Module 4 - Audio File Legend

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Learning Objectives and Basics of merchandising operations

Recording merchandise purchases and sales Problem: Purchase and sale journal entries Income Statement Formats and Using the

information - Gross Profit Ratio Summary and Review Problems 1

2 3 4 5

Part Content

Part 1 – Learning Objectives

their effects on financial statements (Level 2) 2. Determine the cost of goods sold and ending

inventory using:

– a perpetual inventory accounting system (Level 1); and

– a periodic inventory accounting system (Level 2)

3. Explain the ethical issues related to cash discounts (Level1)

4. Record shrinkage adjustments for a merchandiser (Level 2)

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Part 1 – Learning Objectives

merchandise and the collection of payment (Level 1)

6. Complete a worksheet and prepare the closing entries for a merchandising business (Level 2)

7. Prepare income statements in alternative formats(Level 1)

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Part 1 – Basics of Merchandising Operations

Merchandising company - purchases merchandise inventory and resells it at a profit

• Net sales - Cost of goods sold

= Gross profit (also called “Gross margin”)

• Gross profit - Operating expenses

= Net income (or Net loss)

Service enterprise - charges a fee for service performed

• Fee or commission revenue - operating expenses

= Net income (or Net loss)

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Part 1 – Basics of Merchandising Operations

• Cost of goods sold (COGS) is also called Cost of sales (COS)

• It is the expense of buying and preparing merchandise inventory for resale

Basic Formula:

COGS = Opening Balance, Inventory Add: Purchases (net)

= Goods Available for Sale (GAS) Less: Closing Balance, Inventory

= Cost of Goods Sold (COGS)

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Basic Formula - COGS: Example Assume:

• opening inventory was $1,000,

• purchases during the year were $15,000 and

• the inventory count at year-end showed inventory to be $3,000

Required: Calculate COGS for the year

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Part 1 – Basics of Merchandising Operations

Basic Formula – COGS: Solution

OB, Inv + Purchases = Goods available for sale Goods available for sale – CB, Inv = COGS COGS:

GAS: $1,000 + 15,000 = $16,000 COGS $16,000 – 3,000 = $13,000

Part 1 - Basics of Merchandising Operations

• does NOT keep track of inventory balance during year

• records inventory based on physical count @ year- end

• uses formula to calculate COGS

• uses temporary purchases account

• monthly F/S estimate COGS/inventory balances

• Level 2 (effective 12/02)

Perpetual system

• DOES keep track of inventory balance during year

• purchases & COGS update inventory per G/L on continuous basis

• COGS recorded for each sale

• adjust year-end inventory per G/L based on physical count

• Level 1 (effective 12/02)

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Part 1 - Basics of Merchandising Operations

• does NOT keep track of inventory balance during year

• records inventory based on physical count @ year- end

• uses formula to calculate COGS

• uses temporary purchases account

• monthly F/S estimate COGS/inventory balances

• Level 2 (effective 12/02)

Perpetual system

• DOES keep track of inventory balance during year

• purchases & COGS update inventory per G/L on continuous basis

• COGS recorded for each sale

• adjust year-end inventory per G/L based on physical count

• Level 1 (effective 12/02)

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Part 2 – Recording Purchase Transactions

Periodic system Dr Purchases

Cr Accounts payable Perpetual system

Dr Merchandise inventory Cr Accounts payable

1. Merchandise inventory purchases

• record transaction at purchase date

• assume here that all purchases on credit

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Part 2 – Recording Purchase Transactions

Periodic system Dr Accounts payable

Cr Purchase returns Perpetual system

Dr Accounts payable Cr Merchandise inventory 2. Purchase returns & allowances

• “return” if goods returned to supplier

• “allowance” if goods defective, but kept for sale at a discount, and supplier decreases purchase price

• record entry at date of return/agreement with supplier

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3. Purchase discounts

• purchaser gets a cash discount for prompt payment of purchases made on credit

• discounts reduce cost, so the cost recorded in the merchandise inventory account must reflect prices net of discounts

