mcgraw-hill/irwin © the mcgraw-hill companies, inc., chapter four accounting for merchandising...

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.,

Chapter Four

Accounting for Merchandising

Businesses

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5- 2

Inventory

Inventory is tangible property that is held for resale or will be used in producing goods or services.

Inventory is reported on the balance sheet as an asset.

Types of inventory: Merchandise inventory Raw materials inventory Work in process inventory Finished goods inventory

manufacturer


5- 3

Inventory Cost

The cost principle requires that inventory be recorded for the price paid or the consideration given up.

What type of transaction is the purchase of inventory?

Asset Exchange if cash paid.

Asset Source if “on account”.


5- 4

Inventory Cost The amount recorded for inventory

should include: Invoice price (minus purchase

discounts), transportation-in costs (also called “freight-in”), inspection costs, and preparation costs.

The company should accumulate costs of purchases until raw materials are ready for use or until merchandise is ready for shipment to customers.


5- 5

Income Statement Change

Net Sales 7,500Less: Cost of goods sold -

3,000Gross Profit Margin 4,500

Because of Cost of Goods Sold, the format for the Income Statement is modified:


5- 6

Product Costs Versus Selling and Administrative Costs

Product Costs

Costs that are included in inventory.

Selling & Admin. Costs

Costs that are not included in inventory. They are sometimes called period

costs.


5- 7

Cost of Goods Sold

Cost of goods sold is calculated as the number of units sold during the period multiplied by their unit costs.

Cost of goods sold is a major expense item for most non-service businesses.

The measurement of cost of goods sold is an excellent example of the application of the matching principle Why?

The Cost of Goods Sold EXPENSE is recorded in the period the units are SOLD (REVENUE is recognized), regardless of when the units are paid for. So, the EXPENSE is MATCHED against the related REVENUE.


5- 8

Cost of Goods Sold

Beginning inventory

Add: Purchases (net)

Cost of Goods Available for Sale

Deduct: Ending inventory

Cost of goods sold

Cost of Goods Available for Sale expresses the total cost of what has been available for sale throughout a given time period.


5- 9

5-9

Allocation of Inventory Cost Between Asset and Expense

Accounts

Beginning Inventory Balance

+

Inventory Purchased During the

Period

=

Cost of Goods

Available for Sale

Cost of Goods Available for

Sale

Merchandise Inventory

(Balance Sheet)

Cost of Goods Sold

(Income Statement)


5- 10

Purchase $4,000 of Office Supplies Date Account Title Debit Credit

Jan. 6 Supplies 4,000

Cash 4,000

Post from General Journal to the General Ledger

4,000 4,000

Supplies Cash


5- 11

$1,000 of Supplies left over at the end of the month Date Account Title Debit Credit

Jan. 30 Supplies Expense 3,000

Supplies 3,000

Record use of $3,000 of Supplies Post from General Journal to the General Ledger

3,000 3,000

Supplies Expense Supplies


5- 12

Purchase 1,000 units of Inventory for $4,000 Date Account Title Debit Credit

Jan. 6 Inventory 4,000

Cash 4,000

Purchase 1,000 units @ $4.00 each Post from General Journal to the General Ledger

4,000 4,000

Inventory Cash


5- 13

$1,000 of Inventory left over at the end of the month Date Account Title Debit Credit

Jan. 30 Cost of Goods Sold 3,000

Inventory 3,000

Record sale of 750 units of Inventory Post from General Journal to the General Ledger

3,000 3,000

Cost of Goods Sold Inventory


5- 14

$3,000 of Inventory was sold for $7,500 Cash Date Account Title Debit Credit

Jan. 30 Cash 7,500

Revenue 7,500

Record sale of Inventory @ $10 each Post from General Journal to the General Ledger

7,500 7,500

Cash Sales Revenue


5- 15

A deduction from the invoice price granted to induce early payment

of the amount due.

A deduction from the invoice price granted to induce early payment

of the amount due.

