MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT

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• MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP
  INCOME STATEMENT

Accounting, Fifth Edition
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Learning Objectives

• After studying this chapter, you should be able
  to
• Identify the differences between a service
  company and a merchandising company.
• Explain the recording of purchases under a
  perpetual inventory system.
• Explain the recording of sales revenues under a
  perpetual inventory system.
• Distinguish between a single-step and a
  multiple-step income statement.
• Explain the factors affecting profitability.
• Identify a quality of earnings indicator.

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Merchandising Operations
Merchandising Companies Buy and Sell Goods
Retailer
Wholesaler
Consumer
The primary source of revenues is referred to as
sales revenue or sales.
LO 1 Identify the differences between service
and merchandising companies.
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Merchandising Operations
Income Measurement
Not used in a Service business.
Sales Revenue
Less
Illustration 5-1 Income measurement process for
a merchandising company
Cost of Goods Sold
Gross Profit
Equals
Less
Net Income (Loss)
Operating Expenses
Equals
Cost of goods sold is the total cost of
merchandise sold during the period.
LO 1 Identify the differences between service
and merchandising companies.
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Merchandising Operations
Illustration 5-2
Operating Cycles
The operating cycle of a merchandising company
ordinarily is longer than that of a service
company.
LO 1 Identify the differences between service
and merchandising companies.
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Perpetual vs Periodic Inventory Valuations
Perpetual
Periodic

• Does not keep detailed records of the goods on
  hand.
• Cost of goods sold determined by count at the end
  of the accounting period.
• Cost of Goods Sold calculation
• Beg Inventory 100,000
• Purchases, net 800,000
• Avail for Sale 900,000
• End. Inventory 125,000
• Cost of Goods Sold 775,000

• Maintain detailed records of the cost of each
  inventory purchase and sale.
• Records continuously show inventory that should
  be on hand for every item.
• Company determines cost of goods sold each time a
  sale occurs.
• Traditionally used for merchandise with high unit
  values.
• Shows the quantity and cost of the inventory that
  should be on hand at any time.
• Provides better control over inventories than a
  periodic system.

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Illustration 5-5
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Purchase/Sale of Merchandise
On May 14, Sauk Stereo purchased 5,500 of
merchandise inventory on account, credit terms
are 2/10, n/30.
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Recording Purchases of Merchandise
Freight Costs Terms of Sale
Illustration 5-6 Shipping terms
Freight costs incurred by the seller are an
operating expense.
LO 2
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Recording Purchases of Merchandise
Illustration Assume upon delivery of the goods
on May 6, the BUYER, Sauk Stereo, pays Public
Freight Company 150 for freight charges, the
entry on Sauk Stereos books is
May 6
Inventory 150
Cash 150
Assume the freight terms on the invoice in
Illustration 5-5 had required the SELLER, PW
Audio Supply, to pay the freight charges, the
entry by PW Audio Supply would have been
Freight-out expense 150
May 4
Cash 150
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Recording Purchases of Merchandise
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do
not meet specifications.
Purchase Return
Purchase Allowance
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 a reduction of the purchase price.
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Merchandise/Sales Return
On May 8, Sauk Stereo returns 300 of merchandise.
Buyer Accounts Payable 300 Inventory
300
Seller Sales Returns Allowances 300
Accounts Receivable 300 Inventory 140
Cost of Goods Sold 140
Contra-revenue account to Sales Revenue
(debit). Sales not reduced (debited) because it
would obscure importance of sales returns and
allowances as a percentage of sales. Could
distort comparisons.
4-12
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Recording Purchases of Merchandise
Review Question

• In a perpetual inventory system, a return of
  defective merchandise by a purchaser is recorded
  by crediting
• Purchases
• Purchase Returns
• Purchase Allowance
• Inventory

LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Ex 5-1 (1-4) for BOTH Buyer Seller, p 262
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Recording Purchases of Merchandise
Purchase Discounts

• Credit terms may permit buyer to claim a cash
  discount for prompt payment.
• Advantages
• Purchaser saves money.
• Seller shortens the operating cycle by converting
  the accounts receivable into cash earlier.

Example Credit terms may read 2/10, n/30.
Cash is KING! Collect Quick, Pay Slow
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Recording Purchases of Merchandise
Purchase Discounts - Terms
2/10, n/30
1/10 EOM
n/10 EOM
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.
Net amount due within the first 10 days of the
next month.
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Recording Sales of Merchandise
Sales Discount

• Offered to customers to promote prompt payment of
  the balance due.
• Contra-revenue account (debit) to Sales Revenue.

