acct 652 accounting - pepperdine...

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ACCT 652 Accounting

Week 3–Merchandisers and special journals

Some slides © Times Mirror Higher Education Division, Inc. Used by permission

© Michael D. Kinsman, Ph.D.

ACCT 652 Week 3 2

Review of last week

•  Some highlights of what we did last week are:– We introduced the General Journal.– We introduced the General Ledger.– We posted from the GJ to the GL.– We use explanations in only five situations.– Dollar signs only go in formal financial

statements.

ACCT 652 Week 3 3

Review of last time (2)

– The accounting process. – Contra accounts.– Cash and accrual accounting.– Reversing entries.

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ACCT 652 Week 3 4

General Journal and General Ledger posting

GENERAL JOURNAL Page 1

Date DescriptionPost. Ref. Debit Credit

Dec. 1 Cash 101 30,000.00 T. Dow, Capital 30,000.00

Investment by owner.

GENERAL LEDGERAccount: Cash Acct. No. 101

Date ItemPost. Ref. Debit Credit Balance

Dec. 1 J1 30,000.00 30,000.00

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Five explanations only in the GL

•  Opening•  Closing•  Adjusting•  Error Correction•  Reversing

•  ONLY those five have explanations.

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Contra accounts•  Contra accounts are, in fact, parts of other

accounts. You can usually spot them in a Balance Sheet or an Income Statement because of the word “less” or “net of”, as in Accounts receivable, less allowance for doubtful accounts Accounts receivable, net of allowance for doubtful accounts

•  We have contra accounts because they preserve information: In the above example, we know how much accounts receivable we have and how much we expect to write off.

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Cash basis businesses

•  When is revenue? That is to say, when do you recognize revenue?

•  You recognize revenue when you get the cash.

•  That means cash basis businesses don’t have accounts receivable on their books. They simply keep a list of receivables.•  They also recognize expense when they actually pay the bill.

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Accrual basis businesses

•  When is revenue? That is to say, when do you recognize revenue?

•  You recognize revenue when you complete a sale.

•  Completing a sale means that you have shipped product and the customer has agreed to pay.

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The example from last week

•  A company had accrual basis profits of $95,000 in 2015.

•  It had ending 2014 (beginning 2015) A/R of $5,000, and ending 2015 A/R of $10,000.

•  It had ending 2014 (beginning 2015) A/P of $3,000, and ending 2015 A/P of $5,000.

•  What is the company’s cash basis profit for 2015?

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Last week’s problem answerAccrual basis income 95,000.00

Minus change in accounts receivable -Ending receivables (10,000.00) +Beginning receivables 5,000.00 (5,000.00)

Plus change in accounts payable: +Ending payables 5,000.00 -Beginning payables (3,000.00) 2,000.00

Cash basis income 92,000.00

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Reversing entries•  When a bookkeeper is keeping books on a

cash basis, and we convert them to an accrual basis with adjusting entries, there is a chance the bookkeeper will become confused.

•  To fix that problem, we do reversing entries which exactly reverse the accrual adjustment. Those are posted the first day of the period.

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Miscellaneous little stuff•  Remember that, despite the fact that most of

the examples do not include cents in their answers (for neatness in the book, I suppose), you should include them in your answers: $100 is not written as $100 or even as $100--. It should be written as $100.00.

ACCT 652 Week 3 12

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Miscellaneous little stuff•  Underlines are another “little stuff” that you

should be aware of. When you have a column of numbers that is (sub) totalled, you put a single underline under the last number to be totalled. Below the final total you put a double underline.

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ACCT 652 Week 3 14

Miscellaneous little stuff•  Finally, you put dollar signs at the top of a

column of numbers and above the double underline--see the next page for an example.

