Accounting for Merchandising Operations

• Accounting for Merchandising Operations

Learning Objectives

• Identify the differences between service and merchandising companies.
• Explain recording purchases under a perpetual inventory system.
• Explain recording sales revenues under a perpetual inventory system.
• Explain the steps in the accounting cycle for a merchandising company.
• Distinguish between a multiple-step and a single-step income statement.

Merchandising Operations

• Merchandising companies buy and sell goods.
• The primary source of revenues is referred to as either sales revenue or sales.
• Cost of goods sold is the total cost of merchandise sold during the period.
• Calculation: Sales Revenue less Cost of Goods Sold equals Gross Profit, Gross Profit less Operating expenses equals Net Income (Loss)
• The operating cycle of a merchandising company is longer than that of a service company.
• Companies use either a perpetual inventory system or a periodic inventory system to account for inventory.

Flow of Costs - Perpetual System

• 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.

Flow of Costs - Periodic System

• Does not keep detailed records of the goods on hand.
• Cost of goods sold determined by a count at the end of the accounting period.
• Calculation of Cost of Goods Sold:
  • Beginning inventory plus Purchases (net) equals Goods available for sale

Perpetual System Advantages

• 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.

Recording Purchases of Merchandise

• Normally recorded when goods are received from the seller.
• Purchase invoice should support each credit purchase.
• Sauk Stereo uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc.
• Made using cash or credit (on account).

Freight Costs – Terms of Sale

• Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller: FOB Shipping Point, the buyer pays freight costs.
• Ownership of the goods remains with the seller until the goods reach the buyer: FOB Destination, the seller pays freight costs.
• Freight costs incurred by the seller are an operating expense.

Purchase Returns and Allowances

• Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.
• Purchase return: Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.
• Purchase allowance: May choose to keep the merchandise if the seller will grant a reduction of the purchase price.

Purchase Discounts

• Credit terms may permit the buyer to claim a cash discount for prompt payment.
• Purchaser saves money and the seller shortens the operating cycle.
• Examples are 2/10, n/30 (2% discount if paid within 10 days, otherwise net amount due within 30 days), 1/10 EOM (1% discount if paid within first 10 days of next month), and n/10 EOM (Net amount due within the first 10 days of the next month).
• Discounts should be taken when offered.

Summary of Purchasing Transactions

• Includes a debit for Purchase and Freight-in on the 4th and 6th respectively, Credit for Return and Discount on the 8th and 14th.

Recording Sales of Merchandise

• Revenue, like service revenue, is recorded when the performance obligation is satisfied.
• Performance obligation is satisfied when the goods are transferred from the seller to the buyer.
• Sales invoice should support each credit sale.
• Two journal entries to record are a sale: debit Cash or Accounts receivable credit Sales revenue, and debit Cost of goods sold credit Inventory.
• Made using cash or credit (on account).

Sales Returns and Allowances

• "Flip side” of purchase returns and allowances.
• Contra-revenue account to Sales Revenue (debit).
• Sales are not reduced (debited) because doing so would obscure importance of sales returns and allowances as a percentage of sales, and distort comparisons.

Sales Discount

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

Completing the Accounting Cycle

• Adjusting entries are the same as a service company.
• One additional adjustment to make records agree with the actual inventory on hand by adjusting Inventory and Cost of Goods Sold.
• Closing involves all of the income summaries, owner's capital, and drawings.

Forms of Financial Statements - Multiple-Step Income Statement

• Shows several steps in determining net income.
• Two steps relate to principal operating activities.
• Distinguishes between operating and non-operating activities.
• Key items:
  • Net Sales
  • Gross Profit
  • Operating Expenses
  • Nonoperating activities
  • Net income

Forms of Financial Statements - Single-Step Income Statement

• Subtract total expenses from total revenues.
• Two reasons for using the single-step format:
  • Company does not realize any profit until total revenues exceed total expenses.
  • Format is simpler and easier to read.

Forms of Financial Statements - Classified Balance Sheet

• Assets, liabilities, and equity
• Assets are split up between current assets, and property plant and equipment
  • Current Assets: accounts receivable, cash, inventory and prepaid insurance
  • Property, plant, and equipment: equipment, and accumulated deprecation-equipment

Periodic Inventory System

• No running account of changes in inventory.
• Ending inventory determined by physical count.
• Cost of goods sold not determined until the end of the period.

Periodic Inventory System - Recording Merchandise Transactions

• Record revenues when sales are made.
• Purchases are recorded in the Purchases account.
• Do not record the cost of merchandise sold on the date of the sale.
• The physical inventory count determines the cost of merchandise on hand and that of goods sold during the period.
• Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts.