Exam 2 Study Guide Financial Accounting Chapter 5 5 1 merchandising firms buy and sell goods and make a profit on the difference between the buying and selling price wholesalers sell only to other merchandising firms retailers sell to customers operating revenues come from core operations of buying selling merch Interest revenue credit card operations Expenses 1 COGS 2 Operating expenses 3 Other expenses Gross Profit Sales Revenue COGS Net Income Gross Profit Operating Expenses In accrual accounting revenues and expenses are matched Cash in and cash out are the same Cash non cash assets Liabilities Contributed Capital Retained Earnings Cash Retained Earnings Liabilities Contributed Capital non cash Assets Periodic System determines Cost of Goods Sold at the end of the accounting period COGS is an adjusting entry based on the Ending Balance of Inventory Perpetual System keeps detailed records of the cost of each inventory purchase and sale and determines the COGS after each sale occurs Companies that sell merchandise at high unit values use perpetual Begin Inventory Balance Purchases COGS End Inventory Balance 5 2 Cost of Purchases Includes all Freight and Insurance Measured net of discount FOB Shipping Point shipping is paid by the buyer expense Dr inventory Cr cash Dr Freight Out FOB Destination seller pays the shipping cost Freight cost just adds to the cost of the item purchased NOT freight Cr Cash Purchase invoice buy items on account Dr inventory Cr accounts payable Purchase Returns and Allowances Returned goods costing 300 Dr Accounts Payable 300 Cr Inventory 300 Dr Accounts payable 50 Cr Inventory 50 Purchase allowance kept the goods that were defective for a discounted price Purchase Discounts cash discount for prompt payment 2 10 n 30 2 discount if paid in 10 days net due in 30 days 1 10 EOM 1 discount if paid in the first 10 days of next month Discount of 2 for paying total 3500 in 10 days Dr Accounts Payable 3500 Cr cash Cr inventory 70 3430 Credit inventory for discount amount because inventory is measured by cost Net method values the purchased goods net of discount and takes a loss if the discount is not taken Gross method values the purchased goods at full cost and reduces the cost of inventory if the discount is taken 5 3 Measuring Sales Revenue Sales invoice records a sale on account Dr accounts receivable Cr sales revenue Dr COGS Cr Inventory Cr accounts receivable Dr Sales Returns Dr inventory Cr COGS Dr Accts Receivable 1000 Cr Sales Revenue 1000 5 4 Sales Returns Allowances Sales returns is a contra revenue account debited when goods are returned Sell 100 items at 10 ea but expect 5 returns Record at time of sale Dr COGS Cr Inventory Dr Sales Revenue 50 Cr Sales Returns Allowances 50 5 5 Sales Discounts when we are expecting prompt payment Contra revenue account 2 discount if paid in 10 days Dr Cash Dr Sales Discounts Cr Accounts Receivable 5 6 Adjusting Entries Illustration 5 7 Daily recurring and adjusting and closing entries 5 7 Income Statement Sales Revenues Less Sales Returns Allowances Sales Discounts Net Sales Net Sales Cost of Goods Sold Gross Profit Gross Profit Net Sales Gross Profit Rate Multi Step Income Statement Illustration 5 13 Multiple step income statement Single Step Income Statement Illustration 5 14 Single step income statement Illustration 5A 2 Cost of goods sold for a merchandiser using a periodic inventory system Chapter 6 6 1 Types of Inventory 1 Finished Goods Inventory completed and ready for sale 2 Work in progress placed in production but not yet complete 3 Raw materials used for production 6 2 Physical Inventory is taken at the end of the accounting period Determining Ownership Goods In Transit FOB Shipping Point buyer pays for shipping ownership of the goods passes from the seller to the buyer when the public carrier accepts the goods FOB Destination seller pays for shipping seller owns the goods until the goods reach the buyer Consigned goods hold goods and try to sell them for other parties for a fee without taking ownership Goods held on consignment from another company are NOT included in physical inventory Goods shipped on consignment to another company ARE included in physical inventory 6 3 Inventory is accounted for at cost Cost includes expenditures to get the good ready for sale Specific identification method can positively identify which particular units it sold and which are still in ending inventory Cash Flow Assumptions Periodic Very few companies use perpetual LIFO FIFO average cost in a perpetual system FIFO COGS will be the same as in a periodic system FIFO First In First Out earliest goods purchased are sold first Add up total Cost of Goods Available for Sale Add up cost of earliest goods purchased in the amount of the amount sold Subtract from Ending Inventory LIFO Last In First Out Add up total Cost of Goods Available for Sale Add up cost of the last goods purchased Subtract from Ending Inventory LIFO will produce higher net income than FIFO when the prices go up Average Cost assumes goods are similar in nature Cost of Goods Available for Sale Total Units Available for Sale Weighted Avg Unit multiply the weighted average times the number of goods on hand Cost 6 4 Under a periodic inventory system both the beginning and ending inventories appear in the income statement Income Statement Effects COGS expense so Net Income OPPOSITE An error in the ending inventory of the current period results in a reverse effect on net income of the next accounting period Balance Sheet Effects Illustration 6 19 Effects of ending inventory errors on balance sheet If ending inventory is overstated stockholders equity is overstated but the following year it will be properly stated because it will cancel out 6 5 lower of cost or market record inventory cost by whichever is the lower number Inventory turnover measures the number of times on average inventory is sold during the period Days in Inventory the average number of days inventory is held Cost of Goods Sold beginning inventory ending inventory 2 Turnover Days in inventory 365 Turnover Ratio Appendix 6B Estimating Inventories estimating happens in large retail stores where inventory is often tracked at the sales counters at sales prices rather than costs Gross Profit Method estimates the cost of ending inventory Estimated Gross Profit Gross Profit Rate x Net Sales Net Sales Gross Profit Rate x Net Sales Estimated Cost of Goods Sold Cost of Goods Available for Sale Estimated