accounting
Chapter 5: Merchandising Options
Merchandising Operations
Merchandising Operations and Inventory Systems:
Income measurement process
Inventory systems
Recording purchases and sales of merchandise
Presentation of statement of income: single-step, multi-step, comprehensive income
Evaluating profitability
Periodic inventory system
Sales returns and discounts under ASPE
Differences Between Service and Merchandising Companies
Service Companies:
Primary source of revenue through services provided.
Merchandising Companies:
Buy and sell inventory.
Types: Retailers to customers, wholesalers to retailers, manufacturers to wholesalers.
Operating Cycle
Definition:
Period from cash spent to buy inventory until cash is collected from customers.
Comparison:
Longer for merchandising companies due to purchasing, storing, and selling inventory, adding more steps.
Income Measurement Process
Revenue:
Revenue from merchandise sales (referred to as sales).
Expenses:
Divided into cost of goods sold and operating expenses.
Gross Profit Calculation
Formula:
Gross profit = Sales - Cost of Goods Sold
Income Measurement for a Merchandising Company
Stepwise Calculation:
Sales - Cost of Goods Sold = Gross Profit
Gross Profit - Operating Expenses = Income Before Income Tax
Income Before Income Tax - Income Tax Expense = Net Income
Inventory Systems
Flow of Costs:
Starting inventory + cost of goods purchased = Cost of goods available for sale.
Sold costs assigned to Cost of Goods Sold; unsold become ending inventory.
Types of Systems:
Periodic or perpetual.
Perpetual Inventory System
Characteristics:
Detailed records kept for each product's cost.
Records updated continuously.
Allows for constant knowledge of cost of goods sold and inventory balance.
Year-end physical count reconciles records to actual inventory.
Periodic Inventory System
Characteristics:
Does not maintain detailed records throughout the period.
Cost of goods sold calculated at period-end.
Considered "old school".
Page 3: Purchases of Merch
Recording Purchases
Recorded in inventory account.
Includes all costs to acquire merchandise and prepare for resale (transportation, taxes, etc).
Purchases made for cash or on credit.
Sales Taxes and Freight
GST and HST:
These do not form part of the cost of goods.
FOB Terms:
FOB Destination: Ownership transfers at buyer's location; seller covers shipping.
FOB Shipping Point: Ownership transfers upon shipping; buyer covers cost.
Purchase Returns and Allowances
Goods returned to seller for cash or credit.
An allowance may be given if the buyer keeps the merchandise, reducing cost of goods purchased.
Discounts
Discounts offered for early payment (e.g., 2/10, n/30).
Recorded at payment time; reduces inventory account.
Page 4: Adjusting Entry and End of Period
Inventory Counts
Conducted at least annually to check for discrepancies.
Differences lead to adjustments for shrinkage, needing investigation.
Recording Sales of Merchandise
Perpetual System:
Sales tax recorded as liability, not revenue.
For FOB destination, seller pays freight as operating expense.
Under IFRS, sales recorded net of estimated returns.
Statement of Income Presentation
Two forms: single-step and multi-step.
Multi-step includes gross profit, operating income, income before tax, and net income.
Statement of Comprehensive Income
Shows items not included in net income but in comprehensive income.
Page 5: Evaluating Profitability
Profitability Metrics
Gross Profit Margin:
Measures gross profit as a percentage of sales (GPM = Gross Profit/Sales). Higher values are better.
Profit Margin:
Measures profit percentage on sales (Profit Margin = Net Income/Sales). Higher values are better.
Appendix: Periodic System Comparisons
Differences in Recording:
Purchases and sales differ from perpetual systems.
Cost of Goods Sold Calculation:
Done at period-end using:
Calculating cost of goods purchased.
Determining ending inventory.
Calculating cost of goods sold.
Chapter 6: Reporting and Analyzing Inventory
Determining Inventory Quantities
Methods:
Ownership determination, physical inventory, making cost adjustments, and internal controls.
Errors in Inventory:
Need to present and analyze inventory correctly, adhering to cost formulas.
Ownership of Goods
Considerations:
Goods in transit complicate ownership determination.
Ownership remains with the original owner, not the holder.
Taking Physical Inventory
Effective counting necessitates strong internal control systems for accuracy and accountability.
Inventory Cost Formulas
Unit Costs:
Requires application of unit costs to totaled inventory quantities.
Methods of Cost Flow Assumptions
Specific Identification:
Tracks actual goods sold; applicable in perpetual systems with specific projects.
FIFO (First In, First Out):
Assumes oldest merchandise sold first; ending inventory reflects recent purchases costs.
Average Cost:
Uses average unit costs after each purchase.
Page 7: FIFO and Average Cost
FIFO Characteristics
Ending inventory recorded at current cost; cost of goods sold reflects oldest costs.
Identical for periodic and perpetual systems.
Average Cost Characteristics
Averaging typically applied when inventory flow isn't straightforward; utilizes moving averages.
Choice of Inventory Cost Formula
Opt for a formula representing actual or approximated physical flow of goods and yields recent costs.
Page 8: Financial Statement Effects Summary
Effects of Cost Fluctuations
Rising Costs:
FIFO typically results in lower gross profit and net income.
Average Cost may yield a higher gross profit.
Falling Costs:
FIFO results in higher gross profit; average cost may lead to lower values.
Advantages of Cost Formulas
Specific Identification:
Accurate reporting of cost of goods sold with revenues.
FIFO:
Ending inventory reflects replacement costs.
Average Cost:
Provides closer matching of costs to actual sales.
Page 9: Inventory Errors
Common Errors
Counting and cost determination inaccuracies; errors impact both financial position and income statement.
Understated inventory results in overstated cost of goods sold, reducing gross profit.
Reporting Inventory
On Financial Position:
Reported at lower of cost or net realizable value (NRV).
Page 10: Cash and Internal Control
Internal Control Systems
Purpose:
Provides reliable reporting, efficient operations, legal compliance; aids in fraud prevention.
Components:
Risk assessment, control environment, control activities, monitoring, communication.
Cash Controls
Controls over receipts and payments are critical given cash susceptibility to theft.
Bank Accounts:
Utilizing banks adds a safeguard, providing additional records for transactions.
Online Banking
Authorized staff can manage transactions and monitor accounts in real time, enhancing efficiency.
Page 13: Reconciling Bank Accounts
Bank Reconciliation Process
Balance per bank statement reconciled with company’s cash balance to identify discrepancies.
Reporting Cash
Cash listed first in current assets; can include equivalents.
Chapter 8: Reporting and Analyzing Receivables
Accounts Receivable
Represents amounts owed by customers; classified into accounts and notes receivable.
Recording Accounts Receivable
Recorded at the initial transaction price, adjusted for returns, allowances, and sales discounts.
Managing Uncollectible Accounts
Use of allowance method to estimate expected credit losses; reduces receivables in current assets.
Page 15: Summary of Allowance Method
Credit Losses Recognition
Detailed procedures for measuring, recording, and recovering uncollectible accounts; impacts income statements and balance sheets.
Notes Receivable
Legal claims with repayment obligations and interest benefits, used primarily beyond standard credit terms.
Statement Presentation
Properly shown as current assets with an associated allowance for doubtful accounts.