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$ millions for Research In Motion and Apple. 4-9, Nokia, Research in Motion, and Apple are competitors in the global marketplace. Key comparative figures for

$ millions for Research In Motion and Apple. 4-9, Nokia, Research in Motion, and Apple are competitors in the global marketplace. Key comparative figures for each company follow. Nokia* . . . . . . . . . . . . . . . . . . . . 40,984 27,720 Research In Motion . . . . . . . . . $14,953 $ 8,369 Apple . . . . . . . . . . . . . . . . . . . . $42,905 $25,683 Required 1. Rank the three companies (highest to lowest) based on the gross margin ratio. 2. Which of the companies uses a multiple-step income statement format? (These companies' income statements are in Appendix A.) Cash Merchandise inventory Store supplies Prepaid insurance Store equipment Accumulated depreciation Store equipment Accounts payable 2,200 11,500 4,800 2,300 41,900 15,000 9,000 Common stock 5,000 Retained earnings 27,000 Dividends Sales Sales discounts Sales returns and allowances Cost of goods sold Depreciation expenseStore equipment Salaries expense Insurance expense Rent expense Store supplies expense Advertising expense Totals 2,000 104,000 1000 37,400 0 31,000 0 14,000 0 9,900 160,000 160,000 Rent expense and salaries expense are equally divided between selling activities and the general and administrative activities. Rex Company uses a perpetual inventory system. Required 1. Prepare adjusting journal entries to reflect each of the following: a. Store supplies still available at fiscal year-end amount to $1,650. b. Expired insurance, an administrative expense, for the fiscal year is $1,500. c. Depreciation expense on store equipment, a selling expense, is $1,400 for the fiscal year. d. To estimate shrinkage, a physical count of ending merchandise inventory is taken. It shows $11,100 of inventory is still available at fiscal year-end. 2. Prepare a multiple-step income statement for fiscal year 2011. 3. Prepare a single-step income statement for fiscal year 2011. 4. Compute the current ratio, acid-test ratio, and gross margin ratio as of January 31, 2011. The following information is available to reconcile Clark Company's book balance of cash with its bank statement cash balance as of July 31, 2011. A. On July 31, the company's Cash account has a $26,193 debit balance, but its July bank statement B. shows a $28,020 cash balance. C. Check No. 3031 for $1,380 and Check No. 3040 for $552 were outstanding on the June 30 bank reconciliation. Check No. 3040 is listed with the July canceled checks, but Check No. 3031 is not. Also, Check No. 3065 for $336 and Check No. 3069 for $2,148, both written in July, are not among the canceled checks on the July 31 statement. D. In comparing the canceled checks on the bank statement with the entries in the accounting records, it is found that Check No. 3056 for July rent was correctly written and drawn for $1,250 but was erroneously entered in the accounting records as $1,230. E. A credit memorandum enclosed with the July bank statement indicates the bank collected $9,000 cash on a non-interest-bearing note for Clark, deducted a $45 collection fee, and credited the remainder to its account. Clark had not recorded this event before receiving the statement. F. A debit memorandum for $805 lists a $795 NSF check plus a $10 NSF charge. The check had been received from a customer, Jim Shaw. Clark has not yet recorded this check as NSF. G. Enclosed with the July statement is a $15 debit memorandum for bank services. It has not yet been recorded because no previous notification had been received. H. Clark's July 31 daily cash receipts of $10,152 were placed in the bank's night depository on that date, but do not appear on the July 31 bank statement. I. Required a. Prepare the bank reconciliation for this company as of July 31, 2011. wiL10874_ch05_178-225.indd Page 178 7/30/10 10:02:49 AM user-f500 /Users/user-f500/Desktop 5 Accounting for Merchandising Operations A Look Back A Look at This Chapter A Look Ahead Chapters 3 and 4 focused on the final steps of the accounting process. We explained the importance of proper revenue and expense recognition and described the adjusting and closing processes. We also prepared financial statements. This chapter emphasizes merchandising activities. We explain how reporting merchandising activities differs from reporting service activities. We also analyze and record merchandise purchases and sales transactions, and explain the adjustments and closing process for merchandisers. Chapter 6 extends our analysis of merchandising activities and focuses on the valuation of inventory. Topics include the items in inventory, costs assigned, costing methods used, and inventory estimation techniques. Learning Objectives CAP CONCEPTUAL C1 Describe merchandising activities and identify income components for a merchandising company. (p. 180) C2 Identify and explain the inventory asset and cost flows of a merchandising company. (p. 181) ANALYTICAL A1 A2 PROCEDURAL Compute the acid-test ratio and explain its use to assess liquidity. (p. 196) P1 Compute the gross margin ratio and explain its use to assess profitability. (p. 196) Analyze and record transactions for merchandise purchases using a perpetual system. (p. 182) P2 Analyze and record transactions for merchandise sales using a perpetual system. (p. 187) P3 Prepare adjustments and close accounts for a merchandising company. (p. 190) P4 Define and prepare multiplestep and single-step income statements. (p. 192) P5 Appendix 5ARecord and compare merchandising transactions using both periodic and perpetual inventory systems. (p. 201) LP5 wiL10874_ch05_178-225.indd Page 179 8/2/10 5:17:47 PM user-f500 /Users/user-f500/Desktop Decision Insight Out of Africa LOS ANGELESSelena Cuffe was in Johannesburg as part of a student exchange program when she discovered wine at the Soweto Wine Festival. \"They have wine here?\" asked a puzzled Selena. That festival unleashed Selena's passion to pursue the merchandising of wine. But not just any wineshe would import and distribute wine produced by indigenous African vintners. She and her husband, Khary, launched Heritage Link Brands (HeritageLinkBrands.com). Our mission, says Selena, is \"to showcase the very best wines from Africa and the African Diaspora. \" But the start-up was a struggle. \"Our business is a family business so whatever decisions we make have to be made with the best interest of my family and those we work with, \" explains Selena. She describes how the business required a merchandising accounting system to account for purchases and sales transactions and to effectively track the levels of the various wines. Inventory was especially important to account for and monitor. Khary explains, \"It is very easy to underestimate expenses. \" To succeed, Selena and Khary needed to make smart business decisions. They set up an accounting system to capture and \"We are changing history and . . . we are all going to make a whole lot of money\" SELENA CUFFE communicate costs and sales information. Tracking