Accounting for Merchandising Transactions What is a merchandising business A merchandising business buys products for resale to customers The company can have a traditional bricks and mortar store can conduct operations on line or both Each merchandising transaction involves two parties a buyer and a seller The merchandising company takes the part of the buyer when acquiring its merchandise and the seller when it sells the merchandise to its customers Sales revenue Sales revenue represents amounts earned from selling merchandise inventory to customers a sale is a transfer of ownership title of goods sales may be for cash or credit on account What are sales discounts Some sellers to encourage prompt payment by the buyer offer a discount if the invoice is paid within a certain time period For example if a company sells merchandise and offers credit terms of 3 10 n 30 it means the buyer can take a 3 discount if payment is made within 10 days of the purchase the full amount of the invoice must be paid within 30 days Credit terms of 2 15 n eom mean the buyer can take a 2 discount if payment is made within 15 days of the sale the full amount is due at the end of the month From the buyer s point of view this same discount taken due to early payment is called a purchase discount What are sales returns Sales allowances A sales return is recorded by a seller if the merchandise is returned by the buyer Buyers may return merchandise that is damaged defective or simply because it is not as expected Some sellers have a very liberal return policy others have a strict guidelines regarding what merchandise can be returned and when A sales allowance is a reduction in the price of the merchandise allowed by the seller usually offered if the buyer is somewhat dissatisfied but willing to keep the goods From the buyer s point of view any returns or allowances are called purchase returns and allowances How are sales discounts and sales returns and allowances recorded Both sales discounts and sales returns and allowances represent reductions in total sales revenues Rather than directly reduce the Sales account most companies maintain separate accounts for Sales discounts and for Sales returns and allowances because these amounts provide important information to sellers The income statement of a merchandising company shows Net Sales Net Sales Sales Sales Discounts Sales returns and allowances What does FOB mean FOB is a shipping term that stands for free on board When goods are shipped FOB shipping point the buyer must pay the cost of shipping When goods are shipped FOB destination the seller is paying the cost of shipping FOB terms usually determine when title to the goods passes from the buyer to the seller What are two basic systems used to account for purchasing merchandise inventory 1 Perpetual inventory system Each purchase of inventory and each sale of inventory is recorded in the inventory account The inventory account is continuously updated so that the balance in the inventory account matches the actual count of inventory on hand This system offers more control over inventory for a company but it is more time consuming and costly to maintain Due to the amount of record keeping involved many companies could not afford to use this system in the past Computer software and inventory bar codes have made perpetual systems more affordable and practical 2 Periodic inventory system The inventory account is not updated with each purchase and sale Instead purchases of inventory are added to a special Purchases account At the end of the accounting period an adjusting entry is made to update the inventory account to reflect the actual amount of merchandise on hand and to show the cost of the merchandise sold during the period Even though bar codes and computers have made the perpetual system more affordable than previously many companies continue to use the periodic inventory system 2 What costs should be included in Inventory Generally assets are recorded at cost For inventory cost includes the purchase price AND costs such as freight costs incurred by the buyer to ship the merchandise to the place of business cost of insurance acquired to cover the merchandise while in transit taxes such as excise and sales taxes any costs incurred to get the inventory ready for sale to customers Cost of goods sold Cost of goods sold is also known as cost of merchandise sold or simply cost of sales For many companies COGS is the largest expense COGS represents the selling company s cost for the merchandise that was sold in the current period Using a periodic inventory system COGS is calculated at the end of an accounting period Calculating Cost of Goods Sold The basic computation of cost of goods sold is that it is equal to the cost of beginning inventory plus the net cost of goods purchased during the period less the cost of ending inventory Cost of goods sold Beginning inventory Purchases Net cost of inventory purchased Less Purch Discounts Goods available for sale Freight in Purch R A Cost of goods sold Net cost of inv purch Ending inventory Plus How does the income statement of a merchandising company differ from that of a service business The income statement for any type of company shows the results of operations that is it shows revenues and gains for the period less expenses and losses incurred during the period Often the income statement for a merchandising company is more complex because the merchandising company has more accounts Also merchandising companies often use the multi step format which Classified Income Statement Merchandising Company Net Sales Revenue Cost of goods sold Gross profit Operating expenses1 Income from operations Non operating revenues2 Non operating expenses3 Income before taxes 1 Operating expenses are costs incurred in performing ordinary functions of the business 2 and 3 Non oper revenues are expenses are items such as interest that are not related to the sale of goods and services Gross profit Gross profit is simply the net sales less COGS Gross profit is a shown as a dollar amount Many companies and analysts also look at the gross profit percentage or gross profit as a percentage of total sales GP Gross profit net sales revenue Example problem Income statement for a merchandising firm At the end of its most recent fiscal year Hempstead Company s ledger included the following accounts and balances Administrative expenses 460 Purchase returns Freight in 45 Interest expense Rent