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Lecture 7

Updated October 28 Lecture 7 Class Notes - (Oct 22, 24, 28); Chapter 8 - COMM 2AA3
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Department
Chemistry
Course
CHEM 1A03
Professor
Aadil Merali Juma
Semester
Fall

Description
LECTURE 7 COMM 2AA3 Chapter 8: Reporting and Interpreting Cost of Goods Sold and Inventory October 22, 24, 2013 Merchandising and Manufacturing vs. Service  Merchandising and Manufacturing (Merchandiser = Retailer) o Sales revenue o Cost of good sold o Gross profit = Sales – COGS o Operating expenses  Operating Income = Gross Profits – Operating Expenses  Different from Net Income – income tax and interest; NI is the bottom line (after tax figure)  Operating income = EBIT (earnings before interest and taxes)  Service o Service revenue o Operating expenses  Inventory – asset held for resale or used to produce services and goods for sale  Merchandising firms have only merchandise inventory (buys inventory; sells inventory)  Manufacturing firms have three types of inventory o Raw materials – put in labor and overhead (utilities, machines, factory, rent, hydro, security, insurance etc) to produce goods o Work in process or progress – unfinished items that have not yet been finished; has conversion costs (labor) o Finished goods – ready for sale  Relationships between inventories o Ending raw materials = beginning raw material inventory + raw materials purchases – raw materials used o Ending work in process = beginning work in process + (direct law + raw materials used + overhead) – cost of goods manufactures o Ending finished gods inventory = beginning finished goods inventory + cost of goods manufactured – cost of goods sold  Cost included in inventory purchases o The cost principle requires that inventory be recorded at the price paid plus all costs incurred to bring the inventory to saleable conditions  Invoice price  Freight and insurance – freight in (transportation paid to obtain goods); freight out (transportation paid to transport goods to customer)  Inspection costs  Preparation costs – eg/ packaging cost, labeling cost etc prepare goods for sale; cut off point (cut off costs) is the point in time when good reaches position to be sold  Inventory Systems o Perpetual – updating inventory, where inventory is a physical, permanent, tangible item on the balance sheet (asset)  Detailed records of the cost of each inventory purchase and sales are maintained  Cost of goods sold determined and inventory account updated each time a sale occurs  Provides better control over inventory  Elaborate system makes perpetual system easier – eg/ everything yous can an item at checkout, it is accounted for o Periodic – do not update inventory when buy and sell; temporary “purchases” account to keep track of buying and selling;  Detailed records are not kept throughout the period  Cost of goods sold determined and inventory account updated only at the end of the accounting period, when a physical inventory count is taken  B. Inv + Net Purchases = COGAS  Net Purchases = Purchases – Purch. Disc. – Purch R&A  COGAS = cost of goods available for sale  COGAS – E. Inv = COGS  Small stores can use periodic system; perpetual system too difficult  An adjusting entry is required  Purchases – temporary expense account; will not see it in a financial statement; helps in calculation of COGS  Freight In – pay to have goods delivered from supplier; temporary asset (part of the cost of inventory) OR temporary expense depending on whether goods are sold; when goods are sold it is transferred to COGS – affects gross profit and net income, and operating income 1 LECTURE 7 COMM 2AA3  Freight Out – pay to deliver goods to customers; operating expense – affects operating income, not NI or gross profit  Purchases R&A – contra-expense; contra to purchaes rd o Eg/ Jan 3 , 2013 – Seller Inc. sold merchandise to Buyer Inc. for $10,000, received $3,000 cash and the balance to be paid in one week; the cost of goods sold by Seller Inc, is 80% of the sales price  Jan 7 , Buyer Inc. returned $1,000 goods to seller Inc. and received credit for the amount  Journal Entries for Seller Inc.  