Terms

Time

Due

Discount Period

Full amountless discount

Credit Period

Full amount due

Purchase or Sale

Cash Discounts


5- 16

Terms of Sales & PurchasesDiscount Terms: 2/10, n/30 (for example)

2% discount if balance paid in ten days,remainder to be paid within 30 days of sale

tells when and how much must be paid There is a high interest cost of not taking

purchase discounts when offered.


5- 17

2/10, n/30Percentage of Discount

# of Days Discount Is Available

Otherwise, the Full

Amount Is Due

# of Days when Full Amount Is

Due

Cash Discounts


5- 18

Terms of Sales & PurchasesF. O. B. (Free On Board) shipping

point or F.O.B. destination tells who pays for the shipping and

when ownership “title” passes from the seller to the buyer.


5- 19

FOB Shipping and FOB Destination

FOB Shipping Point: Buyer pays the shipping costs because ownership “title” transfers to buyer at the point the shipment starts on its journey.

FOB Destination: Seller pays shipping costs because title does not transfer to the buyer until the goods reach their destination (the buyer’s place of business).


Who Pays for FOB?

5- 20

Business

Supplier

Customer

Shipping Point

Shipping Point

Destination

Destination

Shipping Pt –

Business pays

Shipping Pt –

Customer pays

Destination –

Business pays

Destination –

Supplier pays


5- 21

1. Purchased 1000 units for $4 each on account. (Terms: 2/10, n/30)

BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW ASSETS = LIABILITY + STK. EQUITY STATEMENT

Accts. Accounts Com. Retain. Rev./ Exp./ Net OA,IA,FA

Cash + Receiv. + Inventory = Payable + Stk. + Earn. Gain - Loss = Inc. $ amt

1 4,000 = 4,000 =

Asset Source Transaction


5- 22 1. Journalize & Post the purchase.

BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW ASSETS = LIABILITY + STK. EQUITY STATEMENTAccts. Accounts Com. Retain. Rev./ Exp./ Net OA,IA,FA


1 4,000 = 4,000 =

GENERAL JOURNALDate Account Titles Debit Credit

1 Inventory 4000Accounts Payable 4000

to record 1000 units purchased for $4 ea. on credit

GENERAL LEDGER ("T" - Accounts) Assets = Liabilities + Equity

Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 bb 4000 1000 bb 6000 bb 2000 bb

4000 (1) Sales Returns Sales Revenue

Inventory Cost of Gds Sold Transportation Out(1) 4000


5- 23

2. Paid a trucking company $500to deliver the purchased unitsto our warehouse.




2 (500) 500 = = (500) OA

Freight charges paid to get inventory to our place of business (called TRANSPORTATION IN) is part of the cost of the purchase. It is added to the Inventory account, thus increasing the asset value. It is NOT “expensed”.

Asset ExchangeTransaction


5- 242. Journalize & Post the transportation cost



2 (500) 500 = = (500) OA


2 Inventory 500Cash 500

to record $500 Transportation In cost


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 1000 bb 6000 bb 2000 bb

4000 (1) Sales Returns Sales Revenue

Inventory Cost of Gds Sold Transportation Out(1) 4000(2) 500


5- 25

3. Sold 620 units on account for $6 each. (Terms 1/10, n/30)




3a 3,720 = 3,720 3,720 = 3,720

$6 sales price x 620 units = $3720

3a. Record the Sales Revenue and related Receivable.

Asset SourceTransaction


5- 26

3a. Journalize and Post the sale. BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW

ASSETS = LIABILITY + STK. EQUITY STATEMENTAccts. Accounts Com. Retain. Rev./ Exp./ Net OA,IA,FA


3a 3,720 = 3,720 3,720 = 3,720


3a Accounts Receivable 3720Sales Revenue 3720

to record 620 units sold @ $6 ea.



