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Accounting for Merchandising Business
 

Accounting for Merchandising Business

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    Accounting for Merchandising Business Accounting for Merchandising Business Presentation Transcript

    • Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds
      • PowerPoint ® presentation by
      • J. Lawrence Bergin
    • Chapter 5
      • Accounting
      • for
      • Merchandising Businesses
    • Chapter 5: Accounting for Merchandising Businesses
      • What is the difference between a service firm and a merchandising firm?
      • How does a firm account for inventory?
      • How are financial statements affected by the purchase and sale of merchandise inventory?
      Sale In Chapter 5 we will consider the following questions.
    • Four Major Types of Businesses
      • Service
        • accountants, attorneys, physicians
      • Merchandising
        • Wal-Mart, Safeway, The Gap
      • Manufacturing
        • General Motors, 3M, Reynolds Metals
      • Financial
        • Citicorp, Merrill Lynch, American Express
      • [Obviously, some businesses provide more than one of the functions listed above]
    • Four Major Types of Businesses Which type of business is a musician? Service, Merchandising, Manufacturing, Financial?
      • Performs at concerts
      • Service business
      • Sells CDs during breaks
      • Merchandiser
      • Records and duplicates
      • own CDs
      • Manufacturer
    • Net Sales Sales (sometimes called “Gross Sales”) Minus: Sales Returns and Allowances Minus: Sales Discounts (often given to credit customers who pay the seller quickly) = Net Sales
    • Cost of Goods Sold
      • Cost of goods sold is calculated as the number of units sold during the period multiplied by their unit costs.
      • Cost of goods sold is a major expense item for most non-service businesses.
      • The measurement of cost of goods sold is an excellent example of the application of the matching principle Why?
      The Cost of Goods Sold EXPENSE is recorded in the period the units are SOLD (REVENUE is recognized), regardless of when the units are paid for. So, the EXPENSE is MATCHED against the related REVENUE.
    • Cost of Goods Sold Cost of Goods Available for Sale expresses the total cost of what has been available for sale throughout a given time period. What is included in the “net” cost of purchases? Beginning inventory Add: Purchases (net) Cost of Goods Available for Sale Deduct: Ending inventory Cost of goods sold
    • Cost of Goods Sold “ Cost of Goods Available for Sale” is the total cost of what has been available for sale throughout a given time period. Beginning inventory Plus: Purchases Minus: Purchase Returns & Allowances Minus: Purchase Discounts Plus: Transportation-in Purchases, net = Cost of Goods available for sale Minus: Ending inventory = Cost of goods sold
    • Income Statement Formats
      • Single Step -
      • with details
      • Single Step -
      • condensed
      • Multi-step -
      • with details
      • Multi-step -
      • condensed
      Let’s look at examples…..
    • Income Statement Formats
      • Net Sales 100
      • Less: Cost of goods sold 60
      • Gross Profit Margin 40
      • Operating Expenses:
      • Selling:
      • Sales Salaries 8
      • Advertising 2
      • Total Selling 10
      • Administrative:
      • Admin. Salaries 3
      • Building Rent 8
      • Total Adm. Exp. 11
      • Total Operating Exp. 21
      • Operating Income 19
      • Non-Operating Rev. (Exp.)
      • Interest Expense (1)
      • Income before tax 18
      • Income Tax expense 3
      • Net Income 15
      Multi-step with details Multi-step: condensed Net Sales 100 Less: Cost of goods Sold 60 Gross Profit Margin 40 Operating Expenses: Selling Expenses 10 Administrative Exp. 11 Total Operating Exp. 21 Operating Income 19 Non-Operating Rev. (Exp.) Interest Expense (1) Income before tax 18 Income Tax expense 3 Net Income 15
    • Income Statement Formats
      • Net Sales 100
      • Less: Cost of goods sold 60
      • Gross Profit Margin 40
      • Operating Expenses:
      • Selling:
      • Sales Salaries 8
      • Advertising 2
      • Total Selling 10
      • Administrative:
      • Admin. Salaries 3
      • Building Rent 8
      • Total Adm. Exp. 11
      • Total Operating Exp. 21
      • Operating Income 19
      • Non-Operating Rev. (Exp.)
