Chapter+5+Notes+-+Merchandising+Operations+-+Perpetual+Inventory+System

Homework: SS1, SS2, SS5; BE5-1, BE5-2; E5-1 Highlights:
 * __SO 1- 2 (purchases of inventory under perpetual inventory system)__**

- accounting for merchandising (goods) business (click here for a link to the grade 11 accounting summary of merchandising businesses) is unlike accounting for service business

- to calculate profitability for a merchandising business: revenues - cost of goods sold = gross profit (gross margin) - operating expenses = net income

- operating cycle (cash to cash) for service business consists of: perform services on account -> collect payment -> perform services on account

- operating cycle (cash to cash) for merchandising business consists of: purchase inventory -> sell goods on account -> collect payment -> purchase inventory

- periodic inventory system vs modern, technologically-based perpetual inventory system

- perpetual inventory system keeps updated records of inventory purchased, sold and on hand, often with help of UPC bar codes and scanners

- perpetual inventory system automatically updates merchandise inventory (current asset) and cost of goods sold (expense) after each sale (see below)

- periodic inventory system only updates merchandise inventory and cost of goods sold at end of period following physical inventory count

- purchase orders are used to order inventory from suppliers - when inventory arrives at purchaser's place of business, accompanying sales invoice (containing price and quantity) becomes purchase invoice in hands of purchaser

- purchases of inventory under **perpetual inventory system** (**which is examined in this chapter**) result in debit to Merchandise Inventory and credit to Cash or Accounts Payable

- Merchandise Inventory is a control account found in general ledger - separate subsidiary account (found in subsidiary ledger) exists for each individual merchandise item in stock

- when delivery costs are paid by the purchaser, those freight/delivery/shipping costs (e.g., train, plane, truck, etc.) are added to purchase price of inventory (i.e., to the Merchandise Inventory account) whereas in Grade 11 we added those shipping costs to separate Freight-In account

- freight terms are described as either **FOB shipping point** (meaning __purchaser__ of inventory pays shipping costs and assumes risk during transit) or **FOB destination point** (meaning __seller__ of inventory pays shipping costs and assumes risk during transit)

- FOB refers to "free on board" for purchaser of inventory until goods reach either shipping point (seller's place of business) or destination point (purchaser's place of business)

- other shipping terms for FOB include FCA (free carrier) and CIF (cost, insurance, freight)

- purchase returns on damaged or defective goods results in credit to Merchandise Inventory


 * - volume (quantity) discounts** involve price reductions on larger orders of inventory (e.g., 10 % discount on orders of 25 or more units) - volume discounts are __not__ accounted for separately

- on the other hand, **sales/purchase discounts** must be accounted for separately and refer to discounts offered to purchasers on early payment of outstanding balance due on invoice (e.g., credit terms of sale 2/10, n/30 meaning 2% discount on invoice price if payment received within 10 days of invoice date, otherwise net or full balance due within 30 days)

- purchase/sales discounts are very rare in Canada with the exception of a few select industries, and as such will not be discussed in this chapter

- other terms of sale include net EOM (full payment due by __e__nd __o__f current __m__onth) and net 60 or n/60 (full payment due within 60 days)

Depending on the terms of the purchase agreement, freight or delivery costs will either become the responsibility of the seller or the purchaser of goods.
 * __Freight terms explained__**

Common freight terms include “**FOB shipping point**” and “**FOB destination**.”

FOB refers to “free on board.”

“Shipping point” usually refers to the seller’s place of business, while “destination” typically refers to the purchaser’s place of business.


 * FOB shipping point** means that shipping is __free__ for the __purchaser__ __until__ the goods reach the seller’s place of business. At that point, shipping costs become the responsibility of the purchaser. In other words, if the purchaser wishes to see the goods purchased, the purchaser must pay for shipping from the seller’s place of business to its own place of business.

On the other hand, **FOB destination** means that shipping is __free__ for the __purchaser__ __until__ the goods reach the purchaser’s place of business. In other words, the purchaser is not responsible for shipping costs at all.

