For Individual Project 1
First and foremost when completing the assignment for Unit 4 IP1, DO NOT CONVERT THE
EUROS TO US DOLLARS! Replace the word "Euros" in the problem with US $.
Remember, there are 6 parts to Unit 4 IP1: (1) calculate net sales revenue, there is an example in
the Austin Sound Center Income Statement on page 270; (2) Calculate cost of goods sold, which
you can find a great example of on page 274 Chapter 5; (3) Calculate gross profit, again look on
page 270 Chapter 5 the Austin Sound Center income statement for a good example; (4) Calculate
Net income; (5) Create a Balance sheet, as of December 31, 20X2; and (6) Create a Statement
of Owner's Equity, December 31, 20X2. Chapter 5 pages 270-274 (our old friend, Chapter 3
pages 148-151) should help guide you on format.
Additional figures you may need: Cash balance on December 31, 20x1 is $10,000 and on
December 31, 20x2 is $130,000. Note that your balance sheet will have no liabilities (the balance
sheet will be very short). Remember that the income statement is based on net sales revenue
minus cost of goods sold minus administrative expenses.
Don't confuse purchase returns and allowances (which belong in the cost of goods calculation)
and sales returns and allowances (which belong in the calculation of net sales revenue).
Remember, that the issue here is disclosure to shareholders, lenders and others that will use the
audited financial statements. Disclosure usually takes the form of notes in the footnotes of the
annual report. An example of foot notes can be found in Amazon’s annual report, those footnotes
can be found on pages A-13 through A-21. Who is affected by this lack of disclosure? What is
the downside to the company in future years should they decide not to disclose future sales?
What regulations are in the news recently that might make company execs think twice about
Presentation: Accounting for the Merchandising Business
A merchandising entity earns its revenue by selling products called merchandise inventory, or
simply inventory. This unit demonstrates the central role of inventory in a business that sells
merchandise. Inventory includes all goods that the company owns and expects to sell in the
normal course of operations.
The major revenue of a merchandising business is sales revenue, or simply sales. The major
expense is cost of goods sold. Net sales minus cost of goods sold is the gross profit, or gross
margin. This amount measures the business's success or failure in selling its products at a higher
price than it paid for them.
The merchandiser's major asset is inventory. In a merchandising entity, the accounting cycle is
from cash to inventory as the inventory is purchased for resale, and back to cash as the inventory
is sold. The invoice is the business document generated by a purchase or sale transaction. Most
merchandising entities allow customers to return unsuitable merchandise, as well as offer
discounts for early payment. They grant allowances for damaged goods that the buyer chooses to
keep. Returns and Allowances and Discounts are contra accounts to Sales Revenue.
The end-of-period adjusting and closing process of a merchandising business is similar to that of
a service business. If a work sheet is used, the trial balance is entered, and the work sheet is
completed to determine net income or net loss. The work sheet provides the data for journalizing
the adjusting and closing entries and for preparing the financial statements. In addition, a
merchandiser adjusts inventory for theft losses, damage, and accounting errors.
The income statement may appear in single-step or multi-step format. A single-step income
statement has only two sections—one for revenues, and the other for expenses—and a single
income amount for net income. A multi-step income statement has subtotals for gross profit and
income from operations. Both formats are widely used.
Merchandise inventory is the most important asset to a merchandising business because it
captures the essence of the entity. To manage the firm, owners and managers focus on the best
way to sell inventory. Two key decision aids for a merchandiser are the gross profit percentage
(which is gross margin/net sales revenue), and the rate of inventory turnover (which is cost of
goods sold/average inventory). Increases in these measures usually signal an increase in profits.
The perpetual inventory accounting system that we have illustrated is designed to produce up-to-
date records of inventory and cost of goods sold. Cost of goods sold is the cost of the inventory
that the business has sold. It is the largest single expense of most merchandising businesses. Cost
of goods sold is the sum of the cost of goods sold amounts recorded during the period. In a
periodic inventory system, Cost of goods sold = Beginning inventory + Purchases + Freight in -
Questions and Answers
What does gross margin measure and why is it important?
Gross margin is the difference between sales revenue and the cost of sales of those goods or
services. Gross margin measures the profit before all supporting and selling costs are considered.
Gross margin is the net contribution margin (which subtracts all variable costs from sales). Gross
margin is important because it is a simple and meaningful way to compare margins across
companies or across time. The focus is on sales price and/or cost to produce or buy the product.
For companies engaged in the same business, gross margins should be similar, unless one
company is able to command a higher price, or leverage their purchases for lower costs.
Expenses below gross margin focus on expenses other than the sale or distribution processes.
What are the formats for income statements? Are there specific businesses to which each
format best applies?
Income statement formats are, generally, either multi-step or single-step. The single step shows
all revenues and then all expenses with no subtotals. Subtotals such as gross profit are not
reported. The multi-step income statement shows operating revenues and operating expenses,
with subtotals, and then other revenues and expenses separately with additional subtotals.
Businesses that have minimal need for subtotals, such as gross margin (service businesses with
no "goods" or "cost of goods"), or have minimal "other" revenues and expenses, generally use
the single-step approach. The multi-step approach is the most common format for most publicly-
Does a merchandiser prefer a high or low rate of inventory turnover? Why?
Inventory turnover is the ratio of cost of sales to average inventory balance. It measures how
rapidly inventory is sold or used (if raw materials and supplies). High inventory turns is
preferable because it means the inventory is being sold more times. This is important for
products that may become obsolete (technology goods) or stale (perishable goods). In addition,
slow-moving inventory means the costs of carrying and maintaining the inventory are higher for
every sale. For retailers, inventory turns also relate to the volume of sales which is critical in
tight margin businesses such as retail.
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