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ACCT 652 Week 3 15

Miscellaneous little stuffSales $10,100.00Cost of goods sold 7,520.00Shippi ng 181.22

Gross profit 2,398.78

Sales salar ies $800.15Rent 720.00Other stu ff 15.85

$1,536.00 1,536.00

Net income $862.78ACCT 652 Week 3 15

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Miscellaneous little stuff•  Remember that the balance sheet is, in fact,

two statements--a statement of assets and a statement of liabilities and owners’ equity. Therefore, there are two “tops of columns.” Even though they are on the same page, they are two statements.

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ACCT 652 Week 3 17

Consider merchandisers

•  The difference between merchandisers and service businesses is that merchandisers sell tangible merchandise. That means that they will have inventories.

•  But having inventories means they must be accrual basis.

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First, a puff-ball question

•  How do you record the entry when a merchandiser makes a sale?

GENERAL JOURNAL Page


M M DD Cash (or Accounts Receivable) 200.00 Sales 200.00

Record sales

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ACCT 652 Week 3 19

Suppose you have returns?

•  Both of those items, which cost $100 each, were returned, one because it was not needed, the other because it was a little dirty.

•  Because you are a good salesperson, you are able to convince the buyer to accept $5 as a cleaning allowance instead of returning the item.

•  How do you record the return and the allowance?

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Handling returns and allowancesGENERAL JOURNAL Page


M M DD Cash (or Accounts Receivable) 200.00 Sales 200.00

Record sales

M M DD+ Sales returns and allowances 105.00 Cash (or Accounts Receivable) 105.00

Record the return

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Accounts receivable

•  You receive a bill that says TERMS 2/10 net 30.

•  What does that mean?

You can pay with two 10’s, and they send out a net for you at day 30.

Not.

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Accounts receivable

•  You receive a bill that says TERMS 2/10 net 30.

•  What does that mean?

You get a 2 percent discount if you pay the bill within 10 days, and you are expected to pay the full bill by day 30.

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Recording discounts•  How do you record paying a 2/10 net 30 bill

for $100?•  It depends on what you want to emphasize.

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Method A–show opportunities lost•  If you normally expect to take a discount,

and want your statements to show when you goofed by not taking one, record as follows:

GENERAL JOURNAL Page


M M DD Purchases 98.00 Accounts payable 98.00

Record purchase

M M DD+ Accounts payable 98.00 Cash 98.00

Record payment on day 10*********OR*********

M M DD+ Accounts payable 98.00Discounts lost 2.00 Cash 100.00

Record payment after day 10

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Method A–show opportunities lost

•  This will lead to an expense item in your Trial Balance showing the amounts of all discounts lost during the year. This is a measure of how well you are following through in taking expected discounts.

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Method B–show opportunities taken•  Suppose, instead, that you do not expect to

take the discount. Then you would enter:GENERAL JOURNAL Page


M M DD Purchases 100.00 Accounts payable 100.00

Record purchase

M M DD+ Accounts payable 100.00 Cash 98.00 Discounts taken 2.00

Record payment on day 10*********OR*********

M M DD+ Accounts payable 100.00 Cash 100.00

Record payment after day 10

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Method B–show opportunities taken

•  In this method, you end up with a revenue item on your Trial Balance showing discounts taken.

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Which method shows the higher profits?

•  You can prove to yourself with a minimum of effort that both Method A and Method B show exactly the same profits.

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The best method•  The best method is to mix the methods. When

you expect to take the discount, use Method A. Then, if you don’t take a planned discount, you show the error on the trial balance.

•  When you expect not to take the discount (for example, because it isn’t “worth it”), use Method B. Then, if you erroneously take the discount, you show the error on the trial balance.

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Should you always take discounts?•  Suppose that money cost you 50 percent per

year, and that you were offered a discount of 1/10, net 100. Would you take that discount?

•  The interest rate you earn on your money by taking the discount is given by the formula

Rate = [(Discount %)/(100 - discount %)] * [365 / (net days - discount days)]

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Should you always take discounts?

