ADMS2500

Introduction to Financial
Accounting

1
Agenda
1. Housekeeping
2. Week 2 Recap
3. Week 3 materials
i. Lecture materials
ii. Problem walk-through

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House Keeping Info.

⚪ Workload expected: slides, textbook, end-of-

chapter problems, Connect Assignments
⚪ Connect Assignments (Ch1-5 due Feb. 5, 3

attempts, best score stored, 8/11 best scores

counted)
⚪ Data Analytic Quiz (Feb. 25 10, 11-11:30)

Makeup Quiz (Feb. 28 19:00, 20:00-20:30)

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Week 2 Recap : Chapter 4
Accounting Cycle
STEPS (manual records):
1. Analyze transaction
2. Journalize (journal entries) Week 1
3. Post (T-accounts)
4. Trial balance (unadjusted)
5. Adjusting entries (at the end of actg
period) Week 2

6. Trial Balance (adjusted)

7. Financial Statements (4 statements)

Question: How do these steps differ if we are

using computerized accounting software?
Same….but computer handles 3, 4, 6 & 7 4
What we have covered ..
✓ Chapter 1
✓ Chapter 2
✓ Chapter 3
✓ Chapter 4: Adjusting entries

• Chapter 5: Merchandising
• Chapter 6: Cash
• Chapter 7: Receivables
• Chapter 8: Inventory
• Chapter 9: Capital assets
• Chapter 10: Liabilities
• Chapter 11: Owners’ Equity
• Chapter 12: Cash flow statement
• Chapter 13: FS analysis

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Week 3

⚪ Chapter 5 - Introduction to Accounting for

Merchandising Operations

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Learning Outcomes
o Describe merchandising and explain the financial statement
components of sales, cost of goods sold, merchandise
inventory, and gross profit.
o Differentiate between the perpetual and periodic inventory
systems.
o Analyze and record purchase and sales transactions for a
merchandiser.
o Record adjustments to merchandise inventory.
o Explain and identify the entries regarding purchase and sales
transactions in a periodic inventory system.
o Understand cash budgeting.
Revenue recognition and Matching of expenses:

⚪ Revenue is recognized when the earning process is substantially complete, and

the measurability and the collectability of the dollar amount is reasonably
assured.
⚪ For most businesses revenue is recognized when goods are shipped to
customers or services are provided.
⚪ Accountants recognize revenue at the earliest point when the work done to
earn it is substantially complete.
⚪ Revenue is linked with an increase in net assets from operations:

⚪ Under accrual accounting expenses incurred are matched with related revenue
to determine net income for a particular time period.
Determination of Net Income (loss)

Net Income = Revenue - Expenses

Revenues is $7,500: Net Income = $7,500 – Supply Expense

Recognize expenses:
Step 1: at the time of purchase, we take in the asset

Dr Supplies (balance sheet account)

Cr Cash or Accounts Payable

Step 2: at period end or when assets are used/expired

we recognize the expense

Dr Supplies Expense (income statement)

Cr Supplies (balance sheet account)
 Cash vs Accrual basis

⚪ Revenue recognition and matching of expenses are a cornerstone of

accrual basis accounting.
⚪ In contrast to the accrual basis, cash basis accounting recognizes

revenue when money is received and recognizes money when paid.

⚪ Cash basis may distort the portrayal of financial position and over or

understate performance measurement.

⚪ Financial statements use both accrual and cash basis accounting to

report the history of transactions in a company.

⚪ Income statement, Statement of Retained Earnings and the Balance

Sheet use accrual basis of accounting.

⚪ Cash Flow statement uses cash basis of accounting and explains the

changes in the Cash account balance during one the period.

 Three Types of Operations

Manufacturing Merchandising Service

Operations Operations Operations
(Toyota, Air Bus) (BestBuy, (Big 4, RBC)
Walmart)
Produce and Sell Buy and Sell Sell

Goods Goods Services

Cost of Goods
Manufactured (COGM) Purchase Cost (PC) No COGM
Cost of Goods Sold Cost of Goods Sold No COGS
(COGS) (COGS)

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 Merchandising operations
⚪ Buy and sell finished goods.
⚪ Cost of Goods Sold (COGS): the cost of items shipped to customers is
usually a large expense.
● COGS is often reported as a separate line item on the Income
Statement.
⚪ Inventory is reported on the Balance Sheet: it is goods held for sale.
⚪ Often the change in inventory is computed at the time of each sale
(perpetual method) or at the end of the period (the periodic method).
⚪ Recognizing Cost of Goods Sold (using perpetual method):
…not expensed when goods are purchased
Dr Inventory (balance sheet account)
Cr Cash or Accounts Payable
… COGS is recognized when goods are sold
Dr Cost of Goods Sold (income statement)
Cr Inventory (balance sheet account)
Computing COGS
Opening Inventory $xxxx
Plus net cost of purchases
Purchases $xxxx
Less: Purchases returns and allowances (xxx)
Less: Purchase discounts (xx)
Add: Transportation in xx xxx
Cost of Merchandise Available for Sale (MAFS) xxxx
Less: ending inventory (xxx)
Sold MAFS
COGS Unsold MAFS $xxxx

Inventory: Cost of Goods Sold:

Balance Sheet Income Statement
Income Statement: Gross Profit

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Income Statement: Continue from “Gross
Profit”

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Purchase & Sale Transactions

1. Record Sales

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1. Record Sales

1) Journal entry

2) Posting to ledger

What if there exists sales discount? sales returns & allowance?

