1. Learning Objectives 1. Identify the components in measuring net income in a merchandising company. 2. Explain the entries for sales revenues. 3. State

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Learning Objectives1. Identify the components in measuring net

income in a merchandising company.2. Explain the entries for sales revenues.3. State the steps in determining cost of

good sold.4. Explain the computation and importance

of gross profit.5. Identify the unique features of the income

statement for a merchandising company.6. Explain the steps in the accounting cycle

for a merchandising company.7. Distinguish between a multiple-step and a

single step income statement.

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Accounting for Merchandising Operation

Measuring Net Income

Completing the Accounting Cycle

1. Sales Revenue2. Cost of Good Sold3. Gross Profit4. Operating Expenses5. Income Statement /

Net Income

1. Using a work sheet2. Preparing FS3. Adjusting and closing

Entries4. Post-closing Trial

Balance5. Summary of entries6. Form of income

statements

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Income Measurement Process

Sales Revenue

Cost of Good Sold

Gross Profit

Operating Expenses

Net Income

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Time Line of Business Issues Involved With Inventory

COMPUTEBUY

Raw Materials or Goods for Resale

Value

ADD SELL

Finished Inventory

Ending InventoryCost of

Goods Sold

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What Is Inventory?

Inventory designates goods held for sale in the normal course of business and, in the case of a manufacturer,

goods in production or to be placed in production.

Inventory designates goods held for sale in the normal course of business and, in the case of a manufacturer,

goods in production or to be placed in production.

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Raw Materials

Raw Materials are goods acquired for use in the

production process.

Raw Materials are goods acquired for use in the

production process.Materials that are used

directly in the production of goods are frequently

referred to as direct materials.

Materials that are used directly in the production of goods are frequently

referred to as direct materials.

Materials that are necessary in the

production process but are not directly

incorporated into the product are referred to as

indirect materials.

Materials that are necessary in the

production process but are not directly

incorporated into the product are referred to as

indirect materials.

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Work in Process

Work in process consists of materials partly processed and requiring further work before they can be sold. This inventory includes three cost elements.1. Direct materials

2. Direct labor

3. Manufacturing overhead

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Finished Goods

Finished goods are the manufactured products awaiting sale.

Raw Materials

Raw Materials

Finished Goods

Finished Goods

Cost of Goods Sold

Cost of Goods Sold

Balance Sheet Income Statement

Direct Labor

Work in Process

Work in Process

Manufacturing Overhead

Summary

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MerchandiseMerchandiseMerchandiseMerchandise

Balance Sheet Items

IncomeStatement

Items

RetailerCost of Cost of

Goods SoldGoods SoldCost of Cost of

Goods SoldGoods SoldSale

Manufacturer

Raw Raw MaterialsMaterials

Raw Raw MaterialsMaterials

Cost of Cost of Goods SoldGoods Sold

Cost of Cost of Goods SoldGoods Sold

Sale

Finished Goods

Finished Goods

Work in Work in Process Process Work in Work in Process Process

OverheadDirectLabor

Periodic Inventory Systems Cost of Goods Sold is determined and

Inventory is adjusted to proper balance at period end.

All purchases of inventoriable merchandise are recorded in the Purchases account.

Ending inventory is determined by physical count of merchandise on hand.

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12Perpetual Inventory Systems

Cost of Goods Sold is determined and Inventory is adjusted to proper balance each time inventory is purchased or sold.

All purchases of inventoriable goods are recorded in the Inventory account.

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Purchases of Inventory

Periodic MethodPurchases 3,000

Accounts Payable 3,000

Perpetual MethodInventory 3,000

Accounts Payable 3,000

Inventory Systems

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Sales During the Period

Periodic MethodAccounts Receivable 4,125

Sales 4,125

Perpetual MethodAccounts Receivable 4,125

Sales 4,125Cost of Goods Sold 2,750

Inventory 2,750

Inventory Systems

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Sales During the Period

Accounts Receivable 3,800Sales 3,800

OR

Cash 4,125 Sales 4,125

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Sales Return and Allowance

Sales Return and Allowance 300 Accounts Receivable 300

Sales Discounts

Cash 3,430Sales Discounts 70 Accounts Receivable 3,500

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Cost of Goods Sold

Recording Purchases of Merchandise

Purchases 3,800Accounts Payable 3,800

Purchase Returns and Allowances

Accounts Payable 300Purchase Return and Allowances 300

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Cost of Goods Sold

Purchase Discounts

Accounts Payable 3,500Purchase Discounts 70Cash 3,430

Accounts Payable 3,500Cash 3,500

Whose Inventory Is It?

• Goods in Inventory.• Goods in Transit.

–FOB Shipping Point: buyer’s inventory from time of shipment.–FOB Destination: seller’s inventory

until receipt by buyer.• Goods on Consignment: inventory of the

consignor, not the consignee.

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Goods in Transit

Quality

Produce

Goods being shipped are included in inventory of buyer while in transit.

Goods being shipped are included in inventory of buyer while in transit.

FOB Shipping PointFOB Shipping PointFOB Shipping PointFOB Shipping Point

Seller Buyer

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FOB DestinationFOB DestinationFOB DestinationFOB Destination

Quality

Produce

Goods being shipped are included in inventory of seller until received by buyer.

Goods being shipped are included in inventory of seller until received by buyer.

Seller Buyer

Goods in Transit

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Goods on Consignment

Title to goods sold on consignment remains with the shipper until

their sale or use by the dealer or customer.

Title to goods sold on consignment remains with the shipper until

their sale or use by the dealer or customer.

What Is Inventory Cost?

• Inventory Cost is all expenditures related to inventory acquisition, preparation, and placement for sale.

