 Hello and welcome to the session. This is Professor Farhad and this session we would look at merchandising operation specifically the purchasing component of it. This topic is typically covered in a financial accounting basically an introductory accounting course also covered on the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus accounting or I think tax and finance lectures. If you like my lectures, please like them. Click on the like button. It doesn't cost you anything. Share them. Put them in playlists. If they benefit you, it means they might benefit other people. Please connect with me on Instagram. On my website, you will find additional resources such as exercises, multiple choice, true, false. If you're studying for your CPA exam, I have 2,000 plus CPA questions. I strongly suggest you check out my website. Let's talk about reporting income for a merchandiser. Well, what is a merchandiser? Merchandiser is a company that buys and sells goods. So they buy first then they sell second. So first you have to buy something. You cannot sell it if you don't own it. Now, this is different than a service company. In a service company, you sell time. You sell your time. So basically your income statement would look something like this. Revenues minus expenses. So this is what your income statement would look like. Now for a merchandiser, it's a little bit more complicated in the sense that you're going to have some intermediate steps. So a merchandiser sells product to earn revenue. Examples will be sporting goods, clothing, auto parts. Any place if you go to any store, those are merchandisers. So here's what's going to happen in a merchandiser company. You're going to have sales. Yes, you're going to sell something. Then you're going to subtract from sales minus something called cost of goods sold. Where does this cost of goods sold come from? Well, remember, what do you have to do first? First, you have to buy. So let me give you an example. Let's assume you buy a calculator for five dollars. So you debit merchandise inventory for five dollars. And let's assume you paid cash. You paid cash five dollars. Now, when you sell it, you're going to sell it for, let's assume you're going to sell it for twelve dollars. When you sell this calculator for twelve dollars, you're going to debit. You're going to debit. Let's assume you sell it also for cash. You're going to debit cash. Twelve dollars. You're going to credit sales revenue. Twelve dollars. You sold it for twelve. So there we go. So the first number is twelve dollars goes under net sales. Let me clean this up. So the first thing is you have twelve dollars under sales. Twelve dollars under sales. Now, remember, before you purchase this, before you sold it, you had to purchase it. Now, once you sold the calculator, it has to go away. It has to be removed from your inventory. This calculator is no longer there. So what you have to do, I'm going to abbreviate this as merchandise inventory MI. You're going to credit merchandise inventory five dollars. So you're going to remove this credit merchandise inventory five dollars. And merchandise inventory becomes something called cost of goods. Sorry, let me just, I'm going to abbreviate because there's not enough space to write it. So it's going to turn into cost of goods sold five dollars. And this is where the five dollars is cost of goods sold. So you're going to debit cost of goods sold, which is an expense. So for for merchandisers, first they have to buy, which is five dollars, then they have to sell it. They sell it for twelve. But notice what we did and I'm going to I'm going to I'm going to talk about this later. We have two entries. We had two entries, one to one to record the sale and the second one to record the cost of the sale. Now sales minus cost of goods sold equal to something called gross profit of seven dollars. From your gross profit, you incur operating expenses. Let's assume four dollars and you would be left with income with three. Where did the four came from? I just made it up. So this is the income statement for a merchandiser, which is a little bit more involved than a service company because in a service company, what we did is we only had revenues minus expenses. We did not have this cost of goods sold account. Now also also what's different is we introduced the concept of merchandise inventory. Generally speaking, generally speaking, service companies, they don't have merchandise inventory. And if they do have it, they have a small amount. So it's not a major portion of their assets. And this is an income statement for a service company. And this is an income statement for a merchandising company. And notice this new intermediary intermediate steps cost of goods sold, which is gives us gross profit when we deduct it from sales. So this is an overall picture. The other term we need to learn about is something called the operating cycle of a merchandiser. What's the operating cycle? The operating cycle start with cash and end up with more cash. So it begins with the purchase of merchandise inventory and ends with the collection of cash. So first you buy something, then you sell it. How long does it take you from the time to buy to the time to sell? That's called the operating cycle. So let's assume you started with a hundred thousand dollars invested in your merchandise. You bought bicycles, you advertise the bicycles, you put them in your store, then you sold them on credit, then you collected the cash, and you end up collecting 145,000. So the question is how long did it take you from the time to invest that money in the bicycles until you collect your cash? This is called the operating cycle. Now generally speaking, for most merchandisers, the operating cycle is less than one year. It's less than one year. Now what happened if the operating cycle is less than one year? We assume the operating cycle is one year. So if it's less than one year, it's one year. Now for certain companies, the operating cycle is longer. You don't have to worry about this. Just know that that possibility could exist. Now we have two types of inventory system. We have to know the difference between