Q: Define and Discuss the Accounting Treatment for Contingent Liabilities
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 04
Reporting and Analyzing
Merchandising Operations
Conceptual Learning Objectives
C1: Describe merchandising activities and
identify income components for a
merchandising company.
C2: Identify and explain the inventory asset
and cost flows of a merchandising
company.
4-3
Analytical Learning Objectives
A1: Compute the acid-test ratio and
explain its use to assess liquidity.
A2: Compute the gross margin ratio and
explain its use to assess profitability.
4-4
Procedural Learning Objectives
P1: Analyze and record transactions for
merchandise purchases using a perpetual
system.
P2: Analyze and record transactions for
merchandise sales using a perpetual system.
P3: Prepare adjustments and close accounts for
a merchandising company.
P4: Define and prepare multiple-step and
single-step income statements.
P5: Appendix 4A – Record and compare
merchandising transactions using both
periodic and perpetual inventory systems
(see text for details).
4-5
C1
Merchandising Activities
Service organizations sell time to
earn revenue.
Examples: Accounting firms, law firms,
and plumbing services
Revenues
Minus
Expenses
Equals
Net
income
4-6
C1
Merchandising Activities
Merchandising Companies
Manufacturer
Wholesaler
Retailer
Customer
4-7
Reporting Income for
a Merchandiser
C1
Merchandising companies sell products to earn revenue.
Examples: sporting goods, clothing, and auto parts stores
Net
sales
Minus
Cost of Equals
goods sold
Gross
profit
Minus
Expenses
Equals
Net
income
Merchandising Company
Income Statement
For Year Ended December 31, 2011
Net sales
Cost of goods sold
Gross profit
Operating expenses
Net income
$ 150,000
80,000
$
70,000
46,500
$
23,500
4-8
C2
Operating Cycle for a
Merchandiser
Begins with the purchase of merchandise and ends with
the collection of cash from the sale of merchandise.
Credit Sale
Cash Sale
Purchases
Cash
collection
Purchases
Merchandise
inventory
Accounts
receivable
Cash
sales
Merchandise
inventory
Credit sales
4-9
C3
Inventory Systems
Beginning
inventory
+
Net
purchases
= Merchandise
available for sale
Ending inventory
+
Cost of goods
sold
4-10
P1
Merchandise Purchases
On June 20, Jason, Inc. purchased $14,000 of
Merchandise Inventory paying cash.
Dr.
Jun. 20 Merchandise Inventory
Cr.
14,000
Cash
14,000
Purchase merchandise for cash
4-11
P1
Trade Discounts
Used by manufacturers and wholesalers
to offer better prices for greater
quantities purchased.
Example
Matrix, Inc. offers a 30% trade
discount on orders of 1,000
units or more of their popular
product Racer. Each
Racer has a list price of $5.25.
Quantity sold
Price per unit
Total
Less 30% discount
Invoice price
1,000
$ 5.25
5,250
(1,575)
$ 3,675
4-12
Vendor’s Invoice for
Purchase of Merchandise
P1
Seller
Invoice date
Purchaser
Order number
Credit terms
Freight terms
Goods
Invoice amount
Invoice
Main Source, Inc.
614 Tech Avenue
Nashville, TN 37651
S
o
l
d
T
o
P.O. 167
Item
AC417
Sales: 25
Invoice
Date
5/4/12
Number
358-BI
Name: Barbee, Inc.
Attn: Tom Bell
Address: One Willow Plaza
Cookeville, Tennessee
38501
Terms 2/10,n/30
Description
250 Backup System
Ship: FedEx Prepaid
Quanity
Price
500 $ 54.00
$
Amount
27,000
Sub Total
Ship Chg.
Tax
Total
$
27,000
27,000
We appreciate your business!
4-13
P1
Purchase Discounts
A deduction from the invoice price granted to induce
early payment of the amount due.
Terms
Discount Period
Credit
Period
Time
Due
Date of
Invoice
Due: Invoice
price minus
discount
Due: Full Invoice Price
4-14
P1
Purchase Discounts
2/10,n/30
Discount
Percent
Number of
Days
Discount Is
Available
Otherwise,
Net (or All)
Is Due in 30
Days
Credit
Period
4-15
P1
Purchase Discounts
On May 7, Jason, Inc. purchased $27,000 of
merchandise inventory on account, credit
terms are 2/10, n/30.
Merchandise Inventory
Accounts Payable
Dr.
27,000
Cr.
27,000
Purchase merchandise on account
4-16
P1
Purchase Discounts
On May 15, Jason, Inc. paid the amount due
on the purchase of May 7.
Dr.
27,000
May 15 Accounts Payable
Cash
Merchandise Inventory*
Cr.
26,460
540
Pai d accounts payabl e i n ful l
*$27,000 × 2% = $540 discount
4-17
P1
Purchase Discounts
After we post these entries, the
accounts involved look like this:
Merchandise Inventory
Accounts Payable
5/7
5/15 27,000 5/7 27,000
27,000 5/15
Bal. 26,460
540
Bal.
