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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Chapter Five
Accounting for Merchandising
Businesses
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5-2
Merchandising Businesses
Sale
Merchandising businesses
generate revenue by selling goods.
The goods purchased for
resale are called merchandise
inventory.
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5-3
LO 1
Identify and explain the
primary features of the perpetual
inventory system.
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5-4
Product Costs Versus Selling and Administrative Costs
Product Costs
Costs that are included in inventory.
Selling & Admin. Costs
Costs that are not included in
inventory. They are
sometimes called period
costs.
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5-5
Allocation of Inventory Cost Between Asset and Expense Accounts
Beginning Inventory Balance
+
Inventory Purchased During the
Period
=
Cost of Goods
Available for Sale
Cost of Goods Available for Sale
Merchandise Inventory
(Balance Sheet)
Cost of Goods Sold (Income Statement)
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5-6
Gross Margin (or Gross Profit)
Sales Revenue- Cost of Goods Sold
Gross Margin
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5-7
Gross Profit – Op Exp. = Op. Income
Op. Inc + Other Inc. – Exp = Inc. Before taxes
Inc. before taxes – taxes = Net Income
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5-8
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5-9
Perpetual Inventory System
Perpetual Inventory System
Inventory account is adjusted perpetually (continually)
throughout the accounting
period.
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5-10
LO 2
Record and report inventory
transactions in the double-entry accounting
system.
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5-11
Perpetual Inventory System
Let’s see how a perpetual inventory
system works by looking at
transactions for June’s Plant Shop (JPS).
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5-12
Event 1: JPS acquired $15,000 by issuing common stock.
1. Increase assets (cash).
2. Increase equity (common stock).
Asset Source
Transaction
Cash + Inventory = Common
Stock + Retained Earnings Revenue - Expenses =
Net Income
15,000 + n/a = 15,000 + n/a n/a - n/a = n/a 15,000 FA Cash Flow
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Cash $15,000
Common Stock $15,000
Journal Entry
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5-14
Event 2: JPS purchased merchandise inventory for $14,000 cash.
1. Decrease assets (cash).
2. Increase assets (merchandise inventory).
Asset Exchange
Transaction
Cash + Inventory = Common
Stock + Retained Earnings Revenue - Expenses =
Net Income
(14,000) + 14,000 = n/a + n/a n/a - n/a = n/a (14,000) OA Cash Flow
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Journal Entry
Inventory $14,000
Cash $14,000
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5-16
Event 3a: JPS recognized sales revenue from selling inventory for $12,000.
1. Increase assets (cash).
2. Increase equity (sales revenue).
Asset Source
Transaction
Cash + Inventory = Common
Stock + Retained Earnings Revenue - Expenses =
Net Income
12,000 + n/a = n/a + 12,000 12,000 - n/a = 12,000 12,000 OA Cash Flow
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Journal Entry
Cash $12,000
Sales $12,000
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5-18
Event 3b: JPS recognized $8,000 of cost of goods sold.
1. Decrease assets (merchandise inventory).
2. Decrease equity (cost of goods sold).
Asset Use Transaction
Cash + Inventory = Common
Stock + Retained Earnings Revenue - Expenses =
Net Income
n/a + (8,000) = n/a + (8,000) n/a - 8,000 = (8,000) n/a Cash Flow
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Journal Entry
Cost of Goods Sold $8,000
Inventory $8,000
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5-20
Event 4: JPS paid $1,000 cash for selling expenses.
1. Decrease assets (cash).
2. Decrease equity (selling expenses).
Asset Use Transaction
Cash + Inventory = Common
Stock + Retained Earnings Revenue - Expenses =
Net Income
(1,000) + n/a = n/a + (1,000) n/a - 1,000 = (1,000) (1,000) OA Cash Flow
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Journal Entry
Selling Expense $1,000
Cash $1,000
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5-22
Event 5: JPS paid $5,500 cash to purchase land for a place to locate a future store.
1. Decrease assets (cash).
2. Increase assets (land).
Asset Exchange
Transaction
Cash + Inv. + Land = Comm.
Stk. + Ret.
Earn.
