Chapter 6 -The activities of a service business differ from those of a merchandising business (diff.

s illustrated:) Service Business___________________________________ erchandising Business__________________ !ees "arned #$$$ %perating "&penses Sold -$$$ 'et (ncome #$$$ "&penses = $XXX -The revenue activities of a service business involve providing services to customers -%n the income statement for a service business+ the revenues from services are reported as fees earned -The operating e&penses incurred in providing the services are subtracted from the fees earned to arrive at net income -(n contrast+ the revenue activities of a merchandising business involve the bu,ing and selling of merchandise. - merchandising business first purchases merchandise to sell to its customers -.hen this merchandise is sold+ the revenue is reported as sales+ and its cost is recogni/ed as an e&pense. This e&pense is called the cost of merchandise sold. -The cost of merchandise sold is subtracted from sales to arrive at gross profit. The amount is called gross profit because it is the profit before deducting operating e&penses. - erchandise on hand (not sold) at the end of an accounting period is called merchandise inventory. (t is reported as a current asset on the balance sheet. - ost merchandising companies ues computeri/ed accounting s,stems 0ith reports that are similar to specail 1ournals and subsidiar, ledgers (e&: a computeri/ed merchandise accounting s,stem 0ould t,picall, produce sales and inventor, reports.) -$$$ 'et (ncome #$$$ -$$$ = $XXX Sales Cost of erchandise

)ross *rofit %perating

-There are 2 s,stems for accounting for merchandise transactions: perpetual and periodic -(n a perpetual inventory system+ each purchase and sale of merchandise is recorded in the inventor, account and related subsidiar, ledger (the amount of merchandise available for sale and the amount sold are continuousl, 3perpetuall,4 updated in the inventor, records) -(n a periodic inventory system+ the inventor, does not sho0 the amount of merchandise available for sale and the amount sould -- listing of inventor, on hand+ called a physical inventory+ is prepred at the end of the accounting period. This is used to determine the cost of merchandise on hand at the end of the period and the cost of merchandise sold during the period - ost merchandise companies use computeri/ed perpetual inventor, s,stems. Such s,stems use bar codes or radio fre5uenc, identification codes embedded in a product. -The terms for 0hen pa,ments for merchandise are to be made are called the credit terms. (f pa,ment is re5uired on deliver,+ the terms are cash or net cash. %ther0ise+ the bu,er is allo0ed an amount of time+ 6no0n as the credit period+ in 0hich to pa,. the credit period usuall, begins 0ith the date of the sale as sho0n on the invoice -(f pa,ment is due 0ithin a stated number of da,s after the invoice date+ such as 78 da,s+ the terms are net 78 da,s. These terms ma, be 0ritten as n/30. (f the pa,ment is due b, the end of the month in 0hich the sale 0as made+ the terms are 0ritten as n/eom. -To encourage the bu,er to pa, before the end of the credit period+ the seller ma, offer a discount ("&: a seller ma, offer a 29 discount if the bu,er pa,s 0ithin :8 da,s of the invoice date. (f the bu,er does not ta6e the discount+ the total invoice amount is due 0ithin 78 da,s. these terms are e&pressed as 2;:8+ n;78 and are read <29 discount if paid 0ithin :8 da,s+ net amount due 0ithin 78 da,s.<) -=iscounts ta6en b, the bu,er for earl, pa,ment of an invoice are called purchases discounts. -*urchase discounts ta6en b, a bu,er reduce the cost of the merchandise purchased. "ven if the bu,er has to borro0 to pa, 0ithin a dicount period+ it is normall, to the bu,er>s advantage to do so. -257-259 -- bu,er ma, re5uest an allo0ance for merchandise that is returned (purchases return) or a price allo0ance (purchases allo0ance) for damaged or defective merchandise.

