chapter 5 · pdf filechapter 5 accounting for merchandising operations 2. 1. differentiate...
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Chapter 5
Accounting for merchandising operations
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1. Differentiate between a service business and a merchandising business
2. Identify the differences between the perpetual and the periodic inventory system
3. Record purchase transactions under the perpetual inventory system
4. Record sales transactions under the perpetual inventory system
Learning objectives
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5. Prepare adjusting and closing entries under the perpetual inventory system
6. Describe and prepare the multiple-step and single-step income statements
Learning objectives
4
Differentiate between a service business and a merchandising
business
Learning objective 1
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▪Merchandiser - a business that derives their earnings from buying and then selling products to customers– Service business derives earnings from providing
services to customers
▪Merchandise inventory - the goods purchased by a merchandiser for resale to customers– Also known as merchandise or inventory
Merchandising operations
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Two types of merchandising businesses:1. Wholesalers - businesses that purchase
products and sell them to other wholesalers or retailers
2. Retailers - businesses that purchase their products from manufacturers or wholesalers and sell them to the end customer
Merchandising operations
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▪The main differences between a merchandising business and a service business can be seen by comparing the income statements of the two
Merchandising and service businesses
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Merchandiser'sIncome Statement
For the month ended May 31, 2011
$
Sales 1,000
Cost of Goods Sold (400)
Gross Profit 600
Expenses (100)
Net income/(Net loss) 500
Service BusinessIncome Statement
For the month ended May 31, 2011
$
Revenues 1,000
Expenses (500)
Net income/(Net loss) 500
▪The merchandiser uses a Sales or Sales Revenues account to record sales of merchandise– Service business uses a Revenues account to record
earnings from providing services to customers
▪Two new line items unique to merchandisers1. Cost of goods sold2. Gross profit
Merchandising and service businesses
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Cost of goods sold▪The cost of the inventory sold by the business during the accounting period– Also known as cost of sales or cost of merchandise sold
Gross profit▪Net sales revenues minus the cost of goods sold▪Represents the amount of earnings the business has made from selling its goods– Also known as gross margin
Accounts unique to merchandisers
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▪Merchandisers also report the value of merchandise inventory purchased for resale in the Merchandise Inventory account– Also known as just Inventory
▪Reported as a current asset in the balance sheet
Accounts unique to merchandisers
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Operating cycle
▪Length of time varies between business types– E.g. Fruit seller may be a
few weeks– E.g. Car seller may be
months
▪The duration of time between when the business acquires materials or services, uses them in their operations, and finally receives cash from selling their goods or services
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Cost flow of inventory
– Net purchases: purchases less any purchases that are returned
▪Operating cycle of a merchandiser can be translated into the cost flow of inventory over an accounting period
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Identify the differences between theperpetual and the
periodic inventory system
Learning objective 2
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▪Perpetual inventory system continuously keeps track of the value of inventory available for sale and cost of goods sold as each transaction occurs▪Periodic inventory system updates the value of inventory available for sale and the cost of goods sold only at the end of the accounting period
Perpetual and periodic inventory systems
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▪ Inventory transactions are demonstrated using the perpetual inventory system▪Periodic inventory system is illustrated in the appendix
Perpetual and periodic inventory systems
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Record purchase transactions underthe perpetual inventory system
Learning objective 3
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▪A bill created by the seller and sent to the buyer that contains the details of the sale▪ It is a source document used by the seller to record the sale and by the buyer to record the purchase
Invoice
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▪ Seller▪ Invoice date▪ Invoice number▪ Buyer▪ Purchase order
number▪ Credit terms▪ Shipping terms▪ Merchandise
details▪ Invoice total
Invoice
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Example:▪Purchased 10 snowboards for $300 each (10 x $300 = $3,000) and paid for them in cash
Purchase of merchandise for cash
Purchase of merchandise for cash:
Aug. 4 Merchandise Inventory 3,000
Cash 3,000
(Purchased merchandise for cash.)
▪A credit sale credits the Accounts Payable account instead of the Cash account
Purchase of merchandise on credit
Purchase of merchandise for cash:
Aug. 4 Merchandise Inventory 3,000
Accounts Payable 3,000
(Purchased merchandise on credit.)
▪Sometimes when an order of merchandise is received by the buyer it may need to be returned to the supplier▪A purchase return or allowance is an adjustment of the purchase price of merchandise recorded in the accounts of the buyer▪The difference between a purchase return and a purchase allowance is that the merchandise is not returned to the seller in a purchase allowance
Purchase returns and allowances
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Example:▪Returned 3 snowboards for a full refund of (3 x $300 = $900)
Purchase returns and allowances
Purchase return:
Aug. 6 Accounts Payable 900
Merchandise Inventory 900
(Returned merchandise purchased on credit.)
