Cost of Goods Sold

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Financial Accounting:

Tools for Business Decision Making, 3rd Ed.

Kimmel, Weygandt, Kieso

1

Chapter 5

2

Chapter 5

Merchandising Operations

After studying Chapter 5, you should be able to:

Identify the differences between a service enterprise and a merchandising company.

Explain the recording of purchases under a perpetual inventory system.

Explain the recording of sales revenues under a perpetual inventory system.

Distinguish between a single-step and a multiple-step income statement.

3

Chapter 5

Merchandising Operations

After studying Chapter 5, you should be able to

Determine the cost of goods sold under a periodic system.

Explain the factors affecting the profitability.

4

Service enterprises perform services as their primary source of revenue.

Merchandising companies buy and sell merchandise.

5

Differences Between a Service

Enterprise and a Merchandising Company

In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales.

Unlike expenses for a service company, expenses for a merchandising company are divided into two categories:

Cost of goods sold - the total cost of merchandise sold during the period.

Operating expenses - selling and administrative expenses.

6

Terms

Sales revenue or sales = sale of merchandise

Cost of goods sold = total cost of merchandise sold

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Page 202 in book

How Income is Measured in a Merchandising Company

Sales

Revenue

Less

Cost of

Goods Sold

Equals

Gross

Profit

Less

Operating

Expenses

Equals

Net Income

(Loss)

8

Operating cycle of a company is...

the average time it takes to go from cash to cash in producing revenues.

TO

9

Operating cycle of a merchandising company is...

ordinarily longer than than that of a service company;

purchase of merchandise and its sale lengthens the cycle.

10

Receive Cash

Service Company

Perform Services

Cash

Accounts

Receivable

Accounts

Receivable

Merchandising Company

Receive Cash Buy Inventory

Cash

Sell Inventory

Merchandise

Inventory Systems

Perpetual - detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand

Periodic -inventory system in which detailed records are not maintained and the cost is goods sold is determined only at end of accounting period

12

Comparing Periodic and

Perpetual Inventory Systems

Inventory Purchased

Item Sold

End of

Period

No Entry

Record Purchase of Inventory

Record Revenue and compute and record Cost of Goods

Inventory Purchased

Item Sold

End of

Period

Periodic

Record Purchase of Inventory

Record Revenue Only

Compute and record Cost of

13

Goods Sold

Computers

14

and electronic scanners have enabled many companies to install perpetual inventory systems

15

What Is Charged to

Merchandise Inventory?

All costs of getting the inventory to company and ready to sell

+Freight-In

+Special Permits

Only costs associated with merchandise purchased for resale not assets acquired for use, such as supplies

16

Merchandise Purchases

On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.

Task:Record the purchase by getting information from the Purchase Invoice .

The Purchase Invoice is a copy of the sales invoice.

17

1. Seller

2.Invoice Date

3.Purchaser

4.Salesperson

5.Credit terms

6.Freight terms

7.Goods sold: catalog no.,description, quantity, price per unit

8.Total invoice price

Invoice No. 731

Firm Name:

Sauk Stero

Attention o f

James Hoover, Purchasing Agent

Address

125 Main Street

City

Chelsea

Stat

e Illinois

Zip

60915

Date5/4/04 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer

Catalog No. Description QTY Price Amount

A2547Z48

Production Model

Circuits

8 300 1,500

IMPORTANT

18

:

ALL RETURNS MUST BE MADE WITHIN 10 DAYS TOTAL $3,800

Merchandise Purchases

On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.

Merchandise

Inventory

May 4 3,800

Accounts

Payable

May 4 3,800

Freight-out

GENERAL JOURNAL Debit Credit

May 4 Merchandise Inventory 3,800

Accounts Payable 3,800

To record goods purchased on account.

19

Purchases Returns and Allowances

On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc.

