5 MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP I/S

Merchandising Operations Merchandising Companies buy and sell goods. The primary source of revenues is referred to as sales revenue or sales (instead of “service” revenue). Note the order that the selling takes place. Wholesaler Retailers Consumer

Merchandising Operations Income Measurement Sales Revenue Not used in a Service business. Less Cost of Goods Sold Gross Profit Equals Less Net Income (Loss) Operating Expenses Equals Cost of goods sold is the total cost of merchandise (the inventory) sold during the period. Because we have goods for sale the operating cycle is longer.

Merchandising Operations Operating Cycles The operating cycle of a merchandising company ordinarily is longer than that of a service company.

Merchandising Operations Flow of Costs Companies use either a periodic inventory system or a perpetual inventory system to account for inventory. For example, a newspaper provides news periodically, CNN.com provides news perpetually!

Merchandising Operations Flow of Costs – Periodic System This does not keep detailed records of the goods on hand. Cost of goods sold is determined by counting what’s left in inventory at the end of the accounting period (the end of the month, quarter, or year). See below for a calculation of a Cost of Goods Sold example: Beginning inventory $ 100,000 Add: Purchases 800,000 = Goods available for sale 900,000 Less: Ending inventory 125,000 = Cost of goods sold $ 775,000

Merchandising Operations Flow of Costs - Perpetual System The perpetual system continuously maintains records of the cost of each inventory purchase and sale using computerized registers and scanning. Acquisitions are debited to inventory. When sold, the cost of the goods sold is debited and inventory is credited. Advantage: Provides better control over accounting for inventories by: 1. continuously showing total inventory on hand, and 2. the company can determine the cost of goods sold for each sale. Disadvantage: Requires additional work and cost to maintain inventory records.

Recording Purchases of Merchandise Sauk is the buyer, purchasing goods from PW. PW is the seller and prepares a sales invoice for Sauk . Sauk uses PW’s sales invoice as a purchase invoice to record the transaction. Note: this purchase is “on account”. Sauk will pay at a later date. Sauk: May 4 Inventory 3,800 Accounts Payable - PW 3,800

Recording Purchases of Merchandise Purchase Returns and Allowances What if Sauk is dissatisfied because goods are damaged, of inferior quality, or do not meet specifications (wrong color, size, etc.)? Purchase Return Purchase Allowance Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. Decide to keep the goods if the seller will grant an allowance (deduction) from the purchase price. If Sauk returned goods costing $300 on May 8 the entry would be: May 8 Accounts payable - PW 300 Inventory 300 If Sauk was allowed to keep the goods and given an allowance the entry would be similar: Accounts Payable and Inventory would be reduced by only the allowance amount (e.g., $50).

Recording Purchases of Merchandise Purchase Discounts for Early Payment Credit terms permits buyers to take a cash discount for prompt payment. Advantages: the purchaser saves money and the seller shortens the operating cycle. Example 1: If the credit terms read 2/10, n/30. A 2% discount is given if paid within 10 days, otherwise the net amount is due within 30 days. Example 2: If the credit terms read 5/20, n/60. A 5% discount is given if paid within 20 days, otherwise the net amount is due within 60 days.

Recording Purchases of Merchandise May 14, Sauk pays the net amount of $3,500 (the original $3,800 less the return on May 8 of $300) within the discount period and takes the 2% discount, the J/E is: May 14 Accounts payable 3,500 Inventory (the 2% discount) 70 Cash (the 98% balance due) 3,430 (Purchase Discount = $3,500 x 2% = $70) (Cash Payment = $3,500 x 98% = $3,430) If Sauk decided not to take the discount, and instead paid the full $3,500 on June 3 (remember net 30!), the J/E would be: June 3 Accounts payable 3,500 Cash (the100% balance due) 3,500

Recording Purchases of Merchandise Freight Costs - The FOB Terms determines who pays Ownership of the goods passes to the buyer as soon as the public carrier accepts the goods from the seller. From the Shipping Point to the Destination Ownership of the goods remains with the seller until the goods reach the buyer. FOB simply means Free on Board, a very old term still used today

Recording Purchases of Merchandise The freight terms of FOB shipping point on the invoice required Sauk (the buyer) to pay the freight charges. Upon delivery of the goods on May 6, Sauk Stereo pays an independent trucking firm Haul-It Freight Company $150 for the freight charges. Freight charges cannot be discounted! The entry for Sauk is: May 6 Inventory 150 Cash 150 If the freight terms were FOB Destination, then PW Audio (the seller) would pay the freight charges. The entry by PW Audio Supply would have been: May 4 Freight-out Expense 150 Cash 150 Freight costs incurred by the seller are an operating expense.

