Merchandising (Perpetual and Periodic) PDF

lOMoARcPSD|14391650 Merchandising per and periodic terms Bachelor of Science in Accountancy (Polytechnic University of the Philippines) Scan to open on Studocu Studocu is n...

lOMoARcPSD|14391650 Merchandising per and periodic terms Bachelor of Science in Accountancy (Polytechnic University of the Philippines) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Chapter 6.1® - Accounting for Merchandising Activities, Sample Balance Sheet Representation of Inventory, Perpetual & Periodic Inventory Systems & Merchandise Purchases  Part 6.1 - Accounting for Merchandising Activities, Balance Sheet Representation of Inventory, Perpetual & Periodic Inventory Systems & Merchandise Purchases  Part 6.2 - Types of Merchandising Inventory Systems - Perpetual & Periodic Inventory Systems & Journal Entries for Merchandise Purchases – Perpetual Inventory System  Part 6.3 - Transfer of Ownership, FOB Shipping & FOB Destination Points - Accounting for Transportation Costs of Merchandise Inventory  Part 6.4 - Accounting for Merchandise Sales, Sales Discounts, Sales Returns & Allowances & Shrink – Perpetual Inventory System  Part 6.5 - Sales Returns & Allowances & Shrink (Merchandise Adjusting Journal Entries) - Continued from Accounting for Merchandise Sales– Perpetual Inventory System  Part 6.6 - Glossary of Merchandise Accounting Terms A merchandising company has different business operations than that of a servicing company. A merchandising company earns net income by buying and selling merchandise. A good example is Costco that buys groceries, electronics and clothes from manufacturers and resells it to customers for a margin (profit). Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers. The cost of this merchandise is called Cost of goods sold and is a direct expense item on the Income statement. Merchandising companies can either be wholesalers like Costco or retailers like Rogers Video. Net income for a merchandiser arises when revenue from selling merchandise exceeds both the cost of merchandise sold to customers (margin) and the cost of operations for the period, including salaries of employees working at the head office, marketing & accounting costs, costs for the Information Technology department, and more. The accounting term for revenue derived from selling merchandise is known as Sales. Servicing Company The business model of a servicing company is to sell merchandise and earn revenues, and have front line employees helping customers as well as head office employees support front line employees and form part of the operating expenses. The income left over after paying operating expenses is called Net Income. Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 This diagram shows the revenue models of the two major types of businesses out there, i) Servicing companies and ii) Merchandising companies). Servicing companies are those that offer services such as accounting, law representation, computer programming, etc and thus they do not have any 'Cost of Goods Sold' because they do not hold inventory for resale. Merchandising companies on the other hand are those that hold inventory for resale to consumers and the best example is for instance Bestbuy in the electronics industry or Costco in the groceries industry. Notice that both merchandising & servicing companies have Operating expenses because both types of businesses must employ people in order to run their operations and pay salaries; which are then treated as operating expenses. Calgary Sweets Ltd. Condensed Income Statement For Year Ended December 31st, 2009 Net Sales.................................................. $458,000 Cost of Goods Sold..................................... ($253,000) Gross Profit from Sales................................ $205,000 General, Admin & Other expenses................... ($166,000) Net Income................................................ $39,000 The condensed income statement of Calgary Sweets Ltd. above shows us the relationship between net sales, cost of goods sold and the arrival to the gross profit calculation. General and administration expenses such as employee salaries, warehouse rents, etc are then deducted from the gross profit to arrive at the net income. Costco Wholesale Balance Sheet As at 2008-08-31 (in millions of USD) Cash & Equivalents $2,619.43 Short Term Investments $655.58 Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Cash and Short Term Investments $3275.01 Net Accounts Receivable $664.48 Receivables - Other $0 Total Receivables, Net $747.97 Total Merchandise Inventory $5,039.41 Prepaid Expenses Other Current Assets, Total $399.65 Total Current Assets $9,462.05 Property/Plant/Equipment $14,329.22 Goodwill, Net $73.71 Intangibles, Net Long Term Investments $432.47 Other Long Term Assets $300.26 Total Assets $20,682.35 Attached above is the balance sheet of Costco Wholesale as of August 31st, 2008. Notice the line item we are interested in looking at is Total Merchandise Inventory totalling $5,039.41 million dollars. That’s how much inventory Costco has for resale to customers; notice how it makes up greater than 25% of their balance sheet! The cost of merchandise inventory also includes the costs incurred to buy the goods, ship them to the stores or warehouses, and other costs necessary to make them ready for sale such as employee costs