merchandising activities was necessary to set prices and to manage discounts, allowances, and returns of both sales and purchases. A perpetual inventory system enabled them to stock the right kind and amount of merchandise and to avoid the costs of out-of-stock and excess inventory. Khary stressed that they monitored current assets and current liabilities (working capital). \"Understand working capital, insists Khary. \"If you don't understand working capi\" tal, stop right here and open an accounting book. \" Mastering accounting for merchandising is a means to an end for Selena and Khary. \"My training is really about how to run a successful business, says Selena. \"How to get the most \" profit you can out of something. Still, Selena recognizes that \" her merchandising business is more than profits and losses. \"What we're able to do and how we're able to make an impact with this business only matters in as much as the people here and on the continent are able to be successful and thrive. \" [Sources: Heritage Link Brands Website, January 2011; TIME, September 2007; Black Enterprise, May 2009; Inc, March 2009] wiL10874_ch05_178-225.indd Page 180 7/30/10 10:02:58 AM user-f500 /Users/user-f500/Desktop Chapter Preview Buyers of merchandise expect many products, discount prices, inventory on demand, and high quality. This chapter introduces the accounting practices used by companies engaged in merchandising. We show how financial statements reflect merchandising activities and explain the new financial statement items created by merchandising activities. We also analyze and record merchandise purchases and sales, and explain the adjustments and the closing process for these companies. Accounting for Merchandising Operations Merchandising Activities Reporting income Reporting inventory Operating cycles Inventory systems Merchandising Purchases Merchandising Sales Purchase discounts Purchase returns and allowances Transportation costs Sales of merchandise Sales discounts Sales returns and allowances Accounting Cycle Adjusting entries Preparing financial statements Closing entries Financial Statement Formats Multiple-step income statement Single-step income statement Classified balance sheet MERCHANDISING ACTIVITIES C1 Describe merchandising activities and identify income components for a merchandising company. Previous chapters emphasized the accounting and reporting activities of service companies. A merchandising company's activities differ from those of a service company. Merchandise consists of products, also called goods, that a company acquires to resell to customers. A merchandiser earns net income by buying and selling merchandise. Merchandisers are often identified as either wholesalers or retailers. A wholesaler is an intermediary that buys products from manufacturers or other wholesalers and sells them to retailers or other wholesalers. A retailer is an intermediary that buys products from manufacturers or wholesalers and sells them to consumers. Many retailers sell both products and services. Reporting Income for a Merchandiser Net income for a merchandiser equals revenues from selling merchandise minus both the cost of merchandise sold to customers and the cost of other expenses for the period, see Exhibit 5.1. The EXHIBIT 5.1 Computing Income for a Merchandising Company versus a Service Company Service Company Minus Revenues Expenses Equals Net income Equals Net income Merchandiser Net sales Point: Fleming, SuperValu, and SYSCO are wholesalers. Gap, Oakley, Target, and Walmart are retailers. Minus Cost of goods sold Equals Gross profit Minus Expenses usual accounting term for revenues from selling merchandise is sales, and the term used for the expense of buying and preparing the merchandise is cost of goods sold. (Some service companies use the term sales instead of revenues; and cost of goods sold is also called cost of sales.) The income statement for Z-Mart in Exhibit 5.2 illustrates these key components of a merchandiser's net income. The first two lines show that products are acquired at a cost of $230,400 and sold for $314,700. The third line shows an $84,300 gross profit, also called wiL10874_ch05_178-225.indd Page 181 7/30/10 10:03:01 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations EXHIBIT 5.2 Z-MART Income Statement For Year Ended December 31, 2011 Net sales . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . Gross profit . . . . . . . . . . . . . . . Expenses . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . 181 Merchandiser's Income Statement $314,700 230,400 84,300 71,400 $ 12,900 gross margin, which equals net sales less cost of goods sold. Additional expenses of $71,400 are reported, which leaves $12,900 in net income. Point: Analysis of gross profit is important to effective business decisions, and is described later in the chapter. Reporting Inventory for a Merchandiser A merchandiser's balance sheet includes a current asset called merchandise inventory, an item not on a service company's balance sheet. Merchandise inventory, or simply inventory, refers to products that a company owns and intends to sell. The cost of this asset includes the cost incurred to buy the goods, ship them to the store, and make them ready for sale. C2 Identify and explain the inventory asset and cost flows of a merchandising company. (e) C as h on cti lle o ( a) EXHIBIT 5.3 Pu r Merchandiser's Operating Cycle a ch Cash s se A merchandising company's operating cycle begins by purchasing merchandise and ends by collecting cash from selling the merchandise. The length of an operating cycle differs across the types of businesses. Department stores often have operating cycles of two to five months. Operating cycles for grocery merchants usually range from two to eight weeks. Exhibit 5.3 illustrates an operating cycle for a merchandiser with credit sales. The cycle moves from (a) cash purchases of merchandise to (b) inventory for sale to (c) credit sales to (d ) accounts receivable to (e) cash. Companies try to keep their operating cycles short because assets tied up in inventory and receivables are not productive. Cash sales shorten operating cycles. c Operating Cycle for a Merchandiser 1 Rd. Cherry W9797 WI 54409 Antigo, INVOICE 3 tO Agent Z-Mart Purchasing Firm Name Tom Novak, of Street Attention 10 Michigan Address Chicago Zip 60521 City 5 Illinois State Terms n 4 2/10, n/30 Salesperso #141 n P.O. Date Descriptio 10/30/11 X7 No. Challenger Model Demon Speed CH015 7 and returns. SD099 of sale for terms See reverse 2 SOLD 6 Invoice Number 4657-2 Date 11/2/11 Freight FOB Destination Price Quantity 1 1 Ship Via FedEx Amount 490 710 SubTotal Shipping Tax Total 490 710 1,200 1,200 8 date 4 Order 3 Purchaser amount date invoice 2 Invoice 8 Total Seller 7 Goods Key: 1 terms 6 Freight 5 Credit terms (d) Accounts receivable (b) Merchandise inventory (c) C es redit sal Inventory Systems Cost of goods sold is the cost of merchandise sold to customers during a period. It is often the largest single expense on a merchandiser's income statement. Inventory refers to products a company owns and expects to