Recording Purchases of Merchandise A Summary of Sauk’s Purchasing Transactions 4th - Purchase $3,800 $300 8th - Return 6th – Inventory (the freight charge) 150 70 14th - Discount Balance $3,580 Note: $3,800 – 300 – 70 = $3,430 owed to PW The $150 freight charge was paid separately to an independent shipping company and not subject to a discount

Recording PW’s Sale to Sauk You need 2 Journal Entries to Record PW’s Sale #1 Accounts receivable (or cash) XXX Selling Price Sales revenue XXX Cost of the Goods Sold #2 Cost of goods sold XXX Inventory XXX When the inventory is sold, it turns into an inventory expense called the cost of the goods sold!

Recording PW’s Sale to Sauk PW records the original May 4 sale of $3,800 (slide 8) to Sauk on account (no cash was paid). Assume PW’s cost of the merchandise inventory sold to Sauk was $2,400 (the cost of the goods sold): 2 entries are needed! May 4 Accounts receivable 3,800 Sales revenue 3,800 May 4 Cost of goods sold 2,400 Inventory 2,400 $3,800 - $2,400 = $1,400 called the gross profit on this sale - Slide 3. GP / Sales = $1,400 / $3,800 = 36.8% called the gross profit rate!

Recording Sales of Merchandise Sales Returns and Allowances (SR&A) The “Flipside” of Sauk’s purchase returns and allowances from slide 9. SR&A is a Contra-revenue account (kept with a debit balance). Sales are not debited (reduced) because: We want to know how many and why our Sales are being returned or why we are having to give allowances. Otherwise, this could distort comparisons between products, stores, or competitors.

Recording Sales of Merchandise The entry PW would make to record Sauk’s returned goods (slide 9) that had a $300 selling price and a $140 cost. Assume the goods were put back in inventory. May 8 Sales returns and allowances 300 Accounts receivable 300 May 8 Inventory 140 Cost of goods sold 140 Note: If this was just a $50 allowance (no inventory was returned) you would only have one J/E: Sales returns and allowances 50 Accounts Receivable 50 In other words, with an allowance, no inventory is returned!

Recording Sales of Merchandise Sales Discounts Offered to customers to promote prompt payment. This is the “Flipside” of Sauk’s purchase discount. Contra-revenue account (kept with a debit balance). $3,430 is the amount Sauk pays PW – slides 11 & 14. Note that the $150 freight was paid by Sauk to an independent shipper, not to PW

Recording Sales of Merchandise Assume Sauk pays the balance due of $3,500 less the 2% discount of $70 (slide 11). For Sauk the $70 is a reduction in the cost of the inventory. For PW the $70 is a reduction in the sale (a sales discount). PW records this receipt as: May 14 Cash 3,430 Sales discount 70 Accounts receivable 3,500 (Sales Discount = $3,500 x 2% = $70) (Cash Received = $3,500 x 98% = $3,430)

Income Statement Presentation The Multiple-Step Income Statement Highlights the components of net income. Three Key Line Items: gross profit, income from operations, and net income.

A Partial Income Statement Presentation Total Sales Revenues to Net Sales Instead of just showing “Net Sales” PW is showing how the total “gross” sales were reduced to “net” sales because of returns, allowances, and discounts

A Partial Income Statement Presentation Gross Profit Comparisons with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies.

A Partial Income Statement Presentation Operating Expenses (See slides 12 & 13) Freight Out is when the seller pays the freight cost – FOB Destination (slides 12 &13)

Additions to Income Statement Presentations Non-operating Activities Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations.

A Complete Multiple-Step Income Statement Presentation Look at Do IT 5-3 (page 261) and the example on p. 245- 246.

Once again, the Debit Credit Summary Assets, Expenses & Dividends all go up with Debits Liabilities, Owners Equity (Common Stock & Retained Earnings) & Revenues all go up with Credits = + DEAD = Debits increase Expenses, Assets, and Dividends CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

Simple Summary For A Sole Proprietor Assets & Expenses go up with Debits. There are no Dividends! Liabilities, Owners Equity & Revenues all go up with Credits Owner’s Equity = + DEA = Debits increase Expenses & Assets CLEaR = Credits increase Liabilities, Equity and Revenues