Merchandising Operations

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Merchandising Operations the Multiple-Step
Income Statement
ACCOUTING 101

• Chapter 5

Professor Walsh Providence College
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You should be able to

• Identify the differences between a service
  enterprise merchandising a manufacturing
  firm. This chapter focuses on which of the
  three? Relate merchandise Inventory to Finished
  Goods Inventory in a manuf envir.
• 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 a
  multiple-step income statement.
• Determine CGS under a periodic system.
• Explain the factors affecting profitability.

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1 Identify Differences a Between Service
Enterprise Merchandising Company

• Think of some service enterprisesexamples???

• Hair salons, banks, mechanics, plumbers

Think of some merchandisersexamples???

• Grocery stores, department stores, pharmacies,
  book stores

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Merchandising Co Vs Service
Merchandising Primary source of revenue is sale
of merchandise We call this type of revenue
sales revenue or sales Service What might we
call revenue in a service firm ? consulting fees
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Income Measurement for Merchandise Companies
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What is an Operating Cycle?

• The average time between purchasing or acquiring
  inventory and receiving cash proceeds from its
  sale.
• The time it takes to sell a product and collect
  cash from the sale. An operating cycle can last
  from several weeks to a number of years

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Service Operating Cycle
Service entity operating cycle is usually shorter
than merchandising
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Merchandisers operating cycle is longer due to
purchase of inventory and eventual sale
Service entity operating cycle is usually shorter
than merchandising
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Merchandising Operating Cycles
Merchandisers operating cycle is longer due to
purchase of inventory and eventual sale
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Inventory Systems

• There are 2 basic types of inv systems for
  merchandising cos
• Perpetual
• Detailed records of the cost of each inv purchase
  sale are kept
• Shows the inv that should be on hand for every
  item _at_ all times
• CGS is determined each time sale occurs
• Periodic
• Detailed records are NOT kept during the period.
  
• CGS is determined only at the END of the acct
  period when a physical count is done

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Perpetual Vs Periodic Inv Systems

• Calculation of ENDING INV CGS
• PERIODIC
• calc ENDING INV CGS at end of period
• PERPETUAL
• Calc ENDING INV at EVERY purchase
• Calc ENDING INV CGS EVERY sale

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Inventory Systems - Perpetual
Maintain detailed records of purchases sales
cost of goods sold is determined with EACH sale
end of period theoretically no adjustment when a
physical inv is taken.
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Inventory Systems - Perpetual
computers electronic scanning equipment makes
perpetual inventory cost effective!
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Inventory Systems - Periodic
No detailed records CGS calc at end of of the
period by taking a physical count.
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2 Explain Recording of Purchases Under Perpetual
Inv Systems

• Purchase of merchandise (co cost) is recorded
  when goods are received from the seller
• Every purchase should be supported by business
  documents
• Cash purchases have receipt or cancelled check
• Credit purchases are supported by a purchase
  invoice . . .

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Recording an Inv Purchase

• Your co purchases on account merchandise inv to
  sell to your customers that costs your co 3,800
• What is the Journal Entry? How is it shown in
  the T-accounts?

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Purchase of Merchandise
Debit Credit May 4
Merchandise Inventory
3,800 Accounts
Payable 3,800
To record goods purchased on account
Merchandise Inventory
Accounts Payable
3,800
May 4
May 4
3,800
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What gets included in the booking of Merchandise
Inv?

• Inv Cost includes the cost to your co for the
  merchandise for re-sale to customers the costs
  to obtain it
• Does not include supplies for signs packaging,
  equipment such as cash registers, etc., these
  cost are recorded in asset accounts
• If an entity sells cash registers, then the
  registers they have to sell customers would be
  inventory, but the cost of cash registers used to
  record the sales of the registers is NOT inv!

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Business Realities Purchase Returns Allowances

• What happens if the goods/inv received are
  damaged or defective, of inferior quality, or do
  not meet the purchasers specifications? How is
  this handled?
• Return the goods for credit if purchased on
  account, or for cash if the original purchases
  was a cash transaction
• If keep the goods, seller will typically grant a
  discount called a purchase allowance

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So how do I record a Purchase allowance if I need
to?