Jan 3 (1/3) – sale of merchandise for $10,000: $3,000 cash and balance on account; COGS is 80% of sales price o Perpetual Cash 3,000 A/R 7,000 Sales 10,000 Cost of Goods Sold 8,000  update inventory Inventory 8,000 o Periodic  do not calculate COGS Cash 3,000 A/R 7,000 Sales 10,000  Jan 7 (1/7) – return of $1,000 of merchandise o Perpetual Sales R&A 1,000 A/R 1,000 Inventory 800 Cost of Goods Sold 800 o Periodic Sales R&A 1,000 A/R 1,000  Journal Entries for Buyer Inc.  Jan 3 (1/3) – purchase of merchandise for $10,000: $3,000 cash and the balance on account o Perpetual Inventory 10,000 A/P 7,000 Cash 3,000 o Periodic Purchases 10,000 A/R 7,000 Cash 3,000  Jan 7 (1/7) – return of $1,000 merchandise o Perpetual A/P 1,000 Inventory 1,000 2 LECTURE 7 COMM 2AA3 o Periodic A/P 1000 Purchases R&A 1,000 Accounting for Purchase Discount  Just like accounting for sales discount, there are two methods to account for purchase discounts  Gross Method – assumes that discount will not be taken; if discount is taken, it will be given o Purchases and A/P are recorded at the gross amount o Purchase discounts taken by customers are credited to the Purchase Discounts account, only when buyer pays within the discount period  Purchase discounts – contra-expense; contra to purchases (expense)  Net Method – assumes that discount will be taken; if time elapsed, the discount lost o Purchases and A/P are recorded at the net amount o Purchase discounts not taken by buyers are credited to the Purchase Discounts Lost account  Purchase Discount Lost – expense; purchases increase  Eg/ On May 24 , 2013, Seller Inc. sold to Buyer Inc. goods for $20,000 on credit with the following terms: (2/10, n/30) nd o On June 2 , 2013, Buyer Inc. paid 60% of the invoice to Seller Inc (within period) o On June 22nd2013, Buyer Inc. paid the balance of their account to Seller Inc. (not within period) o Journal entries for Buyer Inc.  Periodic System  May 24, 2013 – the purchase of $20,000 merchandise o Gross Method Purchases 20,000  temporary expense A/P 20,000 o Net Method Total Discount = 20,000 x 2% Net = 20,000-400 Purchases 19,600 A/P 19,600  June 2, 2013 – the payment of 60% of the balance o Gross Method Discount = 20,000 x 60% x 2% = $240 A/P 12,000 Cash 11,760 Purchase Discount 240  contra-expense o Net Method A/P 11,760 Cash 11,760  June 22, 2013 – the payment of 40% of the balance o Gross Method Balance of A/P = 20,000 x 40% A/P 8,000 Cash 8,000 o Net Method – reverse discount given (2% discount of 40% of the amount) Balance of A/P = 19,600 x 40% = $7,840 Discount lost = 8,000 x 2% A/P 7,840 P. Discount Lost 160  temporary adjunct expense; cannot exist Cash 8,000 without purchases  Perpetual System  May 24, 2013 – the purchase of $20,000 merchandise o Gross Method Inventory 20,000 immediately; rather than purchases A/P 20,000 o Net Method Total Discount = 20,000 x 2% Net = 20,000 – 400 Inventory 19,600 A/P 19,600  June 2, 2013 – the payment of 60% of the balance o Gross Method 3 LECTURE 7 COMM 2AA3 Discount = 20,000 x 60% x 2% A/P 12,000 Cash 11,760 Inventory 240 o Net Method A/P 11,760 Cash 11,760  June 22, 2013 – the payment of 40% of the balance o Gross Method Balance of A/P = 20,000 x 40% A/P 8,000 Cash 8,000 o Net Method Balance of A/P = 19,600 x 40% = $7,840 Discount lost = 8,000 x 2% A/P 7,840 P. Discount Lost 160 Cash 8,000  Cash flow issues if company has purchase discount lost i) do not have cash ii) weak credit policies, cannot collect money from creditors iii) weak management, cannot reach deadlines, poor centers of control  Periodic System Adjusting Entries 1. Physical count of ending inventory 2. Calculate cost of goods purchased as  Purchases -- Purchase returns and allowances -- Purchase discounts + Freight in 3. Calculate cost of goods available for sale as Beginning inventory + Cost of goods purchased 4. Calculate cost of goods sold as Cost of goods available for sale (from step 3) -- Ending inventory (from step 1) 5. Prepare the following ent
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