for organizing the merchandise on warehouse displays and grocery stands. PART 2 i) Perpetual Inventory System A perpetual inventory system, as the name suggests, gives a continuous record of the amount of inventory on hand. A perpetual inventory system adds up all the merchandise purchases in the Inventory account, and removes them from this account when an item is sold, and transfers it to Cost of Goods sold. Therefore, a merchandise piece sits as Inventory on the balance sheet of Costco when it is not sold. However as soon as it is sold, it is moved from the Inventory account to Cost of goods sold, an expense item on the Income statement. The advantage of using a perpetual inventory system is that at any given point in time, we can see the amount of merchandise inventory on hand without doing any calculations. The perpetual inventory system has become popular due to advancements in computer technology that continually post inventory transactions and keep an updated account. Doing this on paper or by hand using human accountants is impossible, especially for a large company such as Costco Wholesale. Perpetual inventory systems therefore provide more timely information to investors, are currently widely used across all businesses and will be the focus of our tutorials here. Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 ii) Periodic Inventory System A periodic inventory system, as the name suggests, provides a periodic balance of the inventory account only at the end of an accounting period such as March 31st, 2009 which is the end of first quarter for most large corporations. Periodic inventory system does not update the inventory account after every transaction. The cost of new purchases of merchandise is recorded in a temporary expense account known as Purchases. When merchandise is sold, revenue is recorded but the cost of the merchandise sold is not yet recorded as cost. When financial statements are prepared at the end of the year, the company takes a physical inventory count of its entire warehouse(s). Each item on this physical inventory count is assigned a cost, and total inventories are tabulated. Periodic inventory systems were largely used by large hardware, drug & department stores that sold large quantities of low-value items such as shampoo, soap, toothpaste, etc. Without today’s Point of Sale (POS) scanners, computers and cameras, it was not feasible enough for accounting systems to track such small items. Accounting for Merchandise Purchases – Perpetual Inventory System i) Purchase of Inventory Any purchase of merchandise is debited to the Merchandise Inventory account and creates an accounts payable liability or cash payment entry. Consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009. September 14th, 2009 Account Name Debit Credit Dr. Merchandise Inventory $1,500 Cr. Accounts Payable $1,500 Entry to record purchase of merchandise inventory on credit ii) Purchase Returns & Allowances Purchase returns are merchandise received by a buyer but returned to the supplier due to reasons such as incorrect size, color, defective merchandise, etc. This triggers a purchase return and a purchase allowance entry is made to reduce the cost of merchandise purchased. For example, consider the camera bought from Sony was defective but still able to be sold. Here are the set of journal entries made to record the initial purchase of the camera, and the defective return. September 14th, 2009 Account Name Debit Credit Dr. Merchandise Inventory $1,500 Cr. Accounts Payable $1,500 Entry to record purchase of merchandise inventory on credit Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Assume on October 9th, 2009, the defective camera is returned to Sony. The journal entry made to record this is: October 9th, 2009 Account Name Debit Credit Dr. Accounts Payable $400 Cr. Merchandise Inventory $400 Purchase allowance on inventory bought September 14th, 2009 due to defectiveness. If this merchandise was bought for cash, then the journal entry will look like: October 9th, 2009 Account Name Debit Credit Dr. Cash $400 Cr. Merchandise Inventory $400 Cash refund on inventory bought September 14th, 2009 due to defectiveness iii) Purchase Discounts Merchandise that is bought on credit requires a clear statement of expected amounts & dates of future payments as well as terms of credit. Credit terms are a listing of the amounts & timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period. The equation for setting up the terms is: n/10 = EOM. The EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days. The “n” in this case means the discount percent if the payment is made within 10 days. Thus, the following equation means 2.5/10 = 30 days -> 2.5% discount if invoice is paid within 10 days, otherwise the invoice is due in 30 days. A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment. The buyer thus views this as a purchase discount. In the eyes of the seller, this is a sales discount. To illustrate these concepts, let’s do a journal entry. Consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009, for terms of 2/10 n30 days. September 14th, 2009 Account Name Debit Credit Dr. Merchandise Inventory $1,500 Cr. Accounts Payable $1,500 To record purchase of merchandise inventory on credit Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Now consider that Binti Kiziwi Corp. takes advantage