Chapter 5

Single-step income statement equation

(All) Revenues - (All) Expenses = Net Income

Operating Income

(or income from operations) is derived by deducting operating expenses from gross profit.

Inventory shrinkage The shortage may result from:

1. Errors 2. Employee theft 3. Shoplifting

Ratio analysis using the gross profit and net income measures provide important insights into an entity's operating efficiency

1. Gross profit rate (percentage) = gross profit/net sales 2. Profit margin (percentage) = net income/net sales

Multiple-step income statement

A financial statement containing the following sections and sub-sections

Even companies employing perpetual systems need to verify inventory balances from time to time

A. Account of physical inventory is compared to the accounting records balance. B. This count takes place at the end of the accounting period. C. Inventory shrinkage D. A journal entry is recorded to adjust the accounting records (the book amount) so it agrees with the physical count of the inventory.

Single-step income statement

A. Does NOT include gross profit or operating income sub-total line items. B. This format emphasizes total revenues and total expenses as the factors for determining net income. C. (All) Revenues - (All) Expenses = Net Income

Credit terms (example: credit terms of 1/15, n/30)

A. First number represents the discount percent available if payment is made within the discount period. B. Second number represents the number of days in the discount period. C. N = net D. The last number represents the number of days credit has been extended. The full amount of the bill must be paid within the number of days listed.

Purchasing goods (merchandise) using the Perpetual inventory method

A. Goods purchased for resale to others are debited to inventory when received. B. credit inventory C. Purchase allowance. The amount of the price reduction is credited to inventory. D. Vendors sometimes offer early payment discounts to buyers. See the discussion below on credit terms. The amount of the discount is credited to Inventory.

Selling goods (merchandise) using the Perpetual inventory method

A. Goods sold require two journal entries. 1. Debit accounts receivable (or cash) and credit sales revenue. 2. Debit cost of goods sold and credit (merchandise) inventory. B. Sometimes goods sold are returned by the purchaser because the goods were damaged or some other problem with the goods. 1. Debit sales returns and allowances, which is a contra-revenue account and credit accounts receivable (or cash). 2. Debit (merchandise) inventory and credit cost of goods sold. C. sales allowance. 1. Debit sales returns and allowances and credit accounts receivable (or cash). 2. No entry is made to cost of goods sold or inventory. D. Sellers sometimes offer early payment discounts to buyers. See the discussion below on credit terms. The amount of the discount is debited to sales discounts, which is a contra revenue account.

Multiple-step income statement

A. Net sales 1. Gross sales 2. Less: a. Sales returns and allowances b. Sales discounts B. Cost of goods (merchandise) sold C. Gross profit D. Operating expenses E. Operating income F. Other income and expense adjusts operating income for revenue (and gains) or expenses (and losses) that are not part of the primary operating purpose of the company. 1. Other income increases operating income a. Interest income b. Gains 2. Other expenses decrease operating income. a. Interest expense b. Losses G. Income before income tax is determined by deducting other expense and adding other income to operating income. H. Income taxes I. Net income is computed by deducting income taxes from income before taxes.

Inventory methods

A. Periodic method 1. Maintain a record of beginning inventory and all purchases during the accounting period. 2. No effort is made to determine the number of goods sold (used) during the accounting period. 3. Count the inventory remaining at the end of the accounting period. 4. Beginning Inventory+goods purchased 5. Requires little, if any, technology and can readily be used by small businesses. B. Perpetual method 1. Inventory records are constantly updated and management has current operating information always available. 2. Enhanced by the utilization of technology. 3. Relies on bar coding and optical scanning.

Types of Businesses

A. Service business B. Merchandising business C. Manufacturing business

Merchandising Business

An enterprise that generates revenues buying goods for resale. (Example: retail stores such as Dillard's and Old Navy).

Service Business

An enterprise that generates revenues by providing services to customers. (Example: doctors and lawyers).

Manufacturing Business

An enterprise that generates revenues by selling products it has transformed (built, made) from raw materials into new products. (Example: Goodyear Tires and Ford).

Single-step income statement deff

Another format for presenting the income statement

Revenues generated in a merchandising business result from the sale of products

As a result, merchandisers record revenues as sales revenue.

Sales returns and allowances

Damaged (or the wrong) goods returned by customers, considered a contra (or offsetting) account to sales.

Perpetual method

Determine the cost of inventory by continually tracking purchases and sales during the accounting period.

Periodic method

Determine the cost of inventory by physically counting the goods at the end of each accounting period.

Cost of Goods (merchandise) sold using the periodic inventory system

Draw an example

Net sales

Gross sales reduced by sales discounts and sales returns and allowances.

Gross profit

Net sales minus cost of goods (merchandise) sold.

Operating Expense

Period (nonproduct) costs that are incurred to generate net revenue. Most expense accounts from Chapters 3 and 4

Sales Discounts

Sale price reductions allowed to customers for early payment, considered a contra (or offsetting) account to sales.

sales allowance

Sometimes Sellers offer a reduction in price due to problems with goods sold, which is known as a

credit inventory

Sometimes goods purchased for resale are returned to the seller because the goods were damaged or some other problem with the goods

purchase allowance

Sometimes vendors offer a reduction in price due to problems with goods received, but retained by the buyer

Cost of goods (merchandise) sold

The cost paid by the seller to obtain the merchandise sold to customers. Also referred to as product cost.

Income taxes

The percentage of income paid to various levels of government for taxes.

Gross Sales

The total amount charged to customers for merchandise sold

Subsidiary ledgers keeps track of the amount owed by each customer, the value of each type of inventory item, and the amount owed to each supplier

The total amount of accounts receivable, inventory, and accounts payable is represented in the general ledger as a controlling account, which must equal the addition of the related subsidiary ledger.

Beginning Inventory+goods purchased

ending inventory = cost of goods sold (used)

Gross profit rate (percentage)

gross profit/net sales

Profit margin (percentage)

net income/net sales

Inventory shrinkage

the shortage between the perpetual accounting records and the actual count.

N=Net

which means the full (or remaining) amount must be paid with-in the number of days represented by the last number.