Chapter 6

Accounting for retailing

©2020 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

6.1describe the nature of inventory and retail
operations
6.2describe the basic format of an income statement
for retail businesses
6.3account for sales transactions of retail businesses,
including GST, the treatment of sales returns,
cash discounts, trade discounts and freight costs
 Learning objectives

6.4account for purchases of inventory and cost of sales

under both the perpetual and periodic inventory
systems by retail businesses
6.5prepare worksheets and close the accounts for
retail businesses for both the perpetual and periodic
inventory systems
6.6prepare a detailed statement of financial
performance for a retail business
 Learning objectives

6.7describe the net method of recording purchases

and sales whenever there are settlement discounts
6.8perform a brief analysis of profitability in a retail
business for decision-making purposes.
 Inventory

• Inventory means goods or property purchased and

held for sale.
• Also means other assets held for future sale but not
normally sold as part of regular business activities.
• Stock and stock in trade are commonly used terms
for inventory.
 Inventory

• Retail business operations:

– Determination of profit is a major objective of
accounting for inventory.
– Cost of sales for a given period is often the
business’s largest expense.
– Inventory is one of the most active assets in a
retail business.
– The control and safeguarding of inventory is
essential for efficient and profitable operations.
 Condensed statement of financial
performance for a retailer

• Sales (a revenue) is of primary importance.

• Cost of sales represents inventory sold during the period.
• The cost of sales is subtracted from net sales revenue to
arrive at an intermediate amount called gross profit (or
gross margin) on sales.
• Expenses are grouped by function:
– Selling and distribution expenses.
– Administrative expenses.
– Finance expenses.
 Condensed statement of financial
performance for a retailer

• Simplified statement of financial performance for a

retail business:
 Accounting for sales transactions,
including GST

• Retailing and the goods and services tax:

– Retail business have to register for an Australian
Business Number (ABN) if their gross taxable
supplies (sales of goods) exceed $75 000 per year.
• They must also register for GST.
• They must issue tax invoices.
• They can claim input credits.
 Accounting for sales transactions,
including GST

• Tax invoices:
– Required for all sales in excess of $82.50.
– All tax invoices must have:
• ‘Tax invoice’ stated prominently.
• ABN of entity issuing.
• Date of issue.
• Name of suppliers.
• Description of items being supplied.
– Invoices over $1,000 have additional
requirements.
 Accounting for sales transactions,
including GST

• Tax invoice, less than $1000 – cash sale:

 Accounting for sales transactions,
including GST

• Tax invoice, more than $1000 – credit sale:

 Accounting for sales transactions,
including GST

• Adjustment notes:
– Adjustment notes are used when:
• all or part of goods sold are returned
• an allowance (discount) is given
• the price of supply is changed
• part or full amount owing has to be written off.
– They are essentially a ‘negative invoice’.
 Accounting for sales transactions,
including GST

• Adjustment notes:
– Other options:
• It allows a valid tax invoice to serve both as a
tax invoice and as an adjustment note.
• The statement can replace adjustment notes
for returns, refunds, allowances and discounts
provided certain requirements are met.
 Accounting for sales transactions,
including GST

• Accounting for sales transactions:

– Recorded when inventory is transferred from the
business to the customer.
– To record a sale an asset account is debited and
the sales account is credited.
– Significant difference between cash collections
from sales and the balance accumulated in the
Sales account.
– Accounts Receivable balance includes GST.
 Accounting for sales transactions,
including GST

• Accounting for sales transactions:

 Accounting for sales transactions,
including GST

• Sales returns and allowances:

– Sales returns and allowances account is debited
for an amount excluding GST.
– Sales returns and allowances are subtracted from
sales in the statement of financial performance in
order to show net sales.
 Accounting for sales transactions,
including GST

• Sales returns and allowances:

– To provide information on the volume of returns
and allowances, a contra sales account called
Sales Returns and Allowances is debited as
follows:
 Accounting for sales transactions,
including GST

• Cash (settlement) discounts:

– The inventory is sold on credit, the terms of
payment, called the credit terms — e.g. ‘n/30’.
– Provide an incentive for the buyer to make payment
before the end of the credit period.
– The seller may grant a cash discount called ‘discount
allowed by the seller’ and ‘discount received by the
buyer’.
– Cash discounts are also known as settlement
discounts.
 Accounting for sales transactions,
including GST

• Cash (settlement) discounts:

– If sales returns and settlement discounts have
both occurred.
– GST included in the discount amount must be
adjusted on the net amount receivable.
 Accounting for sales transactions,
including GST

• Trade discounts:
– A percentage reduction granted from the normal
list price.
– Trade discounts are not recorded in the accounts
by either the buyer or the seller.
 Accounting for sales transactions,
including GST

• Freight outwards:
– There are a variety of costs incurred in moving
goods from seller to buyer.
– Obligations of the seller and/or buyer in relation
to these costs are stated on the invoice issued by
the seller.
– Standardised trade terms used:
• EXW: ex works.
• DDP: delivered duty paid.
Accounting for purchases and cost of sales

