5 Day – Chapter 6 Survival Guide
There are 23 Excercises that Each Student Must Master in this Note Packet
Pg. 254
I.
Students must know how the income statement is different for a Service
Business and a Merchandising Business.
Service Business
Merchandising Business
Fees Earned
- Operating Expenses
= Net Income(Loss)
Sales
- Cost of Merchandise Sold
= Gross Profit
- Operating Expenses
= Net Income(Loss)
*Note: with a Merchandising business, they must first purchase the material that they will
ultimately sell to the final customer. The cost to buy the merchandise from the
manufacturer or wholesaler is referred to as COMS (Cost of Merchandise Sold).
**Important: What’s the difference between Gross Sales & Net Sales? Answer: Gross Sales
represents the total sales of the merchandiser while Net Sales is the final sales that the
company had. The two differ because Net Sales pulls out those sales that were returned to
the store by the customer. Net Sales also pulls out any Sales Discounts that were given by
the company.
Practice: (4 Exercises) (Remember: All answers are on Edmodo)
1. PE 6-1A & PE 6-1B (Determining Gross Profit)
2. EX 6-1 (Determining Gross Profit)
3. EX 6-2 (Determing COMS)
4. EX 6-3 (Income Statement for Merchandiser)
Pg. 255
I.
The Operating Cycle
a. Step 1 – Purchase the merchandise from the manufacturer
b. Step 2 – Sell the merchandise to your customers (most customers buy on
credit)
c. Step 3 – Complete the collection activities once the customer pays for the
merchandise.
II.
Operating Cycles are longer for products that have a high markup such as Jewelry
(30%-50% Markup). In other words, the average time that a diamond rings sits at
a jewelers is longer than the time that a bottle of Coke sits on the shelf at Publix.
Products that fly off of the shelves have a shorter Operating Cycle and a smaller
markup (1%-5% Markup).
III.
Multi-Step Income Statement
A multi-step income statement is one that solves from Gross Profit first by
subtracting COMS from Net Sales. Then, the Operating Expenses are subtracted
to determine the company’s Operating Income. Finally, Other Revenues & Other
Expenses are removed from Operating Income to arrive at the Net Income(Loss).
Pg. 256
I.
To determine Net Sales, you must:
Start with Gross Sales
then subtract the Contra Revue Accounts
II.
III.
IV.
Gross Sales
-Sales Returns & Allowances
-Sales Discounts
Net Sales
Sales Returns & Allowances = the products that were purchased by customers
and then returned for whatever reason (i.e. – they decided that they didn’t want
them, they were missing parts or broken, etc.)
Sales Discounts = the discount that the store gave to the customer if they pay
their bill before the expiration of the credit terms.
Sales Discount Example:
Johnny received the credit terms of 2/10 n30 on a $1000 purchase from Best
Buy. This means that Johnny will receive a 2% discount ($20) if he pays within 10
days of the purchase. If he doesn’t pay his bill in the first 10 days, then the entire
$1000 balance is due in 30 days. Companies offer Sales Discounts to encourage
their customers to pay early because “A Dollar Today is Worth More Than A
Dollar Tomorrow.”
Pg. 257
I.
Cost of Merchandise Sold (COMS)
a. There are 2 ways to determine COMS
i. The Periodic Inventory System (we will discuss this in a later
chapter) – this system doesn’t calculate COMS until the end of
the fiscal period when the company takes a physical hard count
of their inventory and then compares it to their accounting
records to determine how much was sold and what the COMS
was.
ii. The Perpetual Inventory System (the focal point of this chapter)
– with computer systems today, most companies use the
Perpetual System, whereby the amount of inventory and COMS is
automatically updated by the computer every time a transaction
takes place.
II.
Income from Operations – sometimes called Operating Income, is
determined by subtracting Operating Expenses from Gross Profit.
Gross Profit – Operating Expenses = Operating Income
a. Operating Expenses can be broken down into 2 types:
i. Selling Expenses – those expenses directly incurred in the
process of selling the company’s products. Examples include
Sales Salaries, Store Supplies Used, Depreciation of Store
Equipment, Delivery Expense, and Advertising Expense.
ii. Administrative Expenses – aka General Expenses, are incurred in
the administration or general operations of the business.
Examples include: Office Salaries, Depreciation of Equipment, and
Office Supplies used.
iii.
Pg. 258-259
I.
