1. Slide 5-1 Chapter 5 Accounting for Merchandising Operations Financial Accounting, IFRS Edition Weygandt Kimmel Kieso

2. Slide 5-2 1. 1.Identify the differences between service and merchandising companies. 2. 2.Explain the recording of purchases under a perpetual inventory system. 3. 3.Explain the recording of sales revenues under a perpetual inventory system. 4. 4.Explain the steps in the accounting cycle for a merchandising company. 5. 5.Prepare an income statement for a merchandiser. 6. 6.Explain the computation and importance of gross profit. Study Objectives

3. Slide 5-3 Forms of Financial Statements Accounting for Merchandising Operations Freight costs Purchase returns and allowances Purchase discounts Summary of purchasing transactions MerchandisingOperationsMerchandisingOperations Recording Purchases of Merchandise Recording Sales of Merchandise Completing the Accounting Cycle Operating cycles Flow of costs— perpetual and periodic inventory systems Sales returns and allowances Sales discounts Adjusting entries Closing entries Summary of merchandising entries Income statement Classified statement of financial position

4. Slide 5-4 Merchandising Operations SO 1 Identify the differences between service and merchandising companies. Merchandising Companies Buy and Sell Goods WholesalerRetailerConsumer The primary source of revenues is referred to as sales revenue or sales.

5. Slide 5-5 Merchandising Operations Income Measurement Illustration 5-1 Cost of goods sold is the total cost of merchandise sold during the period. Not used in a Service business. Net Income (Loss) Less = = Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses SO 1 Identify the differences between service and merchandising companies.

6. Slide 5-6 The operating cycle of a merchandising company ordinarily is longer than that of a service company. Illustration 5-2 SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Operating Cycle

7. Slide 5-7 SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Flow of Costs Illustration 5-3

8. Slide 5-8 Perpetual System 1.Purchases increase Merchandise Inventory. 2.Freight costs, Purchase Returns and Allowances and Purchase Discounts are included in Merchandise Inventory. 3.Cost of Goods Sold is increased and Merchandise Inventory is decreased for each sale. 4.Physical count done to verify Merchandise Inventory balance. The perpetual inventory system provides a continuous record of Merchandise Inventory and Cost of Goods Sold. SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Flow of Costs

9. Slide 5-9 1.Purchases of merchandise increase Purchases. 2.Ending Inventory determined by physical count. 3.Calculation of Cost of Goods Sold: Beginning inventory$ 100,000 Add: Purchases, net+ 800,000 Goods available for sale900,000 Less: Ending inventory- 125,000 Cost of goods sold$ 775,000 SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Flow of Costs Periodic System

10. Slide 5-10 Made using cash or credit (on account). Normally recorded when goods are received. Purchase invoice should support each credit purchase. Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration 5-5

11. Slide 5-11 Under the perpetual inventory system, companies record in the Merchandise Inventory account the purchase of goods they intend to sell. Illustration: Illustration: From INVOICE NO. 731 (Illustration 5-5) record the journal entry Sauk Stereo would make to record its purchase from PW Audio Supply. Merchandise inventory3,800May 4 Accounts payable 3,800 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system.

12. Slide 5-12 Illustration 5-6 Seller places goods Free On Board the carrier, and buyer pays freight costs. Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs. Recording Purchases of Merchandise – Terms of Sale Freight Costs – Terms of Sale Freight costs incurred by the seller are an operating expense. SO 2

13. Slide 5-13 Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company €1 50 for freight charges, the entry on Sauk Stereo’s books is: Merchandise inventory150May 6 Cash 150 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: Freight-out (or Delivery Expense)150May 4 Cash 150

14. Slide 5-14 Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Returns and Allowances Recording Purchases of Merchandise Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price. Purchase Return Purchase Allowance SO 2 Explain the recording of purchases under a perpetual inventory system.

15. Slide 5-15 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing € 300. Accounts payable300May 8 Merchandise inventory 300

16. Slide 5-16 Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages: Purchaser saves money. Seller shortens the operating cycle. Purchase Discounts Recording Purchases of Merchandise Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.” 2% cash discount if payment is made within 10 days. SO 2 Explain the recording of purchases under a perpetual inventory system.

