Accounting in Merchandising Companies
5.6.2 Analysis of transactions for illustration #2 of accounting for inventory
Event No. 1. The effect of $5,000 inventory purchase is increases in both assets (Inventory) and liabilities (Accounts Payable). This is an asset source transaction.
Event No. 2. In Event No. 1 the Inventory account was debited. However, the company returned some goods, which resulted in a reverse operation. In this connection, the company needs to reduce both assets (Inventory) and liabilities (Accounts Payable) by the cost of the goods returned. This is an asset use transaction.
Event No. 3a. Dav's Books got a cash discount. A cash discount means that the seller lets the buyer (in our example, the bookstore) pay less in case of a prompt settlement. So, the bookstore will have a right to pay the amount due reduced by a 2% discount, that is $4,606 ($4,700 x [100% - 2%] = $4,606), and not the initial amount ($5,000 minus $300 of returned goods = $4,700). This event the same effect as the goods return in Event No. 2. Both assets (Inventory) and liabilities (Accounts Payable) decrease by the $94 discount ($4,700-$4,606). This is an asset use transaction.
Event No. 3b. We are familiar with the payment of accounts payable transaction. Cash and Accounts Payable decrease. The accounts payable balance at May 18 was $4,606 ($5,000 - $300 - $94). This is an asset use transaction.
Event No. 4. Sale of the goods is composed of two events which are revenue recognition and expense recognition. The first one acts to increase assets (Accounts Receivable because the company sold on account) and equity (Sales Revenue) by $4,000. The second transaction decreases both equity (Retained Earnings, by increasing Cost of Goods Sold) and assets (Inventory) by the amount of $2,000. Revenue recognition is an asset source transaction and cost of goods sold recognition is an asset use transaction.
Event No. 5. Incurring transportation expense acts to decrease assets (Cash) and equity (Retained Earnings, by increasing Transportation-out) by $400. This represents an asset use transaction.
Event No. 6a & 6b. Getting back some goods sold in Event No.4 has a twofold effect on the company's accounting records. The first one acts to adjust the revenue recognition. Because some goods were returned, it is necessary to reduce Sales Revenue and Accounts Receivable by $500. The second effect is to adjust the expense recognition. Cost of Goods Sold decreases, and Inventory increases. In this event, the company just makes reverse entries to those from Event No. 4.
Event No. 7. Providing a 2% cash discount to customers has a similar effect on the accounting records as Event No. 6. However, this time the bookstore does not receive any goods back, and, therefore, does not have to adjust expense part of the transaction (Cost of Goods Sold). Therefore, the company only decreases Accounts Receivable and Sales Revenue by $70 ([$4,000 minus $500 of returned goods] x 2%). This is an asset use transaction.
Event No. 8. Collection of cash from accounts receivable is already familiar to us. Cash increases and Accounts Receivable decrease. This is an asset exchange transaction.
5.6.3 Journal entries for illustration #2 of accounting for inventory
Let us see how these transactions look like in the general journal.
Illustration 5-10: General journal for illustration #2
Event No |
Account titles |
Debit |
Credit |
1 |
Merchandise Inventory |
5,000 |
|
|
Accounts Payable |
|
5,000 |
2 |
Accounts Payable |
300 |
|
|
Merchandise Inventory |
|
300 |
3a |
Accounts Payable |
94 |
|
|
|
Merchandise Inventory |
|
94 |
| 3b |
Accounts Payable |
4,606 |
|
|
|
Cash |
|
4,606 |
4a |
Accounts Receivable |
4,000 |
|
|
Sales Revenue |
|
4,000 |
4b |
Cost of Goods Sold |
2,000 |
|
|
Merchandise Inventory |
|
2,000 |
5 |
Transportation-out |
400 |
|
|
Cash |
|
400 |
6a |
Sales Revenue |
500 |
|
|
Accounts Receivable |
|
500 |
6b |
Merchandise Inventory |
250 |
|
|
Cost of Goods Sold |
|
250 |
7 |
Sales Revenue |
70 |
|
|
Accounts Receivable |
|
70 |
8 |
Cash |
3,430 |
|
|
Accounts Receivable |
|
3,430 |
Closing |
Sales Revenue |
3,430 |
|
entry |
Cost of Goods Sold |
|
1,750 |
|
Transportation-out |
|
400 |
|
Retained Earnings |
|
1,280 |
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