▪Sellers may grant customers a reduction to the price of the goods if a minimum quantity is purchased ▪A trade discount is a reduction of the list price of merchandise that is granted to the buyer▪The list price is the full price of an item listed in the catalog of the seller before deducting any trade discounts▪The value of the trade discount is not separately recorded in the accounts
Trade discounts on purchases
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Example:▪Supplier offers 10% trade discount on snowboarding pants if total purchase is greater than $3,000▪Purchased 30 pairs at a list price of $120 (30 x $120 = $3,600)▪Eligible for 10% discount (10% x $3,600 = $360)▪Amount recorded in Merchandise Inventory account ($3,600 - $360 = $3240)
Trade discounts on purchases
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Remember:▪Amount of trade discount is not recorded in the accounts!
Trade discounts on purchases
Trade discount on purchase:
Aug. 7 Merchandise Inventory 3,240
Cash 3,240
(Cash purchase of inventory with trade discount.)
Purchase discounts: ▪Discounts received for payment of an account within the discount period▪Recorded in the accounts of the buyer
Purchase discounts
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Credit terms:▪Specify when the full amount of an invoice is due to be paid, including:– Percentage discount– Discount period– Credit period of an invoice
Credit terms
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▪Credit terms may be stated as:2/14, n/30▪2 = percentage discount▪14 = discount period, the time that a customer has to take advantage of the purchase discount▪n/30 = net 30 = credit period, the time that a customer has to pay an invoice by the due date▪Where no discount is given terms are stated as n/30
Credit terms
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Example:
2/14, n/30▪The customer gets a 2% discount on the purchase price if the invoice is paid in full within 14 days of the invoice, otherwise they are liable to pay the full balance within 30 days of the invoice
Credit terms
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Credit period
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▪Alternatively credit terms could be stated n/EOM (net end of month)▪n/15 EOM means that the invoice is to be paid in full 15 days after the end of the month in which the invoice was issued
Credit terms
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Steps to calculate purchase discounts:1. Calculate the outstanding amount of the invoice to
be paid2. Calculate the amount of the discount3. Calculate the amount of cash to be paid4. Record the journal entry
Example – calculating purchase discounts
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Example:▪Purchases = $3,000▪Purchase returns = $900▪Credit terms = 2/10 n/30▪Paid invoice within discount period
Example – calculating purchase discounts
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Step 1: Calculate the outstanding amount of the invoice to be paid
Example – calculating purchase discounts
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Accounts Payable = Invoice total - purchase returns & allowances= $3,000 - $900= $2,100
Step 2: Calculate the amount of the discount
Example – calculating purchase discounts
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Discount = Accounts payable x discount (%)= $2,100 x 2%= $2,100 x 0.02= $42
Step 3: Calculate the amount of cash to be paid
Example – calculating purchase discounts
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Cash payment = Accounts payable - discount ($)= $2,100 - $42= $2,058
Step 4: Record the journal entry
▪ If the invoice was paid after the discount period then the journal entry for the repayment debits Accounts Payable and credits Cash for the full amount of the invoice less the purchase return
Example – calculating purchase discounts
Purchase discount:
Aug. 1 Accounts Payable 2,100
Merchandise Inventory 42
Cash 2,058
(Payment of accounts payable within discount period.)
▪There are usually additional costs associated with transporting purchased goods▪Buyer and seller must agree who pays for these costs▪The party that owns the title of the goods is responsible for paying the costs incurred to transport the goods▪Shipping terms determine when the title passes from the seller to the buyer
Transportation costs
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▪The FOB point (free on board) determines when the ownership passes from the seller to the buyer▪There are two FOB points:1. FOB shipping point2. FOB destination
Shipping terms
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FOB shipping point:▪Title of the goods passes to the buyer when the merchandise leaves the shipping point▪The buyer is responsible for paying transport costs and bears the risk of damage to the goods while they are in transit
FOB shipping point
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FOB destination:▪Title of the goods passes to the buyer when the merchandise arrives at the buyers ▪The seller is responsible for paying transport costs and bears the risk of damage to the goods while they are in transit
FOB destination
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Shipping Terms
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▪$90 charge to transport snowboards from the seller to the buyer▪Different journal entries depending on whether it is the seller or the buyer that pays for these costs
Example – transportation costs
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FOB shipping point: ▪Buyer records the payment as part of inventory because it is a cost incurred to transport the inventory and prepare it so it is ready to be sold
Example – transportation costs
FOB shipping point transportation charges (in the books of the buyer):
Aug. 4 Merchandise Inventory 90
Cash 90
(Paid transportation charges with cash.)
