1. ACCOUNTING FUNDAMENTALS FOR MANAGERS
University of Management and Technology
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Arlington, VA 22209
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2. Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

3. Accounting for Merchandise Operations
Chapter 4
Accounting for Merchandise Operations

4. After studying this chapter, you should be able to:
Learning Objectives
After studying this chapter, you should be able to:
Distinguish the operating activities of a service business from those of a merchandising business.
Describe and illustrate the financial statements of a merchandising business.
Describe the accounting for the sale of merchandise.
Describe the accounting for the purchase of merchandise.
Continued

5. Learning Objectives
Describe the accounting for transportation costs and sales taxes.
Illustrate the dual nature of merchandising transactions.
Describe the accounting for merchandise shrinkage.
Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.

6. Learning Objectives 1
Distinguish the operating activities of a service business from those of a merchandising business.

7. In prior chapters, you were introduced to how to report the financial condition and changes in financial condition for a service business.

8. In this chapter, you will be exposed to the accounting for merchandise operations.

9. Condensed Income Statement
Home Depot Inc.
Condensed Income Statement
For the Year Ending December 28, 2001
(in millions)
Net sales $45,738
Cost of merchandise sold 32,057
Gross profit $13,681
Operating expenses 9,490
Operating income $ 4,191
Other income
Income before taxes $ 4,217
Income taxes 1,636
Net income $ 2,581
Net sales is the revenue received from selling merchandise less any merchandise returned or any discounts reported.
The revenue account for merchandise is Sales.
The cost of merchandise sold is matched against net sales.
Revenue minus cost provides gross profit.
What’s different on a merchandising income statement?

10. Learning Objectives 2
Describe and illustrate the financial statements of a merchandising business.

11. Multiple-Step Income Statement
Online Solutions
Income Statement
For the Year Ended December 31, 2007
Net sales $708,255
Cost of merchandise sold 525,305
Gross profit $182,950
Operating expenses 105,710
Operating income $ 77,240
Other income and expense (net) (1,840)
Operating income before taxes $ 75,400
Income taxes ,000
Net income $ 60,400

12. Multiple-Step Income Statement
Sales $720,185
Less sales returns and allowances $6,140
Less sales discounts 5, ,930
Net sales $708,255
Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account.
Detailed Revenue Section

13. Multiple-Step Income Statement
Sales $720,185
Less sales returns and allowances $6,140
Less sales discounts 5, ,930
Net sales $708,255
Sales returns and allowances are granted by the seller for damaged or defective merchandise.

14. Multiple-Step Income Statement
Sales $720,185
Less sales returns and allowances $6,140
Less sales discounts 5, ,930
Net sales $708,255
Sales discounts are granted by the seller to customers for early payment of amounts owed.

15. Multiple-Step Income Statement
Purchases $521,980
Less: Purchases returns and allowances $9,100
Purchases discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased $527,755
Purchases is the full cost of buying merchandise for resale.
Detailed Cost of Merchandise Purchased Section

16. Multiple-Step Income Statement
Purchases $521,980
Less: Purchases returns and allowances $9,100
Purchases discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased $527,755
A Purchase allowance is a reduction in purchase price because the item has a defect or was the wrong item ordered.
A Purchase return is the cost of the merchandise returned to the seller.

17. Multiple-Step Income Statement
Purchases $521,980
Less: Purchases returns and allowances $9,100
Purchases discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased $527,755
A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.

18. Multiple-Step Income Statement
Purchases $521,980
Less: Purchases returns and allowances $9,100
Purchases discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased $527,755
Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.

19. Multiple-Step Income Statement
“Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which follows the revenue section.

20. Multiple-Step Income Statement
Note on the next slide that the only change is that the section begins by adding the beginning inventory and ends by subtracting the ending inventory.

21. Multiple-Step Income Statement
Merchandise inventory, Jan. 1, $ 59,700
Purchases $521,980
Less: Pur. returns and allow. $9,100
Purchases discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased ,755
Merchandise available for sale $587,455
Less merchandise inventory, Dec. 31, ,150
Cost of merchandise sold $525,305
Detailed Cost of Merchandise Sold Section

22. Multiple-Step Income Statement
This income statement was prepared using the periodic inventory method. The number of units on hand was determined by a physical count.

