Chapter 5

Question 1

Operating cycles

Answer 1

The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase of inventory and its eventual sale lengthen the cycle.

Question 2

Operating cycle of a Merchandising company

Answer 2

Cash->buy inventory->merchandize inventory->Sell inventory->Accounts Receivable->Cash-> repeat.

Question 3

Operating cycle of a service company

Answer 3

Cash->Perform services->Accounts receivable->cash->repeat

Question 4

perpetual inventory system

Answer 4

• In a perpetual inventory system, companies maintain detailed records of the cost of each inventory purchase and sale.
• These records continuously—perpetually—show the inventory that should be on hand for every item.
• Under a perpetual inventory system, a company determines the cost of goods sold each time a sale occurs.
• Even under perpetual inventory systems, companies perform physical inventory counts. This is done as a control procedure to verify inventory levels, in order to detect theft or “shrinkage.”

Question 5

Determine cost of goods under periodic inventory system

Answer 5

1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand as determined by the physical inventory count at the end of the accounting period.

Question 6

periodic inventory system

Answer 6

• companies do not keep detailed inventory records of the goods on hand throughout the period.
• They determine the cost of goods sold only at the end of the accounting period—that is, periodically.
• At that point, the company takes a physical inventory count to determine the cost of goods on hand.
• Under a periodic system, separate accounts are used to record purchases, freight costs, returns, and discounts.
• A running account of changes in inventory is not maintained. Instead, the balance in ending inventory, as well as the cost of goods sold for the period, is calculated at the end of the period.

Question 7

Determine costs of goods at a perpetual inventory system

Answer 7

1. inventory purchased-record purchase of inventory
2. Item sold-Record Revenue and COMPUTE AND RECORD COST OF GOODS SOLD.
3. No entry under end of period

if someone had bought on account, then you would have two entries, debit accounts receivables, credit sales revenue. AND then debit cost of goods sold and credit inventory

Question 8

Freight Costs incurred from purchaser

Answer 8

When the purchaser directly incurs the freight costs, the account Merchandise Inventory is debited and Cash is credited.

Question 9

sales agreement

Answer 9

The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business.

Question 10

FOB Shipping point

Answer 10

FOB Shipping Point
Goods placed free on board the carrier by seller.
Buyer pays freight costs.

Question 11

FOB Destination

Answer 11

Goods placed free on board at buyer’s business.

Seller pays freight costs.

Question 12

Freight Costs incurred by seller

Answer 12

Freight costs incurred by the seller on outgoing merchandise are debited to Freight-out (or Delivery Expense) and Cash is credited.

Question 13

purchase allowance.

Answer 13

the purchaser may choose to keep the merchandise if the seller grants an allowance
For purchases returns and allowances, Accounts Payable is debited and Merchandise Inventory is credited.

Question 14

purchase discount

Answer 14

• Credit terms may permit the buyer to claim a cash discount for the prompt payment of a balance due.
• A purchase discount is based on the invoice cost less returns and allowances, if any.
• If payment is made within the discount period, Accounts Payable is debited, Cash is credited, and Merchandise Inventory is credited for the discount taken.

Question 15

sales of goods held for resale

Answer 15

The merchandiser credits the Sales Revenue account only for sales of goods held for resale. Sales of assets not held for resale, such as equipment or land, are credited directly to the asset account.

Question 16

Sales revenues

Answer 16

• happens at the point of purchase
• Each sales transaction should be supported by a business document which provides written evidence of the sale.
• Cash register tapes provide evidence of cash sales.
• A sales invoice provides written evidence of a credit sale.
• Cash sales are recorded by increasing Cash and increasing Sales.
• Debits Accounts receivable credits sales
• Debits cost of goods sold, credits merchandise invendory

Question 17

Sales Returns and Allowances

Answer 17

Sales Returns and Allowances, a contra revenue account to Sales, may be used to record credit for returned goods.

Question 18

Sales Discount

Answer 18

• A sales discount is recorded by increasing Cash for the amount received from the customer, decreasing Accounts Receivable for the amount owed by the customer, and increasing Sales Discounts by the amount of the discount.
• Sales Discounts is a contra revenue account to Sales.

Question 19

When customer return goods, the seller debits

Answer 19

debit merchandise inventory

Question 20

Single-Step income statement

Answer 20

one step is required in determining
net income—subtract total expenses from total revenues.
In a single-step statement, all data are classified into two categories: (1) revenues, which include both operating revenues and nonoperating revenues and gains (for example, interest revenue and gain on sale of equipment); and (2) expenses, which include cost of goods sold, operating expenses, and nonoperating expenses and losses (for example, interest expense, loss on sale of equipment, or income tax expense)

Question 21

Multiple step income statement

Answer 21

• Highlights the components of net income.
• Distinguishes between operating and non-operating activities.
• Step process= Sales - Cost of Goods sold=Gross Profit -Operating expenses =income from operations = net profit or net loss

Question 22

gross profit

Answer 22

• Cost of goods sold is deducted from net sales to determine gross profit
• Gross profit is the merchandising profit of the company but not an overall
• The excess of net sales over cost of goods sold is gross profit.
• It is determined by deducting cost of goods sold from net sales.
• This computation uses net sales, which takes into account sales returns and allowances and sales discounts.

Question 23

Operating expenses

Answer 23

are subtracted from gross profit in order to determine income from operations.

Question 24

non-operating expenses

Answer 24

Unrelated to the company’s primary line of operations.
Are presented after Income from operations
Other revenues and gains
Other expenses and losses

Question 25

When external users forecasting for next year’s profit,

Answer 25

External users will use operating income as sustainable

and they put the most weight on this year’s operating income and less weight on non-operating activities.

Question 26

Periodic Inventory System :BASIC FORMULA FOR COST OF GOODS SOLD USING THE PERIODIC SYSTEM

Answer 26

Beginning Inventory+ cost goods purchased
= Cost of goods available to sell
-Ending inventory
=Cost of goods sold

Question 27

Gross Profit rate

Answer 27

A company’s gross profit may be expressed as a percentage by ->
Gross profit / Net sales = Gross Profit rate

Question 28

Profit margin ratio

Answer 28

Divide Net income/ Net sales

and is one measure of profitability.
-Measures the extent by which selling price covers all expenses (including cost of goods sold).

Question 29

Earnings Quality or Quality of Earnings

Answer 29

Earnings have a high quality if they provide a full and transparent depiction of how a company performed

Question 30

Earnings Quality or Quality of Earnings

Answer 30

• Earnings have a high quality if they provide a full and transparent depiction of how a company performed.
• In general, a measure significantly less than 1 suggests that a company may be using more aggressive techniques to accelerate income recognition.
• A measure significantly greater than 1 suggests that a company is using more conservative accounting techniques.

Question 31

Income Statement: Other Revenues and Gains

Answer 31

Interest revenue from notes receivable and marketable securities.
Dividend revenue from investments in capital stock.
Rent revenue from subleasing a portion of the store.
Gain from the sale of property, plant, and equipment.

Question 32

income statement: Other Expenses and Losses

Answer 32

Interest expense on notes and loans payable.
Casualty losses from such causes as vandalism and accidents.
Loss from the sale or abandonment of property, plant, and equipment.
Loss from strikes by employees and suppliers.

Question 33

Who pays freight when you buy inventory

Answer 33

when you pay for frieght, you will record that price under inventory