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Accounting:Tools for Business Decision Making, 2nd Ed.

Kimmel, Weygandt, Kieso

CHAPTER 5

Prepared by

Ellen L. Sweatt

Georgia Perimeter College

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MERCHANDISING MERCHANDISING OPERATIONS AND OPERATIONS AND

THE MULTIPLE-THE MULTIPLE-STEP INCOME STEP INCOME STATEMENTSTATEMENT

Chapter 5

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1.1. Identify the difference between a service Identify the difference between a service enterprise and a merchandising company. enterprise and a merchandising company.

2.2. Explain the recording of purchases under a Explain the recording of purchases under a perpetual inventory system.perpetual inventory system.

3.3. Explain the recording of sales revenues Explain the recording of sales revenues under a perpetual inventory system.under a perpetual inventory system.

4.4. Distinguish between a single-step and a Distinguish between a single-step and a multiple-step income statement.multiple-step income statement.

Study Objectives

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5.5. Determine cost of goods sold under a Determine cost of goods sold under a periodic system.periodic system.

6.6. Explain the factors affecting profitability.Explain the factors affecting profitability.

7.7. Appendix- Explain the recording of Appendix- Explain the recording of purchases and sales of inventory under a purchases and sales of inventory under a periodic inventory system.periodic inventory system.

Study Objectives

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Differences Between a Service Company and a Merchandising Company

Primary Source of Revenue Service Company- performs services

Barber, electrician, plumber, attorney, CPA Merchandise Company- sale of merchandise

Cars, clothing, food, office supplies

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Income Measurement for Income Measurement for Merchandise CompaniesMerchandise Companies

Total cost of Total cost of merchandise merchandise sold during sold during the periodthe period Selling and Selling and

AdministrativeAdministrative

Operating Cycles

Inventory Systems - Inventory Systems - PerpetualPerpetual

Maintain detailed records of purchases and salesMaintain detailed records of purchases and sales

Cost of goods sold is determined with each saleCost of goods sold is determined with each sale

Compute and record Cost of goods sold

Inventory Systems - Inventory Systems - PerpetualPerpetual

Computers and Computers and electronic scanning electronic scanning

equipment make equipment make perpetual inventory perpetual inventory

cost effective!cost effective!

Inventory Systems - Inventory Systems - PeriodicPeriodic

No detailed records No detailed records

Cost of goods sold determined at end of Cost of goods sold determined at end of the period by taking a physical count and the period by taking a physical count and pricing it.pricing it.

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Recording Purchases of Merchandise

Purchase of merchandise is recorded when Purchase of merchandise is recorded when goods are received from the sellergoods are received from the seller

Every purchase should be supported by Every purchase should be supported by business documentsbusiness documents

Cash purchases have receipts or cancelled Cash purchases have receipts or cancelled checkschecks

Credit purchases are supported by Credit purchases are supported by purchase invoicespurchase invoices

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SellerSeller

Invoice Invoice datedate

BuyerBuyer

Credit Credit termsterms

Item details

Item detailsTot

alTot

al

PurchasePurchase of Merchandise of Merchandise

Debit CreditDebit Credit

May 4 Merchandise Inventory 3,800 May 4 Merchandise Inventory 3,800 Accounts Payable Accounts Payable 3,800 3,800

To record goods purchased on accountTo record goods purchased on account

3,8003,800

Accounts Accounts PayablePayable

Merchandise Merchandise InventoryInventory

May 4May 4 May 4May 4 3,8003,800

Sauk purchased $ 3,800 of goods on account.Sauk purchased $ 3,800 of goods on account.

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Merchandise InventoryMerchandise Inventory Includes all purchases of merchandise for Includes all purchases of merchandise for

re-sale to customers and costs to get it to re-sale to customers and costs to get it to the businessthe business

Does not include items purchased for use Does not include items purchased for use and not for resaleand not for resale

If an entity sells cash registers, then the If an entity sells cash registers, then the cash registers it buys to re-sell would be cash registers it buys to re-sell would be inventoryinventory- ones used to ring-up sales for ones used to ring-up sales for the business would be recorded as the business would be recorded as equipmentequipment

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Purchase Returns and Purchase Returns and AllowancesAllowances

Purchase ReturnPurchase Return – A return of the – A return of the goods from the buyer or seller for cash goods from the buyer or seller for cash or creditor credit..

