Differences between Income Statements for a Service Company and a Merchandise Company
Merchandise companies have complex income statements dealing with physical goods, while service companies have more straightforward views as their revenue comes from services. Merchandise companies add COGS to sales revenue to determine gross margin, subtract expenses from net operating income, and finally account for non-operating items for net income.
To calculate gross margin, a merchandising company subtracts sales returns and discounts from total sales to get net sales revenue. Next, they calculate the cost of goods sold by factoring in the inventory value at the start and end of the accounting period and net purchases. The net income is obtained by subtracting operating expenses and non-operating items from the gross margin.
Methods for Determining Merchandise Inventory and Circumstances for Their Use
Merchandise companies employ different methods to determine the value of their inventory. Two standard methods are perpetual and periodic inventory procedures suited to specific circumstances and business needs.
Perpetual inventory is a real-time method of tracking inventory levels using advanced systems like barcode scanners or inventory management software. Large businesses commonly use it to ensure accurate and up-to-date inventory tracking, enabling timely replenishment, preventing stockouts, and optimizing supply chain operations.
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Small retail stores or businesses with relatively stable inventory levels often find the periodic inventory procedure a practical and cost-effective method for managing their inventory. In contrast, small businesses and those with less complex inventory management need often utilize the irregular inventory procedure.
This method involves conducting physical inventory counts at regular intervals, such as monthly or quarterly. The cost of goods sold and the value of the ending inventory are determined by comparing the beginning inventory with the total purchases made during the period and subtracting the counted value of the ending list. This approach is more straightforward and requires less sophisticated systems or technology.
Computation for Cost of Goods Sold on a Merchandising Company’s Income Statement
The cost of goods sold (COGS) figure on a merchandising company’s income statement is determined through a specific calculation process. This computation reflects the direct costs associated With goods sold during a given accounting period.
To calculate the COGS, several factors need to be considered. First, the beginning inventory must be determined. This involves multiplying the number of units in stock at the start of the period by their respective unit costs. The result represents the total value of the goods available for sale at the beginning of the period.
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Next, the cost of units purchased during the accounting period is added. This includes the total cost of acquiring additional inventory, considering factors such as purchase price, transportation costs, and any applicable discounts or returns. The net worth of purchases is calculated by subtracting purchase discounts and purchase returns from the total investments made.
Finally, the value of the ending inventory is subtracted from the sum of the beginning inventory and the net cost of purchases. The ending list represents the value of the goods remaining unsold at the end of the period. The resulting figure represents the cost of goods sold during the period, which is essential in calculating the gross margin and determining the company’s profitability.
The contrast between Unclassified and Classified Income Statements
Income statements can be classified as either unclassified or classified, depending on the level of detail provided in the presentation of revenues and expenses.
An unclassified income statement provides a basic overview of a company’s financial performance, but a classified income statement offers a more detailed analysis. In an unclassified report, revenues and expenses are categorized as a whole, whereas classified information breaks them down into subcategories. This includes separating revenues and expenses into operating and non-operating items and classifying operating expenses into selling and administrative expenses.
BUS 3061 Unit 4 Assignment 2 Accounting Knowledge Transfer
A classified income statement provides valuable insights into a company’s revenue sources, cost structure, and profitability drivers. It allows stakeholders to analyze financial performance more clearly and meaningfully, benefiting investors, creditors, and management.
The classified format provides a comprehensive view of the company’s financial operations by breaking down the income statement into various sections, such as operating revenues, cost of goods sold, operating expenses, and non-operating expenses and payments.
This segmentation facilitates better decision-making and strategic planning by highlighting areas of strength or weakness within the business. It also enables comparisons across different periods, allowing for trend analysis and identifying changes in revenue and expense patterns over time.
Why would a company present its income statement data in a classified format? Describe the major sections of a classified income statement.
The decision to present income statement data in a classified format is often influenced by industry practices, comparability with other companies, and the cost of data accumulation. Classifying the data makes it easier to analyze and understand the different components of revenue and expenses.
