©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Five Accounting for Merchandising...

©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin

Chapter Five

Accounting for Merchandising Businesses

Merchandising Businesses

Sale

Merchandising businesses

generate revenue by selling goods.

The goods purchased for

resale are called merchandise

inventory.

Product Costs Versus Selling and Administrative Costs

Product Costs

Costs that are included in inventory.

Selling & Admin. Costs

Costs that are not included in

inventory. They are

sometimes called period

costs.

Allocation of Inventory Cost Between Asset and Expense Accounts

Beginning Inventory Balance

+

Inventory Purchased During the

Period

=

Cost of Goods

Available for Sale

Cost of Goods Available for Sale

Merchandise Inventory

(Balance Sheet)

Cost of Goods Sold (Income Statement)

Gross Margin (or Gross Profit)

Sales Revenue- Cost of Goods Sold

Gross Margin

Perpetual Inventory System


Inventory account is adjusted perpetually (continually)

throughout the accounting

period.


Let’s see how a perpetual inventory

system works by looking at

transactions for June’s Plant Shop (JPS).

Event 1: JPS acquired $15,000 by issuing common stock.

1. Increase assets (cash).

2. Increase equity (common stock).

Asset Source

Transaction

Cash + Inventory = Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

15,000 + n/a = 15,000 + n/a n/a - n/a = n/a 15,000 FA Cash Flow

Event 2: JPS purchased merchandise inventory for $14,000 cash.

1. Decrease assets (cash).

2. Increase assets (merchandise inventory).

Asset Exchange

Transaction



Net Income

(14,000) + 14,000 = n/a + n/a n/a - n/a = n/a (14,000) OA Cash Flow

Event 3a: JPS recognized sales revenue from selling inventory for $12,000.


2. Increase equity (sales revenue).

Asset Source

Transaction



Net Income

12,000 + n/a = n/a + 12,000 12,000 - n/a = 12,000 12,000 OA Cash Flow

Event 3b: JPS recognized $8,000 of cost of goods sold.

1. Decrease assets (merchandise inventory).

2. Decrease equity (cost of goods sold).

Asset Use Transaction



Net Income

n/a + (8,000) = n/a + (8,000) n/a - 8,000 = (8,000) n/a Cash Flow

Event 4: JPS paid $1,000 cash for selling expenses.


2. Decrease equity (selling expenses).




Net Income

(1,000) + n/a = n/a + (1,000) n/a - 1,000 = (1,000) (1,000) OA Cash Flow

Purchasing inventory often involves:

•Transportation costs•Inventory returns•Purchase allowances•Cash discounts

Other Topics

Let’s look at these transactions for JPS.

Event 1: JPS purchased merchandise inventory on account with a list price of $8,000. The payment terms are 2/10 n/30.

Before analyzing this transaction, let’s learn a little about

cash discounts.

A deduction from the invoice price granted to induce early payment

of the amount due.

A deduction from the invoice price granted to induce early payment

of the amount due.

Terms

Time

Due

Discount Period

Full amountless discount

Credit Period

Full amount due

Purchase or SalePurchase or Sale

Cash Discounts

2/10, n/30Percentage of Discount

# of Days Discount Is Available

Otherwise, the Full

Amount Is Due

# of Days when Full Amount Is

Due

Cash Discounts

Event 1: JPS purchased merchandise inventory on account with a list price of $8,000. The payment terms are 2/10 n/30.


2. Increase liabilities (accounts payable).

Asset Source

Transaction

Cash + Accts. Rec. + Inventory =

Accts. Pay. +

Common Stock +

Retained Earnings Revenue - Expenses =

Net Income

n/a + n/a + 7,840 = 7,840 + n/a + n/a n/a - n/a = n/a n/a Cash Flow

8,000$ 98% = 7,840$ Net Method

Event 2: JPS returned some of the inventory purchased in Event 1. The list price of the returned merchandise was $1,000.