23. Multiple-Step Income Statement
In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary for verification purposes.

24. Single-Step Income Statement
Online Solutions
Income Statement
For the Year Ended December 31, 2007
Revenue:
Net sales $708,255
Expenses:
Cost of merchandise sold $525,305
Operating expenses 105,710
Income taxes ,000
Other income and expense (net) , ,855
Net income $ 60,400

25. Retained Earnings Statement
Online Solutions
Retained Earnings Statement
For the Year Ended December 31, 2007
Retained earnings, January 1, $128,800
Net income for the year $60,400
Less dividends 18,000
Increase in retained earnings ,400
Retained earning, December 31, $171,200

26. Balance Sheet Online Solutions Balance Sheet Assets Current assets:
December 31, 2007
Assets
Current assets:
Cash $ 52,950
Accounts receivable 76,080
Merchandise inventory 62,150
Office supplies 480
Prepaid insurance ,650
Total current assets $194,310
Continued

27. Property, plant, and equipment:
Land $ 20,000
Store equipment $27,100
less accumulated depr ,700 21,400
Office equipment $15,570
less accumulated depr , ,850
Total property, plant, and equip ,250
Total assets $246,560
Liabilities
Current liabilities:
Accounts payable $ 22,420
Note payable 5,000
Salaries payable 1,140
Unearned rent ,800
Total current liabilities $ 30,360
Continued

28. Long-term liabilities:
Note payable (final payment
due 2017) ,000
Total liabilities $ 50,360
Stockholders’ Equity
Capital stock $ 25,000
Retained earnings , ,200
Total liabilities and stockholders’ equity $246,560

29. Statement of Cash Flows
Online Solutions
Statement of Cash Flows
For the Year Ended December 31, 2007
Cash flows from operating activities:
Net income $ 60,400
Add: Depreciation expense—store equipment $ 3,100
Depreciation expense—office equipment 2,490
Decrease in office supplies 120
Decrease in prepaid insurance 350
Increase in accounts payable 8,150 14,210
Continued

30. Deduct:
Increase in accounts receivable $(24,080)
Increase in merchandise inventory (2,450)
Decrease in salaries payable (360)
Decrease in unearned rent (600) (27,400)
Net cash flow form operating activities $47,120
Cash flows from investing activities:
Purchase of store equipment $ (7,100)
Purchase of office equipment (5,570)
Net cash flows used in investing activities (12,670)
Cash flows from financing activities:
Payment of note payable $ (5,000)
Payment of dividends (18,000)
Net cash flows used in financing activities (23,000)
Net increase in cash $11,450
January 1, 2007 cash balance ,500
December 31, 2007 cash balance $ 52,950

31. 3 Describe the accounting for the sale of merchandise.
Learning Objective 3
Describe the accounting for the sale of merchandise.

32. Transactions involving MasterCard or Visa are treated as cash sales.
On January 3 Online Solutions sells merchandise costing $1,200 for $1,800. The customer charges the purchase on a MasterCard.
Transactions involving MasterCard or Visa are treated as cash sales.

33. Cash sales of $1,800 on January 3; cost of merchandise sold, $1,200.

34. 2/10, n/30 Credit Terms The net (full) amount is due by the 30th day.
Sales Discounts
Credit Terms
2/10, n/30
The net (full) amount is due by the 30th day.
The buyer is allowed a 2% discount if…
…the account is paid within 10 days.

35. Sales Discounts
On January 12 Online Solutions sells merchandise on account to Omega Tech for $1,500. Credit terms are 2/10, n/30.

36. Payment is received from Omega Tech on January 22.
Sales Discounts
Payment is received from Omega Tech on January 22.

37. Sales Returns and Allowances
On January 13 Online Solutions issues a $2,000 credit memorandum to Krier Company for merchandise that was returned. The merchandise (cost $1,200) was sold on account.

