BE210: Financial Accounting
BE210 Course Structure
There are 6 Course Chapters:
Chapter / The Subject1 / Accounting and the Business Environment
2 / Recording Business Transactions
3 / The Adjusting Process
4 / Completing the Accounting Cycle
5 / Merchandising Operations
6 / Merchandise Inventory
Chapter 5: Merchandising Operations
Financial Statements of a Service Company and a Merchandiser:
· Service Companies:
Ø Revenues earned through performance of services.
Ø Examples: Dentists, Accounting Firms, Attorneys.
· Merchandising Companies:
Ø Revenues earned through sales of merchandise.
Ø Examples: Restaurants, Dept. Stores.
Income Statement:
Service CompanyCentury 21 Real Estate
Income Statement
Year Ended December June 30, 2008 / Merchandising Company
General Motors Corporation
Income Statement
Year Ended December 31, 2008
Service revenue / $ x,xxx / Sales revenue / $ x,xxx
Expenses: / Cost of goods sold / x
Salary expense / x / Gross profit / x,xxx
Depreciation expense / x / Operating expenses: / x
Rent expense / x / Salary expense / x
Net income / $ x,xxx / Depreciation expense / x
Rent expense / x
Net income / $ x,xxx
Balance Sheet:
Service CompanyCentury 21 Real Estate
The balance sheet
Year Ended December June 30, 2008 / Merchandising Company
General Motors Corporation
The balance sheet
Year Ended December 31, 2008
Current assets: / $ x / Current assets: / $ x
Cash / x / Cash / x
Short-term investments / x / Short-term investments / x
Accounts receivable, net / x / Accounts receivable, net / x
Prepaid expenses / x / Inventory / x
Prepaid expenses / x
What Are the Merchandising Operations?
Merchandising consists of buying and selling products rather than the services. Merchandisers have some new balance sheet and income statement items.
Balance Sheet / Income Statement· Inventory, an asset. / · Sales revenue (often abbreviated as Sales).
· Cost of good sold, an expense
Objectives 1: Account for the purchase of inventory
The operating Cycle of a Merchandising Business
The operating cycle of a merchandiser:
1- Begins when the company purchases inventory.
2- Then sells the inventory.
3- And, last, collect cash from customers.
Inventory Systems
• Periodic.
• Perpetual.
Perpetual Inventory System / Periodic Inventory System· The accounting inventory system in which the business keeps a running record of all inventory as it is bought and sold. The inventory account is continuously updated to reflect items on hand.
· Record of quantity of goods is constantly updated.
· Better control of inventory.
· Popular now due to bar codes and computer scanning. / · A system in which the business does not keep a running or continuous record of inventory on hand. At the end of the period, it makes a physical count of on-hand inventory and uses this information to prepare the financial statements.
· Goods counted periodically to determine quantity.
· Used by small businesses.
· Less popular now because of computerized inventory systems.
Inventory Accounting Systems:
· Periodic system:
Ø Does not keep a running record of all goods bought and sold.
Ø Inventory counted at least once a year
Ø Used for inexpensive goods
· Perpetual system:
Ø Keeps a running record of all goods bought and sold.
Ø Used for all types of goods.
Accounting for Inventory
Inventory (balance sheet) = Number of units of inventory on hand × Cost per unit of inventory.
Inventory (income statement) = Number of units of inventory sold × Cost per unit of inventory.
Accounting for Inventory in the Perpetual System:
· Maintain detailed records of purchases and sales.
· Cost of goods sold is determined with each sale.
· Any transaction affecting inventory is recorded in the inventory account.
· Purchases, purchase discounts, purchase returns and allowances, transportation-in accounts are not used.
· Cost of merchandise sold is recorded at the time of the sale.
· Provides “real-time” information on inventory levels and cost of merchandise sold.
Purchase of Inventory:
Purchase Discounts:
• Discount for early payment.
• A deduction from the invoice price granted to encourage early payment of the amount due.
- Expressed as follows 1/10, n/30 (Credit terms 1/10, n/30 means 1% discount if paid within 10 days. If the discount period is missed, the full amount is due within 30 days. This decreases the cost of the inventory).
- EOM (end of month).
Purchase Returns and Allowances:
• Purchase Return: Merchandise returned by the purchaser to the supplier.
• Purchase Allowance: A reduction in the cost of defective merchandise received by a purchaser from a supplier.
