Ch. 05: Accounting For Merchandising Operations

25 July 2022
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question
what are examples of merchandising companies?
answer
REI, Wal-Mart, and Amazon.com
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merchandising companies
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they buy and sell merchandise rather than perform services as their primary source of revenue
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retailers
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merchandising companies that purchase and sell directly to consumers
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wholesalers
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merchandising companies that sell to retailers
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what is the primary source of revenues for merchandising companies?
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the sale of merchandise, often referred to simply as sales revenue or sales.
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what are the two categories of expenses that a merchandising company has?
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cost of goods sold operating expenses
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cost of goods sold
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the total cost of merchandise sold during the period -this expense is directly related to the revenue recognized from the sale of goods
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what is the income measurement process for a merchandising company?
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Sales Revenue --(less)--> Cost of Goods Sold (unique to a merchandising company, not used by a service company) --(equals)--> Gross Profit (unique to a merchandising company, not used by a service company) --(less)-->Operating expenses --(equals)--> Net Income/Net Loss
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Is the operating cycle of a merchandising company or a service company longer?
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ordinarily the operating cycle of a merchandising company is ordinarily longer
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what is the added asset account for a merchandising company?
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is the Inventory account -companies report inventory as a current asset on the balance sheet
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what is the flow of costs for a merchandising company?
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-beginning inventory plus the cost of goods purchased is the cost of goods available for sale -As goods are sold, they are assigned to cost of goods sold. -Those goods that are not sold by the end of the accounting period represent ending inventory
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what are the two systems to account for inventory?
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a perpetual inventory system and a periodic inventory system
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perpetual inventory system
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companies keep detailed records of the cost of each inventory purchase and sale -these records continuously --perpetually-- show the inventory that should be on hand for each item -under a perpetual inventory system, a company determines the cost of goods sold each time a sale occurs -although it requires both additional clerical work and expense to maintain the subsidiary records, a computerized system can minimize this cost
question
what is an example of perpetual inventory system?
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-ie: a Ford dealership has separate inventory records for each automobile, truck and van on its lot and showroom floor -ie: A Kroger grocery store uses bar codes and optical scanners to keep a daily running record of every box of cereal and jar of jelly that it buys and sells
question
periodic inventory system
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companies do not keep detailed inventory records of the goods one hand throughout the period. -Instead, they determine the cost of goods sol only at the end of the accounting period-- that is periodically. -at that point, the company takes a physical inventory count to determine the cost of goods on hand
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how do you determine the cost of goods sold under a periodic inventory system?
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1. determine the cost of goods on hand at the beginning of the accounting period 2. Add to it the cost of goods purchased 3. Subtract the cost of goods on hand at the end of the accounting period
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what (traditionally) do companies that sell merchandise with high unit values, such as automobiles, furniture and major home appliances use in terms of inventory systems?
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perpetual inventory systems -the growing use of computers and electronic scanners has enabled many more companies to install perpetual inventory systems.
question
which system provides better control over inventories?
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perpetual inventory system -since the inventory records show the quantities that should be on hand, the company can count the goods at any time to see whether the amount of goods actually on hand agrees with the inventory records -if shortages are uncovered, the company can investigate immediately
question
why would some companies use periodic inventory systems?
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some businesses find it either unnecessary or uneconomical to invest in a sophisticated, computerized perpetual inventory system such as Amazon's. Many small merchandising businesses find that basic accounting software provides some for the essential benefits of a perpetual inventory system -also managers of some small businesses still find that they can control their merchandise and manage day-to-day operations using a periodic inventory system
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how do companies purchase inventory?
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using cash or credit (on account)
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each cash purchase should be supported by a...? and how is it recorded?
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canceled check or a cash register receipt indicating the items purchased and amounts paid -companies record cash purchases by an increase in Inventory and a decrease in Cash
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purchase invoice
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should support each credit purchase -this invoice indicates the total purchase price and other relevant info -however the purchaser does not prepare a separate purchase invoice -instead, the purchaser uses as a purchase invoice a a copy of the sales invoice sent by the seller
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Under the perpetual inventory system, companies record purchases of merchandise for sale in which account? give an example.
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Inventory -REI would increase (debit) Inventory for clothing, sporting goods and anything else purchased for resale to customers
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Are all purchases debited to Inventory?
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no; companies record purchases of assets acquired for use but not for resale, such as supplies, equipment and similar items, as increases to specific asset accounts rather than to inventory
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what should the sales agreement indicate?
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who--the seller or the buyer-- is to pay for transporting the goods to the buyer's place of business -the carrier prepares a freight bill in accord with the sales agreement
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what are examples of who is considered the common carrier?
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a railroad, trucking company or airline
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what does FOB stand for?
