accounting

1. FINANCIAL ACCOUNTING II
Faculty of Political Science
Business Administration Department
CHAPTER 4: Merchandise
Transactions - Continues

2. Gross Profit
• Net income = Revenues – Expenses
• When a company purchases inventories, they are initially classified as assets
because they are owned by the company, and because they have future
benefits to the company.
• As these goods are sold to customers, the asset (inventory) is consumed,
thus becoming an expense incurred to generate revenues. This expense is
the COGS.
• For example, the cost of Toyota Avensis to the dealer becomes an expense
when that Toyota is sold.
• Similarly, the cost of food items bought by Migros is first added inventory,
but when the items are sold, that cost becomes an expense.
• The difference between the sales revenue and the COGS is called the Gross
Margin or Gross Profit.

3. Gross Profit
• Gross profit represents the merchandising profit of a company.
• In other words, it shows the amount of revenue that is available to
cover the operating expenses and, eventually, to provide net income.
• The gross profit is a measure of how profitable sales transactions are,
but it is not a measure of the overall profitability of a firm.
• In terms of reporting, a merchandising company should show the
amount of sales revenue and the cost of goods sold, in addition to the
operating expenses.
• Furthermore, managers need to know the profitability of each type of
product, for planning purposes.

4. Net
Sales
TL 1,000
COGS 600
Gross
Profit
TL 400

5. Operating Expenses
• Operating expenses refer to expenditures that are not directly tied to the
production of goods or services. Typically,
selling, general, and administrative (SG&A) expenses are siloed under this
category, as a separate line item. Examples of operating
expenses include:
• Rent
• Utilities
• Office supplies
• Legal costs
• Sales and marketing
• Payroll
• Insurance
• Administrative expenses

6. COGS
• Cost of goods sold refers to the business expenses directly tied to
the production and sale of a company's goods and services. Simply
put: COGS represents expenses directly incurred when a
transaction takes place. When the coffee shop sells a double
espresso, COGS accounts for the price of the to-go cup, the
protective sleeve, the coffee filter, the water, the processed beans,
and so forth. Examples of COGS include:
• Labor directly tied to production
• Direct materials needed for the production of goods and services
• Taxes on the production facilities
• In retail (merchandise), COGS includes payment for merchandise
purchased from suppliers and manufacturers.

7. Accounting Cycle for a Merchandising Company
• Analyze and record transactions
• Post the journal entries to the ledger
• Prepare the trial balance
• Record and post the adjusting entries
• Prepare the financial statements

8. Closing Entries in the Perpetual Inventory System
• Let’s assume that Giysi Giyim A.Ş. uses the perpetual inventory
system, and the year-end physical count reflects that the value of
inventory on hand is TL4,800.

9. Giysi Giyim A.Ş. Adjusted Trial Balance
Account Title Debit Credit
Cash TL3170
Accounts Receivable 1.960
Inventory 4.800
Prepaid Insurance 480
Equipment 12.480
Accumulated Depreciation: equipment TL3480
Accounts Payable 2.000
Notes Payable 1.640
Salaries Payable 150
Common Stock 10.000
Retained Earnings 4.720
Sales 30.700
Sales Discounts 500
Sales Returns and Allowances 200
COGS 16.300
Rent Expense 1.500
Salaries Expense 6.100
Utilities Expense 1.100
Delivery Expense 700
Advertising Expense 1.300
Depreciation Expense 1.000
Insurance Expense 900
Inventory Shrinkage 200
Interest Expense 600
Interest Revenue 400
Gain on Sale of Equipment 200
Total TL53.290 TL53.290

10. Income Summary
• In the closing process, the balances of
revenue and expense accounts are
transferred to the Income Summary
account, and the resulting balance of
the Income Summary account
provides the net income or loss of the
entity for a period.
First, close the temporary accounts that
have credit balances to Income
Summary, i.e., all revenue accounts or
other temporary accounts with credit
balances are debited for the amount of
their balances, and the Income
Summary is credited for the total
amount.
Date
Account Title and
Description Debit Credit
31 December 2011 Sales 30.700
Interest
Revenue 400
Gain on Sale of
Equipment 200
Income
Summary 31.300

11. Income Summary
• Second, close the temporary accounts that have debit balances to
Income Summary, i.e., all expense accounts or other temporary
accounts with debit balances are credited for the amount of their
balances, and the Income Summary is debited for the total amount.
• So, in this case, all income statement accounts with debit balances
(including the merchandising accounts such as Sales Returns and
Allowances, Sales Discounts, and COGS) are closed to the Income
Summary account.

