Principles of Accounting: Exam 3 Study Guide (Merchandising, Inventory, Cash, Receivables)

Merchandising Operations

Purchase of Merchandise Inventory

Merchandising companies buy goods to resell, and must record inventory transactions accurately. Understanding purchase returns, discounts, and freight is essential for proper accounting.

• Journal Entry for Merchandise Returns/Allowances (Buyer): When merchandise is returned or an allowance is granted, the buyer reduces the Merchandise Inventory account and records the return or allowance.

• Cash Payment Calculation with Credit Terms: Credit terms (e.g., 2/10, n/30) specify the discount and payment period. To calculate payment, subtract any applicable discount from the invoice price.

• Net Cost of Inventory Purchased: Net cost includes purchase price, plus freight-in, minus returns, allowances, and discounts.

• Formula: $\text{Net Cost} = \text{Purchase Price} + \text{Freight-In} - \text{Returns} - \text{Discounts}$

• Example: If inventory is purchased for $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 merchandise.

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

• 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: If net sales revenue is $5,000 and cost of goods sold is $3,000, gross profit is $2,000.

Credit Terms, Freight Costs, and Shrinkage

Credit terms, freight costs, and inventory shrinkage affect the accounting for inventory transactions.

• Credit Terms Interpretation: Terms like 2/10, n/30 mean a 2% discount is available if paid within 10 days; otherwise, net amount is due in 30 days.

• Freight Costs:

  • FOB Shipping Point: Buyer pays freight; record as Merchandise Inventory.

  • FOB Destination: Seller pays freight; record as Delivery Expense.

• Inventory Shrinkage: Shrinkage is the loss of inventory due to theft, damage, or error. Calculate shrinkage by comparing physical count to book balance.

• Journal Entry for Shrinkage: Debit Cost of Goods Sold, credit Merchandise Inventory for the amount of shrinkage.

Merchandise Inventory

Key Accounting Principles

Several principles guide inventory accounting:

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

• Matching Principle: Expenses should be matched to revenues in the period they are incurred.

• 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 determine how costs are assigned to goods sold and remaining inventory.

• Weighted Average Cost: Average cost per unit is calculated and applied to both cost of goods sold and ending inventory.

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

• FIFO (First-In, First-Out): Oldest inventory costs are assigned to cost of goods sold; newest costs remain in ending inventory.

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

  • If ending inventory is overstated, cost of goods sold is understated and gross profit is overstated.

Internal Control and Cash

Bank Reconciliation

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

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

• Book-side Adjustments: Include bank fees, NSF checks, and errors in the company's records.

• Adjusted Cash Balance Calculation: Adjust the book balance for all 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. It is replenished periodically.

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

• Cash Over/Short: If the amount in petty cash does not match receipts, record the difference in the Cash Short & Over account.

• Replenishment Entry: Debit expense accounts and Cash Short & Over (if shortage), credit Cash.

• Cash Short & Over: A debit indicates a shortage; a credit indicates an overage.

Receivables

Allowance for Bad Debts

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

• Nature: Contra-asset account reducing Accounts Receivable.

• Percent-of-Sales Method: Bad debts expense is calculated as a percentage of credit sales.

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

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

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

• Recovery Entry: Reverse the write-off, then record the collection.

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 past due, 60 days past due).

• Estimated Uncollectible Value: Apply different percentages to each age group to estimate total uncollectibles.

• Bad Debts Expense Calculation: The amount needed to adjust Allowance for Bad Debts to the target balance.

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

• Interest Revenue Calculation: For a 360-day year:

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

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

Summary Table: Key Journal Entries

Transaction	Journal Entry	Account(s) Affected
Inventory Purchase	Debit Merchandise Inventory, Credit Cash/Accounts Payable	Merchandise Inventory, Cash/AP
Inventory Return (Buyer)	Debit Accounts Payable, Credit Merchandise Inventory	AP, Merchandise Inventory
Inventory Sale	Debit Cash/AR, Credit Sales Revenue; Debit Cost of Goods Sold, Credit Merchandise Inventory	Cash/AR, Sales Revenue, CoGS, Merchandise Inventory
Sales Return (Seller)	Debit Sales Returns & Allowances, Credit Cash/AR; Debit Merchandise Inventory, Credit CoGS	Sales Returns, Cash/AR, Merchandise Inventory, CoGS
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
Bank Reconciliation Adjustment	Debit/credit Cash, Debit/credit relevant expense/revenue accounts	Cash, Expense/Revenue Accounts
Petty Cash Replenishment	Debit Expenses, Debit/credit Cash Short & Over, Credit Cash	Expenses, Cash Short & Over, Cash

Additional info: This guide expands on brief study points by providing definitions, formulas, and examples for each topic. It is structured to help students master journal entries, calculations, and conceptual understanding for exam preparation in Principles of Accounting.