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Chapter 5 Accounting for Merchandising Operations QUESTIONS 1.

Merchandising companies report Merchandise Inventory on the balance sheet, service companies do not. Also, merchandising companies report both Sales (of goods) and Cost of Goods Sold on the income statement, while service companies do not.

2.

Additional accounts of a merchandising company likely include Merchandise Inventory, Sales (of goods), Cost of Goods Sold, Sales Discounts, and Sales Returns and Allowances (and possibly Delivery Expense).

3.

A company can have a net loss if its expenses (absent cost of goods sold) are greater than its gross profit from sales of merchandise.

4.

A cash discount can be offered to encourage customers to promptly pay. This provides cash more quickly to the seller and avoids the costs of additional collection activities. Of course, the seller must perform a costs vs. benefits analysis on the merits and terms of any cash discount offered to customers.

5.

For a perpetual inventory system, inventory shrinkage is determined by taking a physical count of the inventory available at the end of a period and comparing that amount with the amount recorded in the Merchandise Inventory account.

6.

Cash discounts are granted in return for early payment and reduce the amount paid below the negotiated price. Cash discounts are recorded in the accounting records (as a reduction of Merchandise Inventory). Trade discounts are deducted from the list or catalog price to determine the purchase (negotiated) price. Trade discounts are not recorded in the accounting records.

7.

Sales discount is a term used by a seller to describe a cash discount granted to a customer. Purchase discount is a term used by a purchaser to describe a cash discount received from a seller. (It is a matter of perspective: seller versus buyer.)

8.

A manager is concerned about the quantity of its purchase returns because the company incurs costs in receiving, inspecting, identifying, and returning the merchandise. More returns create more expenses. By knowing more about returns, the manager can decide if they are a problem and how they can be minimized.

9.

The sender (maker) of a debit memorandum records a debit in an account of the recipient; and the recipient records a credit in an account maintained for the sender.

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t o ru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

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10. The single-step income statement format presents cost of goods sold and expenses in one list, totals the list, and subtracts the total from net sales in one step. The multiple-step format presents intermediate totals, including gross profit (the difference between net sales and cost of goods sold) and sub-categories of expenses (often by key activities). 11. Polaris calls its inventory account “Inventories, net.” A detailed calculation of cost of sales is not presented by Polaris. 12. Arctic Cat titles its cost of goods sold account “Cost of goods sold.” Arctic Cat presents Costs of good sold separate for “Snowmobiles & ATV units” and “Parts, garments, & accessories”. 13. Piaggio titles its cost of goods sold account “Cost for materials.” 14. KTM reports a separate gross margin figure on its consolidated income statement. Its 2011 gross profit is $155,049 (in thousands Euros). 15. A buyer should attempt to negotiate the shipping terms FOB destination. In this case, title will pass after the goods are safely delivered to the buyer’s business and transportation charges will be the responsibility of the supplier (seller).

QUICK STUDIES Quick Study 5-1 (10 minutes) 1.

G.

6.

H.

2.

B.

7.

I.

3.

A.

8.

F.

4.

J.

9.

C.

5.

E.

10.

D.

Quick Study 5-2 (5 minutes) Answer: e

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

288

Fundamental Accounting Principles, 21st Edition

Quick Study 5-3 (15 minutes) Nov. 5 Merchandise Inventory ...................................... 6,000 Accounts Payable .....................................

6,000

To record credit purchase [(600 x $10].

Nov. 7 Accounts Payable .............................................. Merchandise Inventory .............................

250 250

Returned defective units [(25 x $10].

Nov. 15 Accounts Payable ............................................. 5,750 Cash ............................................................ Merchandise Inventory* ............................

5,635 115

Paid for purchase less cash discount *[(6,000 - $250) x 2%].

Quick Study 5-4 (10 minutes) Apr. 1 Accounts Receivable ..................................... 3,000 Sales .......................................................

3,000

To record credit sale.

1 Cost of Goods Sold ........................................ 1,800 Merchandise Inventory .........................

1,800

To record cost of credit sale.

