Type
Solution Manual
Book Title
Financial Accounting Fundamentals 5th Edition
ISBN 13
978-0078025754

978-0078025754 Chapter 4 Lecture Note Part 1

March 26, 2020
CHAPTER 4
ACCOUNTING FOR MERCHANDISING OPERATIONS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Describe merchandising
activities and identify income
components for a
merchandising company.
1, 2,
3, 4
4-1, 4-18
4-1, 4-3, 4-13
4-3, 4-5, 4-6,
4-7, 4-8
C2. Identify and explain the
inventory asset and cost flows
of a merchandising company.
1, 2
4-2, 4-3
4-1, 4-2
4-3, 4-4
4-4, 4-6, 4-7,
Analytical objectives:
A1. Compute the acid-test ratio and
explain its use to assess
liquidity.
4-11, 4-12
4-13, 4-15
4-5
4-1
A2. Compute the gross margin ratio
and explain its use to assess
profitability.
4-13
4-14
4-5
4-2, 4-5, 4-9,
Procedural objectives:
P1. Analyze and record transactions
for merchandise purchases
using a perpetual system.
6, 7,
8, 9,
14, 15
4-4, 4-5, 4-6
4-4, 4-6, 4-7,
4-8, 4-9, 4-10
4-1, 4-2
P2. Analyze and record transactions
for merchandise sales using a
perpetual system.
5, 7
8, 9
4-7
4-5, 4-7, 4-8,
4-9, 4-10
4-1, 4-2
4-3
P3. Prepare adjustments and close
accounts for a merchandising
company.
4-8, 4-9
4-11
4-4, 4-5, 4-6
4-4
P4. Define and prepare multiple-
step and single-step income
statements.
2, 3,
10, 11,
13
4-10, 4-14
4-12, 4-20
4-3, 4-5
4-7, 4-9
P5A. Record and compare
merchandising transactions
using both periodic and
perpetual inventory systems.
(Appendix 4A)
4-15, 4-16,
4-17
4-16, 4-17,
4-18, 4-19
4-4
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used
in practice, homework, or exam mode.
Synopsis of Chapter Revisions
Sseko Designs: NEW opener
Enhanced exhibit on transportation costs and FOB terms
New T-accounts to highlight inventory flow
Enhanced two-step process for recording merchandise sales
Updated gross margin and quick ratios section using JCPenney
Chapter Outline
Notes
I. Merchandising Activities
A. Merchandise consists of products, also called goods, which a
company acquires to resell to customers. Merchandisers can be
either wholesalers (those that buy from manufacturers or other
wholesalers and sell to retailers or other wholesalers) or retailers
(those that buy from wholesalers or manufacturers and sell to
consumers).
B. Reporting Income for a Merchandiser
Revenue from selling merchandise (net sales) minus the cost of
goods (merchandise) sold to customers is called gross profit.
Gross profit minus expenses (generally called operating expenses)
determines the net income or loss for the period.
C. Reporting Inventory for a Merchandiser
A merchandiser's balance sheet is the same as service businesses
with the exception of one additional current asset called:
1. Merchandise Inventory, or Inventory, refers to products a
company owns and intends to sell.
2. The cost of this asset includes the cost incurred to buy the
goods, ship them to the store, and make them ready for sale.
D. Operating Cycle for a Merchandiser
Begins by purchasing merchandise and ends by collecting cash
from selling the merchandise.
E. Inventory Systems
Two alternative inventory systems that can be used to collect
information about the cost of goods sold and the inventory (cost of
goods available) are:
1. Perpetual inventory system which continually updates
accounting records for merchandising transactions
specifically, those records of inventory available for sale and
inventory sold. Technological advances and competitive
pressures have dramatically increased the use of this method.
2. Periodic inventory system which updates the accounting
records for merchandise transactions only at the end of a
period.
Note: This outline describes the accounting using a Perpetual
Inventory System. Periodic Inventory is only discussed in the
appendix section of this outline. Also note, the terms inventory
and merchandise inventory are synonymous. Inventory is used for
brevity.
Chapter Outline
Notes
II. Accounting for Merchandise Purchases
The invoice serves as a source document for this event.
A Transactions are recorded using invoice price.
1. Entry to record purchase: debit Inventory, credit Cash or
Accounts Payable.
2. Trade Discounts: deductions from list price (catalog price) to
determine the invoice price (actual selling price). Trade
discounts are not entered into accounts.
B. Purchase Discounts
1. Credit terms describe cash discounts offered to purchasers by
seller for payment within a specified period of time called the
discount period.
2. Cash Discounts- granted by the seller to encourage buyers to
pay the amount they owe earlier. Buyers view cash discounts
as purchase discounts and sellers view them as sales discounts.
3. Example: credit terms, 2/10 n/30, offer a 2 % discount if
invoice is paid within 10 days of invoice date, if not full
payment is due within 30 days of invoice date.
4. Entry (for buyer) for payment within discount period: debit
Accounts Payable (full invoice amount), credit Cash (amount
paid = invoice discount), credit Inventory (amount of
discount).
5. Managing Discounts: Missing out on cash discounts can be
very costly. A system should be set-up to ensure that all
invoices are paid on the last day of discount period.
C. Purchase Returns and Allowances
1. Purchase returns refers to merchandise a buyer acquires but
then returns to the seller.
