Merchandising Firms Principles of Accounting Created 2005 By Michael Worthington Elizabeth City State University INVENTORY Traditional bookkeeping uses separate accounts for different types of transactions Purchases Purchase Discounts Purchase Returns and Allowances Freight-in But since this course is about principles of accounting rather than bookkeeping, use the generic Inventory account COST OF GOODS SOLD The Cost of Section appears on the Income Statement COST OF GOODS SOLD SECTION Beginning Inventory Plus Purchases Less Purchase Discounts Less Purchase Returns and Allowances Plus Freight-in Less Ending Inventory Equals Cost of Goods Sold 1
PURCHASE DISCOUNTS The company may be able to deduct a cash discount for early It is a Purchase Discount when the company deducts a cash discount from a payment to a supplier for a purchase SALES DISCOUNTS A may be able to deduct a cash discount for early payment It is a Sales Discount when a customer deducts a cash discount from the payment that the company receives for a sale PURCHASE RETURNS Purchase Returns is when a company sends merchandise back to a The company would issue a debit memorandum to inform the supplier that Accounts Payable was reduced by the cost of the returned merchandise 2
SALES RETURNS Sales Returns is when a returns merchandise The company would issue a credit memorandum to inform the customer that Accounts Receivable was reduced by the price of the returned merchandise PURCHASE ALLOWANCES Purchase Allowances is a reduction in the invoice amount from a to resolve a problem with damaged merchandise, but the company keeps the items The company would issue a debit memorandum to inform the supplier that Accounts Payable was reduced by the amount of the allowance SALES ALLOWANCES Sales Allowances is a price reduction given to a to resolve a problem with damaged merchandise, but the customer keeps the items The company would issue a credit memorandum to inform the customer that Accounts Receivable was reduced by the amount of the allowance 3
FREIGHT COSTS The freight costs for purchases of merchandise increases inventory But the freight costs on shipments sold to customers is an expense Supplier Company Freight-in costs are added to inventory costs Freight Expense Customer COMPARISON SELLER Sales Discount Sales Returns Sales Allowances BUYER Purchase Discount Purchase Purchase Allowances Freight Expense Freight-in (inventory) Purchase Cycle On August 1 st the company purchased $10,000 of on account with payment terms of 1%/10 days But on August 3 rd the company returned $500 of the merchandise Then on August 5 th the supplier gave the company an allowance of $1,000 to resolve a problem with damaged merchandise Finally on August 9 th the company paid the remaining amount due on the invoice 4
August 1 st The company purchased $10,000 of merchandise on account Inventory Account increased by $10,000 Inventory is an asset account with a normal debit balance, so debit inventory to increase the balance Accounts Payable increased by $10,000 Accounts Payable is a liability account with a normal credit balance, so credit Accounts Payable to increase the balance August 3 rd The company returned $500 of merchandise Accounts Payable decreased by $500 Accounts Payable is a liability account with a normal credit balance, so debit Accounts Payable to reduce the balance Inventory decreased by $500 when the merchandise was sent back Inventory is an asset account with a normal debit balance, so credit the Inventory account to reduce the balance August 5 th Supplier gave the company an allowance of $1,000 to resolve a problem with damaged merchandise Accounts Payable decreased by $1,000 Accounts Payable is a liability account with a normal credit balance, so debit Accounts Payable to reduce the balance Inventory costs decreased by $1,000 Inventory is an asset account with a normal debit balance, so credit Inventory to reduce the balance 5
August 9 th The company paid the remaining amount due on the $10,000 invoice with terms of 1%/10 days Accounts Payable should be decreased by the remaining balance of $8,500 ($10,000 less $500 return and $1,000 allowance) Accounts Payable is a liability account with a normal credit balance, so debit Accounts Payable to reduce the balance August 9 th continued The company paid the remaining amount due on the $10,000 invoice with terms of 1%/10 days The company paid within terms, so they are entitled to the cash discount of $85 (1% of the remaining balance of $8,500) Inventory is an asset account with a normal debit balance, so credit Inventory to reduce the cost by the amount of the cash discount The word paid indicates that the cash account decreased Cash is an asset account with a normal debit balance, so credit Cash to reduce the balance by $8,415 ($8,500-$85) Sales Cycle On September 1 st the company sold $8,000 of merchandise on account with payment terms of 2%/10 days But on September 5 th the customer returned $300 of merchandise Then on September 7 th the company gave the customer an allowance of $800 to resolve problem with damaged merchandise On September 9 th the company received a payment from the customer for the remaining amount due on the invoice 6
September 1 st Company sold $8,000 of merchandise on account Accounts Receivable increased by $8,000 Accounts Receivable is an asset account with a normal debit balance, so debit the AR account to increase the balance Sales Account increased by $8,000 Sales is a revenue account with a normal credit balance, so credit the Sales Account to increase the balance September 5 th The customer returned $300 of the merchandise Sales Returns and Allowances is indicated by the words customer returned Sales Returns and Allowances account is a contrarevenue account with a normal debit balance Accounts Receivable decreased by $300 because the customer returned items Accounts Receivable is an asset account with a normal debit balance, so credit the AR account to reduce the balance September 7 th Company gave the customer an allowance of $800 to resolve a problem with damaged merchandise Sales Returns and Allowances is indicated by the words customer allowance Sales Returns and Allowances account is a contra-revenue account with a normal debit balance Accounts Receivable decreased by $800 because of the allowance Accounts Receivable is an asset account with a normal debit balance, so credit the AR account to reduce the balance 7
September 9 th Company received a payment from the customer for the remaining amount due on the invoice The customer still owes $6,900 ($8,000 less $300 returns and $800 allowance) The customer paid within terms, so they are entitled to the cash discount of $138 (2% of the remaining balance of $6,900) Sales Discounts is a contra-revenue account with a normal debit balance September 9 th continued Company received a payment from the customer for the remaining amount due on the invoice The company received a payment of $6,762 from the customer ($6,900 minus $138) Cash is an asset account with a normal debit balance, so debit cash to increase the balance The customer still owes $6,900 ($8,000 less $300 returns and $800 allowance) Accounts Receivable is an asset account which has a debit normal balance, so credit AR account to decrease the balance 8