MERCHANDISINGMERCHANDISING

Service Businesses - Make money by providing a service- Services can’t be created and stockpiled for later sale.- An advantage is usually less Rs. needed to start and

operate business.- A disadvantage relates to staffing employees during

erratic demand periods.

3 BASIC TYPES OF COMPANIES

MERCHANDISINGMERCHANDISING

Merchandiser- Make money by selling a product. - Usually more Rs. needed to start and operate business because inventory must be available for sale.- Bigger risk also due to obsolescence, theft,

competition on price.- Inventory is purchased from a supplier. Merchandiser

doesn’t “add value” to product.

3 BASIC TYPES OF COMPANIES

MERCHANDISINGMERCHANDISING

Manufacturer - Convert a raw material to a finished good.- Direct labor and manufacturing processes used in

conversion.- 3 types of inventories: Raw materials

Work in processFinished goods

3 BASIC TYPES OF COMPANIES

INCOME STATEMENT

SERVICERevenues

- Expenses--------------------Net Income===========

MERCHANDISINGSales- Contra Sales Net Sales- Cost of Goods Sold (CGS or COGS)Gross Profit- Operating ExpensesIncome from operations+ or - other income or expenseNet Income==================================

Inventory MethodsInventory Methods - 2 GAAP options:

EXAMPLE Perpetual EXAMPLE Perpetual : : InventoryInventory C G SC G S

• 1 - PERPETUALPERPETUAL records CGS for each sale.

Start 10 units, cost = Rs.1 each 10Sell 2 units 2 2Sell 5 units 5 5Purchase 10 units 10Sell 8 units 8 8 . Balances 5 15

• 2 - PERIODICPERIODIC doesn’t record CGS at all!

EXAMPLE Periodic EXAMPLE Periodic : : InventoryInventory Purchases CGSCGSStart 10 units 10Sell some No recording Inv/CGS (record revenue but not CGS)

Sell some more No recording Inv/CGS Purchase 10 units 10 (must record purchase)Sell some more No recording Inv/CGS

What is needed to compute amount CGS?

COMPARISON OF SYSTEMSCOMPARISON OF SYSTEMS• PERPETUAL

- On-Line Inventory Info- Control over theft amount, errors.- Lots of inventory record keeping.

• PERIODIC- Ease of use. Much less records. Count inventory once per year and Record inventory purchases only. - No ongoing record of inventory amounts.- No direct calculation of theft

Computers and electronic scanning Computers and electronic scanning equipment make perpetual inventory cost equipment make perpetual inventory cost

effectiveeffective!!Scans be used to create

automated journal entries with no human accounting.

SALES & Cost of Goods Sold (CGS)• Revenue Recognition Principle • requires revenue be recorded at point of sale.

- When “legal ownership” changes from seller to buyer.

- Goods must be transferred to buyer (shipped).

• Matching Principle also requires the expense of the sale be recorded at the same time as revenue.

Recording a Sale• Two things need to be recorded for each sale:1. Revenue Dr. Cash (or A/R) xxxx

Cr. Sales xxxx2. Expense (Perpetual method only) Dr. Cost of Goods Sold (or CGS) xxxx

Cr. Inventory xxxx

Inventory costComponents of Full inventory cost:• Purchase price from vendor

• plus Freight cost if paid separately by purchasing company

• less Discounts allowed by vendor (Generally based on credit terms)

Example: Recording a saleKonk Co. Sold 10 units of inventory for Rs.100 each.• The units were purchased last month for Rs.60 each. - Freight charges on the purchase were Rs.5 each. - Discounts granted on the purchase were Rs.2 each.Journal entry to record the sale?

Cash (or A/R) 1000 Sales

1000For perpetual method also:Cost of Goods Sold 630

Inventory 630To record sale (10 x 100) and cost [10 x (60+5-2)]

Sales & Sales Discounts text p. 227, also see purchase discounts on p 223• Most business to business sales are on

account. (competition, business practice, etc)- Credit terms are listed on invoice.

• Seller’s often provide an incentive for buyers to pay before the normal due date.- Called a cash discount- Usually a % reduction in payment

- Why would they do this?- What is the cost to do this?

Example: Sales DiscountsKonk Co. had a sale of Rs.1000, terms 2 / 10, n / 30.

This means : Buyer gets 2 % price reduction IF buyer pays within 10

days of the sale, OTHERWISE the entire net (full price) is due within 30 days of the sale.

Record sale as before. See previous example.

