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

Merchandising Operations (Chapter 5)

Purchase of Merchandise Inventory

Merchandise inventory transactions involve buying goods for resale. Understanding the correct journal entries and calculations is essential for accurate financial reporting.

• Journal Entry for Merchandise Returns/Allowances (Buyer): When merchandise is returned or an allowance is granted, the buyer records a reduction in inventory and accounts payable.

• Cash Payment Calculation with Credit Terms: To determine the cash payment, consider purchase price, credit terms (e.g., 2/10, n/30), and whether a purchase discount applies.

• Net Cost of Inventory Purchased: Compute by adjusting for purchase price, freight-in, returns, and discounts.

• Formula:

$\text{Net Cost} = \text{Purchase Price} + \text{Freight-In} - \text{Purchase Returns/Allowances} - \text{Purchase Discounts}$

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

Sale of Merchandise Inventory

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

• Compound Journal Entry for Sales: Record sales revenue and the reduction in inventory (cost of goods sold).

• Journal Entry for Merchandise Returns (Seller): Reverse sales revenue and cost of goods sold for returned items.

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

• Gross Profit Calculation: Gross profit is the difference between net sales revenue and cost of goods sold.

• Formula:

$\text{Gross Profit} = \text{Net Sales Revenue} - \text{Cost of Goods Sold}$

• Example: Net sales revenue is $5,000, cost of goods sold is $3,000; gross profit is $2,000.

Credit Terms, Freight Costs, and Shrinkage

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

• Credit Terms: Indicate payment conditions (e.g., 2/10, n/30 means 2% discount if paid within 10 days, net due in 30 days).

• Freight Costs: Under FOB Shipping Point, buyer records freight-in; under FOB Destination, seller records freight-out.

• Inventory Shrinkage: The loss of inventory due to theft, damage, or error. Calculate shrinkage and record a journal entry to adjust inventory.

• Formula:

$\text{Shrinkage} = \text{Inventory per records} - \text{Inventory per physical count}$

• Example: If records show $10,000 and physical count is $9,800, shrinkage is $200.

Merchandise Inventory (Chapter 6)

Key Accounting Principles

Several principles guide inventory accounting:

• 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 should be disclosed in financial statements.

Inventory Costing Methods

Inventory costing methods affect the calculation of cost of goods sold and ending inventory.

• Weighted Average Cost per Unit: Calculate by dividing total cost by total units.

• Formula:

$\text{Weighted Average Cost per Unit} = \frac{\text{Total Cost of Inventory}}{\text{Total Units Available}}$

• Example: $6,000 cost for 1,000 units = $6 per unit.

• Cost of Goods Sold (Weighted Average): Multiply units sold by weighted average cost.

• FIFO Method: First-In, First-Out assumes oldest inventory is sold first. Layered inventory must be considered.

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

• Inventory Errors: An error in ending inventory affects cost of goods sold and gross profit. If ending inventory is understated, cost of goods sold is overstated and gross profit is understated.

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 and outstanding checks.

• Book-side Adjustments: Include bank fees, NSF checks, and errors.

• Adjusted Cash Balance Calculation: Adjust both bank and book balances for reconciling items.

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

Petty Cash

Petty cash is a small fund used for minor expenses.

• Purpose: To pay for small, incidental expenses without writing checks.

• Cash Over/Short: If the fund does not balance, record the difference in the Cash Short & Over account.

• Debit or Credit: Cash Short & Over is debited for shortages and credited for overages.

Receivables (Chapter 7)

Allowance for Bad Debts

The Allowance for Bad Debts account estimates uncollectible receivables, improving accuracy of financial statements.

• Nature: Contra-asset account reducing Accounts Receivable.

• Adjusting Entry for Bad Debts Expense (Percent-of-Sales Method): Estimate bad debts as a percentage of sales.

• Formula:

$\text{Bad Debts Expense} = \text{Credit Sales} \times \text{Estimated Percentage}$

• Write-off Entry: Remove uncollectible accounts from Accounts Receivable and Allowance for Bad Debts.

• Recovery Entry: Reinstate previously written-off accounts and record cash collection.

Aging of Receivables Method

Classify accounts by age to estimate uncollectible amounts.

• Target Balance: Sum estimated uncollectibles for each age category.

• Bad Debts Expense: Difference between target balance and current allowance account.

Accounts Receivable, Net

Net accounts receivable is the amount expected to be collected.

• Formula:

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

Notes Receivable

Notes receivable are formal promises to pay, often with interest.

• Maturity Date: Add the term (in days) to the issue date.

• Interest Revenue Calculation: Use a 360-day year for simplicity.

• Formula:

$\text{Interest} = \text{Principal} \times \text{Rate} \times \frac{\text{Term (days)}}{360}$

• Collection Entry: Record principal and interest received at maturity.

Summary Table: Key Journal Entries

Transaction	Journal Entry	Account(s) Affected
Purchase of Inventory	Debit Merchandise Inventory, Credit Accounts Payable	Merchandise Inventory, Accounts Payable
Sales of Inventory	Debit Accounts Receivable/Cash, Credit Sales Revenue; Debit Cost of Goods Sold, Credit Merchandise Inventory	Accounts Receivable/Cash, Sales Revenue, Cost of Goods Sold, Merchandise Inventory
Inventory Shrinkage	Debit Cost of Goods Sold, Credit Merchandise Inventory	Cost of Goods Sold, Merchandise Inventory
Bad Debts Expense (Allowance Method)	Debit Bad Debts Expense, Credit Allowance for Bad Debts	Bad Debts Expense, Allowance for Bad Debts
Write-off Uncollectible Account	Debit Allowance for Bad Debts, Credit Accounts Receivable	Allowance for Bad Debts, Accounts Receivable
Recovery of Written-off Account	Debit Accounts Receivable, Credit Allowance for Bad Debts; Debit Cash, Credit Accounts Receivable	Accounts Receivable, Allowance for Bad Debts, Cash
Bank Reconciliation (Book-side)	Debit/Credit Cash, Credit/Debit relevant accounts (e.g., Bank Fees, Interest Revenue)	Cash, Bank Fees, Interest Revenue
Petty Cash Replenishment	Debit Expenses, Credit Cash; Debit/Credit Cash Short & Over as needed	Expenses, Cash, Cash Short & Over

Additional info: This guide expands on brief study points by providing definitions, formulas, and examples for each topic, ensuring students have a comprehensive resource for exam preparation.