17. Slide 5-17 Purchase Discount Terms Recording Purchases of Merchandise 2% discount if paid within 10 days, otherwise net amount due within 30 days. 1% discount if paid within first 10 days of next month. 2/10, n/301/10 EOM Net amount due within the first 10 days of the next month. n/10 EOM SO 2 Explain the recording of purchases under a perpetual inventory system.

18. Slide 5-18 Merchandise Inventory 70 Accounts payable3,500May 14 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume Sauk Stereo pays the balance due of € 3,500 (gross invoice price of € 3,800 less purchase returns and allowances of € 300) on May 14, the last day of the discount period. Prepare the journal entry Sauk makes to record its May 14 payment. Cash 3,430

19. Slide 5-19 Accounts payable3,500June 3 Recording Purchases of Merchandise Cash 3,500 SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of € 3,500 on June 3, the journal entry would be:

20. Slide 5-20 Should discounts be taken when offered? Purchase Discounts Recording Purchases of Merchandise Example: 2% for 20 days = Annual rate of 36.5% (365/20 = 18.25 twenty-day periods x 2% = 36.5%) Passing up the discount offered equates to paying an interest rate of 2% on the use of $3,500 for 20 days. SO 2 Explain the recording of purchases under a perpetual inventory system.

21. Slide 5-21 € 3,800 8 th - Return € 300 Balance 4 th - Purchase 3,580 € 3,580 7014 th - Discount Recording Purchases of Merchandise Summary of Purchasing Transactions 1506 th – Freight-in Illustration SO 2 Explain the recording of purchases under a perpetual inventory system.

22. Slide 5-22 Made for cash or credit (on account). Normally recorded when earned, usually when goods transfer from seller to buyer. Sales invoice should support each credit sale. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Illustration 5-5

23. Slide 5-23 Two Journal Entries to Record a Sale Cash or Accounts receivableXXX Sales XXX Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. #1 Cost of goods soldXXX Merchandise inventory XXX #2 Selling Price Cost

24. Slide 5-24 Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Accounts receivable3,800May 4 Sales 3,800 Illustration: Assume PW Audio Supply records its May 4 sale of € 3,800 to Sauk Stereo (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply € 2,400. Cost of goods sold2,4004 Merchandise inventory 2,400

25. Slide 5-25 “Flipside” of purchase returns and allowances. Contra-revenue account (debit). Sales not reduced (debited) because:  would obscure importance of sales returns and allowances as a percentage of sales.  could distort comparisons between total sales in different accounting periods. Sales Returns and Allowances Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system.

26. Slide 5-26 Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a € 300 selling price (assume a € 140 cost). Assume the goods were not defective. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300May 8 Accounts receivable300 Merchandise inventory 1408 Cost of goods sold140

27. Slide 5-27 Illustration: Assume the returned goods were defective and had a scrap value of € 50, PW Audio would make the following entries: Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300May 8 Accounts receivable300 Merchandise inventory 508 Cost of goods sold50

28. Slide 5-28 Offered to customers to promote prompt payment. “Flipside” of purchase discount. Contra-revenue account (debit). Sales Discount Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system.

29. Slide 5-29 Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Cash3,430May 14 Accounts receivable3,500 Sales discounts70 * [(€3,800 – €300) X 2%] * Illustration: Assume Sauk Stereo pays the balance due of € 3,500 (gross invoice price of € 3,800 less purchase returns and allowances of € 300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.

30. Slide 5-30 Generally the same as a service company. One additional adjustment to make the records agree with the actual inventory on hand. Involves adjusting Merchandise Inventory and Cost of Goods Sold. Adjusting Entries Completing the Accounting Cycle SO 4 Explain the steps in the accounting cycle for a merchandising company.

31. Slide 5-31 Completing the Accounting Cycle SO 4 Explain the steps in the accounting cycle for a merchandising company. Illustration: Suppose that PW Audio Supply has an unadjusted balance of € 40,500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is € 40,000. The company would make an adjusting entry as follows. Cost of goods sold 500 Merchandise inventory500

32. Slide 5-32 Completing the Accounting Cycle Closing Entries

33. Slide 5-33 Primary source for evaluating a company’s performance. Format designed to differentiate between the various sources of income and expense. Income Statement Forms of Financial Statements SO 5 Prepare an income statement for a merchandiser.

34. Slide 5-34 Illustration 5-13 Income Statement Presentation of Sales Forms of Financial Statements SO 5 Prepare an income statement for a merchandiser.

