Accounting Chapter 6 Practice Questions

Which type of system (perpetual or periodic) provides better inventory control over inventory?

A consequence of this difference in record updating is that a perpetual inventory system provides better internal control over inventory because it provides more timely information than periodic systems, allowing companies to keep just the right quantity of products on the shelves for the right amount of time. Another benefit of a perpetual inventory system is that it allows managers to estimate "shrinkage."

Describe how transportation costs to obtain inventory (freight-in) are accounted for by a merchandising company using a perpetual inventory system. Explain the reasoning behind this accounting treatment.

A general principle is that a purchaser should include in its Inventory account any costs needed to get its inventory into a condition and location ready for sale. Consistent with this reasoning, transportation costs to obtain inventory (freight-in) are included as a cost of inventory. Any costs incurred after the inventory is ready for sale (such as freight-out to deliver goods to customers) are considered selling, general, and administrative expenses.

Why is a physical count of inventory necessary in a periodic inventory system?

A physical count of inventory is needed in a periodic system to determine the quantity of inventory on hand so that its cost can be determined and used to calculate and adjust cost of goods sold. These adjustments can only be made in a periodic system after a physical inventory count is completed.

What is a sales discount? Use 2/30, n/45 in your explanation.

A sales discount is a cash discount given to a customer for prompt payment on account. When merchandise is sold on credit, terms such as 2/30, n/45 are sometimes specified. The 2/30 part means that if the customer pays within 30 days of the date of sale, a 2 percent sales discountis given on the selling price. The n/45 part means that if payment is not received within the 30-day discount period, the full amount is due 45 days after the sale.

Define beginning inventory and ending inventory

Beginning inventory is the stock of goods on hand (in inventory) at the start of the accounting period. Ending inventory is the stock of goods on hand (in inventory) at the end of the accounting period. The ending inventory of one period automatically becomes the beginning inventory of the next period.

What is the difference between FOB shipping point and FOB destination? How do these terms relate to the revenue principle?

FOB shipping point and FOB destination define different points at which ownership of merchandise transfers from the seller (merchandiser) to the buyer (customer). This is significant in the context of the revenue principle because merchandisers earn revenues at the point of sale. When merchandise must be transported a distance to reach the customer, the terms of shipment will affect when revenue is reported by the merchandiser. Under FOB shipping point, the sale is considered complete when the goods leave the merchandiser's shipping department. Under FOB destination, the sale is considered complete when the goods reach the destination (the customer).

Define Goods available for sale. How does it differ from cost of goods sold?

Goods available for sale is the sum of the beginning inventory and the amount of goods purchased or made during the period. Cost of goods sold is the cost of goods actually sold, which can be determined by subtracting the cost of ending inventory from the cost of goods available for sale.

What is gross profit? How is the gross profit percentage computed? Illustrate its calculation and interpretation assuming Net Sales is $100,000 and Cost of Goods Sold is $60,000.

Gross Profit is Net Sales minus Cost of Goods Sold. The gross profit percentage is computed by dividing the amount of Gross Profit by the amount of Net Sales and expressing that amount as a percentage (by multiplying by 100). For example, assuming Sales of $100,000 and Cost of Goods Sold of $60,000, the Gross Profit would be $40,000 ($100,000 $60,000). The gross profit percentage would be ($40,000/$100,000) x 100 =40%. This ratio may be interpreted to mean that out of each $1 of sales, $0.40 was earned above the amount incurred to obtain the goods that were sold.

Why is a physical count still necessary in a perpetual inventory system?

In a perpetual inventory system, although goods sold are recorded as they occur, it is still necessary to conduct a physical inventory count to ensure the inventory records are accurate and properly reflect the effects of any shrinkage that has occurred.

Describe in words the journal entries that are made in a perpetual inventory system when inventory is sold on credit?

In a perpetual system, two journal entries are made when inventory is sold on credit: (1) record the increase in Sales Revenue and a corresponding increase in Cash (for a cash sale) or Accounts Receivable (for a credit sale). (2) record a reduction in Inventory and a corresponding increase in Cost of Goods Sold.

What is the main distinction between perpetual and periodic inventory systems?

