CHAPTER 6
M
T
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Service Organizations vs.
Merchandising Companies
Service organizations sell time to earn revenue
 Examples include accounting firms, law firms, and plumbing services
 These have been our emphasis up to now
Not a plumber!
Service Company
Income Statement
For the Year Ended December 31, 1999
Service revenues
Expenses
Net income
$ 150,000
137,500
$ 12,500
6-2

Service Organizations vs.
Merchandising Companies
Merchandising companies sell products to earn revenue
 Examples include sporting goods, clothing, and auto parts stores
 These will be our emphasis for the rest of the semester
Merchandising Company
Income Statement
For the Year Ended December 31, 1999
6-3
Sales revenues
Cost of goods sold
Gross margin
Expenses
Net income
$ 150,000
80,000
70,000
46,500
$ 23,500

Merchandising Companies
Transfers Products
Cash or
Promise to Pay
Seller Customer/
Buyer
6-4

Merchandising Companies
 Inventory
 Products held for sale
 Classified as asset
 Sales
 Exchange of merchandise for an asset
 Classified as revenue
 Cost of Goods Sold (COGS)
 Cost of inventory sold during the period
 Classified as expense
6-5

Merchandising Companies
CLASSIFIED INCOME STATEMENT a/k/a
MULTIPLE STEP INCOME STATEMENT a/k/a
“SATURDAY NIGHT” PAGE
226
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ROLL ‘EM !
Video #1
(Approx. 6 min.)
Video #2
(Approx. 8 min.)
6-7

Merchandising Companies
210
“Channel of Distribution”
(5 points on next test)
Manufacturer Wholesaler Retailer
Final
Customer
Can manufacturer sell direct to final customer?
(i.e., can green box be skipped?)
6-8

Accounting Terminology
Sales Invoice vs.
Purchase Invoice
What’s the difference?
prepares?
Who cares?
211
6-9

Recording and Reporting Sales
Gross sales
Less: Sales discounts
Less: Sales returns and allowances
Net sales
6-10

Recording Gross Sales
On May 13, TCom sold $25,000 of merchandise for cash.
GENERAL JOURNAL
Date Description
May 13 Cash
Sales
To record the sale of
Page 74
PR Debit Credit
25,000
25,000 debit Accounts Receivable instead of Cash.
6-11

Two Types of Discounts

Trade Discounts
 A percentage deduction from the list or catalog price to arrive at the gross selling
(invoice) price
 Know the three reasons for using (p. 213)

Not recorded on either seller’s or buyer’s
FastBan, Inc. offers a 30% trade discount if you purchase at least
1,000 of their most popular product known as Zippy. Each
Zippy has a list price of $5.25.
Quantity sold
Price per unit
Total
1,000
$ 5.25
5,250
Less 30% discount (1,575)
Invoice price $ 3,675
6-12

Two Types of Discounts

Cash Discounts
 A deduction from the invoice price granted to induce early payment of the amount due
 Two other names for cash discounts
• Sales discounts
• Purchase discounts
 Recorded on whose books?
• Both seller’s and buyer’s books
 They are pervasive
6-13

Two Types of Discounts

Cash Discounts
A deduction from the invoice price granted 
 to induce early payment of the amount due 3/15,n/30
• Sales discounts
• Purchase discounts
Recorded on whose books?
Percent Days Net (or All)
 They are pervasive
Available is Due
In This
Number of
Days
6-14

Cash (Sales) Discount Example
On November 8, Borey Co. sold merchandise to West, Inc. for $6,000 on account; credit terms 2/10, n/30.
General Journal
Date Description
Nov. 8 Accounts Receivable
Sales
Page 61
PR Debit Credit
6,000
6,000
To record the sale on account
6-15

Cash (Sales) Discount Example
On November 14, West, Inc. paid its account in full.
General Journal
Date Description
Nov. 14 Cash
Sales Discount
Accounts Receivable
Page 68
PR Debit Credit
5,880
120
6,000
To record cash received on account
Discount = $6,000 × 2% = $120
6-16

Other Deductions from Sales
 Sales Return
Merchandise returned by the buyer as unsatisfactory or defective.

