Inventory and Cost of Goods
Rmadrid2015
chapter05.pdf
study objectives
After studying this chapter, you should be able to:
1 Identify the differences between a service company and a merchandising company.
2 Explain the recording of purchases under a perpetual inventory system.
3 Explain the recording of sales revenues under a perpetual inventory system.
4 Distinguish between a single-step and a multiple-step income statement.
5 Determine cost of goods sold under a periodic system.
6 Explain the factors affecting profitability.
7 Identify a quality of earnings indicator.
chapter
MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP
INCOME STATEMENT
5
226
● Scan Study Objectives
● Read Feature Story
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● Read Text and Answer p. 235 p. 239 p. 243 p. 245
● Work Using the Decision Toolkit
● Review Summary of Study Objectives
● Work Comprehensive p. 254
● Answer Self-Test Questions
● Complete Assignments
● Go to WileyPLU S for practice and tutorials
● Read A Look at I FR S p. 276
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feature story
227
In his book The End of Work, Jeremy Rifkin notes that
until the 20th century the word consumption evoked
negative images; to be labeled a “consumer” was an
insult. (In fact, one of the deadliest diseases in history,
tuberculosis, was often referred to as “consumption.”)
Twentieth-century merchants realized, however, that in
order to prosper, they had to convince people of the
need for things not previously
needed. For example, General
Motors made annual changes in its
cars so that people would be dis-
contented with the cars they already owned. Thus
began consumerism.
Today, consumption describes the U.S. lifestyle in
a nutshell. We consume twice as much today per per-
son as we did at the end of World War II. The amount
● Morrow Snowboards Improves Its Stock Appeal (p. 231) ● Should Costco Change Its Return Policy? (p. 238) ● Disclosing More Details (p. 242) ● Strategic Errors Can Be Costly (p. 248)
INSIDE CHAPTER 5 . . .
Wal-Mart net sales, years ending January 31st (billions)
$
2004
2005
2006
0 50 100 150 200 250 300 350 400 450
2003
2001
2000
2002
2008
Total number of stores,‘000
2009
4.9
5.3
6.1
2007 6.8
4.7
4.4
4.2
4.0
7.9
7.3
Source: “How Big Can It Grow?” The Economist (April 17, 2004), pp. 67–69, and www.walmart.com (accessed March 17, 2008).
of U.S. retail space per person is
vastly greater than that of any other
country. It appears that we live to shop.
The first great retail giant was Sears, Roebuck. It
started as a catalog company enabling people in ru-
ral areas to buy things by mail. For decades it was the
uncontested merchandising leader.
Today, Wal-Mart is the undis-
puted champion provider of basic
(and perhaps not-so-basic) human
needs. Wal-Mart opened its first
store in 1962, and it now has almost 8,000 stores,
serving more than 100 million customers every week.
A key cause of Wal-Mart’s incredible growth is its
amazing system of inventory control and distribution.
Wal-Mart has a management information system that
employs six satellite channels, from which company
computers receive 8.4 million updates every minute on
what items customers buy and the relationship among
items sold to each person.
Measured by sales revenues, Wal-Mart is the
largest company in the world. In six years, it went from
selling almost no groceries to being America’s largest
grocery retailer.
It would appear that things have never looked bet-
ter at Wal-Mart. On the other hand, a Wall Street Jour-
nal article, entitled “How to Sell More to Those Who
Think It’s Cool to Be Frugal,” suggests that con-
sumerism as a way of life might be dying. Don’t bet
your high-definition 3D TV on it though.
W H O D O E S N ’ T S H O P AT W A L- M A R T ?
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Illustration 5-1 Income measurement process for a merchandising company Sales
Revenue
Cost of Goods Sold
Gross Profit
Operating Expenses
Net Income (Loss)
Less
Equals Less
Equals
study objective
Merchandising Operations
Merchandising is one of the largest and most influential industries in the United States. It is likely that a number of you will work for a merchandiser. Therefore, understanding the financial statements of merchandising com- panies is important. In this chapter, you will learn the basics about reporting merchandising transactions. In addi- tion, you will learn how to prepare and analyze a commonly used form of the income statement—the multiple- step income statement. The content and organization of the chapter are as follows.
Merchandising Operations Wal-Mart, Kmart, and Target are called merchandising companies because they buy and sell merchandise rather than perform services as their primary source of revenue. Merchandising companies that purchase and sell directly to con- sumers are called retailers. Merchandising companies that sell to retailers are known as wholesalers. For example, retailer Walgreens might buy goods from wholesaler McKesson; retailer Office Depot might buy office supplies from wholesaler United Stationers. The primary source of revenues for merchandis- ing companies is the sale of merchandise, often referred to simply as sales revenue or sales. A merchandising company has two categories of expenses: the cost of goods sold and operating expenses.
The cost of goods sold is the total cost of merchandise sold during the period. This expense is directly related to the revenue recognized from the sale of goods. Illustration 5-1 shows the income measurement process for a merchandising company. The items in the two blue boxes are unique to a merchandising com- pany; they are not used by a service company.
preview of chapter 5
• Operating cycles • Flow of costs—
perpetual and periodic inventory systems
Merchandising Operations
• Freight costs • Purchase returns and
allowances • Purchase discounts • Summary of
purchasing transactions
Recording Purchases of Merchandise
• Sales returns and allowances
• Sales discounts
Recording Sales of Merchandise
• Sales revenues • Gross profit • Operating expenses • Nonoperating
activities • Determining cost of
goods sold—periodic system
Income Statement Presentation
• Gross profit rate • Profit margin ratio
Evaluating Profitability
228
1 Identify the differences between a service company and a merchandising company.
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Illustration 5-2 Operating cycles for a service company and a merchandising company
Sell Inventory
Service Company
Cash
Accounts Receivable
Receive Cash Perform Services
Merchandising Company
Cash
Inventory Accounts Receivable
Receive Cash Buy Inventory
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Illustration 5-3 Flow of costs
Beginning Inventory
Cost of Goods Purchased
Cost of Goods Available for Sale
Cost of Goods Sold
Ending Inventory
OPERATING CYCLES
The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase of merchandise inventory and its eventual sale lengthen the cycle. Illustration 5-2 contrasts the operating cycles of service and merchandising companies. Note that the added asset account for a mer- chandising company is the Inventory account.
FLOW OF COSTS
The flow of costs for a merchandising company is as follows: Beginning in- ventory plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold. Those goods that are not sold by the end of the accounting period represent ending inventory. Illustration 5-3 describes these relationships. Companies use one of two sys- tems to account for inventory: a perpetual inventory system or a periodic inventory system.
Merchandising Operations 229
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230 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Perpetual System In a perpetual inventory system, companies maintain detailed records of the cost of each inventory purchase and sale. These records continuously—perpetually— show the inventory that should be on hand for every item. For example, a Ford dealership has separate inventory records for each automobile, truck, and van on its lot and showroom floor. Similarly, a grocery store uses bar codes and op- tical scanners to keep a daily running record of every box of cereal and every jar of jelly that it buys and sells. Under a perpetual inventory system, a company determines the cost of goods sold each time a sale occurs.
Periodic System In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. They determine the cost of goods sold only at the end of the accounting period—that is, periodically. At that point, the company takes a physical inventory count to determine the cost of goods on hand.
To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:
1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.
Illustration 5-4 graphically compares the sequence of activities and the tim- ing of the cost of goods sold computation under the two inventory systems.
Additional Considerations Companies that sell merchandise with high unit values, such as automobiles, furniture, and major home appliances, have traditionally used perpetual systems. The growing use of computers and electronic scanners has enabled many more companies to install perpetual inventory systems. The perpetual inventory sys- tem is so named because the accounting records continuously—perpetually— show the quantity and cost of the inventory that should be on hand at any time.
Helpful Hint Even under perpetual inventory systems, companies perform physical inventories. This is done as a control procedure to verify inventory levels, in order to detect theft or “shrinkage.”
Illustration 5-4 Comparing perpetual and periodic inventory systems
Perpetual
End of PeriodInventory Purchased
Record revenue and
compute and record cost of goods sold
Record purchase of inventory
Item Sold
No entry
Periodic
Inventory Purchased Item Sold
Record purchase of inventory
Record revenue only
End of Period
Compute and record cost
of goods sold
SO LD
SO LD
SO LD
SO LD
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A perpetual inventory system provides better control over inventories than a periodic system. Since the inventory records show the quantities that should be on hand, the company can count the goods at any time to see whether the amount of goods actually on hand agrees with the inventory records. If short- ages are uncovered, the company can investigate immediately. Although a per- petual inventory system requires additional clerical work and additional cost to maintain inventory records, a computerized system can minimize this cost. As noted in the Feature Story, much of Wal-Mart’s success is attributed to its so- phisticated inventory system.
Some businesses find it either unnecessary or uneconomical to invest in a sophisticated, computerized perpetual inventory system such as Wal-Mart’s. However, many small merchandising businesses, in particular, find that basic computerized accounting packages provide some of the essential benefits of a perpetual inventory system. Yet, managers of some small businesses still find that they can control their merchandise and manage day-to-day operations us- ing a periodic inventory system.
Because the perpetual inventory system is growing in popularity and use, we illustrate it in this chapter. An appendix to this chapter describes the journal en- tries for the periodic system.
Recording Purchases of Merchandise 231
Morrow Snowboards Improves Its Stock Appeal
Investors are often eager to invest in a company that has a hot new prod- uct. However, when snowboard maker Morrow Snowboards, Inc., issued shares of stock to the public for the first time, some investors expressed reluctance to invest in Morrow because of a number of accounting control problems. To reduce investor concerns, Morrow implemented a perpetual inventory system to improve its control over inventory. In addition, it stated that it would perform a physical inventory count every quarter until it felt that the perpetual inventory system was reliable.
Investor Insight
? If a perpetual system keeps track of inventory on a daily basis, why do companiesever need to do a physical count? (See page 276.)
Recording Purchases of Merchandise Companies may purchase inventory for cash or on account (credit). They nor- mally record purchases when they receive the goods from the seller. Every pur- chase should be supported by business documents that provide written evidence of the transaction. Each cash purchase should be supported by a canceled check or a cash register receipt indicating the items purchased and amounts paid. Com- panies record cash purchases by an increase in Inventory and a decrease in Cash.
Each purchase should be supported by a purchase invoice, which indicates the total purchase price and other relevant information. However, the purchaser does not prepare a separate purchase invoice. Instead, the purchaser uses as a purchase invoice the copy of the sales invoice sent by the seller. In Illustration 5-5 (page 232), for example, Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller).
The associated entry for Sauk Stereo for the invoice from PW Audio Supply increases Inventory and increases Accounts Payable.
2 Explain the recording of purchases under a perpetual inventory system.
study objective
May 4 Inventory 3,800 Accounts Payable 3,800
(To record goods purchased on account from PW Audio Supply)
Cash Flows no effect
A SEL= +
�3,800 �3,800
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232 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Under the perpetual inventory system, companies record purchases of merchandise for sale in the Inventory account. Thus, Wal-Mart would increase (debit) Inventory for clothing, sporting goods, and anything else purchased for resale to customers. Not all purchases are debited to Inventory, however. Companies record purchases of assets acquired for use and not for resale, such as supplies, equipment, and similar items, as increases to specific asset accounts rather than to Inventory. For example, to record the purchase of ma- terials used to make shelf signs or for cash register receipt paper, Wal-Mart would increase (debit) Supplies.
FREIGHT COSTS
The sales agreement should indicate who—the seller or the buyer—is to pay for transporting the goods to the buyer’s place of business. When a common carrier such as a railroad, trucking company, or airline transports the goods, the car- rier prepares a freight bill in accord with the sales agreement.
Freight terms are expressed as either FOB shipping point or FOB destina- tion. The letters FOB mean free on board. Thus, FOB shipping point means that the seller places the goods free on board the carrier, and the buyer pays the freight costs. Conversely, FOB destination means that the seller places the goods free on board to the buyer’s place of business, and the seller pays the freight. For example, the sales invoice in Illustration 5-5 indicates FOB shipping point.
Helpful Hint To better understand the contents of this invoice, identify these items: 1. Seller 2. Invoice date 3. Purchaser 4. Salesperson 5. Credit terms 6. Freight terms 7. Goods sold: catalog number,
description, quantity, price per unit
8. Total invoice amount
Illustration 5-5 Sales invoice used as purchase invoice by Sauk Stereo
27 Circle Drive Harding, Michigan 48281
PW Audio Supply, Inc.
INVOICE NO. 731
Firm Name
Attention of
Address
S O L D
T O
City State Zip
IMPORTANT: ALL RETURNS MUST BE MADE WITHIN 10 DAYS TOTAL
Date 5/4/12 Salesperson Malone Terms 2/10, n/30 FOB Shipping Point
Catalog No. Description Quantity Price Amount
X572Y9820 Printed Circuit Board-prototype 1 2,300 $2,300
A2547Z45 Production Model Circuits 5 300 1,500
$3,800
Sauk Stereo
James Hoover, Purchasing Agent
125 Main Street
Chelsea Illinois 60915
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Thus, the buyer (Sauk Stereo) pays the freight charges. Illustration 5-6 illustrates these shipping terms.
Freight Costs Incurred by Buyer When the buyer pays the transportation costs, these costs are considered part of the cost of purchasing inventory. As a result, the account Inventory is in- creased. For example, if Sauk Stereo (the buyer) pays Haul-It Freight Company $150 for freight charges on May 6, the entry on Sauk Stereo’s books is:
Thus, any freight costs incurred by the buyer are part of the cost of merchan- dise purchased. The reason: Inventory cost should include any freight charges necessary to deliver the goods to the buyer.
Freight Costs Incurred by Seller In contrast, freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. These costs increase an expense ac- count titled Freight-out or Delivery Expense. For example, if the freight terms on the invoice in Illustration 5-5 had required that PW Audio Supply (the seller) pay the $150 freight charges, the entry by PW Audio Supply would be:
When the seller pays the freight charges, the seller will usually establish a higher invoice price for the goods, to cover the expense of shipping.
PURCHASE RETURNS AND ALLOWANCES
A purchaser may be dissatisfied with the merchandise received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser’s spec- ifications. In such cases, the purchaser may return the goods to the seller for
Recording Purchases of Merchandise 233
Illustration 5-6 Shipping terms
FOB Shipping Point FOB Destination
Public Carrier Co.
Seller Buyer
Ownership passes to
buyer here
Buyer pays freight costs Seller pays freight costs
Public Carrier Co.
Seller Buyer
Ownership passes to
buyer here
May 6 Inventory 150 Cash 150
(To record payment of freight on goods purchased)
A SEL= +
�150 �150
Cash Flows �150
May 4 Freight-out 150 Cash 150
(To record payment of freight on goods sold)
A SEL= +
�150 Exp �150
Cash Flows �150
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234 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
credit if the sale was made on credit, or for a cash refund if the purchase was for cash. This transaction is known as a purchase return. Alternatively, the pur- chaser may choose to keep the merchandise if the seller is willing to grant a reduction of the purchase price. This transaction is known as a purchase allowance.
Assume that Sauk Stereo returned goods costing $300 to PW Audio Supply on May 8. The following entry by Sauk Stereo for the returned merchandise de- creases Accounts Payable and decreases Inventory.
Because Sauk Stereo increased Inventory when the goods were received, Inventory is decreased (credited) when Sauk Stereo returns the goods.
Suppose instead that Sauk Stereo chose to keep the goods after being granted a $50 allowance (reduction in price). It would reduce (debit) Accounts Payable and reduce (credit) Inventory for $50.
PURCHASE DISCOUNTS
The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. This incentive offers advantages to both parties: The purchaser saves money, and the seller is able to shorten the operating cycle by converting the ac- counts receivable into cash earlier.
The credit terms specify the amount of the cash discount and time period during which it is offered. They also indicate the length of time in which the purchaser is expected to pay the full invoice price. In the sales invoice in Il- lustration 5-5 (page 232), credit terms are 2/10, n/30, which is read “two-ten, net thirty.” This means that a 2% cash discount may be taken on the invoice price less (“net of ”) any returns or allowances, if payment is made within 10 days of the invoice date (the discount period). Otherwise, the invoice price, less any returns or allowances, is due 30 days from the invoice date. Alternatively, the discount period may extend to a specified number of days following the month in which the sale occurs. For example, 1/10 EOM (end of month) means that a 1% discount is available if the invoice is paid within the first 10 days of the next month.
