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©2006 Prentice Hall, Inc.

 ACCOUNTING FOR
MERCHANDISING OPS (1 of 2)
 Learning objectives
 Merchandising firms
 Acquiring merchandise for sale
 Sale of merchandise

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©2006 Prentice Hall, Inc.
 ACCOUNTING FOR
MERCHANDISING OPS (2 of 2)
 Recording inventory
 Multiple-step income statement
 Financial statement analysis
 Business risk, controls, and ethics

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©2006 Prentice Hall, Inc.
 Learning Objectives
(1 of 2)

1. Describe the differences between service

and merchandising firms
2. Explain how merchandise in acquired
and perform the related record-keeping
3. Explain how sales are made and perform
the related record-keeping
4. Explain the differences between a
periodic and perpetual inventory system
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©2006 Prentice Hall, Inc.
 Learning Objectives
(2 of 2)

5. Explain the difference between a single-

step income statement and a multiple-
step income statement
6. Compute the gross profit ratio and
profit margin ratio to evaluate a firm’s
profitability
7. Recognize the special risks and controls
related to inventory
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©2006 Prentice Hall, Inc.
 Merchandising Firms
(1 of 3)

 Two types of merchandising firms

Retailers
sell products to the final consumer
Wholesalers sell products to retailers or
other wholesalers
 Cost of Goods Sold (CoGS)
Cost of merchandise sold during the period

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©2006 Prentice Hall, Inc.
 Merchandising Firms
(2 of 2)

 Gross profit (also called gross margin)

Sales Revenue – CoGS
 Operating cycle for merchandising firm
Purchase inventory
Sell inventory, creating accounts receivable
(AR)
Collect cash from customers, reducing AR
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©2006 Prentice Hall, Inc.
 Acquiring Merchandise For Sale
(1 of 2)

 What is merchandise inventory?

Where on the balance sheet is it?
 Acquisition process for inventory
 Periodic & perpetual inventory

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©2006 Prentice Hall, Inc.
 Acquiring Merchandise For Sale
(2 of 2)

 Recording purchases: perpetual

Freightcosts
Purchase Returns and Allowances
Purchase Discounts
Goods available for sale

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©2006 Prentice Hall, Inc.
 Acquisition Process for Inventory
(1 of 3)

 Inventory manager sends purchase

requisition to purchase agent
 Purchase agent sends purchase order
(PO) to chosen vendor
Copies to accounts payable (AP) and
receiving departments
No quantity on receiving dept’s copy
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©2006 Prentice Hall, Inc.
 Acquisition Process for Inventory
(2 of 3)

 Objectives of purchase process

Quality
Purchase from reliable vendors
Timeliness
Vendors must have an adequate supply of
merchandise to avoid stock-outs
Accuracy
Receive only items ordered 5-11
©2006 Prentice Hall, Inc.
 Acquisition Process for Inventory
(3 of 3)

 Receiving dept notifies AP dept when

goods arrive
 AP pays for goods when it receives
invoice from vendor
Invoice matched with purchase order
 How does a computer change this
process?
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©2006 Prentice Hall, Inc.
 Periodic and Perpetual Inventory
 Perpetual inventory system
Every purchase of inventory is recorded
directly to inventory account
 Periodic inventory system
Inventory account only updated at the
end of the accounting period

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©2006 Prentice Hall, Inc.
 Recording Purchases: Perpetual
Transaction 1

 Gravity Power Sports (GPS) Purchase 20

skateboards on account for $150 each
Increase inventory $3,000
Increase AP $3,000
 Record the journal entry
Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Freight Costs
Transaction 2 (1 of 3)

 FOB (free on board) shipping point

Shipping is free until it leaves the
seller’s loading dock
Buying firm pays freight
Recorded as freight-in
Included in cost of inventory

Who owns the goods while they are in

transit? Where does title pass? 5-15
©2006 Prentice Hall, Inc.
 Freight Costs
Transaction 2 (2 of 3)

 FOB destination
Shipping is free until it arrives at the
buyer’s place of business
Selling firm pays the freight
No freight-in charge
Not included in cost of inventory

Who owns the goods while they are in

transit? Where does title pass? 5-16
©2006 Prentice Hall, Inc.
 Freight Costs
Transaction 2 (3 of 3)

 Shipping charges to GPS on skateboards

were $100 with terms FOB shipping point
What accounts are affected?
Do they increase or decrease?

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Purchase Returns and Allowances
Transaction 3 (1 of 3)

 Amounts that reduce $$ of inventory

purchases due to returned or
damaged inventory
Also reduce accounts payable for
inventory purchased on account
Which account is affected if the inventory
was purchased for cash?

