Visit UMT online at © South-Western 2004 Survey of Accounting, 2/e 1 of 64 Chapter 4, ACCT125...

Visit UMT online at www.umtweb.edu© South-Western 2004Survey of Accounting, 2/e

1 of 64Chapter 4, ACCT125

ACCOUNTING ACCOUNTING FUNDAMENTALS FOR FUNDAMENTALS FOR

MANAGERSMANAGERS

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2 of 64Visit UMT online at www.umtweb.eduChapter 4, ACCT125

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Visit UMT online at www.umtweb.edu© South-Western 2004Survey of Accounting, 2/e

3 of 64Chapter 4, ACCT125

Chapter 4Chapter 4

Accounting for Merchandise Accounting for Merchandise OperationsOperations



After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

Learning ObjectivesLearning Objectives

1. Distinguish the operating 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 sale of merchandise.

4. Describe the accounting for the purchase of merchandise.




5. Describe the accounting for transportation costs and sales taxes.

6. Illustrate the dual nature of merchandising transactions.

7. Describe the accounting for merchandise shrinkage.

8. Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.



1Distinguish the operating activities of a service business from those of a merchandising business.




In prior chapters, you were introduced to how to report the financial condition and changes

in financial condition for a service business.

In prior chapters, you were introduced to how to report the financial condition and changes

in financial condition for a service business.



In this chapter, you will be exposed to the accounting for

merchandise operations.

In this chapter, you will be exposed to the accounting for

merchandise operations.


Home Depot Inc.Condensed Income StatementFor the Year Ending December 28, 2001

(in millions)

Net sales $45,738Cost of merchandise sold 32,057Gross profit $13,681Operating expenses 9,490Operating income $ 4,191Other income 26Income before taxes $ 4,217Income taxes 1,636Net income $ 2,581

Home Depot Inc.Condensed Income StatementFor the Year Ending December 28, 2001

(in millions)

Net sales $45,738Cost of merchandise sold 32,057Gross profit $13,681Operating expenses 9,490Operating income $ 4,191Other income 26Income before taxes $ 4,217Income taxes 1,636Net income $ 2,581

The revenue account for

merchandise is Sales.

The revenue account for

merchandise is Sales.

The cost of merchandise sold is matched against

net sales.

The cost of merchandise sold is matched against

net sales.

Net sales is the revenue received from selling merchandise less

any merchandise returned or any discounts reported.

Net sales is the revenue received from selling merchandise less

any merchandise returned or any discounts reported.

Revenue minus cost provides gross profit.

Revenue minus cost provides gross profit.

What’s different on a What’s different on a merchandising income statement?merchandising income statement?

What’s different on a What’s different on a merchandising income statement?merchandising income statement?


Describe and illustrate the financial statements of a merchandising business.2



Online SolutionsIncome Statement

For the Year Ended December 31, 2007

Net sales $708,255Cost of merchandise sold 525,305Gross profit $182,950Operating expenses 105,710Operating income $ 77,240Other income and expense (net) (1,840)Operating income before taxes $ 75,400Income taxes 15,000Net income $ 60,400

Multiple-Step Income StatementMultiple-Step Income Statement


Sales $720,185Less sales returns and allowances $6,140Less sales discounts 5,790 11,930Net sales $708,255

Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account.

Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account.

Detailed Revenue SectionDetailed Revenue SectionDetailed Revenue SectionDetailed Revenue Section




Sales returns and allowances are granted by the seller for damaged or defective merchandise.

Sales returns and allowances are granted by the seller for damaged or defective merchandise.




Sales discounts are granted by the seller to customers for early payment of amounts owed.

Sales discounts are granted by the seller to customers for early payment of amounts owed.



Purchases $521,980Less: Purchases returns and allowances $9,100

Purchases discounts 2,525 11,625Net purchases $510,355Add transportation-in 17,400 Cost of merchandise purchased $527,755

Purchases is the full cost of buying merchandise for resale.

Purchases is the full cost of buying merchandise for resale.

Detailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased SectionDetailed Cost of Merchandise Purchased Section





A Purchase return is the cost of the merchandise returned to the seller.

A Purchase return is the cost of the merchandise returned to the seller.A Purchase allowance is a reduction in purchase price because the item has a defect or was the wrong item ordered.

A Purchase allowance is a reduction in purchase price because the item has a defect or was the wrong item ordered.





