5-1 Accounting for Merchandise Operations Chapter 5 Electronic Presentation by Douglas Cloud Pepperdine University

5-1

Accounting for Merchandise Operations

Chapter 5

Electronic Presentation by Douglas Cloud

Pepperdine University

Electronic Presentation by Douglas Cloud

Pepperdine University

5-2

1. Distinguish the operating activities of a service business from those of a merchandising business.

2. Describe and illustrate the financial statements of a merchandising business.

3. Describe the accounting for the sale of merchandise.

4. Describe the accounting for the purchase of merchandise.

Learning GoalsLearning GoalsLearning GoalsLearning Goals

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

5-3

5. Describe the accounting for transportation costs and sales taxes.6. Illustrate the dual nature of merchandising transactions.7. Describe the accounting for merchandise shrinkage.8. Describe and illustrate the effects of inventory misstatements on

the financial statements.



5-4

9. Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.


5-5

1Learning GoalLearning GoalLearning GoalLearning Goal

Distinguish the operating activities of a service business from those of a merchandising business.

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In prior chapters, you were introduced to how to report the financial condition and changes

in financial condition for a service business.

In prior chapters, you were introduced to how to report the financial condition and changes

in financial condition for a service business.

5-7

In this chapter, you will be exposed to the accounting for

merchandise operations.

In this chapter, you will be exposed to the accounting for

merchandise operations.

5-8

Home Depot Inc.Condensed Income StatementFor the Year Ending December 28, 2001

(in millions)

Net sales $45,738Cost of merchandise sold 32,057Gross profit $13,681Operating expenses 9,490Operating income $ 4,191Other income 26Income before taxes $ 4,217Income taxes 1,636Net income $ 2,581

Home Depot Inc.Condensed Income StatementFor the Year Ending December 28, 2001

(in millions)

Net sales $45,738Cost of merchandise sold 32,057Gross profit $13,681Operating expenses 9,490Operating income $ 4,191Other income 26Income before taxes $ 4,217Income taxes 1,636Net income $ 2,581

The revenue account for

merchandise is Sales.

The revenue account for

merchandise is Sales.

The cost of merchandise sold is matched against

net sales.

The cost of merchandise sold is matched against

net sales.

Net sales is the revenue received from selling merchandise less

any merchandise returned or any discounts reported.

Net sales is the revenue received from selling merchandise less

any merchandise returned or any discounts reported.

Revenue minus cost provides gross profit.

Revenue minus cost provides gross profit.

What’s different on a What’s different on a merchandising income statement?merchandising income statement?

What’s different on a What’s different on a merchandising income statement?merchandising income statement?

5-9

Describe and illustrate the financial statements of a merchandising business.2

Learning GoalLearning GoalLearning GoalLearning Goal

5-10

Multiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income Statement

Online SolutionsIncome Statement

For the Year Ended December 31, 2007

Net sales $708,255Cost of merchandise sold 525,305Gross profit $182,950Operating expenses 105,710Operating income $ 77,240Other income and expense (net) (1,840)Operating income before taxes $ 75,400Income taxes 15,000Net income $ 60,400

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Sales $720,185Less sales returns and allowances $6,140Less sales discounts 5,790 11,930Net sales $708,255

Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account.

Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account.

Detailed Revenue SectionDetailed Revenue SectionDetailed Revenue SectionDetailed Revenue Section

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Sales returns and allowances are granted by the seller for damaged or defective merchandise.

Sales returns and allowances are granted by the seller for damaged or defective merchandise.

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Sales discounts are granted by the seller to customers for early payment of amounts owed.

Sales discounts are granted by the seller to customers for early payment of amounts owed.

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Purchases $521,980Less: Purchases returns and allowances $9,100

Purchases discounts 2,525 11,625Net purchases $510,355Add transportation-in 17,400 Cost of merchandise purchased $527,755

Purchases is the full cost of buying merchandise for resale.

Purchases is the full cost of buying merchandise for resale.

Detailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased Section

5-15




A Purchase return is the cost of the merchandise returned to the seller.

A Purchase return is the cost of the merchandise returned to the seller.A Purchase allowance is a reduction in purchase price because the item has a defect or was the wrong item ordered.

A Purchase allowance is a reduction in purchase price because the item has a defect or was the wrong item ordered.

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A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.

A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.

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Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.

Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.

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“Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which

follows the revenue section.

“Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which

follows the revenue section.

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Note on the next slide that the only change is that the section begins by adding the beginning

inventory and ends by subtracting the ending inventory.

