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Merchandising Activities

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1 Merchandising Activities
Chapter 6 Chapter 6: Merchandising Activities

2 Operating Cycle of a Merchandising Company
The operating cycle of a business is the time it takes a business to start with cash, purchase inventory, sell the inventory, and finally collect cash from customers. The operating cycle of a business that sells inventory on credit is typically longer than that of a business that sells only on a cash basis. This is due to additional time between when a customer buys inventory and when the customer pays off the accounts receivable.

3 Comparing Merchandising Activities with Manufacturing Activities
Manufacture inventory and have a longer and more complex operating cycle. Purchase inventory in ready-to-sell condition. Manufacturing companies use raw materials to make the inventory they sell. Their operating cycles are typically longer and more complex because of the time it takes to make and sell the inventory and then to collect the accounts receivable. Merchandising companies purchase the inventory they sell in a ready-to-sell condition. Since they do not have to make the inventory, their operating cycle is typically shorter. Manufacturing Company Merchandising Company

4 Retailers and Wholesalers
Wholesalers buy merchandise from several different manufacturers and then sell this merchandise to several retailers. After making their inventory, manufacturing companies sell the inventory to wholesalers who then sell it to retailers to sell directly to the public. Retailers sell merchandise directly to the public.

5 Income Statement of a Merchandising Company
Cost of goods sold represents the expense of goods that are sold to customers. Gross profit is a useful means of measuring the profitability of sales transactions. The income statements of merchandising companies have an additional expense item called Cost of Goods Sold. The Cost of Goods Sold account represents the cost of merchandise sold during the period to help earn revenue. Cost of Goods Sold is presented as a separate expense item on the income statement. Net Sales minus Cost of Goods Sold equals Gross Profit. Gross Profit is the amount left, after subtracting the cost of the inventory sold, to cover all other expenses and a profit.

6 Accounting System Requirements for Merchandising Companies
Control Account Subsidiary Ledgers In the General Ledger, the control account for Accounts Receivable indicates that customers owe seven thousand dollars. But, it does not indicate how much each customer owes. To find out the amount due from each customer, we must look at the Accounts Receivable Subsidiary Ledger. Detail information for each specific customer can be found by looking in the subsidiary ledgers. By looking at the subsidiary ledgers, it’s clear that Sparks, Inc. owes $2,000 and that Heather Jacobs Company owes $5,000. Notice that the total of the balances in the subsidiary accounts equals the total balance in the control account, $7,000.

7 Perpetual Inventory Systems
On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account. In the perpetual inventory system, the inventory account is continuously updated to reflect purchases, sales, and returns of inventory. On September 5th, Worley Company purchased on account from Electronic City one hundred laser lights for $30 each. Worley Company would debit Inventory and credit Accounts Payable for $3,000.

8 Perpetual Inventory Systems
On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios. Retail 10 ´ $50 = $500 On September 10th, Worley Company sold 10 laser lights for $50 each to ABC Radios on account. Under the perpetual inventory system, a sale of inventory requires two entries. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is $500. Another entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is $300. The retail amount is the selling price to the customer and the cost amount is the cost paid for the inventory sold. 10 ´ $30 = $300 Cost

9 Perpetual Inventory Systems
On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase. On September 15th, Worley Company paid Electronic City $3,000 for the September 5th purchase. Worley Company would debit Accounts Payable and credit Cash for $3,000.

10 Perpetual Inventory Systems
On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10. On September 22nd, Worley Company received $500 from ABC Radios for their purchase on September 10th. Worley Company would debit Cash and credit Accounts Receivable for $500.

11 Taking a Physical Inventory
In order to ensure the accuracy of their perpetual records, most businesses take a complete physical count of the merchandise on hand at least once a year. Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage and theft. On December 31, Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered. Most companies take a physical count of inventory at least once a year. Theoretically, the physical count should match the number of items in the inventory records. In reality, this is not the case. The physical count does not match the records due to spoilage, breakage, damage, obsolescence, and theft. The physical count helps get the records up to date to reflect what is actually on hand. When a physical count identifies inventory shrinkage, an entry is made to debit Cost of Goods Sold and credit Inventory. This entry increases Cost of Goods Sold, an expense account, and decreases the Inventory account.

12 Closing Entries in a Perpetual Inventory System
The closing entries are the same! Close Revenue accounts (including Sales) to Income Summary. Close Expense accounts (including Cost of Goods Sold) to Income Summary. Close Income Summary account to Retained Earnings. Close Dividends to Retained Earnings. The steps for closing entries in a perpetual inventory system are the same as discussed earlier. Step 1 is to close Revenue to Income Summary. Since Revenue has a credit balance, a debit is made to close it and a credit is made to Income Summary. Step 2 is to close all expense accounts to Income Summary. This includes the Cost of Goods Sold expense account. Since these accounts have a debit balance, they are credited and a debit is made to Income Summary for their total. Step 3 is to close Income Summary to Retained Earnings. Step 4, the final step, is to close Dividends to Retained Earnings. Since the Dividend account has a debit balance, a credit is made to close it and a debit is made to the Retained Earnings account.