35. Slide 5-35 SO 6 Explain the computation and importance of gross profit. SO 6 Explain the computation and importance of gross profit. Illustration 5-13 Illustration 5-10 Gross Profit Forms of Financial Statements

36. Slide 5-36 Forms of Financial Statements SO 5 Distinguish between a multiple-step and a single-step income statement. Illustration 5-13 Operating Expenses IFRS allows presentation by nature and presentation by function.

37. Slide 5-37 Forms of Financial Statements Other Income and Expense SO 5 Illustration 5-13 Various revenues and gains and expenses and losses that are unrelated to the company’s main line of operations.

38. Slide 5-38 Forms of Financial Statements Interest Expense SO 5 Illustration 5-13 Interest expense, if material, must be disclosed on the face of the income statement.

39. Slide 5-39 SO 6 Explain the computation and importance of gross profit. SO 6 Explain the computation and importance of gross profit. Comprehensive Income Forms of Financial Statements Includes certain adjustments to pension plan assets, gains and losses on foreign currency translation, and unrealized gains and losses on certain types of investments. Reported in a combined statement of net income and comprehensive income, or in a separate schedule that reports only comprehensive income. Illustration 5-14

40. Slide 5-40 Forms of Financial Statements Illustration 5-15 Classified Statement of Financial Position SO 5 Distinguish between a multiple-step and a single-step income statement.

41. Slide 5-41 As noted in the chapter, under IFRS companies must classify expenses by either nature or by function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional expense method on the income statement, disclosure by nature is required in the notes to the financial statements. In contrast, under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions such as administration, distribution, and manufacturing. Accounting for Merchandising Operations Understanding U.S. GAAP Key Differences

42. Slide 5-42 Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach although the approach used is similar to that referred to as a multiple- step statement under GAAP. IFRS requires that two years of income statement information be presented, whereas GAAP requires three years. Accounting for Merchandising Operations Understanding U.S. GAAP Key Differences

43. Slide 5-43 Looking to the Future Understanding U.S. GAAP The IASB and FASB are working on a project that would rework the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. Finally, this approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature. Accounting for Merchandising Operations

44. Slide 5-44 Periodic System Separate accounts used to record purchases, freight costs, returns, and discounts. Company does not maintain a running account of changes in inventory. Ending inventory determined by physical count. SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Periodic Inventory System

45. Slide 5-45 Calculation of Cost of Goods Sold Illustration 5A-1 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Periodic Inventory System

46. Slide 5-46 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the € 3,800 purchase as follows. Purchases3,800May 4 Accounts payable 3,800 Recording Purchases under Periodic System

47. Slide 5-47 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: If Sauk pays Acme Freight Company € 150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is: Freight-in (Transportation-in)150May 6 Cash 150 Freight Costs Recording Purchases under Periodic System

48. Slide 5-48 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: Sauk Stereo returns € 300 of goods to PW Audio Supply and prepares the following entry to recognize the return. Accounts payable300May 8 Purchase returns and allowances 300 Purchase Returns and Allowances Recording Purchases under Periodic System

49. Slide 5-49 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk Stereo records the payment and discount as follows. Accounts payable3,500May 14 Purchase discounts 70 Purchase Discounts Cash 3,430 Recording Purchases under Periodic System

50. Slide 5-50 No entry is recorded for cost of goods sold at the time of the sale under a periodic system. SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: PW Audio Supply, records the sale of € 3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows. Accounts receivable3,800May 4 Sales 3,800 Recording Sales under Periodic System

51. Slide 5-51 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the € 300 sales return as follows. Sales returns and allowances300May 4 Accounts receivable 300 Sales Returns and Allowances Recording Sales under Periodic System

52. Slide 5-52 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: Illustration: On May 14, PW Audio Supply receives payment of € 3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows. Sales Discounts Cash3,430May 14 Accounts receivable3,500 Sales discounts70 Recording Sales under Periodic System

53. Slide 5-53 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration 5A-2 Comparison of Entries-Perpetual vs. Periodic

54. Slide 5-54 SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration 5A-2 Comparison of Entries-Perpetual vs. Periodic

55. Slide 5-55 Illustration 5B-1 SO 8 Worksheet for a Merchandising Company

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