My video lectures covers operating cycle, perpetual inventory and periodic inventory, FOB shipping, FOB destination, journalize buyer and seller entries. Whether you are an accounting student or CPA candidate, these lectures will help you.
Financial Accounting Course
The primary source of revenues for merchandising companies is the sale of merchandise, often referred to simply as sales revenue or sales. A merchandising company has two categories of expenses: cost of goods sold and operating expenses.
Cost of goods sold is the total cost of merchandise sold during the period. This expense is directly related to the revenue recognized from the sale of goods.
The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase of merchandise inventory and its eventual sale lengthen the cycle.
Flow of Costs
The flow of costs for a merchandising company is as follows. Beginning inventory plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold. Those goods that are not sold by the end of the accounting period represent ending inventory.
In a perpetual inventory system, companies keep detailed records of the cost of each inventory purchase and sale. These records continuously—perpetually—show the inventory that should be on hand for every item.
In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting period—that is, periodically. At that point, the company takes a physical inventory count to determine the cost of goods on hand.
To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:
- 1.Determine the cost of goods on hand at the beginning of the accounting period.
- 2.Add to it the cost of goods purchased.
- 3.Subtract the cost of goods on hand as determined by the physical inventory count at the end of the accounting period.
Companies purchase inventory using cash or credit (on account). They normally record purchases when they receive the goods from the seller. Every purchase should be supported by business documents that provide written evidence of the transaction. Each cash purchase should be supported by a canceled check or a cash register receipt indicating the items purchased and amounts paid. Companies record cash purchases by an increase in Inventory and a decrease in Cash.
A purchase invoice should support each credit purchase. This invoice indicates the total purchase price and other relevant information. However, the purchaser does not prepare a separate purchase invoice. Instead, the purchaser uses as a purchase invoice a copy of the sales invoice sent by the seller.
The sales agreement should indicate who—the seller or the buyer—is to pay for transporting the goods to the buyer’s place of business. When a common carrier such as a railroad, trucking company, or airline transports the goods, the carrier prepares a freight bill in accord with the sales agreement.
Freight terms are expressed as either FOB shipping point or FOB destination. The letters FOB mean free on board. Thus, FOB shipping point means that the seller places the goods free on board the carrier, and the buyer pays the freight costs. Conversely, FOB destination means that the seller places the goods free on board to the buyer’s place of business, and the seller pays the freight.
FREIGHT COSTS INCURRED BY THE BUYER
When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory.
Thus, any freight costs incurred by the buyer are part of the cost of merchandise purchased. The reason: Inventory cost should include all costs to acquire the inventory, including freight necessary to deliver the goods to the buyer. Companies recognize these costs as cost of goods sold when inventory is sold.
FREIGHT COSTS INCURRED BY THE SELLER
In contrast, freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. These costs increase an expense account titled Freight-Out (sometimes called Delivery Expense).
Purchase Returns and Allowances
A purchaser may be dissatisfied with the merchandise received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser’s specifications. In such cases, the purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. This transaction is known as a purchase return. Alternatively, the purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) from the purchase price. This transaction is known as a purchase allowance.
The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. This incentive offers advantages to both parties. The purchaser saves money, and the seller is able to shorten the operating cycle by converting the accounts receivable into cash.
In accordance with the revenue recognition principle, companies record sales revenue when the performance obligation is satisfied. Typically, the performance obligation is satisfied when the goods transfer from the seller to the buyer. At this point, the sales transaction is complete and the sales price established.
Sales may be made on credit or for cash. A business document should support every sales transaction, to provide written evidence of the sale. Cash register documents provide evidence of cash sales. The original copy of the invoice goes to the customer, and the seller keeps a copy for use in recording the sale. The invoice shows the date of sale, customer name, total sales price, and other relevant information.
The seller makes two entries for each sale. The first entry records the sale: The seller increases (debits) Cash (or Accounts Receivable if a credit sale) and also increases (credits) Sales Revenue. The second entry records the cost of the merchandise sold: The seller increases (debits) Cost of Goods Sold and also decreases (credits) Inventory for the cost of those goods. As a result, the Inventory account will show at all times the amount of inventory that should be on hand.