Merchandise Inventory

  • July 2020
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Merchandising Activities

Operating Cycle of a Merchandising Company Cash

Accounts Receivable

Inventory 2. Sale of merchandise on account

Retailers and Wholesalers

Wholesalers buy merchandise from several different manufacturers and then sell this merchandise to several retailers. Retailers sell merchandise directly to the public.

Income Statement Merchandising Company Computer City Condensed Income Statement For the Year Ended December 31, 2007 Revenue from sales Less: Cost of goods sold Gross profit Less: Expenses Net income

$ $ $

Cost of goods sold represents the expense of goods that are sold to customers.

900,000 540,000 360,000 270,000 90,000

Gross profit is a useful means of measuring the profitability of sales transactions.

Accounting System Requirements for Merchandising Companies Although general ledger accounts provide useful information, they do not provide much of the detailed information needed in the daily business operations. Who owes us money?

General Ledger Accounts Receivable Date

Debit

Credit

Balance

2007 June

1 15

10,000

10,000 3,000

7,000

Accounting System Requirements for Merchandising Companies Control Account Subsidiary Ledgers

Date 2007 June 1 15

Date 2007 June 1 15

Subsidiary Ledger Jake Sparks Debit Credit 3,000 1,000 Subsidiary Ledger Heather Jacobs Debit Credit 7,000 2,000

Date 2007 June 1 15

Balance 3,000 2,000

Balance 7,000 5,000

General Ledger Accounts Receivable Debit Credit Balance 10,000 3,000

10,000 7,000

Two Approaches Used in Accounting for Merchandise Inventories

Perpetual Inventory System

Periodic Inventory System

1. Perpetual Inventory Systems The inventory account is continuously updated to reflect items on hand.

1. Perpetual Inventory Systems On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 5 Inventory Accounts Payable (Electronic City)

Debit

Credit

3,000 3,000

1. Perpetual Inventory Systems On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

Retail GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 10 Accounts Receivable (ABC Radios)

Debit 500

Sales 10 Cost of Goods Sold Inventory

Credit 500

Cost

300 300

1. Perpetual Inventory Systems On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 15 Accounts Payable (Electronic City) Cash

Debit

Credit

3,000 3,000

1. Perpetual Inventory Systems On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 22 Cash Accounts Receivable (ABC Radios)

Debit

Credit

500 500

1.2 Taking a Physical Inventory To ensure the accuracy of their perpetual records

complete physical count

of the merchandise on hand at least once a year

Taking a Physical Inventory Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage and theft. On December 31, Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered.

GENERAL JOURNAL Date

Account Titles and Explanation

Dec. 31 Cost of Goods Sold Inventory

Debit

Credit

2,000 2,000

Closing Entries in a Perpetual Inventory System  Revenue (including Sales)

Income Summary

 Expense (including Cost of Goods Sold)

Income Summary

 Income Summary

Retained Earnings

 Dividends

Retained Earnings The closing entries are the same!

2. Periodic Inventory System No effort is made to keep up-to-date records of either inventory or cost of goods sold.

2. Periodic Inventory System On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account. Notice that no entry is made to Inventory.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 5 Purchases Accounts Payable (Electronic City)

Debit

Credit

3,000 3,000

2. Periodic Inventory System On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

Retail

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 10 Accounts Receivable (ABC Radios) Sales

Debit

Credit

500 500

2. Periodic Inventory System On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 15 Accounts Payable (Electronic City) Cash

Debit

Credit

3,000 3,000

2. Periodic Inventory System On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

GENERAL JOURNAL Date

Account Titles and Explanation

Sept. 22 Cash Accounts Receivable (ABC Radios)

Debit

Credit

500 500

2.1 Computing Cost of Goods Sold The accounting records of Worley Co. show the following: Inventory, Jan. 1 $ 14,000 Purchases (during year) 130,000

At December 31, Party Supply counted the merchandise on hand at $12,000.

Cost of Goods Sold for the year…?

2.1 Computing Cost of Goods Sold Inventory (beginning of the year)

$

14,000

Add: Purchases

130,000

Cost of goods available for sale

144,000

Less: Inventory (end of year) Cost of goods sold

12,000 $ 132,000

2.2 Creating a Cost of Goods Sold Account

Now, Worley Co. must create the Cost of Goods Sold account.

GENERAL JOURNAL Date

Account Titles and Explanation

Dec. 31 Cost of Goods Sold Inventory (beginning of year) Purchases

Debit

Credit

144,000 14,000 130,000

2.2 Creating a Cost of Goods Sold Account

Now, Worley Co. must record the ending inventory amount.

GENERAL JOURNAL Date

Account Titles and Explanation

Dec. 31 Inventory (end of year) Cost of Goods Sold

Debit

Credit

12,000 12,000

Closing Entries in a Perpetual Inventory System  Revenue (including Sales)

Income Summary

 Expense (including Cost of Goods Sold)

Income Summary

 Income Summary

Retained Earnings

 Dividends

Retained Earnings The closing entries are the same!

Selecting an Inventory System Factors Suggesting a Perpetual Inventory System

Factors Suggesting a Periodic Inventory System

Large company with professional management.

Small company, run by owner.

