ACCTG 211 Chapter 4 and 5

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A company has the following selected account balances: Sales $ 250,000 Sales Discounts 1,500 Sales Returns and Allowances 2,300 Sales Salaries Expense 56,000 Store Supplies Expense 15,000 Advertising Expense 8,000 Cost of Goods Sold 125,000 What is the gross profit that would appear on a multiple-step income statement:

$121,200 Gross profit equals net sales minus cost of goods sold. Net sales equals sales minus sales discounts and minus sales returns and allowances. Sales $250,000 − $1,500 − $2,300 − $125,000 = $121,200.

gross profit

= net sales - cost of goods sold

A company uses a periodic inventory system. On August 1, the company had 6 items of beginning inventory with a cost of $7 per unit. On August 3, the company purchased 16 units at $14 per unit. Then, on August 5, the company sold 12 units. The 12 units sold consisted of 7 units from the August 3rd purchase and 5 units from the August 1st beginning inventory. Using specific identification, the cost of the 12 units sold is _____.

$133 Specific identification assigns costs based on the actual units sold. 7 units sold were from the August 3 purchase and the remaining 5 units sold were from the beginning inventory, to the total cost of the units sold is:(7 × $14) + (5 × $7) = $133.

Intercontinental, Incorporated, uses a perpetual inventory system. Consider the following information about its inventory: August 1, purchased 10 units for $910 or $91 per unit; August 3, purchased 15 units for $1,590 or $106 per unit; August 14, sold 20 units; August 17, purchased 20 units for $2,300 or $115 per unit; August 28, purchased 10 units for $1,190 or $119 per unit; August 30, sold 23 units. Using FIFO, the cost of goods sold for the sale of 23 units on August 30 is ____ and the inventory balance at August 30 is _____.

$2,600; $1,420

A company reports the following information: Invoice cost of merchandise purchases $110,000 Purchase discounts $15,000 Purchase returns and allowances $7,000 Transportation costs $3,000 The company's total cost of merchandise purchases equals:

$91,000 Invoice cost of $110,000 minus discounts of $15,000 and minus returns and allowances of $7,000 plus transportation costs of $3,000 equals $91,000.

costs of good sold =

(beginning inventory + net purchases) - ending inventory = (merchandise available for sale) - ending inventory

Periodic Inventory System

- At the time of sale, there is no record of COGS or decrease in merchandise inventory. - At the end of the year, calculations are made to determine the COGS and inventory balance.

Sales of Merchandise Inventory: Perpetual Method

- You earned revenue, so there will be a sales account that will increase (i.e., will be credited). - You received either cash or an IOU, which creates a receivable, so either cash or accounts receivable will be affected (debited). - You sold stuff, meaning you used your inventory to generate revenue, so the inventory account must decrease (be credited) since it is no longer available for sale. - And, since you used it to generate revenue, the "stuff" becomes an expense known as cost of goods sold (COGS, also known as cost of merchandise sold), so the expense increases (is debited).

merchandise inventory includes

- costs to purchase - shipping costs - costs to prepare for sale

What About Returns?

Another contra account called sales returns is created to provide information concerning this reduction in sales.

Inventory Shrinkage

At the end of the accounting period, we are required to complete a physical count of inventory on hand. We will compare the inventory recorded in our accounting records to the actual inventory on hand. Shrinkage is the difference between the inventory recorded in the accounting records and the actual inventory on hand.

An advantage of the _____ costing method is that the cost of goods sold approximates its current cost.

LIFO

The two main inventory accounting systems are: a) FIFO and LIFO b) perpetual and periodic c) cash method and accrual method d) weighted-average and specific identification

b) perpetual and periodic

Net realizable value

is the net amount estimated to be received from the sale of the inventory. The net realizable value equals the expected selling price less any associated selling costs. Calculating net realizable value for inventory is beyond the scope of the material covered in this course.