0
4-18
P1
When Discount Is Not Taken
If we fail to take a 2/10, n/30
discount, is it really expensive?
365 days ÷ 20 days × 2% = 36.5% annual rate
Days
in a
year
Number
of additional
days before
payment
Percent
paid to
keep
money
4-19
P1
Purchase Returns and
Allowances
Purchase returns . . .
refer to merchandise a buyer acquires but then
returns to the seller.
Purchase allowance . . .
is a reduction in the cost of defective or
unacceptable merchandise that a buyer
acquires.
4-20
Purchase Returns and
Allowances
P1
On May 9, Matrix, Inc. purchased $20,000
of merchandise inventory on account,
credit terms are 2/10, n/30.
May 9
Merchandise Inventory
Accounts Payable
20,000
20,000
Purchase merchandise on account
4-21
P1
Purchase Returns and
Allowances
On May 10, Matrix, Inc. returned $500 of
defective merchandise to the supplier.
May 10 Accounts Payable
Merchandise Inventory
Dr.
500
Cr.
500
Returned defective merchandise
4-22
Purchase Returns and
Allowances
P1
On May 18, Matrix, Inc. paid the amount
owed for the purchase of May 9.
May 18
Accounts Payable
Cash
Merchandise Inventory
Dr.
19,500
Cr.
19,110
390
Pa i d a ccount i n ful l
Purchase
Returns
Amount Due
Discount
Cash Paid
$ 20,000
(500)
19,500
(390)
$ 19,110
4-23
P1
Transportation Costs
Buyer
Seller
FOB shipping point
(buyer pays)
Terms
FOB shipping point
FOB destination
Merchandise
FOB destination
(seller pays)
Ownership transfers
to buyer when goods
are passed to
Transportation
costs paid by
Carrier
Buyer
Buyer
Seller
4-24
P1
Transportation Costs
On May 12, Jason, Inc. purchased $8,000 of
merchandise inventory for cash and also
paid $100 transportation costs.
May 12 Merchandise Inventory
Cash
Dr.Dr.
8,100
Cr.
8,100
Paid for merchandise and transportation
4-25
P1
Quick Check
On July 6, 2011, Seller Co. sold $7,500 of merchandise to
Buyer, Co. on account; terms of 2/10,n/30. The shipping terms
were FOB shipping point. The shipping cost was $100. Which
of the following will be part of Buyer’s July 6 journal entry?
a. Credit Sales $7,500
b. Credit Purchase Discounts $150
c. Debit Merchandise Inventory $7,600
d. Debit Accounts Payable $7,450
FOB shipping point indicates the buyer ultimately
pays the freight. This is recorded with
a debit to Merchandise Inventory.
4-26
P1
Cost of Merchandise Purchased
MATRIX, INC.
Itemized Cost of Merchandise Purchases
For Year Ended May 31, 2011
Invoice cost of merchandise purchases
$ 692,500
Less:
Purchase discounts
(10,388)
Purchase returns and allowances
(4,275)
Add:
Cost of transportation-in
4,895
Total cost of merchandise purchases
$ 682,732
4-27
P2
Accounting for Merchandise Sales
MATRIX, INC.
Computation of Gross Profit
For Year Ended May 31, 2011
Sales
Less:
Sales discounts
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
$ 2,451,000
$ 29,412
18,500
47,912
$ 2,403,088
(1,928,600)
$
474,488
Sales discounts and returns and allowances are contra revenue accounts.
4-28
P2
Sales of Merchandise
On March 18, Diamond Store sold $25,000 of
merchandise on account. The merchandise was carried
in inventory at a cost of $18,000.
Mar. 18 Accounts Receivable
Sales
Dr.
25,000
Cr.
25,000
Sa l es of mercha ndi se on credi t
Cost of Goods Sold
Merchandise Inventory
18,000
18,000
To record cost of sa l es
4-29
P2
Sales Discounts
On June 8, Barton Co. sold merchandise costing $3,500
for $6,000 on account. Credit terms were 2/10, n/30. Let’s
prepare the journal entries.
Jun. 8
Accounts Receivable
Sales
Dr.
6,000
Cr.
6,000
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
3,500
3,500
To record cost of sales
4-30
P2
Sales Discounts
On June 17, Barton Co. received a check for $5,880
in full payment of the June 8 sale.
Jun 17
Cash
Sales Discounts
Accounts Receivable
5,880
120
6,000
Received payment less discount
4-31
P2
Sales Returns and Allowances
On June 12, Barton Co. sold merchandise
costing $4,000 for $7,500 on account. The
credit terms were 2/10, n/30.
Jun. 12 Accounts Receivable
Sales
Dr.
7,500
Cr.
7,500
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
4,000
4,000
To record cost of sales
4-32
P2
Sales Returns and Allowances
On June 14, merchandise with a sales price of $800 and
a cost of $470 was returned to Barton. The return is
related to the June 12 sale.
Jun. 14 Sales Returns and Allowances
Accounts Receivable
Dr.
800
Cr.