•  Using the 1/10 net 100 example, we’d have:

•  Comparing the approximately 4% annual return you get with the 50% cost of financing it, you don’t want to take the discount.

Rate = [1 / (100 - 1)] * [365 /(100 - 10)] = [1/99] * 365/90 = 4.096% per year

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Cost of goods sold•  Cost of goods sold is like a bathtub:

•  Where 1 is beginning inventory, 2 is purchases, 3 is cost of goods, 4 is ending inventory, and 5 is “evaporation.”

4

3

5

1

2

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Cost of goods sold (2)•  You know that it’s true in bathtubs that 1 + 2 = 3 + 4 + 5•  Beginning water + Additions = What went out the drain + Ending water + Evaporation Or, for inventory•  Beginning inventory + Purchases = Cost of goods sold + Ending inventory + Evaporation

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What we know in the cost of goods sold equation

•  In inventory, we know the beginning inventory, because we counted it.

•  We know the ending inventory, because we counted it.

•  We know our purchases, because we logged them in.

•  We do not, necessarily, know CGS or Evaporation.

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Calculating cost of goods sold•  So now we have to calculate CGS and

Evaporation: Cost of Goods Sold + Evaporation =

Beginning inventory + Purchases -Ending inventory

•  How much is CGS and how much is evaporation does matter, because evaporation is stuff we “lost.”

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Cost of goods sold: Evaporation

•  We must estimate, based on history (markup percentages) or sampling, how much is evaporation and how much is CGS. This is needed for management purposes, to make sure we don’t get ripped off.

•  For financial accounting, both are treated as part of Cost of Goods Sold (CGS).

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Freight In

•  Freight in is just part of cost of goods sold. We may choose to keep it in a separate account, but it will end up as part of CGS.

ACCT 652 Week 3 38

Worksheet for a merchandiserNo. Name Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.101 Cash 8,200.00 8,200.00 - 106 Accounts receivable 11,200.00 11,200.00 - 119 Inventory 19,000.00 19,000.00 21,000.00 21,000.00 - 124 Office supplies 2,350.00 1,800.00 550.00 125 Store supplies 1,450.00 1,200.00 250.00 128 Prepaid insurance 900.00 600.00 300.00 163 Office equipment 4,200.00 4,200.00 - 164 Accumulated deprec. OE 700.00 700.00 - 1,400.00 165 Store equipment 30,000.00 30,000.00 - 166 Accumulated deprec. SE 3,000.00 3,000.00 - 6,000.00 201 Accounts payable 16,000.00 - 16,000.00 209 Salaries payable 800.00 - 800.00 301 Meg capital 34,000.00 - 34,000.00 302 Meg withdrawals 4,000.00 4,000.00 - 413 Sales 321,000.00 - 321,000.00 414 Sales returns and allow 2,000.00 2,000.00 - 415 Sales discounts 4,300.00 4,300.00 - 505 Purchases 235,800.00 235,800.00 - 506 Purchase R&A 1,500.00 - 1,500.00 507 Purchase discounts 4,200.00 - 4,200.00 508 Transportation in 2,300.00 2,300.00 - 612 Depreciation exp, SE 3,000.00 3,000.00 613 Depreciation exp, OE 700.00 700.00 620 Office salaries expense 25,000.00 300.00 25,300.00 621 Sales salaries expense 18,000.00 500.00 18,500.00 637 Insurance expense 600.00 600.00 641 Rent expense Office 900.00 900.00 642 Rent expense. Selling 8,100.00 8,100.00 650 Office supplies expense 1,800.00 1,800.00 651 Store supplies expense 1,200.00 1,200.00 655 Advertising expense 2,700.00 2,700.00

380,400.00 380,400.00 8,100.00 8,100.00 326,200.00 347,700.00 79,700.00 58,200.00 21,500.00 21,500.00

