Ch05

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  • 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)
  • Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods
  • Ch05

    1. 2. <ul><li>Merchandising Operations </li></ul><ul><li>and the Multiple-Step </li></ul><ul><li>Income Statement </li></ul>Accounting, Third Edition
    2. 3. <ul><li>Identify the differences between a service company and a merchandising company. </li></ul><ul><li>Explain the recording of purchases under a perpetual inventory system. </li></ul><ul><li>Explain the recording of sales revenues under a perpetual inventory system. </li></ul><ul><li>Distinguish between a single-step and a multiple-step income statement. </li></ul><ul><li>Determine cost of goods sold under a periodic system. </li></ul><ul><li>Explain the factors affecting profitability. </li></ul><ul><li>Identify a quality of earnings indicator. </li></ul>Study Objectives
    3. 4. Merchandising Operations Recording Purchases of Merchandise Recording Sales of Merchandise Income Statement Presentation Evaluating Profitability Merchandising Operations <ul><li>Operating cycles </li></ul><ul><li>Flow of costs- perpetual and periodic inventory systems. </li></ul><ul><li>Freight costs </li></ul><ul><li>Purchase returns and allowances </li></ul><ul><li>Purchase discounts </li></ul><ul><li>Summary of purchasing transactions </li></ul><ul><li>Sales returns and allowances </li></ul><ul><li>Sales discounts </li></ul><ul><li>Sales revenues </li></ul><ul><li>Gross profit </li></ul><ul><li>Operating expenses </li></ul><ul><li>Nonoperating activities </li></ul><ul><li>Determining cost of goods sold-periodic system </li></ul><ul><li>Gross profit rate </li></ul><ul><li>Profit margin ratio </li></ul>
    4. 5. Merchandising Operations SO 1 Identify the differences between service and merchandising companies. Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales .
    5. 6. Merchandising Operations SO 1 Identify the differences between service and merchandising companies. Income Measurement Cost of goods sold is the total cost of merchandise sold during the period. Not used in a Service business. Net Income (Loss) Less Less Equals Equals Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Illustration 5-1 Income measurement process for a merchandising company
    6. 7. Merchandising Operations The operating cycle of a merchandising company ordinarily is longer than that of a service company . Illustration 5-2 SO 1 Identify the differences between service and merchandising companies. Operating Cycles
    7. 8. Merchandising Operations Flow of Costs Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. SO 1 Identify the differences between service and merchandising companies. Illustration 5-3
    8. 9. Merchandising Operations Perpetual System SO 1 Identify the differences between service and merchandising companies. Flow of Costs <ul><ul><li>Maintain detailed records of the cost of each inventory purchase and sale. </li></ul></ul><ul><ul><li>Records continuously show inventory that should be on hand. </li></ul></ul><ul><ul><li>Company determines cost of goods sold each time a sale occurs. </li></ul></ul>
    9. 10. Merchandising Operations Periodic System <ul><ul><li>Do not keep detailed records of the goods on hand. </li></ul></ul><ul><ul><li>Determine cost of goods sold only at end of accounting period. </li></ul></ul><ul><ul><li>Physical inventory count to determine cost of goods on hand. </li></ul></ul><ul><ul><li>Calculation of Cost of Goods Sold: </li></ul></ul>Beginning inventory $ 100,000 Add: Purchases, net 800,000 Goods available for sale 900,000 Less: Ending inventory 125,000 Cost of goods sold $ 775,000 SO 1 Identify the differences between service and merchandising companies. Flow of Costs
    10. 11. Merchandising Operations Additional Consideration <ul><ul><li>Perpetual System: </li></ul></ul><ul><ul><li>Traditionally used for merchandise with high unit values. </li></ul></ul><ul><ul><li>Provides better control over inventories. </li></ul></ul><ul><ul><li>Requires additional clerical work and additional cost to maintain inventory records. </li></ul></ul>SO 1 Identify the differences between service and merchandising companies. Flow of Costs
    11. 13. Recording Purchases of Merchandise <ul><li>Made using cash or credit (on account). </li></ul><ul><li>Normally recorded when goods are received. </li></ul><ul><li>Purchase invoice should support each credit purchase. </li></ul>SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration 5-5
    12. 14. Recording Purchases of Merchandise Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. Merchandise inventory 3,800 May 4 Accounts payable 3,800 SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration 5-5
    13. 15. Recording Purchases of Merchandise Illustration 5-6 Seller places goods Free On Board the carrier, and buyer pays freight costs. Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs. Freight Costs – Terms of Sale Freight costs incurred by the seller are an operating expense.