When the seller elects not to offer a cash discount for prompt payment, credit terms will specify only the maximum time period for paying the balance due. For example, the credit terms may state the time period as n/30, n/60, or n/10 EOM. This means, respectively, that the buyer must pay the net amount in 30 days, 60 days, or within the first 10 days of the next month.
When an invoice is paid within the discount period, the amount of the dis- count decreases Inventory. Why? Because the merchandiser records inventory at its cost and, by paying within the discount period, it has reduced that cost. To illustrate, assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. The cash discount is $70 ($3,500 � 2%), and the amount of cash Sauk Stereo paid is $3,430 ($3,500 � $70). The entry Sauk Stereo makes to record its May 14 payment decreases (debits) Accounts Payable by the amount of the gross invoice price, reduces (credits) Inventory by the $70 discount, and reduces (credits) Cash by the net amount owed.
Helpful Hint The term net in “net 30” means the remaining amount due after subtracting any returns and allowances and partial payments.
May 8 Accounts Payable 300 Inventory 300
(To record return of goods purchased from PW Audio Supply)
Cash Flows no effect
A SEL= +
�300 �300
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Recording Purchases of Merchandise 235
May 14 Accounts Payable 3,500 Cash 3,430 Inventory 70
(To record payment within discount period)
A SEL= +
�3,500 �3,430
�70
Cash Flows �3,430
June 3 Accounts Payable 3,500 Cash 3,500
(To record payment with no discount taken)
A SEL= +
�3,500 �3,500
Cash Flows �3,500
If Sauk Stereo failed to take the discount and instead made full payment of $3,500 on June 3, Sauk Stereo would reduce (debit) Accounts Payable and reduce (credit) Cash for $3,500 each.
A merchandising company usually should take all available discounts. Pass- ing up the discount may be viewed as paying interest for use of the money. For example, passing up the discount offered by PW Audio Supply would be like Sauk Stereo paying an interest rate of 2% for the use of $3,500 for 20 days. This is the equivalent of an annual interest rate of approximately 36.5% (2% � 365/20). Obvi- ously, it would be better for Sauk Stereo to borrow at prevailing bank interest rates of 6% to 10% than to lose the discount.
SUMMARY OF PURCHASING TRANSACTIONS
The following T account (with transaction descriptions in blue) provides a sum- mary of the effect of the previous transactions on Inventory. Sauk Stereo origi- nally purchased $3,800 worth of inventory for resale. It then returned $300 of goods. It paid $150 in freight charges, and finally, it received a $70 discount off the balance owed because it paid within the discount period. This results in a balance in Inventory of $3,580.
Inventory
Purchase May 4 3,800 May 8 300 Purchase return
Freight-in 6 150 14 70 Purchase discount
Balance 3,580
Action Plan
• Purchaser records goods at cost.
• When goods are returned, purchaser reduces Inventory.
On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500. On September 8, De La Hoya returns defective goods with a selling price of $200. Record the transactions on the books of De La Hoya Company.
Solution
Sept. 5 Inventory 1,500 Accounts Payable 1,500
(To record goods purchased on account)
8 Accounts Payable 200 Inventory 200
(To record return of defective goods)
Related exercise material: BE5-4, 5-1, and E5-1.Do it!
PURCHASE TRANSACTIONS
before you go on...
Do it!
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236 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Recording Sales of Merchandise Companies record sales revenues, like service revenues, when earned, in com- pliance with the revenue recognition principle. Typically, companies earn sales revenues when the goods are transferred from the seller to the buyer. At this point the sales transaction is completed and the sales price is established.
Sales may be made on credit or for cash. Every sales transaction should be supported by a business document that provides written evidence of the sale. Cash register tapes provide evidence of cash sales. A sales invoice, like the one that was shown in Illustration 5-5 (page 232), provides support for each sale. The original copy of the invoice goes to the customer, and the seller keeps a copy for use in recording the sale. The invoice shows the date of sale, customer name, total sales price, and other relevant information.
The seller makes two entries for each sale: (1) It increases (debits) Accounts Receivable or Cash, as well as increases (credits) Sales Revenue. (2) It increases (debits) Cost of Goods Sold and decreases (credits) Inventory. As a result, the Inventory account will show at all times the amount of inventory that should be on hand.
To illustrate a credit sales transaction, PW Audio Supply records the sale of $3,800 on May 4 to Sauk Stereo (see Illustration 5-5) as follows (assume the merchandise cost PW Audio Supply $2,400).
For internal decision-making purposes, merchandising companies may use more than one sales account. For example, PW Audio Supply may decide to keep separate sales accounts for its sales of TV sets, DVD players, and microwave ovens. Wal-Mart might use separate accounts for sporting goods, children’s cloth- ing, and hardware—or it might have even more narrowly defined accounts. By using separate sales accounts for major product lines, rather than a single com- bined sales account, company management can monitor sales trends more closely and respond more strategically to changes in sales patterns. For exam- ple, if TV sales are increasing while microwave oven sales are decreasing, the company might reevaluate both its advertising and pricing policies on each of these items to ensure they are optimal.
On its income statement presented to outside investors a merchandising com- pany would normally provide only a single sales figure—the sum of all of its in- dividual sales accounts. This is done for two reasons. First, providing detail on all of its individual sales accounts would add considerable length to its income statement. Second, companies do not want their competitors to know the de- tails of their operating results. However, at one time Microsoft expanded its dis- closure of revenue from three to five types. The reason: The additional categories will better enable financial statement users to evaluate the growth of the com- pany’s consumer and Internet businesses.
3 Explain the recording of sales revenues under a perpetual inventory system.
study objective
Cash Flows no effect
A SEL= +
�3,800 �3,800 Rev
May 4 Accounts Receivable 3,800 Sales Revenue 3,800
(To record credit sale to Sauk Stereo per invoice #731)
4 Cost of Goods Sold 2,400 Inventory 2,400
(To record cost of merchandise sold on invoice #731 to Sauk Stereo)
Cash Flows no effect
A SEL= +
�2,400 Exp �2,400
Helpful Hint The merchandiser credits the Sales Revenue account only for sales of goods held for resale. Sales of assets not held for resale, such as equipment or land, are credited directly to the asset account.
Ethics Note Many companies are trying to improve the quality of their financial reporting. For example, General Electric now provides more detail on its revenues and operating profits.
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SALES RETURNS AND ALLOWANCES
We now look at the “flipside” of purchase returns and allowances, which the seller records as sales returns and allowances. These are transactions where the seller either accepts goods back from a purchaser (a return) or grants a reduction in the purchase price (an allowance) so that the buyer will keep the goods. PW Audio Supply’s entries to record credit for returned goods involve (1) an increase (debit) in Sales Returns and Allowances (a contra account to Sales Revenue) and a decrease (credit) in Accounts Receivable at the $300 selling price, and (2) an increase (debit) in Inventory (assume a $140 cost) and a decrease (credit) in Cost of Goods Sold, as shown below. (We have assumed that the goods were not de- fective. If they were defective, PW Audio Supply would make an adjustment to the Inventory account to reflect their decline in value.)
May 8 Sales Returns and Allowances 300 Accounts Receivable 300
(To record credit granted to Sauk Stereo for returned goods)
8 Inventory 140 Cost of Goods Sold 140
(To record cost of goods returned)
Suppose instead that the goods were not returned, but the seller granted the buyer an allowance by reducing the purchase price. In this case, the seller would debit Sales Returns and Allowances and credit Accounts Receivable for the amount of the allowance.
At the end of “Anatomy of a Fraud” stories, which describe real-world frauds, we discuss the missing control activity that would likely have presented or uncovered the fraud.
Recording Sales of Merchandise 237
1The “Anatomy of a Fraud” stories in this textbook are adapted from Fraud Casebook: Lessons from the Bad Side of Business, edited by Joseph T. Wells (Hoboken, NJ: John Wiley & Sons, Inc., 2007). Used by permission. The names of some of the people and organizations in the stories are fictitious, but the facts in the stories are true.
Holly Harmon was a cashier at a national superstore for only a short while when she began stealing merchandise using three methods. First, her husband or friends took UPC labels from cheaper items and put them on more expensive items. Holly then scanned the goods at the register. Second, Holly rang an item up but then voided the sale and left the merchandise in the shopping cart. A third approach was to put goods into large plastic containers. She rang up the plastic containers but not the goods within them. One day, Holly did not call in sick or show up for work. In such instances, the company reviews past surveillance tapes to look for suspicious activity by employees. This enabled the store to observe the thefts and to identify the participants.
A N AT O M Y O F A F R AU D 1
Total take: $12,000
THE MISSING CONTROLS
Human resource controls. A background check would have revealed Holly’s previous criminal record. She would not have been hired as a cashier. Physical controls. Software can flag high numbers of voided transactions or a high number of sales of low-priced goods. Random comparisons of video records with cash register records can ensure that the goods reported as sold on the register are the same goods that are shown being purchased on the video recording. Finally, employees should be aware that they are being monitored.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 251–259.
Cash Flows no effect
A SEL= +
�300 Rev �300
Cash Flows no effect
A SEL= +
�140 �140 Exp
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238 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
As mentioned previously, Sales Returns and Allowances is a contra revenue account to Sales Revenue. The normal balance of Sales Returns and Allowances is a debit. Companies use a contra account, instead of debiting Sales Revenue, to disclose in the accounts and in the income statement the amount of sales re- turns and allowances. Disclosure of this information is important to management. Excessive returns and allowances suggest problems—inferior merchandise, in- efficiencies in filling orders, errors in billing customers, or mistakes in delivery or shipment of goods. Moreover, a decrease (debit) recorded directly to Sales Revenue would obscure the relative importance of sales returns and allowances as a percentage of sales. It also could distort comparisons between total sales in different accounting periods.
SALES DISCOUNTS
As mentioned in our discussion of purchase transactions, the seller may offer the customer a cash discount—called by the seller a sales discount—for the prompt payment of the balance due. Like a purchase discount, a sales discount is based on the invoice price less returns and allowances, if any. The seller in- creases (debits) the Sales Discounts account for discounts that are taken. The entry by PW Audio Supply to record the cash receipt on May 14 from Sauk Stereo within the discount period is:
May 14 Cash 3,430 Sales Discounts 70
Accounts Receivable 3,500 (To record collection within 2/10, n/30 discount period from Sauk Stereo)
Like Sales Returns and Allowances, Sales Discounts is a contra revenue account to Sales Revenue. Its normal balance is a debit. Sellers use this account, instead of debiting sales, to disclose the amount of cash discounts taken by cus- tomers. If the customer does not take the discount, PW Audio Supply increases (debits) Cash for $3,500 and decreases (credits) Accounts Receivable for the same amount at the date of collection.
The following T accounts summarize the three sales-related transactions and show their combined effect on net sales.
If a company expects significant returns, what are the implications for revenue recognition? (See page 276.)
Should Costco Change Its Return Policy?
In most industries, sales returns are relatively minor. But returns of consumer electronics can really take a bite out of profits. Recently, the marketing executives at Costco Wholesale Corp. faced a difficult decision. Costco has always prided itself on its generous return policy. Most goods have had an unlimited grace period for returns. A new policy will require that certain electronics must be returned within 90 days of their purchase. The reason? The cost of returned products such as high-definition TVs, computers, and iPods cut an estimated 8¢ per share off Costco’s earnings per share, which was $2.30.
Source: Kris Hudson, “Costco Tightens Policy on Returning Electronics,” Wall Street Journal (February 27, 2007), p. B4.
Accounting Across the Organization
?
Cash Flows
�3,430
A SEL= +
�3,430 �70 Rev
�3,500
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Income Statement Presentation 239
Sales Revenue Sales Returns and Allowances Sales Discounts
3,800 300 70
Net Sales $3,430
Action Plan
• Seller records both the sale and the cost of goods sold at the time of the sale.
• When goods are returned, the seller records the return in a contra account, Sales Returns and Allowances, and reduces Accounts Receivable.
• Any goods returned increase Inventory and reduce Cost of Goods Sold. The merchandise inventory should be recorded at its fair value (scrap value).
On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns goods with a selling price of $200 and a cost of $105. Record the transactions on the books of Junot Diaz Company.
Solution
Sept. 5 Accounts Receivable 1,500 Sales Revenue 1,500
(To record credit sale)
5 Cost of Goods Sold 800 Inventory 800
(To record cost of goods sold on account)
Sept. 8 Sales Returns and Allowances 200 Accounts Receivable 200
(To record credit granted for receipt of returned goods)
8 Inventory 105 Cost of Goods Sold 105
(To record cost of goods returned)
SALES TRANSACTIONS
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Related exercise material: BE5-2, BE5-3, 5-2, E5-2, E5-3, and E5-4.Do it!
4 Distinguish between a single-step and a multiple- step income statement.
study objective
Income Statement Presentation Companies widely use two forms of the income statement. One is the single- step income statement. The statement is so named because only one step, sub- tracting total expenses from total revenues, is required in determining net in- come (or net loss).
In a single-step statement, all data are classified into two categories: (1) rev- enues, which include both operating revenues and nonoperating revenues and gains (for example, interest revenue and gain on sale of equipment); and (2) expenses, which include cost of goods sold, operating expenses, and nonoper- ating expenses and losses (for example, interest expense, loss on sale of equip- ment, or income tax expense). The single-step income statement is the form we have used thus far in the text. Illustration 5-7 (page 240) shows a single-step statement for Wal-Mart.
There are two primary reasons for using the single-step form: (1) A company does not realize any type of profit or income until total revenues exceed total expenses, so it makes sense to divide the statement into these two categories. (2) The form is simple and easy to read.
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240 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
A second form of the income statement is the multiple-step income state- ment. The multiple-step income statement is often considered more useful be- cause it highlights the components of net income. The Wal-Mart income state- ment in Illustration 5-8 is an example.
The multiple-step income statement has three important line items: gross profit, income from operations, and net income. They are determined as follows.
1. Subtract cost of goods sold from net sales to determine gross profit. 2. Deduct operating expenses from gross profit to determine income from
operations. 3. Add or subtract the results of activities not related to operations to determine
net income.
WAL-MART STORES, INC. Income Statements
(in millions)
For the years ended January 31
2009 2008
Revenues Net sales $401,244 $374,307 Other revenues 4,363 4,169
405,607 378,476
Expenses Cost of goods sold 306,158 286,350 Selling, general, and administrative
expenses 76,651 70,174
Interest expense 1,900 1,794 Other expense 353 538 Income taxes 7,145 6,889
392,207 365,745
Net income $ 13,400 $ 12,731
Illustration 5-7 Single- step income statements
WAL-MART STORES, INC. Income Statements
(in millions)
For the years ended January 31
2009 2008
Net sales $401,244 $374,307 Cost of goods sold 306,158 286,350
Gross profit 95,086 87,957 Operating expenses
Selling, general, and administrative expenses 76,651 70,174
Income from operations 18,435 17,783 Other revenues and gains
Other revenues 4,363 4,169 Other expenses and losses
Interest expense 1,900 1,794 Other expense 353 538
Income before income taxes 20,545 19,620 Income tax expense 7,145 6,889
Net income $ 13,400 $ 12,731
Illustration 5-8 Multiple-step income statements
International Note The IASB and FASB are involved in a joint project to evaluate the format of financial statements. The first phase of that project involves a focus on how to best present revenues and expenses. One longer-term result of the project may well be an income statement format that better reflects how businesses are run.
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Note that companies report income tax expense in a separate section of the in- come statement before net income. The net incomes in Illustrations 5-7 and 5-8 are the same. The difference in the two income statements is the amount of detail displayed and the order presented. The following discussion provides additional in- formation about the components of a multiple-step income statement.
SALES REVENUES
The income statement for a merchandising company typically presents gross sales revenues for the period. The company deducts sales returns and allowances and sales discounts (both contra accounts) from sales revenue in the income statement to arrive at net sales. Illustration 5-9 shows the sales revenues sec- tion of the income statement for PW Audio Supply.
Income Statement Presentation 241
PW AUDIO SUPPLY, INC. Income Statement (partial)
Sales revenues
Sales revenue $ 480,000 Less: Sales returns and allowances $12,000
Sales discounts 8,000 20,000
Net sales $460,000
Illustration 5-9 Statement presentation of sales revenues section
GROSS PROFIT
Companies deduct cost of goods sold from sales revenue to determine gross profit. As shown in Illustration 5-8, for example, Wal-Mart had a gross profit of $95.1 billion in fiscal year 2009. Sales revenue used for this computation is net sales, which takes into account sales returns and allowances and sales discounts.
