Acct 230 1st Edition Exam 4 Study Guide Lectures 18 22 Lecture 18 October 7 I Know the difference between merchandising and manufacturing companies Merchandising Companies a Merchandising companies purchase inventories that are primarily in finished form for resale to customers b These companies may assemble sort repackage redistribute store refrigerate deliver or install the inventory but they don t manufacture it They simply serve as intermediaries in the process of moving inventory from the manufacturer the company that actually makes the inventory to the end user II Manufacturing Companies a These companies manufacture the inventories they sell rather than buying them in finished form from suppliers b Manufacturers classify inventory into three categories c Raw materials inventory Includes the cost of components that will become part of the finished product but have not yet been used in production d Work in process inventory Refers to the products that have started the production process but are not yet complete at the end of the period e Finished goods inventory It includes the cost of the units that have been completed by the end of the period but not yet sold III Calculate cost of goods sold a The costs of beginning inventory plus additional purchases make up the cost of goods or inventory available for sale b The costs of beginning inventory plus the additional purchases during the year make up the cost of inventory cost of goods available for sale c Remember that inventory represents the cost of inventory not sold while cost of goods sold represents the cost of inventory sold IV Determine the cost of goods sold and ending inventory using different inventory cost methods a First In first Out FIFO b Last In first Out LIFO c Weighted average cost d Specific Identification V Comparison of Cost of Goods Sold Under the Three Inventory Cost Flow Assumptions a A company purchases three units of inventory and sells two b Using FIFO we assume inventory is sold in the order purchased that is the first purchase is sold first and the second purchase is sold second c Using LIFO we assume inventory is sold in the opposite order that we purchased it The last unit purchased is sold first and the second to last unit purchased is sold second d Using Weighted average cost we assume inventory is sold using an average of all inventory purchased VI Accountants often call FIFO the balance sheet approach The amount it reports for ending inventory which appears in the balance sheet better approximates the current cost of inventory The ending inventory amount reported under LIFO in contrast generally includes old inventory costs that do not realistically represent the cost of today s inventory VII Accountants often call LIFO the income statement approach The amount it reports for cost of goods sold which appears in the income statement more realistically matches the current costs of inventory needed to produce current revenues Recall that LIFO assumes the last purchases are sold first reporting the most recent inventory cost in cost of goods sold However also note that the most recent cost is not the same as the actual cost FIFO better approximates actual cost of goods sold for most companies since most companies actual physical flow follows FIFO Lecture 19 October 9 I Inventory Purchases a To record the purchase of new inventory we debit inventory an asset to show that the company s balance of this asset account has increased At the same time if the purchase was paid in cash we credit cash Or more likely if the company made the purchase on account we credit accounts payable increasing total liabilities II Inventory Sales a We make two entries to record the sale b The first entry shows an increase to the asset account in this case Accounts Receivable and an increase in sales revenue c The second entry adjusts the Inventory and Cost of Goods Sold accounts III Freight Charges a When goods are shipped they are shipped with terms FOB shipping point or FOB destination FOB stands for free on board and indicates when title ownership passes from the seller to the buyer b FOB shipping point means title passes when the seller ships the inventory not when the buyer receives it The fact that a buyer does not have actual physical possession of the inventory does not prevent transfer of title to the buyer s inventory In contrast if the seller ships the inventory c FOB destination then title does not transfer to the buyer when the inventory is shipped The buyer would not record the purchase transaction until the shipped inventory reached its destination the buyer s location IV Purchase Discounts a Just as freight charges add to the cost of inventory and therefore increase the cost of goods sold once those items are sold purchase discounts subtract from the cost of inventory and therefore reduce cost of goods sold once those items are sold V Purchase Returns a Purchase Returns Occasionally a company will find inventory items to be unacceptable for some reason perhaps they are damaged or are different from what was ordered In those cases the company returns the items to the supplier and records the purchase return as a reduction in both Inventory and Accounts Payable VI Preparing Multiple Step a After gross profit we see that the next item reported is selling general and administrative expenses often referred to as operating expenses We discussed several types of operating expenses in earlier chapters wages utilities advertising supplies rent insurance and bad debts These costs are normal for operating most companies Gross profit reduced by these operating expenses is referred to as operating income or sometimes referred to as income from operations b After operating income a company reports nonoperating revenues and expenses Nonoperating revenues and expenses arise from activities that are not part of the company s primary operations Interest revenue and interest expense are examples In Chapter 7 we will discuss another common nonoperating item gains and losses on the sale of long term assets Investors focus less on nonoperating items than on income from operations as these nonoperating activities often do not have longterm implications on the company s profitability c Combining operating income with nonoperating revenues and expenses yields income before income taxes Lecture 20 October 11 I Calculating the Lower of Cost or Market a The write down of inventory has the effect not only of reducing total assets