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Chapter notes for financial accounting with David Deeds...

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Chapter 4: Reporting and Analyzing Merchandising Operations

Chapter 4: Reporting and Analyzing Merchandising Operations

Merchandising Activities: ● Merchandisers consists of products, also called goods that a company acquires to resell to its customers. ○ Merchandisers earn net income by buying and selling merchandise. ○ Often called: wholesalers or retailers ■ Wholesaler: an intermediary that buys products from manufacturers or other wholesalers then sells them to retailers (kinda like the middle man). ● e.g) SYSCO is a wholesaler that buys their ketchup from the manufacturers, then they sell the ketchup to Walmart. ■ Retailer: person who buys products from manufacturers then sells them to consumers. ● e.g ) Walmart buys the ketchup from SYSCO, then sells it to consumers. Reporting Income for a Merchandiser ● Net income = Net sales - Cost of Goods Sold and Cost of Other Expenses ● Gross profit (gross margin) = Net Sales - Cost of Goods Sold ● Just like how people who provide services use the term revenue, merchandisers use the term sales. Reporting Inventory for a Merchandiser ● Merchandiser’s balance sheet is different than a service company because: ○ It has a current asset called merchandise inventory (inventory).

○ Merchandise inventory: the products that a company owns and intends to sell. ○ The cost of this asset includes the costs incurred to buy the goods, ship them to the store, and make them ready for sale. Operating Cycle for a Merchandiser ● The operating cycle begins by purchasing merchandise and ends by collecting cash as a result from selling the merchandise. ● Operating cycle:

Inventory Systems ● Cost of goods sold is the largest expense on a merchandiser’s income statement. ● Merchandise Available for Sale = beginning inventory + net purchases ○ Two things can happen to Merchandise Available for sale: ■ If sold then it becomes cost of goods sold ■ If kept for future sales then it becomes ending inventory ● Two alternative inventory accounting systems: ○ Perpetual Inventory System: CONTINUALLY updates accounting records for merchandising transactions. ○ Periodic Inventory System: Updates accounting records for merchandise transactions ONLY at the END of a period.

Purchases Without Cash Discounts ● E.g ) Z-mart records a $500 cash purchase of merchandise on November 2 Accounts Affected

Debit

Merchandise Inventory

500

Credit

Cash

500

Purchases With Cash Discounts ● Credit Terms: includes the amounts and timing of payments from a buyer to a seller. ● Example: n/10 EOM means sellers require payment within 10 days after the end of the month of the invoice date. ● When sellers require payment within 30 days after the invoice date the credit terms are shown as n/30 (net 30 days). ● Credit Period: the amount of time allowed before full payment is due. ● Cash Discount: a discount to encourage buyers to pay earlier. Buyers view this as a purchase discount, while sellers view it as a sales discount. ● Example: 2/10, n/60 = the buyer can deduct 2% of the invoice amount if payment is made within 10 days (2/10). The full payment is still due in 60 days (n/60). ● Gross Method: enters the full invoice (gross) amount for merchandise. Purchase of Merchandise on credit using the Gross Method Example: Z-mart purchases $500 of merchandise on credit with terms of 2/10, n/30 on November 2. Accounts Affected Merchandise Inventory

Debit

Credit 500

Accounts Payable ● NOTE: the amount recorded for merchandise inventory includes: ○ Purchase cost ○ Shipping fees ○ Taxes ○ Any other costs necessary to make it ready for sale ● Implied annual interest rate formula is: ○ 365 days / (credit period- discount period) x cash discount rate Payment Within Discount Period Example: Z- mart pays the $500 due on November 12 (from example earlier).

500

● Note: Z- mart paid within the 10 days… so.. ○ Z- mart gets the purchase discount ○ $500 x 2% Accounts Affected

Debit

Accounts Payable

500

Credit

Merchandise Inventory

10

Cash

490

Payment AFTER the discount period ● Example: Let’s say Z- mart pays the amount after November 12. ○ They do not get the discount because: ■ Its payment exceeded the original 10 days within the invoice date (n/10). Accounts Affected

Debit

Accounts Payable

500

Cash

Credit

500

Purchases WITH Returns and Allowances ● Purchase returns: the merchandise a buyer acquires but then returns to the seller. ● Purchase allowances: refer to a reduction in the cost of defective or unacceptable merchandise that a buyer acquires. Buyers usually keep defective goods but the seller grants them an allowance.

Example: Z-mart agrees to a $30 allowance from Trex for defective merchandise. Accounts Affected Accounts Payable Merchandise Inventory

Debit

Credit

30 30

Purchase Returns ● Returns are recorded at the costs charged to buyers. Example: ● On June 1, Z-mart purchased $250 of goods with terms 2/10, n/60. ● On June 3, Z-mart returns $50 of those goods. ● When Z-mart pays on June 11, it takes the 2% discount only on the remaining $200. ● When goods are returned, a buyer can only take a discount on only the remaining balance of the invoice.