On the basis of the PW Audio Supply sales data presented in Illustration 5-9 (net sales of $460,000) and the cost of goods sold (assume a balance of $316,000), PW Audio Supply’s gross profit is $144,000, computed as follows.
It is important to understand what gross profit is—and what it is not. Gross profit represents the merchandising profit of a company. Because operating expenses have not been deducted, it is not a measure of the overall profit of a company. Nevertheless, management and other interested parties closely watch the amount and trend of gross profit. Comparisons of current gross profit with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies.
OPERATING EXPENSES
Operating expenses are the next component in measuring net income for a mer- chandising company. At Wal-Mart, for example, operating expenses were $76.7 billion in fiscal year 2009.
At PW Audio Supply, operating expenses were $114,000. The firm determines its income from operations by subtracting operating expenses from gross profit. Thus, income from operations is $30,000, as shown below.
Alternative Terminology Gross profit is sometimes referred to as gross margin.
Net sales $ 460,000 Cost of goods sold 316,000
Gross profit $144,000
Gross profit $144,000 Operating expenses 114,000
Income from operations $ 30,000
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NONOPERATING ACTIVITIES
Nonoperating activities consist of various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations. When non- operating items are included, the label “Income from operations” (or “Operat- ing income”) precedes them. This label clearly identifies the results of the com- pany’s normal operations, an amount determined by subtracting cost of goods sold and operating expenses from net sales. The results of nonoperating activi- ties are shown in the categories “Other revenues and gains” and “Other expenses and losses.” Illustration 5-10 lists examples of each.
Nonoperating income is sometimes very significant. For example, in a re- cent quarter Sears Holdings earned more than half of its net income from in- vestments in derivative securities.
The distinction between operating and nonoperating activities is crucial to external users of financial data. These users view operating income as sustain- able and many nonoperating activities as nonrecurring. When forecasting next year’s income, analysts put the most weight on this year’s operating income, and less weight on this year’s nonoperating activities.
Other Revenues and Gains
Interest revenue from notes receivable and marketable securities. Dividend revenue from investments in capital stock. Rent revenue from subleasing a portion of the store. Gain from the sale of property, plant, and equipment.
Other Expenses and Losses
Interest expense on notes and loans payable. Casualty losses from recurring causes, such as vandalism and accidents. Loss from the sale or abandonment of property, plant, and equipment. Loss from strikes by employees and suppliers.
Illustration 5-10 Examples of nonoperating activities
Ethics Note Companies manage earnings in various ways. ConAgra Foods recorded a nonrecurring gain for $186 million from the sale of Pilgrim’s Pride stock to help meet an earnings projection for the quarter.
Why have investors and analysts demanded more accuracy in isolating “Other gains and losses” from operating items? (See page 276.)
Disclosing More Details
After Enron, increased investor criticism and regulator scrutiny forced many companies to improve the clarity of their financial disclosures. For example, IBM an- nounced that it would begin providing more detail regarding its “Other gains and losses.” It had previously included these items in its selling, general, and administrative expenses, with little disclosure.
Disclosing other gains and losses in a separate line item on the income statement will not have any effect on bottom-line income. However, analysts complained that bury- ing these details in the selling, general, and administrative expense line reduced their ability to fully understand how well IBM was performing. For example, previously if IBM sold off one of its buildings at a gain, it would include this gain in the selling, general, and administrative expense line item, thus reducing that expense. This made it appear that the company had done a better job of controlling operating expenses than it actually had.
Other companies that also recently announced changes to increase the informative- ness of their income statements included PepsiCo and General Electric.
Ethics Insight
? The nonoperating activities are reported in the income statement immediately
after the operating activities. Included among these activities in Illustration 5-8
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(page 240) for Wal-Mart is interest expense of $1.9 billion for fiscal year 2009. The amount remaining, after adding the operating and nonoperating sections together, is Wal-Mart’s net income of $13.4 billion.
In Illustration 5-11 we have provided the multiple-step income statement of a hypothetical company. This statement provides more detail than that of Wal- Mart and thus is useful as a guide for homework. (For WileyPLUS homework, individual revenues and expenses are listed in order of magnitude.) For homework problems, use the multiple-step form of the income statement unless the requirements state otherwise.
Income Statement Presentation 243
PW AUDIO SUPPLY, INC. Income Statement
For the Year Ended December 31, 2012
Sales revenues Sales revenue $480,000 Less: Sales returns and allowances $12,000
Sales discounts 8,000 20,000
Net sales 460,000 Cost of goods sold 316,000
Gross profit 144,000 Operating expenses
Salaries and wages expense 64,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000
Total operating expenses 114,000
Income from operations 30,000 Other revenues and gains
Interest revenue 3,000 Gain on disposal of
plant assets 600
3,600
Other expenses and losses Interest expense 1,800 Casualty loss from vandalism 200
2,000
1,600
Income before income taxes 31,600 Income tax expense 10,100
Net income $ 21,500
Illustration 5-11 Multiple- step income statement
Calculation of gross profit
Calculation of income from operations
Results of activities not related to operations
The following information is available for Art Center Corp. for the year ended December 31, 2012.
Other revenues and gains $ 8,000 Net sales $442,000 Other expenses and losses 3,000 Operating expenses 187,000 Cost of goods sold 147,000
Prepare a multiple-step income statement for Art Center Corp. The company has a tax rate of 25%.
MULTIPLE-STEP INCOME STATEMENT
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Action Plan
• Subtract cost of goods sold from net sales to determine gross profit.
• Subtract operating expenses from gross profit to determine income from operations.
• Multiply the tax rate by income before tax to determine tax expense.
Solution
ART CENTER CORP. Income Statement
For the Year Ended December 31, 2012
Net sales $442,000 Cost of goods sold 147,000
Gross profit 295,000 Operating expenses 187,000
Income from operations 108,000 Other revenues and gains 8,000 Other expenses and losses 3,000 5,000
Income before income taxes 113,000 Income tax expense 28,250
Net income $ 84,750
Related exercise material: BE5-5, BE5-6, 5-3, and E5-5.Do it!
DETERMINING COST OF GOODS SOLD UNDER A PERIODIC SYSTEM
Determining cost of goods sold is different when a periodic inventory system is used rather than a perpetual system. As you have seen, a company using a per- petual system makes an entry to record cost of goods sold and to reduce inven- tory each time a sale is made. A company using a periodic system does not de- termine cost of goods sold until the end of the period. At the end of the period the company performs a count to determine the ending balance of inventory. It then calculates cost of goods sold by subtracting ending inventory from the goods available for sale. Goods available for sale is the sum of beginning in- ventory plus purchases, as shown in Illustration 5-12.
Another difference between the two approaches is that the perpetual system directly adjusts the Inventory account for any transaction that affects inventory (such as freight costs, returns, and discounts). The periodic system does not do this. Instead, it creates different accounts for purchases, freight costs, returns, and discounts. These various accounts are shown in Illustration 5-13 (page 245), which presents the calculation of cost of goods sold for PW Audio Supply using the periodic approach. Note that the basic elements from Illustration 5-12 are highlighted in Illustration 5-13. You will learn more in Chapter 6 about how to determine cost of goods sold using the periodic system.
The use of the periodic inventory system does not affect the form of presen- tation in the balance sheet. As under the perpetual system, a company reports inventory in the current assets section.
Appendix 5A provides further detail on the use of the periodic system.
5 Determine cost of goods sold under a periodic system.
study objective
Illustration 5-12 Basic formula for cost of goods sold using the periodic system
Beginning Inventory � Cost of Goods Purchased
Cost of Goods Available for Sale � Ending Inventory
Cost of Goods Sold
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Evaluating Profitability 245
PW AUDIO SUPPLY, INC. Cost of Goods Sold
For the Year Ended December 31, 2012
Cost of goods sold Inventory, January 1 $ 36,000 Purchases $325,000 Less: Purchase returns and
allowances $10,400 Purchase discounts 6,800 17,200
Net purchases 307,800 Add: Freight-in 12,200
Cost of goods purchased 320,000
Cost of goods available for sale 356,000 Inventory, December 31 40,000
Cost of goods sold $316,000
Illustration 5-13 Cost of goods sold for a merchandiser using a periodic inventory system
Helpful Hint The far right column identifies the primary items that make up cost of goods sold of $316,000. The middle column explains cost of goods purchased of $320,000. The left column reports contra purchase items of $17,200.
Action Plan
• To determine cost of goods purchased, adjust purchases for returns, discounts, and freight-in.
• To determine cost of goods sold, add cost of goods purchased to beginning inventory, and subtract ending inventory.
Aerosmith Company’s accounting records show the following at the year- end December 31, 2012.
Purchase Discounts $ 3,400 Freight-in 6,100 Purchases 162,500 Beginning Inventory 18,000 Ending Inventory 20,000 Purchase Returns 5,200
Assuming that Aerosmith Company uses the periodic system, compute (a) cost of goods purchased and (b) cost of goods sold.
Solution
(a) Cost of goods purchased � $160,000: Purchases � Purchase returns � Purchase discounts � Freight-in $162,500 � $5,200 � $3,400 � $6,100 � $160,000
(b) Cost of goods sold � $158,000: Beginning inventory � Cost of goods purchased � Ending inventory
$18,000 � $160,000 � $20,000 � $158,000
COST OF GOODS SOLD—PERIODIC SYSTEM
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Evaluating Profitability GROSS PROFIT RATE
A company’s gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales. This is referred to as the gross profit rate. For PW Audio Supply, the gross profit rate is 31.3% ($144,000 � $460,000).
Analysts generally consider the gross profit rate to be more informative than the gross profit amount because it expresses a more meaningful (qualitative) re- lationship between gross profit and net sales. For example, a gross profit amount of $1,000,000 may sound impressive. But if it was the result of sales of $100,000,000, the company’s gross profit rate was only 1%. A 1% gross profit rate is acceptable in very few industries. Illustration 5-14 (page 246) demonstrates that gross profit rates differ greatly across industries.
6 Explain the factors affecting profitability.
study objective
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246 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
A decline in a company’s gross profit rate might have several causes. The company may have begun to sell products with a lower “markup”—for example, budget blue jeans versus designer blue jeans. Increased competition may have resulted in a lower selling price. Or, the company may be forced to pay higher prices to its suppliers without being able to pass these costs on to its customers. The gross profit rates for Wal-Mart and Target, and the industry average, are presented in Illustration 5-15.
Wal-Mart’s gross profit rate increased from 23.5% in 2008 to 23.7% in 2009. In its Management Discussion and Analysis (MD&A), Wal-Mart ex- plained, “The gross profit margin increase in fiscal 2009 compared to fiscal 2008 was primarily due to lower inventory shrinkage and less markdown ac- tivity as a result of more effective merchandising in the Wal-Mart U.S. seg- ment. Additionally, the increase in gross profit margin in fiscal 2008 included a $97 million refund of excise taxes previously paid on past merchandise sales of prepaid phone cards.”
At first glance, it might be surprising that Wal-Mart has a lower gross profit rate than Target and the industry average. It is likely, however, that this can be explained by the fact that grocery products are becoming an increasingly large component of Wal-Mart’s sales. (In 2010, Wal-Mart announced that groceries now represent more than 50% of its sales.) In fact, in its MD&A, Wal-Mart once stated, “Because food items carry a lower gross margin than our other mer- chandise, increasing food sales tends to have an unfavorable impact on our to- tal gross margin.” Also, Wal-Mart has substantial warehouse-style sales in its Sam’s Club stores, which are a low-margin, high-volume operation. In later chapters, we will provide further discussion of the trade-off between sales vol- ume and gross profit.
Industry
74.8%
10% 20% 30% 40% 50% 60% 70% 80%
70.9%
51%
44.5%
21.4%
30.4%
Software and programming
Pharmaceutical
Semiconductors
Footwear
Food processing
Chemical manufacturing
Illustration 5-14 Gross profit rate by industry
Illustration 5-15 Gross profit rate
Gross Profit Rate � Gross Profit Net Sales
Wal-Mart Industry ($ in millions) Target Average
$95,086 = 23.7% 23.5% 30.0% 25.1%
$401,244
2009 2008 2009 2009
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PROFIT MARGIN RATIO
The profit margin ratio measures the percentage of each dollar of sales that re- sults in net income. We compute this ratio by dividing net income by net sales (revenue) for the period.
How do the gross profit rate and profit margin ratio differ? The gross profit rate measures the margin by which selling price exceeds cost of goods sold. The profit margin ratio measures the extent by which selling price covers all expenses (including cost of goods sold). A company can improve its profit mar- gin ratio by either increasing its gross profit rate and/or by controlling its oper- ating expenses and other costs. For example, at one time Radio Shack reported increased profit margins which it accomplished by closing stores and slashing costs. While its total sales have been declining, its profitability as measured by its profit margin has increased.
Profit margins vary across industries. Businesses with high turnover, such as grocery stores (Safeway and Kroger) and discount stores (Target and Wal-Mart), gen- erally experience low profit margins. Low-turnover businesses, such as high-end jew- elry stores (Tiffany and Co.) or major drug manufacturers (Merck), have high profit margins. Illustration 5-16 shows profit margin ratios from a variety of industries.
Evaluating Profitability 247
DECISION TOOLKIT DECISION CHECKPOINTS TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS
Is the price of goods keeping pace with changes in the cost of inventory?
Gross profit and net sales Gross profit �
Gross profit rate Net sales
Higher ratio suggests the average margin between selling price and inventory cost is increasing. Too high a margin may result in lost sales.
INFO NEEDED FOR DECISION
Industry
19.7%
10% 20% 30%
15.3%
15%
10%
7.6%
6.4%
Software and programming
Semiconductors
Pharmaceutical
Footwear
Chemical manufacturing
Food processing
Illustration 5-16 Profit margin ratio by industry
Profit margins for Wal-Mart and Target and the industry average are pre- sented in Illustration 5-17.
Profit Margin Ratio � Net Income Net Sales
Wal-Mart Industry ($ in millions) Target Average
$13,400 = 3.3% 3.4% 3.4% 3.5%
$401,244
2009 2008 2009 2009
Illustration 5-17 Profit margin ratio
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Wal-Mart’s profit margin declined from 3.4% to 3.3% between 2008 and 2009. This means that the company generated 3.3¢ of profit on each dollar of sales. This occurred even though the gross profit rate increased. The cause of the decline in the profit margin ratio was increased operating expenses. Wal-Mart’s MD&A dis- cussion states: “In fiscal 2009, operating expenses increased primarily due to higher utility costs, a pre-tax charge of approximately $352 million resulting from the set- tlement of 63 wage and hour class action lawsuits, higher health benefit costs and increased corporate expenses compared to fiscal 2008. Corporate expenses have increased primarily due to our long-term transformation projects to enhance our information systems for merchandising, finance and human resources.”
How does Wal-Mart compare to its competitors? Its profit margin ratio was lower than Target’s in 2009 and was less than the industry average. Thus, its profit margin ratio does not suggest exceptional profitability. However, we must again keep in mind that an increasing percentage of Wal-Mart’s sales is from low-margin groceries.
Explain how Wal-Mart’s profitability gave it a strategic advantage over Kmart. (See page 276.)
Strategic Errors Can Be Costly
In its death spiral toward bankruptcy, Kmart appeared to make two very costly strategic errors. First, in an effort to attract customers, it decided to reduce selling prices on over 30,000 items. The problem was that this reduced its gross profit rate—and didn’t even have the intended effect of increasing sales because Wal-Mart quickly matched these price cuts. Because Wal-Mart operated much more efficiently than Kmart, Wal-Mart could afford to absorb these price cuts and still operate at a profit. Kmart could not. Its second error was to try to reduce operating costs by cutting its advertising expenditures. This resulted in a reduction in customers—and sales revenue.
Accounting Across the Organization
?
DECISION TOOLKIT DECISION CHECKPOINTS TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS
Is the company maintaining an adequate margin between sales and expenses?
Net income and net sales Profit margin �
Net income ratio Net sales
Higher value suggests favorable return on each dollar of sales.
