Week 5. ACT102 Introduction to Accounting. Objectives 21/02/2018. What are retailing operations?

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1 ACT102 Introduction to Accounting Week 5 Objectives Describe retailing operations, perpetual and periodic inventory systems and understand how to account for GST Account for the purchase of inventory using a perpetual system Account for the sale of inventory using a perpetual system Adjust and close the accounts of a retailing business Prepare a retailer s financial statements Use gross profit percentage, inventory turnover and days in inventory to evaluate a business 2 What are retailing operations? Retailing consists of buying and selling goods rather than services Retailers have some new balance sheet and income statement items, for example Inventory, Sales revenue, and Cost of sales The operating cycle of a retailing business begins when the business purchases inventory from a vendor. It then sells the inventory to a customer. Finally, the business collects cash from customers 3 1

2 Income Statements Service Co. Income Statement Year ended June 30, 2009 Service revenue $xxx Expenses: Salary expense x Depreciation expense x Income tax expense x Net profit $ xx Retailing Co. Income Statement Year ended June 30, 2009 Sales revenue $xxx Cost of sales x Gross profit xx Operating expenses: Salary expense x Depreciation expense x Net profit $ xx 4 Operating Cycle of a Retailing Business Purchase and Cash Sale Purchase and Sale on Credit Cash Cash Inventory Accounts Receivable Inventory 5 GST (Goods and Services Tax) GST is a tax levied on the supply of goods and services The tax is a flat percentage charge Most retailers are registered for GST: The GST collected is paid to the ATO. The GST paid is claimed back from the ATO. (Reality net difference is paid or claimed) So sales and purchases are shown net of GST. Retailers who are not registered: They do not charge GST on sales. GST paid on purchases is added to the cost. 6 2

3 Inventory Systems Perpetual System maintains a running record of inventory and COGS i.e.cogs calculated as soon as sale is completed. Usually business carries high value goods, computerised a/c systems makes it easier Periodic COGS calculated periodically, stocktake often determines the value of COGS, suitable for inexpensive goods 7 Purchase of Inventory Example (Perpetual Inventory System) On May 1, the Sporting Store acquired on account $2,000 of various items for resale. The supplier sent the inventory along with a bill (invoice) stating the quantity, price, and terms of sale. What is the journal entry? Show the posting to the general ledger account 8 Accounting for inventory in the perpetual system May 1 Inventory 2,000 GST Clearing 200 Accounts Payable 2,200 Purchased inventory on account (on credit) Inventory Accounts Payable GST Clearing 2,000 2,

4 Purchase Returns and Allowances Example Businesses allow customers to return goods that are defective, damaged or otherwise unsuitable purchase returns Assume that on May 4 a $100 item was returned prior to payment of the invoice. Journal Entry: May 4 Accounts Payable 110 Inventory 100 GST Clearing 10 Inventory returned 10 Purchase Returns and Allowances Example The seller may also deduct an allowance from the amount the buyer owes purchase allowance Assume that one of the items of inventory is slightly damaged, and the store was given a $10 allowance. May 4 Accounts Payable 11 Inventory 10 GST Clearing 1 Received a purchase allowance 11 Settlement Discounts Many businesses offer customers a settlement discount for early payment On the other hand, quantity or trade discounts simply reduce the cost of purchases. Settlement discounts have credit terms stated in expressions such as: 2/10, N/30: meaning that a discount of 2% is allowed if the invoice is paid within 10 days; otherwise the full (net) amount is due within 30 days. Settlement discounts reduce the cost of inventory. 12 4

