1. CHAPTER FIVE MERCHANDISING OPERATIONS

2. OBJECTIVES : Compare the F/S between the service company and merchandising operation Use sales and gross margin to evaluate a company Account for the inventory under the perpetual inventory system

3. TERMINOLOGY MERCHANDISER: purchases goods, marks up the cost price and sells to its customers in the same form, e.g. Sears, Walmart, London Drugs, Douglas College Bookstore MANUFACTURER: buys “raw materials” from their suppliers, changes the form in some way, and sells a different product to customers, e.g. McDonalds, General Motors RETAILER: sells to the end user (you and me) WHOLESALER: the “middleman” -purchases from a manufacturer and sells to a retailer

4. OBJECTIVE 1 Compare the F/S between the service company and merchandising operation

5. Income Statements Service Corp. Income Statement For the Year Ended June 30,2005 Service revenue$xxx Expenses: Salary expense Amortization expense Income tax expense Net income$ xx Merchandising Co. Income Statement For the Year Ended June 30,2005 Sales revenue$ xx Cost of goods sold Gross margin $ xx Operating expenses: Salary expense Amortization expense Net income$ xx

6. BALANCE SHEET Service Corp. Balance Sheet June 30,2005 Current Assets Cash Short-term investments Accounts Receivable, net Prepaid expenses Merchandising Co. Balance Sheet June 30,2005 Current Assets Cash Short-term investments Accounts Receivable, net Inventory Prepaid expenses

7. OBJECTIVE 2 Use sales and gross margin to evaluate a company Gross Margin = Net Sales – Cost of goods sold Net sales = Sales Revenue - Sales Returns - Sales Discounts

8. Mark’s Company Income Statement For the Year Ended December 31, 2005 Net sales revenue (same as Net sales) $33,212 Cost of goods sold (same as Cost of sales)23,029 Gross margin (same as Gross profit)10,183 Expenses: Selling, general, administrative 7,490 Amortization expense 854 Interest expense 393 Other expenses, net 302 Total operating expenses9,039 Net earnings (same as Net income) $ 1,144

9. OBJECTIVE 3 Account for the inventory under the perpetual inventory system The G/L account “Inventory” is PERPETUALLY (continually) updated so that it should represent the actual amount, at cost, of the stock on hand at any time Thus, all of the following transactions will increase or decrease the Inventory balance every time the business: A. buys inventory (AKA INVT) B. returns INVT to suppliers for credit,or receives a purchase allowance C. pays freight charges to bring in stock D. records a purchase discount for early payment E. sells goods to customers F. accepts goods returned by customers Note the actual stock on hand is determined only by taking a physical count, which must be done at least once a year

10. RECORDING PURCHASES On Nov 1, Mandy buys merchandise on account from Sam Company for $ 15,000 plus 7% GST Date Nov 1 Inventory 15,000 GST Recoverable 1,050 Accounts Payable 16,050 To record purchase of merchandise from Sam on credit

11. RECORDING PURCHASE ALLOWANCE On Nov 2, Mandy receives a credit note for $500 as a purchase allowance from Sam Co. Some of the merchandise was not the colour ordered. Note the merchandise was not returned. Date Nov 2 Accounts Payable 535 GST Recoverable 35 Inventory 500 To record purchase allowance from Sam

12. RECORDING PURCHASE RETURN On Nov 3, Mandy receives a credit note from Sam Co for $1,500. Some of the merchandise was the wrong size and was returned. Date Nov 3 Accounts Payable 1,605 GST Recoverable 105 Inventory 1,500 To record return of goods to Sam for credit

13. PAYING FOR TRANSPORTATION - SHIPPING TERMS “FOB” is an abbreviation meaning “Free On Board.” It determines who pays the transportation costs. FOB SHIPPING POINT (or “factory” or “our dock” or “our plant”) Title to the goods will pass at the time they leave Sam’s warehouse (“dock”) and Mandy would pay freight, insurance, etc from there TRANSPORTATION IN, AKA Freight In, for Mandy (part of merchandise cost), would be no cost for Sam FOB DESTINATION (or “your dock” or “your plant”) Title to the goods does not pass until they are received by Mandy at their warehouse; therefore Sam would pay freight, insurance, etc until they arrive FREIGHT OUT for Sam (Delivery Expense); would be no cost for Mandy

14. RECORDING FREIGHT IN Nov 4 - Since the shipping terms were FOB shipping point, Mandy pays David’s Freight $3,000 plus GST for freight charges to transport the merchandise from Sam’s warehouse to Mandy’s warehouse Date Nov 4 Inventory 3,000 GST Recoverable 210 Cash 3,210 To record payment for transportation to David

15. PAYING THE BILL - DISCOUNT FOR EARLY PAYMENT Now suppose Sam has given Mandy credit terms of “3/10, n/30" (pronounced “THREE TEN NET THIRTY”). This means that if Mandy pays within 10 days of invoice date, they can deduct 3% off the net amount owing as a discount for early payment. This is called a “purchase discount.” Nov 10 - Mandy pays the amount owing, LESS THE 3% DISCOUNT.