• How do I show in my accounting records a purchase
  allowance? The invoice shows one amount but the
  seller has agreed to another
• You originally booked the entry at the invoice
  amount which is HIGHER than what the co has to
  pay
• Need to ADJUST the amount payable and the amount
  of the inventory cost.
• Lets say the supplier granted you 300 off your
  original purchase price

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Purchase Returns Allowances
Debit Credit May 8 Accounts
Payable
300 Merchandise
Inventory 300 To
record return of goods purchased on account
Merchandise Inventory
Accounts Payable
May 8
300
May 4 3,800
300
May 8
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Okay, but I know that

• Inv Cost includes the cost to your co for the
  merchandise for re-sale to customers the costs
  to obtain it

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Freight Costs - Incoming Inventory
Merchandise inv costs should include freight cost
(transportation-in) incurred by buyer
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Lets say the cost of shipping is 150
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Recording Freight Cost Incurred by Buyer
Debit Credit May 9
Merchandise Inventory
150 Cash
150
To record payment of freight on goods
purchased
Merchandise Inventory
Cash
3,800
May 9
150
May 4
May 8
300
150
May 9
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What about if it costs my co money to ship to the
customer?

• Freight OUT costs are considered SELLING COSTS
• Is this a product or period cost??

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Record Freight-OUT Cost Incurred by Seller
Debit Credit May 4
Freight-out (or Delivery Expense)
150 Cash

150 To record payment of
freight on goods sold
Cash
Freight-out Expense
150
May 4
May 4
150
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Purchase Discounts

• Credit terms may allow buyer to claim a cash
  discount if payment is made within a certain
  specified time
• Purchaser saves money and seller converts account
  receivable to cash more quickly

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Business Realities Purchase Discounts

• A seller may offer the buyer of merchandise a
  cash discount to induce early payment for the
  goods. This offer is expressed in the credit
  terms of the seller.

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Purchase Discounts

• Credit terms may be written 2/10, net
  30 which means 2 cash discount if paid within
  10 days of invoice date, otherwise pay the full
  amount within 30 days

• What do you think 1/10, EOM means?

1 cash discount if paid within 10 days,
otherwise pay by the end of the month
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Cash Discountsa beautiful thing

• Ok your co purchased that 3,800 of goods from
  your supplier and that co offered you the cash
  discount shown on the invoice
• Lets say your co took advantage of this discount
  what would you book? What is the cost of the
  inv?
• Now you booked the inv at 3,800 (plus your
  T-account will show the FREIGHT-IN charge of 150
  and any returns, say 300), but the fact that you
  are taking advantage of the cash discount changes
  how much it is really costing you you need to
  make an entry to reflect this

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Purchase Discounts you really owe
Original Invoice
3,800 Return on May 8
(300) Amount due before discount
3,500 2 discount
(70) Net due
3,430
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Purchase Discounts
May 14
3,500
3,430
May 14
May 14
70
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Summary of Purchasing Transactions Perpetual
System
Purchase return
Purchase
May 14
70
Freight-in
Purchase discount
Balance 3,580
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3 Explain Recording of Sales Under Perpetual
Inventory Systems

• Sales revenues recorded when goods are
  transferred from the seller to the buyer
• Follow revenue recognition principle YOU KNOW
  WHAT THIS IS!

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Inv recording vs Rev recording

• Okay you know get inv stuff lets look at
  the revenue side of things

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Sales

• Every purchase should be supported by business
  documents, i.e., cash register tape or sales
  invoice

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Recording of Sales Under Perpetual Inventory
Systems

• Sales may be on credit or for cash
• Two entries required
• Increase Accounts Receivable or Cash, and
  increase Sales for the sales price of goods sold
• Increase CGS decrease Merchandise Inventory for
  the CGS

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SELLERRecording of Sales Under Perpetual
Inventory Systems
Assume same invoice as before, but now we are the
seller to Sauk for a price of 3,800 assume
that the goods cost us 2,400 to obtain
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SELLERSales Returns Allowances when WE are the
seller not the buyer

• This is the

flip-side
of purchase returns
and allowances

• If a customer returns goods for credit that we
  sold for 300, but cost us 140
• increase Sales Returns and Allowances
• decrease Accounts Receivable
• Return goods to the Merchandise Inventory by
  increasing it and reduce CGS (you got the inv
  back)

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SELLERSales Returns Allowances

• Sales Returns Allowances is a contra-revenue
  account, normal balance is debit
• Mang needs to keep track of returns allowances,
  so they are not deducted directly from sales. An
  example on the IS

Sales 2,500,000 Returns and Allowances
25,000 Net Sales 2,475,000
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Sales Returns Allowances
If a customer returns goods for credit that we
sold for 300, but cost us 140
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Understanding Financials Sales Returns
Allowances
What do excessive returns and allowances suggest?