5 Settlement Discounts Example Assume the Sporting Store purchased inventory for $1,000 (plus GST) with terms of 2/10, N/30. The store paid within the discount period. The 2% discount ($22) is deducted from the amount due ($1,100) and $1,078 is remitted (paid). Journal Entry: Accounts Payable 1,100 Cash (1100 x.98) 1,078 Inventory (1100 x.02 x 10/11) 20 GST Clearing (1100 x.02 x 1/11) 2 Payment of invoice within the discount period 13 Recording Transportation Costs The purchase agreement may specify FOB terms to determine when title to the good transfers to the purchaser and who pays the freight. FOB stands for Free on Board and governs the passing of title of the goods. FOB delivery point means the buyer takes ownership (title) to the goods at delivery point. FOB destination means the buyer takes ownership (title) to the goods at the delivery destination point. Freight in charges increase the cost of inventory (if the supplier had to deliver the goods they would have charged us a higher price). Freight out is an operating expense and is debited to the Delivery Expenses account. 14 Sale of inventory in the perpetual inventory system After a business buys inventory, the next step is to sell the goods The amount a business earns from selling inventory is called Sales revenue (Sales) At the time of the sale, two entries must be recorded in the perpetual system: one entry records the sale and the cash (or receivable) at the time of the sale; the second entry records Cost of sales (debit the expense) and reduces the Inventory (credit the asset) Cost of sales (COS) is the cost of inventory that has been sold to customers 15 5

6 Sale of inventory in the perpetual inventory system Assume that on May 11 the store sold inventory costing $1,000 for $3,300 in cash (GST inclusive). What are the journal entries? May 11 Cash 3,300 Sales Revenue (3, ) 3,000 GST Clearing (3,300 11) 300 To record the cash sale May 11 Cost of Sales 1,000 Inventory 1,000 To record the cost of inventory sold 16 Sale of inventory in the perpetual inventory system Assume that on May 11 the store sold inventory costing $2,900 for $5,500 on account (GST inclusive). What are the journal entries? May 11 Accounts receivable 5,500 Sales Revenue (5, ) 5,000 GST Clearing (5,500 11) 500 To record the cash sale May 11 Cost of Sales 2,900 Inventory 2,900 To record the cost of inventory sold June 10 Cash 5,500 Accounts receivable 5,500 Collection on account 17 Sale of inventory Sales returns and allowances and sales settlement discounts decrease the net amount of revenue earned on sales Sales returns and allowances and Sales discounts are contra accounts to Sales revenue Net sales revenu e Sales revenu e Sales returns and allowances Sales discoun ts 18 6

7 Sale of inventory: Sales returns On May 15, the store sold on account to Maria Gym $5,000 (plus GST) worth of goods with a cost of $3,000 (terms are 5/10, N/60). Invoice Maria Gym Terms 5/10, N/60 Total $5,000 plus GST 19 Sale of inventory: Sales returns On May 17, Maria Gym returned $1,100 (includes GST) worth of goods that cost $600. In addition, a credit of $220 was allowed for inventory that was damaged. What are the journal entries? 20 Sale of inventory: Sales returns May 17 Sales Returns and Allowance 1,000 GST Clearing 100 Accounts Receivable 1,100 Received returned inventory (no GST in Sales return because Sales recorded net GST) May 17 Inventory 600 Cost of Sales 600 Returned goods to inventory (no GST as inventory is recorded net GST) 21 7

8 Sale of inventory: Sales returns May 17 Sales Returns and Allowance 200 GST Clearing 20 Accounts Receivable 220 Credit granted for damaged goods There is no entry required for inventory since the goods were not returned. 22 Sale of inventory: Sales discounts On May 20, the store received a cheque from Maria Gym for the balance due. What is the balance due? Accounts Receivable May 15 = $5,500 Less: May 17 returns and allowances $1,320 Equals: May 20 balance due of $4, Sale of inventory: Sales discounts Maria took advantage of the sales terms 5/10, N/60. May 20 Cash (4,180 x.95) 3,971 Sales Discounts (209 x 10/11) 190 GST Clearing (209 x 1/11) 19 Accounts Receivable 4,180 Cash collected within the discount period The Sales Discount is a contra Sales account 24 8