Purchase AllowancePurchase Allowance – A reduction – A reduction made in the selling price of the made in the selling price of the merchandise, granted by the seller so merchandise, granted by the seller so that the buyer will keep the goods.that the buyer will keep the goods.

Return of MerchandiseReturn of MerchandiseSauk Stereo returned goods costing $ 300 to PW Audio.Sauk Stereo returned goods costing $ 300 to PW Audio.


May 8 May 8 Accounts Payable Accounts Payable 300 300 Merchandise Inventory Merchandise Inventory 300 300

To record return of goods purchased on accountTo record return of goods purchased on account

300300

Accounts Accounts PayablePayable


May 8 May 8 May 8May 8 3003003,8003,800May 4May 4 May 4May 4 3,8003,800

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Freight Costs… On incoming goods you purchase

are charged to inventory.

On outgoing goods you sell are an operating expense to the seller.

Freight Cost Incurred by BuyerFreight Cost Incurred by Buyer


May 9 Merchandise Inventory May 9 Merchandise Inventory 150 150 Cash Cash 150 150 To record payment of freight on goods purchased To record payment of freight on goods purchased


3,8003,800May 4May 4 May 8May 8May 9May 9 150150

CashCash

May 9May 9 150150

Freight Cost Incurred by SellerFreight Cost Incurred by Seller

300300

150150Freight-outFreight-out

May 4May 4CashCash

May 4May 4 150150


May 9 Freight-Out 150 May 9 Freight-Out 150 Cash 150 Cash 150 To record payment of freight on goods sold To record payment of freight on goods sold

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Purchase DiscountsPurchase Discounts Credit terms may allow buyer to Credit terms may allow buyer to

claim a cash discount if payment is claim a cash discount if payment is made within a certain specified timemade within a certain specified time

Purchaser saves money and seller Purchaser saves money and seller converts account receivable to cash converts account receivable to cash fasterfaster

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Purchase DiscountsPurchase DiscountsCredit terms may be written“Credit terms may be written“2/10, net 302/10, net 30” ”

which means which means 2% cash discount if paid 2% cash discount if paid within 10within 10 days days of invoice date, otherwise of invoice date, otherwise pay the full amount within 30 dayspay the full amount within 30 days

Guess what “1/10, EOM” means? Guess what “1/10, EOM” means?

1% cash discount if paid within 10 days, 1% cash discount if paid within 10 days, otherwise pay by the end of the monthotherwise pay by the end of the month

Invoice Invoice datedate

Credit Credit termsterms

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Purchase DiscountsPurchase Discounts

Original Invoice $3,800Original Invoice $3,800

Return on May 8 Return on May 8 -300 -300

Amount due before discount $3,500Amount due before discount $3,500

2% discount2% discount -70-70

Net due $3,430Net due $3,430

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May 14 Accounts Payable 3,500 May 14 Accounts Payable 3,500 Cash 3,430 Cash 3,430 Merchandise Inventory Merchandise Inventory

70 70

To record payment within discount period To record payment within discount period

CashCashAccounts Accounts PayablePayable

May 14May 14 3,5003,500 3,4303,430May 14May 143,8003,800


May 4May 4 May 8May 8 300300May 9May 9 150150 May 14May 14 7070

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Summary of Purchasing Summary of Purchasing Transactions – Perpetual SystemTransactions – Perpetual System

3,8003,800

MerchandiseMerchandise InventoryInventory

May 4May 4 May 8May 8 300300May 9May 9 150150 May 14May 14 7070

Balance 3,580Balance 3,580

PurchasePurchaseFreight-inFreight-in

Purchase returnPurchase returnPurchase discountPurchase discount

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RevieRevieww

Which of the following statements about a Which of the following statements about a periodicperiodic inventory system is inventory system is truetrue??

a.a. Cost of goods sold is determined only at the Cost of goods sold is determined only at the end of the accounting period.end of the accounting period.

d.d. The increased use of computerized systems The increased use of computerized systems has increased the use of the periodic system.has increased the use of the periodic system.

c.c. The periodic system provides better control The periodic system provides better control over inventories than a perpetual systemover inventories than a perpetual system..

bb. Detailed records of the cost of each . Detailed records of the cost of each inventory purchase and sale are maintained inventory purchase and sale are maintained continuously.continuously.