INFO NEEDED FOR DECISION
In Chapter 4, you learned that earnings have high quality if they provide a full and transparent depiction of how a company performed. In order to quickly assess earnings quality, analysts sometimes employ the quality of earnings ratio. It is calculated as net cash provided by operating activities divided by net income.
KEEPING AN EYE ON CASH
Quality of Earnings Ratio � Net Cash Provided by Operating Activities Net Income
7 Identify a quality of earnings indicator.
study objective
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Using the Decision Toolkit 249
In general, a measure significantly less than 1 suggests that a company may be using more aggressive accounting techniques in order to accelerate income recognition (record income in earlier periods). A measure significantly greater than 1 suggests that a company is using conservative accounting techniques, which cause it to delay the recognition of income.
Measures that are significantly less than 1 do not provide definitive evidence of low-quality earnings. Low measures do, however, indicate that analysts should investigate the company’s earnings quality by evaluating the causes of the differ- ence between net income and net cash provided by operating activities. Examples of factors that would cause differences are presented in Chapter 4 (pp. 191–192).
Here are recent quality of earnings ratios for a number of well-known com- panies, all of which have measures in excess of 1.
Company Name Net Cash Provided by Quality of ($ in millions) Operating Activities � Net Income � Earnings Ratio
DuPont $4,741 $1,769 2.7 Intel $11,170 $4,369 2.6 Nike $1,736 $1,487 1.2 Microsoft $19,037 $14,569 1.3 Wal-Mart $26,249 $14,335 1.8
After having once been as dominant as Wal-Mart, in recent years Sears has struggled to survive. It has enacted many changes trying to turn itself around. In the 1990s, it shocked and disappointed many loyal customers by closing its catalog business. It also closed 113 stores and eliminated 50,000 jobs. None of these changes was enough to make Sears truly competitive, so in March 2005 Sears merged with Kmart to form the third largest U.S. retailer. Here is recent data for Sears Holdings, Inc.
Year ended
($ in millions) 01/30/10 01/31/09
Net income $ 235 $ 53 Sales revenue 44,043 46,770 Cost of goods sold 31,824 34,118
Instructions
Using the basic facts in the table, evaluate the following components of Sears’s prof- itability for the years ended January 30, 2010, and January 31, 2009.
Profit margin ratio Gross profit rate
How do Sears’s profit margin ratio and gross profit rate compare to those of Wal-Mart and Target for 2009?
USING THE DECISION TOOLKIT
Solution
Year ended
($ in millions) 01/30/10 01/31/09
Profit margin ratio $235 � 0.5%
$53 � 0.1%
$44,043 $46,770
Gross profit rate $12,219* � 27.7%
$12,652** � 27.1%
$44,043 $46,770
*$44,043 � $31,824 **$46,770 � $34,118
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Sears’s profit margin ratio (income per dollar of sales) increased from 0.1% to 0.5%. This is well below both Wal-Mart’s (3.3%) and Target’s (3.4%). Thus, Sears is not as effective at turning its sales into net income as these two competitors.
Sears’s gross profit rate improved from 27.1% to 27.7%. This suggests that its ability to maintain its mark-up above its cost of goods sold improved during this pe- riod. Sears’s gross profit rate of 27.7% is lower than Target’s (30.0%) but higher than Wal-Mart’s (23.7%). As discussed in the chapter, Wal-Mart’s gross profit is depressed by the fact that it sells many grocery products, which are very low-margin. Target is superior to Sears both in its ability to maintain its mark-up above its costs of goods sold (its gross profit rate) and in its ability to control operating costs (its profit mar- gin ratio).
Summary of Study Objectives 1 Identify the differences between a service company and
a merchandising company. Because of the presence of inventory, a merchandising company has sales rev- enue, cost of goods sold, and gross profit. To account for inventory, a merchandising company must choose between a perpetual inventory system and a periodic inventory system.
2 Explain the recording of purchases under a perpetual inventory system. The Inventory account is debited for all purchases of merchandise and for freight costs, and it is credited for purchase discounts and purchase re- turns and allowances.
3 Explain the recording of sales revenues under a perpet- ual inventory system. When inventory is sold, Accounts Receivable (or Cash) is debited and Sales Revenue is credited for the selling price of the merchandise. At the same time, Cost of Goods Sold is debited and Inven- tory is credited for the cost of inventory items sold. Subsequent entries are required for (a) sales returns and allowances and (b) sales discounts.
4 Distinguish between a single-step and a multiple-step income statement. In a single-step income statement, companies classify all data under two categories, rev- enues or expenses, and net income is determined in one step. A multiple-step income statement shows nu- merous steps in determining net income, including re- sults of nonoperating activities.
5 Determine cost of goods sold under a periodic system. The periodic system uses multiple accounts to keep track of transactions that affect inventory. To deter- mine cost of goods sold, first calculate cost of goods purchased by adjusting purchases for returns, al- lowances, discounts, and freight-in. Then calculate cost of goods sold by adding cost of goods purchased to beginning inventory and subtracting ending inventory.
6 Explain the factors affecting profitability. Profitability is affected by gross profit, as measured by the gross profit rate, and by management’s ability to control costs, as measured by the profit margin ratio.
7 Identify a quality of earnings indicator. Earnings have high quality if they provide a full and transparent de- piction of how a company performed. An indicator of the quality of earnings is the quality of earnings ratio, which is net cash provided by operating activities di- vided by net income. Measures above 1 suggest the company is employing conservative accounting prac- tices. Measures significantly below 1 might suggest the company is using aggressive accounting to accelerate the recognition of income.
DECISION CHECKPOINTS TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS
Is the price of goods keeping pace with changes in the cost of inventory?
Gross profit and net sales Gross profit �
Gross profit rate Net sales
Higher ratio suggests the average margin between selling price and inventory cost is increasing. Too high a margin may result in lost sales.
INFO NEEDED FOR DECISION
Is the company maintaining an adequate margin between sales and expenses?
Net income and net sales Profit margin �
Net income ratio Net sales
Higher value suggests favorable return on each dollar of sales.
DECISION TOOLKIT A SUMMARY
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Appendix 5A: Periodic Inventory System 251
As described in this chapter, companies may use one of two basic systems of ac- counting for inventories: (1) the perpetual inventory system or (2) the periodic inventory system. In the chapter, we focused on the characteristics of the per- petual inventory system. In this appendix, we discuss and illustrate the periodic inventory system. One key difference between the two systems is the point at which the company computes cost of goods sold. For a visual reminder of this difference, you may want to refer back to Illustration 5-4 on page 230.
RECORDING MERCHANDISE TRANSACTIONS
In a periodic inventory system, companies record revenues from the sale of merchandise when sales are made, just as in a perpetual system. Unlike the per- petual system, however, companies do not attempt on the date of sale to record the cost of the merchandise sold. Instead, they take a physical inven- tory count at the end of the period to determine (1) the cost of the merchan- dise then on hand and (2) the cost of the goods sold during the period. And, un- der a periodic system, companies record purchases of merchandise in the Purchases account rather than the Inventory account. Also, in a periodic sys- tem, purchase returns and allowances, purchase discounts, and freight costs on purchases are recorded in separate accounts.
To illustrate the recording of merchandise transactions under a periodic in- ventory system, we will use purchase/sale transactions between PW Audio Sup- ply, Inc. and Sauk Stereo, as illustrated for the perpetual inventory system in this chapter.
RECORDING PURCHASES OF MERCHANDISE
On the basis of the sales invoice (Illustration 5-5, shown on page 232) and re- ceipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows.
appendix 5A
Periodic Inventory System
May 4 Purchases 3,800 Accounts Payable 3,800
(To record goods purchased on account from PW Audio Supply)
May 6 Freight-in (Transportation-in) 150 Cash 150
(To record payment of freight on goods purchased)
Purchases is a temporary account whose normal balance is a debit.
FREIGHT COSTS
When the purchaser directly incurs the freight costs, it debits the account Freight- in (or Transportation-in). For example, if Sauk Stereo pays Haul-It Freight Com- pany $150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk Stereo’s books is:
Like Purchases, Freight-in is a temporary account whose normal balance is a debit. Freight-in is part of cost of goods purchased. The reason is that cost
8 Explain the recording of purchases and sales of inventory under a periodic inventory system.
study objective
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of goods purchased should include any freight charges necessary to bring the goods to the purchaser. Freight costs are not subject to a purchase discount. Pur- chase discounts apply on the invoice cost of the merchandise.
Purchase Returns and Allowances Because $300 of merchandise received from PW Audio Supply is inoperable, Sauk Stereo returns the goods and prepares the following entry to recognize the return.
Purchase Returns and Allowances is a temporary account whose normal balance is a credit.
Purchase Discounts On May 14, Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio Supply for payment within 10 days. Sauk Stereo records the payment and discount as follows.
May 8 Accounts Payable 300 Purchase Returns and Allowances 300
(To record return of goods purchased from PW Audio Supply)
May 14 Accounts Payable ($3,800 � $300) 3,500 Purchase Discounts ($3,500 �.02) 70 Cash 3,430
(To record payment within the discount period)
Purchase Discounts is a temporary account whose normal balance is a credit.
RECORDING SALES OF MERCHANDISE
The seller, PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5, page 232) as follows.
May 4 Accounts Receivable 3,800 Sales Revenue 3,800
(To record credit sales to Sauk Stereo per invoice #731)
May 8 Sales Returns and Allowances 300 Accounts Receivable 300
(To record credit granted to Sauk Stereo for returned goods)
Sales Returns and Allowances To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows.
Sales Discounts On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio Supply honors the 2% cash discount and records the payment of Sauk Stereo’s account receivable in full as follows.
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Glossary
Contra revenue account (p. 238) An account that is off- set against a revenue account on the income statement.
Cost of goods sold (p. 228) The total cost of merchan- dise sold during the period.
Gross profit (p. 241) The excess of net sales over the cost of goods sold.
Gross profit rate (p. 245) Gross profit expressed as a per- centage by dividing the amount of gross profit by net sales.
Glossary 253
COMPARISON OF ENTRIES— PERPETUAL vs. PERIODIC
May 14 Cash 3,430 Sales Discounts ($3,500 �.02) 70
Accounts Receivable ($3,800 � $300) 3,500 (To record collection within 2/10, n/30 discount period from Sauk Stereo)
ENTRIES ON SAUK STEREO’S BOOKS
Transaction Perpetual Inventory System Periodic Inventory System
May 4 Purchase of Inventory 3,800 Purchases 3,800 merchandise on credit. Accounts Payable 3,800 Accounts Payable 3,800
May 6 Freight costs on Inventory 150 Freight-in 150 purchases. Cash 150 Cash 150
May 8 Purchase returns and Accounts Payable 300 Accounts Payable 300 allowances. Inventory 300 Purchase Returns
and Allowances 300
May 14 Payment on account Accounts Payable 3,500 Accounts Payable 3,500 with a discount. Cash 3,430 Cash 3,430
Inventory 70 Purchase Discounts 70
ENTRIES ON PW AUDIO SUPPLY’S BOOKS
Transaction Perpetual Inventory System Periodic Inventory System
May 4 Sale of merchandise Accounts Receivable 3,800 Accounts Receivable 3,800 on credit. Sales Revenue 3,800 Sales Revenue 3,800
Cost of Goods Sold 2,400 No entry for cost of Inventory 2,400 goods sold
May 8 Return of merchandise Sales Returns and Sales Returns and sold. Allowances 300 Allowances 300
Accounts Receivable 300 Accounts Receivable 300
Inventory 140 No entry Cost of Goods Sold 140
May 14 Cash received on Cash 3,430 Cash 3,430 account with a Sales Discounts 70 Sales Discounts 70 discount. Accounts Receivable 3,500 Accounts Receivable 3,500
Summary of Study Objective for Appendix 5A 8 Explain the recording of purchases and sales of inven-
tory under a periodic inventory system. To record pur- chases, entries are required for (a) cash and credit purchases, (b) purchase returns and allowances,
(c) purchase discounts, and (d) freight costs. To record sales, entries are required for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales dis- counts.
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Net sales (p. 241) Sales less sales returns and al- lowances and sales discounts.
Periodic inventory system (p. 230) An inventory sys- tem in which a company does not maintain detailed records of goods on hand and determines the cost of goods sold only at the end of an accounting period.
Perpetual inventory system (p. 230) A detailed inven- tory system in which a company maintains the cost of each inventory item and the records continuously show the inventory that should be on hand.
Profit margin ratio (p. 247) Measures the percentage of each dollar of sales that results in net income, com- puted by dividing net income by net sales.
Purchase allowance (p. 234) A deduction made to the selling price of merchandise, granted by the seller so that the buyer will keep the merchandise.
Purchase discount (p. 234) A cash discount claimed by a buyer for prompt payment of a balance due.
Purchase invoice (p. 231) A document that supports each purchase.
Purchase return (p. 234) A return of goods from the buyer to the seller for cash or credit.
Quality of earnings ratio (p. 248) A measure used to indicate the extent to which a company’s earnings pro- vide a full and transparent depiction of its performance; computed as net cash provided by operating activities di- vided by net income.
Sales discount (p. 238) A reduction given by a seller for prompt payment of a credit sale.
Sales invoice (p. 236) A document that provides sup- port for each sale.
Sales returns and allowances (p. 237) Transactions in which the seller either accepts goods back from the purchaser (a return) or grants a reduction in the pur- chase price (an allowance) so that the buyer will keep the goods.
Sales revenue (p. 228) Primary source of revenue in a merchandising company.
Comprehensive
The adjusted trial balance for the year ended December 31, 2012, for Dykstra Company is shown below.
DYKSTRA COMPANY Adjusted Trial Balance
For the Year Ended December 31, 2012
Dr. Cr.
Cash $ 14,500 Accounts Receivable 11,100 Inventory 29,000 Prepaid Insurance 2,500 Equipment 95,000 Accumulated Depreciation—Equipment $ 18,000 Notes Payable 25,000 Accounts Payable 10,600 Common Stock 70,000 Retained Earnings 11,000 Dividends 12,000 Sales Revenue 536,800 Sales Returns and Allowances 6,700 Sales Discounts 5,000 Cost of Goods Sold 363,400 Freight-out 7,600 Advertising Expense 12,000 Salaries and Wages Expense 56,000 Utilities Expense 18,000 Rent Expense 24,000 Depreciation Expense 9,000 Insurance Expense 4,500 Interest Expense 3,600 Interest Revenue 2,500
$673,900 $673,900
Do it!
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Self-Test Questions 255
Do it!
Action Plan
• In preparing the income statement, remember that the key components are net sales, cost of goods sold, gross profit, total operating expenses, and net income (loss). These components are reported in the right-hand column of the income statement.
• Present nonoperating items after income from operations.
Instructions Prepare a multiple-step income statement for Dykstra Company. Assume a tax rate of 30 percent.
Solution to Comprehensive
DYKSTRA COMPANY Income Statement
For the Year Ended December 31, 2012
Sales revenues Sales revenue $536,800 Less: Sales returns and allowances $ 6,700
Sales discounts 5,000 11,700
Net sales 525,100 Cost of goods sold 363,400
Gross profit 161,700 Operating expenses
Salaries and wages expense 56,000 Rent expense 24,000 Utilities expense 18,000 Advertising expense 12,000 Depreciation expense 9,000 Freight-out 7,600 Insurance expense 4,500
Total operating expenses 131,100
Income from operations 30,600 Other revenues and gains
Interest revenue 2,500 Other expenses and losses
Interest expense 3,600 1,100
Income before income taxes 29,500 Income tax expense 8,850
Net income $ 20,650
Self-Test Questions
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS
Note: All Questions, Exercises, and Problems marked with an asterisk relate to material in the appendix to the chapter.
Answers are on page 276.
1. Which of the following statements about a periodic inventory system is true? (a) Companies determine cost of goods sold only at
the end of the accounting period. (b) Companies continuously maintain detailed
records of the cost of each inventory purchase and sale.
(c) The periodic system provides better control over inventories than a perpetual system.
(d) The increased use of computerized systems has increased the use of the periodic system.
2. Which of the following items does not result in an adjustment in the Inventory account under a perpetual system? (a) A purchase of merchandise. (b) A return of merchandise inventory to the supplier. (c) Payment of freight costs for goods shipped to a
customer. (d) Payment of freight costs for goods received from
a supplier.
3. Which sales accounts normally have a debit balance? (a) Sales discounts. (b) Sales returns and allowances.
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(c) Both (a) and (b). (d) Neither (a) nor (b).
