Principles of Accounting: Exam 3 Study Guide (Chapters 5-7)

Merchandising Operations (Chapter 5)

Purchase of Merchandise Inventory

Merchandise inventory transactions involve recording purchases, returns, discounts, and freight costs. Accurate journal entries are essential for reflecting the buyer's perspective.

• Journal Entry for Merchandise Returns/Allowances (Buyer): When merchandise is returned or an allowance is granted, the buyer debits Accounts Payable and credits Merchandise Inventory.

• Cash Payment with Credit Terms: Calculate payment by considering purchase discounts. For example, terms "2/10, n/30" mean a 2% discount if paid within 10 days.

• Net Cost of Inventory Purchased: Net cost = Purchase price + Freight in - Returns - Discounts.

• Example: If inventory is purchased for $1,000, freight in is $50, returns are $100, and a 2% discount applies, net cost = $1,000 + $50 - $100 - $18 = $932.

Sale of Merchandise Inventory

Sales transactions require compound journal entries to record both revenue and cost of goods sold.

• Compound Journal Entry for Sales: For a cash sale, debit Cash, credit Sales Revenue; also debit Cost of Goods Sold, credit Merchandise Inventory.

• Journal Entry for Merchandise Returns (Seller): Debit Sales Returns and Allowances, credit Accounts Receivable; also debit Merchandise Inventory, credit Cost of Goods Sold.

• Cash Receipts with Sales Discount: If a customer takes a sales discount, record the reduced cash received and the discount in Sales Discounts.

• Gross Profit Calculation: Gross Profit = Net Sales Revenue - Cost of Goods Sold.

• Net Sales Revenue Formula: $\text{Net Sales Revenue} = \text{Sales} - \text{Sales Returns and Allowances} - \text{Sales Discounts}$

• Example: If sales are $5,000, returns $200, discounts $100, and CoGS $3,000, Net Sales Revenue = $5,000 - $200 - $100 = $4,700; Gross Profit = $4,700 - $3,000 = $1,700.

Credit Terms, Freight Costs, and Shrinkage

Understanding credit terms, freight costs, and inventory shrinkage is crucial for accurate accounting.

• Credit Terms Interpretation: Terms like "2/10, n/30" indicate payment conditions and possible discounts.

• Freight Costs: Under FOB Shipping Point, buyer records freight in Merchandise Inventory; under FOB Destination, seller records freight in Delivery Expense.

• Inventory Shrinkage: Shrinkage is the loss of inventory due to theft, damage, or error. Journal entry: Debit Cost of Goods Sold, credit Merchandise Inventory.

• Example: If physical count shows $500 less inventory than records, entry is: Debit CoGS $500, Credit Merchandise Inventory $500.

Merchandise Inventory (Chapter 6)

Key Accounting Principles

Several principles guide inventory accounting and reporting.

• Materiality Concept: Only information that would influence decisions should be reported.

• Matching Principle: Expenses should be matched with related revenues in the same period.

• Conservatism: When in doubt, report lower asset values and higher expenses.

• Disclosure Principle: All relevant information must be disclosed in financial statements.

Inventory Costing Methods

Inventory costing methods affect the calculation of Cost of Goods Sold (CoGS) and inventory value.

• Weighted Average Cost per Unit: $\text{Weighted Average Cost per Unit} = \frac{\text{Total Cost of Goods Available for Sale}}{\text{Total Units Available for Sale}}$

• Example: If 100 units cost $1,000, average cost per unit = $1,000 / 100 = $10.

• FIFO Method: First-In, First-Out assumes earliest inventory is sold first. CoGS is based on oldest costs; ending inventory is based on most recent costs.

• Lower-of-Cost-or-Market Rule: Inventory is reported at the lower of its historical cost or current market value.

• Inventory Errors: If ending inventory is overstated, CoGS is understated and Gross Profit is overstated; if understated, the opposite occurs.

Internal Control and Cash (Chapter 7)

Bank Reconciliation

Bank reconciliation ensures the Cash account matches the bank statement by identifying necessary adjustments.

• Bank-side Adjustments: Include deposits in transit, outstanding checks, and bank errors.

• Book-side Adjustments: Include interest earned, service charges, NSF checks, and book errors.

• Adjusted Cash Balance Calculation: Adjust the book balance for all book-side items.

• Journal Entries for Reconciliation Items: Only book-side items require journal entries.

• Example: If service charge is $20, entry: Debit Bank Expense $20, Credit Cash $20.

Petty Cash and Cash Over/Short

Petty cash is used for small, incidental expenses. Cash overage/shortage is tracked in the Cash Short & Over account.

• Petty Cash Definition: A small fund for minor expenditures.

• Cash Over/Short Calculation: If cash in the fund is less than expected, debit Cash Short & Over; if more, credit it.

• Example: If petty cash should be $100 but is $98, entry: Debit Cash Short & Over $2.

Receivables (Chapter 7)

Allowance for Bad Debts

The Allowance for Bad Debts account estimates uncollectible receivables, ensuring expenses are matched to revenues.

• Nature of Allowance for Bad Debts: Contra-asset account reducing Accounts Receivable.

• Percent-of-Sales Method: Bad Debts Expense = Sales x Estimated Uncollectible Percentage.

• Adjusting Journal Entry: Debit Bad Debts Expense, credit Allowance for Bad Debts.

• Write-off Entry: Debit Allowance for Bad Debts, credit Accounts Receivable.

• Recovery Entry: Reverse write-off, then record collection: Debit Accounts Receivable, credit Allowance for Bad Debts; then debit Cash, credit Accounts Receivable.

Aging of Receivables Method

This method estimates uncollectible accounts based on the age of receivables.

• Classify Accounts: Group receivables by age (e.g., current, 30 days, 60 days).

• Estimated Uncollectible Value: Multiply each group by its estimated uncollectible percentage; sum for total allowance.

• Bad Debts Expense: Amount needed to adjust Allowance for Bad Debts to target balance.

• Example Table:

Age Group	Balance	Estimated % Uncollectible	Estimated Uncollectible
Current	$10,000	2%	$200
30 Days	$5,000	5%	$250
60 Days	$2,000	10%	$200
Total			$650

Accounts Receivable, Net

Net Accounts Receivable is calculated by subtracting Allowance for Bad Debts from Accounts Receivable.

• Formula: $\text{Accounts Receivable, Net} = \text{Accounts Receivable} - \text{Allowance for Bad Debts}$

Notes Receivable

Notes receivable are formal promises to pay, including interest, with a specified maturity date.

• Maturity Date: Calculated by adding the term (in days) to the issue date.

• Interest Revenue Calculation: $\text{Interest} = \text{Principal} \times \text{Rate} \times \frac{\text{Days}}{360}$

• Collection Entry at Maturity: Debit Cash, credit Notes Receivable and Interest Revenue.

• Example: $10,000 note at 6% for 90 days: Interest = $10,000 \times 0.06 \times \frac{90}{360} = $150$

Additional info: These notes expand on the study guide by providing definitions, formulas, and examples for each topic. Students should review textbook chapters, practice journal entries, and memorize key formulas for exam success.