Accounting for merchandise business

Accounting for merchandise business

1. Accounting for merchandising business

2. Merchandise inventory A merchandise business is a business that purchases goods and resells them for profit. Examples of merchandise business are Target, Walmart, Best Buy, etc. The goods that merchandise businesses purchase are called merchandise inventory. Merchandise Inventory is classified as an asset on the balance sheet, All costs incurred to acquire merchandise and get it ready for sale are included in the inventory account. In this unit we track inventory using the perpetual inventory system – on a continuous basis

3. Examples of costs incurred in getting inventory ready for sale: Shipping and handling costs / Transportation in Transit insurance Storage costs Any other costs incurred to get the product ready for sale Inventory costs are referred to as product cost. Just like the name implies, product costs is the cost of inventory plus the costs of getting it ready for sale.

4. Transportation cost Earlier we mentioned that all costs incurred to get inventory ready for sale is added to the inventory. However, only the costs that the business is responsible for is added to inventory. In the case of transportation costs,  the cost of shipping is added to the inventory only when the business pays to get the goods delivered.  Since the business is responsible for the costs of delivery from the shipping point,  the terms given to postal carrier to deliver the goods is FOB shipping point. The cost is added to the inventory account.

5. Transportation in When a buyer is responsible for freight cost, it is called transportation in Transportation in increases the cost of inventory Transportation in is debited to the inventory account

6. Transportation out When goods are delivered FOB Destination to the customer, the seller is responsible. This is called transportation out Transportation out is a selling and administrative cost (discussed next)

7. Transportation cost summary In this chapter, the business will mostly be on the buying side. Responsible party Buyer Seller FOB Shipping point Merchandise Inventory N/A Fob destination N/A Transportation out

8. Inventory cost example Which of the following cost will be debited to the inventory account ( added to the cost of inventory) for ABC Co. Purchase price of inventory Goods were shipped to ABC, FOB Destination ABC Co returned some of the goods ABC Co received a cash discount ABC Co shipped goods to customer FOB destination Storage costs

9. Problem 1: Inventory cost Which of the following cost will be debited to the inventory account ( added to the cost of inventory) for ABC Co. Purchase price of inventory Goods were shipped to ABC, FOB Shipping point Transit insurance for inventory goods Cost to adjust the goods before sale ABC Co received a cash discount ABC Co shipped goods to customer FOB shipping point Storage costs

10. Selling and administrative cost Cost that are not included as part of inventory are called selling and administrative costs. Examples of selling and administrative costs are: Transportation out cost Advertising cost Wages and salaries Supplies expense Selling and administrative cost are sometimes called period cost Matched to the period they occur.

11. Selling and administrative cost example Which of the following cost will be debited to the selling and administrative cost account for ABC Co. Purchase price of inventory Goods were shipped to ABC, FOB Destination ABC Co returned some of the goods ABC Co received a cash discount ABC Co shipped goods to customer FOB destination Transit insurance for customer goods Storage costs

12. Problem 2: Selling and administrative cost Which of the following cost will be debited to the selling and administrative cost account for ABC Co. Purchase price of inventory Goods were shipped to ABC, FOB Shipping point Cost to adjust the goods before sale ABC Co received a cash discount ABC Co shipped goods to customer FOB shipping point Wages for customer service rep Storage costs

13. INVENTORY BECOMES COST OF GOODS SOLD We learned that the matching principle aims to match expenses with revenue. In honor of the matching principle, when inventory is sold the cost of the inventory has to be matched with the corresponding revenue. So therefore, when inventory is sold, we have to move inventory from the asset section of the balance sheet (inventory) to the expense section of the income statement (costs of goods sold). The expense account inventory is moved to (expensed to) is called cost of goods sold.

