Financial Accounting Chapter 5 Notes The Operating Cycle And Merchandising Operations

Transcription

1 Financial Accounting Chapter 5 Notes The Operating Cycle And Merchandising Operations I. Management Issues in Merchandising Business Merchandising business earns income by buying and selling goods. Such companies uses same basic accounting methods as service companies but the buying and selling of goods adds to the complexity of the process. A. Cash Flow Management Merchandising companies are required to plan for its cash. If the company does not have enough cash to pay its bills when they are due or pay employee s payroll on time, for example, it may be force to close. Even though this is true of all companies, purchasing of inventory puts additional burdens on a company as compare to a service organization, which is not required to keep inventory on hand. Operating Cycle of a merchandising company: 1. Purchase of merchandise inventory for cash or on credit 2. Payment made on credit 3. Sales of merchandise inventory 4. Collection of cash from credit sales Cash Flow Management involves planning the company s receipts and payment of cash. Most companies buy inventory on credit that must pay within 30 days. Management need to plan for cash flows from within the company or from borrowing (loans) to finance the inventory until it is sold and the resulting revenue is collected. B. Profitability Management Chapter 5 1 Author: Anna Rovira Beavers

2 Includes the following 1. Achieving a satisfactory gross margin by setting appropriate prices. 2. Maintain acceptable levels of operating expenses and controlling expenses and operate efficiently. Companies prepare an Operating Budget to control expenses. II. Terms of Sales When goods are sold, cash or credit, there must be certain terms that must be understood by both parties. Such as: Shipping cost Who pays for shipping? Special terms in the invoice designate who is responsible for payment for freight. Shipping Terms Where Title Passes Who Pays the Cost of Transportation FOB shipping point At origin Buyer FOB Destination At destinations Seller Trade Discounts In the case of catalogue merchandise the price of an item may be quoted as a percentage of the list price. That is called trade discount. Trade discounts are not recorded in the accounting records. Sales Discount Intended to increase the seller s liquidity by reducing the amount of money tied up if accounts receivable. An invoice that offers a sales discount might be label as 2/10, n/30, which reads: 2 percent discount is given if paid within 10 days or paid net invoice (full amount) if paid within 30 days. In-Class Exercise: SE5 Other transactions: 1. Shipping cost If shipping cost is invoiced separate, (not in the original invoice) a new entry will be needed: Dr. Freight-In Cr. Accounts Payable or Cash To record the Shipping cost of merchandise purchase If shipping cost is invoiced in the same invoice as the merchandise, the entry will be as follow: Dr. Merchandise Inventory Dr. Freight-In Cr. Accounts Payable Chapter 5 2 Author: Anna Rovira Beavers

3 To record the Shipping cost of merchandise purchase 2. Returned merchandise purchase When merchandise purchase is returned the journal entry to record this transaction will be: In-Class Exercise: SE8 Dr. Accounts Payable Cr. Merchandise Inventory To record the return of defective merchandise III. Choice of Inventory Systems There are two types of inventory systems, Perpetual Inventory and Periodic Inventory. A. Perpetual Inventory Perpetual Inventory keeps a continues record of what is bought and what is sold. This system allows managers to respond to customer s inquiries about product availability and order inventory more effectively when quantities are determine low avoiding, this way, running out of stock. Perpetual Inventory has been greatly improved thanks to the technological advances of Information Systems. In Perpetual Inventory, two journal entries need to be done, one to record the sale, the other to record the reduction of inventory. Here are examples of the journal entries needed. Remember that under Perpetual Inventory system there is the need to take physical inventory but less often. a. Journal Entries Memorize the following journal entries 1. Recording of the purchase of merchandise for resale under Perpetual Inventory: Dr Merchandise Inventory Cr. Accounts Payable (if pay on credit) or Cash To record the purchase of merchandise 2. When merchandise is sold two entries need to be prepared, one to record the sale and the second one to reduce the inventory account. Dr. Accounts Receivable (if sold on credit) or Cash Cr. Sales To record the sale of merchandise Dr. Cost of Good sold (Expense Account, Income Statement Account) Cr. Merchandise Inventory To transfer the cost of merchandise inventory to Cost of Good Sold Income Statement under Perpetual Inventory: Chapter 5 3 Author: Anna Rovira Beavers