Sales discount: e.g. “1/10, n/30” => buyer is eligible for 1% discount of full
payment, if making payment within 10 days
Sales returns: buyer return goods to the seller. Seller issues refund to buyer.
Sales allowance: buyer not return goods to seller (e.g. as a result of a shortage in a
shipment). Seller issue refund to buyer. 17
Net Sales

⚪ Sales recognition
● Gross method vs. net method
⚪ Sales discount: e.g. “2/10, n/30”
● 2% discount if payment received in 10 days, full amount if
payment received within 30 days
⚪ Sales returns and allowance
● Depends on if gross or net method is used
● Depend on if sales discount is taken
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Gross Method:
1) CBA sells 7 widgets to ABC for $490 (terms 2/10, n/30)
Seller CBA Buyer ABC
Dr Accounts Receivable 490 Dr Purchases 490
Cr Sales 490 Cr Accounts Payable 490
2) 2 units returned for credit within the discount period
Seller Buyer
Dr Sales Returns & Allowances 140 Dr Accounts Payable 140
Cr Purchase Returns & Allowances 140
Cr Accounts Receivable 140

3) Payment made within the discount period ($490 -$140)x.98=$343

Seller Buyer
Dr Cash 343 Dr Accounts Payable 350
Dr Sales Discounts 7 Cr Purchase Discounts 7
Cr Accounts Receivable 350 Cr Cash 343
Net Method
1) CBA sells 10 widgets to ABC for $500 (terms 2/10, n/30)
Seller CBA Buyer ABC (assuming periodic inventory system)
Dr Accounts Receivable 490 Dr Purchases 490
Cr Sales i.e.500*(1-2%) 490 Cr Accounts Payable 490
2) 4 units returned for credit within the discount period
Seller Buyer
Dr Sales Returns & Allowances 196 Dr Accounts Payable 196
Cr Accounts Receivable i.e.200*(1-2%) 196 Cr Purchase Returns & Allowances 196
3) Payment made within the discount period ($500 -$200)x.98=$294
Seller Buyer
Dr Cash 294 Dr Accounts Payable 294
Cr Accounts Receivable 294 Cr Cash 294
4) What if Payment is not made within the discount period? That is, the buyer did not take
cash discount? (500-200)*100% = 300
Seller Buyer
Dr Cash 300 Dr Accounts Payable 294
Cr Accounts Receivable 294 Purchase discount Forfeited 6
Cr Sales Discount Forfeited 6 Cr Cash 300
Net method: record transaction at NET amount, as if cash discount is to be taken. In the case the cash discount
is indeed not taken, record discount taken as “Sales Discount Forfeited” (seller) or “Purchase Discount
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Forfeited” (buyer)
Purchase & Sale Transactions

2. Record Cost of Goods Sold (COGS)

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Account Equations
✓ Purchase Equation
GP + TI – PRA – PD = NP

✓ Inventory Equation
(OI + NP) – COGS = EI

✓ Cost of Goods Sold Equation (same equation)

(OI + NP) – EI = COGS
I = Inventory CoGS = Cost of Goods Sold (also CofGS)
OI = Opening Inventory EI = Ending Inventory
NP = Net Purchases GP = Gross Purchases,
TI = Transportation In PD = Purchase Discounts
PRA = Purchase Returns and Allowances
Cost of Goods Sold

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 Transportation In:
FOB Shipping vs. FOB Destination

Who's paying shipping cost depends on the contract term (i.e.

who’s assuming the risk during shipment)

If the term is “FOB Shipping” If the term is “FOB Destination”

