1. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Julia Banks, Cairine Wilson Weygandt · Kieso · Kimmel · Trenholm

2. ACCOUNTING FOR MERCHANDISING OPERATIONS CHAPTER 5

3. A merchandising company is an enterprise that buys and sells goods to earn a profit. 1. Wholesalers sell to retailers. 2. Retailers sell to consumers. A merchandiser’s primary source of revenue is sales, whereas a service company’s primary source of revenue is service revenue. MERCHANDISING COMPANY

4. OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY Accounts Receivable Cash Service Company Cash Merchandising Company Receive Cash Perform Services Sell Inventory Accounts Receivable Receive Cash Buy Inventory Merchandise Inventory

5. Sales Revenue Cost of Goods Sold Cost of Goods Sold Less INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANY Gross Profit Gross Profit Equals Operating Expenses Less Net Income (Loss) Equals

6. INVENTORY SYSTEMS Merchandising entities may use either (or both) of the following inventory systems: 1. Perpetual – where detailed records of each inventory purchase and sale are maintained. Cost of goods sold is calculated at the time of each sale. Example: Made $100 cash sale of sweater. Thecost of the sweater was $25. Cash100 Sales 100 Cash receipt #123 Cost of Good Sold25 Merchandise Inventory 25 To record cost of goods sold 2. Periodic – detailed records are not maintained. Cost of goods sold is calculated only at the end of the accounting period. Cash100 Sales 100 This chapter covers the perpetual method.

7. When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is debited for the cost of the goods. Purchases may be made for cash or on account (credit). The purchase is normally recorded by the purchaser when the goods are received from the seller. RECORDING COST OF GOODS PURCHASED

8. PURCHASES OF MERCHANDISE For purchases on account, Merchandise Inventory is debited and Accounts Payable is credited. For cash purchases, Merchandise Inventory is debited and Cash is credited.

9. FREIGHT COSTS The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business. FOB Shipping Point 1. Goods delivered to shipping point by seller 2. Buyer pays freight costs from shipping point to destination FOB Destination 1. Goods delivered to destination by seller 2. Seller pays freight costs

10. Merchandise Inventory is debited by the buyer, if the buyer pays the freight bill (FOB shipping point). (Company pays for inventory they are purchasing) Freight Out (or Delivery Expense) is debited by the seller, if the seller pays the freight bill (FOB destination). (Company pays shipping to send to customer) ACCOUNTING FOR FREIGHT COSTS

11. When the purchaser directly incurs the freight costs, the account Merchandise Inventory is debited and Cash is credited. In grade 11, you debited the freight to the Transportation-In account. Now you will simply debit the Merchandise Inventory account directly. ACCOUNTING FOR FREIGHT COSTS

12. A purchaser may be dissatisfied with merchandise received because the goods 1. are damaged or defective, 2. are of inferior quality, or 3. are not in accord with the purchaser’s specifications. PURCHASE RETURNS AND ALLOWANCES

13. For purchases returns and allowances that were originally made on account, Accounts Payable is debited and Merchandise Inventory is credited. For cash returns and allowances, Cash is debited and Merchandise Inventory is credited. Separate accounts are not used to record purchase returns or allowances when a company is using the perpetual inventory method.

14. QUANTITY DISCOUNTS Volume purchase terms may permit the buyer to claim a quantity discount. The merchandise inventory is simply recorded at the discounted cost. Quantity Discount is NOT the same as a Purchase Discount.

15. PURCHASE DISCOUNTS Credit terms may permit the buyer to claim a cash discount for the prompt payment of a balance due. 1/10 = 1% cash discount may be taken on invoice (less any returns or allowances) if payment is made within 10 days. n/30 = full payment on invoice (less any allowances or returns) is due 30 days from invoice date. The buyer calls this discount a purchase discount. A purchase discount is based on the invoice cost less any returns and allowances granted. Rarely used in Canada, but when it is, a separate account is used

16. Revenues are reported when earned in accordance with the revenue recognition principle. In a merchandising company. revenues are earned when the goods are transferred from seller to buyer. SALES TRANSACTIONS

17. 1. The first entry records the sale of goods to a customer at the retail (selling) price. 2. The second entry releases the goods from inventory at cost and charges the goods to cost of goods sold.

18. SALES TAXES Sales tax is expressed as a percentage of the sales price on selected goods sold to customers by a retailer. They are collected on most revenues, and paid on many costs. Sales taxes may include the federal goods and services tax (GST) and the provincial sales tax (PST), if any. These two taxes have been combined into one harmonized sales tax (HST) in some Atlantic Provinces.

19. SALES TAXES ON REVENUES The retailer collects the tax from the customer when the sale occurs, and periodically (usually monthly) remits the collections to the Receiver General. Sales taxes are not revenue but are a current liability until remitted.

20. Accounting For Taxes PST – Provincial Sales Tax - 8% Paid by the end consumer Collected by the business Amount collected remitted (sent) to the provincial Receiver General Exemptions exist where no PST is paid (i.e. groceries, residential rent, insurance) Exemptions and regulations vary by province Business purchasing goods for resale (i.e. inventory) do not pay PST as they are not the “end consumer’) GST – Goods and Services Tax – 5% Paid by everyone Collected by the business Amount remitted (Amount collected – Amount paid) (Amount Payable – Amount Recoverable) GST legislation varies depending on the type of organization and amount of revenue.