Revenues for a merchandiser are called

sales

conservatism

suggests that a company should always choose to report items in a way that does not overstate assets or profits. Accountants are expected to anticipate no profit but provide for all possible losses. If there is a chance of a loss, it must be addressed—but if there is a chance of a gain, that must be ignored. We would make the adjustment to report inventory at the lower of cost or net realizable value because we do not want to overstate assets (overstate inventory) or overstate net income (understate the cost of goods sold). It is important not to mislead stakeholders when we report the cost of our inventory. We will not be recording the adjusting entry required to report inventory at the lower of cost and net realizable value in this course.

GAAP will not allow the sales revenue account to be changed, so in order to reflect what was really sold, we must create contra accounts that will indicate any reductions in the original sales.

there is a contra account called the sales discount account that indicates how much the company did not receive due to the use of discounts.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, cost of goods sold would be _____ for Year 1.

understated

An error in the ending inventory balance in Year 1 will also affect:

year 1 cost of goods sold year 2 cost of goods sold year 2 beginning inventory The ending inventory balance will also affect the year end cost of goods sold. Also, ending inventory becomes the beginning inventory balance in the next year, so an error at year end also affects the next period's inventory and cost of goods sold.

credit terms

Credit terms refer to the number of days allowed before payment is due; a discount may also apply if the invoice is paid within a limited time. The following are examples of possible credit terms: cash: Payment is due on delivery. n/30: Payment is due in 30 days. n/eom: Payment is due at end of month. 2/10, n/30: There will be a 2% discount if invoice is paid within 10 days. Otherwise, the net is due in 30 days.

In a period of rising costs, which inventory method results in the highest dollar value for ending inventory?

FIFO

Inventory Cost Flow Assumptions

FIFO, LIFO, weighted average

FOB destination point

Goods become the buyer's when the buyer receives them (at the buyer's destination). The seller owns the goods while they are on the freight carrier; therefore, the seller pays the freight charges. The title changes at the time the goods reach the destination.

FOB shipping point

Goods become the buyer's when the goods are delivered to the freight carrier (that is, the seller's location). The buyer owns the goods while they are on the freight carrier; therefore, the buyer pays the freight charges. The title changes at the time the goods leave the seller (at the shipping point).

Reporting Merchandise Inventory in the Financial Statements

Inventory is a current asset and is reported on the balance sheet. Normally, we record inventory based on what we paid for it (the historical cost). There is an additional step that may be required. We may need to make an adjustment to the amount reported on the balance sheet, because GAAP requires companies to report inventory at the lower of cost and net realizable value. This is the lower of: 1) cost or 2) net realizable value.

Under the conformity rule, companies who use the _____ method for tax reporting, are required by the IRS to also use it in their financial statements.

LIFO

merchandise inventory

Merchandise inventory refers to the goods on hand held for sale (a current asset).

contra revenue accounts

Merchandisers also have contra revenue accounts that are subtracted from sales to get net sales. The contra revenue accounts include sales discounts, sales returns, and allowances.

purchases of inventory

Purchases are recorded as a debit to merchandise inventory. The merchandise inventory account must always reflect the cost of the merchandise.

Inventory Shrinkage: What happened?

We purchased items of inventory, recorded them in the accounting records, and believed that they were in inventory and available for sale, but they are either damaged or missing.

purchase returns and allowances

When the buyer returns merchandise that is unacceptable, the cost of the goods returned reduces (credits) the merchandise inventory account.

How to record inventory shrinkage

When we prepare the adjusting entry, the merchandise inventory account is adjusted to equal the physical count. This adjustment decreases (credits) the merchandise inventory account and increases (debits) the cost of goods sold. We decrease the inventory account because we don't have the inventory. We debit COGS because their cost was attributed to inventory that is no longer available to be sold.

If a perpetual inventory system is in use

a physical inventory count should be taken at least annually.

