5-1 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 OperationsMerchandising 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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The operating

cycle of a

merchandising

company

ordinarily is

longer than that

of a service

company.

Operating Cycles


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MerchandisingMerchandising Operations OperationsMerchandisingMerchandising 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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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

$ 100,000

Add: Purchases

800,000

= Goods available for sale

900,000

Less: Ending inventory

125,000

= Cost of goods sold

$ 775,000


Flow of Costs – Periodic System

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The perpetual system continuously maintains detailed records of the cost of each inventory purchase and sale. This is done electronically though computerized registers and scanning. Each acquisition of merchandise for resale is debited to inventory, when sold inventory is credited and the cost of the goods sold is debited.

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 MerchandiseRecording 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


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 $3,500 (original invoice price of $3,800 less the

return on May 8 of $300) within the discount period. 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 6

Cash 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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Inventory

Debit Credit

$3,800 8th - Return$300

Balance

4th - Purchase

$3,580

70 14th - Discount


A Summary of Sauk’s Purchasing Transactions

1506th – Inventory (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) XXX

Sales revenue XXX

Recording PW’s Sale to SaukRecording 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 XXX

Inventory XXX

#2

Selling Price

Cost of the Goods Sold

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

$3,800 - $2,400 = $1,400 called the gross profit on this sale - Slide 4.

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 4

Inventory 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 MerchandiseRecording 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 8

Accounts receivable 300

Inventory 140May 8

Cost 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 – slide 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 (the original

$3,800 less the purchase return of $300), less the 2%

discount of $70 (slide 14). For Sauk the $70 is a reduction

in the cost of the inventory. For PW the $70 is a reduction

in the sale (a discount). PW records the May 14 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 PresentationIncome 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 PresentationA 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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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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Operating Expenses

(See slides 9 &10)

Freight Out is when the seller pays the freight cost – FOB Destination (slides 9 & 10)

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Additions to Income Statement PresentationsAdditions to Income Statement PresentationsAdditions to Income Statement PresentationsAdditions to Income Statement Presentations

Non-operating Activities

Various 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

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

AssetsAssets



Chapter 3-24

LiabilitiesLiabilities



Chapter 3-25



StockholdersStockholders’’ EquityEquity

Chapter 3-25



Common StockCommon Stock

Chapter 3-23

DividendsDividends



= +

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

AssetsAssets



Chapter 3-24

LiabilitiesLiabilities



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

Documents

5-1 5 MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP I/S