Note on the next slide that the only change is that the section begins by adding the beginning

inventory and ends by subtracting the ending inventory.

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Merchandise inventory, Jan. 1, 2007 $ 59,700Purchases $521,980Less: Pur. returns and allow. $9,100

Purchases discounts 2,525 11,625Net purchases $510,355Add transportation-in 17,400 Cost of merchandise purchased 527,755Merchandise available for sale $587,455Less merchandise inventory, Dec. 31, 2007 62,150Cost of merchandise sold $525,305

Detailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold Section

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This income statement was prepared using the periodic

inventory method. The number of units on hand was

determined by a physical count.

This income statement was prepared using the periodic

inventory method. The number of units on hand was

determined by a physical count.

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In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary

for verification purposes.

In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary

for verification purposes.

5-23

Single-Step Income StatementSingle-Step Income StatementSingle-Step Income StatementSingle-Step Income Statement

Online SolutionsIncome Statement


Revenue:Net sales $708,255

Expenses:Cost of merchandise sold $525,305Operating expenses 105,710Income taxes 15,000Other income and expense (net) 1,840 647,855

Net income $ 60,400

5-24

Retained Earnings StatementRetained Earnings StatementRetained Earnings StatementRetained Earnings Statement

Online SolutionsRetained Earnings StatementFor the Year Ended December 31, 2007

Retained earnings, January 1, 2007 $128,800Net income for the year $60,400Less dividends 18,000Increase in retained earnings 42,400Retained earning, December 31, 2007 $171,200

5-25

Balance SheetBalance Sheet

Online SolutionsBalance SheetDecember 31, 2007

AssetsCurrent assets:

Cash $ 52,950Accounts receivable 76,080Merchandise inventory 62,150Office supplies 480Prepaid insurance 2,650 Total current assets $194,310


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Property, plant, and equipment:Land $ 20,000Store equipment $27,100 less accumulated depr. 5,700 21,400Office equipment $15,570 less accumulated depr. 4,720 10,850 Total property, plant, and equip. 52,250

Total assets $246,560

LiabilitiesCurrent liabilities:

Accounts payable $ 22,420Note payable 5,000Salaries payable 1,140Unearned rent 1,800 Total current liabilities $ 30,360


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Long-term liabilities:Note payable (final payment due 2017) 20,000

Total liabilities $ 50,360

Stockholders’ EquityCapital stock $ 25,000Retained earnings 171,200 196,200Total liabilities and stockholders’ equity $246,560

5-28

Statement of Cash FlowsStatement of Cash FlowsStatement of Cash FlowsStatement of Cash Flows

Online SolutionsStatement of Cash Flows


Cash flows from operating activities:Net income

$ 60,400Add: Depreciation expense—store equipment $ 3,100

Depreciation expense—office equipment 2,490Decrease in office supplies 120Decrease in prepaid insurance 350Increase in accounts payable 8,150 14,210


5-29

Deduct: Increase in accounts receivable $(24,080)Increase in merchandise inventory (2,450)Decrease in salaries payable (360)Decrease in unearned rent (600) (27,400)

Net cash flow form operating activities $47,120Cash flows from investing activities:

Purchase of store equipment $ (7,100)Purchase of office equipment (5,570)Net cash flows used in investing activities (12,670)

Cash flows from financing activities:Payment of note payable $ (5,000)Payment of dividends (18,000)Net cash flows used in financing activities (23,000)

Net increase in cash $11,450January 1, 2007 cash balance 41,500December 31, 2007 cash balance $ 52,950

5-30

Describe the accounting for the sale of merchandise.3


5-31

On January 3 Online Solutions sells merchandise costing $1,200 for

$1,800. The customer charges the purchase on a MasterCard.

On January 3 Online Solutions sells merchandise costing $1,200 for

$1,800. The customer charges the purchase on a MasterCard.

Transactions involving MasterCard or Visa are treated as cash sales.

5-32

Jan. 3 Cash 1,800Sales 1,800

This entry is made whether the company uses the periodic or perpetual system.

This entry is made whether the company uses the periodic or perpetual system.

Jan. 3 Cost of Merchandise Sold 1,200Merchandise Inventory 1,200

An additional entry is made if the firm uses a perpetual inventory system.

An additional entry is made if the firm uses a perpetual inventory system.

5-33

During January Online Solutions sold merchandise costing $68,000 to American Express customers for $100,000. Online

Solutions uses a perpetual inventory.