LO 3 Explain the recording of sales revenues
under a perpetual inventory system.
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Payment Made/Received w/ Discount
Buyer - May 14 Accounts PAYABLE 3,500 Cash
3,430 Merchandise
Inventory 70
Seller Cash 3,430 Sales Discounts
70 Accounts RECEIVABLE 3,500
4-18
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Payment Made/Received w/ NO Discount
Buyer - May 14 Accounts PAYABLE 3,500 Cash
3,500
Seller Cash 3,500 Accounts RECEIVABLE
3,500
4-19
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Recording Purchases of Merchandise
Purchase Discounts
Should discounts be taken when offered?
Example 2 for 20 days Annual rate of
36.5 3,500 x 36.5 x 20 365 70
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Recording Purchases of Merchandise
Summary of Purchasing Transactions
3,800
8th - Return
300
4th - Purchase
70
14th - Discount
150
6th Freight-in
Balance
3,580
LO 2 Explain the recording of purchases under a
perpetual inventory system.
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Ex 5-1 (5) for BOTH Buyer Seller, p 262
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Income Statement Presentation
Single-Step Income Statement

• Subtract total expenses from total revenues
• Two reasons for using the single-step format
• Company does not realize any type of profit or
  income until total revenues exceed total
  expenses.
• Form is simple and easy to read.

LO 4 Distinguish between a single-step and a
multiple-step income statement.
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Income Statement Presentation
Single-Step
Illustration 5-7
LO 4
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Income Statement Presentation
Multiple-Step Income Statement

• Highlights the components of net income.
• Three important line items
• gross profit,
• income from operations, and
• net income.

LO 4 Distinguish between a single-step and a
multiple-step income statement.
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Income Statement Presentation
Multiple-Step
Illustration 5-8
Key Line Items
LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales

LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales
• Gross profit

LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales
• Gross profit
• Operating expenses

LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales
• Gross profit
• Operating expenses
• Nonoperating activities

LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales
• Gross profit
• Operating expenses
• Nonoperating activities

LO 4
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Multiple- Step
Illustration 5-11

• Key Items
• Net sales
• Gross profit
• Operating expenses
• Nonoperating activities
• Net income

LO 4
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Aerosmith Companys accounting records show the
following at the yearend December 31,
2014. Purchase Discounts 3,400 Freight-In
6,100 Purchases 162,500 Beginning Inventory
18,000 Ending Inventory 20,000 Purchase
Returns and Allowances 5,200 Assuming that
Aerosmith Company uses the periodic system,
compute (a) cost of goods purchased and (b) cost
of goods sold.
Solution
Beginning Inventory 18,000 Purchases
162,500 Purchase Returns and Allowances -
5,200 Purchase Discounts - 3,400 Freight-In
6,100 160,000 (a) Goods Available
for Sale 178,000 Ending Inventory - 20,000 Cost
of Goods Sold 158,000 (b)
LO 5 Determine cost of goods sold under a
periodic system.
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Evaluating Profitability
Gross Profit Rate
May be expressed as a percentage by dividing the
amount of gross profit by net sales.

• A decline in the gross profit rate might have
  several causes.
• Selling products with a lower markup.
• Increased competition may result in a lower
  selling price.
• Company forced to pay higher prices to its
  suppliers without being able to pass these costs
  on to its customers.

LO 6 Explain the factors affecting profitability.
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Evaluating Profitability
Gross Profit Rate
Illustration 5-15
Why does REIs gross profit rate differ so much
from that of Dicks Sporting Goods and the
industry average?
LO 6 Explain the factors affecting profitability.
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Evaluating Profitability
Profit Margin Ratio
Measures the percentage of each dollar of sales
that results in net income.

• How do the gross profit rate and profit margin
  ratio differ?
• Gross profit ratio - measures a merchandising
  firms ability to earn a profit from the sale of
  inventory.
• Profit margin ratio - measures the extent by
  which selling price covers all expenses
  (including cost of goods sold).

LO 6 Explain the factors affecting profitability.
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Evaluating Profitability
Profit Margin Ratio
Illustration 5-17
How does REI compare to its competitors? Its
profit margin was lower than Dicks in 2010 and
was less than the industry average. Thus, its
profit margin does not suggest exceptional
profitability.
LO 6 Explain the factors affecting profitability.
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Evaluating Profitability
Earnings have high quality if they provide a full
and transparent depiction of how a company
performed.

• A measure significantly less than 1 suggests that
  a company may be using more aggressive accounting
  techniques in order to accelerate income
  recognition.
• A measure significantly greater than 1 suggests
  that a company is using conservative accounting
  techniques which cause it to delay the
  recognition of income.

LO 7 Identify a quality of earnings indicator.