__**SO 3 - 4 (sale****s**__ **__of inventory under perpetual inventory system)__** Homework: SS3, SS4, SS6, SS11; BE5-4, BE5-6, BE5-7, E5-6 (a) (but ignore July 15 transaction) Highlights:

- recording sales of merchandise requires __two__ entries under the __perpetual__ inventory system, one at sale price (A/R or Cash dr, Sales cr) and one at cost price (Cost of Goods Sold dr, Merchandise Inventory cr)

- source/business documents provide evidence of business transactions: cash register tape (receipt) is sufficient proof of cash sale while sales invoice is sufficient proof of credit sale/sale on account

- sellers of merchandise use contra revenue account Sales Returns and Allowances (SRA) for customer returns of goods and once again two entries are required under perpetual inventory system, one at sale price (SRA dr, A/R or Cash cr) and one at cost price (MI dr, COGS cr)

- return refers to physical return of damaged goods to seller with accompanying reduction in amount owing, while allowance refers to damaged goods kept by purchaser with identical reduction in amount owing

- returned goods that are later determined to be defective or damaged and therefore unsaleable require third entry at cost price using special expense account (Inventory Shrinkage dr, MI cr)

- when seller assumes delivery costs on outgoing merchandise (i.e., FOB destination), these transportation charges are recorded in regular operating expense account called Freight Out or Delivery Expense

- merchandising firms generally record same adjusting entries as service businesses (i.e., prepayments, accruals, estimates) -> yet due to loss, theft and errors concerning inventory, a year-end physical inventory count is also necessary in merchandising firms to ensure compatibility between actual inventory on hand and computerized inventory records -> any discrepancy between the two figures is added or subtracted to the Cost of Goods Sold and Merchandise Inventory accounts via an additional adjusting entry

- three closing entries are necessary for merchandising firms: (1) revenue and temporary credit accounts into capital (2) expenses and temporary debit accounts (including COGS, SRA and Freight Out) into capital and (3) drawings into capital

- post-closing trial balance containing permanent accounts only (assets, liabilities and capital) is final step in accounting cycle for merchandising firms so as to ensure debits equal credits

- sales taxes (either federal GST + provincial PST, or combined HST in some provinces including Ontario) are charged on most purchases and sales of goods and services in Canada -> sales taxes on sales of goods are collected on behalf of federal and/or provincial governments, credited to current liability account GST/PST/HST Payable, and must be remitted monthly or quarterly

- businesses that pay GST or HST on disbursements (purchases) are entitled to full refund of said taxes as an input tax credit (or offset) against any sales taxes collected from customers and owing to government -> sales taxes paid on purchases to which businesses are entitled to a refund are debited to contra liability account GST Recoverable

__**Journal entries for merchandising businesses under perpetual inventory system**__

(a) Purchase of inventory for $60 plus sales taxes (13% HST in Ontario)
 * __Purchaser__**

Merchandise Inventory (current asset) - dr - 60 (+) HST Recoverable - dr - 7.80 -- Cash or A/P - cr - 67.80

//+ = Purchases account under periodic inventory system//

(b) Freight costs of $10 cash on purchase of inventory plus sales taxes (assuming FOB shipping point)

Merchandise Inventory - dr - 10 (+) HST Recoverable - dr - 1.30 -- Cash - cr - 11.30

+ //= Freight In account under periodic inventory system//

(c) Return of inventory (50% of original purchase) by purchaser

Cash or A/P - dr - 33.90 -- Merchandise Inventory - cr - 30 (+) -- HST Recoverable - cr - 3.90

//+ = Purchase Returns and Allowances account under periodic inventory system//

(d) Payment on account of outstanding invoice (assuming original purchase on account)

A/P - dr - 33.90 - Cash - cr - 33.90

(a) Sale of goods for $100 ($60 cost price) plus sales taxes
 * __Seller__**

Cash or A/R - dr - 113 -- Sales - cr - 100 -- HST Payable - cr - 13

Cost of Goods Sold (expense) - dr - 60 (+) -- Merchandise Inventory - cr - 60 (+)

