1. Chapter 5

2. Service enterprises perform services as their primary source of revenue.
Merchandising companies buy and sell merchandise.

3. Differences Between a Service Business and a Merchandising Company
PowerPoint Slides
In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales.
Unlike expenses for a service company, expenses for a merchandising company are divided into two categories:
Cost of goods sold - the total cost of merchandise sold during the period.
Operating expenses - selling and administrative expenses. 2

4. Calculating Net Income
Net Income--A measure of the overall performance of a business entity.

5. Calculating Net Income
Net Income--A measure of the overall performance of a business entity.
Service Company
Revenues
- Operating Expenses
Net Income

6. Calculating Net Income
Net Income--A measure of the overall performance of a business entity.
Service Company
Revenues
- Operating Expenses
Net Income
Product Company
Revenues
- Cost of Goods Sold
Gross Margin
- Operating Expenses
Net Income

7. Terms Sales revenue or sales = sale of merchandise
Cost of goods sold = total cost of merchandise sold

8. Operating cycle of any company is...
the average time it takes to go from cash to cash in producing revenues. TO

9. merchandising company is...
Operating cycle of a
merchandising company is...
Ordinarily longer than that of a service company;
Purchase of merchandise and its sale lengthens the cycle.

10. Merchandising Company
Receive Cash
Perform Services
Buy Inventory
Sell Inventory
Service Company
Merchandising Company
Cash
Accounts
Receivable
Merchandise
Inventory

11. Inventory
The Inventory account is one of the largest assets for any company.
The determination of which goods should be included in inventory at the end of a period is “Inventory Cutoff.”
Inventory errors will affect the financial statements for 2 years.

12. Merchandise Inventory?
What Is Charged to
Merchandise Inventory?
All costs needed to get inventory to a company and ready to sell
+Freight-In
+Special Permits
Only costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies

13. Transportation Costs
The cost of inbound transportation is added to the cost of inventory.
For the perpetual method, the cost must be added to the Inventory account to reflect actual cost of acquiring inventory.
For the periodic method, a Freight-In account is used.

14. Inventory Control Methods
Perpetual Inventory Method--A system of accounting in which cost of goods sold and inventory are adjusted when the merchandise is purchased or sold.
Periodic Inventory Method--A system of accounting in which the cost of goods sold and inventory are adjusted at the end of the accounting period.

15. First:
Let’s look at the whole process assuming
Perpetual Inventory

16. Perpetual Inventory
Transaction records of every sale or purchase are required to account for inventory.
The perpetual method is similar to how you would account for cash.
The Inventory account should represent the amount of inventory on hand at any time.

17. Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.
Task: Record the purchase by getting information from the Purchase Invoice.
The Purchase Invoice is the buyer’s copy of the sales invoice.

18. Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.
GENERAL JOURNAL Debit Credit
May 4 Merchandise Inventory , Accounts Payable ,800
To record goods purchased on account.

19. Merchandise Purchases
On May 5 the company received an invoice from a freight company for $ 120 for delivery of the merchandise from PW Audio
GENERAL JOURNAL Debit Credit
May 5 Merchandise Inventory Accounts Payable
To record in-coming freight on account.

20. Purchase Returns
On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc.
GENERAL JOURNAL Debit Credit
May 8 Accounts Payable Merchandise Inventory
Record goods returned on account.

21. Purchase Discounts
A purchase discount is a reduction in the purchase price, usually when payment is made within a specified period.
Purchase discounts reduce the net cost of the purchases account.
For perpetual inventory, a purchase discount reduces inventory by the same amount.

22. Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.

23. Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.
3/1 Inventory ………… ,000
Accounts Payable … ,000
Received books from Wiley, purchase
order #M1234 with terms of 2/10, n/30.

24. Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.
3/10 Accounts Payable ,000
Inventory………… …
Cash
Paid Wiley’s invoice for purchase of books with 2% discount.

25. Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made for the payment to the supplier, but assume the payment was Apr 1
4/1 Accounts Payable ,000
Cash
Paid Wiley’s invoice for purchase of books. No discount taken.

26. Sales Revenues: are recorded when earned-revenue recognition principle
must be supported by a business document-written evidence
2 entries are made for each sale
one to record sale
one to record cost of merchandise sold

27. Sales Revenue Example:
On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900.
3/1 Accounts Receivable ,000
Sales………… … ,000
Record sale to Acme Inc.
3/1 Cost of Goods Sold ,900
Merchandise Inventory ,900
Record Cost of Goods

28. Merchandise Inventory Sales Returns & Allowances
Sales Revenue Example:
Cash
Accounts Receivable
Merchandise Inventory
Mar 1 5,000
2,900 Mar 1
Cost of Goods Sold
Sales Returns & Allowances
Sales
5, Mar 1
Mar 1 2,900

29. Periodic Inventory
Inventory levels on the general ledger are not affected by purchases or sales.
Might be used in a juice bar or a small clothing store.
The Inventory and Cost of Goods Sold accounts are only correct at the end of the fiscal period, when a physical inventory is taken.

30. Cost of Goods Sold -Periodic Method
A running account of changes in inventory is not maintained.
Separate accounts are used to record
Purchases
Freight in,
Purchase returns
Discounts
Cost of goods sold is calculated at end of period.

