Ch 9 - Completing the Cycle - Merchandising

7/29/2019 Ch 9 - Completing the Cycle - Merchandising

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Completing the Cycle for aMerchandising Business

CHAPTER 9

Ma. Rona Corda-Prado, CPAUniversity of St. La Salle


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Physical Inventory taken for two reasons:

Perpetual System

1. Check accuracy of inventory records.2. Determine amount of inventory lost (wasted raw

materials, shoplifting, or employee theft).

Periodic System1. Determine the inventory on hand

2. Determine the cost of goods sold for the period.

DETERMINING INVENTORY QUANTITIES

Prepared by: RCPrado Chapter 9 - 2


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Involves counting, weighing, or measuring each

kind of inventory on hand.Taken,

when the business is closed or when business

is slow.

at end of the accounting period.

Taking a Physical Inventory




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Goods in Transit

Purchased goods not yet received.

Sold goods not yet received by the customer.

Determining Ownership of Goods


Goods in transit should be included in the inventory ofthe company that has legal title to the goods. Legal

title is determined by the terms of sale.



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Ownership of the goodspasses to the buyer whenthe public carrier acceptsthe goods from the seller.

Ownership of the goodsremains with the seller

until the goods reach thebuyer.

Terms of Sale



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Goods in transit should be included in the

inventory of the buyer when the:a. public carrier accepts the goods from the

seller.

b. goods reach the buyer.

c. terms of sale are FOB destination.

d. terms of sale are FOB shipping point.

Review Question




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Consigned Goods

In some lines of business, it is common to holdthe goods of other parties and try to sell thegoods for them for a fee, but without taking

ownership of goods. These are called consigned goods.

Determining Ownership of Goods




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Goods in transit purchased FOB shipping point are includedin the count.

Goods in transit purchased FOB destination are excluded in

the count.

Goods in transit sold FOB shipping point are excluded in thecount.

Goods in transit sold FOB destination are included in thecount.

Goods out on consignment are included in the count.

Goods accepted on consignment are excluded in the count.




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Set up of inventory is done for a periodic system after aphysical count is done. Physical count involves thefollowing steps:

1.All merchandise owned by the business is counted2.Total Cost per Item = Quantity counted/item xcost/unit

3.Total Cost of Inventory = Total Cost per Item

COMPLETING THE ACCOUNTING

CYCLE - PERIODIC



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At the end of the period, entries are made to reflect in theinventory account the ending balance to:

1. Remove the beginning balance from the merchandiseinventory account and to transfer to incomesummary

2. Record the ending balance in the merchandiseinventory and to establish it to the income summary

Methods: Adjusting Entry Method or Closing Entry

Method


CYCLE - PERIODIC



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ADJUSTING ENTRY

METHOD

CLOSING ENTRY

METHOD

Income Summary xxx

Merchandise Inventory,

Beginning xxx

Income Summary xxx


Beginning xxx

Temporary Accounts with

Debit Balances xxx


CYCLE - PERIODIC



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ADJUSTING ENTRYMETHOD

CLOSING ENTRYMETHOD


Ending xxx

Income Summary xxx


Ending xxx

Temporary Accounts

With Credit Balances xxx

Income Summary xxx


CYCLE - PERIODIC



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Generally the same as a service company.

One additional adjustment to make the recordsagree with the actual inventory on hand.

Involves adjusting Merchandise Inventory andCost of Goods Sold.

Adjusting Entries


CYCLE - PERPETUAL



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In order to ensure the accuracy of their perpetualinventory records, most businesses take a complete

physical count of the merchandise on hand at least once ayear.

When a physical inventory is taken ,management uses theinventory ledger to determine whether the inventory on

hand corresponds to the amount indicated in theinventory subsidiary ledger.

Inventory shrinkage or shortage - unrecorded decreasein inventory resulting from breakage, spoilage, employeetheft and shoplifting (count < records)


CYCLE - PERPETUAL



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PERIODIC PERPETUAL

To adjust perpetual inventory records to reflect the results of

the year end physical count: Actual < RecordsNo entry Cost of Goods Sold xxx

Merchandise Inventory xxx

To adjust perpetual inventory records to reflect the results of

the year end physical count: Actual > Records

No entry Merchandise Inventory xxx

Cost of Goods Sold xxx



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INVENTORY ERRORS

Common Cause:

Failure to count or price inventory correctly.

Not properly recognizing the transfer oflegal title to goods in transit.

Errors affect both the income statement andbalance sheet.



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Inventory Error Cost of Goods Sold Net Income

Understate ending inventory Overstated Understated

Understate beginning inventory Understated Overstated

Overstate ending inventory Understated Overstated

Overstate beginning inventory Overstated Understated

Income Statement Effects



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INVENTORY ERRORS

Inventory errors affect the computation of cost ofgoods sold and net income in two periods.

An error in ending inventory of the current periodwill have a reverse effect on net income of thenext accounting period.