of this discount offering, and pays the invoice by September 20th, 2009. Here is the journal entry we record in our books: September 20th, 2009 Account Name Debit Credit Dr. Accounts Payable $1,500 Cr. Cash ($1,500 x 98%) $1,470 Cr. Merchandise Inventory ($1,500 x 2%) $30 To record payment of invoice of Sony camera purchased on credit with 2/10 n30 terms on September 14th, 2009. PART3 The buyer and seller must reach an agreement on who is responsible for paying any freight costs and who bears the risk of loss during transit when the merchandise is being shipped. This question basically asks, “At what point does ownership transfer from the buyer to the seller?” The point of transfer is called the FOB point, and FOB stands for free on board. The point when ownership transfers from the seller to the buyer are a very important consideration because it determines who pays transportation costs and associated costs such as insurance while in transit. The party responsible for paying shipping costs is also responsible for insuring the merchandise during transit. There are 2 alternative points of transfer. i) FOB shipping point FOB shipping point is also known as FOB factory and means the buyer accepts ownership at the seller’s place of business. The buyer is then responsible for paying shipping costs, and bears ownership and risks of damage/loss when the goods are in transit or in transport. The goods also become a part of the buyer’s merchandise inventory at the shipping point. ii) FOB destination FOB destination means ownership of the goods transfers to the buyer when goods are delivered at the buyer’s place of business. This means the seller is responsible for paying shipping costs and bears the risk of damage/loss while in transit/transport. The seller also does not record revenue from this sale until the goods arrive at the destination because this transaction is not complete before that point. Accounting for Transportation Costs Shipping costs incurred on purchases are known as transportation-in or freight-in costs. If the terms of the purchase are FOB shipping, then this means the buyer is responsible for paying freight-in costs and the accounting cost principle requires these transportation costs to be included as part of the cost of acquiring merchandise inventory. This requires a separate accounting journal entry, and one is illustrated below. Consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 September 14th, 2009 and the shipping costs are 5% of the purchase price. Below is the journal entry recorded in the books of Binti Kiziwi Corp. September 14th, 2009 Account Name Debit Credit Dr. Merchandise Inventory (5% x $1,500) $75 Cr. Cash $75 Entry to record freight-in charges on purchase of merchandise. Recording Purchases of Inventory In this section, we will tie in costs of inventory purchased, purchase discounts & allowances, returns and freight-in costs to compute the total cost of merchandise inventory. We will use the example of Binti Kiziwi Corp. Binti Kiziwi Corp. Net Cost of Merchandise Purchases For Year Ended December 31st, 2009 Invoice Cost of Merchandise Purchases................. $1,500 Less: Purchase Discounts ($30) Less: Purchase returns and allowances ($400) Add: Cost of transportation in $75 Net Income........................................................ $1,145 Looking at the inventory purchase schedule above, you get an idea of the entries involved in accounting for merchandise purchases. Also with this schedule, we fully satisfy the accounting cost principle that states that all costs incurred to get inventory ready for re-sale and for its intended purpose should be included in the final costs of the inventory purchases. PART 4 i) Accounting for Merchandise Sales Merchandising companies also have to account for the sales side of things, including sales, sales discounts, sales returns and allowances, and cost of goods sold. Accounting for the sale of merchandise needs 2 critical pieces of information: 1) Revenue received from the sale of the merchandise to the customer 2) Recognition of the cost of merchandise that was sold to the customer Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit. Here is the journal entry to record the sale: September 27th, 2009 Account Name Debit Credit Dr. Accounts Receivable $2,200 Cr. Sales $2,200 Entry to record sale of Sony Camera on credit. With this journal entry, there is an increase on the Current assets side (Debit to AR) as well as an increase to revenue (credit to sales). The expense or cost of the merchandise sold is accounted for via the journal entry below: September 27th, 2009 Account Name Debit Credit Dr. Cost of Goods Sold $1,500 Cr. Merchandise Inventory $1,500 To record the cost of Sept 27th, 2009 sale of Sony camera and to reduce inventory. This journal entry records the cost of the camera sold and credits Merchandise inventory as we are reducing it, and debits an expense (Cost of Goods sold) that is reported on the income statement. ii) Accounting for Sales Discounts Companies giving cash discounts to their customers recognize these discounts as ‘Sales discounts’ on their books. Why do they do this? Well to increase the number of customer walk-ins, to increase their sales during times when consumers are not buying (recession) or during periods of holiday sales when the decreases in their prices are offset with a