(3a)3720 4000 (1) Sales Returns Sales Revenue3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000(2) 500


5- 27

620 units sold x $4.50 cost each = $2790

3b. Record the Cost of the Goods Sold and their removal from inventory.

What is the cost of each item in inventory?$4.00 invoice price + $0.50 transportation

= $4.50 per unit$500 transport / 1000 units


5- 28




3b (2,790) = (2,790) 2,790 = (2,790)

620 units sold x $4.50 cost each = $2790

3b. Record the Cost of the Goods Sold and their removal from inventory.

Cost of goods sold

Asset UseTransaction


5- 29

3b. Journalize and Post the cost of the sale. BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW



3b (2,790) = 2,790 = (2,790) GENERAL JOURNAL

Date Account Titles Debit Credit

3b Cost of Goods Sold 2790Inventory 2790

to record the $4.50 cost of 620 units sold



(3a)3720 4000 (1) Sales Returns Sales Revenue3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000 (3b) 2790 (3b) 2790(2) 500


5- 30

4. The customer in Transaction #3A returned 20 units for credit.



4a (120) = (120) (120) = (120)

$6 sales price x 20 units = $120

4a. Remove the previously recorded Sales Revenue and related Account Receivable.

A separate “Sales Return” contra-revenue account may be used.

Asset UseTransaction


5- 31

4a. Journalize and Post the sales return. BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW



4a (120) = (120) = (120)


4a Sales Returns (a contra-revenue) 120Accounts Receivable 120

record 20 units returned by customer @ $6 ea.


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) 1000 bb 6000 bb 2000 bb

(3a)3720 4000 (1) Sales Returns Sales Revenue(4a) 120 3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000 2790 (3b) (3b)2790(2) 500


5- 32

4b. Put the cost of the 20 returned units back into inventory and out of Cost of Goods Sold. (Recall, the units were “costed out” of inventory and charged to Cost of Goods Sold at $4.50 each in Tr. #3b.)



4b 90 = 90 (90) = 90

$4.50 x 20 units = $90Reduction in “Cost of Goods Sold”.



5- 33

4b. Journalize and Post the return to inventory. BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW



4b 90 = 90 (90) = 90


4b Inventory 90Cost of Goods Sold 90

record 20 units returned to inventory @ $4.50 ea.



(3a)3720 4000 (1) Sales Returns Sales Revenue(4a) 120 3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000 2790 (3b) (3b)2790 90 (4b)(2) 500(4b) 90


5- 34

5a. The Transaction #3a customer paid within the ten day discount period.Record the Sales Discount. (1/10, n/30)



3a 3,720 = 3,720 3,720 = 3,720

4a (120) = (120) (120) = (120)

5a (36) = (36) (36) = (36)

Original Account Receivable (Transaction 3a) $3,720Less: Sales Return (Transaction 4a) 120Amount owed by customer before discount 3,600x 1% sales discount 1% Sales Discount $ 36



5- 35

5a. Journalize and Post the 1% Sales Discount. ASSETS = LIABILITY + STK. EQUITY STATEMENTAccts. Accounts Com. Retain. Rev./ Exp./ Net OA,IA,FA


5a (36) = (36) (36) = (36)


5a Sales Revenue (or Sales Discount) 36Accounts Receivable 36

to record 1% discount on Trans. #3a credit sale



(3a)3720 36 (5a) 4000 (1) Sales Returns Sales Revenue(4a) 120 (5a) 36 3720 (3a)



5- 36

5b. The Transaction #3a customer paid within the ten day discount period. Record the cash collection.




3a 3,720 = 3,720 3,720 = 3,720

4a (120) = (120) (120) = (120)

5a (36) = (36) (36) = (36)

5b 3,564 (3,564) = = 3,564 OA

Original Account Receivable (Transaction 3a) $3,720Less: Sales Return (Transaction 4a) (120)Less: Sales Discount (Transaction 5a) (36) Cash receipt that will satisfy the account $3,564

Asset ExchangeTransaction


5- 37

5b. Journalize and Post the cash collection.



