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MERCHANDISINGACTIVITIES
Chapter
6
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The operating cycle of a business is the time it takesthe business to start with cash, purchase inventory,
sell the inventory, and finally collect the cash from
customers.
The operating cycle of a business that sells inventory
on credit is typically longer than that of a business
that sells only on a cash basis. This additional time isdue to time between when the customer buys the
inventory and the time the customer pays off the
account receivable.
Operating Cycle of a MerchandisingCompany
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Operating Cycle of a MerchandisingCompany
2. Sale of merchandiseon account
Cash
InventoryAccounts
Receivable
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Comparing Merchandising Activities withManufacturing Activities
Merchandising
Company
Purchaseinventory inready-to-sell
condition.
Manufacturing
Company
Manufactureinventory and
have a longer andmore complex
operating cycle.
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Retailers and Wholesalers
Retailers sellmerchandise directly
to the public.
Wholesalers buymerchandise from
several differentmanufacturers and
then sell thismerchandise to
several retailers.
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The income statements of merchandising companieswill have an additional expense item called Cost of
Goods Sold. The Cost of Goods Sold account
represents the cost of the merchandise sold during the
period to help earn revenue.
Cost of Goods Sold is presented as a separate expense
item on the income statement. Net Sales minus Cost ofGoods Sold equals Gross Profit. Gross Profit is the
amount left, after subtracting the cost of the inventory
sold, to cover all other expenses and a profit .
Income Statement of a MerchandisingCompany
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Income Statement of a MerchandisingCompany
Computer Barn
Condensed Income Statement
For the Year Ended December 31, 2005
Revenue from sales 900,000$Less: Cost of goods sold 540,000
Gross profit 360,000$
Less: Expenses 270,000
Net income 90,000$
Cost ofgoods soldrepresents
the expenseof goodsthat are
sold tocustomers.
Gross profit is a useful means of measuring
the profitability of sales transactions.
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Accounting Systems Requirements forMerchandising Companies
General Ledger
Accounts Receivable
Date Debit Credit Balance2001
June 1 10,000 10,000
15 3,000 7,000
Although general ledger accounts provideuseful information, they do not provide
much of the detailed information needed inthe daily business operations.
Who
owes usmoney?
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Accounting Systems Requirements forMerchandising Companies
Subsidiary Ledger
Heather Jacobs
Date Debit Credit Balance
2001
June 1 7,000 7,00015 2,000 5,000
General LedgerAccounts Receivable
Date Debit Credit Balance
2001
June 1 10,000 10,000
15 3,000 7,000Subsidiary LedgerJake Sparks
Date Debit Credit Balance
2001
June 1 3,000 3,000
15 1,000 2,000
Control AccountSubsidiary Ledgers
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Two Approaches Used in Accounting forMerchandise Transactions
Perpetual
InventorySystem
Periodic
InventorySystem
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Two Approaches Used in Accounting forMerchandise Transactions
In the past, both systems were in widespread use.
Today, however, the growing use of computerized accounting systems has
made the perpetual approach very easy and cost-effective to implement.
Thus, the periodic approach is used primarily by very small businesses with
manual accounting systems.
Before we examine perpetual and periodic inventory systems, it is important
to realize that accounting for inventory is similar to accounting for the
prepaid expenses we discussed in chapter 4 (for example, office supplies,
unexpired insurance policies, prepaid rent, etc.).
As inventory is purchased, it is initially reported as an asset in the balance
sheet.
As it is sold to customers, this asset is converted to an expense, specifically,
the cost of goods sold.
Both perpetual and periodic inventory systems account for the flow of
inventory costs from the balance sheet to the income statement.
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Perpetual Inventory Systems
The inventory account is continuouslyupdated to reflect items on hand.
Lets look
at someentries!
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Perpetual Inventory Systems
On September 5, Worley Co. purchased 100laser lights for resale for $30 per unit from
Electronic City on account.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 5 Inventory 3,000
Accounts Payable (Electronic City) 3,000
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Perpetual Inventory Systems
On September 10, Worley Co. sold 10 laserlights for $50 per unit on account to ABC
Radios.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 10 Accounts Receivable (ABC Radios) 500Sales 500
10 Cost of Goods Sold 300
Inventory 300
10 $30 = $300
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Perpetual Inventory Systems
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 10 Accounts Receivable (ABC Radios) 500Sales 500
10 Cost of Goods Sold 300
Inventory 300Cost
Retail
On September 10, Worley Co. sold 10 laserlights for $50 per unit on account to ABC
Radios.
