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Unformatted text preview: Page 168 4 ACCOUNTING FOR MERCHANDISING OPERATIONS CHAPTER PREVIEW MERCHANDISING ACTIVITIES C1Income and inventory for merchandisers C2Operating cycle Inventory cost flows 3. NTK 4-1 1. 2. MERCHANDISING PURCHASES 1. 2. 3. 4. 5. P1Accounting for: Purchases discounts Purchases returns and allowances Transportation costs NTK 4-2 MERCHANDISING SALES 1. 2. 3. 4. 5. P2Accounting for: Sales of merchandise Sales discounts Sales returns and allowances NTK 4-3 MERCHANDISER REPORTING 1. 2. 3. 4. 5. P3Adjusting and closing P4Multiple-step and single-step income statements A1Acid-test analysis A2Gross margin analysis NTK 4-4, 4-5 Page 169 © Bart Young/Invision for Intuit/AP Images “Whatever you dream, you can do” —Lt. Emily Núñez Cavness Soldier On! DENVER—Jeff Bezos founded Amazon in a garage, Mark Zuckerberg founded Facebook in a dorm room, and Lt. Emily Núñez Cavness co-founded Sword & Plough (SwordandPlough.com) while deployed in Afghanistan. “It was not the usual start-up location,” recalls Emily as she describes a Skype meeting that was interrupted by mortar fire. Emily and her sister Betsy recycle military surplus materials to create totes, handbags, backpacks, and accessories. The sisters reuse materials that “would otherwise be burned or buried in a landfill,” according to Emily. To date, Emily and Betsy have recycled 30,000 pounds of surplus materials into over 7,000 bag and accessory sales. Importantly, their business success enables them to support 38 veteran jobs, one of their main goals. Emily and Betsy stress that their success is in part due to the merchandising accounting system they use for purchases and sales transactions. “We were able to pinpoint some immediate problems to solve,” explains Emily, including identifying which products were selling poorly and which were unprofitable. Emily insists that the information gained from the accounting system “didn’t just stay stored on my iPhone, or scrap piece of paper —we took action!” “The momentum behind Sword & Plough continues to grow,” says Emily, and reliance on their merchandising accounting system grows as well. Tracking merchandising activities was necessary to set prices and to manage discounts, allowances, and returns for both sales and purchases. A perpetual inventory system enabled Emily and Betsy to stock the right kind and amount of merchandise and to avoid the costs of out-of-stock and excess inventory. “We took the idea seriously and today we can show you that the concept has become a powerful reality,” asserts Emily. Emily continues to both serve her country as a lieutenant in the Army and act as CEO of Sword & Plough. “It has been challenging at times, but the two roles complement each other,” explains Emily. “I want Sword & Plough to be a leader in the field of social entrepreneurship that is able to communicate effectively the awesome skill that veterans bring to communities.” Hoo-ah! Sources: Sword & Plough website, January 2017; Bloomberg Businessweek, April 2013; ABC News, August 2014; Military Times, September 2015; NationSwell, January 2016; Opportunity Lives, October 2015; Good Magazine, May 2013 Page 170 MERCHANDISING ACTIVITIES C1 Describe merchandising activities and identify income components for a merchandising company. Previous chapters emphasized the accounting activities of service companies. A merchandising company’s activities differ from those of a service company. Merchandise consists of products, also called goods, that a company buys to resell to customers. A merchandiser earns net income by buying and selling merchandise. Merchandisers are often wholesalers or retailers. A wholesaler buys products from manufacturers and sells them to retailers. A retailer buys products from manufacturers or wholesalers and sells them to consumers. Reporting Income for a Merchandiser Net income for a merchandiser equals revenues from selling merchandise minus both the cost of merchandise sold to customers and other expenses for the period—see Exhibit 4.1. The usual accounting term for revenues from selling merchandise is sales, and the term used for the expense of buying and preparing the merchandise is cost of goods sold. (Some service companies use the term sales instead of revenues; and cost of goods sold is also calledcost of sales.) EXHIBIT 4.1 Computing Income for a Merchandising Company versus a Service Company The income statements for a service company, Liberty Tax, and for a merchandiser, Nordstrom, are shown in Exhibit 4.2 ($ millions). The statement for Liberty Tax shows revenues of $173 followed by expenses of $155, which yields $18 in net income. The first two lines of the statement for Nordstrom, a merchandiser, show that products are acquired at a cost of $9,168 and sold for $14,437. The third line shows its $5,269 gross profit, also called gross margin, which equals net sales less cost of goods sold. Additional expenses of $4,669 are reported, which leaves $600 in net