12. Second Step in Closing Entries
Date Account Title and Description Debit Credit
31 December 2011 Income Summary 30.400
Sales Discounts 500
Sales Returns and Allowances 200
COGS 16.300
Rent Expense 1.500
Salaries Expense 6.100
Utilities Expense 1.100
Delivery Expense 700
Advertising Expense 1.300
Depreciation Expense 1.000
Insurance Expense 900
Inventory Shrinkage 200
Interest Expense 600

13. Third Step in Closing Entries
• To complete the closing process,
the Income Summary is closed to
the Retained Earnings Account or
to the Capital Account.
• If the company is a corporation
(A.Ş.), then the Income Summary
account is closed to the Retained
Earnings account.
• If it is a sole proprietorship or
partnership, then it is closed to
the Capital account.
Date
Account Title and
Description Debit Credit
31 December 2011
Income
Summary 900
Retained
Earnings 900

14. Preparing Income Statement
• Merchandising and manufacturing companies can prepare their
income statements according to single-step or multiple-step income
statement formats.
• Although the Turkish Uniform Chart of Accounts allows for condensed
or detailed income statement formats, it requires multiple-step
income statements.

15. Single-Step Income Statement
• The single step approach has the advantage of simplicity.
• One can determine the amount of income (or loss) before tax in a
single step, i.e., by deducting all the expenses from the total
revenues.
• There is no distinction among the different sources of revenues or
causes of expenses.

16. Single-Step Income Statement
Giysi Giyim A.Ş.
Income Statement
For the Year Ended 31 December 2011
Revenues
Net Sales TL30.000
Interest Revenue 400
Gain on Sale of Equipment 200
Total Revenues 30.600
Expenses
Cost of Goods Sold TL16.500
Selling Expenses:
Salaries Expense 6.100
Advertising Expense 1.300
Delivery Expense 700
Total Selling Expenses 8.100
Administrative Expense
Rent Expense 1.500
Utilities Expense 1.100
Depreciation Expense 1.000
Insurance Expense 900
Total Administrative Expense 4.500
Total Operating Expenses 12.600
Interest Expense 600
Total Expenses 29.700
Income Before Tax TL900

17. Single-Step Income Statement
• Example in previous slide shows that all revenues and expenses are
grouped together.
• We can also combine selling expenses (such as delivery) and
administrative expenses (such as office salaries) under operating
expenses, keeping the interest expense separate, because it is a
financing cost, not an operating cost.

18. Exhibit 4.3 Multiple-Step Income Statement
Giysi Giyim A.Ş.
Income Statement
For the Year Ended 31 December 2011
Sales 30.700
Less: Sales Discounts (500)
Sales Returns and Allowances (200)
Net Sales 30.000
Cost of Goods Sold (16.500)
Gross Profit 13.500
Operating Expenses (12.600)
Selling and Marketing Expenses (8.100)
General and Administrative Expenses (4.500)
Other Operating Revenues and Gains 600
Operating Income 1.500
Financial Expenses (600)
Net Income before Tax 900

19. Multiple-Step Income Statement
• The multiple-step income statement provides more information about the
profitability of a company, because it discloses numerous parts or steps in the
determination of net income.
• Exhibit 4.3 illustrates a multiple-step income statement.
• These parts or steps show income from operating and non-operating activities.
• It is crucial for external users to know how a company generate its income;
usually, the operating income is an indication of how well the operations of a
company are run, and thus it is taken as a long-term indicator of a performance.
• On the other hand, non-operating income is believed to be non-revurring, and
thus is period specific or short-term.

20. Multiple-Step Income Statement
• Operating income reflects income from merchandising business.
• It is determined after Cost of Goods Sold and operating expenses (such as
administrative and selling expenses) are deducted from Net Sales.
• Non-operating revenue and expenses, on the other hand, include interest
revenue and expense, dividend revenue on investments, rent revenue, gain or
loss from sale or disposal of property, plant and equipment, and loss caused
by fires, earthquakes or strikes.

21. Chapter Summary
• Merchandising entities buy and sell ready-made goods.
• They can use two methods to record their purchases and sales: the
periodic and perpetual inventory systems.
• Under the periodic system, the Cost of Goods Sold is determined after
the physical count and valuation of inventories at the end of the
period.
• Under the perpetual system, the inventory account is affected by each
sale or purchase transaction, i.e., the cost of merchandise dold is
deducted from inventory and accumulated in the Cost of Goods Sold
account, and the cost of Purchases (including the freight-in) is added
to inventory.

22. Chapter Summary
• The net sales amount is determined by deducting sales returns and
allowances and sales discounts from the sales revenue.
• Gross Margin (or Gross Profit) is the difference between Net Sales and the
Cost of Goods Sold, and represents the merchandising profit of a
company.
• The income statement of a merchandising company has three main
sections:
Sales Revenue
COGS, and
Operating Expenses.
Companies usually prepare a multiple-step income statement that provides
more information on how profitable the difference activities of a
merchandising company are.