Fundame 1 Accounting chapter3 LSCM.pptx

Fundamental Accounting l from hawassa university

1. aWASA University College of Business and Economics Department of Accounting and Finance Principles of Accounting I For First Year Accounting and Finance Students Instructor: Alemayehu T. 1

2. CHAPTER THREE: ACCOUNTING CYCLE FOR MERCHANDISING BUSINESS 2

3. 1. Distinguish the activities of a service business from those of a merchandising business. 2. Describe and illustrate the financial statements of a merchandising business. 3. Describe the accounting for the purchase of merchandise. 4. Describe the accounting for the sale of merchandise. OBJECTIVES After studying this chapter, you should be able to: 3

4. 5. Describe the accounting for transportation costs, sales taxes, and trade discounts. 6. Illustrate the dual nature of merchandising transactions. 7. Prepare a chart of accounts for a merchandising business. 8. Describe the accounting cycle for a merchandising business. 9. Compute the ratio of net sales to assets as a measure of how effectively a business is using its assets. OBJECTIVES 4

5. Accounting for Merchandising Operations Freight costs Purchase returns and allowances Purchase discounts Summary of purchasing transactions Merchandising Operations Recording Purchases of Merchandise Recording Sales of Merchandise Completing the Accounting Cycle Forms of Financial Statements Operating cycles Perpetual and periodic Inventory systems Sales returns and allowances Sales discounts Adjusting entries Closing entries Summary of merchandising entries Multiple-step income statement Single-step income statement Classified balance sheet Determining cost of goods sold under a periodic system 5

6. Characteristics of Merchandising Business Merchandising consists of buying and selling products rather than services. Merchandising business buys goods in finished form for resale to customers. Merchandising business sells tangible goods to its customers . Merchandising company sells to its customers are called merchandise inventory. A merchandising company is an enterprise that buys and sells goods to earn a profit. 1. Wholesalers sell to retailers 2. Retailers sell to consumers A merchandiser’s primary source of revenue is sales. 6

7. Manufacturer Wholesaler Retailer Customer Merchandising Companies Merchandising Activities Wholesaler , which buys goods from manufacturers and sells them to a retailer or another wholesaler. Retailer who sells the goods to the final consumer by buying them from wholesalers (or sometimes from a manufacturer). 7

8. OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY Accounts Receivable Cash Service Company Cash Merchandising Company Receive Cash Perform Services Sell Inventory Accounts Receivable Receive Cash Buy Inventory Merchandise Inventory 8

9. Cont’d The operating cycle of a merchandiser is as follows: It begins when the company purchases inventory from a vendor or suppliers. The company then sells the inventory to a customer. Finally, the company collects cash from customers 9

10. Income Measurement Cost of goods sold is the total cost of merchandise sold during the period. Not used in a Service business. Net Income (Loss) Less Less Equals Equals Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses INCOME MEASUREMENT PROCESS FOR MERCHANDISING COMPANY 10

11. Comparison of Financial Statements for Merchandising and Service Businesses Income Statement A model income statement for a merchandising business and a service business are shown below. Compare them carefully. 11 ABC Service company Income statement For the year ended Dec.31, 2014 XYZ Merchandising Income statement For the year ended Dec.31, 2014 Revenue: Service fee………………….Birr 23,200 Revenue: Net Sales…………………Birr 360,000 Cost of goods sold…………….( 256,000 ) Gross Profit …………………….104,000 Expenses: Various Operating Expenses ( 7120 ) Net Income 16080 Various Operating Expenses……………………….( 79,400 ) Net Income …………………….. 24,600

12. Income Statement Differences 12

13. Cont’d Balance Sheet Balance Sheet of a service business and a merchandising business are similar in every aspect except one thing, i.e., Merchandise inventory. Merchandise inventory refers to goods bought by a merchandising business for resale to customers. If a merchandising business has some unsold goods (merchandise) on hand at the end of the year this would be reported as one asset on the Balance Sheet as an ending inventory of Merchandising inventory. 13

14. Balance Sheet Differences * Smart Touch, in textbook Chapters 1-4, is a service company. ** Greg’s Tunes, in your textbook, is an example of a merchandising company . 14

15. Operating Cycle in merchandising company 15

16. Operating Cycle for a Merchandiser Begins with the purchase of merchandise and ends with the collection of cash from the sale of merchandise. Purchases Merchandise inventory Credit sales Account receivable Cash collection Purchases Merchandise inventory Cash sales Cash Sale Credit Sale 16