21. Accounting For Taxes - Examples Examples: Purchase of Inventory May 31 Suzy Shier purchases 10 dresses for $50 each, plus GST on account. Merchandise Inventory$500.00 GST Recoverable 25.00 Accounts Payable 525.00 To record purchase on account. Sale to End Consumer June 1 Suzy shier sells a dress for $100 cash plus GST and PST. The cost of the dress to Suzy Shier is $50. Cash113 Sales100 GST Payable 5 PST Payable 8 Cost of Goods Sold 50 Merchandise Inv.50

22. Accounting for Taxes Business is the end consumer June 15 Suzy shier receives phone bill of $30.00 plus PST and GST. Pays bill immediately. Telephone Expense33.90 Cash33.90 (Suzy shier is the end consumer so the company will pay the GST and PST and include it in the expense total.) Customer returns goods. June 15 Customer returns dress sold for $100 for full cash refund. The dress cost the company $50. Sales Returns and Allowances 100 PST Payable 8 GST Payable 5 Cash113 Merchandise Inventory50 Cost of Goods Sold50

23. Sales Returns occur when customers are dissatisfied with merchandise and are allowed to return the goods to the seller for credit or a refund. Sales Allowances occur when customers are dissatisfied, and the seller allows a deduction from the selling price. SALES RETURNS AND ALLOWANCES

24. The normal balance of Sales Returns and Allowances is a debit. It’s balance is subtracted from the Revenue or Sales accounts on the Income Statement. Sales Returns and Allowances is a contra revenue account to the Sales account. SALES RETURNS AND ALLOWANCES

25. RECORDING SALES RETURNS AND ALLOWANCES 1. The first entry reduces the balance owed by the customer and records the goods returned at retail price. 2. The second entry records the physical return of goods to inventory at cost and removes the goods from the cost of goods sold account.

26. A quantity discount is the offer of a cash discount to a customer in return for a volume sale. Quantity discounts result in a sales price reduction. They are not separately journalized. Instead the sale is recorded at the reduced price. QUANTITY DISCOUNTS

27. A sales discount is the offer of a cash discount to a customer in exchange for the prompt payment of a balance due. These are rare in business Similar to Sales Returns and Allowances, Sales Discounts is also a contra revenue account with a normal debit balance. Example: A $5.00 sales discount is taken on an amount owing by a customer of $100. Account is paid in full. Cash 95 Sales discount 5 A/R 100 SALES DISCOUNTS

28. COMPLETING THE ACCOUNTING CYCLE A merchandising company requires the same types of adjusting entries as a service company, with one additional adjustment for inventory to ensure the recorded inventory amount agrees with the actual quantity on hand. A physical count is an important control feature since a perpetual system indicates what should be there but a count will determine what is actually there.

29. COMPLETING THE ACCOUNTING CYCLE A merchandising company also requires the same types of closing entries as a service company. The additional accounts that need to be closed out in a merchandising account include Sales, Sales Returns and Allowances, Cost of Goods Sold, and Freight Out. Merchandise Inventory is an asset account and is not closed at the end of the period.

30. STATEMENT PRESENTATION OF SALES REVENUE SECTION As contra revenue accounts, sales returns and allowances (and sales discounts, if any) are deducted from sales in the income statement to arrive at Net Sales.

31. CALCULATION OF GROSS PROFIT Gross profit is often expressed as a percentage of sales called Gross Profit Margin: Gross Profit/Net Sales 144,000/460,000 = 31% Gross profit is calculated by deducting cost of goods sold from net sales as follows:

32. Gross Profit Margin % Considered to be a more meaningful and useful number than the gross profit expressed in $’s. A gross margin of say $1,000,000 does not mean much if it only represents 7% of net sales. Comparing GPM with that of other companies in the industry help a company to examine the effectiveness of its purchasing and pricing policies. Compared from year to year.

33. CALCULATION OF NET INCOME Net income is the “bottom line” of a company’s income statement. Net income is calculated by deducting operating expenses from gross profit as follows:

34. ILLUSTRATION 5-14 This is the format of a multi-step income statement that has both operating and non- operating activities. As shown, the non- operating activities are reported immediately after the company’s primary operating activities.

35. Classified Income Statement Operating Expenses Selling Expenses Expenses directly related to selling the product (i.e. sales promotions, Advertising Expenses, Salary, Delivery Expense etc_ Administrative Expenses General expenses associated with running the overall business (i.e. Rent, Utilitities, Insurance)

36. Non-Operating Activities Reported After Operating Expenses Other Revenues and Gains Interest from notes receivable and temporary investments Dividend revenue from investments in share captial Rent revenue from subleasing a portion of the store Gain from the disposal (sale) of a capital asset Other Expenses and Losses Interest expense on notes and loans payable Losses from vandalism or accidents Losses from the disposal of capital assets Losses from strikes

37. CLASSIFIED BALANCE SHEET On the balance sheet, merchandise inventory is reported as a current asset and appears immediately below accounts receivable. This is because current assets are listed in the order of their liquidity.

38. USING THE INFORMATION IN THE FINANCIAL STATEMENTS It is a large current asset on the balance sheet It becomes a large expense on the income statement It is vulnerable to theft or misuse Inventory is particularly important because:

39. USING THE INFORMATION IN THE FINANCIAL STATEMENTS A balancing act is needed to ensure that a sufficient, but not excessive, quantity of inventory is on hand. Two ratios help evaluate the management of inventory: Inventory turnover Days sales in inventory

40. INVENTORY TURNOVER Inventory turnover = Cost of goods sold Average inventory Measures the number of times, on average, inventory is sold during the period. Average Inventory: Beginning Inventory + Ending Inventory 2 The greater the number of times per year the inventory turns over, the more efficiently sales are being made.

41. DAYS SALES IN INVENTORY Days sales in inventory = 365 days Inventory turnover This number provides you with the average number of days inventory sits in stock before it is sold. Again, generally the lower the number, the better.

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