WILEY

Recording and Analyzing

Merchandising Transactions,
Receivables, and Inventory
Kimmel ● Weygandt ● Kieso
Survey of Accounting, First Edition

Prepared by
Coby Harmon
University of California, Santa Barbara
6-1 Westmont College

CHAPTER OUTLINE
LEARNING OBJECTIVES

Describe inventory systems and record purchases and

1 sales.

Discuss how to classify and determine cost of inventory

2 under a periodic approach.

3 Explain how companies recognize and value receivables.

Prepare a multiple-step income statement and a

4 comprehensive income statement.

5 Compute and analyze gross profit rate and profit margin.

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2
 Describe inventory systems and record
LEARNING
OBJECTIVE 1 purchases and sales.

Merchandising Companies
Buy and Sell Goods
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as

sales revenue or sales.
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Merchandising Company

Income Measurement

Not used in a
Sales Less
ILLUSTRATION 6-1
Service business.
Revenue Income measurement process for a
merchandising company

Cost of Equals Gross Less

Goods Sold Profit

Operating Equals Net

Cost of goods sold is the total Income
Expenses
cost of merchandise sold (Loss)
during the period.

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 FLOW OF COSTS
ILLUSTRATION 6-2
Flow of costs

Companies use either a perpetual inventory system or a

periodic inventory system to account for inventory.
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FLOW OF COSTS

Perpetual System
 Maintain detailed records of the cost of each inventory
purchase and sale.

 Records continuously show inventory that should be

on hand for every item.

 Company determines cost of goods sold each time a

sale occurs.

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 FLOW OF COSTS

Periodic System
 Does not keep detailed records of the goods on hand.

 Cost of goods sold determined by count at the end of

the accounting period.

 Calculation of Cost of Goods Sold:

Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

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RECORDING PURCHASES UNDER A

PERPETUAL INVENTORY SYSTEM

 Made using cash or on account (credit).

 Normally record when goods are received from the

seller.

 Purchase invoice should support each credit

purchase.

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 RECORDING PURCHASES UNDER A
PERPETUAL INVENTORY SYSTEM

Illustration: Suppose Sauk Stereo received an invoice from

PW Audio Supply for goods with a purchase price to Sauk
Stereo of $3,800. This event is recorded as follows:

INCOME
STATEMENT

No effect

This transaction has no effect on cash flow.

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RECORDING PURCHASES UNDER A

PERPETUAL INVENTORY SYSTEM

Illustration: Now suppose that Sauk Stereo subsequently

returned goods to PW Audio Supply with a cost of $300. This
event is recorded as follows:

INCOME
STATEMENT

No effect

No effect

This transaction has no effect on cash flow.

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 RECORDING SALES UNDER A
PERPETUAL INVENTORY SYSTEM

 Sales may be made on credit or for cash.

 Sales revenue, like service revenue, is recorded when

the performance obligation is satisfied.

 Performance obligation is satisfied when the goods are

transferred from the seller to the buyer.

 A sales invoice provides support for each sale.

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RECORDING PURCHASES UNDER A

PERPETUAL INVENTORY SYSTEM

To illustrate a credit sales transaction, PW Audio Supply

records the sale of $3,800 on May 4 to Sauk Stereo as follows
(assume the merchandise cost PW Audio Supply $2,400).

INCOME
STATEMENT

Sales Revenue

COGS

This transaction has no effect on cash flow.

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 RECORDING PURCHASES UNDER A
PERPETUAL INVENTORY SYSTEM

Sales Returns and Allowances, and Sales

Discounts
 Sales Returns and Allowances is shown as a
subtractive item under revenues.

 Accounts receivable also reduced.

 If goods are returned, Inventory is increased and Cost

of Goods Sold is decreased for the cost of the goods.
 If the goods were defective, Inventory is reduced to
reflect the decline in value.
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Sales Returns and Allowances, and Sales

Discounts

If PW Audio Supply received returned goods that had a selling

price of $300 and a cost of $140, it would be recorded as
follows.

INCOME
STATEMENT

Sales Returns
and Allowance

COGS

This transaction has no effect on cash flow.

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 Purchases and Sales of
DO IT! 1 Inventory
On September 5, De La Hoya Company buys merchandise on account
from Junot Diaz Company. The purchase price of the goods paid by De
La Hoya is $1,500. On September 20, De La Hoya sells $750 of the
merchandise to Marin Inc. for $1,100 cash. Use a tabular summary to
record the transactions for the books of De La Hoya Company.

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LO 1

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Discuss how to classify and determine

LEARNING
OBJECTIVE 2 cost of inventory under a periodic
approach.

Merchandising Manufacturing
Company Company

One Classification: Three Classifications:

 Merchandise  Raw Materials

Inventory
 Work in Process

 Finished Goods
▼ HELPFUL HINT
Regardless of the classification,
companies report all inventories
under Current Assets on the
balance sheet.

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 DETERMINING THE COST OF INVENTORY

Inventory is accounted for at cost.

