Exam 2 Notes Study Guides Material Drawn from Kimmel Financial Accounting 7E AccountingCoach com and of course myself Chapter 5 Merchandising Operations What is a Merchandising company A merchandising company is any company that buy and sell merchandise rather than performing services as their primary source of revenue Office Depot Wal Mart Walgreens when they purchase and sell directly to consumers they are called retailers Office Depot when they sell to retailers they are known as wholesalers United Stationers they have two categories of expenses cost of goods sold and operating expenses Cost of Goods Sold the total cost of merchandise sold during the period A merchandising company calculates income by doing the following Sales Revenue CGS Gross Profit Operating Expenses Net Income Loss Operating Cycles merchandising companies normally have longer operating cycles than a service company This is because of the added asset account inventory which lengthens the amount of time taken for the company to receive revenue think of it like this It s much faster for a service company to fix a car and be paid for it than for a merchandising company to purchase inventory put the inventory on sale then sell the inventory and finally receive cash for it Flow of Costs This illustration from the book shows the flow of costs in a merchandising company This simple illustration translates to Beginning Inventory and Cost of Goods Purchased C of G available for sale When we sell goods they are assigned to CGS Any leftover inventory at the end of the accounting period is our ending inventory Perpetual System in this system companies keep records of the cost of each inventory purchase and sale Every time there is a sale the company determines cost of goods sold Ex Grocery stores they scan the bar code on each product you purchase which records the transaction for each individual product you purchase Periodic System in this system the company determines CGS at the end of the accounting period they do this by 1 Determining the cost of goods on hand at the beginning of the accounting period 2 Add cost of goods purchased 3 Subtract cost of goods on hand at the end of the accounting period So the main difference in accounting methods in these two systems is that in the perpetual system CGS is recorded when revenue is recorded In the periodic system revenue is recorded when the transaction takes place and then CGS is recorded at the end of the accounting period Advantages of the Perpetual System gives better control over inventories than the periodic system since inventory records show the quantities that should be on hand the company can check to see if the amount of goods on hand corresponds to the inventory records For the purposes of this chapter we use the Perpetual System Recording Purchases of Merchandise when we record purchases of merchandise we prepare an invoice invoice indicates the total purchase price and other relevant information regarding the purchase when recording purchases of merchandise you should always be thinking to yourself How does this affect the accounting equation A L S E Which accounts are being affects by the transaction Freight Costs buyer The sales agreement should indicate who is paying for the transportation of goods to the FOB free on board shipping point seller places goods on the carrier for free and the FOB destination seller places the goods free on board to the buyer s place of business buyer pays he freight costs and the seller pays the freight Something important to note here is the difference in timing of the transfer of ownership With FOB shipping point the ownership of the goods passes to the buyer as soon as the seller loads it to the carrier In FOB destination the ownership passes to the buyer when the carrier is unloaded at the destination This is important to note because the buyer records the effect on the asset inventory only when they are in ownership of the merchandise When the buyer incurs freight costs the amount of the freight costs is included in the debited inventory account When the seller incurs freight costs they incur operating expenses on the outgoing merchandise and usually compensate the higher cost to their company by setting a higher invoice price for the merchandise Purchase Returns and Allowances If a buyer is dissatisfied with the merchandise they received from the seller then can return it for a refund of credit or cash Or they can keep the merchandise if the seller is willing to reduce the purchase price called a purchase allowance When recorded a purchase refund would show a credit to inventor for the amount refunded and a debit to either cash or accounts payable for the amount paid An purchase allowance is recorded by a credit to inventory for the amount the price was reduced and a debit to either cash or accounts payable for the same amount Purchase Discounts Sometimes a seller will have terms on the invoice which allows the buyer to receive a discount called a purchase discount for paying for their merchandise within a certain period The discount period is specified in the format discount of days Ex If in the terms the number is 2 10 n 30 then if payment is made within 10 days the buyer will receive a 2 discount Otherwise the invoice price is due 30 days from the invoice date When calculating discount we always use the invoice price any returns or allowances Ex If we purchased 4 000 worth of inventory returned 500 of it and paid for the merchandise within the discount period 2 10 what would our discount be 4000 500 3 500 3 500 is now our gross invoice price 3 500 x 2 70 Our discount is 70 and is recorded by crediting inventory 70 because it is reducing the price for the asset credit cash for the amount owed 3 430 and debit accounts payable for the gross invoice price Debits Credits so we are in good shape Recording Sales of Merchandise We record sales revenue when the goods are transferred from seller to buyer Every sales transaction is supported by a document that provides written evidence of the sale such as cash register documents For every sales transaction the seller makes 2 entries 1 debits A R or cash 2 credits sales revenue 3 debits CGS and 4 credits inventory Sales Returns and Allowances Here we look at the flip side or the seller s perspective on sales returns and allowances If the buyer of goods returns merchandise the seller needs to account for this with an account called Sales returns and allowances which is a
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