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Chapter 5
Service enterprises perform services as their primary source of revenue.
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Merchandising companies buy and sell merchandise.
Differences Between a Service Businessand a Merchandising Company
In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales.
Unlike expenses for a service company, expenses for a merchandising company are divided into two categories:oCost of goods sold - the total cost of merchandise
sold during the period.oOperating expenses - selling and administrative
expenses.
Calculating Net Income
Net Income--A measure of the overall performance of a business entity.
Calculating Net Income
Service Company
Revenues- Operating Expenses Net Income
Net Income--A measure of the overall performance of a business entity.
Calculating Net Income
Service Company
Revenues- Operating Expenses Net Income
Product Company
Revenues- Cost of Goods Sold Gross Margin- Operating Expenses Net Income
Net Income--A measure of the overall performance of a business entity.
Terms
Sales revenue or sales = sale of merchandise
Cost of goods sold = total cost of merchandise sold
Operating cycle of any company is...
the average time it takes to go from cash to cash in producing revenues.
TO
Operating cycle of amerchandising company is...
Ordinarily longer than that of a service company;
Purchase of merchandise and its sale lengthens the cycle.
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Receive Cash
Receive Cash
Perform Services
Buy Inventory
Sell Inventory
Service Company
Merchandising Company
Cash
Cash
AccountsReceivable
AccountsReceivable
MerchandiseInventory
Inventory
• The Inventory account is one of the largest assets for any company.
• The determination of which goods should be included in inventory at the end of a period is “Inventory Cutoff.”
• Inventory errors will affect the financial statements for 2 years.
What Is Charged to Merchandise Inventory?
All costs needed to get inventory to a company and ready to sell
• +Freight-In
• +Special Permits
Only costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies
Transportation Costs
• The cost of inbound transportation is added to the cost of inventory.
• For the perpetual method, the cost must be added to the Inventory account to reflect actual cost of acquiring inventory.
• For the periodic method, a Freight-In account is used.
Inventory Control Methods
• Perpetual Inventory Method--A system of accounting in which cost of goods sold and inventory are adjusted when the merchandise is purchased or sold.
• Periodic Inventory Method--A system of accounting in which the cost of goods sold and inventory are adjusted at the end of the accounting period.
• First:Let’s look at the whole process assuming
Perpetual Inventory
Perpetual Inventory
• Transaction records of every sale or purchase are required to account for inventory.
• The perpetual method is similar to how you would account for cash.
• The Inventory account should represent the amount of inventory on hand at any time.
Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio
Supply, Inc.
Task: Record the purchase by getting information from the Purchase Invoice.The Purchase Invoice is the buyer’s copy of the sales invoice.
Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio
Supply, Inc.
GENERAL JOURNAL Debit Credit
May 4 Merchandise Inventory 3,800 Accounts Payable 3,800
To record goods purchased on account.
Merchandise Purchases
On May 5 the company received an invoice from a freight company for $ 120 for delivery of the merchandise
from PW Audio
GENERAL JOURNAL Debit Credit
May 5 Merchandise Inventory 120 Accounts Payable 120 To record in-coming freight on account.
Purchase Returns
On May 8 the company returned $300 worth of merchandise to PW Audio
Supply, Inc.
GENERAL JOURNAL Debit Credit
May 8 Accounts Payable 300 Merchandise Inventory 300 Record goods returned on account.
Purchase Discounts
A purchase discount is a reduction in the purchase price, usually when payment is made within a specified period.
Purchase discounts reduce the net cost of the purchases account.
For perpetual inventory, a purchase discount reduces inventory by the same amount.
Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.
3/1 Inventory ………….................... 1,000
Accounts Payable ...........… 1,000
Received books from Wiley, purchase
order #M1234 with terms of 2/10, n/30.
Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made Mar. 1 and the entry made on Mar. 10 for the payment to the supplier.
3/10 Accounts Payable..................... 1,000
Inventory…………...........… 20
Cash................................... 980
Paid Wiley’s invoice 1234 for purchase of books with 2% discount.
Purchase Discount Example:
On March 1, the Morris Company purchased (received) 10 accounting books for $100 each. The terms of the contract were 2/10, n/30. Write down the journal entry made for the payment to the supplier, but assume the payment was Apr 1
4/1 Accounts Payable..................... 1,000
Cash................................... 1000
Paid Wiley’s invoice 1234 for purchase of books. No discount taken.
Purchase Discount Example:
are recorded when earned-revenue recognition principle
must be supported by a business document-written evidence
2 entries are made for each sale one to record sale one to record cost of merchandise sold
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Sales Revenues:
On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900.
3/1 Accounts Receivable.......... 5,000 Sales………….............… 5,000
Record sale to Acme Inc.
3/1 Cost of Goods Sold............ 2,900 Merchandise Inventory.. 2,900
Record Cost of Goods
Sales Revenue Example:
CashAccounts
ReceivableMerchandise
Inventory
Cost of Goods Sold
Sales Returns & AllowancesSales
5,000 Mar 1
2,900 Mar 1
Mar 1 2,900
Mar 1 5,000
Sales Revenue Example:
Periodic Inventory
• Inventory levels on the general ledger are not affected by purchases or sales.
• Might be used in a juice bar or a small clothing store.
• The Inventory and Cost of Goods Sold accounts are only correct at the end of the fiscal period, when a physical inventory is taken.
Cost of Goods Sold -Periodic Method
A running account of changes in inventory is not maintained.
Separate accounts are used to record – Purchases– Freight in, – Purchase returns– Discounts
Cost of goods sold is calculated at end of period.
