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MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT

MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT. 5. Financial Accounting, Sixth Edition. Study Objectives. Identify the differences between a service company and a merchandising company. Explain the recording of purchases under a perpetual inventory system.

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MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT

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  1. MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT 5 Financial Accounting, Sixth Edition

  2. Study Objectives • Identify the differences between a service company and a merchandising company. • Explain the recording of purchases under a perpetual inventory system. • Explain the recording of sales revenues under a perpetual inventory system. • Distinguish between a single-step and a multiple-step income statement. • Determine cost of goods sold under a periodic system. • Explain the factors affecting profitability.

  3. Merchandising Operations Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales. SO 1 Identify the differences between service and merchandising companies.

  4. Merchandising Operations Income Measurement Not used in a Service business. Sales Revenue Less Illustration 5-1 Income measurement process for a merchandising company Cost of Goods Sold Gross Profit Equals Less Net Income (Loss) Operating Expenses Equals Cost of goods sold is the total cost of merchandise sold during the period. SO 1 Identify the differences between service and merchandising companies.

  5. Merchandising Operations Illustration 5-2 Operating Cycles The operating cycle of a merchandising company ordinarily is longer than that of a service company. SO 1 Identify the differences between service and merchandising companies.

  6. Merchandising Operations Flow of Costs Illustration 5-3 Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. SO 1 Identify the differences between service and merchandising companies.

  7. Merchandising Operations Flow of Costs Perpetual System • Maintain detailed records of the cost of each inventory purchase and sale. • Records continuously show inventory that should be on hand. • Company determines cost of goods sold each time a sale occurs. SO 1 Identify the differences between service and merchandising companies.

  8. Merchandising Operations Flow of Costs Periodic System • Do not keep detailed records of the goods on hand. • Cost of goods sold determined by count at the end of the accounting period. • Calculation of Cost of Goods Sold: Beginning inventory $ 100,000 Add: Purchases, net 800,000 Goods available for sale 900,000 Less: Ending inventory 125,000 Cost of goods sold $ 775,000 SO 1

  9. Merchandising Operations Flow of Costs Additional Consideration Perpetual System: • Traditionally used for merchandise with high unit values. • Provides better control over inventories. • Requires additional clerical work and additional cost to maintain inventory records. • Easier now with bar codes and inexpensive software. SO 1 Identify the differences between service and merchandising companies.

  10. Recording Purchases of Merchandise • Made either cash or credit (on account). Illustration 5-5 • Normally recorded when goods are received. • Purchase invoice should support each credit purchase. SO 2 Explain the recording of purchases under a perpetual inventory system.

  11. Recording Purchases of Merchandise Illustration 5-5 Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. May 4 Inventory 3,800 Accounts payable 3,800 SO 2 Explain the recording of purchases under a perpetual inventory system.

  12. Recording Purchases of Merchandise Freight Costs–Terms of Sale Illustration 5-6 Shipping terms Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Ownership of the goods remains with the seller until the goods reach the buyer. Freight costs incurred by the seller are an operating expense.

  13. Recording Purchases of Merchandise Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Haul-It Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: May 6 Inventory 150 Cash 150 Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: May 4 Freight-out 150 Cash 150 SO 2 Explain the recording of purchases under a perpetual inventory system.

  14. Recording Purchases of Merchandise Purchase Returns and Allowances Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Allowance Purchase Return Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price. SO 2 Explain the recording of purchases under a perpetual inventory system.

  15. Recording Purchases of Merchandise Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. May 8 Accounts payable 300 Inventory 300 SO 2 Explain the recording of purchases under a perpetual inventory system.

  16. Recording Purchases of Merchandise Purchase Discounts • Credit terms may permit buyer to claim a cash discount for prompt payment. • Advantages: • Purchaser saves money. • Seller shortens the operating cycle. Example: Credit terms may read 2/10, n/30. 2% cash discount offered if payment is made within 10 days of invoice date; otherwise full (net) amount is due within 30 days. SO 2 Explain the recording of purchases under a perpetual inventory system.

  17. Recording Purchases of Merchandise Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk Stereo makes to record its May 14 payment. May 14 Accounts payable 3,500 Inventory 70 Cash 3,430 (Discount = $3,500 x 2% = $70) SO 2 Explain the recording of purchases under a perpetual inventory system.

  18. Recording Purchases of Merchandise Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be: June 3 Accounts payable 3,500 Cash 3,500 SO 2 Explain the recording of purchases under a perpetual inventory system.

  19. Recording Purchases of Merchandise Purchase Discounts Should discounts be taken when offered? Example: 2% for 20 days = Annual rate of 36.5% (365/20 = 18.25 twenty-day periods x 2% = 36.5%) SO 2 Explain the recording of purchases under a perpetual inventory system.