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free on board
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FOB shipping point
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means that the seller places the goods free on board the carrier; and the buyer pays the freight cost
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FOB destination
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means that the seller places the goods free on boardto the buyer's place of business and the seller pays the freight
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where does the ownership pass in FOB Shipping Point?
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between the seller and the Public Carrier Co.
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where does the ownership pass in FOB Destination?
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between the Public Carrier Co. and the Buyer
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when the buyer incurs the transportation costs, these costs are considered part of what?
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-part of the cost of purchasing inventory. (any freight cost incurred by the buyer are part of the cost of merchandise purchased-companies recognize these costs as cost of goods sold when inventory is sold) -therefore, the buyer debits (increases) the Inventory account
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The freight cost incurred by the seller on outgoing merchandise, what cost are these considered part of?
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an operating expense to the seller -these costs increase an expense account titled Freight-Out (sometimes called Delivery Expense)
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When a seller pays the freight charges, the seller will usually do what?
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establish a higher invoice price for the goods to cover the shipping expense
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A purchaser may be dissatisfied with the merchandise received becasue the goods are damaged or defective, of inferior quality or do not meet the purchaser's specifications. In such cases what will happen?
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-the purchaser may return the good to the seller for credit if the sale was made on credit or for a cash refund if the purchase was for cash. This transaction is known as a purchase return -the purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) from the purchase price. This transaction is known as a purchase allowance
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how would you record it if a customer returned goods to a company?
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the following entry by the customer for the returned merchandise decreases debits (accounts payable) and decreases (credit) Inventory -because the customer increased inventory when the goods were received, Inventory is decreased when the customer returns the goods
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how would you record it if a customer chooses to keep a good after being granted a $50 allowance (reduction on price)?
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it would reduce (debit) Accounts payable and reduce (credit) Inventory for $50.
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purchase discount
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the credit terms of purchase on account may permit the buyer to claim a cash discount for prompt payment -this incentive offers advantages to both parties. The purchaser saves money and the seller is able to shorten the operating cycle by converting the accounts receivable into cash
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credit terms
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specify the amount of the cash discount and time period in which it is offered -they also indicate the time period in which the purchaser is expected to pay the full invoice price
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what does 2/10, n/30 mean?
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they are credit terms read: "two-ten, net thirty" -the buyer may take a 2% cash discount on the invoice price, less ("net of") any returns or allowances, if payment is made within 10 days of the invoice date (the discount period). Otherwise the invoice price, less any returns or allowances, is due 30 days from the invoice date
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what does net 30 (n/30) mean?
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the remaining amount due after subtracting any sales returns and allowances and partial payments
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what does 1/10 EOM mean?
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-EOM means end of month -that 1% discount is available if the invoice is paid within the first 10 days of the next month
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when the buyer pays an invoice within the discount period, the amount of the discount decreases inventory. why?
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becasue the companies record inventory at cost and, by paying within the discount period, the buyer has reduced its cost
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passing up the discount may be viewed how?
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as paying interest for use of the money
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in accordance with the revenue recognition principle, companies record sales revenue when?
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when the performance obligation is satisfied
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typically when is the performance obligation satisfied?
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when the goods transfer from the seller to the buyer. At this point, the sales transaction is complete and the sales price established
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sales may be made on what?
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may be made on credit or for cash
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business document
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should support every sales transaction, to provide written evidence of the sale
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cash register documents
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provide evidence of cash sales
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sales invoice
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provides support for a credit sales -shows the date of sale, customer name, total sales price and other relevant information
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the original copy of the sale invoice goes to whom?
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to the customer -the seller keeps a copy for use in recording the sale.
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what are the two entries that a seller makes?
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1. (first) records the sale 2. records the cost the merchandise sold -as a result, the Inventory account will show at all times the amount of inventory that should be on hand
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when the seller makes the two entries, the first entry records the sale. how is this recorded?
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the seller increases (debits) cash (or accounts receivable if a credit sale) and also increases (credits) Sales Revenue
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when the seller makes the two entries, the second entry records the cost of the merchandise sold. how is this recorded?
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the seller increases (debits) cost of goods sold and also decreases (credits) inventory for the cost of those goods
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For internal decision-making purposes, merchandising companies may do what?
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may use more than one sales account (IE: REI might use separate accounts for camping gear,children's clothing and ski equipment-- or it may have even more narrowly defined accounts) -by using separate accounts for major product lines, rather than a single combined sales account, company management can more closely monitor sales trends and respond more strategically to changes in sales patterns
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on its income statement present to outside investors, a merchandising company normally would provide what?
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only a single sales figure-- the sum of all of its individual sales accounts
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why does a merchandising company normally present only a single sales figure in the income statement to outside investors?