FOB destination: ▪Seller records the payment in the Delivery Expense account▪This is because transport charges are considered costs incurred in order to sell the merchandise, not a cost of the merchandise itself
Example – transportation costs
FOB destination transportation charges (in the books of the seller):
Aug. 4 Delivery Expense 90
Cash 90
(Paid transportation charges with cash.)
Record sales transactions under theperpetual inventory system
Learning objective 4
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▪Perpetual inventory system requires two journal entries ▪One records the revenue earned▪The other transfers the cost of the merchandise sold to an expense account and records the reduction of the value of the inventory held
Sale of merchandise on credit
Example:▪Sold 5 Slopestyle jackets on credit for $450 each (5 x $450 = $2,250) ▪Cost $200 each (5 x $200 = $1,000)
Sale of merchandise on credit
Sale of merchandise on credit
Sale of merchandise on credit (record revenue earned):
Aug. 17 Accounts Receivable 2,250
Sales Revenues 2,250
(Sold merchandise on credit.)
Sale of merchandise on credit (transfer asset to expense account):
Aug. 17 Cost of Goods Sold 1,000
Merchandise Inventory 1,000
(Cost of merchandise sold.)
▪A sales return or allowance is an adjustment to the selling price of merchandise recorded in the accounts of the seller▪The difference between a sales return and a sales allowance is that the merchandise is not returned to the seller in a sales allowance▪Different journal entries for the sales return and the sales allowance
Sales returns and allowances
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A sales return must record two journal entries: 1. The reduction in the revenue earned and
associated asset, either Cash or Accounts Receivable
2. The increase in the merchandise inventory held by the business and the reduction in the expense of the cost of merchandise sold
A sales allowance only records the first entry because the merchandise is not returned
Sales returns and allowances
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▪Reduction in revenue is recorded in an account called Sales Returns and Allowances▪Sales Returns and Allowances is a contra revenue account that has a normal debit balance▪ It is reported as a reduction in sales revenue in the income statement
Sales returns and allowances
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Example:▪Customer returned 2 Slopestyle jackets▪Originally sold for $450 each (2 x $450 = $900) ▪Cost $200 each (2 x $200 = $400)▪ Jackets were in good condition so can be returned to inventory at full cost
Example – sales return
Example – sales return
Sales return (reduction in revenue and asset):
Aug. 21 Sales Returns and Allowances 900
Accounts Receivable 900
(Customer returned merchandise purchased on credit.)
Sales return (merchandise returned to inventory):
Aug. 21 Merchandise Inventory 400
Cost of Goods Sold 400
(Cost of merchandise returned to inventory.)
▪ If the goods are returned damaged then an estimate is made as to how much they can be sold for▪ If they are estimated to be sold for lower than their original cost, then they must be recorded in inventory at this lower value▪The difference in the new selling price and the cost of the merchandise is recorded as a debit to an expense account called Loss from Defective Merchandise
Sales returns – damaged goods
Example:▪Customer returned 2 Slopestyle jackets▪Cost $200 each (2 x $200 = $400)▪Estimated can only be sold for $150 each (2 x $150 = $300)▪Difference is loss from defective merchandise ($400 - $300 = $100)
Sales returns – damaged goods
▪First journal entry to record the reduction in revenue and asset is the same▪Second journal entry to record the merchandise returned to inventory recognizes the loss from the damaged goods
Sales returns – damaged goods
Sales return (damaged merchandise returned to inventory):
Aug. 21 Merchandise Inventory 300
Loss from Defective Merchandise 100
Cost of Goods Sold 400
(Cost of damaged merchandise returned to inventory.)
▪A sales allowance may refund part or all of the purchase price▪The buyer keeps the merchandise, so the seller only needs to record the first journal entry
Sales allowance
Example:▪The goods arrived damaged at the buyers▪Seller agreed to a $340 reduction in the price of the goods
▪The buyer kept the goods so the seller does not record the return of the merchandise to inventory
Example - sales allowance
Sales allowance (only records the reduction in revenue and asset):
Aug. 21 Sales Returns and Allowances 340
Accounts Receivable 340
(Sales allowance for damaged merchandise.)