• supplier receives cash early and reduces risk of uncollectible accounts

• don’t confuse with a trade discount, which is when a merchandiser negotiates a purchase price lower than the ‘list’ price. If trade discount received, simply record purchase at actual invoice price

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Credit terms:

n/30: payment is due 30 days after invoice date n = net amount (balance that is due) /30 = # days after the invoice date that the payment is due

if n/45

n/10 EOM (net 10, end of month) - payment is due 10 days after the end of the month in which the sale occurred

Part 2 – Recording Purchase Transactions

Credit terms:

2/10, n/30 - payment is due 30 days after date of invoice, but a 2% discount can be taken if the invoice is paid within 10 days

2 = percentage of discount

10 = # of days after the invoice date that payment is due

n/30 = normal credit terms

3/15, n/45: can take a 3% discount if paid within 15 days, otherwise balance is due in 45 days Ethical issue

• when taking the discount, pay on time!

Part 2 – Recording Purchase Transactions

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Part 2 – Recording Purchase Transactions

Periodic system Dr Accounts payable Cr Cash

Cr Purchase discounts Perpetual system

Dr Accounts payable Cr Cash

Cr Merchandise inventory

Recording purchase discounts – Gross Method

• record the discount only when taken

• in perpetual system, discount directly reduces cost of inventory; in periodic system it is accumulated in “purchase discounts” account To record payment for the inventory, less purchase discount:

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Recording purchase discounts – Net Method

• net method records the discount at the time of purchase, not at the time of payment

• any discounts lost due to missing the payment deadline are recorded as an operating expense

• the net method is the preferred theoretical approach, as it highlights cost to organization of not taking discount

• notes state that “gross method will be

emphasized” and students should be aware that other alternatives exist. So, I think you should just make a note of what the net method is.

Part 2 – Recording Purchase Transactions

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Part 2 – Recording Purchase Transactions

Periodic system Dr Transportation-in

Cr Accounts payable Perpetual system

Dr Merchandise inventory Cr Accounts payable 4. Transportation-In costs

• cost to receive inventory from supplier

• does NOT include cost to ship goods to customers, which is a selling cost

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Transportation Costs: FOB “Free On Board”

• the supplier records the sale and purchaser records the purchase at time that title to the goods is transferred

• transfer of ownership depends on WHO pays transportation costs and determines WHEN revenue is recognized

• FOB identifies WHEN ownership has transferred

• seller pays to deliver goods to specified location- either FOB shipping point or FOB destination. At the FOB point, title passes from seller to buyer

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Part 2 – Recording Purchase Transactions

FOB Shipping Point

• Ownership transfers when goods passed to carrier(shipping point)

• Seller records revenue

• Buyer records inventory

• Buyer pays transport costs, which are included in inventory

FOB Destination

•Ownership transfers when goods reach buyer (destination)

•Seller records revenue

•Buyer records inventory

•Seller pays transport costs (operating not COGS)

SELLER BUYER

Example: Buyer located in Toronto Seller located in Vancouver

Terms: FOB, Vancouver

 ownership transfers when goods delivered to transportation company in Vancouver

 buyer pays transportation costs (cost added to inventory)

 seller recognizes revenue/receivable &

buyer accrues payable/inventory on date goods shipped

Part 2 – Recording Purchase Transactions

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Example: Buyer located in Toronto Seller located in Vancouver

Terms: FOB, Toronto

 ownership transfers when goods arrive in Toronto

 seller pays transportation costs (selling cost)

 seller recognizes revenue/receivable &

buyer accrues payable/inventory on date goods arrive in Toronto

Part 2 – Recording Purchase Transactions

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Part 2 – Recording Purchase Transactions

Periodic system No entry

Perpetual system Dr COGS

Cr Merchandise inventory 5. Shrinkage

• Loss of inventory due to theft or deterioration

• In perpetual system, it is the difference between actual inventory per count, and inventory per G/L

