Chapter 5 Merchandising Operationslrbrasher.com/images/Chapter_5_Powerpoint.pdfPerpetual and...

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Chapter 5Merchandising

Operations

Chapter 5 Learning Objectives

1. Describe merchandising operations and the two types of merchandise inventory systems

2. Account for the purchase of merchandise inventory using a perpetual inventory system

3. Account for the sale of merchandise inventory using a perpetual inventory system

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4. Adjust and close the accounts of a merchandising business

5. Prepare a merchandiser’s financial statements

6. Use the gross profit percentage to evaluate business performance



7. Account for multiple performance obligations using a perpetual inventory system (Appendix 5A)

8. Account for the purchase and sale of merchandise inventory using a periodic inventory system (Appendix 5B)


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Learning Objective 1

Describe merchandising operations and the two types of merchandise inventory systems


WHAT ARE MERCHANDISING OPERATIONS?

• A merchandiser is a business that sells merchandise, or goods, to customers. – The merchandise that this type of business

sells is called merchandise inventory.• A wholesaler buys goods from a

manufacturer and sells them to retailers.• A retailer buys merchandise from

manufacturers or a wholesaler and then sells the goods to consumers.


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The Operating Cycle of a Merchandising Business

The operating cycle:1. It begins when the company purchases

inventory from an individual or a business, called a vendor.

2. The company then sells the inventory to a customer.

3. Finally, the company collects cash from customers.




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• The income statement of a merchandiser reports: • Sales Revenue rather than Service Revenue• The cost of merchandise sold to customers,

called Cost of Goods Sold (COGS)• Gross profit, which is net Sales Revenue minus

Cost of Goods Sold• Operating expenses, which are expenses other

than Cost of Goods Sold




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(continued)

Merchandise Inventory Systems: Perpetual and Periodic Inventory Systems

• Businesses need to determine the value of merchandise inventory on hand and the value sold.

• The two inventory accounting systems:• A periodic inventory system requires a physical

count of inventory to determine inventory on hand.

• A perpetual inventory system keeps a running computerized record of merchandise inventory.


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Account for the purchase of merchandise inventory using a perpetual inventory system


HOW ARE PURCHASES OF MERCHANDISE INVENTORY RECORDED IN A PERPETUAL

INVENTORY SYSTEM?

• The cycle of a merchandiser begins with the purchase of merchandise inventory.

• An invoice is the seller’s request for payment from the purchaser.– Invoices are also called bills.– Sellers have sales invoices.– Purchasers have purchase invoices


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Purchase of Merchandise Inventory

Smart Touch Learning receives the goods from Exhibit 5-3 on June 3 and makes a payment on that date.


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Purchase of Merchandise Inventory

Now assume that on June 3, instead of paying cash, Smart Touch Learning receives the merchandise inventory on account.


Purchase Discounts

• A purchase discount is a discount that businesses offer to purchasers as an incentive for early payment.

• Credit terms are the payment terms of purchase or sale as stated on the invoice.– Most credit terms express the discount, the

discount time period, and the final due date.– Example: 3/15, n/30 means a 3% discount if

paid within 15 day, otherwise the full amount is due in 30 days.


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Purchase Discounts

Under credit terms of “3/15, NET 30 DAYS”, If Smart Touch Learning pays on June 15, which is within the discount period, the cash payment entry would be:


Purchase Discounts

The purchase discount is credited to the Merchandise Inventory account because the discount for early payment decreases the actual cost paid for Merchandise Inventory:


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Purchase Discounts

Assume instead that Smart Touch Learning pays on June 24, after the discount period ends, the cash payment entry would be:


Purchase Returns and Allowances

The invoice price for a purchaser may need to be adjusted for purchase returns or purchase allowances.• Purchase returns exist when sellers allow

purchasers to return merchandise that is defective, damaged, or otherwise unsuitable.

• Purchase allowances are amounts granted to purchasers as an incentive to keep goods that are not “as ordered.”


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On June 4, Smart Touch Learning returns 20 tablets valued at a total of $7,000 from the June 1 purchase.


On June 10, Smart Touch Learning purchased 15 tablets on account with credit terms of 3/15, n/30 at a cost of $5,250. Five tablets are returned on June 15 for $1,750, and payment is made on June 20.



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Transportation Costs

Purchase agreements specify shipping terms to determine when title of the goods transfers to the purchaser and who pays the freight. • FOB shipping point means the buyer takes

ownership (title) to the goods after the goods leave the seller’s place of business (shipping point). – The buyer (owner of the goods while in transit) usually

pays the freight.• FOB destination means the buyer takes

ownership (title) to the goods at the delivery destination point. – The seller (owner of the goods while in transit) usually

pays the freight.



When merchandisers are required to pay for shipping costs:• Freight in is the transportation cost to ship goods

into the purchaser’s warehouse; thus, it is freight on purchased goods.

• Freight out is the transportation cost to ship goods out of the seller’s warehouse and to the customer; thus, it is freight on goods sold to a customer.


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Freight InAssume Smart Touch Learning pays a $60 freight charge on June 3 for a purchase with FOB shipping point:


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Freight In Within Discount Period• Under FOB shipping point, the seller sometimes prepays the

transportation cost as a convenience and lists this cost on the invoice.