them. One is called perpetual and the other one is called periodic. So you need to know the difference between perpetual and periodic. And a perpetual inventory system. Think in a perpetual inventory system as a computerized system. What do I mean by computerized? It's automated. It's automated. What does it mean? It's automated. It means it's going to keep your accounting record up to date after each purchase and each sale. So when you buy something, your inventory goes up. When you sell something, your inventory goes down. And this is what I did implicitly when I bought that calculator that I sold it. When I bought it, I updated my merchandise inventory account. When I sold it, I reduced my merchandise inventory account. So think of it as a, it's not really smart, but let's start, let's think of it this way. It's a smart system relative to the periodic inventory system. Under a periodic inventory system, it's a manual. Think of periodic inventories. Think of it as a manual system, not computerized. Update record for purchase and sale only at the end of the accounting period. What does that mean? It means you don't know how much inventory you have until you do a count. You do the count and you know how much inventory you have left. Now for our purposes, we're going to be using the perpetual inventory system in the appendix. They will look at the periodic inventory system and mostly in the appendix of each chapter because the perpetual is what's commonly used for a financial accounting course. So let's take a look at an example to see how this all work. So on November 2, Zmart purchased $500 worth of merchandise for cash. Simply put, we debit merchandise inventory, which means we bring it up $500, we reduce cash $500. Now let's assume we made a purchase and they offer us a cash discount. So something like this. On November 2, Zmart purchased $500 worth of merchandise. On account credit terms, now this is important, are 2 slash 10 and 30. What do we need to do? Basically the same journal entry. We debit merchandise inventory, $500. We credit accounts payable, $500. Credit, it's going to increase accounts payable by $500. Now we need to understand what does 2 slash 10 and 30 means. This is how you read it. It means the seller has given you a discount of 2% if you pay within 10 days. So you have 10 days to pay me. If you pay within 10 days, I'm going to give you 2% off. Otherwise or none, otherwise the full amount is due within 30 days. The full amount is due within 30 days. Okay, this is what it means. So you have 30 days. We call this 30 days is the credit period and the discount period for this purpose is 10 days. The discount period, let me just erase this. The discount period is 10 days. Pay me within 10 days and I will give you a discount. Now why do sellers offer this discount? Because they want to be paid early. Why? Because cash is coming. They need the cash for other purposes. And this is what an invoice would look like. So when you buy something, you have a purchase invoice. What do you have on purchase invoice? The name of the seller is Tracks. The invoice date, this is important because the invoice date determined whether you're going to get the discount or not. The purchaser is Zmart. Order date. When did you order this? Order date on 10.30. The invoice due on 11.2. Credit terms. We talked about the credit terms. Freight terms. We're going to talk about the freight terms later. The goods. You bought those two items. Toddler Challenger X7 and Boys slash Girls Speed Demin 1, 350, 150 the price. And the total invoice amount is 500. If you pay within the discount period, they're trying to empice you. You only pay us $490 because you're going to get $500 and you're going to get 2% off. 2% off is $10. So you can save yourself $10 if you pay us, if you pay us early, if you pay us early. So let's assume we did pay early. Well, how much do we have to pay if we pay early? By November the 12th, we pay only $490. So we credit cash $490. We debit accounts payable for the full amount. It means you owe us $500. We're only going to pay you $490. The difference is $10. This is the savings. So we save $10 on our inventory cost. Now this is what the T accounts would look like. The accounts payable, we had a $500 balance. We debited $500. The balance is zero. We paid the bill. We credited cash $490. Now initially we thought we're going to pay for the inventory $500. Therefore the cost was $500, but since we paid $490, we reduced the cost by $10. Therefore our inventory is $490. Now if we did not pay within the discount period, guess what? We have to pay a full $500. Therefore if we did not pay, let's assume we pay December 2nd, which is 30 days after the purchase, we have to pay the full amount of $500. Another thing that merchandisers deal with is purchases with returns and allowances. And what is a purchase return? It's when the merchandise are returned to the supplier. You purchase something, and I'm pretty sure most of you are familiar with a purchase return. At some point in your life you had a return. So you return the merchandise. Purchase allowance is a little bit different. Purchase allowance, it's a price reduction. All what you do is you call the seller and you tell them I'm not happy with the product or you send me the wrong size, the wrong color. The product was damaged during shipment and the seller might say keep it and I'm going to give you a discount, a price reduction for the defective or unacceptable merchandise. So let's look at entries to deal with this. Let's look at a purchase allowance. Let's assume November 5th, Zeemar the buyer issue a $30 debit memorandum. When you receive a reduction in the price of your reduction, in the price of the merchandise, it's called the debit memorandum. That's the term for an allowance from tracks for defective merchandise. You remember we purchased 500 worth of tracks? Now we called them. We said, you know, there was some defective merchandise. They said keep it. We're going to give you a $30 deduction. So what you do is you flip the entry. What do I mean by flip? When you buy, you debit merchandise inventory and you credit accounts payable. That's when you