Accounting for merchandise chapter four ppt
- 1. Chapter Four Accounting for merchandising business
- 2. What is a Merchandising Business? • A merchandising business buys finished goods for resale to customers. • These goods that a merchandising company sells to its customers are called merchandise inventory. • The value of goods (merchandise) on hand at the end of the year would be reported on the Balance Sheet as one asset. • This means that we need to open a separate ledger account to record merchandise inventory information.
- 3. • The two alternatives in dealing with this account are: – To update this account every time goods are bought and sold (continuously or perpetually) – To update this account only at the end of the period (periodically). • These two alternatives (Inventory systems) are used to determine the amount of • merchandise inventory and • cost of goods sold reported in the statement of financial position and statement of financial performance, respectively.
- 4. • The inventory account is updated only periodically i.e., only at the end of a period. • When goods are bought, a temporary purchases account is debited. • At the time of sale only revenue from sales is recorded and no attempt is made to record cost of goods sold. • Ending inventory is known only at the end of an 'accounting period by taking physical inventory. • Thus, any inventory not on hand by the end of an accounting period is assumed to be sold. • Does not provide timely inventory information for preparation of financial statements and inventory control. 1. The Periodic Inventory System
- 5. 2. Perpetual Inventory Systems • A perpetual inventory system continuously records the amount of inventory on hand. • The merchandise inventory account is debited or credited in every time or when goods are bought or sold. • When an item is sold, its cost is recorded in a separate cost of goods sold account in addition to recording sales. • The cost of merchandise on hand can be looked up from the merchandise Inventory account at any time, without conducting a physical count.
- 6. Recording Sales • When a merchandising company transfers goods to the buyer, in exchange for cash or a promise to pay at a later date, revenue is produced to the company. • This revenue is recorded in a Sales account. Recording purchase and sales transaction Under periodic Inventory System
- 7. • Recording Cash Sales • When goods are sold on cash, the Cash account is debited and the revenue account Sales is credited. • Example – Ika Company in Bahir Dar, buys and sells used commodities. On January 14. 2001. Ika sold goods for Birr 20,000 on cash. Record the transaction. January 14, Cash………………………………..20,000 Sales……………………………………20,000
- 8. Recording Credit Sales • The Accounts Receivable account is debited when goods are sold on account (for credit). Example - Ika sold goods worth Birr 35,000 on account on January 15, 2001. January 15. Accounts Receivable…………………..35,000 Sales…………………………………………35,000 Recording Deductions from Gross Sales Sales reported on the income statement is net sales, i.e., after deduction of sales discounts and sales returns and allowances.
- 9. Sales Discounts • Sales Discounts are deductions from invoice price to customers who pay early when goods are sold on credit. • The discount amount depends on the credit terms. These terms (agreements) are usually stated on the invoice. Example • 2/10, n/30 –means the due date of the payment is after 30 days of the sale. But if the customer pays within 10 days, she/he will get a 2% discount. • 1/10, EOM- the buyer will get 1% discount if s/he pay within 10 days, unless the payment should be made at the End of the Month.
- 10. Cont… Example: • On January 21, 2001 IKA Company sold merchandise for birr 20,000 on account. The credit terms are 2/10, n/30. The customer paid on January 31, (10 days after invoice date). A. How much would IKA Company collect from this sale? B. Record the necessary journal entries on January 21 and January 31.
- 11. Cont.… A- Since the customer paid within the discount period, i.e., within 10 days, she will get a 2% discount. Invoice price………..............……………..20,000 Less: Sales Discount (2% X 20,000)……… (400) Cash collected …………..……………….19,600
- 12. Cont.… B- journal Entries: January 21 A/R…………………..20,000 Sales……………………..20,000 January 31, Cash………………….19600 Sales Discounts ………...400 A/R………………..20,000 NB: Sales discount is a contra sales account which decrease sales.
- 13. Cont.… • Sales Returns and Allowances • A purchaser may be dissatisfied with the merchandise received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser’s specifications. • At this time the purchaser may return such goods and this is called sales return to the seller. • When the customer keeps the merchandise a deduction from the original invoice price is made and it is called a sales allowance
- 14. Cont.… • Example: IKA Company sold merchandise worth Birr 15, 000 on February 3, 2001 on account terms 2/10, n/30. • On February 5, the buyer returned a portion of the goods worth Birr 5,000 as they were found to be of the wrong model. The buyer then paid on February 13, 2001. • Record the necessary journal entries on February 3, 5 and 13.
