Merchandising Operations

and the Accounting Cycle

Chapter 5

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-1
 Income Statements

Service Co. Merchandising Co.

Income Statement Income Statement
Year ended June 30, 20xx Year ended June 30, 20xx
Service revenue $xxx Sales revenue $xxx
Expenses: Cost of goods sold x
Salary expense x Gross profit xx
Depreciation expense x Operating expenses:
Income tax expense x Salary expense x
Net income $ xx Depreciation expense x
Net income $ xx
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-2
 Objective 1

Use sales and gross profit

to evaluate a company.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-3
 Sales Revenue

Net sales

Sales Revenue less Sales Returns and Sales Discounts

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-4
 Gross Profit or Gross Margin

Target Corporation
Income Statement (Adapted)
Year Ended December 31, 2000 Millions
Net sales revenue (same as Net sales) $33,212
Cost of goods sold (same as Cost of sales) 23,029
Gross profit (same as Gross margin) 10,183
Expenses:
Selling, general, administrative 7,490
Depreciation expense 854
Interest expense 393
Other expenses, net 302
Total operating expenses 9,039
Net earnings (same as Net income) $ 1,144
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-5
 Operating Cycle of a
Merchandising Business
Purchase and Cash Sale Purchase and Sale on Account

Cash Cash

Accounts
Receivable Inventory
Inventory

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-6
 Inventory Systems

Perpetual

Periodic

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-7
 Objective 2

Account for the purchase

and sale of inventory.

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 Purchase of Inventory

Merchant Suppliers
prepares send
purchase merchandise
order and a bill

Compares

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5-9
 Purchase of Inventory Example

 On May 1, the Sporting Store acquired on

account $2,000 of various items for resale.
 The supplier sent the merchandise along
with a bill stating the quantity, price, and
terms of sale.
 What is the journal entry?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 10

 Purchase of Inventory Example

May 1
Inventory $2,000
Accounts Payable $2,000
Purchased inventory on account
Inventory Accounts Payable
2,000 2,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 11

 Recording Purchase Returns
and Allowances Example

 Assume that on May 4 a $100 item was

returned prior to payment of the invoice.
 What is the journal entry?

May 4
Accounts Payable 100
Inventory 100
Merchandise was returned
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 12
 Recording Purchase Returns
and Allowances Example
 Assume that one of the items of merchandise
is slightly damaged, and the store was given
a $10 allowance.
 What is the journal entry?

May 4
Accounts Payable 10
Inventory 10
Received a purchase allowance
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 13
 Recording Purchase Returns
and Allowances Example

Inventory Accounts Payable

2,000 100 100 2,000
10 10
Bal. 1,890 Bal. 1,890

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 14

 Purchase Discounts

 Credit terms are stated in expressions such as:

 2/10, N/30, meaning that a discount of 2% is
allowed if the invoice is paid within 10 days;
otherwise the full (net) amount is due within
30 days.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 15

 Purchase Discounts Example

 Assume the Sporting Store purchased

merchandise for $1,000 with terms of
2/10, N/30.
 The store paid within the discount period.
 The 2% discount ($20) is deducted from the
amount due ($1,000) and $980 is remitted.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 16

 Purchase Discounts Example

 What is the journal entry?

Accounts Payable 1,000

Cash 980
Inventory 20
To record payment of invoice within the
discount period

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 17

 Recording Transportation Costs

 Transportation costs are the cost of moving

inventory from seller to buyer.
 FOB stands for Free on Board and governs
the passing of title of the goods.
 Selling/buying agreements usually specify
FOB terms.

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 Recording Transportation Costs

FOB Shipping Point

FOB Destination

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 Freight Charges Example

 Assume that on May 9 the Sporting Store

paid $60 for freight.
 What is the journal entry?

May 9
Inventory 60
Cash 60
Paid a freight bill

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 20

 Sporting Store Example

 Assume that on May 11 the store sold

merchandise costing $1,800 for $2,600
in cash.
 What are the journal entries?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 21

 Sporting Store Example

May 11
Cash 2,600
Sales Revenue 2,600
To record sale of merchandise

May 11
Cost of Goods Sold 1,800
Inventory 1,800
To record the cost of merchandise sold
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 22
 Sporting Store Example

 On May 15, the store sold to Maria Gym

$5,000 worth of merchandise with a cost
of $3,000.
 Terms are 2/10, N/30.

