1. CHAPTER 7
Setting Up A Merchandising Company

2. Let’s Review
Let’s review the basic principle of debits and credits and chapter 6 learning objectives

3. Review
In the debit and credit system, debits are always recorded on which side?
Left
Right
Left or right depending on the financial transaction
Income statement only

4. Review An increase to an asset should always be a: Credit Debit
Debit or credit depending on the asset

5. Review An increase to an expense is always a: Debit Credit
Debit or credit depending on the type of expense

6. Review What is the entry to record paying cash for rent?
Debit cash, credit rent expense
Credit cash, credit rent expense
Credit cash, debit rent expense
Debit cash, debit rent expense

7. Review
What is the entry to record a payment towards an account that is due?
Dr accounts payable, Cr accounts receivable
Dr accounts payable, Cr cash
Dr accounts receivable, Cr cash
Cr accounts payable, Dr cash

8. Checklist Chapter 7 Financing a Business Merchandising Sales
Gross Profit Margin
Classified Balance Sheet
Multi-Step Income Statement

9. What is a Merchandising Company?
Any business that buys and sells products for the purpose of making a profit
Examples:
Retailers
Supermarkets
Car Dealerships

10. What is a Corporation?
A business that is a separate legal entity from its owners
Liable for its own debts
The owners are separate and financial risk is limited to their investment
Net worth of a corporation is called Stockholders’ Equity
Stockholder
Management

11. Stockholders’ Equity
Stockholders’ Equity is divided amongst the stockholders in proportion to the number of shares they own. Each owner would be entitled to their proportion of profits, or sale price if the business was sold.

12. Stockholders’ Equity: Two Parts
Common Stock (Contributed Capital ):
Money invested directly in a company by its owners in the form of stocks
COMMON STOCK
Retained Earnings:
Profits that the business has retained
(not distributed to the owners)
RETAINED EARNINGS
STOCKHOLDERS’ EQUITY
Stockholders’ Equity:
The net worth of the company

13. Dividends
Corporations can declare dividends: A dividend represents the portion of a company's earning pie (profits) which is divided amongst the stockholders according to their stock.

14. Financing a Company Example
Chad and Joe are two avid skiers who have decided to open a ski shop (as a corporation). Chad agrees to contribute $70,000, and Joe agrees to contribute $30,000. Each owner will receive their shares of stock according to their cash contribution.

15. Financing a Company Example
Record the $100,000 investment by the owners.
BALANCE SHEET
JOURNAL
ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
ASSETS
LIABILITIES
CASH
ACCOUNTS PAYABLE
100,000 DR x
Cash ?
100,000 ?
ACCOUNTS RECEIVABLE
UNEARNED REVENUE
Common Stock - Chad ?
70,000 x
Common Stock - Joe ?
30,000 x
BANK LOAN
INVENTORY
Record investment by owners x x
STOCKHOLDERS’ EQUITY
PREPAID EXPENSES
COMMON STOCK x
100,000 CR
PROPERTY, PLANT & EQUIPMENT
PROPERTY, PLANT & EQUIPMENT
RETAINED EARNINGS
100,000 CR x

16. Financing a Business - Question
What is the effect on retained earnings if a company pays dividends for a given period?
Increases retained earnings
Decreases retained earnings
No effect

17. Financing a Business - Question
What does stockholders’ equity equal?
Retained Earnings + Common Stock
Retained Earnings + Common Stock + Dividends Paid
Common Stock – Dividends Paid
Retained Earnings – Common Stock

18. Checklist Chapter 7 Financing a Business Merchandising Sales
Gross Profit Margin
Classified Balance Sheet
Multi-Step Income Statement

19. Merchandise Sales Terminology
There are different terms for sale of product or services. We will refer to sales as sales revenue.
INCOME STATEMENT
SALES REVENUE X
EXPENSES
Cost of Goods Sold (COGS) represents the amount paid to purchase inventory that is sold.
COST OF GOODS SOLD x
GROSS PROFIT
Gross profit = Revenue – COGS
ADVERTISING
MAINTENANCE x x
DEPRECIATION
MISCELLANEOUS x x
Operating expenses are all those expenses incurred in in order to sell products or services.
INCOME TAX
PAYROLL x x
INSURANCE
RENT x x
INTEREST
TELEPHONE x x
Net income = Gross profit - operating expenses
NET INCOME (LOSS)

