Chapter 5 Merchandising Operations

LEARNING OBJECTIVES

1. Apply the revenue recognition principle (MASTER) 2. Apply the matching principle to recognize expenses (MASTER)

Revenue is recognized when earned. More specifically when:

l l l

Performance achieved Amount measurable Collection assured

BUT WHAT DOES THIS MEAN?

LO1

Performance achieved:

The company must substantially complete whatever it has to do to earn its revenues.
Examples to enhance your learning: Transferring ownership of goods, rendering services, making leased space available, fulfilling obligations under a contract, etc.
LO1

Amount measurable: The price to be received from the customer must be known or can be estimated.
Enhance your learning: Concept of reliably measurable (also applies to costs or expenses incurred to generate the revenue). Allows means related profit can be estimated.

LO1

Collection assured: If we have not already received the cash, the accounts receivable amount must be collectible at a point in the future.
Enhance your learning: Concept of reasonable assurance as to collectability.
LO1

Generally when we sell something we know the price and we have reasonable assurance that we will collect the Account Receivable (otherwise, we wouldnt deliver the goods or render the service in the first place). The key is often performance (or rather its completion and timing). Most of the time, performance has occurred when a customer takes delivery but not always.

Publisher Inc. delivers newspapers to Veronica Variety on a daily basis. At the end of the month Veronica Variety returns all the unsold papers. On the 10th of the following month Veronica Variety pays Publisher Inc. for the papers that have been sold. When should Publisher Inc. recognize revenue? In order to answer that question, accountants need to identify alternatives points when revenue might be recognized, then consider which alternative best satisfies ALL the recognition criteria, and make a choice or recommendation.

Publisher Inc. delivers newspapers to Veronica Variety on a daily basis. At the end of the month Veronica Variety returns all the unsold papers. On the 10th of the following month Veronica Variety pays Publisher Inc. for the papers that have been sold. When should Publisher Inc. recognize revenue? Possible points in time to recognize revenue are:
When delivered End of the month when unsold papers returned When Veronica Variety is paid in the following month

Discuss with an elbow partner the 3 criteria for EACH of these points and then answer the M/C question on the next slide.

Publisher Inc. delivers newspapers to Veronica Variety on a daily basis. At the end of the month Veronica Variety returns all the unsold papers. On the 10th of the following month Veronica Variety pays Publisher Inc. for the papers that have been sold.

Publisher Inc. should recognize revenue:

A. Daily, when the newspapers are delivered. B. At then end of the month when Veronica Variety returns all the unsold papers. C. On the 10th of the following month, when Veronica Variety pays for the papers sold.
(Be ready to support your answer with REASONING based on all the criteria!)

A hockey fan purchases season tickets. The price includes tickets for the teams 40 home games plus exhibition games. Ticket buyers pay the full price of the tickets in the summer before the season begins and receive the tickets at the time of payment. There are no refunds. At what points could revenue be recognized? Analyze each of these points using the criteria.
In total, when the tickets are sold / purchased A. ____________________________________________ In total, when the season ends B. ____________________________________________ Proportionately, as the games are played C. ____________________________________________

A toll highway sells passes to customers. The passes are equipped with an electronic sensor that subtracts the toll fee from a prepaid balance on a PASS as the motorist approaches a special toll booth. The PASSES are issued in $10 increments. Refunds are available to motorists who do not use the pass balance but these are issued very infrequently. Last year $2,000,000 of passes were issues and $1,700,000 of passes were used at the special toll booths. At what points could revenue be recognized? Analyze each of these points using the criteria. When the PASSES are sold to customers A. ____________________________________________

Gradually, every month when use for the month is known. B. ____________________________________________
In total at the end of the year. C. ____________________________________________

Expenses FOLLOW Revenues. More specifically when:

when used up/consumed when sold (transferred) when incurred (passage of time) TO HELP GENERATE REVENUE!