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Perpetual Inventory Systems
On September 15, Worley Co. paid ElectronicCity $3,000 for the September 5 purchase.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 15 Accounts Payable (Electronic City) 3,000
Cash 3,000
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Perpetual Inventory Systems
On September 22, Worley Co. received $500from ABC Radios as payment in full for their
purchase on September 10.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 22 Cash 500
Accounts Receivable (ABC Radios) 500
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Taking a Physical Inventory
In order to ensurethe accuracy oftheir perpetual
records, mostbusinesses take acomplete physical
count of themerchandise on
hand at least once
a year.
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Taking a Physical Inventory
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Dec. 31 Cost of Goods Sold 2,000
Inventory 2,000
Reasonable amounts of inventory shrinkage are viewed asa 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.
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Closing Entries in a Perpetual InventorySystem
Close Revenue accounts(including Sales) toIncome Summary.
Close Expense accounts(including Cost ofGoods Sold) to IncomeSummary.
Close Income Summaryaccount to RetainedEarnings.
Close Dividends to
Retained Earnings.
The closingentries are the
same!
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Next is theperiodic
inventorysystem!
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Periodic Inventory Systems
No effort is made to keep up-to-date records ofeither inventory or cost of goods sold.
Only on a periodic basis are these two
accounts updated.
Lets look
at someentries!
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Periodic Inventory Systems
On September 5, Worley Co. purchased 100laser lights for resale for $30 per unit from
Electronic City on account.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 5 Purchases 3,000
Accounts Payable (Electronic City) 3,000
Notice that no entry ismade to Inventory.
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Periodic Inventory Systems On September 10, Worley Co. sold 10 laser lights for $50 per unit on account
to ABC Radios. Under the periodic inventory system, a sale of inventory requiresonly one entry: a debit to Accounts Receivable and a credit to Sales for the retail
amount of the sale, which in this case is five hundred dollars.
The cost entry that we made under the perpetual inventory system is not required
because the periodic system does not attempt to keep the inventory and cost of goodsold accounts up to date.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 10 Accounts Receivable (ABC Radios) 500
Sales 500
Retail
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Periodic Inventory Systems
On September 15, Worley Co. paid Electronic City$3,000 for the September 5 purchase. This entry is
the same as under the perpetual inventory system.
Worley Company would debit Accounts Payable and
credit Cash for three thousand dollars.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 15 Accounts Payable (Electronic City) 3,000
Cash 3,000
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Periodic Inventory Systems
On September 22, Worley Co. received $500 from ABCRadios as payment in full for their purchase onSeptember 10. This entry is also the same as under theperpetual inventory system. Worley Company would debit
Cash and credit Accounts Receivable for five hundred dollars.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Sept. 22 Cash 500
Accounts Receivable (ABC Radios) 500
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6-27Computing Cost of Goods Sold.Because the periodic system does not maintain a cost of good sold
account, at the end of the period, cost of goods sold must be calculated.
The accounting records of PartySupply show the following:
Inventory, Jan. 1, 2005 $ 14,000
Purchases (during 2005) 130,000
At December 31, 2005, Party
Supply counted the merchandiseon hand at $12,000.
Calculate Party Supplys cost of goods sold
for 2005.
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Computing Cost of Goods Sold
Inventory (beginning of the year) 14,000$
Add: Purchases 130,000
Cost of goods available for sale 144,000Less: Inventory (end of year) 12,000
Cost of goods sold 132,000$
Cost of Goods Sold can becalculated as follows:
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Creating a Cost of Goods Sold Account
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Dec. 31 Cost of Goods Sold 144,000
Inventory (beginning of year) 14,000
Purchases 130,000
Now, Party Supply must create the Cost of Goods Soldaccount. This is accomplished by zeroing out the balances in therelated accounts that have a debit balance, namely the beginning
inventory balance and the Purchases account.
So, we credit the Purchases account for its balance and we credit
the Inventory account for its beginning balance. This part of the
entry creates a zero balance in each of these accounts. The related
debit is for the total to the Cost of Goods Sold account.
Now, we still have one more entry to make to finish this process.
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Creating a Cost of Goods Sold Account
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Dec. 31 Inventory (end of year) 12,000
Cost of Goods Sold 12,000
Now, Party Supply must record the endinginventory amount.The second entry records the physical count in the Inventory
account and adjusts the balance in the Cost of Goods Sold
account.
After this entry, the Inventory account balance reflects the
ending inventory amount and the Cost of Goods Soldbalance reflects the calculated cost of goods sold amount.
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Completing the Closing Process
Close Revenue accounts(including Sales) toIncome Summary.
Close Expense accounts(including Cost ofGoods Sold) to IncomeSummary.
Close Income Summaryaccount to RetainedEarnings.
