Chapter 5

1. Chapter 5 Merchandising Operations

2. Merchandising Operations • Previously we have only been looking at service companies • Like lawn care or Painting for example • This chapter we shift focus to those who sell goods • Like Canadian Tire or Mountain Equipment Co-op for example

3. Revenue & Expenses • Revenue for a merchandising company is called Sales Revenue • Expenses are split into 2 categories • Operating expenses (same as service company) • Cost of Goods Sold or COGS • COGS is the total cost of the merchandise sold during the period

4. Gross Profit • Gross Profit is the difference between the sales revenue and the COGS Gross Profit Sales Revenue COGS Example: Bought bike for $125, sold for $300 175 300 125

5. Net Income Equations Expanded Revenue Cost of Goods Sold Gross Profit Operating Expenses Net Income / Loss

6. Inventory Systems We Will Use This One!!!!! • Perpetual Inventory • Always have an up to date inventory • Update COGS with every transaction • Growing in popularity, especially for bigger companies as it is automated and gives real time information • Periodic Inventory • Calculate inventory at the end of the period • Update COGS at the end of the period • Still used, usually in smaller companies that don’t want to spend the money on an automated system

7. How We Record Buying Inventory • Every purchase should have a business document to support it, used by buyer and seller • Receipt, Invoice, Purchase Order, etc • When merchandise is purchased for resale the asset that is debited is called Merchandise Inventory • If other assets are purchased, but not for resale they go into their own corresponding asset account, like supplies or equipment for example Example Bought 5 TVs on account at $500 each for the purpose or resale Merchandise Inventory $2 500 Accounts Payable $2 500

8. Buying InventorySubsidiary Inventory Records • Merchandise Inventory is a catch all account that contains all of the goods that a company has available for sale • However when a company offers more than 1 good for sale (and they usually do) it is nice to know how many of each item you have available for sale • To keep this information organizations keep a subsidiary inventory ledger, that has separate accounts for each item or sku (stock keeping unit) to keep track of how much is available • You can have subsidiary ledgers for any group of accounts that share a common characteristic, like inventory, or accounts receivable

9. Buying InventoryFreights Costs • Eddie’s Canoes manufactures a high quality all wood canoe and is located in Newstadt, Ontario. Eddie’s has sold 20 canoes to Grand River Outfitters, located in Kitchener Ontario. The travel time between the two businesses is approximately 1.5 hours. • The shipping costs to hire a truck to deliver the goods is $800 • The insurance cost to insure the load while in transit against damage is $100 • Who should pay for these fees?

10. Buying InventoryFreights Costs Cont. • Go back to the business document, that is where the terms of the sale will be listed • If the purchase order had said FOB destination, which means that the seller is responsible for the delivery of the goods • However, the purchase states FOB shipping point, so the buyer is responsible for the delivery • When buying goods for resale and you incur freight fees your journal entry will look like this, because the freight is part of the inventory we are getting ready to sell Merchandise Inventory $900 Cash $900

11. Buying InventoryPurchase Returns and Allowances • Buyers may want to return goods if the goods are not what they wanted, goods are damaged or defective, etc • Seller can either accept the good back and give a refund or offer an allowance for the buyer to keep the good (like 25% off for example)

12. Buying InventoryPurchase Returns and Allowances Cont. • One of the canoes Grand River bought from Eddie cost $1 200, and was supposed to be blue, but instead it was red • Grand River complained and Eddie said that he would either issue a full refund or Grand River could keep the canoe for 15% off Return Accounts Payable $1 200 Merchandise Inventory $1 200 OR Allowance Accounts Payable $ 180 Merchandise Inventory $180

13. Buying InventoryDiscounts • 2 types of discounts can be offered • Quantity • Purchase Quantity discount is when there is a price or percentage reduction when a large amount is purchased, when buying this way you reduce the cost of your inventory and therefore your COGS Purchase discount is incentive some companies offer to get their money sooner, these terms are on the business document and look like this 2/10, n/30 which means 2% off is paid in 10 days and the total is due in 30 days, taking advantage of this discount reduces the inventory cost and therefore COGS

14. Buying InventoryDiscounts Cont. • Eddie’s usually sells their canoes for $1500, but for orders over 10 they sell them for $1200. • Grand River’s journal entry looks like this: Merchandise Inventory $24 000 Accounts Payable $24 000 • Eddie’s policy is 4/7, n/30, and Grand River’s pays the full bill on the 6th day, and the journal entry looks like this: Accounts Payable $24 000 Merchandise Inventory $960 Cash $23 040

15. Summary of all that has happened while buying inventory • Initial purchase of product $24 000 • Freight Costs of $900 • Purchase allowance of $180 • Purchase discount of $960 Merchandise Inventory 24 000 180 900 960 23 760 Total