Sales Allowance
A deduction from the original invoice price when the customer keeps merchandise but is dissatisfied with it.
6-17

Sales Returns and Allowances
Before making a payment to you, a customer returns $135 of goods sold on account.
General Journal
Date Description
Sales Returns and Allowances
Accounts Receivable
To record return of defective item.
Page 68
PR Debit Credit
135
135
6-18

Partial Income Statement
Gross sales
Less: Sales discounts
Less: Sales returns and allowances
Net sales
Sales discounts and Sales returns and allowances are
Contra Revenue accounts.
6-19

Inventory Methods
 Perpetual Method
 Periodic Method
6-20

Perpetual Method
The inventory account is continuously up-dated as purchases and sales of inventory occur.
6-21

Perpetual Method
The inventory account is continuously up-dated as purchases and sales of inventory occur.
6-22
More on this method in Chapter 7.

Periodic Method
This is the method used in this chapter.
Entries are not made to the inventory account during the year.
At the end of the accounting period, a physical count of inventory is needed to update the inventory account and calculate cost of goods sold.
What is the mechanism for updating the inventory account?
Closing entries
6-23

Closing Entries for
Merchandising Company
232 233
Closing Entry #1
General Journal
Date Description
Dec. 31 Merchandising Inventory (ending)
Sales
Purchase Discounts
Purchase Returns and Allowances
Income Summary
Page 88
PR Debit Credit
XXX
XXX
XXX
XXX
XXX
To close accounts with credit balances and set up proper balance in ending inventory account.
6-24

Closing Entries for
Merchandising Company
Closing Entry #2
General Journal
Date Description
Dec. 31 Income Summary
Merchandising Inventory (beginning)
Page 88
PR Debit Credit
XXX
XXX
Sales Discounts XXX
Sales Returns and Allowances
Other accounts including all expenses
XXX
XXX
To close accounts with debit balances including the beginning inventory account.
6-25

Cost of Goods Sold
...is an expense representing the cost of the inventory sold during the period.
6-26
...appears on the income statement.
...must be calculated using a multiple-step process when using the periodic method.

Calculation of
Cost of Goods Sold
Multiple-Step Process
Beginning Inventory
+ Purchases
- Purchase Discounts
- Purchase Returns and Allowances
+ Transportation-in
= Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
6-27

Calculation of
Cost of Goods Sold
Formal Income Statement Presentation
Cost of goods sold:
Merchandise inventory, January 1, 1999
Purchases:
Less: Purchase discounts
Purchase returns and allowances
Net purchases
Add: Transportation-in
Net cost of purchases
$ 3,000
8,000
Cost of goods available for sale
Less: Merchandise inventory, December 31, 1999
Cost of goods sold
$ 167,000
11,000
156,000
10,000
$ 24,000
166,000
190,000
31,000
$ 159,000
6-28

Purchase of Merchandise
One May 7, Barbee, Inc. purchased
$27,000 of merchandise on account; terms 2/10, n/30.
General Journal
Date Description
May 7 Purchases
Accounts Payable
Page 26
PR Debit Credit
27,000
27,000
6-29
Purchase merchandise on account

Purchase of Merchandise
One May 16, Barbee, Inc. paid for the purchase of May 7 in full.
General Journal
Date Description
May 16 Accounts Payable
Cash
Purchase Discounts
Payment on account
Page 41
PR Debit Credit
27,000
26,460
540
$27,000 × 2% = $540 discount
6-30

Purchase of Merchandise
One May 16, Barbee, Inc. paid for the purchase of May 7 in full.
General Journal
Date Description
Purchase Discounts is a
Page 41
PR Debit Credit
27,000
26,460
540 Purchase Discounts
Payment on account
$27,000 × 2% = $540 discount
6-31

Purchase Returns and Allowances
The buyer returns, or accepts a reduction in invoice price of, merchandise to the seller.
On May 27, Barbee, Inc. returns $200 of defective merchandise purchased on account before payment is made to the supplier.
6-32

Purchase Returns and Allowances
The buyer returns, or accepts a reduction in invoice price of, merchandise to the seller.
On May 27, Barbee, Inc. returns $200 of defective merchandise purchased on account before payment is made to the supplier.
6-33
General Journal
Date Description
May 27 Accounts Payable
Purchase Returns and Allowances
Returned defective merchandise
Page 88
PR Debit Credit
200
200

Transportation Costs
Transportation-In
Inward freight costs of acquiring merchandise.
Transportation-In is part of cost of goods sold!
6-34

Transportation Costs
Transportation Out/Delivery Expense
Outgoing freight costs that must be paid by the seller.
Delivery Expense is a selling expense on the income statement!
6-35

Transportation Costs
 Free on Board (FOB) Shipping Point.
 FOB Destination.
 Freight Prepaid
 Freight Collect
Who pays the freight charges?
6-36