20. Merchandise Sales Example
On July 15th, Skyline Enterprise purchased $1,000 of inventory using cash. How should the purchase of inventory be recorded?
CASH
ASSETS
ACCOUNTS RECEIVABLE
INVENTORY
PREPAID EXPENSES
BANK LOAN
ACCOUNTS PAYABLE
BALANCE SHEET
UNEARNED REVENUE
LIABILITIES
PROPERTY, PLANT & EQUIPMENT
RETAINED EARNINGS
COMMON STOCK
STOCKHOLDERS’ EQUITY
- 1,000 CR
JOURNAL
Date
ACCOUNT TITLE
DEBIT
CREDIT
Jul 15 ?
Inventory ?
1,000 ?
+ 1,000 DR ?
Cash ?
1,000
Purchased inventory
What happened to equity?
No change to equity. One asset was exchanged for another.

21. Merchandise Sales Example
On July 21st, Skyline Enterprise sold $1,000 of inventory for $1,500. How should the sale of inventory be recorded?
1. Record the sale (revenue and cash)
BAD DEBT
SALES REVENUE
INCOME STATEMENT
EXPENSES
NET INCOME (LOSS)
INTEREST
INSURANCE
DEPRECIATION
CASH
ASSETS
ACCOUNTS RECEIVABLE
INVENTORY
PREPAID EXPENSES
BANK LOAN
ACCOUNTS PAYABLE
BALANCE SHEET
UNEARNED REVENUE
LIABILITIES
PROPERTY, PLANT & EQUIPMENT
MAINTENANCE
UTILITES
RENT
SALARIES
COST OF GOODS SOLD
GROSS PROFIT
RETAINED EARNINGS
COMMON STOCK
STOCKHOLDERS’ EQUITY
+ 1,500 CR
+ 1,500 CR
+ 1,500 DR
JOURNAL
Date
ACCOUNT TITLE
DEBIT
CREDIT
+ 1,000 DR
Jul 21 ?
Cash ?
1,500 ?
2. Match the cost of the product against the sale ?
Sales Revenue ?
1,500
Sold product for cash
- 1,000 CR
Jul 21 ?
Cost of Goods Sold ?
1,000 ? ?
Inventory ?
1,000
Cost of product sold

22. Merchandise Sales - Question
True or False: If a company sells a product on account, accounts receivable will be credited.
True
False

23. Checklist Chapter 7 Financing a Business Merchandising Sales
Gross Profit Margin
Classified Balance Sheet
Multi-Step Income Statement

24. Gross Profit Margin Gross Profit Gross Profit Margin = Revenue
Measures gross profit as a percentage of revenue The higher the percentage, the higher the contribution per dollar of revenue.
Gross Profit
Gross Profit Margin =
Revenue

25. Gross Profit - Question
True or False: When a product is sold, the gross profit on the sale is precisely equal to sales revenue.
True
False

26. Gross Profit Margin - Question
Which company had the higher gross profit margin?
EK Skylines
Smart Systems Corporation
EK Skylines
Smart Systems Corp.
Gross Profit
$200,000
$300,000
Revenue
1,000,000
2,000,000
Gross Profit Margin
20%
15%
This means that EK Skylines was able to generate more gross profit dollars per dollar in sales than Smart Systems Corp.

27. Checklist Chapter 7 Financing a Business Merchandising Sales
Gross Profit Margin
Classified Balance Sheet
Multi-Step Income Statement

28. Classified Balance Sheet
Assets and liabilities are subdivided into current and long-term categories to further define a company’s financial position.

29. Classified Balance Sheet
Current Assets
(less than a year )
Long-Term Assets
(longer than a year)
Assets likely to convert to cash in the next 12 months through day-to-day operations.
Assets that have been bought for the long-term and will not be sold on a daily basis. Also called capital or long-term assets.

