Chapter 4 accounting unit 2

what are the two ways we can account for inventory? (what are the two different inventory systems?)

1. perpetual inventory system 2. periodic inventory system

a multistep income statement provided better what?

A multistep income statement provides better information than the simple "Revenue - Expenses = Net Income" model that we have used thus far.

What are inventory cost? what are they called? what are period costs?

All costs incurred to acquire merchandise and prepare it for sale are included in the inventory account. These inventory costs are often called *product cost* (all the cost it takes to get it to you) - Examples include the price of goods purchased, shipping and handling, transit insurance, and storage costs. Selling and administrative costs are not included in inventory and are recognized as expenses in the period incurred and are often called *period costs* - Examples include advertising, administrative salaries, sales commissions, and insurance. Inventory costs are shown on the balance sheet in an asset account named Merchandise Inventory. Inventory costs are frequently called product costs. Examples of inventory costs include the price of the goods purchased, shipping and handling costs, transit insurance, and storage costs. Costs that are not included in inventory are usually called selling and administrative costs or period costs. Examples of period costs include advertising, administrative salaries, sales commissions, insurance, and interest.

Just Write purchased merchandise inventory for $28,000 cash.

Just Write decreases *cash* (an *asset* account) Just Write increases *inventory* (an *asset* account)

Just Write paid $10,000 cash to purchase land for a future store location.

Just Write decreases *cash* (an *asset* account) Just Write increases *land* (an *asset* account)

Just Write paid $7,000 cash for selling and administrative expenses.

Just Write decreases *cash* (an *asset* account) Just Write increases *selling and administrative expenses* (a *contra equity* account)

what is subtracted from gross profit to calculate operating income?

Selling and administrative expenses (period costs) are then subtracted from gross profit to calculate *operating income* Selling and administrative expenses are often called *operating income* Operating income represents a company's profitability from its core business operations.

At the end of the accounting period, inventory that was not sold to customers remains on hand. what is the cost of inventory items that has *not been* sold reported as? what is the cost of inventory that *has been* sold reported at?

The cost of inventory items that have not been sold is reported as *merchandise inventory* an asset on the balance sheet. The cost of inventory items sold is expensed as *cost of goods sold* on the income statement. - Cost of goods sold represents the price the selling company paid for inventory that was sold to customers during the accounting period. The cost of goods available for sale is allocated between the asset account Merchandise Inventory and an expense account called Cost of Goods Sold. The Merchandise Inventory account reports the cost of inventory items that have not been sold during the period. The cost of items sold is reported in the expense account, Cost of Goods Sold. The difference between sales revenue and cost of goods sold is called gross margin or gross profit. Selling and administrative expenses are subtracted from gross margin to arrive at net income.

When Just Write sells inventory for more than its cost, the difference between sales revenue and cost of goods sold is called what?

*gross profit* (or gross margin Revenue is earned when Just Write sells inventory, which is what they got in business to do. Cost of goods sold represents the price that Just Write paid for the inventory that they sold during the period. The calculation of gross profit (Sales Revenue - Cost of Goods Sold) is shown at the top of the income statement.

what does gross profit show? what does operating income demonstrate? what does non operating items indicate?

*gross profit* shows Just Write's mark-up on its products. *operating income* demonstrates Just Write's profitability from its normal business operations (core business activities). *non operating* items indicate to users that these activities are not part of Just Write's normal scope of business (other income/expenses). - Gains, losses, interest revenue, and interest expense are included in this nonoperating section.

To examine the effects of inventory on financial statements, we will analyze the accounting events of Just Write. The company sells quality pens, pencils, and journals to customers. Just Write began business on January 1, Year 1, when the company acquired $40,000 cash by issuing common stock. What happens to these financial statements?

Just Write increases *cash* (an *asset* account) Just Write increases *common stock* (a *stockholders equity* account)

Just Write sold the land that had a $10,000 cost for $11,200 cash.

Just Write increases *cash* (an *asset* account) for the $11,200 selling price. Just Write decreases *land* (an *asset* account) for the $10,000 original cost. Just Write increases *gain* (a *stockholders equity* account) for the $1,200 difference.

Just Write recognized sales revenue from selling inventory for $19,000 cash. Just Write recognized $11,000 of cost of goods sold.

Just Write increases *cash* (an *asset* account) for the $19,000 selling price. Just Write increases *revenue* (a *stockholders equity* account) for the $19,000 selling price. The revenue is earned when the goods were sold. Just Write decreases *inventory* (an *asset* account) for the $11,000 cost of inventory sold, as this inventory is no longer on hand. Just Write increases *cost of goods sold* (a *contra equity* account) for the $11,000 cost of inventory sold. The matching principle requires the recognition of revenue and related expenses in the same period.

what is merchandising businesses? what are the goods purchased for resale called? what type of account are these?

Merchandising businesses generate revenue by selling goods. The goods purchased for resale are called *merchandise inventory* (an *asset* account). Merchandising businesses include retail companies (companies that sell goods to the final consumer) and wholesale companies (companies that sell to other businesses).

what is the perpetual inventory system?

Most companies utilize a *perpetual* inventory system to maintain their inventory records. In a perpetual system, the inventory account is updated perpetually (continually) throughout the accounting period. - Inventory is increased each time the company purchases inventory. - Inventory is decreased each time the company sells inventory. This perpetual system is more accurate than a *periodic* inventory system, which updates inventory balances only at the end of the accounting period. grocery stores use a perpetual inventory system! periodic makes it hard to say what they have on hand. it is used by small businesses or where technology is somewhat limited

what does the term inventory sinkage reflect?

Most merchandising companies experience some level of inventory *sinkage* a term that reflects decreases in inventory for reasons other than sales to customers. - Shrinkage includes inventory that is lost, stolen, or damaged. Companies that use a perpetual inventory system can determine shrinkage by performing a physical count of their inventory on hand and comparing that amount to the inventory balance in the accounting records. For example, Just Write's accounting records showed $17,000 of inventory on hand at the end of Year 1. When Just Write counted their inventory, they only counted $16,600 of inventory on hand. Therefore, Just Write had $400 of shrinkage during Year 1.

what is added or subtracted to calculate income before taxes?

Next, the company will present *other income/expenses* items that are added or subtracted to calculate income before taxes. - These "other" items are often called *non operating* or peripheral activities, because they are not part of the company's normal business operations. - Examples include gains, losses, interest revenue, and interest expense. If Just Write sells land for more than its cost, the difference between the sales price and cost is called a *gain* - If the land is sold for less than its cost, the difference would be a *loss* - Gains increase net income; losses decrease net income. - Buying and selling land is not Just Write's primary business; this is not an ongoing transaction. Due to their nonrecurring nature, gains and losses are shown separately in the Other Income/Expense section of the income statement. *income tax expense* is then subtracted to calculate the company's net income.