Other Income (Gains) and Expenses (Losses) – Companies often receive
additional income that is not directly related to their main core business. For
example, Duncan Donuts’ main revenue comes from selling donuts, coffee,
bagels, etc. However, if the owner of a Duncan Donuts restaurant owns the
shopping center that his store is located in, he is receiving rental income from the
other tenants that are leasing space in the shopping center. This Other Income
would be added at the bottom of Duncan Donuts’ Income Statement.
Furthermore, if the company sold a fixed asset for a gain (its sales price was
greater than its book value), this would be a gain reported at the bottom of the
Income Statement. When it comes to Other Expenses, these are expenses that
cannot be directly traced to the normal operations of the donut company. Such
expenses might include the loss received from selling an oven (a fixed asset).
II.
Single Step Income Statement
Differs from the Multi-Step Income Statement in that Gross Profit and Operating
Income are not calculated. Instead, ALL revenues are listed at the top of the
Income Statement and totaled. Then, ALL expenses are listed immediately below
and subtracted in order to determine the company’s Net Income(Loss).
Practice: (4 Exercises)
1. EX 6-4
2. EX 6-5
3. EX 6-6
4. EX 6-8 *USE THE TEMPLATE PROVIDED ON EDMODO
Pg. 260
MERCHANDING TRANSACTIONS
I.
Chart of Accounts
a. Differs from the Chart of Accounts for a Service Company because there
are now 3 digits for a Merchandising Company.
i. 1st Digit – indicates the major classification of the account (1 –
Assets, 2- Liabilities, 3-Equity, 4-Revenues, 5-Expenses)
ii. 2nd Digit – indicates the sub-classication of the account (1- Current
Asset, 2- Long-term Asset).
iii. 3rd Digit – indicates the specific account (110 – Cash, 111 – Accounts
Receivable, 121 Equipment).
Pg. 261-265
Sales Transactions
Example A: Cash Sale
NetSolutions sells merchandise for $1800 for cash. The merchandise originally cost
NetSolutions $1200. This transaction involves 2 entries into the General Journal.
Entry 1 – NetSolutions records the sale by:
Cash
Sales
Sold Merchandise for Cash
1800
1800
*Note: Sales is credited by a Merchandising Company instead of Fees Earned. Fees Earned
is only used by a Service Company.
Entry 2 – NetSolutions now must remove the merchandise from its Merchandise
Inventory account and record this amount as an expense to Cost of Merchandise Sold.
Cost of Merchandise Sold
1200
Merchandise Inventory
1200
To Record the COMS
Example B: Credit Sale using a Bank Card (i.e. – Visa & Master Card)
*When a customer uses a Bank Card, the company treats the transaction just as if it were
a cash transaction because the company will be paid with a few days by the clearing-house
that processes the transaction for both the company and the bank that the credit card was
issued on. Even though American Express is not a bank card, the process works the same,
with the clearing-house processing the transaction for the both the company & AMEX.
Entry 1
Cash
Sales
1800
1800
Sold Merchandise for Cash
Entry 2
Cost of Merchandise Sold
Merchandise Inventory
To Record the COMS
1200
1200
The only difference is that Visa, Mastercard & AMEX all charge a very small convenience
fee to the company. The company does not receive the full amount of the sale due to this
fee. The fees are based on a per transaction basis and are paid periodically during each
month.
For example, suppose NetSolutions Credit Card fees for the month are $48. At the the
month, NetSolutions would record the following journal entry.
Entry 3
Credit Card Expense
48
Cash
Service charges on Credit Card Sales
48
Example C: Credit Sale using a Store Charge Card
NetSolutions sells merchandise for $1800 on account to Bill Daniel. The merchandise
originally cost NetSolutions $1200. This transaction involves 2 entries into the General
Journal.
Entry 1 – NetSolutions records the sale by:
Accounts Receivable/Bill Daniel
Sales
Sold Merchandise on Account
1800
1800
*The only difference is now the Accounts Receivable controlling account & corresponding
A.R. Subsidiary Account are now debited.
Entry 2 – NetSolutions now must remove the merchandise from its Merchandise
Inventory account and record this amount as an expense to Cost of Merchandise Sold.
Cost of Merchandise Sold
1200
Merchandise Inventory
1200
To Record the COMS
Entry 3 – The customer pays his bill at a later time.