800
Customer returned merchandise
Merchandise Inventory
Cost of Goods Sold
470
470
Returned goods placed in inventory
4-33
P2
Sales Returns and Allowances
On June 20, Barton received the amount owed to it from
the sale of June 12.
Jun. 20
Cash
Sales Discount
Accounts Receivable
Dr.
6,566
134
Cr.
6,700
Recei ved payment l ess di scount
Sale
Return
Amount due
Discount
Cash received
$ 7,500
(800)
$ 6,700
(134)
$ 6,566
4-34
Completing the
Accounting Cycle
P3
BARTON COMPANY
Adjusted Trial Balance
December 31, 2011
Cash
Accounts receivable
Merchandise inventory
Supplies
Equipment
Accum. depr.- Equip.
Accounts payable
Salaries payable
Common Stock
Retained Earnings
Dividends
Sales
Sales discounts
Sales returns
Cost of goods sold
Admin. salaries expense
Sales salaries expense
Insurance expense
Rent expense
Supplies expense
Advertising expense
$
7,700
11,200
14,300
1,300
41,200
$
Next, let’s complete
the accounting cycle
by preparing the
7,000
16,400 closing entries for
1,000
Barton Company.
42,400
4,000
323,800
$
4,300
2,000
233,200
18,200
29,600
1,200
8,100
1,000
13,300
390,600
$
390,600
4-35
P3
Step 1: Close Credit Balances in
Temporary Accounts to Income Summary
Dec. 31 Sales
Income Summary
Dr.
323,800
Cr.
323,800
To close credit balances
in temporary accounts
BARTON COMPANY
Adjusted Trial Balance (partial)
December 31, 2011
Salaries payable
Common Stock
Dividends
Sales
Sales discounts
Sales returns
Cost of goods sold
Admin. salaries expense
Sales salaries expense
Insurance expense
Rent expense
Supplies expense
Advertising expense
1,000
42,400
4,000
323,800
4,300
2,000
233,200
18,200
29,600
1,200
8,100
1,000
13,300
Income Summary
323,800
4-36
P3
Step 2: Close Debit Balances in
Temporary Accounts to Income Summary
Dr.
De c. 31
Incom e Sum m ary
Cr.
310,900
Sale s Dis counts
4,300
Sale s Re turns
2,000
Cos t of Goods Sold
233,200
Adm . Salarie s Expe ns e
18,200
Sale s Salarie s Expe ns e
29,600
Ins urance Expe ns e
1,200
Re nt Expe ns e
8,100
Supplie s Expe ns e
1,000
Adve rtis ing Expe ns e
13,300
To cl ose debi t ba l a nces i n tempora ry a ccounts
Income Summary
310,900
323,800
12,900
4-37
P3
Step 3: Close Income Summary to
Retained Earnings
Dec. 31 Income Summary
Retained Earnings
Dr.
12,900
Cr.
12,900
To close Income Summary account
Income S ummary
310,900
323,800
12,900
-04-38
P3
Step 4: Close Dividends to
Retained Earnings
Dec. 31 Retained Earnings
Dividends
Dr.
4,000
Cr.
4,000
To cl ose the di vi dends account
4-39
P4
Multiple-Step Income Statement
BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Sales
Less: Sales discounts
Sales returns
Net sales
Cost of goods sold
Gross profit
Operating expenses:
Selling expenses:
Salaries expense
$ 29,600
Advertising expense
13,300
General and administrative expenses:
Adm. salaries expense
$ 18,200
Insurance expense
1,200
Rent expense
8,100
Supplies expense
1,000
Total operating expenses
Net income
$ 323,800
$
$
4,300
2,000
6,300
$ 317,500
233,200
$ 84,300
42,900
28,500
71,400
$ 12,900
4-40
P4
Single-Step Income Statement
BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Net sales
Cost of goods sold
Operating expenses
Total expenses
Net income
$ 317,500
$ 233,200
71,400
304,600
$ 12,900
4-41
P4
Balance Sheet
BARTON COMPANY
Balance Sheet
December 31, 2011
Assets:
Cash
$
7,700
Accounts receivable
11,200
Merchandise inventory
14,300
Supplies
1,300
Equipment
41,200
Accum. depr.- Equip.
(7,000)
Total assets
Liabilities
Accounts payable
Salaries payable
Total liabilities
Equity
Common stock
Retained earnings
Total liabilities
Total liabilities & equity
$
68,700
16,400
1,000
17,400
$
$
42,400
8,900
51,300
68,700
4-42
A1
Acid-Test Ratio
Acid-test
=
ratio
Acid-test
=
ratio
Quick assets
Current liabilities
Cash + S/T investments + receivables
Current liabilities
A common rule of thumb is the acid-test ratio should
have a value of at least 1.0 to conclude a company is
unlikely to face liquidity problems in the near future.
4-43
Gross Margin Ratio
A2
Gross
margin =
ratio
Net sales – Cost of goods sold
Net sales
Percentage of dollar sales available to
cover expenses and provide a profit.
4-44
End of Chapter 04
4-45
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 05
Reporting and Analyzing
Inventories
Conceptual Chapter Objectives
C1: Identify the items making up
merchandise inventory.