On April 1, our company purchases $10,000 worth of merchandise inventory on credit with the terms 2/10, n/30. On April 2 we return $2,000 worth of damaged inventory related to this purchase. If this invoice is paid within 10 days, what is the amount of the discount? a) $160 b) $200 c) $240 d) $800

a) $160

During a period of steadily rising costs, this method results in the highest amount of inventory reported on the balance sheet. a) FIFO b) LIFO c) Weighted Average

a) FIFO

Our company sold merchandise on account with a cost of $700 for $1,000. Our company uses a perpetual inventory system. What account and amount would we debit to record the sales revenue? a) accounts receivable, $1,000 b) sales, $1,000 c) merchandise inventory, $700 d) cost of goods sold, $700

a) accounts receivable, $1,000

Net sales for a merchandiser is calculated as: a) gross sales − sales returns and allowances − sales discounts b) gross sales − cost of goods sold c) net sales − sales returns and allowances − sales discounts d) gross sales − merchandise inventory

a) gross sales − sales returns and allowances − sales discounts

A single-step income statement: a) Is not permitted when financial statements are prepared in accordance with generally accepted accounting principles. b) Reports the same amount of net income as that reported on a multiple-step income statement. c) Reports revenues and expenses, but not gains and losses. d) Always includes a gross profit subtotal. e) Never includes selling expenses.

b) Reports the same amount of net income as that reported on a multiple-step income statement. A single-step income statement reports the same amount of net income as that reported on a multiple-step income statement. Both are permitted under generally accepted accounting principles. The single-step format includes a single subtotal for revenues and gains and a single subtotal for expenses and losses.

Which of the following totals and subtotals are not found on a multiple-step income statement? a) Cost of goods sold b) Total current assets c) Net sales d) Total operating expenses e) Net income

b) Total current assets A multiple-step income statement will have the following totals and subtotals: Net sales, cost of goods sold, gross profit, total selling expenses, total operating expenses, income from operations, and net income. Total current assets belong on a classified balance sheet.

Colman Company reports ending inventory in year 1 of $25,000 instead of the correct amount of $20,000. The effects of this error include: a) Year 1 ending inventory is understated and year 1 cost of goods sold is overstated b) Year 1 ending inventory is overstated and year 1 cost of goods sold is understated c) Year 1 ending inventory is understated and year 1 cost of goods sold is understated d) Year 1 ending inventory is overstated and year 1 cost of goods sold is overstated

b) Year 1 ending inventory is overstated and year 1 cost of goods sold is understated The ending inventory is overstated by $5,000, which means that the cost of goods sold is understated by this amount. The understatement of cost of goods sold also means that gross profit and net income for the year are overstated.

merchandising business

buys merchandise (goods) at a wholesale price and resells the goods at a retail price. Therefore, a merchandiser is both a buyer and seller. It is imperative that the accountant knows which role the merchandiser is assuming in each transaction because the recording for each role is different.

Merchandise inventory includes all of the following except: a) Goods held for sale b) Goods located in the warehouse c) Goods sold d) Goods located in an off-site warehouse

c) Goods sold

When a classified balance sheet is prepared, merchandise inventory is: a) Not reported as a current asset because it is not sufficiently liquid. b) Usually listed after prepaid expenses according to its nearness to liquidity. c) Reported as a current asset. d) Usually reported before accounts receivable according to its nearness to liquidity. e) Reported as a current liability.

c) Reported as a current asset. The merchandiser's classified balance sheet reports merchandise inventory as a current asset. Inventory is usually less liquid than accounts receivable because inventory must first be sold before cash is received. As such, it is listed after accounts receivable. It is more liquid than supplies and prepaid expenses, and as such, it is listed before these assets.