2. Decrease liabilities (accounts payable).



Accts. Pay. +

Common Stock +


Net Income

n/a + n/a + (980) = (980) + n/a + n/a n/a - n/a = n/a n/a Cash Flow

1,000$ 98% = 980$ Net Method

Event 3: JPS paid cash to settle the account payable due on the inventory purchased in Event 1. The payment was made after the end of the discount period.



3. Decrease equity (interest expense).



Accts. Pay. +

Common Stock +


Net Income

(7,000) + n/a + n/a = (6,860) + n/a + (140) n/a - 140 = (140) (7,000) OA Cash Flow

8,000$ 1,000$ = 7,000$ Cash Payment

7,840$ 980$ = 6,860$ Accounts Payable

Event 4: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise.

Before analyzing this transaction, let’s learn a little about

transportation costs.

Transportation Costs

FOB shipping point(buyer pays)

FOB destination(seller pays)

Merchandise

Seller Buyer

Buyer Seller

Freight Terms FOB Shipping Point FOB DestinationCost Title Transportation-in Transportation-out

Responsible Party

FOB = Free on Board

Event 4: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise.



Asset Exchange

Transaction


Accts. Pay. +

Common Stock +


Net Income

(300) + n/a + 300 = n/a + n/a + n/a n/a - n/a = n/a (300) OA Cash Flow

Event 5a: JPS recognized $24,750 of revenue on the cash sale of merchandise that cost $11,500.



Asset Source

Transaction


Accts. Pay. +

Common Stock +


Net Income

24,750 + n/a + n/a = n/a + n/a + 24,750 24,750 - n/a = 24,750 24,750 OA Cash Flow






Accts. Pay. +

Common Stock +


Net Income

n/a + n/a + (11,500) = n/a + n/a + (11,500) n/a - 11,500 = (11,500) n/a Cash Flow

Event 6: JPS incurred $450 of freight costs on inventory delivered to customers.


2. Decrease equity (transportation-out).


Buyer Seller


Responsible Party


Accts. Pay. +

Common Stock +


Net Income

(450) + n/a + n/a = n/a + n/a + (450) n/a - 450 = (450) (450) OA Cash Flow

Event 7: JPS purchased $14,000 of merchandise inventory on account with credit terms of 1/10 n/30. The inventory was delivered FOB destination. The freight costs were $400.1. Increase assets

(merchandise inventory).

2. Increase liabilities (accounts payable).

Asset Source

Transaction


Accts. Pay. +

Common Stock +


Net Income

n/a + n/a + 13,860 = 13,860 + n/a + n/a n/a - n/a = n/a n/a Cash Flow

Buyer Seller


Responsible Party

14,000$ 99% = 13,860$ Net Method

Event 8a: JPS recognized $16,800 of revenue from the sale on account of merchandise that cost $8,660. The freight terms were FOB shipping point. The party responsible paid freight costs of $275 in cash. JPS does not offer a cash discount to purchasers.

1. Increase assets (accounts receivable).


Asset Source

Transaction


Accts. Pay. +

Common Stock +


Net Income

n/a + 16,800 + n/a = n/a + n/a + 16,800 16,800 - n/a = 16,800 n/a Cash Flow

Buyer Seller


Responsible Party






Accts. Pay. +

Common Stock +


Net Income


Event 9: JPS paid $9,900 cash in partial settlement of the account payable that arose from purchasing inventory on account in Event 7. The partial payment was made within the discount period for merchandise with a list price of $10,000.





Accts. Pay. +

Common Stock +


Net Income

(9,900) + n/a + n/a = (9,900) + n/a + n/a n/a - n/a = n/a (9,900) OA Cash Flow

10,000$ 99% = 9,900$ Net Method

Event 10: JPS paid $8,000 cash for selling and administrative expenses.