A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.

A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.





Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.

Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.



“Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which

follows the revenue section.

“Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which

follows the revenue section.



Note on the next slide that the only change is that the section begins by adding the beginning

inventory and ends by subtracting the ending inventory.

Note on the next slide that the only change is that the section begins by adding the beginning

inventory and ends by subtracting the ending inventory.



Merchandise inventory, Jan. 1, 2007 $ 59,700Purchases $521,980Less: Pur. returns and allow. $9,100

Purchases discounts 2,525 11,625Net purchases $510,355Add transportation-in 17,400 Cost of merchandise purchased 527,755Merchandise available for sale $587,455Less merchandise inventory, Dec. 31, 2007 62,150Cost of merchandise sold $525,305

Detailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold SectionDetailed Cost of Merchandise Sold Section



This income statement was prepared using the periodic

inventory method. The number of units on hand was

determined by a physical count.

This income statement was prepared using the periodic

inventory method. The number of units on hand was

determined by a physical count.



In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary

for verification purposes.

In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary

for verification purposes.



Online SolutionsIncome Statement


Revenue:Net sales $708,255

Expenses:Cost of merchandise sold $525,305Operating expenses 105,710Income taxes 15,000Other income and expense (net) 1,840 647,855

Net income $ 60,400

Single-Step Income StatementSingle-Step Income Statement


Online SolutionsRetained Earnings StatementFor the Year Ended December 31, 2007

Retained earnings, January 1, 2007 $128,800Net income for the year $60,400Less dividends 18,000Increase in retained earnings 42,400Retained earning, December 31, 2007 $171,200

Retained Earnings StatementRetained Earnings Statement


Online SolutionsBalance SheetDecember 31, 2007

AssetsCurrent assets:

Cash $ 52,950Accounts receivable 76,080Merchandise inventory 62,150Office supplies 480Prepaid insurance 2,650 Total current assets $194,310


Balance SheetBalance Sheet


Property, plant, and equipment:Land $ 20,000Store equipment $27,100 less accumulated depr. 5,700 21,400Office equipment $15,570 less accumulated depr. 4,720 10,850 Total property, plant, and equip. 52,250

Total assets $246,560

LiabilitiesCurrent liabilities:

Accounts payable $ 22,420Note payable 5,000Salaries payable 1,140Unearned rent 1,800 Total current liabilities $ 30,360ContinuedContinuedContinuedContinued


Long-term liabilities:Note payable (final payment due 2017) 20,000

Total liabilities $ 50,360

Stockholders’ EquityCapital stock $ 25,000Retained earnings 171,200 196,200Total liabilities and stockholders’ equity $246,560


Online SolutionsStatement of Cash Flows


Cash flows from operating activities:Net income

$ 60,400Add: Depreciation expense—store equipment $ 3,100

Depreciation expense—office equipment 2,490Decrease in office supplies 120Decrease in prepaid insurance 350Increase in accounts payable 8,150 14,210


Statement of Cash FlowsStatement of Cash Flows


Deduct: Increase in accounts receivable $(24,080)Increase in merchandise inventory (2,450)Decrease in salaries payable (360)Decrease in unearned rent (600) (27,400)

Net cash flow form operating activities $47,120Cash flows from investing activities:

Purchase of store equipment $ (7,100)Purchase of office equipment (5,570)Net cash flows used in investing activities (12,670)

Cash flows from financing activities:Payment of note payable $ (5,000)Payment of dividends (18,000)Net cash flows used in financing activities (23,000)

Net increase in cash $11,450January 1, 2007 cash balance 41,500December 31, 2007 cash balance $ 52,950


Describe the accounting for the sale of merchandise.3

Learning ObjectiveLearning Objective


On January 3 Online Solutions sells merchandise costing $1,200 for

$1,800. The customer charges the purchase on a MasterCard.

On January 3 Online Solutions sells merchandise costing $1,200 for

$1,800. The customer charges the purchase on a MasterCard.

Transactions involving MasterCard or Visa are treated as cash sales.


Cash sales of $1,800 on January 3; cost of merchandise sold, $1,200.

