Foundmental of accounting I Chap 3.pptx

ch 3 fundmental

1. Chapter 3 Accounting for Merchandising Businesses

2. Nature of Merchandising Businesses Merchandising Businesses:- A type of business that buys and sell goods. Merchandise on hand (not sold) at the end of an accounting period is called merchandise inventory. Merchandise inventory is reported as a current asset on the balance sheet.

3. Comparison of Income statement: Service Co. and Merchandising Co. . Service Company Income Statement For the Year ended Dec 31, 20xx Service revenue……………….xx Less: Expenses : Salary expense…………..…xx Rent expense……………….xx Depreciation expense...xx Income tax expense……. xx Net income………………….$ xxx Merchandising Company Income Statement For the Year ended Dec 31, 20xx Sales revenue…………………....xxx Less: Cost of goods sold ……… xx Gross profit ………………….…..… xx Less: Operating expenses: Salary expense……………………xx Rent expense………………….….xx Depreciation expense………..xx Income tax expense………….... xx Net income…………………….….$ xxx

4. Special terms in Merchandizing business Sales revenue or sales:- The amount that a business earns from selling merchandizing inventories. Cost of merchandising sold:- The major expenses of a merchandising business. COGS is the purchasing cost of the goods sold. It is the manufacturing cost of the items sold in manufacturing business. Gross profit: The excess of sales over cost of sales or Cost of goods sold. Merchandising inventory: Goods held for sale in merchandising business.

5. Merchandise transactions Merchandise transactions are recorded in the accounts, using the rules of debit and credit that are described and illustrated in Chapter 2 . There are two inventory systems to account for inventories or merchandising transactions: 1. Perpetual inventory system 2. Periodic inventory system

6. Perpetual inventory system In a perpetual inventory system, t he cost of goods sold and the decrease in inventory is continuously recorded at the time of each sale. In this way, the amount of merchandise available for sale and the amount sold are continuously (perpetually) updated in the inventory records . In a perpetual inventory system, each purchase are recorded in Merchandising inventory account . Purchase discounts, purchase return and allowances are recorded in Merchandising inventory account. Most companies use perpetual inventory system.

7. Periodic inventory system In a periodic inventory system, the inventory does not show the amount of merchandise available for sale and the amount sold at the time of each sale. Instead , physical inventory count is used to determine the cost of merchandise on hand at the end of the period and the cost of merchandise sold during the period. The purchase of inventory is recorded in the purchase account. S ales are recorded in the same manner as in the perpetual inventory system. However , cost of merchandise sold is not recorded on the date of sale. Purchase discounts, purchase return and allowances are recorded in a separate account called purchase discount , purchase return and allowances account respectively.

8. Accounting for Purchase Transactions Under the perpetual inventory system, cash purchases of merchandise are recorded as Debit to Merchandising inventory and Credit Cash. Purchases of merchandise on account are recorded as Debit to Merchandise inventory and Credit to Account payable . The terms for when payments for merchandise are to be made are called the credit terms.

9. Purchases Discounts To encourage the buyer to pay before the end of the credit period, the seller may offer a discount. For example, a seller may offer a 2% discount if the buyer pays within 10 days of the invoice date. If the buyer does not take the discount, the total invoice amount is due within 30 days. These terms are expressed as 2/10, n/30 and are read as “2% discount if paid within 10 days, net amount due within 30 days.” Discounts taken by the buyer for early payment of an invoice are called purchases discounts. Purchases discounts taken by a buyer reduce the cost of the merchandise purchased . When paying the invoice within the discount period, the buyer credits Merchandise Inventory for the amount of the discount. In this way, Merchandise Inventory shows the net cost to the buyer.

10. Purchases Returns and Allowances A buyer may return merchandise (purchases return) or request a price allowance (purchases allowance) from the seller. This might occur if the merchandise is defective, damaged during shipment, or does not meet the buyer’s expectations. In both cases, the buyer normally sends the seller a debit memorandum. A debit memorandum , often called a debit memo. A debit memo informs the seller of the amount the buyer proposes to debit to the account payable due the seller. It also states the reasons for the return or the request for the price allowance. The buyer may use the debit memo as the basis for recording the return or allowance or wait for approval from the seller (creditor). In either case, the buyer debits Accounts Payable and credits Merchandise Inventory.

11. Accounting for sales Cash Sales :- A business may sell merchandise for cash . Such sales are recorded as a debit to Cash and a credit to Sales. Under the perpetual inventory system, the cost of merchandise sold and the decrease in merchandise inventory are also recorded at the time of each sale. Sales on Account:- A business may sell merchandise on account. The seller records such sales as a debit to Accounts Receivable and a credit to Sales.

12. Sales Discounts The terms of a sale are normally indicated on the invoice or bill that the seller sends to the buyer. If payment is required on delivery, the terms are cash or net cash. Otherwise, the buyer is allowed an amount of time, known as the credit period , in which to pay. The credit period usually begins with the date of the sale. If payment is due within a stated number of days after the invoice date/sales, such as 30 days, the terms are net 30 days. These terms may be written as n/30 .

13. Cont. If payment is due by the end of the month in which the sale was made, the terms are written as n/ eom . Discounts taken by the buyer for early payment are recorded as sales discounts by the seller. For this reason, sales discounts are recorded in a separate sales discounts account , which is a contra (or offsetting ) account to Sales.

14. Sales Returns and Allowances Merchandise sold may be returned to the seller (sales return). In other cases, the seller may reduce the initial selling price (sales allowance). If the return or allowance is for a sale on account, the seller usually issues the buyer a credit memorandum , often called a credit memo . A credit memo authorizes a credit to (decreases) the buyer’s account receivable. A credit memo indicates the amount and reason for the returns and allowances. Like sales discounts, sales returns and allowances reduce sales revenue . Also, returns often result in additional shipping and handling expenses.

15. Cont. S ales returns and allowances are recorded in a separate sales returns and allowances account, which is a contra (or offsetting ) account to Sales. The seller debits Sales Returns and Allowances for the amount of the return or allowance. If the sale was on account , the seller credits Accounts Receivable . If cash is refunded, the seller debits Sales Returns and Allowances and credits Cash . Using a perpetual inventory system , the seller must also debit (increase) Merchandise Inventory and decrease (credit) Cost of Merchandise Sold for the cost of the returned merchandise.

16. Transportation costs/Freight The terms of agreement between the buyer & the seller include: When the ownership title of the merchandise transfers to the buyer Which party is to bear the cost of delivering the merchandising to the buyer (transportation cost ). There are two terms: FOB shipping point and FOB destination. This point determines whether the buyer or the seller pays the freight costs. The ownership of the merchandise may pass to the buyer when the seller delivers the merchandise to the freight carrier. In this case, the terms are said to be FOB ( free on board) shipping point.

17. Cont. Free on board :- indicates whether the seller or the buyer is liable for goods that are damaged or destroyed during shipping This term means that the buyer pays the freight costs from the shipping point to the final destination. Such costs are part of the buyer’s total cost of purchasing inventory and are added to the cost of the inventory by debiting Merchandise Inventory. Under perpetual inventory system , the transportation costs paid by the buyer are then debited to Merchandise inventory account & credited to cash. Under periodic inventory system , the transportation costs paid by the buyer are then debited to Transportation/Freight In & credited to cash.

18. Cont. The ownership of the merchandise may pass to the buyer when the buyer receives the merchandise. In this case, the terms are said to be FOB (free on board) destination. This term means that the seller pays the freight costs from the shipping point to the buyer’s final destination. When the seller pays the delivery charges, the seller debits Delivery Expense or Freight Out/Transportation out and credit Cash. Delivery Expense is reported on the seller’s income statement as a selling expense .

19. Cont. The seller may prepay the freight, even though the terms are FOB shipping point. The seller will then add the freight to the invoice by debiting to Accounts Receivable & crediting to cash T he buyer will debit Transportation In & credit Accounts Payable (Under periodic inventory system). Under perpetual inventory system , the buyer debits Merchandise Inventory for the total amount of the invoice, including the freight and credit A/P account . Any discount terms would not apply to the prepaid freight .

20. Assume the following are the business transactions of ABC Company for the month of June, 2020. Required (a) Journalise each transaction using the periodic and perpetual inventory systems.

21. Cont.

22. Cont. On June 30 ABC Co. pays the following expenses: Selling expenses ( sales salaries $ 500, delivery expense $ 200 , and advertising expense $ 300) , Administrative expense (office salaries $ 1,800, depreciation of office equipment $ 400, and office supplies used $ 300) Selling and admin expense… .$ 3,500 Cash……………..…………$ 3,500 Selling and admin expenses.$ 3,500 Cash………………………..$ 3,500

23. Sales taxes and Trade discounts

24. Trade Discounts A merchandiser often offer special discounts to government agencies or business that order large quantities. Such discounts are called trade discounts.

25. Financial Statements for a Merchandising Business The four basic financial statements for merchandising business are prepared in the same manner as for a service business . The financial statements of merchandising business are similar under the perpetual and periodic inventory systems . In merchandising business, income statement can be prepared in to two formats (1) Single step (2) M ultiple step

26. 1. Single-Step Income Statement:- This form emphasizes total revenues and total expenses in determining net income. A criticism of the single-step form is that gross profit and income from operations are not reported . ABC COMPANY INCOME STATEMENT For the month ended June 30, 2020 Revenue: Net Sales ……………………………………………………………….. $ 28, 015 Less: Expenses: Cost of Goods sold………………………………….......20,000 Selling expenses…………………………………………..1,000 Administrative expenses…………………………….2,500 Total expenses………………………………………………………….(23,500) Net Income………………………………………………………………...$ 4,515

27. 2. Multiple-Step Income Statement It c ontains several sections, subsections, and subtotals. It has the following sections: Revenue from Sales:- This section of the multiple-step income statement consists of sales, sales returns and allowances, sales discounts, and net sales . Sales is the total amount charged customers for merchandise sold, including cash sales and sales on account. Sales returns and allowances are granted by the seller to customers for damaged or defective merchandise. In such cases, the customer may either return the merchandise or accept an allowance from the seller. Sales discounts are granted by the seller to customers for early payment of amounts owed. Net sales is determined by subtracting sales returns and allowances and sales discounts from sales.

28. Cost of Goods sold:-The purchasing cost of the items sold. Gross profit:- The excess of sales over COGS Operating expenses are normally classified as either selling expenses or administrative expenses. Selling expenses are incurred directly in the selling of merchandise. Examples of selling expenses include sales salaries, store supplies used, delivery expense, and advertising expense etc. Administrative expenses , sometimes called general expenses , are incurred in the administration or general operations of the business. Examples of administrative expenses include office salaries, depreciation of office equipment, and office supplies used etc . However, many companies report selling, administrative, and operating expenses as single line items. Income from Operations:- Income from operations , sometimes called operating income , is determined by subtracting operating expenses from gross profit.

29. Other Income and Expense:- Other income and expense items are not related to the primary operations of the business. Other income is revenue from sources other than the primary operating activity of a business. Examples of other income include income from interest, rent, and gains resulting from the sale of fixed assets. Other expense is an expense that cannot be traced directly to the normal operations of the business . Examples of other expenses include interest expense and losses from disposing of fixed assets. If the total of other income exceeds the total of other expense, the difference is added to income from operations to determine net income. If the reverse is true, the difference is subtracted from income from operations.