      • Interest Expense (1)
      • Income before tax 18
      • Income Tax expense 3
      • Net Income 15
      Multi-step with details Multi-step: condensed Net Sales 100 Less: Cost of goods Sold 60 Gross Profit Margin 40 Operating Expenses: Selling Expenses 10 Administrative Exp. 11 Total Operating Exp. 21 Operating Income 19 Non-Operating Rev. (Exp.) Interest Expense (1) Income before tax 18 Income Tax expense 3 Net Income 15 The multi-step INCOME Statement format classifies interest as a NON-operating item . But, interest is still an OPERATING ACTIVITY on the CASHFLOW Statement.
    • Income Statement Formats
      • Net Sales 100
      • Less Expenses:
      • Cost of goods sold 60
      • Sales Salaries 8
      • Advertising 2
      • Admin. Salaries 3
      • Building Rent 8
      • Interest Expense 1
      • Income Tax Expense 3
      • Total Expenses 85
      • Net Income 15
      Single-step with details Single-step: condensed Net Sales 100 Less Expenses: Cost of goods sold 60 Selling 10 Administrative 11 Interest Expense 1 Income Tax Expense 3 Total Expenses 85 Net Income 15 When using the Condensed form for either multi- or single-step, if there isn’t enough information to separate the expenses into Selling & Administrative categories, list their sum as “Operating Expenses”.
    • Income Statement Formats
      • Net Sales 100
      • Less Operating Exp.
      • Cost of goods sold 60
      • Sales Salaries 8
      • Advertising 2
      • Admin. Salaries 3
      • Building Rent 8
      • Interest Expense 1
      • Total Oper. Exp. 82
      • Income before taxes 18
      • Income Tax Expense 3
      • Net Income 15
      Single-step with details Single-step: condensed Net Sales 100 Less Expenses: Cost of goods sold 60 Selling 10 Administrative 11 Total Oper. Exp. 81 Income before taxes 19 Income Tax Expense 4 Net Income 15 A common modification of the single-step method is to have the income tax expense separated out.
    • Income Statement Formats Treatment of Special items Sales 100 Less Expenses: Cost of goods sold 60 Selling 10 Administrative 11 Total Oper. Exp. 81 Income before taxes 19 Income Tax Expense 4 Inc. from Continuing Operations 15 Discontinued Operation-Disposal Gain 2 Extraordinary Item-Tornado Loss (3) Cumulative Effect of a Change in Accounting Principle 4 Net Income 18 Results of Discontinued Operations, Extraordinary Gains and Losses, and Cumulative Effect of a Change in Accounting Principle No matter which income statement format is used, these 3 special items are ALWAYS at the bottom of the income statement. The meaning of these three special items are covered in more advanced courses.
    • Inventory
      • Inventory is tangible property that is held for resale or will be used in producing goods or services.
      • Inventory is reported on the balance sheet as an asset .
      • Types of inventory:
        • Merchandise inventory
        • Raw materials inventory
        • Work in process inventory
        • Finished goods inventory
      manufacturer
    • Inventory Cost
      • The cost principle requires that inventory be recorded for the price paid or the consideration given up.
      • What type of transaction is the purchase of inventory?
      Asset Exchange if cash paid. Asset Source if “on account”.
    • Inventory Cost
      • The amount recorded for inventory should include:
        • Invoice price (minus purchase discounts), transportation-in costs (also called “freight-in”), inspection costs, and preparation costs.
      • The company should accumulate costs of purchases until raw materials are ready for use or until merchandise is ready for shipment to customers.