Close Dividends to
Retained Earnings.
The closingentries are the
same!
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Selecting an Inventory System
Factors Suggesting aPerpetual Inventory System
Factors Suggesting aPeriodic Inventory System
Large company with
professional management.
Small company, run by
owner.
Management and employees
wanting information about
items in inventory and the
quantities of specificproducts that are selling.
Accounting records of
inventories and specific
product sales not needed in
daily operations; suchinformation developed
primarily for use in annual
income tax returns.
Items in inventory with a high
per-unit cost.
Inventory with many different
kinds of low-cost items.
Low volume of sales
transactions or a
computerized accounting
system.
High volume of sales
transactions and a manual
accounting system.
Merchandise stored at
multiple locations or in
warehouses separate from
sales sites.
Lack of full-time accounting
personnel.
All merchandise stored at the
sales site.
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Credit Terms and Cash Discounts
2/10, n/30
Read as: Two ten, net thirty
When manufacturers and wholesalers sell their products onaccount, the credit terms are stated in the invoice.Cash discounts are provided to customers as a incentive for them to
pay early. The credit period is the normal period of time the company
allows for customers to extend their account receivable, typically 30 or
60 days.
The discount period is a much shorter period of time, typically 10 or 15
days. If payment is received during the discount period, a discount may
be taken. If payment is made after the discount period expires, then the
full payment is due on or before the end of the credit period.
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Credit Terms and Cash Discounts
2/10, n/30Percentageof Discount
# of DaysDiscount IsAvailable
Otherwise,the Full
Amount IsDue
# of Dayswhen FullAmount Is
Due
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Many companies plan to take advantage of cashdiscounts offered so they go ahead and record their
purchases net of the discount. Since they typically
take the discount, this process simplifies future
entries. If a cash discount is not taken in the future,
then a purchase discounts lost account is used.
Lets see how these entries work.
Recording Purchases at Net Cost
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Recording Purchases at Net Cost
Purchases arerecorded at their
net amounts.
PurchaseDiscounts Lost
are recordedwhen paymentis made outside
the discount
period.
NetMethod
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Recording Purchases at Net Cost
On July 6, Play Clothes purchased $4,000 ofmerchandise on credit with terms of
2/10, n/30 from Kids Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Recording Purchases at Net Cost
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 6 Inventory 3,920
Accounts Payable (Kid's Clothes) 3,920
$4,000 98% = $3,920
On July 6, Play Clothes purchased $4,000 ofmerchandise on credit with terms of
2/10, n/30 from Kids Clothes.
Prepare the journal entry for Play Clothes.
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Recording Purchases at Net Cost
On July 15, Play Clothes pays the full amountdue to Kids Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Recording Purchases at Net Cost
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 15 Accounts Payable (Kid's Clothes) 3,920
Cash 3,920
On July 15, Play Clothes pays the full amountdue to Kids Clothes.
Prepare the journal entry for Play Clothes.
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Recording Purchases at Net Cost
Now, assume that Play Clothes waited until July20 to pay the amount due in full to Kids
Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Recording Purchases at Net Cost
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 20 Accounts Payable (Kid's Clothes) 3,920
Purchase Discounts Lost 80
Cash 4,000
Nonoperating Expense
Now, assume that Play Clothes waited until July20 to pay the amount due in full to Kids
Clothes.
Prepare the journal entry for Play Clothes.
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R di P h t G I i
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Recording Purchases at Gross InvoicePrice
Purchases arerecorded at theirgross amounts.
Purchasediscounts taken
are recordedwhen paymentis made insidethe discount
period.
GrossMethod
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R di P h t G I i
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Recording Purchases at Gross InvoicePrice
On July 6, Play Clothes purchased $4,000 ofmerchandise on credit with terms of
2/10, n/30 from Kids Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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R di P h t G I i
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Recording Purchases at Gross InvoicePrice
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 6 Inventory 4,000
Accounts Payable (Kid's Clothes) 4,000
On July 6, Play Clothes purchased $4,000 ofmerchandise on credit with terms of
2/10, n/30 from Kids Clothes.
Prepare the journal entry for Play Clothes.
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Recording Purchases at Gross InvoicePrice
On July 15, Play Clothes pays the full amountdue to Kids Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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R di P h t G I i
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Recording Purchases at Gross InvoicePrice
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 15 Accounts Payable (Kid's Clothes) 4,000
Cash 3,920
Purchase Discounts Taken 80
Reduces Cost ofGoods Sold
$4,000 98% = $3,920
On July 15, Play Clothes pays the full amountdue to Kids Clothes.
Prepare the journal entry for Play Clothes.
