CHAPTER 5: ACCOUNTING FOR MERCHANDISING OPERATIONS MERCHANDISING OPERATIONS Sales Revenue (sale of merch) less Cost of Goods Sold

d (cost of merch in period) = Gross Profit Gross Profit less Operating Expenses (incurred in process of sales revenue) = Net Income/Loss OPERATING CYCLES Average time to go from cash cash = revenues Merchandising company: Cash buy inventory Merchandise Inventory (current asset) Sell Inventory Accounts Receivable receive cash Cash (longer than service company) INVENTORY SYSTEMS Recording inventory: 1) what is available for sale (inventory), 2) what has been sold (cost of goods sold) 1) 2) PERPETUAL INVENTORY SYSTEM Perpetual record of inventory purchase + sale (inventory purchased, sold, on hand) Each sale: purchase cost is obtained from inventory records, cost Merchandise Inventory (asset) Cost of Goods Sold (expense) ADV: Perpetual Inventory System: internal control. Perpetual record goods counted any time to test, shortages uncovered and investigated. Control physical inventory once a year. Management can answer salespeople + customers (merchandise availability) + maintain inventory levels (not out of stock) DIS: Extra clerical work + costs (even with automated). PERIODIC INVENTORY SYSTEM Cost of goods sold determined at the end w/ physical inventory How? 1) Cost of goods sold at start (beginning inventory), 2) + Cost of goods purchased, 3) less cost of goods end (ending inventory) Who? 1) low-unit-value items that turn over rapidly, 2) homogeneous goods, 3) small businesses

RECORDING PURCHASES OF MERCHANDISE Recorded when goods received. Business documents w/ written evidence: Larger Companies: purchase order (origin): document that places order with supplier Cash purchases: cash register receipt: items purchased Purchase invoice: cash purchases + credit purchases: total purchase price, etc. (from copy of sales invoice sent) DR MERCHANDISE INVENTORY ($$) CR ACCOUNTS PAYABLE ($$). To record goods purchased on account, terms n/30 SUBSIDIARY INVENTORY RECORDS Subsidiary accounts: for different products individual balances Merchandise Inventory = control account = total of individuals Records linked to purchases + sales. Unit quantities + costs updated w/ transaction FREIGHT COSTS Purchase agreement: seller/buyer pays cost of transportation. Freight bill (bill of lading) prepared by carrier w/ purchase agreement (who assumes risk) FOB SHIPPING POINT(free on board): goods placed free on board by seller, buyer pays freight costs. Part of cost of merchandise purchased. DR MERCHANDISE INVENTORY, CR CASH. To record payment of freight on goods purchased. FOB DESTINATION: goods placed free on board to buyer, seller pays PURCHASE RETURNS AND ALLOWANCES Dissatisfaction: damaged/defective goods, inferior quality, doesnt meet specifications Purchase return: returning goods for cash refund or credit grant Purchase allowance: keeping goods for allowance (deduction) from purchase price DR ACCOUNTS PAYABLE ($$), CR MERCHANDISE INVENTORY ($$). To record return of goods to NAME. DISCOUNTS Quantity Discount: reduction in price based on volume of purchases. Only discounted price recorded. Purchase Discounts: for early payment of balance. Noted with credit terms: 1/10, n/30 (one ten, net thirty): amount + time period for discount, length of time for full invoice price.

No purchase discount, credit terms only maximum time period

RECORDING SALES OF MERCHANDISE Recorded when goods transferred. Business documents w/ written evidence: Cash Register Tapes: evidence of cash sales Sales invoice: supports credit or cash sale. Original copy customer, Copy records. Date, name, sales price, total amount due, etc SALES 2 entries: 1) DR ACCOUNTS RECEIVABLE (CASH), CR SALES. To record credit sale per invoice # to NAME. 2) DR COST OF GOODS SOLD, CR MERCHANDISE INVENTORY. To record cost of merchandise sold per invoice # to NAME. Can use more than 1 sales account internal purposes, monitoring sales trends, respond strategically to changes in sales patterns On IS to outside investors 1 single sales figure. 1) Too much length for detail, 2) Not disclosing details to competitors SALES TAXES Harmonized Sales Tax: GST + PST Combined Not revenue, collected on behalf of federal + provincial governments, periodically remitted. Current Liability. Complexity: not all goods + services are taxable. SALES RETURNS AND ALLOWANCES DR SALES RETURNS AND ALLOWANCES, CR ACCOUNTS RECEIVABLE. To record credit granted to NAME for returned goods. DR MERCHANDISE INVENTORY, CR COST OF GOODS SOLD. To record cost of goods returned. Damaged goods: 2nd entry: DR LOSS (EXPENSE) ACCOUNT, CR COST OF GOODS SOLD. Some companies use separate Merch Inventory to record used/ damaged goods for resale. Sales Returns and Allowances: contra revenue account: debit. Separate account (info important to management). Excessive returns inferior merchandise, inefficiencies in filling orders, errors in billing customers, mistakes in delivery + shipment of goods. Debit to sales distorts comparisons of total sales. DISCOUNTS Quantity discount: recorded at cost (price actually paid) Sales Discount: for prompt payment of balance due FREIGHT COSTS Freight costs by seller on outgoing merch operating expense (Freight Out / Delivery Expense) Seller usually has higher invoice price for goods to cover expense COMPLETING THE ACCOUNTING CYCLE ADJUSTING ENTRY Perpetual Inventory system: Merchandise Inventory = cost of merchandise on hand (E.I.) all times Physical Inventory Count: control feature (inventory errors/stolen or damaged?) 1) Counting units on hand for each item of inventory, 2) unit costs to total units on hand, 3) totaling costs Adjusting Entry for inventory shortage (losses). Maintaining accuracy + performance measures using inventory not distorted. DR COST OF GOODS SOLD, CR MERCHANDISE INVENTORY: To record difference between inventory records and physical units on hand. CLOSING ENTRIES (temp: revenues, expenses, drawings) Temporary Credit accounts debited to Capital. (sales) Temporary Debit accounts credited to Capital. (Sales R + A, Cost of Goods Sold, Freight Out) Drawings (Temp Debit) credited to Capital. POST CLOSING TRIAL BALANCE New account: Merchandise Inventory: current asset. SUMMARY OF MERCHANDISING ENTRIES SALES Selling merchandise to customers

Cash or Accounts Receivable Sales

Granting sales returns or allowances to customers.