During January Online Solutions sold merchandise costing $68,000 to American Express customers for $100,000. Online

Solutions uses a perpetual inventory.

Transactions involving American Express are recorded as sales on account.

5-34

Jan. 31 Accounts Receivable— American Express 100,000

Sales 100,000

31 Cost of Merchandise Sold 68,000Merchandise Inventory 68,000

Online receives cash from American Express of $100,000, less a 4% service fee on February 15..

Online receives cash from American Express of $100,000, less a 4% service fee on February 15..

Feb. 15 Cash 96,000 Credit Card Expense 4,000

Accounts Receivable– American Express 100,000

5-35

Sales DiscountsSales DiscountsSales DiscountsSales Discounts

2/10, n/30

Credit Terms

The buyer is allowed a 2% discount if…

…the account is paid within 10

days.

The net (full) amount is due by

the 30th day.

5-36


On January 12 Online Solutions sells merchandise costing $850 on account to

Omega Tech for $1,500. Credit terms are 2/10, n/30. Payment is received on January 22.



Jan. 12 Accounts Receivable— Omega Tech 1,500

Sales 1,500

12 Cost of Merchandise Sold 850Merchandise Inventory 850

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Jan. 22 Cash 1,470Sales Discounts 30

Accounts Receivable— Omega Tech. 1,500





Contra Contra (offsetting) (offsetting) account to account to

SalesSales


SalesSales

5-38

Sales Returns and AllowancesSales Returns and AllowancesSales Returns and AllowancesSales Returns and Allowances

On January 13 Online Solutions issues a $2,000 credit memorandum to Krier Company for

merchandise that was returned. The merchandise (cost $1,200) was sold on account.

On January 13 Online Solutions issues a $2,000 credit memorandum to Krier Company for

merchandise that was returned. The merchandise (cost $1,200) was sold on account.

Jan. 13 Sales Returns and Allowances 2,000Accounts Receivable— Krier Company 2,000


SalesSales


SalesSales 13 Merchandise Inventory 1,200

Cost of Merchandise Sold 1,200

5-39

Describe the accounting for the purchase of merchandise.4


5-40

On January 3 Online Solutions purchased $2,500 of merchandise for cash. Recall that Online Solutions uses the perpetual system.

On January 3 Online Solutions purchased $2,500 of merchandise for cash. Recall that Online Solutions uses the perpetual system.

Jan. 3 Merchandise Inventory 2,500Cash 2,500

If this transaction had been on account from Max Corporation (terms: 1/15, n/30), the

entry would have been:

If this transaction had been on account from Max Corporation (terms: 1/15, n/30), the

entry would have been:

Jan. 3 Merchandise Inventory 2,500Accounts Payable—Max Corporation 2,500

5-41

Purchase DiscountsPurchase DiscountsPurchase DiscountsPurchase Discounts

On January 17 Online Solutions pays Max Corporation the invoice amount less the discount.

On January 17 Online Solutions pays Max Corporation the invoice amount less the discount.

Jan. 17 Accounts Payable—Max Corp. 2,500Merchandise Inventory 25Cash 2475

The asset The asset account is account is reduced.reduced.

The asset The asset account is account is reduced.reduced.

Instead, assume the payment is made on Feb. 1 .Instead, assume the payment is made on Feb. 1 .

Feb. 1 Accounts Payable—Max Corp. 2,500Cash 2,500

5-42

Purchases Returns and AllowancesPurchases Returns and AllowancesPurchases Returns and AllowancesPurchases Returns and Allowances

On January 22 Online Solutions returns $5,000 of merchandise purchased from Quantum Inc.

On January 22 Online Solutions returns $5,000 of merchandise purchased from Quantum Inc.

Jan. 22 Accounts Payable—Quantum Inc. 5,000Merchandise Inventory 5,000

If the above return represents only part of the total purchase and credit terms are 2/10, n/45, the

discount, if taken on the balance of the order, only applies to the merchandise kept.

If the above return represents only part of the total purchase and credit terms are 2/10, n/45, the

discount, if taken on the balance of the order, only applies to the merchandise kept.

5-43

Describe the accounting for transportation costs and sales taxes.5


5-44

Transportation CostsTransportation CostsTransportation CostsTransportation Costs

PhilPhil’s ’s TruckTruckiinn

gg

5-45

5-46


On January 19 Online Solutions buys merchandise from Data Max on Account, $2,900,

terms FOB shipping point, and prepays the transportation cost of $150.

