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

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5MERCHANDISING OPERATIONS

AND THE MULTIPLE-STEP I/S

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Merchandising OperationsMerchandising 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

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MerchandisingMerchandising Operations Operations

Income Measurement

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.

Not used in a Service business.

Net Income (Loss)

Less

LessEquals

Equals

SalesRevenue

Cost of Goods Sold

Gross Profit

Operating Expenses

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The operating cycle of a merchandising company ordinarily is longer than that of a service company.

Operating Cycles


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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!


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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

$ 100,000Add: Purchases

800,000= Goods available for sale

900,000Less: Ending inventory

125,000= Cost of goods sold

$ 775,000


Flow of Costs – Periodic System

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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.

Flow of Costs - Perpetual System

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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.

Inventory 3,800Sauk: May 4 Accounts Payable - PW 3,800

Recording Purchases of MerchandiseRecording Purchases of Merchandise

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What if Sauk is dissatisfied because goods are damaged, of inferior quality, or do not meet specifications (wrong color, size, etc.)?

Purchase Returns and Allowances


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.

Purchase Return Purchase Allowance

If Sauk returned goods costing $300 on May 8 the entry would be: May 8 Accounts payable - PW 300

Inventory 300

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).

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Credit terms permits buyers to take a cash discount for prompt payment. Advantages: the purchaser saves money and the seller shortens the operating cycle.

Purchase Discounts for Early Payment


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.

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Accounts payable 3,500May 14

Cash (the 98% balance due) 3,430


Inventory (the 2% discount) 70

(Purchase Discount = $3,500 x 2% = $70) (Cash Payment = $3,500 x 98% = $3,430)

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:

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:

Accounts payable 3,500

Cash (the100% balance due) 3,500

June 3

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Ownership of the goods passes to the buyer as soon as the public carrier accepts the goods from the seller.

Ownership of the goods remains with the seller until the goods reach the buyer.


Freight Costs - The FOB Terms determines who pays

From the Shipping Point to the Destination

FOB simply means Free on Board, a very old term still used today

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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:

Inventory 150May 6Cash 150


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:

Freight-out Expense 150May 4 Cash 150

Freight costs incurred by the seller are an operating expense.

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InventoryDebit Credit

$3,800 8th - Return$300

Balance

4th - Purchase

$3,580

70 14th - Discount


A Summary of Sauk’s Purchasing Transactions

1506th – Inventory (the freight charge)

Note: $3,800 – 300 – 70 = $3,430 owed to PWThe $150 freight charge was paid separately to an

independent shipping company and not subject to a discount

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You need 2 Journal Entries to Record PW’s Sale

Accounts receivable (or cash) XXXSales revenue XXX

Recording PW’s Sale to Sauk

When the inventory is sold, it turns into an inventory expense called the cost of the goods sold!

#1

Cost of goods sold XXXInventory XXX

#2

Selling Price

Cost of the Goods Sold

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Recording Recording PW’sPW’s Sale to Sale to SaukSauk

$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!

Accounts receivable 3,800 May 4

Sales revenue 3,800

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!

Cost of goods sold 2,400May 4Inventory 2,400

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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.

Sales Returns and Allowances (SR&A)

Recording Sales of MerchandiseRecording Sales of Merchandise

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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.


Note: If this was just a $50 allowance (no inventory was returned) you would only have one J/E:

Sales returns and allowances 50

Accounts Receivable 50

In other words, with an allowance, no inventory is returned!

Sales returns and allowances 300May 8Accounts receivable 300

Inventory 140May 8Cost of goods sold 140

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Offered to customers to promote prompt payment.

This is the “Flipside” of Sauk’s purchase discount.

Contra-revenue account (kept with a debit balance).

Sales Discounts


$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

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Cash 3,430May 14

Accounts receivable 3,500

Sales discount 70

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:

(Sales Discount = $3,500 x 2% = $70)

(Cash Received = $3,500 x 98% = $3,430)

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Highlights the components of net income.

Three Key Line Items:

1) gross profit,

2) income from operations, and

3) net income.

Income Statement PresentationIncome Statement Presentation

The Multiple-Step Income Statement

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Total Sales Revenues to Net Sales

A Partial Income Statement PresentationA Partial Income Statement Presentation

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

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A Partial Income Statement PresentationA Partial Income Statement Presentation

Comparisons with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies.

Gross Profit

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A Partial Income Statement PresentationA Partial Income Statement PresentationOperating Expenses

(See slides 12 & 13)

Freight Out is when the seller pays the freight cost – FOB Destination (slides 12 &13)

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Additions to Income Statement PresentationsAdditions to Income Statement Presentations

Non-operating ActivitiesVarious revenues and expenses and gains and losses that are unrelated to the company’s main line of operations.

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A Complete A Complete Multiple-Step Multiple-Step Income Income Statement Statement PresentationPresentation

Look at Do IT 5-3 (page 261) and the example on p. 245- 246.

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Once again, the Debit Credit Summary

Chapter 3-26

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

RevenueRevenue

Chapter 3-27



ExpenseExpense

Chapter 3-23

AssetsAssetsDebit / Dr. Credit / Cr.


Chapter 3-24

LiabilitiesLiabilitiesDebit / Dr. Credit / Cr.


Chapter 3-25



StockholdersStockholders’’ EquityEquity

Chapter 3-25



Common StockCommon Stock

Chapter 3-23

DividendsDividendsDebit / Dr. Credit / Cr.


= +

Assets, Expenses & Dividends all go up with DebitsLiabilities, Owners Equity (Common Stock & Retained Earnings)

& Revenues all go up with Credits

Chapter 3-25



Retained EarningsRetained Earnings

DEAD = Debits increase Expenses, Assets, and

Dividends

CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

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Simple Summary For A Sole Proprietor

Chapter 3-26



RevenueRevenue

Chapter 3-27



ExpenseExpense

Chapter 3-23

AssetsAssetsDebit / Dr. Credit / Cr.


Chapter 3-24

LiabilitiesLiabilitiesDebit / Dr. Credit / Cr.


Chapter 3-25



StockholdersStockholders’’ EquityEquity

= +

Assets & Expenses go up with Debits. There are no Dividends!Liabilities, Owners Equity & Revenues all go up with Credits

DEA = Debits increase Expenses & Assets

CLEaR = Credits increase Liabilities, Equity and Revenues

Owner’s Equity

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

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