Lecture #5: Accounting for a Merchandising Concern

• The accounting records and reports of the Dow Law Practice is a service enterprise.
• A merchandising company , on the other hand, earns revenue by selling goods or merchandise.  The net income results  when revenue from sales exceeds the cost of the goods sold (including operating expenses).

• Eastside Hardware Store sold goods to customers for $100,000.
• The cost of the goods are $60,000.
• The gross profit is $40,000.(The amount by which revenue exceeds the cost of goods sold).

Revenue from Sales

It is reported as the following example.
 

Iowa Sales, Incorporated Income Statement For Year Ended December 1, 1990
Revenue from sales
Gross sales	$306,200
Less cost of goods sold	1,900
Sales discounts	4,300
Net Sales	$300,000

1.Gross Sales

These are the goods that were sold to the customers. The sales are rung up on the cash register.
 
 

Nov. 3	Cash	$1,205
	Sales		$1,205
	To record the day’s cash sales.
Nov. 3	Accounts Receivable	$45
	Sales		$45
	Sold merchandise on credit

2.Sales Returns and Allowances.

In most stores, customers are allowed to return any unsatisfactory merchandise they bought. This is important information for the store managers. This indicates dissatisfied customers, so it deserves its own account.
 
 

Nov. 4	Sales Returns and Allowances	$20
	Accounts Receivable (or Cash)		$20
	Customer returned unsatisfactory merchandise.

 
3.Sales Discounts.

When goods are sold on credit, the amount and time of the payment is stated clearly. When credit periods are long, creditors often grant discounts for early payments.  

For example, Iowa Sales, Incorporated sold $100 of merchandise to a customer on credit. The terms of the agreement are  2/10, N/60
 
 

Nov. 12	Accounts Receivable	$100
	Cash		$100
	Sold merchandise, terms 2/10, N/60.

  F  The customer can pay $98 up to Nov. 22 or the customer can wait and pay the amount on Jan. 11.The customer paid  early and received the discount.
 
 

Nov. 22	Cash	$98
	Sales Discounts		$2
	Accounts Receivable		$100
	Received payment for the Nov. 12 sale less the discount.

F  All sales discounts are recorded in one account.  This account is closed at the end of the accounting period. Sales discounts reduce revenue from sales.
 
 

Periodic and Perpetual Inventory Systems

Stores sell thousands of goods, so when goods are sold, the store does not know the cost of selling that good. Stores usually wait to the end of the accounting period to take an inventory to determine the cost of goods sold. This is called a periodic inventory system. (This is this chapter).

If a business is small and sells a limited number of goods (such as a car dealership), the cost of the goods sold can be recorded, when the good is sold. This is called a perpetual inventory system.
 

Cost of Goods Sold, Periodic Inventory System

To use a periodic inventory system, you need three pieces of information.

1. The cost of the merchandise on hand at the beginning of the period.
2. The cost of the merchandise purchased during the period.
3. The cost of unsold goods that remain at the end of the period. 

 

Cost of goods on hand at the beginning of the period	$19,000
Cost of goods purchased during the period	232,000
Goods available for sale during the period	$251,000
Less unsold goods on hand at the period end*	21,000
Cost of goods sold during the period	$230,000

  *This is determined by inventory count.
 

1.Merchandise Inventories.

1. Count the unsold items on the shelves in the store and in the stockroom.
2. Multiply the total count of each good by its unit cost.
3. Add all the cost of all the goods together.
    

2.Cost of Merchandise Purchased.

To determine the cost of merchandise purchased, you must note the invoice price of goods purchased and subtract any discounts, returns, and allowances.
 
 

Nov. 5	Purchases	$1,000
	Accounts Payable		$1,000
	Purchased merchandise on credit, invoice dated Nov. 2, terms 2/10, N/30

The firm pays for the goods to get the discount.
 
 

Nov. 12	Accounts Payable	$1,000
	Purchase Discount		$20
	Cash		$980
	Paid for the purchase of Nov. 5 less the discount.

• The purchase discount is important account. Many companies pay within the time period to get the discount. A store can save alot of money by using discounts.
• Another account of important information is the Returns and Allowances account. When the store buys defective merchandise, the store can return the merchandise to the factory. 

 

Nov. 14	Accounts Payable	$65
	Purchase Returns and Allowances		$65
	Returned defective merchandise.

Sometimes the store has to pay for the transportation cost of getting the goods from the factory to the store.
 
 

Nov. 24	Transportation-in	$22
	Cash		$22
	Paid express charges on merchandise purchased.

When there are transportation charges, the buyer and seller must agree to which party pays for it.
 
 

Income Statement
Purchases	$235,800
Less: Purchase returns and allowances	1,200
Purchase discounts	4,100
Net purchases	$230,500
Add transportation-in	1,500
Cost of goods purchased	$232,000

3.Cost of Goods Sold.