4 Sales Returns and Allowances ..................... 600 Accounts Receivable ............................

600

To record sales return.

4 Merchandise Inventory .................................. 360 Cost of Goods Sold ...............................

360

Restore cost of returned goods to inventory.

11 Cash ................................................................. 2,352 Sales Discounts* ............................................ 48 Accounts Receivable.............................

2,400

Received payment less cash discount *[($3,000 - $600) x 2%].

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

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Quick Study 5-5 (10 minutes) (a) (b) Sales............................................$150,000 $550,000 Sales discounts.......................... (5,000) (17,500) Sales returns and allowances....... (20,000) (6,000) Net sales...................................... 125,000 526,500 Cost of goods sold..................... (79,750) (329,589) Gross profit.................................$ 45,250 $196,911 Gross margin ratio: (Gross profit / Net sales).......

36.2%

(c) (d) $38,700 $255,700 (600) (4,800) (5,100) (900) 33,000 250,000 (24,453) (126,500) $ 8,547 $123,500

37.4%

25.9%

49.4%

Interpretation of gross margin ratio for case a: The ratio of 36.2% implies that for each dollar in net sales the company earns 36.2 cents in gross profit. The company must still deduct other expenses that it incurs in running the business when computing net income.

Quick Study 5-6 (10 minutes) July 31 Cost of Goods Sold .................................... Merchandise Inventory ......................

1,900 1,900

To adjust for shrinkage based on physical count [$37,800 - $35,900].

Quick Study 5-7 (10 minutes) July 31 Sales .............................................................. 160,200 Income Summary..................................

160,200

To close temporary accounts with credit balances.

July 31 Income Summary .......................................... 165,900 Sales Discounts ................................... Sales Returns and Allowances ........... Cost of Goods Sold*............................. Depreciation Expense ......................... Salaries Expense ................................. Miscellaneous Expenses......................

4,700 6,500 106,900 10,300 32,500 5,000

To close temporary accounts with debit balances. (*$105,000 + $1,900 —from QS 5-6)

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

290

Fundamental Accounting Principles, 21st Edition

Quick Study 5-8 (10 minutes) Acid-test ratio = ($1,490 + $2,800) / ($5,750 + $850) = 0.65 Explanation of acid-test ratio: The acid-test ratio is used to evaluate (reflect on) the liquidity of a company. It helps in determining whether a company will be able to meet its current obligations as they come due with its most liquid assets. In this case, the company only has 65 cents available in quick assets to pay $1.00 in current liabilities as they come due. An acid-test ratio less than one usually suggests some concern and encourages further analysis of liquidity.

Quick Study 5-9 (10 minutes) Similarities: Both the acid-test ratio and current ratio are used to assess liquidity. Both ratios are computed with current liabilities as the denominator. Differences: The current ratio includes all current assets in the numerator. The acid-test ratio includes current assets less inventories and prepaids in its numerator (leaving cash & equivalents, current receivables, and short-term investments). Comparison and Description: Compared with the current ratio, the acid-test ratio is a more stringent test of a company’s ability to meet its current obligations. The acid-test ratio is more stringent as it does not assume a company relies on prepaids and inventory to pay current liabilities. This is because prepaids and inventory assets are not generally available to satisfy current obligations.

Quick Study 5-10 (10 minutes) Answer: e

Quick Study 5-11A (5 minutes) a. b. c. d. e.

Periodic inventory system Perpetual inventory system Perpetual inventory system Perpetual inventory system Perpetual inventory system

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

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Quick Study 5-12A (10 minutes) Nov. 5 Purchases............................................................ 6,000 Accounts Payable......................................

6,000

To record credit purchase [(600 x $10].

7 Accounts Payable............................................... Purchases Returns & Allowances............

250 250

Returned defective units [(25 x $10].

15 Accounts Payable............................................... 5,750 Cash............................................................. Purchases Discounts*...............................

5,635 115

Paid for purchase less cash discount * [(6,000 - $250) x 2%)].

