Finance and Accounting Chapter 6

Manufacturing Firm

A firm that converts raw materials into products that are sold to other firms or to consumers

Service firm

a firm that provides services to consumers or other business, governmental or not-for-profit organization

merchandising firm

a firm that purchases goods for resale to other manufacturing firms or for resale to consumers

The biggest differences between a service company and a merchandising company

what they sell, their typical financial transactions, their operating cycles and how these translate to financial statements

operating cycle

the amount of time it takes a company to use its cash to provide a product or service and collect payment from the customer

characteristics of merchandising transactions

separated into purchase transaction and sale transaction

purchase transaction

occurs between a manufacturer and the merchandiser, also called a retailer

sales transaction

occurs between a customer and the merchandiser or retailer

What terms are most frequently used for goods held for resale

inventory, merchandise, and merchandise inventory

Beginning inventory

the cost of inventory on hand at the beginning of the period

Purchases

the cost of inventory purchased during the period

Cost of goods sold

the cost of inventory that was sold during the period

Ending inventory

the cost of inventory on and at the end of the period

What are the ways in which a company may account for their inventory?

Perpetual or periodic inventory system

Perpetual inventory system

automatically update the merchandise inventory account to show the purchase

Periodic inventory system

an account called “purchases” will be updated, while merchandise inventory will remain unchanged until the company counts and verifies its inventor balance

How are purchases of inventory accounted for under the periodic system?

a special, temporary account called “purchases” is increased for the cost of inventory as it is purchased during the period

is the purchases account used to record purchases of other assets?

no, the purchases account is used only to record purchases of merchandise held for resale to customers

the purchases account is never used to record the purchase of assets used in the business

Are firms always satisfied with the goods they purchase for resale?

no, sometimes goods are damaged and not salable. sometimes goods are inferior in quality and are salable only at reduced prices

What do firms do when they are not satisfied with the goods

Returned to the supplier. in this instance the purchasing firm no longer owes the supplier for the goods

the supplier may reduce the cost of the goods to the purchaser (called “giving an allowance on the goods”). in this instance the purchasing firm owes a lesser amount to the supplier than was originally recorded.

Why don’t accountants simply reduce the Purchases account for inventory allowances and return?

reducing the purchases account hides important information. to determine if suppliers are dependable and efficient, managers look at the percentage of purchases that are returned or marked down. a large percentage of returns and allowances indicated inefficiency and lack of dependability on the part of suppliers

Why do managers care about efficiency and dependability of suppliers?

it is costly to return goods and try to sell inferior goods

out-of-stock costs

loss of sales

loss of reputation

labor and paperwork to record and make the return

What are purchase discounts?

a reduction in the cost of goods offered to the purchaser if the purchaser pays for the goods within a specified period of tme

How are purchase discounts stated?

Example: 2/10 n/30

“2/10” means that s 2% reduction (the discount percentage) in cost will be given on all amounts that the purchaser pays for within 10 days (the discount period)

“n/30” means that amounts not paid within 10 days must be paid within 30 days (n stand for net amount)

Why do sellers of goods offer purchase discounts?

timely and prompt collection of accounts receivable is important to businesses with large accounts receivable

Why don’t accountants simply reduce the Purchases account to reflect purchase discounts?

the amount of purchase discounts taken is important information. it is costly to ignore purchase discounts

What is the cost of ignoring a 2/10 n/30 purchase discount?

on an annual basis, about 37.3%

What is the interest formula

interest = principal * annual interest rate * length of time funds are borrowed

Besides the cost of the actual merchandise, what other costs are included in the cost of goods sold?

the cost to transport the goods from the supplier to the merchandising firm

What is the technical name for these costs?

Transportation-in or freight-in

How are freight charges stated?

freight charges are stated as either F.O.B shipping point or F.O.B destination

What does F.O.B mean?

that the seller of the goods will place the goods on board a freight carrier at no cost to the buyer. F.O.B. stands for “free on board”

What does F.O.B. shipping point mean?

the seller’s responsibility for the goods ends at the point of shipment. thus, the buyer must pay all of the costs to have the merchandise delivered to the buyer’s warehouse

What does F.O.B. destination mean?

the seller’s responsibility for the goods ends at the final destination of the goods. thus, the seller must pay all of the costs to have the merchandise delivered to the buyer’s warehouse

What is the effect of the sale of goods on the basic accounting equation?

a revenue account called “sales” will be increased for the total sales price (not cost!!!!) of the items sold. “sales” is a revenue account

What are sales return and allowances?

as with purchases, sometimes the goods sold are damaged, or are of inferior quality. the selling firm will either take back the goods, or offer the customer a reduced price (allowance) on the goods

What are sales discounts?

sellers of goods will offer a reduction in price if the customer pays within a certain timer period, and when customers purchase in higher quantities

How is cost of goods (COGS) sold calculated when the periodic inventory system is used?

Step one: calculate the cost of inventory purchased

Step two: calculate the cost of goods sold

thus: COGS = beginning inventory + cost of goods purchased - ending inventory

Sales allowance

a customer receives a partial refund but keeps the defective merchandise

Purchase return

a retailer returns merchandise for a full refund

Sales discount

a customer pays their account in full within the discount window

Purchase discount

a retailer pays their account in full within the discount window

Sales return

a customer returns merchandise for a full refund

Trade discount

a retailer returns merchandise for a full refund

Purchase allowance

a retailer pays their account in full within the discount window