LiabilitiesJan. 3

Jan. 3

Net Effect

Revenue Net IncomeJan. 3 Sales 1,800 1,800

Jan. 3 -1,200

1,800 6001,200

Trans. Date

Trans. Date

Income StatementExpense

Cost of Merch. Sold 1,200

Retained Earnings

(Net Income)

Merch. Inv. - 1,200

600 600

Balance SheetAssets Stockholders' Equity

Cash 1,800


2/10, n/30Credit Terms

The buyer is allowed a 2% discount if…

…the account is paid within 10

days.

The net (full) amount is due by

the 30th day.

Sales DiscountsSales Discounts


On January 12 Online Solutions sells merchandise on account to Omega Tech for $1,500. Credit terms are 2/10, n/30.

LiabilitiesJan. 12

Net Effect

Revenue Net IncomeJan. 12 Sales 1,500

Net Effect 1,500


Accounts Rec. 1,500

1,500 1,500

Retained Earnings

Trans. Date

Trans. Date




Payment is received from Omega Tech on January 22.

LiabilitiesJan. 22

Jan. 22

Net Effect

Revenue Net IncomeJan. 22 Sales Dis. 30 -30

Net Effect 30 -30

Trans. Date

Trans. Date


Retained Earnings

(Net Income)

Accounts Rec. - 1,500

-30 -30


Cash 1,470



On January 13 Online Solutions issues a $2,000 credit memorandum to Krier Company for merchandise that was returned. The merchandise (cost $1,200) was sold on account.

LiabilitiesJan. 13

Jan. 13

Net Effect

Revenue Net IncomeJan. 13 SR&A 2,000 -2,000

Jan. 13 1,200

Net Effect 2,000 -800

Trans. Date

Trans. Date


Cost of Merch. Sold -1,200

Retained Earnings

(Net Income)

Merch. Inv. 1,200

-800 -800


Accounts Rec. -2,000

Sales Returns and AllowancesSales Returns and Allowances


Describe the accounting for the purchase of merchandise.4



On January 6 Online Solutions purchased $2,500 of merchandise on account (terms: 1/15, n/30). Recall that Online Solutions uses the perpetual system.

LiabilitiesJan. 3 A/Pay. 2,500

Net Effect 2,500

Revenue Net Income

Trans. Date

Trans. Date


2,500


Merch. Inv. 2,500


On January 21 Online Solutions pays invoice of $1,800, terms 1/15, n/30 within the discount period.

LiabilitiesJan. 21 A/P -1,800

Jan. 21

Net Effect -1,800

Revenue Net Income

Trans. Date

Trans. Date


Cash - 1,782

-1,800


Merch. Inv. -18

Purchase DiscountsPurchase Discounts


On January 22 Online Solutions returns $5,000 of merchandise purchased from Quantum Inc.

LiabilitiesJan. 22 A/P -5,000

Net Effect -5,000

Revenue Net Income

Trans. Date

Trans. Date


-5,000


Merch. Inv. -5,000

Purchase Returns and Purchase Returns and AllowancesAllowances


Describe the accounting for transportation costs and sales taxes.5



PhilPhil’s ’s TruckTruckiinn

gg

Transportation CostsTransportation Costs



On January 19 Online Solutions buys merchandise from Data Max on account, $2,900, terms FOB shipping point, and prepays the transportation cost of

$150.

LiabilitiesJan. 19 A/P 2,900

Jan. 19

Jan. 19

Net Effect 2,900

Revenue Net Income

Trans. Date

Trans. Date


2,900

Merch. Inv. 150

Cash - 150


Merch. Inv. 2,900

Transportation CostsTransportation Costs


Illustrate the dual nature of merchandising transactions.6



Scully Co. (Seller)Scully Co. (Seller)Scully Co. (Seller)Scully Co. (Seller)

July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB destination; 2/10, n/30. The cost of the merchandise

sold was $4,500

Liabilities1-Jul

1-Jul

Net Effect

Revenue Net Income1-Jul Sales 7,500 7,500

Jan. 3 -4,500

7,500 3,000


Accts. Rec. 7,500

(Net Income)

Merch. Inv. - 4,500

3,000 3,000

4,500

Trans. Date

Trans. Date



Retained Earnings


July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB destination; 2/10, n/30. The cost of the merchandise sold was $4,500

Burton Co. (Buyer)Burton Co. (Buyer)Burton Co. (Buyer)Burton Co. (Buyer)

Liabilities1-Jul A/P 7,500

Net Effect 7,500

Revenue Net Income


Merch. Inv. 7,500

7,500

Trans. Date

Trans. Date



July 5. Scully Company. paid transportation charges of $300 on July 1 sale to Burton Co.