sell in its normal operations. Exhibit 5.4 shows that a company's merchandise available for sale consists of what it begins with (beginning inventory) and what it Beginning inventory + Net purchases EXHIBIT 5.4 Merchandiser's Cost Flow for a Single Time Period Point: Mathematically, Exhibit 5.4 says BI 1 NP 5 MAS, 5 Merchandise where BI is beginning inventory, NP is net purchases, and MAS is merchandise available for sale. Exhibit 5.4 also says available for sale MAS 5 EI 1 COGS, Ending inventory + Cost of goods sold which can be rewritten as MAS 2 EI 5 COGS or MAS 2 COGS 5 EI, where EI is ending inventory and COGS is cost of goods sold. wiL10874_ch05_178-225.indd Page 182 8/2/10 5:01:50 PM user-f500 182 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations Point: Growth of superstores such as Costco and Sam's is fueled by efficient use of perpetual inventory. purchases (net purchases). The merchandise available is either sold (cost of goods sold) or kept for future sales (ending inventory). Two alternative inventory accounting systems can be used to collect information about cost of goods sold and cost of inventory: perpetual system or periodic system. The perpetual inventory system continually updates accounting records for merchandising transactions specifically, for those records of inventory available for sale and inventory sold. The periodic inventory system updates the accounting records for merchandise transactions only at the end of a period. Technological advances and competitive pressures have dramatically increased the use of the perpetual system. It gives managers immediate access to detailed information on sales and inventory levels, where they can strategically react to sales trends, cost changes, consumer tastes, and so forth, to increase gross profit. (Some companies use a hybrid system where the perpetual system is used for tracking units available and the periodic system is used to compute cost of sales.) Quick Check Answers p. 207 1. Describe a merchandiser's cost of goods sold. 2. What is gross profit for a merchandising company? 3. Explain why use of the perpetual inventory system has dramatically increased. The following sections, consisting of the next 10 pages on purchasing, selling, and adjusting merchandise, use the perpetual system. Appendix 5A uses the periodic system (with the perpetual results on the side). An instructor can choose to cover either one or both inventory systems. ACCOUNTING FOR MERCHANDISE PURCHASES P1 Analyze and record transactions for merchandise purchases using a perpetual system. Assets 5 Liabilities 1 Equity 11,200 21,200 Point: The Merchandise Inventory account reflects the cost of goods available for resale. The cost of merchandise purchased for resale is recorded in the Merchandise Inventory asset account. To illustrate, Z-Mart records a $1,200 cash purchase of merchandise on November 2 as follows: Nov. 2 Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchased merchandise for cash. 1,200 1,200 The invoice for this merchandise is shown in Exhibit 5.5. The buyer usually receives the original invoice, and the seller keeps a copy. This source document serves as the purchase invoice of Z-Mart (buyer) and the sales invoice for Trex (seller). The amount recorded for merchandise inventory includes its purchase cost, shipping fees, taxes, and any other costs necessary to make it ready for sale. This section explains how we compute the recorded cost of merchandise purchases. Decision Insight Decision Insight Trade Discounts When a manufacturer or wholesaler prepares a catalog of items it has for sale, it usually gives each item a list price, also called a catalog price. However, an item's intended selling price equals list price minus a given percent called a trade discount. The amount of trade discount usually depends on whether a buyer is a wholesaler, retailer, or final consumer. A wholesaler buying in large quantities is often granted a larger discount than a retailer buying in smaller quantities. A buyer records the net amount of list price minus trade discount. For example, in the November 2 purchase of merchandise by Z-Mart, the merchandise was listed in the seller's catalog at $2,000 and Z-Mart received a 40% trade discount. This meant that Z-Mart's purchase price was $1,200, computed as $2,000 2 (40% 3 $2,000). wiL10874_ch05_178-225.indd Page 183 7/30/10 10:03:06 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations EXHIBIT 5.5 1 INVOICE 183 Invoice W9797 Cherry Rd. Antigo, WI 54409 SOLD TO 3 Firm Name Z-Mart Attention of Tom Novak, Purchasing Agent Address 10 Michigan Street City Chicago State Illinois 4 P.O. Date 10/30/11 Model No. 7 Invoice Date Number 2 11/2/11 4657-2 Zip 60521 5 Terms Salesperson 2/10, n/30 #141 Description CH015 SD099 6 Freight FOB Destination Quantity Price Challenger X7 Speed Demon 1 1 490 710 8 2 Invoice date 6 Freight terms 3 Purchaser 490 710 SubTotal Shipping See reverse for terms of sale and returns. Key: 1 Seller Ship Via FedEx Amount 1,200 Tax Total 4 Order date 1,200 5 Credit terms 7 Goods 8 Total invoice amount Purchase Discounts The purchase of goods on credit requires a clear statement of expected future payments and dates to avoid misunderstandings. Credit terms for a purchase include the amounts and timing of payments from a buyer to a seller. Credit terms usually reflect an industry's practices. To illustrate, when sellers require payment within 10 days after the end of the month of the invoice date, the invoice will show credit terms as \"ny10 EOM,\" which stands for net 10 days after end of month (EOM). When sellers require payment within 30 days after the invoice date, the invoice shows credit terms of \"ny30,\" which stands for net 30 days. Exhibit 5.6 portrays credit terms. The amount of time allowed before full payment is due is called the credit period. Sellers can grant a cash discount to encourage buyers to pay earlier. A buyer views a cash discount as a purchase discount. A seller views a cash discount as a sales discount. Any cash discounts are described in the credit terms on the invoice. For example, credit terms of \"2y10, ny60\" mean that full payment is due within a 60-day credit period, but the buyer can deduct 2% of the invoice amount if payment is made within 10 days of the invoice date. This reduced payment applies only for the discount period. Credit period Credit Terms Time Due: Invoice price minus discount* EXHIBIT 5.6 Credit Terms Discount* period Date of invoice Amount Due Point: Since both the buyer and seller know the invoice date, this date is used in setting the discount and credit periods. Due: Invoice price *Discount refers to a purchase discount for a buyer and a sales discount for a seller. wiL10874_ch05_178-225.indd Page 184 7/30/10 10:03:10 AM user-f500 /Users/user-f500/Desktop 184 Chapter 5 Accounting for Merchandising Operations Point: Appendix 5A repeats journal entries a through f using a periodic inventory system. To illustrate how a buyer accounts for a purchase discount, assume that Z-Mart's $1,200 purchase of merchandise is on credit with terms of 2y10, ny30. Its entry is (a) Nov. 2 Assets 5 Liabilities 1 Equity 11,200 11,200 Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchased merchandise on credit, invoice dated Nov. 2, terms 2y10, ny30. 