13 Periodic Inventory System
On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account. Notice that no entry is made to Inventory. Under the periodic inventory system, no effort is made to keep the inventory account or the cost of goods sold account up to date. Only on a periodic basis are these two accounts updated. On September 5th, Worley Company purchased on account from Electronic City 100 laser lights for $30 each. Worley Company would debit Purchases and credit Accounts Payable for $3,000. Notice that an entry is not made to the Inventory account. Instead, the purchase is debited to a new account called Purchases.

14 Periodic Inventory System
On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios. Retail On September 10th, Worley Company sold 10 laser lights for $50 each to ABC Radios on account. Under the periodic inventory system, a sale of inventory requires only one entry: a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is $500. The cost entry that was made under the perpetual inventory system is not required because the periodic system does not attempt to keep the inventory and cost of good sold accounts up to date.

15 Periodic Inventory System
On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase. On September 15th, Worley Company paid Electronic City $3,000 for the September 5th purchase. This entry is the same as under the perpetual inventory system. Worley Company debits Accounts Payable and credits Cash for $3,000.

16 Periodic Inventory System
On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10. On September 22nd, Worley Company received $500 from ABC Radios for their purchase on September 10th. This entry is also the same as under the perpetual inventory system. Worley Company debits Cash and credits Accounts Receivable for $500.

17 Computing Cost of Goods Sold
The accounting records of Party Supply show the following: Inventory, Jan $ 14,000 Purchases (during year) ,000 Inventory, Dec ,000 Because the periodic system does not maintain a cost of goods sold account, cost of goods sold must be calculated at the end of the period. Here is some information for Party Supply. On January 1st, they have beginning inventory of $14,000. They have purchases during the year totaling $130,000. On December 31st, the physical inventory count was $12,000. To calculate the cost of goods sold for Party Supply, start with the beginning inventory and add the purchases during the year. This provides the cost of goods available for sale during the period. From this, subtract the ending inventory and arrive at the cost of goods sold during the period.

18 Creating a Cost of Goods Sold Account
Party Supply must create the Cost of Goods Sold account. Party Supply must record the ending inventory amount. A Cost of Goods Sold account is created with two special closing entries. The first entry zeroes out the balances in the beginning Inventory account and the Purchases account. For Party Supply, this entry consists of a credit to Inventory for $14,000 and to Purchases for $130,000 and a debit to Cost of Goods Sold for $144,000. The second closing entry records the physical count in the Inventory account and adjusts the balance in the Cost of Goods Sold account. For Party Supply, this entry requires a debit to Inventory and a credit to Cost of Goods Sold for $12,000. After these special closing entries, the Purchases account is closed, the Inventory account reflects the ending inventory amount, and the Cost of Goods Sold account reflects the calculated cost of goods sold amount. The remaining steps for completing closing entries in a periodic inventory system are the same as discussed earlier for the perpetual inventory system.

19 Selecting an Inventory System
Which inventory system should a company use? This table suggests some characteristics to consider when selecting an inventory system. If a company has a professional management team, needs timely information about items in inventory, and has a computerized accounting system, then a perpetual inventory system is likely the better option. However, if a company is run by its owners, does not need timely information about items in inventory, uses a manual accounting system, and maintains merchandise on site, then a periodic inventory may be the solution. Many companies can find an accounting software package that is able to handle a perpetual inventory system very effectively.

20 Credit Terms and Cash Discounts
When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice. Percentage of Discount # of Days Discount Is Available Otherwise, the Full Amount Is Due # of Days when Full Amount Is Due Read as: “Two ten, net thirty” 2/10, n/30 Cash discounts are provided to customers as an incentive for them to pay early. The credit period is the normal period of time a company allows for customers to extend their account receivable, typically 30 or 60 days. The discount period is a much shorter period of time, typically 10 or 15 days. If payment is received during the discount period, a discount may be taken. If payment is made after the discount period expires, then the full payment is due on or before the end of the credit period. Cash discount terms are typically written as this slide shows. This particular discount term would be read as “two ten, net thirty.” The first number represents the discount percentage. The second number represents the discount period. The letter “n” stands for the word net. The last number represents the entire credit period. In this case, if the customer pays within 10 days, then a 2% discount may be taken. If not, then the full amount is due within 30 days.

