Download Service Business - Computer Basics a Review

by Eugene Howell -Instructor
Part A
Most of the accounting completed to date has been based on a service type of business. Service
sector businesses usually have straight forward accounting transactions. A second type of
business that exists
in most economies is the Merchandising Businesses. Theses businesses buy goods from other
companies
and resell them to customers at higher prices.
Service Business
A Lawyer
A Doctor
A Lawn Mowing Co.
Merchandising Business
Canadian Tire
London Drugs
Safeway
Etc.
Operating Cycle for a Merchandising Business – Page 220
Manufacturers
Make goods for others. Usually
these are large companies that
sell all over the world.
Ex: General Motors, Micro-Soft,
McansFoods, Etc.
Wholesalers
Retailers
Usually buy goods from the
Retailers are usually the
Manufactures and sell them to
main stream store we see
smaller stores and business around
every day in our cities and
the world. Usually wholesales sell to towns. Some retailer are no
the retailer and not directly to the
longer visable, they are
public. This situation has changed setting up using the Internet
with the introduction of stores like
to sell to the consumer.
Cosco.
Wallmart, Londo Drugs, etc
Selling Inventory – What new Accounts/Accounting terms are needed?
1. Inventory (Asset)
2. Cost of Goods Sold (Expense – the cost to the business owner to buy the goods to
resell)
3. Gross Profit (Revenue – Cost of Goods Sold = Gross Profit)
Income Statement:
Subsidary Ledgers
Review subsidiary ledger knowledge from pages 230-234. Remember that the General Ledger
will have one account showing the balance of all Accounts Receivable or Accounts Payable,
however in the subsidiary ledger there will be accounts for al the Customers and the Vendors.
Assignment#1
Discussion Questions 1-8 page 264
Exercise 5-2
Exercise 5-3
Exercise 5-4
Pages266-267
Part B
(Pages 234-244)
One of the biggest differences for the accounting of a Merchandising Business is the constant
need to update the inventory. Business who buy goods, mark them up at a higher price and sell
them to others to make a profit must account for inventory each time a sale or a purchase is
made.
Two choices of recording transactions in a Merchandising Business regarding inventory will be
discussed:
1. The Perpetual Method
2. The Periodic Inventory System
The Perpetual Method (Most popular Method)
a.
Inventory and the cost of goods sold are updated each time a purchase or a sale
is mad.
Purchase of Inventory
Sale of Inventory
Inventory is considered to be a Current Asset on the Balance Sheet and Cost of Goods Sold
is an expense that will appear on the Income Statement.
b. Subsidary ledger accounts will now be setup for Accounts Receivable, Accounts Payable
and now Inventory. Updating the subsidiary ledgers on a continuous basis is required in
the Perpetual Inventory System.
Review Transaction Examples pages 227-230.
The Inventory Subsidary Ledger is updated for each time a purchase or a sale is made.
Example- Inventory Subsidary Ledger Record
Assignmnet #2
Exercise 5-5
Problem 5-1 Part A
Problem 5-2
Other Transactions Related to Inventory Purchases
When purchases and sales are made there are often discount given and taken by businesses.
Discount Periods
net/30, 2/10 net amount in 30 days or a 2% discount if paid within 10 days.
10 eom full payment is due within 10 days after the end of the month a
purchase occurs.
Purchases Discounts = Cash Discounts or Purchase Discounts (A negative
Expenses
or a Revenue)
Sales Discounts =
Sales Discounts or Discounts Given ( Recorded as an
Expenses or a Negative sale)
Examples (Recording Discounts at Net):
1. Purchased Inventory from PC Products 100 units at $100/unit. This company takes
any discounts upfront. Instead of recording $10,000 the amount will be reduced by
the discount amount.
2. If this bill is not paid on time the discount is lost and a special expense must be
recorded to recognize the 2% discount lost. Recording discounts not taken as
a loss alerts management to a problem that should be addressed. Losing
discounts like these can lead to thousands of dollars of expenses.
Examples (Recording Discounts at Gross):
1. The Gross Price Method is used to record the original purchase at the total amount.
2.
When the Payment is made in 10 days the discount is taken at $200. The Purchase
Discount Taken is treated as a reduction to the Cost of Goods Sold or added to the
Revenue section.
Purchase Returns:
When inventory is purchased and later returned to the supplier, an adjustment needs to be
made to reflect the change in the original purchase.
There are two ways to record inventory as discussed earlier:


The Net Amount method
The Gross Amount method
Returned to PC Packers 5 units of the spreadsheet program because they were defective.
These
units were recorded earlier using the Net amount method (Review Example Above).
The Net Method
The Gross Method
Transportation Costs on Purchases:
When a company purchases goods and services there is usually transportation cost
involved in getting the goods delivered to the company. This additional cost can be
dealt with in two different ways:
1. If the Transportation Costs are directly related to inventory a separate expense
is not need and the extra cost is charged off to the asset inventory which will
eventually be written off as Cost of Goods Sold when the inventory is sold.
2. Often times transportation cost are associated with many items and it is often difficult
to separate the individual costs for particular items. If this is the case, the transportation
costs are written off to a separate expense account titled Transportation-in and are
added
the Cost of Goods Sold on the Income Statement.
Sales Returns, Discounts and Delivery Expense:
When a company sells inventory to the customer there is a possibility that the customer will
return the goods and wish to have the sale reversed. Customers may also take davantage of
sale discounts offered by a company. And finally, there may be delivery charges to get the
goods purchase to the customer’s destination.
Sales Returns:
When ever a sale of inventory is returned a two step process must be followed:
1. Reverse the sale. Instead of Debiting the Sales account a new account titled
Sales Returns and Allowance will be used. This is a Contra Revenue Account to Sales
as Acc. Depreciation is a contra asset account.
2. Increase the Inventory and decrease the Cost of Goods Sold.
Customer returns goods purchased last month, Sale of $200 must be reversed from the
customers account. These goods cost the seller $160 to purchase originally.
Reverse Sale – Step 1
Adjust the Inventory/COGS
Sales Discounts:
Sellers often offer discounts to their customers to entice them to pay on time and keep
their accounts in good standing.
When a sale is recorded, it is recorded at the Gross amount. Sold to Susan Hall $1000
worth of goods, these goods cost the company $625 to buy from its supplier.
Step1
Step 2
Collecting the money from a previous sale:
When the customer send you the money for this sale you only receive a cheque for $980.
This amout is the Gross Ammout minus(–) any Discounts. $1000-$20(discount) = $980.00.
The original sale amount was recorded at Sales $10000. The revenue account is too high
and it must be lowered by the $20 discount.
Another contra revenue account will be used to record any discount. This new
contra revenue account named Sales Discount will be a negative sales account.
Journal Entry to record the receipt of $980.00 from customer on a sale of $1000.00.
Delivery Expenses:
Any expense associated with the delivery of goods to customers by the seller has to be
written off in a separate account called – Delivery Expense. This expense is a normal
operating expense and NOT a part of Cost of Goods Sold.
Updated Income Statement with Revenue Contra accounts
Assignmnet #3
Exercise 5-10 cash Discounts
Exercise 5-12 Returned Merchandise
Problem 5-6
Problem 5-7
Problem 5-8
Problem 5-9
Problem 5-10
Physical Inventory Account
(page 244)
The Perpetual Inventory System is continually updated and keeps the Current Asset –
Inventory
and the Expense – Cost of Goods Sold accurate and ready to use in financial statements at
any given time.
On a monthly basis or at least once a year the Inventory needs to be Physically counted and
compared to the Inventory amount in the General Ledger (Subsidary Ledger) accounts. The
reasons for the differences in the actual inventory count the ledger accounts can result
from a variety of reasons:


Spoilage
Theft


Inproper accounting
Shoplifting
Example(#1):
The General Ledger (Subsidary Ledger) Account for Inventory shows a balance of $72,200
while a physical count of the inventory shows a balance of only $70,000. This requires an
adjustment of $2,200 to the Inventory Account. The current asset will decrease and the
Cost of Goods Sold expense account will increase to reflect the changes.
Example(#2):
If the Inventory adjustment is to be made because of a dramatic difference in the
physical
count and the General Ledger balance a separate Inventory Loss account must be
created
to highlight this exceptional difference between the physical and actual amount reported in
the ledger accounts.
Assignmnet #4
Exercise 5-6
Closing Entries - Perpetual Inventory System
The Four Step Process to close out the books have not changed, however under the
Perpetual
Inventory System a few new accounts need to be closed out.
Revenue 1
Revenue 2
Income Summary
20,000
56,000
76,000
Income Summary
125,000
Sales Return and allowances
Sales Discounts
Cost of Goods Sold
Expense1
Expense2
Expense3
Expense4
2,000
3,000
50,000
25,000
15,000
15,000
15,000
Classified Financial Statements:
The Financial Statements are one of the most important aspects resulting from the
accounting records.
The Balance Sheet