large number of customers buying (customer walk-ins). Another advantage to offering cash discounts on sales is for prompt payment, which reduces the time needed to pay suppliers for merchandise, as well as take advantage of any supplier discounts on merchandise. A seller does not know whether a customer will pay within the discount period and take advantage of any cash discounts, thus a sales discount is not recorded until it is taken by the customer. As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit on 2/10 n60 days terms. Here is the journal entry to record the sale: September 27th, 2009 Account Name Debit Credit Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Dr. Accounts Receivable $2,200 Cr. Sales $2,200 Entry to record sale of Sony Camera on credit. With this journal entry, there is an increase on the Current assets side (Debit to AR) as well as an increase to revenue (credit to sales). The expense or cost of the merchandise sold is accounted for via the journal entry below: September 27th, 2009 Account Name Debit Credit Dr. Cost of Goods Sold $1,500 Cr. Merchandise Inventory $1,500 Entry to record Cost of Goods Sold expense for sale of merchandise and to lower the merchandise inventory account (credit). The customer has 2 options, one is to take the 2% discount and pay within the 60 day period, and the second is to pay after 60 days and forfeit the discount. In scenario i) when the customer pays within 60 days, here is the journal entry recorded: October 25th, 2009 Account Name Debit Credit Dr. Cash $1,470 Dr. Sales Discounts $30 Cr. Accounts Receivable $1,500 To record payment of camera purchased on credit and take advantage of 2% discount – 2% x $1,500 = $30 In scenario ii), the customer can wait 60 days and pay after the discount period ends. In this case, the journal entry is simple enough: November 25th, 2009 Account Name Debit Credit Dr. Cash $1,500 Cr. Accounts Receivable $1,500 Entry to record receipt of cash for camera purchased on credit by customer. Sales discount is a contra-revenue account and the set up is because management can monitor sales discounts to assess their effectiveness and costs. The sales discount is deducted from total sales to arrive at a company’s net sales in a given period. Usually the company reports the Net Sales number Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 on their income statement as the sales discount information although useful, is not that important enough to be reported on the income statement; it is more for effective management. PART 5 Sales returns refers to merchandise that customers return back after a sale is completed due to a variety of reasons including defective merchandise, incorrect item, poor quality, wrong specifications, etc. Most companies allow customers to return merchandise for a full refund. Sales allowance on the other hand refers to reductions in the selling price of merchandise sold to customers and can happen in cases of damaged merchandise. Damaged merchandise can make customers very unhappy and in order to avoid future lost sales and customers, most companies offer an allowance (reduction in price) to the customer to keep the item. As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit on 2/10 n60 days terms. But what happens if the customer returns part of this merchandise on October 10th, 2009 and gets a $700 cash refund (original cost = $500). The revenue part of this transaction is recorded below: October 10th, 2009 Account Name Debit Credit Dr. Sales Returns & Allowances $700 Cr. Accounts Receivable $700 Entry to record return of defective merchandise. Some companies prefer to record this return with a debit to the Sales account instead of Sales Returns and Allowances. This practice has the same effect but does not provide information to managers about sales returns and allowances. If the merchandise returned above is not defective and can be re- sold to another customer, Binti Kiziwi Corp. returns the goods to its inventory by debiting it, and crediting Cost of goods sold expense. Here is the journal entry in this scenario: October 10th, 2009 Account Name Debit Credit Dr. Merchandise Inventory $500 Cr. Cost of Goods Sold $500 To relocate returned goods back to inventory. Another possibility that can happen is say the customer returns $700 worth of merchandise and the company allows him to pay it off for $500 and keep the merchandise, and thus not accept a return back. Here is the only journal entry that would be made: Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 October 10th, 2009 Account Name Debit Credit Dr. Sales Returns & Allowances $500 Cr. Accounts Receivable $500 To record return of defective merchandise with original sales revenue of $700, but with a sales allowance being granted for a total of $500. Merchandise Adjusting Entries – Shrinkage Merchandising companies using a perpetual inventory system are often required to make additional adjustments to their inventory by updating the merchandise inventory account to reflect any losses of merchandise including loss from theft, deterioration, loss in transit, loss in store, misplacement, etc; this is known as inventory shrinkage or “shrink” for short form. Using the perpetual system, we can compute shrinkage by doing a physical inventory count at given periods during the year and compare with accounting records of stated inventory