Chapter 4 Merchandising Companies and Inventory Accounting

Chapter 4 Study Notes on Merchandising Companies and Inventory Accounting

Basic Accounting Equation

• Accounting Equation:

  • ext{ASSETS} = ext{LIABILITIES} + ext{COMMON STOCK} + ext{STOCKHOLDER’S EQUITY}

Revenue Recognitions in Merchandising Companies

• Introduction of two Revenue Types:

  • Sales Revenue: relates to goods sold.

  • Service Revenue: relates to services being provided.

• In merchandising, goods held for sale create the need for an Inventory account.

  • Inventory: Represents goods held by a business for sale.

  • Expense Account Related to Inventory: Known as Cost of Goods Sold (COGS).

• Types of Companies:

  • Wholesalers: sell goods to other businesses (suppliers).

  • Retailers: sell goods directly to final customers.

Typical Operating Cycle for a Merchandising Company

1. Purchasing Inventory: Goods are acquired for profit.

2. Profit Calculation:

   • Equation 1: Profit = Revenue from a single transaction.

   • Equation 2:

     • Revenue: Price charged to the customer for the product or service.

     • Expense: Cost of the product sold + other costs associated with the sale.

     • *Equation 2 represents profits over a defined period from multiple transactions.

Types of Costs Related to Inventory

• Product Costs:

  • Costs incurred to acquire inventory and prepare it for sale:

  • Final price (including discounts, returns, allowances).

  • Freight and handling costs.

  • Transit insurance and storage costs.

• Accounting Treatment of Costs:

  • Held as an asset when inventory is acquired.

  • Expensed when the inventory is sold.

Cost Classification

• Product Costs: Affect the inventory account.

• Period Costs: Affect expense accounts.

Multi-Step Income Statement

• Structure Changes: The income statement will include more items and subtotals.

  • Gross Margin:

  • Calculation: ext{Gross Margin} = ext{Revenue} - ext{Cost of Goods Sold}

  • Operating Income:

  • Calculation: ext{Operating Income} = ext{Gross Margin} - ext{Operating Expenses}

  • Non-Operating Items: Affect income but occur outside of normal business operations.

  • Examples: Gain/Loss on sale of long-term assets, interest expense/income.

  • Gain/Loss Calculation:

    • Gain: Selling Price - Historical Cost

    • Loss: Historical Cost - Selling Price

Example of Multi-Step Income Statement for Green Market

• Secret to constructing the income statement includes identifying revenues, gross margins, operating expenses, and non-operating items which will lead to net income.

Accounting for Inventory

• Cost of Goods Available for Sale (COGAS):

  • Consists of beginning inventory plus purchases.

  • Calculation:

  • ext{COGAS} = ext{Beginning Inventory} + ext{Purchases}

  • Cost of Goods Sold is calculated by subtracting ending inventory from COGAS.

Inventory Tracking Systems

• Perpetual Inventory System:

  • Continuously updates inventory account as transactions occur.

• Periodic Inventory System:

  • Updates at the end of accounting period based on physical inventory count.

• Inventory Shrinkage: Represents loss of inventory due to theft, damage, or misplacement.

  • Adjustment Entry: To correct inventory on hand discrepancies.

Recording Inventory Transactions Example

1. Transaction Recording in General Journal:

   • Record each financial event along with its financial impact.

2. T-Accounts Representation:

   • Show assets and equity impact in T-account format for clarity.

3. Gross Margin Calculation: Deduct COGS from sales revenue for determining profitability.

Accounting for Freight Costs

• Freight Terms: Understanding when ownership of goods transfers depending on shipping terms (FOB Shipping Point vs. FOB Destination).

  • FOB Shipping Point: Ownership transfers when shipped; buyer pays freight.

  • FOB Destination: Ownership transfers upon delivery; seller pays freight.

Purchase Returns, Allowances and Discounts

• Cost Definition: Reflects the actual price paid for goods and can be lower due to returns or allowances.

• Recording Returns: Reverse original purchase entries to reflect returns and allowances correctly.

• Discounts for Early Payment: Encourages quick payments within specified windows, often leading to a percentage reduction in total payable amounts.

(Note: Ensure completion of all exercises and practical applications based on the content noted.)