5b 3,564 (3,564) = = 3,465 OA


5b Cash 3564Accounts Receivable 3564

Collect from Tr. 3 customer (less return and disc.)


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) 1000 bb 6000 bb 2000 bb(5b) 3564 (3a)3720 36 (5a) 4000 (1) Sales Returns Sales Revenue

3564 (5b) (4a) 120 (5a) 36 3720 (3a)



5- 38

6. Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.



6 (225) = (200) (25) 25 = (25)

Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account.That’s what we’ll do here.

Supplier cost was $4.00 per unit x 50 = $200. Transportation cost recorded when units were purchased was $0.50 per unit x 50 = $25.


5- 39

6. Returned 50 units to our supplier who granted us credit for the

cost of the items but not for any transportation costs. BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW



6 (225) = (200) (25) 25 = (25)


6 Accounts Payable 200Cost of Goods Sold (or "Inventory Loss") 25

Inventory 225Adjustment for inventory returned to our supplier.


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) (6) 200 1000 bb 6000 bb 2000 bb(5b) 3564 (3a)3720 36 (5a) 4000 (1) Sales Returns Sales Revenue

3564 (5b) (4a) 120 (5a) 36 3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000 2790 (3b) (3b)2790 90 (4b)(2) 500 225 (6) (6) 25(4b) 90


5- 40

7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.



7 (45) = (45) 45 = (45)

Units in Beginning Inventory 0+ Units Purchased this period (1000- 50 purchase returns) 950= Units Available for Sale 950- Units Sold (620 – 20 sales returns) (600)= Units that should be in ending inventory

350- Actual ending inventory from count (340)= Units missing 10x $4.50 cost per unit $45.00


5- 41

7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.



7 (45) = (45) 45 = (45)

Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account.

That’s what we’ll do here.


5- 427. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.



7 (45) = (45) 45 = (45)


7 Cost of Goods Sold (or "Inventory Loss") 45Inventory 45

Adjustment for missing inventory


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) (6) 200 1000 bb 6000 bb 2000 bb(5b) 3564 (3a)3720 36 (5a) 4000 (1) Sales Returns Sales Revenue

3564 (5b) (4a) 120 (5a) 36 3720 (3a)

Inventory Cost of Gds Sold Transportation Out(1) 4000 2790 (3b) (3b)2790 90 (4b)(2) 500 225 (6) (6) 25(4b) 90 45 (7) (7) 45


5- 438a. Paid within discount period, so record the 2% discount on the $4000 Tran. #1 purchase

less $200 Tran. #6 return.



8a (76) = (76) =

Purchase (Transaction #1) $4000

Less Purchase Return (Trans. #6) 200

Amount owed 3800

X discount % 2%

Amount of Purchase Discount $ 76

This reduces the cost of the inventory and the amount we owe the supplier.


5- 44

8a. Paid within discount period, so record the discount on the $4000 Tr. #1 purchase less $200 Tr. #6 return.



8a (76) = (76) =


8a Accounts Payable 76Inventory 76

2% discount taken on $3,800 purchase less return


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) (6) 200 1000 bb 6000 bb 2000 bb(5b) 3564 (3a)3720 36 (5a) (8a) 76 4000 (1) Sales Returns Sales Revenue

3564 (5b) (4a) 120 (5a) 36 3720 (3a) Inventory(1) 4000 2790 (3b) Cost of Gds Sold Transportation Out(2) 500 225 (6) (3b)2790 90 (4b)(4b) 90 45 (7) (6) 25

76 (8a) (7) 45


5- 45

8b. Paid the remaining balance on the Transaction #1 inventory purchase.

$4000 purchase (Trans. #1)- 200 purchase return (Trans. #6)- 76 purchase discount (Trans. #8a)$3724 remainder to pay supplier



8b (3,724) = (3,724) = (3,724) OA


5- 46

8b. Paid the remaining balance on the Transaction #1 inventory purchase. ($4000-200-76=$3724 to pay)



8b (3,724) = (3,724) = (3,724) OA


8b Accounts Payable 3724Cash 3724

Paid balance due to supplier after return and discount.


