Exam Review (Chapters 5,6)

Chapter 5
Objective 1: Merchandising Operations and Inventory Systems

Cost of Goods Sold

Define:
Type of Account Normal Balance Financial Statement
Expenses Debit Income Statement

Inventory
Define:
Type of Account Normal Balance Financial Statement
Asset Debit Balance Sheet

Merchandising Measurement Process (income statement) Illustration 5.1:

Sales Revenue - СOGS = Gross Profit - - Operating Expense=Net Income (
Loss )

Flow of Costs:
1) Beginnig Inventory + Cost of Goods Purchased = Cost of Goods
Available for Sale

2) Cost of Goods Available for Sale - COGS =

Ending Inventory
OR
3) Cost of Goods Available for Sale - Cost of Goods Purchased =
Beginning Inventory

Define
Periodic:
Perpetual:
Objective 2: Recording a Purchase
Freight Costs:
FOB Shipping Point:
Who pays for shipping The Buyer

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Exam Review (Chapters 5,6)

Who owns the inventory in transit The Buyer

What account does shipping charges go to (The cost purchasing) Inventory

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Exam Review (Chapters 5,6)
Example: The company purchases inventory FOB shipping point from the Seller. The shipping
were $400. Record the entry for shipping chargers for the company.
Inventory 400

Cash 400

FOB Destination:
Who pays for shipping The seller
Who owns the inventory in transit The seller
What account does shipping charges go to Operating Expense

Example: The company purchases inventory FOB destination from the Seller. The shipping
were $400. Record the entry for shipping chargers for the seller.
Freight-out 400

Cash 400

Purchase Returns and Allowances:

Define Purchase Return: A purchase return occurs when the buyer of merchandise, inventory,
fixed assets, or other items sends these goods back to the seller.
Define Purchase Discount: A purchase discount is a deduction that a company may receive if the
supplier offers it and the company pays the supplier's invoice within a specified period of time.
Identify each number in 2/10, n/30

2 = 2% cash discount on the invoice N = less "net of" any returns or

price
10 = if payment is made within 10 days 30 = The invoice price less any returns
of the invoice date (discount period) or allowances is due 30 days from the
invoice date

The Buyer purchases inventory of $2,000 on account with the terms 2/10, n/30.
Record the Purchase:
Inventory 2,000
Accounts Payable 2,000

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Exam Review (Chapters 5,6)
Record the Payment within discount period:
Account Payable 2000
Cash 1,960

Inventory 40

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 Exam Review (Chapters 5,6)
Record the Payment after discount period:
Accounts Payable 2000
cash 2000

Objective 3: Recording a Sale

Sales Returns and Allowances
Define: transactions where the seller either accepts goods back from the buyer (a return) or grants a
reduction in the purchase price (an allowance) so the buyer will keep the goods.

Type of Account Normal Balance Financial Statement

Contra Revenue debit Income statement

Sales Discount
Define:a reduction in the price of a product or service that is offered by the seller, in exchange
for early payment by the buyer.
Type of Account Normal Balance Financial Statement
Contra Revenue debit Income statement

The Seller sells inventory of $2,000 on account with the terms 2/10, n/30. The cost of the
inventory was $800.
Record the Sale:
Account receivable 2000
Sales Revenue 2000
Cost of goods sold 800
Inventory 800

Record the receipt of payment within discount period:

Cash 1,960

Sales discount 40

Account receivable 2,000

Record the receipt of payment after discount period:

Cash 2,000

Account receivable 2,000

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Exam Review (Chapters 5,6)
Sales Return and Allowance:
The Seller receives a return with an initial selling price of $1,250. The cost of the goods is $500.
Record the entry:
Sales Returns and Allowances 1,250

Accounts Receivable 1,250

Inventory 500

Cost of goods sold 500

Objective 4: Apply the Accounting Cycle

Adjusting Entry to reduce Inventory if physical count is lower than balance in account:
Cost of goods sold Debit
Inventory Credit

Closing Entries:
Account Normal Balance Closed with a Debit or Credit
Sales Revenue Credit Debit
Sales Returns and Allowance Debit Credit
Sales Discount Debit Credit
Cost of Goods Sold Debit Credit
Freight Out Debit Credit

