Merchandising Companies
Buy and sell goods
Wholesalers
Sell merchandise to retailers
Retailers
Sell to consumers
Sales Revenue or Sales
The primary source of revenue for merchandising companies
How is revenue recorded for wholesalers and retailers?
The same. The revenue recognition principle is observed.
Cost of Goods Sold
The total cost of merchandise sold during the period. It is so important that it is the first expense recorded on the income statement. It's also the largest expense.
What steps in calculating net income do not apply to service businesses?
Cost of Goods Sold and therefore Gross Profit.
Gross Profit
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Net Income in a Merchandising Company
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Operating Cycles of a Merchandising Company
Ordinarily longer than that of a service company. They involve the time needed to complete the cycle, and there are simply more steps for these companies.
Periodic System
Do not keep detailed records of the goods on hand, and the cost of goods sold is determined by count at the end of the accounting period (so, once).
Calculating Cost of Goods Sold
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Goods Available for Sale
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Perpetual System
Maintain detailed records of the cost of each inventory purchase and sale. The records continuously show inventory that should be on hand for every item; the company determined cost of goods sold each time a sale occurs.
What are the advantages to the perpetual system?
-Show the quantity and cost of the inventory that should be on hand at any time
-Provides better control over inventories than a periodic system
-Traditionally used for merchandise with high unit values
Recording Purchase of Merchandise in a Perpetual System
Made using cash or credit (on account). Debits must equal credits. Transactions are recorded when you assume ownership of the good. When a purchase is made, debit Inventory and credit either Cash or Accounts Payable
Purchase Invoice
Source document received after a purchase that is used to provide evidence of the transaction for journalizing. It should support each credit purchase.
Freight Costs
Also known as shipping costs. The cost of the buyer to receive goods or cost of seller to deliever goods.
FOB
Free on Board
FOB Shipping Point
Buyer pays freight costs. Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.
FOB Destination
Seller pays freight costs. Ownership of the goods remains with the seller until the goods reach the buyer.
Freight costs incurred by the seller are an operating expense.
How is shipping recorded for the buyer in an FOB Shipping Point scenario?
As a debit to inventory, and if "paid", as a credit to cash.
How is shipping recorded for the seller in an FOB Shipping Point scenario?
It's not recorded.
How is shipping recorded for the seller in an FOB Destination scenario?
As a debit to the Freight-Out operating expense and a credit to cash (if "paid").
Reasons for Purchase Returns
The purchaser may be dissatisfied because goods are damaged, defective, of inferior quality, or do not meet specifications.
Purchase Return
Return of goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash
Purchase Allowance
Purchaser may choose to keep the merchandise if the seller will grant a reduction of the purchase price
How are returns recorded for the purchaser in a perpetual inventory system?
A debit to Accounts Payable or Cash and a credit to Inventory.
Purchase Discounts
Credit terms may permit the buyer to claim a cash discount for prompt payment
Advantages to Purchase Discounts
The purchaser saves money and the seller shortens the operating cycle by converting the accounts receivable into cash earlier (making more profits).
Credit Terms examples
-2/10, n/30
-1/10 EOM
-n/10 EOM
2/10, n/30
Two ten net thirty." A 2% discount if paid within 10 days, otherwise net amount due within 30 days.
1/10 EOM
1% discount if paid within the first 10 days of the next month
n/10
Net amount due within the first 10 days of the next month
How are purchase discounts recorded in a perpetual inventory system?
A full debit to Accounts Payable, and two credits. There is a credit to inventory of the discount, and a credit to cash of the amount actually paid.
Recording Sales of Merchandise in a Perpetual Inventory System
Made using cash or credit (on account). Sales revenue is recorded when the performance obligation is satisfied, which is when goods are transferred from the seller to the buyer.
Sales Invoice
It should support each credit sale, and is the source document for journalizing the transactions.
How many journal entries are necessary when recording sale of merchandise in a perpetual system?
Two
How do you record sales of merchandise in a perpetual system in the journal?
First, a debit to cash or Accounts Receivable, and a credit to Sales Revenue. Then, a debit to the Cost of Goods Sold expense and a credit to Inventory.
Sales Returns and Allowances
A contra-revenue account to Sales Revenue (so a debit). It is the flip side to purchase returns and allowances.
Why is sales simply not reduced when returns and allowances are made?
Reducing the Sales account would obscure the importance of sales returns and allowances as a percentage of sales, and could therefore distort comparisons.
How are sales returns and allowances recorded in a perpetual system?
First, a debit to Sales Returns and Allowances and a credit to Accounts Receivable. Then, a debit to Inventory and a credit to Cost of Goods Sold.
Sales Discount
Offered to customers to promote prompt payment of the balance due. It is another contra-revenue account to Sales Revenue.
How are sales discounts recorded in a perpetual system?
A debit to Cash of the amount paid, and then another debit to Sales Discounts of the discount. Then, a credit to Accounts Receivable of the full amount.
Single-Step Income Statement
Subtract total expenses from total revenues.
Why would a company use the single-step format?
1. The company does not realize any type of profit or income until total revenues exceed total expenses
2. Form is simple and easy to read
Multiple-Step Income Statement
Highlights the components of net income. It displays key items such as net sales, gross profit, operating expenses, non-operating activities, and net income.
What are the three important line items displayed on a Multiple-Step Income Statement?
Gross profit, income from operations, and net income.
Non-Operating Activities
Include interest, plant assets, rent, dividends, casualties, and loss from striking.
Ethics in Disclosure
Disclosing more details is important. Sometimes relevant information is lost in "Other Gains and Losses" to make the company look better, and this is a practice that should be avoided.
Determining the Cost of Goods Sold in a Periodic System
There is no running account or changes in inventory, and the ending inventory is determined by a physical count. The Cost of Goods Sold is not determined until the end of the period.
Find Gross Profit Rate
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Gross Profit Rate
Profitability ratio, can be expressed as a percentage. A high one is desired. Measures the margin by which selling price exceeds cost of goods sold.
Decline in the Gross Profit Rate
Could be caused by...
-selling products with a lower "markup," that is they're more costly relative to sales revenue
-increased competition may result in a lower selling price
-company forced to pay higher prices to its suppliers without being able to pas
Profit Margin Ratio
A profitability ratio. Measures the percentage of each dollar of sales that results in net income. Measures the extent by which selling price covers all expenses, including cost of goods sold.
How do the gross profit rate and profit margin ratio differ?
Gross profit rate uses the cost of goods sold as a measure of comparison to selling price, while profit margin ratio is a measurement of all expenses.
Find Profit Margin Rate
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Quality of Earnings Indicator
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 (record income in earlier periods). A measure significantly greater than 1 suggests that a
Quality of Earnings Ratio
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Recording Merchandise Transactions in a Periodic Inventory System
Record revenues when sales are made, but do not record the cost of merchandise sold on the date of sale. A physical inventory count determines the cost of merchandise on hand and therefore the cost of merchandise sold during the period. Purchases are reco