• Accounting for inventory involves:

– Recording cost of purchased inventories.
– To determine which part of the inventory can be
allocated to:
• cost of sales
• ending inventory.
Accounting for purchases and cost of sales

• Accounting for inventory involves:

– There are two distinctly different inventory
systems:
• perpetual inventory system
• periodic inventory system.
Accounting for purchases and cost of sales

• Perpetual inventory system:

– Involves keeping current and continuous records
of all inventory transactions.
– Separate computer record or inventory card for
each type of inventory item held:
• Quantity, unit cost and total cost for each
purchase and each sale.
• Running inventory balance.
Accounting for purchases and cost of sales

• Perpetual inventory system:

– Inventory record:
Accounting for purchases and cost of sales

• Periodic inventory system:

– A store operating with high volume may
conveniently record the amount of each sale.
– Entities that do not use a perpetual inventory
system use a periodic inventory system.
Accounting for purchases and cost of sales

• Perpetual and periodic inventory systems

contrasted:
– The perpetual inventory system and the balance in
the Inventory account provides a continuous and
current record of inventory on hand.
– A physical inventory count is taken under the
perpetual system only to verify the accuracy of the
recorded ending inventory.
 End of period processes

• Illustration of worksheets in retail businesses:

– A worksheet can be used to organise the
information needed to prepare financial
statements and closing entries.
– In the trial balance columns there are new equity
accounts — Share Capital and Retained Earnings.
 End of period processes

• Perpetual inventory system:

– It is used to account for the flow of goods.
– The balance in the Inventory account is the ending
inventory amount.
– The cost of sales, freight inwards and discounts
received are extended along with the other
temporary accounts to the proper statement of
financial performance columns.
 End of period processes

• Periodic inventory system:

– The unadjusted trial balance debit column is the
beginning inventory amount.
– The accounts that affect the cost of net purchases
— Purchases, Purchases Returns and Allowances,
Discount Received, and Freight Inwards.
– It is necessary to remove the beginning inventory
balance and record the ending inventory in the
Inventory account.
 Detailed statement of financial
performance for a retailer

• Expenses classified as:

– Selling and distribution expenses.
– Administrative expenses.
– Financial and other expenses.
• A detailed listing of individual expenses was not
included in the worksheet.
 Net price method and settlement
discounts

• Under the gross price method:

– Inventory purchases are recorded at the gross, or
full, invoice price, and any discount received is not
recorded unless payment is made within the
discount period.
– This assumes initially that discounts will not be
taken.
– They are recorded later in the accounts only when
the discounts are taken by the seller or buyer.
 Net price method and settlement
discounts

• Under the gross price method:

– The discount amounts involved are often
immaterial.
 Profitability analysis for decision making

• The statement of financial performance is structured to

present a picture of the main items of income and
expense.
• This structure enables management to assess the:
– profitability of operations
– by monitoring over time the relationships that exist
among sales
– cost of sales
– gross profit
– expenses and profit.
 Profitability analysis for decision making

• Gross profit ratio:

– The gross profit ratio expresses gross profit as a
percentage of net sales.
– It represents the portion of the sales dollar that is
reflected in gross profit.
– This ratio also indirectly reflects the relationship of
cost of sales to sales.
 Profitability analysis for decision making

• Profit margin:
– Reflects the portion of each sales dollar that ends
up as final profit.
– Ratio is considered more informative than simply
stating profit in absolute terms.
 Profitability analysis for decision making

• Expenses to sales ratio:

– Expenses to sales ratio reflects the portion of each
sales dollar that is needed to meet the entity’s
expenses other than cost of sales.
 Profitability analysis for decision making

• Inventory turnover:
– Ratio used to assess performance in a retail
business is the inventory turnover.
– Indicates the number of times average inventory
has been sold during a period.
 Summary

• The nature of inventory and retailing operations.

• The basic format of an statement of financial
performance for retail businesses.
• Accounting for sales transactions of retail businesses,
including goods and services tax, the treatment of
sales returns, cash discounts, trade discounts and
freight costs.
• Accounting for purchases of inventory and cost of
sales under both the perpetual and periodic
inventory systems by retail businesses.
 Summary

• Preparing worksheets and close the accounts for

retail businesses for both the perpetual and periodic
inventory systems.
• Preparing a detailed statement of financial
performance for a retail business.
• The net method of recording purchases and sales
whenever there are settlement discounts.
• Performing a brief analysis of profitability in a retail
business for decision‐making purposes.
 Concepts of Capital

• Financial capital
– Capital is synonymous with the net assets (equity) of the entity
– Profit exists only after the entity has maintained its capital,
measured as the dollar value (or purchasing power) of equity
at the beginning of the period

• Physical capital
– Capital is viewed as the operating capability of the entity’s
assets
– Profit exists only after the entity has set aside enough capital
to maintain the operating capability of its assets