• Assume, Smart Touch Learning purchases $5,000 of goods, with freight charge of $400, on June 20 on account with terms of 3/5, n/30. The terms of shipment are FOB shipping point.



Freight In Within Discount PeriodIf Smart Touch Learning pays within the discount period, the discount will be computed only on the $5,000 merchandise cost, resulting in a $150 discount:


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Cost of Inventory Purchased

• Knowing the net cost of inventory allows a business to determine the actual cost of the merchandise purchased.

• Net cost of inventory is calculated as follows:


Cost of Inventory Purchased

During the year, Smart Touch Learning buys $281,750 of inventory, returns $61,250 of the goods, and takes a $4,410 early payment discount. The company also pays $14,700 of freight in. Net costs are calculated as:


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Account for the sale of merchandise inventory using a perpetual inventory system


HOW ARE SALES OF MERCHANDISE INVENTORY RECORDED IN A PERPETUAL

INVENTORY SYSTEM?

• The amount a business earns from selling merchandise inventory is called Sales Revenue.

• Two entries are required to record sale transactions:– The first entry records Sales Revenue and

Cash or Accounts Receivable.– The second entry records Cost of Goods Sold

and Merchandise Inventory.


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Cash and Credit Card Sales

As Smart Touch Learning makes sales, sales invoices are issued to customers.• Exhibit 5-5 illustrates

the invoice for two tablets sold for cash on June 19, 2019.

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Cash and Credit Card Sales

Smart Touch Learning sold the two tablets for $1,000 cash. The cost of the tablets was $700.


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Sales on Account

Smart Touch Learning sold 5 tablets for $500 each, making a $2,500 sale on account on June 15. The goods cost $1,750.


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Sales Discounts

• Many sellers offer customers a discount for early payment.

• Sales discounts are a reduction in the amount of revenue earned on sales for early payment.

• The new revenue recognition standards require sales to be recorded at the net amount or the amount of the sale less any sales discounts.


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Sales Discounts

On June 21, Smart Touch Learning sold 10 tablets for $500 each on account with terms of 2/10, n/30. The goods cost $3,500.


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Sales Discounts

When the customer makes payment within the discount period, Smart Touch Learning will record the receipt of cash and decrease the Accounts Receivable for $4,900 as follows:


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Sales Discounts

If the customer does not pay within the discount period, the customer must pay the full $5,000 amount. Smart Touch Learning would record the discount lost as follows:


Sales Returns and Allowances

• The return of goods by a customer or the granting of an allowance is called Sales Returns and Allowances.

• Estimating Sales Returns– Under the new revenue recognition standard,

companies should only record sales revenue in the amount they expect to eventually realize.

– Companies must decrease sales revenue by an estimated amount of sales returns.

– Historical data can be used for this estimate.


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Estimating Sales ReturnsSmart Touch Learning had sales of $1,000,000 and cost of goods sold of $600,000 for the period. Smart Touch Learning estimates that approximately 4% of the merchandise sold will be returned.

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Actual Return of InventoryOn January 20, 2020, a customer returned merchandise purchased with cash with a sales price of $2,000. The cost of the goods was $800.


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Sales AllowanceOn January 28, 2020, Smart Touch Learning grants a $100 sales allowance for goods damaged in transit. The goods were sold on account and remain unpaid.


Transportation Costs—Freight Out

Smart Touch Learning paid $30 to ship goods to a customer on June 21.

Remember: Freight out is a delivery expense to the seller.


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Adjust and close the accounts of a merchandising business


WHAT ARE THE ADJUSTING AND CLOSING ENTRIES FOR A MERCHANDISER?

• Actual inventory on hand may differ from what the books show.– Inventory shrinkage is loss of inventory

occurring from theft, damage, and errors.• Businesses take a physical count of

inventory at least once a year.• Merchandise Inventory is adjusted based

on the physical count.


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Adjusting Merchandise Inventory Based on a Physical Count

Smart Touch Learning’s Merchandise Inventory account shows an unadjusted balance of $31,530, but a physical count comes to only $30,000.


Closing the Accounts of a Merchandiser

The four-step closing process for a merchandising company follows:• Step 1: Make the revenue accounts equal zero

via the Income Summary account.• Step 2: Make expense accounts equal zero via

the Income Summary account.• Step 3: Make the Income Summary account

equal zero via the Retained Earnings account.– This closing entry transfers net income (or net loss) to

Retained Earnings.• Step 4: Make the Dividends account equal zero

via the Retained Earnings account.


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• Exhibit 5-6 presents Smart Touch Learning’s adjusted trial balance and closing entries for the year (new accounts are highlighted in blue).

• Closing means to zero out all temporary accounts.



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Prepare a merchandiser’s financial statements


HOW ARE A MERCHANDISER’S FINANCIAL STATEMENTS PREPARED?

The formats for income statements are:• The single-step income statement groups all

revenues together and then lists and deducts all expenses together without calculating any subtotals.

• The multi-step income statement contains subtotals to highlight significant relationships. – In addition to net income, it reports gross

profit and operating income.


