Chapter 5 Accounting for Merchandising Operations Merchandising Operations Merchandising companies 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 Merch co has 2 categories of expenses Primary source of revenues for merchandising companies is sale of merchandise Sales revenue Costs of goods sold total cost of merchandise sold during the period directly related to revenue recognized from the sale of goods Sales rev cost of goods sold gross profit operating expenses net income Operating expenses Operating Expenses longer than service company merch inventory lengthen cycle Flow of Costs Beginning inventory plus cost of goods purchased is the cost of goods available for sale As goods are sold they are assigned to cost of goods sold Goods not sold are ending inventory Companies use one of two systems to account for inventory Perpetual System keep detailed records of the cost of each inventory purchase and sale Continuously perpetually show the inventory that should be on hand for every intern Company determines the cost of goods sold each time a sale occurs Periodic system Companies do not keep detailed inventory records of the goods on hand throughout the period Determine costs of goods sold only at the end of the accounting period Following steps are necessary 1 determine cost of goods on hand at beginning of accounting period 2 Add to it the cost of goods purchased 3 subtract the cost of goods on one hand at the end of the accounting period Additional Considerations Companies that sell merch with high unit values usually use perpetual Perp inventory system provides better control over inventories than periodic Small merch businesses find perpetual system costs more than it is worth Companies either purchase inventory using cash or credit normally record purchases when they receive the goods from the seller Purchase invoice should support each credit purchase Recording Purchases of Merchandise Indicates the total purchase price and other relevant information Purchaser does not prepare a separate purchase invoice Uses as a purchase invoice a copy of the sales invoice sent by th4e seller Not all purchases are debited to inventory Companies record purchases of assets acquired for use and not for resale to specific asset accounts rather than to Inventory Freight Costs Sales agreement should indicate who is paying for transporting the goods to the buyer s place of business FOB means Free On Board FOB Shipping Point means that the seller places the goods free on board the carrier and the buyer pays the freight costs FOB Destination means that the seller places the good FOB to the buyer s place of business and the seller pays the freight Chapter 5 Pg 1 Freight Costs Incurred by the Seller expense Purchase Returns and Allowances Purchase Discounts Freight Costs Incurred by the Buyer When a buyer incurs transportation costs these costs are considered part of the cost of purchasing inventory Debit the account Inventory the cost of the freight charges Inventory cost should include all costs to acquire the inventory including freight necessary to deliver the goods to the buyer Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller Increase an expense account titled Freight Out or Delivery Expense When the seller pays the freight charges it will usually establish a higher invoice price for the goods to cover the shipping Purchase Return when a customer returns a product they find inferior or unsatisfactory Purchase Allowance Purchaser may choose to keep the merchandise if the seller is willing to grant an allowance from the purchase price Returning an item would debit Accounts Payable and decrease Inventory The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment Buyer calls this cash discount a purchase discount Offers incentives to two parties Purchaser saves money Seller shortens operating cycle by more quickly converting the accounts receivable to cash Credit terms specify the amount of the cash discount and time period in which it is offered May also indicate the time period in which the purchaser is expected to pay the full invoice price Buyers can take a 2 cash discount on the invoice price less any returns or allowances if the payment is made within 10 days of the invoice date discount period Merchandising company usually should take all available discounts Passing up the discount may be viewed as paying interest for use fo the money Recording Sales of Merchandise Companies follow the revenue recognition principle by recording sales revenue when the performance obligation is satisfied Typically satisfied when the goods transfer from the seller to the buyer Sales can be made credit or cash Business Documents should support every sales transaction to provide written evidence of the sale Cash Register Tapes provide evidence of cash sales Sales Invoice provide support for a credit sale Seller makes two entries for each sale First entry records the sale Debits cash and credits sales revenue Second entry records the cost of the merchandise sold Debits Cost of Goods Sold and credits Inventory for the cost of those goods Companies may use more than one sales account Sales Returns and Allowances The flipside of purchase returns and allowances which the seller records as sales returns and allowances Seller either accepts goods back from the buyer a return or grants a reduction in the purchase price allowance so the buyer will keep the goods Sales Returns and Allowances is a contra revenue account to sales revenue A debit recorded directly to Sales Revenue would obscure the relative importance of sales returns and allowances as a percentage of sales Sales Discounts Sales discount is based on the invoice price less returns and allowances if any Seller debits Sales Discounts Completing the Accounting Cycle Pgs 232 240 Chapter 5 Pg 2 Adjusting Entries Generally has same types of adjusting entries as a service company Merchandiser using a perpetual system will require one additional adjustment to make the records agree with the actual inventory on hand At the end of each period merchandising company that uses perpetual will take physical count of its good on hand Company needs to adjust perpetual records to