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two reasons: 1. providing detail on all of its individual sales accounts would add considerable length to its income statement 2. companies do not want their competitors to know the details of their operating results
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sales returns and allowance for the seller
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these are transactions where the seller either accepts goods back from the buyer (a return) or grants a reduction in the purchase price (an allowance) so the buyer will keep the good -1. an increase (debit) in Sales Returns and Allowances (a contra account to Sales Revenue) and decrease (credit) in Accounts receivable at the selling price -2. an increase (debit) in Inventory and a decrease (credit) in Cost of Goods Sold
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what happens if the goods are not returned but the seller grants the buyer an allowance by reducing the purchase price?
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in this case, the seller debits Sales Returns and Allowances and credits Accounts Receivable for the amount of the allowance. An allowance has no impact on Inventory or Cost of Goods Sold
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what are Sales Returns and Allowances to Sales Revenue? And what does that mean?
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Sales Returns and Allowances is a contra revenue account to Sales Revenue -This means that it is offset against a revenue account on the income statement
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what is the normal balance of Sales Returns and Allowances?
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a debit
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why do companies use a contra account, instead of debiting Sales Revenue?
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to disclose in the accounts and in the income statement the amount of sales returns and allowances. Disclosure of this information is important to management -excessive returns and allowances may suggest problems --inferior merchandise, inefficiencies in filling orders, errors in billing customers or delivery or shipment mistakes
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what would happen with a decreased (debit) recorded directly to Sales Revenue?
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would obscure the relative importance of sales returns and allowances as a percentage of sales. It also could distort comparisons between total sales in different accounting periods
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sales discount
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the seller calls it this -the seller may offer the customer a cash discount for the prompt payment of the balance due -like a purchase discount, a sales discount is based on the invoice price less returns and allowance, if any -a contra revenue account to Sales Revenue and its normal balance is a debit
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how can sales discount be recorded?
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the seller increases (debits) the Sales Discounts account for discounts that are taken
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does a merchandising company generally have the same types of adjusting entries as a service company?
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yes; however, a merchandiser using a perpetual system will require one additional adjustment to make the records agree with the actual inventory on hand =because at the end of each period period, for control purposes, a merchandising company that uses a perpetual system will take a physical count of a good on hand -the company's unadjusted balance in Inventory usually does not agree with the actual amount of inventory on hand -the perpetual inventory records may be incorrect due to recording errors, theft, or waste. Thus, the company needs to adjust the perpetual records to make the recording inventory amount agree with the inventory on hand. This involves adjusting Inventory and Cost of Goods Sold
question
a merchandising company, like a service company, closes to Income Summary all accounts that affect what?
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net income
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In journalizing, the company credits all temporary accounts with what?
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debit balances and debits all temporary accounts with credit balances
question
multiple-step income statement
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named this because it shows several steps in determining net income. -two of these steps relate to the company's principle operating activities -distinguishes between operating and nonoperating activities -highlights intermediate components of income and hows subgroupings of expenses
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how does the multiple-step income statement begin?
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by presenting sales revenues. -it then deducts contra revenue accounts --sales returns and allowances, and sales discounts-- from sales revenue to arrive at net sales
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how do you determine gross profit?
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deduct cost of goods sold from sales revenue -for this computation, companies use net sales as the amount of sales revenue
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net sales
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-takes into consideration Sales Returns and Allowances and Sales Discounts
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gross profit rate equation
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gross profit divided by net sales
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Do analysts generally consider the gross profit rate or the gross profit amount to be more useful?
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gross profit rate -the rate expresses a more meaningful (qualitative) relationship between net sales and gross profit -IE a gross profit of $1,000,000 may sound impressive but if it is the result of a gross profit rate of only 7%, it is not so impressive
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gross profit rate
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tells how many cents to each sales dollar go to gross profit
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what does gross profit represent ?
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the merchandising profit of a company
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is gross profit a measure of the overall profitability?
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no; because operating expenses are not yet deducted -but its important to closely watch and compare with past periods and competitors, etc.
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operating expenses
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the net component in measuring net income for a merchandising company -they are the expenses incurred in the process of earning sales revenue -these expenses are similar in merchandising and service companies
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nonoperating activities
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consist of various revenues and expenses and gains and losses that are unrelated to the company's main line of operations -when nonoperating items are included, the label "income from operations" (or "Operating income") precedes them -this label clearly identifies the results of the company's normal operations, an amount determined by subtracting cost of goods sold and operating expenses from net sales
question
whats a list of nonoperating activities?
