Accounting Midterm #1 Study Review
Chapter 5: Merchandising Operations
Merchandise Inventory: is needed to describe the many different items that make up
the total inventory.
Retailers: merchandising companies that purchase and sell directly to consumers.
Wholesalers: merchandising companies that sell to retailers.
Manufacturers: companies that produce goods for sale to wholesalers (or others).
Raw Materials: the basic goods and materials that are on hand and will be used in
production but have not yet been sent into production.
Work in Process: that portion of inventory on which production has started but is not
Finished goods: inventory is manufactured items that we are completed and ready for
Income Measurement Process
Sales Revenue/Sales: the main source of revenue from the sale of merchandise.
Cost of goods sold: the total cost of the merchandise that was sold during the period.
This expense is directly related to the revenue that is recognized from the sale of goods.
Gross profit: sales revenue less the cost of goods sold.
Operating expenses: expenses that are incurred in the process of earning sales
revenue. The operating expenses of the merchandising company include many of the
same expenses found in a service company, such as salaries, insurance, utilities, and
depreciation. Inventory Systems
Flow of costs for a merchandising company: Beginning inventory + purchases = cost of
goods available for sale
o Once sold, these costs are assigned to cost of goods sold
o Goods left over are ending inventory
Perpetual System: detailed records are maintained for the cost of each product that is
purchased and sold.
o These records continuously- perpetually- show the quantity and cost of the
inventory purchased, sold, and on hand.
o A physical count is done at least once a year to adjust perpetual records to
actual records. o This system enables the effective control of inventory which is an important
asset to all businesses
Periodic System: Detailed records of merchandise are not kept throughout the period
o Cost of goods sold is only determined at the end of the accounting period: once
inventory is counted
o Cost of goods sold = Beginning inventory + cost of purchases less ending
Sales Taxes and Freight
GST and HST paid does not form part of cost of goods (refunded)
FOB (Free on Board) – refers to where title or ownership of goods transfers:
FOB destination: seller pays freight costs
FOB shipping point: buyer pays freight costs
Freight paid by buyer (FOB shipping point) is part of the cost of merchandise purchased
Purchase Returns and Allowances
A purchaser returns the goods to the seller and receives a cash refund or credit
The buyer may choose to keep the merchandise if the seller is willing to give an allowance
(deduction) from the purchase price
In both cases, the result is a decrease to the cost of goods purchased
A quantity discount gives a price reduction according to the volume of the purchase:
Not recorded separately – discounted price is recorded as cost of purchase
A purchase discount is offered to encourage early payment of a balance due. Example:
Recorded separately when payment made. Results in a decrease to Merchandise
Inventory account Summary of Purchase Transactions
Recording Inventory Sales Perpetual Vs. Periodic Chapter 6: Reporting and Analyzing Inventory
Taking a Physical Inventory
Involves counting, weighing, or measuring kind of inventory on hand.
An inventory count is generally more accurate when a limited number of, or no, goods are
being sold or received during the counting. So, businesses count inventory when the
business is slow or closed.
Internal Control: process designed to help an organization achieve reliable financial
reporting, effective and efficient operations, and compliance with relevant laws and
Goods in Transit
Goods in transit should be included in the inventory of the company that has legal title to
FOB destination: the seller has legal title to the goods while they are in transit.
FOB shipping point: the buyer has legal title to goods while they are in transit.
In some lines of business, it is customary to hold goods belonging to other parties and sell
them, for a fee, without ever taking ownership of the goods.
Example: Artists often display their paintings in galleries on consignment, the art gallery
does not take ownership of the art- it is still the artists. Therefore, if an inventory count is
taken, any art on consignment should not be included in the art gallery’s inventory. When
the art sells, the gallery makes a commission and pays the artist the remainder.
Specific Identification Method
Tracks the actual physical flow of the goods in a perpetual inventory system. Each
inventory is marked, tagged or coded with its specific unit cost so that, at any point in
time, the cost of the ending inventory and the cost of the goods sold can be determined.
Appropriate and required for goods that are not ordinarily inter-changeable, and for goods
that are produced and segregated for specific products.
First In, First Out (FIFO)
Assumes that the earliest (oldest) goods purchased are the first ones to be sold. As a result, FIFO assumes that the last goods purchased are still in ending inventory.
Whether periodic or perpetual, FIFO will always result in the same cost of goods sold and
ending inventory amounts.
Recognizes that it is not possible to measure a specific physical flow of inventory when the
goods available for sale are homogenous or non-distinguishable.
Example: a fuel storage tank at a gas station, more gas keeps getting added in so you can’t
tell what gas was bought at what price.
EQUATION: Cost of Goods Available for Sale / Units Available for Sale = Weighted Average
Measures the number of times, on average, that inventory is sold during the period.
EQUATION: Cost of Goods Sold / Average Inventory
DAYS IN INVENTORY EQUATION: 365 / Inventory Turnover
Just in Time Approach: rather than ordering large amounts of quantities of an inventory
item, particularly one that is not in high demand, a company places a purchase order when
the item is needed to fulfil a specific order. Chapter 7: Internal Control and Cash
Consists of all the related methods and measures adopted within a company to help it
achieve reliable financial reporting, effective and efficient operations, and compliance with
relevant laws and regulations.
Control Environment: is the responsibility of management to make it clear that the
organization values integrity, and that unethical activity will not be tolerated (often
referred to as “setting the tone at the top”.
Risk Assessment: companies must identify and analyze the various factors that create risk
for the business and determine how to best manage these risks.
Control activities: to reduce the occurrence of unintentional and intentional errors,
management must assign policies and procedures to address the specific risks faced by the
Information and communication: the internal control system must capture and
communicate all pertinent information to the appropriate internal and external users.
Monitoring: internal control systems must be monitored periodically for their adequacy.
To be effective, significant deficiencies must be communicated to those in authority, such
as management and the Board of Directors.
Authorization of transactions and activities
Segregation of duties
Independent checks of performance
Human resource controls
Authorization of Transactions and Activities
The assignment of responsibility to specific employees.
This control activity is the most effective when only one person is authorized to perform a
specific task. Segregation of Duties
Responsibility for related activities should be assigned to different individuals.
When the same individual is responsible for related activities, the potential for errors
Documents provide evidence that transactions and events have occurred at specified times
and specified amounts.
Requirement that original documents (source documents) required for accounting entries
be promptly forwarded to the accounting department to help ensure timely and accurate
recording of the transaction.
Can be used to safeguard assets and enhance the reliability of accounting records.
1. Safe vaults and safety deposit boxes, alarms, television monitors, etc.
Independent Checks of Performance
Internal Reviews: independent internal reviews are especially useful in comparing
accounting records with existing assets to ensure that nothing has been stolen.
Internal Auditors: are company employees who evaluate the effectiveness of the
company’s system of internal control. They periodically review the activities of
departments and individuals to determine whether prescribed internal controls are
External Reviews: it is useful to contrast independent internal reviews with independent
External Auditors: perform an important type of external review. They, in contrast with
internal auditors, are independent of the company.
Human Resource Controls
1. Conducting through background checks.
2. Bonding of employees who handle cash.
3. Rotating employee’s duties and requiring employees to take vacations. Limitations of Internal Control
Reasonable assurance: that assets are properly safeguarded and that the accounting
records are accurate and reliable. Th