• Inferior merchandise
• Inefficiencies in filling orders
• Errors in billing customers
• Mistakes in delivery or shipment of goods

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Sales Discounts for the SELLER

• Recall, credit terms may allow buyer to claim a
  cash discount if payment is made within a certain
  specified time, 2/10, net 30
• Sales Discounts Account is the

flip-side
of purchase discounts
Contra-revenue account, normal balance is debit
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Sales Discounts
Assume same credit terms as before, but now we
are the seller not the buyer
Why did the buyer pay 3,430?? How was the
3,430 calc?? Did you follow?
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Freight Costs - Outgoing Inventory
Freight cost (transportation-out) incurred by
seller on sales is an operating (period) exp
NOT part of the INV cost or CGS calc!!!
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Lets say

• Okay, you now have a sale with a customer and
  your co has agreed to pay the 150 shipping
  charge to get the product to the customers
  doorhow do you record this?

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4 Distinguish between a single-step a
multiple-step income statement

• There are 2 forms of IS used by Cos
• Single-step total revenues minus total
  expenses
• simple, easy to read
• Multi-step components broken out
• highlights components distinguishes activities

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Single-step Income Statement
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Multi-step Income Statement
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Multi-step Income Statement
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Net Sales
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Multi-step Gross Profit

• CGS is an expense
• CGS is traditionally the largest expense for a
  merchandising entity

• Gross profit represents merchandising profit
• Amount and trend of gross profit is closely
  watched

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Multi-step Operating Expenses

• Operating Period expenses
• Selling expenses all of the expenses associated
  w/ selling the merchandise, from the solicitation
  of the sale to the shipping to the buyers
• Administrative expenses general expenses
  related to general operating activities, human
  resources, accounting, clericalof running the
  business

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Multi-step Nonoperating Activities

• Various rev exp NOT RELATED to the cos main
  or primary line of business

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Multi-step Nonoperating Activities

• Label Income from Operations precedes to
  clearly identify results of a companys normal
  operations

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Multi-step Nonoperating Revenues
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Multi-step Nonoperating Expenses
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5 Determine CGS under a periodic system

• Find balance of beg inventory ? (ending inv
  of previous period is beg inv next period)

• Add amount of purchases to find cost of goods
  available for sale (COGAS)

• Subtract the ending inv balance ending inv must
  be determined by physical count

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Cost of Goods Sold - Periodic

• An example of quantities only, no dollars (cost
  dollars is how it is shown on the IS)
• Beginning inventory of bicycles -0-
• Purchases of bicycles 1,250
• Goods available 1,250
• Ending inventory 250
• Good sold (number of bicycles) 1,000

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CGS- Periodic
For more, see appendix!
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6 Explain the Factors Affecting Profitability

• Gross Profit Rate
• Profit Margin Ratio

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Gross Profit Rate

• Gross Profit
• Net Sales

Why is a companys gross profit more
informative than just the dollar amount of gross
profit?
The context of the figure is more meaningful is
it profit on 1,000,000 or 100,000,000 of sales?
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Gross Profit Rates
In addition to calculating the rate, we should
compare to similar industry rates, with caution
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Why Do Gross Profits Rates Change?

• Selling products with a lower mark-up
• Increased competition can lower sale prices

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Profit Margin Ratio

• Net Income
• Net Sales

Percentage of mark-up on merchandise sold
alters this percentage
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Profit Margin Ratio
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Evaluate Profits Margins

• In 2001, Wal-Mart generated 3.3 cents on each
  dollar of sales in 2002, it generated 3.1 cents
  (note grocery industry average is only 2)

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Study Objectives - Appendix

• Explain the recording of purchases and sales of
  inventory under a periodic inventory system.

