1. Merchandising company VS Service company V.S Manufacturing company

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1 Chapter 6 Mechandising Activities 1. Merchandising company VS Service company V.S Manufacturing company Manufacturing companies use raw materials to make the inventory they sell. Their operating cycles are typically longer and more complex because of the time it takes to make and sell the inventory and then to collect the account receivable. Merchandising companies purchase the inventory they sell in a ready-to-sell condition. Since they do not have to make the inventory, their operating cycle is typically shorter 2. Cost of Goods Sold 1. Show Income statement of a merchandising company 2. Explain the nature of cost of goods sold The Cost of Goods Sold account represents the cost of the merchandise sold during the period to help earn revenue. Cost of Goods Sold is presented as a separate expense item on the income statement. Net Sales minus Cost of Goods Sold equals Gross Profit. Gross Profit is the amount left, after subtracting the cost of the inventory sold, to cover all other expenses and a profit 3.Control Account and Subsidiary Account 4.Perpetual Inventory System vs Periodic Inventory System Perpetual System: In the perpetual inventory system, the inventory account is continuously updated to reflect purchases, sales and returns of inventory. Let s look at how entries are made in the perpetual inventory system. 9/5 Worley Company purchased on account from Electronic City 100 laser lights for 30 dollars each 9/10, Worley Company sold 10 laser lights for 50 dollars each to ABC Radios on account

2 9/15 Worley Company paid Electronic City the three thousand dollars for the September 5 th purchase 9/22 Worley Company received five hundred dollars from ABC Radios for their purchase on September 10 th. 9/31 Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered. Periodic System Under the periodic inventory system, no effort is made to keep the inventory account or the cost of goods sold account up to date. Only on a periodic basis are these two accounts updated. Because the periodic system does not maintain a cost of good sold account, at the end of the period, cost of goods sold must be calculated. Here is some information for Party Supply. On January 1 st they have beginning inventory of $14,000. They have purchases during the year totaling $130,000. On December 31 st, the physical inventory count was $12,000. What is Cost of Goods Sold for the whole period? Inventory (beginning of the year) $ 14,000 Add: Purchases 130,000 Cost of goods available for sale 144,000 Less: Inventory (end of year) 12,000 Cost of goods sold $132, Credit Terms and Cash Discounts Cash Discounts Credit Terms: 2/10, n/30 Accounting Treatment: 1. Net Cost Method: Purchases are recorded at their net amounts. Purchase Discounts Lost are recorded when payment is made outside the discount period.

3 Example: 1. On July 6th, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid s Clothes. 2. On July 15, Play Clothes pays the full amount due to Kid s Clothes. 3. Now, assume that Play Clothes waited until July 20 to pay the amount due in full to Kid s Clothes. 2.Gross Method ( Gross Price Method ) The purchases are originally recorded at the full amount. If a cash discount is taken in the future, then a purchase discount account is used. 6. Returns Example: On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kid s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost. Accounts Payable 490 Inventory Transportation Cost In general, the cost of any asset includes any transportation costs related to getting the asset to the buyer s place of business. This is also the case for inventory. Transportation costs incurred by the buyer are included in the cost of Inventory. If the seller is in charge of transportation, the delivery cost should be included in operating cost 8. Sales Just as inventory returns and cash discounts impact the buyer s entries, they also impact the seller s entries(page 241 Exhibit 6-8) Sellers use the Sales Returns and Allowances account to record inventory returned to the seller or adjustments in prices seller s allow due to customer dissatisfaction. Sellers use the Sales Discounts account to record cash discounts taken by customers who pay within the discount period.

4 Net sales is Sales minus Sales Returns and Allowances and Sales Discounts Example on Sales Return and Allowance: On August 2, Kid s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid s Clothes originally paid $1,000 for the merchandise ( perpetual inventory system and full Aug 2. Accounts Receivable 2,000 Sales 2,000 COGS 1,000 Inventory 1,000 On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid s Clothes from the August 2 sale. Kid s Clothes cost for this merchandise was $250. Aug 5 Sales Return and Allowance 500 Accounts Receivable 500 Inventory 250 COGS 250 Example on Sales Discount On August 2, Kid s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid s Clothes originally paid $1,000 for the merchandise ( perpetual inventory system and full Aug 5 Accounts Receivable 2,000 Sales 2,000 COGS 1,000 Inventory 1,000 On August 12, Kid s Clothes receives the full amount due from Play Clothes from the August 2nd sale Aug 12. Cash 3,920 Sales Discount 80

5 Accounts Receivable 4,000 Now, assume that it wasn t until August 20 that Kid s Clothes received the full amount due from Play Clothes from the August 2 sale. Cash 2000 Accounts Receivable Net Sales & Gross Profit Margin