The last example was the cost of the merchandise purchased.  You have to add in the beginning and ending inventories.
 
 

Cost of goods sold:
Merchandise inventory, December 31, 1989		$19,000
Purchases	$235,800
Less: Purchase returns and allowances	1,200
Purchase discounts	4,100
Net purchases	$230,500
Add transportation-in	1,500
Cost of goods purchased		$232,000
Goods available for sale		$251,000
Merchandise inventory, December 31, 1990		21,000
Cost of goods sold			$230,000

Inventory Losses

Stores lose merchandise in a variety of ways, such as shrinkage, spoilage, and shoplifting. When you use a periodic inventory system, these lost items are hidden in the cost of goods sold figure.  

Income Statement of a Merchandising Company

A classified income statement for a store has:

1.  A revenue section.

2.   A cost of goods section.

3.  An operating expenses section.  This section is broken-down into two parts.

(i)  Selling expense - The expense for storing and preparing goods for sale, advertising, delivering goods, etc.

(ii)  General and administrative expense - These expenses are for the overall management of a business, which includes departments: Central office, accounting, personnel, and collections office.
 

 

Iowa Sales, Incorporated Income Statement For Year Ended December 31, 1990
Revenue from sales:
Gross sales			$306,200
Less :Sales returns and allowances		1,900
Sales discounts		4,300	6,200
Net sales			$300,000
Cost of goods sold:
Merchandise inventory, December 31, 1989		$19,000
Purchases	$235,800
Less: Purchase returns and allowances	1,200
Purchase discounts	4,100
Net purchases	$230,500
Add transportation-in	1,500
Cost of goods purchased		$232,000
Goods available for sale		$251,000
Merchandise inventory, December 31, 1990		21,000
Cost of goods sold			$230,000
Gross profit from sales			$70,000
Operating expenses:
Selling expenses:
Sales salaries expense           Rent expense, selling expense           Advertising expense           Store supplies expense           Depreciation expense, store equipment	$18,500 8,100 700 400 3,000
Total selling expense		$30,700
General and administrative expenses:
Office salaries expense           Rent expense, office space           Insurance expense           Office supplies expense           Depreciation expense, office equipment	$25,800 900 600 200 700
Total general and administrative expenses		28,200
Total operating expenses			58,900
Income from operations			$11,100
Less income taxes expense			1,700
Net Income			$9,400

Work Sheet of a Merchandising Company

The account period is 1 year.

1. List all the accounts in the ledger and their balances.

2. You make the adjustments.  In the U.S., the corporations have to pay taxes periodically.  The corporations do not know what their net income is, so they have to estimate it. The corporations pay taxes on this estimated income periodically, such as once a month.  Each tax payment is recorded as an expense.

 

Iowa Sales, Incorporated Work Sheet for Year Ended December 31, 1990
	Unadjusted Trial Balance		Adjustments		Income Statement		Balance Sheet
	Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit
Cash	8,200						8,200
Accounts receivable	11,200						11,200
Merchandise inventory	19,000				19,000	21,00	21,000
Prepaid insurance	900			600			300
Store supplies	600			400			200
Office supplies	300			200			100
Store equipment	29,100						29,100
Accum. depr. store equipment		2,500		3,000				5,500
Office equipment	4,400						4,400
Accum. depr. office equipment		600		700				1,300
Accounts payable		3,600						3,600
Income taxes payable				100				100
Common stock		50,000						50,000
Retained earnings		8,600						8,600
Dividends declared	4,000						4,000
Sales		306,200				306,200
Sales returns and allowances	1,900				1,900
Sales discounts	4,300				4,300
Purchases	235,800				235,800
Pur. returns and allowances		1,200				1,200
Purchases discounts		4,100				4,100
Transportation-in	1,500				1,500
Sales salaries expense	18,500				18,500
Rent expense, selling space	8,100				8,100
Advertising expense	700				700
Store supplies expense				400	400
Depr. expense, store equipment				3,000	3,000
Office salaries expense	25,800				25,800
Rent expense, office space	900				900
Insurance expense				600	600
Office supplies expense				200	200
Depr. expense, office equipment				700	700
Income taxes expense	1,600			100	1,700
	376,800	376,800	5,000	5,000	323,100	332,500	78,500	69,100
Net Income					9,400			9,400
Total					332,500	332,500	78,500	78,500

However, at the end of the year, the corporation knows its net income.  Usually the corporation underestimated its taxes, so it makes an adjustment at the end of the year to pay the correct amount of taxes (lines 12 and 33). The business owes $100 to the government.

After you make all other adjustments, you place the new balances on its appropriate section (Income or Balance Sheet sections).