June 3

Accounts Affected

Debit

Accounts Payable

50

Credit

Merchandise inventory June 11

50

Accounts Payable

200

Merchandise Inventory

4

Cash

196

Purchases and Transportation Costs ● FOB Point (free on board point): Determines who pays transportation costs. Whoever owns the goods in transit is responsible for shipping costs ● FOB Shipping Point: The buyer accepts ownership when the goods depart seller’s place of business (paying for shipping when ordering online). The buyer is responsible for shipping charges. ● FOB Destination: Ownership of goods transfers to the buyer when goods arrive at the buyer’s place of business (getting free shipping online). Only the seller is responsible for these shipping charges. Example: FOB Shipping Point Accounts Affected

Debit

Merchandise Inventory

75

Cash

Credit

75 FOB Destination

Accounts Affected

Debit

Delivery Expense

75

Cash

Credit

75

NOTE: INcoming freight costs are charged to INventory. When inventory EXits, freight costs are charged to EXpenses. Purchases and Their Itemized Costs ● Purchases are recorded as debits to merchandise inventory. ● Purchase discounts, returns, and allowances are credited to merchandise inventory. ● Supplementary Records: information outside the usual general ledger accounts. Each Sale of Merchandise has TWO parts: Revenue and the Cost Side Sales WITHOUT Cash Discounts ● Example: Z-mart sold $1,000 of merchandise on credit terms n/60 on November 12. Revenue Side: Inflow of Assets Accounts Affected

Debit

Accounts Receivable

1,000

Sales

Credit

1,000

Cost Side: Outflow of Assets Example: The cost of merchandise Z-mart sold on November 12 is $300. Accounts Affected

Debit

Cost of Goods Sold

300

Merchandise Inventory

Sales WITH Cash Discounts

Credit

300

● Two methods to record sales with cash discounts ○ Gross Method: records sales at the gross amount and records sales discounts, if, and when they are taken. ○ Net method: records sales at the net amount, which assumes that all discounts are taken. Buyer Pays WITHIN Discount Period ● Example: Z-mart completes a credit sale for $1,000 on November 12 with terms 2/10, n,45. ○ Buyer pays the amount on November 22. ○ The buyer can deduct the 2% discount. Accounts Affected

Debit

Cash

980

Sales Discounts

20

Credit

Accounts Receivable

1000

Returns Received by Seller Sales returns and allowances are a contra account to Sales. Example: Customer returns items that had been sold for $15 and cost $9. Accounts Affected

Debit

Sales Returns and Allowances

15

Cash

Credit

15

Returned Goods Not Defective Example: Accounts Affected

Debit

Merchandise Inventory

9

Cost of Goods Sold

Credit

9

Returned Goods Are Defective Accounts Affected

Debit

Credit

Merchandise Inventory

2

Loss from Defective Merchandise

7

Cost of Goods Sold

9

Allowances Granted by Seller Example: Seller offers buyer a $10 reduction in their $40 purchase. Accounts Affected

Debit

Sales Returns and Allowances

10

Cash

Credit

10

Adjusting Entries for Merchandisers Inventory Shrinkage- Adjusting Entry ● Shrinkage: refers to the loss of inventory, and is computed by comparing a physical count of inventory with recorded amounts. Example: Z-mart’s Merchandise inventory in 2016 had a balance of $21,250, but a physical count shows that only $21,000 of inventory exists. Accounts Affected

Debit

Cost of Goods Sold

250

Merchandise Inventory Expected Sales Discounts- Adjusting Entry

Credit

250

● A period-end adjusting entry is needed to estimate sales discounts for current period's sales that are expected to be taken in future periods. Example: Accounts receivable has a $11,250 balance. $2500 of them are within the 2% discount period, and we expect buyers to take $50 in future period discounts. Accounts Affected

Debit

Sales Discounts

50

Allowance for Sales Discounts

Credit

50

Allowance for Sales discounts is a contra asset account and is reported on the balance sheet as a reduction to Accounts Receivable. Expected Returns and Allowances- Adjusting Entries ● We must estimate returns and allowances to avoid overstatement of sales and cost of sales. ○ Required by the new revenue recognition rules ● Current asset account affected: Inventory Returns Estimated ● Current liability account affected: Sales Refund Payable. ● Allowance for sales discounts- contra asset account and is reported on balance sheet as a reduction to Accounts Receivable

Revenue Side for Expected Returns and Allowances ● Sales Refund Payable- current liability, reported on balance sheet. Example: A company estimates future sales refund to be $1,200. Also assume that the unadjusted balance of Sales refund Payable is $300 credit. ● You get $900 because the current balance was $300 but it should be $1,200. So you must account for the extra $300. Accounts Affected

Debit

Sales Returns and Allowances

900

Sales Refund Payable Cost Side for Expected Returns and Allowances

Credit

900

● Inventory Returns Estimated- current asset account (subcategory of inventory). Example: A company estimates future inventory returns to be $500 and the beginning balance of the unadjusted Inventory returns estimated account is a $200 debit. Accounts Affected