In a perpetualinventory system, the inventory records show the number of units and costs of each type of merchandise stocked, and are updated every time an item is bought, sold, or returned. A periodic inventory system differs from a perpetual system in several ways. The main distinction is that, rather than update the inventory records immediately after each purchase and sale (as is done in a perpetual system), a periodic system updates the inventory records onlyat theend of the accounting period.

What is the distinction between merchandising and manufacturing companies?

Merchandising companies sell physical products that are purchased from a supplier and manufacturing companies sell physical products that they made from raw goods that they bought from suppliers.

Transportation costs incurred by XO Group when it delivers goods to customers under terms FOB destination.

No. FOB destination means that the seller is responsible for the transportation costs. XO Group is the purchaser, so they are not responsible for the costs

Transportation costs incurred by XO Group's customers when XO Group sells goods under terms FOB shipping point.

No. Since XO Group is the seller in this situation, they are not responsible for costs under FOB shipping point. Even if they were responsible for the costs, they would be treated as selling expenses, not an increase to inventory

In its annual report, American Eagle Outfitters states that its "e-commerce operation records revenue upon the estimated customer receipt date of the merchandise." Is this FOB shipping point or FOB destination? If American Eagle were to change to other terms of shipment, would it report its Sales Revenue earlier or later?

Recording revenue when goods reach the customer (the destination) is considered FOB destination. If American Eagle were to ship as FOB shipping point, then American Eagle would record its revenues earlier( as soon as the products were shipped).

What is the distinction between retail and wholesale merchandising companies?

Retail merchandising companies sell directly to consumers and wholesale merchandising companies sell to the retailers rather than end consumers.

Why is revenue between selling a product/service bundle allocated between the product and service?

Revenue must be allocated between the product and service within a bundle because revenue recognition may occur at different times. Usually, when a product is sold, revenue can be recognized at a point in time - "when" the product is delivered to the customer. However, service revenues are usually recognized over a period of time - "as" the service is provided. Allocation of revenue is needed so that the company knows how much revenue can be recorded at the point in time for the product, and how much must be recognized over time.

Explain the difference between Sales Revenue (gross) and Net Sales.

Sales Revenue represents the total selling price of all goods sold to customers. Net Sales represents the company's sales revenue after deducting sales returns and allowances and sales discounts from total Sales Revenue.

What is the distinction between service and merchandising companies?

Service companies sell services and merchandising companies sell physical products.

In response to the weak economy, your company's sales force is urging you, the sales manager, to change sales terms from 1/10, n/30 to 2/40, n/60. Explain what these terms mean and how this switch could increase or decrease your company's profits.

Terms of 1/10, n/30 mean that a 1 percent discount may be taken by the buyer if payment is made within 10 days, otherwise the balance is due in 30 days (after which interest may be charged). Terms of 2/30, n/60 offer a larger discount and a longer period to pay. The change in terms could cause either an increase or decrease in the seller's profits. By itself, a more generous sales policy could cost the company in two ways: (1) if customers take advantage of the increased discount, from 1% to 2%, the company will report a decrease in net sales revenue and (2) if customers do not take advantage of the increased discount but instead take longer to pay, the company will forgo the opportunity to use the cash that would have been collected earlier. This lost opportunity could mean lower interest revenue (if the cash had been invested) or higher interest expense (if the cash had been used to pay down loans). The more generous sales policy could increase profits, though, if it entices customers to buy more goods from our company. Ultimately, the decision to switch should be based on a comparison of the gross profit to be generated from any increased sales with the lost opportunities to collect a greater proportion of the initial selling price and to use the cash that might have been collected from customers within 30 days (rather than 60 days).

What is the distinction between Sales Returns and Sales Allowances?

When goods are damaged or otherwise unsatisfactory, a merchandiser may accept the goods returned by the customer (a Sales Return) or may authorize the customer to pay less than the original selling price without requiring that the goods be returned (a Sales Allowance). In both cases, the selling price and the account receivable from the customer are reduced. Only sales returns cause the merchandiser to reverse the Inventory and Cost of Goods Sold accounts.

Transportation costs incurred by XO Group when it buys goods from suppliers under terms FOB shipping point.

Yes. FOB shipping point means that the purchaser is responsible for the transportation costs. XO Group is the purchaser, so they are responsible for the costs