Invoice
Maria Gym Terms 2/10, N/30
Total $5,000
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 23
 Sales Discounts and Sales
Returns and Allowances Example
 On May 17, Maria Gym returned $1,500
worth of goods that cost $900.
 In addition, a credit of $100 was allowed
for merchandise that was damaged.
 What are the journal entries?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 24

 Sales Discounts and Sales
Returns and Allowances Example

May 17
Sales Returns and Allowance 1,500
Accounts Receivable 1,500
Received returned merchandise

May 17
Inventory 900
Cost of Goods Sold 900
Returned goods to inventory
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 25
 Sales Discounts and Sales
Returns and Allowances Example

May 17
Sales Returns and Allowance 100
Accounts Receivable 100
Credit granted for damaged goods

 There is no entry required for inventory

since the goods were not returned.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 26

 Sales Discounts and Sales
Returns and Allowances Example
 On May 20, the store received a check from
Maria Gym for the balance due.
 What is the balance due?

Accounts Receivable May 15 = $5,000

Less May 17 returns and allowances $1,600

Equals May 20 balance due of $3,400

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 27
 Sales Discounts and Sales
Returns and Allowances Example
 Maria took advantage of the sales terms –
2/10, N/30.

May 20
Cash 3,332
Sales Discounts 68
Accounts Receivable 3,400
Cash collected within the discount period

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 28

 Objective 3

Adjust and close the accounts

of a merchandising business.

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 Adjustments to Inventory
Example

Book Inventory Physical

Balance Count
$255,000 $252,500

$2,500 difference

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 30

 Adjustments to Inventory
Example
 What is the journal entry?

December 31
Cost of Goods Sold 2,500
Inventory 2,500
To adjust inventory to physical count

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 31

 Closing Entries for a
Merchandising Business
Revenues Income
2,760,000 Summary
7,348 1,884,348 2,767,348
C.G.S.
883,000
1,490,400
Sales Discount
22,824

Returns and A. Capital

32,605 Account
Other Exp. 883,000
338,519
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 32
 Objective 4

Prepare a merchandiser’s
financial statements.

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 Income Statement Formats

 There are two basic formats for the income

statement:
1 Multi-step
2 Single-step

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 34

 Multi-Step Format

Sporting Store
Income Statement
Year Ended December 31, 2002
Sales revenue $2,760,000
Sales discounts – 22,824
Returns and allowances – 32,605
Net sales revenue $2,704,571
Cost of goods sold –1,490,400

Gross margin $1,214,171

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 35
 Multi-Step Format

Gross margin $1,214,171

Operating expenses:
Wage expense – 166,285
Rent expense – 137,000
Insurance expense – 16,302
Depreciation expense – 9,781
Supplies expense – 8,151

Operating income $ 876,652

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 36
 Multi-Step Format

Operating income $876,652

Other revenue and expenses:
Interest revenue 7,348
Interest expense – 1,000

Net income $883,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 37

 Single-Step Format

Sporting Store
Income Statement
Year Ended December 31, 2002
Revenues:
Net sales (net of sales discounts) $2,704,571
Interest revenue 7,348

Total revenues $2,711,919

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 38

 Single-Step Format

Expenses:
Cost of goods sold $1,490,400
Wage expense 166,285
Rent expense 137,000
Interest expense 1,000
Insurance expense 16,302
Depreciation expense 9,781
Supplies expense 8,151
Total expenses $1,828,919
Net income $ 883,000
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 39
 Objective 5

Use the gross margin percentage

and the inventory turnover
ratio to evaluate a business.

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 Using the Financial Statements
for Decision Making

Gross profit percentage = Gross profit

÷ Net sales revenue

Inventory turnover = Cost of goods sold

÷ Average inventory

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 41

 Gross Profit on $1 for Three
Merchandisers
$1.00 — Gross
Gross Gross
margin margin margin
$0.21
$0.75 — $0.45 $0.42
Cost of Cost of
goods sold goods sold
$0.50 — Cost of $0.79
$0.58
goods sold
$0.55
$0.25 —

$0.00
Austin Target Wal-Mart
Sound Corporation Stores, Inc.
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 42
 Rate of Inventory Turnover for
Three Merchandisers
Wal-Mart Stores, Inc. 7.0 times
per year
1 2 3 4 5 6 7

Target Corporation
5.4 times
per year
1 2 3 4 5

Austin Sound
2.3 times
per year
1 2
Jan Mar Jun Sep Dec
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 43
 Objective 6

Compute the
cost of goods sold.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 44

 Computing the Cost of Goods
Sold in a Periodic System
Purchases of inventory – Purchases discounts –
Purchases returns and allowances = Net purchases

Beginning inventory + Net purchases + Freight-in

= Cost of goods available for sale

Cost of goods available for sale – Ending inventory

= Cost of goods sold

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 45

 Computing the Cost of Goods
Sold in a Periodic System

Beginning Ending
Inventory Inventory
$20,000 Cost of Goods $15,000
Available
for Sale
Purchases and $121,000 Cost of Goods
Freight-In Sold
$101,000 $106,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 46

 End of Chapter 5

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 5 - 47