Chapter 5

Question 1

Sales revenue

Answer 1

The main source of revenue in a merchandising company.

Question 2

Cost of goods sold

Answer 2

The total cost of inventory sold during the period.

In a perpetual inventory system, it is calculated and recorded for each sale.

In a periodic inventory system, it is calculated at the end of the accounting period by deducting ending inventory from the cost of goods available for sale.

Question 3

Gross profit (aka gross margin)

Answer 3

Gross Profit = Sales Revenue - Cost of Goods Sold

Question 4

Operating expenses

Answer 4

Expenses incurred in the process of earning sales revenue. They are deducted from gross profit to arrive at income from operations (income before income tax).

Question 5

Perpetual inventory system

Answer 5

An inventory system in which the quantity and cost of each inventory item is maintained. The records continuously show the inventory that should be on hand and the cost of the items sold.

Question 6

Periodic inventory system

Answer 6

An inventory system in which detailed records are not maintained and the ending inventory and cost of goods sold are determined only at the end of the account period, after a physical inventory count has been completed.

Question 7

Cost of goods available for sale

Answer 7

Beginning Inventory + Cost of Goods Purchased.

Question 8

Cost of goods purchased

Answer 8

Net Purchases + Freight Costs.

Question 9

Purchase returns and allowances

Answer 9

A return of goods for cash or credit, or a deduction granted by the seller on the selling price of unsatisfactory merchandise.

Question 10

Purchase discount

Answer 10

A price reduction, based on the invoice price less any returns and allowances, to encourage customers to make an early payment of a credit purchase.

Question 11

FOB Shipping Point

Answer 11

BUYER is responsible for the freight costs from the shipping point to the buyer’s destination, and for any lost/damage along the way.

Goods become part of the buyer’s inventory at the shipping point.

Question 12

FOB Destination

Answer 12

SELLER is responsible for the freight costs from the shipping point to the buyer’s destination, and for any lost/damage along the way.

Goods stay in the seller’s inventory until delivery.

Question 13

Sale returns and allowances

Answer 13

A return of goods or reduction in price due to unsatisfactory merchandise.

Question 14

Contra revenue account

Answer 14

An account that is offset against (reduces) a revenue account on the income statement.

Examples: Sale returns and allowances account; Sales discounts account.

Question 15

Quantity discount

Answer 15

A price reduction that reduces the invoice price and is given to the buyer for volume purchases. Quantity discounts are NOT separately recorded.

Question 16

Sales discount

Answer 16

A price reduction that is based on the invoice price, less any returns and allowances, and is give by a seller for early payment of a credit sale.

Question 17

Gross sales

Answer 17

Total sales, before deducting and sale returns, allowances and discounts.

Question 18

Net Sales

Answer 18

Net Sales = Gross Sales - Sales Returns and Allowances - Sale Discounts

Question 19

Single-step income statement

Answer 19

Income statement that shows only one step (revenues - expenses) in determining income before income tax, after which income tax expense is deducted to determine net income (loss).

Question 20

Nature

Answer 20

A method of organizing expenses on the income statement by way of their natural classifications (ex. salaries, transportation, depreciation, advertising).

Question 21

Function

Answer 21

A method of organizing expenses on the income statement by way of the activity (business function) for which they were incurred (ex. cost of goods sold, administrative, and selling).

Question 22

Multiple-step income statement

Answer 22

An income statement that shows several steps to determine net income (loss), by separately reporting net sales, gross profit, income from operations, income before income tax, and net income.

Question 23

Income from operations

Answer 23

The results of a company’s normal operating activities, calculated as Gross Profit - Operating Expenses.

Question 24

Gross profit margin

What does it indicate?

Answer 24

Gross profit expressed as a percentage of sales.

GPM = Gross Profit / Net Sales

GPM indicates how much higher the selling price is than the cost of goods sold.

Question 25

Profit margin

What does it indicate?

Answer 25

Net income expressed as a percentage of net sales.

PM = Net Income / Net Sales

PM indicates how well the selling price covers all expenses.

Question 26

What are the five main steps of the multi-step income statement?

Answer 26

1. Net sales: Gross sales less sales returns and allowances and sales discounts.
2. Gross profit: Net sales less cost of goods sold.
3. Income from operations: Gross profit less operating expenses.
4. Income before income tax: Income from operations plus non-operating revenues and less
   non-operating expenses.
5. Net income: Income before income tax less income tax expense.