Debit

Inventory Returns Estimated

300

Cost of Goods Sold

Credit

300

Closing Entries for Merchandisers 1. Close credit balances in Temporary Accounts to Income Summary 2. Close debit balances in temporary accounts to income summary a. New balances are: i. Sales discounts ii. Sales returns and allowances iii. Cost of goods sold 3. Close income summary to retained earnings 4. Close dividends to retained earnings Multiple-Step Income Statement ● Shows detailed computations of net sales and other costs and expenses, and reports subtotals for various classes of items. ● Contains three main parts: ○ Gross profit (net sales - cost of goods sold) ○ Income from operations (gross profit - operating expenses) ○ Net income (income from operations - nonoperating items) ● Sellings expenses: expenses such as advertising, making sales, and delivering goods to customers. ● General and administrative expenses: are the company’s overall operations and include expenses related to accounting, human resource management, and financial management. ● Nonoperating activities: ○ Other revenues and gains include interest revenue, dividend revenue, rent revenue, and gains from asset disposals. ○ Other expenses and losses include interest expenses, losses from asset disposals, and casualty losses. ● Single-step income statement: list cost of goods sold as another expense and shows only one subtotal for total expenses. Classified Balance Sheet ● The merchandiser’s classified balance sheet reports merchandise inventory, and inventory returns estimated account.

● Inventory is usually less liquid than accounts receivable. ● U.S GAAP reports current items on balance sheets first from most liquid to least liquid and liabilities from nearest maturity to furthest maturity. ● IFRS balance sheet presents noncurrent items first. Acid-Test Ratio ● One measure of a merchandiser’s ability to pay its liabilities is the acid-test ratio. ● Excludes less current asses like inventory and prepaid expenses. ● Also called quick ratio. ● Acid-test ratio: Cash and cash equivalent + short term investments + current receivables / current liabilities Gross Margin Ratio ● Differs from profit margin ratio because it excludes all costs except cost of goods sold. ● Gross margin ratio: Net sales - Cost of Goods Sold / Net Sales

Credit Purchases with Cash Discounts Example: Z-mart purchases $500 on credit with terms 2/10, n/30 Periodic Accounts Affected

Debit

Purchases

500

Credit

Accounts Payable

500 Perpetual

Accounts Affected

Debit

Merchandise Inventory

500

Credit

Accounts Payable

500

Payment of Purchases Example: payment of $500 within the discount period Periodic Accounts Affected

Debit

Accounts Payable

500

Credit

Purchases Discount

10

Cash

490 Perpetual

Accounts Affected

Debit

Accounts Payable

500

Credit

Merchandise inventory

10

Cash

490

Example: payment of $500 is made after discount period

Periodic and Perpetual Accounts Affected

Debit

Accounts Payable

500

Cash

Credit

500

Purchases Returns and Allowances Example: the buyer and seller agree to a $30 purchase allowance for defective goods (assume terms are $30 whether paid within the discount period or not). Periodic Accounts Affected

Debit

Accounts Payable

30

Credit

30

Purchase Returns and Allowances Perpetual Accounts Affected

Debit

Accounts Payable

30

Credit

30

Merchandise Inventory Example: Buyer returns $50 of merchandise within discount period Periodic Accounts Affected

Debit

Accounts Payable

50

Credit

50

Purchase Returns and Allowances

Perpetual

Accounts Affected

Debit

Accounts Payable

50

Credit

50

Merchandise Inventory

Transportation-In Example: The buyer paid $75 of a freight charge to transport goods with terms FOB destination. Periodic Accounts Affected

Debit

Transportation-In

75

Cash

Credit

75 Perpetual

Accounts Affected

Debit

Merchandise Inventory

75

Cash

Credit

75

Recording Merchandise Sales Example: record $1,000 in credit sales. (no cost-side entry) Periodic Accounts Affected

Debit

Accounts Receivable

1000

Sales

Credit

1000

Perpetual Accounts Affected

Debit

Credit

Accounts Receivable

1000

Sales

1000

Accounts Affected

Debit

Cost of Goods Sold

300

Credit

Merchandise Inventory

300

Returns received by Seller Example: A customer returned merchandise for a cash refund. Goods sell for $15 and cost $9. Periodic (no entry for cost effect) Accounts Affected

Debit

Sales Returns and Allowances

15

Credit

Cash

15 Periodic

Accounts Affected

Debit

Credit

Sales Returns and Allowances 15 Cash

15

Merchandise Inventory

9 9

Cost of Goods Sold

Allowances granted by Seller Example: A customer received an allowance of $10; only the revenue side is impacted as no inventory was returned and cost stays the same. Periodic and Perpetual Accounts Affected

Debit

Credit

Sales Returns and Allowances Cash

10 10

Refer to page 197-199 in book for gross and net method transactions....