1,200 1,200 If Z-Mart pays the amount due on (or before) November 12, the entry is Assets 5 Liabilities 1 Equity 224 21,200 21,176 Point: These entries illustrate what is called the gross method of accounting for purchases with discount terms. (b) Nov. 12 Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid for the $1,200 purchase of Nov. 2 less the discount of $24 (2% 3 $1,200). 1,200 24 1,176 The Merchandise Inventory account after these entries reflects the net cost of merchandise purchased, and the Accounts Payable account shows a zero balance. Both ledger accounts, in T-account form, follow: Merchandise Inventory Nov. 2 1,200 Balance Accounts Payable 1,176 Nov. 12 24 Nov. 12 1,200 Nov. 2 Balance 1,200 0 A buyer's failure to pay within a discount period can be expensive. To illustrate, if Z-Mart does not pay within the 10-day 2% discount period, it can delay payment by 20 more days. This delay costs Z-Mart $24, computed as 2% 3 $1,200. Most buyers take advantage of a purchase discount because of the usually high interest rate implied from not taking it.1 Also, good cash management means that no invoice is paid until the last day of the discount or credit period. Decision Maker Answer p. 206 Entrepreneur You purchase a batch of products on terms of 3y10, ny90, but your company has limited cash and you must borrow funds at an 11% annual rate if you are to pay within the discount period. Do you take advantage of the purchase discount? Purchase Returns and Allowances Point: The sender (maker) of a debit memorandum will debit the account of the memo's receiver. The memo's receiver will credit the sender's account. Purchase returns refer to merchandise a buyer acquires but then returns to the seller. A purchase allowance is a reduction in the cost of defective or unacceptable merchandise that a buyer acquires. Buyers often keep defective but still marketable merchandise if the seller grants an acceptable allowance. When a buyer returns or takes an allowance on merchandise, the buyer issues a debit memorandum to inform the seller of a debit made to the seller's account in the buyer's records. 1 The implied annual interest rate formula is: (365 days 4 [Credit period 2 Discount period]) 3 Cash discount rate. For terms of 2y10, ny30, missing the 2% discount for an additional 20 days is equal to an annual interest rate of 36.5%, computed as [365 daysy(30 days 2 10 days)] 3 2% discount rate. Favorable purchase discounts are those with implied annual interest rates that exceed the purchaser's annual rate for borrowing money. wiL10874_ch05_178-225.indd Page 185 7/30/10 10:03:10 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations 185 To illustrate purchase allowances, assume that on November 15, Z-Mart (buyer) issues a $300 debit memorandum for an allowance from Trex for defective merchandise. Z-Mart's November 15 entry to update its Merchandise Inventory account to reflect the purchase allowance is Purchase Allowances (c) Nov. 15 Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . Allowance for defective merchandise. 300 300 Assets 5 Liabilities 1 Equity 2300 2300 The buyer's allowance for defective merchandise is usually offset against the buyer's current account payable balance to the seller. When cash is refunded, the Cash account is debited instead of Accounts Payable. Purchase Returns Returns are recorded at the net costs charged to buyers. To illustrate the accounting for returns, suppose Z-Mart purchases $1,000 of merchandise on June 1 with terms 2/10, n/60. Two days later, Z-Mart returns $100 of goods before paying the invoice. When Z-Mart later pays on June 11, it takes the 2% discount only on the $900 remaining balance. When goods are returned, a buyer can take a purchase discount on only the remaining balance of the invoice. The resulting discount is $18 (2% 3 $900) and the cash payment is $882 ($900 2 $18). The following entries reflect this illustration. June 1 June 3 June 11 Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchased merchandise, invoice dated June 1, terms 2/10, n/60. Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . Returned merchandise to seller. Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid for $900 merchandise ($1,000 2 $100) less $18 discount (2% 3 $900). Decision Ethics 1,000 1,000 100 100 900 18 882 Answer p. 206 Credit Manager As a new credit manager, you are being trained by the outgoing manager. She explains that the system prepares checks for amounts net of favorable cash discounts, and the checks are dated the last day of the discount period. She also tells you that checks are not mailed until five days later, adding that \"the company gets free use of cash for an extra five days, and our department looks better. When a supplier complains, we blame the computer system and the mailroom. Do you continue this payment policy? \" Transportation Costs and Ownership Transfer The buyer and seller must agree on who is responsible for paying any freight costs and who bears the risk of loss during transit for merchandising transactions. This is essentially the same as asking at what point ownership transfers from the seller to the buyer. The point of transfer is called the FOB ( free on board ) point, which determines who pays transportation costs (and often other incidental costs of transit such as insurance). Exhibit 5.7 identifies two alternative points of transfer. (1) FOB shipping point, also called FOB factory, means the buyer accepts ownership when the goods depart the seller's place of business. The buyer is then responsible for paying shipping costs and bearing the risk of damage or loss when goods are in transit. The goods are part of the buyer's inventory when they are in transit since ownership has transferred to the buyer. 1-800-FLOWERS.COM, a floral and gift Example: Assume Z-Mart pays $980 cash for $1,000 of merchandise purchased within its 2% discount period. Later, it returns $100 of the original $1,000 merchandise. The return entry is Cash . . . . . . . . . . . . . . . . . . . . . . 98 Merchandise Inventory . . . . 