30. ABC COMPANY INCOME STATEMENT For the month ended June 30, 2020 Revenue: Gross Sales……………………………………………………………………………..$ 32, 100 Less: Sales discount…………………………………………….…...85 Sales Return and Allowances……………………………..… 4,000 Net Sales…………………………………………………………………………………28,015 Less: Cost of Goods sold…………………………………………… 20,000 Gross Profit……………………………………………………………………………...8,015 Less: Operating expenses: Selling expenses: Sales salaries ……………………………………………………….$ 500 Delivery expense…………………………………………………... $ 200 Advertising expense……………………………………………….. $ 300 Total selling expenses……………………………………………….............$ 1,000 Administrative expenses: Office salaries……………………………………………………….$ 1,800 Depreciation of office equipment…………………………………..$ 400 Office supplies expense………………………………………………... $ 300 Total administrative expenses…………………………………………….…$ 2,500 Total Operating expenses……………………………………………………………..( $ 3,500) Income from operations……………………………………………………………….4, 515 Other income and expense…………………………………………………………… $ 0 Net Income……………………………………………………………………………$ 4, 515

31. Determining the cost of goods sold using periodic inventory system (Assume that the cost of merchandising inventory left on hand is $ 24, 660) Cost of merchandise sold: Merchandise inventory, June 1, 2020 . . . . . . . . . . ……..……….. $ 0 Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . ………45,000 Less : Purchases returns and allowances . . ..500 Purchases discounts . . . . . ……………….... 590 Net purchases . . . . . . . . . . . . . . . . . . . . . ……. . … 43,910 Add : Freight in . . . . . . . . . . . . . . . . . . . . . . …. . ….. 750 Cost of merchandise purchased . . . . . . . . ……………….......... 44, 660 Marchandise avalable for sale . . . . . . . . . ……………... . …….44,660 Less: Merchandise inventory, June 30,2020 . . . …………....... (24,660) Cost of merchandise sold . . . . . . . . . . . …...................……….. $ 20,000

32. Cont. In the preceding computation, merchandise inventory at the end of the period ( which is determined through physical count) is subtracted from the merchandise available for sale to determine the cost of merchandise sold. The merchandise inventory at the end of the period is determined by taking a physical count of inventory on hand . This method of determining the cost of merchandise sold and the amount of merchandise on hand is called the periodic inventory system .

33. Adjusting Entry for Inventory Shrinkage Under the perpetual inventory system , the merchandise inventory account is continually updated for purchase and sales transactions. Thus , the physical inventory on hand at the end of the accounting period is usually less than the balance of Merchandise Inventory in the ledger. This difference is called inventory shrinkage or inventory shortage.

34. Cont. Under the perpetual inventory system, the ending inventory physical count is compared to the balance of Merchandise Inventory. The inventory shrinkage is then recorded as a debit to Cost of Merchandise Sold and a credit to Merchandise Inventory. Note that the adjusting process is the same under the periodic and perpetual inventory systems.

35. Closing entries under perpetual inventory system

36. Closing entries Date Account titles and description Debit Credit 2020 June 30 Sales revenue $ 32,100   Income summary (To close revenue by income summary)   $ 32,100 June 30 Income summary Sales discount Sales return and allowances Cost of Goods sold Sales salaries Delivery expense Advertising expense Office salaries Depreciation of office equipment Office supplies expense $ 27,585   $ 85 4,000 20,000 500 200 300 1,800 4 00 300   (To close expenses to income summary)     June 30 Income summary $ 4,515   Retained earnings (To close income summary by equity)   $ 4,515

37. Closing Entries under periodic inventory system The closing entries differ in the periodic inventory system in that there is no cost of merchandise sold account to close to Income Summary. Instead, the purchases, purchases discounts, purchases returns and allowances, and freight in accounts are closed to Income Summary. In addition, the merchandise inventory account is adjusted to the end-of-period physical inventory count during the closing process.

38. Summary