347,700.00 347,700.00 79,700.00 79,700.00

AccountIncome Balance

Statement SheetAdjustmentsUnadjusted

Trial Balance

ACCT 652 Week 3 39

Adjusting entry methodNo. Name Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.101 Cash 8,200.00 8,200.00 - 106 Accounts receivable 11,200.00 11,200.00 - 119 Inventory 19,000.00 21,000.00 19,000.00 21,000.00 124 Office supplies 2,350.00 1,800.00 550.00 125 Store supplies 1,450.00 1,200.00 250.00 128 Prepaid insurance 900.00 600.00 300.00 163 Office equipment 4,200.00 4,200.00 - 164 Accumulated deprec. OE 700.00 700.00 - 1,400.00 165 Store equipment 30,000.00 30,000.00 - 166 Accumulated deprec. SE 3,000.00 3,000.00 - 6,000.00 201 Accounts payable 16,000.00 - 16,000.00 209 Salaries payable 800.00 - 800.00 301 Meg capital 34,000.00 - 34,000.00 302 Meg withdrawals 4,000.00 4,000.00 - 413 Sales 321,000.00 - 321,000.00 414 Sales returns and allow 2,000.00 2,000.00 - 415 Sales discounts 4,300.00 4,300.00 - 505 Purchases 235,800.00 2,000.00 233,800.00 - 506 Purchase R&A 1,500.00 - 1,500.00 507 Purchase discounts 4,200.00 - 4,200.00 508 Transportation in 2,300.00 2,300.00 - 612 Depreciation exp, SE 3,000.00 3,000.00 613 Depreciation exp, OE 700.00 700.00 620 Office salaries expense 25,000.00 300.00 25,300.00 621 Sales salaries expense 18,000.00 500.00 18,500.00 637 Insurance expense 600.00 600.00 641 Rent expense Office 900.00 900.00 642 Rent expense. Selling 8,100.00 8,100.00 650 Office supplies expense 1,800.00 1,800.00 651 Store supplies expense 1,200.00 1,200.00 655 Advertising expense 2,700.00 2,700.00

380,400.00 380,400.00 29,100.00 29,100.00 305,200.00 326,700.00 79,700.00 58,200.00 21,500.00 21,500.00

326,700.00 326,700.00 79,700.00 79,700.00

AccountIncome Balance

Statement SheetAdjustmentsUnadjusted

Trial Balance

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Which method do I use?•  You can use either method to adjust

ending inventory that you wish–but you must only use one of the two methods.

•  Note that the “answer” (net income and ending inventory) is identical for both methods. Which you use is simply a matter of which makes most sense to you.

ACCT 652 Week 3 41

Items to Include in Merchandise Inventory

•  To determine whether goods in transit or goods sold but not delivered should be included in inventory, the FOB terms must be reviewed.– FOB destination: seller’s goods in transit.– FOB selling point: buyer’s goods in

transit.

ACCT 652 Week 3 42

What gets included in Merchandise Inventory?

•  Goods on consignment are shipped by their owner (the consignor) to another person or business (the consignee) who sells the goods for the owner.

•  Goods that are not sold at the inventory date are included in the consignor’s inventory count.

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Items to Include in Merchandise Inventory

•  Obsolete and damaged goods should not be counted in the inventory if they are not saleable.–  If these goods can be sold at a reduced price,

they should be included in the inventory at a conservative estimate of their net realizable value (sales price less cost of making the sale).

ACCT 652 Week 3 44

Assigning Costs to Inventory Items

What are the commonly used inventory methods?

Specific Invoice PricesWeighted-Average CostFirst-in, First-Out (FIFO)Last-in, First-Out (LIFO)First-in, Still-Here (FISH)

ACCT 652 Week 3 45

Method 1: �Specific Invoice Prices

•  Specific cost of each inventory item is known.

•  Used with small volume, high dollar inventory such as cars, mobile homes, and jewelry.

•  Prices are assigned to each item in the inventory.

