Chapter 6 Notes Accounting 1

Chapter 6: Merchandising Operations and the Multistep Income Statement

Learning Objectives

6.1: Distinguish between service and merchandising operations.6.2: Explain differences between periodic and perpetual inventory systems.6.3: Analyze purchase transactions under a perpetual inventory system.6.4: Analyze sales transactions under a perpetual inventory system.6.5: Analyze sales of bundled items under a perpetual inventory system.6.6: Prepare and analyze a merchandiser's multistep income statement.

Operating Cycles

Service Companies:

• Sell services directly to customers, generate income through service fees, and receive cash upon completion.

• Typical operations include receiving payment, delivering services, and paying for operational costs, often focusing on immediate cash flow management.

Merchandising Companies:

• Engage in buying and selling physical products, starting with procurement of inventory and culminating in inventory sales to customers.

• This model includes cycles of purchasing inventory, selling products, collecting cash from sales, and addressing any operational expenses that arise during the selling process.

Inventory Systems

Key Accounts

• Inventory: Reflects the total acquisition cost of unsold goods available for sale, crucial for maintaining accurate financial statements.

• Sales Revenue: Represents the total selling price earned from sold goods, indicating the company’s ability to generate income from sales.

• Cost of Goods Sold (COGS): Measures the total direct costs attributable to the production or purchase of the goods that were sold during the period.

Inventory System Types

1. Periodic Inventory System:

   • Updates inventory records at the end of the accounting period through a physical count, often leading to discrepancies if not managed accurately.

   • This method does not provide real-time inventory monitoring, making it challenging for managers to make immediate purchasing decisions.

2. Perpetual Inventory System:

   • Continuously updates inventory records with each transaction, often leveraging technology such as barcodes and computerized systems for accuracy.

   • Enables real-time inventory tracking, assisting businesses in inventory management and timely decision-making.

Accounting for Inventory Transactions

Purchase Transactions

• Inventory Purchase: Increases both Inventory and Accounts Payable, representing the obligation to pay suppliers.

• Transportation Costs: If inventory is shipped under FOB shipping point, the buyer incurs costs that are added to inventory value, thus impacting inventories on the balance sheet.

• Purchase Returns: Reflects goods returned to suppliers, resulting in a decrease in both Inventory and Accounts Payable.

• Purchase Discounts: Provides adjustments for early payments made to suppliers, encouraging timely settlements and managing cash flow effectively.

Sales Transactions

• Recording Sales: Involves two entries: one for cash or accounts receivable received and another for COGS, recording the expense associated with the sale.

• Sales Returns and Allowances: Requires adjustments to revenue and inventory if products are returned, reflecting accurate financial positions and maintaining customer satisfaction.

• Sales Discounts: Encourages customers to pay promptly by offering reductions, affecting both the revenue earned and the cash flow of the company.

Bundled Sales

• 5-Step Model for Revenue Recognition:

  1. Identify contract with the customer.

  2. Identify distinct performance obligations within that contract.

  3. Determine the transaction price agreed upon between the two parties.

  4. Allocate that price to the performance obligations.

  5. Recognize revenue when the performance obligations have been satisfied, ensuring compliance with accounting standards.

Multistep Income Statement Example

• Displays sections including Net Sales, COGS, Gross Profit, Operating Expenses, and ultimately Net Income over multiple financial years, presenting a clear picture of profitability and operational efficiency.

• Gross Profit Percentage: Offers insights into the trend of profitability over time, which can be vital for investment decisions.

Effects of Inventory Errors

• Overstated ending inventory inflates current year profits while underreporting COGS, leading to distorted financial results; conversely, the subsequent period would reflect lower profits as adjustments are made for previous overstatements.

Purchase and Sales Discounts

• Gross Method: Initially records purchases at full price and only adjusts for discounts when payment is made, potentially affecting cash flow management until adjustments are noted.

• Net Method: Records purchases at the discounted price reflecting expected payment reductions from the outset, providing a more accurate picture of anticipated costs.

Importance of Accurate Inventory Accounting

• Accurate inventory accounting affects financial statements significantly, encompassing aspects of gross profit, net income, and overall financial health, making it essential for sustainable business operations and informed decision-making.