9 Sales revenue, cost of sales and gross profit Net sales revenue (abbreviated as Sales) Cost of sales Gross profit (same as Gross margin) 25 Adjusting inventory based on a physical count The Inventory account should stay current at all times in a perpetual inventory system The actual amount of inventory on hand may differ from what the books show For this reason, businesses take a physical count of inventory at least once a year The business then adjusts the Inventory account based on the physical count 26 Adjustments to Inventory Example Book Inventory Balance $2,500 $255,000 difference Physical Count $252,500 June 30 Cost of Sales 2,500 (or Inventory Loss) Inventory 2,500 To adjust inventory to physical count 27 9

10 Closing Entries for a Retailing Business Revenues Sales Disc. 276, ,000 7,348 7,348 Sales R&Allow C.O.S. 22,824 22,824 90,400 90, ,000 P & L Summary 151, ,696 Rent Exp. Other Exp. 2,605 2,605 Capital 1,519 1, , Retailer s Financial Statements AASB 101, Presentation of Financial Statements, refers to two different income statement formats based upon the method used for analysing expenses The by nature of expenses method begins by showing sales and other revenues and then deducts expenses analysed into categories such as employee benefits (for example, wages), the cost of depreciation and advertising The alternative function of expenses method begins with sales but then deducts cost of sales to show the gross profit, adds other revenues and classifies the remaining operating expenses into categories such as distribution, administration, marketing and finance Under both alternatives, revenues and finance costs must be shown separately on the face of the income statement 29 Retailer s Financial Statements 30 10

11 Using the Financial Statements for Decision Making The gross profit percentage is one of the most carefully watched measures of profitability. Gross profit percentage = Gross profit / Net sales revenue Inventory turnover measures how rapidly inventory is sold Inventory turnover = Cost of sales / Average inventory Days in inventory ratio measures the average number of days inventory is held by the business Days in inventory = 365 days / Inventory turnover ratio 31 Gross Profit on $1 Three Retailers (example only not real numbers) $1.00 Gross profit $0.75 $0.45 Gross profit $0.32 Gross profit $0.21 Cost of $0.50 Cost of goods sold Cost of goods sold $0.79 goods sold $0.68 $0.25 $0.55 $0.00 Polo Target Woolworths 32 Rate of Inventory Turnover for Three Retailers 1 1 Woolworths Target Polo times per year 5.4 times per year 2.3 times per year 33 11

12 Accounting for Inventory in a Periodic Inventory System Purchases With the perpetual inventory system when a purchase is made Inventory is debited With the periodic inventory system when inventory is purchased we debit Purchases account. Purchase returns are treated the same credit Purchase Returns and Allowances. 34 Accounting for Goods in a Periodic Inventory System Sales With the perpetual inventory system when a sale is made we record both the money flow ( Accounts Receivable and Sales ) and the goods flow ( Inventory and Costs of Sales ). With the periodic inventory system when inventory is sold we only record the money flow. 35 Accounting for Goods in a Periodic Inventory System Cost of Sales (COS) In the periodic inventory system COS must be calculated at the end of the accounting period after a stock-take is conducted

13 Calculating the Cost of Goods Sold in a Periodic System Purchases of inventory Purchases returns and allowances = Net purchases Beginning inventory + Net purchases + Freight-in = Cost of goods available for sale Cost of goods available for sale Ending inventory = Cost of sales Calculating the Cost of Goods Sold in a Periodic System Beginning Inventory $20,000 Net Purchases and Freight-In $101,000 Cost of Goods Available for Sale $121,000 Ending Inventory $15,000 Cost of Sales $106, Accounting for Goods in a Periodic Inventory System Cost of Sales (COS) Beginning Inventory Plus Purchases Plus Freight In Less Purchase Returns and Allowances Equals Cost of Goods Available for Sale Less Ending Inventory Equals COS 39 13

14 Financial Statements The only difference between the financial statements of a periodic inventory system and a perpetual system is COS Perpetual COS is an account and appears as a single line in the Income Statement (see Appendix 5A) 40 Next Week Lecture - Topic 6 Retail Inventory Tutorial - Topic 5 Tutorial Questions Complete the following questions for next weeks tutorial Starters: S5.1, S5.2, S5.3 Exercises: E5.5, E5.12 Continuing Exercise: E