Merchandising Accounting

Merchandising Activities

• This is about accounting issues related to merchandising businesses
• How to evaluate their performance, and unique features of their financial statements

Managing Inventory

• Managing inventory, goods for resale, is vital for merchandising businesses
• Must acquire and sell inventory items quickly with competitive pricing
• Inventory should be a liquid asset sold in days or weeks
• Appears near the top of the balance sheet, below accounts receivable

The operating cycle of a merchandising company

• Operating cycle called the series of transactions for revenue and cash from customers
• Transactions: Purchasing merchandise, selling on account, and collecting receivables
• The cycle repeats as cash from customers is used to purchase more merchandise

Revenue Recognition

• A key aspect for merchandising companies is including revenue on the income statement
• Revenue results in accounts receivable, cash and operating cash flows
• Revenue is only recognized when earned
• All functions within the customer agreement are performed, and costs are reasonably estimated
• Revenue typically recognized at the point of sale

Merchandising Activities

• Most merchandising companies purchase ready-to-sell inventories
• Manufacturing companies like General Motors, IBM, and Boeing Aircraft differs from merchandisers
• Manufacturers produce their inventories, and are not merchandisers
• Manufacturing company cycles longer and more complex than merchandising due to production

Retailers and Wholesalers

• Retailers sell directly to consumers like Lowe’s, The Gap, and Walmart, to small local shops
• Wholesalers buy large quantities and resell to retailers instead of public
• Wholesaling is a major merchandising activity
• Retailers and wholesalers alike use these accounting operations

Income Statement of a Merchandising Company

• Income Statement structure differs more from that of service-based companies

Income Statement for Services

• Revenue less expenses resulting in net income

Income Statement for Merchandising

• Sales less the cost of goods sold equals the Gross Profit
• From the Gross Profit other expenses are removed like taxes and interest
• That results in the Net Income

Computer City’s Income Statement

• $900,000 in sales is the selling price of goods sold
• Costs are removed from the balance sheet and offset them against sales revenue, in this case $540,000
• Cost of goods sold is shown separately due to size and importance, is also an explicit expense
• The $360,000 difference is the gross profit, which is a measure of measuring profitability from sales transactions
• Gross profit does not represent the overall profitability of the business
• Other expenses are not included like Depreciation
• Net income is only earned when the gross profit goes above its expenses

Accounting System Requirements for merchandising companies

• General ledger accounts or "control" accounts prepare financial statements
• Summarize the business's financial position and operations results
• Subsidiary ledgers provide detailed information to manage business enterprises

Subsidiary Ledgers

• These contain info about specific control accounts in the general ledger
• Merchandising companies maintain accounts receivable and payable subsidiary ledgers
• For example, having 500 credit customers, has 500 accounts in the accounts receivable subsidiary ledger
• The account balances are equal to the Accounts Payable control balance in the general ledger
• The accounts show all data on products, with quantities purchased, sold, and currently in stock

Posting transactions

• In a computerized system, subsidiary ledger accounts and general ledger control accounts are posted automatically

Accounting For Merchandise Inventories

• Perpetual and periodic inventory systems
• Perpetual inventory systems is easy with technological advancements
• Periodic approach is used small businesses with many systems
• Accounting for inventory similar to prepaid expenses
• Inventory is initially reported as an asset on the balance sheet
• As it's sold, it becomes an expense called the cost of goods

Perpetual inventory systems

• Cost of transactions or sales of merchandise is recorded immediately
• Accounting records are perpetually up-to-date
• Purchases recorded in the "Inventory" asset account
• Two entries when sold, revenue earned and cost of goods sold
• Second entry reduces the balance to reflect the sale

Inventory subsidiary ledger

• The ledger provides info on product, per-unit cost, and number of units
• Cost of goods sold are matched via the matching principle in the system at the date of sale
• This requires a second entry to record the cost of goods sold

Payments, and costs

• Sales is equal to the sale price of merchandise by units sold
• Payment to Suppliers, is added to the general ledger and reduces cash
• Reductions are also used in the subsidiary ledger for each sale
• The basic feature of the system is that the Inventory account is continuously updated for purchases and sales

Physical Inventories

• Over time discrepancies may result between records and actual on-hand quantities
• Inventory shrinkage refers to unrecorded decreases due to breakage, spoilage, theft etc
• Corporations required to take an annual physical count of the merchandise on hand
• Inventory Account adjusted to the quantities indicated by the physical inventory

Inventory Shortage

• Shortage due to cost of good
• It may be charged to a special loss account, such as Fire Loss
• On the income statement, a loss of this type is deducted from revenue in the same manner as an expense