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.

1.Gross Sales

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

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.

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

→ 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.

→ All sales discounts are recorded in one account. This account is closed at the end of the accounting period. Salesdiscounts 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.

*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.

The firm pays for the goods to get 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.

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

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

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.

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.

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 amonth. Each tax payment is recorded as an expense.

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 Sheetsections).

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.

See income statement of Iowa Sale, Inc.

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.

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

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.

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.