Inventories

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Accounting for Merchandising Operations
Chapter
5
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Learning objective

• Specialty of merchandising activities
• Accounting for merchandise purchasing
• Accounting for merchandise sales
• Completing Accounting cycle
• Financial statement format
• Decision Analysis
• Current Ratio
• Acid-test ratio
• Gross margin ratio
• Case Walmart Target

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1. Specialties of Merchandising Activities

• Merchandising companies sell goods to earn
  revenue.
• Example supermarket

Revenues
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Merchandising Activities
Merchandising Companies
Manufacturer
Wholesaler
Retailer
Customer
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Reporting Income for a Merchandiser

• Merchandising companies sell products to earn
  revenue.
• Examples sporting goods, clothing, and auto
  parts stores

Cost ofGoods Sold
GrossProfit
Expenses
NetIncome
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Operating Cycle for a Merchandiser

• Begins with the purchase of merchandise and ends
  with the collection of cash from the sale of
  merchandise.

Credit Sale
Cash Sale
Cashcollection
Purchases
Purchases
Merchandiseinventory
Accountreceivable
Cashsales
Merchandiseinventory
Credit sales
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Inventory Systems
Beginninginventory
Net cost ofpurchases

Merchandiseavailable for sale

Ending Inventory
Cost of GoodsSold

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Inventory Systems

• Perpetual inventory system continuously updates
  accounting records for merchandising transactions
  specifically, for those records of inventory
  available for sale and inventory sold.
• Periodic inventory system updates the accounting
  records for merchandise transactions only at the
  end of a period. What are the disadvantages of
  periodic inventory system?

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2. Accounting for Merchandise Purchases

• Trade discounts vs. purchase discounts
• Purchase returns and allowances
• Transportation costs

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?Seller ?Invoice date ?Purchaser ?Order
number?Credit terms ?Freight terms?Goods
?Invoice amount
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Accounting for Merchandise Purchases
On November 2, Z-Mart, purchased 1200 of
Merchandise Inventory by paying cash.
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Trade Discounts

• Used by manufacturers and wholesalers to offer
  better prices for greater quantities purchased.

Example Matrix, Inc. offers a 30 trade discount
on orders of 1,000 units or more of their
popular product Racer. Each Racer has a list
price of 5.25.
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Purchase Discounts Credit term
2/10,n/30
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Purchase Discounts

• A deduction from the invoice price granted to
  induce early payment of the amount due.

Terms Time Due
Discount Period
Credit Period
Full amount less discount
Full amount due
Purchase or Sale
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Purchase Discounts

• On Nov 2, Z-Mart purchased 1200 of Merchandise
  Inventory on account, credit terms are 2/10, n/30.

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Purchase Discounts

• On Nov. 12, Z-Mart paid the amount due on the
  purchase of Nov. 2.

1,200 2 24 discount
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Purchase Discounts

• After we post these entries, the accounts
  involved look like this

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Failure to Pay Within the Discount Period

• If we fail to take a 2/10, n/30 discount, is it
  really expensive?

365 days 20 days 2 36.5 annual rate
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Purchase Returns and Allowances
Purchase Return Merchandise returned by the
purchaser to the supplier. Purchase Allowance A
reduction in the cost of defective merchandise
received by a purchaser from a supplier.
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Purchase Returns and Allowances

• On Nov. 9, Z-Mart purchased 20,000 of
  Merchandise Inventory on account, credit terms
  are 2/10, n/30.

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Purchase Returns and Allowances

• On Nov. 10, Z-Mart returned 500 of defective
  merchandise to the supplier.

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Purchase Returns and Allowances

• On Nov. 18, Z-Mart paid the amount owed for the
  purchase of Nov 9.

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Transportation Costs
Seller
Buyer
Merchandise
FOB shipping point (buyer pays)
FOB destination (seller pays)
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Transportation Costs

• On Nov. 12, Z-Mart purchased 8,000 of
  Merchandise Inventory for cash and also paid 100
  transportation costs.

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Quick Check ?
On July 6, 2005 Seller Co. sold 7,500 of
merchandise to Buyer, Co. terms of 2/10,n/30.
The shipping terms were FOB shipping point. The
shipping cost was 100. Which of the following
will be part of Buyers July 6 journal entry?
a. Credit Sales 7,500 b. Credit Purchase
Discounts 150 c. Debit Merchandise Inventory
100 d. Debit Accounts Payable 7,450
FOB shipping point indicates the buyer ultimately
pays the freight. This is recorded witha debit
to Merchandise Inventory.
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Itemized Cost of Merchandise Purchased
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3. Accounting for Merchandise Sales

• Sales of merchandise
• Sales discounts
• Sales returns and allowances

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Accounting for Merchandise Sales
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Sales of Merchandise

• On Nov. 3, Z-Mart sold 2,400 of merchandise on
  credit. The merchandise was carried in inventory
  at a cost of 1,600.