//+ = not recorded under periodic inventory system//

(b) Freight costs of $10 cash on sale of goods (assuming FOB destination and no sales taxes)

Freight Out (expense) or Delivery Expense - dr -10 -- Cash - cr - 10

(c) Return of $100 goods to seller ($60 cost price)

Sales Returns and Allowances - dr - 100 HST Payable - dr - 13 -- Cash or A/R - cr - 113

Merchandise Inventory - dr - 60 (+) -- Cost of Goods Sold - cr - 60 (+)

//+ = not recorded under periodic inventory system//

(d) Receipt of payment on account of outstanding invoice (assuming original sale on account)

Cash - dr - 33.90 A/R - cr - 33.90

(a) Year-end __adjustment__ of inventory on hand following physical inventory count revealing $350 __shortage__ due to loss, theft or accounting error
 * __Period-ending adjusting entries for seller of inventory__**

Cost of Goods Sold - dr - 350 -- Merchandise Inventory - cr - 350

(b) Year-end __adjustment__ of inventory on hand following physical inventory count revealing $350 __overage__ due to accounting error

Merchandise Inventory - dr - 350 --- Cost of Goods Sold - cr – 350

Homework: SS7, SS8; BE5-10, BE5-11; E5-8, E5-9, E5-10(b) only Highlights: **multiple-step income statements** (net sales - cost of goods sold = gross profit - operating expenses = net income + non-operating revenues and gains - non-operating expenses and losses) display multiple steps in the calculation of net income including income from primary (normal) operations vs. non-operating (unusual) activities, cost of goods sold (expense) vs. operating expenses, and categories of operating expenses such as selling expenses vs. administrative expenses (see below for further explanations)
 * __SO 5 - 7__**

- sales - sales returns and allowances = net sales

- net sales - cost of goods sold = gross profit or merchandising profit -> **gross profit margin (%) = gross profit / net sales**

- gross profit - operating expenses = net income or income from operations or operating income -> **profit margin (%) = net income / net sales**

- note that both gross profit margin and profit margin are only calculated on __normal__ operating revenues and expenses

- operating expenses can further be divided into selling expenses (promotion and advertising, delivery, salespersons wages) and administrative expenses (rent, utilities, insurance, repairs and maintenance, management and clerical staff wages)

- on a multi-step income statement, operating (normal) activities are separated from non-operating (unusual) activities -> net non-operating income = revenues and gains unrelated to company operations (interest revenue, dividend and rent revenue, gain on sale of capital asset) minus expenses and losses unrelated to company operations (interest expense, insurance losses from vandalism and accidents, loss on sale of capital asset, strike losses, one-time losses)

- single-step income statements classify all accounts as either revenues (operating revenues and other revenues and gains) or expenses (cost of goods sold, operating expenses [selling and administrative] and other expenses and losses) so that revenues - expenses = net income

- merchandisers generally attempt to turn over (or sell) inventory as quickly as possible so as to avoid unnecessary storage and insurance costs and the risk of damage or obsolescence, yet merchandisers still benefit from maintaining sufficient stock on hand in the form of enhanced customer selection and avoidance of stockouts and disappointed customers


 * - inventory turnover ratio** **(in times per year**) **= cost of goods sold / average inventory (beginning inventory + ending inventory / 2)**


 * - days sales in inventory (in days) = 365 days / inventory turnover**


 * __Multi-step income statement__**

Net sales (S - SRA) __- COGS__ Gross profit __- Operating expenses (selling and administrative)__
 * Income from (normal) operations**

Other non-operating revenues and gains (interest/dividend/rent revenues, gains on capital asset disposals) __- Other non-operating expenses and losses (interest expenses, insurance losses, losses on capital asset disposals)__
 * Net non-operating (unusual) income**

__**+** **Net non-operating (unusual) income**__
 * Income from (normal) operations**
 * Net (final) income**