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Other Revenues and Gains: -interest revenue (from notes receivable and marketable securities -dividend revenue (from investment in common stock) -rent revenue (from subleasing a portion of the store) -gain (from the sale of property, plant and equipmet Other Expenses and Losses: -Interest expense (on notes and loans payable) -Casualty losses (from recurring causes, such as vandalism and accidents) -Loss (from the sale or abandonment of property, plant and equipment -Loss (from strikes by employees and suppliers
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when does merchandising companies report the nonoperating activities in the income statement?
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immediately after the company's operating activities
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what is the distinction between operating and nonoperating activities
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-crucial to many external users of financial data -these users view operating income as sustainable and many nonoperating activities as non-recurring.
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when forecasting next year's income, analysts put the most on weight on what?
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this year's operating income and less weight on this year's nonoperating activities
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single-step income statement
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named because only one step --subtracting total expenses from total revenues-- is required in determining net income
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in a single-step statement, all data is classified into which two categories?
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1. revenues (include both operating revenues and other revenues and gains) 2. expenses (include cost of goods sold, operating expenses, and other expenses and loss)
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what are the two primary reasons for using the single-step format?
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1. a company does not realize any type of profit or income until total revenue exceeds total expenses, so it makes sense to divide the statement into two categories 2.the format is simpler and easier to read
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in the balance sheet, merchandising companies report inventory as what?
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current asset immediately below accounts receivable (inventory is less close to cash (liquidity) than accounts receivable because the goods must be sold and then collection made form the customer
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worksheet
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enables companies to prepare financial statements before they journalize and post adjusting entries -the steps in preparing a worksheet for a merchandising company are the same as for a service company
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adjusted trial balance
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shows the balance of all accounts after adjustment at the end of the accounting period
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after a company enters all adjustments data on the worksheet, what does it do?
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it establishes the equality of the adjustments column totals. -it then extends the balances in all accounts to the adjusted trial balance columns
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once a company extends the balances in all accounts to the adjusted trial balance columns, what happens?
answer
the merchandising company transfers the accounts and balances that affect the income statement form the adjusted trial balance columns tot he income statement columns -finally the company totals all the credits in the income statement column and compares those totals to the total of the debits in the income statement column. If the credits exceed the debits, the company has net income
question
what is the major difference between the balance sheet of a service company and a merchandiser ?
answer
inventory
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when does a net loss result?
answer
when the total of the credits exceeds the total of the debit balances
question
how is determining cost of goods sold different when a periodic inventory system is used rather than a perpetual system?
answer
a company using a perpetual system makes an entry to record cost of goods sold and to reduce inventory each time a sale is made -a company using a periodic system does not determine cost of foods sold until the end of the period. At the end of the period, the company performs a count to determine the ending balance of inventory. It then calculates cost of good sold by subtracting ending inventory from the cost of goods available for sale -Also the perpetual system directly adjust the inventory account for any transaction that affects inventory (such as freight cost, returns, and discounts). The periodic system doesnt do this. Instead it creates different accounts for purchases, freight cost, returns and discounts
question
what is the equation for cost of goods sold?
answer
Beginning Inventory + Cost of Goods Purchased = Cost of Goods Available for Sale ; Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold
question
Do companies record revenues from the sale of merchandise when sales are made in the periodic or perpetual inventory system?
answer
both systems
question
periodic inventory system
answer
companies do not attempt on the date of sale to record the cost of the merchandise sold -instead, they take a physical inventory count at the pend of the period to determine 1. cost of the merchandise then on hand and 2. the cost of the goods sold during the period -companies record purchases of merchandise in the Purchases account rather than in the Inventory account -purchase returns and allowances, purchase discounts and freight costs on purchases are recorded in separate accounts
question
Freight-In
answer
like purchases, Freight-In is a temporary account whose normal balance is a debit -part of the cost of goods purchased (the reason is that cost of goods purchased should include any freight charges necessary to bring the gods to the purchaser -not subject to a purchase discount. purchase discounts apply only to the invoice cost of the merchandise
question
Purchase Returns and Allowances is a temporary account who normal balance is _______
answer
a credit
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Purchase Discounts is a temporary account whose normal balance is _______
answer
a credit
question
For a merchandising company, like a service company, all accounts that affect the determination of net income are closed to _______
answer
Income Summary
question
where can you obtain data for the preparation of closing entries?
answer
from the income statement columns of the worksheet.
question
In journalizing, all debit column amounts are _____ and all credit columns amounts are _______
answer
credited; debited
question
how do you close the merchandise inventory in a periodic inventory system?
answer
-the beginning inventory balance is debited to Income Summary and credited to Inventory -the ending inventory balance is debited to inventory and credited to Income Summary
question
what balances do all temporary accounts have after closing entries are posted?
answer
zero balances
question
Owner's capital equation
answer
beginning balance + net income - drawings