Cash Accounts Receiv. Accounts Payable Common Stock Retained Earningsbb 5000 500 (2) bb 4000 120 (4a) (6) 200 1000 bb 6000 bb 2000 bb(5b) 3564 3724 (8b) (3a)3720 36 (5a) (8a) 76 4000 (1) Sales Returns Sales Revenue

3564 (5b) (8b) 3724 (4a) 120 (5a) 36 3720 (3a) Inventory(1) 4000 2790 (3b) Cost of Gds Sold Transportation Out(2) 500 225 (6) (3b)2790 90 (4b)(4b) 90 45 (7) (6) 25

76 (8a) (7) 45


5- 47

9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost.



9 (340) = (340) 340 = (340) (340) OA

Transportation charges on PURCHASES are added to the cost of the asset, INVENTORY. (Transportation IN)

Transportation charges to ship products TO CUSTOMERS are reported as operating expenses on the income statement. The appropriate account title is TRANSPORTATION OUT (or FREIGHT OUT or SHIPPING EXPENSE).


5- 48

9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost.



9 (340) = (340) 340 = (340) (340) OA


9 Transportation Out (or Shipping Exp.) 340Cash 340

Paid $340 cost to ship to customer.



340 (9) 3564 (5b) (8b) 3724 (4a) 120 (5a) 36 3720 (3a) Inventory(1) 4000 2790 (3b) Cost of Gds Sold Transportation Out(2) 500 225 (6) (3b)2790 90 (4b) (9) 340(4b) 90 45 (7) (6) 25

76 (8a) (7) 45


5- 49

Clock CompanyEnding Balances of LEDGER Accounts



340 (9) 3564 (5b) (8b) 3724 (4a) 120 (5a) 36 3720 (3a)eb 4000 eb 4000 1000 eb 3684 eb

Inventory Cost of Gds Sold Transportation Out(1) 4000 2790 (3b) (3b)2790 90 (4b) (9) 340(2) 500 225 (6) (6) 25(4b) 90 45 (7) (7) 45

76 (8a) eb 2770eb 1454


5- 53

Timing is EVERYTHING...

Recognize revenue when “earned” earned when an exchange (seller to buyer) occurs

Three levels of the matching principle Product costs (e.g., inventory costs): assets until

produce revenuedirect cause & effect relationship between

revenue and expense Period costs: systematic & rational allocation

e.g., depreciation costs Period costs: recognize as expense as incurred

e.g., advertising costs


5- 54

Perpetual Inventory Systems The inventory account is continuously updated for the

following events: Purchases Purchase Discounts Taken Purchase Returns & Allowances Sales (remove from inventory the COST of the units sold) Sales Returns (add to inventory the COST of units returned)

The necessary detailed record-keeping required by the perpetual system has become much easier with current computer technology.

A physical count of the inventory is still required at the end of the accounting period to assure accurate inventory records in case of errors or theft.


5- 55

Perpetual Inventory Systems

Cost of Goods Sold . . . Contains the cost of units that have

been sold to customers. Is a temporary account.

(It will be closed out at

the end of the period.) Is an expense account.


5- 56

When using the Periodic system, inventory transactions are not recorded directly in the INVENTORY account. Instead, separate accounts are used for

PURCHASESPURCHASE RETURNS &

ALLOWANCESPURCHASE DISCOUNTSTRANSPORTATION IN

Periodic Inventory SystemSeparate Accounts Used

Let’s look at another Inventory system.


5- 57

Periodic Inventory Systems Because entries are not made to the

inventory account during the accounting period, the amount of inventory is not known until the end of the period when the inventory count is done.

The PERIODIC system is being used less and less due to advancements in technology that make the extra record keeping of the perpetual system easy and inexpensive.