98 wiL10874_ch05_178-225.indd Page 186 7/30/10 10:03:10 AM user-f500 186 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations EXHIBIT 5.7 Ownership Transfer and Transportation Costs Shipping point Carrier Destination Ownership Transfers When Goods Passed to FOB shipping point Assets 5 Liabilities 1 Equity 175 275 Carrier Buyer FOB destination Point: The party not responsible for shipping costs sometimes pays the carrier. In these cases, the party paying these costs either bills the party responsible or, more commonly, adjusts its account payable or account receivable with the other party. For example, a buyer paying a carrier when terms are FOB destination can decrease its account payable to the seller by the amount of shipping cost. Transportation Costs Paid by Buyer Seller merchandiser, and Bare Escentuals, a cosmetic manufacturer, both use FOB shipping point. (2) FOB destination means ownership of goods transfers to the buyer when the goods arrive at the buyer's place of business. The seller is responsible for paying shipping charges and bears the risk of damage or loss in transit. The seller does not record revenue from this sale until the goods arrive at the destination because this transaction is not complete before that point. Kyocera, a manufacturer, uses FOB destination. Z-Mart's $1,200 purchase on November 2 is on terms of FOB destination. This means Z-Mart is not responsible for paying transportation costs. When a buyer is responsible for paying transportation costs, the payment is made to a carrier or directly to the seller depending on the agreement. The cost principle requires that any necessary transportation costs of a buyer (often called transportation-in or freight-in) be included as part of the cost of purchased merchandise. To illustrate, Z-Mart's entry to record a $75 freight charge from an independent carrier for merchandise purchased FOB shipping point is (d) Nov. 24 Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid freight costs on purchased merchandise. 75 75 A seller records the costs of shipping goods to customers in a Delivery Expense account when the seller is responsible for these costs. Delivery Expense, also called transportation-out or freight-out, is reported as a selling expense in the seller's income statement. In summary, purchases are recorded as debits to Merchandise Inventory. Any later purchase discounts, returns, and allowances are credited (decreases) to Merchandise Inventory. Transportationin is debited (added) to Merchandise Inventory. Z-Mart's itemized costs of merchandise purchases for year 2011 are in Exhibit 5.8. EXHIBIT 5.8 Itemized Costs of Merchandise Purchases Z-MART Itemized Costs of Merchandise Purchases For Year Ended December 31, 2011 Invoice cost of merchandise purchases . . . . . . . . . . . . Less: Purchase discounts received . . . . . . . . . . . . . . . . Purchase returns and allowances . . . . . . . . . . . . Add: Costs of transportation-in . . . . . . . . . . . . . . . . . Total cost of merchandise purchases . . . . . . . . . Point: Some companies have separate accounts for purchase discounts, returns and allowances, and transportation-in. These accounts are then transferred to Merchandise Inventory at period-end. This is a hybrid system of perpetual and periodic. That is, Merchandise Inventory is updated on a perpetual basis but only for purchases and cost of goods sold. $ 235,800 (4,200) (1,500) 2,300 $232,400 The accounting system described here does not provide separate records (accounts) for total purchases, total purchase discounts, total purchase returns and allowances, and total transportation-in. Yet nearly all companies collect this information in supplementary records because managers need this information to evaluate and control each of these cost elements. Supplementary records, also called supplemental records, refer to information outside the usual general ledger accounts. wiL10874_ch05_178-225.indd Page 187 7/30/10 10:03:13 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations Quick Check 187 Answers p. 207 4. How long are the credit and discount periods when credit terms are 2y10, ny60? 5. Identify which items are subtracted from the list amount and not recorded when computing purchase price: (a) freight-in; (b) trade discount; (c) purchase discount; (d ) purchase return. 6. What does FOB mean? What does FOB destination mean? ACCOUNTING FOR MERCHANDISE SALES Merchandising companies also must account for sales, sales discounts, sales returns and allowances, and cost of goods sold. A merchandising company such as Z-Mart reflects these items in its gross profit computation, as shown in Exhibit 5.9. This section explains how this information is derived from transactions. Analyze and record transactions for merchandise sales using a perpetual system. EXHIBIT 5.9 Z-MART Computation of Gross Profit For Year Ended December 31, 2011 Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Sales discounts . . . . . . . . . . . . . . . . . . . . Sales returns and allowances . . . . . . . . . Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . P2 Gross Profit Computation $321,000 $4,300 2,000 6,300 314,700 230,400 $ 84,300 Sales of Merchandise Each sales transaction for a seller of merchandise involves two parts. 1. Revenue received in the form of an asset from the customer. 2. Recognition of the cost of merchandise sold to the customer. Accounting for a sales transaction under the perpetual system requires recording information about both parts. This means that each sales transaction for merchandisers, whether for cash or on credit, requires two entries: one for revenue and one for cost. To illustrate, Z-Mart sold $2,400 of merchandise on credit on November 3. The revenue part of this transaction is recorded as (e) Nov. 3 Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sold merchandise on credit. 2,400 2,400 Assets 5 Liabilities 1 Equity 12,400 12,400 This entry reflects an increase in Z-Mart's assets in the form of accounts receivable. It also shows the increase in revenue (Sales). If the sale is for cash, the debit is to Cash instead of Accounts Receivable. The cost part of each sales transaction ensures that the Merchandise Inventory account under a perpetual inventory system reflects the updated cost of the merchandise available for sale. For example, the cost of the merchandise Z-Mart sold on November 3 is $1,600, and the entry to record the cost part of this sales transaction is (e) Nov. 3 Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . To record the cost of Nov. 3 sale. 1,600 1,600 Assets 5 Liabilities 1 Equity 21,600 21,600 wiL10874_ch05_178-225.indd Page 188 7/30/10 10:03:13 AM user-f500 188 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations Decision Insight Decision Insight Suppliers and Demands Large merchandising companies often bombard suppliers with demands. These include discounts for bar coding and technology support systems, and fines for shipping errors. Merchandisers' goals are to reduce inventories, shorten lead times, and eliminate errors. Sales Discounts Sales discounts on credit sales can benefit a seller by decreasing the delay in receiving cash and reducing future collection efforts. At the time of a credit sale, a seller does not know whether a customer will pay within the discount period and take advantage of a discount. This means the seller usually does not record a sales discount until a customer actually pays within the discount period. To illustrate, Z-Mart completes a credit sale for $1,000 on November 12 with terms of 2y10, ny60. The entry to record the revenue part of this sale is Assets 5 Liabilities 1 Equity 11,000 11,000 Nov. 12 Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sold merchandise under terms of 2y10, ny60. 