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Method 2: �Weighted Average

•  Compute cost of goods available for sale:

CGAS = Dollars of beginning inventory + Dollars of Purchases

•  Compute total units available for sale:

TUAS = Units in beginning inventory + Units Purchased

ACCT 652 Week 3 47

Weighted Average•  Compute weighted-average cost (WAC) per

unit•  WAC per Unit = CGAS ÷ TUAS

•  Compute ending inventory•  Ending Inventory = Units in Ending Inventory * WAC per Unit

•  Compute COGS•  COGS = Units Sold * WAC per Unit

ACCT 652 Week 3 48

Weighted Average Example (1)•  The schedule on the next screen shows the mouse pad inventory for Computers, Inc. The physical inventory count shows 800 mouse pads in ending inventory.

•  Use the weighted average inventory pricing method to determine:

(1) Ending inventory cost

(2) Cost of goods sold

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Weighted Average Example (2)Computers, Inc.

Mouse Pad InventoryDate Units $/Unit Total

Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00

Goods Available for Sale 1,550 8,370.00$

Ending Inventory 800

Cost of Goods Sold

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Weighted Average Example Answer

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00

Goods Available for Sale 1,550 5.40 8,370.00$

Ending Inventory 800 5.40 4,320.00$

Cost of Goods Sold 750 5.40 4,050.00$

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Method 3: �First-In, First-Out

•  The costs of the oldest inventory items are charged to COGS when goods are sold.

•  The costs of the newest inventory items remain in ending inventory.

•  The actual physical flow of inventory items may differ from the FIFO cost flow assumptions.

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ACCT 652 Week 3 52

First-In, First-Out Example (1)The schedule on the next screen shows the mouse

pad inventory for Computers, Inc.

The physical inventory count shows 800 mouse pads in ending inventory.

Use the FIFO inventory pricing method to determine:



ACCT 652 Week 3 53

First-In, First-Out Example (2)Computers, Inc.



1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00



Cost of Goods Sold

ACCT 652 Week 3 54

First-In, First-Out Ending Inventory (in blue)


Date Units $/Unit TotalBeginning Inventory 750 5.25$ 3,937.50$

250 5.25$ 1,312.50$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00


Ending Inventory 800 4,432.50$

Cost of Goods Sold

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ACCT 652 Week 3 55

First-In, First-Out Cost of Goods Sold (in green)



250 5.25$ 1,312.50$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00



Cost of Goods Sold 750 5.25$ 3,937.50$

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Method 4: �Last-In, First-Out

•  The costs of the newest inventory items are charged to COGS when goods are sold.

•  The costs of the oldest inventory items remain in ending inventory.

•  The actual physical flow of inventory items may differ from the LIFO cost flow assumptions, although I do think I got some hundred year old lettuce last night at the store!

ACCT 652 Week 3 57

Last-In, First-Out Example (1)The schedule on the next screen shows the mouse

pad inventory for Computers, Inc.

The physical inventory count shows 800 mouse pads in ending inventory.

Use the LIFO inventory pricing method to determine:



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ACCT 652 Week 3 58

Last-In, First-Out Example (2)Computers, Inc.



1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00



Cost of Goods Sold 750

ACCT 652 Week 3 59

Last-In, First-Out Ending Inventory (in blue)



200 5.25$ 1,050.00$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00



Cost of Goods Sold 750

ACCT 652 Week 3 60

Last-In, First-Out Cost of Goods Sold (in green)



200 5.25$ 1,050.00$ Purchases:

1/3 100 5.30 530.00 6/20 150 5.60 840.00 9/15 200 5.80 1,160.00 11/29 100 5.90 590.00



Cost of Goods Sold 750 4,170.00$

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ACCT 652 Week 3 61

Comparison of MethodsComputers, Inc.