    • Terms of Sales & Purchases
      • Discount Terms: 2/10, n/30 (for example)
        • 2% discount if balance paid in ten days,
        • remainder to be paid within 30 days of sale
        • tells when and how much must be paid
        • There is a high interest cost of not taking purchase discounts when offered.
        • Let’s look at an example.
    • What is the annual interest rate equivalent of NOT taking a 2/10, n30 discount?
      • Q. How many “extra” days can ABC Co. keep its money if it gives up the 2% discount?
      • A. 20 extra days .
      • ABC could pay on day 10 and still take the discount.
      • By not taking the discount ABC can keep the money
      • from day 11 through day 30, which is 20 more days.
      • Q. How many 20 day periods are there in a 360 day year?
      • A. 360/20 = 18 twenty day periods in a year.
      • Q. What is the approximate ANNUAL interest rate cost of not taking 2% discounts?
      • A. 2% lost discount for each of 18 twenty day periods = (2%x18) =
              • 36% annual interest rate
      CONCLUSION If you can borrow at less than 36% APR, borrow to take the discount.
    • Terms of Sales & Purchases
      • F. O. B. ( F ree O n B oard) shipping point or F.O.B. destination
        • tells who pays for the shipping and when ownership “title” passes from the seller to the buyer.
    • FOB Shipping and FOB Destination
      • FOB Shipping Point: Buyer pays the shipping costs because ownership “title” transfers to buyer at the point the shipment starts on its journey.
      • FOB Destination: Seller pays shipping costs because title does not transfer to the buyer until the goods reach their destination (the buyer’s place of business).
    • Timing is EVERYTHING...
      • Recognize revenue when “earned”
        • earned when an exchange (seller to buyer) occurs
      • Three levels of the matching principle
        • Product costs (e.g., inventory costs): assets until produce revenue
          • direct cause & effect relationship between revenue and expense
        • Period costs: systematic & rational allocation
          • e.g., depreciation costs
        • Period costs: recognize as expense as incurred
          • e.g., advertising costs
    • Perpetual Inventory Systems
      • The inventory account is continuously updated for the following events:
        • Purchases
        • Purchase Discounts Taken
        • Purchase Returns & Allowances
        • Sales (remove from inventory the COST of the units sold)
        • Sales Returns (add to inventory the COST of units returned)
        • The necessary detailed record-keeping required by the perpetual system has become much easier with current computer technology.
      • A physical count of the inventory is still required at the end of the accounting period to assure accurate inventory records in case of errors or theft.
    • Perpetual Inventory Systems
      • Cost of Goods Sold . . .
        • Contains the cost of units that have been sold to customers.
        • Is a temporary account.
        • (It will be closed out at
        • the end of the period.)
        • Is an expense account.
    • Transaction Analysis
      • The following selected events occurred during 2004 at Clock Company which uses the PERPETUAL INVENTORY SYSTEM.
      • For each event:
        • Determine the effect on the financial statements.
        • Record the event in the journal and ledger.
    • Transactions
      • 1. Purchased 1000 units for $4 each on account. Terms: 2/10, n/30
      • 2. Paid a trucking company $500 to deliver the purchased units to our warehouse.
      • 3. Sold 620 units on account for $6 each. (Terms 1/10, n/30)
        • 3A: Record the revenue. 3B: Record cost of goods.
      • 4. The customer in Transaction #3 returned 20 units for credit.
        • 4A: Remove the revenue. 4B: Return the units to inventory.
      • 5. Customer in Trans. #3 paid within the 10 day discount period.
        • 5A: Record the 1% sales discount. 5B: Record the cash collection.
      • 6. Returned 50 units to our supplier who granted us credit for the cost of the units but not for any transportation costs.
      • 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.
      • 8. Paid for the Trans. #1 purchase within the 10 day discount period.
        • 8A: Record 2% purchase discount. 8B: Record the cash payment.
      • 9. Record payment of the $340 shipping cost to customer in Tran. #3.
        • (Original sale was based on F.O.B. destination.)
      • Purchased 1000 units for $4 each on account. (Terms: 2/10, n/30)
    • 1. Journalize & Post the purchase.
      • Paid a trucking company $500 to deliver the purchased units to our warehouse.
      Freight charges paid to get inventory to our place of business (called TRANSPORTATION IN) is part of the cost of the purchase . It is added to the Inventory account , thus increasing the asset value. It is NOT “expensed”.
    • 2. Journalize & Post the transportation cost
    • 3. Sold 620 units on account for $6 each. (Terms 1/10, n/30) $6 sales price x 620 units = $3720 3a. Record the Sales Revenue and related Receivable.
    • 3a. Journalize and Post the sale.
    • 3b. Record the Cost of the Goods Sold and their removal from inventory. 620 units sold x $4.50 cost each = $2790 What is the cost of each item in inventory? $4.00 invoice price + $0.50 transportation = $4.50 per unit $500 transport / 1000 units Cost of goods sold
    • 3b. Journalize and Post the cost of the sale.
    • 4. The customer in Transaction #3A returned 20 units for credit. $6 sales price x 20 units = $120 4a. Remove the previously recorded Sales Revenue and related Account Receivable. A separate “Sales Return” contra-revenue account may be used.
    • 4a. Journalize and Post the sales return.
    • 4b. Put the cost of the 20 returned units back into inventory and out of Cost of Goods Sold. (Recall, the units were “costed out” of inventory and charged to Cost of Goods Sold at $4.50 each in Tr. #3b.) $4.50 x 20 units = $90 Reduction in “Cost of Goods Sold”.
    • 4b. Journalize and Post the return to inventory.
    • 5a. The Transaction #3a customer paid within the ten day discount period. Record the Sales Discount. (1/10, n/30) Original Account Receivable (Transaction 3a) $3,720 Less: Sales Return (Transaction 4a) 120 Amount owed by customer before discount 3,600 x 1% sales discount 1 % Sales Discount $ 36
    • 5a. Journalize and Post the 1% Sales Discount.
    • 5b. The Transaction #3a customer paid within the ten day discount period. Record the cash collection. Original Account Receivable (Transaction 3a) $3,720 Less: Sales Return (Transaction 4a) (120) Less: Sales Discount (Transaction 5a) (36) Cash receipt that will satisfy the account $3,564
    • 5b. Journalize and Post the cash collection.
      • Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.
      Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account. That’s what we’ll do here. Supplier cost was $4.00 per unit x 50 = $200. Transportation cost recorded when units were purchased was $0.50 per unit x 50 = $25.
    • 6. Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.
    • 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.
      • Units in Beginning Inventory 0
      • + Units Purchased this period (1000- 50 purchase returns) 950
      • = Units Available for Sale 950
      • Units Sold (620 – 20 sales returns) (600)
      • = Units that should be in ending inventory 350
      • Actual ending inventory from count (340)
      • = Units missing 10
      • x $4.50 cost per unit $45.00
    • 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost. Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account. That’s what we’ll do here.
    • 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.
    • 8a. Paid within discount period, so record the 2% discount on the $4000 Tran. #1 purchase less $200 Tran. #6 return. Purchase (Transaction #1) $4000 Less Purchase Return (Trans. #6) 200 Amount owed 3800 X discount % 2% Amount of Purchase Discount $ 76 This reduces the cost of the inventory and the amount we owe the supplier .
    • 8a. Paid within discount period, so record the discount on the $4000 Tr. #1 purchase less $200 Tr. #6 return.
