Notes on chapter 5:

Statement of Owner's Equity:

This represents the calculation of ending capital for analytical purposes along with the Balance Sheet and Income Statement.



Link between the 3 financial statements:

The Income Statement value for NI (NL) is added to the statement of Owner's Equity and the value for ending capital is added to the Balance Sheet in the Owner's Equity section.



Balance Sheet:

  1. The Balance Sheet listed with Assets on left and Liabilities & Owner's Equity on the right is known as the Account Form.
  2. When the Balance Sheet is classified into Assets, Liabilities and Owner's Equity vertically is known as the Report Form.
  1. On a Classified Balance Sheet the accounts are classified into:
    1. Current Assets (these can be converted to cash within a year)

E.g. Bank, A/R, Supplies, Prepaid expenses and Inventory.

    1. Fixed Assets (held for long-term revenue generation)

E.g. Equipment, Land, Building and Accumulated Depreciation.

    1. Current Liabilities (due within a year)

E.g. Accounts Payable, Salaries Payable.

    1. Long Term Liabilities (due after a year)

E.g. Notes Payable, Mortgage.



Merchandising companies sell products, not services, that are purchased as a finished product & sold @ a profit. They differ from service companies because they have:

  1. On BS, the current asset, Inventory.
  2. On IS, their largest expense, Cost of Goods Sold (COGS) representing the cost they paid for the product they are selling.


Retailers:

sell products to the public & purchase their products to sell from wholesalers.

Wholesalers:

buy products in large volume from manufacturers & sell only to retailers, not the public.

Manufacturers:

create products & sell them to wholesalers. Do not usually sell to the public. Some companies may be manufacturers who do sell to the public, eg. Laura Secord.



COGS:

Begining Inventory
Purchases
Freight in
Cost of Goods Available for Sale (COGAS).
COGAS+Ending Inventory
COGS


The methods of recording inventory in merchandising companies:

Record the COGS as they occur & Inventory increases or decreases as purchased or sold.

Take physical inventory at the end og the fiscal period and calculate COGS.



Taking physical inventory:

inventory is updated immediately when purchased or sold, thus, by year-end the value in the 'inventory' ledger account is fairly correct. A physical inventory count is taken for the exact figure to appear on the BS. Inventory shrinkage may have accrued due to:

The adjusting entry required would be to allocate the 'loss' in inventory to the COGS expense.



Closing entries in a perpetual inventory system:

The revenue + expense are closed as in a service industry.

The new accounts are Inventory, COGS. Inventory is a real account therefore it is not closed. COGS is a nominal account so it is closed to zero.



Perpetual system of inventory:

Inventory is adjusted @ fiscal year end (never touch inventory).

Purchases is a nominal account used to reflect inventory & has a debit balance.



Begining inventory
purchases
freight in
COGAS.
(end inventory)
COGS


Comparing the Income Statements for the 2 methods:

Perpetual Periodic
Revenue Revenue
Sales $x Sales
COGS y COGS: Beginning inventory
Gross profit $x-y Purchases
Operating expenses Freight-in
Advertising $a COGAS
Rent b Ending inventory
(a+b) Gross profit
Net Income $x-y-a-b Operating expenses
Net Income


At times merchandising companies purchase inventory & are offered a discount to pay for the inventory within a certain time period. If the inventory they purchase is defective they record this into a new account.



Terms:

Every purchase or invoice includes terms of payment & any discount offered.

E.g. 2/10, n,30 means a 2% discount if paid within 10 days else whole amount is due in 30 days.



The accounts recorded for this are:

1. Purchase Discounts (CR bal)

2. Purchase returns & allowances (CR bal)

These are contra purchase accounts.





When a merchandiser sells inventory & issues terms that allow for a discount period, customers that pay for their goods will involve the following accounts:

1. Sales Discount (DR bal)

2. Sales returns & allowance (DR bal)

These are contra sales accounts.

COGS: Beginning Inventory
Net Purchases
Freight-in
COGAS
(Ending Inventory)
COGS


Income Stmt:

Revenues
Sales
(Sales R & A)
(Sales Discounts)
COGS
Beginning Inventory
Purchases
(Purchase Discounts)
(Purchase R & A)
Freight-in
COGAS
(Ending Inventory)
Gross Profit