Lecture 5-Accounting for Merchandise Operations

Question 1

Flow of Costs

Answer 1

Companies use either a perpetual inventory system or a periodic inventory system to account for inventory.

Perpetual System
* Maintain detailed records of the cost of each inventory purchase and sale
* Records continuously show inventory that should be on hand for every item
* Company determines cost of goods sold each time a sale occurs
* Does not keep detailed records of goods on hand
* Cost of goods sold determined by count

Question 2

Flow of Costs-Advantages of the Perpetual System

Answer 2

• Traditionally used for merchandise with high unit values
• Shows quantity and cost of inventory that should be on hand at any time
• Provides better control over inventories than a periodic system

Question 3

Recording Purchases Under a Perpetual Inventory System

Answer 3

Made using cash or credit (on account)
* Normally record when goods are received from the seller *
Purchase invoice should support each credit purchase

Question 4

Freight Costs

Answer 4

Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.
Ownership of the goods remains with the seller until the goods reach the buyer.
Freight costs incurred by the seller are an operating expense.

Question 5

Purchase Returns and Allowances

Answer 5

Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.
Purchase Return Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.
Purchase Allowance May choose to keep the merchandise if the seller will grant a reduction of the purchase price

Question 6

Purchase Discounts

Answer 6

Credit terms may permit buyer to claim a cash discount for prompt payment.
Advantages:
* Purchaser saves money
* Seller shortens the operating cycle by converting the accounts receivable into cash earlier Example: Credit terms may read 2/10, n/30.

Question 7

Purchase Discounts-Percentages?

Answer 7

2/10, n/30 2% discount if paid within 10 days, otherwise net amount due within 30 days.

1/10 EOM 1% discount if paid within first 10 days of next month.

n/10 EOM Net amount due within the first 10 days of the next month.

Question 8

Recording Sales Under a Perpetual Inventory System

Answer 8

Sales may be made on credit or for cash
* Sales revenue, like service revenue, is recorded when the performance obligation is satisfied
* Performance obligation is satisfied when goods are transferred from seller to buyer
* Sales invoice should support each credit sale

Question 9

Sales Returns and Allowances

Answer 9

“Flip side” of purchase returns and allowances
* Contra revenue account to Sales Revenue (debit)
* Sales not reduced (debited) because:
 Would obscure importance of sales returns and allowances as a percentage of sales
 Could distort comparisons

Question 10

Sales Discounts

Answer 10

Offered to customers to promote prompt payment of balance due
* Contra-revenue account (debit) to Sales Revenue

Question 11

The Accounting Cycle for a Merchandising Company

Answer 11

Adjusting Entries
* Generally same as a service company
* One additional adjustment to make records agree with actual inventory on hand
* Involves adjusting Inventory and Cost of Goods Sold

Question 12

Income Statement

Answer 12

Primary source of information for evaluating a company’s performance
* Format is designed to differentiate between various sources of income and expense

Question 13

Income Statement-Gross Profit

Answer 13

We also can express a company’s gross profit as a percentage, called the gross profit rate.

Analysts generally consider the gross profit rate to be more useful than the gross profit amount.

Question 14

Income Statement- Operating Expenses

Answer 14

Incurred in the process of earning sales revenue. Operating expense for PW Audio Supply include the following

Question 15

Income Statement-Other Income and Expense

Answer 15

Various revenues and gains and expenses and losses that are unrelated to the company’s main line of operations.
Other Income
* 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

Other Expense
* Casualty losses from such causes as vandalism and accidents
* Loss from sale or abandonment of property, plant, and equipment
* Loss from strikes by employees and suppliers Interest expense, if material, must be disclosed on the face of the income statement.

Question 16

Comprehensive Income Statement

Answer 16

Presents items not included in the determination of net income.

Items included in comprehensive income are either reported in a combined statement of net income and comprehensive income, or in a separate comprehensive income statement.

Question 17

Worksheet for a Merchandising Company

Answer 17

As indicated in Chapter 4, a worksheet enables companies to prepare financial statements before they journalize and post adjusting entries. The steps in preparing a worksheet for a merchandising company are the same as for a service company. The following Illustration shows the worksheet for PW Audio Supply (excluding non-operating items). The unique accounts for a merchandiser using a perpetual inventory system are in red.

Question 18

Periodic Inventory System Determining Cost of Goods Sold Under a Periodic Inventory System

Answer 18

Determining Cost of Goods Sold Under a Periodic Inventory System
* No running account of changes in inventory
* Ending inventory determined by physical count * Cost of goods sold not determined until the end of the period

Question 19

Recording Merchandise Transactions

Answer 19

Record revenues when sales are made
* Do not record cost of merchandise sold on date of sale.
* Physical inventory count determines:
 Cost of merchandise on hand and
 Cost of merchandise sold during the period
* Record purchases in Purchases account
* Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts

Question 20

Closing Entries

Answer 20

• All accounts that affect the determination of net income are closed to Income Summary
• In journalizing, all debit column amounts are credited, and all credit columns amounts are debited
• Beginning inventory balance is debited to Income Summary and credited to Inventory
• Ending inventory balance is debited to Inventory and credited to Income Summary

Question 21

A Look at U.S. GAAP
Key Points
Similarities

Answer 21

Under both GAAP and IFRS, a company can choose to use either a perpetual or periodic inventory systems.
* Inventories are defined by IFRS as held-for-sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the performing of services. The definition under GAAP is essentially the same.
* Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such as those on non-trading securities) that are not included in the calculation of net income.

Question 22

A Look at U.S. GAAP
Key Points
Differences

Answer 22

-Under GAAP companies generally classify income statement items by function. Classification by function leads to descriptions like administration, distribution (selling), and manufacturing. Under IFRS, companies must classify expenses either by nature or by function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional-expense method on the income statement, disclosure by nature is required in the notes to the financial statements
.Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach.
* Under IFRS revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS results in more transactions affecting equity (other comprehensive income) but not net income.
* IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.

Question 23

A Look at U.S. GAAP
Looking to the Future

Answer 23

The IASB and FASB are working on a project that would rework the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. For example, the amount of income that is generated by operations would be traceable to the assets and liabilities used to generate the income. This approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature. The new financial statement format was heavily influenced by suggestions from financial statement analysts.