Record cash received if within 10 days of sale? Cash 980 Sales Discounts 20

Accounts Receivable 1000

SALES RETURNS & ALLOWANCES text p226 • Use to record returns of merchandise from buyer,

or a special allowance.Dr. Sales R & A xxxx

Cr. A/R (or Cash) xxxxNote: If inventory is returned (not just an

allowance), also record (perpetual only):Dr. Inventory xxxx

Cr. Cost of Goods Sold xxxx

INCOME STATEMENT PRESENTATION

SALES 1000. Less: Sales Discounts 20. Sales Returns & Allowances 100.

(120.) Net Sales 880. Less: Cost of Goods Sold (630.)Gross Profit 250.

These sales accounts are called CONTRA-REVENUE accounts (not EXPENSES).

Other issues for Purchaser• Purchase Discounts - Buying company that pays

early records discount effect in inventory.Example: Buy Rs.1000 of inventory on terms 2/10, n/30

On date of purchase: Inventory (perpetual method only) 1000

Accounts Payable 1000

If paid within 10 days of purchase Accounts Payable 1000

Inventory (perpetual method only) 20 Cash 980

Other issues for Purchaser• Purchase Returns & Allowances - Company that returns or gets allowance

reduces inventory.Dr. A/P (or Cash) xxxx Cr. Inventory (perpetual method only) xxxx

Other issues for Purchaser• Freight on purchases - Buying company adds freight they pay to inventory cost.Dr. Inventory

(perpetual method only) xxxx Cr. A/P (or Cash) xxxxNote: If seller agrees to pay freight, record operating expense called freight out on seller’s books:

Dr. Freight- out expense xxxx Cr. A/P (or Cash) xxxx

Inventory Account (Perpetual)Beginning Balance

Purchase InventoryFreight on purchase

Purchase DiscountsPurchase R & ACost of Inventory sold

Cost of Sale Returns

Ending Balance

Data needed for PERIODIC methodData needed for PERIODIC method1 Start with beginning inventory amount – Count it!

2 Keep track of full costs of inventory bought during the year. Don’t record in inventory, but use the following periodic accounts:

• Purchases• Freight-In• Purchase discounts• Purchase returns & allowances

3 Subtract inventory left over at year end – Count it!Note an AJE will be needed at period end to update the

inventory account to reflect the ending physical count balance! (We won’t worry about in this class.)

Inventory Account (Periodic)Beginning Balance

Additional periodic accounts for:- Purchases- Freight in on purchase- Purchase R & A- Purchase discounts

Year end adjustment (debit or credit) to physical count

Ending Balance

CGS on PERIODIC Income Statement

COST OF GOODS SOLD: Beginning Inventory 100. Purchases 700. Less: Purchase Discounts -50. Purchase R & A -10. Add: Freight In 30. Cost of goods purchased 670. Cost of Goods Available for Sale 770. Less: Ending Inventory -150. Cost of Goods Sold 620.

Operating cycle of a company is...

the average time it takes to go from cash to cash in producing revenues.

TO

Merchandising Company Operating Cycle

Cash

AccountsReceivable

MerchandiseInventory

Buy Inventory

Sell Inventory

Receive Cash

Gross Profit Rate=Gross ProfitNet Sales

Company’s gross profit expressed as a percentage

x (100)

Reasons Gross Profits Rates ChangeReasons Gross Profits Rates Change

•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

Profitability - Profit Margin Ratio Measures the percentage of each dollar of sales that results in net income

Profit Margin Ratio = Net IncomeNet Sales

Similar to gross profit ratio except it considers ALL costs, including operating expenses (not just CGS).

General Journal- Perpetual7/1 Inventory (70 units @ Rs.30 each) 2100

A/P 21007/3 A/R (40 units @ Rs.50 each) 2000

Sales 2000CGS (40 x Rs.30) 1200

Inventory 1200

P5-2B text p 255 - First 2 transactions only, Perpetual, then periodic

• On 7/1, buy 70 suitcases for Rs.30 each. On 7/3 sell 40 cases for Rs.2,000.

On income statement: Sales 2000 -CGS -1200 Gross profit 800

On balance sheet: Inventory balance = 900 (2100 dr and 1200 cr)

General Journal – P E R I O D I C7/1 Purchases 2100

A/P 21007/3 A/R 2000

Sales 2000NOTE: To prepare statements, inventory must be counted and cost

calculated (30 units @ Rs.30 = Rs.900).On income statement: Sales 2000

-CGS: BI 0 Purchases 2100

Cost Available 2100 - EI - 900 -1200 Gross profit 800

On balance sheet: Inventory = 900 (adj made to physical count)