4. A company makes a credit sale of $750 on June 13, terms 2/10, n/30, on which it grants a return of $50 on June 16. What amount is received as payment in full on June 23? (a) $700. (c) $685. (b) $686. (d) $650.
5. To record the sale of goods for cash in a perpetual inventory system: (a) only one journal entry is necessary to record
cost of goods sold and reduction of inventory. (b) only one journal entry is necessary to record the
receipt of cash and the sales revenue. (c) two journal entries are necessary: one to record
the receipt of cash and sales revenue, and one to record the cost of goods sold and reduction of inventory.
(d) two journal entries are necessary: one to record the receipt of cash and reduction of inventory, and one to record the cost of goods sold and sales revenue.
6. Gross profit will result if: (a) operating expenses are less than net income. (b) sales revenues are greater than operating ex-
penses. (c) sales revenues are greater than cost of goods
sold. (d) operating expenses are greater than cost of
goods sold.
7. If sales revenues are $400,000, cost of goods sold is $310,000, and operating expenses are $60,000, what is the gross profit? (a) $30,000. (c) $340,000. (b) $90,000. (d) $400,000.
8. The multiple-step income statement for a merchan- dising company shows each of these features except: (a) gross profit. (b) cost of goods sold. (c) a sales revenue section. (d) All of these are present.
9. If beginning inventory is $60,000, cost of goods pur- chased is $380,000, and ending inventory is $50,000, what is cost of goods sold under a periodic system? (a) $390,000. (c) $330,000. (b) $370,000. (d) $420,000.
10. Bufford Corporation had reported the following amounts at December 31, 2012: Sales revenue $184,000;
ending inventory $11,600; beginning inventory $17,200; purchases $60,400; purchase discounts $3,000; pur- chase returns and allowances $1,100; freight-in $600; freight-out $900. Calculate the cost of goods available for sale. (a) $69,400. (c) $56,900. (b) $74,100. (d) $197,700.
11. Which of the following would affect the gross profit rate? (Assume sales remains constant.) (a) An increase in advertising expense. (b) A decrease in depreciation expense. (c) An increase in cost of goods sold. (d) A decrease in insurance expense.
12. The gross profit rate is equal to: (a) net income divided by sales. (b) cost of goods sold divided by sales. (c) net sales minus cost of goods sold, divided by
net sales. (d) sales minus cost of goods sold, divided by cost
of goods sold.
13. During the year ended December 31, 2012, Bjornstad Corporation had the following results: Sales revenue $267,000; cost of good sold $107,000; net income $92,400; operating expenses $55,400; net cash pro- vided by operating activities $108,950. What was the company’s profit margin ratio? (a) 40%. (c) 20.5%. (b) 60%. (d) 34.6%.
14. A quality of earnings ratio: (a) is computed as net income divided by net cash
provided by operating activities. (b) that is less than 1 indicates that a company
might be using aggressive accounting tactics. (c) that is greater than 1 indicates that a company
might be using aggressive accounting tactics. (d) is computed as net cash provided by operating
activities divided by total assets.
*15. When goods are purchased for resale by a company using a periodic inventory system: (a) purchases on account are debited to Inventory. (b) purchases on account are debited to Purchases. (c) purchase returns are debited to Purchase Re-
turns and Allowances. (d) freight costs are debited to Purchases.
Go to the book’s companion website, www. wiley.com/college/kimmel, to access addi- tional Self-Test Questions.
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Questions 1. (a) “The steps in the accounting cycle for a merchan-
dising company differ from the steps in the ac- counting cycle for a service company.” Do you agree or disagree?
(b) Is the measurement of net income in a merchan- dising company conceptually the same as in a service company? Explain.
2. How do the components of revenues and expenses differ between a merchandising company and a ser- vice company?
3. Rachel Harpole, CEO of Bargain Den Stores, is considering a recommendation made by both the company’s purchasing manager and director of
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Questions 257
finance that the company should invest in a sophis- ticated new perpetual inventory system to replace its periodic system. Explain the primary difference be- tween the two systems, and discuss the potential ben- efits of a perpetual inventory system.
4. (a) Explain the income measurement process in a merchandising company.
(b) How does income measurement differ between a merchandising company and a service company?
5. Markoff Co. has sales revenue of $100,000, cost of goods sold of $70,000, and operating expenses of $18,000. What is its gross profit?
6. Peggy Wilder believes revenues from credit sales may be earned before they are collected in cash. Do you agree? Explain.
7. (a) What is the primary source document for record- ing (1) cash sales and (2) credit sales?
(b) Using XXs for amounts, give the journal entry for each of the transactions in part (a), assuming per- petual inventory.
8. A credit sale is made on July 10 for $900, terms 1/15, n/30. On July 12, the purchaser returns $100 of goods for credit. Give the journal entry on July 19 to record the receipt of the balance due within the discount period.
9. As the end of Agnew Company’s fiscal year- end approached, it became clear that the company had considerable excess inventory. Belden Glass, the head of marketing and sales, ordered salespeople to “add 20% more units to each order that you ship. The customers can always ship the extra back next period if they decide they don’t want it. We’ve got to do it to meet this year’s sales goal.” Discuss the accounting implications of Belden’s action.
10. To encourage bookstores to buy a broader range of book titles, and to discourage price discount- ing, the publishing industry allows bookstores to re- turn unsold books to the publisher. This results in very significant returns each year. To ensure proper recognition of revenues, how should publishing com- panies account for these returns?
11. Goods costing $1,900 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, the purchaser receives a $300 credit from the sup- plier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period.
12. Frattura Company reports net sales of $800,000, gross profit of $560,000, and net income of $230,000. What are its operating expenses?
13. Rai Company has always provided its cus- tomers with payment terms of 1/10, n/30. Members of its sale force have commented that competitors are of- fering customers 2/10, n/45. Explain what these terms mean, and discuss the implications to Rai of switching its payment terms to those of its competitors.
14. In its year-end earnings announcement press release, Longwell Corp. announced that its earnings in- creased by $15 million relative to the previous year. This
represented a 20% increase. Inspection of its income statement reveals that the company reported a $20 mil- lion gain under “Other revenues and gains” from the sale of one of its factories. Discuss the implications of this gain from the perspective of a potential investor.
15. Identify the distinguishing features of an income statement for a merchandising company.
16. Why is the normal operating cycle for a merchandis- ing company likely to be longer than for a service company?
17. What title does Tootsie Roll use for gross profit? How did it present gross profit? By how much did its total gross profit change, and in what direction, in 2009?
18. What merchandising account(s) will appear in the post-closing trial balance?
19. What types of businesses are most likely to use a per- petual inventory system?
20. Identify the accounts that are added to or deducted from purchases to determine the cost of goods pur- chased under a periodic system. For each account, indicate (a) whether it is added or deducted, and (b) its normal balance.
21. In the following cases, use a periodic inventory sys- tem to identify the item(s) designated by the letters X and Y. (a) Purchases �X � Y � Net purchases. (b) Cost of goods purchased � Net purchases � X. (c) Beginning inventory � X � Cost of goods avail-
able for sale. (d) Cost of goods available for sale � Cost of goods
sold � X.
22. What two ratios measure factors that affect profitability?
23. What factors affect a company’s gross profit rate—that is, what can cause the gross profit rate to increase and what can cause it to decrease?
24. Corliss Ford, director of marketing, wants to reduce the selling price of his company’s products by 15% to increase market share. He says, “I know this will reduce our gross profit rate, but the increased number of units sold will make up for the lost margin.” Before this action is taken, what other factors does the company need to consider?
25. Howard Paulson is considering investing in Stevenson Pet Food Company. Stevenson’s net income increased considerably during the most recent year, even though many other companies in the same industry reported disappointing earnings. Howard wants to know whether the company’s earnings provide a reasonable depiction of its results. What initial step can Howard take to help determine whether he needs to investigate further?
*26. On July 15, a company purchases on account goods costing $1,900, with credit terms of 2/10, n/30. On July 18, the company receives a $400 credit memo from the supplier for damaged goods. Give the jour- nal entry on July 24 to record payment of the balance due within the discount period assuming a periodic inventory system.
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258 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Brief Exercises BE5-1 Presented here are the components in Korinek Company’s income statement. Determine the missing amounts.
Sales Cost of Gross Operating Net Revenue Goods Sold Profit Expenses Income
$ 71,200 (b) $ 30,000 (d) $12,100 $108,000 $70,000 (c) (e) $29,500
(a) $71,900 $109,600 $46,200 (f )
BE5-2 Pocras Company buys merchandise on account from Wedell Company. The selling price of the goods is $900 and the cost of the goods sold is $590. Both compa- nies use perpetual inventory systems. Journalize the transactions on the books of both companies.
BE5-3 Prepare the journal entries to record the following transactions on Graff Com- pany’s books using a perpetual inventory system. (a) On March 2, Graff Company sold $800,000 of merchandise to Rodriguez Company,
terms 2/10, n/30. The cost of the merchandise sold was $540,000. (b) On March 6, Rodriguez Company returned $140,000 of the merchandise purchased
on March 2. The cost of the merchandise returned was $94,000. (c) On March 12, Graff Company received the balance due from Rodriguez Company.
BE5-4 From the information in BE5-3, prepare the journal entries to record these trans- actions on Rodriguez Company’s books under a perpetual inventory system.
BE5-5 Bangura Company provides this information for the month ended October 31, 2012: sales on credit $300,000; cash sales $150,000; sales discounts $5,000; and sales re- turns and allowances $19,000. Prepare the sales revenues section of the income state- ment based on this information.
BE5-6 Explain where each of these items would appear on a multiple-step income state- ment: gain on disposal of plant assets; cost of goods sold; depreciation expense; and sales returns and allowances.
BE5-7 Berry Company sold goods with a total selling price of $800,000 during the year. It purchased goods for $380,000 and had beginning inventory of $67,000. A count of its ending inventory determined that goods on hand was $50,000. What was its cost of goods sold?
BE5-8 Assume that Logan Company uses a periodic inventory system and has these ac- count balances: Purchases $404,000; Purchase Returns and Allowances $13,000; Purchase Discounts $9,000; and Freight-in $16,000. Determine net purchases and cost of goods purchased.
BE5-9 Assume the same information as in BE5-8 and also that Logan Company has beginning inventory of $60,000, ending inventory of $90,000, and net sales of $612,000. Determine the amounts to be reported for cost of goods sold and gross profit.
BE5-10 Modder Corporation reported net sales of $250,000, cost of goods sold of $150,000, operating expenses of $50,000, net income of $32,500, beginning total assets of $520,000, and ending total assets of $600,000. Calculate each of the following values and explain what they mean: (a) profit margin ratio and (b) gross profit rate.
BE5-11 Delzer Corporation reported net sales $800,000; cost of goods sold $520,000; operating expenses $210,000; and net income $68,000. Calculate the following values and explain what they mean: (a) profit margin ratio and (b) gross profit rate.
BE5-12 Wasley Corporation reported net income of $346,000, cash of $67,800, and net cash provided by operating activities of $221,200. What does this suggest about the qual- ity of the company’s earnings? What further steps should be taken?
*BE5-13 Prepare the journal entries to record these transactions on Koeller Company’s books using a periodic inventory system. (a) On March 2, Koeller Company purchased $800,000 of merchandise from Reeves Com-
pany, terms 2/10, n/30. (b) On March 6, Koeller Company returned $95,000 of the merchandise purchased on
March 2. (c) On March 12, Koeller Company paid the balance due to Reeves Company.
Compute missing amounts in determining net income.
(SO 1, 4), AP
Journalize perpetual inventory entries.
(SO 2, 3), AP
Journalize sales transactions.
(SO 3), AP
Journalize purchase transactions.
(SO 2), AP Prepare sales revenue section of income statement.
(SO 4), AP
Identify placement of items on a multiple-step income statement.
(SO 4), AP Determine cost of goods sold using basic periodic formula.
(SO 5), AP
Compute net purchases and cost of goods purchased.
(SO 5), AP
Compute cost of goods sold and gross profit.
(SO 5), C
Calculate profitability ratios.
(SO 6), AP
Calculate profitability ratios.
(SO 6), AP
Evaluate quality of earnings.
(SO 7), C
Journalize purchase transactions.
(SO 8), AP
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Exercises 259
5-1 On October 5, Longhini Company buys merchandise on account from Okern Company. The selling price of the goods is $5,000, and the cost to Okern Company is $3,000. On October 8, Longhini returns defective goods with a selling price of $640 and a scrap value of $240. Record the transactions of Longhini Company, assuming a per- petual approach.
5-2 Assume information similar to that in 5-1. That is: On October 5, Longhini Company buys merchandise on account from Okern Company. The selling price of the goods is $5,000, and the cost to Okern Company is $3,000. On October 8, Longhini returns defective goods with a selling price of $640 and a scrap value of $240. Record the transactions on the books of Okern Company, assuming a perpetual approach.
5-3 The following information is available for Jain Corp. for the year ended December 31, 2012:
Other revenues and gains $ 12,700 Net sales $552,000 Other expenses and losses 13,300 Operating expenses 186,000 Cost of goods sold 156,000
Prepare a multiple-step income statement for Jain Corp. The company has a tax rate of 30%.
5-4 Crystal Lake Corporation’s accounting records show the following at year- end December 31, 2012:
Purchase Discounts $ 5,900 Beginning Inventory $31,720 Freight-in 8,400 Ending Inventory 27,950 Freight-out 11,100 Purchase Returns 3,600 Purchases 162,500
Assuming that Crystal Lake Corporation uses the periodic system, compute (a) cost of goods purchased and (b) cost of goods sold.
Do it!
Do it!
Do it!Do it!
Do it! Record transactions of purchasing company.
(SO 2), AP
Record transactions of selling company.
(SO 3), AP
Prepare multiple-step income statement.
(SO 4 ), AP
Determine cost of goods sold using periodic system.
(SO 5), AP
Exercises E5-1 This information relates to Percy Co.
1. On April 5, purchased merchandise from Lyman Company for $28,000, terms 2/10, n/30.
2. On April 6, paid freight costs of $700 on merchandise purchased from Lyman. 3. On April 7, purchased equipment on account for $30,000. 4. On April 8, returned some of April 5 merchandise to Lyman Company, which cost
$3,600. 5. On April 15, paid the amount due to Lyman Company in full.
Instructions (a) Prepare the journal entries to record the transactions listed above on the books of
Percy Co. Percy Co. uses a perpetual inventory system. (b) Assume that Percy Co. paid the balance due to Lyman Company on May 4 instead
of April 15. Prepare the journal entry to record this payment.
E5-2 Assume that on September 1, Office Depot had an inventory that included a vari- ety of calculators. The company uses a perpetual inventory system. During September, these transactions occurred.
Sept. 6 Purchased calculators from Abacus Co. at a total cost of $1,650, terms n/30.
9 Paid freight of $50 on calculators purchased from Abacus Co. 10 Returned calculators to Abacus Co. for $66 credit because they did not
meet specifications. 12 Sold calculators costing $520 for $690 to Union Book Store, terms n/30. 14 Granted credit of $45 to Union Book Store for the return of one cal-
culator that was not ordered. The calculator cost $34. 20 Sold calculators costing $570 for $760 to Commons Card Shop, terms
n/30.
Journalize perpetual inventory entries.
(SO 2, 3), AP
ReviewDo it!
Journalize purchase transactions.
(SO 2), AP
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260 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Instructions Journalize the September transactions.
E5-3 The following transactions are for Masland Company. 1. On December 3, Masland Company sold $500,000 of merchandise to Parker Co.,
terms 1/10, n/30. The cost of the merchandise sold was $330,000. 2. On December 8, Parker Co. was granted an allowance of $25,000 for merchandise
purchased on December 3. 3. On December 13, Masland Company received the balance due from Parker Co.
Instructions (a) Prepare the journal entries to record these transactions on the books of Masland
Company. Masland uses a perpetual inventory system. (b) Assume that Masland Company received the balance due from Parker Co. on January 2
of the following year instead of December 13. Prepare the journal entry to record the receipt of payment on January 2.
E5-4 On June 10, Harris Company purchased $9,000 of merchandise from Goetz Com- pany, terms 3/10, n/30. Harris pays the freight costs of $400 on June 11. Goods totaling $600 are returned to Goetz for credit on June 12. On June 19, Harris Company pays Goetz Company in full, less the purchase discount. Both companies use a perpetual inventory system.
