Needles Powers Crosson Principles of Accounting 12e Accounting for Merchandising Operations 6 C H A P T E R © human/iStockphoto.

Needles Powers Crosson Principles of Accounting 12e Accounting for Merchandising Operations 6 C H A P T E R © human/iStockphoto

LEARNING OBJECTIVES ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  LO1: Define merchandising accounting, and differentiate perpetual from periodic inventory systems.  LO2: Describe the features of multistep and single-step classified income statements.  LO3: Describe the terms of sale related to merchandising transactions.  LO4: Prepare an income statement, and record merchandising transactions under the perpetual inventory system.  LO5: Prepare an income statement, and record merchandising transactions under the periodic inventory system.  LO6: Explain the role of the operating cycle and foreign business transactions in evaluating the liquidity of a merchandising company.

SECTION 1: CONCEPTS ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Faithful representation: financial information is complete, neutral, and free from material error  Classification: the process of assigning transactions to the appropriate accounts

Concepts Underlying Merchandising Accounting  A merchandising company earns income by buying and selling goods, which are called merchandise inventory. –The buying and selling of goods adds to the complexity of the accounting process. –One complexity is the classification of items on the merchandising income statement so that the statement faithfully represents the operations of the company. –Merchandise inventory is an important component on the operating cycle, which is the cycle of buying and holding merchandise until it is sold and then collecting payment for the sales. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Concepts Underlying Merchandising Accounting - Perpetual inventory system—Under this system, continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold.  At all times, the balance of the Merchandise Inventory account equals the cost of goods on hand. - Periodic inventory system—Under this system, the inventory not yet sold is counted periodically.  The physical count is called physical inventory, which is usually taken at the end of the accounting period.  The figure for inventory is accurate only on the balance sheet date. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Two basic systems of accounting for merchandise inventory are used:

Concepts Underlying Merchandising Accounting –Perpetual system:  Allows managers to respond to customers’ inquiries about product availability.  Allows inventory to be ordered more effectively to avoid running out of stock.  Companies that sell items with a high unit value have tended to use this system. –Periodic system:  Reduces the amount of clerical work, so is less expensive for small businesses.  Companies that sell items of low value in high volume have traditionally used the periodic inventory system, although computerization and bar coding are changing that. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Comparison of the two inventory systems:

SECTION 2: ACCOUNTING APPLICATIONS  Prepare a multistep income statement  Prepare a single-step income statement  Record inventory transactions under the perpetual method  Record inventory transactions under the periodic method ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Multistep Income Statement  A multistep income statement goes through a series of steps or subtotals to arrive at net income. –In the income statement of a service company (which provides services as opposed to products), the operating expenses are deducted from revenues in a single step to arrive at income from operations. –The income statements of manufacturing companies (which make and sell products) and merchandising companies (which buy and sell products) include an additional step of calculating gross margin by subtracting the cost of goods sold from net sales. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