    • 8b. Paid the remaining balance on the Transaction #1 inventory purchase. $4000 purchase (Trans. #1) - 200 purchase return (Trans. #6) - 76 purchase discount (Trans. #8a) $3724 remainder to pay supplier
    • 8b. Paid the remaining balance on the Transaction #1 inventory purchase. ($4000-200-76 = $3724 to pay)
    • 9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost. Transportation charges on PURCHASES are added to the cost of the asset, INVENTORY. (Transportation IN) Transportation charges to ship products TO CUSTOMERS are reported as operating expenses on the income statement. The appropriate account title is TRANSPORTATION OUT (or FREIGHT OUT or SHIPPING EXPENSE).
    • 9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost.
    • Clock Company Ending Balances of LEDGER Accounts
    • Summary Transactions using the Perpetual Inventory System
      • When using the Periodic system, inventory transactions are not recorded directly in the INVENTORY account. Instead, separate accounts are used for
      • PURCHASES
      • PURCHASE RETURNS & ALLOWANCES
      • PURCHASE DISCOUNTS
      • TRANSPORTATION IN
      Periodic Inventory System Separate Accounts Used Let’s look at another Inventory system.
    • Periodic Inventory Systems
      • Because entries are not made to the inventory account during the accounting period, the amount of inventory is not known until the end of the period when the inventory count is done.
      • The PERIODIC system is being used less and less due to advancements in technology that make the extra record keeping of the perpetual system easy and inexpensive.
      • Periodic inventory systems require more closing entries at the end of the period. ( Purchases , Purchase Returns and Allowances , Purchase Discounts , and Transportation In are all separate TEMPORARY accounts that must be closed out at the end of the period.)
      Bar codes/scanners
    • Periodic Inventory System Purchases and Purchase Returns and Allowances
      • Purchases is an account that holds the current period’s inventory purchases (a debit balance) and is used in the calculation of Cost of Goods Sold on the Income Statement.
      • The Purchase Returns and Allowances account also is used to calculate Cost of Goods Sold on the income statement. It is a deduction from the cost of purchases in a periodic inventory system.
      • When using the Periodic system Purchase Discounts are recorded in a separate account. This helps managers keep track of the company’s performance in taking advantage of discounts.
      Periodic Inventory System Purchase Discounts
    • Periodic Inventory Systems
      • The ending inventory is determined at the end of the period by taking a physical count of the goods remaining on hand.
      • Cost of goods sold is calculated at the end of the accounting period by subtracting the ending inventory (determined from the physical count) from the Cost of Goods Available for Sale.
      • Beginning Inventory $ 400 + Purchases, net 2000
      • = Goods Available for Sale 2400
      • Ending Inv. (from count) 500
      • = Cost of Goods Sold $1900
    • Using a few selected transactions, let’s look at the differences between the journal entries for the Perpetual and Periodic Inventory Systems.
    • Selected transactions comparing the PERPETUAL vs. PERIODIC Inventory Systems
    • Selected transactions comparing PERPETUAL vs. PERIODIC Inventory Systems – Cont’d Use a Yr.-end inventory count to determine the inventory adjustment.
    • Selected transactions comparing PERPETUAL vs. PERIODIC Inventory Systems – Cont’d A Yr-end count shows 350 units (at a cost of $4.50 each) still in stock =$1575
      • Begin. Inventory $ 0
      • + Purchase $ 4000
      • Purchase Returns ( 200)
      • Purchase Discounts ( 76)
      • + Transportation In 551
      • Purchases, net 4275
      • Cost of Goods Avail. for Sale 4275
      • Less: Ending Inventory ( 1575)
      • Cost of Goods Sold $2700
      Use the Cost of Goods Sold schedule to calculate the cost of the units that are “gone” and ASSUMED to have been sold. Could some of the units actually have been lost, stolen, or thrown away? Ending Inventory $1575 Less: Begin. Inv. 0 Add to Inv. account $1575
    • Accounting and Inventory Management
      • The accounting system plays three roles in inventory management:
      • Provides accurate information for financial statements and tax reports.
      • Provides up-to-date information on inventory quantities and cost .
      • Provides information necessary to protect inventory from theft and misuse.
