Condensed Income Statement For Year Ended December 31, 19X2

Net sales ...........................................    $314,700

Cost of goods sold............................... (230,400)

Gross profit from sales.......................  $ 84,300

Total operating expenses ….... …… (62,800)

Net income..........................................  $ 21,500

 

This income statements tells us that Meg’s Mart sold goods to its customers for $314,700. The company acquired those goods at a total cost of $230,400. As a result, it earned $84,300 of gross profit, which is the difference between the net sales and the cost of goods sold. In addition, the company incurred $62,800 of operating expenses and achieved $21,500 of net income for the year.

A merchandising company’s balance sheet includes an additional element that is not on the balance sheet of a service company. In Illustration 1, we present the classified balance sheet for Meg’s Mart. Notice that the current asset section includes an item called merchandise inventory. Even though they also have inventories of supplies, most companies simply refer to mer­chandise inventory as inventory. This asset consists of goods the company owns on the balance sheet date and expects to sell to its customers. The $21,000 amount listed for the inventory is the cost incurred in buying the goods, shipping them to the store, and otherwise making them ready for sale.

The next sections of the chapter provide more information about these unique elements of the financial statements for merchandising companies.

Total Revenue from Sales

This schedule shows how Meg’s Mart calculates its net sales for 19X2:

 MEG’S MART

             Calculation of Net Sales

           For Year Ended December 31, 19X2

Sales..................................................... $321,000

Less: Sales returns and allowances . . $2,000

 Sales discounts..................  4,300 6,300

Net sales............................................... $314,700

The components of this calculation are described in the following paragraphs.

ILLUSTRATION 1 Classified Balance Sheet for a Merchandising Company

MEG’S MART

Balance Sheet

     December 31,19X2

        Assets

Current assets:

Cash.................................................................... $ 8,200

Accounts receivable.............................................. 11,200

Merchandise inventory......................................... 21,000

Prepaid expenses.................................              1,100

Total current assets..............................                       $41,500

Plant and equipment:

 Office equipment.....  $ 4,200

Less accumulated depreciation ….      1,400  $ 2,800

Store equipment......  $30,000

Less accumulated depreciation ….     6,000   24,000

Total plant and equipment ….....                                 26,800

Total assets.................................... . . .                      $68,300

Liabilities

Current liabilities:

Accounts payable . . ............................           $16,000

Salaries payable........................ . … . .               800

Total liabilities ….............                                      $16,800

Owner’s Equity

Meg Harlowe, capital...........................                     51,500

Total liabilities and owner’s equity  ….                  $68,300

Sales

The sales item in this calculation is the total cash and credit sales made by the company during the year. Each cash sale was rung up on one of the company’s cash registers when it was completed. At the end of each day, the registers were read and the total cash sales for the day were recorded with a journal entry like this one for November 3:

 

Nov. 3 Cash …………………………………….1,205.00

Sales………………………………   1,205.00

Sold merchandise for cash.

This journal entry records an increase in the company’s cash for the amount received from the customers. It also records the revenue in the Sales account.

In addition, a journal entry would be prepared each day to record the credit sales made on that day. For example, this entry records $450 of credit sales on November 3:

Nov. 3 Accounts Receivable …………………….450.00

Sales………………………………         450.00

Sold merchandise on credit. 

This entry records the increase in the company’s assets in the form of the accounts receivable from the customers. It also records the revenue from the credit sales.

Sales Returns and Allowances

To meet their customers’ needs, most companies allow customers to return any unsuitable merchandise for a full refund. If a customer keeps the unsatisfac­tory goods and is given a partial refund of the selling price, the company is said to have provided a sales allowance. Either way, returns and allowances in­volve dissatisfied customers and the possibility of lost future sales. Careful managers try to reduce customer dissatisfaction by minimizing returns and allowances. A company’s accountants can help by providing information to the manager about actual returns and allowances. Thus, many accounting sys­tems record returns and allowances in a separate contra-revenue account like the one used in this entry to record a $200 cash refund:

 

Nov. 3 Sales Returns and Allowances ……….200.00

Cash ……………………             200.00

Customer returned defective merchandise.

The company could record the refund with a debit to the Sales account. Although this practice would provide the same measure of net sales, it would not provide information that the manager can use to monitor the refunds and allowances. By using the Sales Returns and Allowances contra account, the information is readily available. To simplify the reports provided to external decision makers, published income statements usually omit this detail and present only the amount of net sales.

Sales Discounts

When goods are sold on credit, the expected amounts and dates of future pay­ments need to be clearly stated to avoid misunderstandings. The credit terms for a sale describe the amounts and timing of payments that the buyer agrees to make in the future. The specific terms usually reflect the ordinary practices of most companies in the industry. For example, companies in an industry might customarily expect to be paid 10 days after the end of the month in which a sale occurred. These credit terms would be stated on sales invoices or tickets as “n/10 EOM,” with the abbreviation EOM standing for “end of the month.” In other industries, invoices become due and payable 30 calendar days after the invoice date. These terms are abbreviated as “n/30,” and the 30-day period is called the credit period.

When the credit period is long, the seller often grants a cash discount if the customer pays promptly. These early payments are desirable because the seller receives the cash more quickly and can use it to carry on its activities. In addition, prompt payments reduce future efforts and costs of billing custom­ers. These advantages are usually worth the cost of offering the discounts.

If cash discounts for early payment are granted, they are described in the credit terms on the invoice. For example, the terms of “2/10, n/60” mean that a 60-day credit period passes before full payment is due. However, to encourage early payment, the seller allows the buyer to deduct 2% of the invoice amount from the payment if it is made within 10 days of the invoice date. The discount period is the period in which the reduced payment can be made.

At the time of a credit sale, the seller does not know that the customer will pay within the discount period and take advantage of a cash discount. As a suit, the discount is usually not recorded until the customer pays within the discount period. For example, suppose that Meg’s Mart completed a credit sale on November 12 at a gross selling price of $100, subject to terms of 2/10, i/60. The sale is recorded with this entry:

 

Nov.12 Accounts Receivable …………………100.00

Sales ………………………………… 100.00

Sold merchandise under terms of 2/10, n/60.

.

Even though the customer may pay less than the purchase price, the entry records the receivable and the revenue as if the full amount will be collected. In fact, the customer has two alternatives. One option is to wait 60 days until January 11 and pay the full $100. If this option is chosen, Meg’s Mart records the collection with this entry:

Jan 11 Cash ………………………………………  100.00

Accounts Receivable …………………… 100.00

Collected account receivable .

 

The customer’s other option is to pay $98 within a 10-day period that runs through November 22. If the customer pays on November 22, Meg’s Mart re­cords the collection with this entry:

 

Nov.12 Cash …………………………………………….. 98.00

Sales Discounts ………………………………  2.00 

Accounts Receivable……………………..         100.00

Received payment for the November 12

sale less the discount.

 

Cash discounts granted to customers are called sales discounts. Because man­agement needs to monitor the amount of cash discounts to assess their effec­tiveness and their cost, their amounts are recorded in a contra-revenue ac­count called Sales Discounts. The balance of this account is deducted from the balance of the Sales account when calculating the company’s net sales. Al­though information about the amount of discounts is useful internally, it is seldom reported on income statements distributed to external decision makers.