Overview of Revenue Generating Activities in Businesses

• Two primary ways businesses earn revenue:
    - Providing services
    - Selling products

Types of Companies

• Three types of companies that operate in revenue generation:
    1. Service Company
       - Generates revenue by providing services
       - Examples: Tattoo shops, lawyers, accountants
    2. Manufacturing Company
       - Manufactures goods from raw materials
       - Adds labor to create products for sale
    3. Merchandising Company
       - Purchases finished goods from manufacturing companies
       - Sells these goods to consumers

Focus on Merchandising Companies

• Merchandising companies:
    - Act as middlemen in the retail process
    - Generate revenue by selling inventory
    - Inventory is a critical asset for cash flow generation

Accounting for Inventory Purchases and Sales

• Merchandising companies have two systems of inventory accounting:
    1. Perpetual System
       - Inventory is adjusted continuously after every purchase and sale
       - Examples: Large retail stores like Walmart that use self-checkout systems to maintain updated inventory records
    2. Periodic System
       - Inventory is adjusted periodically (e.g., weekly, monthly)
       - Common in small shops where inventory is counted physically at intervals

Income Statements of Service vs. Merchandising Companies

• Service Company Income Statement:
    - Revenue generated from service provision
    - Expenses reported as operating expenses (e.g., salaries, utilities)
    - Example:
      - Total operating expenses = Salaries + Utilities + Delivery = Net Income

• Merchandising Company Income Statement:
    - Revenue generated from selling goods
    - Key components include:
      - Cost of Goods Sold (COGS): The expense incurred from selling inventory
      - Gross Profit: Calculated as Sales Revenue - COGS
        - Example Calculation: Gross Profit = $13,000
    - Operating expenses are listed below gross profit to calculate net income.

Balance Sheets of Service vs. Merchandising Companies

• Service Company Balance Sheet:
    - Typically has no inventory
• Merchandising Company Balance Sheet:
    - Includes inventory as a current asset (e.g., reported at $6,000)
    - Rationale: Inventory expected to convert to cash within 12 months

Transportation Costs and Title of Ownership During Inventory Transactions

• Two key aspects to address:
    1. Transportation Costs
       - Freight In: Shipping costs for goods received, added to inventory cost
       - Freight Out: Shipping costs for goods sent out, considered an expense (delivery expense)
    2. Title of Ownership
       - Free On Board (FOB) Shipping Point:
         - Title passes from seller to buyer at the shipping point
         - Buyer owns the goods during transit
       - Free On Board (FOB) Destination:
         - Title passes when goods reach their destination
         - Seller remains responsible until goods are delivered

Examples of Shipping Charges and Title Ownership

• Example of Freight Charge Accounting:
    - On October 1, paid $300 for shipping on inventory (Freight In):
      - Journal Entry: Debit Inventory $300, Credit Cash $300
    - On October 7, paid $1,000 to ship inventory to client (Freight Out):
      - Journal Entry: Debit Delivery Expense $1,000, Credit Cash $1,000

• Example of Title Ownership:
    - Purchase of $20,000 inventory with shipping terms FOB Shipping Point (recorded on balance sheet)
    - Purchase under FOB Destination does not affect the balance sheet until received

Accounting for Purchases under the Perpetual System

• Merchandising cycle:
    1. Purchase inventory using cash or on account
    2. Sell inventory for cash or on account (collecting cash)

Purchasing Inventory Example

• On April 1, purchased inventory on account for $10,000 under terms 2/10, net 30:
    - Journal Entry: Debit Inventory $10,000, Credit Accounts Payable $10,000

Discounts on Purchases

• Understanding Purchase Discounts:
    - A 2/10 net 30 term provides a 2% discount if paid within 10 days
• Example of Payment within Terms:
    - If $2,000 is paid within discount terms:
    - Cash Payment = $2,000 x 0.98 = $1,960
    - Accounts Payable: Debit $2,000 (full amount), Credit Inventory $40 (discount amount)

Purchase Returns and Allowances

• Handling inventory returns:
    - A return reduces inventory and accounts payable:
      - Example: Return of $1,000 inventory - Journal Entry: Debit Accounts Payable $1,000, Credit Inventory $1,000
• Allowances reduce liability without returning goods:
      - Example: Receive a $500 allowance - Journal Entry: Debit Accounts Payable $500, Credit Inventory $500

Accounting Outside of Discount Terms

• If a payment is made after the discount period:
    - Journal Entry records the full amount of payment without discount.