Periodic inventory systems require more closing entries at the end of the period. (Purchases, Purchase Returns and Allowances, Purchase Discounts, and Transportation In are all separate TEMPORARY accounts that must be closed out at the end of the period.)


5- 58

Periodic Inventory System Purchases and Purchase Returns and Allowances Purchases is an account that

holds the current period’s inventory purchases (a debit balance) and is used in the calculation of Cost of Goods Sold on the Income Statement.

The Purchase Returns and Allowances account also is used to calculate Cost of Goods Sold on the income statement. It is a deduction from the cost of purchases in a periodic inventory system.

Bar codes/scanners


5- 59

When using the Periodic system Purchase Discounts are recorded in a separate account. This helps managers keep track of the company’s performance in taking advantage of discounts.

Periodic Inventory SystemPurchase Discounts


5- 60

Periodic Inventory Systems The ending inventory is determined at the

end of the period by taking a physical count of the goods remaining on hand.

Cost of goods sold is calculated at the end of the accounting period by subtracting the ending inventory (determined from the physical count) from the Cost of Goods Available for Sale.

Beginning Inventory $ 400 + Purchases, net 2000= Goods Available for Sale 2400- Ending Inv. (from count) 500= Cost of Goods Sold $1900


5- 61

Gross Margin Percentage

Gross MarginNet Sales

This measure indicates how muchof each sales dollar is left after deducting the cost of goods sold to cover expenses

and provide a profit.

Other things being equal, the company with the higher gross margin percentage is pricing its

products higher.


5- 62

Ratios: Gross Margin Percentage

Gross margin %:

Gross margin as a percent of sales

Net sales – CGS gross margin

Net sales net sales=


5- 63

Ratios: Gross Margin Percentage

Net sales – CGS = $1,000 – 400

Net sales $1,000

= $600___ = 60% or $.60

$1,000

This tells us that each dollar of sales

contributes 60 cents to the

Gross Margin.


5- 64

Return on Sales

Net IncomeNet Sales

Net income expressed as a percentage of sales provides insight as to how much of each sales dollar

is left as net income after all expenses are paid.

Other things being equal, the company with the higher return on sales

percentage is doing a better job of controlling costs.


5- 65

Ratios: Return on sales

Return on sales =

Net income

Net sales

Revenues - expenses

Net sales


5- 66

Ratios: Return on sales

Return on sales =Net income = Net sales

$500___ = 50% or $.50$1,000

Each dollar of sales is generating 50 cents of Net Income


5- 67

Income Statement Formats

Single Step -

with details

Single Step -

condensed

Multi-step -

with details

Multi-step -

condensed

Let’s look at examples…..


5- 68


Net Sales 100Less: Cost of goods sold 60Gross Profit Margin 40Operating Expenses: Selling:

Sales Salaries 8 Advertising 2

Total Selling 10 Administrative:

Admin. Salaries 3 Building Rent 8

Total Adm. Exp. 11Total Operating Exp. 21Operating Income 19Non-Operating Rev. (Exp.)

Interest Expense (1)Income before tax 18

Income Tax expense 3Net Income 15

Multi-step with details Multi-step: condensed

Net Sales 100Less: Cost of goods Sold 60Gross Profit Margin 40Operating Expenses: Selling Expenses 10 Administrative Exp. 11 Total Operating Exp. 21 Operating Income 19Non-Operating Rev. (Exp.) Interest Expense (1)Income before tax 18 Income Tax expense 3Net Income 15


5- 69


Net Sales 100Less: Cost of goods sold 60Gross Profit Margin 40Operating Expenses: Selling:

Sales Salaries 8 Advertising 2

Total Selling 10 Administrative:

Admin. Salaries 3 Building Rent 8

Total Adm. Exp. 11Total Operating Exp. 21Operating Income 19Non-Operating Rev. (Exp.)