Which of the following would we credit to record the purchase of merchandise inventory on account if the company uses a perpetual inventory system? a) purchases b) cash c) accounts payable d) merchandise inventory

c) accounts payable

If all units are purchased at the same unit cost, cost of goods sold will ____? a) differ under FIFO and LIFO and be the same under Weighted-Average and Specific Identification. b) differ under Specific Identification and FIFO, but LIFO and Weighted-Average methods will be the same. c) be the same for all four methods. d) be different for all four methods.

c) be the same for all four methods.

Which of the following appears on a multi-step income statement but not on a single-step income statement? a) net sales b) cost of goods sold c) gross profit d) net income

c) gross profit

Under FOB destination, title to merchandise passes to the purchaser when: a) the sale is recorded b) merchandise is shipped to the purchaser c) merchandise is received by the purchaser d) payment is made

c) merchandise is received by the purchaser

Cost vs. Price

cost = is the amount the merchandiser pays for goods. sales price = is the amount the merchandiser charges its customers.

Periodic Inventory System: Calculating Cost of goods sold

cost of goods available for sale - inventory at the end of the year = cost of goods sold

Our company sold merchandise on account with a cost of $700 for $1,000. Our company uses a perpetual inventory system. What account and amount would we debit to record the cost of the merchandise sold? a) accounts receivable, $1,000 b) sales, $1,000 c) merchandise inventory, $700 d) cost of goods sold, $700

d) cost of goods sold, $700

Shrinkage includes

damaged items that were never counted, damaged goods that were received but never set out for sale, spoiled merchandise that was thrown out and not counted, and items lost due to theft.

Revenues for a service business are referred to as

fees earned

A perpetual inventory system updates the accounting records ____

for each purchase and each sale

net income =

gross profit - expenses

LIFO

inventory accounting in which the most recently acquired items are assumed to be the first sold; method is supposed to create the lowest ending inventory in a period of rising prices. Also create a lower taxable income, lower gross profit.

FIFO

inventory accounting in which the oldest items (those first acquired) are assumed to be the first sold; creates a higher ending inventory and lower cost of goods sold, higher gross profit and higher taxable income.

Periodic Inventory System: Calculating Cost of goods available for sale

inventory at the beginning of the year + all purchases for the year + all costs attributable to purchases - returns - purchase discounts - purchase allowances = cost of goods available for sale (This is what you have paid for inventory that could have been sold.)

perpetual inventory system

is used by most merchandisers; it records every purchase and sale of inventory by the merchandiser directly into the merchandise inventory account. (This is a computerized system.) In this way, the merchandise inventory account should at all times be equal to the goods that are still on the store's shelves. In reality, theft, breakage, and errors create what accountants refer to as inventory shrinkage. As a result, there are discrepancies in the system. GAAP requires that every company must complete a physical count of inventory on hand at the end of the company's fiscal year to determine the amount of inventory shrinkage. This course will use the perpetual inventory system when recording transactions.

Specific identification

matches each unit of inventory with its actual cost

net purchases + beginning inventory =

merchandise available for sale

gross profit

net sales - cost of goods sold

A multistep income statement for a merchandiser includes the following sections:

net sales: The contra accounts (sales returns, allowances, and sales discounts) are subtracted from gross sales to determine net sales. cost of goods sold: Cost of goods sold is the amount we paid for the merchandise sold during the period. gross profit: Cost of goods sold is subtracted from net sales to get gross profit. selling expenses: These are expenses related to marketing and selling the company's products. administrative expenses: These are expenses that are not related to marketing and selling the company's products. operating income: This measures the results of the entity's major ongoing activities. It is gross profit minus operating expenses. other revenues and expenses: These revenues and expenses are outside the normal, day-to-day operations of a business. We would include gains or losses on the sale of a plant asset, interest expenses, and interest revenues.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, cost of goods sold would be _____ for Year 2.

overstated

A company overstated its ending inventory for Year 1. If the error was not detected, total assets would be _____ for Year 1.

overstated

the merchandise inventory account is decreased by

purchase returns, purchase discounts, goods sold (at cost), and shrinkage.

the merchandise inventory account is increased by

purchases, freight-in, and goods returned (at cost)

net sales =

sales - (sales discounts) - (sales returns) - (sales allowances).

