1. Chapter 4 Completing the Accounting Cycle
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2. How Do We Prepare Financial Statements?
The financial statements:
Income statement:
Reports revenues and expenses and calculates net income or loss for the period.
Statement of owner’s equity:
Shows how capital changed during the period.
Balance sheet:
Reports assets, liabilities, and stockholders’ equity as of the last day of the period.
After the adjusted trial balance is prepared, it is time to prepare the financial statements. The financial statements are prepared in the following order: income statement, statement of owner’s equity, and then the balance sheet. The income statement reports revenues and expenses and calculates net income or net loss for the time period. The statement of owner’s equity shows how capital changed during the period due to owner contributions, net income (or net loss), and owner withdrawals. The balance sheet reports assets, liabilities, and owner’s equity as of the last day of the period.
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The financial statements are prepared from the adjusted trial balance.
Exhibit 4-1 shows the adjusted trial balance for Smart Touch Learning. The financial statements will be prepared from the adjusted trial balance. Each account on the adjusted trial balance will be used on only one financial statement, except Owner’s Capital, which appears on the statement of owner’s equity and the balance sheet.
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Assets
Current assets
Converted to cash or used within 12 months or within the operating cycle.
Long-term assets
Not converted to cash or used up within the operating cycle or one year.
Long-term investments
Plant assets
Intangible assets
A current asset is an asset that is expected to be converted to cash, sold, or used up within the next 12 months or within the business’s normal operating cycle if the cycle is longer than a year. The operating cycle is the time span during which cash is paid for goods and services, which are then sold to customers, from whom the business collects cash.
Long-term assets are assets that will not be converted to cash or used up within the business’s operating cycle or one year, whichever is greater. A long-term investment is an investment in bonds (debt securities) or stocks (equity securities) in which the company intends to hold the investment for longer than one year. Plant assets are long-lived, tangible assets, such as land, buildings, and equipment used in the operations of a business. An intangible asset is an asset with no physical form that is valuable because of the special right it carries. Examples of intangible assets include Patents, Copyrights, and Trademarks.
The operating cycle is the time span during which cash is paid for goods and services, which are then sold to customers, from whom the business collects cash.
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Liabilities
Current liabilities must be paid either with cash or with goods and services within one year or within the entity’s operating cycle.
Examples:
Accounts Payable
Salaries Payable
Unearned Revenue
Long-term liabilities are all liabilities that do not need to be paid within one year or within the operating cycle.
A current liability is a liability that must be paid with cash or with goods and services within one year or within the entity’s operating cycle if the cycle is longer than a year. Accounts Payable, Notes Payable due within one year, Salaries Payable, Interest Payable, and Unearned Revenue are all current liabilities. A long-term liability is a liability that does not need to be paid within one year or within the entity’s operating cycle, whichever is longer. Many Notes Payable are long-term, such as a mortgage on a building.
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Owner’s Equity
Owner’s equity represents the owner’s claims to the assets of the business.
Reflects the owner’s contributions to the business, net income or net loss of the business, and owner’s withdrawals.
Represents the amount of assets left over after the corporation has paid its liabilities.
Owner’s equity represents the owner’s claims to the assets of the business. The owner’s equity section reported on the balance sheet is transferred from the ending balance of the Owner’s Capital account on the statement of owner’s equity. The equity balance also reflects the owner’s contributions, net income or net loss of the business, and owner’s withdrawals. It represents the amount of assets left over after the corporation has paid its liabilities.
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Exhibit 4-3 presents Smart Touch Learning’s classified balance sheet. Notice that the company classifies each asset and each liability as either current or long-term, and that the total assets of $133,550 is the same as the total assets on the unclassified balance sheet in Exhibit 4-2.
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8. How Do We Use the Current Ratio to Evaluate Business Performance?
The current ratio measures a company’s ability to pay its current liabilities with its current assets.
The formula is:
The current ratio measures a company’s ability to pay its current liabilities with its current assets. A company prefers to have a high current ratio because that means it has plenty of current assets to pay its current liabilities. A strong current ratio is 1.50, which indicates that the business has $1.50 in current assets for every $1.00 in current liabilities. A current ratio of 1.00 is considered low and somewhat risky.
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9. Chapter 5 Merchandising Operations (part 1)
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10. What Are Merchandising Operations?
A merchandiser is a business that sells merchandise, or goods, to customers.
The merchandise that this type of business sells is called merchandise inventory.
A wholesaler buys goods from a manufacturer and sells them to retailers.
A retailer buys merchandise from manufacturers or a wholesaler and then sells the goods to consumers.
A merchandiser is a business that sells merchandise, or goods, to customers. The merchandise that a business sells to customers is called merchandise inventory. Merchandisers are often identified as either wholesalers or retailers.
A wholesaler is a type of merchandiser that buys goods from manufacturers and then sells them to retailers. A retailer is a type of merchandiser that buys merchandise either from a manufacturer or a wholesaler and then sells those goods to consumers.
