Accounting 2000 Chapter 5 Notes 1 Identify the differences between a service company and a merchandising company 2 Explain the recording of purchases under a perpetual inventory system 3 Explain the recording of sales revenues under a perpetual inventory system 4 Distinguish between a single step and a multiple step income statement 5 Determine cost of goods sold under a periodic system 6 Explain the factors affecting profitability Merchandising Companies Buy and sell goods Primary source of revenue is Sales Revenue Income Measurement NOT USED FOR SERVICE COMPANY SALES COST OF GOODS SOLD GROSS PROFIT COGS is the total cost of goods sold during the period Accounting 2000 Chapter 5 Notes Operating Cycles Which generally takes more time Merchandise Inventory Flow of Costs Accounting 2000 Chapter 5 Notes Expense income statement Asset Balance Sheet Companies use either a perpetual inventory system or a periodic inventory system account for inventory What s the difference Perpetual continuous o Maintain detailed records of the cost of each inventory purchase and sale o Records continuously show inventory that should be on hand o Company determines cost of goods sold each time a sale occurs o Do not keep detailed records of the goods on hand o Cost of goods sold determined by count at the end of the accounting Periodic period Accounting 2000 Chapter 5 Notes o Calculation of Cost of Goods Sold Example Cindy s Boutique had 5 000 of inventory on hand at the start of the year During the year she purchased 60 000 of inventory At year end she counted inventory with a cost of 8 000 on hand What is her Cost of Goods Sold at year end Beginning inventory 5 000 Add Purchases net 60 000 Goods available for sale 65 000 Less Ending inventory 8 000 Cost of goods sold 57 000 We will learn how to record inventory related transactions using the perpetual system Let s Start with the Purchaser Recording Purchases Can be made using cash or credit Normally recorded when goods are received Purchase invoice should support each credit purchase Accounting 2000 Chapter 5 Notes Saulk Stereo the purchaser would record this purchase as Dr Inventory increase 3800 5 4 Cr Accounts Payable Increase 3800 Assume upon delivery of the goods on May 6 Sauk Stereo pays Haul It Freight Company 150 for freight charges the entry on Sauk Stereo s books is 5 6 Dr Inventory 150 Cr Cash 150 Accounting 2000 Chapter 5 Notes A Purchaser may be dissatisfied because goods are damaged or defective of inferior quality or do not meet specifications Purchase Return or Purchase Allowance return goods keep goods with a price reduction Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing 300 5 8 Dr Accounts Payable decrease 300 Cr Inventory decrease 300 Credit terms may permit buyer to claim a cash discount for prompt payment What were Sauk s credit terms 2 10 n 30 This means 2 discount paid in 10 days net balance due in 30 days Assume Sauk Stereo pays the balance due of 3 500 gross invoice price of 3 800 less purchase returns and allowances of 300 on May 14 the last day of the discount period Prepare the journal entry Sauk Stereo makes to record its May 14 payment 3 500 x 2 70 3500 70 3430 5 14 Dr Accounts Payable decrease 3500 Cr Cash decrease 3430 Inventory decrease 70 What if Saulk did paid on 5 15 5 15 Dr Accounts Payable decrease 3 500 Cr Cash decrease 3 500 Accounting 2000 Chapter 5 Notes What is the inventory balance after these transactions Inventory Dr Cr purchase 5 4 3800 5 8 300 return freight in 5 6 150 5 14 70 discount 3580 total Now let s see the FLIP SIDE The Seller Recording Sales of Merchandise Can be made using cash or credit Normally recorded when earned usually when goods transfer from seller to buyer Sales invoice should support each credit sale Assume PW Audio Supply records its May 4 sale of 3 800 to Sauk Stereo on account Illustration 5 5 as follows Assume the merchandise cost PW Audio Supply 2 400 5 4 Dr Accounts Receivable increase 3800 SALES Cr Sales Revenue increase 3800 5 4 Dr COGS increase 2400 COST Cr Inventory decrease 2400 Accounting 2000 Chapter 5 Notes Sales Returns and Allowances 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 Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a 300 selling price assume a 140 cost Assume the goods were not defective 5 8 Dr Sales Revenue Allowances increase 300 Cr Accounts receivable decrease 300 5 8 Dr Inventory increase 140 Cr COGS decrease 140 Assume the returned goods were defective and had a scrap value of 50 PW Audio would make the following entries 5 8 Dr Sales Revenue Allowances increase 300 Cr Accounts Receivable decrease 300 Accounting 2000 Chapter 5 Notes 5 8 Dr Inventory increase 50 Cr COGS decease 50 Sales Discounts Offered to customers to promote prompt payment Flipside of purchase discount Contra revenue account debit Assume Sauk Stereo pays the balance due of 3 500 gross invoice price of 3 800 less purchase returns and allowances of 300 on May 14 the last day of the discount period Prepare the journal entry PW Audio Supply makes to record the receipt on May 14 3500 x 2 70 3500 70 3430 5 14 Dr Cash increase 3430 Sales discount 70 Revenue Cr Accounts Receivable decrease 3500 Accounting 2000 Chapter 5 Notes Gross What s the profit for PW Audio Supply COGS COGS 5 4 2400 I 5 8 140 Net Sales Dr I CR Gross Profit I 2260 Exercise 5 4 How are Merchandiser s Financial Statements different from Service Companies Balance Sheet includes an inventory account current asset Income Statement most prefer a multiple step income statement Single Step Advantages Easy to read Accounting 2000 Chapter 5 Notes Multiple Step Advantages Highlights the components of net income Three important line items 1 gross profit 2 income from operations 3 net income Nonoperating Activities Various revenues and expenses and gains and losses that are unrelated to a company s main line of operations Accounting 2000 Chapter 5 Notes Why is Wal Mart s lower than Target Lower profit margin mark up cost cost leader Accounting 2000 Chapter 5 Notes What does Profit Margin mean of sales kept as net income Class Exercises Exercise 5 4 Problem 5 3A Problem 5 4A mult step income statement ratios only