Ch 5 Merchandising Operations and the Multiple Step Income Statement Merchandising Operations Walmart Kmart and Target are called merchandising companies because they buy and sell merchandise rather than perform services as their primary source of revenue Merchandising companies that purchase and sell directly to consumers are called retailers Merchandising companies that sell to retailers are known as wholesalers The primary source of revenues for merchandising companies is the sale of merchandise often referred to as sales revenue or sales A merchandising company has 2 categories of expenses The cost of goods sold o o Operating expenses Cost of goods sold COGS the total cost of merchandise sold during the period o This expense is directly related to the revenue recognized from the sale of goods OPERATING CYCLES The operating cycle of a merchandising company ordinarily is longer than that of a service company The purchase of merchandise inventory and its eventual sale lengthen the cycle FLOW OF COSTS Flow of costs for merchandising company o Beginning inventory is added to the cost of goods purchases to arrive at cost of goods available for sale Cost of goods available for sale is assigned to the COGS goods sold this period and ending inventory goods to be sold in the future Companies use one of 2 system to account for inventory a perpetual inventory system or a periodic inventory system Perpetual System In a perpetual inventory system companies maintain detailed records of the cost of each inventory purchase and sale These records continuously perpetually show the inventory that should be on hand for every item Under a perpetual inventory system a company determines the COGS each time a sale occurs Periodic System In a periodic inventory system companies don t keep detailed inventory records of the goods on hang throughout the period They determine the COGS only at the end of the accounting period periodically l At that point the company takes a physical inventory count to determine the cost of goods on hand determine the COGS under a periodic inventory system the following steps are necessary 1 Determine the cost of goods on hand at the beginning of the accounting period 2 Add to it the cost of goods purchases 3 Subtract the cost of gods on hand at the end of the accounting period Additional Considerations A perpetual inventory system provides better control over inventories than a periodic system Recording Purchases of Merchandise Companies may purchase inventory for cash or on account credit They normally record purchases when they receive the goods from the seller Every purchase should be supported by business documents that provide written evidence of the transaction Each cash purchase should be supported by a canceled check or a cash register receipt indicating the items purchased and amounts paid Companies record cash purchases by an increase in Merchandise Inventory and a decrease in Cash Each purchase should be supported by a purchase invoice which indicates the total purchase price and other relevant info o However the purchases doesn t prepare a separate purchase invoice Instead the purchases uses as a purchase invoice the copy of the sales invoice sent by the seller Under the perpetual inventory system companies record purchases of merchandise for sale in the Merchandise Inventory account FREIGHT COSTS The sales agreement should indicate who the seller or the buyer is to pay for transporting the goods to the buyer s place of business When a common carrier ex railroad trucking company or airline transports the goods the carrier prepares a freight bill in accord with the sales agreement Freight terms are expressed as either FOB shipping point or FOB destination FOB free on board Thus FOB shipping point means that the seller places the goods free on board the carrier and the buyer pays the freight costs Conversely FOB destination means that the seller places the goods free on board to the buyer s place of business and the seller pays the freight Freight Costs Incurred by Buyer When the buyer pays the transportation costs these costs are considered part of the cost of purchasing inventory As a result the account Merchandise Inventory is increased Thus any freight costs incurred by the buyer are part of the cost of merchandise purchases o The reason inventory cost should include any freight charges necessary to deliver the goods to the buyer Example Freight Costs Incurred by Seller Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller These costs increase an expense account titled Freight out or Delivery expense When the seller pays the freight charges the seller will usually establish a higher invoice price for the goods to cover the expense on shipping Example price PURCHASE RETURNS AND ALLOWANCES The purchaser may return the goods to the seller for credit if the sale was made on credit or for chase refund if the purchase was for cash o Known as a purchase return Incentives to both parties the purchaser saves money and the seller is able to shorten the operating cycle by converting the accounts receivable into cash earlier The credit terms specify the amount of the cash discount and time period during which it is offered o Also indicate the length of time in which the purchaser is expected to pay the full invoice When the seller elects not to offer a cash discount for prompt payment credit terms will specify only the maximum time period for paying the balance due o Ex the credit terms may state the time period as n 30 n 60 or n 10 EOM This means the buyer must pay the net amount in 30 days 60 days or within the first 10 days of the next month When an invoice is paid within the discount period the amount of the discount decreases Merchandise Inventory o This is because the merchandiser records inventory at its cost and by paying within the discount period it has reduced that cost A merchandise company usually should take all available discounts Passing up the discount may be viewed as paying interest for use of the money Example PURCHASE DISCOUNTS The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment o The buyer calls this cash discount a purchase discount The incentives are the purchaser saves money and the seller is able to shorten the operating cycle by converting the A R into cash earlier The credit terms specify the amount of the cash discount and time period during
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