14. Cost of goods available for sale Inventory is either sold or not sold When it is not sold, it sits down on the balance sheet as merchandise inventory When it is sold, it sits on the income statement as cost of goods sold The cost of goods on the balance sheet are also known as cost of goods available for sale To compute cost of goods available for sale add beginning inventory to inventory purchased during the period To compute ending inventory, subtract cost of goods sold from cost of goods available for sale

15. Cost of goods sold example ABC started the year with $30,000 worth of inventory. ABC purchased $52,000 of inventory in March. In April, ABC sold $26,000 worth of inventory. What is ABC cost of inventory available for sale Beginning inventory + Purchases = $30,000 + $52,000 = $82,000 What is cost of goods sold $26,000 What is ending inventory as of April Cost of goods available for sale – cost of goods sold = $82,000 - $26,000=$56,000

16. Problem 3: Cost of goods sold ABC started the year with $20,000 worth of inventory. ABC purchased $32,000 of inventory in March. In April, ABC sold $24,000 worth of inventory. What is ABC cost of inventory available for sale What is cost of goods sold What is ending inventory as of April

17. Gross profit The difference between revenue and cost of goods sold is called gross profit.

18. Gross profit Example ABC sold $26,000 worth of inventory for $48,000. What is ABC ‘s gross profit Gross profit = Revenue – cost of goods sold Gross profit = $48,000 - $26,000 = $22,000

19. Problem 4: Gross profit ABC sold $36,000 worth of inventory for $58,000. What is ABC ‘s gross profit

20. Buying a product When a merchandise business buys products for resale it is an asset. The journal entry to record the initial purchase is: Debit Merchandise inventory ( increase the merchandise inventory account by debiting it) Credit Cash/ Accounts payable (decrease the cash account if cash was used or increase the accounts payable otherwise)

21. Cash discounts Encourages buyers to promptly pay Use credit terms like 2/10 n/30 Save 2% if paid within 10 days Else net amount due in 30 days Also called purchase discount when used to purchase inventory Purchase discounts reduce inventory cost

22. Cash discounts Cash discounts are recorded at the time of payment The journal entry will decrease the inventory account The cost of buying the inventory is decreased by the cash discount The accounts payable account will also be decreased There is less to pay due to the discount The cash account is decreased A cash payment goes out Journal entry Debit Accounts Payable Credit Cash Credit Merchandise Inventory

23. Purchase returns Damaged goods or unwanted goods are often return This is called a purchase return A purchase return reduces the inventory account

24. Purchase return The journal entry will decrease the inventory account The return decreases inventory The accounts payable account will also be decreased There is less to pay Journal entry Debit Accounts payable Credit Merchandise Inventory

25. Example Uncle Joe Inc purchased $8,400 worth of merchandise on account, subject to terms of 2/10, n/30. Uncle Joe Inc. found one merchandise defective and returned it. The returned merchandise cost $840. 9 days later, Uncle Joe paid the balance on his accounts payable. Record the journal entries for this transaction To record the inventory purchase Debit Merchandise Inventory 8,400            Credit Accounts Payable 8,400 To record the purchase return Debit Accounts payable 840            Credit Merchandise Inventory 840 To record the payment Debit Accounts payable 7,560            Credit Merchandise Inventory 151.20 Credit cash 7,408.80

26. Problem 5: Test your knowledge Uncle Joe Inc purchased $7,200 worth of merchandise on account, subject to terms of 8/10, n/60. Uncle Joe Inc. found one merchandise defective and returned it. The returned merchandise cost $720. 8 days later, Uncle Joe paid the balance on his accounts payable. Record the journal entries for this transaction To record the inventory purchase To record the purchase return To record the payment

27. Selling a product When inventory is sold, 2 events actually happen The business earns revenue Inventory is reduced Both events require journal entries.

28. Selling a product: The business earns revenue We have learned in previous units that when a service is completed the business recognized revenue by crediting the service revenue account. In the same way, a merchandise business also has to recognize revenue from the sale. To recognize revenue, the merchandise business will: Debit cash or accounts receivable Credit revenue

29. Selling a product: Inventory is reduced One difference between a service and product business is a product business has inventory. In addition to earning revenue when a sale is made, a merchandise business experiences a reduction in inventory. This has to be accounted for too. To do this: Debit cost of goods sold ( expense the inventory sold) Credit merchandise inventory ( decrease the merchandise inventory account)

