Introduction to Financial Accounting
Merchandising Operations (Chapter 5)
February 25th, 2013
by Professor Victoria Chiu
The main objectives of this lecture is to describe and illustrate merchandising operations & the two main types of inventory systems. We also aim to master how to account for the purchase & sale of inventory using a perpetual system. How to adjust & close the accounts of a merchandising business, as well as preparing merchandisers' financial statements is covered, as well as using the gross profit percentage & inventory turnover to evaluate the health of a business.
The operating cycle consists of the company purchasing inventory from the vendor / supplier, & then collects cash by selling the inventory to a customer. Merchandisers are businesses that sell a product to customers. New accounts that they use (that we didn't already cover) include inventory (a current asset account listed on the balance sheet). Inventory is the merchandise that a company holds for sale to customers. Sales revenue and cost of goods sold (type of expense) are also two new accounts we deal with (listed on the income statement). Sales revenue is the retail price of the inventory sold to the customer & cost of goods sold is the cost (to the company) of the inventory sold to the customer.
A perpetual inventory system keeps a running computerized record of inventory (thanks to bar codes). A contemporary perpetual inventory system constantly records units purchased & cost amount, the units sold & sales & cost amounts, & the quantity of inventory on hand & its cost. It also better controls inventory due to the fact the inventory & purchasing systems are integrated with accounts receivable & sales. Despite it being computerized, physical counts do occur once every year to double check that the ending inventory listed is the correct amount (since spoilage, theft, & other factors may result in loss of inventory without a sale). The perpetual system is most popular.
Bar cods are used by businesses today to streamline many formerly repetitive & labor intensive processes related to inventory. It is used to record sales & cost of goods sold, as well as to update the inventory count. It also updates purchasing & generates purchase orders (replenishes inventory by communicating with the company's purchasing systems).
Under the periodic inventory system, goods are counted periodically to determine quantity. Under this system, businesses physically count their inventories periodically to determine the quantities on hand. It is used by small businesses, restaurants, & small retail stores (that lack optical-scanning cash registers). It is normally used for relatively inexpensive goods. However, it is less popular than the perpetual system due to computerized inventory systems being much easier & more convenient to use.
When inventory is purchased, the inventory account ( a current asset) is increased with each purchase. The vendor submits an invoice for payment (the seller's request for payment from the buyer). The invoice contains the seller, the purchaser, the date of purchase / shipment, the credit terms, the total amount due, & the due date. It should be noted that the inventory account is also impacted by shipping costs, returned purchased items, & early payment discounts.
The journal entry to purchase inventory is simply a debit to the inventory account & a credit to the accounts payable account for the same amount. If purchased with cash rather than with credit, simply credit cash instead of crediting accounts payable.
Purchase discounts involve the customer getting a discount for making an early payment within a given period (determined by the seller). For example, the buyer is legible for a 3% discount if the buyer pays for the goods within 15 days. If the buyer does not pay within 15 days, they are responsible for the full amount (within 30 days). The above example would be denoted 3/15, n/30. EOM stands for end of month.
Purchase Returns & allowances are also discussed, as well as transportation & freight costs (FOB destination & shipping point).
Video begins with overview of learning objectives
Operating Cycle: 3:31
Balance Sheet Diff: 10:18
Income Statement Diff: 10:59
Perpetual Inventory System: 12:59
Bar Codes: 16:19
Periodic Inventory System: 17:35
Purchasing Inventory: 20:03
Journal Entry for Purchase of Inventory: 22:53
Purchase Discounts: 24:46
Payment Within Discount Period: 29:53
Purchase Returns and Allowances: 34:23
Journal Entry for Purchase Returns & Allowances: 37:34
Transportation Costs: 40:22
FOB Shipping Point: 45:20
Purchase Discount - Shipping is Added to Invoice: 46:06
FOB Destination: 49:56
Summary of Purchase Returns & Allowances,
Discounts, & Transportation Costs: 52:53
Exercise S5-2 - (Analyzing Purchase Transactions - Perpetual Inventory): 55:50
Midterm Review: 1:04:54