balances. For instance, say Binti Kiziwi Corp. has merchandise inventory of $738,000 at the end of 2009 in its accounting books, but a physical inventory done in its warehouse says it only has $712,000 worth of merchandise remaining. Shrink in this case is computed as follows: December 31st, 2009 Account Name Debit Credit Dr. Cost of Goods Sold $26,000 Cr. Merchandise Inventory $26,000 To record shrinkage of merchandise inventory by expensing it on the Income statement, and reducing the inventory account balance: $738,000 - $712,000 = $26,000 PART 6 Cash discount - Companies giving cash discounts to their customers recognize these discounts as ‘Sales discounts’ on their books. Why do they do this? Well to increase the number of customer walk-ins, to increase their sales during times when consumers are not buying (recession) or during periods of holiday sales when the decreases in their prices are offset with a large number of customers buying (customer walk-ins). Another advantage to offering cash discounts on sales is for prompt payment, which reduces the time needed to pay suppliers for merchandise, as well as take advantage of any supplier discounts on merchandise. Cost of Goods Sold - Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers. The cost of this merchandise is called Cost of goods sold and is a direct expense item on the Income statement. Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 Credit Period – The time period that can pass before a customer’s payment becomes due. Credit Terms - Credit terms are a listing of the amounts & timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period. The equation for setting up the terms is: n/10 = EOM. The EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days. The “n” in this case means the discount percent if the payment is made within 10 days. Discount period – The time period in which a cash discount is available and a reduced payment can be made by the buyer, taking advantage of a reduction in selling price. The equation for setting up the terms is: n/10 = EOM. The EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days. The “n” in this case means the discount percent if the payment is made within 10 days. EOM – EOM is an abbreviation for End of Month and is used to describe credit terms for transactions of merchandise purchases on credit. FOB - The buyer and seller must reach an agreement on who is responsible for paying any freight costs and who bears the risk of loss during transit when the merchandise is being shipped. This question basically asks, “At what point does ownership transfer from the buyer to the seller?” The point of transfer is called the FOB point, and FOB stands for free on board. FOB shipping point: FOB shipping point is also known as FOB factory and means the buyer accepts ownership at the seller’s place of business. The buyer is then responsible for paying shipping costs, and bears ownership and risks of damage/loss when the goods are in transit or in transport. The goods also become a part of the buyer’s merchandise inventory at the shipping point. FOB destination: FOB destination means ownership of the goods transfers to the buyer when goods are delivered at the buyer’s place of business. This means the seller is responsible for paying shipping costs and bears the risk of damage/loss while in transit/transport. The seller also does not record revenue from this sale until the goods arrive at the destination because this transaction is not complete before that point. Merchandise - Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers. Periodic Inventory System - A periodic inventory system, as the name suggests, provides a periodic balance of the inventory account only at the end of an accounting period such as March 31st, 2009 which is the end of first quarter for most large corporations. Periodic inventory system does not update the inventory account after every transaction. Perpetual Inventory System - A perpetual inventory system, as the name suggests, gives a continuous record of the amount of inventory on hand. A perpetual inventory system adds up all the merchandise purchases in the Inventory account, and removes them from this account Downloaded by Stephanie Anne Bernales ([email protected])  lOMoARcPSD|14391650 when an item is sold, and transfers it to Cost of Goods sold. Therefore, a merchandise piece sits as Inventory on the balance sheet of Costco when it is not sold. However as soon as it is sold, it is moved from the Inventory account to Cost of goods sold, an expense item on the Income statement. Purchase Discount - A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment. The buyer thus views this as a purchase discount. In the eyes of the seller, this is a sales discount. Sales Discount - A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment. The buyer thus views this as a purchase discount. In the eyes of the seller, this is a sales discount. Shrinkage - Merchandising companies using a perpetual inventory system are often required to make additional adjustments to their inventory by updating the merchandise inventory account to reflect any losses of merchandise including loss from theft, deterioration, loss in transit, loss in store, misplacement, etc; this is known as inventory shrinkage or “shrink” for short form. Downloaded by Stephanie Anne Bernales ([email protected])