21 Recording Purchases at Net Cost
On July 6, Jack & Jill, Inc. purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. Many companies plan to take advantage of cash discounts offered, so they record their purchases net of the discount. Since they typically take the discount, this process simplifies future entries. If a cash discount is not taken in the future, then a purchase discounts lost account is used. On July 6th, Jack & Jill, Inc. purchased $4,000 of merchandise on account from Kid’s Clothes with terms two ten net thirty. Jack & Jill, Inc. debits Inventory and credits Accounts Payable for $3,920, which is net of the two percent cash discount. $4,000 ´ 98% = $3,920

22 Recording Purchases at Net Cost
On July 15, Jack & Jill, Inc. pays the full amount due to Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. On July 15th, Jack & Jill, Inc. pays the full amount due to Kid’s Clothes. In this entry, Jack & Jill, Inc. debits Accounts Payable and credits Cash for $3,920. Since Accounts Payable was originally recorded for the net amount, this entry completely takes care of the balance in the Accounts Payable account.

23 Recording Purchases at Net Cost
Now, assume that Jack & Jill, Inc. waited until July 20 to pay the amount due in full to Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. Now, assume that Jack & Jill, Inc. waited until July 20th to pay Kid’s Clothes. This is outside the discount period. Jack & Jill, Inc. will have to pay the full amount of $4,000 since they did not pay within the discount period. This is recorded as a credit to Cash. The debit to Accounts Payable can only be for the originally recorded amount of $3,920. The difference is a debit to Purchase Discounts Lost, a nonoperating expense account, for $80. Nonoperating Expense

24 Recording Purchases at Gross Invoice Price
On July 6, Jack & Jill, Inc. purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. Other companies use the gross method to record their purchases. Under the gross method, the purchases are originally recorded at the full amount of the inventory purchased. If a cash discount is taken in the future, then a purchase discounts account is used. On July 6th, Jack & Jill, Inc. purchased $4,000 of merchandise on account from Kid’s Clothes with terms two ten net thirty. Jack & Jill, Inc. debits Inventory and credits Accounts Payable for $4,000, which is the gross amount of the purchase.

25 Recording Purchases at Gross Invoice Price
On July 15, Jack & Jill, Inc. pays the full amount due to Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. Reduces Cost of Goods Sold $4,000 ´ 98% = $3,920 On July 15th, Jack & Jill, Inc. pays the full amount due to Kid’s Clothes. Jack & Jill, Inc. does not have to pay the full amount of $4,000 since they are paying within the discount period. As a result, the credit to Cash is for $3,920, which is the net amount. This payment removes the entire accounts payable of $4,000 and is recorded as a debit to Accounts Payable for $4,000. The difference of $80 is a credit to Purchase Discounts Taken, an account that reduces the cost of goods sold for the period.

26 Recording Purchases at Gross Invoice Price
Now, assume that Jack & Jill, Inc. waited until July 20 to pay the full amount due to Kid’s Clothes. Prepare the journal entry for Jack & Jill, Inc. Now, assume that Jack & Jill, Inc. waited until July 20th to pay Kid’s Clothes. This is outside the discount period. In this entry, Jack & Jill, Inc. debits Accounts Payable and credits Cash for $4,000. This payment must be for the gross amount since it is made outside of the discount period.

27 Returns of Unsatisfactory Merchandise
On August 5, Jack & Jill, Inc. returned $500 of unsatisfactory merchandise purchased from Kid’s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost. Prepare the entry for Jack & Jill, Inc. On August 5th, Jack & Jill, Inc. returned $500 of unsatisfactory merchandise to Kid’s Clothes. The inventory was originally purchased on credit with terms of two ten net thirty, and the purchase was originally recorded at net cost. To record the return, Jack & Jill, Inc. would debit Accounts Payable and credit Inventory for the net cost of the goods returned, which in this case would be $490. $500 ´ 98% = $490

28 Transportation Costs on Purchases
Transportation costs related to the acquisition of assets are part of the cost of the asset being acquired. In general, the cost of any asset includes any transportation costs related to getting the asset to the buyer’s place of business. This is also the case for inventory. Transportation costs incurred by the buyer are included in the cost of Inventory.

29 Transactions Related to Sales
Just as inventory returns and cash discounts impact a buyer’s entries, they also impact a seller’s entries. Sellers use the Sales Returns and Allowances account to record inventory returned to the seller, or adjustments in prices sellers allow due to customer dissatisfaction. Sellers use the Sales Discounts account to record cash discounts taken by customers who pay within the discount period. Net sales equals Sales minus Sales Returns and Allowances and Sales Discounts. Let’s see how these accounts are treated in journal entries. Credit terms and merchandise returns affect the amount of revenue earned by the seller.

30 Sales On August 2, Kid’s Clothes sold $2,000 of merchandise to Jack & Jill, Inc. on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries. Kid’s Clothes sold $2,000 of merchandise to Jack & Jill, Inc. on credit terms of two ten net thirty. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this sale. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is $2,000. Another required entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is $1,000.