Current Assets (Converted into cash usually in one year. Listed in order of
liquidity)
Plant and Equipment or Fixed Assets ( Used over a period of time – Depreciation
Allowed
Current Liabilities (Usually Paid within one year)
Owner’s Equity
Classified Balance Sheet
The Current Ratio:
The relationship between the Current Assets and the Current Liabilities can tell a lot about the
performance of a business and its solvency ( ability of a business to pay its bills). The Current
Liabilities are debts that must be paid within a year and the moneys to pay these debts must
come from converting the currents assets into cash.
Current Ratio = Current Assets / Current Liabilities
Example from the Classified Balance Sheet above:
Current Ratio = 180,000/100,000
Current ratio = 1.8 to 1
( This means that this company’s Current Assets are 1.8 times its Current Liabilities)
The higher the Ratio the more Solvent the company appears to be.
Comparing your company’s Current Ratio to other similar campanies in the country you
can tell if you are in a good postion or not. For example it is generally accepted that retail
businesses should have a Current Ratio of 2:1
Computer Barns has a ratio of only 1.8:1 which could alert banks and other
creditors that your company could be a credit risk.
Working Capital
Another ratio used to express the relationship between Current Assets and Current Liabilities
is the Working Capital.
Working Capital = Current Assets – Current Liabilities
Working Capital = 180,000 –100,000
Working Capital = 80,000
If all Current Liabilities were to be paid today the company would have $80,000 left over to
continue to operate.
These ratios do have limitations and often other data must be used in combination with
these ratios to make better judgement. (pages 252-253)
Owner’s Responsibility for Debts:
Incorporated vs Unincorporated:
An unincorporated business is one in which the owners (usually sole proprietorship and
partnerships) are held personally liable for the debts of a business. Creditors often look at
the business owners as a whole rather than looking only at the financial position of a business.
A business organized as a corporation will only look at the financial position of a business
only not at the personal assets of the shareholders.
Small business people may have to sign personal commitment using their personal assets to
secure credit which makes it personally liable. Often times a creditor may require a co-signer
in order for credit to be disbursed.
Classified Income Statement:


Multi-Step Income Statement
Single-Step Income Statement
Multi-Step Income Statement




Revenue Section
Cost of Goods Sold Section
Gross Profit Section (The Gross Profit Rate = Gross Profit/Net Sales)
Operating Expenses
o Selling expenses ( Expenses Directly Related to the Selling of gods and
Services)
o Administrative expenses (Expenses used indirectly in the operations of the
business)
Nonoperating Items (Expenses not directly from the operations of a business)
 Interest Expense (-)
 Purchase Discount Lost (-)
 Interest Revenue (+)
Multiple Step Income Statement
Single-Step Income Statement
A single step income statement avoids many of the sub-totals used in a Multiple-Step statement.
Single-step Income Statement Example
Evaluating the Adequacy of Net Income:
Assignmnet #4
Exercise 5-14
Exercise 5-15
Problem 5-11
Problem 5-12
Problem 5-13
Part C
The Periodic Inventory system:
Some companies do not keep track of their inventory using the Perpetual Inventory method,
but rather use another method that does not require inventory to be updated on a daily basis
when sales and purchase transactions are made.
In the Periodic System, no attempt is made to update the Inventory od the Cost of Goods Sold
on a contiuous basis. Rather these accounts are calculated and updated periodically.
Major Differences:

When a purchase of inventory is made a new account called Purchases is debited
instead
of debiting Inventory as in the Perpetual system.

When merchandise is sold an entry to recognize the revenue is made but no entry is
recorded to reduce the Inventory and increase the Cost of Goods Sold.

A Phyical count is necessary in a Periodic stste in order to calculate the Cost of Goods
Sold.
There is no Inventory Subsidary Ledger in a Periodic System.
Transaction comparsions between the the methods:
Calculate the Cost of Goods Sold
Periodic System
Click for Comparsion Summary
Perpetual Vs Periodic
Assignmnet #5
Exercise 5-7
Exercise 5-8
Problem 5-3
Problem 5-4
Problem 5-5
Practice Quiz Reviews
Quiz Reviewa
Quiz Reviewd
Quiz Reviewb
Quiz-self Test
Quiz Reviewc