Interest Expense (1)Income before tax 18

Income Tax expense 3Net Income 15

Multi-step with details Multi-step: condensed

Net Sales 100Less: Cost of goods Sold 60Gross Profit Margin 40Operating Expenses: Selling Expenses 10 Administrative Exp. 11 Total Operating Exp. 21 Operating Income 19Non-Operating Rev. (Exp.) Interest Expense (1)Income before tax 18 Income Tax expense 3Net Income 15

The multi-step INCOME Statement format classifies interest as a NON-operating item. But, interest is still an OPERATING ACTIVITY

on the CASHFLOW Statement.


5- 70


Net Sales 100

Less Expenses: Cost of goods sold 60 Sales Salaries 8 Advertising 2 Admin. Salaries 3 Building Rent 8 Interest Expense 1 Income Tax Expense 3Total Expenses 85Net Income

15

Single-step with details Single-step: condensed

Net Sales 100Less Expenses: Cost of goods sold 60 Selling 10 Administrative 11 Interest Expense 1 Income Tax Expense 3Total Expenses 85Net Income 15


5- 71


Net Sales 100

Less Operating Exp. Cost of goods sold 60 Sales Salaries 8 Advertising 2 Admin. Salaries 3 Building Rent 8 Interest Expense 1Total Oper. Exp. 82Income before taxes 18 Income Tax Expense 3Net Income

15

Single-step with details Single-step: condensed

Net Sales 100Less Expenses: Cost of goods sold 60 Selling 10 Administrative 11Total Oper. Exp. 81Income before taxes 19Income Tax Expense 4Net Income 15

A common modification of the single-step method is to have the income tax expense separated out.


5- 72

Common-size Income Statement

Each item on the income statement is expressed as a % of that year’s Net Sales.

Comparisons are made to:

Budget

Previous year(s)

Competitors

%

Net Sales 100.0

- Cost 60.0

=G.P 40.0


5- 74

Comparative Common-size Income Statements

2013 2012

Net Sales $3,000 $2,000

Cost of Goods Sold 2,000 1,200

Gross Profit 1,000 800

Operating Expenses:

Selling Expenses 600 400

Administrative Exp. 700 300

Total Oper. Exp. 1,300 700

Net Income ($300) $100

% of N.Sales

100.0

66.7

33.3

20.0

23.3

43.3

(10.0)

% of N.Sales

100.0

60.0

40.0

20.0

15.0

35.0

5.0


5- 75

Income Statement Trend Analysis

Trend Analysis shows both Dollar and % changes from one year to the next year for each item on the income statement.

Example:

From 2012 to 2013 Net Sales increased from $2,000 to $3,000. So……Net Sales increased $1,000 which is a 50% increase over 2012 Net Sales. ($1,000 incr./$2,000 Net Sales of 2012 = 50%)


5- 76

Income Statement Trend Analysis

2013 2012

Net Sales $3,000 $2,000

Cost of Goods Sold 2,000 1,200

Gross Profit 1,000 800

Operating Expenses:

Selling Expenses 600 400

Administrative Exp. 700 300

Total Oper. Exp. 1,300 700

Net Income ($300) $100

% inc.(dec)

50.0

66.7

25.0

50.0

133.3

85.7

(400.0)

$ inc.(dec.)

$1,000

800

200

200

400

600

($400)


5- 77

How about analyzing the Balance Sheet?

The same techniques are used to analyze the Balance Sheet.

Common-size Analysis: Use the TOTAL ASSETS amount as the 100%

figure. So, …….. Express each Balance Sheet item as a % of Total Assets.

Trend Analysis:Same approach as used on the income statement. 1. Calculate the $ change for each bal. sheet item. 2. Express the $ change as a % of the previous

year’s (or base year’s) amount.


5- 78

End of Chapter 4

Remember,

Your objectives are to understand what you are doing and to be able to analyze the financial information.

Memorization without understanding is meaningless!

mcgraw-hill/irwin © the mcgraw-hill companies, inc., chapter four accounting for merchandising...

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