31 Sales Returns and Allowances
On August 5, Jack & Jill, Inc. returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries. Contra-revenue On August 5th, Jack & Jill, Inc. returned $500 of merchandise to Kid’s Clothes. The cost of this inventory to Kid’s Clothes is $250. Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this return. One entry is a debit to Sales Returns and Allowances and a credit to Accounts Receivable for the retail amount of the sale, which in this case is $500. Another required entry is a debit to Inventory and a credit to Cost of Goods Sold for the cost of the inventory returned, which in this case is $250. Sales Returns and Allowances is a contra-revenue account that is subtracted from Sales to arrive at Net Sales for the period.

32 Sales Discounts On July 6, Kid’s Clothes sold $4,000 of merchandise to Jack & Jill, Inc. on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries. We have explained that sellers frequently offer cash discounts, such as 2/10,n/30, to encourage customers to make early payments for purchases on account. To the seller, the cost associated with cash discounts is the discounts taken by customers who do pay within the discount period. Therefore, sellers design their accounting systems to measure the sales discounts taken by their customers. To achieve this goal, sellers record the sale and the related account receivable at the gross (full) invoice price. To illustrate, assume that on July 6th, Kid’s Clothes sold $4,000 of merchandise to Jack & Jill, Inc. on credit terms of two ten net thirty. Kid’s Clothes originally paid $2,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this sale. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is $4,000. Another required entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is $2,000.

33 Prepare the journal entry for Kid’s Clothes.
Sales Discounts On July 15, Kid’s Clothes receives the full amount due from Jack & Jill, Inc. from the July 6 sale. Prepare the journal entry for Kid’s Clothes. Contra-revenue $4,000 ´ 98% = $3,920 On July 15th, Kid’s Clothes receives the full payment due from Jack & Jill, Inc. Kid’s Clothes debits Cash for $3,920, which is the net amount due since payment was made within the discount period. Accounts Receivable is credited for the entire original amount of $4,000. The difference is debited to Sales Discounts, a contra-revenue account, for $80.

34 Prepare the journal entry for Kid’s Clothes.
Sales Discounts Now, assume that it wasn’t until July 20 that Kid’s Clothes received the full amount due from Jack & Jill, Inc. from the July 6 sale. Prepare the journal entry for Kid’s Clothes. Now assume that payment was not received until July 20th, which is outside the discount period. Kid’s Clothes would debit Cash and credit Accounts Receivable for the full amount of $4,000.

35 Delivery Expenses Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense. When sellers incur transportation costs, they are debited to an operating expense account called Delivery Expense. This is considered a cost of doing business and is treated as a regular operating expense of the business.

36 Accounting for Sales Taxes
Businesses collect sales tax at the point of sale. Then, they remit the tax to the appropriate governmental agency at times specified by law. $1,000 sale ´ 7% tax = $70 sales tax When a business makes a sale, in most cases it collects more than the selling price of the goods sold. This extra amount is the sales tax on the transaction. Sellers do not get to keep this amount. They must remit it to the proper taxing authority. The entry to record the collection of sales tax includes a debit to Cash for the entire amount of cash collected, a credit to Sales for the retail amount of the sale, and a credit to Sales Tax Payable for the amount of the sales tax to be remitted to the proper taxing authority.

37 Modifying an Accounting System
Most businesses use special journals rather than a general journal to record routine transactions that occur frequently. Most businesses use special journals to help streamline the recording of routine entries. When companies use special journals, similar entries are recorded together. Companies may have several special journals such as a Cash Receipts Journal, Cash Payments Journal, Sales Journal, and several others. When using special journals, the General Journal is used only for a few entries that do not fit in a special journal. Relative to the general journal, special journals offer the following advantages: • Transactions are recorded faster and more efficiently. • Many special journals may be in operation at one time, further increasing the company’s ability to handle a large volume of transactions. • Automation may reduce the risk of errors. • Employees maintaining special journals generally do not need expertise in accounting. • The recording of transactions may be an automatic side effect of other basic business activities, such as collecting cash from customers.

38 Financial Analysis Gross Profit Margins Net Sales Trends over time
Comparable store sales Sales per square foot of selling space Gross profit ¸ Net sales Overall gross profit margin Gross profit margins by department and products Analysts and investors use many different measures to gain insights about a company. Looking at the trends in net sales and gross profit margins over time can provide information on how well a company is doing. Reviewing net sales for stores may help identify individual stores that are struggling or that are doing extremely well. Sales per square foot of selling space helps measure how efficiently stores are generating sales with the space they have to use. Reviewing gross profit margins for departments or products may help identify individual departments or products that are not performing as expected or that are exceeding expectations.

39 End of Chapter 6 End of Chapter 6.


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