 Hello, and welcome to the session. This is Professor Farhad, and this session will look at accounting for the merchandising operation from the seller's perspective. In the prior session, we looked at the purchasing perspective. Now, after we purchased the asset, after we purchased the inventory, we're gonna turn around and sell it. That's what merchandisers do. This topic is covered in a financial accounting course, and this is an introductory financial accounting course also covered on the CPA exam, the FAR section. If you haven't connected with me on LinkedIn, please do so. YouTube is where you would need to subscribe. I have 1,600 plus accounting, auditing, tax, and finance lectures. I cover more than 12 accounting courses, including many CPA questions. If you like my lectures, please click on the like button, share them, put them in playlist. If they benefit you, it means they might benefit other people as well. And please connect with me on LinkedIn, on Instagram. On my website, you'll have access to additional resources. If you are looking to supplement your studies, check out my website. If you're looking to study for your CPA exam, I have 2,000 plus CPA questions and many other resources. So now we're gonna turn around as a merchandising operation, and we're gonna sell our goods, sell the goods that we purchase. So the sale of merchandise involved two parts. Why two parts? It means two transactions. Here's why. When we purchased an item, let's assume we purchased a calculator for $10. What we do is we debit, merchandise, inventory for the cost, and happens to be $10. And let's assume we paid cash $10. That's what make the purchase. Now when we make a sale, let's assume we sold it for $22. We're gonna debit cash. We're gonna assume we sold it for cash $22. Credit sales $22. Now we're gonna go a step further because we are using the perpetual inventory system. This means we have to update our inventory. This means this merchandise inventory will have to be eliminated. Therefore, we're gonna credit merchandise inventory and the amount is $10. And merchandise inventory turn into cost of goods sold. Basically what we did is we expensed. We expensed the inventory into cost of goods sold. So that's why we need two journal entries. This is one and this is two and we're gonna see it. So let me eliminate all the ink and let's take a look at it. So we are looking at two journal entries. The first one revenue received in the form of an asset from the customer. This asset could be cash or a count receivable. That's the first thing we have to look at. The second entry recognition of the cost of the merchandise. This is when we debit cost of goods sold and we credit merchandise inventory or for short inventory. And the best way to look at this, let's take a look at some transactions. Let's assume we Zmart sold $1,000 worth of merchandise on credit. The merchandise has a cost basis of 300. So we sold them for 1,000. The cost basis is 300. We're gonna debit. Debit account receivable, credit sales for 1,000. This is to record the sale. Now we also have to record the cost of the sale and the cost is giving as 300. Now on some textbook, they will tell you, for example, cost is 50% of sales. It means the cost is $500. Or they tell you cost 70% of sales. It means cost is $700. In this example, they make it easy. They just tell you upfront the cost is 300. No nothing to worry about. Therefore we debit cost of goods sold, which is an expense. And we reduce our inventory because that inventory is no longer in our warehouse. So we need to update our inventory. Okay, let's take a look at sales discount. What is a sales discount? Sales discount on credit sales can benefit a seller by decreasing the delay and receiving the cash. Sales discount is basically saying, I'm gonna give you an incentive to pay early. What is an incentive to pay early? Well, what's the incentive? I'm gonna give you a reduction in the price. I'll make you pay early. Why? Because cash is king. You can use cash for any purpose. Therefore I would like to receive my cash as early as possible. So there is a discount period. Just like when we did the purchase discount, sales discount is practically the same. So it's basically something like this. You'll get two slash 10 and 30. How do we interpret this? It means we're gonna give you 30 days as the credit period. Then the discount period is 10 days. This is 10 days. And if you pay within the discount period, we're gonna give you 2%. So I'm gonna give you 2% to slash 10 if you pay within 10 days. None, no discount. And you have to pay the bill in 30 days. In 30 days, okay? So that's the idea of it. This is the sales discount. Sales returns and allowances. What are sales returns and allowances? Just like we have a purchase returns and allowances, we also have a sales returns and allowances. Usually involve dissatisfied customer and the possibility of lost future sales. Simply put, sales return refer to merchandise and the customer return to the seller after a sale. Simply put, most likely you are familiar with this. You purchase something, you don't like it, you can return it. Or you would receive a sales allowance. Sales allowance, you don't return anything. You refer to the reduction and the selling price of the merchandise sold to customers. Simply put, they're gonna give you a discount. They're gonna give you a discount in your price, okay? Now the new sales discount return and allowances follow the new revenue recognition principle to require the reporting of sales at the net amount expected. Adjusting entries required for expected sales discount, expected return and allowances and expected returns and allowances also because it could be return, it could be allowance because we also have to reduce the cost size aside, okay? So the best way to illustrate this is to look at an exam. So let's take a look at this example. On June 21st, smart touch learning sold 10 tablets for $500. On account with terms two slash 10 and 30, the cost is 3,500. What we're gonna do now, we're gonna record the sale net of discount, net of discount. What does that mean? Because this is basically following the new revenue recognition standard. The sale we sold 10 tablets each for $500. Total sales is 5,000. Now, what we do is we