Chapter 4 Outline PDF

Chapter 4 Outline ================= **I. Merchandising Activities** A. Merchandise refers to products, also called goods, which a company buys to resell. Merchandisers can be either wholesalers (those that buy from manufacturers and sell to retailers) or retailers (those that buy from manufacturer...

Chapter 4 Outline ================= **I. Merchandising Activities** A. Merchandise refers to products, also called goods, which a company buys to resell. Merchandisers can be either wholesalers (those that buy from manufacturers and sell to retailers) or retailers (those that buy from manufacturers or wholesalers and sell to consumers). B. Reporting Income for a Merchandiser\ Revenue from selling merchandise (*net sales*) minus the *cost of goods sold* to customers is called *gross profit*. Gross profit minus *operating expenses* determines the net income or loss for the period. C. Reporting Inventory for a Merchandiser\ A merchandiser's balance sheet is the same as a service business with the exception of one additional *current* asset called: 1*. Merchandise inventory,* or *Inventory*, refers to products that a company owns and intends to sell. 2\. The cost of this asset includes the cost incurred to buy the goods, ship them to the store, and make them ready for sale. D. Operating Cycle for a Merchandiser\ Begins with purchasing merchandise for cash and ends with collecting cash from selling the merchandise. E. Inventory Systems\ Two alternative inventory systems that can be used to collect information about the cost of goods sold and the inventory (cost of goods available) are: 1*.* *Perpetual inventory system*---updates accounting records for *each* purchase and *each* sale of inventory. Technological advances and competitive pressures have drastically increased the use of this method. 2\. *Periodic inventory system*---updates the accounting records for purchases and sales of inventory *only at the* *end of a period*. **II. Merchandise Purchases\ **The *invoice* serves as a *source document* for the event. A. Purchases [without] Cash Discounts. B. Purchase [with] Cash Discounts 1. *Credit Terms* describe cash discounts offered to purchasers by the seller for payment within a specified period of time called the *discount period*. 2. *Cash Discounts*---granted by the seller to encourage buyers to pay the amount they owe earlier. Buyers view cash discounts as purchase discounts and sellers view them as sales discounts. 3. Example: *credit terms*, 2/10 n/30, offer a 2% discount if invoice is paid within 10 days of invoice date; if not, full payment is due within 30 days of invoice date. 4. Purchases on Credit---entry for buyer for purchase using full invoice, gross method is: debit Merchandise Inventory and credit Accounts payable. 5. Payment within Discount Period---debit Accounts Payable (full invoice amount), credit Cash (full invoice -- discount), credit Inventory (amount of discount). 6. Managing Discounts---Missing out on cash discounts can be very costly. A system should be set up to ensure that all invoices are paid on the last day of discount period. 7. Payment after Discount Period---debit Accounts Payable and credit Cash. C. Purchases [with] Returns and Allowances 1\. *Purchases allowances* refers to a reduction in the cost of defective merchandise that a buyer acquires. 2\. *Purchases returns* are merchandise a buyer acquires but then returns to the seller. 3\. A *debit memorandum* informs the seller of a debit made to the seller's account payable in the buyer's records. 4\. Entry on buyer's books---debit Accounts Payable or Cash (if refund given) and credit Inventory. D. Purchases and Transportation Costs---the point at which ownership is transferred (called FOB or *free on board*). Two alternative points of title transfer are: 1\. FOB shipping point---title transfers at shipping point and buyer pays shipping costs. a\. Increases cost of merchandise (cost principle) b\. Debit Inventory, credit Cash or Accounts Payable (if to be paid for with merchandise later) 2\. FOB destination---title transfers at destination and seller pays shipping costs. a\. Operating expense for seller b\. Debit Delivery Expense and credit Cash E. Itemized Costs of Purchases---the net cost of purchased merchandise according to the *cost principle* is recorded in the Inventory account. Inventory is debited (increased) for invoice and transportation costs, and credited (decreased) for returns, allowances, and purchase discounts. *Supplemental records* are often used to collect information about each of these cost elements for management to evaluate and control. **III. Merchandise Sales---**involves sales, sales discount, sales returns and allowances, and cost of goods sold A. Each sale of merchandise transaction involves two entries: the revenue entry and the cost entry. 1\. Recognize revenue---debit Accounts Receivable (or cash), credit Sales (both for the invoice amount). 2\. Recognize cost---debit Cost of Goods Sold, credit Inventory (both for the cost of the inventory sold). C. Sales [with] Cash Discounts 3\. Buyer Pays [after] discount period---debit Cash, Credit Accounts Receivable (full invoice amount). 