    14. 16. Recording Purchases of Merchandise Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Haul-It Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: Merchandise inventory 150 May 6 Cash 150 SO 2 Explain the recording of purchases under a perpetual inventory system. Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: Freight-out 150 May 4 Cash 150
    15. 17. Recording Purchases of Merchandise Purchaser may be dissatisfied because g oods are damaged or defective, of inferior quality, or do not meet specifications. 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. May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price. Purchase Return Purchase Allowance SO 2 Explain the recording of purchases under a perpetual inventory system.
    16. 18. Recording Purchases of Merchandise <ul><li>In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: </li></ul><ul><ul><li>Purchases </li></ul></ul><ul><ul><li>Purchase Returns </li></ul></ul><ul><ul><li>Purchase Allowance </li></ul></ul><ul><ul><li>Merchandise Inventory </li></ul></ul>Question SO 2 Explain the recording of purchases under a perpetual inventory system.
    17. 19. Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. Accounts payable 300 May 8 Merchandise inventory 300
    18. 20. Recording Purchases of Merchandise <ul><li>Credit terms may permit buyer to claim a cash discount for prompt payment. </li></ul><ul><li>Advantages: </li></ul><ul><ul><li>Purchaser saves money. </li></ul></ul><ul><ul><li>Seller shortens the operating cycle. </li></ul></ul>Purchase Discounts Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.” 2% cash discount if payment is made within 10 days. Otherwise, net amount due within 30 days. SO 2 Explain the recording of purchases under a perpetual inventory system.
    19. 21. Recording Purchases of Merchandise Purchase Discounts - Terms 2% discount if paid within 10 days, otherwise net amount due within 30 days. 1% discount if paid within first 10 days of next month. 2/10, n/30 1/10 EOM Net amount due within the first 10 days of the next month. n/10 EOM SO 2 Explain the recording of purchases under a perpetual inventory system.
    20. 22. Recording Purchases of Merchandise Accounts payable 3,500 May 14 Cash 3,430 Merchandise Inventory 70 (Discount = $3,500 x 2% = $70 ) SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk makes to record its May 14 payment.
    21. 23. Recording Purchases of Merchandise Accounts payable 3,500 June 3 Cash 3,500 SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be:
    22. 24. Recording Purchases of Merchandise Should discounts be taken when offered? Purchase Discounts Example: 2% for 20 days = Annual rate of 36.5% (365/20 = 18.25 twenty-day periods x 2% = 36.5%) Passing up the discount offered equates to paying an interest rate of 2% on the use of $3,500 for 20 days. SO 2 Explain the recording of purchases under a perpetual inventory system.
    23. 25. Recording Purchases of Merchandise $3,500 8 th - Return $300 Balance 4 th - Purchase $3,280 70 14 th - Discount Summary of Purchasing Transactions 150 6 th – Freight-in Illustration SO 2 Explain the recording of purchases under a perpetual inventory system.
    24. 26. Recording Sales of Merchandise <ul><li>Made for cash or credit (on account). </li></ul><ul><li>Normally recorded when earned, usually when goods transfer from seller to buyer. </li></ul><ul><li>Sales invoice should support each credit sale. </li></ul>SO 3 Explain the recording of sales revenues under a perpetual inventory system. Illustration 5-5
    25. 27. Recording Sales of Merchandise Two Journal Entries to Record a Sale Cash or Accounts receivable XXX Sales XXX SO 3 Explain the recording of sales revenues under a perpetual inventory system. #1 Cost of goods sold XXX Merchandise inventory XXX #2 Selling Price Cost
    26. 28. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Accounts receivable 3,800 May 4 Sales 3,800 Illustration: Assume PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo on account (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply $2,400. Cost of goods sold 2,400 4 Merchandise inventory 2,400
    27. 29. Recording Sales of Merchandise <ul><li>“ Flipside” of purchase returns and allowances. </li></ul><ul><li>Contra-revenue account (debit). </li></ul><ul><li>Sales not reduced (debited) because: </li></ul><ul><ul><li>would obscure importance of sales returns and allowances as a percentage of sales. </li></ul></ul><ul><ul><li>could distort comparisons between total sales in different accounting periods. </li></ul></ul>Sales Returns and Allowances SO 3 Explain the recording of sales revenues under a perpetual inventory system.