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Sales Discounts

• On Nov. 12, Z-Mart sold merchandise costing 600
  for 1,000 on account. Credit terms were 2/10,
  n/60. Lets prepare the journal entries.

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Sales Discounts

• On Nov. 22, Z-Mart received a check for 980 in
  full payment of the Nov. 12 sale.

Contra Revenue Account
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Sales Returns and Allowances

• On Nov. 3, Z-Mart sold merchandise costing 4,000
  for 7,500 on account The credit terms were
  2/10, n/30.

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Sales Returns and Allowances

• On Nov. 6, customer returns merchandises with a
  sales price of 800 and a cost of 600. The
  return is related to the Nov. 3 sale.

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Sales Returns and Allowances

• Assume that 800 of merchandise Z-Mart sold on
  Nov. 3 is defective but the buyer decides to keep
  it because Z-Mart offers a 100 price reduction.

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4. Completing accounting cycle

• Prepare adjustments and close accounts for a
  merchandising company.

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Shrinkage

• Compare a physical count of inventory with
  recorded amounts.
• Z-Marts Merchandise Inventory account at the end
  of year 2005 has a balance of 21,250, but a
  physical count reveals that only 21,000 of
  inventory exists. The adjusting entry is
• 12/31/2005 Dr. Cost of goods sold
  250
• Cr. Merchandise
  inventory 250
• To adjust for 250 shrinkage.

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Completing the accounting cycle
Lets complete the accounting cycle by preparing
the closing entries for Z-Mart.
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Step 1 Close Credit Balances in Temporary
Accounts to Income Summary.
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Step 2 Close Debit Balances in Temporary
Accounts to Income Summary.
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(No Transcript)
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Step 3 Close Income Summary to Owners Capital
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Step 4 Close Withdrawals Account to Owners
Capital.
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5. Financial statement format

• Define and prepare multiple-step and single-step
  income statements.

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Income Statement Formats

• Multiple-Step
• Single-Step

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Multiple-Step Income Statement
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Operating expenses

• Selling expenses include the expenses of
  promoting sales by displaying and advertising
  merchandise, making sales, and delivering goods
  to customers.
• General and administrative expenses support a
  companys overall operations and include expenses
  related to accounting, HR management, and
  financial management.

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Single-Step Income Statement
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Multiple-Step vs. Single-Step Income statement

• A multiple-step income statement format shows
  detailed computations of net sales and other
  costs and expenses, and report subtotals for
  various classes of items.
• Gross profit
• Income from operations
• Net income
• A single-step income statement lists revenues and
  expenses with very few categories.

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Classified Balance Sheet
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6. Decision Analysis - Current Ratio
Acid-Test Ratio

• Helps assess the companys ability to pay its
  debts in the near future
• Liquidity measure

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6. Decision Analysis - Acid-Test Ratio
A common rule of thumb is the acid-test ratio
should have a value of at least 1.0 to conclude a
company is unlikely to face liquidity problems in
the near future.
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6. Decision Analysis - Gross Margin Ratio
Percentage of dollar sales available to cover
expenses and provide a profit.
Indicate the companys pricing capability of its
products
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6. Decision Analysis - Supermarket

• Industry Characteristics
• High volume, Low profit margin
• Chain of stores
• Key success factors
• Inventory control
• Store location decision
• Companies for analysis
• Walmart
• Target

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6. Walmat Target - Current Ratio
CR 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
WMT 0.90 0.90 0.90 0.90 1.00 0.90 0.90 1.20 1.30 1.70 1.50
Target 1.50 1.69 1.55 1.59 1.37 1.16          
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6. Walmat Target - Acid-test Ratio
ATR 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
WMT 0.19 0.17 0.17 0.13 0.15 0.13          
Target 0.76 0.89 0.78 0.84 0.61 0.36          
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6. Walmat Target - Gross Profit Margin
GPM 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
WMT 23.06 22.94 22.46 22.35 22.02 22.16 22.03 21.48 21.29 20.81 20.85
Target 33.62 32.87 32.45 21.79 17.80 15.22 31.67 31.23 31.08    
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6. Walmat Target - Profit Margin
PM 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
WMT 3.59 3.60 3.53 3.46 3.23 3.45 3.41 3.37 3.13 3.05 3.07
Target 4.58 4.02 3.85 3.68 3.33 3.23 3.39 3.05 2.73    
Industry   3.50 3.37 3.71