No effect.

Liabilities5-Jul

Net Effect

Revenue Net Income5-Jul -300

Net Effect -300

Trans. Date

Trans. Date


Delivery Expense 300

(Net Income)

-300 -300

Retained Earnings


Cash -300


July 6. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1,000. The merchandise had been purchased by Burton Co. on

account on July 1. The cost of the merchandise returned was $600.


Liabilities6-Jul

6-Jul

Net Effect

Revenue Net Income6-Jul SR&A 1,000 -1,000

Jan. 13 600

Net Effect 1,000 -400


Accounts Rec. -1,000

(Net Income)

Merch. Inv. 600

-400 -400

Trans. Date

Trans. Date


Cost of Merch. Sold -600

Retained Earnings


July 6. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1,000. The merchandise had been purchased by Burton

Co. on account on July 1. The cost of the merchandise returned was $600.


Liabilities6-Jul A/P -1,000

Net Effect -1,000

Revenue Net Income


Merch. Inv. -1,000

-1,000

Trans. Date

Trans. Date



July 11. Scully Company received payment from Burton Co. for purchase of July 11, less discount (2% x $6,500).


Liabilities11-Jul

11-Jul

Net Effect

Revenue Net Income11-Jul Sale Dis. 130 -130

Net Effect 130 -130


Cash 6,370

(Net Income)

Accounts Rec. - 6,500

-130 -130

Trans. Date

Trans. Date


Retained Earnings


July 11. Scully Company received payment from Burton Co. for purchase of July 11, less discount (2% x $6,500).


Liabilities11-Jul A/P -6,500

11-Jul

Net Effect -6,500

Revenue Net Income


Merch. Inv. -130

Cash - 6,370

-6,500

Trans. Date

Trans. Date



Describe the accounting for merchandise shrinkage.7



When a company uses a perpetual inventory, a

physical count is taken at the end of the accounting period to determine the

accuracy of the perpetual records and to record any

inventory shrinkage.


Online Solutions’ inventory records indicate that $63,950 of merchandise should be available for sale on December 31, 2007. The physical inventory taken on

that date indicates that only $62,150 of merchandise is available for sale.

Inventory shrinkage is $1,800Inventory shrinkage is $1,800Inventory shrinkage is $1,800Inventory shrinkage is $1,800

LiabilitiesDec. 31

Net Effect

Revenue Net IncomeDec. 31 1,800

Net Effect 1,800

Trans. Date

Trans. Date



1,800

(Net Income)

-1,800 -1,800

Retained Earnings


Merch. Inv. - 1,800


Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.

8Learning ObjectiveLearning Objective


Gross profit and operating income are two important

profitability measures analyst use in assessing…

Gross profit and operating income are two important

profitability measures analyst use in assessing…

…the efficiency and effectiveness of a

merchandiser’s operations.

…the efficiency and effectiveness of a

merchandiser’s operations.


Net sales $32,004Cost of merchandise sold 22,789Gross profit $ 9,215Operating expenses 8,459Operating income $ 756

$9,2l5$32,004

= 28.8%

Gross Profit PercentGross Profit Percent


J. C. Penney’s gross profit percentage went from 28.8% to 27.7%, then recovered back to

29.8%.

J. C. Penney’s gross profit percentage went from 28.8% to 27.7%, then recovered back to

29.8%.



The recovery in the third year was attributed to better merchandise assortment, improved inventory

productivity, and centralized buying.

The recovery in the third year was attributed to better merchandise assortment, improved inventory

productivity, and centralized buying.



Net sales $32,004Cost of merchandise sold 22,789Gross profit $ 9,215Operating expenses 8,459Operating income $ 756

$756$32,004

= 2.4%

Operating Income PercentOperating Income Percent


The company’s operating income percentage dropped from 2.4% to

0.6%, then recovered back to 2.7%.

The company’s operating income percentage dropped from 2.4% to

0.6%, then recovered back to 2.7%.



This recovery was attributed to lower catalog and marketing costs,

lower telemarketing costs, and a shift from development to

maintenance of JCPenney.com.

This recovery was attributed to lower catalog and marketing costs,

lower telemarketing costs, and a shift from development to

maintenance of JCPenney.com.


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