1. 5
MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP I/S

2. Merchandising Operations
Merchandising Companies buy and sell goods.
The primary source of revenues is referred to as sales revenue or sales (instead of “service” revenue). Note the order that the selling takes place.
Wholesaler
Retailers
Consumer

3. Merchandising Operations
Income Measurement
Sales
Revenue
Not used in a Service business.
Less
Cost of
Goods Sold
Gross
Profit
Equals
Less
Net
Income
(Loss)
Operating
Expenses
Equals
Cost of goods sold is the total cost of merchandise (the inventory) sold during the period. Because we have goods for sale the operating cycle is longer.

4. Merchandising Operations
Operating Cycles
The operating cycle of a merchandising company ordinarily is longer than that of a service company.

5. Merchandising Operations
Flow of Costs
Companies use either a periodic inventory system
or a perpetual inventory system to account for inventory. For example, a newspaper provides news periodically, CNN.com provides news perpetually!

6. Merchandising Operations
Flow of Costs – Periodic System
This does not keep detailed records of the goods on hand.
Cost of goods sold is determined by counting what’s left in inventory at the end of the accounting period (the end of the month, quarter, or year).
See below for a calculation of a Cost of Goods Sold example:
Beginning inventory $ 100,000
Add: Purchases 800,000
= Goods available for sale 900,000
Less: Ending inventory 125,000
= Cost of goods sold $ 775,000

7. Merchandising Operations
Flow of Costs - Perpetual System
The perpetual system continuously maintains records of the cost of each inventory purchase and sale using computerized registers and scanning. Acquisitions are debited to inventory. When sold, the cost of the goods sold is debited and inventory is credited.
Advantage: Provides better control over accounting for inventories by: 1. continuously showing total inventory on hand, and 2. the company can determine the cost of goods sold for each sale.
Disadvantage: Requires additional work and cost to maintain inventory records.

8. Recording Purchases of Merchandise
Sauk is the buyer, purchasing goods from PW.
PW is the seller and prepares a sales invoice for Sauk .
Sauk uses PW’s sales invoice as a purchase invoice to record the transaction. Note: this purchase is “on account”. Sauk will pay at a later date.
Sauk: May 4
Inventory 3,800
Accounts Payable - PW ,800

9. Recording Purchases of Merchandise
Purchase Returns and Allowances
What if Sauk is dissatisfied because goods are damaged, of inferior quality, or do not meet specifications (wrong color, size, etc.)?
Purchase Return
Purchase Allowance
Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.
Decide to keep the goods if the seller will grant an allowance (deduction) from the purchase price.
If Sauk returned goods costing $300 on May 8 the entry would be:
May 8
Accounts payable - PW
Inventory
If Sauk was allowed to keep the goods and given an allowance the entry would be similar: Accounts Payable and Inventory would be reduced by only the allowance amount (e.g., $50).

10. Recording Purchases of Merchandise
Purchase Discounts for Early Payment
Credit terms permits buyers to take a cash discount for prompt payment. Advantages: the purchaser saves money and the seller shortens the operating cycle.
Example 1: If the credit terms read 2/10, n/30.
A 2% discount is given if paid within 10 days, otherwise the net amount is due within 30 days.
Example 2: If the credit terms read 5/20, n/60.
A 5% discount is given if paid within 20 days, otherwise the net amount is due within 60 days.

11. Recording Purchases of Merchandise
May 14, Sauk pays the net amount of $3,500 (the original $3,800 less the return on May 8 of $300) within the discount period and takes the 2% discount, the J/E is:
May 14
Accounts payable 3,500
Inventory (the 2% discount) 70
Cash (the 98% balance due) ,430
(Purchase Discount = $3,500 x 2% = $70) (Cash Payment = $3,500 x 98% = $3,430)
If Sauk decided not to take the discount, and instead paid the full $3,500 on June 3 (remember net 30!), the J/E would be:
June 3
Accounts payable ,500
Cash (the100% balance due) ,500

12. Recording Purchases of Merchandise
Freight Costs - The FOB Terms determines who pays
Ownership of the goods passes to the buyer as soon as the public carrier accepts the goods from the seller.
From the Shipping Point to the Destination
Ownership of the goods remains with the seller until the goods reach the buyer.
FOB simply means Free on Board, a very old term still used today

13. Recording Purchases of Merchandise
The freight terms of FOB shipping point on the invoice required Sauk (the buyer) to pay the freight charges. Upon delivery of the goods on May 6, Sauk Stereo pays an independent trucking firm Haul-It Freight Company $150 for the freight charges. Freight charges cannot be discounted! The entry for Sauk is:
May 6
Inventory
Cash
If the freight terms were FOB Destination, then PW Audio (the seller) would pay the freight charges. The entry by PW Audio Supply would have been:
May 4
Freight-out Expense
Cash
Freight costs incurred by the seller are an operating expense.

