Chapter 5

Purchases of the merchandise Sales of the merchandise, often on account Collection of the account receivable from customers

Fast Forward Condensed Income Statement For the Year Ended December 31, 2001 Revenue from Sales $900,000 Less: Cost of Goods Sold 540,000 Gross Profit $360,000 Less: Expenses 270,000 Net Income $90,000

Information in the financial statements is very condensed. Managers an other employees need more information.
Subsidiary ledgers: A source of detailed needs
Accounts receivable subsidiary ledger Accounts payable subsidiary ledger Inventory subsidiary ledger

Controlling Account-A general ledger account that summarizes the content of a subsidiary ledger

Perpetual Inventory System-transactions are recorded as they occur

Periodic Inventory System-transactions are recorded periodically-usually at the end of the year

Today most large business use computers to assist In maintaining perpetual systems

Purchases of merchandise are recorded by debiting an asset account entitled Inventory

When merchandise is sold two entries are necessary:
The revenue earned is recognized Cost of goods sold is recorded

Sep 1- Purchased 10 Regent computer monitors on account from Okawa Wholesale Co. The monitors cost $600 each, for a total of $6,000; payment is due in 3o days

Inventory 6,000 Accounts Payable 6,000 Purchased 10 Regent computer monitors for $600 Each; payment due in 30 days

Sep 7- Sold two monitors on account to RJ Travel agency at a retail sales price of $1000 each, for a total of $2000. Payment is due in 30 days.
2,000 2,000

Accounts Receivable(RJ Travel Agency) Sales

Matching Principle
Cost of Goods Sold Inventory 1,200 1,200

Oct 1- Paid the $6,000 account payable to Okawa Wholesale Co.

Accounts Payable( Okawa Wholesale Co.) 6,000 Cash 6,000 Paid account payable

Oct 7- Collected the $2000 account receivable from RJ Travel Agency

Cash 2,000 Accounts Receivable(RJ Travel Agency) 2,000 Collected an account receivable from a credit customer

Taking a physical inventory is a complete physical count of the merchandise on hand at least once a year Inventory shrinkage

Example: Computer barn shows an inventory with a cost of $72,200. The items actually on hand have a total cost of $70,000.
Cost of Goods Sold Inventory 2,200 2,200

The purchase of merchandise is debited to an account called Purchases rather than Inventory
When merchandise is sold an entry is made to recognize the sales revenue, but no entry is made to record Cost of Goods Sold or to reduce the inventory account There is no inventory subsidiary ledger

Jan 6- Purchased merchandise for resale to customers worth $2,000

Purchases 2,000 Accounts Payable( Paper Products Co.) 2,000 Purchased inventory on account; payment due in 30 days

At Dec 31, 2001 the following information is available:

1. The inventory on hand at the end of 2000 cost $14,000 2. During 2001, purchases of merchandise for resale to customers totaled $130,000. 3. Inventory on hand at the end of 2001 cost $12,000

Inventory (beginning of the year) (1)

$14,000

Add: Purchases(2)
Cost of Goods available for sale Less: Inventory( end of the year) (3) Cost of goods sold

130,000
$144,000 12,000 $132,000

A Cost of Goods Sold Account is created by two closing entries

Dec 31 Cost of Goods Sold Inventory(beginning balance) Purchases To close the temporary accounts contributing of goods sold for the year

144,000 14,000 130,000 to the cost

Special Occasions COGS account now includes the cost of all goods available for sale during the year. Not all of the goods were sold and merchandising costing $12000 is still on hand at the end of the year.

