ACTG 2110 Chapter 6 – Accounting for Merchandising Businesses

Merchandising Companies Businesses that buy goods with the intention of reselling the goods at a higher price Ex.: Target, WalMart, Dillards, Krogers, Books- a-Million, Old Navy, Sears, Etc. Two new accounts –Inventory – merchandise to be resold Listed as a current asset on the balance sheet –Cost of goods sold – merchandise that has been sold Expensed on the income statement Generally a large expense (often the largest)

Operating cycle Cash>>>>>Buy inventory>>>>>>>Sell inventory>>>>>>>>>Collect cash from customers or the accounts receivable collections Shorter the operating cycle, the better off you are (get cash back fast!!!)

Multi-step Income Statement Net sales (Sales – sales returns and allowances – sales discounts) Less cost of goods sold Gross profit margin Operating expenses –Selling expenses –General & Administrative expenses Income from operations (Operating income) Add other income (interest income) Subtract other expenses (interest expense) Net income

Other Financial Statements Single-step income statement –All revenues listed together (no other income) –All expenses listed together (no gross profit margin or other expenses) Statement of owner’s equity –Same as for service businesses Balance sheet –Now includes inventory as a current asset

Inventory Systems Perpetual –Inventory account continuously updated –Inventory is counted at the end of the period to see whether it agrees with accounting records –All purchases increase “Inventory” –Cost of goods sold is recorded every time a sale occurs Periodic –Inventory account only updated occasionally or “periodically” –Inventory is counted at end of the period –All purchases go to an expense account entitled “Purchases” –Cost of goods sold is backed into

Accounting for Inventory Perpetual System Sales of Inventory (2 entries): Cost of goods soldXXX InventoryXXX Accts. Rec./CashXXX SalesXXX Sales Discounts CashXXX Sales DiscountsXXX Accounts ReceivableXXX Sales Returns and Allowances Sales Returns and Allowances XXX Accounts Receivable/CashXXX

Accounting for Inventory Perpetual System Purchases of inventory: InventoryXXX Accounts PayableXXX Purchases Discounts –Payment terms 2/10, n/30 –2% discount if paid in 10 days, net must be paid by 30 days –Gross method (purchases discounts reduce the inventory amounts) –Net method (purchase recorded at the amount after the discount; if discount not taken, inventory is increased)

Accounting for Inventory Perpetual System Purchases returns and allowances –Recorded as decreases in inventory Transportation Costs –Freight in (Added to inventory cost) –FOB Shipping point Buyer generally pays freight Buyer owns inventory when it reaches the “shipping point” –FOB Destination Seller generally pays freight Seller owns inventory until it reaches the buyer or the “destination” –Freight out/Delivery expense (Selling/marketing cost to deliver goods)

Sales Taxes Example: Cash/Accts. Rec.1,060 Sales1,000 Sales Tax Payable 60 ($1,000 sale + 6% sales tax collected) Sales Tax Payable 60 Cash60 (Business pays sales tax to state)

Adjusting Entries Adjust for inventory shrinkage Example: Inventory records show $1,000, while inventory count shows $950 Cost of goods sold50 Inventory50

Financial Analysis and Interpretation Ratio of net sales to assets (Asset turnover) –Net sales/Average assets –Represents how effective a business uses its assets to increase sales –Higher the ratio, the better Net sales trends Gross profit margins (Gross profit/Net sales)