-!rom a bu,er>s perspective+ such returns and allo0ances are called purchases returns and allowances. -(n both cases the bu,er normall, sends the seller a debit memorandum to notif, the seller of reasons for the return (purchase return) or to re5uest a price reduction (purchase allo0ance) -- debit memorandum is often called a debit memo. - debit memo informs the seller of the amount the bu,er proposes to debit to the account pa,able due to the seller. 2?@AAAAAA -Bevenue from merchandise is usuall, recorded as Sales. Sometimes a business ma, use the title Sales of Merchandise -- Business ma, sell merchandise for cash. Cash sales are normall, entered on a cash register and recorded in the accounts. 260-262 -- business ma, sell merchandise on account. The seller records such sales as a debit to -ccounts Beceivable and a credit to Sales. -- seller ma, offer the bu,er credit terms that include a discount for earl, pa,ment. The seller referes to such discounts as sales discounts -Sales discounts reduce sales revenue. To reduce sales revenue+ the sales account could be debited. - anagers usuall, 0ant to 6no0 the amount of the sales discounts for a period. Sales discounts are recorded in a separate sales discounts account+ 0hich is a contra (or offsetting) account to Sales - erchandise sold ma, be returned to the seller (sales return) -(n other cases+ the seller ma, reduce the initial selling price (sales allo0ance). This might occure if the merchandise is defective+ damaged during shipment+ or does not meet the bu,er>s e&pectations. -!rom a seller>s perspective+ such returns and allo0ances are called sales returns and allowances -(f the return or allo0ance is for a sale on account+ the seller usuall, issues the bu,er a credit memorandum+ often called a credit memo. -- credit memo authori/es a credit decrease) to the bu,er>s account receivable. - credit memo indicates the amount and reason for the credit -Ci6e sales discounts+ sales returns and allo0ances reduce sales revenue.

-Beturns often result in additional shipping and handling e&penses. Thus+ managers usuall, 0ant to 6no0 the amount of returns and allo0ances for a period. !or this reason+ sales returns and allo0ances are recorded in separate sales returns and allo0ances account+ 0hich is a contra (or ofsetting) account to sales -The seller debits Sales Beturns and -llo0ances for the amount of the return or allo0ance. (f the sale 0as on account+ the seller credits -ccounts Beceivable -Dsing a perpetual inventor, s,stem+ the seller must also debit (increase) erchandise (nventor, and decrease (credit) Cost of erchandise Sold for the cost of the returned merchandise -- bu,er must pa, for merchandise and then later return it. (n this case+ the seller ma, do one of the follo0ing: :. (ssue a credit that is applied against the bu,er>s other receivables 2. (ssue a cash refund -(f the credit is applied against the bu,er>s other receivables+ the seller records the credit 0ith entries similar to those sho0n on pg 26E -(f cash is refunded+ the seller debits Sales Beturns and -llo0ances and credits Cash -*urchases and sales of merchandise often involve freight -The terms of a sale indicate 0hen o0nership (title) of the merchandise passes from the seller to the bu,er. This point determines 0hether the bu,er or the seller pa,s the freight costs. -The o0nership of the merchandise ma, pass to the bu,er 0hent he seller delivers the merchandise to the freight carrier. (n this case+ the terms are said to be FOB (free on board) shipping point. This term means that the bu,er pa,s the freight costs from the shipping point to the final destination. -These costs are part of the bu,er>s total cost of purchasing inventor, adn are added to the cost of the inventor, b, debiting erchandise (nventor,. 264-266 -The o0nership fo the merchandise ma, pass tot he bu,er 0hen the bu,er receives the merchandise. -(n this case+ the terms are said to be FOB (free on board) destination. This term means that the seller pa,s the freight costs from the shipping point to the bu,er>s final destination -.hen the seller pa,s the deliver, charges+ the seller debits =eliver, "&pense or !reight %ut. =eliver, "&pense is reported ont the seller>s income statement as a selling

e&pense. -The seller ma, prepar, the freight+ even though the terms are !%B shipping point. The seller 0ill then add the freight to the invoice. The bu,er debits erchandise (nventor, for the total amount of the invoice+ including the freight. -n, discount terms 0ould not appl, tothe prepaid freight. -"ach merchandising transaction affects a bu,er and a seller 268-269 -2F8