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RevieRevieww

Which of the following statements about a Which of the following statements about a periodicperiodic inventory system is inventory system is truetrue??

a. Cost of goods sold is determined only at the a. Cost of goods sold is determined only at the end of the accounting period.end of the accounting period.

d.d. The increased use of computerized systems The increased use of computerized systems has increased the use of the periodic system.has increased the use of the periodic system.

c.c. The periodic system provides better control The periodic system provides better control over inventories than a perpetual systemover inventories than a perpetual system..

bb. Detailed records of the cost of each . Detailed records of the cost of each inventory purchase and sale are maintained inventory purchase and sale are maintained continuously.continuously.

ReviewReviewWhich of the following items does Which of the following items does notnot result in result in

an adjustment in the merchandise inventory an adjustment in the merchandise inventory account under a account under a perpetual perpetual system?system?

a. A purchase of merchandise.a. A purchase of merchandise.

d.d. Payment of freight costs for goods Payment of freight costs for goods received from a supplier.received from a supplier.

c. Payment of freight costs for goods c. Payment of freight costs for goods shipped to a customer.shipped to a customer.

b. A return of merchandise inventory to b. A return of merchandise inventory to the supplier.the supplier.

ReviewReviewWhich of the following items does Which of the following items does notnot result in result in

an adjustment in the merchandise inventory an adjustment in the merchandise inventory account under a account under a perpetual perpetual system?system?

a. A purchase of merchandise.a. A purchase of merchandise.

d.d. Payment of freight costs for goods Payment of freight costs for goods received from a supplierreceived from a supplier..

c. Payment of freight costs for goods c. Payment of freight costs for goods shipped to a customer.shipped to a customer.

b. A return of merchandise inventory to b. A return of merchandise inventory to the supplier.the supplier.

ReviewReviewA purchase of $1,200 is made on March 2, terms 2/10, A purchase of $1,200 is made on March 2, terms 2/10, n/30, on which a return of $200 is granted on March 5. n/30, on which a return of $200 is granted on March 5.

What amount should be paid on March 12?What amount should be paid on March 12?

a.a. $1,176$1,176

d.d. $ 980$ 980

c.c. $1,000$1,000

b.b. $1,200$1,200

ReviewReviewA purchase of $1,200 is made on March 2, terms 2/10, A purchase of $1,200 is made on March 2, terms 2/10, n/30, on which a return of $200 is granted on March 5. n/30, on which a return of $200 is granted on March 5.

What amount should be paid on March 12?What amount should be paid on March 12?

a.a. $1,176$1,176

d.d. $ 980$ 980

c.c. $1,000$1,000

b.b. $1,200$1,200

$1,200-$200= $1,000- $20 ($1,000 x .02) = $ 980$1,200-$200= $1,000- $20 ($1,000 x .02) = $ 980

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Recording Sales Recording Sales Under Perpetual Under Perpetual Inventory SystemInventory System

Sales revenues recorded Sales revenues recorded when goods are transferred when goods are transferred from the seller to the buyerfrom the seller to the buyer

Follows revenue recognition Follows revenue recognition principleprinciple

Every purchase should be Every purchase should be supported by business supported by business documents, i.e., cash documents, i.e., cash register tape or sales invoiceregister tape or sales invoice

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Recording Sales Under Recording Sales Under Perpetual Inventory SystemPerpetual Inventory System

Two entries required:Two entries required:One for Sales- may be on credit or cashOne for Sales- may be on credit or cashOne to record Cost of Goods SoldOne to record Cost of Goods Sold

Same invoice as before, but now we are the seller Same invoice as before, but now we are the seller and goods cost us $2,400and goods cost us $2,400

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Sales Returns and Allowances- flip side of Sales Returns and Allowances- flip side of Purchase Returns and AllowancesPurchase Returns and Allowances

Same return as before, but now we are the Same return as before, but now we are the seller and goods cost us $300.seller and goods cost us $300.