• In periodic system, shrinkage can not be isolated

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Part 2 – Recording Purchase Transactions

Periodic system Dr Inventory, CB Dr Purchase returns Dr Purchase discounts Dr Income Summary Cr Purchases Cr Transport-In Cr Inventory, OB Perpetual system

Dr Income Summary Cr COGS 6. Closing Entries

• recorded at month-end and/or year-end

• entries that are specific to inventory accounts

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Summary – Periodic calculations:

COGS = Inventory, Opening Balances + Net Purchases

= Goods Available for Sale (GAS) - Inventory, Closing Balance

= COGS Net Purchases: Purchases

- Purchase returns - Purchase discounts + Transportation-In

= Net purchases

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Part 2 – Recording Sale Transactions

Periodic system Dr Accounts

Receivable Cr Sales Revenue No entry for COGS Perpetual system

Dr Accounts Receivable Cr Sales Revenue Dr COGS

Cr Merchandise Inventory 1. Gross sales and cost of sales

• Gross sales revenue from cash and credit sales is recorded when earned - usually when the goods are delivered (refer to FOB)

• Cost of sales are recorded at the time of sale in the perpetual system only

Part 2 – Recording Sale Transactions

Periodic system 1. Return AND allowance Dr Sales Returns & Allow Cr Accounts Receivable 2. Return only

No entry Perpetual system

1. Return AND allowance Dr Sales Returns & Allow Cr Accounts Receivable 2. Return only

Dr Merchandise Inventory Cr COGS

2. Sales returns and allowances

• goods returned by customer(sales return) or kept at a reduced sales price(sales allowance) – contra revenue account

• cost of sales related to returns (not allowances!) are recorded in the perpetual system only

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Part 2 – Recording Sale Transactions

Periodic system Dr Cash

Dr Sales Discounts Cr Accounts Receivable Perpetual system

Dr Cash

Dr Sales Discounts Cr Accounts Receivable 3. Sales discounts

• same concept as purchase discounts where a discount is offered for prompt payment of accounts receivable

• record discount when cash payment is received

• sales discounts is a contra-revenue account

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Part 2 – Recording Sale Transactions

Sales (net) - COGS

= Gross Profit (or Gross Margin) Sales (net): Sales

- Sales returns and allowances - Sales discounts

= Net Sales

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Part 3 – Problem: Purchase & Sale Journal Entries

Problem – Purchase and Sale Journal entries REQUIRED:

The handout lists sales and purchase transactions which occurred during the year. For each transaction, prepare the required journal entry under both the perpetual & periodic systems.

Complete handout then come back for solution

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The following sales and purchase transactions occurred during the year. For each transaction, prepare the required journal entry under both the perpetual & periodic systems.

TRANSACTION # 1:

Make purchase of $10,000, terms 2/10 net 30 JOURNAL ENTRY – Perpetual system

Inventory 10,000 Accounts Payable 10,000 JOURNAL ENTRY – Periodic system

Purchases 10,000 Accounts Payable 10,000

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Part 3 – Problem: Purchase & Sale Journal Entries

TRANSACTION # 2:

Return $2,000 of purchases to supplier JOURNAL ENTRY – Perpetual system

Accounts Payable 2,000

Inventory 2,000

JOURNAL ENTRY – Periodic system Accounts Payable 2,000

Purchase return 2,000

Part 3 – Problem: Purchase & Sale Journal Entries

Pay for purchases within discount period JOURNAL ENTRY – Perpetual system

Accounts Payable 8,000(i)

Cash 7,840

Inventory 160(ii)

JOURNAL ENTRY – Periodic system Accounts Payable 8,000(i)

Cash 7,840

Purchase discount 160 (ii) (i) Accounts Payable: $10,000 – 2,000 = $8,000 (ii) Purchase discount: $8,000 * 2% = $160

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Part 3 – Problem: Purchase & Sale Journal Entries

TRANSACTION # 4:

Pay transportation-in costs

JOURNAL ENTRY – Perpetual system

Inventory 300

Cash 300

JOURNAL ENTRY – Periodic system Transportation-in 300

Cash 300

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Part 3 – Problem: Purchase & Sale Journal Entries

Sell ½ the inventory for $12,000; terms 1.5/15 net 30 JOURNAL ENTRY – Perpetual system

Accounts Receivable 12,000

Sales Revenue 12,000

Cost of goods sold 4,070(i)

Inventory 4,070

(i) Inventory: $10,000 – 2,000 – 160 +300 = $8,140 Therefore, COGS: $8,140 X ½ = $4,070 JOURNAL ENTRY – Periodic system

Accounts Receivable 12,000

Sales Revenue 12,000

No entry for Cost of goods sold

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Part 3 – Problem: Purchase & Sale Journal Entries

10% of sales returned for credit JOURNAL ENTRY – Perpetual system

Sales returns 1,200 Accounts receivable 1,200 Inventory 407(i)

Cost of goods sold 407 (i)10% of sales returned, cost: $4,070* 10%

JOURNAL ENTRY – Periodic system Sales returns 1,200

Accounts Receivable 1,200 No entry for Cost of goods sold

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TRANSACTION # 7:

Cash received within discount period JOURNAL ENTRY – Perpetual system

Cash 10,638

Sales discounts 162 (i) Accounts receivable 10,800

JOURNAL ENTRY – Periodic system

Cash 10,638

Sales discounts 162 (i) Accounts receivable 10,800 (i) A/R: $12,000 – 1,200 = 10,800 * 1.5% = $162

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Part 3 – Problem: Purchase & Sale Journal Entries

Do year-end inventory count: $4,400 JOURNAL ENTRY – Perpetual system

Cost of goods sold 77

Inventory 77 (i)

(i) Inventory: Per general ledger $4,070 + 407 = $4,477

Per count 4,400

Shrinkage $ 77

JOURNAL ENTRY – Periodic system No entry

Part 3 – Problem: Purchase & Sale Journal Entries

Do closing entries:

JOURNAL ENTRY – Perpetual system Sales revenue 12,000 Sales returns 1,200 Sales discounts 162 Income summary 10,638

Income summary 3,740 COGS 3,740(i) (i) COGS: $4,070 – 407 – 77 = $3,740

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Part 3 – Problem: Purchase & Sale Journal Entries

JOURNAL ENTRY – Periodic system Sales revenue 12,000 Sales returns 1,200 Sales discounts 162 Income summary 10,638

Inventory, CB 4,400 Income summary 3,740 Purchase discount 160 Purchase return 2,000

Purchases 10,000

Transportation-in 300

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Part 4 - Income Statement Formats

1. Classified, Multiple-Step: Text pg 283

• details net sales: sales-returns-discounts &

gross profit

• details operating expenses: selling are classified separately from general and administrative expenses

• for internal reporting only

Turn to Text Page 283

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Part 4 - Income Statement Formats

• similar to classified except eliminates detail of net sales and combines costs of selling &

general and administration

3. Single-Step: Text pg 284

• groups all revenues together and all expenses together (including COGS), and usually shows a very summarized listing of operating expenses

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Gross Profit Ratio = Gross Profit x 100 Net sales

Gross Profit (or Gross Margin) = Net sales – COGS

• a strong gross profit ratio is important to ensure that the merchandising company’s operating expenses are covered and net income is earned;

• usually compare gross profit ratio to prior years and to industry standards.

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Part 4 - Using the Information- Gross profit ratio

Example:

Sales $10,200

Sales discounts 200

Net sales $10,000

Less: Cost of goods sold 5,000

Gross profit $ 5,000

Gross profit ratio (5,000/10,000) 50%

Gross profit Net sales

Part 4 – Exercise: Income Statements & Ratio

Required:

a. Prepare a multi-step income statement;

b. Calculate the gross profit ratio;

c. Prepare a single-step income statement;

Stop Presentation Complete required

Then come back for solution!