LO1

Balance Sheet

Income Statement

ASSETS:
Inventory
when sold as used / consumed

EXPENSES:
Cost of goods sold Supplies expense Insurance expense Rent expense

Supplies Prepaid assets

PP&E Intangibles

over period as they are incurred

Amortization expense
Other expenses (e.g. salaries) - as incurred

LO2

DIRECT EXPENSES

INDIRECT EXPENSES

Expenses that are connected to revenues (i.e. the revenue causes or triggers the expense)
e.g. Cost of goods sold

Expenses that result from or arise in the course of running a business but are not directly connected to revenue.
e.g. Hydro costs

LO2

Asset or Expense?

Direct or Indirect?

Record the cost as either a: 1. Asset first, expense later, OR 2. Expense immediately.
LO2

The cost is either:

1. Directly related to revenues,

OR 2. Indirectly related to revenues.

A. Asset first, expense later, direct

B. Expense immediately, direct C. Asset first, expense later, indirect D. Expense immediately, indirect

(ensure you can explain why you choose this option!)

A. Asset first, expense later, direct

B. Expense immediately, direct C. Asset first, expense later, indirect D. Expense immediately, indirect

(ensure you can explain why you choose this option!)

A. Asset first, expense later, direct

B. Expense immediately, direct C. Asset first, expense later, indirect D. Expense immediately, indirect

(ensure you can explain why you choose this option!)

A. Asset first, expense later, direct

B. Expense immediately, direct C. Asset first, expense later, indirect D. Expense immediately, indirect

(ensure you can explain why you choose this option!)

The remaining Learning Objectives will be covered in the follow order:

LO3: Describe the basic format and the content of the income statement. (UNDERSTAND) LO4: Prepare entries for purchases under a perpetual inventory system. (MASTER) LO5: Prepare entries for sales under a perpetual inventory system. (MASTER)

Revenues $$$ Less: expenses ($$) Net income $$

Single Step

LO3

Multi-Step Income Statement

Income Statement Format Gross Sales Less: Sales returns and allowances Less: Sales discounts Net sales Cost of goods sold $XXX XX XX XXX XX XXX XX XX XXX XXX XX XX XXX XX $XXX

Gross profit
Operating Expenses Selling expenses General & Admin expenses Total operating expenses Income from operations Other revenues and gains Other expenses and losses Income before taxes Income tax expense Net Income LO3

MultipleStep Income Statement Four important subtotals

A.
B. C.

Yes because. No because. Could not tell you if my life depended on it!

Remember if you answer a question like this on the midterm or final exam you have to support your answer with reasoning!

Net Sales
Total sales revenue Less: Sales returns & allowances Sales discounts Net sales $ 368,000 ( 6,000) ( 4,500) $ 357,500

Are these expense accounts?

The issue in a merchandising company is that you, the accountant, wear two different hats: The Purchaser of Inventory The Seller of Inventory This is because merchandising companies are both: they purchase inventory from suppliers and they sell inventory to their customers.

If you are completing a question, ask yourself: what is my role at this time: Purchaser or Seller?

The Purchaser of Inventory

Lets wear the Purchaser hat first to see what affect these transactions have on the accounting equation.

Baby Room Inc. has 20 change tables in their store, each costing $120 on April 1, 2013. This is their opening balance in their inventory account.

Assets

= Liabilities + Shareholders Equity

Should an entry be made for the opening balance in inventory? A. Yes, absolutely. B. No, definitely not. C. Uncertain!

Baby Room Inc. purchases 50 change tables for $120 each on account on April 3, 2013. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

A. Increase assets, decrease assets. B. Decrease assets, decrease shareholders equity through expenses. C. Increase assets, increase liabilities. D. Increase assets, increase shareholders equity through revenue. E. Uncertain!

Baby Room Inc. purchases 50 change tables for $120 each on account on April 3, 2013. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

To record purchases: If purchased for cash: Assets + (inventory) Assets - (cash) If purchased on account: Liabilities + (accounts payable) Assets + (inventory)

FOB Destination: Freight is paid by the seller (supplier/shipper). FOB Shipping Point: Freight is paid by the purchaser (buyer)

Baby Room Inc. purchases 50 change tables for $120 each on account on April 3, 2013, FOB destination. The appropriate party paid $200 freight costs on April 4. What is the impact on the accounting equation? Assets = Liabilities + Shareholders Equity

A. Increase assets, decrease assets. B. Decrease assets, decrease shareholders equity through expenses. C. Increase assets, increase liabilities. D. No entry. E. Uncertain!

