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CHAPTER 5:Merchandising OperationsFINANCIAL ACCOUNTINGTools for Business Decision-MakingKIMMEL WEYGANDT KIESO TRENHOLM IRVINESO 1: Identify the differences between service and merchandising companies.SO 2: Prepare entries for purchases under a perpetual inventory system.SO 3: Prepare entries for sales under a perpetual inventory system.SO 4: Prepare a single-step and multiple-step income statement.SO 5: Calculate the gross profit margin and profit margin.SO 6: Prepare entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A).STUDY OBJECTIVESDifferences Between Service and Merchandising CompaniesService companies perform services as their primary source of revenueMerchandising companies buy and sell inventory (e.g. Loblaws):Retailers sell to consumersWholesalers sell to retailersManufacturers produce goods for saleOperating CycleThe time it takes to go from cash to cash in producing revenuesLonger for a merchandising company that for a service company:Merchandise must first be purchased before it can be soldAdds an additional step to the cycleIncome Measurement ProcessRevenue:Sales revenue (from the sale of merchandise): the main sourceExpenses are divided into two categories:Cost of goods sold: total cost of merchandise sold in a periodOperating expenses: incurred in the process of earning sales revenueGross profit= Sales revenue less cost of goods soldIncome Measurement Process for Merchandiser

Inventory SystemsFlow of costs for a merchandising company:Beginning inventory + purchases = cost of goods available for saleOnce sold, these costs are assigned to cost of goods soldGoods left over are ending inventoryOne of two systems is used to account for inventory and cost of goods sold:Perpetual inventory systemPeriodic inventory systemPerpetual SystemDetailed records are kept for the cost of each product purchased and soldThese records are updated continuously (perpetually) for purchases and salesA physical count is done at least once a year to adjust perpetual records to actualThis system enables the effective control of inventory which is an important assetPeriodic SystemDetailed records of merchandise are not kept throughout the periodCost of goods sold is only determined at the end of the accounting period:Once inventory is countedCost of goods sold = Beginning inventory + cost of purchases less ending inventory Discussion QuestionHow do companies decide which inventory system to use?

Purchases of MerchandisePurchases are recorded in the Merchandise Inventory accountIncludes all costs to get merchandise to place of business and ready for resale:Includes freight and applicable taxesLess purchase returns, allowances, discountsCredit purchases are supported by a purchase invoiceSales Taxes and Freight GST and HST paid does not form part of cost of goods (refunded)Generally no PST on goods purchased for resaleFOB (Free on Board) refers to where title or ownership of goods transfers:FOB destination: buyers place of businessFOB shipping point: sellers place of businessFreight paid by buyer (FOB shipping point) is part of the cost of merchandise purchasedFOB DestinationOwnership of the goods does not pass from the seller to the buyer until the goods are received by the buyer (i.e. destination point)

FOB Shipping PointOwnership of the goods passes from the seller to the buyer as soon as the goods are shipped

Discussion QuestionWho pays the freightthe seller or the buyerwhen the shipping terms are (a) FOB shipping point and (b) FOB destination?

Purchase Returns and AllowancesA purchaser returns the goods to the seller and receives a cash refund or creditThe buyer may choose to keep the merchandise if the seller is willing to give an allowance (deduction) from the purchase priceIn both cases, the result is a decrease to the cost of goods purchasedDiscountsA quantity discount gives a price reduction according to the volume of the purchase:Not recorded separately discounted price is recorded as cost of purchaseA purchase discount is offered to encourage early payment of a balance due. Example: 2/10, n/30:Recorded separately when payment made. Results in a decrease to Merchandise Inventory accountSummary of Purchase Transactions

Sales of MerchandiseRecording of sales:Two entries required: one to record sales price and one to record cost of saleSales taxes are not recorded as revenueWhen freight is FOB destination, seller records cost of freight as an expenseSales returns and allowances are a contra revenue account to SalesSales discounts are also a contra revenue account to SalesSummary of Sales Transactions

Recording Inventory Sales

Income Statement PresentationTwo different forms of income statement:Single-stepAll data classified into two categories: revenues and expensesMultiple-stepShows several steps in determining profit or lossNet salesGross profitProfit from operationsNon operating revenues and expensesProfitSingle-Step Income StatementRevenuesNet salesInterest revenueTotal revenuesExpensesCost of goods soldOperating expensesInterest expenseLoss on sale of equipment Total expensesProfit before income taxIncome tax expenseProfit$460,000 3,400 463,400

316,000 114,0001,800 200 432,00031,600 6,300$ 25,300Multiple-Step Income StatementSales revenues Sales Less: Sales returns and allowancesSales discountsNet salesCost of goods soldGross profitOperating expenses Salaries expense Rent expense Utilities expense Advertising expense Depreciation expense Freight out Loss on sale of equipment Total operating expenses Profit from operations$12,000 8,000

$45,00019,000 17,00016,0008,0009,000 200$480,000

20,000460,000316,000144,000

114,20029,800Multiple-Step Income Statement (continued)Profit from operations (continued)Other revenues and gains Interest revenueOther expenses and losses Interest expense

Profit before income taxIncome tax expenseProfit$3,400

1,600

$ 29,800

1,800

31,600 6,300$ 25,300Evaluating Profitability:Gross Profit MarginMeasures the gross profit expressed as a percentage of net salesGross profit margin = Gross profit Net salesHigher is generally betterEvaluating Profitability:Profit MarginMeasures the percentage of each dollar of sales that results in profitProfit margin = Profit Net salesHigher is generally betterDiscussion QuestionWhy would food stores (e.g. Sobeys), generally experience lower gross profit and profit margins than businesses such as computer services (e.g., Microsoft)?

Appendix 5A:Periodic Inventory System Compare to perpetual inventory system:Differences in recording purchasesDifferences in recording salesCost of goods sold is calculated only at the end of a period, using ending inventory count

Comparison of Entries for Inventory Purchases

Comparison of Entries for Sales

Calculating Cost of Goods SoldThree steps are required:Calculate cost of goods purchasedDetermine ending inventoryCalculate the cost of goods sold

Multiple-Step Income StatementSales revenue Sales Less: Sales returns and allowances Sales discounts Net salesCost of goods sold Inventory, January 1 Purchases Less: Purchase returns Purchase discounts Net purchases Add: Freight in Cost of goods purchased Cost of goods available for sale Inventory, December 31Cost of goods soldGross profit$325,000 10,400 6,800307,800 12,200$12,000 8,000

$ 36,000

320,000356,00040,000$480,000

20,000460,000

316,000144,000Multiple-Step Income Statement (continued)Gross profit (continued)Operating expenses Salaries expense Rent expense Utilities expense Advertising expense Depreciation expense Freight out Insurance expense Loss on sale of equipment Total operating expenses Profit from operations$45,00019,00017,00016,0008,0007,0002,000 200$144,000

114,20029,800Multiple-Step Income Statement (continued)Profit from operations (continued)Other revenues and gains Interest revenueOther expenses and losses Interest expense

Profit before income taxIncome tax expenseProfit$3,400

1,600

$ 29,800

1,80031,600 6,300$ 25,300Comparing IFRS and ASPE

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