=> "Free on board” at shipping point
=> Buyer assume risk of shipping
=> Buyer pays shipping cost
=> Shipping cost is recorded in buyer’s
“Transportation In” account (also called
“Freight In”)
=> “Free on board” at destination point
=> Seller assumes risk of shipping
=> Seller pays shipping cost
=> Shipping cost is recorded in seller’s
“Transportation Out” account (also called
“Freight Out”)
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Timing of Inventory Computations
Perpetual Inventory
● Purchases are debited directly to inventory as items for
resale are acquired
● Items sold are credited to inventory at their acquisition
cost at the time of sale
Dr Accounts Receivable
Cr Sales
Dr Cost of Goods Sold
Cr Inventory
● Sub-ledger kept for inventory and is updated after
each transaction
Periodic Inventory Method
Acquisitions:
Charged to “Purchases” account
Valuation:
Inventory is counted and valued only at the end of
the accounting period
Weakness:
On any given day during month:
Clueless what balance is of inventory
Advantage:
In pre-computer era…less bookkeeping
Perpetual vs. Periodic Inventory System
Periodic
Interval inventory account is updated
periodically
Control Not a better system to control inventory
(loss/theft may not be detected in time)
Scope Widely used in small business
For each inventory Goods purchased is recorded in
purchase “Purchase” account
For each sale Only sales journal entry is needed. That
is, “Sales” account is updated but not
the “CoGS” account. CoGS is only
updated at the end of period.
Dr: Cash (or A/R)
Cr: Sales Revenue
Perpetual
inventory account is updated
continuously
a better system to control inventory
Widely used in large corporations
Goods purchased is recorded in
“Inventory” account
A sales journal entry and a CoGS
journal entry are both required. That is,
both “Sales” and “CoGS” accounts are
updated upon each sale.
Dr: Cash (or A/R)
Cr: Sales Revenue
Dr: Cost of Goods Sold
Cr: Inventory
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End-of-Chapter Practice

⚪ Chapter 5 - PROBLEM 01

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Chapter 5 - PROBLEM 01
PROBLEM 01 – JOURNAL ENTRIES The following transactions occurred between the Seinfeld Company
and Simpson Stores during March of the current year.

Mar. 8...Seinfeld sold $2,600 worth of merchandise to Simpson Stores, terms 2/10, n/30, F.O.B.
shipping point. Seinfeld paid freight charges of $40 and added it to the amount of the invoice for the
merchandise.

Mar.12... Simpson Stores returned $200 worth of the merchandise shipped on March 8. Seinfeld
issued a credit memo for this amount.

Mar17... Seinfeld received full payment for the net amount due from the March 8 sale.

Mar 20... Simpson Stores returned goods that had been billed originally at $100. Seinfeld issued a
cheque.

REQUIRED Record the above transactions in general journal form as they would appear on
a) the books of Seinfeld Company (net method) and
b) the books of Simpson Stores. Simpson Stores records purchases at invoice price, uses periodic
inventory system and gross method.
Chapter 5 - PROBLEM 01
REQUIRED Record the above transactions in general journal form as they would appear on
a) the books of Seinfeld Company (net method):

Mar. 8...Seinfeld sold $2,600 worth of merchandise to Simpson Stores, terms 2/10, n/30, F.O.B.
shipping point. Seinfeld paid freight charges of $40 and added it to the amount of the invoice for the
merchandise.

Mar.12... Simpson Stores returned $200 worth of the merchandise shipped on March 8. Seinfeld
issued a credit memo.
Chapter 5 - PROBLEM 01
REQUIRED Record the above transactions in general journal form as they would appear
on
a) the books of Seinfeld Company (net method):

Mar17... Seinfeld received full payment for the net amount due from the March 8 sale.

Mar 20... Simpson Stores returned goods that had been billed originally at $100. Seinfeld issued a
cheque.
Chapter 5 - PROBLEM 01
REQUIRED Record the above transactions in general journal form as they would
appear on
b) the books of Simpson Stores. Simpson Stores records purchases at invoice price,
uses periodic inventory system and gross method.

Mar. 8...Seinfeld sold $2,600 worth of merchandise to Simpson Stores, terms 2/10, n/30, F.O.B.
shipping point. Seinfeld paid freight charges of $40 and added it to the amount of the invoice for
the merchandise.

Mar.12... Simpson Stores returned $200 worth of the merchandise shipped on March 8. Seinfeld
issued a credit memo for this amount.
Chapter 5 - PROBLEM 01
REQUIRED Record the above transactions in general journal form as they would appear on
b) the books of Simpson Stores. Simpson Stores records purchases at invoice price, uses
periodic inventory system and gross method.

Mar17... Seinfeld received full payment for the net amount due from the March 8 sale.

