Accounting Principles I – Accounting for a Merchandising Company - Quick Guides

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Study GuideAccounting Principles I–Accounting for aMerchandising Company1. Recording Sales1) Sales invoices: your proof that a sale happenedAsales invoiceis asource document. That means it’s the paperwork thatshows the details of asale(who bought it, what they bought, how much it cost, and the date).To keep good control over sales, companies usually make sales invoicessequentially prenumbered(for example: 15930, 15931, 15932…).This helps the accounting departmenttrack every invoiceand make surenone are missing.2) What “sales revenue” meansSales revenueis theselling price of all products that are sold.So if a business sells products for a total of $5,000, thensales revenue = $5,000.3) When do we record sales revenue? (Revenue Recognition Principle)Businesses follow therevenue recognition principle, which says:Sales revenue is recorded when the customer receives title (ownership) of themerchandiseThis is trueeven if the customer has not paid yetSo revenue depends onownership transfer,not on when cash is received.

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Study Guide4) Recording a sale at the counter (instant possession)If a customer buys something at a store counter andtakes the goods immediately, then onlyonedocumentis needed to record the sale:•thesales invoiceOR thecash register receiptThat single document is enough because it proves the customer received the goods right away.5) Recording a sale when goods are shippedIf the companyships merchandise to the customer, then they need extra proof that the customeractually got the goods.So the business matches:•thesales invoice•with•adelivery record or shipping documentThis matching is important because it proves the items wereactually shipped to the customer.Example: Music Suppliers, Inc. sells on accountLet’s sayMusic Suppliers, Inc.sells $1,000 worth of merchandiseon accountto a retail store calledMusic World.“On account” means:The customer buys nowThe customer will pay laterTo record this sale, Music Suppliers, Inc. makes the journal entry shown in the image.

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Study Guide2. Sales Returns and AllowancesTwo ideas, one accountEven thoughsales returnsandsales allowancesare technically two different types of transactions,businesses usually record both in thesame accountcalled:Sales Returns and AllowancesThis keeps the accounting system simpler and makes tracking easier.What is a sales return?Asales returnhappens when a customersends merchandise backto the seller.This usually happens when the product is:•defective•damaged•not what the customer expected or wantedSo the customer returns the goods, and the company reduces the sale.What is a sales allowance?Asales allowancehappens when the customerkeeps the merchandise, but the seller agrees tolower the price.

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Study GuideThis usually happens when the merchandise isn’t perfect (maybe damaged or defective), but thecustomer decides it is still usable—just not worth the full price.Example: Music World returns $100 of merchandiseIfMusic Worldreturns merchandise worth$100, thenMusic Suppliers, Inc.prepares acreditmemorandum.Acredit memorandumis a document that proves the customer is receiving a credit for the return.This credit memo becomes thesource documentfor the journal entry.To record the return, Music Suppliers, Inc. makes an entry that:increases (debits) Sales Returns and Allowancesdecreases (credits) Accounts ReceivableThat means the customer now owesless money, because the sale was reduced.A $100 allowance uses the same entryIf the customer does not return the merchandise but receives a$100 price reduction(asalesallowance), the journal entry isthe same:•DebitSales Returns and Allowances•CreditAccounts ReceivableIn both cases, the company is reducing the amount it expects to collect from the customer.

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Study GuideWhy this account reduces sales on the income statementOn the income statement,Sales Returns and Allowancesis shown in thesales revenue sectionas a subtraction.It is subtracted fromSalesbecause it has theopposite effect on net income.It lowers revenue, which lowers profit.Because it works opposite of normal sales revenue,Sales Returns and Allowancesis called a:contra-revenue accountA contra-revenue account normally has a:debit balanceWhy businesses track returns and allowances separatelyKeepingSales Returns and Allowancesin a separate contra-revenue account helps managementmeasure:returns and allowancesas a percentage of total salesIf return levels arehigh, 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 methodsThe best way to catch these issues early is tocarefully monitorreturns and allowances in their owncontra-revenue account.

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Study Guide3. Sales DiscountsWhat is a sales discount?Asales discountis a reward a seller offers to encourage customers topay quicklyfor credit sales.In simple words:Pay early → save money.Sales discounts are recorded in a separatecontra-revenue accountcalledSales Discounts.This helps managementtrack how well the discount policy is working.Credit terms on invoices (what they mean)Most invoices includecredit terms. These terms tell the customer:•when payment is due•whether a discount is available•how long the customer has to earn the discountA common example is:2/10, n/30(read as“two-ten, net thirty”)Understanding “2/10, n/30”

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Study GuideThe terms2/10, n/30mean:•The customer can take a2% discountif they paywithin 10 daysof the invoice date.•If they don’t pay within 10 days, then thefull amount is due within 30 days.Important detail:The discount is taken on theoutstanding balance, which is:original invoice amount − returns and allowancesWhat does “EOM” mean?Sometimes invoices include the abbreviationEOM, which means:End of monthExample:n/15 EOMThis means the full outstanding balance is due:15 days after the end of the monthin 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 = $900If the credit terms are2/10, n/30and Music World payswithin 10 days, they earn the discount:•Discount =2% of $900 = $18

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

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Study GuideNetSalesFormulaTo calculatenet sales, use this formula:Net Sales = Sales − Sales Returns andAllowances − Sales DiscountsThis 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:$1,200Now subtract the reductions:$116,500 − $9,300 − $1,200 =$106,000So,net sales for June = $106,000.

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Study Guide5. Inventory SystemsTwo ways to track inventoryBusinesses usetwo main systemsto account for inventory:1.Perpetual inventory system2.Periodic inventory systemBoth systems help a company know what inventory it has, but they do it in different ways.1. Perpetual inventory system (updates every time)In aperpetual system, theInventory account is updated after every purchase or sale.That means the inventory records change continuously, so the company can see inventory levelsatany time.Before computers were common, this system was usually only practical for companies that soldasmall number of high-priced items,because it took too much time to update inventory manually forlots of products.2. Periodic inventory system (updates at the end)In aperiodic system, inventory is not updated after every sale.Instead, the company does acareful inventory evaluation only at the end of the accountingperiod.At that time:•Each product available for sale iscounted•The number of units is multiplied by thecost per unit•All those totals are added together to find theending inventory valueSo, the final total ofthose calculations equals the value of inventory at the end of the period.

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