C2: Identify the costs of merchandise
inventory.
5-3
Analytical Chapter Objectives
A1: Analyze the effects of inventory methods
for both financial and tax reporting.
A2: Analyze the effects of inventory errors on
current and future financial statements.
A3: Assess inventory management using both
inventory turnover and days’ sales in
inventory.
5-4
Procedural Chapter Objectives
P1: Compute inventory in a perpetual system
using the methods of specific identification,
FIFO, LIFO, and weighted average.
P2: Compute the lower of cost or market
amount of inventory.
P3: Appendix 5A – Compute inventory in a
periodic system using the methods of
specific identification, FIFO, LIFO, and
weighted average (see text for details).
P4: Appendix 5B – Apply both the retail
inventory and gross profit methods to
estimate inventory (see text for details).
5-5
C1
Determining Inventory Items
Merchandise inventory includes all goods that
a company owns and holds for sale, regardless
of where the goods are located when inventory
is counted.
Items requiring special attention include:
Goods in
Transit
Goods on
Consignment
Goods
Damaged or
Obsolete
5-6
C1
Goods in Transit
FOB Shipping Point
Public
Carrier
Seller
Buyer
Ownership passes
to the buyer here.
Public
Carrier
Seller
FOB Destination Point
Buyer
5-7
C2
Determining Inventory Costs
Include all expenditures necessary to bring an
item to a salable condition and location.
Minus
Discounts
and
Allowances
Plus Import
Duties
Invoice
Cost
Plus
Freight
Plus
Insurance
Plus
Storage
5-8
C2
Internal Controls and Taking a Physical
Count
➢
Most companies take
a physical count of
inventory at least once
each year.
➢
When the physical
count does not match
the Merchandise
Inventory account, an
adjustment must be
made.
5-9
P1
Inventory Costing Under a Perpetual
System
Accounting for
inventory
requires several
decisions . . .
➢
Costing Method
⚫ Specific Identification, FIFO, LIFO,
or Weighted Average
➢
Inventory System
⚫ Perpetual or Periodic
5-10
P1
Frequency in Use of Inventory
Methods
FIFO
46%
LIFO
30%
Weighted
Average
20%
Other*
4%
5-11
P1
Inventory Cost Flow Assumptions
First-In, First-Out
(FIFO)
Assumes costs flow in the order
incurred.
Last-In, First-Out
(LIFO)
Assumes costs flow in the
reverse order incurred.
Weighted
Average
Assumes costs flow at an
average of the costs available.
5-12
P1
Inventory Costing Illustration
Cost of Goods Available for Sale
Aug. 1 Beg. Inventory
10 units @
Aug. 3 Purchased
15 units @
Aug. 17 Purchased
20 units @
Aug. 28 Purchased
10 units @
Retail Sales of Goods
Aug. 14 Sales
Aug. 31 Sales
$ 91
$ 106
$ 115
$ 119
=
=
=
=
$
910
$ 1,590
$ 2,300
$ 1,190
20 units @ $ 130 =
23 units @ $ 150 =
$ 2,600
$ 3,450
5-13
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
10 @
$
15 @
$ 106 =
91 =
Cost of Goods Sold
$
910
$ 1,590
8 @
20 @
10 @
Inventory
Balance
$
910
$ 2,500
$
91 =
$
728
12 @purchases
$ 106 =
$ were
1,272 $
500
The above
$ 115 = $ 2,300
$ 2,800
made
in
August.
On
August
14,
$ 119 = $ 1,190
$ 3,990
a company
8 bikes
2 @ sold
$
91
=
$
182
@ $ 106 $91
=
$and
31812
originally3 costing
14 @ $ 115 =
$ 1,610
bikes originally
costing
$106.
4 @
$ 119 =
$
476
$ 1,404
5-14
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
8
@
$ 91
=
$
Inventory
Balance
$
910
$
2,500
728
The cost of goods sold 12
for the
bikes
on $
@ 20
$ 106
= sold
$ 1,272
the August 14 sale is $2,000.
20 @ $ 115 = $ 2,300
$
10 @ $ 119
= $@1,190
$
8 bikes
91 =
$ 728
12 bikes @ 106 =2 @ $1,272
$ 91 =
$ 182
3
@
$ 106
=
$
500
2,800
3,990
318
After this sale, there are five units in inventory
14 @ $ 115 =
$ 1,610
at $500:
2 bikes @ $91 =
$ 182
3 bikes @ $106 =
$ 318
5-15
P1
Specific Identification
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
8
@
$ 91
=
$
12
@
$ 106
=
$ 1,272
2
@
$ 91
=
$
728
$
500
$ 2,800
$ 3,990
182
Additional purchases were made
3 @ on$ August
106 = 17$ and
31828.