Instructions (a) Prepare separate entries for each transaction on the books of Harris Company. (b) Prepare separate entries for each transaction for Goetz Company. The merchandise
purchased by Harris on June 10 cost Goetz $5,000, and the goods returned cost Goetz $310.
E5-5 The adjusted trial balance of Dredge Company shows these data pertaining to sales at the end of its fiscal year, October 31, 2012: Sales Revenue $900,000; Freight-out $14,000; Sales Returns and Allowances $22,000; and Sales Discounts $13,500.
Instructions Prepare the sales revenues section of the income statement.
E5-6 Presented below is information for Yu Co. for the month of January 2012.
Cost of goods sold $212,000 Rent expense $32,000 Freight-out 7,000 Sales discounts 8,000 Insurance expense 12,000 Sales returns and allowances 20,000 Salaries and wages expense 60,000 Sales revenue 370,000
Instructions (a) Prepare an income statement using the format presented on page 243. Assume a 25%
tax rate. (b) Calculate the profit margin ratio and the gross profit rate.
E5-7 Financial information is presented here for two companies.
Indig Perez Company Company
Sales revenue $90,000 ? Sales returns ? $ 5,000 Net sales 84,000 100,000 Cost of goods sold 58,000 ? Gross profit ? 40,000 Operating expenses 14,380 ? Net income ? 17,000
Instructions (a) Fill in the missing amounts. Show all computations. (b) Calculate the profit margin ratio and the gross profit rate for each company. (c) Discuss your findings in part (b).
E5-8 In its income statement for the year ended December 31, 2012, Misra Company reported the following condensed data.
Prepare sales revenues section of income statement.
(SO 4), AP
Prepare an income statement and calculate profitability ratios.
(SO 4, 6), AP
Compute missing amounts and calculate profitability ratios.
(SO 4, 6), AP
Prepare multiple-step income statement and calculate profitability ratios.
(SO 4, 6), AP
Journalize perpetual inventory entries.
(SO 2, 3), AP
Journalize sales transactions.
(SO 3), AP
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Exercises 261
Administrative expenses $465,000 Loss on disposal of Cost of goods sold 987,000 plant assets $ 83,500 Interest expense 71,000 Net sales 2,050,000 Interest revenue 65,000 Income tax expense 25,000 Selling expenses 420,000
Instructions (a) Prepare a multiple-step income statement. (b) Calculate the profit margin ratio and gross profit rate. (c) In 2011, Misra had a profit margin ratio of 5%. Is the decline in 2012 a cause for
concern? (Ignore income tax effects.)
E5-9 In its income statement for the year ended June 30, 2009, The Clorox Company reported the following condensed data (dollars in millions).
Selling and Research and administrative expenses $ 715 development expense $ 114
Net sales 5,450 Income tax expense 274 Interest expense 161 Other expense 46 Advertising expense 499 Cost of goods sold 3,104
Instructions (a) Prepare a multiple-step income statement. (b) Calculate the gross profit rate and the profit margin ratio and explain what each
means. (c) Assume the marketing department has presented a plan to increase advertising ex-
penses by $340 million. It expects this plan to result in an increase in both net sales and cost of goods sold of 25%. Redo parts (a) and (b) and discuss whether this plan has merit. (Assume a tax rate of 34%, and round all amounts to whole dollars.)
E5-10 The trial balance of Pollard Company at the end of its fiscal year, August 31, 2012, includes these accounts: Beginning Inventory $18,700; Purchases $154,000; Sales Revenue $190,000; Freight-in $8,000; Sales Returns and Allowances $3,000; Freight-out $1,000; and Purchase Returns and Allowances $5,000. The ending merchandise inventory is $21,000.
Instructions Prepare a cost of goods sold section (periodic system) for the year ending August 31.
E5-11 Below is a series of cost of goods sold sections for companies A, F, L, and V.
A F L V
Beginning inventory $ 250 $ 120 $ 700 $ ( j) Purchases 1,500 1,080 (g) 43,590 Purchase returns and allowances 80 (d) 290 (k) Net purchases (a) 1,040 7,410 42,290 Freight-in 130 (e) (h) 2,240 Cost of goods purchased (b) 1,230 8,050 (l) Cost of goods available for sale 1,800 1,350 (i) 49,530 Ending inventory 310 (f ) 1,150 6,230 Cost of goods sold (c) 1,230 7,600 43,300
Instructions Fill in the lettered blanks to complete the cost of goods sold sections.
E5-12 Pardow Corporation reported sales revenue of $257,000, net income of $45,300, cash of $9,300, and net cash provided by operating activities of $23,200. Accounts receiv- able have increased at three times the rate of sales during the last 3 years.
Instructions (a) Explain what is meant by high quality of earnings. (b) Evaluate the quality of the company’s earnings. Discuss your findings. (c) What factors might have contributed to the company’s quality of earnings?
*E5-13 This information relates to Edyburn Co.
1. On April 5, purchased merchandise from Hansen Company for $27,000, terms 2/10, n/30.
2. On April 6, paid freight costs of $1,200 on merchandise purchased from Hansen Company.
Prepare multiple-step income statement and calculate profitability ratios.
(SO 4, 6), C
Prepare cost of goods sold section using periodic system.
(SO 5), AP
Prepare cost of goods sold section using periodic system.
(SO 5), AP
Evaluate quality of earnings.
(SO 7), C
Journalize purchase transactions.
(SO 8), AP
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262 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
3. On April 7, purchased equipment on account for $30,000. 4. On April 8, returned some of the April 5 merchandise to Hansen Company, which
cost $3,600. 5. On April 15, paid the amount due to Hansen Company in full.
Instructions (a) Prepare the journal entries to record these transactions on the books of Edyburn Co.
using a periodic inventory system. (b) Assume that Edyburn Co. paid the balance due to Hansen Company on May 4 instead
of April 15. Prepare the journal entry to record this payment.
Exercises: Set B and Challenge Exercises Visit the book’s companion website, at www.wiley.com/college/kimmel, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.
Problems: Set A P5-1A Janssen Hardware Store completed the following merchandising transactions in the month of May. At the beginning of May, Janssen’s ledger showed Cash of $8,000 and Common Stock of $8,000.
May 1 Purchased merchandise on account from Vanco Wholesale Supply for $8,000, terms 1/10, n/30.
2 Sold merchandise on account for $4,400, terms 2/10, n/30. The cost of the merchandise sold was $3,300.
5 Received credit from Vanco Wholesale Supply for merchandise re- turned $200.
9 Received collections in full, less discounts, from customers billed on May 2.
10 Paid Vanco Wholesale Supply in full, less discount. 11 Purchased supplies for cash $900. 12 Purchased merchandise for cash $3,100. 15 Received $230 refund for return of poor-quality merchandise from sup-
plier on cash purchase. 17 Purchased merchandise from Strickler Distributors for $2,500, terms
2/10, n/30. 19 Paid freight on May 17 purchase $250. 24 Sold merchandise for cash $5,500. The cost of the merchandise sold
was $4,100. 25 Purchased merchandise from Fasteners Inc. for $800, terms 3/10, n/30. 27 Paid Strickler Distributors in full, less discount. 29 Made refunds to cash customers for returned merchandise $124. The
returned merchandise had cost $90. 31 Sold merchandise on account for $1,280, terms n/30. The cost of the
merchandise sold was $830.
Janssen Hardware’s chart of accounts includes Cash, Accounts Receivable, Inventory, Supplies, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold.
Instructions (a) Journalize the transactions using a perpetual inventory system. (b) Post the transactions to T accounts. Be sure to enter the beginning cash and com-
mon stock balances. (c) Prepare an income statement through gross profit for the month of May 2012. (d) Calculate the profit margin ratio and the gross profit rate. (Assume operating ex-
penses were $1,400.)
P5-2A Hayes Warehouse distributes hardback books to retail stores and extends credit terms of 2/10, n/30 to all of its customers. During the month of June, the following mer- chandising transactions occurred.
Journalize, post, prepare partial income statement, and calculate ratios.
(SO 2, 3, 4, 6), AP
(c) Gross profit $2,828
Journalize purchase and sale transactions under a perpetual system.
(SO 2, 3), AP
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Problems: Set A 263
June 1 Purchased books on account for $1,040 (including freight) from Brooks Publishers, terms 2/10, n/30.
3 Sold books on account to the Mission Viejo bookstore for $1,200. The cost of the merchandise sold was $720.
6 Received $40 credit for books returned to Brooks Publishers. 9 Paid Brooks Publishers in full.
15 Received payment in full from the Mission Viejo bookstore. 17 Sold books on account to Book Nook for $1,200. The cost of the mer-
chandise sold was $730. 20 Purchased books on account for $720 from Cook Book Publishers,
terms 1/15, n/30. 24 Received payment in full from Book Nook. 26 Paid Cook Book Publishers in full. 28 Sold books on account to NewTown Bookstore for $1,300. The cost of
the merchandise sold was $780. 30 Granted NewTown Bookstore $130 credit for books returned costing
$80.
Instructions Journalize the transactions for the month of June for Hayes Warehouse, using a perpet- ual inventory system.
P5-3A At the beginning of the current season on April 1, the ledger of Thousand Oaks Pro Shop showed Cash $2,500; Inventory $3,500; and Common Stock $6,000. The follow- ing transactions were completed during April 2012.
Apr. 5 Purchased golf bags, clubs, and balls on account from Ryder Co. $1,500, terms 3/10, n/60.
7 Paid freight on Ryder purchase $80. 9 Received credit from Ryder Co. for merchandise returned $200.
10 Sold merchandise on account to members $1,340, terms n/30. The mer- chandise sold had a cost of $820.
12 Purchased golf shoes, sweaters, and other accessories on account from Birdie Sportswear $830, terms 1/10, n/30.
14 Paid Ryder Co. in full. 17 Received credit from Birdie Sportswear for merchandise returned $30. 20 Made sales on account to members $810, terms n/30. The cost of the
merchandise sold was $550. 21 Paid Birdie Sportswear in full. 27 Granted an allowance to members for clothing that did not fit prop-
erly $80. 30 Received payments on account from members $1,220.
The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, and Cost of Goods Sold.
Instructions (a) Journalize the April transactions using a perpetual inventory system. (b) Using T accounts, enter the beginning balances in the ledger accounts and post the
April transactions. (c) Prepare a trial balance on April 30, 2012. (d) Prepare an income statement through gross profit.
P5-4A Chapman Department Store is located in midtown Metropolis. During the past several years, net income has been declining because suburban shopping centers have been attracting business away from city areas. At the end of the company’s fiscal year on November 30, 2012, these accounts appeared in its adjusted trial balance.
Accounts Payable $ 26,800 Accounts Receivable 17,200 Accumulated Depreciation—Equipment 68,000 Cash 8,000 Common Stock 35,000 Cost of Goods Sold 614,300 Freight-out 6,200
Journalize, post, and prepare trial balance and partial income statement.
(SO 2, 3, 4), AP
Prepare financial statements and calculate profitability ratios.
(SO 4, 6), AP
(c) Tot. trial balance $8,150 (d) Gross profit $ 700
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264 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Equipment $157,000 Depreciation Expense 13,500 Dividends 12,000 Gain on Disposal of Plant Assets 2,000 Income Tax Expense 10,000 Insurance Expense 9,000 Interest Expense 5,000 Inventory 26,200 Notes Payable 43,500 Prepaid Insurance 6,000 Advertising Expense 33,500 Rent Expense 34,000 Retained Earnings 14,200 Salaries and Wages Expense 117,000 Sales Revenue 904,000 Salaries and Wages Payable 6,000 Sales Returns and Allowances 20,000 Utilities Expense 10,600
Additional data: Notes payable are due in 2016.
Instructions (a) Prepare a multiple-step income statement, a retained earnings statement, and a clas-
sified balance sheet. (b) Calculate the profit margin ratio and the gross profit rate. (c) The vice president of marketing and the director of human resources have developed
a proposal whereby the company would compensate the sales force on a strictly com- mission basis. Given the increased incentive, they expect net sales to increase by 15%. As a result, they estimate that gross profit will increase by $40,443 and expenses by $58,600. Compute the expected new net income. (Hint: You do not need to prepare an income statement.) Then, compute the revised profit margin ratio and gross profit rate. Comment on the effect that this plan would have on net income and on the ra- tios, and evaluate the merit of this proposal. (Ignore income tax effects.)
P5-5A An inexperienced accountant prepared this condensed income statement for McDowell Company, a retail firm that has been in business for a number of years.
MCDOWELL COMPANY Income Statement
For the Year Ended December 31, 2012
Revenues Net sales $850,000 Other revenues 22,000
872,000 Cost of goods sold 555,000
Gross profit 317,000 Operating expenses
Selling expenses 109,000 Administrative expenses 103,000
212,000
Net earnings $105,000
As an experienced, knowledgeable accountant, you review the statement and determine the following facts.
1. Net sales consist of sales $911,000, less freight-out expense on merchandise sold $33,000, and sales returns and allowances $28,000.
2. Other revenues consist of sales discounts $18,000 and rent revenue $8,000. 3. Selling expenses consist of salespersons’ salaries $80,000; depreciation on equipment
$10,000; advertising $15,000; and sales commissions $6,000. The commissions rep- resent commissions paid. At December 31, $3,000 of commissions have been earned by salespersons but have not been paid. All compensation should be recorded as Salaries and Wages Expense.
Prepare a correct multiple- step income statement.
(SO 4), AP
(a) Net income $ 32,900 Tot. assets $146,400
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Problems: Set A 265
4. Administrative expenses consist of office salaries $47,000; dividends $18,000; utili- ties $12,000; interest expense $2,000; and rent expense $24,000, which includes pre- payments totaling $6,000 for the first quarter of 2013.
Instructions Prepare a correct detailed multiple-step income statement. Assume a 25% tax rate.
P5-6A The trial balance of Dealer’s Choice Wholesale Company contained the accounts shown at December 31, the end of the company’s fiscal year.
DEALER’S CHOICE WHOLESALE COMPANY Trial Balance
December 31, 2012
Debit Credit
Cash $ 31,400 Accounts Receivable 37,600 Inventory 70,000 Land 92,000 Buildings 200,000 Accumulated Depreciation—Buildings $ 60,000 Equipment 83,500 Accumulated Depreciation—Equipment 40,500 Notes Payable 54,700 Accounts Payable 17,500 Common Stock 160,000 Retained Earnings 67,200 Dividends 10,000 Sales Revenue 922,100 Sales Discounts 6,000 Cost of Goods Sold 709,900 Salaries and Wages Expense 51,300 Utilities Expense 11,400 Maintenance and Repairs Expense 8,900 Advertising Expense 5,200 Insurance Expense 4,800
$1,322,000 $1,322,000
Adjustment data: 1. Depreciation is $8,000 on buildings and $7,000 on equipment. (Both are operating
expenses.) 2. Interest of $4,500 is due and unpaid on notes payable at December 31. 3. Income tax due and unpaid at December 31 is $24,000.
Other data: $15,000 of the notes payable are payable next year.
Instructions (a) Journalize the adjusting entries. (b) Create T accounts for all accounts used in part (a). Enter the trial balance amounts
into the T accounts and post the adjusting entries. (c) Prepare an adjusted trial balance. (d) Prepare a multiple-step income statement and a retained earnings statement for the
year, and a classified balance sheet at December 31, 2012.
P5-7A At the end of Snyder Department Store’s fiscal year on November 30, 2012, these accounts appeared in its adjusted trial balance.
Freight-in $ 5,060 Inventory (beginning) 41,300 Purchases 613,000 Purchase Discounts 7,000 Purchase Returns and Allowances 6,760 Sales Revenue 902,000 Sales Returns and Allowances 20,000
Journalize, post, and prepare adjusted trial balance and financial statements.
(SO 4), AP
Determine cost of goods sold and gross profit under a periodic system.
(SO 4, 5), AP
Net income $69,500
(c) Tot. trial balance $1,365,500 (d) Net income $81,100
Tot. assets $399,000
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266 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Additional facts: 1. Merchandise inventory on November 30, 2012, is $36,200. 2. Note that Snyder Department Store uses a periodic system.
Instructions Prepare an income statement through gross profit for the year ended November 30, 2012.
P5-8A Reza Inc. operates a retail operation that purchases and sells snowmobiles, amongst other outdoor products. The company purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2010 through 2013, inclusive.