buy. When you have a purchase allowance, you flip the entry, you debit accounts payable, you credit merchandise. If you return the item, if the items were returned, the entry is the same. Let's assume you return $30, the entry will be the same. So the purchase allowance and the purchase return are the same, are the same. Okay, let's take a look at a purchase return. Zeemar purchased $250 of merchandise on June 1st with a term 2 slash 10 and 60. The following day, two days later, Zeemar returned $50 of goods before paying the invoice. When Zeemar pays on June 11th, it takes a 2% discount on the remaining $200 balance. So let's take a look at the journal entries. First, we bought the inventory. We debit merchandise inventory, credit accounts payable. So this is for the purchase right here. Now, two days later, we returned $50. We flipped the entry for $50. We debit accounts payable, we credit merchandise inventory. Now, originally, we purchased $250. When we returned $50, what's left in the balance is $200. Now, when we paid the balance, and this is where students kind of fall into the trap here, is they take the discount based on the $250. No, the discount is based on $200, which is you're going to get $4 off. You're going to get $4 off. So you pay cash $196, accounts payable. You remove the whole accounts payable, and you reduce your merchandise inventory cost. The $4 that discount that you received is a reduction in your inventory cost. Therefore, you credit inventory cost. Now, let's talk about the topic that I said I'm going to talk about later, which is shipping, not shipping, the freight terms. Basically, when you buy something, it might be either FOB shipping or FOB destination. So what does it mean if it's FOB shipping, FOB destination? It tells you who's paying for the shipment and whose goods is it while in transit. Let's start with FOB shipping point. FOB shipping point. Think of FOB shipping point when the buyer drives their car to the seller. So if you want to buy something, you can drive your car, you can drive your truck to the seller and pick it up. You don't have to drive your car, you can hire someone, but the point is you are paying for the shipment. So if it's FOB shipping and you drove your car all the way to the seller and you picked up the product, ownership transferred at shipping point. So if you drove to this warehouse right here and you picked up something from this warehouse, it becomes shipping point because you're the buyer and you picked it up. When you're driving that vehicle, that truck back to your place, it's your goods. That's important. So goods in transit while on the road, in the air and the sea, if you pay for the shipment, if you're the buyer and you pay for the shipment, it's your goods. And when you pay for the shipment, it's part of your inventory. And that should make sense. If you purchase something online for $50 and you happen to pay $5 for shipping, how much did that item cost you? It cost you $55, $54 the item itself and $5 shipping. Therefore, shipping cost is an asset for the buyer. If you are the buyer and you pay shipping cost means you are buying something FOB shipping, then it's an asset. On the other hand, here's what you can do. You can call the seller and tell them, I want to order 10 units and please deliver the 10 units to my place of business and let me know what the bill is. Now, the seller is going to drive their vehicle to the buyer or send them on a boat or in a plane, but the seller is responsible. So the seller is responsible until they reach the destination. The destination is the buyer, is the buyer, place of business. So anything that happens in transit, let's assume this drug get into an accident, then it's the seller's responsibility because the inventory is still seller's inventory. Now, how does the seller account for the shipping cost? I hope you know it, it's an expense. When the seller pays for shipment, it's a delivery expense. It's basically a selling expense. Well, if you want to sell, sometime you're going to have to incur cost to ship the product. Therefore, it's a selling expense. So make sure you know the difference between FOB shipping point and FOB destination. Where does the ownership takes place? Whose goods is it in transit? In the journal entry. The buyer, if they pay for the shipping, it's an asset. The seller, if they pay for the shipping, it's an expense. It's an operating expense. So let's take a look at an example. Zmart purchased merchandise on terms FOB shipping. It means the buyer is paying. The transportation cost happens to be 75. They will debit merchandise inventory, which is an asset and they credit cash. Okay. Now let's take a look at the net cost of merchandise purchases. When you buy merchandise, you're going to have a net cost. What is the net cost? Well, when you buy something, it's going to be starting with the cost of that something. So for this company, they purchased 235,800 worth of goods. Then they receive discounts. Remember that discount reduces your cost. Notice minus 4,200 in discount. Then if you return anything or if the buyer, if the seller granted you any allowance, you're going to reduce your cost by the allowance. Now remember, if you paid for transportation cost, you're going to add your transportation cost of 2,300. So simply put, the cost of the merchandise minus the discount, minus the returns and the allowances plus the shipping cost will give you your net purchase cost. How much did you pay for how much did you, how much did it cost you to buy those merchandise? In the next session, what we will do is we would look at the selling. In this session, we looked at the buyer, at the buying. What happened after you buy, you're going to sell. Now, if you like this recording, please click on the like button. As always, I would like to remind you if you're looking for additional resources, check out my website, especially if you're studying for your CPA exam. It might help you earn that 5, 7, 10 extra points to move on with your life and be a CPA. It's a 20 to 30 year investment in your career. Make that investment wisely. I'm always here to help you study hard and good luck on your CPA exam.