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ACCT 201 FINANCIAL REPORTING Chapter 5 Dr. Lale Guler Office: CAS 102 E-Mail: [email protected] edu. tr 5 -1 1
CHAPTER 5 Study Objectives 1. The differences between service and merchandising companies Accounting for Merchandising Operations 2. The differences between perpetual and periodic inventory systems 3. The differences between a multi-step and single-step income statement 4. Comparison between the U. S. GAAP and IFRS 5 -2
Merchandising Operations Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales. 5 -3
Merchandising vs. Service Companies Illustration 5 -2 Operating Cycles The operating cycle of a merchandising company ordinarily is longer than that of a service company. 5 -4
Merchandising Operations Flow of Costs Illustration 5 -3 Cost of goods sold is the total cost of merchandise sold during the period. 5 -5 Companies use either a perpetual inventory system or a periodic inventory system to account for inventory.
Merchandising Operations Income Measurement Not used in a Service business. Illustration 5 -1 5 -6
Perpetual vs. Periodic Systems Perpetual system: l l 5 -7 Inventory is adjusted for each change in inventory COGS is adjusted for each sale/sale return Directly determines how many goods are on hand on any date (without taking physical count) Directly determines how many items are sold Periodic system: l l l Inventory is NOT adjusted for each change in inventory COGS is NOT adjusted for each sale/sale return; physical count determines cost of goods on hand cost of goods sold Based on physical count, inventory is adjusted periodically at the end of a reporting period.
Perpetual vs. Periodic Systems Perpetual system: Periodic system: u u Record purchases in Purchases account. u 5 -8 Record purchases in Inventory account. Purchase returns and allowances, Purchase discounts, and Freight costs are not recorded in separate accounts. u Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts.
Perpetual vs. Periodic Systems Fesmire Co. reports the following data for 2000: Beginning Inventory January 1: 10 units at $10 Purchases and Sales (all credit) March 12: Purchased 30 units at $10. April 8: Sold 18 units at $16. July 6: Purchased 25 units at $10 August 9: Sold 24 units at $18. Required: Provide journal entries. 5 -9 .
Perpetual System Date Mar 12 Purchase Apr 8 Sale Jul 6 Purchase Aug 9 Sale 5 -10 Record Inventory Changes Record Sales Revenue
Periodic System Date Mar 12 Apr 8 Jul 6 Aug 9 Dec 31 5 -11 Record Inventory Changes Record Sales Revenue
Periodic Cost of Goods 5 -12 System Sold Equation
Perpetual Inventory System Recording Purchases of Merchandise Illustration 5 -5 Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. May 4 Inventory Accounts payable 5 -14 3, 800
Perpetual Inventory System Freight Costs (Terms of Sale) Buyer pays freight costs. Seller pays freight costs. 5 -15
Perpetual Inventory System Freight Costs (Terms of Sale) Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo (the buyer) pays Acme Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: May 6 Inventory 150 Cash 150 Assume the freight terms on the invoice in Illustration 5 -5 had required PW Audio Supply (the seller) to pay the freight charges, the entry by PW Audio Supply would have been: May 4 Freight-out Cash 5 -16 150 Freight costs incurred by the seller are an operating expense.
Perpetual Inventory System Purchase Returns and Allowances Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. 5 -17 Purchase Allowance May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price.
Perpetual Inventory System Purchase Returns Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. May 8 Accounts payable Inventory 5 -18 300
Perpetual Inventory System Purchase Discounts Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages: Example: terms may read 2/10, n/30. u Purchaser saves money. u 5 -19 Credit Seller shortens the operating cycle.
Perpetual Inventory System Purchase Discounts 2/10, n/30 n/10 EOM 2% discount if paid within 10 days, otherwise net amount due within 30 days. 5 -20 1/10 EOM 1% discount if paid within first 10 days of next month. Net amount due within the first 10 days of the next month.
Perpetual Inventory System Purchase Discounts Illustration: Assume Sauk Stereo pays the balance due of $3, 500 (gross invoice price of $3, 800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk Stereo makes to record its May 14 payment. May 14 Accounts payable Inventory Cash (Discount = $3, 500 x 2% = $70) 5 -21 3, 500 70 3, 430
Perpetual Inventory System Purchase Discounts Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3, 500 on June 3, the journal entry would be: June 3 Accounts payable Cash 5 -22 3, 500
Perpetual Inventory System – Summary of Purchasing Transactions 4 th - Purchase 6 th – Freight-in $3, 500 150 Balance $3, 580 5 -23 $300 70 8 th - Return 14 th - Discount
Perpetual Inventory System – Sales of Merchandise u Made using cash or credit (on account). u Normally recorded when earned, usually when goods transfer from seller to buyer. u Sales invoice should support each credit sale. 5 -24 Illustration 5 -5
Perpetual Inventory System – Sales of Merchandise #1 Cash or Accounts receivable XXX Sales revenue #2 Cost of goods sold Inventory 5 -25 XXX XXX Selling Price Cost
Perpetual Inventory System – Sales of Merchandise Illustration: Assume PW Audio Supply records its May 4 sale of $3, 800 to Sauk Stereo on account (Illustration 5 -5) as follows. Assume the merchandise cost PW Audio Supply $2, 400. May 4 Accounts receivable 3, 800 Sales revenue 4 Cost of goods sold Inventory 5 -26 3, 800 2, 400
Perpetual Inventory System – Sales returns and allowances u Account : Sales returns and allowances u “Flipside” of purchase returns and allowances. u Contra-revenue account (debit). u Sales not reduced (debited) because: ► ► 5 -27 Would obscure importance of sales returns and allowances as a percentage of sales. Could distort comparisons.