38. 4 Describe the accounting for the purchase of merchandise.
Learning Objective 4
Describe the accounting for the purchase of merchandise.

39. On January 6 Online Solutions purchased $2,500 of merchandise on account (terms: 1/15, n/30). Recall that Online Solutions uses the perpetual system.

40. Purchase Discounts
On January 21 Online Solutions pays invoice of $1,800, terms 1/15, n/30 within the discount period.

41. Purchase Returns and Allowances
On January 22 Online Solutions returns $5,000 of merchandise purchased from Quantum Inc.

42. 5 Describe the accounting for transportation costs and sales taxes.
Learning Objective 5
Describe the accounting for transportation costs and sales taxes.

43. Transportation Costs
Phil’s Trucking

45. Transportation Costs
On January 19 Online Solutions buys merchandise from Data Max on account, $2,900, terms FOB shipping point, and prepays the transportation cost of $150.

46. 6 Illustrate the dual nature of merchandising transactions.
Learning Objective 6
Illustrate the dual nature of merchandising transactions.

47. July 1. Scully Company sold merchandise on account to Burton Co
July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB destination; 2/10, n/30. The cost of the merchandise sold was $4,500
Scully Co. (Seller)

48. July 1. Scully Company sold merchandise on account to Burton Co
July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB destination; 2/10, n/30. The cost of the merchandise sold was $4,500
Burton Co. (Buyer)

49. Scully Co. (Seller) Burton Co. (Buyer) No effect.
July 5. Scully Company. paid transportation charges of $300 on July 1 sale to Burton Co.
Scully Co. (Seller)
Burton Co. (Buyer)
No effect.

50. July 6. Scully Company issued Burton Co
July 6. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1,000. The merchandise had been purchased by Burton Co. on account on July 1. The cost of the merchandise returned was $600.
Scully Co. (Seller)

51. July 6. Scully Company issued Burton Co
July 6. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1,000. The merchandise had been purchased by Burton Co. on account on July 1. The cost of the merchandise returned was $600.
Burton Co. (Buyer)

52. July 11. Scully Company received payment from Burton Co
July 11. Scully Company received payment from Burton Co. for purchase of July 11, less discount (2% x $6,500).
Scully Co. (Seller)

53. July 11. Scully Company received payment from Burton Co
July 11. Scully Company received payment from Burton Co. for purchase of July 11, less discount (2% x $6,500).
Burton Co. (Buyer)

54. 7 Describe the accounting for merchandise shrinkage.
Learning Objective 7
Describe the accounting for merchandise shrinkage.

55. When a company uses a perpetual inventory, a physical count is taken at the end of the accounting period to determine the accuracy of the perpetual records and to record any inventory shrinkage.

56. Inventory shrinkage is $1,800
Online Solutions’ inventory records indicate that $63,950 of merchandise should be available for sale on December 31, The physical inventory taken on that date indicates that only $62,150 of merchandise is available for sale.
Inventory shrinkage is $1,800

57. Learning Objective 8
Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.

58. …the efficiency and effectiveness of a merchandiser’s operations.
Gross profit and operating income are two important profitability measures analyst use in assessing…

59. Gross Profit Percent
Net sales $32,004
Cost of merchandise sold 22,789
Gross profit $ 9,215
Operating expenses 8,459
Operating income $
$9,2l5
= 28.8%
$32,004

60. Gross Profit Percent
J. C. Penney’s gross profit percentage went from 28.8% to 27.7%, then recovered back to 29.8%.

61. Gross Profit Percent
The recovery in the third year was attributed to better merchandise assortment, improved inventory productivity, and centralized buying.

62. Operating Income Percent
Net sales $32,004
Cost of merchandise sold 22,789
Gross profit $ 9,215
Operating expenses 8,459
Operating income $
$756
= 2.4%
$32,004

63. Operating Income Percent
The company’s operating income percentage dropped from 2.4% to 0.6%, then recovered back to 2.7%.

64. Operating Income Percent
This recovery was attributed to lower catalog and marketing costs, lower telemarketing costs, and a shift from development to maintenance of JCPenney.com.