Dec 31 Inventory( year end balance) 12,000 Cost of Goods Sold 12,o00 To reduce the balance of the COGS account by the cost of merchandise still on hand at year end With this entry the inventory on hand has been brought up to date

The company will make the usual four closing entries 1. Revenue accounts 2. Expense accounts( including COGS) 3. Income summary account 4. Drawings account

A special journal is an accounting record or device designed to record a specific type of routine transactions quickly and efficiently

Advantages: 1. Transactions are recorded faster and more efficiently 2. Many special journals may be in operation at one time, further increasing the companys ability to handle a large volume of transactions 3. Automation may reduce the risk of errors 4. Employees maintaining special journals generally do not need expertise in accounting 5. The recording of transactions may be an automatic side effect of other basic business activities, such as collecting cash from customers

Credit terms net 30 days-payment due in 30 days n/30- payment due in 30 days 10 eom-pymt is due 10 days after the end of the mth in which the purchase occurred

2/10, n/30- read as 2, 10, net 30

The period in which the discount is available is termed the discount period

Example: Fast Forward purchases 100 spreadsheet programs from PC products.The cost of these programs is $100 each, for a total of $10,000. However, PC products offers credit terms of 2/10, n/30.
Inventory 9,800 Accounts Payable 9,800 To record purchase of 100 spreadsheet programs at net cost( $100*98%*100 units)

If the invoice is paid within the time period the following entry will be made to record the transaction:

Accounts Payable 9,800 Cash To record payment of invoice

9,800

If Fast Forward forgets to make the payment within the discount period, the following entry will be made Accounts Payable 9,800 Purchase Discounts Lost 200 Cash 10,000 To record the payment of invoice after expiration of discount period

Example: Fast Forward purchases 100 spreadsheet programs from PC products.The cost of these programs is $100 each, for a total of $10,000. However, PC products offers credit terms of 2/10, n/30
Inventory 10,000 Accounts Payable 10,000 To record purchase of 100 spreadsheet programs at gross invoice price( $100*100 units)

If the invoice is paid within the time period the following entry will be made to record the transaction

Accounts Payable 10,000 Cash 9,800 Purchase Discount Taken 200 Paid a $10,000 invoice within the discount period; taking a 2% purchase discount
If the invoice is not paid on time the following entry is made:

Accounts Payable 10,000 Cash 10,000 To record the payment of invoice after expiration of discount period

Example: Fast Forward returns to PC Products 5 of the spreadsheet programs purchased on November 3( Gross price $500). Fast Forward has not yet paid for the merchandise, and it recorded the purchases at net cost.
Accounts Payable 490 Inventory 490 Returned five defective spreadsheet programs to supplier. Net cost of the returned items, $490($100*98%*5

Example: The customer returns merchandise purchased on account for $200. The following entry will be made:
Sales Returns and Allowances 200 Accounts Receivable( or Cash) 200 Customer returned merchandise purchased on account for $200. Allowed customer full credit for returned merchandise. Inventory 160 Cost of Goods Sold 160 To restore in the inventory account the cost of merchandise returned by a customer

Example: Fast Forward sells merchandise to Susan Hall for $1000, offering terms of 2/10, n/30. The sales revenue is recorded at the full invoice price, as follows:
Accounts Receivable 1,000 Sales 1,000 Sold merchandise on account, invoice price, $1,000;terms, 2/10,n/30

If Susan Hall pays after the discount period the following entry will be made: Cash 1,000 Accounts Receivable 1,000 Collected a $1,000 account receivable from a customer If Hall makes the payment within the discount period: Cash 980 Sales Discount 20 Accounts Receivable 1,000 Collected a $1,000 account receivable from a

Revenue: Sales Less: Sales Returns and Allowances Sales Discounts Net Sales 912,000 8,000 4,000 12,000 $900,000

The liability to the governmental unit for sales taxes may be recorded at the time the sale is made, as shown in the following journal entry
Cash 1,07o Sales Tax Payable 70 Sales 1,000 To record sales of $1,000 subject to 7% sales

Gross profit margin= Gross Profit Net Sales revenue = 100,000 *100 400,000 = 25%

*100

Gross profit margins can be calculated for the business as a whole, for specific departments or for individual products

Exercise 5.10 and Exercise 5.11