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Chapter 5 introduced a new format for the income statement- the Multi Step Income Statement. Please discuss why this format is more useful for a merchandiser which was also introduced in Chapter 5. Chapter 6 focuses on inventory. Please discuss why a business using a perpetual inventory method must still at least once per year take an actual physical inventory count. Feel free to share any job related examples as well. Review and Practice Learning Objectives Review 1 Describe merchandising operations and inventory systems. Because of the presence of inventory, a merchandising company has sales revenue, cost of goods sold, and gross profit. To account for inventory, a merchandising company must choose between a perpetual inventory system and a periodic inventory system. 2 Record purchases under a perpetual inventory system. The Inventory account is debited for all purchases of merchandise and for freight costs, and it is credited for purchase discounts and purchase returns and allowances. 3 Record sales under a perpetual inventory system. When inventory is sold, Accounts Receivable (or Cash) is debited and Sales Revenue is credited for the selling price of the merchandise. At the same time, Cost of Goods Sold is debited and Inventory is credited for the cost of inventory items sold. Separate contra revenue accounts are maintained for Sales Returns and Allowances and Sales Discounts. These accounts are debited as needed to record returns, allowances, or discounts related to the sale. 4 Prepare a multiple-step income statement and a comprehensive income statement. In a single-step income statement, companies classify all data under two categories, revenues or expenses, and net income is determined in one step. A multiple-step income statement shows numerous steps in determining net income, including results of nonoperating activities. A comprehensive income statement adds or subtracts any items of other comprehensive income to net income to arrive at comprehensive income. 5 Determine cost of goods sold under a periodic inventory system. The periodic system uses multiple accounts to keep track of transactions that affect inventory. To determine cost of goods sold, first calculate cost of goods purchased by adjusting purchases for returns, allowances, discounts, and freight-in. Then calculate cost of goods sold by adding cost of goods purchased to beginning inventory and subtracting ending inventory. 6 Compute and analyze gross profit rate and profit margin. Profitability is affected by gross profit, as measured by the gross profit rate, and by management's ability to control costs, as measured by the profit margin. *7 Record purchases and sales of inventory under a periodic inventory system. To record purchases, entries are required for (a) cash and credit purchases, (b) purchase returns and allowances, (c) purchase discounts, and (d) freight costs. To record sales, entries are required for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales discounts. *8 Prepare adjusting entries for credit sales with returns and allowances. Adjusting credit sales for returns and allowances requires two entries at the end of the period. The first entry requires a debit to Sales Returns and Allowances and a credit to Allowance for Sales Returns and Allowances for the selling price of the estimated returns. The second entry requires a debit to Estimated Inventory Returns and a credit to Cost of Goods Sold for the cost of the estimated returns. The Allowance for Sales Returns and Allowances account is a contra account to Accounts Receivable. The Estimated Inventory Returns will generally be added to the Inventory account at the end of the period. Learning Objectives Review 1 Discuss how to classify and determine inventory. Merchandisers need only one inventory classification, merchandise inventory, to describe the different items that make up total inventory. Manufacturers, on the other hand, usually classify inventory into three categories: finished goods, work in process, and raw materials. To determine inventory quantities, manufacturers (1) take a physical inventory of goods on hand and (2) determine the ownership of goods in transit or on consignment. 2 Apply inventory cost flow methods and discuss their financial effects. The primary basis of accounting for inventories is cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. Cost of goods available for sale includes (a) cost of beginning inventory and (b) cost of goods purchased. The inventory cost flow methods are specific identification and three assumed cost flow methods, FIFO, LIFO, and average-cost. The cost of goods available for sale may be allocated to cost of goods sold and ending inventory by specific identification or by a method based on an assumed cost flow. When prices are rising, the first-in, first-out (FIFO) method results in lower cost of goods sold and higher net income than the average-cost and the last-in, first-out (LIFO) methods. The reverse is true when prices are falling. In the balance sheet, FIFO results in an ending inventory that is closest to current value, whereas the inventory under LIFO is the farthest from current value. LIFO results in the lowest income taxes (because of lower taxable income). 3 Explain the statement presentation and analysis of inventory. Companies use the lower-of-cost-or-net realizable value (LCNRV) basis when the net realizable value is less than cost. Under LCNRV, companies recognize the loss in the period in which the price decline occurs. Inventory turnover is calculated as cost of goods sold divided by average inventory. It can be converted to average days in inventory by dividing 365 days by the inventory turnover. A higher inventory turnover or lower average days in inventory suggests that management is trying to keep inventory levels low relative to its sales level. The LIFO reserve represents the difference between ending inventory using LIFO and ending inventory if FIFO were employed instead. For some companies this difference can be significant, and ignoring it can lead to inappropriate conclusions when using the current ratio or inventory turnover. *4 Apply inventory cost flow methods to perpetual inventory records. Under FIFO, the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Under LIFO, the cost of the most recent purchase prior to sale is charged to cost of goods sold. Under the average-cost method, a new average cost is computed after each purchase. *5 Indicate the effects of inventory errors on the financial statements. In the income statement of the current year: (1) An error in beginning inventory will have a reverse effect on net income (e.g., overstatement of inventory results in understatement of net income, and vice versa). (2) An error in ending inventory will have a similar effect on net income (e.g., overstatement of inventory results in overstatement of net income). If ending inventory errors are not corrected in the following period, their effect on net income for that period is reversed, and total net income for the two years will be correct. In the balance sheet: Ending inventory errors will have the same effect on total assets and total stockholders' equity and no effect on liabilities. Chapter 5 introduced a new format for the income statement- the Multi Step Income Statement. Please discuss why this format is more useful for a merchandiser which was also introduced in Chapter 5. Chapter 6 focuses on inventory. Please discuss why a business using a perpetual inventory method must still at least once per year take an actual physical inventory count. Feel free to share any job related examples as well. Review and Practice Learning Objectives Review 1 Describe merchandising operations and inventory systems. Because of the presence of inventory, a merchandising company has sales revenue, cost of goods sold, and gross profit. To account for inventory, a merchandising company must choose between a perpetual inventory system and a periodic inventory system. 