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Chapter 5 The Operating Cycle and Merchandising Operations

Chapter 5 The Operating Cycle and Merchandising Operations . Financial Accounting, 11e. Learning Objectives . Identify the management issues related to merchandising businesses. Describe the terms of sale related to merchandising transactions.

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Chapter 5 The Operating Cycle and Merchandising Operations

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  1. Chapter 5 The Operating Cycle and Merchandising Operations Financial Accounting, 11e © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  2. Learning Objectives Identify the management issues related to merchandising businesses. Describe the terms of sale related to merchandising transactions. Prepare an income statement and record merchandising transactions under the perpetual inventory system. Prepare an income statement and record merchandising transactions under the periodic inventory system. Describe the components of internal control, control activities, and limitations on internal control. Apply internal control activities to common merchandising transactions. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  3. Managing Merchandising Businesses • Merchandising business:Earns income by buying and selling goods. • Merchandise inventory:Goods for sale. • Evaluation of Liquidity • Sufficient money on hand to pay bills when due and cash for unexpected needs. • Working capital: Measure of liquidity; the amount by which current assets exceed current liabilities. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  4. Current Ratiofor Best Buy • Current ratio:The ratio of current assets to current liabilities. • If Best Buy’s current assets are $10,566 and current liabilities are $8,978: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  5. Operating Cycle • Operating cycle: A series of transactions a business engages in for an amount of time. • Common transactions: • Purchase of merchandise inventory for cash or on credit • Payment for purchases made on credit • Sales of merchandise inventory for cash or on credit • Collection of cash from credit sales • Financing period: Period between the time the supplier must be paid and the end of the operating cycle. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  6. Cash Flows in the Operating Cycle © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  7. The Financing Period © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  8. Choice of Inventory System • Perpetual inventory system: Continuous records kept of the quantity and cost of individual items bought and sold. • Periodic inventory system: Unsold inventory is counted periodically. • Physical count is usually taken at the end of the accounting period. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  9. Foreign Business Transactions • If a domestic company bills a foreign company in a foreign currency and accepts payment in that foreign currency, it will incur an exchange gain or loss if the exchange rate between the domestic and foreign currencies changes between the date of sale and the date of payment. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  10. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  11. The Need for Internal Controls • Internal controls:Accounting systems and control procedures to protect a company’s assets. • Physical inventory: An actual count of all merchandise on hand. • Includes all goods intended for sale. • Includes goods in transit from suppliers if title to the goods has passed to the merchandiser. • Does not include merchandise that a company has sold but not yet delivered to customers. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  12. Management’s Responsibility for Internal Control • Safeguard the firm’s assets • Ensure the reliability of the accounting records • See that employees comply with all legal requirements and operate the firm to the best advantage of its owners © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  13. The management of SavRite Corporation made the following decisions. Indicate whether each decision pertains primarily to (a) cash flow management, (b) choice of inventory system, or (c) foreign transactions. 1. Decided to decrease the credit terms offered to customers from 30 days to 20 days to speed up collection of accounts. 2. Decided to purchase goods made by a supplier in India. 3. Decided to measure working capital monthly to ensure that there is an adequate reserve to maintain liquidity. 4. Decided that sales would increase if salespeople knew how much inventory was on hand at any one time. 5. Decided to try to negotiate a longer time to pay suppliers than had been previously granted. SOLUTION 1. a; 2. c; 3. a; 4. b; 5. a © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  14. Terms of Sale • Trade discount: Percentage (usually 30 percent or more) off list or catalogue prices. • Sales discount: Discounts a buyer takes when paying an invoice within a set number of days from the invoice date. • Purchases discount: Discounts a buyer takes for early pa.yment of merchandise © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  15. Transportation Costs • FOB shipping point: “Free on board” for the seller; the buyer bears the shipping costs. • Freight-in: When the buyer pays transportation charge. • FOB destination: The seller bears the transportation costs. • Delivery expense(or freight-out): When the seller pays the transportation charge. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  16. Terms of Debit and Credit Card Sales • Debit cards deduct directly from a person’s bank account. • Credit cards allow for payment later. • Seller does not have to establish the customer’s credit, collect from the customer, or tie up money in accounts receivable. • Lender does not pay the total amount of the credit card sales, but discounts 2 to 6 percent. The discount is a selling expense for the merchandiser. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  17. A local company sells refrigerators that it buys from the manufacturer. a. The manufacturer sets a list or catalogue price of $1,200 for a refrigerator. The manufacturer offers its dealers a 40 percent trade discount and terms of FOB destination. b. Assume the same terms as a, except the manufacturer sells the refrigerator under terms of FOB shipping point. The cost of shipping is $120. c. Assume the same terms as b, except the manufacturer offers a sales discount of 2/10, n/30. Sales discounts do not apply to shipping costs. What is the net cost of the refrigerator to the dealer in each case, assuming payment is made within 10 days of purchase? SOLUTION a. $1,200 – ($1,200 × 0.40) = $720 b. $720 + $120= $840 c. $840 – ($720 × 0.02) = $825.60 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  18. Perpetual Inventory System • Under the perpetual inventory system, the Merchandise Inventory and Cost of Goods Sold accounts are continually updated during the accounting period as purchases, sales, and other inventory transactions that affect these accounts occur. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  19. Income Statement Under the Perpetual Inventory System © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  20. EXAMPLE: Purchases on Credit (slide 1 of 2) • Aug. 3: Received merchandise purchased on credit, invoice dated August 1, terms n/10, $4,890. • Analysis:Under the perpetual inventory system, the cost of merchandise is recorded in the Merchandise Inventory account at the time of purchase, which ▲increases the Merchandise Inventory account and ▲increases the Accounts Payable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  21. EXAMPLE: Purchases on Credit (slide 2 of 2) Comment: In the transaction described here, payment is due 10 days from the invoice date. If an invoice includes a charge for shipping or if shipping is billed separately, it should be debited to Freight-In. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  22. EXAMPLE: Purchases Returns and Allowances • Aug. 6: Returned part of merchandise received on August 3 for credit, $480. • Analysis:Under the perpetual inventory system, purchases returns and allowances ▼decrease the Accounts Payable account and ▼decrease the Merchandise Inventory account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  23. EXAMPLE: Payments on Account • Aug. 10: Paid amount due in full for the purchase of August 3, part of which was returned on August 6, $4,410. • Analysis:Payment is made for the net amount due of $4,410 ($4,890 – $480), which ▼decreases the Accounts Payable account and ▼ decreases the Cash account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  24. Recording Purchase Transactions Under the Perpetual Inventory System © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  25. EXAMPLE: Sales on Credit (slide 1 of 2) • Aug. 7: Sold merchandise on credit, terms n/30, FOB destination, $1,200; the cost of the merchandise was $720. • Analysis: Under the perpetual inventory system, sales always require two entries. • First, the sale is recorded, which ▲increases the Accounts Receivable account and ▲increases the Sales account. • Second, Cost of Goods Sold is updated by a transfer from Merchandise Inventory, which ▲increases the Cost of Goods Sold account and ▼decreases the Merchandise Inventory account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  26. EXAMPLE: Sales on Credit (slide 2 of 2) • Comment:In the case of cash sales, Cash rather than Accounts Receivable is debited for the amount of the sale. If the seller pays for the shipping, the shipping cost should be debited to Delivery Expense. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  27. Sales Returns and Allowances • The Sales Returns and Allowances account gives management a readily available measure of unsatisfactory products and dissatisfied customers. • This account is a contra-revenue account with a normal debit balance, and it is deducted from sales on the income statement. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  28. EXAMPLE: Sales Returns and Allowances (slide 1 of 3) • Aug. 9: Accepted return of part of merchandise sold on August 7 for full credit and returned it to merchandise inventory, $300; the cost of the merchandise was $180. • Analysis: Under the perpetual inventory system, when a seller allows the buyer to return all or part of a sale or gives an allowance—a reduction in amount—two entries are necessary. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  29. EXAMPLE: Sales Returns and Allowances (slide 2 of 3) • First, the original sale is reversed, which ▲increases the Sales Returns and Allowances account and ▼decreases the Accounts Receivable account. • Second, the cost of the merchandise must also be transferred from the Cost of Goods Sold account back into the Merchandise Inventory account, which ▲increases the Merchandise Inventory account and ▼decreases the Cost of Goods Sold account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  30. EXAMPLE: Sales Returns and Allowances (slide 3 of 3) • Comment:If the company makes an allowance instead of accepting a return or if the merchandise cannot be returned to inventory and resold, this transfer is not made. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  31. EXAMPLE: Receipts on Account • Sept. 5: Collected in full for sale of merchandise on August 7, less the return on August 9, $900. • Analysis: Collection is made for the net amount due of $900 ($1,200 – $300), which ▲increases the Cash account and ▼decreases the Accounts Receivable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  32. Recording Sales Transactions Under the Perpetual Inventory System © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  33. The numbered items below are account titles, and the lettered items that follow are types of merchandising transactions. For each transaction, indicate which accounts are debited or credited by placing the account numbers in the appropriate columns, assuming use of a perpetual inventory system. 