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Accounting for a Merchandising Business

Income Statement:

Sales xxxLess: Cost of Sales xxxGross Profit xxxLess: Expenses xxxNet Income (Loss) xxx

Gross Profit -- difference between sales and cost of sales (cost of goods sold), and is reported as an intermediate amount in the income statement

Sales -- a revenue account used strictly for sales of merchandise; in the income statement, sales has to be presented at net, to compute for net sales:

Sales xxxLess: Sales Returns and Allowances xxx

Sales Discounts xxx xxxNet Sales xxx

• Sales are recorded at invoice price , meaning list price less any trade discounts• Occasionally, a customer returns merchandise. When that occurs, the account Sales Returns and Allowances is debited for the amount of merchandise returned:

If the merchandise that was returned was previously purchased on account, the entry would be:

Sales Returns and Allowances xxxAccounts Receivable xxx

If the merchandise that was returned was previously purchased for cash, the entry would be:

Sales Returns and Allowances xxxCash xxx

• When merchandise is sold on account, the seller would like to be paid promptly after billing, and may encourage prompt payment by offering cash discount (also known as sales discount on the seller's part).• To receive the cash discount, the buyer must pay the invoice promptly.• The amount of time one has available to pay is expressed in a unique manner, such as

2/10, n/30 — these terms mean that "a 2% discount is available if the invoice is paid within 10 days, otherwise, the net amount is expected to be paid within 30 days"

If the customer pays the invoice in time to receive the the discount, the entry would be:

Cash (A/R less the cash discount) xxxSales Discounts xxx

Accounts Receivable xxx

If the customer pays too late to get the discount, the payment received should be for the full invoice amount , and would be recorded as follows:

Cash xxxAccounts Receivable xxx

Cost of Sales— pertains to the cost of goods sold , and is computed as follows:

Merchandise Inventory, beginning Add: Net Purchases

xxx xxx

----> prior period's ending inventory----> extracted from the ledger

Cost of Goods Available for Sale Less: Merchandise Inventory, ending

xxx xxx ----> from physical count

Cost of Sales xxx

• Purchases should be stated at net , computed as follows:

Purchases xxxAdd: Freight In (Transportation In) xxxTotal xxxLess: Purchase Returns and Allowances xxx

Purchase Discounts xxx xxxNet Purchases xxx

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Purchases— The first phase of the merchandising cycle occurs when the entity acquires goods to be stocked for

resale to customers. The appropriate accounting for this action requires the recording of the purchase.

When a purchase occurs and a periodic inventory system is in use, the entry would be:

Purchases xxxAccounts Payable xxx

• The Purchases account is unique to the periodic system. The purchases account is not an expense or an asset, per se.

• The balance of the Purchases account represents total inventory purchased during the period, and this amount shall be ultimately apportioned between cost of goods sold in the income statement, and inventory on the balance sheet.

When a merchandise is returned to a supplier, the entry would be:

Accounts Payable xxxPurchase Returns and Allowances xxx

Gross Method of Recording Purchases/ Discounts

— this technique records purchases at their total gross or full invoice amount: Purchases xxx

Accounts Payable xxx

If payment is made within the discount period, the entry would be:

Accounts Payable xxxPurchase Discounts xxxCash (A/P less cash discount) xxx

If payment is made outside the discount period, the entry would be:

Accounts Payable xxxCash xxx

Net Method of Recording Purchases/ Discounts Lost

— the initial purchase is recorded for the net amount of the purchase (invoice amount less the available discount):

Purchases (at net amount) xxxAccounts Payable (at net amount) xxx

If payment is made within the discount period, the entry would be:

Accounts Payable xxxCash xxx

If payment is made outside the discount period, the lost discounts are recorded on a separate account:

Accounts Payable (at net amount) xxxPurchase Discounts Lost (amount of the cash discount) xxx

Cash (A/P plus the discount lost) xxx

Freight Charges (see related discussion on the other hand-out)

• If goods are sold FOB Destination, the seller is responsible for costs incurred in moving the goods to their destination. Freight cost incurred by the seller is called freigh-out , and is reported as a selling expense that is subtracted from gross profit in calculating net income.

Seller's entry: Accounts Receivable xxxFreight-out xxx

Cash (the payment for the freight) xxxSales xxx

Buyer's entry: Purchases xxx

Accounts Payable xxx

• If goods are sold FOB Shipping Point, the purchaser/ buyer is responsible for paying freight costs incurredin transporting the merchandise from the point of shipment to its destination. Freight cost incurred by a purchaser is called freight-in , and is added to purchases in calculating net purchases.

Seller's entry: Accounts Receivable xxx

Sales xxx