Accounting for Merchandising Operations 2 PDF

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Textbook: Merchandising operations Part 2...

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Merchandising Operations LEARNING OBJECTIVE 1 Describe the differences between service and merchandising companies. Merchandising involves purchasing products—also called merchandise inventory or just inventory—to resell to customers. Merchandising companies that purchase and sell directly to consumers—such as Best Buy, Aeropostale, lululemon, GAP, Mountain Equipment Co-op, and Toys “R” Us—are called retailers. Merchandising companies that sell to retailers are known as wholesalers. The steps in the accounting cycle for a merchandising company are the same as the steps for a service company. However, merchandising companies need additional accounts and entries in order to record merchandising transactions. The calculations of profit for both a service and a merchandising company are shown in Illustration 5-1. As you can see, the items in the blue box are used only by a merchandising company because service companies do not sell goods. Service company Merchandising company Revenue Sales − Operating expenses− Cost of goods sold = Profit (Loss) = Gross profit  − Operating expenses  = Profit (Loss) ILLUSTRATION5-1Earnings measurement process for a service company and a merchandising company Measuring profit for a merchandising company is basically the same as for a service company. That is, profit (or loss) is equal to revenues less expenses. In a merchandising company, the main source of revenues is the sale of merchandise. These revenues are called sales revenue, or simply sales. Expenses for a merchandising company are divided into two categories: (1) cost of goods sold, and (2) operating expenses. A service company does not have a cost of goods sold because it provides services, not goods. The cost of goods sold is the total cost of merchandise sold during the period. This expense is directly related to revenue from the sale of the goods. Sales revenue less cost of goods sold is called gross profit. For example, when a tablet that costs $150 is sold for $250, the gross profit is $100. After gross profit is calculated, operating expenses are deducted to determine profit (or loss). Operating expenses are expenses that are incurred in the process of earning sales revenue or service revenue. The operating expenses of a merchandising company include the same basic expenses found in a service company, such as salaries, advertising, insurance, rent, and depreciation. You learned about the operating cycle in Chapter 4. The operating cycle is the time that it takes to go from cash to cash in producing revenues. It is usually longer in a merchandising company than in a service company. The purchase of merchandise inventory and the lapse of time until it is sold lengthen the cycle. Illustrations 5-2 and 53 show the operating cycles of a service company and a merchandising company, respectively.

ILLUSTRATION5-2Operating cycle of a service company

ILLUSTRATION5-3Operating cycle of a merchandising company

INVENTORY SYSTEMS A merchandising company must keep track of its inventory to determine what is available for sale (inventory) and what has been sold (cost of goods sold). Companies use one of two kinds of systems to account for inventory: a perpetual inventory system or a periodic inventory system.

Perpetual Inventory System In a perpetual inventory system, the company keeps detailed records of each inventory purchase and sale. This system continuously—perpetually—shows the quantity and cost of the inventory that should be on hand for every item. With the use of bar codes, optical scanners, and point-of-sale software, a store can keep a running record of every item that it buys and sells. Illustration 5-4 shows the flow of costs in a perpetual inventory system, using T accounts to illustrate the inflows and outflows. When inventory is purchased under a perpetual system, the purchase is recorded by increasing (debiting) the Merchandise Inventory account. When inventory items are sold under a perpetual inventory system, the cost of the goods sold (the original purchase cost of the merchandise) is transferred from the Merchandise Inventory account (an asset) to the Cost of Goods Sold account (an expense). Under a perpetual inventory system, the company determines and records the cost of goods sold and the reduction in inventory each time a sale occurs.

Helpful hint “Flow of costs” in an inventory system refers to the manner in which the cost of an item of inventory moves through a company's records.

ILLUSTRATION5-4Flow of costs through a merchandising company using a perpetual inventory system

Periodic Inventory System In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. Instead, the cost of goods sold is determined only at the end of the accounting period;

that is, periodically. At that point, the company takes a physical inventory count to determine the quantity and cost of the goods on hand. To determine the cost of goods sold in a periodic inventory system, the following steps are necessary: 1.Determine the beginning inventory—the cost of goods on hand at the beginning of the accounting period. (This is the same amount as the previous period's ending inventory.) 2.Add the cost of goods purchased during the period. 3.Subtract the ending inventory—the cost of goods on hand at the end of the accounting period as determined from the physical inventory count. Illustration 5-5 illustrates the relationship of cost flows in a periodic system in equation form.