MERCHANDISE INVENTORY
$25,000BEG. BALANCE
Periodic Inventory
MERCHANDISE INVENTORY
$25,000
This account is NOTchanged during theaccounting period
Periodic Inventory
MERCHANDISE INVENTORY
$25,000PURCHASES
XXX
Merchandise bought duringthe year is debited toPurchases instead ofMerchandise Inventory
Periodic Inventory
MERCHANDISE INVENTORY
$25,000PURCHASES
XXX
The COST of merchandise sold is NOT recorded.The selling price is credited to the Sales account
XXX
SALES
Periodic Inventory
On March 1, the Morris Company sold merchandise for $5,000 with terms of 2/10, n/30. The cost to Morris was $2,900.
3/1 Accounts Receivable.......... 5,000 Sales………….............… 5,000
Record sale to Acme Inc.
3/1 Cost of Goods Sold............ 2,900 Merchandise Inventory.. 2,900
Record Cost of Goods
Sales Revenue Periodic
Periodic
MERCHANDISE INVENTORY
$25,000
After a year of purchasing and selling merchandise, the balance is no longer accurate!
Periodic Inventory
MERCHANDISE INVENTORY
$25,000
An adjustment is needed to update the balance of the Merchandise Inventory account. That takes a physical count.
Periodic Inventory
The calculation to determine Cost of Goods Sold using the periodic method is as follows:
Beginning Inventory, Jan 1
+ Purchases for the year
= Cost of goods available for sale
- Ending Inventory, Dec. 31
= Cost of Goods Sold
Periodic Inventory
What Is the Sales Returns and Allowances Account?
Contra Revenue Account to salesUsed to show how much came back in returns
and allowances
Excessive returns and allowances suggest: inferior merchandise inefficiencies in filing orders errors in billing customers mistakes in delivery or shipment of
goods
Sales Returns and Allowances
Flip side of purchase returns and allowanceOn buyer’s books
GENERAL JOURNAL Debit Credit
Mar 1 Accounts Payable 300 Merchandise Inventory 300 To record goods returned to Sauk.
On seller’s books
GENERAL JOURNAL Debit Credit
Mar 1 Sales Returns and Allowance 300 Accounts Receivable 300 To record return of goods sold to Sauk Stereo.
Mar 1 Merchandise Inventory 170 Cost of Goods Sold 170 To record cost of goods returned from Sauk Stereo.
What Is the Sales Discount Account?
• Contra Revenue Account to sales
• Used to disclose amount of cash discounts given to customers
Sales DiscountsFlip side of purchase discounts
On seller’s books
GENERAL JOURNAL Debit Credit
May 14 Cash 3,430 Sales Discounts 70
Accounts Receivable 3500
To record collection within discount period.
On buyer’s books
GENERAL JOURNAL Debit Credit
May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70
To record payment within discount period
Transportation Costs
LOOK OUT !!!
For the
Outbound freight
It’s not part of inventory!
Freight Costs-on outgoing inventory
On May 6 we paid $150 to have merchandise inventory delivered to the
buyer.
GENERAL JOURNAL Debit Credit
May 6 Freight-Out Expense 150
Cash 150
To record payment of freight on goods sold.
Freight-Out Expense
Merchandise Inventory Cash
May 6 150May 6 150
Two Forms OfIncome Statements
• Single-step income statement• Multiple-step income statement
Single-Step Income Statement
One step… subtract total
expenses from total revenues
Revenues $10,000Expenses 3,000Net income $ 7,000
PW AUDIO, Inc.Single-step Income Statement
For the Year Ended December 31, 20xx
Sales $460,000Interest Revenue 3,000Gain on Sale of equipment 600
Total Revenues $463,600
ExpensesCost of goods sold $316,000
Selling expenses 76,000Administrative expenses 38,000Interest expense 1,800Casualty Loss from vandalism 200Income tax expense 10,100
Total expenses 442,100Net income $ 21,500
Sales revenuesSales $ 480,000Less: Sales returns and allowance $12,000
Sales discounts 8,000 20,000Net sales 460,000Cost of goods sold 316,000Gross profit $ 144,000Operating expenses Selling expenses:
Store salaries expense $45,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000
Total selling expenses $76,000 Administrative expenses Salaries expense $19,000
Utilities expense 17,000 Insurance Expense 2,000
Total administrative expenses 38,000 Total operating expenses 114,000 Income from operations $ 30,000
PW AUDIO SUPPLY, INC.Multi-step Income Statement
For the Year Ended December 31, 20xx
Income from operations (continued) $ 30,000 Other revenues and gains Interest revenue $ 3,000 Gain on sale of equipment 600
$ 3,600Other expenses and losses Interest expense $ 1,800 Casualty loss from vandalism 200 2,000 1,600Income before income taxes 31,600 Income tax expense 10,100Net income $21,500
PW AUDIO SUPPLY, INC.Multi-step Income Statement
For the Year Ended December 31, 20xx
Cost of goods sold Inventory, January 1 $ 36,000
Purchases $325,000Less Purchase returns and allowances $10,400Purchase discounts 6,800 17,200
Net purchases 307,800Add: Freight-in 12,200
Cost of goods purchased 320,000 Cost of goods available for sale 356,000 Inventory, December 31 40,000
Cost of goods sold 316,000
PW AUDIO SUPPLY, INC.Cost of Goods Sold
For the Year Ended December 31, 2005
Gross Profit Rate=
Gross Profit
Net Sales
Company’s gross profit expressed as a percentage of revenue
Profit Margin Ratio
Measures the percentage of each dollar of
sales that results in net income
Profit Margin Ratio = Net IncomeNet Sales
Higher value suggests favorable return on each dollar of sales.
Now, that wasn’t so bad! Was it?
