CONT3011 Examen 3

Merchandise: refers to products aka goods that a company buys to resell

Merchandiser: earns net income by buying and selling merchandise

Wholesaler: buys products from manufacturers and sells them to retailers

Retailer: buys products from manufacturers or wholesalers and sells them to customers

Net Income for merchandiser: equals revenue from selling merchandise minus both the cost of goods sold and other expenses

Sales: revenue from selling merchandise

Cost of Goods Sold/Cost of Sales: expense of buying and preparing merchandise 

Merchandiser Formula: Net Sales – Cost of Goods Sold = Gross Profit – Expenses = Net income

Gross Profit/Gross Margin: Net sales – Cost of Goods Sold

Merchandise inventory: products that a company owns and intends to sell

Inventory Cost: cost to buy the goods, ship them to the store, and make them ready for sale

Operating Cycle for Merchandiser (varies in length):

1. Cash purchases of merchandise

2. to inventory for sale

3. to credit sales

4. to accounts receivables

5. to receipt of cash

Perpetual Inventory System: records cost of goods sold at the time of each sale

Periodic inventory system: records cost of goods sold at the end of the period

Credit Period: amount of time allowed before full payment is due

Cash Discount: granted by sellers to encourage buyers to pay earlier

Purchases discount: how a buyer views a cash discount

Sales discount: how a seller views a cash discount

Discount Period: period of time the cash discount is offered

Gross Method: records the credit purchase at its gross (full) invoice amount until it’s paid.

Purchase Returns: are merchandise a buyer purchases but then returns

Purchase Allowances: seller granting a price reduction to a buyer of defective or unacceptable merchandise

• Credits accounts payable

• debits merchandise inventory

FOB (Free on board) shipping point: buyer accepts ownership when the goods DEPART the seller’s place of business. The buyer pays shipping costs and has the risk of loss in transit. The goods are part of the buyer’s inventory when they are in transit because ownership has transferred to the buyer.

FOB destination: ownership of goods transfers to the buyer when the goods ARRIVE at the buyer’s place of business. The seller pays shipping charges and has the risk of loss in transit. Seller does not record revenue until the goods arrive at the destination.

Transportation costs of a buyer are part of the cost of merchandise inventory.

When a seller is responsible for paying shipping costs, it records these costs in a Delivery Expense account and is reported as a selling expense in the seller’s income statement.

In summary, purchases are recorded as debits to Merchandise Inventory. Purchases discounts, returns, and allowances are credited to (subtracted from) Merchandise Inventory. Transportation-in is debited (added) to Merchandise Inventory.

The perpetual accounting system requires that each sales transaction for a merchandiser, whether for cash or on credit, has two entries: 

• one for revenue recorded from the customer

• one for cost of goods sold incurred to the customer

As inventory is sold, its cost is recorded in cost of goods sold on the income statement; what remains is ending inventory on the balance sheet.

Inventory Shrinkage: Loss of inventory, including theft and deterioration, and is computed by comparing a physical count of inventory with recorded amounts.

Temporary accounts unique to merchandisers: Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold

Closing Process for Merchandisers

• Step 1: Sales are debited

• Step 2: Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold are credited

• Step 3: income summary is debited & capital credited

• Step 4: Capital is debited and Withdrawals are credited

Multiple-Step Income Statement: details net sales and expenses and reports subtotals for various types of items. This statement has three parts

1. Gross profit: Net sales – Cost of goods sold

2. Income from Operations: Gross profit minus operating expenses

3. Net Income: Income from operations plus or minus nonoperating items.

• Operating expenses are separated into two sections

  • Selling expenses: costs to market and distribute products and services such as advertising of merchandise, store supplies and rent, and delivery of goods to customers.

  • General and administrative expenses: costs to administer a company’s overall operations such as office salaries, equipment, and office supplies.

  • Expenses are allocated between these two sections when they contribute to more than one.

• Nonoperating activities: consist of other expenses, revenues, losses, and gains that are unrelated to a company’s operations.