3.  The income statement should include revenue, cost of goods sold, and expense items.

4.  The beginning inventory amount.  The $19,000 inventory balance is recorded as a debt on the income statement, because it is a  positive element in the calculation of cost of goods sold.  Then you add purchases of goods to this amount.

5.  The Ending Inventory Amount.

At the end of the year (i.e. accounting period), you have to take an inventory count. This is $21,000.This appears as a credit on the Income Statement, because you have to subtract this off from the cost of goods sold (i.e. it was not sold). The store has this inventory, so it is an debit item on the balance sheet (i.e. asset).
 

Completing the Work Sheet and Preparing the Financial Statements

After completing the work sheet and sorting the accounts to the proper columns for the income statement and balance sheet, you can prepare the financial statements.

1.  Income Statement.

2.  The second statement is the retained earnings statement. This is equivalent to changes in owner’s equity, but this is a corporation. This information is found on the last two columns on the worksheet.
 
       

Iowa Sales, Incorporated Retained Earnings Statement For Year Ended December 1, 1990
Retained earnings,  December 31, 1989	$8,600
Add 1990 net income	$9,400
Total	$18,000
Deduct dividends earned	$4,000
Retained earnings, December 31, 1990	$14,000

   
  3.  Then finally you prepare the balance sheet. The $14,000 retained earnings is placed on the balance sheet statement.
 
 

Iowa Sales, Incorporated Balance Sheet December 31, 1990
Assets
Current assets:
Cash      Accounts receivables      Merchandise inventory      Prepaid expenses	$8,200 11,200 21,000 600
Total current assets		$41,000
Plant and equipment:
Store equipment      Less accumulated depreciation      Office equipment      Less accumulated depreciation	$29,100 5,500 4,400 1,300
Total plant and equipment		26,700
Total Assets		$67,700
Liabilities
Current liabilities:
Accounts payable      Income taxes payable	$3,600 100
Total liabilities		$3,700
Stockholders’ Equity
Common stock, $5 par value, 10,000 shares authorized and outstanding Retained earnings Total stockholders’ equity		$50,000 14,000 64,000
Total liabilities and stockholders’ equity		$67,700

Adjusting and Closing Entries

From the worksheet, you have the necessary journal entries.  Then you close the temporary accounts into the Income Summary and also the other accounts.

Closing Entries and the Inventory

Before closing entries, the merchandise inventory account had a balance of $19,000 from the beginning of the accounting cycle. When the first closing is posted, this account goes to zero.  When you post the second closing entry, this account goes to $21,000. This balance will remain throughout the succeeding year.
 
 

1990	Adjusting Entries
Dec. 31	Insurance Expense	$600
	Prepaid Insurance		$600
31	Store Supplies Expense	$400
	Store Supplies		$400
31	Office Supplies Expense	$200
	Office Supplies		$200
31	Depreciation Expense, Store Equipment	$3,000
	Accumulated Depreciation, Store Equipment		$3,000
31	Depreciation Expense, Office Equipment	$700
	Accumulated Depreciation, Office Equipment		$700
31	Income Taxes Expense	$100
	Income Taxes Payable		$100
	Closing Entries
31	Income Summary	$323,100
	Merchandise Inventory      Sales Returns and Allowances      Sales Discounts      Purchases      Transportation-in      Sales Salaries Expense      Rent Expense, Selling Space      Advertising Expense      Store Supplies Expense      Office Salaries Expense      Rent Expense, Office Space      Insurance Expense      Office Supplies Expense      Depreciation Expense, Office Equipment      Income Taxes Expense		$19,000 1,900 4,300 235,800 1,500 18,500 700 400 3,000 25,800 900 600 200 700 1,700
31	Merchandise Inventory Sales Purchases Returns and Allowances Purchase Discounts	$21,000 306,200 1,200 4,100
	Income Summary		$332,500
31	Income Summary	$9,400
	Retained Earnings		$9,400
31	Retained Earnings	$4,000
	Dividends Declared		$4,000

Multiple-Step and Single-Step Income Statements

The first income statement shows all major groups of the cost of goods sold and the expenses. Corporations usually simplify their income statements to their shareholders, investors, etc., which is called a single-step income statement. The multi-step income statement is the first income statement you saw for this lecture. Then corporations will simplify their financial statements further by combining the single-step income statement with the Retained Earnings Statement.

 

Iowa Sales, Incorporated Statement of Income and Retained Earnings For Year Ended December 31, 1990
Revenue from sales		$300,000
Expenses:
Cost of goods sold	$230,000
Selling expenses	30,700
General and administrative expenses	28,200
Income taxes expense	1,700
Total expenses		$290,600
Net income		$9,400
Add retained earnings,  December 31, 1989		$8,600
Total		$18,000
Deduct dividends declared		4,000
Retained earnings, December 31, 1990		$14,00