31. Periodic Inventory
MERCHANDISE INVENTORY
BEG. BALANCE
$25,000

32. Periodic Inventory This account is NOT changed during the
MERCHANDISE INVENTORY
$25,000
This account is NOT
changed during the
accounting period

33. Periodic Inventory $25,000 Merchandise bought during
MERCHANDISE INVENTORY
PURCHASES
$25,000
XXX
Merchandise bought during
the year is debited to
Purchases instead of
Merchandise Inventory

34. Periodic Inventory
MERCHANDISE INVENTORY
PURCHASES
$25,000
XXX
SALES
XXX
The COST of merchandise sold is NOT recorded.
The selling price is credited to the Sales account

35. Sales Revenue Periodic
On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900.
3/1 Accounts Receivable ,000
Sales………… … ,000
Record sale to Acme Inc.
3/1 Cost of Goods Sold ,900
Merchandise Inventory ,900
Record Cost of Goods
Periodic

36. Periodic Inventory $25,000 After a year of purchasing
MERCHANDISE INVENTORY
$25,000
After a year of purchasing
and selling merchandise,
the balance is no
longer accurate!

37. Periodic Inventory $25,000 An adjustment is needed to update the
MERCHANDISE INVENTORY
$25,000
An adjustment is needed to update the
balance of the Merchandise Inventory
account. That takes a physical count.

38. Periodic Inventory
The calculation to determine Cost of Goods Sold using the periodic method is as follows:
Beginning Inventory, Jan 1
+ Purchases for the year
= Cost of goods available for sale
- Ending Inventory, Dec. 31
= Cost of Goods Sold

39. What Is the Sales Returns and Allowances Account?
Contra Revenue Account to sales
Used to show how much came back in returns and allowances
Excessive returns and allowances suggest:
inferior merchandise
inefficiencies in filing orders
errors in billing customers
mistakes in delivery or shipment of goods

40. Sales Returns and Allowances
Flip side of purchase returns and allowance
On buyer’s books
GENERAL JOURNAL Debit Credit
Mar 1 Accounts Payable Merchandise Inventory
To record goods returned to Sauk.
On seller’s books
GENERAL JOURNAL Debit Credit
Mar 1 Sales Returns and Allowance Accounts Receivable
To record return of goods sold to Sauk Stereo.
Mar 1 Merchandise Inventory Cost of Goods Sold
To record cost of goods returned from Sauk Stereo.

41. What Is the Sales Discount Account?
Contra Revenue Account to sales
Used to disclose amount of cash discounts given to customers

42. Flip side of purchase discounts
Sales Discounts
Flip side of purchase discounts
On buyer’s books
GENERAL JOURNAL Debit Credit
May 14 Accounts Payable , Cash ,430 Merchandise Inventory
To record payment within discount period
On seller’s books
GENERAL JOURNAL Debit Credit
May 14 Cash , Sales Discounts Accounts Receivable
To record collection within discount period.

43. LOOK OUT !!! Transportation Costs It’s not part of inventory!
For the Outbound freight

44. Merchandise Inventory
Freight Costs-on outgoing inventory
On May 6 we paid $150 to have merchandise inventory delivered to the buyer.
Merchandise Inventory
Freight-Out Expense
Cash
May
May 6 150
GENERAL JOURNAL Debit Credit
May 6 Freight-Out Expense
Cash
To record payment of freight on goods sold.

45. Two Forms Of Income Statements
Single-step income statement
Multiple-step income statement

46. Single-Step Income Statement
One step… subtract total expenses from total revenues
Revenues $10,000
Expenses 3,000
Net income $ 7,000

47. PW AUDIO, Inc. Single-step Income Statement For the Year Ended December 31, 20xx
Sales $460,000
Interest Revenue ,000
Gain on Sale of equipment
Total Revenues $463,600
Expenses
Cost of goods sold $316,000
Selling expenses ,000
Administrative expenses ,000
Interest expense ,800
Casualty Loss from vandalism
Income tax expense ,100
Total expenses ,100
Net income $ 21,500

48. PW AUDIO SUPPLY, INC. Multi-step Income Statement
For the Year Ended December 31, 20xx
Sales revenues
Sales $ 480,000 Less: Sales returns and allowance $12,000
Sales discounts , ,000
Net sales ,000
Cost of goods sold ,000
Gross profit $ 144,000 Operating expenses
Selling expenses:
Store salaries expense $45,000
Advertising expense ,000
Depreciation expense ,000
Freight-out ,000
Total selling expenses $76,000
Administrative expenses
Salaries expense $19,000
Utilities expense ,000
Insurance Expense ,000
Total administrative expenses ,000
Total operating expenses ,000
Income from operations $ 30,000

49. PW AUDIO SUPPLY, INC. Multi-step Income Statement
For the Year Ended December 31, 20xx
Income from operations (continued) $ 30,000
Other revenues and gains
Interest revenue $ 3,000
Gain on sale of equipment
$ 3,600
Other expenses and losses
Interest expense $ 1,800
Casualty loss from vandalism
2, ,600
Income before income taxes ,600
Income tax expense ,100
Net income $21,500

50. PW AUDIO SUPPLY, INC. Cost of Goods Sold For the Year Ended December 31, 2005
Cost of goods sold Inventory, January 1 $ 36,000
Purchases $325,000
Less Purchase returns and allowances $10,400
Purchase discounts , ,200
Net purchases ,800
Add: Freight-in ,200
Cost of goods purchased ,000
Cost of goods available for sale ,000
Inventory, December ,000 Cost of goods sold ,000

51. Gross Profit Rate= Gross Profit Net Sales
Company’s gross profit expressed as a percentage of revenue

52. Profit Margin Ratio
Measures the percentage of each dollar of sales that results in net income
Profit Margin Ratio =
Net Income
Net Sales
Higher value suggests favorable return on each dollar of sales. 19

53. Now, that wasn’t so bad! Was it?