Perpetual Inventory System – Sales returns and allowances Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective. May 8 Sales returns and allowances 300 Accounts receivable 8 Inventory Cost of goods sold 5 -28 300 140
Perpetual Inventory System – Sales returns and allowances Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries: May 8 Sales returns and allowances 300 Accounts receivable 8 Inventory Cost of goods sold 5 -29 300 50 50
Perpetual Inventory System – Sales discounts u u “Flipside” of purchase discount. u 5 -30 Offered to customers to promote prompt payment. Contra-revenue account (debit).
Perpetual Inventory System – Sales discounts Illustration: Assume Sauk Stereo pays the balance due of $3, 500 (gross invoice price of $3, 800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14 Cash Sales discounts Accounts receivable * [($3, 800 – $300) X 2%] 5 -31 3, 430 * 70 3, 500
Completing the Accounting Cycle Adjusting Entries u u One additional adjustment to make the records agree with the actual inventory on hand. u 5 -32 Generally the same as a service company. Involves adjusting Inventory and Cost of Goods Sold.
Completing the Accounting Cycle Illustration: Suppose that PW Audio Supply has an unadjusted balance of $40, 500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is $40, 000. The company would make an adjusting entry as follows. Cost of goods sold Inventory 5 -33 500
Periodic Inventory System Recording Purchases of Merchandise Illustration: On the basis of the sales invoice (Illustration 5 -5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3, 800 purchase as follows. May 4 Purchases Accounts payable 5 -34 3, 800
Periodic Inventory System Freight Costs Illustration: If Sauk pays Haul-It Freight Company $150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is: May 6 Freight-in (Transportation-in) Cash 5 -35 150
Periodic Inventory System Purchase Returns and Allowances Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return. May 8 Accounts payable 300 Purchase returns and allowances 5 -36 300
Periodic Inventory System Purchase Discounts Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk Stereo records the payment and discount as follows. May 14 Accounts payable Purchase discounts Cash 5 -37 3, 500 70 3, 430
Periodic Inventory System Recording Sales of Merchandise Illustration: PW Audio Supply, records the sale of $3, 800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5 -5) as follows. May 4 Accounts receivable Sales revenue 3, 800 No entry is recorded for cost of goods sold at the time of the sale under a periodic system. 5 -38
Periodic Inventory System Sales Returns and Allowances Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows. May 4 Sales returns and allowances Accounts receivable 5 -39 300
Periodic Inventory System Sales Discounts Illustration: On May 14, PW Audio Supply receives payment of $3, 430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows. May 14 Cash Sales discounts Accounts receivable 5 -40 3, 430 70 3, 500
Summary Comparison of Entries—Perpetual Vs. Periodic Illustration 5 A-3 5 -41
Summary Comparison of Entries—Perpetual Vs. Periodic Illustration 5 A-3 5 -42
Forms of Financial Statements Single-Step Income Statement u u 5 -43 Subtract total expenses from total revenues Format is simpler and easier to read.
Forms of Financial Statements Single-Step Income Statement Illustration 5 -14 5 -44
Forms of Financial Statements Multiple-Step Income Statement u u Two steps relate to principal operating activities. u 5 -45 Shows several steps in determining net income. Distinguishes between operating and non-operating activities.
Forms of Financial Statements Income Statement Presentation of Sales 5 -46 Illustration 5 -13
Forms of Financial Statements Illustration 5 -13 Gross Profit Key Items: u Net sales u Gross profit rate Illustration 5 -10 5 -47
Forms of Financial Statements Operating Expenses Key Items: u Net sales u Gross profit u Operating expenses 5 -48 Illustration 5 -13
Forms of Financial Statements Key Items: u Net sales u Gross profit u Operating expenses u Non-operating activities u Net income Illustration 5 -13 5 -49
Forms of Financial Statements Key Items: u Net sales u Gross profit u Operating expenses u Non-operating activities u Net income Illustration 5 -12 5 -50
Periodic Inventory System Determining Cost of Goods Sold Illustration 5 A-2 5 -51
Key Points u u 5 -52 Under IFRS, revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS results in more transactions affecting equity (other comprehensive income) but not net income. IAS 1, “Presentation of Financial Statements, ” provides general guidelines for the reporting of income statement information. Subsequently, a number of international standards have been issued that provide additional guidance to issues related to income statement presentation.
Key Points u u 5 -53 Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such as those on so-called “available-for-sale securities”) that are not included in the calculation of net income. IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.
Looking to the Future The IASB and FASB are working on a project that would rework the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number —net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. For example, the amount of income that is generated by operations would be traceable to the assets and 5 -54
Looking to the Future liabilities used to generate the income. Finally, this approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature. The new financial statement format was heavily influenced by suggestions from financial statement analysts. 5 -55
Recording Purchases of Merchandise Question In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: a. Purchases b. Purchase Returns c. Purchase Allowance d. Inventory 5 -56
Recording Sales of Merchandise Question The cost of goods sold is determined and recorded each time a sale occurs in: a. periodic inventory system only. b. a perpetual inventory system only. c. both a periodic and perpetual inventory system. d. neither a periodic nor perpetual inventory system. 5 -57
Forms of Financial Statements Question The multiple-step income statement for a merchandiser shows each of the following features except: a. gross profit. b. cost of goods sold. c. a sales revenue section. d. investing activities section. 5 -58