201Lec05.pptx 1 Accrual Accounting Concepts - PowerPoint Presentation

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201Lec05.pptx

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Accrual Accounting Concepts

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Merchandising & Multi-Step Income Statement

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Service Businesses Make money by providing a service Services can’t be created and stockpiled for later sale. (no MERCHANDISE INVENTORY!)Usually less working capital needed to start and operate business. Simpler accounting system

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3 basic types of companies: SERVICE

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Merchandiser Make money by selling a product. Usually more working capital needed because inventory must be available for sale.Bigger risk also due to obsolescence, theft, competition on price.Inventory is manufactured by another company. Merchandiser doesn’t “add value” to product.

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3 basic types of companies: MERCHANDISER

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Manufacturer Convert a raw material to a finished good. Direct labor and manufacturing processes used in conversion. 3 types of inventories: Raw materials Work in process Finished goods

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3 basic types of companies: MANUFACTURER

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SERVICE

Revenues- ExpensesNet Income=========

MERCHANDISINGSales- Contra Sales Net Sales- Cost of Goods Sold (CGS or COGS)Gross Profit- Operating ExpensesIncome from operations+ other revenues and gains- other expenses and lossesIncome before taxes- Income tax expenseNet Income=================

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Income Statement:

MULTIPLE STEP FORMAT

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Beginning Inventory

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Cost of Goods Purchased

Ending Inventory

Cost of Goods

Available for Sale

Cost of Goods Sold

Flow of Inventory Costs

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Periodic method or Perpetual method Both methods end up with same balances in inventory and CGS. GAAP allows either one1 - PERPETUAL records CGS at the time of each sale. 2 - PERIODIC doesn’t record CGS at all! It gets calculated at the End of Period!

Inventory Methods - 2 options

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To record revenues: Sales Cash

EXAMPLE

:

You are in USB drive business. Say sell for $3, cost is $1.

Start 10 units, cost = $1 each Sell 2 units 6 6Sell 5 units 15 15Purchase 10 units 10Sell 8 units 24 24 . Balances 45 35

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Inventory C G S

1 -

Use

PERPUTUAL METHOD :

Start 10 units, cost = $1 each 10Sell 2 units 2 2Sell 5 units 5 5Purchase 10 units 10Sell 8 units 8 8 . Balances 5 15 Gross profit = sales of $45 - CGS of $15 = $30

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Inventory Purchases CGS

Start 10 units

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Sell some

No recording Inv/CGS (record revenue but not CGS)Sell some more No recording Inv/CGS Purchase 10 units 10 (must record purchase)Sell some more No recording Inv/CGS What is needed to compute amount CGS?Beginning 10 + Purchases 10 – Ending 5 = 15

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2 -

Use

PERIODIC

METHOD

:

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PERPETUAL

- On-Line Inventory Info

- Control over theft amount, errors. - Lots of record keeping. PERIODIC - Ease of use. Much less records. Count inventory once per year and Record inventory purchases only. - No clue of inventory balances in accounting records. Physical count suggested for Perpetual to verify balance. Absolutely required for Periodic.

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Comparison of Systems

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Computers and electronic scanning equipment make perpetual inventory cost effective

!

Scans be used to create automated journal entries with no human accounting.

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Revenue Recognition Principle requires revenue be recorded at point of sale. - That is, record when “legal ownership” changes from seller to buyer. - Goods must be transferred to buyer (shipped).Matching Principle also requires the expense of the sale be recorded in the same reporting period as revenue.

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Sales & Cost of Goods Sold (CGS)

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Things needed to be recorded for each sale:1. Revenue Dr. Cash (or A/R) xxxx Cr. Sales xxxx 2. Expense (Perpetual method only) Not for periodic Dr. Cost of Goods Sold (or CGS) xxxx Cr. Inventory xxxx

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Recording a Sale

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Components of Full inventory cost:Purchase price from supplier-vendorplus Freight-In cost if paid by purchasing company (Freight-Out paid by seller in their operating expense.) less Discounts allowed by vendor (Often based on credit terms)

Invoice from vendor

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Merchandise Inventory Cost

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Example: Recording a sale

Konk Co. Sold 10 units of inventory for $100 each. The units were purchased last month for $60 each. - Freight charges on the purchase were $5 each. - Discounts granted on the purchase were $2 each.Journal entry to record the sale?

Cash (or A/R) 1000 Sales 1000For perpetual method also: Not for periodicCost of Goods Sold 630 Inventory 630 cost = [10 x (60+5-2)]

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Many sales are on account. (competition, business practice, etc) - Credit terms are listed on invoice

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Sales Discounts

also see purchase discounts

Seller’s often provide an incentive for buyers to pay

before

the normal due date

.

Why would they do this?

- Called a “

cash discount

”

- Usually a % reduction in payment

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Example: Sales Discounts

Konk Co. had a sale of $1000, terms 2 / 10, n / 30. This means : Buyer gets 2 % price reduction IF buyer pays within 10 days of the sale, OTHERWISE the entire net (full price) is due within 30 days of the sale.

Record sale as before. See previous example.If payment received within 10 days of sale:Cash 980 Sales Discounts 20 Accounts Receivable 1000

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Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.

May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price.

Sale Return

Sale Allowance

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Sales Returns & Allowances

Purchaser may be dissatisfied

because goods are damaged or defective, of inferior quality, or do not meet specifications.

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Dr. Sales R & A xxxx Cr. A/R (or Cash) xxxx Note: If inventory is returned (not just an allowance), also record (perpetual only):Dr. Inventory xxxx Cr. Cost of Goods Sold xxxx

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Sales Returns & Allowances

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SALES 1,000

Less: Sales Discounts 20 Sales Returns & Allowances 90 -110 Net Sales 890 Less: Cost of Goods Sold -630 Gross Profit 260

These sales accounts are called CONTRA-REVENUE accounts (not EXPENSES).

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Income Statement Presentation

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Purchase Discounts - Buying company that pays early records discount effect in inventory.

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Other Issues for PURCHASE of merchandise

Example: Buy $1000 of inventory on terms 2/10, n/30

On date of purchase:

Inventory

(perpetual method only)

1000 Accounts Payable 1000

If paid within 10 days of purchase

Accounts Payable 1000 Inventory

(perpetual method only)

20 Cash 980

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Purchase Returns & Allowances - Company that returns or gets allowance reduces inventory. Dr. A/P (or Cash) xxxx Cr. Inventory (perpetual method only) xxxx

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Freight-In on purchases

- Buying company adds freight they pay to inventory cost.

Dr.

Inventory

(perpetual method only)

xxxx

Cr.

A/P (or Cash)

xxxx

If

seller

agrees to pay freight-Out, they record it as a

shipping expense

.

Other Issues for PURCHASE of merchandise

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Inventory Account (Perpetual)

Beginning Balance

Purchase Inventory

Freight-In on purchase

Purchase Discounts

Purchase R & A

Cost of goods sold

Cost of Sale Returns

Ending Balance

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1 Start with beginning inventory amount – Count it!2 Keep track of full costs of inventory bought during the year. Don’t record in inventory, but use the following temporary periodic accounts:PurchasesFreight-InPurchase discountsPurchase returns & allowances3 Subtract inventory left over at year end – Count it!Note an AJE will be needed at period end to update the inventory account to reflect the ending physical count balance! (We won’t worry about in this class.)

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Data needed for PERIODIC method

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Inventory Account (Periodic)

Beginning Balance

Additional periodic accounts for:

- Purchases

(debit balance) - Freight in on purchase (debit balance) - Purchase R & A (credit balance) - Purchase discounts (credit balance)

Year end adjustment (debit or credit) to physical count

Ending Balance

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Net Sales 1,000

less: COST OF GOODS SOLD: Beginning Inventory 100 Purchases 700 Less: Purchase Discounts -50 Purchase R & A -10 Add: Freight In 30 Cost of goods purchased 670 Cost of Goods Available for Sale 770 Less: Ending Inventory -150 Cost of Goods Sold - 620Gross Profit 380

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CGS on Periodic Income Statement

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the average time it takes to go from cash to cash in producing revenues.

TO

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Operating Cycle for a company is . . .

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Cash

AccountsReceivable

MerchandiseInventory

Buy Inventory

Sell Inventory

Receive Cash

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Merchandising Company operating Cycle

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Gross ProfitNet Sales

x (100)

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Gross Profit Rate =

Sometimes called “mark-up”.

Sometimes used to price products.

Cost plus markup = selling price.

Used in marketing to determine best product to concentrate sales efforts

Used in breakeven calculations

How much sales do we need to cover operating expenses?

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Profit Margin =

Net Income

Net Sales

x (100)

Measures the percentage of each dollar of sales that results in net income

Affected by gross profit, operating costs and non- operating items.

Often looked at when downsizing.

Reduce overhead (operating expenses) can increase margin.

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General Journal- Perpetual7/1 Inventory (90 units @ $30 each) 2700 A/P 27007/3 A/R (50 units @ $50 each) 2500 Sales 2500 CGS (50 x $30) 1500 Inventory 1500

EXAMPLE, Perpetual, then periodicOn 7/1, buy 90 items for $30 each. On 7/3 sell 50 items for $50 each.

On income statement: Sales 2500 -CGS -1500 Gross profit 1000On balance sheet: Inventory balance = 1200 (2700 dr and 1500 cr)

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General Journal – P E R I O D I C7/1 Purchases 2700 A/P 27007/3 A/R 2500 Sales 2500

NOTE: To prepare statements, inventory must be counted and cost calculated (40 items @ $30 = $1200).On income statement: Sales 2500 -CGS: BI 0 Purchases 2700 Cost Available 2700 - EI - 1200 -1500 Gross profit 1000On balance sheet: Inventory = 1200 (adj made to physical count)

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