16. Practice Questions • Pages 258-259 • BE5-1, BE5-2, BE5-3, BE5-4, BE5-5 • Page 260 EP5-2

17. Selling Inventory • Revenue is recorded when it is earned, sales revenue is no different • Each sale should be supported by a business document • Because we are working in a perpetual inventory system we need to make 2 entries for every sale • Record the sales revenue Dr Cash/AR and Cr Sales Revenue • Record cost of the merchandise sold Dr COGS and Cr Merchandise Inventory

18. Selling Inventory Cont. • Merchandise Inventory currently 20 canoes 24 000 + 900 (freight) – 960 (purchase discount) =23 940 / 20 =1197 =19 at 1197 =1 at 1197 – 180 (purchase allowance on blue canoe) = 1017 • Sold a red canoe for $1 800 cash Cash 1 800 Revenue 1 800 Sold Canoe for Cash COGS 1 197 Merchandise Inventory 1 197 To record cost of goods sold to cash customer, invoice #25

19. Selling InventoryFreight Costs • As mentioned earlier in the Buying Inventory Section the party responsible for the cost of freight is negotiated and noted on the business document • FOB shipping point means buyer pays to pick goods up • FOB destination means seller pays to deliver goods • When seller pays for freight they will increase the price to compensate and set up a Freight out or delivery expense account to record fees incurred this way Grand River Outfitters sells a canoe FOB customer’s house Delivery Expense $100 Accounts Payable $100 Shipped a canoe to customer’s house, invoice #29

20. Selling InventorySales Returns and Allowances • Buyers sometimes want to return goods because of a variety of reasons • When sales are returned or allowances given the revenue needs to be decreased • Want to keep track of this amount in a separate account • Use a contra revenue account called Sales Returns and Allowances • Must reverse the second journal entry to decrease COGS and increase Merchandise Inventory if the good is still able to be sold

21. Selling InventorySales Returns and Allowances Cont. • Sold a canoe, for 1800 • It was returned because the customer did not like the model and wanted to upgrade at a later date, it had not been used and is still fine quality for sale Sales Returns and Allowances $1 800 Cash $1 800 To record canoe returned, put back into inventory, invoice #17 Merchandise Inventory $1 197 Cost of Goods Sold $1 197 To record the cost of goods returned

22. Selling InventorySales Returns and Allowances Cont. • Sold a canoe for $2 200 cash, FOB customer’s house • Did not buy insurance for shipping and the canoe fell off the truck and was crushed by a transport truck, customer canceled order Sales Return and Allowances $2 200 Cash $2 200 To record canoe returned, invoice #21 Loss Expense $1 197 COGS $1197 To record canoe damaged, invoice #21

23. Selling InventoryDiscounts • As mentioned earlier we have quantity discount and sales discount (when from seller’s perspective) • No entry is needed for quantity discount, the sales revenue would just be reported as less on the initial journal entry • Sales discount account is a contra revenue account • Sold canoe for $2 000, 2/8, n30, customer paid on 7th day Cash $1960 Sales Discount $40 Accounts Receivable $2000 To record collection of invoice #7 within discount period

24. Practice Questions • Page 258-259 BE 6, 7 • Page 260 E5-3 • Page 264 P5-2A

25. Completing the Accounting CycleAdjusting Entries • The adjusting entries for a Merchandising company is the same as for a service company, with one exception • Inventory needs to by physically verified • If some stock is missing an adjusting entry needs to be made • Inventory shows that Grand River should have 14 canoes, but a physical count reveals they only have 13 COGS $1197 Merchandise Inventory $1197 To record the difference between inventory records and physical units on hand

26. Completing the Accounting CycleClosing Entries • Same as a service company, just a few new temporary accounts • Sales • Sales returns and allowances • Sales Discount • COGS • Freight Out • All of which are closed to the Income Summary

27. Practice Questions • Page 259 BE 8, 9 • Page 261-262 E5-4, E5-5, E5-6

28. Multiple-Step Income Statement • More useful that single-step because it highlights more information • Net Sales (sales – returns allowances and sales discounts) • Gross Profit (Net sales – COGS) • Income from Operations (Gross Profit – Operating Expenses) • Non-Operating Activities (gains or losses outside of normal operations) • Net Income (income from operation + non-operating income)

31. Practice Questions • Page 259 BE 10 • Page 262 E5-7, E5-9

32. Profitability Ratios • Gross Profit Margin • Profit Margin

33. Gross Profit Margin • More useful than Gross Profit, because it takes into account Net Sales • The higher the better Gross Profit Net Sales Gross Profit Margin 26% $220 000 $845 000 $125 000 $275 000 45.5%

34. Profit Margin • Explains how much of every dollar in sales is profit • Higher is better Net Sales Profit Margin Net Income $110 000 $845 000 13% $65 000 $ 275 000 23.6%

35. Practice Questions • Page 259 BE 11, 12 • Page P5-4A (a & b only)