Cash
1800
Accounts Receivable/Bill Daniel
Received payment on account
1800
Example D: Credit Sale using a Store Charge Card & the Customer takes the Sales
Discount
NetSolutions sells merchandise for $1800 on account to Bill Daniel and offers him Credit
Terms of 2/10 n30. The merchandise originally cost NetSolutions $1200. This transaction
initially involves the same 2 entries into the General Journal as in Example C above.
Entry 1 – NetSolutions records the sale by:
Accounts Receivable/Bill Daniel
Sales
Sold Merchandise on Account
1800
1800
*The only difference is now the Accounts Receivable controlling account & corresponding
A.R. Subsidiary Account are now debited.
Entry 2 – NetSolutions now must remove the merchandise from its Merchandise
Inventory account and record this amount as an expense to Cost of Merchandise Sold.
Cost of Merchandise Sold
1200
Merchandise Inventory
1200
To Record the COMS
However, if the customer (Bill Daniel) decides to take NetSolutions up on their Sales
Discount when paying his liability, the journal entry will look very different from the one
presented in that last transaction.
To illustrate this, the Sales Discount of 2% must be calculated. 2% of $1800 = $36. This
means that if Bill Daniel pays is liability before the end of 10 days, he’ll receive a $36 Sales
Discount. The journal entry would then look like:
Cash
Sales Discount
Accounts Receivable/Bill Daniel
Received Payment on Account
1764
36
1800
Whenever a customer takes a Sales Discount, the Sales account is NEVER decreased with a
debit. Instead, the Contra Revenue account Sales Discounts is debited. The same goes for
when a customer buys something and then returns either all or a portion of what was
purchased. Instead of reducing the Sales account with a debit, the Contra Revenue account
Sales Returns & Allowances is debited. A CREDIT MEMO IS ISSUED BY THE STORE WHEN
THERE IS A RETURN. THE CREDIT MEMO AUTHORIZES A CREDIT TO THE CUSTOMER’S
ACCOUNTS RECEIVABLE.
Example E: The customer buys $2000 on account using a store charge card. The
merchandise originally cost NetSolutions $1000. The customer then returned $500 of the
merchandise. The returned merchandise originally cost NetSolutions $250.
Entry 1 – NetSolutions records the original sale.
Accounts Receivable/John Thompson
2000
Sales
Sold Merchandise on Account
2000
Entry 2 – NetSolutions now must remove the merchandise from its Merchandise
Inventory account and record this amount as an expense to Cost of Merchandise Sold.
Cost of Merchandise Sold
1000
Merchandise Inventory
1000
To record the COMS
Entry 3 – NetSolutions must record a journal entry when the customer returns some of
the merchandise.
Sales Returns & Allowances
500
Accounts Receivable/John Thompson
500
Merchandise Returned
Entry 4 – NetSolutions must increase their inventory and reduce their COMS since the
merchandise was returned.
Merchandise Inventory
250
Cost of Merchandise Sold
250
Merchandise Returned
Practice: (4 Exercises)
1. PE 6-2A
2. PE 6-2B
3. EX 6-10
4. EX 6-11
Pg. 266-270
PURCHASE TRANSACTIONS
Example A: Under a Perpetual Inventory System, cash purchases of merchandise are
recorded as:
Merchandise Inventory
2500
Cash
2500
Purchased Merchandise from Bowen Co.
Example B: Under a Perpetual Inventory System, purchases of merchandise on account
are recorded as:
Merchandise Inventory
2500
Accounts Payable/Bowen Co.
2500
Purchased Merchandise on Account
PURCHASE DISCOUNTS
The buyer may receive a discount from the seller if they pay their bill off early. This
transaction is the opposite of a Sales Discount. The seller records a Sales Discount when
the customer pays his/her bill early. The buyer records a Purchase Discount in their
General Journal. To analyze how both sides of the transaction would be recorded, please
sell the example below.
Scenario: General Store Incorporate buys $1400 of food items on account from Frito Lay.
Frito Lay offers credit terms of 1/5 n/30.
General Store
Merchandise Inventory 1400
Accounts Pay/Frito Lay
1400
Bought Merch. On Account
Frito Lay
Accounts Rec./General Store
Sales
Sold Merch. On Account
COMS
Merchandise Inventory
Sold Merch. On Account
1400
1400
600
600
When General Store pays their bill off early, here’s what it would look like for both
companies.