A Comparison of the Components of Multistep Income Statements for Service and Merchandising or Manufacturing Companies ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Net Sales (or Net Revenue)  Net sales (or net revenue) is computed as follows: Net Sales = Gross Sales − Sales Returns and Allowances –Gross sales consist of the total revenue from cash and credit sales during a period. –Sales returns and allowances include cash refunds and credits on account. They also include any discounts from selling prices made to customers who have returned defective products or products that are otherwise unsatisfactory. –For Davila, net sales is computed as follows: $1,300,924 − $52,300 = $1,248,624 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost of Goods Sold (or Cost of Sales)  Cost of goods sold (or cost of sales or cost of revenue) is the amount a merchandiser paid for the merchandise it sold during a period.  For a manufacturer, it is the cost of making the products it sold during a period.  For Davila, cost of goods sold is $815,040. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gross Margin (or Gross Profit)  Gross margin (or gross profit) is computed as follows: Gross Margin = Net Sales − Cost of Goods Sold  Davila’s gross margin is computed as follows: $1,248,624 − $815,040 = $433,584  Managers and owners are also interested in percentage of gross margin, which is computed as follows: Percentage of Gross Margin = Gross Margin ÷ Net Sales ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Expenses  Operating expenses are the expenses, other than cost of goods sold, that are incurred in running a business. They are computed as follows: Operating Expenses = Selling Expenses + General and Administrative Expenses –Selling expenses include the costs of storing goods and preparing them for sale; preparing displays, advertising, and otherwise promoting sales; and delivering goods to the buyer. –General and administrative expenses include accounting, personnel, credit checking, collections, and any other expenses that apply to overall operations. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Income from Operations (or Operating Income)  Income from operations (or operating income) is the income from a company’s main business and is computed as follows: Income from Operations = Gross Margin − Operating Expenses  For Davila, income from operations is computed as follows: $433,584 − $357,136 = $76,448 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Other Revenues and Expenses (or Nonoperating Revenues and Expenses)  Other revenues and expenses (or nonoperating revenues and expenses) are not related to a company’s operating activities. Among the items included in this section are: –Revenues from investments (such as dividends and interest on stocks, bonds, and savings accounts) –Interest expenses and other expenses that result from borrowing money ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Net Income (or Net Earnings)  Net income (or net earnings) is the final figure, or “bottom line,” of an income statement and is computed as follows: Net Income = Gross Margin − Operating Expenses +/ − Other Revenues and Expenses  For Davila, net income is computed as follows: $433,584 − $357,136 − $4,924 = $71,524 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Single-Step Income Statement  In a single-step income statement, net income is derived in a single step by putting the major categories of revenues in the first part of the statement and the major categories of costs and expenses in the second part.  Both the multistep form and the single-step form have advantages. –The multistep form shows the components used in deriving net income. –The single-step form has the advantage of simplicity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Terms of Sale  When goods are sold on credit, both parties should understand the amount and timing of payment, as well as other terms of the purchase.  Manufacturers and wholesalers often quote prices as a percentage (usually 30 percent or more) off their list or catalogue prices. Such a reduction is called a trade discount. –If an article is listed at $1,000 with a trade discount of 40 percent, or $400, the seller records the sale at $600, and the buyer records the purchase at $600. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales and Purchases Discounts  The terms of sale are usually printed on the sales invoice and are part of the sales agreement. - If the invoice is marked “n/10” (“net 10”) or “n/30” (“net 30”), the invoice is due either 10 days or 30 days after the invoice date. - If the invoice is marked “n/10 eom,” it is due 10 days after the end of the month (“eom”). ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales Discount  In some industries, it is customary to give a sales discount for early payment. –An invoice that offers a sales discount of “2/10, n/30” means that the buyer either can pay within 10 days of the invoice date and receive a 2 percent discount or wait 30 days and pay the full amount. –Discounts are recorded by the seller only at the time the customer pays. If the customer takes advantage of the sales discount, the difference between the payment amount and the sales price is debited to Sales Discounts, which is a contra-revenue account. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchase Discounts  Purchase discounts are discounts that a buyer takes for the early payment of merchandise. –The buyer records the purchase at the full sales price. Then, if the buyer pays in time to take advantage of the discount, the difference between the payment amount and the sales price is recorded as a credit to an account called Purchases Discounts. –The Purchases Discounts account reduces the Cost of Goods Sold account or the Purchases account, depending on the inventory method use. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Transportation Costs (slide 1 of 2)  Special terms designate whether the seller or purchaser pays the freight charges: –FOB shipping point means that the seller places the merchandise “free on board” at the point of origin and the buyer bears the shipping costs. The title to the merchandise passes to the buyer at that point. –FOB destination means that the seller bears the transportation costs to the delivery point. The seller retains title until the merchandise reaches its destination and usually prepays the shipping costs, in which case the buyer makes no accounting entry for freight. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Transportation Costs (slide 2 of 2)  When the buyer pays the transportation charge, it is called freight-in, and it is added to the cost of merchandise purchased.  When the seller pays the transportation charge, it is called delivery expense (or freight-out), and it is included in selling expenses on the income statement. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Terms of Debit and Credit Card Sales  Debit cards deduct directly from a person’s bank account.  Credit cards allow for payment later. –The customer establishes credit with the lender (credit card issuer), not with the seller. –The lender takes a discount from each sale, which is a selling expense for the seller. –The sale is communicated to the seller’s bank, resulting in a cash deposit (of the sales amount, less the discount) in the seller’s bank account. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Perpetual Inventory System  Under the perpetual inventory system, the Merchandise Inventory and Cost of Goods Sold accounts are continually updated during the accounting period as purchases, sales, and other inventory transactions occur.  Kawar’s income statement is shown on the next slide. The focal point of the statement is cost of goods sold, which is deducted from net sales to arrive at gross margin. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Income Statement Under the Perpetual Inventory System ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchases of Merchandise The graphic below shows how transactions involving purchases of merchandise are recorded under the perpetual inventory system. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales of Merchandise The graphic below shows how transactions involving sales of merchandise are recorded under the perpetual inventory system. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Periodic Inventory System (slide 1 of 2)  Under the periodic inventory system, cost of goods sold must be computed on the income statement because it is not updated for purchases, sales, and other transactions during the accounting period.  It is important to distinguish between the cost of goods sold and the cost of goods available for sale. –The cost of goods sold is the cost of merchandise actually sold in the accounting period. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Periodic Inventory System (slide 2 of 2) –The cost of goods available for sale is the total cost of merchandise that could be sold in the accounting period. It is the sum of the following two factors:  The amount of merchandise on hand at the beginning of the period.  The net purchases during the period. (Net purchases consist of total purchases plus freight-in less any deductions, such as purchases returns and allowances and discounts from suppliers for early payment.) –The difference between cost of goods available for sale and cost of goods sold is the amount not sold, or the ending merchandise inventory. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Income Statement Under the Periodic Inventory System ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchases of Merchandise The graphic below shows how purchases of merchandise are recorded under the periodic inventory system. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales of Merchandise The graphic below shows how transactions involving sales of merchandise are recorded under the periodic inventory system. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Merchandising Income Statement Groups Accounts in Useful Categories ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SECTION 3: BUSINESS APPLICATIONS  Calculating operating cycle  Liquidity ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Cycle  Merchandising businesses engage in a series of transactions to buy, sell, and collect for merchandise inventory called the operating cycle. –Most companies buy merchandise on credit and sell it on credit, thereby engaging in the following four transactions: 1. Purchase of merchandise inventory for cash or on credit 2. Sales of merchandise inventory for cash or on credit 3. Collection of cash from credit sales 4. Payment for purchases made on credit ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Financing Period (slide 1 of 2)  As shown below, the financing period (or cash gap) is the amount of time from the purchase of inventory until it is sold and payment is collected, less the amount of time creditors give the company to pay for the inventory. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Financing Period (slide 2 of 2)  If it takes 60 days to sell the inventory, 60 days to collect for the sale, and creditors’ payment terms are 30 days, the financing period is 90 days [(60 + 60) − 30].  During the financing period, the company will be without cash from this series of transactions and will need either to have funds available internally or to borrow from a bank.  By reducing its financing period, a company can improve its cash flows. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Foreign Business Transactions  An international business transaction is measured in two different currencies, and one currency has to be translated into another by using an exchange rate.  If a U.S. company bills a foreign company in the foreign company’s currency and accepts payment in the foreign currency, it will incur an exchange gain or loss if the exchange rate changes between the date of the sale and the date of payment. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Needles Powers Crosson Principles of Accounting 12e Accounting for Merchandising Operations 6 C H A P T E R © human/iStockphoto.

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Needles Powers Crosson Principles of Accounting 12e Accounting for Merchandising Operations 6 C H A P T E R © human/iStockphoto.

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