income. EXHIBIT 4.2 Income Statement for a Service Company and a Merchandising Company ($ millions) Merchandising Company NORDSTROM INC. Service Company Income Statement LIBERTY TAX For Year Ended January 31, Income Statement 2016 For Year Ended April 30, Net sales $14,437 2016 Cost of goods Revenues $173 sold 9,168 Expenses 155 Gross profit 5,269 Net income $ 18 Expenses 4,669 Net income $ 600 Point: Fleming, SuperValu, and SYSCO are wholesalers. Aeropostale, Coach, Target, and Walmart are retailers. Reporting Inventory for a Merchandiser C2 Identify and explain the inventory asset and cost flows of a merchandising company. A merchandiser’s balance sheet includes a current asset called merchandise inventory, an item not on a service company’s balance sheet.Merchandise inventory, or simply Inventory, refers to products that a company owns and intends to sell. The cost of this asset includes the cost incurred to buy the goods, ship them to the store, and make them ready for sale. Page 171 Operating Cycle for a Merchandiser A merchandising company’s operating cycle begins by purchasing merchandise and ends by collecting cash from selling the merchandise. The length of an operating cycle differs across the types of businesses. Department stores often have operating cycles of two to five months. Operating cycles for grocery merchants usually range from two to eight weeks. A grocer has more operating cycles in a year than clothing or electronics retailers. EXHIBIT 4.3 Merchandiser’s Operating Cycle Exhibit 4.3 illustrates an operating cycle for a merchandiser with credit sales. The cycle moves from (a) cash purchases of merchandise to (b) inventory for sale to (c) credit sales to (d) accounts receivable to (e) cash. Companies try to keep their operating cycles short because assets tied up in inventory and receivables are not productive. Cash sales shorten operating cycles. Inventory Systems Exhibit 4.4 shows that a company’s merchandise available for sale consists of what it begins with (beginning inventory) and what it purchases (net purchases). The merchandise available is either sold (cost of goods sold) or kept for future sales (ending inventory). EXHIBIT 4.4 Merchandiser’s Cost Flow for a Single Time Period Merchandise Inventory Beg. inventory # Net purchases # Merchandise avail. for sale # COGS End. inventory # Point: Mathematically, Exhibit 4.4 says BI + NP = MAS, # where BI is beginning inventory, NP is net purchases, and MAS is merchandise available for sale. Exhibit 4.4 also says MAS = EI + COGS, which can be rewritten as MAS − EI = COGS or MAS − COGS = EI, where EI is ending inventory and COGS is cost of goods sold. Companies account for inventory in one of two ways: perpetual system or periodic system. Perpetual inventory system updates accounting records for each purchase and sale of inventory. Periodic inventory system updates the accounting records for purchases and sales of inventory only at the end of a period. Technological advances and competitive pressures have dramatically increased the use of the perpetual system. It gives managers immediate access to information on sales and inventory levels, which allows them to strategically react and increase profit. (Some companies use a hybrid system where the perpetual system is used for tracking units available and the periodic system is used to compute cost of sales.) Point: Growth of superstores such as Costco and Sam’s Club is fueled by efficient use of perpetual inventory. The following sections on purchasing, selling, and adjusting merchandise use the perpetual system (ending with NTK 4-3). Appendix 4A uses the periodic system (with the perpetual results on the side). An instructor can choose to cover either one or both inventory systems. If the periodic system only is covered, then read Appendix 4A and return to the section titled “Financial Statement Formats” (after NTK 4-3). Page 172 NEED-TO-KNOW 4-1 Merchandise Accounts and Computations (C1 C2) Use the following information (in random order) from a merchandising company and from a service company. Hint: Not all information may be necessary for the solutions. 1. For the merchandiser only, compute a. Goods available for sale. b. Cost of goods sold. c. Gross profit. 2. Compute net income for each company. SaveCo Merchandiser $ Supplies 10 Beginning 10 inventory Ending inventory Expenses Net purchases 0 50 20 80 19 Net sales 0 Hi-Tech Services $1 Expenses 70 20 Revenues 0 Cash 10 Prepaid rent 25 Accounts payable 35 Supplies 65 Solution 1. a. Computation of goods available for sale (SaveCo) b. Computation of cost of goods sold (SaveCo) 2. Computation of net income for each company SaveCo Merchandiser $19 Net sales 0 1. Less: Cost of goods sold (see part 1b) 130 Gross profit 60 Less: Expenses Net income Revenues Hi-Tech Services 20 $ 40 $20 0 c. Computation of gross profit (SaveCo) Less: Expenses Net income Do More: QS 4-3, E 4-1, E 4-2 17 0 $ 30 ACCOUNTING FOR MERCHANDISE PURCHASES P1 Analyze and record transactions for merchandise