▪Sellers may grant customers a reduction to the price of the goods if a minimum quantity is purchased ▪The value of the trade discount is not separately recorded in the accounts
Trade discounts on sales
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Example:▪The list price of snow mittens is $100▪A 20% trade discount is given for purchases of 10 or more, so discount price is $80 each▪A customer purchases 10 for $80 each▪Seller records revenue of $800 based on the discounted price (not the list price)
Example - trade discounts on sales
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Sales discounts: ▪Discounts offered to customers to encourage payment of their account within the discount period▪Recorded in the accounts of the seller▪Sales returns and allowances and any transport costs on the invoice do not receive the discount
Sales discounts
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Steps to calculate sales discounts:1. Calculate the outstanding amount of the invoice to
be received from customer2. Calculate the amount of the discount3. Calculate the amount of cash to be received4. Record the journal entry
Example – calculating sales discounts
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Example:▪ Invoice total = $ 4,500▪Sales returns = $850▪Transport costs = $250 (included in invoice total)▪Credit terms = 3/14 n/60▪Customer paid invoice within discount period
Example – calculating sales discounts
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Step 1: Calculate the outstanding amount of the invoice to be received from customer
Example – calculating sales discounts
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Accounts Receivable = Invoice
total - Sales returns & allowances - Transport
costs= $4,500 - $850 - $250= $3,400
Step 2: Calculate the amount of the discount
Example – calculating sales discounts
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Discount = Accounts receivable x discount (%)= $3,400 x 3%= $3,400 x 0.03= $102
Step 3: Calculate the amount of cash to be received
Example – calculating sales discounts
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Cash receipt = Accounts receivable - discount ($)= $3,400 - $102= $3,298
Step 4: Record the journal entry
▪ If the invoice was paid after the discount period then the journal entry for the cash receipt debits Cash and credits Accounts Receivable for the full amount of the invoice less the sales return
Example – calculating sales discounts
Sales discount:
Aug. 27 Cash 3,298
Sales Discounts 102
Accounts Receivable 3,400
(Receipt of accounts receivable within discount period.)
▪Most states and many other taxation authorities impose a tax on the sale of merchandise to the final consumer▪Seller collects tax at time of sale, incurring a liability to forward the tax to the taxation authority▪Recorded in the Sales Tax Payable account▪Sales taxes usually stated as a % of the sales price
Sales Taxes
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Example:▪Sales price = $100▪Sales tax = 5% = $5▪Price charged to customer = $105
Example – sales taxes
Credit sale with sales tax:
Aug. 30 Cash 105
Revenues 100
Sales Tax Payable 5
(Credit sale with sales tax.)
▪Periodically, the seller remits the tax collected over a period to the taxation authority in one lump sum
Example – sales taxes
Payment of sales tax to taxation authority:
Jan. 15 Sales Tax Payable 7,000
Cash 7,000
(Paid sales tax collected to taxation authority.)
▪Taxation authorities normally exempt businesses from paying sales taxes on merchandise purchased if that merchandise is to be resold to customers and they hold a resellers certificate▪Generally only the final consumer that pays the sales taxes on their purchases
Sales taxes
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Prepare adjusting and closing entries under the
perpetual inventory system
Learning objective 5
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▪At the end of the accounting period a physical inventory count is taken▪This is used to calculate the dollar value of the inventory on hand▪The value of inventory on hand is compared to the balance of the Merchandise Inventory account▪These values are rarely equal due to inventory shrinkage
Adjusting entries for a merchandiser
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▪ Inventory shrinkage (or shortage) is the reduction in the value of inventory due to: – Theft – Deterioration– Breakage– Errors in the Merchandise Inventory account
▪Calculated as the difference between the value of Inventory reported in the Merchandise Inventory account and the value of inventory revealed through the inventory count
Inventory shrinkage
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▪An adjusting entry is recorded to make the balance of the Merchandise Inventory account equal to the value of inventory physically on hand▪ Inventory shrinkage is recorded in the Cost of Goods Sold account when not material
Inventory shrinkage
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Example:▪Balance of Merchandise Inventory account before adjustment = $70,000▪ Inventory count = $68,000 worth of inventory on hand▪Shrinkage = $70,000 - $68,000 = $2,000
Example - inventory shrinkage
Journal entry:
Example - inventory shrinkage
Inventory shrinkage:
Aug. 31 Cost of Goods Sold 2,000
Merchandise Inventory 2,000
(Adjusting entry for inventory shrinkage.)