ILLUSTRATION5-5Equation to determine cost of goods sold in a periodic inventory system

Choosing an Inventory System How do companies decide which inventory system to use? They compare the cost of the detailed record keeping that is required for a perpetual inventory system with the benefits of having the additional information about, and control over, their inventory. Traditionally, only companies that sold merchandise with high unit values— such as automobiles or major home appliances—used the perpetual inventory system. However, advances in technology, coupled with the reduced cost of computers and electronic scanners, have enabled many more companies to install perpetual inventory systems. A perpetual inventory system gives better control over inventories. Since the inventory records show the quantities that should be on hand, the goods can be counted at any time to see whether the amount of goods actually on hand agrees with the inventory records. Any shortages that are uncovered can be immediately investigated. A perpetual inventory system also makes it easier to answer questions from customers about merchandise availability. Management can also maintain optimum inventory levels and avoid running out of stock, like what happened to Frank & Oak in our feature story when it first started business. Some businesses find it unnecessary or uneconomical to invest in a computerized perpetual inventory system. Many small businesses, in particular, find that a perpetual inventory system costs more than it is worth. Managers of these businesses can control merchandise and manage day-to-day operations using a periodic inventory system. A complete physical inventory count is always taken at least once a year under both the perpetual and periodic inventory systems. Companies using a periodic inventory system must count their merchandise to determine quantities on hand and establish the cost of the goods sold and the ending inventory for accounting purposes. In a perpetual inventory system, they must count their merchandise to verify that the accounting records are correct. We will learn more about how to determine the quantity and cost of inventory later in this chapter and in the next chapter. In summary, no matter which system is chosen, the flow of costs for a merchandising company is as follows: Beginning inventory (inventory on hand at the beginning of the period) plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, the cost of these goods becomes an expense (cost of goods sold). Those goods not sold by the end of the accounting period represent ending inventory. The ending inventory is reported as a current asset on the balance sheet. The cost of goods sold is an expense on the income statement. Because the perpetual inventory system is widely used, we illustrate it in this chapter. The periodic system is described in Appendix 5A.

ACCOUNTING IN ACTION BUSINESS INSIGHT

Perpetual inventory systems provide more accurate information than periodic inventory systems. However, perpetual inventory systems also increase the amount of time spent on inventory management. In the past, most retailers used a periodic inventory system to record and report inventory. The periodic system was easier to use but provided little in the way of timely information and was much less accurate, making management of inventory challenging. In 1986, the first commercially available point-of-sale (POS) system was introduced, making perpetual inventory systems easier. Now retailers have an array of products to choose from that will instantaneously process inventory transactions from purchase to sale. For example, Lightspeed POS, a Montrealbased IT company, develops and sells POS systems for retail and restaurant markets. The products allow businesses to track inventory purchases, inventory levels, and sales in real time without sophisticated and expensive equipment. The system also provides a manager or owner with relevant analytics.  What advantages does a perpetual inventory system give a retailer?

BEFORE YOU GO ON…DO IT 1 Merchandising Operations and Inventory Systems Indicate whether the following statements are true or false. 1.The primary source of revenue for a merchandising company results from performing services for customers. 2.The operating cycle of a service company is usually shorter than that of a merchandising company. 3.Sales revenue less cost of goods sold equals gross profit. 4.Ending inventory plus the cost of goods purchased equals cost of goods available for sale. Action Plan •Review merchandising concepts. •Recall the flow of costs in a merchandising company: . Solution 1.False. The primary source of revenue for a service company results from performing services for customers. 2.True. 3.True. 4.False. Beginning inventory plus the cost of goods purchased equals cost of goods available for sale.

Related exercise material: BE5-1, BE5-2, and E5-1. Copyright © 2016 John Wiley & Sons Canada, Ltd. All rights reserved....