Paying freight costs on sales, FOB destination Receiving payment from customers Purchases Purchasing merchandise for resale Paying freight costs on merchandise purchased, FOB shipping point Receiving purchase returns or allowances from suppliers Paying suppliers End of Period Physical count determined inventory in general ledger is higher than inventory actually on hand Close temporary accounts with credit balances

Close temporary accounts with debit balances (drawings closed separately

Close drawings account

Cost of Goods Sold Merchandise Inventory Sales Returns and Allowances Cash or Accounts Receivable Merchandise Inventory Cost of Goods Sold Freight Out Cash Cash Accounts Receivable Merchandise Inventory Cash or Accounts Payable Merchandise Inventory Cash Cash or Accounts Payable Merchandise Inventory Accounts Payable Cash Adjusting Entry Cost of Goods Sold Merchandise Inventory Closing Entries Sales Capital Capital Sales Returns and Allowances Cost of Goods Sold Freight Out Other expenses Capital Drawings

MERCHANDISING FINANCIAL STATEMENTS MULTIPLE-STEP INCOME STATEMENT Steps in determining net income/loss: 1) Net Sales Cost of Goods Sold = Gross Profit. 2) Gross Profit Operating Expenses = Net Income Distinguishes operating / non operating activities: more info about income performance Highlights intermediate parts of income + subgroups of expenses NET SALES Key aspects of principal revenue-producing activities. Can be condensed + reported only as net sales Sales Revenue Sales $480,000 Less: Sales returns and allowances 20,000 Net Sales 460,000 GROSS PROFIT Net Sales $460,000 Cost of Goods Sold 316,000 Gross Profit 144,000 Gross Profit Margin: gross profit expressed as percentage. Gross Profit / Net Sales = Gross Profit Margin Meaningful/relative relationship between net sales + gross profit. Gross Profit: merchandising profit (not overall profitability). Amount + trend watched by management, compared with past amounts, compare the margin to other competitors + industry averages = effectiveness of purchasing + soundness of pricing policies Not reporting gross profit separately, combined with cost of goods sold + operating expenses. 1) sensitive information undisclosed to competitors, 2) considered on consolidated + combined basis, not a meaningful # OPERATING EXPENSES AND NET INCOME Gross Profit Operating Expenses Net Income

$144,000 114,000 $30,000

Net Income / Net Sales = Profit Margin SUBGROUPING OF OPERATING EXPENSES Selling Expenses: associated w/ making sales. E.g. for sales promotion, completing sale (delivery + shipping) Administrative Expenses (general expenses): general operating activities: personnel management, accounting, store security Some prorated (70% selling, 30% administrative expenses). E.g. store building for selling + general functions, expenses like amortization, utilities, property taxes allocated. Statements for managements internal use: expense data in lines of responsibility

NON OPERATING ACTIVITIES Revenues and Expenses from auxiliary operations Gains and losses unrelated to companys operations Other Revenues and Gains Interest from notes receivable and temporary investments Dividend revenue from investments in share capital Rent revenue from subleasing a portion of the store Gain from the disposal of capital assets

Other Expenses and Losses Interest expense on notes and loans payable Casualty losses from recurring causes such as vandalism and accidents Losses from the disposal of capital assets Losses from strikes Income from operations heading precedes non operating sections: results of normal operations. = Net Sales Cost of Goods Sold Operating Expenses Non operating activities section: net amounts. Results are netted. Difference is added to/subtracted from = net income Combining into: Other revenues and expenses section. Calculation of Gross Profit Sales Revenue Cost of Goods Sold Gross Profit Calculation of Income from Operations Operating Expenses Selling Expenses Administrative Expenses Income from Operations Calculation of non-operating activities Other revenues and gains Other expenses and losses Net income

SINGLE STEP INCOME STATEMENT Total Revenues (operating revenues, other revenues and gains) Total Expenses (cost of goods sold, operating expenses, other expenses and losses) = Net Income/Loss Corporations report income tax expense separately whether multiple step or single step (proprietorship: owner pays income tax not company) 2 Reasons: 1) company doesnt realize profit/income until revenues exceed expenses, 2) simpler + easier to read Revenues XX XX Total Revenues Expenses XX XX Total Expenses Net Income CLASSIFIED BALANCE SHEET Merchandise Inventory: current asset account under Accounts Receivable USING THE INFORMATION IN THE FINANCIAL STATEMENTS Inventory: largest current asset on BS, largest expense on IS. Affects financial position + part of working capital + current ratio 1) Management wants good selection. excessive carrying costs (investment, storage, insurance, taxes, obsolescence, damage) 2) low inventory levels stockouts, lost sales, disgruntled customers.

$XX XX XX $XX XX XX XX

Inventory turnover ratio: efficiency of sale of inventory. Avg number of times inventory is sold in period. Higher number: higher efficiency. Cost of Goods Sold / Average Inventory (ending+beginning inventory for the period) = Inventory Turnover. Day Sales in Inventory: converting inventory turnover ratio into period of time (age of inv.) Days in a year / Inventory Turnover = Day Sales in Inventory