(5,500) + n/a + 5,500 = n/a + n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a (5,500) IA
Cash Flow
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Journal Entry
Land $5,500
Cash $5,500
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5-24
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5-25
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5-26
LO 3Explain the
meaning of terms used to describe transportation
costs, cash discounts, returns or allowances, and
financing costs.
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5-27
Purchasing inventory often involves:
•Transportation costs•Inventory returns•Purchase allowances•Cash discounts
Other Topics
Let’s look at these transactions for JPS.
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5-28
Event 1: JPS borrowed $4,000 cash by issuing a note payable.
1. Increase assets (cash).
2. Increase liabilities (notes payable).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
4,000 + n/a + n/a + n/a = n/a + 4,000 + n/a + n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a 4,000 OA
Cash Flow
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Journal Entry
Cash $4,000
Note Payable $4,000
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5-30
Event 2: JPS purchased on account merchandise inventory with a list price of $11,000.
1. Increase assets (merchandise inventory).
2. Increase liabilities (accounts payable).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
n/a + n/a + 11,000 + n/a = 11,000 + n/a + n/a + n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a n/a
Cash Flow
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Journal Entry
Inventory $11,000
Accounts Payable$11,000
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5-32
Event 3: JPS returned some of the inventory purchased in Event 2. The list price of the returned merchandise was $1,000.1. Decrease assets
(merchandise inventory).
2. Decrease liabilities (accounts payable).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+
Ret.
Earn.
n/a + n/a + (1,000) + n/a = (1,000) + n/a + n/a
+ n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a n/a
Cash Flow
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Journal Entry
Accounts Payable $1,000
Inventory $1,000
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5-34
Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms are 2/10 n/30.
Before analyzing this transaction, let’s learn a little about
cash discounts.
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5-35
A deduction from the invoice price granted to induce early payment
of the amount due.
A deduction from the invoice price granted to induce early payment
of the amount due.
Terms
Time
Due
Discount Period
Full amountless discount
Credit Period
Full amount due
Purchase or SalePurchase or Sale
Cash Discounts
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5-36
2/10, n/30Percentage of Discount
# of Days Discount Is Available
Otherwise, the Full
Amount Is Due
# of Days when Full Amount Is
Due
Cash Discounts
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5-37
Event 4: JPS received a cash discount on goods purchased in Event 2. The credit terms were 2/10, n/30.
1. Decrease assets (merchandise inventory).
2. Decrease liabilities (accounts payable).
Asset Use Transaction
Rev. - Exp. = Net Inc.
n/a - n/a = n/a n/a
Cash Flow
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+
Ret.
Earn.
n/a + n/a + (200) + n/a = (200) + n/a + n/a
+ n/a
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Journal Entry
Accounts Payable $200
Inventory $200
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5-39
Event 5: JPS paid the $9,800 balance due on the account payable.
1. Decrease assets (merchandise inventory).
2. Decrease liabilities (accounts payable).
Asset Use Transaction
List Price Discount Balance Due10,000$ - $200 = 9,800$ Cash +
Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+
Ret.
Earn.
(9,800) + n/a + n/a + n/a = (9,800) + n/a + n/a
+ n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a n/a
Cash Flow
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Journal Entry
Accounts Payable $9,800
Cash $9,800
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5-41
Event 6: The shipping terms for the inventory purchased in Event 2 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise.
Before analyzing this transaction, let’s learn a little about
transportation costs.
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5-42
Transportation Costs
FOB shipping point(buyer pays)
FOB destination(seller pays)
Merchandise
Seller Buyer
Buyer Seller
Freight Terms FOB Shipping Point FOB DestinationCost Title Transportation-in Transportation-out
Responsible Party
FOB = Free on Board
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5-43
Event 6: The shipping terms for the inventory purchased in Event 1 were FOB shipping point. JPS paid the freight company $300 cash for delivering the merchandise.1. Decrease assets (cash).
2. Increase assets (merchandise inventory).
Asset Exchange
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+
Ret.
Earn.
(300) + n/a + 300 + n/a = (200) + n/a + n/a
+ n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a (300) OA
Cash Flow
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Journal Entry
Inventory $300
Cash $300
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5-45
Event 7a: JPS recognized $24,750 of revenue on the cash sale of merchandise that cost $11,500.