Assume that INSTEAD, Baby Room Inc. purchases 50 change tables for $120 each on account on April 3, 2013, FOB shipping point. The appropriate party paid $200 freight costs on April 4. What is the impact on the accounting equation? Assets = Liabilities + Shareholders Equity

A. Increase assets, decrease assets. B. Decrease assets, decrease shareholders equity through expenses. C. Increase assets, increase liabilities. D. No entry. E. Uncertain!

Assume that INSTEAD, Baby Room Inc. purchases 50 change tables for $120 each on account on April 3, 2013, FOB shipping point. The appropriate party paid $200 freight costs on April 4. What is the impact on the accounting equation? Assets = Liabilities + Shareholders Equity

To record freight: If paid for cash: Assets + (inventory) Assets - (cash)

Baby Room Inc. returns 5 change tables due to defects on April 8. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

A. Decrease assets, increase assets. B. Decrease assets, decrease shareholders equity through expenses. C. Decrease assets, Decrease liabilities. D. No entry. E. Uncertain!

Baby Room Inc. returns 5 change tables due to defects on April 8. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

To record returns you simply reverse the original entry: If originally purchased for cash: Assets + (cash) Assets - (inventory) If purchased on account: Liabilities - (accounts payable) Assets (inventory)

 In

order to encourage early payment of accounts some companies provide terms These terms relate to how much needs to be paid and when. Example: 2/10, n/30 means: Pay within 10 days, get a 2% discount on the purchase price If you choose not to pay within 10 days, you must pay the n = net amount by the 30th day.

To record payments to suppliers, you have to consider if the buyer has taken advantage of the terms. If paying NET amount (no discount taken): Liabilities - (accounts payable) Assets (cash)
If paying DISCOUNTED amount (pay within 10 days) how would your entry change?

Steps to determine how much needs to be paid:

1. 2.

3.

FIRST, determine correct accounts payable amount (go back to original entry and deduct any returns). SECOND, determine what the last date to take the discount was (add # of days to the DAY that the original shipment was received). THEN, determine the amount that you need to pay the supplier.

Baby Room Inc. purchases 50 change tables for $120 each, terms 2/10, n/30 on April 3, 2013. They pay on April 12. What is the impact on the accounting equation on the date they pay? Assets = Liabilities + Shareholders Equity

Follow the steps on the next slide in order to determine what the impact will be.

Steps to determine how much needs to be paid:

1.

2.

3.

FIRST, original purchase was 50 @ $120 = $6,000. There were returns of 5 @ $120 = $600. Therefore, the total amount is $5,400 in A/P. SECOND, the last day to take the discount is April 3 plus 10 days = April 13th. They are paying on April 12 so they can take the discount. Amount that should be paid is $5,400 * 98% (as they get 2% discount) which is $5,292.

Baby Room Inc. purchases 50 change tables for $120 each, terms 2/10, n/30 on April 3, 2013. They pay on April 12. What is the impact on the accounting equation on the date they pay? A. Decrease cash, decrease A/P by $5,292. B. Decrease cash by $5,292, decrease A/P by $5,400. C. Decrease cash by $5,292, decrease A/P by $5,400, decrease Sales Discounts by $108. D. Decrease cash by $5,292, decrease Purchase Discounts by $108, decrease A/P by $5,400. E. Decrease cash by $5,292, decrease Inventory by $108, decrease A/P by $5,400.

