Exam 2 Study Guide – Financial AccountingChapter 55.1merchandising firms – buy and sell goods and make a profit on the difference between the buying and selling price wholesalers – sell only to other merchandising firmsretailers – sell to customersoperating revenues – come from core operations of buying/selling merchInterest revenue – credit card operationsExpenses: 1. COGS2. Operating expenses3. Other expensesGross Profit = Sales Revenue – COGSNet Income = Gross Profit – Operating ExpensesIn accrual accounting, revenues and expenses are matched. Cash in and cash out are the same.Cash + non cash assets = Liabilities + Contributed Capital + Retained EarningsCash – Retained Earnings = Liabilities + Contributed Capital – non cash AssetsPeriodic System – determines Cost of Goods Sold at the end of the accounting period- COGS is an adjusting entry based on the Ending Balance of InventoryPerpetual 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 perpetualBegin Inventory Balance + Purchases – COGS = End Inventory Balance5.2Cost of Purchases- Includes all Freight and Insurance- Measured net of discountFOB Shipping Point – shipping is paid by the buyer- Freight cost just adds to the cost of the item purchased (NOT freight expense)Dr inventoryCr cashFOB Destination – seller pays the shipping costDr Freight-OutCr CashPurchase invoice – buy items on accountDr inventoryCr accounts payablePurchase Returns and AllowancesReturned goods costing $300Dr Accounts Payable 300Cr Inventory 300Purchase allowance (kept the goods that were defective for a discounted price)Dr Accounts payable 50Cr Inventory 50Purchase Discounts – cash discount for prompt payment2/10 n/30 = 2% discount if paid in 10 days, net due in 30 days1/10 EOM = 1% discount if paid in the first 10 days of next monthDiscount of 2% for paying total 3500 in 10 daysDr Accounts Payable 3500Cr cash 3430Cr inventory 70Credit inventory for discount amount because inventory is measured by costNet method – values the purchased goods net of discount and takes a loss if the discount is not takenGross method – values the purchased goods at full cost and reduces the cost of inventory if the discount is taken5.3Measuring Sales RevenueSales invoice – records a sale on accountDr accounts receivableCr sales revenueDr COGSCr Inventory5.4Sales Returns & AllowancesSales returns is a contra-revenue account (debited when goods are returned)Dr Sales ReturnsCr accounts receivable Dr inventoryCr COGSSell 100 items at $10/ea but expect 5 returns. Record at time of saleDr Accts Receivable 1000Cr Sales Revenue 1000Dr COGSCr InventoryDr Sales Revenue 50Cr Sales Returns & Allowances 505.5Sales Discounts – when we are expecting prompt paymentContra-revenue account2% discount if paid in 10 daysDr CashDr Sales DiscountsCr Accounts Receivable 5.6Adjusting EntriesIllustration5-7Daily recurring and adjusting and closing entries5.7Income StatementSales RevenuesLess: Sales Returns & AllowancesSales DiscountsNet SalesNet Sales – Cost of Goods Sold = Gross ProfitGross Profit / Net Sales = Gross Profit RateMulti-Step Income StatementIllustration5-13Multiple-step income statementSingle Step Income StatementIllustration5-14Single-step income statementIllustration5A-2Cost of goods sold for a merchandiser using a periodic inventory systemChapter 66.1Types of Inventory – 1. Finished Goods Inventory – completed and ready for sale2. Work in progress – placed in production but not yet complete3. Raw materials – used for production6.2Physical Inventory is taken at the end of the accounting periodDetermining OwnershipGoods In TransitFOB Shipping Point – buyer pays for shipping, ownership of the goods passes from the seller to the buyer when the public carrier accepts the goodsFOB Destination – seller pays for shipping, seller owns the goods until the goods reach the buyerConsigned goods – hold goods and try to sell them for other parties for a fee without taking ownershipGoods held on consignment from another company are NOT included in physicalinventoryGoods shipped on consignment to another company ARE included in physical inventory6.3Inventory is accounted for at costCost 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 inventoryCash 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 systemFIFO – 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 InventoryLIFO – 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 upAverage Cost – assumes goods are similar in natureCost of Goods Available for Sale / Total Units Available for Sale = Weighted Avg Unit Cost multiply the weighted average times the number of goods on hand6.4 Under a periodic inventory system, both the beginning and ending inventories appear in the income statement.Income Statement Effects**COGS = expense so Net Income = OPPOSITEAn error in the ending inventory of the current period results in a reverse effect on net income of the next accounting period.Balance Sheet EffectsIllustration6-19Effects of ending inventory errors on balance sheetIf ending inventory is overstated, stockholders equity is overstated, but the following year it will be properly stated because it will cancel out.6.5lower-of-cost-or-market – record inventory cost by whichever is the lower numberInventory turnover – measures the number of times on average inventory is sold during the periodDays in Inventory – the average number of days inventory is heldCost of Goods Sold / ((beginning inventory + ending inventory)/2) = TurnoverDays in inventory = 365 / Turnover RatioAppendix 6B: Estimating Inventories estimating happens in large retail stores where inventory is often tracked at the sales counters at sales prices rather than