1. Increase assets (cash).
2. Increase equity (sales revenue).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+ Ret. Earn.
24,750 + n/a + n/a + n/a = n/a + n/a + n/a
+ 24,750
Rev. - Exp. = Net Inc.
24,750 - n/a = n/a 24,750 OA
Cash Flow
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Journal Entry
Cash $24,750
Sales $24,750
Cost of Goods Sold $11,500
Inventory $11,500
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5-47
Event 7b: JPS recognized $11,500 of cost of goods sold.
1. Decrease assets (merchandise inventory).
2. Decrease equity (cost of goods sold).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+ Ret. Earn.
n/a + n/a + (11,500) + n/a = n/a + n/a + n/a
+ (11,500)
Rev. - Exp. = Net Inc.
n/a - 11,500 = (11,500) n/a
Cash Flow
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5-48
Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers.
1. Decrease assets (cash).
2. Decrease equity (transportation-out).
Asset Use Transaction
Buyer Seller
Freight Terms FOB Shipping Point FOB DestinationCost Title Transportation-in Transportation-out
Responsible Party
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Journal Entry
Transportation Out $450
Cash $450
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5-50
Event 8: JPS paid $450 cash for freight costs on inventory delivered to customers.
1. Decrease assets (cash).
2. Decrease equity (transportation-out).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+ Ret. Earn.
(450) + n/a + n/a + n/a = n/a + n/a + n/a
+ (450)
Rev. - Exp. = Net Inc.
n/a - 450 = (450) (450) OA
Cash Flow
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5-51
Event 9: JPS paid $5,000 cash for selling and administrative expenses.
1. Decrease assets (cash).
2. Decrease equity (selling and admin. expense).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk.
+ Ret. Earn.
(5,000) + n/a + n/a + n/a = n/a + n/a + n/a
+ (5,000)
Rev. - Exp. = Net Inc.
n/a - 5,000 = (5,000) (5,000) OA
Cash Flow
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Journal Entry
Selling & Admin. Expense $5,000
Cash $5,000
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Event 10: JPS paid $360 cash for interest expense on the note described in Event 1.
1. Decrease assets (cash).
2. Decrease equity (interest expense).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
(360) + n/a + n/a + n/a = n/a + n/a + n/a + (360)
Rev. - Exp. = Net Inc.
n/a - 360 = (360) (360) OA
Cash Flow
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Journal Entry
Interest Expense $360
Cash $360
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Event 11: JPS sold the land that had cost $5,500 for $6,200 cash.
Before analyzing this transaction, let’s learn a little about gains and
losses.
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Gains and Losses
Gains and
Losses
Sales Price of Land
- Cost of LandGain or Loss
Gross margin
Sales Revenue-Cost of Goods
SoldGross Margin
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Event 11: JPS sold the land that had cost $5,500 for $6,200 cash.
1. Increase assets (cash).
2. Decrease assets (land).
3. Increase equity (gain on sale of land).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
6,200 + n/a + n/a + (5,500) = n/a + n/a + n/a + 700
Gain - Exp. = Net Inc.
700 - n/a = 700 6,200 IA
Cash Flow
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Journal Entry
Cash $6,200
Land $5,500
Gain on Sale –Land $700
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LO 5
Compare and contrast single and multi-step
income statements.
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LO 6
Show the effect of lost, damaged, or stolen inventory
on financial statements.
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Lost, Damaged, or Stolen Inventory
Most merchandise companies
experience some level of inventory shrinkage, a term
that reflects decreases in inventory for
reasons other than sales to
customers.
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Lost, Damaged, or Stolen Inventory
Assets = Liab. + Equity Revenue - Expenses = Net
Income (500) = n/a + (500) n/a - 500 = (500) n/a
Cash Flow
Assume a company determined that $500 of inventory was lost through shrinkage.
Here is how it would effect the statements:
Account Title Debit CreditInventory Loss (or Cost of Goods Sold) 500 Inventory 500
In general journal form, the entry is as follows:
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Sales of inventory often involves:
•Inventory returns•Purchase allowances•Cash discounts
Events Affecting Sales
Let’s look at these transactions for JPS.
