Accounting for merchandising business and fundamental accounting

Class lectures notes

1. C6 - 1
Learning Objectives
1.Nature of Merchandising Business
2.Accounting for Purchases
3.Accounting for Sales
4.Transportation Costs
5.Merchandise Transactions
6.Merchandising Chart of Accounts
7.Merchandising Income Statement
8.Merchandising Accounting Cycle
9.Financial Analysis and Interpretation
Chapter 6
Accounting for Merchandising Businesses Accounting for Merchandising Businesses

2. C6 - 2
Nature of merchandise business
Service business
–Provide service
–Usually it is a small business
Merchandise business
–Purchase and sell merchandise inventory
–Bigger than service business

3. C6 - 3
Service Co.
Income Statement
Year ended June 30, 20xx
Service revenue $xxx
Expenses:
Salary expense x
Depreciation expense x
Income tax expense x
Net income $ xx
Merchandising Co.
Income Statement
Year ended June 30, 20xx
Sales revenue $xxx
Cost of goods sold x
Gross profit xx
Operating expenses:
Salary expense x
Depreciation expense x
Income tax expense x
Net income $ xx
Comparison of Income Statements:
Service Co. And Merchandising Co.

4. C6 - 4
•sales revenue or sales
– the amount that a business earns from selling
merchandise inventory is called sales revenue, or sales.
•cost of merchandise sold
– the major expense of a merchandiser is cost of goods
sold.
•Gross margin or Gross profit
– The excess of sales over cost of sales is called gross
margin.
•Merchandise inventory
–Merchandise on hand at the end of an account period
Special terms

5. C6 - 5
Compute the net income
•Service business:
–Fees earned – operating expenses = net income
•Merchandise business:
–Sales – cost of merchandise sold = gross profit
–Gross profit – operating expenses = net income
The cost of merchandise sold is the largest expense for the
merchandise business, say 70% or more

6. C6 - 6
Income Statement ComparisonIncome Statement Comparison
Fees earned $150,000
Operating expenses 120,000
Net income $ 30,000
Service Business
Sales revenue $600,000
Cost of mdse. sold 450,000
Gross profit $150,000
Operating expenses 120,000
Net income $ 30,000
Merchandising Business
20% of revenues
5% of revenues
75% of revenues

7. C6 - 7
Merchandise Inventory
Merchandising involves selling inventory
Inventory is usually an important asset
Inventory must be accounted for periodically or
perpetually
Inventory system
Perpetual inventory system
Periodic inventory system

8. C6 - 8
Perpetual inventory system
•In a perpetual inventory system, each
purchase and the cost of each sale are
recorded in Merchandise Inventory.
•Most companies using the perpetual
inventory system.

9. C6 - 9
Periodic inventory system
•In a periodic inventory system, the inventory
records do not show the amount available for sale
or sold during the period. Instead, a detailed
listing of merchandise for sale at the end of the
accounting period is prepared by the physical
count.
•This physical inventory is used to determine the
cost of the merchandise inventory on hand and the
cost of merchandise sold.

10. C6 - 10
Continuous determination of inventory value
Continuous determination of gross profit
Affordable with computers, scanners, and bar codes on most products
Perpetual inventory accounting provides management controls
Managers know which items are selling fastest and the profit margin on
those items
Advantages of Using Perpetual InventoryAdvantages of Using Perpetual Inventory

11. C6 - 11
Accounting for purchase
•Purchase order
•Receive the inventory
•Invoice and payment
•Exhibit 1 invoice
–Netsolutions purchase $1,500 merchandise inventor
–Credit term: 2/10; n/30

12. C6 - 12
Purchase and payment
Jan. 12
Merchandise inventory 1500
Accounts payable 1500
Jan. 22
Accounts payable 1500
Cash 1500
Payment without discount

13. C6 - 13
Purchase and payment
Jan. 12
Merchandise inventory 1500
Accounts payable 1500
Jan. 22
Accounts payable 1500
Cash 1470
Merchandise inventory 30
Payment with the discount: 1500 *2% = $30

14. C6 - 14
Discount rate
•Purchase amount: $1500
•Discount rate: 2% for 20 days
1500* 2% =30
•Interest rate: 12% per year
1470*12%*20/360= 9.80
•Savings from borrowing:
30 –9.80 =20.20

15. C6 - 15
What is the due date of the
invoice?
•Question 1:
–An invoice dated august 13, has terms n/30.
•Question 2:
–An invoice dated November 22

16. C6 - 16
What is the due date of the
invoice?
•Question 1:
–An invoice dated august 13, credit terms n/30.
Solution:
–Sep. 12
•Question 2:
–An invoice dated November 22, credit terms:2/10,n/30
Solution:
–Dec. 2
–Dec. 22

17. C6 - 17
Purchases returns and allowances
•Purchase returns
–Purchase business return the merchandise inventory to
selling business
–get a debit memorandum from the sales business
•Purchase allowances
–Purchase business do not return the merchandise
inventory to selling business
–get a debit memorandum from the sales business
•

18. C6 - 18
Purchases returns and allowances
Example : p.231
1.May 2, purchases $5,000 of inventory.
2.May 4, returns $3,000 of inventory
3.Credit term: 2/10; n/30
4.Discount: (5000-3000) * 2% = $40
Recording in the journal

19. C6 - 19
Accounting for sales
•To record:
–Sales revenue
–Cost of sales
–Sales expenses
•Example: p. 233
–Sales :$ 1000
–Cost of sales: $550
–Credit card charges: $50

20. C6 - 20
Sales discount
To set up a separate account: sales discounts
–It is a contra account to Sales.
–Balance on usually on the debit side.
•Example : p. 233
–Sales: $1500
–Discount: $30
–Net sales: $1470

21. C6 - 21
Sales returns and allowances
To set up a separate account:
–Sales returns and allowances
–It is a contra account to Sales.
–Balance on usually on the debit side.
•Example : p. 234
–Sales returns: $225, cost $140
–Record the deduction of sales
–Record the deduction of cost of sales

22. C6 - 22
Sales taxes
Example p.235
–Sales price $100
–Sales tax rate 6%
–Total amount $106 of accounts receivable

23. C6 - 23
Sales taxes
Example p.235
–Sales price $100
–Sales tax rate 6%
–Total amount $106 of accounts receivable
Accounts receivable 106
Sales 100
sales tax payable 6
Sales tax payable 6
Cash 6

24. C6 - 24
Trade discount
•Wholesalers give the purchaser the discount
for large amount of purchase.
•P. 235
–30% of discount for $2400 sales
–The sales revenue: 2400 * 70%=1680

25. C6 - 25
Transportation cost
•FOB shipping point
•FOB destination
•If FOB shipping point, the buyer pays the
transportation costs.
•If FOB destination, the seller pays the transportation
costs.
seller
Shipping
point
buyer

26. C6 - 26
Example: FOB shipping point
•Buyer’s record:
–Buy merchandise inventory $ 900
–Transportation cost $ 50

27. C6 - 27
Example: FOB shipping point
•Buyer’s record:
Merchandise inventory 900
Accounts payable 900
Merchandise inventory 50
Cash 50

28. C6 - 28
More example
•Under the term of FOB shipping point,
sometimes the seller prepaid the
transportation cost, then to get the refund
from the buyer.
–Selling merchandise inventory $800
–Term: FOB shipping point
–Transportation cost $45

29. C6 - 29
More example
Accounts receivable 800
Sales 800
Cost of merchandise sold 360
Merchandise inventory 360
Transportation out 45
Cash 45
The seller’s record:

30. C6 - 30
Example : FOB destination
•seller’s record
– selling merchandise inventory $700
–Cost of sales $480
–Transportation cost 40

31. C6 - 31
Example : FOB destination
•seller’s record
Accounts receivable 700
Sales 700
Cost of merchandise sold 48
Merchandise inventory 48
Transportation out 40
Cash 40

32. C6 - 32
Illustration of Accounting for
merchandise inventory
Seller: Scully company
Buyer: Burton company

33. C6 - 33
Selling and Buying Merchandise InventorySelling and Buying Merchandise Inventory
Description DebitCredit
Accts. Receivable7,500
Sales 7,500
Cost of Mdse. Sold4,500
Mdse. Inventory 4,500
No entry
Mdse. Inventory 7,500
Accts. Payable 7,500

Mdse. Inventory 150
Cash 150
SellerSeller BuyerBuyer
Description DebitCredit
July1. Merchandise was sold with credit terms of n/45.
July 2. Paid transportation cost.
Recorded at full costRecorded at full cost

34. C6 - 34
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Accts. Receivable5,000
Sales 5,000
Cost of Mdse. Sold3,500
Mdse. Inventory 3,500
Mdse. Inventory 5,000
Accts. Payable 5,000
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 5. Scully Company sold merchandise on account to
Burton Co., $5,000, terms FOB destination, n/30. The cost
of the merchandise sold was $3,500.

35. C6 - 35
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Transportation Out 250
Cash 250
Mdse. Inventory 5,000
Accts. Payable 5,000


No entry.
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 7. Scully Company paid transportation costs of $250
for delivery of merchandise sold to Burton Co. on July 5.
Accts. Receivable5,000
Sales 5,000
Cost of Mdse. Sold3,500
Mdse. Inventory 3,500

36. C6 - 36
Accts. Receivable5,000
Sales 5,000
Cost of Mdse. Sold3,500
Mdse. Inventory 3,500
Transportation Out 250
Cash 250
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Sales Ret. & Allow.1,000
Accts Receivable 1,000
Mdse. Inventory 700
Cost of Mdse. Sold 700
Mdse. Inventory 5,000
Accts. Payable 5,000


No entry.

Accts. Payable 1,000
Mdse. Inventory 1,000
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 13. Scully Company issued Burton Co. a credit memo for
merchandise returned, $1,000. The merchandise cost was $700.

37. C6 - 37
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Cash 4,000
Accts. Receivable 4,000
Accts. Payable 4,000
Cash 4,000
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 15. Scully Company received payment from
Burton Co. for purchase of July 5.

38. C6 - 38
Cash 4,000
Accts. Receivable 4,000
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Accts. Receivable12,500
Sales 12,000
Cash 500
Cost of Mdse. Sold7,200
Mdse. Inventory 7,200
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 18. Scully Company sold merchandise on
account to Burton Co., $12,000, terms FOB
shipping point, 2/10, n/eom. Scully Company
prepaid transportation costs of $500. Cost of
merchandise sold was $7,200.
Accts. Payable 4,000
Cash 4,000

Mdse. Inventory 12,500
Accts. Payable 12,500

39. C6 - 39
Cash 4,000
Accts. Receivable 4,000
Accts. Receivable12,500
Sales 12,000
Cash 500
Cost of Mdse. Sold7,200
Mdse. Inventory 7,200
Accounting for Merchandise TransactionsAccounting for Merchandise Transactions
Description DebitCredit
Cash 12,260
Sales Discounts 240
Accts. Receivable 12,500
Accts. Payable 4,000
Cash 4,000

Mdse. Inventory 12,500
Accts. Payable 12,500


Accts. Payable 12,500
Mdse. Inventory 240
Cash 12,260
Scully Company (Seller)Scully Company (Seller) Burton Co. (Buyer)Burton Co. (Buyer)
Description DebitCredit
July 28. Scully Company received payment from
Burton Co. less discount (2% x $12,000).

40. C6 - 40
Chart of accounts for a
merchandise business
•What are new accounts in the chart of accounts?
1.Assets
2.Liabilities
3.Owner’s equity
4.Revenue
5.Costs and expense
6.Other income
7.Other expense

41. C6 - 41
NetSolutions
Merchandising Chart of Accounts
Balance Sheet Accounts
200 Liabilities
210Accounts Payable
211Salaries Payable
212Unearned Rent
215Notes Payable
300 Owner’s Equity
310Chris Clark, Capital
311Chris Clark, Drawing
312Income Summary
100 Assets
110Cash
111Notes Receivable
112Accounts Receivable
113Interest Receivable
115115Merchandise InventoryMerchandise Inventory
116Office Supplies
117Prepaid Insurance
120Land
123Store Equipment
124Accumulated Depreciation—
Store Equipment
125Office Equipment
126Accumulated Depreciation—
Office Equipment

42. C6 - 42
NetSolutions
Merchandising Chart of Accounts
Income Statement Accounts
600 Other Income
610Rent Income
611Interest Income
700 Other Expense
710Interest Expense
400 Revenues
410410SalesSales
411411Sales Returns and Sales Returns and
AllowancesAllowances
412412Sales DiscountsSales Discounts
500 Costs and Expenses
510510Cost of Merchandise SoldCost of Merchandise Sold
520Sales Salaries Expense
521Advertising Expense
522Depreciation Expense—
Store Equipment
523 Transportation Out523 Transportation Out
529Misc. Selling Expense
530Office Salaries Expense
531Rent Expense
532Depreciation Expense—
Office Equipment
533Insurance Expense
534Office Supplies Expense
539Misc. Admin. Expense

43. C6 - 43
Income statement for a
merchandise business
•A service business
–Single-step form]
•A merchandise business
–Multiple-step form
–Exhibit 7