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Sales Returns and AllowancesSales Returns and Allowances Is a contra-revenue account, normal Is a contra-revenue account, normal

balance is debitbalance is debit Are kept in this separate account so Are kept in this separate account so

you know exactly how much you you know exactly how much you allowed in returns and allowancesallowed in returns and allowances

SalesSales $ 2,500,000$ 2,500,000

Returns and AllowancesReturns and Allowances 25,000 25,000

Net SalesNet Sales $ 2,475,000 $ 2,475,000

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Sales Returns and Sales Returns and AllowancesAllowances

Inferior merchandiseInferior merchandise Inefficiencies in filling ordersInefficiencies in filling orders Errors in billing customersErrors in billing customers Mistakes in delivery or shipment of goodsMistakes in delivery or shipment of goods Overly aggressive sales clerksOverly aggressive sales clerks

What do excessive returns and allowances suggest?What do excessive returns and allowances suggest?

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Sales DiscountsSales Discounts Credit terms may allow buyer to claim Credit terms may allow buyer to claim

a cash discount for prompt paymenta cash discount for prompt payment Sales Discount is a contra-revenue Sales Discount is a contra-revenue

account of sales. Normal debit balance.account of sales. Normal debit balance.

Credit terms 2/10,n/30- Seller’s BooksCredit terms 2/10,n/30- Seller’s Books

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Single-step and and Single-step and and Multiple-step Income Multiple-step Income StatementsStatements

Single-stepSingle-step – total revenues minus – total revenues minus total expenses; simple, easy to readtotal expenses; simple, easy to read

Multi-stepMulti-step – highlights components – highlights components and distinguishes activities and distinguishes activities

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Single-step Income Single-step Income StatementStatement

Multi-step Income Multi-step Income StatementStatement

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Cost of Goods Sold-Cost of Goods Sold-Periodic Periodic

Enter beginning inventoryEnter beginning inventory

Add units or $ amount of Add units or $ amount of purchasespurchases

Subtract ending inventory Subtract ending inventory

Units bought Units bought 1,2501,250

250250

Cost of Goods (Units) Cost of Goods (Units) Available for SaleAvailable for Sale

1,2501,250

In Units (not $) 0In Units (not $) 0

Cost of Goods or Number of Units SoldCost of Goods or Number of Units Sold

1,000 1,000

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Cost of Goods Sold - Cost of Goods Sold - PeriodicPeriodic

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Evaluating ProfitabilityEvaluating Profitability

• Gross Profit RateGross Profit Rate

• Profit Margin RatioProfit Margin Ratio

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Gross Profit RateGross Profit Rate

Gross ProfitGross Profit

Net SalesNet Sales==

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Reasons Gross Profits Rates Reasons Gross Profits Rates ChangeChange

•Selling products with a lower “mark-up” Selling products with a lower “mark-up”

• Increased competition can lower sale pricesIncreased competition can lower sale prices

•Paying higher prices to suppliersPaying higher prices to suppliers

•Sales MixSales Mix

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Profit Margin RatioProfit Margin Ratio

Net IncomeNet Income

Net SalesNet Sales==

Percentage of “mark-up” on Percentage of “mark-up” on merchandise sold alters this merchandise sold alters this percentagepercentage

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Evaluate Profits MarginsEvaluate Profits Margins

Gross Profit Rates by IndustryGross Profit Rates by Industry

Profit Margin Rates by IndustryProfit Margin Rates by Industry

In addition to In addition to computing the computing the company’s company’s gross profit and gross profit and profit margin profit margin rates, you rates, you should should compare to compare to industry industry averagesaverages

ReviewReviewIf beginning inventory is $60,000, cost of If beginning inventory is $60,000, cost of goods purchased is $380,000, and ending goods purchased is $380,000, and ending inventory is $50,000, what is cost of good inventory is $50,000, what is cost of good sold under the periodic system?sold under the periodic system?

a.a. $390,000$390,000

d.d. $420,000$420,000

c.c. $330,000$330,000

b.b. $370,000$370,000

ReviewReviewIf beginning inventory is $60,000, cost of If beginning inventory is $60,000, cost of goods purchased is $380,000, and ending goods purchased is $380,000, and ending inventory is $50,000, what is cost of good inventory is $50,000, what is cost of good sold under the periodic system?sold under the periodic system?