30. Example Uncle Joe Inc purchased $7,400 worth of merchandise on account. He sold the goods for $12,400 cash. What is the journal entry to: To record the inventory purchase Debit Merchandise Inventory 7,400            Credit Accounts Payable 7,400 To record the sold inventory Debit Cost of goods sold 7,400            Credit Merchandise Inventory 7,400 To record the revenue Debit Cash 12,400            Credit Revenue 12,400

31. Problem 6: Test your knowledge Uncle Joe Inc purchased $2,400 worth of merchandise on account. He sold the goods for $5,400 cash. What is the journal entry to: To record the inventory purchase To record the sold inventory To record the revenue

32. Sales return When a customer returns a good, both the revenue and inventory account need adjustment This is the reverse of a sales transaction

33. Example Uncle Joe Inc purchased $7,400 worth of merchandise on account. He sold the goods for $12,400 cash. The customer returned the goods and received cash in return. What is the journal entry to: To record the sold inventory Debit Cost of goods sold 7,400            Credit Merchandise Inventory 7,400 To record the revenue Debit Cash 12,400            Credit Revenue 12,400 To record the returned inventory Debit Merchandise Inventory 7,400            Credit Cost of goods sold 7,400 To record the sales return Debit Revenue 12,400            Credit Cash 12,400

34. Problem 7: Test your knowledge Uncle Joe Inc purchased $5,200 worth of merchandise on account. He sold the goods for $7,300 cash. The customer returned the goods and received cash in return. What is the journal entry to: To record the sold inventory To record the revenue To record the returned inventory To record the sales return

35. Net sales The gross sales amount minus any sales returns and allowances and sales discount is called net sales. Example: ABC Co. sold merchandise worth $1500 for $2500, 2/10, n/30. $500 of ABC’s sales were returned. Assuming all customers paid within 10 days, what is ABC’s net sales? Sales $2,500 Less sales returns 500 Less sales discount 50 Net sales $1,950 It is okay to report net sales as one line item on the income statement. In other words compute net sales separately, and then the first line item on the income statement will be net sales. On the cash flow statement, net sales is cash flow from customers in operating activities. Do not report sales discounts and returns as cash outflow from expenses

36. Gain/ Loss Just like revenue - cost of goods sold = gross profit, the sales price of a fixed asset (like land) minus the cost is called a gain or a loss If the cost exceeds the sales price, it is a loss If the cost is less than the sales price, it is a gain Gains and losses appear on the income statement

37. Gain and loss example ABC Co. purchased land for $10,000 cash in May. ABC sold it for $12,000 in June. What is ABC’s gain/ loss? Gain = $12,000 - $10,000 = $2,000 The journal entry to record the transaction is as follows: Cash $12,000 Land $10,000 Gain $2,000

38. Gain and loss example ABC Co. purchased land for $10,000 cash in May. ABC sold it for $8,000 in June. What is ABC’s gain/loss? Loss = $8,000 - $10,000 = -$2,000 The journal entry to record the transaction is as follows: Cash $8,000 Loss $2,000 Land $10,000

39. Single step income statement A single step income statement shows the relationship between revenue and expenses. ABC Co. Income Statement for Period ended ** Revenue *** Expenses *** Net Income ***

40. Multi step income statement A multistep income statement shows the relationship between : Revenue Cost of goods sold ( cost of goods to produce revenue) Difference between revenue and cost of goods sold is called gross margin Operating expenses: are other expenses used to generate income / selling and administrative expenses Operating income: the difference between gross profit and operating expenses is called operating income Non operating items: are other items generated from non operating activities Net Income Operating income minus – non operating items = net income

41. Interest expense Interest is reported as non operating item on the income statement but reported in the operating activities section of the statement of cash flow This is due to a change in the generally accepted accounting principles (GAAP) that required interest expense be reported as operating activities No change was required on the income statement As a result you find inconsistencies between the way interest is reported on the income statement and the statement of cash flow

42. Example Uncle Joe Inc purchased $2,200 worth of merchandise on account. He sold the goods for $4,400 cash. The goods were shipped to the customer FOB destination for $170 cash. Create a multi step income statement. Uncle Joe Inc Income Statement For the period ended ,** Sales Revenue $4,400 Cost of goods sold (2,200) Gross margin 2,200 Less: Operating expenses Transportation out 170 Operating income $ 2,030

43. Problem 8: Test your knowledge Uncle Joe Inc purchased $7,400 worth of merchandise on account. He sold the goods for $12,400 cash. The goods were shipped to the customer FOB destination for $250 cash. Create a multi step income statement. Uncle Joe Inc Income Statement For the period ended ,**

44. PROBLEM 9: Walmart analysis Take a look at Walmart’s annual report and answer the following questions: What was Walmart's gross margin and gross margin percentage for the most recent fiscal year and the year prior to that? What was Walmart’s net income and net income percentage for the most recent fiscal year and the year prior to that? Based on the percentages computed above, did Walmart’s performance get better or worse. What are some things Walmart can do to increase net income?

45. Excel demonstration The following slides are step by step directions on how to use the excel worksheet to create a complete set of financial reports. ABC Co. Beginning balances Cash $150,000, Common stock $100,000, Retained earnings $50,000 Events Purchased 100 widgets for resale at a cost of $15,000. The widgets were purchases on account with terms 3/10, n 30 The goods from #1 were shipped FOB shipping point and cost $250 cash. Returned one of the widgets that cost $150 Sold 50 widgets with a cost of $7,500 for $12,500. The sale was a cash sale The goods from #4 were shipped FOB destination for $175 cash. Paid cash to settle 50% of the accounts payable in #1 less return in #3 within the discount period Paid cash to settle the balance of the accounts payable in #1 after the discount period. Customer returned 5 widgets from #3. The 5 widgets cost $750 and the customer paid $1,250 for widgets.

46. Prepare the journal entries

47. Prepare the t- accounts It is best for the journal entry and t-accounts windows appear side by side. To do this: Open the excel workbook First move t-account tab to a new worksheet: Go to the t-account tab on the bottom of the excel file Right click t-account Click Move or Copy Click new book

48. Prepare the t- accounts Next view the journal entry and t-account side to side: While pressing the Windows key on your keyboard, press either the Right or Left arrow to move the t-account window to either the left or right portion... Choose the other parts of the excel template to the other side of the window in step one.

49. Step 2: t- accounts Transfer journal entries to t-accounts as shown in the video on the next slide

50. Step 3 Move t-accounts back to main excel file : Go to the t-account tab on the bottom of the excel file Right click t-account Click Move or Copy Click the name of the main excel file Move to right after the journal entry. To do this select the tab after the journal entry The t-account file will be merged back with the main file Be sure to save your work. Add totals in the t-accounts if not automatically calculated in the template

51. Trial balance Move trial balance to new workbook (following same steps as t-accounts) Transfer balances to trial balance as shown in the next video Move trial balance worksheet back to main excel tab when done

52. Financial statements The next step is to create the income statement, statement of changes in stockholders equity and balance sheet To do this move the financial tab to a new book (follow previous steps) Move back to main workbook when done Save your work

53. Cash flow Next step is to create the cash flow statement Move the cash flow tab to new window Open up the journal entry so you can see transaction details Add more details to the cash t-chart Classify as operating, financial, and investing, use color code See next video When done, move cash flow worksheet back to main excel files

54. Closing entries Make closing entries For simplicity closing and trial balance worksheets should be side by side for ease of entry

55. Problem 10: Excel put it all together ABC Co. Beginning balances Cash $120,000, Common stock $80,000, Retained earnings $40,000 Events Purchased 100 widgets for resale at a cost of $12,000. The widgets were purchases on account with terms 4/10, n 30 The goods from #1 were shipped FOB shipping point and cost $370 cash. Returned one of the widgets that cost $120 Sold 50 widgets with a cost of $6,000 for $12,000. The sale was a cash sale The goods from #4 were shipped FOB destination for $225 cash. Paid cash to settle 50% of the accounts payable in #1 less return in #3 within the discount period Paid cash to settle the balance of the accounts payable in #1 after the discount period. Customer returned 5 widgets from #3. The 5 widgets cost $500 and the customer paid $2,250 for widgets.