McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 8 Purchasing/ Human Resources/ Payment Process: Recording and Evaluating Expenditure Process Activities

8-2 What is the Difference between Merchandising and Manufacturing Inventories? Merchandising  Inventory purchased to be resold  Merchandise Inventory account Manufacturing  Inventory purchased to be used to make products  Raw Materials Inventory account

8-3 What is the Difference between Periodic and Perpetual Inventory Systems? Periodic  Determine ending inventory and cost of goods sold at the end of the period Perpetual  Determine cost of goods sold and ending inventory on a continuous basis

8-4 How are Inventory Activities Recorded in a Periodic System? Purchase  Debit Purchases  Credit Accounts Payable Return or allowance  Debit Accounts Payable  Credit Purchase Returns and Allowances Freight or insurance on purchases  Debit Freight-in (Insurance-in)  Credit Accounts Payable (Cash)

8-5 How are Inventory Activities Recorded in a Perpetual System? Purchase  Debit Inventory  Credit Accounts Payable Return or allowance  Debit Accounts Payable  Credit Inventory Freight or insurance on purchases  Debit Inventory  Credit Accounts Payable (Cash)

8-6 What is the Difference between the Net Price and Gross Price Methods? Net price  Purchases and purchase returns/allowances are recorded net of the available discount  Discounts lost are recorded separately Gross price  Purchases and purchase returns/allowances are recorded at the gross price  Discounts taken are recorded separately

8-7 Example A company purchases $1,000 (gross) of inventory (terms: 2/10, n/30), subsequently returns $200 (gross) of the inventory, and pays for the inventory within the discount period.

8-8 Net Price Method/Perpetual Purchase  Increase (debit) inventory by $980 ($1,000 * 0.98)  Increase (credit) accounts payable by $980 Return  Decrease (debit) accounts payable by $196 ($200 * 0.98)  Decrease (credit) inventory by $196 Payment within discount period  Decrease (debit) accounts payable by $784 ($980 - $196)  Decrease (credit) cash by $784

8-9 Gross Price/Perpetual Purchase  Increase (debit) inventory by $1,000  Increase (credit) accounts payable by $1,000 Return  Decrease (debit) accounts payable by $200  Decrease (credit) inventory by $200 Payment within discount period  Decrease (debit) accounts payable by $800 ($1,000 - $200)  Decrease (credit) cash by $784 ($800 * 0.98)  Recognize discount taken (credit inventory) for $16

8-10 What is the Balance in Inventory under Each Pricing Method? Net price  Inventory = $980 - $196 = $784 Gross price  Inventory = $1,000 - $200 - $16 = $784

8-11 What if the Payment is Made After the Discount Period has Expired? Net price  Decrease (debit) accounts payable by $784 ($980 - $196)  Recognize discount lost (debit Discounts Lost) for $16  Decrease (credit) cash by $800 ($784/0.98) Gross price  Decrease (debit) accounts payable by $800 ($1,000 - $200)  Decrease (credit) cash by $800

8-12 Now What is the Balance of Inventory under Each Pricing Method? Net price  Inventory = $980 - $196 = $784 Gross price  Inventory = $1,000 - $200 = $800 Does this mean that the inventory under the gross price method is worth more?  No, it simply reflects management’s beliefs concerning discounts. Gross = cost reduction when taken Net = financing cost when lost

8-13 What is the Basic Flow of Information in the Payroll Process? Employees record time worked on time cards and factory records time worked on time tickets Timekeeping compares time cards and time tickets Payroll records time worked, deductions, etc. Accounts payable approves payroll and notifies cashier Cashier pays employees

8-14 What is the Difference between Gross Pay and Net Pay from the Employer’s Point of View? Gross pay—salary and wage expense (amount incurred in an attempt to generate revenue) Net pay—cash outflow to employees Withholdings—liabilities to pay the entity to which the funds belong

8-15 What is the Difference between Salary/Wage Expense and Payroll Tax Expense? Salary/wage expense—expense incurred from using employees in an attempt to generate revenue Payroll tax expense—expense incurred due to having employees (matching FICA and unemployment taxes)

8-16 When are Expenses Recognized? When incurred, regardless of when cash is paid. Assume December 31 year for examples that follow.  Example #1—receive a utility bill in December, pay the bill in January, expense is recognized in December  Example #2—pay insurance for 6 months in November, recognize 2 months of insurance expense in December  Example #3—pay the local newspaper in December for an ad to be run in December, recognize expense in December

8-17 Inventory Example Inventory is an asset when purchased When inventory is sold, we recognize the expense, called Cost of Goods Sold

8-18 How are Expenditure Process Activities Communicated to Users? Income statement  Discounts lost, Loss on Inventory, other expenses  Cost of goods sold Balance sheet  Ending balance of inventory, other assets, and liabilities Statement of cash flows  Cash paid for inventory and other expenditure process items

8-19 How can we Estimate the Cash Paid for Inventory? Beginning inventory (balance sheet) + Net purchases (calculated) = Maximum inventory available Cost of goods sold (income statement) = Ending inventory (balance sheet) Then,

8-20 Estimating Cash Paid for Inventory, Continued Beginning accounts payable (balance sheet) + Net purchases (from inventory account) = Maximum amount owed to suppliers Cash paid for inventory (calculated) = Ending accounts payable (balance sheet)