Merchandise

Inventory

May 4 3,800 May 8 300

Accounts

Payable

May 8 300 May 4 3,800

Freight-out

GENERAL JOURNAL Debit Credit

May 8 Accounts Payable 300

Merchandise Inventory 300

To record goods returned that were purchased on account.

20

Freight Costs - On Incoming

Inventory

21

Freight Costs - On Incoming Inventory

On May 6 the company paid $ 150 to have the merchandise inventory delivered to them.

Merchandise

Inventory

May 4 3,800 May 8 300

May 6 150

Freight-Out Cash

May 6 150

GENERAL JOURNAL Debit Credit

May 6 Merchandise Inventory 150

Cash 150

To record payment of freight.

22

Freight Costs - On Outgoing

Inventory

23

Freight Costs-on outgoing inventory

On May 6 the seller company paid $ 150 to have merchandise inventory delivered to the buyer.

Merchandise

Inventory Freight-Out

May 6 150

Cash

May 6 150

GENERAL JOURNAL Debit Credit

May 6 Freight-Out 150

Cash 150

To record payment of freight on goods sold.

24

Purchase Discounts

Credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment.

Credit terms specify the amount of cash discounts and the time period during which they are offered.

2/10,n/30

1/10 EOM

25

Purchases Discounts

Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period

Original Invoice $3,800

-Returns 300

Amount due before discount $3,500

2% discount 70

Net due $3,430

26

Purchases Discounts

Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period.

Merchandise

Inventory

May 4 3,800 May 8 300

Accounts

Payable

May 8 300 May 4 3,800

May 6 150

May 14 70 May 14 3,500

Cash

May 6 150

May 14 3430

GENERAL JOURNAL Debit Credit

May 14 Accounts Payable 3,500

Cash 3,430

Merchandise Inventory 70

To record payment within discount period.

27

Payment of Invoice

Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was NOT paid within the discount period.

Merchandise

Inventory

Accounts

Payable Cash

May 4 3,800 May 8 300 May 8 300 May 4 3,800

Jun 3 3,500

Jun 3 3,500

GENERAL JOURNAL Debit Credit

June 3 Accounts Payable 3,500

Cash 3,500

To record payment NOT within discount period.

28

Sales Invoice ...

a business document that provides written evidence of a credit sale.

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1. Seller

2.Invoice Date

3.Purchaser

4.Salesperson

5.Credit terms

6.Freight terms

7.Goods sold: catalog no.,description, quantity, price per unit

8.Total invoice price

Invoice No. 731

Firm Name:

Sauk Stero

Attention o f

James Hoover, Purchasing Agent

Address

125 Main Street

City

Chelsea

Stat

e Illinois

Zip

60915

Date 5/4/04 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer

Catalog No. Description QTY Price Amount

A2547Z48

Production Model

Circuits

8 300 1,500

IMPORTANT

:

30

ALL RETURNS MUST BE MADE WITHIN 10 DAYS TOTAL $3,800

Sales Revenues -

Under a Perpetual System

are recorded when earned-revenue recognition principle

must be supported by a business documentwritten evidence

2 entries are made for each sale

one to record sale

one to record cost of merchandise sold

31

Sales - under a perpetual system

Assume a sale of $ 3,800 ON ACCOUNT

For merchandise having a cost of $2,400

Cash

Accounts

Receivable

May 4 3,800

Merchandise

Inventory

May 4 2,400

Sales

May 4 3,800

Sales Returns &

Allowances

Cost of Goods

Sold

May 4 2,400

32

Sales Returns and

Allowances

Flip side of purchase returns and allowance

On buyer’s books

GENERAL JOURNAL Debit Credit

May 8 Accounts Payable 300

Merchandise Inventory 300

To record goods returned that were purchased on account.

On seller’s books

GENERAL JOURNAL Debit Credit

May 8 Sales Returns and Allowance 300

Accounts Receivable 300

To record return of goods delivered to Sauk Stero.

33

Sales - under a perpetual system

Assume a sale of $ 3,800 ON ACCOUNT

For merchandise having a cost of $2,400

Cash

Accounts

Receivable

May 4 3,800

Merchandise

Inventory

May 4 2,400

Sales

May 4 3,800

Sales Returns &

Allowances

Cost of Goods

Sold

May 4 2,400

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What Is the Sales Returns and Allowances Account?

Contra Revenue Account to sales

Used to show how much came in on returns and allowances

Excessive returns and allowances suggest:

inferior merchandise

inefficiencies in filing orders

errors in billing customers

mistakes in delivery or shipment of goods

35

What Is the Sales

Discount Account?

Contra Revenue Account to sales

Used to disclose amount of cash discounts taken by customers

36

Sales Discounts

Flip side of purchase discounts

On buyer’s books

GENERAL JOURNAL Debit Credit

May 14 Accounts Payable 3,500

Cash 3,430

Merchandise Inventory 70

To record payment within discount period

On seller’s books

GENERAL JOURNAL Debit Credit

May 14 Cash

Sales Discounts

3,430

70

Accounts Receivable 3500

To record collection within discount period.

37

Two Forms Of

Income Statements

Single-step income statement

Multiple-step income statement

38

Single-Step Income

Statement

One step… subtract total expenses from total revenues

Revenues $10,000

Expenses 3,000

Net income $ 7,000

39

PW AUDIO, Inc.

Single-step Income Statement

For the Year Ended December 31, 2004

Sales

Interest Revenue

Gain on Sale of equipment

Total Revenues

$460,000

3,000

600

$463,600

Expenses

Cost of goods sold

Selling expenses

Administrative expenses

Interest expense

Casualty Loss from vandalism

Income tax expense

Total expenses

Net income

$316,000

76,000

38,000

1,800

200

10,100

442,100

$ 21,500

40

PW AUDIO SUPPLY, INC.

Multi-step Income Statement For the Year Ended

December 31, 2004

Sales revenues

Sales

Less: Sales returns and allowance

Sales discounts

Net sales

Cost of goods sold

Gross profit

Operating expenses

Selling expenses:

Store salaries expense $45,000

Advertising expense 16,000

Depreciation expense 8,000

$12,000

8,000

Freight-out 7,000

Total selling expenses

Administrative expenses

Salaries expense $19,000

Utilities expense 17,000

$76,000

Insurance Expense 2,000

Total administrative expenses 38,000

Total operating expenses

Income from operations

$ 480,000

20,000

460,000

316,000

$ 144,000

114,000

PW AUDIO SUPPLY, INC.

Multi-step Income Statement

For the Year Ended December 31, 2004

Income from operations (continued)

Other revenues and gains

Interest revenue $ 3,000

Gain on sale of equipment 600

$ 30,000

$ 3,600

Other expenses and losses

Interest expense $ 1,800

Casualty loss from vandalism 200

2,000 1,600

31,600

Income before income income taxes

Income tax expense 10,100

Net income $21,500

42

Cost of Goods Sold -

Periodic Method

A running account of changes in inventory is not maintained.

Separate accounts use to record freight costs, returns and discounts

Cost of goods sold and ending inventory are calculated at end of period.

43

PW AUDIO SUPPLY, INC.

Cost of Goods Sold

For the Year Ended December 31, 2004

Cost of goods sold

Inventory, January 1 $ 36,000

Purchases

Less Purchase returns and allowances $10,400

$325,000

Purchase discounts 6,800

Net purchases

Add: Freight-in

17,200

307,800

12,200

Cost of goods purchased

Cost of goods available for sale

320,000

356,000

Inventory, December 31 40,000

Cost of goods sold 316,000

44

Gross Profit Rate=

Gross Profit

Net Sales

Company’s gross profit expressed as a percentage

45

Profit Margin Ratio

Measures the percentage of each dollar of sales that results in net income

Profit Margin Ratio =

Net Income

Net Sales

Higher value suggests favorable return on each dollar of sales.

46

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