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11. The Operating Cycle of a Merchandising Business
The operating cycle begins when the company purchases inventory from a vendor.
The company then sells the inventory to customers.
The company collects cash from customers.
The operating cycle has three main steps: A company purchases inventory from a vendor, the company sells the inventory to a customer, and the company collects cash from customers. A vendor is an individual or a business from whom a company purchases goods.
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12. The Operating Cycle of a Merchandising Business
The operating cycle of a merchandiser is presented in Exhibit 5-1. The merchandising process begins when the company purchases inventory from an individual or business, called a vendor. Then the company sells the inventory to a customer. Finally, the company collects cash from customers.
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13. The Operating Cycle of a Merchandising Business
The income statement of a merchandiser reports:
Sales Revenue rather than Service Revenue
The cost of merchandise sold to customers, called Cost of Goods Sold (COGS)
Gross profit, which is net Sales Revenue minus Cost of Goods Sold
Operating expenses, which are expenses other than Cost of Goods Sold
Because the operating cycle of a merchandiser is different from that of a service company, the financial statements differ. On the income statement, a merchandising company reports revenues using an account called Sales Revenue rather than the account Service Revenue. A merchandiser also reports the cost of merchandise inventory that has been sold to customers, or Cost of Goods Sold (COGS). The Cost of Goods Sold is the cost of merchandise inventory that the business has sold to customers.
Because COGS is usually a merchandiser’s main expense, an intermediary calculation, gross profit, is determined before calculating net income. Gross profit is the excess of net Sales Revenue over Cost of Goods Sold. After calculating gross profit, expenses are then deducted to determine net income. Operating expenses are expenses, other than Cost of Goods Sold, that are incurred in the entity’s major ongoing operations.
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14. The Operating Cycle of a Merchandising Business
Exhibit 5-2 shows how a service entity’s income statement (on the left) differ from a merchandiser’s income statement (on the right). As you can see, merchandisers have some new income statement items.
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15. The Operating Cycle of a Merchandising Business
Exhibit 5-2 compares the balance sheet of a service company to a merchandiser. On the balance sheet, a merchandiser includes Merchandise Inventory in the current assets section representing the value of inventory that the business has on hand to sell to customers. Merchandise Inventory is a current asset since it is expected to be sold within the operating cycle.
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Merchandise Inventory Systems: Perpetual and Periodic Inventory Systems
Businesses need to determine the value of merchandise inventory on hand and the value sold.
The two inventory accounting systems:
A periodic inventory system requires a physical count of inventory to determine inventory on hand.
A perpetual inventory system offers continuous computerized record of merchandise inventory.
There are two main types of inventory accounting systems used to determine the value of inventory on hand. A periodic inventory system is an inventory system that requires businesses to obtain a physical count of inventory to determine quantities on hand. The system is normally used for relatively inexpensive goods, such as in a small, local store without optical-scanning cash registers that do not keep a running record of every loaf of bread and every key chain that it sells.
The perpetual inventory system keeps a running computerized record of merchandise inventory – that is, the number of inventory units and the dollar amounts associated with the inventory are perpetually (constantly) updated. A perpetual inventory system keeps a running computerized record of merchandise inventory.
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How Are Purchases of Merchandise Inventory Recorded in a Perpetual Inventory System?
A merchandising entity begins with the purchase of merchandise inventory.
The vendor ships the product to the merchandiser.
The seller sends the buyer an invoice that requests payment.
The buyer pays the vendor after the merchandise inventory is received.
The cycle of a merchandising entity begins with the purchase of merchandise inventory. Continuing with the fictitious company, Smart Touch Learning, which has now decided to discontinue its service business and instead has plans to sell touch screen tablet computers. Smart Touch Learning will purchase these tablets from a vendor. The vendor ships the tablet computers to Smart Touch Learning and sends an invoice the same day. The invoice is the seller’s request for payment from the buyer. An invoice is also called a bill.
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Exhibit 5-3 is the bill that Smart Touch Learning receives from Southwest Electronics Direct.
It shows that Smart Touch Learning acquired $35,000 of inventory on June 1, For Southwest Electronics Direct, the seller, the invoice is called a sales invoice. For Smart Touch Learning, the purchaser, the invoice is called a purchase invoice.
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19. Purchase of Merchandise Inventory
Assume that Smart Touch Learning receives the goods on June 3 and makes a payment on that date.
Suppose Smart Touch Learning receives the goods on June 3, 2017, and makes payment on that date. Smart Touch Learning will record the purchase by debiting Merchandise Inventory and crediting Cash.
The Merchandise Inventory account, an asset, is used only for goods purchased that the business owns and intends to resell to customers. Office Supplies, Equipment, and other assets are recorded in their own accounts.
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20. Purchase of Merchandise Inventory
Now assume that on June 3, instead of paying cash, Smart Touch Learning receives the merchandise inventory on account.
If the transaction is on account, then Smart Touch Learning will record a debit to Merchandise Inventory and a credit to Accounts Payable for $35,000.
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