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Part 4 – Exercise: Income Statements & Ratio

Compu-Soft Income Statement (Multi-Step) For the month ended November 30, 2005 Net sales(27,700 – 45 - 720) $26,935 Cost of goods sold 14,800 Gross profit from sales 12,135 Operating expenses:

Wages $4,200

Utilities 2,100

Amortization 120 6,420 Income from operations 5,715 Other revenue and expense

Rental revenue 850

Net income $ 6,565

Exercise 6 – 15 , Part (a) solution

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Part 4 – Exercise: Income Statements & Ratio

Gross Profit Ratio:

$12,135

$26,936

= 45%

• Need to compare this ratio to

 prior years

 industry averages

Exercise 6 – 15 , Part (b) solution

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Part 4 – Exercise: Income Statements & Ratio

Compu-Soft Income Statement(Single-Step) For the month ended November 30, 2005 Revenues:

Net sales $26,935

Rent revenue 850

Total revenues $ 27,785

Expenses:

Cost of goods sold 14,800 Other operating costs 6,420

Total expenses 21,220

Net income $ 6,565

Exercise 6 – 15 , Part (c) solution

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1. Under a perpetual inventory system (level 1)

• purchases are recorded as a debit to merchandise inventory and a credit to accounts payable

• purchase returns and allowances, purchase discounts, and transportation-in are all recorded directly to the merchandise inventory account

• as sales are recorded, the cost of goods sold is taken out of the merchandise inventory account

• the merchandise inventory account is continually updated

• at the end of the year,when a physical count is performed, the actual inventory is reconciled to the inventory recorded in the general ledger and any shrinkage is charged/credited to cost of goods sold.

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Part 5 - Summary

• purchases are recorded as a debit to purchases and a credit to accounts payable

• purchase returns and allowances, purchase discounts, and transportation-in are all recorded in separate accounts that net against purchases

• when sales are recorded, NO cost of goods sold is recorded. Cost of goods sold is determined at the end of the period based on a physical count

• the merchandise inventory account is only updated at the end of the year when the physical count is performed

Part 5 - Summary

• Gross profit = Net sales - Cost of goods sold

• Cost of goods sold = Beginning inventory + Cost of goods purchased - Ending inventory

• Net income = Gross profit - Operating expenses

4. Sales, Sales returns and allowances, and Sales discounts are recorded in separate accounts.

Under the perpetual system, sales returns that are returned to inventory must be also be recorded in the inventory account, and cost of goods sold must be adjusted.

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Part 5 - Summary

5. FOB, or Free On Board, is term that identifies who is responsible for shipping costs and consequently, when ownership transfers from the seller to the buyer. FOB shipping pt – buyer pays shipping

FOB destination – seller pays 6. The closing process for a merchandise company is

identical to that for a service company. The only difference is that there are additional temporary accounts to close.

7. The gross profit ratio = Gross Profit/Net sales. It is used to assess a company’s profitability before deducting operating expenses.

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Part 5 - Review Questions

a. Prepare journal entries;

b. Calculate closing inventory

Complete handout then come back for solution

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Part 5 - Review Questions

to Needer Ltd. for the year ended December 31, 2003. The company uses a perpetual inventory system using the gross method of accounting for purchase discounts.

1. Purchases of merchandise, all on account, totaled

$590,000. The company’s suppliers offer purchase discounts with the terms of 1/10, n/30.

Inventory 590,000

Accounts payable 590,000

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March 2004 Exam, Question 3 (13 marks) 2. Needer incurred transportation-in costs of

$6,000. The transportation costs were paid for in cash.

Inventory 6,000

Cash 6,000

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Part 5 - Review Questions

purchased, taking advantage of the purchase discount of 60% of the inventory paid for.

Accounts payable 560,000

Inventory 3,360

Cash 556,640

Part 5 - Review Questions

March 2004 Exam, Question 3 (13 marks), con’t 4. Inventory, purchased at a cost of $20,000,

was returned to the supplier in exchange for cash. The inventory had already been paid for and Needer did not take advantage of the purchase discount when it paid for the inventory.