2. A purchase allowance is a reduction in the cost of defective
merchandise that a buyer acquires.
3. A debit memorandum is a document that a buyer issues to
inform the seller of a debit made to the seller’s account in the
buyers records.
4. Entry on buyer’s books: debit Accounts Payable or Cash (if
refund given) and credit Inventory.
5. Discounts can only be taken on the remaining balance on the
invoice if a return is made before payment is made.
D. Transportation Costs and Ownership Transfer
The point at which ownership is transferred (called FOB or free on
board) determines who is responsible for paying any freight costs
and/or bearing any loss. Two alternative points of title transfer
are:
Chapter Outline
Notes
1. FOB shipping pointtitle transfers at shipping point and
buyer bears any loss and pays shipping costs.
a. Increases cost of merchandise (cost principle)
b. Debit Inventory, credit Cash or Accounts Payable (if to be
paid for with merchandise later)
2. FOB destinationtitle transfers at destination and seller bears
any loss and pays shipping costs.
a. Operating expense for seller
b. Debit Delivery Expense (or Transportation-Out or Freight-
Out), credit Cash.
E. Recording Purchases Information
The net cost of purchased merchandise according to the cost
principle is recorded in the Inventory account. (Inventory is
debited (increased) for invoice and transportation costs, and
credited (decreased) for returns, allowances, and purchase
discounts. Supplemental records are often used to collect
information about each of these cost elements for management to
evaluate and control.
III. Accounting for Merchandise Salesinvolves sales, sales discount,
sales returns and allowances and cost of goods sold
A. Each sale of merchandise transaction involves two parts (resulting
in two journal entries; the revenue entry and the cost entry.
1. Recognize revenuedebit Accounts Receivable (or cash),
credit Sales (both for the invoice amount).
2. Recognize costdebit Cost of Goods Sold, credit Inventory
(both for the cost of the inventory sold).
B. Sales Discounts
Cash discounts awarded to customers for payment within the
discount period. Recorded upon collection for sale.
1. Collection after discount periodDebit Cash, Credit Accounts
Receivable (full invoice amount).
2. Collection within discount perioddebit Cash (invoice
amount less discount), debit Sales Discount (discount
amount), credit Accounts Receivable (invoice amount).
3. Sales Discounts is a contra-revenue accountsubtraction
from Sales.
C. Sales Returns and Allowances
1. Sales returnsmerchandise that a customer returned to the
seller after a sale.
2. Sales allowancesreductions in the selling price of
merchandise sold to customers (usually for damaged
merchandise that a customer is willing to keep at a reduced
price).
Chapter Outline
Notes
3. Entry: debit Sales Returns and Allowances and credit
Accounts Receivable; additional entry to restore cost of
returned goods to inventory if merchandise is returned and it is
salable: debit Inventory, credit Cost of Goods Sold.
4. Sales Returns and Allowances is a contra-revenue account that
is subtracted from Sales.
5. Net Sales = Sales (Sales Discount + Sales Returns and
Allowances).
6. Credit Memorandumdocument issued by the seller to
confirm a buyer’s return or allowance and the credit to
Accounts Receivable on the seller’s books.
IV. Completing the Accounting Cycle
A. Adjusting Entries for Merchandisers
Generally same as discussed in chapter 4 for a service business
with an additional adjustment needed to update inventory to reflect
any loss of merchandise referred to as shrinkage.
1. Shrinkage is determined by comparing a physical count of the
inventory with recorded quantities.
2. Adjusting entry: debit Cost of Goods Sold, credit Inventory.
B. Preparing Financial Statements
Statements similar to service business with the following
differences:
1. Income Statement includes the cost of goods sold and gross
profit. Also, net sales is affected by discounts, returns, and
allowances and delivery expense as an additional possible
expense.
2. Balance Sheet includes merchandise inventory as part of
current assets.
C. Closing Entries
Similar to a service business except there are additional temporary
accounts to close (sales, sales discount, sales returns and
allowances, and cost of goods sold). Debit balance accounts are
closed with the expense accounts to Income Summary.
V. Financial Statement FormatsGAAP does not require any specific
format. Common formats:
A. Multiple-Step Income Statementshows details of net sales and
other costs and expenses. Has three main parts:
1. Gross profitnet sales less cost of goods sold.
2. Income from operationsgross profit less operating expenses
(classified into selling and general & administrative).
3. Net incomeIncome from operations adjusted for
nonoperating items.
Chapter Outline
Notes
B. Single-Step Income Statement
Lists cost of goods sold with the other expense and shows only
one subtotal for total expenses, one subtraction to arrive at net
income.
C. Classified Balance Sheetreports merchandise inventory as a
current asset, usually after accounts receivable (use liquidity
order).
VI. Global ViewCompares U.S. GAAP to IFRS
A. Accounting for Merchandise Purchases and Salesboth systems
are identical in and account as illustrated in this chapter.
