Principles of financial accounting 12e by needles crosson chapter 06

Concepts Underlying Merchandising Accounting - Perpetual inventory system —Under this system, continuous records are kept of the quantity and, usually, the cost of individual items

Principles of

Accounting

12e

Accounting for Merchandising Operations

6

C H A P T E R

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

– 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.

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

- 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

 Two basic systems of accounting for

merchandise inventory are used:

Multistep Income Statement

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 from net sales.

Net Sales and Cost of Goods Sold

 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 or unsatisfactory products.

 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

Gross Margin and Income from Operations

 Gross margin (or gross profit) is computed as

follows:

Gross Margin = Net Sales − Cost of Goods Sold

– Managers and owners are also interested in percentage of gross margin , which is computed as follows:

Percentage of Gross Margin = Gross Margin ÷ Net Sales

 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

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.

Other Revenues and Expenses and

Net Income

 Other revenues and expenses (or

nonoperating revenues and expenses) are not

related to a company’s operating activities

Included in this section are:

– Revenues from investments (such as dividends on stock) – Interest expenses and other expenses that result from borrowing money

 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

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.

Terms of Sale

 Manufacturers and wholesalers often quote prices

as a percentage 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.

 If an invoice is marked “n/30” (“net 30”), the

invoice is due 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”).

Sales and Purchases Discounts

 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.

 Purchase discounts are discounts that the

buyer takes for the early payment of

merchandise.

– Both the seller and the buyer record the purchase at the full amount If the buyer pays in time to get the discount, it is recorded as “Sales Discount” for the

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.

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.

Perpetual Inventory System

 Under the perpetual inventory system,

Merchandise Inventory and Cost of Goods Sold are continually updated during the

accounting period as purchases, sales, and other inventory transactions occur.

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.

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.

Cash Flows in the Operating Cycle

The Financing Period

 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.

Foreign Business Transactions

measured in two different currencies, and one currency has to be translated into

another by using an exchange rate.

in the foreign company’s currency and

accepts payment in the foreign currency,

the exchange rate changes between the date of the sale and the date of payment.