- 15. Cont.… February 3 A/R…………………….15, 000 Sales …………………….15, 000 • February 5 Sales Returns and Allowances ………5,000 A/R………………………………………….5,000 • February 13 Cash…………………………………..9800 Sales Discount ……………………….. 200 A/R………………………………….10,000
- 16. Cont.… Recording Purchases • Under the periodic inventory system a merchandising company uses the Purchases account to record the cost of goods bought for resale to customers. Example: on January 4, 2001, IKA Company bought goods worth Birr 43,000 from Saba Co., which is based in Addis Ababa, on account, the term of purchased is 2/10, n/30. Record the transaction Solution: January 4 – Purchases …………………..43,000 Accounts payable………………………..43,000
- 17. cont.… Deductions from Purchases Purchase Discounts • Purchase Discounts are deductions from invoice price to buyer who pay early when goods are purchased on credit. Example: • on January 14, 2001, IKA Company bought goods worth Birr 50,000 from Gibir Company on account, terms 1/10,n/60. Ika Company paid on January 24, 2001. Record the transactions on both dates.
- 18. Cont.…. Solution: Jan. 14. Purchases…………..50,000 A/P………………………50,000 Jan. 24. A/P…………………50,000 Purchase Discounts ……........500 Cash…………………….. 49,500
- 19. Cont.… Purchase Returns and allowances A purchase return occurs when a buyer returns merchandise to a seller. A purchase allowance is a reduction on the price of goods bought for dissatisfaction on the side of the buyer. Both purchase returns and purchase allowances are recorded in a contra purchase account called Purchase Returns and Allowances.
- 20. Cont.… • Example: In the previous example for IKA Company, a portion of the goods worth birr 5,000 bought on January 14 from Gibir Company were of the wrong size. Gibir Company acknowledged this and gave IKa Company a 5% price allowance on January 17. What should IKA Company record on January 17? January 17 A/P………………………………250 Purchase Returns and Allowance…………250
- 21. Transportation costs • Once merchandise has been bought, it has to be moved from the seller’s place to the buyer’s place. This often involve freight. • The terms of a sale indicate when ownership (title and control) of the merchandise passes from the seller to the buyer. • This point determines whether the buyer or the seller pays the freight costs. • It depends on the agreement between the buyer and the seller. • This agreement is two types: – FOB (Free-on-Board) Destination and – FOB Shipping Point
- 23. Cont.… FOB Destination Based on this agreement, the destination of the goods is the buyer’s place. Ownership of the goods will not pass from the seller to the buyer until the goods reach their destination i.e. the buyer's location or store. Goods are shipped to the buyer without transportation charge to the buyer. i.e. the transportation cost is paid by the seller. When the seller pays the delivery charges, it debits Delivery Expense or Freight Out. Delivery Expense is reported on the seller’s income statement as a selling expense.
- 24. Cont.… • FOB shipping Point – All the responsibilities of goods in transit is to the buyer. – The buyer pays transportation costs when the goods reach at the buyer place. – Any freight costs incurred by the buyer are part of the cost of merchandise purchased. • The reason: Inventory cost should include all costs to acquire the inventory, including freight necessary to deliver the goods to the buyer. • Companies recognize these costs as cost of goods sold when the inventory is sold.
- 25. Cont… • Example: IKA Company bought goods worth Birr 85,000 on account, terms 2/10,n/60 FOB shipping point on March 2, 2001.Transportoin cost of Birr 1,500 was paid on March 2. • Record the necessary journal entries. Here, since the terms are FOB Shipping Point, the buyer (Ika) pays transportation cost. March 2 Purchase…………………..85,000 A/P…………....……………..85,000 Transportation In……….....1500 Cash………………………1500
- 26. Cont.… Example: IKA Company sold goods on account worth Birr 135,000 terms 1/15, n/EOM on February 1, 2001. FOB Destination. It also paid transportation costs of Birr 800 on Feb. 1. The customer paid on February 16, 2001. Record the relevant journal entries. Here, since the terms are FOB destination, the seller (Ika) pays transportation cost.
