Merchandising Activities: Inventory Systems, Purchases, Sales, and Discounts

1. Chapter 6

2. Merchandising Activities • A merchandising company is an enterprise that buys and sells goods to earn a profit. 1. Wholesalers sell to retailers. 2. Retailers sell to consumers. • A merchandiser’s primary source of revenue is sales, whereas a service company’s primary source of revenue is service revenue.

3. Less Equals Cost of Goods Sold Gross Profit Less Equals Net Income (Loss) Operating Expenses Financial Performance of a Merchandising Company Sales Revenue

4. Merchandising Cash Flow Ending Inventory (Balance Sheet) Beginning Inventory Cost of Goods Available for Sale Not Sold Sold Goods Purchased during period Cost of Goods Sold (Income Statement)

5. Inventory Systems Merchandising entities may use either (or both) of the following inventory systems: 1. Perpetual – where detailed records of each inventory purchase and sale are maintained. Cost of goods sold is calculated at the time of each sale. 2. Periodic – detailed records are not maintained. Cost of goods sold is calculated only at the end of the accounting period.

6. Recording Purchases For purchases on account, Merchandise Inventory is debited and Accounts Payable is credited. For cash purchases, Merchandise Inventory is debited and Cash is credited.

7. Accounting for Merchandise Purchases • To determine the inventory value, we must adjust the invoice cost for: • Discounts given to a purchaser by a supplier. • Any returns and allowances for unsatisfactory items received from a supplier. • Any required freight costs paid by a purchaser.

8. Trade Discounts vs. Purchase/Sales Discounts • Trade Discounts: Used by manufacturers and wholesalers to change selling prices without republishing their catalogues. • Already deducted from the purchase price before the transaction is recorded • Sales and Purchase Discounts: A deduction from the invoice price granted to induce early payment of the amount due. Example – 2/10, n30 • Deducted after the initial journal entry that recorded the purchase

9. Purchase Discounts 2/10,n/30 Discount Percent Number of Days Discount is Available Otherwise, Net (or All) is Due Within CreditPeriod

10. Example • Purchased $900 of merchandise on credit on March 1st. Discount terms 2/10 n/30 • Company paid the bill on March 10th.

11. Purchase Returns and Allowances • Purchase returns are merchandise received by a purchaser but returned to the supplier. • A purchase allowance is a reduction in the cost of defective merchandise received by a purchaser from a supplier. • A debit memorandum is a form issued by the purchaser to inform the supplier of a debit made to the supplier's account, including the reason for a return or allowance. Memorandum gets its name from the issuer. • Entry (On the books of the purchaser) Debit Accounts Payable or Cash (if refund given) and Credit Inventory

12. Transportation Costs • FOB shipping point—buyer pays shipping costs. • Title transfers at shipping point • Increases cost of merchandise • Debit Inventory, Credit Cash or Accounts Payable (if to be paid for with merchandise later) • FOB destination—seller pays shipping costs. • Title transfers at destination. • Operating expense for seller • Debit Delivery Expense (if you are the seller), Credit Cash.

13. Accounting for Merchandise Sales • Sales transactions—Recording has two parts: • Recognize revenue—Debit Accounts Receivable (or cash), Credit Sales (both for the invoice amount) • Recognize cost—Debit Cost of Goods Sold, Credit Inventory (both for the cost of the inventory sold)

14. Example • A company sold $500 worth of merchandise for $800 on credit on March 1st. Credit terms 3/10 n/EOM.

15. Sales Discounts • Discounts awarded to customers for payment within the discount period. Recorded upon collection for sale. • Sales Discount is a contra-revenue account—subtraction from Sales. • Collection after discount period—Debit Cash, Credit Accounts Receivable (full invoice amount). • Collection within discount period—Debit Cash (invoice amount less discount), Debit Sales Discount (discount amount), Credit Accounts Receivable (invoice amount).

16. Example • Customer paid for March 1st purchase on March 8th.

17. Sales Returns and Allowances • Sales returns—merchandise customers return to the seller after a sale. • Sales allowances—reductions in the selling price of merchandise sold to customers (usually for damaged merchandise that a customer is willing to keep at a reduced price). • Sales Returns and Allowances is a contra-revenue account—subtraction from Sales

18. Sales Returns and Allowances • Entry: Debit Sales Returns and Allowances and a Credit Accounts Receivable.Additional entry if returned merchandise is saleable:Debit Inventory, Credit Cost of Goods Sold • Sales Returns and Allowances is a contra-revenue account—subtraction from Sales.

19. Example • March 15: Customer purchased 100 items for $12 per item. Each item has a cost of $5. • March 18: Customer returned 5 items that were damaged. Items were destroyed. • March 20: Customer returned 3 items that were the wrong colour. Items were returned to inventory.

20. Example Continued

21. Shrinkage • An adjusting entry is required to account for any inventory loss. • Shrinkage is determined by comparing a physical count of the inventory with recorded quantities. • Entry: Debit Cost of Goods Sold, Credit Inventory

22. Gross Margin Ratio • Shows the relation between sales and cost of goods sold by showing the percentage of net sales available after deducting COGS. • The higher the value, the better. Gross Margin (Profit) Net Sales Gross Margin =