2 Record purchases under a perpetual inventory system. The Inventory account is debited for all purchases of merchandise and for freight costs, and it is credited for purchase discounts and purchase returns and allowances. 3 Record sales under a perpetual inventory system. When inventory is sold, Accounts Receivable (or Cash) is debited and Sales Revenue is credited for the selling price of the merchandise. At the same time, Cost of Goods Sold is debited and Inventory is credited for the cost of inventory items sold. Separate contra revenue accounts are maintained for Sales Returns and Allowances and Sales Discounts. These accounts are debited as needed to record returns, allowances, or discounts related to the sale. 4 Prepare a multiple-step income statement and a comprehensive income statement. In a single-step income statement, companies classify all data under two categories, revenues or expenses, and net income is determined in one step. A multiple-step income statement shows numerous steps in determining net income, including results of nonoperating activities. A comprehensive income statement adds or subtracts any items of other comprehensive income to net income to arrive at comprehensive income. 5 Determine cost of goods sold under a periodic inventory system. The periodic system uses multiple accounts to keep track of transactions that affect inventory. To determine cost of goods sold, first calculate cost of goods purchased by adjusting purchases for returns, allowances, discounts, and freight-in. Then calculate cost of goods sold by adding cost of goods purchased to beginning inventory and subtracting ending inventory. 6 Compute and analyze gross profit rate and profit margin. Profitability is affected by gross profit, as measured by the gross profit rate, and by management's ability to control costs, as measured by the profit margin. *7 Record purchases and sales of inventory under a periodic inventory system. To record purchases, entries are required for (a) cash and credit purchases, (b) purchase returns and allowances, (c) purchase discounts, and (d) freight costs. To record sales, entries are required for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales discounts. *8 Prepare adjusting entries for credit sales with returns and allowances. Adjusting credit sales for returns and allowances requires two entries at the end of the period. The first entry requires a debit to Sales Returns and Allowances and a credit to Allowance for Sales Returns and Allowances for the selling price of the estimated returns. The second entry requires a debit to Estimated Inventory Returns and a credit to Cost of Goods Sold for the cost of the estimated returns. The Allowance for Sales Returns and Allowances account is a contra account to Accounts Receivable. The Estimated Inventory Returns will generally be added to the Inventory account at the end of the period. Learning Objectives Review 1 Discuss how to classify and determine inventory. Merchandisers need only one inventory classification, merchandise inventory, to describe the different items that make up total inventory. Manufacturers, on the other hand, usually classify inventory into three categories: finished goods, work in process, and raw materials. To determine inventory quantities, manufacturers (1) take a physical inventory of goods on hand and (2) determine the ownership of goods in transit or on consignment. 2 Apply inventory cost flow methods and discuss their financial effects. The primary basis of accounting for inventories is cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. Cost of goods available for sale includes (a) cost of beginning inventory and (b) cost of goods purchased. The inventory cost flow methods are specific identification and three assumed cost flow methods, FIFO, LIFO, and average-cost. The cost of goods available for sale may be allocated to cost of goods sold and ending inventory by specific identification or by a method based on an assumed cost flow. When prices are rising, the first-in, first-out (FIFO) method results in lower cost of goods sold and higher net income than the average-cost and the last-in, first-out (LIFO) methods. The reverse is true when prices are falling. In the balance sheet, FIFO results in an ending inventory that is closest to current value, whereas the inventory under LIFO is the farthest from current value. LIFO results in the lowest income taxes (because of lower taxable income). 3 Explain the statement presentation and analysis of inventory. Companies use the lower-of-cost-or-net realizable value (LCNRV) basis when the net realizable value is less than cost. Under LCNRV, companies recognize the loss in the period in which the price decline occurs. Inventory turnover is calculated as cost of goods sold divided by average inventory. It can be converted to average days in inventory by dividing 365 days by the inventory turnover. A higher inventory turnover or lower average days in inventory suggests that management is trying to keep inventory levels low relative to its sales level. The LIFO reserve represents the difference between ending inventory using LIFO and ending inventory if FIFO were employed instead. For some companies this difference can be significant, and ignoring it can lead to inappropriate conclusions when using the current ratio or inventory turnover. *4 Apply inventory cost flow methods to perpetual inventory records. Under FIFO, the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Under LIFO, the cost of the most recent purchase prior to sale is charged to cost of goods sold. Under the average-cost method, a new average cost is computed after each purchase. *5 Indicate the effects of inventory errors on the financial statements. In the income statement of the current year: (1) An error in beginning inventory will have a reverse effect on net income (e.g., overstatement of inventory results in understatement of net income, and vice versa). (2) An error in ending inventory will have a similar effect on net income (e.g., overstatement of inventory results in overstatement of net income). If ending inventory errors are not corrected in the following period, their effect on net income for that period is reversed, and total net income for the two years will be correct. In the balance sheet: Ending inventory errors will have the same effect on total assets and total stockholders' equity and no effect on liabilities

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