Q1. Explain the gross and net methods of recording receivables?
If using the gross method, a company reports sales discounts as a deduction from
sales in the income statement. Proper expense recognition dictates that the company
also reasonably estimates the expected discounts to be taken and charges that amount
against sales. If using the net method, a company considers Sales Discounts Forfeited
as an “Other revenue” item.4
Theoretically, the recognition of Sales Discounts Forfeited is correct. The receivable
is stated closer to its realizable value, and the net sales figure measures the revenue
earned from the sale. As a practical matter, however, companies seldom use the net
method because it requires additional analysis and bookkeeping. For example, the net
method requires adjusting entries to record sales discounts forfeited on accounts receivable
that have passed the discount period.
Q2. What are the systems for maintaining inventory records?
Companies use one of two types of systems for maintaining accurate inventory
records for these costs—the perpetual system or the periodic system.
Aperpetual inventory system continuously tracks changes in the Inventory account.
That is, a company records all purchases and sales (issues) of goods directly in
the Inventory account as they occur. The accounting features of a perpetual inventory
system are as follows.
1. Purchases of merchandise for resale or raw materials for production are debited to
Inventory rather than to Purchases.
2. Freight-in is debited to Inventory, not Purchases. Purchase returns and allowances
and purchase discounts are credited to Inventory rather than to separate accounts.
3. Cost of goods sold is recorded at the time of each sale by debiting Cost of Goods
Sold and crediting Inventory.
4. Asubsidiary ledger of individual inventory records is maintained as a control measure.
The subsidiary records show the quantity and cost of each type of inventory on hand.
The perpetual inventory system provides a continuous record of the balances in both
the Inventory account and the Cost of Goods Sold account.
Under a periodic inventory system, a company determines the quantity of inventory
on hand only periodically, as the name implies. It records all acquisitions of inventory
during the accounting period by debiting the Purchases account. Acompany then adds
the total in the Purchases account at the end of the accounting period to the cost of the
inventory on hand at the beginning of the period. This sum determines the total cost
of the goods available for sale during the period.
To compute the cost of goods sold, the company then subtracts the ending inventory
from the cost of goods available for sale. Note that under a periodic inventory system,
the cost of goods sold is a residual amount that depends on a physical count of
ending inventory. This process is referred to as “taking a physical inventory.” Companies
that use the periodic system take a physical inventory at least once a year.