1,000 1,000 This entry records the receivable and the revenue as if the customer will pay the full amount. The customer has two options, however. One option is to wait 60 days until January 11 and pay the full $1,000. In this case, Z-Mart records that payment as Assets 5 Liabilities 1 Equity 11,000 21,000 Jan. 11 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . Received payment for Nov. 12 sale. 1,000 1,000 The customer's second option is to pay $980 within a 10-day period ending November 22. If the customer pays on (or before) November 22, Z-Mart records the payment as Assets 5 Liabilities 1 Equity 1980 220 21,000 Nov. 22 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . Received payment for Nov. 12 sale less discount. 980 20 1,000 Sales Discounts is a contra revenue account, meaning the Sales Discounts account is deducted from the Sales account when computing a company's net sales (see Exhibit 5.9). Management monitors Sales Discounts to assess the effectiveness and cost of its discount policy. Sales Returns and Allowances Point: Published income statements rarely disclose sales discounts, returns and allowances. Sales returns refer to merchandise that customers return to the seller after a sale. Many companies allow customers to return merchandise for a full refund. Sales allowances refer to reductions in the selling price of merchandise sold to customers. This can occur with damaged or defective merchandise that a customer is willing to purchase with a decrease in selling price. Sales returns and allowances usually involve dissatisfied customers and the possibility of lost future sales, and managers monitor information about returns and allowances. To illustrate, recall Z-Mart's sale of merchandise on November 3 for $2,400 that had cost $1,600. Assume that the customer returns part of the merchandise on Sales Returns wiL10874_ch05_178-225.indd Page 189 7/30/10 10:03:13 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations 189 November 6, and the returned items sell for $800 and cost $600. The revenue part of this transaction must reflect the decrease in sales from the customer's return of merchandise as follows: (f ) Nov. 6 Sales Returns and Allowances . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . Customer returns merchandise of Nov. 3 sale. 800 800 Assets 5 Liabilities 1 Equity 2800 2800 If the merchandise returned to Z-Mart is not defective and can be resold to another customer, Z-Mart returns these goods to its inventory. The entry to restore the cost of such goods to the Merchandise Inventory account is Nov. 6 Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . Returned goods added to inventory. 600 600 Assets 5 Liabilities 1 Equity 1600 1600 This entry changes if the goods returned are defective. In this case the returned inventory is recorded at its estimated value, not its cost. To illustrate, if the goods (costing $600) returned to Z-Mart are defective and estimated to be worth $150, the following entry is made: Dr. Merchandise Inventory for $150, Dr. Loss from Defective Merchandise for $450, and Cr. Cost of Goods Sold for $600. Decision Insight Decision Insight Return to Sender Book merchandisers such as Barnes & Noble, Borders Books, Books-A-Million, and Waldenbooks can return unsold books to publishers at purchase price. Publishers say returns of new hardcover books run between 35% and 50%. To illustrate sales allowances, assume that $800 of the merchandise Z-Mart sold on November 3 is defective but the buyer decides to keep it because Z-Mart offers a $100 price reduction. Z-Mart records this allowance as follows: Sales Allowances Nov. 6 Sales Returns and Allowances . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . To record sales allowance on Nov. 3 sale. 100 100 The seller usually prepares a credit memorandum to confirm a buyer's return or allowance. A seller's credit memorandum informs a buyer of the seller's credit to the buyer's Account Receivable (on the seller's books). Quick Check Answers p. 207 7. Why are sales discounts and sales returns and allowances recorded in contra revenue accounts instead of directly in the Sales account? 8. Under what conditions are two entries necessary to record a sales return? 9. When merchandise is sold on credit and the seller notifies the buyer of a price allowance, does the seller create and send a credit memorandum or a debit memorandum? Assets 5 Liabilities 1 Equity 2100 2100 Point: The sender (maker) of a credit memorandum will credit the account of the receiver. The receiver of a credit memorandum will debit the sender's account. wiL10874_ch05_178-225.indd Page 190 7/30/10 10:03:20 AM user-f500 190 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations COMPLETING THE ACCOUNTING CYCLE Exhibit 5.10 shows the flow of merchandising costs during a period and where these costs are reported at period-end. Specifically, beginning inventory plus the net cost of purchases is the merchandise available for sale. As inventory is sold, its cost is recorded in cost of goods sold on the income statement; what remains is ending inventory on the balance sheet. A period's ending inventory is the next period's beginning inventory. EXHIBIT 5.10 Beginning inventory Period 1 Merchandising Cost Flow in the Accounting Cycle Net purchases From supplier Merchandise available for sale Ending inventory Cost of goods sold To Income Statement To Balance Sheet Period 2 Beginning inventory Net purchases From supplier Merchandise available for sale Ending inventory Cost of goods sold To Income Statement To Balance Sheet Adjusting Entries for Merchandisers P3 Prepare adjustments and close accounts for a merchandising company. Point: About two-thirds of shoplifting losses are thefts by employees. Assets 5 Liabilities 1 Equity 2250 2250 Each of the steps in the accounting cycle described in the prior chapter for a service company applies to a merchandiser. This section and the next two further explain three steps of the accounting cycle for a merchandiser adjustments, statement preparation, and closing. Adjusting entries are generally the same for merchandising companies and service companies, including those for prepaid expenses (including depreciation), accrued expenses, unearned revenues, and accrued revenues. However, a merchandiser using a perpetual inventory system is usually required to make another adjustment to update the Merchandise Inventory account to reflect any loss of merchandise, including theft and deterioration. Shrinkage is the term used to refer to the loss of inventory and it is computed by comparing a physical count of inventory with recorded amounts. A physical count is usually performed at least once annually. To illustrate, Z-Mart's Merchandise Inventory account at the end of year 2011 has a balance of $21,250, but a physical count reveals that only $21,000 of inventory exists. The adjusting entry to record this $250 shrinkage is Dec. 31 Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . To adjust for $250 shrinkage revealed by a physical count of inventory. 