Quick Study 5-13A (10 minutes) Apr. 1 Accounts Receivable ......................................... 3,000 Sales ...........................................................

3,000

To record credit sale.

4 Sales Returns and Allowances ......................... Accounts Receivable ................................

600 600

To record sales return.

11 Cash .................................................................... 2,352 Sales Discounts* ................................................ 48 Accounts Receivable.................................

2,400

Received payment less cash discount *($3,000 - $600) x 2%.

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

292

Fundamental Accounting Principles, 21st Edition

Quick Study 5-14 (20 minutes) 1. Multiple-step income statement adidas Group Income Statement (€ millions) For Year Ended December 31, 2011 Net sales...................................................................... Cost of sales................................................................ Gross profit.................................................................. Royalty and commission income ........................... Other operating income............................................. Other operating expenses.......................................... Operating profit........................................................... Financial income......................................................... Financial expenses..................................................... Income before taxes................................................... Income taxes............................................................... Net income...................................................................

€13,344 7,000 6,344 93 98 5,524 1,011 31 115 927 257 € 670

2. Single-step income statement adidas Group Income Statement (€ millions) For Year Ended December 31, 2011 Revenues Net sales...................................................................... Royalty and commission income ............................. Other operating income............................................. Financial income......................................................... Total revenues.............................................................

€13,344 93 98 31 13,566

Expenses Cost of sales................................................................ €7,000 Other operating expenses.......................................... 5,524 Financial expenses..................................................... 115 Income taxes............................................................... 257 Total expenses............................................................ Net income...................................................................

€

12,896 670

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

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Quick Study 5-15 (10 minutes) a.

Both U.S. GAAP and IFRS include broad and similar guidance for the accounting of merchandise purchases and sales. b. Under IFRS, reference to finance costs usually refers to interest expense. c. IFRS permits alternative measures of income to be reported as part of the income statement.

Quick Study 5-16 (10 minutes) a) Aug. 1 Merchandise Inventory....................................... 60,000 Accounts Payable...................................... 60,000 To record credit purchase.

b) Aug. 11 Accounts Payable............................................... 60,000 Cash*........................................................... 58,800 Merchandise Inventory.............................. 1,200 Paid for purchase less cash discount. * [(60,000 x (100% - 2%)].

Quick Study 5-17 (10 minutes) a) Sept. 15 Merchandise Inventory....................................... 35,000 Accounts Payable...................................... 35,000 To record credit purchase.

b) Sept. 28 Accounts Payable............................................... 35,000 Cash............................................................. 35,000 Paid for purchase and discount period missed.

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

294

Fundamental Accounting Principles, 21st Edition

Quick Study 5-18 (15 minutes) Computation of net income: Krug Service Co. Revenues................................................... Less: Expenses......................................... Net income.................................................

$14,000 8,500 $ 5,500

Kleiner Merchandising Co. Sales........................................................... Less: Cost of goods sold (see below*)... Gross profit............................................... Less: Operating expenses....................... Net income.................................................

$ 9,500 7,200 2,300 1,450 $ 850

*Computation of cost of goods sold: Beginning Inventory Plus: Purchases Goods available for sale Less: Ending inventory Cost of goods sold

_ $ 5,000 3,900 8,900 1,700 $ 7,200

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a t e d, f o r wa r d e d, d i s t r i b u t e d, o rp o s t e do nawe b s i t e , i nwh o l eo rp a r t .

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EXERCISES Exercise 5-1 (10 minutes) Operating cycle of a merchandiser with credit sales follows (chronological): 2

(a) inventory made available for sale

5

(b) cash collections from customers

3

(c) credit sales to customers

1

(d) purchases of merchandise

4

(e) accounts receivable accounted for

©2013 by McGraw-Hill Education. Thi si sp r o p r i e t a r yma t e r i a l s o l e l yf o ra u t h o r i z e di n s t r u c t oru s e . No t a u t h o r i z e df o rs a l eo rd i s t r i b u t i o ni n a n yma n n e r . T h i sd o c u me n t ma yn o t b ec o p i e d, s c a n n e d , d u p l i c a...