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Chapter Four. Accounting for Merchandising Businesses. Inventory. Inventory is tangible property that is held for resale or will be used in producing goods or services. Inventory is reported on the balance sheet as an asset . Types of inventory: Merchandise inventory
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Chapter Four Accounting for Merchandising Businesses
Inventory • Inventory is tangible property that is held for resale or will be used in producing goods or services. • Inventory is reported on the balance sheet as an asset. • Types of inventory: • Merchandise inventory • Raw materials inventory • Work in process inventory • Finished goods inventory manufacturer
Inventory Cost The cost principle requires that inventory be recorded for the price paid or the consideration given up. What type of transaction is the purchase of inventory? Asset Exchange if cash paid. Asset Source if “on account”.
Inventory Cost • The amount recorded for inventory should include: • Invoice price (minus purchase discounts), transportation-in costs (also called “freight-in”), inspection costs, and preparation costs. • The company should accumulate costs of purchases until raw materials are ready for use or until merchandise is ready for shipment to customers.
Net Sales 7,500 Less: Cost of goods sold -3,000 Gross Profit Margin 4,500 Income Statement Change Because of Cost of Goods Sold, the format for the Income Statement is modified:
Product Costs Selling & Admin. Costs Costs that are included in inventory. Costs that are not included in inventory. They are sometimes called period costs. Product Costs Versus Selling and Administrative Costs
Cost of Goods Sold • Cost of goods sold is calculated as the number of units sold during the period multiplied by their unit costs. • Cost of goods sold is a major expense item for most non-service businesses. • The measurement of cost of goods sold is an excellent example of the application of the matching principle Why? The Cost of Goods Sold EXPENSE is recorded in the period the units are SOLD (REVENUE is recognized), regardless of when the units are paid for. So,the EXPENSE is MATCHED against the related REVENUE.
Beginning inventory Add: Purchases (net) Cost of Goods Available for Sale Deduct: Ending inventory Cost of goods sold Cost of Goods Sold Cost of Goods Available for Sale expresses the total cost of what has been available for sale throughout a given time period.
Allocation of Inventory Cost Between Asset and Expense Accounts Merchandise Inventory (Balance Sheet) Cost of Goods Available for Sale Cost of Goods Sold (Income Statement) 5-9
Purchase $4,000 of Office Supplies Date Account Title Debit Credit Jan. 6 Supplies 4,000 Cash 4,000 Post from General Journal to the General Ledger Supplies Cash 4,000 4,000
$1,000 of Supplies left over at the end of the month Date Account Title Debit Credit Jan. 30 Supplies Expense 3,000 Supplies 3,000 Record use of $3,000 of Supplies Post from General Journal to the General Ledger Supplies Expense Supplies 3,000 3,000
Purchase 1,000 units of Inventory for $4,000 Date Account Title Debit Credit Jan. 6 Inventory 4,000 Cash 4,000 Purchase 1,000 units @ $4.00 each Post from General Journal to the General Ledger Inventory Cash 4,000 4,000
$1,000 of Inventory left over at the end of the month Date Account Title Debit Credit Jan. 30 Cost of Goods Sold 3,000 Inventory 3,000 Record sale of 750 units of Inventory Post from General Journal to the General Ledger Cost of Goods Sold Inventory 3,000 3,000
$3,000 of Inventory was sold for $7,500 Cash Date Account Title Debit Credit Jan. 30 Cash 7,500 Revenue 7,500 Record sale of Inventory @ $10 each Post from General Journal to the General Ledger Cash Sales Revenue 7,500 7,500
Terms Time Due Discount Period Credit Period Full amount less discount Full amount due Purchase or Sale Cash Discounts A deduction from the invoice price granted to induce early payment of the amount due.
Terms of Sales & Purchases Discount Terms: 2/10, n/30 (for example) • 2% discount if balance paid in ten days, remainder to be paid within 30 days of sale • tells when and how much must be paid • There is a high interest cost of not taking purchase discounts when offered.
Cash Discounts 2/10, n/30 Percentage of Discount # of Days Discount Is Available Otherwise, the Full Amount Is Due # of Days when Full Amount Is Due
Terms of Sales & Purchases • F. O. B. (Free On Board) shipping point or F.O.B. destination • tells who pays for the shipping and when ownership “title” passes from the seller to the buyer.
FOB Shipping and FOB Destination • FOB Shipping Point: Buyer pays the shipping costs because ownership “title” transfers to buyer at the point the shipment starts on its journey. • FOB Destination:Seller pays shipping costs because title does not transfer to the buyer until the goods reach their destination (the buyer’s place of business).