Objective 5: Multi-step Income Statement

Section 1: Net Sales
Sales revenue - Sales returns and allowances - Sales
discounts = Net Sales Section

2: Gross Profit
Net sales - Cost of goods sold = Gross Profit
Section 3: Income from Operation
Gross profit - Operating expenses = Income from Operations
Section 4: Nonoperating Activites
revenues + cost of goods sold - operating expenses = Net Income

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Exam Review (Chapters 5,6)
Chapter 6
Objective 1: Classify and Determine Inventory
Define
Raw Materials: are the basic goods that will be used in production but have not yet been placed
into production.
Work in Process: is that portion of manufactured inventory that has been placed into the
production process but is not yet complete.
Finished Goods: : is manufactured items that are completed and ready for sale

Determine Ownership: Fill in the blank options: Buyer, Seller, Ownership

In transit, FOB Shipping Point, ownership belongs to Buyer. .

In transit, FOB Destination, ownership belongs to Seller .
Consigned goods do not transfer Ownership .

Objective 2: Inventory Cost Flow Methods

Define:
Specific Identification: If Crivitz can positively identify which particular units it sold and which are
still in ending inventory, it can use the specific identification method of inventory
First-in, First-out (FIFO): The FIFO method assumes the earliest goods purchased are the first to
be sold. Under the FIFO method, the costs of the earliest goods purchased are the first to be
recognised in determining the cost of goods sold.
Last-in, First-out (LIFO): The LIFO assumes the latest goods purchased are the first to be sold.
Under the LIF0 method, the costs of the latest goods purchased are the first to be recognised in
determining the cost of goods sold.
Average Cost: The average-cost method allocates the cost of goods available for sale on the
basis of the weighted-average unit cost incurred. The average-cost method
assumes that goods are similar in nature

Cost of goods sold formula:

Beginning Inventory + Purchased - Ending Inventory = Cost of
Goods Sold

The accounting records of a company show the following data:

Date Transaction Total cost

March 1 beginning inventory 100 units @ $2.50 each $250
March 15 Purchase 60 units @ $3.50 each $210
March 28 Purchase 80 units @ $4.00 each $320
Total 240 units $780
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Exam Review (Chapters 5,6)

During the month of March, 110 units were sold for $10 each.

Ending inventory = 240 units - 110 units = 130 units

Determine the cost of goods sold and ending inventory under FIFO, LIFO, and average cost
methods:
FIFO Ending Inventory

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Exam Review (Chapters 5,6)
Date Units Unit Cost Total Cost
March 15 50 $ 3.50 $175
March 28 80 $ 4.00 $ 320

Ending Inventory = $175 + $320 = = $495

COGS = $780 - $495 = $285

LIFO Ending Inventory

Date Units Unit Cost Total Cost
March 1 100 $ 2.50 $ 250
March 15 30 $ 3.50 $ 105

Ending Inventory = $250 + $105 = $355

COGS = $780 - $355 = = $425

Weighted average unit cost formula:

Total Cost Available / 110 = Average cost

$ 780 / 240 = $ 3.25

Ending Inventory 130 x $3.25 = $422.5

COGS = 110 x $3.25 = $375.5

Objective 3: Effects on financial statements

Assuming that costs are rising during the year:
LIFO will give you a higher COGS, and a lower Net Income.
FIFO will give you a lower COGS, and a higher Net Income.
Average cost will give you a average COGS, and a average Net Income in
comparison to LIFO and FIFO.

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Exam Review (Chapters 5,6)
Income Statement Effects

Inventory Error COGS is: (overstated or Net Income is: (overstated or

understated) understated)
Beginning Inventory is understated overstated
understated
Beginning Inventory is overstated understated
overstated
Ending Inventory is overstated understated
understated
Ending Inventory is understated overstated
overstated

An error in the ending inventory of the current period, will have a reverse effect
on the net income of the next accounting period.
Balance Sheet Effects
Inventory Error Assets are: Stockholder’s Equity is:
Overstated overstated overstated
Understated understated understated

Objective 4: Inventory Analysis

Lower of Cost or Net Realizable Value (NRV)
1. Determine whether cost or NRV is lower for each inventory type.
2. Sum the lowers value of each inventory type.
Example
Inventory Item Cost NRV
headphones 40 80
chargers 100 120
Phone cases 50 30

The inventory should be valued at $ 170 .

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