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CHAPTER 6 CLASS NOTES ACCOUNTING FOR SALES The Income Statement for a commercial company, including a merchandiser and a manufacturer, has certain key items that one should expect to see. These include net sales, cost of sales (or cost of goods sold), gross profit or margin, operating expenses (that include selling, administrative, general expenses), operating income, as well as income before income taxes, income taxes, and net income. It is important that you recognize that this is a multi-step income statement—because there are subtotals for gross profit, operating income and income before taxes as well as the net income total. While every commercial company has these line items on the Income Statement, two things must be noted. 1. The same line items may have slightly different names as we see for gross profit versus gross margin, cost of sales versus cost of goods sold, etc. 2. A company may choose to expand a specific line item to show several accounts or groups of accounts. One might show net sales only or one may show gross sales less sales returns and discounts in arriving at net sales. A company can decide to show this on the face of the income statement or in a footnote; however, if certain amounts are not significant, they tend to be added together and only one number shown as “net sales”. The same can be true for the details of specific operating expenses, etc. Net sales is made up of a number of different basic accounts and we want to address each one in description as well as journal entry format so you clearly see how they work: 1. Sales revenue whether from product or service has been discussed for several chapters. The sales account is a credit account in that it will always have a credit balance and the entry to record the actual sale is a credit to a revenue account, with a corresponding debit to cash or accounts receivable ( if it is a credit sale). Remember that you rarely, if ever have a debit to a revenue account unless some type of an error occurred or a return, etc. In fact, we can now make it more restrictive and say that if you use the accounts we will describe next, the only time sales revenue will have a debit entry is when an error was made or at the end of the year when you close the account to Income Summary or Retained Earnings in the closing process. 2. Sales returns happens when the sale has already been completed and the customer physically returns merchandise to the seller. When this occurs, the company records a debit to sales returns and a credit to either cash or accounts receivable depending on whether the initial sale was a cash or credit sale. The sales return account is always a debit balance and there should only be debit entries to this account.
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-2- 3. Sales Allowances are similar to sales returns, however, instead of physically returning the merchandise, the seller tells the buyer to retain the merchandise and lowers the price to accommodate any quality, delivery issues, etc. When this occurs, the seller will record a debit to sales allowances and a credit to
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This note was uploaded on 04/19/2008 for the course ACCT 151 taught by Professor Largay during the Spring '07 term at Lehigh University .

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