2010 2011 2012 2013
Income Statement Data Sales revenue $96,890 $ (e) $82,220 Cost of goods sold (a) 28,060 26,490
Gross profit 67,800 59,620 (i) Operating expenses 63,640 (f ) 52,870
Net income $ (b) $ 3,510 $ ( j)
Balance Sheet Data Inventory $13,000 $ (c) $14,700 $ (k) Accounts payable 5,800 6,500 4,600 (l)
Additional Information Purchases of merchandise
inventory on account $25,890 $ (g) $24,050 Cash payments to suppliers (d) (h) 24,650
Instructions (a) Calculate the missing amounts. (b) The vice presidents of sales, marketing, production, and finance are discussing the
company’s results with the CEO. They note that sales declined over the 3-year fiscal period, 2011–2013. Does that mean that profitability necessarily also declined? Ex- plain, computing the gross profit rate and the profit margin ratio for each fiscal year to help support your answer.
*P5-9A At the beginning of the current season on April 1, the ledger of Thousand Oaks Pro Shop showed Cash $2,500; Inventory $3,500; and Common Stock $6,000. These trans- actions occurred during April 2012.
Apr. 5 Purchased golf bags, clubs, and balls on account from Ryder Co. $1,500, terms 3/10, n/60.
7 Paid freight on Ryder Co. purchases $80. 9 Received credit from Ryder Co. for merchandise returned $200.
10 Sold merchandise on account to members $1,340, terms n/30. 12 Purchased golf shoes, sweaters, and other accessories on account from
Birdie Sportswear $830, terms 1/10, n/30. 14 Paid Ryder Co. in full. 17 Received credit from Birdie Sportswear for merchandise returned $30. 20 Made sales on account to members $810, terms n/30. 21 Paid Birdie Sportswear in full. 27 Granted credit to members for clothing that did not fit properly $80. 30 Received payments on account from members $1,220.
The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, Pur- chases, Purchase Returns and Allowances, Purchase Discounts, and Freight-in.
Instructions (a) Journalize the April transactions using a periodic inventory system. (b) Using T accounts, enter the beginning balances in the ledger accounts and post the
April transactions. (c) Prepare a trial balance on April 30, 2012.
Calculate missing amounts and assess profitability.
(SO 4, 5, 6), AN
Journalize, post, and prepare trial balance and partial income statement under a periodic system.
(SO 5, 8), AP
Gross profit $272,600
(c) Tot. trial balance $8,427 Gross profit $700
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Problems: Set B 267
(d) Prepare an income statement through gross profit, assuming merchandise inventory on hand at April 30 is $4,263.
Problems: Set B P5-1B Curtain Distributing Company completed these merchandising transactions in the month of April. At the beginning of April, the ledger of Curtain showed Cash of $9,000 and Common Stock of $9,000.
Apr. 2 Purchased merchandise on account from Luebke Supply Co. $8,700, terms 2/10, n/30.
4 Sold merchandise on account $6,000, terms 2/10, n/30. The cost of the merchandise sold was $3,700.
5 Paid $200 freight on April 4 sale. 6 Received credit from Luebke Supply Co. for merchandise returned $400.
11 Paid Luebke Supply Co. in full, less discount. 13 Received collections in full, less discounts, from customers billed on April 4. 14 Purchased merchandise for cash $4,700. 16 Received refund from supplier for returned merchandise on cash pur-
chase of April 14, $500. 18 Purchased merchandise from Cascade Distributors $5,500, terms 2/10, n/30. 20 Paid freight on April 18 purchase $180. 23 Sold merchandise for cash $8,300. The cost of the merchandise sold was
$5,580. 26 Purchased merchandise for cash $2,300. 27 Paid Cascade Distributors in full, less discount. 29 Made refunds to cash customers for returned merchandise $180. The re-
turned merchandise had a cost of $120. 30 Sold merchandise on account $3,980, terms n/30. The cost of the mer-
chandise sold was $2,500.
Curtain Distributing Company’s chart of accounts includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, and Freight-out.
Instructions (a) Journalize the transactions. (b) Post the transactions to T accounts. Be sure to enter the beginning cash and com-
mon stock balances. (c) Prepare the income statement through gross profit for the month of April 2012. (d) Calculate the profit margin ratio and the gross profit rate. (Assume operating ex-
penses were $2,050.)
P5-2B Holiday Warehouse distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of its customers. During the month of July, the following merchandis- ing transactions occurred.
July 1 Purchased suitcases on account for $2,700 from Satchel Manufacturers, terms 2/15, n/30.
3 Sold suitcases on account to Triptik for $2,900. The cost of the merchan- dise sold was $1,800.
9 Paid Satchel Manufacturers in full. 12 Received payment in full from Triptik. 17 Sold suitcases on account to PassPort for $2,000. The cost of the mer-
chandise sold was $1,200. 18 Purchased suitcases on account for $2,200 (including freight) from
Steamer Manufacturers, terms 1/10, n/30. 20 Received $300 credit for suitcases returned to Steamer Manufacturers. 21 Received payment in full from PassPort. 22 Sold suitcases on account to Carry On for $3,120. The cost of the mer-
chandise sold was $1,800. 30 Paid Steamer Manufacturers in full. 31 Granted Carry On $310 credit for suitcases returned costing $170.
Journalize, post, prepare partial income statement, and calculate ratios.
(SO 2, 3, 4, 6), AP
Journalize purchase and sale transactions under a perpetual system.
(SO 2, 3), AP
(c) Gross profit $6,320
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268 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Instructions Journalize the transactions for the month of July for Holiday Warehouse, using a perpet- ual inventory system.
P5-3B At the beginning of the current season, the ledger of Highland Tennis Shop showed Cash $2,500; Inventory $1,700; and Common Stock $4,200. The following trans- actions were completed during April.
Apr. 4 Purchased racquets and balls from Harris Co. $980, terms 2/10, n/30. 6 Paid freight on Harris Co. purchase $60. 8 Sold merchandise to members $750, terms n/30. The merchandise sold
cost $480. 10 Received credit of $130 from Harris Co. for damaged racquets that
were returned. 11 Purchased tennis shoes from Happy Feet for cash $300. 13 Paid Harris Co. in full. 14 Purchased tennis shirts and shorts from Rivera Sportswear $1,300,
terms 3/10, n/60. 15 Received cash refund of $50 from Happy Feet for damaged merchan-
dise that was returned. 17 Paid freight on Rivera Sportswear purchase $60. 18 Sold merchandise to members $660, terms n/30. The cost of the mer-
chandise sold was $440. 20 Received $500 in cash from members in settlement of their accounts. 21 Paid Rivera Sportswear in full. 27 Granted an allowance of $30 to members for tennis clothing that did
not fit properly. 30 Received cash payments on account from members $550.
The chart of accounts for the tennis shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, and Cost of Goods Sold.
Instructions (a) Journalize the April transactions using a perpetual inventory system. (b) Using T accounts, enter the beginning balances in the ledger accounts and post the
April transactions. (c) Prepare a trial balance on April 30, 2012. (d) Prepare an income statement through gross profit.
P5-4B Parkland Department Store is located near the Lyndale Shopping Mall. At the end of the company’s fiscal year on December 31, 2012, the following accounts appeared in its adjusted trial balance.
Accounts Payable $ 73,300 Accounts Receivable 45,500 Accumulated Depreciation—Buildings 52,500 Accumulated Depreciation—Equipment 42,600 Buildings 190,000 Cash 28,000 Common Stock 140,000 Cost of Goods Sold 412,000 Depreciation Expense 23,400 Dividends 15,000 Equipment 100,000 Gain on Disposal of Plant Assets 4,300 Income Tax Expense 15,000 Insurance Expense 8,400 Interest Expense 7,000 Interest Payable 2,000 Inventory 43,000 Mortgage Payable 62,500 Prepaid Insurance 2,400
Journalize, post, and prepare trial balance and partial income statement.
(SO 2, 3, 4), AP
Prepare financial statements and calculate profitability ratios.
(SO 4, 6), AP
(c) Tot. trial balance $5,610 (d) Gross profit $460
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Problems: Set B 269
Maintenance and Repairs Expense $ 6,200 Retained Earnings 19,200 Salaries and Wages Expense 111,000 Sales Revenue 626,000 Salaries and Wages Payable 3,500 Sales Returns and Allowances 8,000 Utilities Expense 11,000
Additional data: $20,000 of the mortgage payable is due for payment next year.
Instructions (a) Prepare a multiple-step income statement, a retained earnings statement, and a clas-
sified balance sheet. (b) Calculate the profit margin ratio and the gross profit rate. (c) The vice president of marketing and the director of human resources have devel-
oped a proposal whereby the company would compensate the sales force on a strictly commission basis. Given the increased incentive, they expect net sales to increase by 25%. As a result, they estimate that gross profit will increase by $50,500 and ex- penses by $27,800. Compute the expected new net income. (Hint: You do not need to prepare an income statement.) Then, compute the revised profit margin ratio and gross profit rate. Comment on the effect that this plan would have on net income and the ratios, and evaluate the merit of this proposal.
P5-5B A part-time bookkeeper prepared this income statement for Kritek Company for the year ending December 31, 2012.
KRITEK COMPANY Income Statement December 31, 2012
Revenues Sales revenue $720,000 Less: Freight-out $14,000
Sales discounts 11,300 25,300
Net sales 694,700 Other revenues (net) 1,300
Total revenues 696,000 Expenses
Cost of goods sold 460,000 Selling expenses 103,000 Administrative expenses 54,000 Dividends 12,000
Total expenses 629,000
Net income $ 67,000
As an experienced, knowledgeable accountant, you review the statement and determine the following facts.
1. Sales include $12,000 of deposits from customers for future sales orders. 2. Other revenues contain two items: interest expense $4,000 and interest revenue
$5,300. 3. Selling expenses consist of sales salaries and wages $82,500, advertising $13,000, and
depreciation on store equipment $7,500. 4. Administrative expenses consist of office salaries $23,000; utilities expense $9,500;
rent expense $14,500; and insurance expense $7,000. Insurance expense includes $1,200 of insurance applicable to 2013.
Instructions Prepare a correct detailed multiple-step income statement. Assume a tax rate of 25%.
P5-6B The trial balance of Runway Fashion Center contained the accounts on the next page at November 30, the end of the company’s fiscal year.
Prepare a correct multiple- step income statement.
(SO 4), AP
Journalize, post, and prepare adjusted trial balance and financial statements.
(SO 4), AP
(a) Net income $28,300 Tot. assets $313,800
Operating expenses $169,800 Net income $51,150
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270 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
RUNWAY FASHION CENTER Trial Balance
November 30, 2012
Debit Credit
Cash $ 37,700 Accounts Receivable 33,700 Inventory 43,000 Supplies 8,800 Equipment 143,000 Accumulated Depreciation—Equipment $ 41,000 Notes Payable 62,000 Accounts Payable 17,800 Common Stock 80,000 Retained Earnings 30,000 Dividends 12,000 Sales Revenue 757,200 Sales Returns and Allowances 6,200 Cost of Goods Sold 505,400 Salaries and Wages Expense 110,000 Advertising Expense 26,400 Utilities Expense 14,000 Maintenance and Repairs Expense 12,100 Freight-out 11,700 Rent Expense 24,000
$988,000 $988,000
Adjustment data:
1. Store supplies on hand total $3,100. 2. Depreciation is $14,000 on the store equipment and $6,000 on the delivery equipment. 3. Interest of $4,400 is accrued on notes payable at November 30. 4. Income tax due and unpaid at November 30 is $3,000.
Other data: $24,000 of notes payable are due for payment next year.
Instructions (a) Journalize the adjusting entries. (b) Prepare T accounts for all accounts used in part (a). Enter the trial balance amounts
into the T accounts and post the adjusting entries. (c) Prepare an adjusted trial balance. (d) Prepare a multiple-step income statement and a retained earnings statement for the
year, and a classified balance sheet at November 30, 2012.
P5-7B At the end of Ehlinger Department Store’s fiscal year on December 31, 2012, these accounts appeared in its adjusted trial balance.
Freight-in $ 7,200 Inventory (beginning) 40,500 Purchases 456,000 Purchase Discounts 12,000 Purchase Returns and Allowances 6,400 Sales Revenue 702,000 Sales Returns and Allowances 8,000
Additional facts:
1. Merchandise inventory on December 31, 2012, is $58,300. 2. Note that Ehlinger Department Store uses a periodic system.
Instructions Prepare an income statement through gross profit for the year ended December 31, 2012.
P5-8B Sandra McLellan operates a clothing retail operation. She purchases all mer- chandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2010, 2011, 2012, and 2013.
Determine cost of goods sold and gross profit under a periodic system.
(SO 4, 5), AP
Calculate missing amounts and assess profitability.
(SO 4, 5, 6), AN
(c) Tot. trial balance $1,015,400 (d) Net income $14,300
Tot. assets $199,500
Gross profit $267,000
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Problems: Set C 271
2010 2011 2012 2013
Inventory (ending) $16,000 $ 11,300 $ 16,400 $ 12,200 Accounts payable (ending) 17,000 Sales revenue 229,700 227,600 222,000 Purchases of merchandise
inventory on account 146,900 155,700 139,200 Cash payments to suppliers 135,900 159,000 127,000
Instructions (a) Calculate cost of goods sold for each of the 2011, 2012, and 2013 fiscal years. (b) Calculate the gross profit for each of the 2011, 2012, and 2013 fiscal years. (c) Calculate the ending balance of accounts payable for each of the 2011, 2012, and
2013 fiscal years. (d) The vice presidents of sales, marketing, production, and finance are discussing the
company’s results with the CEO. They note that sales declined in fiscal 2013. They wonder whether that means that profitability, as measured by the gross profit rate, necessarily also declined. Explain, calculating the gross profit rate for each fiscal year to help support your answer.
*P5-9B At the beginning of the current season, the ledger of Highland Tennis Shop showed Cash $2,500; Inventory $1,700; and Common Stock $4,200. The following trans- actions were completed during April.
Apr. 4 Purchased racquets and balls from Harris Co. $980, terms 2/10, n/30. 6 Paid freight on Harris Co. purchase $60. 8 Sold merchandise to members $750, terms n/30.
10 Received credit of $130 from Harris Co. for damaged racquets that were returned.
11 Purchased tennis shoes from Happy Feet for cash $300. 13 Paid Harris Co. in full. 14 Purchased tennis shirts and shorts from Rivera Sportswear $1,300,
terms 3/10, n/60. 15 Received cash refund of $50 from Happy Feet for damaged merchan-
dise that was returned. 17 Paid freight on Rivera Sportswear purchase $60. 18 Sold merchandise to members $660, terms n/30. 20 Received $500 in cash from members in settlement of their accounts. 21 Paid Rivera Sportswear in full. 27 Granted an allowance of $30 to members for tennis clothing that did
not fit properly. 30 Received cash payments on account from members $550.
The chart of accounts for the tennis shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, Pur- chases, Purchase Returns and Allowances, Purchase Discounts, and Freight-in.
Instructions (a) Journalize the April transactions using a periodic inventory system. (b) Using T accounts, enter the beginning balances in the ledger accounts and post the
April transactions. (c) Prepare a trial balance on April 30, 2012. (d) Prepare an income statement through Gross Profit, assuming merchandise inventory
on hand at April 30 is $3,244.
Journalize, post, and prepare trial balance and partial income statement under a periodic system.
(SO 5, 8), AP
(a) 2012 $150,600
(c) 2012 $24,700
(c) Tot. trial balance $5,846 (d) Gross profit $460
Problems: Set C Visit the book’s companion website, at www.wiley.com/college/kimmel, and choose the Student Companion site to access Problem Set C.
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272 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
Comprehensive Problem CP5 On December 1, 2012, Shiras Distributing Company had the following account balances.
Debits Credits
Cash $ 7,200 Accumulated Depreciation— Accounts Receivable 4,600 Equipment $ 2,200 Inventory 12,000 Accounts Payable 4,500 Supplies 1,200 Salaries and Wages Payable 1,000 Equipment 22,000 Common Stock 15,000
$47,000 Retained Earnings 24,300
$47,000
During December, the company completed the following summary transactions.
Dec. 6 Paid $1,600 for salaries due employees, of which $600 is for Decem- ber and $1,000 is for November salaries payable.