a.a. $390,000$390,000

d.d. $420,000$420,000

c.c. $330,000$330,000

b.b. $370,000$370,000

$60,000 +$380,000- $50,000= $390,000$60,000 +$380,000- $50,000= $390,000

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ReviewReviewIf sales revenues are $400,000, cost of goods If sales revenues are $400,000, cost of goods sold is $310,000, and the operating expenses sold is $310,000, and the operating expenses are $60,000, what is the gross profit?are $60,000, what is the gross profit?

a.a. $ 30,000$ 30,000

d.d. $400,000$400,000

c.c. $340,000$340,000

b.b. $ 90,000$ 90,000

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ReviewReviewIf sales revenues are $400,000, cost of goods If sales revenues are $400,000, cost of goods sold is $310,000, and the operating expenses sold is $310,000, and the operating expenses are $60,000, what is the gross profit?are $60,000, what is the gross profit?

a.a. $ 30,000$ 30,000

d.d. $400,000$400,000

c.c. $340,000$340,000

b.b. $ 90,000$ 90,000

$ 400,000-$ 310,000 = $90,000$ 400,000-$ 310,000 = $90,000

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ReviewReviewWhich of the following would affect the Which of the following would affect the

gross profit rate (assuming sales are gross profit rate (assuming sales are constant)?constant)?

a.a. An increase in advertising expense.An increase in advertising expense.

d.d. A decrease in insurance expense.A decrease in insurance expense.

c.c. An increase in cost of goods sold.An increase in cost of goods sold.

b.b. A decrease in depreciation expense.A decrease in depreciation expense.

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ReviewReviewWhich of the following would affect the Which of the following would affect the

gross profit rate (assuming sales are gross profit rate (assuming sales are constant)?constant)?

a.a. An increase in advertising expense.An increase in advertising expense.

d.d. A decrease in insurance expense.A decrease in insurance expense.

c.c. An increase in cost of goods sold.An increase in cost of goods sold.

b.b. A decrease in depreciation expense.A decrease in depreciation expense.

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Which of the following would Which of the following would NOTNOT affect the gross profit rate?affect the gross profit rate?

a. An increase in the cost of heating the store.a. An increase in the cost of heating the store.

d.d. An increase in the price of inventory An increase in the price of inventory items.items.

c.c. An increase in the use of “discount An increase in the use of “discount pricing” to sell merchandise.pricing” to sell merchandise.

b. An increase in the sale of luxury itemsb. An increase in the sale of luxury items..

ReviewReview

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Which of the following would Which of the following would NOTNOT affect the gross profit rate?affect the gross profit rate?

a. An increase in the cost of heating the store.a. An increase in the cost of heating the store.

d.d. An increase in the price of inventory An increase in the price of inventory items.items.

c.c. An increase in the use of “discount An increase in the use of “discount pricing” to sell merchandise.pricing” to sell merchandise.

b. An increase in the sale of luxury itemsb. An increase in the sale of luxury items..

ReviewReview

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Periodic System – Periodic System – Recording Merchandise Recording Merchandise TransactionsTransactions

Recording of revenues is the sameRecording of revenues is the same At the date of sale, At the date of sale, no cost of no cost of

merchandise sold is recordedmerchandise sold is recorded Physical count taken at period end to Physical count taken at period end to

determine cost of ending inventory, determine cost of ending inventory, and therefore cost of goods soldand therefore cost of goods sold

Record purchase returns and Record purchase returns and allowances, purchase discounts, and allowances, purchase discounts, and freight-in costs in separate accountsfreight-in costs in separate accounts

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Purchase of MerchandisePurchase of Merchandise

Purchase Returns and AllowancesPurchase Returns and Allowances

Freight-CostsFreight-Costs


Sale of MerchandiseSale of Merchandise

Sales Returns and AllowancesSales Returns and Allowances

Sales DiscountsSales Discounts

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Comparison of Perpetual to Comparison of Perpetual to PeriodicPeriodic

BuyerBuyer

SellerSeller

Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that named in Section 117 of the United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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