assume upfront, we make the assumption that the buyer is going to pay within the discount period and what's the discount period, 10 days? What's the discount, 2%. So we're gonna give this individual 2% upfront, although they may or may not. So basically there's a reduction in the sales of $100. When we record our sale, we record the sale for 4,900, not 5,000, we credit sales revenue for 4,900, not 5,000. Are we making an assumption? Yes, we are, but here we are being conservative. We assume that the customer may take the discount, the 2% discount upfront. Now the cost of sales, it's recorded the same, debit cost of goods sold, credit merchandise inventory. So that's the assumption. Now let's keep going with our assumption. Let's assume the customer does indeed pay within the discount period. They only have to pay us 4,900. We debit cash, 4,900. We credit account receivable, 4,900. And the receivable becomes zero and this is exactly what we planned ahead. Basically we assume they will take the discount, indeed they took the discount. Now your question is what if they don't take the discount? What if they don't take the discount? Simply put, if they don't take the discount, they are going to lose $100, which their loss will be our profit. So if the customer fails to take the discount, they have to pay us $5,000. We debit cash $5,000. We credit the receivable, we reduce the receivable by 4,900 and we increase an account called sales discount forfeited. What is this account? Basically it's other revenue. First we thought that we lost this $100. Initially we thought that $100 is lost because they are gonna pay within the discount period. But they failed to do so. Therefore, also in this situation that account receivable will go down to zero, but we increased our sales discount forfeited which is other revenue, which increased our income by 100. So sales returns and allowances is the return of goods by a customer. We talked about this. We need to estimate sales return under the new revenue recognition. And companies must decrease sales revenue by an estimated amount of sales return. Here we are being proactive. Here we are being proactive. We have to estimate. Now, how do we estimate? We look at historical data. We look at what historical data? What happened in the past? And as a business, you would know eventually, if you're in a business for two, three years, you're gonna have some data, some previous data. And based on that previous data, you can estimate how much of your total sales will be returned. Therefore, you would estimate. Now, are you gonna be accurate? The answer is absolutely not. But you're gonna be close enough and by estimating, you are being conservative. And this is what the new revenue recognition standard is trying to do. Trying to project a conservative figure on your sales by estimating those sales returns up front, okay? So let's take a look at an example. Let's assume smart touch learning has a million dollar of sales and cost of goods sold is 600,000. Smart touch learning estimates that 4% of the merchandise sold will be returned. That's an estimate. We really don't know, but that's what we think. So what's gonna happen is we're going to debit sales revenue. We're gonna reduce sales revenue by 4% of total sales. 4% of a million is 40,000. And we're gonna credit liability. This is a liability. Now we're saying we're gonna have to pay back or reduce our receivable by 400,000. So we create a liability. Also what we do is we debit estimated return inventory. Remember, we're gonna be reducing our sales by 40,000. 24% of that is cost. I'm sorry, not 24, 60%. 60% of that is cost. How did I know 60% is cost? Well, look, I made a sale of a million. The cost of the sale is 600,000. That's given to us. Well, 600,000 divided by a million. My cost as a percentage of sales is 60%. Therefore, if they're returning $40,000 of goods that they purchased from me, it means 60% of that is cost. So 60% is 24,000. So what I would do, I will debit estimated return inventory, which is an asset. And I reduce my cost of goods sold. Again, those are not actual. Those are estimates. All what we're doing is we're estimating those numbers. Now what's gonna happen, we're gonna find out on January 20th, a customer returned merchandise with cash, with the sales price of 2,000. Cost of goods sold is 800. Now we're gonna have to give the customer back $2,000. So we're gonna credit cash 2,000. We're gonna reduce our refund payable. Now our refund, remember, we estimated 40,000 worth of refunds. So far, we paid back 2,000. We still have 38,000 in the refund payable. Now we put back the inventory back on the books. We debit merchandise inventory 800 and we credit. We reduce this estimated return inventory because now we have the actual inventory. We have the actual inventory. How do we deal with sales allowance? Sales allowance to a great degree the same concept. On January 28th, Smart Touch Learning grant $100 of sales allowance for goods damaged in transit. There was some goods damaged, the customer complained. We told them, don't worry, we're gonna reduce your bill by $100. What we do is we debit refund payable. We reduce our liability and we reduce our account receivable because they no longer owe us the money. Now remember what we talked about in the prior session, freight out. It means when the seller sells something and incur transportation cost, freight out is an expense. So of Smart Touch Learning paid $30 to ship goods to a customer. Remember, this is freight out, not, let me write this down, not freight in because freight in, if you remember, freight in is an inventoryable cost. It's an asset, freight out is an expense. It's a selling expense. Therefore, what we do is we debit delivery expense which increasing expenses and we credit cash. Freight out is a delivery expense to the seller. It's specifically called a selling expense. Simply put, it's part of your effort to sell the goods that you have. Now in the next session we would look at adjustments and closing entries for merchandising operation. As always, if you like the recording, please click on the like button. Visit my website for additional resources. If you're studying for your CPA exam, study hard. It's worth it. Good luck and I'm always here to help you.