14 August
@ $ 115
=
$as
1,610
The cost of the 23 items sold on
31 were
follows:
4 @ $ 119 =
$ 476 $ 1,404
2 @ $91
3 @ $106
15 @ $115
3 @ $119
5-16
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$
91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
8
@
$
91
=
$
728
12
@
$ 106
=
$ 1,272
2
@
$
91
=
$
182
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
3
@
$ 119
=
$
357
$
500
$ 2,800
$ 3,990
$ 1,408
Cost of goods sold for
August 31 = $2,582
5-17
P1
Specific Identification
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption
used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise inventory
1,590
1,590
2,600
2,600
2,000
2,000
2,300
2,300
1,190
1,190
3,450
3,450
2,582
2,582
5-18
P1
Date
Aug. 1
Aug. 3
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
Aug. 17 20 @ $ 115 = $ 2,300
The above purchases were
Aug. 28 10 @ $ 119 = $ 1,190
made
Aug.
31 in August.
5 @
18
@
On August 14, the company
sold 20 bikes.
$ 2,300
$ 3,490
$ 106
=
$
$ 115
=
$ 2,070
530
$
890
5-19
P1
Date
Aug. 1
Aug. 3
Aug. 14
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
10
@
$ 91
=
$
910
$
530
Aug. 17 20 @ $ 115 = $ 2,300
$ 2,830
Aug. 28 The
10 @Cost
$ 119 of
= goods
$ 1,190 sold for the August$ 4,020
Aug. 31
5 @ $ 106 =
$ 530
14 sale is $1,970. 18 @ $ 115 = $ 2,070 $ 1,420
10
@
$ 106
=
$ 1,060
After this sale, there are five units in
inventory at $530: 5 @ $106
5-20
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
Cost of goods sold for
August 31 = $2,600
5-21
P1
Date
Aug. 1
Aug. 3
Aug. 14
First-In, First-Out (FIFO)
Purchases
Aug. 31
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Income
Statement
Aug. 17 20
@ $ 115 =
Aug.
28 10
@ $ 119 =
COGS
= $4,570
Inventory
Balance
$
910
$ 2,500
910
10
@
$
91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$ 2,300
$ 1,190
$
530
$ 2,830
$ 4,020
530
$ 1,420
Balance Sheet
Inventory = $1,420
5-22
P1
First-In, First-Out (FIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
1,970
1,970
2,300
2,300
1,190
1,190
3,450
3,450
2,600
2,600
5-23
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
Aug.
20 @ $ 115 = $ 2,300
The17above
purchases were
Aug. 28 10 @ $ 119 = $ 1,190
made
Aug.
31 in August.
10 @
$ 119
=
$ 1,190
$ 115
=
$ 1,495
13
@
On August 14, the company
sold 20 bikes.
455
$
455
$ 2,755
$ 3,945
$ 1,260
5-24
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
15
@
$ 106
=
$ 1,590
$
455
Aug. 17 20 @ $ 115 = $ 2,300
$ 2,755
sold for the August$ 3,945
Aug. 28 The
10 @Cost
$ 119 of
= goods
$ 1,190
Aug. 31
10 $2,045.
@ $ 119 =
$ 1,190
14 sale is
13 @ $ 115 =
$ 1,495 $ 1,260
5
@
$ 91
=
$
455
After this sale, there are five units in
inventory at $455:
5 @ $91
5-25
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
910
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
Cost of goods sold for
August 31 = $2,685
5-26
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Aug. 17Income
20 @ $ 115 =
Statement
Aug.
28 10 @COGS
$ 119 =
= $4,730
Aug. 31
Inventory
Balance
$
910
$ 2,500
910
15
@
$ 106
=
$ 1,590
5
@
$
91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$ 2,300
$ 1,190
$
455
$ 2,755
$ 3,945
$ 1,260
Balance Sheet
Inventory = $1,260
5-27
P1
Last-In, First-Out (LIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
2,045
2,045
2,300
2,300
1,190
1,190
3,450
3,450
2,685
2,685
5-28
P1
Weighted Average
When a unit is sold, the
average cost of each unit
in inventory is assigned to
cost of goods sold.
Cost of goods
Units on hand
available for ÷ on the date of
sale
sale
5-29
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
10
15
20
10
Inventory
Balance
Purchases
Cost of Goods Sold
@ $ 91 = $ 910
$
910
@ $ 106 = $ 1,590
$ 2,500
20 @ $ the
100 weighted
= $ 2,000 $
500
First, we need to compute
@average
$ 115 =cost
$ 2,300
per unit of items in inventory. $ 2,800
@ $ 119 = $ 1,190
$ 3,990
Cost of goods available for sale
$ 2,500
23 @ $ 114 = $ 2,622 $ 1,368
Total units in inventory
25
Weighted average cost per unit
$
÷
100
The cost of goods sold for the August 14
sale is $2,000. After this sale, there are five
units in inventory at $500:
5-30
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
Cost of Goods Sold
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
$ 100 =
$
2,000
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
23 @ $ 114 = $ 2,622
Additional purchases were made
on August 17 and 28.
Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit
of items in inventory?