 Cost includes all expenditures necessary to acquire
goods and place them in a condition ready for sale.
 Unit costs are applied to quantities to determine the total
cost of the inventory and the cost of goods sold using
the following costing methods:
► Specific identification
► First-in, first-out (FIFO)
Cost Flow
► Last-in, first-out (LIFO) Assumptions
► Average-cost

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Specific Identification

Illustration: Crivitz TV Company purchases three identical

50-inch TVs on different dates at costs of $700, $750, and
$800. During the year Crivitz sold two sets at $1,200 each.
These facts are summarized below.

ILLUSTRATION 6-3
Data for inventory costing example

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 Specific Identification

If Crivitz sold the TVs it purchased on February 3 and May

22, then its cost of goods sold is $1,500 ($700 + $800), and
its ending inventory is $750. ILLUSTRATION 6-4
Specific identification method

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Specific Identification

Actual physical flow costing method in which items still in

inventory are specifically costed to arrive at the total cost of
the ending inventory.
 Practice is relatively rare.

 Most companies make assumptions (cost flow

assumptions) about which units were sold.

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 COST FLOW ASSUMPTIONS

Cost flow assumption

does not need to be
consistent with the
physical movement of
goods

Illustration 6-10
Use of cost flow methods
in major U.S. companies

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COST FLOW ASSUMPTIONS

Illustration: Data for Houston Electronics’ Astro condensers.

ILLUSTRATION 6-5
Data for Houston Electronics

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

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 First-In, First-Out (FIFO)

 Costs of the earliest goods purchased are the first to

be recognized in determining cost of goods sold.

 Often parallels actual physical flow of merchandise.

 Companies determine the cost of the ending

inventory by taking the unit cost of the most recent
purchase and working backward until all units of
inventory have been costed.

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First-In, First-Out (FIFO)

ILLUSTRATION 6-6
Allocation of costs—FIFO method
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 First-In, First-Out (FIFO)

▼ HELPFUL HINT
Another way of thinking about
the calculation of FIFO ending
inventory is the LISH
assumption—last in still here.

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Last-In, First-Out (LIFO)

 Costs of the latest goods purchased are the first to

be recognized in determining cost of goods sold.

 Seldom coincides with actual physical flow of

merchandise.

 Exceptions include goods stored in piles, such as

coal or hay.

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 Last-In, First-Out (LIFO)

ILLUSTRATION 6-7
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Last-In, First-Out (LIFO)

▼ HELPFUL HINT
Another way of thinking about
the calculation of LIFO ending
inventory is the FISH
assumption—first in still
here.

ILLUSTRATION 6-7
Allocation of costs—LIFO method

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 Average-Cost

 Allocates cost of goods available for sale on the

basis of weighted-average unit cost incurred.

 Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.

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Average-Cost

ILLUSTRATION 6-9
Allocation of costs—average-cost method

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 Average-Cost

ILLUSTRATION 6-9
Allocation of costs—average-cost method

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FINANCIAL STATEMENT AND TAX EFFECTS

ILLUSTRATION 6-11
Comparative effects of cost flow methods
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 Income Statement Effects
In periods of changing prices, the cost flow assumption can have
significant impacts both on income and on evaluations of income,
such as the following.
1. In a period of inflation, FIFO produces a higher net income
because lower unit costs of the first units purchased are matched
against revenue.
2. In a period of inflation, LIFO produces a lower net income because
higher unit costs of the last goods purchased are matched against
revenue.
3. If prices are falling, the results from the use of FIFO and LIFO are
reversed. FIFO will report the lowest net income and LIFO the
highest.
4. Regardless of whether prices are rising or falling, average-cost
produces net income between FIFO and LIFO.
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Balance Sheet Effects

 A major advantage of the FIFO method is that in a

period of inflation, the costs allocated to ending
inventory will approximate their current cost.

 A major shortcoming of the LIFO method is that in a

period of inflation, the costs allocated to ending
inventory may be significantly understated in terms of
current cost.

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 COST FLOW ASSUMPTIONS

Review Question
The cost flow method that often parallels the actual physical
flow of merchandise is the:

a. FIFO method.

b. LIFO method.

c. average cost method.

d. gross profit method.

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DO IT! 2 Cost Flow Methods

The accounting records of Shumway Ag Implement show the

following data.
Beginning inventory 4,000 units at $3
Purchases 6,000 units at $4
Sales 7,000 units at $12
Determine the cost of goods available for sale during the period
under a periodic system using FIFO.

SOLUTION

4,000 units × $3 = $12,000

6,000 units × $4 = 24,000
$36,000
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 DO IT! 2 Cost Flow Methods

The accounting records of Shumway Ag Implement show the

following data.
Beginning inventory 4,000 units at $3
Purchases 6,000 units at $4
Sales 7,000 units at $12
Determine the cost of goods sold during the period under a periodic
system using LIFO.

SOLUTION

6,000 units × $4 = $24,000

1,000 units × $3 = 3,000
$27,000
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DO IT! 2 Cost Flow Methods

The accounting records of Shumway Ag Implement show the

following data.
Beginning inventory 4,000 units at $3 = $12,000
$36,000
Purchases 6,000 units at $4 = $24,000
Sales 7,000 units at $12
Determine the cost of goods sold during the period under a periodic
system using average cost.

SOLUTION

$36,000 ÷ 10,000 units = $3.60 average cost per unit

$36,000 – ($3,000 ending units × $3.60) = $25,200

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