2. Decrease equity (selling and admin. expense).



Accts. Pay. +

Common Stock +


Net Income

(8,000) + n/a + n/a = n/a + n/a + (8,000) n/a - 8,000 = (8,000) (9,900) OA Cash Flow

Sales of inventory often involves:

•Inventory returns•Purchase allowances•Cash discounts

Events Affecting Sales

Let’s look at these transactions for JPS.

Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/20 n/30. The merchandise had cost JPS $5,100.

1. Increase assets (accounts receivable).


Asset Source

Transaction


Accts. Pay. +

Common Stock +


Net Income

n/a + 8,415 + n/a = n/a + n/a + 8,415 8,415 - n/a = 8,415 n/a Cash Flow

8,500$ 99% = 8,415$ Net Method






Accts. Pay. +

Common Stock +

Retained Earnings Revenue - Expenses = Net Income


Event 2a: The customer in Event 1a returned inventory with a $1,000 list price that JPS had sold with 1/10 n/30 payment terms. The merchandise had originally cost JPS $600.

1. Decrease assets (accounts receivable).

2. Decrease equity (retained earnings).



Accts. Pay. +

Common Stock +


Net Income

n/a + (990) + n/a = n/a + n/a + (990) (990) - n/a = (990) n/a Cash Flow

1,000$ 99% = 990$ Net Method

Event 2b: The cost of the goods ($600) is returned to the inventory account.


2. Increase equity (cost of goods sold).

Asset Source

Transaction


Accts. Pay. +

Common Stock +


Net Income

n/a + n/a + 600 = n/a + n/a + 600 n/a - (600) = 600 n/a Cash Flow

Event 3: JPS collected the balance of the account receivable from the customer that purchased the goods in Event 1a.



Asset Exchange

Transaction


Accts. Pay. +

Common Stock +


Net Income

7,425 + (7,425) + n/a = n/a + n/a + n/a n/a - n/a = n/a 7,425 OA Cash Flow

8,415$ 990$ = 7,425$ Accounts Receivable

Let’s assume the customer paid within the discount

period.

Event 3: JPS collected the balance of the account receivable from the customer that purchased the goods in Event 1a.



3. Increase equity (interest revenue).

Asset Exchange & Source


Accts. Pay. +

Common Stock +


Net Income

7,500 + (7,425) + n/a = n/a + n/a + 75 75 - n/a = 75 7,500 OA Cash Flow

7,425$ 75$ = 7,500$ Cash Payment

Now, let’s assume the customer did not pay within

the discount period.

8,415$ 990$ = 7,425$ Accounts Receivable

Lost, Damaged, or Stolen Inventory

Most merchandise companies

experience some level of inventory shrinkage, a term

that reflects decreases in inventory for

reasons other than sales to

customers.

Lost, Damaged, or Stolen Inventory

Assets = Liab. + Equity Revenue - Expenses = Net

Income (500) = n/a + (500) n/a - 500 = (500) n/a

Cash Flow

Assume a company determined that $500 of inventory was lost through shrinkage.

Here is how it would effect the statements:

Account Title Debit CreditInventory Loss (or Cost of Goods Sold) 500 Inventory 500

In general journal form, the entry is as follows:

Gross Margin Percentage

Gross MarginNet Sales

This measure indicates how muchof each sales dollar is left after deducting the cost of goods sold to cover expenses

and provide a profit.

Other things being equal, the company with the higher gross margin percentage is pricing its

products higher.

Return on Sales

Net IncomeNet Sales

Net income expressed as a percentage of sales provides insight as to how much of each sales dollar

is left as net income after all expenses are paid.

Other things being equal, the company with the higher return on sales

percentage is doing a better job of controlling costs.

Financing Merchandise Inventory

Borrow Money from

Bank

Interest Expense

Use CashOpportunity

Cost

Purchase on Account

Higher Prices and/or Interest

End of Chapter Five

©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Five Accounting for Merchandising...

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Transcript of ©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Five Accounting for Merchandising...