Management and employees wanting information about items in inventory and the quantities of specific products that are selling.

Accounting records of inventories and specific product sales not needed in daily operations; such information developed primarily for use in annual income tax returns. Inventory with many different kinds of low-cost items.

Items in inventory with a high perunit cost. Low volume of sales transactions or a computerized accounting system. Merchandise stored at multiple locations or in warehouses separate from sales sites.

High volume of sales transactions and a manual accounting system. All merchandise stored at the sales site (for example, in the store).

Credit Terms and Cash Discounts When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice.

2/10, n/30 Percentage of Discount

# of Days Discount Is Available

Otherwise, the Full Amount Is Due

# of Days when Full Amount Is Due

Recording Purchases

Net Method

Gross Method

1.Recording Purchases at Net Cost Purchases are recorded at their net amounts.

Net Method

Purchase Discounts Lost are recorded when payment is made outside the discount period.

1.Recording Purchases at Net Cost On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes.

GENERAL JOURNAL Date

Account Titles and Explanation

July 6 Inventory

Debit

Credit

3,920

Accounts Payable (Kid's Clothes)

$4,000  98% = $3,920

3,920

1.Recording Purchases at Net Cost On July 15, Play Clothes pays the full amount due to Kid’s Clothes (take advantage of discount)

GENERAL JOURNAL Date

Account Titles and Explanation

July 15 Accounts Payable (Kid's Clothes) Cash

Debit

Credit

3,920 3,920

1. Recording Purchases at Net Cost Now, assume that Play Clothes waited until July 20 to pay the amount due in full to Kid’s Clothes. (Forgo the discount offered) The journal entry for Play Clothes:

Non-operating Expense

GENERAL JOURNAL Date

Account Titles and Explanation

July 20 Accounts Payable (Kid's Clothes) Purchase Discounts Lost Cash

Debit

Credit

3,920 80 4,000

2. Recording Purchases at Gross Invoice Price Purchases are recorded at their gross amounts.

Gross Method

Purchase discounts taken are recorded when payment is made inside the discount period.

2.Recording Purchases at Gross Invoice Price On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes. The journal entry for Play Clothes :

GENERAL JOURNAL Date July

Account Titles and Explanation

6 Inventory Accounts Payable (Kid's Clothes)

Debit

Credit

4,000 4,000

2. Recording Purchases at Gross Invoice Price On July 15, Play Clothes pays the full amount due to Kid’s Clothes (take discount) The journal entry for Play Clothes : Reduces Cost of Goods Sold

$4,000  98% = $3,920

GENERAL JOURNAL Date

Account Titles and Explanation

July 15 Accounts Payable (Kid's Clothes) Cash Purchase Discounts Taken

Debit

Credit

4,000 3,920 80

2. Recording Purchases at Gross Invoice Price Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kid’s Clothes. (Forgo discount) The journal entry for Play Clothes :

GENERAL JOURNAL Date

Account Titles and Explanation

July 20 Accounts Payable (Kid's Clothes) Cash

Debit

Credit

4,000 4,000

3. Returns of Unsatisfactory Merchandise (Net Cost) On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kid’s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost.

GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 5 Accounts Payable (Kid's Clothes) Inventory

$500  98% = $490

Debit

Credit

490 490

4. Transportation Costs on Purchases Transportation costs related to the acquisition of assets are part of the cost of the asset being acquired.

5. Transactions Relating to Sales Computer City Partial Income Statement For the Year Ended December 31, 2007 Revenue Sales Less: Sales returns and allowances Sales discounts Net sales

$ 912,000 $

8,000 4,000

12,000 $ 900,000

Credit terms and merchandise returns affect the amount of revenue earned by the seller.

5. Sales On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 2 Accounts Receivable (Play Clothes) Sales

Debit

Credit

2,000 2,000

5. Sales On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 2 Cost of Goods Sold Inventory

Debit

Credit

1,000 1,000

5. Sales Returns and Allowances On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 5 Sales Returns and Allowances Accounts Receivable (Play Clothes)

Contra-revenue Debit

Credit

500 500

5. Sales Returns and Allowances On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 5 Inventory Cost of Goods Sold

Debit

Credit

250 250

5. Sales On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date July

Account Titles and Explanation

6 Accounts Receivable (Play Clothes) Sales

Debit

Credit

4,000 4,000

5. Sales On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL Date July

Account Titles and Explanation

6 Cost of Goods Sold Inventory

Debit

Credit

2,000 2,000

5. Sales Discounts On July 15, Kid’s Clothes receives the full amount due from Play Clothes from the July 6 sale.

Contra-revenue

$4,000  98% = $3,920

GENERAL JOURNAL Date

Account Titles and Explanation

July 15 Cash Sales Discounts Accounts Receivable (Play Clothes)

Debit

Credit

3,920 80 4,000

5. Sales Discounts Now, assume that it wasn’t until July 20 that Kid’s Clothes received the full amount due from Play Clothes from the July 6 sale.

GENERAL JOURNAL Date

Account Titles and Explanation

July 20 Cash Accounts Receivable (Play Clothes)

Debit

Credit

4,000 4,000

6. Delivery Expenses Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense.

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