    28. 30. Recording Sales of Merchandise Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective. SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300 May 8 Accounts receivable 300 Merchandise inventory 140 8 Cost of goods sold 140
    29. 31. Recording Sales of Merchandise Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries: SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300 May 8 Accounts receivable 300 Merchandise inventory 50 8 Cost of goods sold 50
    30. 32. Recording Sales of Merchandise <ul><li>The cost of goods sold is determined and recorded each time a sale occurs in: </li></ul><ul><ul><li>periodic inventory system only. </li></ul></ul><ul><ul><li>a perpetual inventory system only. </li></ul></ul><ul><ul><li>both a periodic and perpetual inventory system. </li></ul></ul><ul><ul><li>neither a periodic nor perpetual inventory system. </li></ul></ul>Review Question SO 3 Explain the recording of sales revenues under a perpetual inventory system.
    31. 34. Recording Sales of Merchandise <ul><li>Offered to customers to promote prompt payment. </li></ul><ul><li>“ Flipside” of purchase discount. </li></ul><ul><li>Contra-revenue account (debit). </li></ul>Sales Discount SO 3 Explain the recording of sales revenues under a perpetual inventory system.
    32. 35. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Cash 3,430 May 14 Accounts receivable 3,500 Sales discounts 70 * [($3,800 – $300) X 2%] * Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.
    33. 36. Income Statement Presentation <ul><li>Subtract total expenses from total revenues </li></ul><ul><li>Two reasons for using the single-step format: </li></ul><ul><ul><li>Company does not realize any type of profit until total revenues exceed total expenses. </li></ul></ul><ul><ul><li>Format is simpler and easier to read. </li></ul></ul>Single-Step Income Statement SO 4 Distinguish between a single-step and a multiple-step income statement.
    34. 37. Income Statement Presentation Illustration 5-7 Single-Step SO 4 Distinguish between a single-step and a multiple-step income statement.
    35. 38. Income Statement Presentation <ul><li>Considered more useful because it highlights the components of net income. </li></ul><ul><li>Three important line items: </li></ul><ul><ul><li>gross profit, </li></ul></ul><ul><ul><li>income from operations, and </li></ul></ul><ul><ul><li>net income. </li></ul></ul>Multiple-Step Income Statement SO 4 Distinguish between a single-step and a multiple-step income statement.
    36. 39. Income Statement Presentation Key Line Items Multiple-Step SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-8
    37. 40. Income Statement Presentation <ul><li>The multiple-step income statement for a merchandiser shows each of the following features except: </li></ul><ul><ul><li>gross profit. </li></ul></ul><ul><ul><li>cost of goods sold. </li></ul></ul><ul><ul><li>a sales revenue section. </li></ul></ul><ul><ul><li>investing activities section. </li></ul></ul>Review Question SO 4 Distinguish between a single-step and a multiple-step income statement.
    38. 41. Income Statement Presentation Sales Revenues SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-9
    39. 42. Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-11 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
    40. 43. Income Statement Presentation Illustration 5-11 Operating Expenses
    41. 44. Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-10 Nonoperating Activities Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations.
