© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Five Accounting for Merchandising...

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter Five

Accounting for Merchandising

Businesses

5-2

Merchandising Businesses

Sale

Merchandising businesses

generate revenue by selling goods.

The goods purchased for

resale are called merchandise

inventory.

5-3

LO 1

Identify and explain the

primary features of the perpetual

inventory system.

5-4

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.

5-5

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)

5-6

Gross Margin (or Gross Profit)

Sales Revenue- Cost of Goods Sold

Gross Margin

5-7

Gross Profit – Op Exp. = Op. Income

Op. Inc + Other Inc. – Exp = Inc. Before taxes

Inc. before taxes – taxes = Net Income

5-8

5-9

Perpetual Inventory System

Perpetual Inventory System

Inventory account is adjusted perpetually (continually)

throughout the accounting

period.

5-10

LO 2

Record and report inventory

transactions in the double-entry accounting

system.

5-11

Perpetual Inventory System

Let’s see how a perpetual inventory

system works by looking at

transactions for June’s Plant Shop (JPS).

5-12

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

Cash $15,000

Common Stock $15,000

Journal Entry

5-14

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

1. Decrease assets (cash).

2. Increase assets (merchandise inventory).

Asset Exchange

Transaction

Cash + Inventory = Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

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

Journal Entry

Inventory $14,000

Cash $14,000

5-16

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

1. Increase assets (cash).

2. Increase equity (sales revenue).

Asset Source

Transaction

Cash + Inventory = Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

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

Journal Entry

Cash $12,000

Sales $12,000

5-18

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

Cash + Inventory = Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

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

Journal Entry

Cost of Goods Sold $8,000

Inventory $8,000

5-20

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

1. Decrease assets (cash).

2. Decrease equity (selling expenses).

Asset Use Transaction

Cash + Inventory = Common

Stock + Retained Earnings Revenue - Expenses =

Net Income

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

Journal Entry

Selling Expense $1,000

Cash $1,000

5-22

Event 5: JPS paid $5,500 cash to purchase land for a place to locate a future store.

1. Decrease assets (cash).

2. Increase assets (land).

Asset Exchange

Transaction

Cash + Inv. + Land = Comm.

Stk. + Ret.

Earn.

(5,500) + n/a + 5,500 = n/a + n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a (5,500) IA

Cash Flow

Journal Entry

Land $5,500

Cash $5,500

5-24

5-25

5-26

LO 3Explain the

meaning of terms used to describe transportation

costs, cash discounts, returns or allowances, and

financing costs.

5-27

Purchasing inventory often involves:

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

Other Topics

Let’s look at these transactions for JPS.

5-28

Event 1: JPS borrowed $4,000 cash by issuing a note payable.

1. Increase assets (cash).

2. Increase liabilities (notes payable).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

4,000 + n/a + n/a + n/a = n/a + 4,000 + n/a + n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a 4,000 OA

Cash Flow

Journal Entry

Cash $4,000

Note Payable $4,000

5-30

Event 2: JPS purchased on account merchandise inventory with a list price of $11,000.

1. Increase assets (merchandise inventory).

2. Increase liabilities (accounts payable).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

n/a + n/a + 11,000 + n/a = 11,000 + n/a + n/a + n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a n/a

Cash Flow

Journal Entry

Inventory $11,000

Accounts Payable$11,000

5-32

Event 3: JPS returned some of the inventory purchased in Event 2. The list price of the returned merchandise was $1,000.1. Decrease assets

(merchandise inventory).

2. Decrease liabilities (accounts payable).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+

Ret.

Earn.

n/a + n/a + (1,000) + n/a = (1,000) + n/a + n/a

+ n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a n/a

Cash Flow

Journal Entry

Accounts Payable $1,000

Inventory $1,000

5-34

Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms are 2/10 n/30.

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

cash discounts.

5-35

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

5-36

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

5-37

Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms were 2/10, n/30.

1. Decrease assets (merchandise inventory).

2. Decrease liabilities (accounts payable).

Asset Use Transaction

Rev. - Exp. = Net Inc.

n/a - n/a = n/a n/a

Cash Flow

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+

Ret.