1. Cash 2. Accounts Receivable 3. Merchandise Inventory 4. Accounts Payable 5. Sales 6. Sales Returns and Allowances 7. Cost of Goods Sold Account Account Debited Credited a. Purchase on credit ________ _________ b. Purchase return for credit ________ _________ c. Purchase for cash ________ _________ d. Sale on credit ________ _________ e. Sale for cash ________ _________ f. Sales return for credit ________ _________ g. Payment on account ________ _________ h. Receipt on account ________ _________ © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  34. SOLUTION Account Account Debited Credited a. Purchase on credit 3 4 b. Purchase return for credit 4 3 c. Purchase for cash 3 1 d. Sale on credit 2, 7 5, 3 e. Sale for cash 1, 7 5, 3 f. Sales return for credit 6, 3 2, 7 g. Payment on account 4 1 h. Receipt on account 1 2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  35. Periodic Inventory System • Under the periodic inventory system, Cost of Goods Sold is computed on the income statement because it is not updated for purchases, sales, and other transactions as it is under the perpetual inventory system. • Cost of goods available for sale: Total cost of merchandise that could be sold in the accounting period. • The difference between the cost of goods sold and cost of goods available for sale is the amount not sold, or ending merchandise inventory. • Net purchases: Total purchases plus any freight-in less any deductions such as purchases returns and allowances and discounts from suppliers for early payment. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  36. Income Statement Under the Periodic Inventory System © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  37. The Components of Cost of Goods Sold © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  38. EXAMPLE: Purchases on Credit (slide 1 of 2) • Aug. 3: Received merchandise purchased on credit, invoice dated August 1, terms n/10, $4,890. • Analysis: Under the periodic inventory system, the cost of merchandise is recorded in the Purchases account at the time of purchase. This account is a temporary one used only with the periodic inventory system. The Purchases account does not indicate whether merchandise has been sold or is still on hand. Purchases made by a company ▲increase the Purchases account and ▲increase the Accounts Payable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  39. EXAMPLE: Purchases on Credit (slide 2 of 2) • Comment:Its sole purpose is to accumulate the total cost of merchandise purchased for resale during an accounting period. (Purchases of other assets, such as equipment, are recorded in the appropriate asset account, not in the Purchases account.) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  40. EXAMPLE: Purchases Returns and Allowances (slide 1 of 2) • Aug. 6: Returned part of merchandise received on August 3 for credit, $480. • Analysis: This is a contra-purchases account with a normal credit balance, and it is deducted from purchases on the income statement to arrive at net purchases, which ▼decreases the Accounts Payable account and ▲increases the Purchases Returns and Allowances account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  41. EXAMPLE: Purchases Returns and Allowances (slide 2 of 2) • Comment:Under the periodic inventory system, the amount of a return or an allowance is recorded in the Purchases Returns and Allowances account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  42. EXAMPLE: Freight-in (slide 1 of 2) • Aug. 7: Received a bill for freight costs of the purchases on Aug. 3, $230. • Analysis: Freight costs on purchases ▲increase the Freight-in account ▲increase the Accounts Payable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  43. EXAMPLE: Freight-in (slide 2 of 2) • Comment:Freight-in is added on the income statement to net purchases to arrive at net cost of purchases under the periodic method. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  44. EXAMPLE:Payments on Account • Aug. 10: Paid amount in full due for the purchase of August 3, part of which was returned on August 6, $4,410. • Analysis: Payment is made for the net amount due of $4,410 ($4,890 - $480), which ▼decreases the Accounts Payable account and ▼decreases the Cash account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  45. Recording Purchase Transactions Under the Periodic Inventory System © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  46. EXAMPLE: Sales on Credit (slide 1 of 2) • Aug. 7: Sold merchandise on credit, terms n/30, FOB destination, $1,200; the cost of the merchandise was $720. • Analysis:Under the periodic inventory system, sales require only one entry, which ▲increases the Accounts Receivable account and ▲increases the Sales account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  47. EXAMPLE: Sales on Credit (slide 2 of 2) • Comment: In the case of cash sales, Cash rather than Accounts Receivable is debited for the amount of the sale. If the seller pays for the shipping, the amount should be debited to Delivery Expense. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  48. EXAMPLE: Sales Returns and Allowances(slide 1 of 2) • Aug. 9: Accepted return of part of merchandise sold on August 7 for full credit and returned it to merchandise inventory, $300; the cost of the merchandise was $180. • Analysis: Under the periodic inventory system, when a seller allows the buyer to return all or part of a sale or gives an allowance, only one entry is needed, which ▲increases the Sales Returns and Allowances account and ▼decreases the Accounts Receivable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  49. EXAMPLE: Sales Returns and Allowances(slide 2 of 2) • Comment:The Sales Returns and Allowances account is a contra-revenue account with a normal debit balance and is deducted from sales on the income statement. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

  50. EXAMPLE: Receipts on Account (slide 1 of 2) • Sept. 5: Collected in full for sale of merchandise on August 7, less the return on August 9, $900. • Analysis: Collection is made for the net amount due of $900 ($1,200 – $300), which ▲increases the Cash account and ▼decreases the Accounts Receivable account. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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