Once those reductions are recorded at the
end of a period, net sales are calculated. Net
sales (see
Figure 6.7) equals gross sales less sales discounts, sales
returns, and sales allowances. Recording the sale as it occurs
allows the company to align with the revenue recognition principle.
- When a vendor offers a discount to a merchandising business, that discount (when taken) reduces the cost of the merchandise.
- The specific calculation of net purchases will be demonstrated after a few more concepts are introduced.
- There are two kinds of purchase discounts, cash discounts and
trade discounts.
18 Purchased merchandise on account from Tan Company invoiced at $ 28,800; terms 2/15, n/30, FOB shipping point, freight collect. June 1 Stockholders invested $ 384,000 cash and $ 144,000 of merchandise inventory in the business in exchange for capital stock. Take a moment and look at the invoice presented self employed invoice template earlier in this chapter for Barber Shop Supply. Notice that the seller was in Chicago and the purchaser was in Dallas. Just to the right of the invoice date, note that the terms were F.O.B. Dallas. This means that Barber Shop Supply is responsible for getting the goods to the customer in Dallas.
Ethical Discounts
A physical inventory is typically taken once a year and means the actual amount of inventory items is counted by hand. The physical inventory is used to calculate the amount of the adjustment. For both the return and the allowance, if the customer had
already paid their account in full, Cash would be affected rather
than Accounts Receivable. At issue is that the employee of the outside organization is
placed in a conflict between their personal interests and the
interest of their employer. In these situations, it is best for the
accountant’s employer to respect the other organization’s code of
conduct. As well, it might be illegal for the accountant’s employer
to provide discounts to a governmental organization’s employees.
- Accounts payable is considered a current liability, not an asset, on the balance sheet.
- The first entry closes the purchase accounts (purchases, transportation in, purchase discounts, and purchase returns and allowances) into inventory by increasing inventory.
- In a periodic inventory system, the real-time balances in merchandise inventory and cost of goods sold are not known.
- However, the merchandise can vary greatly depending on the type of business and industry.
- This increases Cash (debit) and decreases (credit) Merchandise Inventory-Phones because the merchandise has been returned to the manufacturer or supplier.
Service companies often have simple financial transactions that
involve taking customer deposits, billing clients after services
have been provided, providing the service, and processing payments. These activities may occur frequently within a company’s accounting
cycle and make up a portion of the service company’s operating
cycle. A physical count of merchandise inventory is performed and the total compared to the general ledger balance of Merchandise Inventory.
Separating the accounts
would help a retailer distinguish between items that are returned
and those that the customer kept. This can better identify quality
control issues, track whether a customer was satisfied with their
purchase, and report how many resources are spent on processing
returns. Most companies choose to combine returns and allowances
into one account, but from a manager’s perspective, it may be
easier to have the accounts separated to make current
determinations about inventory. Also assume that the retail’s costs of goods sold in this
example were $560 and we are using the perpetual inventory method.
The number of days allowed for both the discount period and the full payment period begins counting from the invoice date. Purchase discounts provide an incentive for the retailer to pay early on their accounts by offering a reduced rate on the final purchase cost. Receiving payment in a timely manner allows the manufacturer to free up cash for other business opportunities and decreases the risk of nonpayment. Their income statement format is a bit more complicated than for a service company and is discussed in greater detail in Describe and Prepare Multi-Step and Simple Income Statements for Merchandising Companies. A simple retailer income statement is shown in Figure 6.5 for comparison.
Accounting for Purchase Transactions in a Merchandising Business
The periodic inventory methods has TWO additional adjusting entries at the end of the period. The first entry closes the purchase accounts (purchases, transportation in, purchase discounts, and purchase returns and allowances) into inventory by increasing inventory. Merchandise inventory, an asset, is purchased from suppliers and resold to customers to generate sales revenue. The cost of the merchandise inventory sold is an expense called cost of goods sold. The profit realized on the sale of merchandise inventory before considering any other expenses is called gross profit. To track merchandise inventory and cost of goods sold in real time, a perpetual inventory system is used; the balance in each of Merchandise Inventory and Cost of Goods Sold is always up-to-date.
Purchase of Merchandise: What It Is, Accounting, Journal Entry, Example, Definition, Cash or Account
The inventory account is credited for the amount the retailer paid for the inventory and the cost of goods sold account is debited for the same account. As you can see, the guitar store records the cash coming in, inventory going out, the revenues generated from the sale, and the costs allocated to the inventory. In most cases inventory is the biggestasseton aretailer’s balance sheet. Some businesses still use a periodic inventory system in which the purchase of merchandise inventory is debited to a temporary account called Purchases. At the end of the accounting period, inventory is counted (known as a physical count) and the merchandise inventory account is updated and cost of goods sold is calculated.
Internal Controls over Merchandise Returns1
There are a few transactional situations that may occur after a
sale is made that have an effect on reported sales at the end of a
period. When the terms of the sale indicate FOB Destination, the seller records the cost as Delivery Expense or Freight Out. On July 10, CBS discovers that 4 more printers from the July 1 purchase are slightly damaged but decides to keep them, with the manufacturer issuing an allowance of $30 per printer.
This is called separation of duties and is just one example of an internal control that should be used when merchandise is returned. If the retailer does not pay within the discount window, they do not receive a discount but are still required to pay the full invoice price at the end of the term. In this case, Accounts Payable is debited and Cash is credited, but no reductions are made to Merchandise Inventory.
Because shipping has grown to include many modes of transportation, FOB now applies to any means of transport. In the original entry, Terrance Inc. purchased 100 Terrance Action Figures for $5 each. To better illustrate merchandising activities, let’s follow California Business Solutions (CBS), a retailer providing electronic hardware packages to meet small business needs. Each electronics hardware package (see Figure 2.33) contains a desktop computer, tablet computer, landline telephone, and a 4-in-1 desktop printer with a printer, copier, scanner, and fax machine.
Basic Analysis of Purchase Transaction Journal Entries
Of course, before a good relationship is built the company usually needs to purchase the merchandise in cash first. In this case, the company may need to make journal entry for merchandise purchased on credit as well as on merchandise purchased on cash as it may have several or many suppliers in its merchandising business. There are differing opinions as to whether sales returns and allowances should be in separate accounts. Separating the accounts would help a retailer distinguish between items that are returned and those that the customer kept.
On 1 January 2016, John Traders purchased merchandise for $15,000 in cash from Sam & Co. Revenue is only increased when receivables are converted into cash inflows through the collection. Revenue represents the total income of a company before deducting expenses. Importantly, storage costs, insurance, interest and other similar costs are considered to be period costs that are not attached to the product.