A company reports net sales of $600,000, cost of goods sold of $200,000, and net income of $100,000. Its gross profit equals:

$400,000 gross profit = net sales - cost of good sold

A company purchased 10 units for $5 on January 3. It purchased 10 units for $7 each on February 28. It sold 10 units on March 1. If the company uses the weighted-average inventory costing method, what is the dollar amount for ending inventory on the December 31 balance sheet, assuming that the company uses a perpetual inventory system?

$60

average method

average cost is used

Intercontinental, Incorporated, uses a perpetual inventory system. Consider the following information about its inventory: August 1, purchased 10 units for $910 or $91 per unit; August 3, purchased 15 units for $1,590 or $106 per unit; August 14, sold 20 units; August 17, purchased 20 units for $2,300 or $115 per unit; August 28, purchased 10 units for $1,190 or $119 per unit; August 30, sold 23 units. Using weighted average, the cost of goods sold for the sale of 23 units on August 30 is ____ and the inventory balance at August 30 is _____.

$2,622; $1,368 At the time of each sale, the weighted average cost per unit must be calculated. The weighted average cost per unit equals the cost of goods available for sale divided by the units available for sale. At August 28, the total purchases of 55 units (or 10 + 15 + 20 + 10) less the total sales of 20 units equals 35 units available for sale. As such, just before the sale on August 30, the weighted average cost per unit equals $114 per unit (or the inventory balance of $3,990, which is the cost of goods available for sale on that date, divided by the 35 units that are currently available for sale).The cost of goods sold for the August 30 sale of 23 units equals $2,622 (or 23 units @ the weighted average cost of $114 per unit).The inventory balance at August 30 equals $1,368 (or the inventory balance of $3,990 at August 28 − the cost of goods sold for the August 30 sale of $2,622).

Intercontinental, Incorporated, uses a perpetual inventory system. Consider the following information about its inventory: August 1, purchased 10 units for $910 or $91 per unit; August 3, purchased 15 units for $1,590 or $106 per unit; August 14, sold 20 units; August 17, purchased 20 units for $2,300 or $115 per unit; August 28, purchased 10 units for $1,190 or $119 per unit; August 30, sold 23 units. Using LIFO, the cost of goods sold for the sale of 23 units on August 30 is ____ and the inventory balance at August 30 is _____.

$2,685; $1,260

beginning inventory = $11,000 ending inventory = $13,000 expenses = $7,000 net purchases = $23,000 net sales = $38,000 the company's cost of goods sold equals:

$21,000 Beginning Inventory of $11,000 + Net Purchases of $23,000 = Cost of Goods Available for Sale of $34,000. Then, Cost of Goods Available for Sale of $34,000 (from above) − Ending Inventory of $13,000 = Cost of Goods Sold of $21,000.

An item was shipped from a supplier under FOB shipping point. The invoice in the amount of $2,000 included payment terms of 2/10, n/30. When the invoice was paid, a purchase discount in the amount of $40 was taken. Other details relating to the purchase of this item included the following: shipping charges of $300, storage fees of $50, and insurance premium of $100. The cost of this inventory item is _____.

$2410 Merchandise inventory includes costs of expenditures necessary to bring an item to a salable condition and location. This means that the cost of an inventory item includes its invoice cost minus any discount and plus any incidental costs necessary to put it in a place and condition for sale. Incidental costs can include shipping, storage, and insurance. Invoice price of $2,000 − purchase discount of $40 + shipping charges of $300 + storage fee of $50 + insurance premium of $100 = cost of $2,410.

beginning inventory = $11,000 ending inventory = $13,000 expenses = $7,000 net purchases = $23,000 net sales = $38,000 the company's cost of goods available for sale =

$34,000 Beginning Inventory of $11,000 + Net Purchases of $23,000 = Cost of Goods Available for Sale of $34,000.