17. Inventory Systems + + Beginning inventory Net cost of purchases Merchandise available for sale Ending Inventory Cost of Goods Sold = 17

18. INVENTORY SYSTEMS The two alternatives in dealing with Merchandising inventory account are: To up date the account every time goods are bought and sold i.e., continuously and equivalent to perpetually or To up date the account only at the end of the period i.e., periodically Perpetual : where detailed records of each inventory purchase and sale are maintained. Cost of goods sold is calculated at the time of each sale. Periodic : detailed records are not maintained. Cost of goods sold is calculated only at the end of the accounting period . 18

19. Features: Perpetual System Purchases increase Merchandise Inventory. Freight costs, Purchase Returns and Allowances and Purchase Discounts are included in Merchandise Inventory. Cost of goods sold is increased and Merchandise Inventory is decreased for each sale. Physical count done to verify Inventory balance. The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold . Inventory Systems 19

20. Features: Periodic System Purchases of merchandise increase Purchases. Ending Inventory determined by physical count. Calculation of Cost of Goods Sold: Inventory Systems Beginning inventory $ XXX Add: Purchases, net XXX Goods available for sale XXXX Less: Ending inventory XXX Cost of goods sold $ XXXX 20

21. Inventory Systems Perpetual Inventory System Periodic Inventory System Detailed records of the cost of each item are maintained, and the cost of each item sold is determined from records when the sale occurs . Cost of goods sold is determined only at the end of an accounting period . 21

22. 3.2. Accounting for Purchases of Merchandises When merchandise is purchased for resale to customers, the account, Merchandising Inventory , is debited for the cost of the goods. Purchases may be made for cash or on account (credit). Purchase is normally recorded by the purchaser when the goods are received from the seller. Each credit purchase should be supported by a purchase invoice . 22

23. Made using cash or credit (on account). Normally recorded when goods are received. Purchase invoice should support each credit purchase . The formats of purchase or sales invoice should be fulfill the following points; Recording Purchases of Merchandise 23

24.  Seller  Invoice date  Purchaser  Order number  Credit terms  Freight terms  Goods  Invoice amount         24

25. Example: Information related to ABC Company is presented below. Prepare the journal entry to record the transaction under a perpetual inventory system . On April 5, purchased merchandise from XYZ Company for $25,000 terms 2/10, net/30, FOB shipping point. Merchandise inventory 25,000 April 5 Accounts payable 25,000 Recording Purchases of Merchandise 25

26. Not all purchases are increased Merchandising Inventory . Example: Prepare the journal entry to record the transaction under a perpetual inventory system . 3. On April 7, purchased equipment on account for $26,000. Equipment 26,000 April 7 Accounts payable 26,000 Recording Purchases of Merchandise 26

27. Terms FOB shipping point - seller places goods Free On Board the carrier, and buyer pays freight costs. FOB destination - seller places the goods Free On Board to the buyer’s place of business, and seller pays freight costs. Freight Costs Recording Purchases of Merchandise Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller (Freight-out or Delivery Expense). 27

28. Freight Costs/ Transportation Costs/ FOB shipping point (buyer pays) FOB destination (seller pays) Merchandise Seller Buyer 28

29. Example: Prepare the journal entry to record the transaction under a perpetual inventory system . 2. On April 6, ABC Company paid freight costs of $900 on merchandise purchased from XYZ . Merchandise inventory 900 April 6 Cash 900 Recording Purchases of Merchandise 29

30. Purchaser may be dissatisfied because g oods damaged or defective, of inferior quality, or do not meet specifications. Purchase Returns and Allowances Recording Purchases of Merchandise Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price . Purchase Return Purchase Allowance 30

31. Example: Prepare the journal entry to record the transaction under a perpetual inventory system . 4. On April 8, returned damaged merchandise to XYZ Company and was granted a $4,000 credit for returned merchandise . It indicates that there is a reduction on Merchandising inventory accounts. Accounts payable 4,000 April 8 Merchandise inventory 4,000 Recording Purchases of Merchandise 31

32. Two Types of Discounts Trade Discounts A percentage deduction from the list or catalog price to arrive at the gross selling (invoice) price Not recorded on either seller’s or buyer’s books!! Example : XYZ Company offers a 30 % trade discount if you purchase at least 1,000 of their most popular product known as Zippy. Each Zippy has a list price of $5.25 . Quantity sold 1,000 Price per unit 5.25 $ Total 5,250 Less 30% discount (1,575) Invoice price 3,675 $ 32