5-31
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
Cost of Goods Sold
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
Units
Inventory 8/14
5
Purchase 8/17
20
Purchase 8/28
10
Units available for sale
35
20 @
$ 100 =
$
2,000
23 @
$ 114 =
$
2,622
Cost of goods available for sale
Total units in inventory
Weighted average cost per unit
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
$
3,990
÷ 35
$
114
5-32
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
10
@ $ 91
= $
910
15
@ $ 106
= $ 1,590
20
@ $ 115
= $ 2,300
10
@ $ 119
= $ 1,190
Cost of goods sold for
August 31 = $2,622
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Ending inventory is
comprised of 12 units @ an
average cost of $114 each or
$1,368.
5-33
P1
Weighted Average
Date
Purchases
Aug. 1
10 @ $ 91 = $ 910
Aug. 3
15 @ $ 106 = $ 1,590
Aug. 14
Aug. 17 Income
20 @ $ 115 = $ 2,300
Aug.Statement
28 10 @ $COGS
119 = $ 1,190
Aug. 31 = $4,622
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Balance Sheet
Inventory = $1,368
5-34
P1
Weighted Average
Here are the entries to record the purchases and sales
entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
Merchandise Inventory
Accounts Payable
Merchandise Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory
1,590
1,590
2,600
2,600
2,000
2,000
2,300
2,300
1,190
1,190
3,450
3,450
2,622
2,622
5-35
A1
Financial Statement Effects of Costing
Methods
Because prices change, inventory methods nearly
always assign different cost amounts.
TREKKING COMPANY
For Month Ended August 31
Specific
Identification
Sales
$
6,050
Cost of goods sold
4,582
Gross profit
$
1,468
Operating expenses
450
Income before taxes
$
1,018
Income tax expense (30%)
305
Net income
$
713
Balance sheet inventory
$
1,408
$
FIFO
6,050
4,570
1,480
450
1,030
309
721
$
1,420
$
$
$
$
LIFO
6,050
4,730
1,320
450
870
261
609
$
1,260
$
$
$
Weighted
Average
$
6,050
4,622
$
1,428
450
$
978
293
$
685
$
1,368
5-36
A1
Financial Statement Effects of Costing
Methods
Advantages of Methods
Weighted
Average
First-In,
First-Out
Last-In,
First-Out
Smoothes out
price changes.
Ending inventory
approximates
current
replacement cost.
Better matches
current costs in cost
of goods sold with
revenues.
5-37
A1
Tax Effects of Costing Methods
The Internal Revenue Service (IRS)
identifies several acceptable
methods for inventory costing for
reporting taxable income.
If LIFO is used for tax
purposes, the IRS requires
it be used in financial
statements.
5-38
A1
Consistency in Using Costing
Methods
The consistency concept requires a
company to use the same accounting
methods period after period so that
financial statements are comparable
across periods.
5-39
P2
Lower of Cost or Market
Inventory must be reported at market
value when market is lower than
cost.
Defined as current
replacement cost
(not sales price).
Consistent with
the conservatism
principle.
Can be applied three ways:
(1)
(2)
(3)
separately to each
individual item.
to major categories of
assets.
to the whole inventory.
5-40
P2
Lower of Cost or Market
A motorsports retailer has the following items in
inventory:
Per Unit
Inventory Items
Cycles:
Roadster
Sprint
Category subtotal
Off-Road
Trax-4
Blazer
Category subtotal
Total
Units on
Hand
Cost
20 $ 8,000
10
5,000
8
5
5,000
9,000
Total
Cost
Total
Market
$ 7,000
6,000
$160,000
50,000
210,000
$ 140,000
60,000
200,000
6,500
7,000
40,000
45,000
85,000
$295,000
52,000
35,000
87,000
$ 287,000
Market
5-41
P2
Lower of Cost or Market
Here is how to compute lower of cost or
market for individual inventory items.
LCM Applied to
Units on
Inventory Items Hand
Total Cost
Cycles:
Roadster
20 $ 160,000
Sprint
10
50,000
Category subtotal
$ 210,000
$ 140,000 $ 140,000
60,000
50,000
$ 200,000
Off-Road
Trax-4
Blazer
Category subtotal
Total
$ 52,000
40,000
35,000
35,000
$ 87,000
$ 287,000 $ 265,000
8
5
$ 40,000
45,000
$ 85,000
$ 295,000
Total
Market
Items
Categories
Whole
5-42
A2
Financial Statement Effects of Inventory
Errors
Income Statement Effects
Inventory Error
Understate ending inventory
Understate beginning inventory
Overstate ending inventory
Overstate beginning inventory
Cost of Goods Sold
Overstated
Understated
Understated
Overstated
Net Income
Understated
Overstated
Overstated
Understated
5-43
A2
Financial Statement Effects of Inventory
Errors
Balance Sheet Effects
Inventory Error
Understate ending inventory
Overstate ending inventory
Assets
Equity
Understated Understated
Overstated
Overstated
5-44
A3
Inventory Turnover
Shows how many times a company turns over its
inventory during a period. Indicator of how well
management is controlling the amount of
inventory available.