    42. 45. Income Statement Presentation Illustration 5-11
    43. 47. Income Statement Presentation <ul><li>No running account of changes in inventory. </li></ul><ul><li>Ending inventory determined by physical count. </li></ul><ul><li>Directly adjust Merchandise Inventory account for any transaction that affects inventory. </li></ul>SO 5 Determine cost of goods sold under a periodic system. Determining Cost of Goods Sold Under a Periodic System
    44. 48. Income Statement Presentation SO 5 Determine cost of goods sold under a periodic system. Determining Cost of Goods Sold Under a Periodic System Illustration 5-13 Cost of goods sold for a merchandiser using a periodic inventory system
    45. 49. Evaluating Profitability A company’s gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales. SO 6 Explain the factors affecting profitability. Gross Profit Rate <ul><li>A decline in the gross profit rate might have several causes. </li></ul><ul><ul><li>The company may have begun to sell products with a lower “markup.” </li></ul></ul><ul><ul><li>Increased competition may result in a lower selling price. </li></ul></ul><ul><ul><li>Company may be forced to pay higher prices to its suppliers without being able to pass these costs on to its customers. </li></ul></ul>
    46. 50. Evaluating Profitability SO 6 Explain the factors affecting profitability. Gross Profit Rate Illustration 5-15 Why does Wal-Mart have a lower gross profit rate than Target and the industry average?
    47. 51. Evaluating Profitability Measures the percentage of each dollar of sales that results in net income. SO 6 Explain the factors affecting profitability. Profit Margin Ratio <ul><li>How do the gross profit rate and profit margin ratio differ? </li></ul><ul><ul><li>Gross profit rate - measures the margin by which selling price exceeds cost of goods sold. </li></ul></ul><ul><ul><li>Profit margin ratio - measures the extent by which selling price covers all expenses (including cost of goods sold). </li></ul></ul>
    48. 52. Evaluating Profitability SO 6 Explain the factors affecting profitability. Illustration 5-17 Profit Margin Ratio How does Wal-Mart compare to its competitors? Keep in mind that an increasing percentage of Wal-Mart’s sales is from low-margin groceries.
    49. 54. Evaluating Profitability Earnings have high quality if they provide a full and transparent depiction of how a company performed. SO 7 Identify a quality of earnings indicator. <ul><li>In general, a measure significantly less than 1 suggests that a company may be using more aggressive accounting techniques in order to accelerate income recognition. </li></ul><ul><li>A measure significantly greater than 1 suggests that a company is using conservative accounting techniques which cause it to delay the recognition of income. </li></ul>
    50. 55. Periodic Inventory System SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system. <ul><li>Record revenues when sales are made. </li></ul><ul><li>Do not record cost of merchandise sold on the date of sale. </li></ul><ul><li>Physical inventory count at the end of the period to determine: </li></ul><ul><ul><li>cost of merchandise on hand and </li></ul></ul><ul><ul><li>cost of goods sold during the period. </li></ul></ul><ul><li>Record purchases of merchandise in Purchases account. </li></ul><ul><li>Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts. </li></ul>Recording Merchandise Transactions
    51. 56. Periodic Inventory System SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system. Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows. Purchases 3,800 May 4 Accounts payable 3,800 Recording Purchases of Merchandise
    52. 57. Periodic Inventory System Illustration: If Sauk pays Haul-It Freight Company $150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is: Freight-in (Transportation-in) 150 May 6 Cash 150 Freight Costs SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    53. 58. Periodic Inventory System Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return. Accounts payable 300 May 8 Purchase returns and allowances 300 Purchase Returns and Allowances SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    54. 59. Periodic Inventory System Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk Stereo records the payment and discount as follows. Accounts payable 3,500 May 14 Purchase discounts 70 Purchase Discounts Cash 3,430 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    55. 60. Periodic Inventory System No entry is recorded for cost of goods sold at the time of the sale under a periodic system. Illustration: PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows. Accounts receivable 3,800 May 4 Sales 3,800 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system. Recording Sales of Merchandise
    56. 61. Periodic Inventory System Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows. Sales returns and allowances 300 May 4 Accounts receivable 300 Sales Returns and Allowances SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    57. 62. Periodic Inventory System Illustration: On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows. Sales Discounts Cash 3,430 May 14 Accounts receivable 3,500 Sales discounts 70 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    58. 63. Comparison of Entries—Perpetual Vs. Periodic SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
    59. 64. SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system. Comparison of Entries—Perpetual Vs. Periodic
    60. 65. Copyright “ Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”

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