33. Two Types of Discounts Cash Discounts A deduction from the invoice price granted to induce early payment of the amount due Two other names for cash discounts Sales discounts Purchase discounts The amounts discounted should be recorded in either of seller’s or buyer’s books They are universal to both buyers and sellers 33

34. Purchase Discounts A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Full amount less discount Credit Period Full amount due Purchase or Sale 34

35. 2/10, n/30 Purchase Discounts Discount Percent Number of Days Discount is Available Otherwise, Net (or All) is Due Credit Period 35

36. Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages: Purchaser saves money. Seller shortens the operating cycle. Purchase Discounts Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.” 2% cash discount if payment is made within 10 days. 36

37. Purchase Discounts Terms Purchase Discounts 2% discount if paid within 10 days. 1% discount if paid within first 10 days of next month. 2/10 1/10 EOM Net amount due in 30 days, 60 days, or within the first 10 days of the next month. n/30, n/60, or n/10 EOM 37

38. Example: Prepare the journal entry to record the transaction under a perpetual inventory system. 5. On April 15, paid the amount due to XYZ Company in full. Accounts payable 25,000 April 15 Merchandise inventory 500 Purchase Discounts Cash 24,500 ( Discount = $ 25,000 x 2% = $500 ) 38

39. Example: Prepare the journal entry to record the transaction under a perpetual inventory system. 5. On April 15, paid the amount due to XYZ Company in full. Accounts payable 25,000 April 16 or later Cash 25,000 Purchase Discounts What entry would be made if the company failed to pay within 10 days? 39

40. Should discounts be taken when offered? Purchase Discounts Example: 2% for 20 days = Annual rate of 36.5% (365/20 = 18.25 twenty-day periods x 2% = 36.5%) Passing up the discount offered equates to paying an interest rate of 2% on the use of $25,000 for 20 days. 40

41. $25,000 8 th - Return $4,000 Balance 5 th - Purchase $ 21,400 500 15 th - Discount Recording Purchases of Merchandise Summary of Purchasing Transactions 900 6 th – Freight-in 41

42. 3.3. Accounting for sales of Merchandises Recording Sales When a merchandising company transfers goods to the buyer, in exchange for cash or a promise to pay at a later date, revenue is produced to the company. Revenue is recorded in a Sales account. However, the sales revenue, which is reported on the Income Statement is Net Sales . That is,   42 Net Sales =Gross Sales – Sales Discounts-Sales Returns and Allowances

43. Cont’d Recording Gross Sales The gross sales amount is obtained from sales invoices. An invoice is a document, prepared by the seller of merchandise to notify to the buyer the details of the sale. These details can include number of items sold, unit price of items, total price, terms of sale and manner of shipment. When goods are delivered to the customer, the Sales account is credited because revenues are increased by credits. A company can sell goods either for cash or on account. 43

44. Made for cash or credit (on account). Normally recorded when earned, usually when goods transfer from seller to buyer. Sales invoice should support each credit sale . Recording Sales of Merchandise 44

45. Two Journal Entries to Record a Sale Cash or Accounts receivable XXX Sales XXX Recording Sales of Merchandise #1 Cost of goods sold XXX Merchandise inventory XXX #2 Selling Price Cost 45

46. Example: Presented are transactions related to Wheeler Company. 1. On December 3,Wheeler Company sold $500,000 of merchandise to Hashmi Co., terms 2/10, n/30, FOB shipping point. The cost of the merchandise sold was $350,000. 2. On December 8, Hashmi Co. was granted an allowance of $27,000 for merchandise purchased on December 3. 3. On December 13,Wheeler Company received the balance due from Hashmi Co. Instructions: Prepare the journal entries to record these transactions on the books of Wheeler Company using a perpetual inventory system . Recording Sales of Merchandise 46

47. Example: Prepare the journal entries for Wheeler Company . 1. On December 3, Wheeler Company sold $500,000 of merchandise to Hashmi Company, terms 2/10, n/30, FOB shipping point. Cost of merchandise sold was $350,000. Recording Sales of Merchandise Accounts receivable 500,000 Dec. 3 Sales 500,000 Cost of goods sold 350,000 Merchandise inventory 350,000 47

