Accounting for Merchandising Companies: Inventory, Sales, Controls, and Financial Ratios

What distinguishes a merchandising company from a service company?

Merchandising companies sell tangible products to earn revenue; service companies sell time or expertise.

What is the operating cycle for a merchandiser?

It begins with the purchase of merchandise and ends with the collection of cash from sales.

What are the two types of inventory systems?

Perpetual system (continuous updates) and Periodic system (updates at period end).

What is the difference between perpetual and periodic inventory systems?

Perpetual records each sale/purchase in real time; periodic updates inventory and COGS only at the end of the period.

Define 'credit terms' such as 2/10, n/30.

Buyer gets 2% discount if paid within 10 days; otherwise, full payment due in 30 days.

In FOB shipping point, who pays for freight?

The buyer pays freight costs and owns goods in transit.

In FOB destination, who pays for freight?

The seller pays freight and ownership transfers upon arrival.

What is a purchase return?

Merchandise returned by the buyer to the supplier.

What is a purchase allowance?

Price reduction given to the buyer for defective or unacceptable goods kept by buyer.

What account is used to record purchase discounts?

Merchandise Inventory (reduced for discount).

How is transportation cost recorded under FOB shipping point?

Debit Merchandise Inventory, Credit Cash or Accounts Payable.

What is the journal entry for a sale in a perpetual system?

1) Dr. A/R or Cash, Cr. Sales Revenue; 2) Dr. Cost of Goods Sold, Cr. Merchandise Inventory.

What is gross profit?

Net sales minus cost of goods sold.

What are 'sales returns and allowances'?

Contra-revenue accounts used to record merchandise returned or allowances granted.

What is the purpose of adjusting entries for merchandisers?

To record inventory shrinkage and expected sales discounts, returns, and allowances.

Define 'shrinkage'.

Loss of inventory due to theft, damage, or errors; recorded as Dr. COGS, Cr. Inventory.

What are closing entries for a merchandiser?

Close revenues, expenses (including COGS), and dividends to retained earnings.

What is a multi-step income statement?

Separates operating and nonoperating items; shows gross profit, operating income, and net income.

What is the gross margin ratio formula?

(Net Sales − Cost of Goods Sold) ÷ Net Sales.

What does a higher gross margin ratio indicate?

Greater profitability on each dollar of sales.

What is included in merchandise inventory?

All goods a company owns and holds for sale, including goods in transit (FOB shipping point) and consigned goods.

Who reports consigned goods on the balance sheet?

The consignor (owner), not the consignee (seller).

How are damaged or obsolete goods treated?

Excluded if unsellable; if salable, reported at net realizable value (sales price minus selling costs).

What costs are included in inventory?

Invoice cost minus discounts plus shipping, insurance, storage, import duties.

What are the four inventory costing methods?

Specific Identification, FIFO, LIFO, Weighted Average.

How does FIFO affect income during rising prices?

Higher income and higher inventory value.

How does LIFO affect income during rising prices?

Lower income and lower taxes (higher COGS).

What is the LIFO conformity rule?

If LIFO is used for tax reporting, it must also be used for financial reporting.

What is the formula for weighted average cost per unit?

Cost of Goods Available for Sale ÷ Units on Hand.

How does weighted average affect prices?

Smooths price fluctuations by averaging costs over time.

What is 'lower of cost or market' (LCM)?

Inventory is reported at market if market < cost to apply conservatism.

What happens if inventory is overstated?

COGS understated, income overstated in current period; reversed next period.

What happens if inventory is understated?

COGS overstated, income understated.

What is the inventory turnover formula?

COGS ÷ Average Inventory.

What does high inventory turnover mean?

Efficient inventory management or low stock levels.

What is the formula for days' sales in inventory?

Ending Inventory ÷ COGS × 365.

What does a low days' sales in inventory indicate?

Fast-moving inventory; better liquidity.

What are internal controls for inventory?

Physical counts, segregation of duties, and authorization for purchases.

When is a physical count taken?

At least annually to verify records and adjust for shrinkage.

What is the purpose of internal control?

To protect assets, ensure reliable accounting, promote efficiency, and enforce company policies.

What law strengthened internal controls in public companies?

The Sarbanes-Oxley Act (SOX).

What are the five components of internal control (COSO)?

Control Environment, Risk Assessment, Control Activities, Information & Communication, Monitoring.

List the seven principles of internal control.

Establish responsibilities, maintain records, insure assets, separate custody and recordkeeping, divide responsibilities, apply tech controls, regular reviews.

Define the fraud triangle.

Opportunity, Pressure, and Rationalization.

What are the two main types of fraud?

Human error (carelessness/misjudgment) and human fraud (intentional deception).

What is 'bonding' employees?

Purchasing insurance protection against theft by employees.

What are technological controls?

Use of registers, time clocks, ID access, or blockchain to reduce fraud.

Define cash equivalents.

Short-term, highly liquid investments readily convertible to known cash amounts and near maturity.

What are the three basic cash control guidelines?

1. Separate cash handling and recordkeeping. 2. Promptly deposit receipts. 3. Make payments by check/EFT.

What is the purpose of a petty cash fund?

To make small, routine cash payments conveniently.

How is petty cash established?

Debit Petty Cash, Credit Cash.

How is a petty cash fund reimbursed?

Debit expenses, Credit Cash; no entry to Petty Cash account.

What is the Cash Over and Short account used for?

To record differences between expected and actual cash (overage: credit; shortage: debit).

What is a voucher system?

A set of procedures to verify, approve, and record liabilities and payments.

What is a bank reconciliation?

A report explaining the differences between the bank statement and company's cash account.

What are common reconciling items on bank reconciliations?

Deposits in transit, outstanding checks, bank errors, interest earned, service fees.

What is the purpose of cash management?

To ensure sufficient cash for obligations while minimizing idle cash.

List five cash management strategies.

Encourage receivables collection, delay payments, keep minimal assets, plan expenditures, invest idle cash.

What is the formula for days' sales uncollected?

Accounts Receivable ÷ Net Sales × 365.

What does the days' sales uncollected ratio measure?

Liquidity — how quickly receivables are collected.

What are examples of internal cash control procedures?

Two people open mail, immediate deposit of receipts, limited check signing authority.

What are examples of technological internal controls?

Cash registers, time clocks, access cards, surveillance, and blockchain tracking.