Transportation Costs:
Someone must pay the transportation cost of shipping inventory from seller to buyer. The purchase agreement specifies FOB (free on board) to indicate who pays the freight.
· FOB shipping point: means Title passes at origin and buyer pays the freight.
· FOB destination: means Title passes at destination and Seller pays the freight.
Freight costs are either freight in or freight out:
· Freight in: is the transportation cost on purchased goods.
- Amount paid to have merchandise shipped from the supplier.
- Additional cost of the merchandise inventory.
- Transportation cost on purchased goods. Inward freight costs of acquiring merchandise.
- Transportation-In is part of cost of goods sold.
- Debit inventory.
· Freight out: is the transportation cost on goods sold.
- Transportation Out/Delivery Expense.
- Outgoing freight costs that must be paid by the seller.
- Transportation cost on goods sold.
- Debit an expense (delivery expense). Delivery Expense is a selling expense on the income statement!
Transportation Costs:
FOB Shipping Point / FOB Destination· Buyer takes ownership of inventory when goods leave seller’s place of business.
· Purchaser normally pays freight charges
§ Freight-in.
§ Increases cost of inventory. / · Buyer takes ownership of inventory when goods arrive.
· Seller normally pays freight
§ Freight-out.
§ Selling expense.
Computing the Cost of Inventory:
Net cost of inventory = Purchases of inventory – Purchase returns and Allowances – Purchase Discounts + Freight in.
Applying the Perpetual Inventory System:
Inventory and cost of Goods Sold are continually updated during the accounting period, as purchases, sales, and other inventory transactions take place.
Transactions Related to Purchases of Merchandise:
• Purchases of Merchandise on Credit:
ü The cost of merchandise purchased is placed in the Merchandise Inventory account at the time of purchase.
• Transportation Costs on Purchases:
ü Accumulated in a Freight In / Transportation In account.
ü In some cases, the seller pays the freight charges and bills them to the buyer as a separate item on the invoice.
• Purchases Returns:
ü A return of the goods from the buyer or seller for cash or credit.
• Purchases Allowances:
ü A reduction made in the selling price of the merchandise, granted by the seller so that the buyer will keep the goods.
• Payments on Account.
• Payments by cash (or checks) to suppliers.
Objective 2: Account for the sale of inventory:
Sale of Inventory:
• Sales Revenue:
- Amount earned from selling inventory.
- Revenue account
• Cost of Goods Sold:
- Cost of inventory that has been sold to customers.
- Expense account.
• Sales Returns & Allowances :
- When customer returns goods or the seller grants a reduction in price to customer
- Contra-revenue account (debit balance).
• Sales Discounts:
- If customer pays within the discount period allowed by the seller:
- Contra-revenue account (debit balance).
• Delivery Expense (Freight Out).
• Net Sales Revenue = Sales Revenue – Sales returns and Allowances – Purchase Discounts.
• Net Sales - Cost of Goods Sold = Gross profit.
Remember, there are always two entries to record a sale when using the perpetual inventory system. One to record the selling price to the customer and the second to remove the inventory from your books at the amount your company paid to acquire it.
Transactions Related to Sales of Merchandise:
• At the time of sale, the cost of merchandise is transferred from the Merchandise Inventory account to the Cost of Goods Sold account.
• In the case of a return, the cost of the merchandise is transferred from Cost of Goods Sold back to Merchandise Inventory.
• Sales of Merchandise on Credit:
• Two entries are necessary.
• Record the sale as a debit to Accounts Receivable.
• Update the Cost of Goods sold by transferring from Merchandise Inventory.
• Cash sales of Merchandise:
• Debit Cash for the amount of the sale.
• Payment of Delivery Costs:
• Accumulated in the Freight Out Expense account.
• Shown as a selling expense on the income statement.
• Returns of Merchandise Sold:
• Accumulated in the Sales Return and Allowances account, a contra-revenue account, with a normal debit balance, deducted from Sales in the income statement.
• The cost of merchandise must also be transferred from the COGS account back into the Merchandise Inventory account.
• Receipts on Account.
• Receipts of cash (or checks) from credit customers recorded as credits to Accounts Receivable.
Example (p. 269):
Suppose liberty Sales Co. engaged in the following transactions during June of current year:
June / 3 / Purchased inventory on credit terms of 1/10 net eom (end of month), $1,600.9 / Returned 40% of the inventory purchased on June 3. It was defective.
12 / Sold goods for cash, $920 (cost, $550).
