Accounting principles chapter 05

OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY Accounts Receivable Cash Service Company Cash Merchandising Company Receive Cash Perform Services Sell Inventory Accou

Accounting Principles

Second Canadian Edition

Prepared by:

Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel ·

Trenholm

ACCOUNTING FOR MERCHANDISING

OPERATIONS

CHAPTER

5

 A merchandising company is an enterprise

that buys and sells goods to earn a profit.

1 Wholesalers sell to retailers

2 Retailers sell to consumers

 A merchandiser’s primary source of

revenue is sales , whereas a service

company’s primary source of revenue is

service revenue

MERCHANDISING COMPANY

OPERATING CYCLES FOR A

SERVICE COMPANY AND A

MERCHANDISING COMPANY

Accounts Receivable

Cash Service Company

Cash

Merchandising Company

Receive Cash

Perform Services

Sell Inventory

Accounts

Receivable

Receive Cash

Buy Inventory

Merchandise Inventory

Sales

Revenue

Cost of Goods Sold

Cost of Goods Sold

Gross Profit Equals

Operating Expenses

Less

Net Income (Loss) Equals

INVENTORY SYSTEMS

Merchandising entities may use either (or

both) of the following inventory systems:

1 Perpetual – where detailed records of each

inventory purchase and sale are maintained Cost of goods sold is calculated at the time of each sale.

2 Periodic – detailed records are not

maintained Cost of goods sold is calculated only at the end of the accounting period.

This chapter covers the perpetual method

 When merchandise is purchased for

resale to customers, the account,

Merchandise Inventory , is debited for the cost of the goods.

 Purchases may be made for cash or on

account (credit).

 The purchase is normally recorded

by the purchaser when the goods are received from the seller.

RECORDING COST OF GOODS PURCHASED

PURCHASES OF MERCHANDISE

For purchases on account, Merchandise

Inventory is debited and Accounts Payable is

credited For cash purchases, Merchandise

Inventory is debited and Cash is credited.

For purchases on account, Merchandise

Inventory is debited and Accounts Payable is

credited For cash purchases, Merchandise

Inventory is debited and Cash is credited.

J1

Date Account Title and Explanation Ref Debit Credit

May 4 Merchandise Inventory 3,800

Accounts Payable 3,800

To record goods purchased on account, terms n/30.

General Journal

FREIGHT COSTS

 The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business.

 FOB Shipping Point

1 Goods delivered to shipping point by seller

2 Buyer pays freight costs from shipping point to destination

 Merchandise Inventory is debited by the buyer, if the buyer pays the freight bill (FOB shipping

Date Account Title and Explanation Ref Debit Credit

To record payment of freight.

General Journal

When the purchaser directly incurs the freight

costs, the account Merchandise Inventory is

debited and Cash is credited.

When the purchaser directly incurs the freight

costs, the account Merchandise Inventory is

debited and Cash is credited.

ACCOUNTING FOR

FREIGHT COSTS

 A purchaser may be dissatisfied with

merchandise received because the goods

1 are damaged or defective,

2 are of inferior quality, or

3 are not in accord with the

purchaser’s specifications.

PURCHASE RETURNS AND

ALLOWANCES

For purchases returns and allowances that were

originally made on account, Accounts Payable is

debited and Merchandise Inventory is credited

For cash returns and allowances, Cash is debited

and Merchandise Inventory is credited.

For purchases returns and allowances that were

originally made on account, Accounts Payable is

debited and Merchandise Inventory is credited

For cash returns and allowances, Cash is debited

and Merchandise Inventory is credited.

QUANTITY DISCOUNTS

• Volume purchase terms may permit the

buyer to claim a quantity discount

• The merchandise inventory is simply

recorded at the discounted cost.

PURCHASE DISCOUNTS

 Credit terms may permit the buyer to

claim a cash discount for the prompt

payment of a balance due.

 The buyer calls this discount a

purchase discount

 A purchase discount is based on the invoice cost less any returns and allowances granted.

 Revenues are reported when earned in accordance with the revenue recognition principle In a merchandising company revenues are earned when the goods are transferred from seller to buyer.

SALES TRANSACTIONS

Date Account Title and Explanation Ref Debit Credit

May 4 Accounts Receivable 3,800

To record credit sale.

May 4 Cost of Goods Sold 2,400

Merchandise Inventory 2,400

To record cost of merchandise sold.

General Journal

1 The first entry records the sale of goods to a

customer at the retail (selling) price

2 The second entry releases the goods from inventory

at cost and charges the goods to cost of goods sold.

1 The first entry records the sale of goods to a

customer at the retail (selling) price

2 The second entry releases the goods from inventory

at cost and charges the goods to cost of goods sold.