16. 1. What is the balance of Mandy’s Account Payable to Trader ? 16050 – 535 – 1605 = 13910 2.What is the amount of the 3% discount available? 13910 × 3% = 417.3 3. How much cash does Mandy pay ? 13910 – 417.3 = 13492.7

17. RECORDING PURCHASE DISCOUNT Date Nov 10 Accounts Payable Inventory Cash To record payment to Sam less discount 13910 417.3 13492.7

18. RECORDING SALES On Nov 12, Mandy Co sells merchandise to Adell Co for $ 12,000 plus GST. Terms are 2/10, N/30 (“TWO TEN NET THIRTY”), FOB Adell’s warehouse. ( Destination ) Date Nov 12 Accounts Receivable 12,840 GST Payable 840 Sales Revenue 12,000 To record sale of merchandise to Adell Co on account

19. RECORDING COGS Mandy Co records COST OF GOODS SOLD for this sale. Assume cost to Mandy was $ 8,880. Date Nov 12 Cost of Goods Sold 8,880 Inventory 8,880 To record cost of goods sold for sale to Adell Co ( NOTE THAT COST OF GOODS SOLD IS AN EXPENSE ACCOUNT )

20. RECORDING DELIVERY EXPENSE The same day, Mandy Co also pays George $1,600 plus GST to deliver the goods to Adell. Date Nov 12 Delivery Expense 1,600 GST Recoverable 112 Cash 1,712 To record payment for delivery to Adell

21. RECORDING SALES RETURNS Nov 15 - Adell Co returns $800 of this merchandise as unsatisfactory (they were the wrong size). Mandy issues a credit note for Adell’s account. Date Nov 15 Sales Returns & Allowances 800 GST Payable 56 Accounts Receivable 856 To record return of unsatisfactory merchandise by Adell Co NOTE THAT SALES RETURNS & ALLOWANCES IS ACONTRA- REVENUE ACCOUNT (temporary acct)

22. RECORDING SALES RETURNS Mandy Co must also record the return of the goods to stock, and the corresponding reduction of cost of goods sold. Assume cost is $ 740. Date Nov 15 Inventory 740 Cost of Goods Sold 740 To record return of goods to stock due to return by Adell

23. RECORDING SALES ALLOWANCE Nov 16 - Adell Co reports that some of the merchandise was slightly damaged, but does not return it. To compensate, Mandy issues a credit note for Adell’s account of $200 plus GST. Date Nov 16 Sales Returns & Allowances 200 GST Payable 14 Accounts Receivable 214 To record sales allowance to Adell regarding damaged Merchandise NOTE there is no entry to Dr Inventory and Cr COGS as the merchandise has not been returned

24. GST BALANCE At this point, what are the balances in the GST accounts? GST Receivable = 1050 + 210 + 112 – 35 – 105 = 1232 GST Payable = 840 – 56 – 14 = 770 Thus the NET GST owing to/from the government is: 770 – 1232 = - 462

25. PAYING THE BILL - DISCOUNT FOR EARLY PAYMENT Remember Mandy has given Adell terms of 2/10, N/30. This means Adell can deduct 2% from the NET amount owing if they pay within 10 days of invoice date. This is a “sales discount.” Nov 21 - Adell pays the amount owing, LESS THE 2% DISCOUNT.

26. 1. What is the balance of Adell’s Account Receivable ? 12840 – 856 – 214 = 11770 2. What is the amount of the 2% discount taken? 11770 × 2% = 235.4 3. How much cash will Mandy receive 11770 – 235.4 = 11534.6

27. RECORDING SALES DISCOUNTS Date Nov 21 Cash Sales Discounts Accounts Receivable To record receipt of Adell’s A/R less discount NOTE THAT SALES DISCOUNTS IS ALSO ACONTRA-REVENUE ACCOUNT ( temporary acct ) 11534.6 235.4 11770

28. ENDING INVENTORY BALANCE The balance in the Inventory account is NOW? 15000 + 3000 + 740 – 500 – 1500 – 417.3 – 8800 = 7442.7 At the end of the month, Mandy takes a physical count of their ending inventory (EI), and calculates the cost to be $ 6,500. Oops! What’s wrong with this picture? There is an INVT SHORTAGE of 7442.7 – 6500 = 942.7

29. REASON OF DIFFERENCE which could be caused by several factors, e.g. Incorrect physical count and/or costing Breakage INVT growing “legs” and going home with dishonest employees Unrecorded purchase returns or sales Purchase recorded twice

30. AJE Assuming the physical count /costing and the accounting are correct, we must prepare an AJE to correct the INVT account for the B/S, else Date Nov 30 Cost of Goods Sold 942.7 Inventory 942.7 To record INVT shortage

31. QUESTION: what if the physical count revealed the cost of the EI at Nov 30 was$ 8,000 ??Possible reasons: Incorrect physical count and/or costing Unrecorded purchases or customer returns COGS recorded incorrectly Assuming the physical count/costing is correct, invoices and credit memos have been correctly recorded, etc, we must prepare an AJE to correct the INVT account for the B/S, else 8000 – 7442.7 = 557.3

32. AJE Date Nov 30 Inventory 557.3 Cost of Goods Sold 557.3 To adjust merchandise INVT for overage

33. Income statement for November “Multiple step” Mandy Company Income Statement for month ended November 30, 2005 Sales Revenue $12,000.00 Less: Sales Returns & Allowances (1,000.00) Sales Discounts (235.40) NET SALES $10,764.60 Cost of Goods Sold 7,582.70 GROSS MARGIN 3,181.90 Operating Expenses (assumed) Selling Expenses (show details) $ 1,700.00 General Expenses (show details) 1,100.00 TOTAL EXPENSES 2,800.00 NET INCOME $ 381.90

34. “ Single step” Mandy Company Income Statement for month ended November 30, 2005 Net Sales $ 10,764.60 Cost of Goods Sold $ 7,582.70 Operating Expenses 2,800.00 Net Income $ 381.90

35. FEATURES OF SINGLE STEP A “single step” statement is “condensed,” with only one “step” needed to produce NI (Revenue minus Expenses ) ( Easier to read, but DOES NOT SHOW GROSS MARGIN (!) ( Frequently seen in published annual reports, but details of the various expenses would be included as separate schedules