1. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Five Accounting for Merchandising Businesses

2. 5-2 Merchandising Businesses Sale Merchandising businesses generate revenue by selling goods. The goods purchased for resale are called merchandise inventory.

3. 5-3 LO 1 Identify and explain the primary features of the perpetual inventory system.

4. 5-4 Product Costs Versus Selling and Administrative Costs Product Costs Costs that are included in inventory. Selling & Admin. Costs Costs that are not included in inventory. They are sometimes called period costs.

5. 5-5 Allocation of Inventory Cost Between Asset and Expense Accounts Cost of Goods Available for Sale Merchandise Inventory (Balance Sheet) Cost of Goods Sold (Income Statement)

6. 5-6 Gross Margin (or Gross Profit)

7. 5-7 Gross Profit – Op Exp. = Op. Income Op. Inc + Other Inc. – Exp = Inc. Before taxes Inc. before taxes – taxes = Net Income

8. 5-8

9. 5-9 Perpetual Inventory System Inventory account is adjusted perpetually (continually) throughout the accounting period.

10. 5-10 LO 2 Record and report inventory transactions in the double-entry accounting system.

11. 5-11 Perpetual Inventory System Let’s see how a perpetual inventory system works by looking at transactions for June’s Plant Shop (JPS).

12. 5-12 Event 1: JPS acquired $15,000 by issuing common stock. 1.Increase assets (cash). 2.Increase equity (common stock). Asset Source Transaction

13. Cash $15,000 Common Stock $15,000 Journal Entry

14. 5-14 Event 2: JPS purchased merchandise inventory for $14,000 cash. 1.Decrease assets (cash). 2.Increase assets (merchandise inventory). Asset Exchange Transaction

15. Journal Entry Inventory$14,000 Cash$14,000

16. 5-16 Event 3a: JPS recognized sales revenue from selling inventory for $12,000. 1.Increase assets (cash). 2.Increase equity (sales revenue). Asset Source Transaction

17. Journal Entry Cash$12,000 Sales$12,000

18. 5-18 Event 3b: JPS recognized $8,000 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

19. Journal Entry Costof Goods Sold $8,000 Inventory $8,000

20. 5-20 Event 4: JPS paid $1,000 cash for selling expenses. 1.Decrease assets (cash). 2.Decrease equity (selling expenses). Asset Use Transaction

21. Journal Entry Selling Expense $1,000 Cash$1,000

22. 5-22 Event 5: JPS paid $5,500 cash to purchase land for a place to locate a future store. 1.Decrease assets (cash). 2.Increase assets (land). Asset Exchange Transaction

23. Journal Entry Land$5,500 Cash$5,500

24. 5-24

25. 5-25

26. 5-26 LO 3 Explain the meaning of terms used to describe transportation costs, cash discounts, returns or allowances, and financing costs.

27. 5-27 Purchasing inventory often involves: Transportation costs Inventory returns Purchase allowances Cash discounts Other Topics Let’s look at these transactions for JPS.

28. 5-28 Event 1: JPS borrowed $4,000 cash by issuing a note payable. 1.Increase assets (cash). 2.Increase liabilities (notes payable). Asset Source Transaction

29. Journal Entry Cash$4,000 Note Payable$4,000

30. 5-30 Event 2: JPS purchased on account merchandise inventory with a list price of $11,000. 1.Increase assets (merchandise inventory). 2.Increase liabilities (accounts payable). Asset Source Transaction

31. Journal Entry Inventory$11,000 Accounts Payable$11,000

32. 5-32 Event 3: JPS returned some of the inventory purchased in Event 2. The list price of the returned merchandise was $1,000. 1.Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

33. Journal Entry Accounts Payable $1,000 Inventory$1,000

34. 5-34 Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms are 2/10 n/30. Before analyzing this transaction, let’s learn a little about cash discounts.

35. 5-35 A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Full amount less discount Credit Period Full amount due Purchase or Sale Cash Discounts

36. 5-36 2/10, n/30 Percentage of Discount # of Days Discount Is Available Otherwise, the Full Amount Is Due # of Days when Full Amount Is Due Cash Discounts

37. 5-37 Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms were 2/10, n/30. 1.Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

38. Journal Entry Accounts Payable$200 Inventory$200

39. 5-39 Event 5: JPS paid the $9,800 balance due on the account payable. 1.Decrease assets (merchandise inventory). 2.Decrease liabilities (accounts payable). Asset Use Transaction

40. Journal Entry Accounts Payable$9,800 Cash$9,800

41. 5-41 Event 6: The shipping terms for the inventory purchased in Event 2 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise. Before analyzing this transaction, let’s learn a little about transportation costs.