- 27. Cont.… Feb 1 A/R………………………..135,000 Sales…………………………..135,000 Delivery Expense…..……..……800 Cash………………..……………800 Feb 16 Cash………………………….133, 650 Sales discount ………………….1, 350 A/R…………………………135,000
- 28. Entries to handle inventory transactions under perpetual inventory system • To record purchases and transportation costs paid Merchandise inventory…………………………….xx Accounts payable/cash…………………………………..xx Transportation-in…………………………………….xx Cash………………………………………………………………….xx • To record purchase discounts, returns and allowances Accounts payable/cash…………………………. xx Merchandise inventory…………………………….xx
- 29. • To record sales: two entries are made. The first is to record sales revenue and the second is to update the reduction of merchandising inventory. Accounts receivable/ cash…………………..xx Sales………………………………………………………xx Cost of goods sold………..…………………….xx Merchandise inventory………….……..…………………xx
- 30. • To record sales discounts, returns and allowances Sales discounts…………………..…..…………….xx Sales returns and allowances…………………xx Accounts receivable/cash………………………..xx Merchandise inventory (returns) ………….xx Cost of goods sold……………….………………….xx
- 31. • Example: Assume that ABC Co. purchased Br. 20,000 of merchandise on account from XYZ Co, terms 2/10, n/30, FOB Shipping point and paid Br. 3,000 cash for transportation, on Jan 3, 2020 • Returned Br, 5,000 of defective goods to XYZ and received credit memo, on Jan 6,2020. • On Jan 10, 2020, ABC Co. sold goods on account for Br. 15,000,terms 1/10, n/EOM, FOB Shipping point. The cost of goods sold was Br. 9,000. The transportation cost paid on Jan 10, 2020 was Br. 2,200. the customer paid in full on Jan 20, 2020. • Required: pass necessary journal entries to the Buyer and the seller.
- 32. Date Periodic Inventory Systems Perpetual Inventory Systems Jan 3, 2020 Purchase………………………..20,000 A/P………………………………20,000 Transportation-in…………….3,000 Cash……………………………..3,000 Merchandise inventory………20,000 A/p……………………………….20,000 Transportation-in…………….3,000 Cash……………………………..3,000 Jan 6 A/p………………………………….5,000 Purchase returns & Allowances…….5,000 A/p………………………………….5,000 Merchandise inventory………5,000
- 33. Jan 10 A/R…………………………………15,000 Sales……………………………….15,000 No entry for transportation cost(Buyer is responsible) A/R…………………………………15,000 Sales……………………….15,000 Cost of goods sold……………..9,000 Merchandise inventory..9,000 No entry for transportation cost(Buyer is responsible) Jan 20 It is paid on discount period, thus Invoice price …………………….…………15,000 Less: discount (1%*15,000)……………………….150 Cash payment……………………………….14,850 Cash………………………….……14,850 Sales discount…………..………...150 A/R………………………………15,000 Cash………………..………14,850 Sales discount……………...150 A/R………………………………15,000
- 34. •To adjust inventory difference (difference between physical inventory and perpetual inventory record balances) • When there is excess inventory at the end of the period Merchandise inventory……………………... xx Cost of goods sold……………………………………….xx • When there is inventory reduction (shrinkage) at the end of the period Cost of goods sold…………………………….xx Merchandise inventory …………………………….xx
- 35. Summary of Important Relationships on the Income Statement 1. Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances) 2. Net purchases = Purchases – (Purchase Disc. + Purchase Ret. & allowance) 3. Total cost of Purchase = Net purchase + Transportation –In 4. Cost of goods sold = Beg inventory + Total cost of purchase –Ending inventory 5. Gross profit = Net sales – Cost of goods sold 6. Net Income = Gross Profit – operating (i.e., selling & administrative) expenses.
- 36. 36 INCOME STATEMENT FOR MERCHANDISING FIRMS • Income Statement has two forms: • A. Single-step – Has two sections only: total revenues and total expenses – No details of net sales, cost of goods sold, operating expenses, etc – Net income is computed in a single step by deducting total expenses from total revenues –Revenues • Net sales • Rent income • Other income
- 37. 37 –Expenses • Cost of goods sold • Selling expenses • Administrative expenses • Other expense –Net income = total revenues – total expenses
- 38. 38 • B. Multiple-step –Shows in detail net sales, cost of goods sold, operating expenses and other items –Has several steps to compute net income
- 39. 39 • Gross profit section Gross sales xx Less: Sales discounts xx Sales returns and allowances xx (xx) • Net sales xx • Cost of goods sold: Beginning Merchandise Inventory xx Add: Net Purchases: Gross Purchases xx Less: Purchase Discounts (xx) Returns and Allowances (xx) (xx) xx add: Freight in xx Merchandise Available for Sale xx Less: Ending Merchandise Inventory (xx) • Cost of Goods Sold (xx) • Gross profit xx
- 40. 40 • Gross profit xx • Operating expenses section Selling expenses xx administrative expenses xx Total operating expense (xx) • Income from operations xx • Other income and expenses section add other income xx less other expenses (xx) xx • Net Income XX
- 41. The End!