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Accounting Principles I – Accounting for a Merchandising Company

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    Study Guide Accounting Principles I – Accounting for a Merchandising Company 1. Recording Sales 1) Sales invoices: your proof that a sale happened A sales invoice is a source document . That means it’s the paperwork that shows the details of a sale (who bought it, what they bought, how much it cost, and the date). To keep good control over sales, companies usually make sales invoices sequentially prenumbered (for example: 15930, 15931, 15932…). This helps the accounting department track every invoice and make sure none are missing . 2) What “sales revenue” means Sales revenue is the selling price of all products that are sold . So if a business sells products for a total of $5,000, then sales revenue = $5,000 . 3) When do we record sales revenue? (Revenue Recognition Principle) Businesses follow the revenue recognition principle , which says: Sales revenue is recorded when the customer receives title (ownership) of the merchandise This is true even if the customer has not paid yet So revenue depends on ownership transfer , not on when cash is received .

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    Study Guide 4) Recording a sale at the counter (instant possession) If a customer buys something at a store counter and takes the goods immediately , then only one document is needed to record the sale: • the sales invoice OR the cash register receipt That single document is enough because it proves the customer received the goods right away. 5) Recording a sale when goods are shipped If the company ships merchandise to the customer , then they need extra proof that the customer actually got the goods. So the business matches: • the sales invoice • with • a delivery record or shipping document This matching is important because it proves the items were actually shipped to the customer . Example: Music Suppliers, Inc. sells on account Let’s say Music Suppliers, Inc. sells $1,000 worth of merchandise on account to a retail store called Music World . “On account” means: The customer buys now The customer will pay later To record this sale, Music Suppliers, Inc. makes the journal entry shown in the image.

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    Study Guide 2. Sales Returns and Allowances Two ideas, one account Even though sales returns and sales allowances are technically two different types of transactions, businesses usually record both in the same account called: Sales Returns and Allowances This keeps the accounting system simpler and makes tracking easier. What is a sales return? A sales return happens when a customer sends merchandise back to the seller. This usually happens when the product is: • defective • damaged • not what the customer expected or wanted So the customer returns the goods, and the company reduces the sale. What is a sales allowance? A sales allowance happens when the customer keeps the merchandise , but the seller agrees to lower the price .

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    Study Guide This usually happens when the merchandise isn’t perfect (maybe damaged or defective), but the customer decides it is still usable — just not worth the full price. Example: Music World returns $100 of merchandise If Music World returns merchandise worth $100 , then Music Suppliers, Inc. prepares a credit memorandum . A credit memorandum is a document that proves the customer is receiving a credit for the return. This credit memo becomes the source document for the journal entry. To record the return, Music Suppliers, Inc. makes an entry that: increases (debits) Sales Returns and Allowances decreases (credits) Accounts Receivable That means the customer now owes less money , because the sale was reduced. A $100 allowance uses the same entry If the customer does not return the merchandise but receives a $100 price reduction (a sales allowance ), the journal entry is the same : • Debit Sales Returns and Allowances • Credit Accounts Receivable In both cases, the company is reducing the amount it expects to collect from the customer.

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    Study Guide Why this account reduces sales on the income statement On the income statement, Sales Returns and Allowances is shown in the sales revenue section as a subtraction. It is subtracted from Sales because it has the opposite effect on net income . It lowers revenue, which lowers profit. Because it works opposite of normal sales revenue, Sales Returns and Allowances is called a: contra - revenue account A contra - revenue account normally has a: debit balance Why businesses track returns and allowances separately Keeping Sales Returns and Allowances in a separate contra - revenue account helps management measure: returns and allowances as a percentage of total sales If return levels are high , it could signal serious (but fixable) problems, such as: • poor packaging , causing damage during shipping • defective merchandise , meaning the company may need new suppliers • incorrect shipments , caused by weak order - recording or packing methods The best way to catch these issues early is to carefully monitor returns and allowances in their own contra - revenue account.

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    Study Guide 3. Sales Discounts What is a sales discount? A sales discount is a reward a seller offers to encourage customers to pay quickly for credit sales. In simple words: Pay early → save money. Sales discounts are recorded in a separate contra - revenue account called Sales Discounts . This helps management track how well the discount policy is working . Credit terms on invoices (what they mean) Most invoices include credit terms . These terms tell the customer: • when payment is due • whether a discount is available • how long the customer has to earn the discount A common example is: 2/10, n/30 (read as “two - ten, net thirty” ) Understanding “2/10, n/30”

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    Study Guide The terms 2/10, n/30 mean: • The customer can take a 2% discount if they pay within 10 days of the invoice date. • If they don’t pay within 10 days, then the full amount is due within 30 days . Important detail: The discount is taken on the outstanding balance , which is: original invoice amount − returns and allowances What does “EOM” mean? Sometimes invoices include the abbreviation EOM , which means: End of month Example: n/15 EOM This means the full outstanding balance is due: 15 days after the end of the month in which the invoice date occurs. Example with returns + discount (Music World) Music World originally receives a $1,000 order . Later, Music World returns merchandise worth $100 . So now the amount still owed is: $1,000 − $100 = $900 If the credit terms are 2/10, n/30 and Music World pays within 10 days , they earn the discount: • Discount = 2% of $900 = $18

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    Study Guide • Payment amount = $900 − $18 = $882 So Music World pays $882 . Recording the payment (compound journal entry) When Music Suppliers, Inc. receives the payment within the discount period, the company records a compound journal entry (because it affects more than two accounts): Debit Cash for $882 (cash increases) Debit Sales Discounts for $18 (contra - revenue increases) Credit Accounts Receivable for $900 (customer balance decreases) This entry clears out the $900 owed by Music World. 4. Net Sales What does “net sales” mean? Net sales is the amount of sales revenue a company actually earns after subtracting reductions in sales . These reductions include: • Sales Returns and Allowances (returns or price reductions) • Sales Discounts (discounts for early payment)

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    Study Guide Net S ales F ormula To calculate net sales , use this formula: Net Sales = Sales − Sales Returns and Allowances − Sales Discounts This helps show the company’s “real” sales after adjustments. Example: Music Suppliers, Inc. (June totals) During June, suppose Music Suppliers, Inc. has: • Sales: $116,500 • Sales Returns and Allowances: $9,300 • Sales Discounts: $1,200 Now subtract the reductions: $116,500 − $9,300 − $1,200 = $106,000 So, net sales for June = $106,000 .

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    Study Guide 5. Inventory Systems Two ways to track inventory Businesses use two main systems to account for inventory: 1. Perpetual inventory system 2. Periodic inventory system Both systems help a company know what inventory it has, but they do it in different ways. 1. Perpetual inventory system (updates every time) In a perpetual system , the Inventory account is updated after every purchase or sale . That means the inventory records change continuously, so the company can see inventory levels at any time . Before computers were common , this system was usually only practical for companies that sold a small number of high - priced items , because it took too much time to update inventory manually for lots of products. 2. Periodic inventory system (updates at the end) In a periodic system , inventory is not updated after every sale. Instead, the company does a careful inventory evaluation only at the end of the accounting period . At that time: • Each product available for sale is counted • The number of units is multiplied by the cost per unit • All those totals are added together to find the ending inventory value So, the final total of those calculations equals the value of inventory at the end of the period.

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