4 Net Sales Cost of good sold Gross Margin Operating Expenses: Selling expenses General and administrative expenses Total operating expenses Income before income taxes Income taxes Net Income Fenwick Fashions Corporations Income Statements For the Year Ended December 31, 2006 $41,380 37,104 $239, ,360 $107,965 78,484 $29,481 5,000 $24,481 In-Class Exercise: SE5, E8 B. Periodic Inventory System: Inventory on hand is counted periodically. No actual records of inventory on hand are kept. When merchandise is bought for resale, the purchase of merchandise is recorded to a temporary account called Purchases. The purpose of the Purchases account is to accumulate of the merchandise bought during a period. Under period inventory a physical inventory is taken. a. Journal Entries Memorize the following journal entries 1. Recording the Purchase of Merchandise Dr Purchase (Balance Sheet Account) Cr. Accounts Payable (if pay on credit) or Cash To record the purchase of merchandise 2. If merchandise is returned to its manufacturer then a Purchases contra account is used Purchases Returns and Allowance. Dr. Accounts Payable Cr. Purchases Returns and Allowance To record the return of defective merchandise 3. When merchandise is sold, only sales need to be recorded: Dr. Accounts Receivable (if sold on credit) or Cash Cr. Sales To record the sale of merchandise IV. Income Statement Under the Periodic Inventory: Chapter 5 4 Author: Anna Rovira Beavers

5 In-Class Exercise: E11 Fenwick Fashions Corporations Income Statements For the Year Ended December 31, 2006 Net Sales Cost of good sold Merchandise Inventory, December 31, 20x5 Purchases Less purchases returns and allowances Net purchases Freight in Net cost of purchases Good available for sale Less merchandise inventory December 31, 20x6 Cost of good sold Gross Margin Operating Expenses: Selling expenses General and administrative expenses Total operating expenses Income before income taxes Income taxes Net Income $126,400 7,776 $118,624 8,236 $52, ,860 $179,660 48,300 $41,380 37,104 $239, ,360 $107,965 78,484 $29,481 5,000 $24,481 Chapter 5 5 Author: Anna Rovira Beavers

6 Recording differences between Perpetual Inventory and Periodic Inventory: PERPETUAL PERIODIC Date Account Debit Credit Account Debit Credit PURCHASE OF MERCHADISE on credit: Oct. 1 Merchandise Inventory 2,000 Purchases 2,000 Accounts Payable 2,000 Accounts Payable 2,000 SALE OF MERCHADISE on credit: Oct. 5 Accounts Receivable 1,000 Accounts Receivable 1,000 Sales 1,000 Sales 1,000 Oct. 5 Cost of Good Sold 800 No entry needed Merchandise Inventory 800 RETURN OF MERCHANDISE PURCHASE Oct. 6 Accounts Payable 200 Accounts Payable 200 Merchandise Inventory 200 Purchase Returns and Allowances 200 CUSTUMER RETURN OF MERCHANDISE: OCT 8 Sales Returns and Allowances 100 Sales Returns and 100 Allowances Accounts Receivable 100 Accounts Receivable 100 Merchandise Inventory 80 No entry needed Cost of Good Sold 80 V. Internal Control Internal control is needed in all aspects of business, but particularly when assets are involved. When internal control is applied effectively to merchandise transactions, it can achieve important management goals. It can prevent losses due to theft or fraud. Some of the following procedures are follows in many companies as a system of internal control: a. Separate the functions of authorizations, recordkeeping, and custodianship of cash. b. Limit the number of people who have access to cash, and designate who those people are. c. Bond all employees who have access to cash d. Keep the amount of cash on hand to a minimum by sing banking facilities as much as possible. Chapter 5 6 Author: Anna Rovira Beavers

7 In-Class Exercise: SE9 e. Physically protect cash on hand by using cash registers, cashiers cages, and safes. f. Record and deposit all cash receipts promptly, and make payments by check rather than by currency. g. Have a person who does not handle or record cash make unannounced audits of the cash on hand. h. Have a person who does not authorize, handle, or record cash transactions reconcile the Cash account each month. Homework: P1 (part 1 only), P2 (part 1 only) Chapter 5 7 Author: Anna Rovira Beavers