Week 3 Key Concepts Flashcards
inventory
is an asset and a balance sheet account (asset). Its balance represents the costs of products purchased for resale that are still ‘on hand’ (not yet been shipped (sold) to customers).
cost of goods sold
is an expense and an income statement account (expense) used to record
the costs of acquiring the products that were delivered to customers during the period.
Cost of Goods Sold = Opening Balance of Inventory + Net Purchases – Ending Balance of
Inventory
Sales Discounts and Sales Returns and Allowances
are Revenue or Sales contra accounts
(normal balances are opposite the Revenue account balance) and they are combined with the
Revenue account to compute the net Revenue reported on the income statement.
Gross profit = Revenue – Cost of Goods Sold
Invoice
the buyer and the seller agree on the price of the merchandise, the terms of payment and
the party to bear the cost of transportation. Only the invoice provides the basis for recording
transactions as it contains the historical cost of goods acquired
Inventory - Perpetual System
● Purchases are debited directly to inventory as items for
resale are acquired
● Items sold are credited to inventory at their acquisition
cost at the time of sale
Dr Accounts Receivable
Cr Sales
Dr Cost of Goods Sold
Cr Inventory
● Sub-ledger kept for inventory and is updated after
each transaction
The Inventory account is increased (debited) every time
merchandise is received and the Inventory account is decreased (credited) and the Cost of Goods
Sold account increased (debited) with each sale when a perpetual inventory system is used.
Inventory - Periodic System
the balance of the Inventory account is only known when
merchandise on hand is counted and costed. In such a periodic inventory system a temporary
Purchases account is debited with the invoiced amount of merchandise received. The temporary
account Purchases, and its contra accounts (Purchase Returns and Allowances and Purchase
Discounts), are reset to $0 at the end of the accounting period and their balances distributed
between Cost of Goods Sold and Inventory, as determined by the physical stock-count at the
financial reporting date.
Acquisitions:
Charged to “Purchases” account
Valuation:
Inventory is counted and valued only at the end of
the accounting period
Weakness:
On any given day during month:
Clueless what balance is of inventory
Advantage:
In pre-computer era…less bookkeeping
Credit Terms
credit period is “n/” followed by the number of days: for example, n/30 indicates
that the credit period is 30 days. To encourage early payment of bills, many firms designate a
discount period that is shorter than the credit period. The discount “2/10’ means that 2% may be
deducted if payment is made within 10 days.
Budget
is a plan showing how resources are to be acquired and used over future periods,
normally a year. The budget serves as a basis for comparison of what should be with what is and
facilitates the control over cash and other assets.
Revenue recognition and Matching of expenses:
Revenue is recognized when the earning process is substantially complete, and
the measurability and the collectability of the dollar amount is reasonably
assured.
⚪ For most businesses revenue is recognized when goods are shipped to
customers or services are provided.
Cash vs Accrual basis
Revenue recognition and matching of expenses are a cornerstone of
accrual basis accounting.
⚪ In contrast to the accrual basis, cash basis accounting recognizes revenue when money is received and recognizes money when paid.
⚪ Cash basis may distort the portrayal of financial position and over or
understate performance measurement.
Three Types of Operations
- Manufacturing
Operations (Produce and sell goods) - Merchandising Operations (Buy and Sell goods)
- Service Operations (Sell Services)
Merchandising operations
Buy and sell finished goods.
⚪ Cost of Goods Sold (COGS): the cost of items shipped to customers is
usually a large expense.
⚪ Inventory is reported on the Balance Sheet: it is goods held for sale.
⚪ Often the change in inventory is computed at the time of each sale
(perpetual method) or at the end of the period (the periodic method).
⚪ Recognizing Cost of Goods Sold (using perpetual method):
…not expensed when goods are purchased
Dr Inventory (balance sheet account)
Cr Cash or Accounts Payable
… COGS is recognized when goods are sold
Dr Cost of Goods Sold (income statement)
Cr Inventory (balance sheet account)
Purchase Equation
GP + TI – PRA – PD = NP
GP = Gross Purchases
TI = Transportation In
PRA = Purchase Returns and Allowances
PD = Purchase Discounts
NP = Net Purchases
Inventory Equation
aka Cost of Goods Sold Equation just rearranged
(OI + NP) - COGS = EI
OI = Opening Inventory
NP = Net purchases
COGS = Cost of Goods Sold
EI = Ending Inventory
If the term is “FOB Shipping”
=> “Free on board” at shipping point
=> Buyer assume risk of shipping
=> Buyer pays shipping cost
=> Shipping cost is recorded in buyer’s
“Transportation In” account (also called
“Freight In”)
