Chapter 5. Learning Objectives. Income Statements. Retailing Operations. Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

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1 PowerPoint to accompany Chapter 5 Retailing Operations Learning Objectives 1. Account for the purchase of inventory and GST 2. Account for the sale of inventory and GST 3. Adjust and close the accounts of a retailing business 4. Prepare a retailer s financial statements 5. Use gross profit percentage and the inventory turnover to evaluate a business 6. Calculate cost of sales in a periodic inventory system Income Statements Service Firm Income Statement Year ended June 30, 20XX Service revenue Expenses: Salary expense Depreciation expense Income tax expense Net profit $xxx x x x $ xx Retailing Firm Income Statement Year ended June 30, 20XX Sales revenue $xxx Cost of goods sold x Gross profit xx Operating expenses: Salary expense x Depreciation expense x Net profit $ xx

2 Operating Cycle of a Retailing Business GST (Goods and Services Tax) Most retailers are registered for GST: The GST paid is claimed back from the ATO. The GST collected is paid to the ATO. (Reality net difference is paid or claimed.) So sales and purchases are shown net of GST. Retailers who are not registered: They do not charge GST on sales. GST paid on purchases is added to the cost. Inventory Systems Periodic Perpetual

3 Objective 1 Account for the purchase of inventory and GST. (The Perpetual Inventory System) Purchase of Inventory Retailer prepares purchase order Suppliers send inventory and a bill Compares Purchase of Inventory Example On May 1, the Sporting Store acquired on account $2,000 (plus 10% GST) of various items for resale. The supplier sent the inventory along with a bill (invoice) stating the quantity, price, and terms of sale. What is the journal entry with GST?

4 Purchase of Inventory Example May 1 Inventory 2,000 GST Clearing 200 Accounts Payable 2,200 Purchased inventory on account (on credit) Inventory Accounts Payable GST 2,000 2, Recording Purchase Returns and Allowances Example Assume that on May 4 a $100 item was returned prior to payment of the invoice. What is the journal entry? May 4 Accounts Payable 110 Inventory 100 GST Clearing 10 Inventory returned Recording Purchase Returns and Allowances Example Assume that one of the items of inventory is slightly damaged, and the store was given a $10 allowance. What is the journal entry? May 4 Accounts Payable 11 Inventory 10 GST Clearing 1 Received a purchase allowance

5 Recording Purchase Returns and Allowances Example Inventory Accounts Payable 2, , Bal. 1,890 Bal. 2,079 GST Clearing Bal 189 A Purchase Returns and Allowances account could be used Settlement Discounts Quantity or trade discounts simply reduce the cost of purchases. Settlement discounts have credit terms stated in expressions such as: 2/10, N/30, meaning that a discount of 2% is allowed if the invoice is paid within 10 days; otherwise the full (net) amount is due within 30 days. Settlement discounts reduce the cost of inventory. Settlement Discount Example Assume the Sporting Store purchased inventory for $1,000 (plus GST) with terms of 2/10, N/30. The store paid within the discount period. The 2% discount ($22) is deducted from the amount due ($1,100) and $1,078 is remitted (paid).

6 Settlement Discounts Example What is the journal entry? Accounts Payable 1,100 Cash ($1,100 x.98 ) 1,078 Inventory ($1, x.02 x 10/11) 20 GST Clearing ($1,100 x.02 x 1/11) 2 Payment of invoice within the discount period Transportation Costs Transportation costs are the cost of moving inventory from seller to buyer. FOB stands for Free on Board and governs the passing of title of the goods. Selling/buying agreements usually specify FOB terms. Transportation Costs FOB Shipping Point FOB Destination

7 Freight Charges Freight in charges increase the cost of inventory (if the supplier had to deliver the goods they would have charged us a higher price). Freight out is an operating expense and is debited to the Delivery Expenses account. Objective 2 Account for sale of inventory and GST. (The Perpetual Inventory System) Sporting Store Example Assume that on May 11 the store sold inventory (merchandise, goods, stock) costing $1,000 for $3,300 cash (GST inclusive). What are the journal entries?

8 Sporting Store Example Cash 3,300 Sales Revenue 3,000 GST Clearing 300 To record the cash sale Cost of Sales 1,000 Inventory 1,000 To record the cost of inventory sold Sporting Store Example On May 15, the store sold on credit to Maria Gym sporting goods for $5,000 (plus GST), goods with a cost of $3,000. Dr Accounts Receivable $5, (not cash). Terms are 5/10, N/60. Invoice Maria Gym Terms 5/10, N/60 Total $5,000 plus GST Sales Returns, Allowances and Settlement Discounts Example On May 17, Maria Gym returned $1,100 (includes GST) of goods that cost $600. In addition, a credit of $220 was allowed for inventory that was damaged. What are the journal entries?