4\. Sales Discounts is a contra revenue account---subtraction from Sales. Sales [with] Returns and Allowances 5\. *Sales returns---*merchandise that a customer returned to the seller after a sale. 6\. *Sales allowances*---reductions in selling price of merchandise sold to customers (usually for damaged merchandise that a customer is willing to keep at a reduced price). 7\. Buyer Returns Goods---seller issues refund for returned goods. Entry: debit Sales Returns and Allowances and credit Cash; additional entry to restore cost of returned goods to inventory if merchandise is returned and it is salable: debit Inventory, credit Cost of Goods Sold. 8\. Seller receives returned goods into inventory---seller also reduces cost of sales. 9\. Returned goods [not] defective---if inventory can be resold, seller debits Inventory and credits Cost of Goods Sold. 10\. Returned goods [are] defective---debit Inventory for estimated value; debit Loss from Defective Merchandise (difference between cost and estimated value) and credit Cost of Goods Sold (for cost). 11\. Sales Returns and Allowances is a contra revenue account that is subtracted from Sales. 12\. Credit Memorandum---issued by the seller to inform buyer of a credit made to buyer's Accounts Receivable in seller's books. 13\. Buyer Granted Allowances---merchandise which is defective but buyer decides to keep, seller will record a debit to Sales Returns and Allowances and a credit to Cash for the reduction in price. If seller has not yet collected cash for goods sold, seller could credit buyer's Accounts Receivable. **IV. Adjusting and Closing for Merchandisers** A. Adjusting Entries for Merchandisers\ Generally same as discussed for a service business with an additional adjustment needed to update inventory to reflect any loss of inventory referred to as *shrinkage*. 1\. Shrinkage determined by comparing a physical count of the inventory with recorded quantities. 2\. Adjusting entry---debit Cost of Goods Sold, credit Inventory---Adjusting Entries. 3\. Sales Discounts, Returns, and Allowances---Sales are to be reported at the net amount expected which follows new revenue recognition rules. Period-end adjusting entries are commonly made for: expected sales discounts; expected returns and allowances (revenue side) and expected returns and allowances (cost side). Appendix 4C explains these adjusting entries. B. Preparing Financial Statements---statements similar to service business with the following differences: +-----------------------------------------------------------------------+ | | +-----------------------------------------------------------------------+ | C. Closing Entries for Merchandisers---similar to a service business, | | except there are additional temporary accounts to close including | | sales, sales discount, sales returns and allowances, and cost of | | goods sold. Debit balance accounts are closed with the expense | | accounts to Income Summary. | +-----------------------------------------------------------------------+ | | +-----------------------------------------------------------------------+ | A. Multiple-Step Income Statement---details of net sales and | | expenses. Has three main parts: | | | | 1\. *Gross profit*---net sales minus cost of goods sold. | | | | 2\. *Income from operations*---gross profit minus operating expenses | | (separated into selling and general & administrative). | | | | B. Single-Step Income Statement---lists cost of goods sold as another | | expense and shows only one subtotal for total expenses. Expenses | | grouped into few, if any, categories. | +-----------------------------------------------------------------------+ | C. Classified Balance Sheet---reports merchandise inventory as a | | current asset, usually after accounts receivable, according to how | | quickly they can be converted to cash. | +-----------------------------------------------------------------------+ | **VI. Decision Analysis---Acid-Test and Gross Margin Ratios** | +-----------------------------------------------------------------------+ | A. Acid‑Test Ratio | +-----------------------------------------------------------------------+ | 1\. Used to assess the company's liquidity or ability to pay its | | current liabilities. Differs from current ratio in that it is based | | on quick assets (which excludes less liquid current assets such as | | inventory and prepaid expenses) rather than all current assets. | | | | 2\. Calculated by dividing *quick assets* by current liabilities. | | | | 3\. Quick assets are cash, short-term investments, and current | | receivables. | +-----------------------------------------------------------------------+ | B. Gross Margin Ratio (Gross Profit Ratio) | +-----------------------------------------------------------------------+ | 1\. Used to determine the percent of every sales dollar that is | | gross profit. | | | | 2\. Calculated by dividing gross margin by net sales. | +-----------------------------------------------------------------------+