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©2006 Prentice Hall, Inc.
 Purchase Returns and Allowances
Transaction 3a (2 of 3)

 Purchase return
Three skateboards were defective
(3@$150) and returned to the vendor

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Purchase Returns and Allowances
Transaction 3b (3 of 3)

 Purchase allowance
The decks had graphics for Bores of Hogtown
movie instead of Lords of Dogtown movie
GPS received a $250 purchase allowance

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Purchase Discounts
Transaction 4 (1 of 4)

3/10, n/45

3% discount
Or full
If received amount Due w/in
w/in 10 days 45 days

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©2006 Prentice Hall, Inc.
 Purchase Discounts
Transaction 4 (2 of 4)

 Annual rate of return if taking

advantage of discount

# of days Annual
Discount ÷ paid early x 360 = rate of
(or 365)
return
 Calculate the annual rate of return if
you pay early with terms 3/10, n/45 5-22
©2006 Prentice Hall, Inc.
 Purchase Discounts
Transaction 4a (3 of 4)

 GPS pays the balance due within the

discount period with terms 3/10, n/45
Discount calculated on balance due

Inventory Accts. Payable

Dr. Cr. Dr. Cr. Dr. Cr.
3,000 450 450 3,000
100 250 250
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©2006 Prentice Hall, Inc.
 Purchase Discounts
Transaction 4b (4 of 4)

 How would the transaction change if GPS

paid outside of the discount period?

Inventory Accts. Payable

Dr. Cr. Dr. Cr. Dr. Cr.
3,000 450 450 3,000
100 250 250
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©2006 Prentice Hall, Inc.
 Goods Available for Sale
Beginning inventory
+ Net purchases (total purchases less
returns and allowances and discounts)
+ Shipping costs (freight in) _
Goods available for sale

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©2006 Prentice Hall, Inc.
 Sale of Merchandise
 Sales are the mirror image of purchases
What the vendor records when you make
an inventory purchase
 Sales process for merchandise inventory
 Recording sales
Sales Returns and Allowances
Sales Discounts
Net sales
Credit card sales and sales taxes 5-26
©2006 Prentice Hall, Inc.
 Sales Process for Merchandise
Inventory
 Steps in the sales process
1. Customer
places an order
2.Company approves the order
3.Warehouse selects goods for shipment
4.Company ships goods
5.Company bills customer for goods
6.Company receives payment for the goods
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©2006 Prentice Hall, Inc.
 Recording Sales
Transaction 5: Revenue (1 of 3)

 GPS sells 11 skateboards on account for

$250 each
 Increase Sales $2,750
 Increase AR $2,750

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Recording Sales
Transaction 5: Expense (2 of 3)

 How much did GPS pay for the 17

(20 – 3 returned) skateboards assuming
they paid w/in the discount period?
$3,000 purchase price
+ 100 freight-in
- 450 purchase return
- 200 purchase allowance
$2,400 for 17 skateboards
 How much did each skateboard cost? 5-29
©2006 Prentice Hall, Inc.
 Recording Sales
Transaction 5: Expense (3 of 3)

 GPS sells 11 skateboards on account for

$250 each 1/15, n/30
 Increase or decrease merchandise inventory?
 Increase CoGS $2,750
 On which fin. stmt. will you find CoGS?

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Sales Returns and Allowances
Transaction 6 (1 of 5)

 Contra-revenue account
Used to reduces a firm’s revenue
 Net revenue
Revenue less contra-revenue
 Sales Returns and Allowances
Decrease revenue because you reduce a
customer’s AR account or give a cash
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refund (if the customer paid cash)
©2006 Prentice Hall, Inc.
 Sales Returns and Allowances
Transaction 6 (2 of 5)

 Customer returned one skateboard

because it was defective
First, undo the revenue side of the
transaction
What was the sale price of the merchandise?
Second, undo the expense side of the
transaction
How much did the merchandise sold cost? 5-32
©2006 Prentice Hall, Inc.
 Sales Returns and Allowances
Transaction 6: Reverse Revenue (3 of 5)

 The sales price was $250

Increase Sales Returns and Allowances
If revenues increase with credits, how would
you increase a contra-revenue?
Decrease AR

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Sales Returns and Allowances
Transaction 6: Reverse Expense (4 of 5)

 Cost of the merchandise sold was $150

ReduceCoGS by $150
What happens to the inventory account?