    • Ratios: Gross Margin Percentage
      • Gross margin %:
        • gross margin as a percent of sales
        • Net sales – CGS Gross Margin
          • Net sales Net Sales
      =
    • Ratios: Return on sales
      • Return on sales =
      • Net income
      • Net sales
      • Revenues - expenses
      • Net sales
    • Common-size Income Statement
      • Each item on the income statement is expressed as a % of that year’s Net Sales.
      • Comparisons are made to:
      • Budget
      • Previous year(s)
      • Competitors
      % Net Sales 100.0 - Cost 60.0 =G.P 40.0
    • Comparative Common-size Income Statements 2005 2004 Net Sales $3,000 $2,000 Cost of Goods Sold 2,000 1,200 Gross Profit 1,000 800 Operating Expenses: Selling Expenses 600 400 Administrative Exp. 700 300 Total Oper. Exp. 1,300 700 Net Income ( $300) $100 % of N.Sales 100.0 % of N.Sales 100.0
    • Comparative Common-size Income Statements 2005 2004 Net Sales $3,000 $2,000 Cost of Goods Sold 2,000 1,200 Gross Profit 1,000 800 Operating Expenses: Selling Expenses 600 400 Administrative Exp. 700 300 Total Oper. Exp. 1,300 700 Net Income ( $300) $100 % of N.Sales 100.0 66.7 33.3 20.0 23.3 43.3 (10.0) % of N.Sales 100.0 60.0 40.0 20.0 15.0 35.0 5.0
    • Question: Why did the company have a net loss when sales increased by $1,000? 2005 2004 Net Sales $3,000 $2,000 Cost of Goods Sold 2,000 1,200 Gross Profit 1,000 800 Operating Expenses: Selling Expenses 600 400 Administrative Exp. 700 300 Total Oper. Exp. 1,300 700 Net Income ( $300) $100 % of N.Sales 100.0 66.7 33.3 20.0 23.3 43.3 (10.0) % of N.Sales 100.0 60.0 40.0 20.0 15.0 35.0 5.0
    • Income Statement Trend Analysis Trend Analysis shows both Dollar and % changes from one year to the next year for each item on the income statement. Example: From 2004 to 2005 Net Sales increased from $2,000 to $3,000. So…… Net Sales increased $1,000 which is a 50% increase over 2004 Net Sales. ($1,000 incr./$2,000 Net Sales of 2004= 50%)
    • Income Statement Trend Analysis 2005 2004 Net Sales $3,000 $2,000 Cost of Goods Sold 2,000 1,200 Gross Profit 1,000 800 Operating Expenses: Selling Expenses 600 400 Administrative Exp. 700 300 Total Oper. Exp. 1,300 700 Net Income ( $300) $100 % inc.(dec) 50.0 66.7 25.0 50.0 133.3 85.7 ( 400.0) $ inc.(dec.) $1,000 800 200 200 400 600 ($400)
    • Income Statement Trend Analysis 2005 2004 Net Sales $3,000 $2,000 Cost of Goods Sold 2,000 1,200 Gross Profit 1,000 800 Operating Expenses: Selling Expenses 600 400 Administrative Exp. 700 300 Total Oper. Exp. 1,300 700 Net Income ( $300) $100 % inc.(dec) 50.0 $ inc.(dec) $1,000
    • How about analyzing the Balance Sheet? The same techniques are used to analyze the Balance Sheet. Common-size Analysis: Use the TOTAL ASSETS amount as the 100% figure. So, …….. Express each Balance Sheet item as a % of Total Assets. Trend Analysis: Same approach as used on the income statement. 1. Calculate the $ change for each bal. sheet item. 2. Express the $ change as a % of the previous year’s (or base year’s) amount.
    • Chapter 5 Remember, Your objectives are to understand what you are doing and to be able to analyze the financial information. Memorization without understanding is meaningless!
    • Chapter 5 The End