  20. Recording Purchases of Merchandise Summary of Purchasing Transactions 4th - Purchase $3,500 $300 8th - Return 6th – Freight-in 150 70 14th - Discount Balance $3,280 SO 2 Explain the recording of purchases under a perpetual inventory system.

  21. Recording Sales of Merchandise • Made using cash or credit (on account). Illustration 5-5 • Normally recorded when earned, usually when goods transfer from seller to buyer. • Sales invoice should support each credit sale. SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  22. Recording Sales of Merchandise Journal Entries to Record a Sale #1 Cash or Accounts receivable XXX Selling Price Sales revenue XXX #2 Cost of goods sold YYY Cost Inventory YYY SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  23. Recording Sales of Merchandise Illustration: Assume PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo on account (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply $2,400. May 4 Accounts receivable 3,800 Sales revenue 3,800 4 Cost of goods sold 2,400 Inventory 2,400 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  24. Recording Sales of Merchandise Sales Returns and Allowances • “Flipside” of purchase returns and allowances. • Contra-revenue account (debit). • Sales not reduced (debited) because: • Would obscure importance of sales returns and allowances as a percentage of sales. • Could distort comparisons. SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  25. Recording Sales of Merchandise Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective. May 8 Sales returns and allowances 300 Accounts receivable 300 8 Inventory 140 Cost of goods sold 140 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  26. Recording Sales of Merchandise Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries: May 8 Sales returns and allowances 300 Accounts receivable 300 8 Inventory 50 Cost of goods sold 50 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  27. Recording Sales of Merchandise Sales Discount • Offered to customers to promote prompt payment. • “Flipside” of purchase discount. • Contra-revenue account (debit). SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  28. Recording Sales of Merchandise Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14. May 14 Cash 3,430 * Sales discounts 70 Accounts receivable 3,500 * [($3,800 – $300) X 98%] SO 3 Explain the recording of sales revenues under a perpetual inventory system.

  29. Income Statement Presentation Single-Step Income Statement • Subtract total expenses from total revenues • Two reasons for using the single-step format: • Conceptually the company does not realize any type of profit until total revenues exceed total expenses. • Format is simpler and easier to read. SO 4 Distinguish between a single-step and a multiple-step income statement.

  30. Single-Step Income Statement Presentation Illustration 5-7 SO 4

  31. Income Statement Presentation Multiple-Step Income Statement • Highlights the components of net income. • Three important line items: • gross profit, • income from operations, and • net income. SO 4 Distinguish between a single-step and a multiple-step income statement.

  32. Multiple-Step Income Statement Presentation Illustration 5-8 Key Line Items SO 4

  33. Income Statement Presentation Sales Revenues Illustration 5-9 SO 4 Distinguish between a single-step and a multiple-step income statement.

  34. Income Statement Presentation Gross Profit Illustration 5-11 Comparisons with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies. SO 4 Distinguish between a single-step and a multiple-step income statement.

  35. Income Statement Presentation Operating Expenses Illustration 5-11

  36. Income Statement Presentation Nonoperating Activities Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations. Illustration 5-10 SO 4 Distinguish between a single-step and a multiple-step income statement.

  37. Income Statement Presentation Illustration 5-11

  38. Income Statement Presentation Determining Cost of Goods Sold Under a Periodic System • No running account of changes in inventory. • Ending inventory determined by physical count. • Cost of goods sold not determined until the end of the period. SO 5 Determine cost of goods sold under a periodic system.

  39. Income Statement Presentation Determining Cost of Goods Sold Under a Periodic System Illustration 5-13 Cost of goods sold for a merchandiser using a periodic inventory system SO 5

  40. Evaluating Profitability Gross Profit Rate May be expressed as a percentage by dividing the amount of gross profit by net sales. • A decline in the gross profit rate might have several causes. • Selling products with a lower “markup.” • Increased competition may result in a lower selling price. • Company forced to pay higher prices to its suppliers without being able to pass these costs on to its customers. SO 6 Explain the factors affecting profitability.

  41. Evaluating Profitability Gross Profit Rate Illustration 5-15 Why does Wal-Mart have a lower gross profit rate than Target and the industry average? SO 6 Explain the factors affecting profitability.

  42. Evaluating Profitability Profit Margin Ratio Measures the percentage of each dollar of sales that results in net income. • How do the gross profit rate and profit margin ratio differ? • Gross profit rate - measures the margin by which selling price exceeds cost of goods sold. • Profit margin ratio - measures the extent by which selling price covers all expenses (including cost of goods sold). SO 6 Explain the factors affecting profitability.

  43. Evaluating Profitability Profit Margin Ratio Illustration 5-17 How does Wal-Mart compare to its competitors? Keep in mind that an increasing percentage of Wal-Mart’s sales is from low-margin groceries. SO 6 Explain the factors affecting profitability.

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