Quiz will occur either on Wed or Thurs next week.

Thursday: Q&A

2

Unit 2: Chapter 5

PURCHASE DISCOUNTSPURCHASE DISCOUNTSPURCHASE DISCOUNTSPURCHASE DISCOUNTS

Credit terms may permit the buyer to claim a cash discount for the prompt payment of a balance due. For example 2/10 net 30

The buyer calls this discount a purchase discount.

A purchase discount is based on the invoice cost less any returns and allowances granted.

Summary of Purchase transactions for buyer (Perpetual system)

•Purchase discount, purchase return, purchase and freight are recorded on Merchandise Inventory ledger account.

•P228 T account

2 Summary of Purchase entries

Sales transactions for seller (Perpetual system)

•As companies sell their products, their sales transactions are made of two components:

May 4 (BB sold 30 units of $1000 Ipad)

Accounts Receivable $30,000

Sales$30,000

COGS $20,000

Merchandise Inventory$20,000

2

Sales Tax

•Remember from G11 Acctg that businesses collect sales tax called HST (13%) for the government.

•HST payable is a liability account, which eventually goes to the government.

•We use HST recoverable when the business pays HST to a supplier.

•At the end of the fiscal period, the business pays net amount of HST (HST payable balance – HST recoverable balance) to the government.

2

Freight Costs

•Seller pays Freight only if the term was FOB Destination

•If seller had to pay:

Freight Expense $50

Bank $50

2

Sales Returns and Allowances

•When the buyer returns merchandise inventory, the seller must record these returns.

•The seller refers to these transactions as “sales returns and allowances”

•Seller would debit a contra revenue account to Sales account called, “Sales Returns and Allowance”.

•By using contra account, managers can easily keep track of both original sales number and sales return number in IS.

2

Sales Returns and Allowances

•If the buyer returned half of what they bought in slide #4 on May 8, we will have to make the following entry:

May 8 (Buyer returned 15 units of $1000 Ipad)

Sales Returns $15,000

AR$15,000

Merchandise Inventory $10,000

COGS$10,000

2

Sales Discounts

When buyer pays before 10 days, they get 2% discount (2/10, n/30), then the seller must record this discount amount in “Sales Discounts” account.

2% * 15000 = 300

Cash 14700

Sales Discount 300

AR 15000

2

Summary of Sales transactions for seller (Perpetual system)

•Sales returns, sales discounts are recorded in contra account of sales account. (Sales Return account and Sales Discount account)

•Sales return: You must reverse both revenue side and cost side of the transaction.

•P233 T account

2

Classwork / Homework

•P258 BE5-6, BE5-7

•P260 E5-3

2

SALES TAXESSALES TAXESSALES TAXESSALES TAXES

• Sales tax is expressed as a percentage of the sales price on selected goods sold to customers by a retailer. They are collected on most revenues, and paid on many costs.

• Sales taxes in Ontario is only harmonized sales tax (HST).

• HST is 13% in Ontario.

SALES TAXES ON REVENUESSALES TAXES ON REVENUESSALES TAXES ON REVENUESSALES TAXES ON REVENUES

• The retailer collects the tax from the customer when the sale occurs, and periodically (usually monthly) remits the collections to the CRA.

• Sales taxes are not revenue but are a current liability until remitted.

ILLUSTRATION ILLUSTRATION 5-105-10 CALCULATION OF GROSS PROFITCALCULATION OF GROSS PROFITILLUSTRATION ILLUSTRATION 5-105-10

CALCULATION OF GROSS PROFITCALCULATION OF GROSS PROFIT

Gross profit is often expressed as a percentage of sales.

Gross profit margin = Gross profit / Net Sales

Net sales 460,000$ Cost of goods sold 316,000 Gross profit 144,000$

Gross profit is calculated by deducting cost of goods sold from net sales as follows:Gross profit is calculated by deducting cost of goods sold from net sales as follows:

Net sales 460,000$ 100%Cost of goods sold 316,000 69%Gross profit 144,000$ 31%

ILLUSTRATION ILLUSTRATION 5-125-12 CALCULATION OF NET INCOMECALCULATION OF NET INCOMEILLUSTRATION ILLUSTRATION 5-125-12 CALCULATION OF NET INCOMECALCULATION OF NET INCOME

Net income is the “bottom line” of a company’s income statement.

Profit Margin = Net Income / Net Sales

Gross profit 144,000$ Operating expenses 114,000 Net income 30,000$

Net income is calculated by deducting operating expenses from gross profit as follows:Net income is calculated by deducting operating expenses from gross profit as follows:

Sales revenueSales 480,000$ Less: Sales returns and allowances 20,000

Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000 Operating expenses

Selling expensesSalaries expense 45,000$ Advertising expense 16,000 Amortization expense 8,000 Freight out 7,000

Total selling expenses 76,000$ Administrative expenses

Rent expense 19,000$ Utilities expense 17,000 Insurance expense 2,000

Total administrative expenses 38,000 Total operating expenses 114,000

Income from operations 30,000 Other revenue and gains

Interest revenue 3,000$ Gain on sale of equipment 600

Total non-operating revenue and gain 3,600$ Other expenses and losses

Interest on expense 1,800$ Casualty loss from vandalism 200

Total non-operating expense and loss 2,000 Net non-operating revenue 1,600

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

For the Year Ended December 31, 2002ILLUSTRATION 5-14

This is the format of a multi-step

income statement that has both

operating and non-operating activities.

As shown, the non-operating activities

are reported immediately after

the company’s primary operating

activities.

CLASSIFIED BALANCE SHEETCLASSIFIED BALANCE SHEETCLASSIFIED BALANCE SHEETCLASSIFIED BALANCE SHEET

Current assetsCash 9,500$ Accounts receivable 16,100 Merchandise inventory 40,000 Prepaid insurance 1,800

Total current assets 67,400 Capital assets

Store equipment 80,000$ Less: Accumulated amortization 24,000 56,000

Total assets 123,400$

HIGHPOINT ELECTRONICBalance Sheet (partial)

December 31, 2002Assets

On the balance sheet, merchandise inventory is

reported as a current asset and appears immediately

below accounts receivable. This is because current assets are listed in the

order of their liquidity.

On the balance sheet, merchandise inventory is

reported as a current asset and appears immediately

below accounts receivable. This is because current assets are listed in the

order of their liquidity.

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• It is a large current asset on the balance sheet

• It becomes a large expense on the income statement

• It is vulnerable to theft or misuse

Inventory is particularly important because:

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL STATEMENTS

A balancing act is needed to ensure that a sufficient, but not excessive, quantity of inventory is on hand.

Two ratios help evaluate the management of inventory:• Inventory turnover• Days sales in inventory

Classwork / HomeworkClasswork / Homework

P262 E5.9 (Profitability ratio)P264 P5.3A (Record Inventory transactions

– perpetual)P268 P5.8A (Calculate ratios and

comment)