Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. Task:Record the purchase by getting information from the Purchase Invoice. The Purchase Invoice is just a copy of the sales invoice.

18 1. Seller 2.Invoice Date 3.Purchaser 4.Salesperso n 5.Credit terms 6.Freight terms 7.Goods sold: catalog no.,descriptio n,quantity, price per unit 8.Total invoice price Invoice No. 731 Address 125 Main Street Attention o f James Hoover, Purchasing Agent Firm Name: Sauk Stero City Chelsea State Illinois Zip Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer Catalog No. Description QTY Price Amount Page 206 in book

19 Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. GENERAL JOURNAL Debit Credit May 4 Merchandise Inventory 3,800 Accounts Payable 3,800 To record goods purchased on account Accounts Payable Merchandise Inventory May 4 3,800 Freight-out May 4 3,800

20 Purchases Returns and Allowances On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Merchandise Inventory 300 To record goods returned that were purchased on account Accounts Payable Merchandise Inventory May 4 3,800 Freight-out May 4 3,800May 8 300

21 Freight Costs - On Incoming Inventory

22 Freight Costs - On Incoming Inventory On May 6 the company paid $ 150 to have the merchandise inventory delivered to them. GENERAL JOURNAL Debit Credit May 6 Merchandise Inventory 150 Cash 150 To record payment of freight. Freight-Out Merchandise Inventory May 4 3,800 Cash May 6 150May May 6 150

23 Freight Costs - On Outgoing Inventory

24 Freight Costs-on outgoing inventory On May 6 the seller company paid $ 150 to have merchandise inventory delivered to the buyer. GENERAL JOURNAL Debit Credit May 6 Freight-Out 150 Cash 150 To record payment of freight on goods sold. Freight-Out Merchandise Inventory Cash May 6 150

25 Purchase Discounts Credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. Credit terms specify the amount of cash discounts and the time period during which it is offered. 2/10,n/30 1/10 EOM

26 Purchases Discounts Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period Original Invoice $3,800 -Returns 300 Amount due before discount $3,500 2% discount 70 Net due $3,430

Purchases Discounts Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period. GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period. Accounts Payable Merchandise Inventory May 4 3,800 Cash May 4 3,800May May May 14 3,500 May

28 Sales Invoice... a business document that provides written evidence of a credit sale.

29 1. Seller 2.Invoice Date 3.Purchaser 4.Salesperson 5.Credit terms 6.Freight terms 7.Goods sold: catalog no.,description, quantity, price per unit 8.Total invoice price Invoice No. 731 Address 125 Main Street Attention o f James Hoover, Purchasing Agent Firm Name: Sauk Stero City Chelsea State Illinois Zip Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer Catalog No. Description QTY Price Amount Page 206 in book

30 Sales Revenues - Under a Perpetual System zare recorded when earned-revenue recognition principle zmust be supported by a business document- written evidence z2 entries are made for each sale yone to record sale yone to record cost of merchandise sold

Sales - under a perpetual system Assume a CASH sale of $ 2,200 Cash Accounts Receivable Merchandise Inventory Cost of Goods Sold Sales Returns & Allowances Sales May 4 2,200 May For merchandise having a cost of $ 1,400

32 Sales Returns and Allowances Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Merchandise Inventory 300 To record goods returned that were purchased on account On seller’s books GENERAL JOURNAL Debit Credit May 8 Sales Returns and Allowance 300 Accounts Receivable 300 To record return of goods delivered to Sauk Stero

Sales - under a perpetual system Assume a sale of $ 3,800 ON ACCOUNT Cash Accounts Receivable Merchandise Inventory Cost of Goods Sold Sales Returns & Allowances Sales May 4 3,800 May 4 2,400 May 2,400 For merchandise having a cost of $2,400 May 4 3,800

34 What Is the Sales Returns and Allowances Account? zContra Revenue Account to sales zUsed to show how much came in on returns and allowances Excessive returns and allowances suggest: zinferior merchandise zinefficiencies in filing orders zerrors in billing customers zmistakes in delivery or shipment of goods

35 What Is the Sales Discount Account? zContra Revenue Account to sales zUsed to disclose amount of cash discounts taken by customers

36 Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period On seller’s books GENERAL JOURNAL Debit Credit May 14Cash 3,430 Sales Discounts 70 Accounts Receivable 3500 To record collection within discount period

Sales revenues Sales$ 480,000 Less: Sales returns and allowance$12,000 Sales discounts 8,000 20,000 Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000Operating expenses Store salaries expense45,000 Rent expense19,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000 Total operating expenses114,000 Net Income $ 30,000 PW AUDIO SUPPLY, INC. Income Statement (Partial) For the Year Ended December 31, 1998 Page 213 in book

38 Gross Profit Rate= Gross Profit Net Sales Company’s gross profit expressed as a percentage

39 Operating Expenses To Sales Ratio= Operating Expenses Net Sales Many companies have improved the efficiency of their operations, thus reducing the ratio of operating expenses to sales.