Earn.

n/a + n/a + (200) + n/a = (200) + n/a + n/a

+ n/a

Journal Entry

Accounts Payable $200

Inventory $200

5-39

Event 5: JPS paid the $9,800 balance due on the account payable.

1. Decrease assets (merchandise inventory).

2. Decrease liabilities (accounts payable).

Asset Use Transaction

List Price Discount Balance Due10,000$ - $200 = 9,800$ Cash +

Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+

Ret.

Earn.

(9,800) + n/a + n/a + n/a = (9,800) + n/a + n/a

+ n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a n/a

Cash Flow

Journal Entry

Accounts Payable $9,800

Cash $9,800

5-41

Event 6: The shipping terms for the inventory purchased in Event 2 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.

5-42

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

5-43

Event 6: 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.1. Decrease assets (cash).

2. Increase assets (merchandise inventory).

Asset Exchange

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+

Ret.

Earn.

(300) + n/a + 300 + n/a = (200) + n/a + n/a

+ n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a (300) OA

Cash Flow

Journal Entry

Inventory $300

Cash $300

5-45

Event 7a: JPS recognized $24,750 of revenue on the cash sale of merchandise that cost $11,500.

1. Increase assets (cash).

2. Increase equity (sales revenue).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+ Ret. Earn.

24,750 + n/a + n/a + n/a = n/a + n/a + n/a

+ 24,750

Rev. - Exp. = Net Inc.

24,750 - n/a = n/a 24,750 OA

Cash Flow

Journal Entry

Cash $24,750

Sales $24,750

Cost of Goods Sold $11,500

Inventory $11,500

5-47

Event 7b: JPS recognized $11,500 of cost of goods sold.

1. Decrease assets (merchandise inventory).

2. Decrease equity (cost of goods sold).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+ Ret. Earn.

n/a + n/a + (11,500) + n/a = n/a + n/a + n/a

+ (11,500)

Rev. - Exp. = Net Inc.

n/a - 11,500 = (11,500) n/a

Cash Flow

5-48

Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers.

1. Decrease assets (cash).

2. Decrease equity (transportation-out).

Asset Use Transaction

Buyer Seller

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

Responsible Party

Journal Entry

Transportation Out $450

Cash $450

5-50

Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers.

1. Decrease assets (cash).

2. Decrease equity (transportation-out).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+ Ret. Earn.

(450) + n/a + n/a + n/a = n/a + n/a + n/a

+ (450)

Rev. - Exp. = Net Inc.

n/a - 450 = (450) (450) OA

Cash Flow

5-51

Event 9: JPS paid $5,000 cash for selling and administrative expenses.

1. Decrease assets (cash).

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

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk.

+ Ret. Earn.

(5,000) + n/a + n/a + n/a = n/a + n/a + n/a

+ (5,000)

Rev. - Exp. = Net Inc.

n/a - 5,000 = (5,000) (5,000) OA

Cash Flow

Journal Entry

Selling & Admin. Expense $5,000

Cash $5,000

5-53

Event 10: JPS paid $360 cash for interest expense on the note described in Event 1.

1. Decrease assets (cash).

2. Decrease equity (interest expense).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

(360) + n/a + n/a + n/a = n/a + n/a + n/a + (360)

Rev. - Exp. = Net Inc.

n/a - 360 = (360) (360) OA

Cash Flow

Journal Entry

Interest Expense $360

Cash $360

5-55

Event 11: JPS sold the land that had cost $5,500 for $6,200 cash.

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

losses.

5-56

Gains and Losses

Gains and

Losses

Sales Price of Land

- Cost of LandGain or Loss

Gross margin

Sales Revenue-Cost of Goods

SoldGross Margin

5-57

Event 11: JPS sold the land that had cost $5,500 for $6,200 cash.

1. Increase assets (cash).

2. Decrease assets (land).

3. Increase equity (gain on sale of land).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

6,200 + n/a + n/a + (5,500) = n/a + n/a + n/a + 700

Gain - Exp. = Net Inc.

700 - n/a = 700 6,200 IA

Cash Flow

Journal Entry

Cash $6,200

Land $5,500

Gain on Sale –Land $700

5-59

5-60

LO 5

Compare and contrast single and multi-step

income statements.