On January 19 Online Solutions buys merchandise from Data Max on Account, $2,900,

terms FOB shipping point, and prepays the transportation cost of $150.

Jan. 19 Merchandise Inventory 2,900Accounts Payable—Data Max 2,900

19 Merchandise Inventory 150Cash 150

5-47


On January 24 Online Solutions sells merchandise to Miller Company on account,

$4,700, terms FOB destination. The cost of the merchandise sold is $2,750, and Online Solutions

pays the transportation cost of $350.




Jan. 24 Accounts Receivable—Miller Co. 4,700Sales 4,700


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Jan. 24 Transportation Out 350Cash 350

An expense







5-49


On January 14 Online Solutions sells merchandise to Golden Company on account, $8,000, terms 2/10, n/30, FOB shipping point. The cost of the merchandise sold is $4,800, and

Online pays the transportation cost of $500.



Jan. 14 Accounts Receivable—Golden Co. 8,000Sales 8,000


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Jan. 14 Accounts Receivable—Golden Co. 500Cash 500

Online prepaid the transportation cost although it is Golden’s responsibility. This debit sets up the reimbursement.

5-51

Sales TaxesSales TaxesSales TaxesSales Taxes

On March 19 Tom’s Meat Market had cash sales totaling $1,700. The local sales tax is 7%, which is collected on each sale. The entry to record the

day’s sales is as follows:

On March 19 Tom’s Meat Market had cash sales totaling $1,700. The local sales tax is 7%, which is collected on each sale. The entry to record the

day’s sales is as follows:

Mar. 19 Cash 1,819Sales 1,700Sales Taxes Payable 119

5-52

Illustrate the dual nature of merchandising transactions.6


5-53

July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB

shipping point, n/45. The cost of the merchandise sold was $4,500



Accounts Receivable—Burton Co. 7,500Sales 7,500

Scully Co. (Seller)Scully Co. (Seller)Scully Co. (Seller)Scully Co. (Seller)

Cost of Merchandise Sold 4,500Merchandise Inventory 4,500

5-54





Merchandise Inventory 7,500Accounts Payable—Scully Co. 7,500

Burton Co. (Buyer)Burton Co. (Buyer)Burton Co. (Buyer)Burton Co. (Buyer)

5-55

July 2. Burton Co. paid transportation charges of $150 on

July 1 purchase of Scully Company.

July 2. Burton Co. paid transportation charges of $150 on

July 1 purchase of Scully Company.

No entry.


Merchandise Inventory 150Cash 150


5-56

July 5. Scully Company sold merchandise on account to Burton Co., $5,000, terms FOB destination, n/45. The cost of the

merchandise sold was $3,500






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5-58

July 7. Scully Co. paid transportation charges of $250 for delivery of

merchandise sold to Burton Co. on July 5.

July 7. Scully Co. paid transportation charges of $250 for delivery of

merchandise sold to Burton Co. on July 5.


No entry


Transportation Out 250Cash 250

5-59

July 13. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1,000. The merchandise had been purchased by Burton Co. on account on July 5. The cost

of the merchandise returned was $700.



Sales Return and Allowances 1,000Accounts Receivable—Burton Co. 1,000


Merchandise Inventory 700Cost of Merchandise Sold 700

5-60





Accounts Payable—Scully Co. 1,000Merchandise Inventory 1,000


5-61

July 15. Scully Company received payment from Burton Co. for purchase of July 5.

July 15. Scully Company received payment from Burton Co. for purchase of July 5.

Cash 4,000Accounts Receivable—Burton Co. 4,000


Accounts Payable—Scully Co. 4,000Cash 4,000


5-62

July 18. Scully Co. sold merchandise on account to Burton Co., $12,000, terms FOB

shipping point, 2/10, n/eom. Scully Co. prepaid transportation costs of $500, which were added to the invoice. The cost of the

merchandise sold was $7,200.






Accounts Receivable—Burton Co. 500Cash 500

The full amount is due by the end of

the month.

The full amount is due by the end of

the month.

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5-64









5-65

July 28. Scully Company received payment from Burton Company for purchase of July 18,

less discount (2% x $12,000).

July 28. Scully Company received payment from Burton Company for purchase of July 18,

less discount (2% x $12,000).

Cash 12,260Sales Discount 240

Accounts Receivable—Burton Co. 12,500


Accounts Payable—Scully Co. 12,500Merchandise Inventory 240Cash 12,260


5-66

Describe the accounting for merchandise shrinkage.7


5-67

When a company uses a perpetual

inventory, a physical count is taken at the

end of the accounting period to

determine the accuracy of the

perpetual records and to record any

inventory shrinkage.