8 Received $1,900 cash from customers in payment of account (no dis- count allowed).
10 Sold merchandise for cash $6,300. The cost of the merchandise sold was $4,100.
13 Purchased merchandise on account from Gong Co. $9,000, terms 2/10, n/30.
15 Purchased supplies for cash $2,000. 18 Sold merchandise on account $12,000, terms 3/10, n/30. The cost of
the merchandise sold was $8,000. 20 Paid salaries $1,800. 23 Paid Gong Co. in full, less discount. 27 Received collections in full, less discounts, from customers billed on
December 18.
Adjustment data:
1. Accrued salaries payable $800. 2. Depreciation $200 per month. 3. Supplies on hand $1,500. 4. Income tax due and unpaid at December 31 is $200.
Instructions (a) Journalize the December transactions using a perpetual inventory system. (b) Enter the December 1 balances in the ledger T accounts and post the December trans-
actions. Use Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Sales Revenue, Sales Discounts, Supplies Expense, Income Tax Expense, and Income Taxes Payable.
(c) Journalize and post adjusting entries. (d) Prepare an adjusted trial balance. (e) Prepare an income statement and a retained earnings statement for December and
a classified balance sheet at December 31.
(d) Totals $65,500 (e) Net income $540
Continuing Cookie Chronicle (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 4.)
CCC5 Because Natalie has had such a successful first few months, she is considering other opportunities to develop her business. One opportunity is to become the exclusive distributor of a line of fine European mixers. Natalie comes to you for advice on how to account for these mixers.
Go to the book’s companion website, at www.wiley.com/college/kimmel, to see the com- pletion of this problem.
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Broadening Your Perspective 273
Financial Reporting and Analysis FINANCIAL REPORTING PROBLEM: Tootsie Roll Industries Inc.
BYP5-1 The financial statements for Tootsie Roll Industries appear in Appendix A at the end of this book.
Instructions Answer these questions using the Consolidated Income Statement. (a) What was the percentage change in total revenue and in net income from 2008 to 2009? (b) What was the profit margin ratio in each of the 3 years? (Use “Total Revenue.”) Comment on
the trend. (c) What was Tootsie Roll’s gross profit rate in each of the 3 years? (Use “Product” amounts.) Com-
ment on the trend.
COMPARATIVE ANALYSIS PROBLEM: Tootsie Roll vs. Hershey
BYP5-2 The financial statements of The Hershey Company appear in Appendix B, following the financial statements for Tootsie Roll in Appendix A.
Instructions (a) Based on the information contained in these financial statements, determine the following
values for each company. (1) Profit margin ratio for 2009. (For Tootsie Roll, use “Total Revenue.”) (2) Gross profit for 2009. (For Tootsie Roll, use “Product” amounts.) (3) Gross profit rate for 2009. (For Tootsie Roll, use “Product” amounts.) (4) Operating income for 2009. (5) Percentage change in operating income from 2009 to 2008.
(b) What conclusions concerning the relative profitability of the two companies can be drawn from these data?
RESEARCH CASE BYP5-3 The April 23, 2008, issue of the Wall Street Journal includes an article by Vanessa O’Connell entitled “Coach Profit Is Up but Margins Are Tightening.”
Instructions Read the article and answer the following questions. (a) Referring to the ratios that were presented in this chapter, interpret the first paragraph of the
article. (b) Explain why investors would be angry that the company has stopped reporting the amount
of its sales from outlet malls separately from its sales at full-priced stores. (c) The article says that the gross margin (gross profit rate) fell from 77.8% to 75%. According
to the article, what were the two causes of this decline?
INTERPRETING FINANCIAL STATEMENTS BYP5-4 Recently, it was announced that two giant French retailers, Carrefour SA and Promodes SA, would merge. A headline in the Wall Street Journal blared, “French Retailers Create New Wal- Mart Rival.” While Wal-Mart’s total sales would still exceed those of the combined company, Wal- Mart’s international sales are far less than those of the combined company. This is a serious concern for Wal-Mart, since its primary opportunity for future growth lies outside of the United States.
Below are basic financial data for the combined corporation (in euros) and Wal-Mart (in U.S. dollars). Even though their results are presented in different currencies, by employing ratios we can make some basic comparisons.
Carrefour Wal-Mart (in millions) (in millions)
Sales C= 70,486 $256,329 Cost of goods sold 54,630 198,747 Net income 1,738 9,054 Total assets 39,063 104,912 Current assets 14,521 34,421 Current liabilities 13,660 37,418 Total liabilities 29,434 61,289
broadening your perspective
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Instructions Compare the two companies by answering the following. (a) Calculate the gross profit rate for each of the companies, and discuss their relative abilities
to control cost of goods sold. (b) Calculate the profit margin ratio, and discuss the companies’ relative profitability. (c) Calculate the current ratio and debt to total assets ratios for the two companies, and discuss
their relative liquidity and solvency. (d) What concerns might you have in relying on this comparison?
FINANCIAL ANALYSIS ON THE WEB BYP5-5 Purpose: No financial decision maker should ever rely solely on the financial information reported in the annual report to make decisions. It is important to keep abreast of financial news. This activity demonstrates how to search for financial news on the Web.
Address: http://biz.yahoo.com/i, or go to www.wiley.com/college/kimmel
Steps
1. Type in either Wal-Mart, Target Corp., or Kmart. 2. Choose News. 3. Select an article that sounds interesting to you and that would be relevant to an investor in
these companies.
Instructions (a) What was the source of the article (e.g., Reuters, Businesswire, Prnewswire)? (b) Assume that you are a personal financial planner and that one of your clients owns stock in
the company. Write a brief memo to your client summarizing the article and explaining the implications of the article for their investment.
Critical Thinking DECISION MAKING ACROSS THE ORGANIZATION BYP5-6 Three years ago, Amy Blodgett and her brother-in-law Dennis Torres opened Megamart Department Store. For the first 2 years, business was good, but the following condensed income statement results for 2012 were disappointing.
MEGAMART DEPARTMENT STORE Income Statement
For the Year Ended December 31, 2012
Net sales $700,000 Cost of goods sold 560,000
Gross profit 140,000 Operating expenses Selling expenses $100,000 Administrative expenses 20,000
120,000
Net income $ 20,000
Amy believes the problem lies in the relatively low gross profit rate of 20%. Dennis believes the problem is that operating expenses are too high. Amy thinks the gross profit rate can be improved by making two changes: (1) Increase average selling prices by 15%; this increase is expected to lower sales volume so that total sales dollars will increase only 4%. (2) Buy merchan- dise in larger quantities and take all purchase discounts; these changes are expected to increase the gross profit rate from 20% to 25%. Amy does not anticipate that these changes will have any effect on operating expenses.
Dennis thinks expenses can be cut by making these two changes: (1) Cut 2012 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales. (2) Reduce store deliver- ies to one day per week rather than twice a week; this change will reduce 2012 delivery expenses of $40,000 by 40%. Dennis feels that these changes will not have any effect on net sales.
Amy and Dennis come to you for help in deciding the best way to improve net income.
274 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
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Instructions With the class divided into groups, answer the following. (a) Prepare a condensed income statement for 2013 assuming (1) Amy’s changes are implemented
and (2) Dennis’s ideas are adopted. (b) What is your recommendation to Amy and Dennis? (c) Prepare a condensed income statement for 2013 assuming both sets of proposed changes are
made. (d) Discuss the impact that other factors might have. For example, would increasing the quan-
tity of inventory increase costs? Would a salary cut affect employee morale? Would decreased morale affect sales? Would decreased store deliveries decrease customer satisfaction? What other suggestions might be considered?
COMMUNICATION ACTIVITY BYP5-7 The following situation is presented in chronological order.
1. Finley decides to buy a surfboard. 2. He calls Surfing USA Co. to inquire about their surfboards. 3. Two days later he requests Surfing USA Co. to make him a surfboard. 4. Three days later Surfing USA Co. sends him a purchase order to fill out. 5. He sends back the purchase order. 6. Surfing USA Co. receives the completed purchase order. 7. Surfing USA Co. completes the surfboard. 8. Finley picks up the surfboard. 9. Surfing USA Co. bills Finley.
10. Surfing USA Co. receives payment from Finley.
Instructions In a memo to the president of Surfing USA Co., answer the following questions. (a) When should Surfing USA Co. record the sale? (b) Suppose that with his purchase order, Finley is required to make a down payment. Would
that change your answer to part (a)?
ETHICS CASE BYP5-8 Margie Anunson was just hired as the assistant treasurer of Northshore Stores, a spe- cialty chain store company that has nine retail stores concentrated in one metropolitan area. Among other things, the payment of all invoices is centralized in one of the departments Margie will manage. Her primary responsibility is to maintain the company’s high credit rating by paying all bills when due and to take advantage of all cash discounts.
Michael Hauer, the former assistant treasurer, who has been promoted to treasurer, is train- ing Margie in her new duties. He instructs Margie that she is to continue the practice of preparing all checks “net of discount” and dating the checks the last day of the discount period. “But,” Michael continues, “we always hold the checks at least 4 days beyond the discount period before mailing them. That way we get another 4 days of interest on our money. Most of our creditors need our business and don’t complain. And, if they scream about our missing the discount period, we blame it on the mail room or the post office. We’ve only lost one discount out of every hundred we take that way. I think everybody does it. By the way, welcome to our team!”
Instructions (a) What are the ethical considerations in this case? (b) What stakeholders are harmed or benefited? (c) Should Margie continue the practice started by Michael? Does she have any choice?
“ALL ABOUT YOU” ACTIVITY BYP5-9 There are many situations in business where it is difficult to determine the proper period in which to record revenue. Suppose that after graduation with a degree in finance, you take a job as a manager at a consumer electronics store called Pacifica Electronics. The company has expanded rap- idly in order to compete with Best Buy.
Pacifica has also begun selling gift cards. The cards are available in any dollar amount and allow the holder of the card to purchase an item for up to 2 years from the time the card is pur- chased. If the card is not used during that 2 years, it expires.
Broadening Your Perspective 275
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Instructions Answer the following questions.
At what point should the revenue from the gift cards be recognized? Should the revenue be recog- nized at the time the card is sold, or should it be recorded when the card is redeemed? Explain the reasoning to support your answers.
FASB CODIFICATION ACTIVITY
BYP5-10 Access the FASB Codification at http://asc.fasb.org to prepare responses to the following (a) Access the glossary (“Master Glossary”) to answer the following.
(1) What is the definition provided for inventory? (2) What is a customer?
(b) What guidance does the Codification provide concerning reporting inventories above cost?
Answers to Insight and Accounting Across the Organization Questions
p. 231 Morrow Snowboards Improves Its Stock Appeal Q: If a perpetual system keeps track of inventory on a daily basis, why do companies ever need to do a physical count? A: A perpetual system keeps track of all sales and purchases on a continuous basis. This provides a constant record of the number of units in the inventory. However, if employees make errors in recording sales or purchases, or if there is theft, the inventory value will not be correct. As a consequence, all companies do a physical count of inventory at least once a year.
p. 238 Should Costco Change Its Return Policy? Q: If a company expects significant returns, what are the implications for revenue recognition? A: If a company expects significant returns, it should make an adjusting entry at the end of the year reducing sales by the estimated amount of sales returns. This is necessary so as not to overstate the amount of revenue recognized in the period.
p. 242 Disclosing More Details Q: Why have investors and analysts demanded more accuracy in isolating “Other gains and losses” from operating items? A: Greater accuracy in the classification of operating versus nonoperating (“Other gains and losses”) items permits investors and analysts to judge the real operating margin, the results of continuing operations, and management’s ability to control operating expenses.
p. 248 Strategic Errors Can Be Costly Q: Explain how Wal-Mart’s profitability gave it a strategic advantage over Kmart. A: If two competitors get into a “price war,” the company with the lower costs can reduce prices further (thus eroding its gross profit rate), but still operate at a profit. Thus, Wal-Mart’s success at minimizing its operating costs has enabled it to drive many competi- tors out of business.
Answers to Self-Test Questions
1. a 2. c 3. c 4. b (($750 � $50) � .98) 5. c 6. c 7. b ($400,000 � $310,000) 8. d 9. a ($60,000 � $380,000 � $50,000) 10. b ($17,200 � ($60,400 � $3,000 � $1,100 � $600)) 11. c 12. c 13. d ($92,400 � $267,000) 14. b *15. b
276 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
IFRS A Look at IFRS The basic accounting entries for merchandising are the same under both GAAP and IFRS. The income statement is a required statement under both sets of standards. The basic format is simi- lar although some differences do exist.
KEY POINTS • Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic system.
• Inventories are defined by IFRS as held-for-sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the providing of services.
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• Under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions like administration, distribution, and manufacturing. Under IFRS, companies must classify expenses by either nature or function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional-expense method on the income statement, disclosure by nature is required in the notes to the financial statements.
• Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach.
• Under IFRS, revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS results in more transactions affecting equity (other comprehensive income) but not net income.
• IAS 1, “Presentation of Financial Statements,” provides general guidelines for the reporting of income statement information. Subsequently, a number of international standards have been issued that provide additional guidance to issues related to income statement presentation.
• Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such as those on so-called “available-for-sale securities”) that are not included in the calculation of net income.
• IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.
LOOKING TO THE FUTURE The IASB and FASB are working on a project that would rework the structure of financial state- ments. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. For example, the amount of income that is generated by operations would be trace- able to the assets and liabilities used to generate the income. Finally, this approach would also pro- vide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature. The new financial statement format was heavily influenced by suggestions from financial statement analysts.
IFRS Self-Test Questions 1. Which of the following would not be included in the definition of inventory under IFRS?
(a) Photocopy paper held for sale by an office-supply store. (b) Stereo equipment held for sale by an electronics store. (c) Used office equipment held for sale by the human relations department of a plastics
company. (d) All of the above would meet the definition.
2. Which of the following would not be a line item of a company reporting costs by nature? (a) Depreciation expense. (b) Salaries expense. (c) Interest expense. (d) Manufacturing expense.
3. Which of the following would not be a line item of a company reporting costs by function? (a) Administration. (b) Manufacturing. (c) Utilities expense. (d) Distribution.
4. Which of the following statements is false? (a) IFRS specifically requires use of a multiple-step income statement. (b) Under IFRS, companies can use either a perpetual or periodic system. (c) The proposed new format for financial statements was heavily influenced by the sugges-
tions of financial statement analysts. (d) The new income statement format will try to de-emphasize the focus on the “net income”
line item.
A Look at IFRS 277
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5. Under the new format for financial statements being proposed under a joint IASB/FASB project: (a) all financial statements would adopt headings similar to the current format of the balance
sheet. (b) financial statements would be presented consistent with the way management usually run
companies. (c) companies would be required to report income statement line items by function only. (d) the amount of detail shown in the income statement would decrease compared to current
presentations.
IFRS Concepts and Application IFRS5–1 Explain the difference between the “nature-of-expense” and “function-of-expense” classifications.
IFRS5–2 For each of the following income statement line items, state whether the item is a “by nature” expense item or a “by function” expense item.
________ Cost of goods sold ________ Depreciation expense ________ Wages and salaries expense ________ Selling expenses ________ Utilities expense ________ Delivery expense ________ General and administrative expenses
IFRS5–3 Gribble Company reported the following amounts in 2012: Net income, C= 150,000; Unrealized gain related to revaluation of buildings, C= 10,000; and Unrealized loss on available-for- sale securities, C= (35,000). Determine Gribble’s total comprehensive income for 2012.
INTERNATIONAL FINANCIAL REPORTING PROBLEM: Zetar plc IFRS5–4 The financial statements of Zetar plc are presented in Appendix C. The company’s complete annual report, including the notes to its financial statements, is available at www.zetarplc.com.
Instructions (a) Is Zetar using a multiple-step or a single-step income statement format? Explain how you
made your determination. (b) Instead of “interest expense,” what label does Zetar use for interest costs that it incurs? (c) What is the approximate tax rate of Zetar’s “Tax on profit from continuing activities”? (d) Using the notes to the company’s financial statements, explain what each of the following
are: (1) Adjusted results. (2) One-off items.
Answers to IFRS Self-Test Questions
1. c 2. d 3. c 4. a 5. b
278 chapter 5 Merchandising Operations and the Multiple-Step Income Statement
●●✓Remember to go back to the navigator box on the chapter opening page and check off your completed work.
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