Chapter 5 Merchandising Operations And The Multi Step Income Statement Seven learning objectives 1 Identify the differences between a service company and a merchandising company a Merchandising operations i Merchandising companies 1 Buy and sell goods ex Amazon Walmart etc a Two types i Retailers sells to customers who are the final ii Wholesalers sells to retailers who sell to final consumer consumer 2 The primary source of revenues is referred to as sales revenue or sales Income measurement 3 a Cost of goods sold is the total cost of merchandise sold Sales Revenue Less Gross Profit Less Operatin g Expenses Equals Net income loss during the period Equal s Cost of Goods Sold Not used in service business 4 Operating Cycles 5 Flow of Costs a The operating cycle of a merchandising company ordinarily is longer than that of a service company a Companies use either a perpetual inventory system or a periodic inventory system to account for inventory i Periodic system on hand 1 Do not keep detailed records of the goods 2 Cost of goods sold determined by count at the end of the accounting period 3 Calculation of Cost of Goods Sold Beginning Inventory Add Purchases net goods available for sale Less Ending inventory Cost of goods sold ii Perpetual System 1 Maintain detailed records of the cost of each inventory purchase and sale 2 Records continuously show inventory that should be on hand for every item 3 Company determines cost of goods sold each time a sale occurs iii Advantages of the Perpetual System 1 Shows the quantity and cost of the inventory that should be on hand at any time 2 Provides better control over inventories than a periodic system 3 Traditionally used for merchandise with high unit values 2 Explain the recording of purchases under a perpetual inventory system a Recording Purchases of Merchandise i Made using cash or credit on account ii Normally record when goods are received from the seller iii Purchase Invoice should support each credit purchase iv Freight Costs terms of Sale 1 FOB free on board Shipping point buyer pays freight costs a Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller 2 FOB free on board Destination Seller pays freight costs a Ownership of the goods remains with the seller until the goods reach the buyer 3 Freight costs incurred by the seller are an operating expense v Purchase Returns and Allowances 1 Purchaser may be dissatisfied because goods are damaged or defective of inferior quality or do not meet specifications Purchase Return Return goods for credit if the sale was made on credit or for a cash refund if the purchase was for cash Purchase Allowance May choose to keep the merchandise if the seller will grant a reduction of the purchase price vi Purchase Discounts 1 Credit terms may permit buyer to claim a cash discount for prompt payment 2 Advantages a Purchaser saves money b Seller shortens the operating cycle by converting the accounts receivable into cash earlier 2 10 n 30 2 discount if paid within 10 days otherwise net amount due within 30 days 1 10 EOM 1 discount if paid within first 10 days of next month n 10 EOM Net amount due within the first 10 fays of the next month 3 Explain the recording of sales revenues under a perpetual inventory system a Recording Sales of Merchandise i Made using cash or credit on account ii Sales revenue like service revenue is recorded when the performance obligation is satisfied iii Performance obligation is satisfied when the goods are transferred from the seller to the buyer iv Sales invoice should support each credit sale Cash or Accounts Receivable b Journal Entries to Record a Sale 1 Debit Credit Sales Revenue Credit Inventory c Sales Returns and Allowances 2 Debit Cost of Goods Sold i Flip Side of purchase returns and allowances ii Contra revenue account to sales Revenue debit iii Sales not reduced debited because 1 Would obscure importance of sales returns and allowances as a percentage of sales 2 Could distort comparison i Offered to customers to promote prompt payment of the balance d Sales Discount due ii Contra revenue account debit to sales revenue 4 Distinguish between a single step and a multi step income statement a Income Statement Presentation i Single Step Income Statement 1 Subtract total expenses from total revenues 2 Two reasons for using the single step format a Company does not realize any type of profit or income until total revenues exceed total expenses b Form is simple and easy to read ii Multiple Step Income Statement 1 Highlights the components of net income 2 Three important line items a Gross profit b c Net income Income from operations 5 Determine cost of goods sold under a periodic system a Determining Cost of Goods Sold Under a Periodic System i No running account of changes in inventory ii Ending inventory determined by physical count iii Cost of Goods sold not determined until the end of the period 6 Explain the factors affecting profitability a Evaluating Profitability i Gross Profit Rate 1 May be expressed as a percentage by dividing the amount of gross profit by net sales 2 A decline in the gross profit rate might have several causes a Selling products with a lower markup b Increased competition may result in a lower selling price c Company forced to pay higher prices to its suppliers without being able to pass these costs on to its customers 1 Measures the percentage of each dollar of sales that results in 2 How do the gross profit rate and profit margin ratio differ a Gross profit rate measures the margin by which selling price exceeds cost of goods sold b Profit margin ratio measures the extent by which selling price covers all expenses including cost of goods sold ii Profit Margin Ratio net income 7 Identify a quality of earnings indicator a Keeping an eye on cash i Earnings have high quality if they provide a full an transparent depiction of how a company performed 8 Explain the recording of purchases and sales of inventory under a periodic inventory system a Appendix 5A i Recording Merchandise Transactions 1 Record revenues when sales are made 2 Do not record cost of merchandise sold on the date of sale 3 Physical inventory count determines a Cost of merchandise on hand b Cost of merchandise sold during the period 4 Record purchases in Purchases account 5 Purchase returns and allowances Purchase discounts and Freight costs are recorded in separate accounts Merchandizin Recording Income Statement Evaluating Review
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