Inventory
turnover
Average
inventory
=
Cost of goods sold
Average inventory
= (Beg. Inv. + End Inv.) ÷ 2
5-45
A3
Days’ Sales in Inventory
Reveals how much inventory is available in
terms of the number of days’ sales.
Days’ sales in
inventory
=
Ending inventory
365
×
Cost of goods sold
5-46
End of Chapter 05
5-47
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 06
Reporting and Analyzing
Cash and Internal Controls
Conceptual Learning Objectives
C1: Define internal control and identify its
purpose and principles.
C2: Define cash and cash equivalents
and explain how to report them.
6-3
Analytical Learning Objectives
A1: Compute the days’ sales uncollected
ratio and use it to assess liquidity.
6-4
Procedural Learning Objectives
P1: Apply internal control to cash receipts
and disbursements.
P2: Explain and record petty cash fund
transactions.
P3: Prepare a bank reconciliation.
P4: Appendix 6A – Describe the use of
documentation and verification to
control cash disbursements (see text for
details).
P5: Appendix 6B – Apply the net method to
control purchase discounts (see text for
details).
6-5
C1
Purpose of Internal Control
Managers use policies and procedures to:
Protect assets.
2. Ensure reliable accounting.
1.
Promote efficient operations.
4. Urge adherence to company
policies.
3.
6-6
C1
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, also known as SOX, requires
management and auditors of publicly held companies to
adhere to or perform specific requirements, such as:
1. Evaluation of internal controls.
2. Oversight of the Auditor’s work by the Public
Company Accounting Oversight Board (PCAOB).
3. Restriction on consulting services performed by
auditors.
4. Term limits on person leading the audit.
5. Harsh penalties for violators, including prison time
with severe fines.
6-7
Principles of Internal Control
C1
1.
Establish responsibilities.
2.
Maintain adequate records.
3.
Insure assets and bond key employees.
4.
Separate recordkeeping from custody
of assets.
5.
Divide responsibility for related transactions.
6.
Apply technological controls.
7.
Perform regular and independent reviews.
6-8
C1
Technology and Internal Control
Reduced
Processing
Errors
More
Extensive Testing
of Records
Limited
Evidence of
Processing
Crucial
Separation of
Duties
Increased
E-commerce
6-9
C1
Limitations of Internal Control
Human Error
Human Fraud
Negligence
Fatigue
Misjudgment
Confusion
Intent to
defeat internal
controls for
personal gain
6-10
C1
Limitations of Internal Control
The costs of internal controls
must not exceed their benefits.
Benefits
Costs
6-11
C1
Control of Cash
An effective system of internal control that
protects cash and cash equivalents should meet
three basic guidelines:
Handling cash is
separate from
recordkeeping of
cash.
Cash receipts are
promptly deposited
in a bank.
Cash
disbursements are
made by check.
6-12
C2
Cash, Cash Equivalents, and
Liquidity
Cash
Currency, coins, and amounts on deposit in
bank accounts, checking accounts, and
many savings accounts. Also includes items
such as customer checks, cashier checks,
certified checks, and money orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
interest rate changes.
6-13
C2
Cash, Cash Equivalents, and
Liquidity
Liquidity
How easily an asset can be converted into
cash to be used to pay for services or
obligations.
Inventory
Cash
6-14
C2
Cash Management Principles
When companies fail, one of the most
common causes is their inability to
manage cash. The goals of cash
management are twofold:
◼ Plan cash receipts to meet cash
payments when due.
◼ Keep the minimum level of cash
necessary to operate.
6-15
Control of Cash Receipts
P1
Over-the-Counter
Cash Receipts
◼
◼
Cash register with
locked-in record of
transactions.
Compare cash
register record with
cash reported.
Cash Receipts By Mail
◼
Two people open the
mail.
✓ Money to cashier’s
office.
✓ List to accounting
dept.
✓ Copy of list filed.
6-16
Control of Cash Disbursements
P1
◼
◼
◼
All expenditures should be made by check.
The only exception is for small payments
from petty cash.
Separate authorization for check signing
and recordkeeping duties.
Use a voucher system.
6-17
Voucher System of Control
P1
A voucher system establishes procedures
for:
⚫
Verifying, approving, and recording obligations
for eventual cash disbursements.
⚫
Issuing checks for payment of verified,
approved, and recorded obligations.
6-18
P1
Voucher System of Control
Sender
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Supplier (Vendor)
Cashier
Accounting, Requesting
& Purchasing
Accounting
Supplier, Requesting,
Receiving & Accounting
Purchasing and
Accounting
Voucher
6-19
P2
Petty Cash System of Control
Small payments required in most
companies for items such as postage,
courier fees, repairs, and supplies.
6-20
P2
Operating a Petty Cash Fund
Petty Cash
Company
Cashier
Petty
Cashier
May 1
Petty cash
Cash
400
400
Accountant
6-21
P2
Operating a Petty Cash Fund
Petty Cash
Petty
Cashier
6-22
P2
Operating a Petty Cash Fund
A petty cash fund
is used only for
business
expenses.
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-23
P2
Operating a Petty Cash Fund
Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.