B. Income Statement PreparationIFRS tends to use the term profit
whereas U.S. GAAP tends to use net income. Presentation is
similar through cost of goods sold, followed by these differences:
1. Expense presentationIFRS requires separate disclosures for
financing expenses, income tax, and some other special items.
2. IFRS permits expense presentation by function or nature;
GAAP has SEC requirement of presentation by function.
3. IFRS permits alternative measures of income on statement;
GAAP does not.
C. Balance Sheet Presentationsame as discussed in chapter 2 & 3.
VII. Decision AnalysisAcid Test Ratio and Gross Margin Ratio
A. Acid-Test Ratio
1. Used to assess the company's liquidity or ability to pay its
current debts. Differs from current ratio in that it is based on
quick assets (which excludes less liquid current assets such as
inventory and prepaid expenses) rather than all current assets.
2. Calculated by dividing quick assets by current liabilities.
3. Quick assets are cash, short-term investments, and receivables.
B. Gross Margin Ratio (Gross Profit Ratio)
1. Used to determine the percent of every sales dollar that is
gross profit.
2. Calculated by dividing gross margin by net sales.
VIII. Periodic Inventory System (Appendix 4A)textbook shows
comparison of periodic and perpetual in this appendix. The following
chapter notes relate only to the periodic system because the preceding
notes outline the perpetual system.
A. A periodic inventory system records merchandise acquisitions,
discounts and returns in temporary accounts (Purchases, Purchase
Returns, Purchases Discounts) rather than the merchandise
inventory account.
Chapter Outline
B. Records only the revenue aspect of sales related events. Updates
inventory and determines cost of goods sold only at the end or the
accounting period. During the period, inventory account remains
unchanged.
C. The inventory account can be updated as part of the adjusting or
closing process.
D. Requires closing additional temporary accounts.
VIV. Work SheetPerpetual System (Appendix 4B)
A work sheet may be used for preparing financial statements of a
merchandiser which differs slightly from the work sheet used in
Chapter 3. The following accounts are included on a work sheet of a
Merchandiser under the perpetual system: Merchandise inventory,
Sales, Sales returns and allowances, Sales discounts, and Cost of goods
Sold.
Notes
VISUAL #4-1
THE OUTDOOR STORE
Income Statement
For the Year Ended December 31, 20xx
Sales revenues
Sales ...............................................
$700,000
Less: Sales returns and allowances. ..............
$ 5,000
Sales discounts ............................
3,000
8,000
Net sales .............................................
$692,000
Cost of goods sold
Inventory, January 1 ...............................
40,300
Purchases ............................................
462,000
Less: Purchase discounts ........... $12,000
Purchase returns and
allowances ............................ 6,400
18,400
Net purchases ............................................
443,600
Add: Freight-in ..................................
3,600
Cost of goods purchased ...............................
447,200
Cost of goods available for sale .......................
487,500
Inventory, December 31................................
70,000
Cost of goods sold ........................
417,500
Gross profit on sales ....................................
274,500
Operating expenses
Selling expenses
Sales salaries expense ...................
76,000
Sales commission expense ..............
14,500
Depreciation expense - Display equip.
13,300
Utilities expense ..........................
6,600
Insurance expense ........................
4,320
Total selling expenses ...................
114,720
Administrative expenses
Office salaries expense ..................
32,000
Depreciation expense building .......
10,400
Property tax expense .....................
4,800
Utilities expense ..........................
4,400
Insurance expense ........................
2,880
Total administrative expenses
54,480
Total operating expenses .............
169,200
Income from operations ................................
105,300
Other revenues and gains
Interest revenue ....................................
4,000
Other expenses and losses
Interest expense ....................................
11,000
7,000
Net income ...............................................
$ 98,300
VISUAL #4-2
COMPONENTS OF NET INCOME (FROM OPERATIONS)
Steps:
(a) Net Sales X
(b) Cost of Goods Sold* X
(c) Gross Profit on Sales X
(d) Operating Expenses X
(e) Net Income (Loss) from Operations X
COMPONENTS OF COST OF GOODS SOLD
Steps:
(a) Inventory, Beginning of Period X
(b) +Cost of Goods Purchased + X
(c) Cost of Goods Available for Sale X
(d) Inventory, End of Period X
(e) Cost of Goods Sold X
COMPONENTS COST OF GOODS PURCHASED
Steps:
(a) Purchases X
(b) (Purchase Returns & Allowances X
+ Purchases Discounts) + X X
(c) Net Purchases X
(d) + Transportation In + X
(e) Cost of Goods Purchased X
* Perpetual inventory systems have a cost of goods sold account that continuously
accumulates costs as items are sold. In a periodic inventory system, this amount is
calculated at the end of period.

Subscribe Now

Sign up to view full document

View Document