48. “Flipside” of purchase returns and allowances. Contra-revenue account (debit). Sales not reduced (debited) because: would obscure importance of sales returns and allowances as a percentage of sales. could distort comparisons between total sales in different accounting periods. Sales Returns and Allowances Recording Sales of Merchandise 48

49. Example: Prepare the journal entries for Wheeler Company. 2. On December 8, Hashmi Co. was granted an allowance of $27,000 for merchandise purchased on December 3. Recording Sales of Merchandise Sales returns and allowances 27,000 Dec. 8 Accounts receivable 27,000 49

50. Example: Prepare the journal entries for Wheeler Company. 2. Variation On Dec. 8, Hashmi Co. returned merchandise for credit of $27,000. The original cost of the merchandise to Wheeler was $19,800. Recording Sales of Merchandise Sales returns and allowances 27,000 Dec. 8 Accounts receivable 27,000 Merchandise inventory 19,800 Cost of goods sold 19,800 50

51. The cost of goods sold is determined and recorded each time a sale occurs in: periodic inventory system only. a perpetual inventory system only. both a periodic and perpetual inventory system. neither a periodic nor perpetual inventory system. Review Question Recording Sales of Merchandise 51

52. Offered to customers to promote prompt payment. “Flipside” of purchase discount. Contra-revenue account (debit). Sales Discount Recording Sales of Merchandise 52

53. Example: Prepare the journal entries for Wheeler Company . 3. On December 13, Wheeler Company received the balance due from Hashmi Co. Recording Sales of Merchandise Cash 463,540 Dec. 13 Accounts receivable 473,000 Sales discounts 9,460 ** [($500,000 – $27,000) X 2%] ** *** ($500,000 – $27,000) *** * * ($473,000 – $9,460) 53

54. Example: Variation Prepare the sales revenue section of the income statement for Wheeler Company. Recording Sales of Merchandise 54

55. Generally the same as a service company. One additional adjustment to make the records agree with the actual inventory on hand. Involves adjusting Merchandise Inventory and Cost of Goods Sold. Adjusting Entries Completing the Accounting Cycle 55

56. Close all accounts that affect net income. Closing Entries Completing the Accounting Cycle Example: Presented is information related to Rogers Co. for the month of January 2008. Rogers uses the perpetual inventory method. Required: (a) Prepare the necessary adjusting entry for inventory. (b) Prepare the necessary closing entries. 56

57. Example: (a) Prepare the necessary adjusting entry for inventory. Completing the Accounting Cycle Cost of goods sold 600 Merchandise inventory 600 57

58. Sales 350,000 Income summary 350,000 Income summary 341,600 Cost of goods sold 218,600 Freight-out 7,000 Insurance expense 12,000 Income summary 8,400 Retained earnings 8,400 Rent expense 20,000 Example: (b) Prepare the necessary closing entries. Completing the Accounting Cycle Salary expense 61,000 Sales discounts 10,000 Sales returns 13,000 58

59. Shows several steps in determining net income. Two steps relate to principal operating activities. Distinguishes between operating and non-operating activities . Multiple-Step Income Statement Forms of Financial Statements 59

60. Forms of Financial Statements Illustration 5-11 Key Items: Net sales Gross profit Gross profit rate 60

61. Forms of Financial Statements Illustration 5-11 Key Items: Net sales Gross profit Gross profit rate Operating expenses 61

62. Forms of Financial Statements Key Items: Net sales Gross profit Gross profit rate Operating expenses Non operating activities Net income Illustration 5-11 62

63. The multiple-step income statement for a merchandiser shows each of the following features except: gross profit. cost of goods sold. a sales revenue section. investing activities section. Review Question Forms of Financial Statements 63

64. Subtract total expenses from total revenues Two reasons for using the single-step format: Company does not realize any type of profit until total revenues exceed total expenses. Format is simpler and easier to read. Single-Step Income Statement Forms of Financial Statements 64

65. Single-Step Forms of Financial Statements 65

66. Forms of Financial Statements Classified Balance Sheet 66

67. Periodic System Separate accounts used to record purchases, freight costs, returns, and discounts. Company does not maintain a running account of changes in inventory. Ending inventory determined by physical count. Determining Cost of Goods Sold Under a Periodic System 67

68. Determining Cost of Goods Sold Under a Periodic System Calculation of Cost of Goods Sold $316,000 68

69. END OF CHAPTER THREE 69