Who Pays for FOB? Shipping Point Supplier Destination Destination – Supplier pays Business Shipping Pt – Business pays Shipping Point Destination – Business pays Destination Shipping Pt – Customer pays Customer
Purchased 1000 units for $4 each on account. (Terms: 2/10, n/30) Asset Source Transaction
Paid a trucking company $500to deliver the purchased unitsto our warehouse. Freight charges paid to get inventory to our place of business (called TRANSPORTATION IN) is part of the cost of the purchase. It is added to the Inventory account, thus increasing the asset value. It is NOT “expensed”. Asset Exchange Transaction
3.Sold 620 units on account for $6 each. (Terms 1/10, n/30) 3a. Record the Sales Revenue and related Receivable. $6 sales price x 620 units = $3720 Asset Source Transaction
3b. Record the Cost of the Goods Sold and their removal from inventory. What is the cost of each item in inventory? $4.00 invoice price + $0.50 transportation = $4.50 per unit $500 transport / 1000 units 620 units sold x $4.50 cost each = $2790
3b. Record the Cost of the Goods Sold and their removal from inventory. 620 units sold x $4.50 cost each = $2790 Cost of goods sold Asset Use Transaction
4.The customer in Transaction #3A returned 20 units for credit. 4a. Remove the previously recorded Sales Revenue and related Account Receivable. A separate “Sales Return” contra-revenue account may be used. $6 sales price x 20 units = $120 Asset Use Transaction
4b. Put the cost of the 20 returned units back into inventory and out of Cost of Goods Sold. (Recall, the units were “costed out” of inventory and charged to Cost of Goods Sold at $4.50 each in Tr. #3b.) Reduction in “Cost of Goods Sold”. $4.50 x 20 units = $90 Asset Source Transaction
5a. The Transaction #3a customer paid within the ten day discount period.Record the Sales Discount. (1/10, n/30) Original Account Receivable (Transaction 3a) $3,720 Less: Sales Return (Transaction 4a) 120 Amount owed by customer before discount 3,600 x 1% sales discount 1% Sales Discount $ 36 Asset Source Transaction
5b. The Transaction #3a customer paid within the ten day discount period.Record the cash collection. Original Account Receivable (Transaction 3a) $3,720 Less: Sales Return (Transaction 4a) (120) Less: Sales Discount (Transaction 5a) (36) Cash receipt that will satisfy the account $3,564 Asset Exchange Transaction
Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs. Supplier cost was $4.00 per unit x 50 = $200. Transportation cost recorded when units were purchased was $0.50 per unit x 50 = $25. Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOTMATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account. That’s what we’ll do here.
6. Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.
7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost. • Units in Beginning Inventory 0 • + Units Purchased this period (1000- 50 purchase returns) 950 • = Units Available for Sale 950 • Units Sold (620 – 20 sales returns) (600) • = Units that should be in ending inventory 350 • Actual ending inventory from count (340) • = Units missing 10 • x $4.50 cost per unit $45.00
7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost. Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account. That’s what we’ll do here.
7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.
8a. Paid within discount period, so record the 2% discount on the $4000 Tran. #1 purchase less $200 Tran. #6 return. Purchase (Transaction #1) $4000 Less Purchase Return (Trans. #6) 200 Amount owed 3800 X discount % 2% Amount of Purchase Discount $ 76 This reduces the cost of the inventory and the amount we owe the supplier.
8a. Paid within discount period, so record the discount on the $4000 Tr. #1 purchase less $200 Tr. #6 return.
8b. Paid the remaining balance on the Transaction #1 inventory purchase. $4000 purchase (Trans. #1) - 200 purchase return (Trans. #6)- 76 purchase discount (Trans. #8a)$3724 remainder to pay supplier
8b. Paid the remaining balance on the Transaction #1 inventory purchase. ($4000-200-76=$3724 to pay)
9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost. Transportation charges on PURCHASES are added to the cost of the asset, INVENTORY. (Transportation IN) Transportation charges to ship products TO CUSTOMERS are reported as operating expenses on the income statement. The appropriate account title is TRANSPORTATION OUT (or FREIGHT OUT or SHIPPING EXPENSE).
9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost.
Timing is EVERYTHING... • Recognize revenue when “earned” • earned when an exchange (seller to buyer) occurs • Three levels of the matching principle • Product costs (e.g., inventory costs): assets until produce revenue • direct cause & effect relationship between revenue and expense • Period costs: systematic & rational allocation • e.g., depreciation costs • Period costs: recognize as expense as incurred • e.g., advertising costs