30. Current Assets vs. Long-Term Assets
COMMON STOCK
CASH
ASSETS
ACCOUNTS RECEIVABLE
INVENTORY
PREPAID EXPENSES
BANK LOAN
ACCOUNTS PAYABLE
BALANCE SHEET
UNEARNED REVENUE
LIABILITIES
PROPERTY, PLANT & EQUIPMENT
RETAINED EARNINGS
STOCKHOLDERS’ EQUITY
Current assets
Long-term assets

31. Current vs. Long-Term Liabilities
A single loan may be divided into two parts: Current and Long-Term
Total Debt
Current Portion of Long-term Debt
Long-Term Portion
Consists of remaining debt
Consists of 12 months of debt

32. Current vs. Long-Term Liabilities Example
Scenario: You apply for a $36,000 business loan. Each month $1,000 will be paid to reduce the loan. The current portion of the loan always consists of the next 12 months of payments, $12,000. The long-term portion of the loan is $24,000 ($36,000 - $12,000).
$1,000
$1,000
Current Portion
Long-Term Portion

33. Current vs. Long-Term Liabilities Example
Each payment reduces the long-term debt. However, the current portion will always consist of the next 12 months.
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000
End of month
Payment
Current Debt
LT Debt
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000 1
$1,000
$12,000
$23,000
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000 2
$1,000
$12,000
$22,000
$1,000
$1,000
$1,000 24
$1,000
$12,000 $0
$1,000
$1,000
$1,000 25
$1,000
$11,000 $0
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000
Notice there is no long-term loan remaining.
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000
From this point forward you can reduce the current portion of debt.
Current Portion
Long-Term
Portion

34. Current vs. Long-Term Assets and Liabilities Summary
Paid in less than 12 months
Short-term debt
Paid over a period longer than 12 months
Long-term debt
Similarly
Converted to cash in less than 12 months
Short-term Assets
Used for the long-term (more than 12 months)
Long-term Assets

35. Current vs. Long-Term - Question
Suppose that a bank loan is due within one year. What type of debt is the bank loan considered?
Long-term
Short-term
A portion is long-term and the remaining portion is short-term
It is not debt, but is equity

36. Current vs. Long-Term - Question
A company holds and sells real estate property as its main business activity. Each piece of property is sold for cash within one year after it is bought. What type of asset is the property?
Long-term
Short-term

37. Checklist Chapter 7 Financing a Business Merchandising Sales
Gross Profit Margin
Classified Balance Sheet
Multi-Step Income Statement

38. Multistep Income Statement
Divides revenues and expenses further to show subtotals such as COGS, gross profit, operating expenses and operating income

39. Multistep Income Statement - Question
Which line item is included in a multistep income statement, but not in a tradition single step income statement?
Revenue
Net Income
Gross Profit

40. Complete the following exercise.

41. Exercise
On January 2nd, AAA Co. purchased $3,500 of inventory with cash.
JOURNAL Page 1
DATE
ACCOUNT TITLE & EXPLANATION PR
DEBIT
CREDIT
Jan 2
Inventory
3,500
Cash
3,500
Purchased inventory with cash

42. Exercise
On January 12th, AAA Co. sold all of the inventory from the January 2nd purchase for $5,000.
JOURNAL Page 1
DATE
ACCOUNT TITLE & EXPLANATION PR
DEBIT
CREDIT
Jan 12
Cash
5,000
Sales Revenue
5,000
Made cash sales
JOURNAL Page 1
DATE
ACCOUNT TITLE & EXPLANATION PR
DEBIT
CREDIT
Jan 12
Cost of Goods Sold
3,500
Inventory
3,500
Sold inventory

43. Exercise What was the gross profit on this sale? Sales Revenue $5,000
JOURNAL Page 1
DATE
ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Jan 12
Cash
5,000
Sales Revenue
5,000
Made cash sales
Sales Revenue
$5,000
-3,500
$1,500
-Cost of Goods Sold
Gross Profit
JOURNAL Page 1
DATE
ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Jan 12
Cost of Goods Sold
3,500
Inventory
3,500
Sold inventory

44. End of Chapter 7