• Trade Discounts–Convert the catalog price to the actual price.–Record inventory at discounted price.

• Cash Discounts–Granted for payment of invoices within a

limited time period.–Record inventory using the net method or

gross method.

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Purchase Date

End of Discount Period

$9,800 Owed

$10,000 Owed

Final Payment

Date

10 Days 20 Days

Supplier “Loan” Period

Cash Discounts

Determining Cost of Goods on Hand

• Computing the units on hand for each item of inventory.

• Applying unit costs to the total units on hand for each item of inventory.

• Aggregating the costs for each item of inventory to determine the total cost of goods on hand.

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Computing Cost of Goods Sold

• Add the cost of goods purchased to the cost of goods on hand at the beginning of the period (beginning inventory) to obtain the cost of goods available for sale.

• Subtract the cost of goods on hand at the end of the period (ending inventory) from the cost of goods available for sale to arrive at the cost of goods sold.

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Revenue $xxxCosts and expenses:

Costs of sales xxxSelling and administrative xxxInterest expense xxxOther income/expense, net xxxRestructuring charge xxx Total costs and expenses xxxIncome before income taxes xxIncome taxes xxNet income $ xx

Single-Step Single-Step Income Income

StatementStatement

Single-Step Single-Step Income Income

StatementStatement

Form of the Income Statement

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Revenue $xxxCosts of goods sold:

Beginning inventory xxxNet purchases xxxCost of goods available for sale xxxLess ending inventory xxx xxx

Gross profit on sales xxxOperating expenses:

Selling expenses xxxGeneral expenses xxx xxx

Other income xxx

Multiple-Step Multiple-Step Income Income

StatementStatement

Multiple-Step Multiple-Step Income Income

StatementStatement


ContinuedContinuedContinuedContinued

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Other income (from previous page) $xxx Other revenue and gains xxx Other expenses and losses (xxx)Income from continuing operations before income taxes xxx Income taxes on continuing operations (xxx)Discontinued operations:

Loss from operations of discontinued business segment (net of tax) $xxxLoss on disposal of segment (net of tax) xxx (xxx)

Extraordinary gain (net of tax) xxx Net income $xxx


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30Components of the Income Statement

Income from Continuing OperationsIncome from Continuing OperationsIncome from Continuing OperationsIncome from Continuing Operations

1. Revenue2. Cost of goods sold3. Operating expenses4. Other revenues and gains5. Other expenses and losses6. Income taxes on continuing operations

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Determining Subtotals

Gross profit:Revenue – Cost of goods sold

Operating income:Gross profit – Operating expenses

ContinuedContinuedContinuedContinued

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Determining SubtotalsIncome from continuing operations before income taxes:

Operating income + Other revenues and gain – Other expenses and losses

Income from continuing operations:Income from continuing operations before income taxes – Income taxes on continuing operations

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RevenueRevenue

Revenue reports the total sales to

customers for the period less any sales

returns and allowances or

discounts.

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Cost of Goods Sold

Beginning inventory

+ Net purchases

+ Freight-in

+ Other inventory acquisition costs

= Cost of goods available for sale

– Ending inventory

= Cost of goods sold

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Cost of Goods Sold

Cost of goods sold is a significant item on merchandising and manufacturing companies’

income statement.

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Gross Profit

Net sales

– Cost of goods sold

= Gross profit

Gross profit ÷ Net sales = Gross profit percentage

Gross profit ÷ Net sales = Gross profit percentage

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Operating Expenses

Operating expenses may be reported in two parts:

1) Selling expenses

2) General and administrative expenses

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Operating Income

Operating income measures the performance of the fundamental business operations conducted by a company.

Gross profit

– Operating expenses

= Operating income

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Other Revenues and Gains

This section usually includes items identified with the peripheral

activities of the company.1) Rent revenue2) Interest revenue3) Dividend revenue4) Gains from the sale of

assets

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Other Expenses and Losses

This section parallels “Other Revenues and Gains” except the items result in deductions from

operating income.1) Interest expense2) Losses from the sale

of assets

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Discontinued Operations

Why would management decide to dispose of a component of a business? The component may be unprofitable. The component may not fit into the long-

range plans for the company. Management may need funds to reduce

long-term debit or to expand into other areas.

Management may be fearful of a corporate takeover.

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42Discontinued Operations

• Income statement section consists of two parts:– Income (loss) from operations--disclosed only

if decision to discontinue operations is made after beginning of the year.

– Gain (loss) on disposal of operations-- consisting of income (loss) during phase out and gain (loss) from disposal of segment assets.

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43Discontinued Operations

According to FASB Statement No. 144, if on the balance sheet date assets

and liabilities associated with discontinued components have not

been completely disposed, they are to be listed separately in the asset and

liability sections of the balance sheet.

According to FASB Statement No. 144, if on the balance sheet date assets

and liabilities associated with discontinued components have not

been completely disposed, they are to be listed separately in the asset and

liability sections of the balance sheet.

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Discontinued Operations

In addition to the summary income or loss number reported in the income

statement, the total revenue associated with the discontinued operations should be disclosed in the financial statement

notes.

In addition to the summary income or loss number reported in the income

statement, the total revenue associated with the discontinued operations should be disclosed in the financial statement

notes.

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Extraordinary Items

Extraordinary items must be both unusual

and infrequent.

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46Never Extraordinary

Write-down or write-off of receivables, inventory, etc.

Gains or losses from exchange or remeasurement of foreign currencies.

Gains or losses on disposal of business segment.

Gains or losses from sale or abandonment of productive assets.

Effects of a strike. Adjustment of accruals on long-term

contracts.

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Documents

1. Learning Objectives 1. Identify the components in measuring net income in a merchandising company. 2. Explain the entries for sales revenues. 3. State