General Store
Frito Lay
Accounts Pay/Frito Lay 1400
Cash
1386
Cash
1386
Sales Discount
14
Merchandise Inventory
14
Accounts Rec./General Store
1400
Paid for Merch. On Account
Customer Paid on Account
PURCHASE RETURNS & ALLOWANCES
Suppose that General Store decided that it was going to return $200 of the $1400
purchase made in previous example.
A DEBIT MEMO WOULD BE ISSUED BY THE BUYER (GENERAL STORE) TO THE SELLER
(FRIT0 LAY), INFORMING THE SELLER OF THE AMOUNT THE BUYER PROPOSES TO DEBIT
TO THE LIABILITY DUE TO THE SELLER.
The transaction would look like:
General Store
Accounts Pay/Frito Lay
Merch. Inventory
Returned Merch.
200
200
Frito Lay
Sales Returns & Allowances
200
Accounts Rec./General Store
Customer Returned Merch.
200
FREIGHT
Freight charges (the cost of delivery of the merchandise) may either by the buyer (FOB
SHIPPING POINT) or buy the seller (FOB DESTINATION).
Example 1: Best Buy buys $90,000 of computers on account from Dell Computer Inc. Best
Buy agrees to pay $300 for shipping (FOB Shipping Point) charges. The COMS for Dell was
$40,000. Best Buy’s journal entry to record to the purchase of inventory would be:
Merchandise Inventory
90000
Accounts Payable/Dell Computer
Computers purchased on account
90000
Best Buy’s journal entry to record the shipping charges would be:
Merchandise Inventory
Cash
Delivery charges
300
300
Dell Computer’s journal entry would be:
Accounts Receivable/Best Buy
Sales
Merchandise sold on account
90000
Cost of Merchandise Sold
40000
Merchandise Inventory
Merchandise sold on account
90000
40000
Example 2: Best Buy buys $90,000 of computers on account from Dell Computer Inc. Dell
Computer Inc. agrees to pay the $300 shipping costs (FOB Destination). The COMS for
Dell was $40,000. Best Buy’s journal entry to record to the purchase of inventory would
be:
Merchandise Inventory
90000
Accounts Payable/Dell Computer
Computers purchased on account
90000
Dell Computer’s journal entry would be:
Accounts Receivable/Best Buy
Sales
Merchandise sold on account
90000
90000
Cost of Merchandise Sold
40000
Merchandise Inventory
Merchandise sold on account
40000
Dell Computer’s journal entry to record the shipping costs would be:
Delivery Expense
300
Cash
Paid shipping costs FOB Destination
300
Example 3: Best Buy buys $90,000 of computers on account from Dell Computer Inc. Best
Buy agrees to pay $300 for shipping (FOB Shipping Point) charges. The COMS for Dell was
$40,000. Dell agrees to pay the shipping costs up front and add it to Best Buy’s Accounts
Receivable. Best Buy’s journal entry to record to the purchase of inventory would be:
Merchandise Inventory
90000
Accounts Payable/Dell Computer
Computers purchased on account
90000
Dell Computer’s journal entry would be:
Accounts Receivable/Best Buy
Sales
Merchandise sold on account
90000
Cost of Merchandise Sold
40000
Merchandise Inventory
Merchandise sold on account
90000
40000
Dell’s entry to show that Best Buy owes them for the shipping costs.
Accounts Receivable/Best Buy
300
Cash
Prepaid shipping costs on merchandise
300
271-272
SALES TAXES – All states levy a tax on the sale of merchandise. In Florida, the tax is 6% on
each dollar sold. When a sale is made, the customer pays the tax and then the company is
required to pay the tax on behalf of the customer to the state. Thus, when the company
collects the tax from the customer, a liability to the state is created.
Example: John Denver buys a $3,000 Bose system from the Bose Outlet on account. The
sound system cost the Bose Outlet $1,200. The sales tax on this purchase is 6% or $180.
The Bose Outlet would record the transaction as follows:
Accounts Receivable/John Denver
Sales
Sales Tax Payable
Sale on Account
3180
Cost of Merchandise Sold
Merchandise Inventory
Sale on Account
1200
3000
180
1200
To record the payment to the state of Florida, the Bose Outlet’s journal entry would be:
Sales Tax Payable
Cash
Payment of State Sales Taxes
Practice: (11 Exercises)
1. PE 6-3A
2. PE 6-4A
3. PE 6-5A
4. EX 6-14
5. EX 6-15
6. EX 6-18
7. EX 6-19
8. EX 6-21
9. EX 6-22
10.EX 6-23
11.EX 6-25
180
180