purchases using a perpetual system. This section explains how we record purchases under different purchase terms. Purchases without Cash Discounts Z-Mart would record a $500 cash purchase of merchandise on November 2 as follows. Nov. 2 Merchandise Inventory 500 Cash 500 Purchased goods for cash. Assets+500−500=Liabilities + EquityAssets=Liabilities + Equity+500−500 If these goods were instead purchased on credit, and no discounts were offered for early payment, Z-Mart would make the same entry except that Accounts Payable would be credited instead of Cash. Point: Costs recorded in Merchandise Inventory are also called inventoriable costs. Page 173 DECISION INSIGHT Trade Discounts When a manufacturer or wholesaler prepares a catalog of items it has for sale, it usually gives each item a list price, also called a catalog price. However, an item’s intended selling price equals list price minus a given percent called a trade discount. The amount of trade discount usually depends on whether a buyer is a wholesaler, retailer, or final consumer. A wholesaler buying in large quantities is often granted a larger discount than a retailer buying in smaller quantities. A buyer records the net amount of list price minus trade discount. For example, a supplier of Z-Mart lists an item of merchandise in its catalog at $625 and it grants Z-Mart a 20% trade discount. This means that Z-Mart’s purchase price for that item is $500, computed as $625 − (20% × $625). ■ Point: Lowe’s and Home Depot offer trade discounts to construction companies and contractors. Trade discounts are not journalized; purchases are recorded based on the invoice amount. Purchases with Cash Discounts The purchase of goods on credit lists credit terms. Credit terms for a purchase include the amounts and timing of payments from a buyer to a seller. To illustrate, when sellers require payment within 10 days after the end of the month of the invoice date, the invoice lists credit terms as “n/10 EOM,” which stands for net 10 days after end of month (EOM). When sellers require payment within 30 days after the invoice date, the invoice lists credit terms of “n/30,” which stands for net 30 days. Exhibit 4.5 portrays credit terms. The amount of time allowed before full payment is due is called the credit period. Sellers can grant a cash discount to encourage buyers to pay earlier. A buyer views a cash discount as apurchases discount. A seller views a cash discount as a sales discount. Any cash discounts are described in the credit terms on the invoice. For example, credit terms of “2/10, n/60” mean that full payment is due within a 60-day credit period, but the buyer can deduct 2% of the invoice amount if payment is made within 10 days of the invoice date. This reduced payment applies only for the discount period. EXHIBIT 4.5 Credit Terms To illustrate how a buyer accounts for a purchases discount, assume that on November 2, Z-Mart purchases $500 of merchandise on credit with terms of 2/10, n/30. The amount due, if paid on or before November 12, is $490, computed as $500 − ($500 × 2%)—or alternatively computed as $500 × (100% − 2%). Many buyers take advantage of a purchases discount because of the usually high interest rate implied by not taking it.1 If Z-Mart does not pay within the 10-day 2% discount period, it can delay payment by 20 more days and pay $500. The gross method for recording purchases enters the full invoice (gross) amount for merchandise. Z-Mart’s entry to record the November 2 purchase of $500 in merchandise on credit follows. Point: Appendix 4A repeats journal entries a through g using the periodic system. (a) Nov. 2 Merchandise Inventory 500 Accounts Payable 500 Purchased goods, terms 2/10, n/30. Assets+500=Liabilities + Equity +500Assets=Liabilities + Equity+500 +500 Page 174 The invoice for this purchase is shown in Exhibit 4.6. This source document is the purchase invoice of Z-Mart (buyer) and the sales invoice for Trex (seller). The amount recorded for merchandise inventory includes its purchase cost, shipping fees, taxes, and any other costs necessary to make it ready for sale. (For recording, it can help to add the name to the payable [and receivable], such as Accounts Payable—Trex.) EXHIBIT 4.6 Invoice Point: The invoice date is used in setting the discount and credit periods as both buyer and seller know this date. Payment within Discount Period Good cash management means that invoices are not paid until the last day of the discount or credit period. This is because the buyer can use that money until payment is required. If Z-Mart pays the amount due on (or before) November 12, the entry is (b1) Nov. 12 Accounts Payable 500 Merchandise Inventory 10 Cash* 490 Paid for goods within discount period. * $500 × (100% − 2%) Assets−490− 10=Liabilities + Equity−500Assets=Liabilities + Equity−490−500− 10 The Merchandise Inventory account reflects the $490 net cost of purchases after these entries, and the Accounts Payable account reveals a zero balance. The relevant ledger