(4) Merchandising Operations (Inventory Systems) Flashcards
What are the differences between merchandising businesses and service businesses?
- Merchandising business buy and resell inventory
- They have an inventory account
- They have cost of sales expense
- The operating cycle is longer than service businesses’ due to purchase of inventory and its eventual sale
- Revenue is referred to sales revenue while for service businesses, it’s service revenue
What is the profit measurement process for merchandising businesses?
Hint: (1) calculate gross profit and (2) calculate profit
Sales Revenue less Cost of Sales equals Gross Profit less Operating Expenses equals Net Profit
*remember to minus sales returns and allowances before subtracting cost of sales
How does the profit measurement process in a merchandising business differ from a service business?
- Sales are the primary source of revenue
2. Expenses are divided into two categories: (1) cost of sales and (2) operating expenses
What are the two inventory systems for maintaining inventory records in a merchandising business?
- Perpetual
2. Periodic
What is the difference between perpetual inventory system and periodic inventory system?
Hint: there are 2 - definition and cost of sales….
- Under the perpetual system, detailed records of the cost of each inventory purchase and sale are maintained. The accounting records continuously show the quantity and cost of inventory that should be on hand at any time during the period.
As for the periodic system, detailed inventory records of the goods on hand are NOT kept throughout the period. - Under the perpetual system, cost of sales is determined each time a sale occurs.
Under the periodic system, cost of sales is determined at the end of the period.
Key features of a perpetual inventory system
- Inventory a/c provides a constant, up-to-date record of inventory on hand
- Cost of sales a/c provides a constant, up-to-date record of cost of inventory sold
What are the effects on the accounts for when inventory is returned by a customer? Use the perpetual inventory system.
- Increase in inventory a/c
- Decrease in cost of sales a/c
Is there a Purchase Returns & Allowances a/c under the perpetual system?
No.
Only the periodic system has the Purchase Returns & Allowances a/c
Explain freight-in and freight-out.
Freight-in is when the buyer pays the transport cost.
Cost of freight is included in the cost of purchasing inventory.
Freight-out is incurred on the seller on outgoing inventory. It is included in the Selling Expenses under operating expenses on the Statement of Profit or Loss.
What are the two categories of purchase discounts?
- Settlement discounts
2. Trade discounts
What are settlement discounts?
Discounts given to encourage prompt payment of accounts receivable
- Discount allowed – treated as an expense
- Discount received – treated as “other income”
What is discount received?
Discount received is a discount that the buyer has received from the supplier upon prompt payment of inventory purchased. It is treated as “other income”.
It is shown on the Statement of Profit or Loss under “other operating revenue” and is one of the temporary accounts.
DR Accounts payable 760
CR Cash 700
CR Discount received 60
(to record payment within discount period)
What is discount allowed?
Discount Allowed this is a discount the business has permitted a customer to take in return for the prompt payment of
inventory they had purchased. Treated as an expense.
It is shown on the Statement of Profit or Loss under “Financial Expenses” under “Operating Expenses”
DR Cash 700
DR Discount allowed 60
CR Accounts receivable 760
(to record collection within discount period)
Explain trade discounts.
Trade discounts are a % reduction in the list price of inventory sold and are not recorded in the records of either the buyer or the seller. The net amount is recorded for journal entry. They are not contingent on any further action on the part of the buyer.
Explain sales returns and allowances.
When goods are returned by a customer, two entries are required by the merchandising firm:
- To record sales return at selling price:
DR Sales returns & allowances
CR a/c receivable or cash
(to record credit granted to customer for returned goods) - To record return to inventory at cost price:
DR Inventory
CR Cost of sales
(to record cost of goods returned)
*If the returned goods are damaged or faulty, replace Inventory with Inventory write-down (an expense)
What are selling expenses?
Cost of making the sale and distributing goods to customers.
E.g. sales salaries, advertising, freight-out
What are administration expenses?
Cost of operating activities of the general, accounting and personnel offices.
E.g. salaries, rent
What are financial expenses?
Costs of financing the business and settlement of debts.
E.g. interest expense, discounts allowed
What are the closing entries for merchandising firms using perpetual system?
- To debit (to close credit accounts) to Profit or Loss Summary (-on the credit side):
- Revenue accounts
- Discount received - credit (to close debit accounts) to Profit or Loss Summary (-on the debit side):
- Sales returns & allowances
- Cost of sales
- Freight-out
- Discount allowed
- Expense accounts - Close Profit or Loss Summary (-on debit side. this is the amount of the difference between the first amount for closing credit a/c and the second amount for closing debit a/c) to retained earnings account (-on credit side)
- Close dividends (-on credit side) to retained earnings (-on debit side)
What is the gross profit ratio formula?
Gross profit ratio = gross profit / net sales
Higher rate suggests the average margin between selling price and inventory cost is increasing. Too high a margin may result in lost sales.
What is the operating expenses to sales ratio formula?
Operating expenses to sales ratio = operating expenses / net sales
A higher value or increasing percentage should be investigated to determine whether cost cutting is necessary.
Key features of a periodic inventory system
- Purchases a/c increases when inventory is purchased
- Increase in Purchase Returns & Allowances a/c when inventory is returned to the supplier
- No journal entry for when inventory is sold or returned by customer
- Cost of sales only emerges at the end of the accounting period in the Statement of Profit or Loss
Explain purchases returns and allowances.
A purchase return is the return of goods by the customer.
The customer will receive a refund in the form of credit or cash.
A purchase allowance occurs where the customer keeps the goods and a reduction in price is granted
*The journal entry is the same for both. Uses the Purchase Returns & Allowances a/c
How do we treat purchases of inventory under a periodic system?
Purchases of inventory are treated as a purchases expense