44. C6 - 44
Revenue from sales:
Sales $720,185
Less:Sales returns and allow. $ 6,140
Sales discounts 5,79011,930
Net sales $708,255
Cost of merchandise sold 525,305
Gross profit $182,950
NetSolutions
Income Statement (Multiple-Step)
For the Year Ended December 31, 2004
Continued

45. C6 - 45
Operating expenses:
Selling expenses:
Sales salaries expense $60,030
Advertising expense 10,860
Depr. expense–store equip. 3,100
Miscellaneous selling expense 630
Total selling expenses $ 74,620
Administrative expenses:
Office salaries expense $21,020
Rent expense 8,100
Depr. expense–office equip. 2,490
Insurance expense 1,910
Office supplies expense 610
Misc. admin. expenses 760
Total admin. expenses 34,890
Total operating expenses 109,510
Income from operations $ 73,440
Continued

46. C6 - 46
Other income:
Interest revenue $ 3,800
Rent revenue 600
Total other income $ 4,400
Other expense:
Interest expense 2,4401,960
Net income $75,400

47. C6 - 47
Revenues:
Net sales $708,255
Interest revenue 3,800
Rent revenue 600
Total revenues $712,655
Expenses:
Cost of merchandise sold $525,305
Selling expenses 74,620
Administrative expenses 34,890
Interest expense 2,440
Total expenses 637,255
Net income $ 75,400
NetSolutions
Income Statement (Single-Step)
For the Year Ended December 31, 2004

48. C6 - 48
NetSolutions
Balance Sheet
December 31, 2002
Continued
Assets
Current assets:
Cash $ 52,950
Notes receivable 40,000
Accounts receivable 60,880
Interest receivable 200
Merchandise inventory 62,150
Office supplies 480
Prepaid insurance 2,650
Total current assets $219,310

49. C6 - 49
NetSolutions
Balance Sheet
December 31, 2002
Property, plant, and
equipment:
Land $ 10,000
Store equipment $ 27,100
Less accum. depreciation 5,70021,400
Office equipment $ 15,570
Less accum. depreciation 4,72010,850Total property, plant,
and
equipment 42,250
Total assets $261,560
Continued

50. C6 - 50
NetSolutions
Balance Sheet
December 31, 2002
Liabilities
Current liabilities:
Accounts payable $ 22,420
Note payable (current portion) 5,000
Salaries payable 1,140
Unearned rent 1,800
Total current liabilities $30,360
Long-term liabilities:
Note payable (due 2004) 20,000
Total liabilities $ 50,360
Owner’s Equity
Chris Clark, capital 211,200
Total liabilities and owner’s equity $261,560

51. C6 - 51
Merchandise inventory shrinkage
•Book records: $63,950
•Physical inventory : $ 62,150
•Inventory shortage: $ 1,800
•Adjusting:
Cost of merchandise sold 1800
Merchandise inventory 1800

52. C6 - 52
Profitability AnalysisProfitability Analysis
Profitability is the ability of an entity to earn profits.
This ability to earn profits depends on the
effectiveness and efficiency of operations as well
as resources available.
Profitability analysis focuses primarily on the
relationship between operating results reported in
the income statement and resources reported in
the balance sheet.

53. C6 - 53
Profitability Measures — Effective Use of AssetsProfitability Measures — Effective Use of Assets
Ratio of Net Sales to AssetsRatio of Net Sales to Assets
2003 2002
Net sales $1,498,000$1,200,000
Total assets:
Beginning of year $1,053,000$1,010,000
End of year 1,044,5001,053,000
Total $2,097,500$2,063,000
Average $1,048,750$1,031,500

54. C6 - 54
Ratio of Net Sales to AssetsRatio of Net Sales to Assets
Use:To assess the effectiveness
in the use of assets
Net sales on account $1,498,000$1,200,000
Total assets:
Beginning of year $1,053,000$1,010,000
End of year 1,044,5001,053,000
Total $2,097,500$2,063,000
Average $1,048,750$1,031,500
Ratio of net sales to assetsRatio of net sales to assets1.4 to 11.4 to 1 1.2 to 11.2 to 1

Profitability Measures — Effective use of AssetsProfitability Measures — Effective use of Assets
2003 2002

55. C6 - 55
HOME WORK
READING:
1.Illustrative problem
2.Self- examination questions
3.Multiple choice
Writing:
1.Exercise: 6-25;6-26;6-27
2.Problem : 6-5B
Discussion:

56. C6 - 56
This is the end of Chapter 6. This is the end of Chapter 6.