A classified income statement typically consists of several major sections:
- Operating Revenues: This section represents the revenue generated from the company’s primary business activities. It includes sales revenue from selling products or services and any other operating income directly related to the business’s core operations.
- Cost of Goods Sold (COGS): This category shows the expenses incurred by the company directly related to the production or acquisition of the goods sold. It includes materials, direct labor, and other expenses directly tied to production.
- Gross Margin: The gross margin is calculated by subtracting the COGS from the net sales revenue. It represents the profitability of the company’s core operations and reflects how efficiently the company converts sales into gross profit.
- Operating Expenses: This section includes expenses incurred in the ordinary course of business operations. It encompasses selling expenses, such as marketing and advertising costs, and administrative expenses, such as salaries, rent, utilities, and other overhead costs.
- Non-Operating Revenues and Expenses: These are revenues and expenses that are not directly related to the company’s core operations. Non-operating payments may include interest income, gains from the sale of assets, or other miscellaneous income. Non-operating expenses may consist of interest expenses, losses from the sale of assets, or additional non-operating costs.
By categorizing the income statement data into these sections, a classified format provides a clearer picture of the company’s financial performance, allowing stakeholders to analyze the different components and identify areas of strength or weakness.
What is the gross margin? How is it calculated? Why might management be interested in using this tool to analyze accounting information?
The gross margin, also known as the gross profit, is a measure of profitability that shows how much money is left after deducting the cost of goods sold from the net sales revenue. It indicates the portion of revenue that contributes to covering operating expenses and generating net income.
The gross margin is calculated by subtracting the cost of goods sold from the net sales revenue. The formula is as follows:
Gross Margin = Net Sales – Cost of Goods Sold
Management is interested in the gross margin because it provides insights into the profitability of the company’s core operations. By analyzing the gross margin, management can assess the efficiency of the production or sales process, identify cost-saving opportunities, and make informed decisions about pricing strategies. A higher gross margin indicates that the company generates more profit from its sales. A lower gross margin may signal the need for cost-control measures or pricing and production strategy adjustments.
Which industry presents a notoriously low gross margin percentage, and conversely, name an industry that traditionally experiences a high gross margin percentage?
The industry’s operating costs and unexpected expenses can significantly impact profitability and make it challenging to sustain business operations. Gas stations are an example of an industry typically presenting a notoriously low gross margin percentage. Due to intense competition, volatile fuel prices, and low-profit margins, gas stations often need help maintaining a gross margin of 2% or less over ten years.
BUS 3061 Unit 4 Assignment 2 Accounting Knowledge Transfer
Conversely, the technology and legal services industries are known for traditionally experiencing high gross margin percentages. For example, companies like Microsoft in the technology sector and Hyatt Legal Services in the legal services sector have historically achieved high gross profit margins. Legal service industries can generate gross profit margins of up to 90% with specialized services and low operating expenses.
Meanwhile, technology industries often operate with a gross profit margin of 50%. These industries benefit from solid demand, high-value services or products, and efficient cost structures, allowing for significant profitability.
References
Biery, Mary E. (2017). Forbes. These Industries Generate The Lowest Profit Margins. Retrieved from: [https://www.forbes.com/sites/sageworks/2017/09/24/these-industries-generate-the-lowest-profit-margins/#5d6d6d3df49d]https://www.forbes.com/sites/sageworks/2017/09/24/these-industries-generate-the-lowest-profit-margins/#5d6d6d3df49d
Butler Consultants (2008-2017). Free Industry Statistics – Sorted by Highest Gross Margin. Retrieved from
http://research.financial-projections.com/IndustryStats-GrossMargin.shtml
Edwards, J. D., Hermanson, R.H., & Maher, M. W. (2011). Accounting principles: A business perspective, financial accounting (Chapters 1–8). Textbook Equity.
Fowler, S. (2014). Differences in gross margins in industries. Retrieved from:
http://smallbusiness.chron.com/differences-gross-margins-industries-19249.html
Murray, J. (2019).The Balance Small Business. How To Calculate Cost of Goods Sold. Retrieved:
