ch 9 - completing the cycle - merchandising
TRANSCRIPT
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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
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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
DETERMINING INVENTORY QUANTITIES
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Goods in Transit
Purchased goods not yet received.
Sold goods not yet received by the customer.
Determining Ownership of Goods
DETERMINING INVENTORY QUANTITIES
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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DETERMINING INVENTORY QUANTITIES
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
DETERMINING INVENTORY QUANTITIES
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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
DETERMINING INVENTORY QUANTITIES
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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.
DETERMINING INVENTORY QUANTITIES
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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
COMPLETING THE ACCOUNTING
CYCLE - PERIODIC
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ADJUSTING ENTRY
METHOD
CLOSING ENTRY
METHOD
Income Summary xxx
Merchandise Inventory,
Beginning xxx
Income Summary xxx
Merchandise Inventory,
Beginning xxx
Temporary Accounts with
Debit Balances xxx
COMPLETING THE ACCOUNTING
CYCLE - PERIODIC
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ADJUSTING ENTRYMETHOD
CLOSING ENTRYMETHOD
Merchandise Inventory,
Ending xxx
Income Summary xxx
Merchandise Inventory,
Ending xxx
Temporary Accounts
With Credit Balances xxx
Income Summary xxx
COMPLETING THE ACCOUNTING
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
COMPLETING THE ACCOUNTING
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)
COMPLETING THE ACCOUNTING
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
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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
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FUNCTIONAL FORMAT
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NOTES TO FINANCIAL STATEMENTS
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Classified Balance Sheet
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