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Chapter 5 Summary
Chapter 5 Summary
INCOME STATEMENT
LO 1: Describe merchandising operations and inventory systems.
• Primary source of revenue for merchandisers like Walmart that buy and sell goods is referred to as
sales revenue.
• Cost of goods sold is the total cost of merchandise sold during the period.
o It is an EXPENSE that is directly related to the revenue recognized from the sale of goods.
Ex: Company C, a retailer, bought chairs from a wholesaler for $15 each. Company C then sold the
chairs to their customers for $20 each.
• The $20 represents Company C’s sales revenue for each chair.
• The $15 that Company C spent on each chair represents Company C’s cost of goods sold and
is recognized when each chair is sold to customers.
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FLOW OF COSTS
• Companies use either a perpetual inventory system or a periodic inventory system to account for
inventory.
2. Periodic: updates the accounting records for merchandise transactions at the END OF A PERIOD.
• Cost of goods sold determined by count at the end of the accounting period.
***Key Formula… Cost of Goods Sold = Beginning Inventory + Net Purchases – Ending Inventory
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LO 2: Record purchases under a perpetual inventory system.
FREIGHT COSTS
Shipping Terms Ownership Transfers when goods passed to Freight cost paid by
Del
PURCHASE DISCOUNTS
• Buyer receives a cash discount for prompt payment.
• Saves the buyer money and helps the seller collect money faster.
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PURCHASE DISCOUNTS (Cont.)
Net amount due within the first 10 days of the next month.
Inventory xxx
2. Purchase inventory for CASH.
B Cash xxx
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Example Journal Entries
Jay Company bought inventory from Z Company on January 1 for $10,000 under the credit terms 3/15,
n/60. On January 10, Jay Company returned goods costing $1,000 to Z Company. Jay Company paid Z
Company for the remaining goods on Jan. 12.
What are the journal entries that need to be recorded in January for Jay Company?
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LO 3: Record sales under a perpetual inventory system.
SALES DISCOUNTS
• Issued by the seller to obtain their money from the customer faster.
• Contra-revenue account on the income statement and has a Debit balance.
Sales Revenue – Sales Returns and Allowances – Sales Discounts = Net Sales
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Example Journal Entries
• Jay Company sold goods costing $6,000 to X Company for $10,000 on March 1 under the terms
2/10, net 30. On March 5, X Company returned goods to Jay Company with a selling price of $3,000
and a cost of $1,800. On March 10, Jay Company received payment from X Company for the
remainder of the goods.
What are the journal entries that need to be recorded on in March for Jay Company?
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• This adjustment impacts Inventory and Cost of Goods Sold.
For example, suppose that PW Audio Supply, Inc. has an unadjusted balance of $40,500 in
Inventory.
Through a physical count, PW Audio Supply determines that its actual merchandise inventory at
December 31 is $40,000. The company would make an adjusting entry as follows.
Closing Entries
A merchandising company, like a service company, closes to Income Summary all accounts that
affect net income. In journalizing, the company credits all temporary accounts with debit
balances, and debits all temporary accounts with credit balances. It also closes both Income
Summary and Dividends to Retained Earnings. (Hint – R.E.D – temporary accounts are
Revenue, Expense, and Dividends)
The following are the closing entries for PW Audio Supply using assumed amounts from its
year-end adjusted trial balance.
• Cost of Goods Sold is an expense account with a normal debit balance,
• Sales Returns and Allowances and Sales Discounts are contra revenue accounts with
normal debit balances
The easiest way to prepare the first two closing entries is to identify the temporary
accounts by their balances and then prepare one entry for the credits and one for the
debits.
Dec.31 Sales Revenue 480,000
Income Summary 480,000
(To close income statement accounts with credit
balances)
31 Income Summary 450,000
Sales Returns and Allowances 12,000
Sales Discounts 8,000
Cost of Goods Sold 316,000
Salaries and Wages Expense 64,000
Freight-Out 7,000
Advertising Expense 16,000
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Utilities Expense 17,000
Depreciation Expense 8,000
Insurance Expense 2,000
(To close income statement accounts with debit
balances)
31 Income Summary 30,000
Retained Earnings 30,000
(To close net income to retained earnings)
31 Retained Earnings 15,000
Dividends 15,000
(To close dividends to retained earnings)
After PW Audio Supply has posted the closing entries, all temporary accounts have zero
balances. Also, Retained Earnings has a balance that is carried over to the next period
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MULTI-STEP INCOME STATEMENT
• Highlights the components of net income.
• Three important line items:
1. Gross profit
2. Income from Operations
3. Net Income
•
***ALL OF THESE ITEMS ARE PART OF NONOPERATING
ACTIVITIES AND ARE ADDED OR DEDUCTED FROM INCOME
FROM OPERATIONS TO GET INCOME BEFORE TAXES.
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