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Exam 2 Notes + Study GuidesMaterial Drawn from: Kimmel, Financial Accounting, 7E; AccountingCoach.com; and of course, myselfChapter 5Merchandising OperationsWhat 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 fora merchandising company to purchase inventory, put the inventory on sale, then sell the inventory, and finally receive cash for it.Flow of CostsThis illustration from the book shows the flow of costs in a merchandising company. This simpleillustration 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 soldEx. 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 period2. Add cost of goods purchased3. 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 SystemRecording 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- The sales agreement should indicate who is paying for the transportation of goods to the buyer.- FOB (free on board) shipping point – seller places goods on the carrier for free, and thebuyer pays he freight costs.- FOB destination – seller places the goods free on board to the buyer’s place of business, 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 canreturn it for a refund of credit or cash. Or, they can keep the merchandise if the seller iswilling to reduce the purchase price, called a purchase allowance. - When recorded, a purchase refund would show a credit to inventor for the amountrefunded, 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 wasreduced, 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 adiscount, called a purchase discount, for paying for their merchandise within a certainperiod.- The discount period is specified in the format discount/# of days. Ex. If in the terms thenumber 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% = $70Our discount is $70 and is recorded by crediting inventory $70 (because it is reducing theprice 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


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