Questions and Answers
Which of the following shows the effects of purchasing inventory on account?
When a merchandising company sells inventory, what is recognized?
Revenue and expense.
How does the recognition of the cost of goods sold affect the company's financial statement?
Where does the gross margin appear?
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What is inventory?
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What is the cost of goods available for sale based on the provided information?
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What is the cost of goods sold based on the provided information?
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Which cost flow method is used if a company expensed $30 for the first item sold?
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What is the amount of the gross margin assuming Alpha uses a FIFO cost flow method?
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What is the amount of ending inventory appearing on the balance sheet assuming a LIFO cost flow?
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Study Notes
Inventory Purchase on Account
- Purchasing inventory on account increases assets (inventory) and liabilities (accounts payable).
- There is no impact on revenue until the inventory is sold; therefore, the income statement remains unaffected.
- Cash flows are not impacted since no cash is spent during the purchase.
Selling Inventory
- When a merchandising company sells inventory, it recognizes both revenue from sales and an expense for the cost of goods sold.
- The sales price generates sales revenue, while the cost of goods sold reflects the expense incurred in selling the merchandise.
Cost of Goods Sold Impact
- Selling shoes costing $5,700 for $8,200 reduces assets through lower inventory and decreases net income as the cost of goods sold expense is recognized.
- The statement of cash flows remains unchanged because cash transactions occurred when inventory was acquired.
Gross Margin Calculation
- Gross margin, calculated as sales revenue minus cost of goods sold, appears on a multi-step income statement.
- Operating expenses are subtracted from gross margin to yield net income, which contrasts with single-step income statements that consolidate expenses.
Definition of Inventory
- Inventory, classified as an asset on the balance sheet, comprises goods available for sale to generate future revenue.
- The cost of goods sold is reported as an expense on the income statement when inventory is sold, while cash transactions from buying/selling inventory are recorded separately.
Cost of Goods Available for Sale
- Cost of goods available for sale is calculated by adding beginning inventory ($5,000) to purchases during the period ($25,000), totaling $30,000.
Cost of Goods Sold Calculation
- Cost of goods sold is calculated as cost of goods available for sale minus ending inventory ($30,000 - $4,000), resulting in $26,000.
FIFO Method of Inventory Flow
- FIFO (First In, First Out) assumes that the first items purchased are the first items sold.
- The example shows an item sold for $40 that had a cost of $30, indicating the use of FIFO in inventory accounting.
Gross Margin Example with FIFO
- Given 900 units sold at $12 each generating $10,800 in sales revenue and a cost of goods sold at $6,600, the gross margin is calculated as $4,200.
- Under FIFO, the cost of goods sold reflects the values of the first units acquired.
LIFO Method of Inventory Flow
- LIFO (Last In, First Out) calculates the cost of goods sold starting from the most recent purchases.
- For 950 units sold, costs are compiled starting from the latest inventory, resulting in ending inventory of $500 after deducting costs from total available goods.
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Description
Test your understanding of how purchasing inventory on account affects the accounting equation. This quiz focuses on the impact on assets, liabilities, and equity. Assess your knowledge of inventory transactions and their effects on financial statements.