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Sales Returns and Allowances
Transaction 6: Reverse Expense (5 of 5)

 How would the transaction change if

GPS granted a Sales Allowance?
Would the revenue side of the sale
need to be reversed?
Would the expense side of the sale
need to be reversed?
 Why would a business record SR&A
in a separate account?
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©2006 Prentice Hall, Inc.
 Sales Discounts
Transaction 7 (1 of 4)

 Sales discount
Reduction in sales price offered for
prompt payment
Contra-revenue
Reduces net sales
Based on customer’s outstanding
balance from sales
Sales price less SR&A 5-36
©2006 Prentice Hall, Inc.
 Sales Discounts
Transaction 7 (2 of 4)

 Amount to be received if payment is

received w/in discount period
Cash collected
($2,750 – $250) x (1 – 1%)
Sales discount – increases contra revenue
($2,750 – $250) x 1%
Accounts receivable decreases by full
amount owed
Customers balance completely satisfied for
99% of the amount due 5-37
©2006 Prentice Hall, Inc.
 Sales Discounts
Transaction 7 (3 of 4)

 Make the journal entry if payment

received w/in discount period
Increase Cash
Increase Sales Discounts
Decrease AR

Accts. Rec.
Dr. Cr. Dr. Cr. Dr. Cr.
2,750 250

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©2006 Prentice Hall, Inc.
 Sales Discounts
Transaction 7 (4 of 4)

 How would the journal entry change

if the customer paid outside the
discount period?
How much cash is received?

Accts. Rec.
Dr. Cr. Dr. Cr. Dr. Cr.
2,750 250

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©2006 Prentice Hall, Inc.
 Net Sales
Sales
- Allowances given
- Sales Discounts _
Net sales

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©2006 Prentice Hall, Inc.
 Credit Card Sales and Sales Taxes
(1 of 4)

 Bank cards
Cash sale
Credit card company pays seller full
amount less a service fee (2% - 4%)
Service fee is an expense
E.g, Visa, MasterCard, American Express

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©2006 Prentice Hall, Inc.
 Credit Card Sales and Sales Taxes
(2 of 4)

 Sales tax
Seller collects sales tax from customer
and remits to state/local government
Liability
Sales tax payable

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©2006 Prentice Hall, Inc.
 Credit Card Sales and Sales Taxes
(3 of 4)

 Sell $100 of merchandise to customer

Salestax rate is 5%
Customer pays with bank card with a
3% service fee
 Cash collected
$100 – (3% x $100) + (5% x $100)
 Service Revenue = $100
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©2006 Prentice Hall, Inc.
 Credit Card Sales and Sales Taxes
(4 of 4)

 Journal entry
Increase Cash
Increase Service Fee (expense)
Increase Sales
Increase Sales Tax Payable

Dr. Cr. Dr. Cr.

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©2006 Prentice Hall, Inc.
 Recording Inventory
(1 of 2)

 Perpetual inventory system

Inventory records updated every time a
purchase, sale, or return is made
 Periodic inventory system
Inventory records only updated at end
of accounting period
 Both systems require an actual
inventory count at end of period 5-45
©2006 Prentice Hall, Inc.
 Recording Inventory
(2 of 2)

 Perpetual inventory system can

detect shrinkage
Shrinkage = Inventory account balance
less actual inventory $$ amount based
on physical count of merchandise

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©2006 Prentice Hall, Inc.
 Multistep Income Statement
(1 of 2)

 Single-step income statement

All revenues presented first
All expense subtracted to arrive at net
income

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©2006 Prentice Hall, Inc.
 Multistep Income Statement
(2 of 2)

 Multiple-step income statement

Gross profit
Sales – CoGS
Operating income
Gross profit – operating expenses
Other revenues and expenses not
directly related to firm’s day-to-day
operations 5-48
©2006 Prentice Hall, Inc.
 Financial Statement Analysis
Profitability Measures (1 of 4)

 Gross profit ratio

Gross Profit ÷ Sales
Portion of each sales $ a company has
left after paying for goods it sold
Amount left over to cover operating
and non-operating expenses and
generate a profit
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©2006 Prentice Hall, Inc.
 Financial Statement Analysis
Profitability Measures (2 of 4)

 Profit margin ratio

Net Income ÷ Sales
Measures % of each sales $ that results
in net income
A measure of how well a company is
controlling its operating expenses

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©2006 Prentice Hall, Inc.
 Financial Statement Analysis
Profitability Measures (3 of 4)

 Example: GPS’s results for 2008 & 2009

Year 2008 2009
Sales $500,000 $600,000
CoGS $300,000 $400,000
Net Income $ 50,000 $ 80,000
Gross Profit Ratio $200K/$500K=40% $200K/$600K=33%
Profit Margin Ratio $50K/$500K=10% $80K/$600K=13%
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©2006 Prentice Hall, Inc.
 Financial Statement Analysis
Profitability Measures (4 of 4)

 Explain the trend in GPS’s gross profit

ratio
 Explain the trend in GPS’s profit
margin ratio
 What can you say about GPS’s
profitability based on these ratios?

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©2006 Prentice Hall, Inc.
Business Risk, Control, and Ethics
 Segregation of duties
Person with physical control over
merchandise should NOT also do the
record-keeping on the merchandise
under her control
However, this control can be defeated
if both people get together to commit
fraud
See In the News—Risks and Controls 5-53
©2006 Prentice Hall, Inc.
 Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
richard.newmark@PhDuh.com
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©2006 Prentice Hall, Inc.