Understanding the learning objectives

  • In a sales transaction, the seller transfers the legal ownership (title) of the goods to the buyer.
  • An invoice is a document, prepared by the seller of merchandise and sent to the buyer, that contains the details of a sale, such as the number of units sold, unit price, total price, terms of sale, and manner of shipment.
  • Usually sales are for cash or on account. When a sale is for cash, the debit is to Cash and the credit is to Sales. When a sale is on account, the debit is to Accounts Receivable and the credit is to Sales.
  • When companies offer trade discounts, the gross selling price (gross invoice price) at which the sale is recorded is equal to the list price minus any trade discounts.
  • Two common deductions from gross sales are (1) sales discounts and (2) sales returns and allowances. These deductions are recorded in contra revenue accounts to the Sales account. Both the Sales Discounts account and the Sales Returns and Allowances account normally have debit balances. Net sales = Sales - (Sales discounts + Sales returns and allowances).
  • Sales discounts arise when the seller offers the buyer a cash discount of 1 per cent to 3 per cent to induce early payment of an amount due.
  • Sales returns result from merchandise being returned by a buyer because the goods are considered unsatisfactory or have been damaged. A sales allowance is a deduction from the original invoiced sales price granted to a customer when the customer keeps the merchandise but is dissatisfied.
  • \text { Cost of goods sold }=\text { Beginning inventory }+\text { Net cost of purchases }-\text { Ending inventory}.
    \text { Net cost of purchases }=\text { Purchases }-(\text { Purchase discounts }+\text { Purchase returns })+\text { Transportation-¿}
  • Two methods of accounting for inventory are perpetual inventory procedure and periodic inventory procedure. Under perpetual inventory procedure, the inventory account is continuously updated during the accounting period. Under periodic inventory procedure, the inventory account is updated only periodically - after a physical count has been made.
  • Purchases of merchandise are recorded by debiting Purchases and crediting Cash (for cash purchases) or crediting Accounts Payable (for purchases on account).
  • Two common deductions from purchases are (1) purchase discounts and (2) purchase returns and allowances. In the general ledger, both of these items normally carry credit balances. From the buyer's side of the transactions, cash discounts are purchase discounts, and merchandise returns and allowances are purchase returns and allowances.
  • FOB shipping point means free on board at shipping point - the buyer incurs the freight.
  • FOB destination means free on board at destination - the seller incurs the freight.
  • Passage of title is a term indicating the transfer of the legal ownership of goods.
  • Freight prepaid is when the seller must initially pay the freight at the time of shipment.
  • Freight collect is when the buyer must initially pay the freight on the arrival of the goods.
  • Expansion and application of the relationship introduced in Learning objective 2. Beginning inventory + Net cost of purchases = Cost of goods available for sale. Cost of goods available for sale - Ending inventory = Cost of goods sold.
  • A classified income statement has four major sections - operating revenues, cost of goods sold, operating expenses, and nonoperating revenues and expenses.
  • Operating revenues are the revenues generated by the major activities of the business - usually the sale of products or services or both.
  • Cost of goods sold is the major expense in merchandising companies.
  • Operating expenses for a merchandising company are those expenses other than cost of goods sold incurred in the normal business functions of a company. Usually, operating expenses are classified as either selling expenses or administrative expenses.
  • Nonoperating revenues and expenses are revenues and expenses not related to the sale of products or services regularly offered for sale by a business.
  • \text { Gross margin percentage }=\frac{\text { Gross margin }}{\text { Net sales }}
  • The gross margin rate indicates the amount of sales dollars available to cover expenses and produce income.
  • Except for the merchandise-related accounts, the work sheet for a merchandising company is the same as for a service company.
  • Any revenue accounts and contra purchases accounts in the Adjusted Trial Balance credit column of the work sheet are carried to the Income Statement credit column.
  • Beginning inventory, contra revenue accounts. Purchases, Transportation-In, and expense accounts in the Adjusted Trial Balance debit column are carried to the Income Statement debit column.
  • Ending merchandise inventory is entered in the Income Statement credit column and in the Balance Sheet debit column.
  • Closing entries may be prepared directly from the work sheet. The first journal entry debits all items appearing in the Income Statement credit column and credits Income Summary. The second entry credits all items appearing in the Income Statement debit column and debits Income Summary. The third entry debits Income Summary and credits the Retained Earnings account (assuming positive net income). The fourth entry debits the Retained Earnings account and credits the Dividends account.