14. Recording Purchases of Merchandise
A Summary of Sauk’s Purchasing Transactions
4th - Purchase
$3,800
$300
8th - Return
6th – Inventory (the freight charge)
150 70
14th - Discount
Balance
$3,580
Note: $3,800 – 300 – 70 = $3,430 owed to PW
The $150 freight charge was paid separately to an independent shipping company and not subject to a discount

15. Recording PW’s Sale to Sauk
You need 2 Journal Entries to Record PW’s Sale #1
Accounts receivable (or cash) XXX
Selling Price
Sales revenue XXX
Cost of the Goods Sold #2
Cost of goods sold XXX
Inventory XXX
When the inventory is sold, it turns into an inventory expense called the cost of the goods sold!

16. Recording PW’s Sale to Sauk
PW records the original May 4 sale of $3,800 (slide 8) to Sauk on account (no cash was paid). Assume PW’s cost of the merchandise inventory sold to Sauk was $2,400 (the cost of the goods sold): 2 entries are needed!
May 4
Accounts receivable 3,800
Sales revenue 3,800
May 4
Cost of goods sold 2,400
Inventory 2,400
$3,800 - $2,400 = $1,400 called the gross profit on this sale - Slide 3.
GP / Sales = $1,400 / $3,800 = 36.8% called the gross profit rate!

17. Recording Sales of Merchandise
Sales Returns and Allowances (SR&A)
The “Flipside” of Sauk’s purchase returns and allowances from slide 9.
SR&A is a Contra-revenue account (kept with a debit balance).
Sales are not debited (reduced) because:
We want to know how many and why our Sales are being returned or why we are having to give allowances. Otherwise, this could distort comparisons between products, stores, or competitors.

18. Recording Sales of Merchandise
The entry PW would make to record Sauk’s returned goods (slide 9) that had a $300 selling price and a $140 cost. Assume the goods were put back in inventory.
May 8
Sales returns and allowances 300
Accounts receivable 300
May 8
Inventory 140
Cost of goods sold 140
Note: If this was just a $50 allowance (no inventory was returned) you would only have one J/E:
Sales returns and allowances
Accounts Receivable
In other words, with an allowance, no inventory is returned!

19. Recording Sales of Merchandise
Sales Discounts
Offered to customers to promote prompt payment.
This is the “Flipside” of Sauk’s purchase discount.
Contra-revenue account (kept with a debit balance).
$3,430 is the amount Sauk pays PW – slides 11 & 14. Note that the $150 freight was paid by Sauk to an independent shipper, not to PW

20. Recording Sales of Merchandise
Assume Sauk pays the balance due of $3,500 less the 2% discount of $70 (slide 11). For Sauk the $70 is a reduction in the cost of the inventory. For PW the $70 is a reduction in the sale (a sales discount). PW records this receipt as:
May 14
Cash 3,430
Sales discount 70
Accounts receivable 3,500
(Sales Discount = $3,500 x 2% = $70)
(Cash Received = $3,500 x 98% = $3,430)

21. Income Statement Presentation
The Multiple-Step Income Statement
Highlights the components of net income.
Three Key Line Items:
gross profit,
income from operations, and
net income.

22. A Partial Income Statement Presentation
Total Sales Revenues to Net Sales
Instead of just showing “Net Sales” PW is showing how the total “gross” sales were reduced to “net” sales because of returns, allowances, and discounts

23. A Partial Income Statement Presentation
Gross Profit
Comparisons with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies.

24. A Partial Income Statement Presentation
Operating Expenses
(See slides 12 & 13)
Freight Out is when the seller pays the freight cost – FOB Destination (slides 12 &13)

25. Additions to Income Statement Presentations
Non-operating Activities
Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations.

26. A Complete Multiple-Step Income Statement Presentation
Look at Do IT 5-3 (page 261) and the example on p

27. Once again, the Debit Credit Summary
Assets, Expenses & Dividends all go up with Debits
Liabilities, Owners Equity (Common Stock & Retained Earnings)
& Revenues all go up with Credits = +
DEAD = Debits increase Expenses, Assets, and Dividends
CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

28. Simple Summary For A Sole Proprietor
Assets & Expenses go up with Debits. There are no Dividends!
Liabilities, Owners Equity & Revenues all go up with Credits
Owner’s Equity = +
DEA = Debits increase Expenses & Assets
CLEaR = Credits increase Liabilities, Equity and Revenues