Chapter 1

ACCOUNTING FOR MERCHANDISING ACTIVITIESChapter5

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2Operating Cycle of a Merchandising Company1. Purchase of merchandise3. Collection of the receivables2. Sale of merchandise on accountCashInventoryAccounts Receivable The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Comparing Merchandising Activities with Manufacturing ActivitiesMerchandising CompanyPurchase inventory in ready-to-sell condition.

Manufacturing CompanyManufacture inventory and have a longer and more complex operating cycle The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinRetailers and Wholesalers

Retailers sell merchandise directly to the public.

Wholesalers buy merchandise from several different manufacturers and then sell this merchandise to several retailers. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Income Statement of a Merchandising Company

Cost of goods sold represents the expense of goods that are sold to customers.Gross profit is a useful means of measuring the profitability of sales transactions. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4General Ledger Accounts

Although general ledger accounts provide useful information, they do not provide much of the detailed information needed in the daily business operations.Who owes us money? The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Subsidiary Ledgers: A Source of Needed Details

Controlling Account The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Two Approaches Used in Accounting for Merchandise TransactionsPerpetual Inventory SystemPeriodic Inventory System The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Perpetual Inventory SystemThe inventory account is continuously updated to reflect items on hand.

Lets look at some entries! The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Perpetual Inventory SystemOn September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account .

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPerpetual Inventory SystemOn September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

10 $30 = $300 The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPerpetual Inventory System

CostRetailOn September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPerpetual Inventory SystemOn September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPerpetual Inventory SystemOn September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinThe Inventory Subsidiary LedgerAt the end of the period, management compares the physical inventory count with the inventory ledger to determine inventory shrinkage.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Taking a Physical Inventory

In order to ensure the accuracy of their perpetual records, most businesses take a complete physical count of the merchandise on hand at least once a year. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Taking a Physical Inventory

Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage and theft.On December 31, Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Closing Entries in a Perpetual Inventory SystemClose Revenue accounts (including Sales) to Income Summary.Close Expense accounts (including Cost of Goods Sold) to Income Summary.Close Income Summary account to Retained Earnings.Close Dividends to Retained Earnings.The closing entries are the same!

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4

Next is the periodic inventory system! The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Periodic Inventory SystemNo effort is made to keep up-to-date records of either inventory or cost of goods sold.Lets look at some entries!

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Periodic Inventory SystemOn September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account .

Notice that no entry is made to Inventory. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPeriodic Inventory SystemOn September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

Retail The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPeriodic Inventory SystemOn September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinPeriodic Inventory SystemOn September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinComputing Cost of Goods Sold in a Periodic Inventory System

The accounting records of Party Supply show the following:Inventory, Jan. 1, 2013 $ 14,000Purchases (during 2013) 130,000At December 31, 2013, Party Supply counted the merchandise on hand at $12,000.Calculate Party Supplys cost of goods sold for 2013. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Computing Cost of Goods Sold in a Periodic Inventory System

Cost of Goods Sold can be calculated as follows: The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Creating Cost of Goods Sold in a Periodic Inventory System

Now, Party Supply must create the Cost of Goods Sold account.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Creating Cost of Goods Sold in a Periodic Inventory System

Now, Party Supply must record the ending inventory amount.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Completing the Closing ProcessClose Revenue accounts (including Sales) to Income Summary.Close Expense accounts (including Cost of Goods Sold) to Income Summary.Close Income Summary account to Retained Earnings.Close Dividends to Retained Earnings.The closing entries are the same!

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Comparison of Perpetual and Periodic Inventory Systems

Periodic Inventory SystemJos Dress Shop

Perpetual Inventory SystemLarge Department Stores The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Modifying an Accounting System

Most businesses use special journals rather than a general journal to record routine transactions that occur frequently.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Credit Terms and Cash Discounts2/10, n/30Read as: Two ten, net thirty When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Credit Terms and Cash Discounts2/10, n/30Percentage of Discount# of Days Discount Is AvailableOtherwise, the Full Amount Is Due # of Days when Full Amount Is Due The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2222Credit Terms and Cash DiscountsPurchases are recorded at their net amounts.Purchase discounts lost are recorded when payment is made outside the discount period.Net Method The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2323Credit Terms and Cash DiscountsOn July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Credit Terms and Cash Discounts

$4,000 98% = $3,920On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Credit Terms and Cash DiscountsOn July 15, Play Clothes pays the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Credit Terms and Cash Discounts

On July 15, Play Clothes pays the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Credit Terms and Cash DiscountsNow, assume that Play Clothes waited until July 20 to pay the amount due in full to Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Credit Terms and Cash Discounts

Nonoperating ExpenseNow, assume that Play Clothes waited until July 20 to pay the amount due in full to Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice PricePurchases are recorded at their gross amounts.Purchase discounts taken are recorded when payment is made inside the discount period.Gross Method The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2323Recording Purchases at Gross Invoice PriceOn July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice Price

On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice PriceOn July 15, Play Clothes pays the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice Price

Reduces Cost of Goods Sold$4,000 98% = $3,920On July 15, Play Clothes pays the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice PriceNow, assume that Play Clothes waited until July 20 to pay the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Recording Purchases at Gross Invoice Price

Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kids Clothes. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Returns of Unsatisfactory MerchandiseOn August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kids Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost. Prepare the journal entry for Play Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Returns of Unsatisfactory Merchandise

$500 98% = $490On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kids Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost. Prepare the journal entry for Play Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Transportation Costs on Purchases

Transportation costs related to the acquisition of assets are part of the cost of the asset being acquired. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424

Now, lets talk about sales! The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Transactions Relating to Sales

Credit terms and merchandise returns affect the amount of revenue earned by the seller. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Returns and Allowances

On August 2, Kids Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kids Clothes originally paid $1,000 for the merchandise.Because Kids Clothes uses a perpetual inventory system, they must make two entries. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Returns and Allowances

On August 2, Kids Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kids Clothes originally paid $1,000 for the merchandise.Because Kids Clothes uses a perpetual inventory system, they must make two entries. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Returns and AllowancesOn August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kids Clothes from the August 2 sale. Kids Clothes cost for this merchandise was $250.Because Kids Clothes uses a perpetual inventory system, they must make two entries.

Contra-revenue The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kids Clothes from the August 2 sale. Kids Clothes cost for this merchandise was $250.Because Kids Clothes uses a perpetual inventory system, they must make two entries.Sales Returns and Allowances

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales DiscountsOn July 6, Kids Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kids Clothes $2,000.Because Kids Clothes uses a perpetual inventory system, they must make two entries.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Discounts

On July 6, Kids Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kids Clothes $2,000.Because Kids Clothes uses a perpetual inventory system, they must make two entries. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales DiscountsOn July 15, Kids Clothes receives the full amount due from Play Clothes. Prepare the journal entry for Kids Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Discounts

$4,000 98% = $3,920Contra-revenueOn July 15, Kids Clothes receives the full amount due from Play Clothes. Prepare the journal entry for Kids Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales DiscountsNow, assume that it wasnt until July 20 that Kids Clothes received the full amount due from Play Clothes. Prepare the journal entry for Kids Clothes.

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Sales Discounts

Now, assume that it wasnt until July 20 that Kids Clothes received the full amount due from Play Clothes. Prepare the journal entry for Kids Clothes. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Delivery Expenses

Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense. The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Accounting for Sales Taxes

Businesses collect sales tax at the point of sale.Then, they remit the tax to the appropriate governmental agency at times specified by law.$1,000 sale 7% tax = $70 sales tax The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin2424Evaluating the Performance of a Merchandising CompanyNet SalesGross Profit Margins Trends overtime Comparable store sales Sales per square foot of selling space Gross Profit Net SalesOverall Gross Profit MarginGross Profit Margins by Department and Products The McGraw-Hill Companies, Inc., 2002McGraw-Hill/IrwinEnd of Chapter 6

The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin4Sheet1Computer BarnCondensed Income StatementFor the Year Ended December 31, 2002Revenue from sales$900,000Less: Cost of goods sold540,000Gross profit$360,000Less: Expenses270,000Net income$90,000

&APage &P

Sheet: Sheet1General LedgerAccounts ReceivableDateDebitCreditBalance2001June10000.015.03000.07000.0Sheet1Subsidiary LedgerJacobsDateDebitCreditBalance2001June17,0007,000152,0005,000

&APage &P

Sheet: Sheet1General LedgerAccounts ReceivableDateDebitCreditBalance2001June10000.015.03000.07000.0Sheet1Subsidiary LedgerSparksDateDebitCreditBalance2001June13,0003,000151,0002,000

&APage &P

Sheet: Sheet1Controlling Account in the General LedgerUnit of Organization Within the Subsidiary LedgerInventoryEach type of product offered for salePlant assetsEach asset (or group of similar assets)Accounts payableEach creditorCapital stockEach stockholderSalesEach department, branch location, or product lineCost of goods soldSame organization as the sales ledgerMany expense accountsEach department incurring these types of expensesPayroll expensesEach employeeSheet1Item LL002Primary supplier Electronic CityDescription Laser LightSecondary supplier Electric CompanyLocation Storeroom 2Inventory level: Min: 25 Max: 200PurchasedSoldBalanceDateUnitsUnit CostTotalUnitsUnit CostCost of Goods SoldUnitsUnit CostTotalSept. 5100$30$3,000100$30$3,000Sept. 1010$30$30090302,700

&APage &P

Sheet: Sheet1Inventory (beginning of the year)14000.0Add: Purchases130000.0Cost of goods available for sale144000.0Less: Inventory (end of year)12000.0Cost of goods sold132000.0Sheet1Computer BarnPartial Income StatementFor the Year Ended December 31, 2002RevenueSales$912,000Less: Sales returns and allowances$8,000Sales discounts4,00012,000Net sales$900,000

&APage &P

Sheet: ]Sheet1GENERAL JOURNALDateAccount Titles and ExplanationPRDebitCreditAug.2.0Cost of Goods Sold1000.0Inventory1000.0Sheet: ]Sheet1GENERAL JOURNALDateAccount Titles and ExplanationPRDebitCredit