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Recording Purchases at Gross InvoicePrice
Now, assume that Play Clothes waited until July20 to pay the full amount due to Kids Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Recording Purchases at Gross Invoice
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Recording Purchases at Gross InvoicePrice
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 20 Accounts Payable (Kid's Clothes) 4,000
Cash 4,000
Now, assume that Play Clothes waited until July20 to pay the full amount due to Kids Clothes.
Prepare the journal entry for Play Clothes.
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Returns of Unsatisfactory Merchandise
On August 5, Play Clothes returned $500 ofunsatisfactory merchandise purchased from Kids
Clothes on credit terms of 2/10, n/30. Thepurchase was originally recorded at net cost.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Returns of Unsatisfactory Merchandise
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Aug. 5 Accounts Payable (Kid's Clothes) 490
Inventory 490
$500 98% = $490
On August 5, Play Clothes returned $500 ofunsatisfactory merchandise purchased from Kids
Clothes on credit terms of 2/10, n/30. Thepurchase was originally recorded at net cost.
Prepare the journal entry for Play Clothes.
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Transportation Costs on Purchases
Transportation costs related to theacquisition of assets are part of the
cost of the assetbeing acquired.
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Now, lets talk
about sales!
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Transactions Relating to Sales
Computer Barn
Partial Income Statement
For the Year Ended December 31, 2005
Revenue
Sales 912,000$
Less: Sales returns and allowances 8,000$
Sales discounts 4,000 12,000
Net sales 900,000$
Credit terms and merchandise returnsaffect the amount of revenue earned by
the seller.
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Sales
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Aug. 2 Accounts Receivable (Play Clothes) 2,000
Sales 2,000
On August 2, Kids Clothes sold $2,000 of merchandise toPlay 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.
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Sales
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Aug. 2 Cost of Goods Sold 1,000
Inventory 1,000
On August 2, Kids Clothes sold $2,000 of merchandise toPlay 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.
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Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactorymerchandise 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.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Aug. 5 Sales Returns and Allowances 500
Accounts Receivable (Play Clothes) 500
Contra-revenue
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On August 5, Play Clothes returned $500 of unsatisfactorymerchandise 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
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Aug. 5 Inventory 250
Cost of Goods Sold 250
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Sales
On July 6, Kids Clothes sold $4,000 of merchandise to PlayClothes 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.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 6 Accounts Receivable (Play Clothes) 4,000
Sales 4,000
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Sales
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 6 Cost of Goods Sold 2,000
Inventory 2,000
On July 6, Kids Clothes sold $4,000 of merchandise to PlayClothes 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.
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Sales Discounts
On July 15, Kids Clothes receives the fullamount due from Play Clothes from the July 6
sale.
Prepare the journal entry for Kids Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Sales Discounts
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 15 Cash 3,920
Sales Discounts 80
Accounts Receivable (Play Clothes) 4,000
$4,000 98% = $3,920Contra-revenue
On July 15, Kids Clothes receives the fullamount due from Play Clothes from the July 6
sale.
Prepare the journal entry for Kids Clothes.
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Sales Discounts
Now, assume that it wasnt until July 20 thatKids Clothes received the full amount due
from Play Clothes from the July 6 sale.
Prepare the journal entry for Kids Clothes.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
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Sales Discounts
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 20 Cash 4,000
Accounts Receivable (Play Clothes) 4,000
Now, assume that it wasnt until July 20 thatKids Clothes received the full amount due
from Play Clothes from the July 6 sale.
Prepare the journal entry for Kids Clothes.
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Delivery Expenses
Delivery costs incurred by sellers are debited to Delivery
Expense, an operating expense.When sellers incur transportation costs, or delivery expense, it is debited
to an operating expense account called Delivery Expense. This is
considered a cost of doing business and is treated as a regular operating
expense of the business.
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Accounting for Sales Taxes
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Cash 1,070
Sales Tax Payable 70
Sales 1,000
Businesses collect sales tax at the point of sale.
Then, they remit the tax to the appropriategovernmental agency at times specified by law.
$1,000 sale 7% tax = $70 sales tax
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Modifying an Accounting System
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Most businesses use special journals rather than a general
journal to record routine transactions that occur frequently.When companies use special journals, similar entries are recorded
together. Companies may have several special journals such as a Cash
Receipts Journal, Cash Payments Journal, Sales Journal, and several
others. When using special journals, the General Journal is used only
for a few entries that do not fit in a special journal.
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Financial Analysis
Net SalesGrossProfit
Margins
Trends over time
Comparable store sales Sales per square foot ofselling space
Gross profit Net sales
Overall gross profitmargin
Gross profit margins bydepartment and
products
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End of Chapter 6