A company has beginning inventory of $20,000, purchases of $15,000, and ending inventory of $2,500. The cost of goods available for sale is ___.

$35,000 Beginning inventory plus net purchases equals goods available for sale. Goods available for sale minus ending inventory equals $20,000 plus $15,000 equals $35,000.

Assume that we use a perpetual inventory system and that five identical units are purchased at the following dates and costs: April 5 $ 10 April 10 $ 12 April 15 $ 14 April 20 $ 16 April 22 $ 17 One unit is sold on April 25. The company uses the last-in, first-out (LIFO) inventory costing method. Identify the cost of the ending inventory on the balance sheet.

$52

Assume that we use a perpetual inventory system and that five identical units are purchased at the following dates and costs: April 5 $ 10 April 10 $ 12 April 15 $ 14 April 20 $ 16 April 22 $ 17 One unit is sold on April 25. The company uses the weighted average inventory costing method. Identify the cost of the ending inventory on the balance sheet. (Round your answer to 2 decimal places.)

$55.2

Assume that we use a perpetual inventory system and that five identical units are purchased at the following dates and costs: April 5 $ 10 April 10 $ 12 April 15 $ 14 April 20 $ 16 April 22 $ 17 One unit is sold on April 25. The company uses the first-in, first-out (FIFO) inventory costing method. Identify the cost of the ending inventory on the balance sheet.

$59

A periodic inventory system updates the accounting records ____

at the end of the period.

purchase discounts

The buyer saves by paying within the discount period; the amount saved is a reduction (credit) to the merchandise inventory account.

What About Allowances?

There may be a third contra account named sales allowances to indicate items that reduced the actual amount of revenue collected.

During a period of regularly rising purchase costs, this method yields the highest reported cost of goods sold amount on the income statement. a) FIFO b) LIFO c) Weighted Average

b) LIFO

During a period of regularly rising purchase costs, this method yields the lowest income tax expense. a) FIFO b) LIFO c) Weighted Average

b) LIFO

periodic inventory system

accounts for the store's purchases as they occur, but the cost of goods sold is not recorded in the accounting records at the time of sale. Instead, at the end of an accounting period, a physical count must be made of the merchandise still on hand. The merchandise inventory account is then adjusted so that the ending balance equals the physical count. This system was used in previous lessons when recording supplies expense. Many small businesses that cannot afford the expense of the perpetual system still use the periodic method of determining inventory.

A merchandising business must maintain records of the number of units of each item held in inventory. All inventory owned by the business on the date of the physical inventory count should be included as follows:

all inventory on hand when the physical count is taken + merchandise in transit purchased, FOB shipping point (the title transferred when it left the seller) + merchandise in transit sold, FOB destination (the title has not transferred until it reaches the buyer) + merchandise on consignment in other locations (products that we have not sold and that belong to us until they sell) - merchandise held for others on consignment (products that we do not own but have agreed to sell for another company = merchandise inventory shown on balance sheet

cost of goods sold

an expense account Cost of goods sold is the amount we paid for the merchandise sold during the period. Cost of goods sold is subtracted from net sales to get gross profit.

Freight terms

are part of the sales agreement; they describe when the legal title of the goods passes from the seller to the buyer. In other words, when does the purchaser (merchandiser) become the owner of the goods? These terms also indicate which party is responsible for paying transportation costs. FOB is a term used in the shipping industry that means free on board or freight on board. Ownership changes (from seller to buyer) become important when a company must identify its assets at the end of an accounting period. Does the company own something that might not be on its premises?

An error in the amount of ending inventory affects

assets (inventory), net income (cost of goods sold), and equity for that period. Because ending inventory is next period's beginning inventory, an error in ending inventory affects next period's cost of goods sold and net income. Inventory errors in one period are offset in the next period.


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