FOB Points
FOB what? (Pick one)
Shipping Point
Destination
6-37
ABC Wholesalers

FOB Points
 FOB Shipping Point

“Free on board” at the shipping (selling) point
 Title passes to buyer upon shipment
 Buyer owns en route and...
• Ultimately bears the cost of the freight
• Assumes risk of loss in transit
 FOB Destination

“Free on board” at the destination point
 Seller owns en route and...
• Ultimately bears the cost of the freight
• Assumes risk of loss in transit
6-38

Transportation Cost Summary
223
Terms
Initially
Pays
FOB Shipping Point - Freight Prepaid Seller
FOB Shipping Point - Freight Collect Buyer
FOB Destination - Freight Prepaid Seller
FOB Destination - Freight Collect Buyer
Ultimately
Bears
Expense
Buyer
Buyer
Seller
Seller
6-39

Transportation Cost Summary
Terms
Initially
Pays
FOB Shipping Point - Freight Prepaid Seller
FOB Shipping Point - Freight Collect Buyer
FOB Destination - Freight Prepaid Seller
FOB Destination - Freight Collect Buyer
Ultimately
Bears
Expense
Buyer
Buyer
Seller
Seller
6-40

Periodic Method
Prepare the journal entries for Jackson Co. Use the periodic inventory method.
6-41
July 5, 1998 Purchased 1,000 units of inventory for $25,000 cash.
July 9, 1998 Sold 300 units of inventory to a customer on account for $35 per unit.

Periodic Method
GENERAL JOURNAL
Date Description
July 5 Purchases
Cash
To record inventory purchases
Page 1
PR Debit Credit
25,000
25,000
At Cost
6-42

Periodic Method
GENERAL JOURNAL
Date Description
July 5 Purchases
Cash
To record inventory purchases
Page 1
PR Debit Credit
25,000
25,000
July 9 Accounts Receivable
Sales
To record inventory sales
300 units × $35 = $10,500
10,500
10,500
At Retail
6-43

Saturday Night Page, Again
6-44

Classified Income Statement:
Earned from the sale of inventory
Sales
Less: Sales Discounts
Sales Ret. & Allow.
Net Sales
$ 250,000
$ 3,000
1,500 4,500
$ 245,500
Alternative way to express income statement relationships?
227
(Hint: 8th Grade)
Net sales = Gross sales - (Sales disc.+ SR&A)
6-45

Classified Income Statement:
Three approaches to Cost of Goods Sold:
6-46
(1) Simplified Income Statement Approach
Beginning Inventory (BI)
“Purchases” (P)
Cost of Goods Avail. for Sale (GAS)
Less: Ending Inventory (EI)
Cost of Goods Sold (COGS)
$ 55,000
176,500
231,500
64,000
$ 167,500
(2) Equation Approach
COGS = BI + P - EI

Classified Income Statement:
(3) Formal Income Statement Approach
6-47
Beginning Inventory
Purchases
Less: Purchase Discounts $ 6,000
Purchase Ret. & Allow. 2,500
Net Purchases
Add: Transportation-in
Net Cost of Purchases
Cost of Goods Avail. for Sale
Less: Ending Inventory
Cost of Goods Sold
$ 175,000
8,500
$ 166,500
10,000
$ 55,000
176,500
$ 231,500
64,000
$ 167,500

Classified Income Statement:
Gross Margin = Net Sales - COGS
Gross Margin is also called Gross Profit
6-48

Classified Income Statement:
 Selling Expenses
 Administrative Expenses
6-49

Classified Income Statement:
Gross margin
Operating expenses:
Selling expenses:
Sales salaries
Delivery expense
Advertising expense
Rent - store building
2,000
4,000
Depreciation - store equip.
2,500
Administrative expenses:
Executive salaries
Rent - office building
Insurance expense
Supplies expense
Total operating expenses
29,000
1,600
1,500
1,100
Income from operations
$ 26,000
3,000
37,500
$ 78,000
33,200
70,700
$ 7,300
6-50

Classified Income Statement:
 Nonoperating Revenues
 Nonoperating Expenses
Income from operations $
Nonoperating revenues and expenses
7,300
Nonoperating revenues:
Interest revenue
Rent Revenue
Nonoperating expenses:
400
2,000
Interest expense
Safe deposit box rental
Net income $
(700)
100
9,100
6-51

Work Sheet and Closing Entries
Appx. 231
6-52

Gross Margin
Percentage of each sales dollar available to cover expenses and a profit
6-53

WE CAN LOOK FORWARD
TO A CLOSER INSPECTION
OF INVENTORY IN CHAPTER
7!
6-54