Financial Accounting

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Previous Lessons
Open Chapter Ch. 1: Basics of Financial Accounting
Lesson #1 Introduction to Financial Accounting
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Lesson #2 Structures of a Business
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Lesson #3 Comparing Internal vs. External Users
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Lesson #4 Business Activities
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Lesson #5 Financial Statements
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Lesson #6 Elements of Financial Accounting
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Open Chapter Ch. 2: Assets, Liability, and Equity
Lesson #7 Assets
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Lesson #8 Liabilities
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Lesson #9 Equity
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Open Chapter Ch. 3: The Double-Entry System and Conceptual Framework
Lesson #10 Accounting Equation
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Lesson #11 Conceptual Framework
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Lesson #12 Double Entry Accounting System
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Lesson #13 Debits and Credits
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Lesson #14 Normal Balances and RED Accounts
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Exam Exam 1
Open Chapter Ch. 4: The Accounting Cycle
Lesson #15 Journalizing and the Accounting Cycle
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Lesson #16 Posting to the General Ledger
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Lesson #17 Trial Balance
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Lesson #18 Adjusting Entries for Accrued Expenses
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Lesson #19 Adjusting Entries for Prepaid Expenses
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Lesson #20 Adjusting Entries for Unearned Revenue
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Lesson #21 Adjusting Entries for Accrued Revenue
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Lesson #22 Adjusting Entries for Amortization and Depreciation
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Lesson #23 Adjusted Trial Balance
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Lesson #24 Preparing the Financial Statements
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Lesson #25 Permanent vs. Temporary Accounts
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Lesson #26 Closing Entries
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Open Chapter Ch. 5: Merchandise Inventory
Lesson #27 Introduction to Merchandise Inventory
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Lesson #28 Periodic vs. Perpetual Inventory Systems
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Lesson #29 Journalizing Purchase Entries
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Lesson #30 Journalizing Sales Transactions
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Lesson #31 Preparing a Multiple-Step Income Statement
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Lesson #32 Periodic Inventory System Purchases
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Lesson #33 Periodic System and the Multiple-Step Accounting System
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Exam Midterm Exam
Open Chapter Ch. 6: Cost Flow Assumptions: FIFO, LIFO, and Average Cost Methods
Lesson #34 Specific Identification Method and Inventory Costing
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Lesson #35 FIFO Method and Inventory Costing
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Lesson #36 Average Cost Method and Inventory Costing
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Lesson #37 The LIFO Method
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Lesson #38 Average Cost Method for the Perpetual System
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Lesson #39 Comparing Inventory Costing Methods
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Open Chapter Ch. 7: Receivables and Bad Debts
Lesson #40 Allowance Method and Uncollectibles
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Lesson #41 The Allowance Method
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Lesson #42 Percentage of Sales Method
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Lesson #43 Percentage of Receivables Method
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Lesson #44 Receivables Method and the Aging Table
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Lesson #45 Write Off Receivables Using the Allowance Method
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Lesson #46 Direct Write-Off Method
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Open Chapter Ch. 8: Revenue Recognition
Lesson #47 Revenue Recognition
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Lesson #48 Revenue Recognition Examples
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Lesson #49 Revenue Recognition and Long Term Contracts
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Lesson #50 Percentage of Completion Method
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Lesson #51 Percentage of Completion Method Journal Entries
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Lesson #52 Percentage of Completion Method and Journalizing Losses
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Lesson #53 Cost Recovery Method
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Lesson #54 Completed Contract Method and Journal Entries
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Lesson #55 Completed Contract Method and Losses
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Exam Exam 3
Open Chapter Ch. 9: Depreciation of Fixed Assets and Gains and Losses
Lesson #56 Depreciation, Amortization and Depletion
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Lesson #57 Straight Line and Declining Balance Methods
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Lesson #58 Straight Line and Double Declining Balance Depreciation Examples
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Lesson #59 Gains and Losses on Disposals of Property, Plant & Equipment
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Open Chapter Ch. 10: Intangible Assets
Lesson #60 Intangible Assets
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Lesson #61 Amortizing Intangible Assets
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Lesson #62 Impairment of Intangible Assets
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Lesson #63 Recording Goodwill, Amortization and Impairment
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Open Chapter Ch. 11: The Indirect Cash Flow Statement
Lesson #64 Preparing a Cash Flow Statement Using the Indirect Method Part 1
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Lesson #65 Cash Flow Statement Using Indirect Method Part 2, Receivables
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Lesson #66 Cash Flow Statement Using Indirect Method Part 3, Inventory
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Lesson #67 Cash Flow Statement Using Indirect Method Part 4, Payables
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Lesson #68 Cash Flow Statement Using Indirect Method Part 5, Non Cash Expenses
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Lesson #69 Cash Flow Statement- Investing and Financing Activities
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Exam Final Exam

Assignments:

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Lesson Objectives:

- The difference between service and merchandise companies
- Accounting steps related to their operations.
- Examples of the business types
- Recording merchandising operations on the income statement.



Merchandise inventory is an asset that we need to understand how to identify, report and collect. There is a good bit of material that we have to cover on this topic but for the purpose of this lesson we will talk about the two types of operations and how they differ when it comes to financial accounting.
 
As you can see from the steps depicted above, service companies perform a service, while a merchandising company buys and sells inventory. These two types of businesses differ in the main fact that a merchandising company has inventory.
 
Both types of companies need to report the collection of accounts receivable and cash, but they have very different methods when it comes to reporting on financial statements.



The definition of merchandising operations is much different for a services company than for a standard merchandising company.

Service companies sell their skills or expertise in the form of a service, instead of a physical item. For example, consulting, fitness coaching, public accounting and attorneys are all examples of service businesses.

They perform a service in exchange for payment; essentially the service is their product. Services businesses do not have to report inventory, because they are not selling tangible items.



In contrast to service companies, merchandising companies carry physical inventory of products. Think of big box retailers such as Home Depot and Wal-Mart, as they carry inventory that is sold to customers.

They need to be able to record and quantify the inventory on their balance sheet. They record the inventory as the lower figure between cost and net realizable value (NRV).
 
Net realizable value is calculated by deducting any amortization, depreciation and impairment from the cost of the inventory. Impairment often means that the merchandise becomes obsolete and is worth a lower amount.
 
For example, if the company has 500 units at $6 a piece, they would have a cost of $3,000 for their total inventory. If a portion of the inventory becomes obsolete and the total inventory is only worth $1,900, the company would need to report the lower NRV of $1,900 on the balance sheet.
 
This ensures that the assets are stated conservatively based on the value of the inventory.
 
Merchandising companies have an extra step when compared to services businesses as they have to record the cost of inventory on the income statement.



On the income statement, the company first lists the net sales, and then subtracts the cost of goods sold, to come up with the gross profit figure. Let's take a look at the sample income statement above, and I will describe what each of these terms means.

The sales revenue also known as net sales is the total amount of sales that the company made during the accounting period.
 
Merchandise businesses need to sell their inventory and record the cost of goods sold, which is the costs incurred to obtain the product or goods for sale to the consumer.
 
Finally, the gross profit is calculated by subtracting the cost of goods sold from the net sales. This figure is also known as the fatty profit, because it represents what is left over after the goods are sold.

Expenses are then deducted from the gross profit to come up with the final figure of operating income.
 
In the next lesson, we will be diving deeper into merchandising concepts, as we cover the differences between perpetual and periodic inventory.