Mar 20... Simpson Stores returned goods that had been billed originally at $100. Seinfeld issued a
cheque.
 Chapter 5 - Problem 3
PROBLEM 03 – INCOME STATEMENT PREPARATION
The following selected information is available for the Newman Wholesale
Company for March of the current year:
Purchases $45,500
Sales 94,500
Transportation In 3,200
Purchases Discounts 700
Inventory, March 1 38,500
Inventory, March 31 31,000
Purchases Returns and Allowances 800 REQUIRED
Sales Returns and Allowances 1,400 a) Prepare the March income statement
Transportation Out 420 for Newman Wholesale Company.
b) Calculate the ratio of gross profit to net
Rent Expense 1,450 sales and express it as a percentage.
Sales Salaries Expense 18,400 c) Calculate the ratio of net income to net
Sales Discounts 1,100 sales and express it as a percentage.
Depreciation Expense-Office Equipment 120
Office Supplies Expense 310
Office Salaries Expense 7,850
Advertising Expense 1,400
Insurance Expense (a selling expense) 150
 Chapter 5 - Problem 3
PROBLEM 03 – INCOME STATEMENT PREPARATION
a) Prepare the March income statement for Newman Wholesale Company.
Purchases $45,500
Sales 94,500
Transportation In 3,200
Purchases Discounts 700
Inventory, March 1 38,500
Inventory, March 31 31,000
Purchases Returns and Allowances 800
Sales Returns and Allowances 1,400 Start with Net revenues:
Transportation Out 420
Revenues 94,500
Rent Expense 1,450
Sales Salaries Expense 18,400 Minus:
Sales Discounts 1,100 Sales Discounts 1,100
Depreciation Expense-Office Equipment 120 Sales Returns
Office Supplies Expense 310 and Allowances 1,400
Office Salaries Expense 7,850
Net revenues 92,000
Advertising Expense 1,400
Insurance Expense (a selling expense) 150
 Chapter 5 - Problem 3
PROBLEM 03 – INCOME STATEMENT PREPARATION
a) Prepare the March income statement for Newman Wholesale Company.
Purchases $45,500
Continue with CGS:
Sales 94,500
Transportation In 3,200 Identify MAFS:
Purchases Discounts 700 Inventory March 1st 38,500
Inventory, March 1 38,500 Add net Purchases:
Inventory, March 31 31,000 Purchases 45,500
Purchases Returns and Allowances 800
Sales Returns and Allowances 1,400 Purchase Discounts 700
Transportation Out 420 Purchase Returns
Rent Expense 1,450 and Allowances 800
Sales Salaries Expense 18,400 Net Purchases 44,000
Sales Discounts 1,100
Depreciation Expense-Office Equipment 120 Add Transportation In 3,200
Office Supplies Expense 310 MAFS 85,700
Office Salaries Expense 7,850
Advertising Expense 1,400 Less:
Insurance Expense (a selling expense) 150 Ending Inventory 31,000

CGS 54,700
 Chapter 5 - Problem 3
PROBLEM 03 – INCOME STATEMENT PREPARATION
a) Prepare the March income statement for Newman Wholesale Company.
Purchases $45,500
Sales 94,500 Income Statement
Transportation In 3,200 Net Revenues 92,000
Purchases Discounts 700 Minus: CGS 54,700
Inventory, March 1 38,500 Gross Profit 37,300
Inventory, March 31 31,000 Minus Expenses:
Purchases Returns and Allowances 800 Salaries 18,400
Sales Returns and Allowances 1,400 Transportation out 420
Transportation Out 420
Advertising 1,400
Rent Expense 1,450
Insurance 150
Sales Salaries Expense 18,400
Sales Discounts 1,100 Total Selling Expenses: 20,370
Depreciation Expense-Office Equipment 120 Rent 1,450
Office Supplies Expense 310 Office Salaries 7,850
Office Salaries Expense 7,850 Office Supplies 310
Advertising Expense 1,400
Depreciation Office 120
Insurance Expense (a selling expense) 150
Total Admin. Expenses: 9,730
Net Income 7,200
 Chapter 5 - Problem 3
PROBLEM 03 – INCOME STATEMENT PREPARATION
The following selected information is available for the Newman Wholesale
Company for March of the current year: REQUIRED
Purchases $45,500 a) Prepare the March income statement
Sales 94,500 for Newman Wholesale Company.
Transportation In 3,200 Net Income $7,200
b) Calculate the ratio of gross profit to net
Purchases Discounts 700
sales and express it as a percentage.
Inventory, March 1 38,500 Gross Profit 37,300 = 40.54%
Inventory, March 31 31,000 Net Sales 92,000
Purchases Returns and Allowances 800 c) Calculate the ratio of net income to net
Sales Returns and Allowances 1,400 sales and express it as a percentage.
Transportation Out 420 Net Income 7,200 = 7.83%
Rent Expense 1,450 Net Sales 92,000
Sales Salaries Expense 18,400
Sales Discounts 1,100
Depreciation Expense-Office Equipment 120
Office Supplies Expense 310
Office Salaries Expense 7,850
Advertising Expense 1,400
Insurance Expense (a selling expense) 150
 Question?
Would a business expect
to pay the same for a
machine purchased
and paid for today, as
the same machine
acquired today but not
paid for for two years?
 Warp-up

➢ Merchandising operation (Chapter 5)

● Sales (Gross vs Net)
● Purchase (Perpetual vs Periodic)
● COGS, Ending Inventory, Cost of goods available for sales