Baby Room Inc. purchases 50 change tables for $120 each, terms 2/10, n/30 on April 3, 2013. They pay on April 12. What is the impact on the accounting equation on the date they pay? Assets = Liabilities + Shareholders Equity

To record payments: If pay the NET amount: Assets - (cash) Liabilities - (A/P) If pay the DISCOUNTED amount: Assets (cash @ the discounted amount) Assets - (Inventory @ the amount of the discount) Liabilities - (A/P the original amount)

Exercise 6-13, page 279

Complete with an elbow partner.

NOTE: record the PERPETUAL entries ONLY and only to Oct. 8th.

You have 5 minutes.

The Seller of Inventory

Now that we have inventory on our shelves to sell to our customers, lets wear the Seller hat to see what affect sales transactions have on the accounting equation.

Baby Room Inc. sells 6 change tables on April 7 for $256 each, terms 1/10, n/45. The change tables were shipped FOB Destination. What is the impact on the accounting equation? Assets = Liabilities + Shareholders Equity

Sales always have 2 entries: 1. Sales entry at the selling price to the Sales account. 2. Cost entry at the cost of inventory to the Cost of goods sold account.

Sell inventory sales entry @ the selling price: Assets + (cash or A/R) Revenues + (Sales) Sell inventory cost entry @ the cost of inventory: Assets - (inventory) Expenses + (cost of goods sold)

Note that when we sell our inventory there are 2 entries a sales entry at the price we sold the inventory for and a cost entry at the original price we paid for the inventory.

The change tables were shipped FOB Destination. On April 8 the appropriate party paid $90 for freight. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

Who would pay the shipping costs? A. Baby Room Inc. B. Buyer of change tables.

The change tables were shipped FOB Destination. On April 8 the appropriate party paid $90 for freight. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

A. Decrease cash, increase inventory by $90 B. Decrease cash, decrease shareholders equity through the Freight Out Expense by $90. C. Increase A/P, decrease shareholders equity through the Freight Out Expense by $90. D. None of the above.

The change tables were shipped FOB Destination. On April 8 the appropriate party paid $90 for freight. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

The customer returns 1change table on April 10 as it was the wrong wood colour. For any return of inventory by the customer we would have to
A. B. C. D.

Reverse the sales entry only. Reverse the cost entry only. Reverse both the sales entry and the cost entry. Not sure!

The customer returns 1change table on April 10 as it was the wrong wood colour. For any return of inventory by the customer we would have to

Assets

= Liabilities + Shareholders Equity

A. B. C. D.

Reverse the sales entry only. Reverse the cost entry only. Reverse both the sales entry and the cost entry. Not sure!

Return inventory reverse sales entry @ the selling price: Assets - (cash or A/R) Revenue - (Sales returns and allowances)

Return inventory reverse cost entry @ the cost of inventory: Assets + (inventory) Expenses - (cost of goods sold)

Note: this is a reversal of the original entries EXCEPT for the use of the Sales Returns and Allowances account instead of Sales!

The customer of Baby Room Inc. pays the outstanding balance on their account on April 17. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

Similar to a purchaser, there are steps that the seller must follow in order to determine the amount that the customer must pay.

Steps to determine how much will be received :

1.

2.

3.

FIRST, determine correct accounts receivable amount (go back to original entry and deduct any returns made by the customer). SECOND, determine what the last date that the customer can take the discount (add # of days to the DAY that the original shipment was received by the customer). THEN, determine the amount that you will receive from the customer.

Steps to determine how much will be received: Use this empty slide to calculate the numbers.

The customer of Baby Room Inc. pays the outstanding balance on their account on April 17. What is the impact on the accounting equation?

Assets

= Liabilities + Shareholders Equity

IF the customer of Baby Room Inc. had paid their bill on April 18th (beyond the discount period) then the entry would have been as follows:

Assets

= Liabilities + Shareholders Equity

Problem 6-1, page 280

Complete as a class on the whiteboard.

Exercise 5-6, page 229 Problem 6-1A, page 284 Problem 5-3, page 231

Exercise 5-6, page 229

Complete as a class on the whiteboard.

Problem 6-1A, page 284

Complete as a class on the whiteboard.

Problem 5-3, page 231

Give students time to categorize the accounts, then take up on next slide.