Receipts
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-24
P2
Operating a Petty Cash Fund
Receipts
$125
Company
Cashier
To reimburse
petty cash fund
May 31
Use a Cash
Over and Short
account if needed.
Petty
Cashier
Postage expense
Delivery expense
Cash
45
80
125
Accountant
6-25
P2
Petty Cash Example
Tension Co. maintains a petty cash fund of $400.
The following summary information was taken from
petty cash vouchers for July:
Travel Expenses
Customer Business Lunches
Express Mail Postage
Miscellaneous Office Supplies
$79.30
93.42
55.00
32.48
Let’s look at replenishing the fund if the balance on
July 31 was $137.80.
6-26
P2
Petty Cash Example
What amount of cash will be required
to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
6-27
Petty Cash Example
P2
What amount of cash will be
required to replenish the petty
cash fund?
a.
b.
c.
d.
$260.20
$262.20
$139.80
$137.80
Desired balance
Actual balance
Amount needed
$ 400.00
137.80
$ 262.20
Let’s prepare the journal entry to replenish the
petty cash fund.
6-28
P2
Petty Cash Example
Journal entry to replenish petty cash fund
Dr.
July 31 Travel Expense
79.30
Entertainment Expense
93.42
Postage Expense
55.00
Office Supplies Expense
32.48
Cash Over and Short
2.00
Cash
Cr.
262.20
6-29
P1
Banking Activities as Controls
Bank Accounts
Signature Cards
Deposit Tickets
Checks
Electronic
Funds
Transfer
Bank
Statements
6-30
Bank Reconciliation
P3
A bank reconciliation is prepared periodically to explain the
difference between cash reported on the bank statement and the
cash balance on company’s books.
Bank Statement
First National Bank
Nashville, TN 37459
May 31, 2011
*
Clothes Mart
Nashville, TN
Why are the
balances different?
Acct No 278609
Previous
Balance
Total Checks
1488.79
5/1
5/2
1,367.09
107
5/4
5/7
5/9
5/12
108
109
110
111
Total
Deposits
2,604.22
55.00
Current
Balance
2,725.92
Account: Cash
GENERAL LEDGER
Acct. No.
1,251.88
279.50
44.75
21.81
37.55
5/15
5/18
5/21
5/27
5/30
112
113
114
175.98
288.31
12.54
5/31
115
451.65
Date
Item
May 31 Balance
PR
Debit
Credit
102
Balance
DR (CR)
2,481.18
825.04
527.30
6-31
P3
Reconciling Items
Bank Statement Balance
⚫ Add:
Deposits in transit.
⚫ Deduct:
Outstanding
checks
⚫ Add or Deduct:
Bank errors.
•
•
•
•
•
Book Balance
Add: Collections
made by the bank.
Add: Interest earned
on checking account.
Deduct:
Nonsufficient funds
check (NSF).
Deduct: Bank
service charge.
Add or Deduct:
Book errors.
6-32
P3
Bank Reconciliation
Two sections:
1. Reconcile bank statement balance to
the adjusted bank balance.
2. Reconcile book balance to the adjusted
book balance.
The adjusted balances should be equal.
6-33
P3
Bank Reconciliation Example
Let’s prepare a July 31 bank reconciliation
statement for the Simmons Company.
◼
◼
The July 31 bank statement indicated a
balance of $9,610.
The cash general ledger account on that
date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next screen.
6-34
P3
Bank Reconciliation Example
1.
Outstanding checks totaled $2,417.
2.
A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
3.
The bank returned a customer’s NSF check for $225
received as payment on account receivable.
4.
The bank statement showed $30 interest earned during
July.
5.
Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.
6.
A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
6-35
P3
Bank Reconciliation Example
Simmons Company
Bank Reconciliation
July 31, 2011
Bank Balance, July 31
Add: Deposit in Transit
Less: Bank Error
$
486
Outstanding Checks
2,417
Adjusted Balance, July 31
Book Balance, July 31
Add: Interest
Less: Recording Error
NSF Check
Adjusted Balance, July 31
$
(2,903)
$ 7,207
$
$
9,610
500
28
225
$
7,430
30
(253)
7,207
6-36
P3
Adjusting Entries from a
Bank Reconciliation
Only amounts shown on the book portion
of the reconciliation require an adjusting
entry.
Dr.
30
July 31 Cash
Interest revenue
July 31 Supplies expense
Accounts receivable
Cash
Cr.
30
28
225
253
6-37
P3
Adjusting Entries from a
Bank Reconciliation
After posting the reconciling entries the cash account
looks like this:
Account: Cash
GENERAL LEDGER
Acct. No.
Date
Item
July 31 Balance
31 Adjusting entry
31 Adjusting entry
PR
Debit
Credit
30
253
101
Balance
DR (CR)
7,430
7,460
7,207
Adjusted balance on July 31.
6-38
A1
Days’ Sales Uncollected
How much time is likely to pass before
we receive cash receipts from credit sales?
Days’
=
sales
uncollected
Accounts receivable
Net sales
× 365
6-39
End of Chapter 06
6-40
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