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October 22 Class Notes - WEEK 7 - Chapter 8 - COMM 2AA3

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Aadil Merali Juma

LECTURE 7 COMM 2AA3 Chapter 8: Reporting and Interpreting Cost of Goods Sold and Inventory October 22, 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 , 2006 – 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 th  Eg/ On May 24 m 2008, Seller Inc. sold to Buyer Inc. goods for $20,000 on credit with the following terms: (2/10, n/30) o On June 2 , 2008, Buyer Inc. paid 60% of the invoice to Seller Inc (within period) o On June 22nd2008, Buyer Inc. paid the balance of their account to Seller Inc. (not within period) o Journal entries for Buyer Inc.  Periodic System  May 24, 2008 – the purchase of $20,000 merchandise o Gross Method Purchases 20,000 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, 2008 – the payment of 60% of the balance o Gross Method Discount = 20,000 x 60% x 2% A/P 12,000 Cash 11,760 Purchase Discount 240 o Net Method A/P 11,760 Cash 11,760  June 22, 2008 – 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  Perpetual System  May 24, 2008 – the purchase of $20,000 merchandise o Gross Method Inventory 20,000 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 3, 2008 – the payment of 60% of the balance o Gross Method 3 LECTURE 7 COMM 2AA3
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