Module 4 - Audio File Legend

Module 4 - Audio File Legend Part 1 2 3 4 5 Content 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 2 Part 1 Learning Objectives 1. Explain merchandising activities and analyze 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) 3 1

Part 1 Learning Objectives 5. Record the revenue from the sales of 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) 4 Part 1 Basics of Merchandising Operations What is a merchandising company? 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) 5 Part 1 Basics of Merchandising Operations What is Cost of Goods Sold? 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) 6 2

Part 1 Basics of Merchandising Operations 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 7 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 8 Part 1 - Basics of Merchandising Operations Periodic system does NOT keep track of inventory balance during year records inventory based on physical count @ yearend 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) 9 3

Part 1 - Basics of Merchandising Operations Periodic system does NOT keep track of inventory balance during year records inventory based on physical count @ yearend 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) 10 Part 2 Recording Purchase Transactions 1. Merchandise inventory purchases record transaction at purchase date assume here that all purchases on credit Perpetual system Dr Merchandise inventory Cr Accounts payable Periodic system Dr Purchases Cr Accounts payable 11 Part 2 Recording Purchase Transactions 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 Perpetual system Dr Accounts payable Cr Merchandise inventory Periodic system Dr Accounts payable Cr Purchase returns 12 4

Part 2 Recording Purchase Transactions 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 13 Part 2 Recording Purchase Transactions 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 = balance due in 45 days n/10 EOM (net 10, end of month) - payment is due 10 days after the end of the month in which the sale occurred 14 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! 15 5

Part 2 Recording Purchase Transactions 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: Perpetual system Dr Accounts payable Cr Cash Cr Merchandise inventory Periodic system Dr Accounts payable Cr Cash Cr Purchase discounts 16 Part 2 Recording Purchase Transactions 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. 17 Part 2 Recording Purchase Transactions 4. Transportation-In costs cost to receive inventory from supplier does NOT include cost to ship goods to customers, which is a selling cost Perpetual system Dr Merchandise inventory Cr Accounts payable Periodic system Dr Transportation-in Cr Accounts payable 18 6

Part 2 Recording Purchase Transactions 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 locationeither FOB shipping point or FOB destination. At the FOB point, title passes from seller to buyer 19 Part 2 Recording Purchase Transactions SELLER BUYER FOB Shipping Point FOB Destination Ownership transfers when goods passed to carrier(shipping point) Seller records revenue Buyer records inventory Buyer pays transport costs, which are included in inventory Ownership transfers when goods reach buyer (destination) Seller records revenue Buyer records inventory Seller pays transport costs (operating not COGS) 20 Part 2 Recording Purchase Transactions 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 21 7

Part 2 Recording Purchase Transactions 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 22 Part 2 Recording Purchase Transactions 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 Perpetual system Dr COGS Cr Merchandise inventory Periodic system No entry 23 Part 2 Recording Purchase Transactions 6. Closing Entries recorded at month-end and/or year-end entries that are specific to inventory accounts Perpetual system Dr Income Summary Cr COGS Periodic system Dr Inventory, CB Dr Purchase returns Dr Purchase discounts Dr Income Summary Cr Purchases Cr Transport-In Cr Inventory, OB 24 8

Part 2 Recording Purchase Transactions 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 25 Part 2 Recording Sale Transactions 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 Perpetual system Dr Accounts Receivable Cr Sales Revenue Dr COGS Cr Merchandise Inventory Periodic system Dr Accounts Receivable Cr Sales Revenue No entry for COGS 26 Part 2 Recording Sale Transactions 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 Perpetual system Periodic system 1. Return AND allowance Dr Sales Returns & Allow Cr Accounts Receivable 2. Return only Dr Merchandise Inventory Cr COGS 1. Return AND allowance Dr Sales Returns & Allow Cr Accounts Receivable 2. Return only No entry 27 9

Part 2 Recording Sale Transactions 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 Perpetual system Dr Cash Dr Sales Discounts Cr Accounts Receivable Periodic system Dr Cash Dr Sales Discounts Cr Accounts Receivable 28 Part 2 Recording Sale Transactions Summary Sales (net) - COGS = Gross Profit (or Gross Margin) Sales (net): Sales - Sales returns and allowances - Sales discounts = Net Sales 29 Part 3 Problem: Purchase & Sale Journal Entries Refer to Module 4 Handout #1 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 30 10

Part 3 Problem: Purchase & Sale Journal Entries 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 Inventory 10,000 Accounts Payable 10,000 Purchases 10,000 Accounts Payable 10,000 31 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 2: Return $2,000 of purchases to supplier Accounts Payable 2,000 Inventory 2,000 Accounts Payable 2,000 Purchase return 2,000 32 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 3: Pay for purchases within discount period Accounts Payable 8,000(i) Cash 7,840 Inventory 160(ii) 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 33 11

Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 4: Pay transportation-in costs Inventory 300 Cash 300 Transportation-in 300 Cash 300 34 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 5: Sell ½ the inventory for $12,000; terms 1.5/15 net 30 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 Accounts Receivable 12,000 Sales Revenue 12,000 No entry for Cost of goods sold 35 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 6: 10% of sales returned for credit 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% Sales returns 1,200 Accounts Receivable 1,200 No entry for Cost of goods sold 36 12

Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 7: Cash received within discount period Cash 10,638 Sales discounts 162 (i) Accounts receivable 10,800 Cash 10,638 Sales discounts 162 (i) Accounts receivable 10,800 (i) A/R: $12,000 1,200 = 10,800 * 1.5% = $162 37 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 8: Do year-end inventory count: $4,400 Cost of goods sold 77 Inventory 77 (i) (i) Inventory: Per general ledger $4,070 + 407 = $4,477 Per count 4,400 Shrinkage $ 77 No entry 38 Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 9: Do closing entries: 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 39 13

Part 3 Problem: Purchase & Sale Journal Entries TRANSACTION # 9: Do closing entries, continued: 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 40 Part 4 - Income Statement Formats Income Statement Formats Turn to Text Page 283 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 41 Part 4 - Income Statement Formats 2. Multi-Step: Text pg 284 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 42 14

Part 4 - Using the Information- Gross Profit Ratio 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. 43 Part 4 - Using the Information- Gross profit ratio Gross profit ratio = Gross profit Net sales 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% 44 Part 4 Exercise: Income Statements & Ratio Exercise 6 15, pg 318 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! 45 15

Part 4 Exercise: Income Statements & Ratio Exercise 6 15, Part (a) solution 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 46 Part 4 Exercise: Income Statements & Ratio Exercise 6 15, Part (b) solution Gross Profit Ratio: $12,135 $26,936 = 45% Need to compare this ratio to prior years industry averages 47 Part 4 Exercise: Income Statements & Ratio Exercise 6 15, Part (c) solution 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 48 16

Part 5 - Summary 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. 49 Part 5 - Summary 2. Under a periodic inventory system (level 2): 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 50 Part 5 - Summary 3. Useful formulas for merchandising companies: 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. 51 17

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. 52 Refer to Module 4 Handout #2 March 2004 Exam, Question 3 (13 marks) REQUIRED: a. Prepare journal entries; b. Calculate closing inventory Complete handout then come back for solution 53 March 2004 Exam, Question 3 (13 marks) The following selected events and transactions relate 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 54 18

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 55 March 2004 Exam, Question 3 (13 marks) 3. Needer paid for $560,000 of the inventory purchased, taking advantage of the purchase discount of 60% of the inventory paid for. Accounts payable 560,000 Inventory 3,360 Cash 556,640 56 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 57 19

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% 58 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 59 March 2004 Exam, Question 3 solution, con t b. Inventory balance December 31, 2003: $179,640 Inventory OB $ 80,000 (1) 590,000 (2) 6,000 CB $179,640 (3) 3,360 (4) 20,000 (5) 460,000 (6) 13,000 60 20

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! 61 Exercise 6 18, solution TRANSACTION # 1: November 1 st Purchase merchandise for $1,400, 2/10 n30 Purchases 1,400 Accounts Payable 1,400 Inventory 1,400 Accounts Payable 1,400 62 TRANSACTION # 2: November 5 th Pay for purchases within discount period Accounts Payable 1,400 Cash 1,372 Purchase discount 28 (i) Accounts Payable 1,400 Cash 1,372 Inventory 28(i) (i) Purchase discount: $1,400 * 2% = $28 63 21

TRANSACTION # 3: November 7 th Receive payment for returned inventory Cash 98(i) Purchase return 98 Cash 98 Inventory 98 (i) Payment net of 2% discount :$100 * 98% 64 TRANSACTION # 4: November 10 th Pay transportation-in costs Transportation-in 80 Cash 80 Inventory 80 Cash 80 65 TRANSACTION # 5: November 13 th Sell inventory for $1,500 that cost $750 Accounts Receivable 1,500 Sales Revenue 1,500 No entry for Cost of goods sold Accounts Receivable 1,500 Sales Revenue 1,500 Cost of goods sold 750 Inventory 750 66 22

TRANSACTION # 6: November 16 th $200 of sales returned that cost $100 Sales returns 200 Accounts Receivable 200 No entry for Cost of goods sold Sales returns 200 Accounts receivable 200 Inventory 100 Cost of goods sold 100 67 b. Month-end adjustments OB $ 1,200 (1) 1,400 (10) 80 (16) 100 CB $ 1,850 Inventory (5) 28 (7) 98 (13) 750 (30) 54 Periodic: No AJE required Inventory per G/L (i) Before adjustment $1,904 Inventory per count 1,850 Required AJE 54 Perpetual: COGS 54 (i) Inventory 54 To record shrinkage at Nov 30th 68 c. COGS under periodic & perpetual systems 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 COGS (13) 750 (30) 54 704 (16) 100 69 23