Cash 20,000

Inventory 20,000

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Part 5 - Review Questions

March 2004 Exam, Question 3 (13 marks), con’t 5. Sales for the year amounted to $920,000, all of

which were cash. The cost of inventory is equal to 50% of its selling price.

Cash 920,000

Sales Revenue 920,000

COGS 460,000*

Inventory 460,000 *

Cost of sales: $920,000 * 50%

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Part 5 - Review Questions

March 2004 Exam, Question 3 (13 marks), con’t 6. At year-end, an inventory count revealed that

actual inventory on hand was $13,000 less than the amount showing in the general ledger inventory account.

COGS 13,000

Inventory 13,000

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Part 5 - Review Questions

b. Inventory balance – December 31, 2003: $179,640 Inventory

OB $ 80,000 (1) 590,000 (2) 6,000

(3) 3,360 (4) 20,000 (5) 460,000 (6) 13,000 CB $179,640

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Complete EXERCISE 6 – 18 , pg 320 Required: Note – B & C are extra!

a. Journalize transactions using both the periodic and perpetual systems; AND

b. Assume that opening inventory was $1,200 and the month-end inventory count showed actual inventory on hand was $1,850. Prepare any month-end

adjustments, if required; AND

c. Compute COGS under periodic & perpetual systems.

Stop Presentation Complete above required Then come back for solution!

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Part 5 - Review Questions

TRANSACTION # 1: November 1^st Purchase merchandise for $1,400, 2/10 n30 JOURNAL ENTRY – Periodic system

Purchases 1,400 Accounts Payable 1,400 JOURNAL ENTRY – Perpetual system

Inventory 1,400 Accounts Payable 1,400

Part 5 - Review Questions

Accounts Payable 1,400

Cash 1,372

Purchase discount 28 (i) JOURNAL ENTRY – Perpetual system

Accounts Payable 1,400

Cash 1,372

Inventory 28(i)

(i) Purchase discount: $1,400 * 2% = $28

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Part 5 - Review Questions

Cash 98(i)

Purchase return 98

JOURNAL ENTRY – Perpetual system

Cash 98

Inventory 98

(i) Payment net of 2% discount :$100 * 98%

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Part 5 - Review Questions

TRANSACTION # 4: November 10^th Pay transportation-in costs

JOURNAL ENTRY – Periodic system Transportation-in 80

Cash 80

JOURNAL ENTRY – Perpetual system

Inventory 80

Cash 80

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Part 5 - Review Questions

JOURNAL ENTRY – Periodic system Accounts Receivable 1,500

Sales Revenue 1,500

No entry for Cost of goods sold JOURNAL ENTRY – Perpetual system

Accounts Receivable 1,500

Sales Revenue 1,500

Cost of goods sold 750

Inventory 750

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TRANSACTION # 6: November 16^th

$200 of sales returned that cost $100

JOURNAL ENTRY – Periodic system Sales returns 200

Accounts Receivable 200 No entry for Cost of goods sold JOURNAL ENTRY – Perpetual system

Sales returns 200 Accounts receivable 200 Inventory 100

Cost of goods sold 100

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b. Month-end adjustments

OB $ 1,200 (1) 1,400 (10) 80 (16) 100

(5) 28 (7) 98 (13) 750 (30) 54 CB $ 1,850

Inventory

Part 5 - Review Questions

Inventory per G/L (i) Before adjustment $1,904 Inventory per count 1,850 Required AJE 54

Periodic: No AJE required

Perpetual: COGS 54 (i) Inventory 54

To record shrinkage at Nov 30th

Part 5 - Review Questions

Periodic OB Inventory $1,200 Purchases 1,400 -Purchase discounts 28 -Purchase returns 98 + Transport-in 80 Net purchases 1,354 GAS 2,554 -CB Inv 1,850 COGS $ 704

Perpetual (13) 750 (30) 54

COGS (16) 100

704 c. COGS under periodic & perpetual systems