• Sales taxes may include the federal goods and

services tax (GST) and the provincial sales tax

(PST) , if any These two taxes have been combined into one harmonized sales tax (HST) in some

Atlantic Provinces.

SALES TAXES ON REVENUES

• The retailer collects the tax from the

customer when the sale occurs, and

periodically (usually monthly) remits the

collections to the Receiver General.

• Sales taxes are not revenue but are a current

liability until remitted.

 Sales Returns occur when customers are

dissatisfied with merchandise and are

allowed to return the goods to the seller for credit or a refund.

 Sales Allowances occur when

customers are dissatisfied, and the seller allows a deduction from the selling price.

SALES RETURNS AND

ALLOWANCES

 The normal balance of Sales Returns and Allowances is a debit

 Sales Returns and Allowances is a contra

SALES RETURNS AND

ALLOWANCES

RECORDING SALES RETURNS

of goods sold account.

1 The first entry reduces the balance owed by the customer and records the goods returned at retail price

2 The second entry records the physical return of goods to inventory at cost and removes the goods from the cost

of goods sold account.

J1

Date Account Title and Explanation Ref Debit Credit

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

To record returned goods.

May 8 Merchandise Inventory 140

Cost of Goods Sold 140

To record cost of goods returned.

General Journal

• A quantity discount is the offer of a cash

discount to a customer in return for a volume sale.

• Quantity discounts result in a sales price

reduction They are not separately

journalized Instead the sale is recorded at the reduced price.

QUANTITY DISCOUNTS

 A sales discount is the offer of a cash discount

to a customer in exchange for the prompt

payment of a balance due.

 Similar to Sales Returns and Allowances,

Sales Discounts is also a contra revenue

account with a normal debit balance.

SALES DISCOUNTS

COMPLETING THE ACCOUNTING CYCLE

 A merchandising company requires the same

types of adjusting entries as a service company, with one additional adjustment for inventory to ensure the recorded inventory amount agrees with the actual quantity on hand.

 A physical count is an important control

feature since a perpetual system indicates what should be there but a count will determine what

is actually there.

COMPLETING THE ACCOUNTING CYCLE

 A merchandising company also requires the

same types of closing entries as a service

company.

 The additional accounts that need to be closed out in a merchandising account include Sales, Sales Returns and Allowances, Cost of Goods Sold , and Freight Out

 Merchandise Inventory is an asset account and

is not closed at the end of the period.

ILLUSTRATION 5-9

STATEMENT PRESENTATION OF

SALES REVENUE SECTION

As contra revenue accounts, sales returns and

allowances (and sales discounts, if any) are

deducted from sales in the income statement to arrive at Net Sales.

As contra revenue accounts, sales returns and

allowances (and sales discounts, if any) are

deducted from sales in the income statement to arrive at Net Sales

Income Statement (Partial)

ILLUSTRATION 5-10

CALCULATION OF GROSS PROFIT

Gross profit is often expressed as a

percentage of sales.

Gross profit is calculated by deducting cost of

goods sold from net sales as follows:

Gross profit is calculated by deducting cost of

goods sold from net sales as follows:

Cost of goods sold 316,000 69%

ILLUSTRATION 5-12

CALCULATION OF NET INCOME

Net income is the “bottom line” of a

company’s income statement.

Utilities expense 17,000 Insurance expense 2,000 Total administrative expenses 38,000 Total operating expenses 114,000

Other revenue and gains Interest revenue $ 3,000 Gain on sale of equipment 600 Total non-operating revenue and gain $ 3,600 Other expenses and losses

Interest on expense $ 1,800 Casualty loss from vandalism 200 Total non-operating expense and loss 2,000 Net non-operating revenue 1,600

HIGHPOINT ELECTRONIC Income Statement For the Year Ended December 31, 2002

that has both

operating and

CLASSIFIED BALANCE SHEET

Assets

On the balance sheet, merchandise inventory is reported as a current asset and appears immediately below accounts receivable

This is because current assets are listed in the order of their liquidity

On the balance sheet, merchandise inventory is reported as a current asset and appears immediately below accounts receivable

This is because current assets are listed in the order of their liquidity

USING THE INFORMATION IN THE

FINANCIAL STATEMENTS

• It is a large current asset

on the balance sheet

USING THE INFORMATION IN THE

FINANCIAL STATEMENTS

 A balancing act is needed to ensure that

a sufficient, but not excessive, quantity of inventory is on hand.

 Two ratios help evaluate the

management of inventory:

INVENTORY TURNOVER

Inventory turnover =

Cost of goods sold

Average inventory

DAYS SALES IN INVENTORY

Days sales in inventory =

365 days Inventory turnover

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