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Chapter 5
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Merchandising Businesses
A. Analyze, using the financial reporting elements and the critical and enhancing
questions, inventory purchases if you are the buyer.
❖ Inventory purchased by cash – inventory (an asset account) goes up, cash (an asset account) goes down
B. Analyze, using the financial reporting elements and the critical and enhancing
questions, inventory sales if you are the seller.
❖ In terms of inventory sales, two things happened at the same time: the inventory was sold at a certain
selling price and at the same time you got rid of some of your inventory which cost a certain amount
❖ Inventory sold on cash; first part of the transaction
▪ Cash (an asset account), sales revenue (a revenue account) goes up
❖ Inventory sold on cash; second part of the transaction
▪ Inventory (an asset account) goes down, cost of goods sold (an expense account) goes up
C. Understand and record the effect of shipping terms on purchases if you are the buyer.
❖ As a buyer, F.O.B. destination is the preferred shipping terms because the shipper pays for the shipping
costs and has ownership of the goods while in transit
❖ As a buyer, F.O.B. shipping point means that I have to pay freight
❖ F.O.B. destination means no entry
❖ F.O.B shipping point means that freight costs must be recorded as in increase to the cost of inventory
❖ Cash (an asset account) decreases assuming that you pay the shipping costs in cash, inventory (an asset
account) goes up
❖ The same process is used to record shipping insurance if the business chooses to purchase it
D. Understand and record the effect of shipping terms on sales if you the seller.
❖ As a seller, F.O.B shipping point is the preferred shipping terms because the buyer pays for the shipping
and they also assume ownership of the goods while it is in transit
❖ As a seller, F.O.B. destination means that I have to pay freight
❖ F.O.B. shipping point means no entry
❖ F.O.B. destination means that I will use the shipping service from the freight company to generate
revenue so therefore it must be recorded as an expense under the account freight out expense
❖ Cash (an asset account) decreases assuming you pay the shipping costs in cash, freight out expense (an
expense account) goes up
E. Record the effect of credit terms on the cost of inventory if you are the buyer.
❖ When you buy on account you are promising the supplier that you will pay the amount owed in the future
❖ E.g. credit terms n/30, which means that you have to pau the net amount on thirty days
❖ Inventory (an asset account) goes up, accounts payable (a liabilities account) goes up
F. Record the effect of credit terms on your revenues if you are the seller.
❖ When you sell on account, you earn the legal right to collect whatever is owed from the customer
❖ Keep in mind that selling inventory involves two transactions, one recording the actual sale at the selling
price and the other recording the cost of the sale based on the inventory price
❖ Accounts receivable (an asset account) goes up, sales revenue (a revenue account) goes up
❖ Inventory (an asset account) goes down, cost of goods sold (an expense account) goes up
G. Understand and record inventory returns if you are the buyer.
❖ If the goods were shipped F.O.B. destination, then you can send the inventory back to the supplier if it
was damaged in transit without having to pay for it
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