250 250 wiL10874_ch05_178-225.indd Page 191 7/30/10 10:03:23 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations 191 Preparing Financial Statements The financial statements of a merchandiser, and their preparation, are similar to those for a service company described in Chapters 2 through 4. The income statement mainly differs by the inclusion of cost of goods sold and gross profit. Also, net sales is affected by discounts, returns, and allowances, and some additional expenses are possible such as delivery expense and loss from defective merchandise. The balance sheet mainly differs by the inclusion of merchandise inventory as part of current assets. The statement of owner's equity is unchanged. A work sheet can be used to help prepare these statements, and one is illustrated in Appendix 5B for Z-Mart. Point: Staples's costs of shipping merchandise to its stores is included in its costs of inventories as required by the cost principle. Closing Entries for Merchandisers Closing entries are similar for service companies and merchandising companies using a perpetual system. The difference is that we must close some new temporary accounts that arise from merchandising activities. Z-Mart has several temporary accounts unique to merchandisers: Sales (of goods), Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. Their existence in the ledger means that the first two closing entries for a merchandiser are slightly different from the ones described in the prior chapter for a service company. These differences are set in red boldface in the closing entries of Exhibit 5.11. Step 1: Close Credit Balances in Temporary Accounts to Income Summary. Dec. 31 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Summary . . . . . . . . . . . . . . . . . . . . . . . . . . To close credit balances in temporary accounts. 321,000 321,000 Step 2: Close Debit Balances in Temporary Accounts to Income Summary. Dec. 31 Income Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . Sales Returns and Allowances . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . Depreciation Expense . . . . . . . . . . . . . . . . . . . . . . . Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplies Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . To close debit balances in temporary accounts. 308,100 4,300 2,000 230,400 3,700 43,800 600 9,000 3,000 11,300 Step 3: Close Income Summary to Owner's Capital. The third closing entry is identical for a merchandising company and a service company. The $12,900 amount is net income reported on the income statement. Dec. 31 Income Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . K. Marty, Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . To close the Income Summary account. 12,900 12,900 Step 4: Close Withdrawals Account to Owner's Capital. The fourth closing entry is identical for a merchandising company and a service company. It closes the Withdrawals account and adjusts the Owner's Capital account to the amount shown on the balance sheet. Dec. 31 K. Marty, Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . K. Marty, Withdrawals . . . . . . . . . . . . . . . . . . . . . . . To close the Withdrawals account. 4,000 4,000 Summary of Merchandising Entries Exhibit 5.12 summarizes the key adjusting and closing entries of a merchandiser (using a perpetual inventory system) that are different from those of a service company described in prior chapters (the Demonstration Problem 2 illustrates these merchandising entries). Point: The Inventory account is not affected by the closing process under a perpetual system. EXHIBIT 5.11 Closing Entries for a Merchandiser wiL10874_ch05_178-225.indd Page 192 7/30/10 10:03:23 AM user-f500 192 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations EXHIBIT 5.12 Merchandising Transactions Merchandising Entries Dr. Cr. Summary of Merchandising Entries Purchases Purchasing merchandise for resale. Paying freight costs on purchases; FOB shipping point. Paying within discount period. Recording purchase returns or allowances. Selling merchandise. Receiving payment within discount period. Sales Granting sales returns or allowances. Paying freight costs on sales; FOB destination. Merchandising Events Adjusting Closing Adjusting due to shrinkage (occurs when recorded amount larger than physical inventory). Closing temporary accounts with credit balances. Closing temporary accounts with debit balances. Merchandise Inventory . . . . . . . . . . . . . . . . Cash or Accounts Payable . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts Payable . . . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash or Accounts Payable . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . Cash or Accounts Receivable . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales Discounts . . . . . . . . . . . . . . . . . . . . . . Accounts Receivable . . . . . . . . . . . . . . Sales Returns and Allowances . . . . . . . . . . . Cash or Accounts Receivable . . . . . . . Merchandise Inventory . . . . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . Delivery Expense . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . # # # # # # # # # # # # # # # # # # # # # # Adjusting and Closing Entries Cost of Goods Sold . . . . . . . . . . . . . . . . . . Merchandise Inventory . . . . . . . . . . . . # Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Summary . . . . . . . . . . . . . . . . Income Summary . . . . . . . . . . . . . . . . . . . . Sales Returns and Allowances . . . . . . . Sales Discounts . . . . . . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . Delivery Expense . . . . . . . . . . . . . . . . \"Other Expenses\" . . . . . . . . . . . . . . . . # Quick Check # # # # # # # # Answers p. 207 10. When a merchandiser uses a perpetual inventory system, why is it sometimes necessary to adjust the Merchandise Inventory balance with an adjusting entry? 11. What temporary accounts do you expect to find in a merchandising business but not in a service business? 12. Describe the closing entries normally made by a merchandising company. FINANCIAL STATEMENT FORMATS P4 Define and prepare multiple-step and singlestep income statements. Generally accepted accounting principles do not require companies to use any one presentation format for financial statements so we see many different formats in practice. This section describes two common income statement formats: multiple-step and single-step. The classified balance sheet of a merchandiser is also explained. wiL10874_ch05_178-225.indd Page 193 8/2/10 5:32:47 PM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations 193 Multiple-Step Income Statement A multiple-step income statement format shows detailed computations of net sales and other costs and expenses, and reports subtotals for various classes of items. Exhibit 5.13 shows a multiple-step income statement for Z-Mart. The statement has three main parts: (1) gross profit, determined by net sales less cost of goods sold, (2) income from operations, determined by gross profit less operating expenses, and (3) net income, determined by income from operations adjusted for nonoperating items. EXHIBIT 5.13 Z-MART Income Statement For Year Ended December 31, 2011 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Sales discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales returns and allowances . . . . . . . . . . . . . . . . . . . . . . . . . . Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold*. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating Expenses Selling expenses Depreciation expenseStore equipment . . . . . . . . . . . . . . . . Sales salaries expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rent expenseSelling space . . . . . . . . . . . . . . . . . . . . . . . . . . Store supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advertising expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative expenses Depreciation expenseOffice equipment . . . . . . . . . . . . . . . Office salaries expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rent expenseOffice space . . . . . . . . . . . . . . . . . . . . . . . . . . Office supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total general and administrative expenses . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other revenues and gains (expenses and losses) Interest revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain on sale of building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other revenue and gains (expenses and losses) . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . *Cost of goods sold consists of the following: Beginning inventory. . . . . . . . . . . . . . . . . . . Cost of goods purchased . . . . . . . . . . . . . . . Cost of goods available for sale . . . . . . . . . . Less ending inventory . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . Multiple-Step Income Statement $ 321,000 $ 4,300 2,000 6,300 314,700 230,400 84,300 3,000 18,500 8,100 1,200 11,300 42,100 Gross profit computation Income from operations computation 700 25,300 600 900 1,800 29,300 71,400 12,900 1,000 2,500 (1,500) 2,000 $ 14,900 Nonoperating activities computation $ 19,000 232,400 251,400 21,000 $230,400 Operating expenses are classified into two sections. 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 company's overall operations and include expenses related to accounting, human resource management, and financial management. Expenses are allocated between sections when they contribute to more than one. Z-Mart allocates rent expense of $9,000 from its store building between two sections: $8,100 to selling expense and $900 to general and administrative expense. Nonoperating activities consist of other expenses, revenues, losses, and gains that are unrelated to a company's operations. Other revenues and gains commonly include interest revenue, Point: Z-Mart did not have any nonoperating activities; however, Exhibit 5.13 includes some for illustrative purposes. wiL10874_ch05_178-225.indd Page 194 8/2/10 5:02:05 PM user-f500 194 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations dividend revenue, rent revenue, and gains from asset disposals. Other expenses and losses commonly include interest expense, losses from asset disposals, and casualty losses. When a company has no reportable nonoperating activities, its income from operations is simply labeled net income. Single-Step Income Statement Point: Many companies report interest expense and interest revenue in separate categories after operating income and before subtracting income tax expense. As one example, see Palm's income statement in Appendix A. EXHIBIT 5.14 Single-Step Income Statement A single-step income statement is another widely used format and is shown in Exhibit 5.14 for Z-Mart. It lists cost of goods sold as another expense and shows only one subtotal for total expenses. Expenses are grouped into very few, if any, categories. Many companies use formats that combine features of both the single- and multiple-step statements. Provided that income statement items are shown sensibly, management can choose the format. (In later chapters, we describe some items, such as extraordinary gains and losses, that must be reported in certain locations on the income statement.) Similar presentation options are available for the statement of owner's equity and statement of cash flows. Z-MART Income Statement For Year Ended December 31, 2011 Revenues Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest revenue . . . . . . . . . . . . . . . . . . . . . . . . . Gain on sale of building . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenses Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative expenses . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $314,700 1,000 2,500 318,200 $230,400 42,100 29,300 1,500 303,300 $ 14,900 Classified Balance Sheet The merchandiser's classified balance sheet reports merchandise inventory as a current asset, usually after accounts receivable according to an asset's nearness to liquidity. Inventory is usually less liquid than accounts receivable because inventory must first be sold before cash can be received; but it is more liquid than supplies and prepaid expenses. Exhibit 5.15 shows the current asset section of Z-Mart's classified balance sheet (other sections are as shown in Chapter 4). EXHIBIT 5.15 Classified Balance Sheet (partial) of a Merchandiser Z-MART Balance Sheet (partial) December 31, 2011 Current assets Cash . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . . Merchandise inventory . . . . . . . . Office supplies . . . . . . . . . . . . . . . . . Store supplies . . . . . . . . . . . . . . . . . . Prepaid insurance . . . . . . . . . . . . . . . Total current assets . . . . . . . . . . . . . $ 8,200 11,200 21,000 550 250 300 $ 41,500 wiL10874_ch05_178-225.indd Page 195 7/30/10 10:03:24 AM user-f500 /Users/user-f500/Desktop Chapter 5 Accounting for Merchandising Operations Decision Insight Decision Insight Merchandising Shenanigans Accurate invoices are important to both sellers and buyers. Merchandisers rely on invoices to make certain they receive all monies for products providedno more, no less. To achieve this, controls are set up. Still, failures arise. A survey reports that 9% of employees in sales and marketing witnessed false or misleading invoices sent to customers. Another 14% observed employees violating contract terms with customers (KPMG 2009). GLOBAL VIEW This section discusses similarities and differences between U.S. GAAP and IFRS in accounting and reporting for merchandise purchases and sales, and for the income statement. Accounting for Merchandise Purchases and Sales Both U.S. GAAP and IFRS include broad and similar guidance for the accounting of merchandise purchases and sales. Specifically, all of the transactions presented and illustrated in this chapter are accounted for identically under the two systems. The closing process for merchandisers also is identical for U.S. GAAP and IFRS. In the next chapter we describe how inventory valuation can, in some cases, be different for the two systems. Income Statement Presentation We explained that net income, profit, and earnings refer to the same (bottom line) item. However, IFRS tends to use the term profit more than any other term, whereas U.S. statements tend to use net income more than any other term. Both U.S. GAAP and IFRS income statements begin with the net sales or net revenues (top line) item. For merchandisers and manufacturers, this is followed by co