▪ If the shrinkage is material, then may need to be disclosed as a separate line item on the income statement▪Debit Loss on Inventory Shrinkage rather than Cost of Goods Sold
Inventory shrinkage
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▪At the end of the accounting period closing entries are recorded▪Same steps for both service businesses and merchandisers:– Step 1: Close all temporary accounts with a credit balance
to the Income Summary account– Step 2: Close all temporary accounts with a debit balance
to the Income Summary account.– Step 3: Close the Income Summary account to equity– Step 4: Close the Withdrawals account to equity
Closing entries of a merchandiser
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▪First two steps include closing the additional temporary accounts unique to merchandising operations▪Last two steps are the same as for service businesses so will not be shown▪Accounts unique to merchandisers are highlighted
Closing entries of a merchandiser
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▪Merchandiser uses the Sales Revenues account rather than the Revenues account used by the service entity
Step 1: Close accounts with credit balance
Journal entry to close all temporary accounts with a credit balance:
Dec. 31 Sales Revenues 200,000
Income Summary 200,000
(To close temporary accounts with a credit balance.)
▪Merchandiser has additional expense accounts that need to be closed at the end of the accounting period
Step 2: Close accounts with debit balance
Journal entry to close all temporary accounts with a debit balance:
Dec. 31 Income Summary 110,000
Sales Returns and Allowances 2,000
Sales Discounts 4,000
Cost of Goods Sold 70,000
Delivery Expense 6,000
Other Expenses 28,000
(To close temporary accounts with a debit balance
Describe and prepare the multiple-step and
single-step income statements
Learning objective 6
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▪Multiple-step income statement is an income statement format that presents revenues and expenses of the business under several categories▪Highlights the relation between categories through the use of subtotals
Multiple step income statement
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There are three main sections of the multiple-step income statement: 1. Calculation of gross profit2. Income from operations3. Nonoperating itemsTogether these sections result in the net income or net loss for the period
Multiple step income statement
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▪Gross profit shows the amount of gross profit earned through the principle revenue generating activities of the business
Calculation of gross profit
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Extremely BoardIncome Statement (extract)
For the month ended December 31, 2011
$ $
Sales Revenues 200,000
Sales returns and allowances (2,000)
Sales discounts (4,000) (6,000)
Net sales 194,000
Cost of goods sold (70,000)
Gross profit 124,000
▪ Income from operations represents the income earned from the central operations of the business▪For a merchandiser or manufacturer it is calculated as gross profit less the operating expenses of the business▪For a service business it is calculated as operating revenues less operating expenses
Income from operations
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▪Operating expenses of the business are further subdivided into two expense categories▪Selling expenses are the expenses incurred in selling the merchandise of the business▪ Include:
– Advertising costs– Display costs– Storage costs– Selling and delivery costs
Income from operations
90
▪General and administrative expenses are the expenses incurred to support the running of the business▪ Include expenses incurred for business support services such as human resource management and the accounting and finance departments
Income from operations
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$ $ $
Gross profit 124,000
Operating expenses:
Selling expenses:
Wages expense - sales staff (11,000)
Delivery expense (6,000)
Advertising expense (5,000)
Total selling expenses (22,000)
General and administrative expenses:
Salaries expense - office staff (10,000)
Depreciation expense - office equipment (2,000)
Total general and administrative expenses (12,000)
Total operating expenses (34,000)
Income from operations 90,000
Income from operations
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▪Nonoperating items are items that are not involved in the central operations of the business▪Generally either:
– Small in value so as not to be considered part of the main operations of the business
– Items that do not recur each period
▪Nonoperating items may be divided into two classifications
Nonoperating items and net income
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1. Other revenues and gains may include:▪ Interest revenue▪Dividend revenue▪Rent revenue▪Gains made by selling an item of property, plant or equipment
Nonoperating items and net income
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2. Other expenses and losses may include:▪ Interest expense▪Losses from the sale of property, plant and equipment▪ You will learn about some of these items later
Nonoperating items and net income
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▪Finally, the net income earned or the net loss incurred during the period is calculated as the final bottom line of the income statement
Nonoperating items and net income
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$ $ $
Income from operations 90,000
Other revenues and gains:
Dividend revenues 2,000
Gain on sale of equipment 5,000
Total other revenues and gains 7,000
Other expenses and losses:
Interest expense (1,000)
Total other expenses and losses (1,000)
Net income / (Net loss) 96,000
Income from operations
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▪Single-step income statement is an income statement format that presents all of the revenues of the business together and then subtracts all of the expenses in one step to arrive at the net income or loss of the business▪More difficult for users to compare and analyze the gross profit or income from operations of the business▪No breakdown of expense categories▪But is simpler to prepare
Single-step income statement
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$ $
Revenues
Net sales 194,000
Dividend revenues 2,000
Gain on sale of equipment 5,000
Total revenues 201,000
Expenses
Cost of goods sold (70,000)
Selling expenses (22,000)
General and administrative expenses (12,000)
Interest expense (1,000)
Total Expenses (105,000)
Net income / (Net loss) 96,000
Single-step income statement
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