  • Other revenues and gains: include interest revenue, dividend revenue, rent revenue, and gains from asset disposals.

  • Other expenses and losses: commonly include interest expense, losses from asset disposals, and casualty losses. 

• When there are no reportable nonoperating activities, its income from operations is simply labeled net income.

Classified Balance Sheet: reports merchandise inventory as a current asset, usually after accounts receivable, according to how quickly they can be converted to cash.

Acid-test ratio/quick ratio: 1.0 or more means that the company has enough current assets to cover current liabilities. This method is more accurate than the current ratio method.

Acid-test ratio/quick ratio formula: quick assets (cash, short-term investments, and current receivables) divided by current liabilities.

Gross Margin Ratio = Net sales – Cost of Goods Sold divided by net sales

Merchandise Inventory: includes all goods that a company owns and holds for sale

FOB shipping point: goods are included in the buyer's inventory once they are shipped.

FOB destination: goods are included in the buyer’s inventory AFTER arrival at the destination.

Consignor: owns the consigned goods and reports them in its inventory.

Consignee: sells goods for the owner. NEVER reports consigned goods in inventory.

Damaged, obsolete, and deteriorated goods: are NOT reported in inventory if they cannot be sold.

• if they can be sold at a lower price, they are included in the inventory at net realizable value.

Net Realizable Value: sales price – cost of making the sale

Merchandise inventory includes costs to bring an item to a salable condition and location. Inventory costs include invoice cost minus any discount, plus any other costs. Other costs include shipping, storage, import duties, and insurance. Inventory costs are expensed as cost of goods sold when inventory is sold.

Physical count of inventory should be done at least once a year.

FIFO: assumes costs flow in the order incurred; inventory items are sold in the order acquired. When sales occur, the costs of the earliest units acquired are changed to cost of goods sold.

LIFO: assumes costs flow in the reverse order incurred; assumes that the most recent purchases are sold first.

Weighted Average: assumes costs flow at an average of the costs available. Add up the total cost of beginning inventory and purchases and divide by the total units to get the average.

• Formula: Cost of goods available for sale / number of units available for sale 

Specific Identification: each item in inventory can be matched with a specific purchase and invoice

Rising Costs:

• FIFO reports the lowest cost of goods sold, yielding the highest gross profit and net income.

• LIFO reports the highest cost of goods sold, yielding the lowest gross profit and net income.

• Weighted average yields results between FIFO and LIFO.

Falling Costs:

• FIFO gives the highest cost of goods sold, yielding the lowest gross profit and net income.

• LIFO gives the lowest cost of goods sold, yielding the highest gross profit and net income.

Method Advantages:

• FIFO – inventory on the balance sheet approximates its current cost; it also follows the actual flow of goods for most businesses.

• LIFO – cost of goods sold on the income statement approximates its current cost; it also better matches current costs with revenues.

• Weighted average – smooths out erratic changes in costs

• Specific identification – matches the costs of items with the revenues they generate.

May companies use LIFO because of less income to be taxed. 

LIFO conformity rule: The IRS requires that when LIFO is used for tax reporting, it also must be used for financial reporting.
Inventory is reviewed to ensure it is reported at the Lower of Cost or Market (LCM).

Inventory Relation: Beginning Inventory + Net purchases – Ending Inventory = Cost of Goods Sold

Understating ending inventory understates both current and total assets. An understatement in ending inventory also yields an understatement in equity because of the understatement in net income.

Inventory turnover aka merchandise inventory turnover: tells us how many times a company turns over (sells) its inventory in a period. It is used to assess whether management is doing a good job controlling the amount of inventory.

• Low ratio: means the company may have more inventory than it needs or is struggling to sell inventory.

• Very high ratio: means inventory might be too low.

Formula: Inventory Turnover = Cost of goods sold / average inventory

Days’ sales in inventory: ratio that shows how much inventory is available in terms of the number of days’ sales. It can be interpreted as the number of days one can sell from existing inventory if no new items are purchased.

• Formula: Days’ Sales in Inventory = (Ending Inventory / Cost of Goods Sold) x 365