15 / Purchased goods for $5,000. Credit terms were 3/15, net 30.
16 / Paid a $260 freight bill on goods purchased.
18 / Sold inventory for $2,000 on credit terms of 2/10, n/30 (cost, $1,180).
22 / Received returned goods from the customer of the June 18 sale, $800 (cost, $480).
24 / Borrowed money from the bank to take advantage of the discount offered on the June 15 purchase. Signed a note payable to the bank for the amount, $4,850.
24 / Paid supplier for goods purchased on June 15, less the discount.
28 / Received cash in full settlement of the account from the customer who purchased inventory on June 18, less the return on June 22, and less the discount.
29 / Paid the amount owed on account from the purchase of June 3, less the June 9 return.
Requirements:
1- Journalize the preceding transactions for Liberty.
2- Set up T-accounts and post the journal entries to show the ending balances in the Inventory and the Cost of Good Sold accounts.
3- Assume that the note payable signed on June 24 requires the payment of $90 interest expense. Was borrowing funds to take the cash discount a wise or unwise decision?
Solution: Requirement 1: Journalizing:
June / 3 / Inventory / 1,600Accounts Payable / 1,600
Purchased inventory on account.
9 / Accounts Payable ($1,600 × 0.40) / 640
Inventory / 640
Returned inventory.
12 / Cash / 920
Sales Revenue / 920
Cash sale.
12 / Cost of Good Sold / 550
Inventory / 550
Recorded the cost of good sold
15 / Inventory / 5,000
Accounts Payable / 5,000
Purchased inventory on account.
16 / Inventory / 260
Cash / 260
Paid a freight bill.
18 / Accounts Receivable / 2,000
Sales Revenue / 2,000
Sales on account.
18 / Cost of Good Sold / 1,180
Inventory / 1,180
Recorded the cost of goods sold.
22 / Sales Returns and Allowances / 800
Accounts Receivable / 800
Received returned goods.
22 / Inventory / 480
Cost of Good Sold / 480
Placed goods back in inventory.
24 / Cash / 4,850
Note Payable / 4,850
Borrowed money from the bank.
24 / Accounts Payable / 5,000
Inventory ($5,000 × 0.03) / 150
Cash ($5,000 × 0.97) or ($5,000 - $150) / 4,850
Paid within discount period.
28 / Cash [($2,000 - $800) × 0.98] / 1176
Sales Discounts [($2,000 - $800) × 0.02] or ($2,000 - $1,176) / 24
Accounts Receivable / 1,200
Cash collection within the discount period.
29 / Accounts Payable ($1,600 - $640) / 960
Cash / 960
Paid after discount period.
Requirement 2: Preparing T- accounts:
Inventory / Cost of Good SoldJune 3 / 1,600 / June 9 / 640 / June 12 / 550 / June 22 / 480
15 / 5,000 / 12 / 550 / 18 / 1,180
16 / 260 / 18 / 1,180 / Bal. / 1,250
22 / 480 / 24 / 150
Bal. / 4,820
Requirement 3:
Liberty’s decision to borrow funds was wise because the discount received ($150) exceeded the interest paid ($90). Thus liberty was $60 better off.
Objective 3: Adjusting and Closing the Accounts of a Merchandiser:
Adjusting Inventory:
• If physical count of inventory is different from amount on the books – Inventory Shrinkage
• Debit Cost of Goods Sold
• Credit Inventory
Closing Entries
1- Close all income statement accounts with credit balances to Income Summary
2- Close all income statement accounts with debit balances to Income Summary
3- Close Income Summary to Capital
4- Close Withdrawals to Capital
Objective 4: Preparing a Merchandiser’s Financial Statements:
Inventory vs. Cost of Goods Sold:
Inventory / Cost of Goods SoldBeginning / Inventory Sold / / Inventory Sold
Purchases
Ending
As Inventory is Sold we remove it’s cost from the Asset side of A=L+E and Insert it’s cost into an Expense on the Equity side of A = L + E.
This property exists for all Assets: As they are used up or sold the cost transfers from the balance sheet as a future economic resource (asset) to the income statement as an expense incurred to generate revenue.
Relationship between Balance Sheet and Income Statement:
· Income Statement Items:
- Sales revenue is based on sale price of inventory sold.
- Cost of goods sold is based on cost of inventory sold.
- Gross profit (gross margin) is sales revenue less cost of goods sold.