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COMMERCE 1AA3 Final: Daniel's Accounting Exam Study Guide

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McMaster University
Aadil Merali Juma

Chapter 6 - Inventory Inventory (1) • Reported on two financial statement accounts, the balance sheet as inventory (asset), and on the income statement as Cost of goods sold (Income statement) o Number of units of inventory sold X Cost per unit of inventory COGS = COGAS (Beg Inv +Purchases) – End Inv o How much the good costs to make ready for sale • Is an asset held for resale or used to produce services and goods for sale • Calculated by: o Inventory = Number of units on hand X cost per unit • Merchandising firms have only merchandise inventory • Costs included in inventory: o Invoice price o Freight and insurance o Inspection costs o Preparation costs • Purchase Price from the seller + Freight In – (Purchase returns, allowances and discounts) = Net Purchases of Inventory • Manufacturing firms have three types of inventory: o Raw materials – stuff that are pure resources no adapt o Work in progress – something on its way to becoming a final product o Finished materials – the final product of the material’s life • Inventory Quantities o Take a physical count o As of the end of the accounting period determine what’s included in inventory ▪ Ownership of goods in transit • FOB Shipping Point • FOB Destination ▪ Consigned Goods • Purchase Returns and Allowances o Return – decrease in the cost of inventory because the buyer returned the merchandise to the seller o Allowance – decreases the cost in inventory because the buyer got an allowance o Discount – decrease the cost in inventory that is earned by paying quickly o Arrangement made states payment terms 2/10 n/30 (2%/10days, no %/30days) ▪ This means: the buyer can take a 2% discount for payment within 10 days or pay full in 30 days o When customers are sold damaged merchandise, they can either: ▪ Return the merchandise and receive full refund: sales return ▪ Keep the merchandise and receive some credit (either reduction in A/R, store credit, or cash) Sales Revenues in Merchandising firms (4) • Sales revenue is reduced by contra revenue accounts o Credit card discounts o Sales returns and allowances o Sales discounts (cash discounts): discounts given to customers to encourage advance payment • On the income statement: Net Sales = Sales Revenue – (Discounts, returns and allowances) Periodic VS Perpetual Inventory Systems (2) • Periodic System o Mainly used by businesses that sell inexpensive goods o Dollar store or convenience store o Restaurants or hometown nurseries (because of low accounting cost) o Not worth keeping track of every single item sold when it is sold o Count inventory periodically (usually about once a year) o Transactions DR Cash or Accounts Receivable CR Sales Revenue • Perpetual System o Uses computer software to keep a running record of inventory on hand o This system achieves more control of the inventory o National sports, parts of a ford dealer, Lumber at Rona, Furniture at Leon’s o Used for all types of goods o Businesses still count the inventory on hand annually o Serves as a check of accuracy on the computer systems o Transactions (2 take place) o 1. The company records the sale DR Cash or A/R CR Sales Revenue o 2. The company then records the cost of inventory DR Cost of Goods Sold CR Inventory Inventory Costing Methods (3) Three methods to costing: 1. Specific Identification Cost A car dealership had a Honda that cost $15,000 and a Toyota at $17,000 as of January 1, 2008. During 2008, the dealership bought a Dodge for $12,000, a Buick for $20,000 and a Chevy for $16,000; and sold the Toyota and the Buick Honda - 15000 Toyota – 17000 *sold Dodge - 12000 Buick – 20000 *sold Chevy – 16000 Cost of Goods available for sale = 80000 (add them all together) Cost of goods sold = 37000 (cost of what was sold) Cost of ending inventory = 43000 (cost of what’s left or [COGAS-COGS]) 2. Weighted Average Cost • The cost per unit is in the same for all units in inventory • 2 different ways: • Periodic System (Weighted Average Cost) o It is the same weighted average cost per unit for the entire period • Perpetual System (Weighted Average Cost) 3. First in, first out (FIFO) Cost • The oldest units are sold first • Cost of inventory consists on the newest units • Both same way: • Periodic System (FIFO) • Perpetual System (FIFO) 2+3 EXAMPLE ABC Inc. began 2006 with $44000 of inventory. The cost of beginning inventory (BI) is 8000 units purchased for $5.5 each. Transactions are as follows: Date Transaction Units Total Unit Cost Jan 7 Sale 4000 Jan 14 Purchase 2000 12 March 5 Purchase 6000 14 April 6 Sale 3000 June 7 Purchase 6000 15 September 14 Sale 6000 Cost Flow Periodic Perpetual CGS Inventory CGS Inventory FIFO (Both Same) 110,000 132,000 110,000 132,000 Weighted Average 143,000 99,000 129,500 112,500 Accounting Standards in Inventory (4) Comparability • Investors want to compare a company’s financial statements from one period to the next • Inventory methods must be the same to be able to compare • Prior statements need to be adjusted if a justified change is made Disclosure Principle • Financial statement should disclose enough information for users to make informed decisions o Information should be relevant and/or representatively faithful • Should hold enough information for outsiders to make informed decisions Lower of Cost and Net Realizable Value • The LCNRV is a rule based on the premise that if inventory or merchandise is damaged it can be valued at lower than financial statement indication Gross Profit Percentage & Inventory Turnover Gross Profit = Sales - COGS Gross profit percentage = Gross profit/Net sales revenue Inventory Turnover = Cost of Goods Sold/Average Inventory Average Inventory = (Beginning Inventory + Ending Inventory)/2 Chapter 7 – Long Term Assets Carrying Amount of Asset = Cost – Accumulated Depreciation Allocated costs over an asset’s life is called Depreciation What makes Depreciation happen? • Wear and tear • Obsolesce Depreciation is not a process of valuation Depreciation does not mean setting aside cash to replace assets as they wear out! How to Measure depreciation?! We need to know… 1. Cost – how much did you pay for this item? 2. Estimated Useful Life – how long is it supposed to last? 3. Estimated Residual Life (salvage value) – an amount of money it will always be worth? a. If the plane doesn’t work, how much is the metal of it worth? Depreciation Methods (3) Straight Line Depreciation Method Straight line depreciation per year = (Cost – Residual Value)/Useful Life DR Depreciation Expense CR Accum
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