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Multi-Step Income Statement

• Operating expenses are reported in two categories:– Selling expenses are related to marketing and

selling the company’s goods and services.– Administrative expenses include expenses not

related to marketing the company’s goods and services.

• Gross profit minus operating expenses equals operating income.


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Multi-Step Income Statement

• Other income and expenses reports revenues or expenses that are outside the normal, day-to-day operations of a business, such as a gain or loss on the sale of plant assets or interest expense.

• Income tax expense reports the federal and state income taxes that are incurred by the corporation.



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Statement of Retained Earnings and the Balance Sheet

• The statements of retained earnings for merchandisers and service businesses are similar.

• The balance sheet for a merchandiser is very similar, except for two new assets accounts:– Merchandise Inventory– Estimated Returns Inventory



Use the gross profit percentage to evaluate business performance


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HOW DO WE USE THE GROSS PROFIT PERCENTAGE TO EVALUATE BUSINESS

PERFORMANCE?

• The gross profit percentage measures the profitability of each sales dollar above the cost of goods sold.

• A high gross profit percentage is desired.


HOW DO WE USE THE GROSS PROFIT PERCENTAGE TO EVALUATE BUSINESS

PERFORMANCE?

Kohl’s Corporation reported the following:

Gross profit percentage for year ending Jan. 2015:

Gross profit percentage for year ending Jan. 2016:


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Account for multiple performance obligations using a perpetual inventory system (Appendix 5A)


HOW ARE MULTIPLE PERFORMANCE OBLIGATIONS RECORDED IN A

PERPETUAL INVENTORY SYSTEM?

• Companies are required to identify the performance obligations associated with each contract.

• A performance obligation is a contractual promise with a customer to transfer a distinct good or service.

• When contracts involve multiple performance obligations, the company is required to allocate the transaction price to each performance obligation separately.


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On November 1 Smart Touch Learning sells one tablet (cost of $350) along with a two-year service contract to a customer for $620 cash. Smart Touch Learning allocates the sales price of $620 as follows: $500 for the tablet and $120 for the two-year service contract.




At December 31, Smart Touch Learning has provided two months of service for the tablet earning $10 of Service Revenue ($120 / 24 months * 2 months).


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Account for the purchase and sale of merchandise inventory using a periodic inventory system (Appendix 5B)


HOW ARE MERCHANDISE INVENTORY TRANSACTIONS RECORDED IN A PERIODIC INVENTORY SYSTEM?

• Perpetual inventory systems are too expensive for smaller businesses.

• Periodic inventory systems require physical counts of inventory to determine quantities on hand.– Merchandise Inventory is updated at the end

of the period, during the closing process.


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Purchases of Merchandise Inventory


Referring back to Exhibit 5-3, the entry to record the receipt of goods on account on June 3 and payment on June 15 using the periodic inventory system is as follows:



Recording Purchase Returns and AllowancesPrior to payment, on June 4, Smart Touch Learning returned 20 tablets to the vendor costing $7,000.

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Recording Purchase Returns and Allowances• During the period, the business records the cost

of all inventory bought in the Purchases account. • The balance of Purchases is a gross amount

because it does not include subtractions for discounts, returns, or allowances.

• Net purchases is the remainder after subtracting the contra accounts from Purchases:



Recording Transportation CostsSmart Touch Learning pays a $60 freight charge on June 3.

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Sale of Merchandise Inventory

• No running record of merchandise inventory is maintained.

• There is no need to record an entry to Merchandise Inventory and Cost of Goods Sold.

• Accounting for sales discount and sales return and allowances is the same as under the perpetual inventory system.


Sale of Merchandise Inventory


On June 21, Smart Touch Learning sold 10 tablets for a total sale of $5,000 on account with terms of 2/10, n/30.

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Preparing Financial Statements

• The periodic inventory system requires an additional calculation—the cost of goods sold.

• At the end of each period, the company combines a number of accounts to compute cost of goods sold for the period, and this calculation is shown on the income statement.


Preparing Financial Statements

Cost of goods sold is calculated as follows for Smart Touch Learning:


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Adjusting and Closing Entries

• No adjustment is required for inventory shrinkage.

• Temporary accounts are closed via the Income Summary:– Purchase Returns and Allowances– Purchase Discounts– Purchases– Freight In




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The four-step closing process under the periodic inventory system:Step 1: • Using the periodic inventory system, Sales

Revenue and Sales Discounts Forfeited are closed with a debit via the Income Summary account.

• All other temporary accounts with credit balances are also closed.

• The ending Merchandise Inventory and Estimated Returns Inventory are recorded as debits.


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The four-step closing process under the periodic inventory system:Step 2: • Expense accounts and other temporary accounts with

debit balances are closed via the Income Summary account.

• The beginning Merchandise Inventory, Purchases, and Freight In are also closed via the Income Summary account.



The four-step closing process under the periodic inventory system:• Step 3 and Step 4: These steps, closing the

Income Summary and Dividends accounts, are the same under both the perpetual and periodic methods.


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Chapter 5 Merchandising Operationslrbrasher.com/images/Chapter_5_Powerpoint.pdfPerpetual and...

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