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Periodic System Recording Merchandise
Transactions

• Recording of revenues is the same
• At the date of sale, no cost of merchandise sold
  is recorded
• Physical count taken at period end to determine
  cost of ending inventory, and therefore cost of
  goods sold
• Record purchase returns and allowances, purchase
  discounts, and freight-in costs in separate
  accounts

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Record Purchase of Merchandise
Purchases is a temporary account, normal balance
is debit
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Purchase Returns Allowances
Purchases Returns Allowances is a temporary
account, normal balance is credit
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Freight-in Costs
Freight-in is a temporary account, normal balance
is debit
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Purchase Discounts
Purchase Discounts is a temporary account, normal
balance is credit
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Record Sale of Merchandise
Only one entry with periodic method
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Sales Returns and Allowances
Only one entry with periodic method
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Sales Discounts
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Comparison of Perpetual to Periodic
Buyer
Seller
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Lets Review
Which of the following statements about a
periodic inventory system is true?
a. Cost of goods sold is determined only at the
end of the accounting period.
b. Detailed records of the cost of each inventory
purchase and sale are maintained continuously.
c. The periodic system provides better control
over inventories than a perpetual system.
d. The increased use of computerized systems has
increased the use of the periodic system.
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Lets Review
Which of the following statements about a
periodic inventory system is true?
a. Cost of goods sold is determined only at the
end of the accounting period.
b. Detailed records of the cost of each inventory
purchase and sale are maintained continuously.
c. The periodic system provides better control
over inventories than a perpetual system.
d. The increased use of computerized systems has
increased the use of the periodic system.
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Lets Review
Which of the following items does not result in
an adjustment in the merchandise inventory
account under a perpetual system??
a. A purchase of merchandise.
b. A return of merchandise inventory to the
supplier.
c. Payment of freight costs for goods shipped to
a customer.
d. Payment of freight costs for goods received
from a supplier.
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Lets Review
Which of the following items does not result in
an adjustment in the merchandise inventory
account under a perpetual system??
a. A purchase of merchandise.
b. A return of merchandise inventory to the
supplier.
c. Payment of freight costs for goods shipped to
a customer.
d. Payment of freight costs for goods received
from a supplier.
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Lets Review
A purchase of 1,200 is made on March 2, terms
2/10, n/30, on which a return of 200 is granted
on March 5. What amount should be paid on March
12?
a. 1,176
c. 1,000
d. 980
b. 1,200
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Lets Review
A purchase of 1,200 is made on March 2, terms
2/10, n/30, on which a return of 200 is granted
on March 5. What amount should be paid on March
12?
a. 1,176
c. 1,000
d. 980
b. 1,200
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Lets Review
If beginning inventory is 60,000, cost of goods
purchased is 380,000, and ending inventory is
50,000, what is cost of good sold under the
periodic system?
a. 390,000
c. 330,000
d. 420,000
b. 370,000
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Lets Review
If sales revenues are 400,000, cost of goods
sold is 310,000, and the operating expenses are
60,000, what is the gross profit?
a. 30,000
c. 340,000
d. 400,000
b. 90,000
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Lets Review
If sales revenues are 400,000, cost of goods
sold is 310,000, and the operating expenses are
60,000, what is the gross profit?
a. 30,000
c. 340,000
d. 400,000
b. 90,000
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Lets Review
Which of the following would affect the gross
profit rate (assuming sales are constant)?
a. An increase in advertising expense.
b. A decrease in depreciation expense.
c. An increase in cost of goods sold.
d. A decrease in insurance expense.
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Lets Review
Which of the following would affect the gross
profit rate (assuming sales are constant)?
a. An increase in advertising expense.
b. A decrease in depreciation expense.
c. An increase in cost of goods sold.
d. A decrease in insurance expense.
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Lets Review
If beginning inventory is 60,000, cost of goods
purchased is 380,000, and ending inventory is
50,000, what is cost of good sold under the
periodic system?
a. 390,000
c. 330,000
d. 420,000
b. 370,000
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Lets Review
Which of the following would not affect the gross
profit rate?
a. An increase in the cost of heating the store.
b. An increase in the sale of luxury items.
c. An increase in the use of discount pricing
to sell merchandise.
d. An increase in the price of inventory items.
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Lets Review
Which of the following would not affect the gross
profit rate?
a. An increase in the cost of heating the store.
b. An increase in the sale of luxury items.
c. An increase in the use of discount pricing
to sell merchandise.
d. An increase in the price of inventory items.