accounts, in T-account form, follow. Merchandise Inventory Nov. 2 500 Bal. 49 0 Nov. 12 10 Accounts Payable Nov. 2 500 50 Nov. 12 0 Bal. Cash Nov. 12 49 0 0 Page 175 Payment after Discount Period If the amount is paid after November 12, the discount is lost. For example, if Z-Mart pays the gross amount due on December 2 (the n/30 due date), it makes the following entry. (b2) Dec. 2 Accounts Payable 500 Cash 500 Paid for goods outside discount period. Assets−500=Liabilities + Equity−500Assets=Liabilities + Equity−500−500 Entries in this chapter apply the gross method of accounting for purchases with discount terms. Appendix 4D shows the net method. Point: Buyers sometimes make partial payments toward amounts owed. Credit terms apply to both partial and full payments. DECISION MAKER Entrepreneur You purchase a batch of products on terms of 3/10, n/90, but your company has limited cash and you must borrow funds at an 11% annual rate if you are to pay within the discount period. Should you take the purchases discount? Explain. ■ [Answer] Purchases with Returns and Allowances Purchases returns are merchandise a buyer acquires but then returns to the seller. Purchases allowances refer to a seller granting a price reduction (allowance) to a buyer of defective or unacceptable merchandise. Buyers often keep defective goods if they can be sold and if the seller grants an acceptable allowance. Point: When a buyer returns or takes an allowance on merchandise, the buyer issues a debit memorandum. This informs the seller of a debit made to the seller’s account payable in the buyer’s records. Purchases Allowances To illustrate purchases allowances, assume that on November 5, Z-Mart (buyer) agrees to a $30 allowance from Trex for defective merchandise (assume allowance terms are $30 whether paid within the discount period or not). Z-Mart’s entry to update Merchandise Inventory and record the purchases allowance is (c1) Nov. 5 Accounts Payable 30 Merchandise Inventory 30 Allowance for defective goods. Assets −30=Liabilities + Equity −30Assets=Liabilities + Equity −30 −30 The buyer’s allowance for defective merchandise is subtracted from the buyer’s account payable balance to the seller. If cash is refunded, the Cash account is debited. Purchases Returns Returns are recorded at the costs charged to buyers. To illustrate the accounting for returns, suppose on June 1 that Z-Mart purchases $250 of merchandise with terms 2/10, n/60. On June 3, Z-Mart returns $50 of those goods. When Z-Mart pays on June 11, it takes the 2% discount only on the $200 remaining balance ($250 − $50). When goods are returned, a buyer takes a discount on only the remaining balance of the invoice. This means the discount is $4 (computed as $200 × 2%) and the cash payment is $196 (computed as $200 − $4). The following entries reflect this illustration. 25 June 1 Merchandise Inventory 0 Accounts Payable 250 Purchased goods, terms 2/10, n/60. (c 2) June 3 Accounts Payable 50 Merchandise Inventory 50 Returned goods to seller. 20 June 11 Accounts Payable 0 Merchandise Inventory 4 Cash 196 Paid for $200 of goods less $4 discount. Assets+250=Liabilities+Equity +250Assets=Liabilities+Equity+250 +250 Assets−50=Liabilities+Equity −50Assets=Liabilities+Equity−50 −50 Assets−196− 0− 4=Liabilities+Equity 4 −200Assets=Liabilities+Equity−196 −20 Page 176 For this example, the following ledger accounts, in T-account form, show the resulting $196 in inventory, the zero balance in Accounts Payable, and the $196 cash payment. Merchandise Inventory Jun. 1 250 Jun. 3 Jun. 11 Bal. Accounts Payable 25 Jun. 1 0 Jun. 3 50 20 Jun. 11 0 50 4 19 6 Bal. Cash Jun. 11 19 6 0 Example: Assume on June 20, Z-Mart returns all goods paid for on June 11. The return entry is Cash Merch. Inv. 19 6 19 6 DECISION INSIGHT Point of No Return Although many companies allow returns, many others do not. Buyers must be especially alert to purchase terms. Companies that often do not permit returns include those selling any of the following items: hair products such as extensions, barrettes, claws, combs, and pins; undergarments including swimsuits, leotards, and shorts; custom products such as tailored suits, pants, and shirts; and beauty and cosmetic items such as lip liners and makeup. Many of these are sold “as is,” meaning returns are not allowed. ■ Purchases and Transportation Costs © Kirby Hamilton/iStock/Getty Images RF The buyer and seller must agree on who is responsible for paying any freight costs and who has the risk of loss during transit for merchandising transactions. This is the same as asking at what point ownership transfers from the seller to the buyer. The point of transfer is called the FOB (free on board) point, which determines who pays transportation costs (and other costs of transit such as insurance). Whoever owns the goods in transit pays the shipping cost. Point: When the party not responsible for shipping pays shipping cost, it either bills the other party...
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