Chapter 4: Merchandising Operations

1. Chapter 4: Merchandising Operations

2. 1. Overview 2. Inventory Transactions 3. Inventory Systems 4. Recording Purchases 5. Recording Sales 6. Multiple Step Income Statement Chapter 4: Merchandising Operations

3. In the first 3 chapters, we looked primarily at service organizations, where the company was selling a service. Now we will be studying companies who sell products. We will recognize sales revenue similar to service revenue, but we will have a new expense account: Cost of Goods Sold (COGS). In Chapters 4 and 5 we will examine the methods for recording and calculating Cost of Goods Sold, as well as recording and valuing Merchandise Inventory. 1. Overview

4. Inventory transactions relate to original acquisition and subsequent activity. What costs relate to acquisition of inventory? General rule: all costs associated with purchase or manufacture of inventory, including shipping to facility. Purchases represent the basic negotiated cost of acquiring the inventory. Freight-in (transportation-in)adds to the cost of purchases. Purchase returns reduce the cost of purchases for returned inventory. Purchase allowances reduce the cost of purchases for reduced prices due to damage or errors. Purchase discountsfrom early cash payments reduce the cost of purchases. 2. Acquiring inventory

5. What items or units to include? General rule: (1) held for sale and (2) complete and unrestricted ownership. Consignments: belong to consignor, ownership not based on physical possession. Goods in transit FOB Shipping Point: belongs to the purchaser while in transit (once inventory leaves seller’s facilities). FOB Destination: belongs to seller while in transit (until inventory reaches purchaser’s facilities). 2. Acquiring Inventory

6. Perpetual Up-to-date record in inventory account. Cost of goods sold computed for each sale. Periodic Inventory purchases are recorded as incurred. Inventory and cost of goods sold determined at the end of each period through physical count. Costs and benefits Perpetual requires more bookkeeping but provides more useful information. General application: Periodic used for general ledger entries; perpetual used for units Trend: more companies are moving to perpetual for general ledger. 3. Perpetual or Periodic Method

7. To record purchase: Inventory (Purchases) xx A/P or Cash xx To record purchase returns (same for purchase allowances): A/P or Cash xx Inventory (Purch.Returns) xx To record freight to ship inventory to facilities: Inventory (Freight-in) xx A/P or Cash xx 4. Journal Entries - Purchases(Accounts for periodic system in parentheses)

8. Assume purchase of $100 on account on 6/1/08, terms 2/15, n/30. GJE to record purchase on 6/1/08: Inventory (Purchases) 100 Accounts Payable 100 GJE to record payment, if on or before 6/16/08: Accounts Payable 100 Inventory (Purchase Disc.) 2 Cash 98 GJE to record payment, if after 6/16/08: Accounts Payable 100 Cash 100 Purchase Discounts

9. Perpetual System: Since the inventory account used for all purchase sales of inventory, the account is perpetually updated. The only potential adjusting journal entry is to adjust ending inventory for any loss due to theft or spoilage. AJE: COGS x Inventory x (The sales side of inventory transactions is discussed in the next section.) Adjusting Journal Entry for Inventory

10. Periodic System: Since individual accounts used for all purchase activity, the accounts must be transferred or closed to Ending Inventory and COGS at the end of the period. This is another Adjusting Journal Entry. This entry follows the formula for COGS: BI + Net Purch + Freight-in = EI + COGS The function of this entry is to transfer the balances in BI and Purchases (net) to EI and COGS, so that the Balance Sheet and Income Statement balances will be correct at the end of the period. (The sales side of inventory transactions is discussed in the next section.) Adjusting Journal Entry for Inventory

11. This AJE under periodic system follows the formula for COGS: COGS xx Ending Inventory xx Purch. Discounts xx Purch. Returns xx Purch. Allowances xx Freight-in xx Purchases xx Beginning inventory xx Note that this journal entry closes out BI and Purchase components, and transfers the balances to EI and COGS. The EI balance will go to the balance sheet, and the COGS balance will go to the income statement. Adjusting Journal Entry for Inventory

12. If one company is buying inventory, another is selling inventory. Sales activity is recorded as follows. Sale of inventory: A/R or Cash xx Sales Revenue xx COGS xx Inventory xx (Note that COGS is not recognized until the end of the period in the periodic system.) Sale returned back to the company: Sales returns xx A/R or Cash xx Note that any freight ("freight-out) the company might pay to ship the inventory to the customer is NOT part of inventory and COGS. 5. Recording Sales

13. If a sales discount is taken by the customer, the company would record it as follows: Cash xx Sales Discount xx Accounts Receivable xx where A/R is removed for the entire amount, but cash received is less than the full amount owed. 5. Recording Sales

14. There are two techniques for presenting the income statement: The multiple step method The single step method Large companies are evenly divided in the choice of method. Within each method, companies may present the income statement in a detailed structure or in a condensed structure. Large companies present their statements in a condensed format. Additional information regarding the income statement may be found in the notes to the financials. 6. Formats for Income Statement

15. The multiple step income statement stresses that merchandising firms have a primary cost of making a sale, that is the COGS. This cost is given a priority position on the income statement, and allows us to calculate a new component called Gross Margin (or Gross Profit). Other levels include: Operating Expenses (also called Selling, General and Administrative Expenses) Other Revenues and Gains Other Expenses and Losses These last two levels are for nonoperating activity like gains and losses on asset sales, and activities like interest revenue and interest expense. 6. Formats for Income Statement

16. Sales $703,000 Less: sales discounts 11,300 Net sales $691,700 Less: COGS 470,000 Gross margin $221,700 Operating expenses Selling 110,000 Administrative 48,400 Income from operations $ 63,300 Other revenues & gains 5,300 Other expenses & losses 4,000 Net income $ 64,600 Example of Multiple-Step Condensed I/S

17. The single step income statement groups everything according to two categories: Revenues or expenses. This statement works best for companies that have many different kinds of activities, including service and sales activities. All revenues are shown at the top of the statement, and all expenses are shown at the bottom of the statement. 6. Formats for Income Statement

18. Sales $703,000 Less: sales discounts 11,300 Net sales $691,700 Other revenues & gains 5,300 Total revenues $697,000 COGS $470,000 Selling expense 110,000 Administrative expense 48,400 Other expenses & losses 4,000 Total expenses $632,400 Net income $ 64,600 Example of Single Step Condensed I/S