42. 5-42 Transportation Costs FOB shipping point (buyer pays) FOB destination (seller pays ) Merchandise Seller Buyer FOB = Free on Board

43. 5-43 Event 6: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise. 1.Decrease assets (cash). 2.Increase assets (merchandise inventory). Asset Exchange Transaction

44. Journal Entry Inventory$300 Cash$300

45. 5-45 Event 7a: JPS recognized $24,750 of revenue on the cash sale of merchandise that cost $11,500. 1.Increase assets (cash). 2.Increase equity (sales revenue). Asset Source Transaction

46. Journal Entry Cash$24,750 Sales$24,750 Cost of Goods Sold$11,500 Inventory$11,500

47. 5-47 Event 7b: JPS recognized $11,500 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

48. 5-48 Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers. 1.Decrease assets (cash). 2.Decrease equity (transportation-out). Asset Use Transaction

49. Journal Entry Transportation Out $450 Cash$450

50. 5-50 Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers. 1.Decrease assets (cash). 2.Decrease equity (transportation-out). Asset Use Transaction

51. 5-51 Event 9: JPS paid $5,000 cash for selling and administrative expenses. 1.Decrease assets (cash). 2.Decrease equity (selling and admin. expense). Asset Use Transaction

52. Journal Entry Selling & Admin. Expense$5,000 Cash$5,000

53. 5-53 Event 10: JPS paid $360 cash for interest expense on the note described in Event 1. 1.Decrease assets (cash). 2.Decrease equity (interest expense). Asset Use Transaction

54. Journal Entry Interest Expense$360 Cash$360

55. 5-55 Event 11: JPS sold the land that had cost $5,500 for $6,200 cash. Before analyzing this transaction, let’s learn a little about gains and losses.

56. 5-56 Gains and Losses Sales Price of Land - Cost of Land Gain or Loss Gross margin Sales Revenue -Cost of Goods Sold Gross Margin

57. 5-57 Event 11: JPS sold the land that had cost $5,500 for $6,200 cash. 1.Increase assets (cash). 2.Decrease assets (land). 3.Increase equity (gain on sale of land). Asset Source Transaction

58. Journal Entry Cash$6,200 Land$5,500 Gain on Sale –Land$700

59. 5-59

60. 5-60 LO 5 Compare and contrast single and multi-step income statements.

61. 5-61

62. 5-62

63. 5-63 LO 6 Show the effect of lost, damaged, or stolen inventory on financial statements.

64. 5-64 Lost, Damaged, or Stolen Inventory Most merchandise companies experience some level of inventory shrinkage, a term that reflects decreases in inventory for reasons other than sales to customers.

65. 5-65 Lost, Damaged, or Stolen Inventory Assume a company determined that $500 of inventory was lost through shrinkage. Here is how it would effect the statements: In general journal form, the entry is as follows:

66. 5-66 Sales of inventory often involves: Inventory returns Purchase allowances Cash discounts Events Affecting Sales Let’s look at these transactions for JPS.

67. 5-67 Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/10 n/30. The merchandise had cost JPS $4,000. 1.Increase assets (accounts receivable). 2.Increase equity (sales revenue). Asset Source Transaction

68. Journal Entry Accounts Receivable$8,500 Sales$8,500

69. 5-69 Event 1b: JPS recognized $4,000 of cost of goods sold. 1.Decrease assets (merchandise inventory). 2.Decrease equity (cost of goods sold). Asset Use Transaction

70. Journal Entry Cost of Goods Sold$4,000 Inventory$4,000

71. 5-71 Event 2a: A customer from Event 1a returned inventory with a $1,000 list price. The merchandise had cost JPS $450. 1.Decrease assets (accounts receivable). 2.Decrease equity (retained earnings). Asset Use Transaction

72. 5-72 Event 2b: The cost of the goods ($450) is returned to the inventory account. 1.Increase assets (merchandise inventory). 2.Increase equity (reduce cost of goods sold). Asset Source Transaction

73. 5-73 Event 3a (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired. 1.Decrease assets (accounts receivable). 2.Decrease equity (sales). Asset Use & Exchange Let’s assume the customer paid within the discount period.

74. 5-74 Event 3b (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). Asset Use & Exchange Let’s assume the customer paid within the discount period.

75. 5-75 Event 3 (Alternative 2): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred after the discount period had expired. 1.Increase assets (cash). 2.Decrease assets (accounts receivable). Asset Exchange Transaction Now, let’s assume the customer did not pay within the discount period.

76. 5-76 LO 7 Use common size financial statements and ratio analysis to evaluate managerial performance.

77. 5-77

78. 5-78 Gross Margin Percentage Gross Margin Net Sales This measure indicates how much of each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit. Other things being equal, the company with the higher gross margin percentage is pricing its products higher.

79. 5-79 Return on Sales Net Income Net Sales Net income expressed as a percentage of sales provides insight as to how much of each sales dollar is left as net income after all expenses are paid. Other things being equal, the company with the higher return on sales percentage is doing a better job of controlling costs.

80. 5-80 Financing Merchandise Inventory Borrow Money from Bank Interest Expense Use Cash Opportunity Cost Purchase on Account Higher Prices and/or Interest

81. Periodic Inventory System (Appendix) A practical alternative for recording inventory in a low-technology, high-volume environment Cost of inventory is recorded in a Purchases account Ending inventory and cost of goods sold are determined by year-end physical count 5-81

82. 5-82

83. Periodic Inventory System (Appendix) 5-83

84. 5-84 End of Chapter Five