Income StatementFor Year Ended December 31, 19X2

Specific Invoice Prices

Weighted Average FIFO* LIFO

Net sales 25,000$ 25,000$ 25,000$ 25,000$ Cost of goods sold:Merchandise inventory, 12/31/X1 5,250$ 5,250$ 5,250$ 5,250$ Net purchases 3,120 3,120 3,120 3,120 Goods available for sale 8,370$ 8,370$ 8,370$ 8,370$ Merchandise inventory, 12/31/X2 4,310 4,320 4,433 4,200 Cost of goods sold 4,060$ 4,050$ 3,938$ 4,170$ Gross profit from sales 20,940$ 20,950$ 21,063$ 20,830$ Operating expenses: 750 750 750 750 Income before taxes 20,190$ 20,200$ 20,313$ 20,080$ Income taxes expense (30%) 6,057 6,060 6,094 6,024 Net income 14,133$ 14,140$ 14,219$ 14,056$

* FIFO amounts were rounded.

ACCT 652 Week 3 62

Comparison of Methods

Computers, Inc.Income Statement

For Year Ended December 31, 19X2 Specific Invoice Prices




In a period of rising prices, FIFO results in the highest ending inventory, the lowest cost of goods sold, the highest gross profit, and the highest net income.

ACCT 652 Week 3 63







In a period of rising prices, LIFO results in the lowest ending inventory, the highest cost of goods sold, the lowest gross profit, and the lowest net income.

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As you might expect, the results of using the weighted average method usually fall between FIFO and LIFO.

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The results for the specific invoice prices method depend entirely on which units are sold.

ACCT 652 Week 3 66

Comparison of Methods•  Each of the four methods is acceptable,

and an argument can be made for using each.

•  The choice of an inventory method must be disclosed in the notes to the financial statements.– This information is important to understanding

the financial statements and is required by the full-disclosure principle.

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Tax Effect of LIFONote that a tax advantage in the form of lower tax expense was gained by using LIFO. This is because LIFO reports the lowest net income amount which results in the lowest tax expense.

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Consistency Principle•  Because the choice of an inventory

method can have a significant effect on the financial statements, a company might be inclined to select a new method each year that would result in the most favorable financial statements.

•  However, the consistency principle requires that companies use the same accounting methods period after period so the financial statements of succeeding periods will be comparable.

ACCT 652 Week 3 69

Inventory Errors-Periodic System•  Misstatements in inventory may cause

errors in the following areas: –  Income Statement

•  COGS, Gross Profit, Net Income– Balance Sheet

•  Inventory, Payables, Retained Earnings

•  Also, the ending inventory of one period becomes the beginning inventory of the next period. Thus, the miscount problem is self-correcting over time.

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Perpetual Inventory Systems•  The inventory account is continuously

up-dated for the following items:–  Inventory purchases–  Inventory returns & discounts–  Inventory sales

•  At the end of period, we do a periodic inventory to check accuracy.

•  Perpetual gives us a better idea of what we have at a moment in time.

ACCT 652 Week 3 71

Lower of Cost or Market

A company may apply LCM three different ways:

Separately to each product.

To major categories of products.

To the inventory as a whole.

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Conservatism Principle

•  Generally accepted accounting principles require writing inventory down to market value when market value is less than cost.

•  However, when market value is greater than cost, the inventory is not written up to market value.

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Estimating Inventories

•  Most companies prepare financial statements on a quarterly or monthly basis.– These financial statements are called

interim financial statements.•  In a periodic inventory system, a

physical inventory is required to determine the ending inventory and cost of goods sold amounts.

ACCT 652 Week 3 74

Estimating Inventories•  However, since taking a physical inventory

is expensive and time consuming, most companies estimate the ending inventory and cost of goods sold amounts using one of two methods:– Retail inventory method– Gross profit method

•  Because these methods are well explained in your book, I am not going over them in class.

ACCT 652 Week 3 75

End of week 3!

•  We are done. Remember that the exam will be passed out next week, to be returned a few days later.

•  The exam is open book, open notes, but is to be done alone without other assistance. I will not answer questions after passing it out so…

•  Ask questions next week!

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