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Event 1a: JPS sold on account merchandise with a list price of $8,500. Payment terms were 1/10 n/30. The merchandise had cost JPS $4,000.
1. Increase assets (accounts receivable).
2. Increase equity (sales revenue).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
n/a + 8,500 + n/a + n/a = n/a + n/a + n/a + 8,500
Rev. - Exp. = Net Inc.
8,500 - n/a = 8,500 n/a OA
Cash Flow
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Journal Entry
Accounts Receivable $8,500
Sales $8,500
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Event 1b: JPS recognized $4,000 of cost of goods sold.
1. Decrease assets (merchandise inventory).
2. Decrease equity (cost of goods sold).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret. Earn.
n/a + n/a + (4,000) + n/a = n/a + n/a + n/a + (4,000)
Gain - Exp. = Net Inc.
700 - 360 = 700 6,200 IA
Cash Flow
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Journal Entry
Cost of Goods Sold $4,000
Inventory $4,000
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Event 2a: A customer from Event 1a returned inventory with a $1,000 list price. The merchandise had cost JPS $450.
1. Decrease assets (accounts receivable).
2. Decrease equity (retained earnings).
Asset Use Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
n/a + (1,000) + n/a + n/a = n/a + n/a + n/a + 700
Rev. - Exp. = Net Inc.
(1,000) - n/a = (1,000) n/a
Cash Flow
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Event 2b: The cost of the goods ($450) is returned to the inventory account.
1. Increase assets (merchandise inventory).
2. Increase equity (reduce cost of goods sold).
Asset Source
Transaction
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
n/a + n/a + 450 + n/a = n/a + n/a + n/a + 450
Rev. - Exp. = Net Inc.
n/a - (450) = 450 n/a
Cash Flow
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Event 3a (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired.
1. Decrease assets (accounts receivable).
2. Decrease equity (sales).
Asset Use & Exchange
Let’s assume the customer paid within the discount
period.
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
n/a + (75) + n/a + n/a = n/a + n/a + n/a + (75)
Rev. - Exp. = Net Inc.
(75) - n/a = (75) n/a
Cash Flow
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Event 3b (Alternative 1): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred before the discount period had expired.
1. Increase assets (cash).
2. Decrease assets (accounts receivable).
Asset Use & Exchange
Let’s assume the customer paid within the discount
period.
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
7,425 + (7,425) + n/a + n/a = n/a + n/a + n/a + (75)
Rev. - Exp. = Net Inc.
n/a - n/a = n/a 7,425 OA
Cash Flow
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Event 3 (Alternative 2): JPS collected the balance of the account receivable generated in Event 1a. The collection occurred after the discount period had expired.
1. Increase assets (cash).
2. Decrease assets (accounts receivable).
Asset Exchange
TransactionNow, let’s assume the
customer did not pay within the discount period.
Cash + Accts.
Rec. + Inv. + Land = Accts.
Pay. + Notes
Pay. + Comm.
Stk. + Ret.
Earn.
7,500 + (7,500) + n/a + n/a = n/a + n/a + n/a + n/a
Rev. - Exp. = Net Inc.
n/a - n/a = n/a 7,500 OA
Cash Flow
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LO 7Use common size
financial statements and ratio analysis to
evaluate managerial
performance.
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Gross Margin Percentage
Gross MarginNet Sales
This measure indicates how muchof each sales dollar is left after deducting the cost of goods sold to cover expenses
and provide a profit.
Other things being equal, the company with the higher gross margin percentage is pricing its
products higher.
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Return on Sales
Net Income
Net Sales
Net income expressed as a percentage of sales provides insight as to how much of each sales dollar
is left as net income after all expenses are paid.
Other things being equal, the company with the higher return on sales
percentage is doing a better job of controlling costs.
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Financing Merchandise Inventory
Borrow Money from
Bank
Interest Expense
Use CashOpportunity
Cost
Purchase on Account
Higher Prices and/or Interest
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Periodic Inventory System (Appendix)
• A practical alternative for recording inventory in a low-technology, high-volume environment
• Cost of inventory is recorded in a Purchases account
• Ending inventory and cost of goods sold are determined by year-end physical count
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Periodic Inventory System (Appendix)
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End of Chapter Five