5-61

5-62

5-63

LO 6

Show the effect of lost, damaged, or stolen inventory

on financial statements.

5-64

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.

5-65

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:

5-66

Sales of inventory often involves:

•Inventory returns•Purchase allowances•Cash discounts

Events Affecting Sales

Let’s look at these transactions for JPS.

5-67

Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/10 n/30. The merchandise had cost JPS $4,000.

1. Increase assets (accounts receivable).

2. Increase equity (sales revenue).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

n/a + 8,500 + n/a + n/a = n/a + n/a + n/a + 8,500

Rev. - Exp. = Net Inc.

8,500 - n/a = 8,500 n/a OA

Cash Flow

Journal Entry

Accounts Receivable $8,500

Sales $8,500

5-69

Event 1b: JPS recognized $4,000 of cost of goods sold.

1. Decrease assets (merchandise inventory).

2. Decrease equity (cost of goods sold).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret. Earn.

n/a + n/a + (4,000) + n/a = n/a + n/a + n/a + (4,000)

Gain - Exp. = Net Inc.

700 - 360 = 700 6,200 IA

Cash Flow

Journal Entry

Cost of Goods Sold $4,000

Inventory $4,000

5-71

Event 2a: A customer from Event 1a returned inventory with a $1,000 list price. The merchandise had cost JPS $450.

1. Decrease assets (accounts receivable).

2. Decrease equity (retained earnings).

Asset Use Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

n/a + (1,000) + n/a + n/a = n/a + n/a + n/a + 700

Rev. - Exp. = Net Inc.

(1,000) - n/a = (1,000) n/a

Cash Flow

5-72

Event 2b: The cost of the goods ($450) is returned to the inventory account.

1. Increase assets (merchandise inventory).

2. Increase equity (reduce cost of goods sold).

Asset Source

Transaction

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

n/a + n/a + 450 + n/a = n/a + n/a + n/a + 450

Rev. - Exp. = Net Inc.

n/a - (450) = 450 n/a

Cash Flow

5-73

Event 3a (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired.

1. Decrease assets (accounts receivable).

2. Decrease equity (sales).

Asset Use & Exchange

Let’s assume the customer paid within the discount

period.

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

n/a + (75) + n/a + n/a = n/a + n/a + n/a + (75)

Rev. - Exp. = Net Inc.

(75) - n/a = (75) n/a

Cash Flow

5-74

Event 3b (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired.

1. Increase assets (cash).

2. Decrease assets (accounts receivable).

Asset Use & Exchange

Let’s assume the customer paid within the discount

period.

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

7,425 + (7,425) + n/a + n/a = n/a + n/a + n/a + (75)

Rev. - Exp. = Net Inc.

n/a - n/a = n/a 7,425 OA

Cash Flow

5-75

Event 3 (Alternative 2): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred after the discount period had expired.

1. Increase assets (cash).

2. Decrease assets (accounts receivable).

Asset Exchange

TransactionNow, let’s assume the

customer did not pay within the discount period.

Cash + Accts.

Rec. + Inv. + Land = Accts.

Pay. + Notes

Pay. + Comm.

Stk. + Ret.

Earn.

7,500 + (7,500) + n/a + n/a = n/a + n/a + n/a + n/a

Rev. - Exp. = Net Inc.

n/a - n/a = n/a 7,500 OA

Cash Flow

5-76

LO 7Use common size

financial statements and ratio analysis to

evaluate managerial

performance.

5-77

5-78

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.

5-79

Return on Sales

Net Income

Net 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.

5-80

Financing Merchandise Inventory

Borrow Money from

Bank

Interest Expense

Use CashOpportunity

Cost

Purchase on Account

Higher Prices and/or Interest

Periodic Inventory System (Appendix)

• A practical alternative for recording inventory in a low-technology, high-volume environment

• Cost of inventory is recorded in a Purchases account

• Ending inventory and cost of goods sold are determined by year-end physical count

5-81

5-82

Periodic Inventory System (Appendix)

5-83

5-84

End of Chapter Five