Over the two years, the total net income is correctbecause the errors offset each other.

The ending inventory depends entirely on theaccuracy of taking and costing the inventory.

Income Statement Effects



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Incorrect Correct Incorrect Correct

Sales 80,000$ 80,000$ 90,000$ 90,000$

Beginning inventory 20,000 20,000 12,000 15,000

Cost of goods purchased 40,000 40,000 68,000 68,000

Cost of goods available 60,000 60,000 80,000 83,000

Ending inventory 12,000 15,000 23,000 23,000

Cost of good sold 48,000 45,000 57,000 60,000

Gross profit 32,000 35,000 33,000 30,000

Operating expenses 10,000 10,000 20,000 20,000

Net income 22,000$ 25,000$ 13,000$ 10,000$

2008 2009

($3,000)Net Incomeunderstated

$3,000Net Incomeoverstated

Combined income for 2-yearperiod is correct.

INVENTORY ERRORS



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Effect of inventory errors on the balance sheet isdetermined by using the basic accounting equation:.

Balance Sheet Effects



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CURRENT YEAR NEXT YEAR

Inv,End COGS

GrossProfit,

Profit &Owners

EquityCurrentAssets Inv, Beg COGS

GrossProfit,

Profit &Owners

Equity

- + - - - - +

+ - + + + + -

EFFECT OF INVENTORY ERROR



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Understating ending inventory will overstate:

a. assets.

b. cost of goods sold.

c. net income.

d. owner's equity.

Review Question

INVENTORY ERRORS



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Close all accounts that affect net income.

CLOSING ENTRIES

1. Close Revenue Accounts to Income Summary

Sales, Sales Discounts, Sales Returns and Allowances

2. Close Costs and Expenses to Income Summary

a) Perpetual: COGS

b) Periodic: Purchases, Purchase Discounts, Purchase Returns andAllowances, Freight-In

3. Close Income Summary to Capital

4. Close Withdrawals to Capital

COMPLETING THE ACCOUNTING CYCLE



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WORKSHEET - PERPETUAL

INVENTORY


Refer to pp 425

for worksheet

used in aperiodic system


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Subtract total expenses from total revenues

Format that we used for the income statement ofservice businesses

Two reasons for using the single-step format:

1) Company does not realize any type of profituntil total revenues exceed total expenses.

2) Format is simpler and easier to read.

Single-Step Income Statement



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Shows several steps in determining net income.

Two steps relate to principal operating activities.Distinguishes between operating and non-operating activities.

Nature of Expense Method - expenses arecombined according to their nature and notreallocated between various functions of thecompany; used in smaller companies

Multiple-Step Income Statement



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Function of Expense Method - also referred to as

COGS method and classifies expenses according totheir function as part of cost of sales, distributionor selling, administrative and other operatingexpenses

More relevant to users but can be arbitraryand subjective

More commonly used

Multiple-Step Income Statement



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SOURCES OF INCOME

Sale of merchandise to customers - allsales to customers during the period. Salesreturns, allowances and discounts should be

deducted from gross sales to arrive at netsales

Rendering of services - includesprofessional fees, media advertisingcommissions, insurance agency commissions,admission fees for artistic performanceand tuition fee, among others



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Use of entity resources - includesinterest, rent, royalty and dividend income

Disposal of resources other than products- gain on sale of investments, gain on sale ofproperty, plant and equipment and gain onsale of intangible assets

SOURCES OF INCOME



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COMPONENTS OF EXPENSE

Cost of sales

Distribution of costs or selling

expenses Administrative expenses

Other expenses

Income tax expense



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SELLING EXPENSES

Costs which are directlyrelated to selling, advertisingand delivery of goods tocustomers

Include salesmens salaries,sales commissions, travelingand marketing expenses,advertising and publicity

expenses, store supplies used,freight out, depreciation ofdelivery equipment and otherexpenses related directly withthe selling function



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ADMINISTRATIVE EXPENSES

Includes all operatingexpenses not related toselling expenses and cost ofgoods sold, such as doubtful

accounts, office salaries andexpenses of generalexecutives and of thegeneral accounting andcredit department, office

supplies used, certain taxes,contributions, professionalfees, depreciation of officebuilding and officeequipment and amortizationof intangibles

Costs of administering thebusiness.



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OTHER EXPENSES

Expenses not directly related to the selling andadministrative function

Expenses include charges to income such as loss

on sale of trading securities, loss on sale ofproperty, plant and equipment, loss on sale oflong-term investments and other losses



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Key Items:

Net sales

Gross profit

Gross profitrate

Operatingexpenses



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Key Items:Nonoperatingactivities

Net incomePrepared by: RCPrado Chapter 9 - 35


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FUNCTIONAL FORMAT



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NOTES TO FINANCIAL STATEMENTS



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Classified Balance Sheet

Prepared by: RCPrado Chapter 9 38

Ch 9 - Completing the Cycle - Merchandising

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