Question

1. List the accounts of a merchandising company which employs a perpetual inventory system that will not appear in the financial statements of a service company. When listing the account names, indicate if it appears on the Income Statement or on the Balance Sheet..
2. Explain what sales discounts and a purchase discounts are. What account will a buyer credit for the amount of the purchase discount.
3. Why would a financial statement user prefer a multiple-step income statement instead of a single-step income statement.
4. Share any struggles you had with this chapter that you would like more clarification on.

Answer 1

Comparing Merchandising versus Service Activities and Transactions

1.Service companies sell intangible services and do not have inventory. Their operating cycle begins with cash-on-hand, providing service to customers, and collecting customer payments.

2.Merchandising companies resell goods to consumers. Their operating cycle begins with cash-on-hand, purchasing inventory, selling merchandise, and collecting customer payments.

3.A purchase discount is an incentive for a retailer to pay their account early. Credit terms establish the percentage discount, and Merchandise Inventory decreases if the discount is taken.

4.A retailer receives a full or partial refund for returning or keeping defective merchandise. This can reduce the value of the Merchandise Inventory account.

5.A customer receives an incentive for paying on their account early. Sales Discounts is a contra revenue account that will reduce Sales at the end of a period.

6.A customer receives a refund for returning or keeping defective merchandise. Sales returns and allowances is a contra revenue account that will reduce Sales at the end of a period.

Definition of Purchase Discount

A purchase discount is a deduction that a company may receive if the supplier offers it and the company pays the supplier's invoice

within a specified period of time. The purchase discount is also known as a cash discount or early-payment discount.

(A supplier offering the discount will record the discounts taken by its customers in the account Sales Discounts.)

Example of Purchase Discount

Assume that a company receives a supplier's invoice of $5,000 with the credit terms 2/10 net 30.

The company will be allowed to subtract a purchase discount of $100 (2% of $5,000) and remit $4,900 if the invoice is paid in 10 days. Otherwise, the company must pay the full $5,000 within 30 days.

Definition of Sales Discount

A sales discount is a cash discount that manufacturers often give retailers for paying off accounts during the discount period.

A sales discount is useful for both the retailer and the manufacturer. The retailer can pay less for its inventory while the manufacturer can receive its cash sooner.

Example:

An additional 2 percent sales discount is a standard cash discount for most businesses. The terms of this discount are usually written

like 2/10, n/30 or 2/10, net/30. This means that if the retailer pays the manufacturer cash for the inventory within the first 10 days after purchase, the retailer will receive a discount of 2 percent.

If the retailer can’t pay for the inventory in the first 10 days, the full-undiscounted purchase price is due 30 days from the purchase date. Retailers can use two ways to account for a cash discount: the gross method and the net method.

There are three benefits to using a multiple-step income statement instead of a single-step income statement:

1.The multiple-step income statement clearly states the gross profit amount. Many readers of financial statements monitor a company's gross margin (gross profit as a percentage of net sales). Readers may compare a company's gross margin to its past gross margins and to the gross margins of the industry.

2.The multiple-step income statement presents the subtotal operating income, which indicates the profit earned from the company's primary activities of buying and selling merchandise.

3.The bottom line of a multiple-step income statement reports the net amount for all the items on the income statement. If the net amount is positive, it is labeled as net income. If the net amount is negative, it is labeled as net loss.