5-68

Online Solutions’ inventory records indicate that $63,950 of merchandise

should be available for sale on December 31, 2007. The physical inventory taken on

that date indicates that only $62,150 of merchandise is available for sale.

Online Solutions’ inventory records indicate that $63,950 of merchandise

should be available for sale on December 31, 2007. The physical inventory taken on

that date indicates that only $62,150 of merchandise is available for sale.

Inventory shrinkage is $1,800Inventory shrinkage is $1,800Inventory shrinkage is $1,800Inventory shrinkage is $1,800


5-69

Describe and illustrate the effects of inventory misstatements on the financial statements.


5-70

Effects of Inventory MisstatementsEffects of Inventory MisstatementsEffects of Inventory MisstatementsEffects of Inventory Misstatements

Income Statement EffectsIncome Statement Effects

Physical Inventory

Misstatement

Inventory Shrinkage Misstated

Cost of Merchandise

Sold Misstated

Gross Profit

Misstated

Net Income

Misstated

Balance Sheet EffectsBalance Sheet Effects

Physical Inventory

Misstatement

Adjusted Mer. Inv. Misstated

Current Assets

Misstated

Total Assets

Misstated

Retained Earnings Misstated

Net Income

Misstated

5-71

On December 31, 2007, Sapra Company incorrectly counted its physical inventory

as $115,000 instead of $125,000.


as $115,000 instead of $125,000.

2007 Financial StatementsAmount of Misstatement Overstated (Understated)

Balance Sheet as of December 31, 2007:Merchandise inventory $(10,000)Current assets (10,000)Total assets (10,000)Total stockholders’ equity (retained earnings) (10,000)

Income Statement for Year Ended December 31, 2007:Cost of merchandise sold $10,000Gross profit (10,000)Net income (10,000)

5-72


as $115,000 instead of $125,000.


as $115,000 instead of $125,000.

2008 Financial StatementsAmount of Misstatement Overstated (Understated)

Balance Sheet as of December 31, 2008:Merchandise inventory CorrectCurrent assets CorrectTotal assets CorrectTotal stockholders’ equity (retained earnings) Correct

Income Statement for Year Ended December 31, 2008:Cost of merchandise sold $(10,000)Gross profit 10,000Net income 10,000

5-73

Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.


5-74

Gross profit and operating income are two important

profitability measures analyst use in assessing…

Gross profit and operating income are two important

profitability measures analyst use in assessing…

…the efficiency and effectiveness of a

merchandiser’s operations.

…the efficiency and effectiveness of a

merchandiser’s operations.

5-75

Gross Profit PercentGross Profit PercentGross Profit PercentGross Profit Percent

Net sales $32,004Cost of merchandise sold 22,789Gross profit $ 9,215Operating expenses 8,459Operating income $ 756

$9,2l5$32,004

= 28.8%

5-76


J. C. Penny’s gross profit percentage went from 28.8% to 27.7%, then

recovered back to 29.8%.

J. C. Penny’s gross profit percentage went from 28.8% to 27.7%, then

recovered back to 29.8%.

5-77


The recovery in the third year was attributed to better merchandise assortment, improved inventory

productivity, and centralized buying.

The recovery in the third year was attributed to better merchandise assortment, improved inventory

productivity, and centralized buying.

5-78

Operating Income PercentOperating Income PercentOperating Income PercentOperating Income Percent

Net sales $32,004Cost of merchandise sold 22,789Gross profit $ 9,215Operating expenses 8,459Operating income $ 756

$756$32,004

= 2.4%

5-79

Operating Income PercentOperating Income PercentOperating Income PercentOperating Income Percent

The company’s operating income percentage dropped from 2.4% to

0.6%, then recovered back to 2.7%.

The company’s operating income percentage dropped from 2.4% to

0.6%, then recovered back to 2.7%.

5-80

Operating Income PercentOperating Income PercentOperating Income PercentOperating Income PercentThis recovery was attributed to

lower catalog and marketing costs, lower telemarketing costs, and a

shift from development to maintenance of JCPenny.com.

This recovery was attributed to lower catalog and marketing costs,

lower telemarketing costs, and a shift from development to

maintenance of JCPenny.com.

5-81

The EndThe End

Chapter 5Chapter 5

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Documents

5-1 Accounting for Merchandise Operations Chapter 5 Electronic Presentation by Douglas Cloud Pepperdine University