9 Sales Returns, Allowances and Settlement Discounts Example Sales Returns and Allowance 1,000 GST Clearing 100 Accounts Receivable 1,100 Received returned inventory (no GST in Sales Ret. and Allow. because Sales are recorded net of GST) Inventory 600 Cost of Sales 600 Returned goods to inventory (no GST because Inventory is recorded net of GST) Sales Returns, Allowances and Settlement Discounts Example Sales Returns and Allowance 200 GST Clearing 20 Accounts Receivable 220 Credit granted for damaged goods There is no entry required for inventory since the goods were not returned. Sales Returns, Allowances and Settlement Discounts Example On May 20, the store received a cheque from Maria Gym for the balance due. What is the balance due? Accounts Receivable May 15 = $5,500 Less May 17 returns and allowances $1,320 Equals May 20 balance due of $4,180

10 Sales Returns, Allowances and Settlement Discounts Example Maria took advantage of the sales terms 5/10, N/60. Cash ($4,180 x.95) 3,971 Sales Discounts ($209 x 10/11) 190 GST Clearing ($209 x 1/11) 19 Accounts Receivable 4,180 Cash collected within the discount period Sales Discount is a contra Sales account Using sales, cost of sales and gross profit to evaluate a business. Sales Revenue Net sales = Sales Revenue less Sales Discounts less Sales Returns

11 Gross Profit Gross Profit (Gross Margin) = Net Sales less Cost of Sales (cost to the retailer of the goods they are selling) Objective 3 Adjust and close the accounts of a retailing business. Adjustments to Inventory Example Book Inventory Physical Balance Count $255,000 $252,500 $2,500 difference

12 Adjustments to Inventory Example What is the journal entry? June 30 Cost of Sales 2,500 (or Inventory Loss) Inventory 2,500 To adjust inventory to physical count Closing Entries for a Retailing Business 2,760,000 Sales Supplies Exp. 22,824 Sales Disc. 7,348 C.O.S. 1,490,400 Income Summary 1,891,696 2,760, ,304 Rent Exp. 32,605 Capital Other Exp. 338, ,304 Closing Entries Before the closing entry Rent Expense had a debit balance of $32,605. June 30 Closing entry Income Summary 32,605 Rent Exp. 32,605 To close the rent expense account After the closing entry Rent Expense has a zero balance.

13 Objective 4 Prepare a retailer s financial statements. Income Statement Formats There are two basic formats for the income statement: 1. Descriptive format (only used for service businesses) 2. Functional format (provides more detail of a retailer s operations) Functional Format Sporting Store Income Statement Year Ended June 30, 20X0 Sales revenue $2,760,000 Less Returns and allowances 0 Less Sales discount 7,348 Net sales revenue 2,752,652 Less Cost of goods sold 1,490,400 Gross profit 1,262,252

14 Functional Format Gross profit $1,262,252 Less Operating expenses: Rent expense 32,605 Other expenses 338,519 Supplies expense 22,824 Total Expenses 393,948 Net profit $ 868,304 Objective 5 Use gross profit percentage and inventory turnover to evaluate a business. Using the Financial Statements for Decision Making Gross profit percentage = Gross profit Net sales revenue Inventory turnover = Cost of Sales Average inventory

15 Gross Profit on $1 of Sales (example only not real numbers) Exhibit 5-9 Rate of Inventory Turnover for Two Retailers (example only) Exhibit 5-10 Objective 5 Calculate cost of sales in a periodic inventory system

16 Cost of Sales In the periodic inventory system COGS must be calculated at the end of the accounting period after a stock-take is conducted. Calculating the Cost of Sales in a Periodic System COS Beginning Inventory Plus Purchases Plus Freight In Less Purchase Returns and Allowances Equals Cost of Goods Available for Sale Less Ending Inventory Equals COS

17 Appendix Accounting for inventory in a periodic inventory system Purchases With the perpetual inventory system when a purchase is made Inventory is debited. With the periodic inventory system when inventory is purchased we debit Purchases account. Purchase returns are treated the same credit Purchase Returns and Allowances. Sales With the perpetual inventory system when a sale is made we record both the money flow ( Accounts Receivable and Sales ) and the goods flow ( Inventory and Costs of Sales ). With the periodic inventory system when inventory is sold we only record the money flow.

18 PowerPoint to accompany End of Chapter 5

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