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Merchandising business
buys products for resale to customers
Transactions involve two parties:
Buyer - acquires it's merchandise Seller- sells it to the customers
operating cycle
Purchasing Selling Collecting $
Perpetual Inventory System
Each purchase of inventory, and each sale of inventory, is recorded in the inventory account
Periodic Inventory System
The inventory account is not updates with each purchase and sale Added to Purchases account and an adjustment entry is made to update the inventory account to reflect actual merch and cost of it
What costs should be included in inventory?
Purchase price Freight cost Cost of transit insurance Taxes (excise and sales tax) Any cost to get product ready
What are credit terms?
When a company buys merchandise inventory on account, the invoice shows the term or conditions of the transaction.
Credit Period
Amount of time the buyer is allowed before payment is due
Amount of time the buyer is allowed before payment is due
Seller offers discount if the invoice is paid within a certain amount of time seller-sales discount buyer-purchase discount
Discount Examples
3/10, n/30 3% if paid within 10 days and full amount in 30 days
Discount example 2
2/15, n/EOM 2% if payment made within 15 days and full payment by the end of the month
Sales/purchase return
sales return recorded by the seller when merch is returned by the buyer
Sales allowance
reduction in price of the merchandise allowed by the seller (usually if damaged)
FOB
"Free on Board" FOB shipping point: buyer pays shipping FOB destination: seller pays shipping
Revenue Section of the Income Statement
Sales Revenue Sales Returns/Allowances Sales Discounts Net Sales
COGS
selling company's cost for the merchandise that was sold in the current period Largest expense Beginning Inventory + Net cost of purchases (including freight in) Goods available for sale -- Ending Inventory Cost of goods sold
Gross Profit
Net sales - COGS
GP %
Gross Profit / New sales revenue
Other Income statement sections
operating expenses (rent, salaries, ads, utilities) Income from operations Other revenues and expenses (not related to primary operations of business) Income before tax Income tax expense Net income
Permanent Accounts
balance sheet accounts Carries over from one year to the next (start year with that cash balance) "real accounts"
Temporary Accounts
Affect retained earnings Rev, Exp, and Dividends not carried over balances must be zeroed out "nominal accounts"
Purpose of closing entries
zero-out balance of temp accounts then transfer the balance to retained earnings (goes from beginning RE to ending Re)
Closing Process
1. Zero out Rev account 2. Zero out Exp account 3. zero out Income summary account into RE 4. Zero out balance in the dividends account into RE
After Closing:
Balance in retained earnings should = ending RE shown on BS All temp accounts (rev, exp, div) should be 0
Fixed Assets (long term)
relatively permanent assets such as land, buildings, equipment, and machinery (also property, plant, equipment)
Characteristics of long term asset?
tangible; physical existence owned by company for use in operations Not held for resale
Cost of long term assets
purchase price, plus amounts to get the asset in place Unnecessary costs are recorded as expenses
Depreciation
lose ability to provide service in producing revenues cost is expensed over the periods that they are used in generating revenues
factors determining depreciation expense?
asset's initial cost asset's expected useful life asset's expected salvage value
Methods to calculate depreciation
Straight line - Equal amounts of expenses for each year of useful life Units of output- provides equal amounts of expense for each unit of output (based on usage) Double declining balance - expenses declingin amount each year over life of asset (accelerated)
MACRS
IRS uses "Modified Accelerated Cost Recovery System" to compute depreciation. Ignores salvage value and assumes all assets are placed in service at the middle of the year assigns useful life for each asset then determines depreciation value. Usually only used for tax purposes…
Capital Expenditure
Improve the asset, extend the useful life, increase efficiency (asset account)
Revenue Expenditure
Ordinary maintenance and repairs (expense account)
Depletion expense
Cost of natural resources over a period of time
Intangible Assets
convey special rights to the owner, but no physical form. (patents, copyrights, trademarks, franchise, and goodwill.)
Amortization
The process of allocating the cost of an intangible asset to expense
Goodwill
special intangible asset. - only when company purchases another company and pays more than the market value of the net assets of the acquired company. -examined regularly
Investments
long term asset usually for future sale Real estate and securities
How long are long term assets reported on the balance sheet?
after current assets. PP&E first then original cost, accumulated depreciation, and book value
Inventory Cost flow assumption
company must determine a consistent method for assigning a cost to both the units sold during the period and to the units left on hand at the end of the period. (tennis racket example)
FIFO
First in, first out Assumes the item is sold in the same order as they are purchased. So the $30 one was in first so they account that one as the one sold and the one left on hand is whichever came next ($38)
LIFO
Last in, First out sold in reverse first in $30 second in $38 total = $68 sold the $38 one first so $30 in ending inventory
How do errors in counting ending inventory affect the financial statements?
Using the Periodic inventory system an error could be made in a year and mess up the balance sheet and income statement. Income=COGS Balance=Inventory
Estimating the goods left in inventory
Historical gross profit as a percentage of sales relationship between inventory cost and its selling price
Effective inventory management
1. inventory turnover 2. Day's sales in inventory
Perpetual System
Records cost of goods sold each time a sales transaction occurs Marked increase in frequency and popularity within the past decade
Periodic System
Updates the inventory account only at year-end. Quantities left on hand determined only by physical count at the end of the period.
FIFO
Report the lowest ending inventory amount. Minimize income taxes
accounting cycle
Journalize post to ledger trial balance adjusting entries prepare financial statements closing entries
Current Ratio
Current assets/Current liabilities
Current assets
Cash Accounts receivable Prepaid insurance Supplies Inventory
Current liabilities
Accounts payable Salary payable Unearned revenue
Net sales
Sales - sales discounts - sales returns
How to find beginning inventory
First find cogs (net sales-gross profit) Then find net purchases & freight in (purchases -purchase returns - purchase discounts + freight in) Use equation (net purchases + Beg. inventory - Ending inventory = COGS)

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