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Effect of inventory purchase on financial statements & ratio

Because of the possibility that Calliope might open an online bookstore, it is important to understand how inventory would be reported in Calliope's books and accounts. What are the allowable methods for recording inventory? How does each method affect the expense of cost of goods sold, and consequently, tax expense and net income?

To: Jan Waters, Controller
From:
Subject: Accounting for Inventory of Possible Online Bookstore

Which accounts are affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
Balance sheet_- current assets increase
Income statement - cogs decrease

How is the balance sheet affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
Current assets increase
Retain earning increase
Inventory increase
Liabilities increase

How is the income statement affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
COGS decrease

How is the statement of cash flows (using the direct method) affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Operating activities (list event) Cash inflow, cash outflow, or no change?
Inventory No change

How are the numerator and denominator of the following ratios affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date. Also assume the ratio is positive before considering the entry.)
Return on Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Net income) increase
Denominator (Average total assets) increase
Total Ratio Depends on the magnitude of change

Return on Equity Increase, decrease, no effect, or cannot be determined?
Numerator (Net income) increase
Denominator (Average total equity) increase
Total Ratio Depends on the magnitude of change

Earnings Per Share Increase, decrease, no effect, or cannot be determined?
Numerator (Net income) increase
Denominator (Weighted average common stock shares outstanding) No effect
Total Ratio increase

Quick Ratio Increase, decrease, no effect, or cannot be determined?
Numerator (Cash, short-term investments, and accounts receivable) No effect
Denominator (Current liabilities) increase
Total Ratio decrease

Gross Margin Increase, decrease, no effect, or cannot be determined?
Numerator (Sales-Cost of goods sold expense) increase
Denominator (Sales) No effect
Total Ratio increase

Debt to Total Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Total liabilities) increase
Denominator (Total assets) increase
Total Ratio Depends on the magnitude

Which accounts are affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)

Account affected Increase or decrease?
Balance sheet - liabilites decrease
Income statement -COGS increase

How is the balance sheet affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Account affected Increase or decrease?
Cash on hand increase
Inventory decrease
liabilities decrease

How is the income statement affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Account affected Increase or decrease?
COGS increase

How is the statement of cash flows (using the direct method) affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Operating activities (list event) Cash inflow, cash outflow, or no effect?
Inventory outflow

How are the numerator and denominator of the following ratios affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense. Assume the ratio is positive before considering the entry.)

Return on Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Net income) decrease
Denominator (Average total assets) increase
Total Ratio decrease

Return on Equity Increase, decrease, no effect, or cannot be determined?
Numerator (Net income) decrease
Denominator (Average total equity) increase
Total Ratio decrease

Earnings Per Share Increase, decrease, no effect, or cannot be determined?
Numerator (net income) decrease
Denominator (Weighted average common stock shares outstanding) No effect
Total Ratio decrease

Quick Ratio Increase, decrease, no effect, or cannot be determined?
Numerator (Cash, Short-term investments and Accounts receivable) increase
Denominator (Current liabilities) decrease
Total Ratio increase

Gross Margin Increase, decrease, no effect, or cannot be determined?
Numerator (Sales-Cost of goods sold expense) increase
Denominator (Sales) increase
Total Ratio Depends on magnitude of change

Debt to Total Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Total liabilities) decrease
Denominator (Total assets) increase
Total Ratio decrease

Instructions: There are two steps to Task 2b. First, complete a set of tables (provided below) detailing Calliope's accounts. Then, write an e-mail to Jan Waters summarizing this information. When you finish both the tables and the e-mail, save the document with your first initial and last name in the file name (e.g., jsmith_task2b.doc). Then send the document to your faculty member using the form on the Task 2b page of the course.

Step 1
Use the tables below to display the requested information for this task. The number of rows in each table is not indicative of the number of accounts affected. Feel free to add or remove rows as necessary.

Step 2
Write a 450-word e-mail to Jan Waters summarizing the information you provided in the tables. The e-mail should describe the allowable inventory valuation methods and their impact on inventory, expense of cost of goods sold, and consequently, on net income and tax expense. If Calliope decides to open a bookstore, inventory will be carried on its accounting books.
Your e-mail should answer the following questions:
? Which accounts are affected when a company purchases merchandise for resale? (Assume a perpetual inventory system. Consider whether the purchase of the merchandise is for cash or on account.)
? Which accounts are affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into expense of cost of goods sold.)
? How are the balance sheet, income statements, and statement of cash flows (using the direct method) affected by the above entries?
? What is the effect of the above entries on the selected ratios in the template tables?
? Evaluate the impact of each entry on the financial statements and ratios of Calliope. For this part of the task, consider the following questions and summarize your analysis in your e-mail.
o How will the financial statements be affected by the entries?
o Which ratios will be affected by the entries?
o How might an investor or creditor be affected with regard to the decision to invest in or lend money to the company, based on your analysis?

To: Jan Waters, Controller
From: [insert your name here]
Subject: Accounting for Inventory of Possible Online Bookstore
Date: [insert the date here]

Which accounts are affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?

How is the balance sheet affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?

How is the income statement affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?

How is the statement of cash flows (using the direct method) affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Operating activities (list event) Cash inflow, cash outflow, or no change?

How are the numerator and denominator of the following ratios affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date. Also assume the ratio is positive before considering the entry.)
Return on Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Net income)
Denominator (Average total assets)
Total Ratio

Return on Equity Increase, decrease, no effect, or cannot be determined?
Numerator (Net income)
Denominator (Average total equity)
Total Ratio

Earnings Per Share Increase, decrease, no effect, or cannot be determined?
Numerator (Net income)
Denominator (Weighted average common stock shares outstanding)
Total Ratio

Quick Ratio Increase, decrease, no effect, or cannot be determined?
Numerator (Cash, short-term investments, and accounts receivable)
Denominator (Current liabilities)
Total Ratio

Gross Margin Increase, decrease, no effect, or cannot be determined?
Numerator (Sales-Cost of goods sold expense)
Denominator (Sales)
Total Ratio

Debt to Total Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Total liabilities)
Denominator (Total assets)
Total Ratio

Which accounts are affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)

Account affected Increase or decrease?

How is the balance sheet affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Account affected Increase or decrease?

How is the income statement affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Account affected Increase or decrease?

How is the statement of cash flows (using the direct method) affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense.)
Operating activities (list event) Cash inflow, cash outflow, or no effect?

How are the numerator and denominator of the following ratios affected when a company sells inventory? (Do not consider the sale side of the entry, only the movement of the item out of inventory and into cost of goods sold expense. Assume the ratio is positive before considering the entry.)

Return on Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Net income)
Denominator (Average total assets)
Total Ratio

Return on Equity Increase, decrease, no effect, or cannot be determined?
Numerator (Net income)
Denominator (Average total equity)
Total Ratio

Earnings Per Share Increase, decrease, no effect, or cannot be determined?
Numerator (net income)
Denominator (Weighted average common stock shares outstanding)
Total Ratio

Quick Ratio Increase, decrease, no effect, or cannot be determined?
Numerator (Cash, Short-term investments and Accounts receivable)
Denominator (Current liabilities)
Total Ratio

Gross Margin Increase, decrease, no effect, or cannot be determined?
Numerator (Sales-Cost of goods sold expense)
Denominator (Sales)
Total Ratio

Debt to Total Assets Increase, decrease, no effect, or cannot be determined?
Numerator (Total liabilities)
Denominator (Total assets)
Total Ratio

Following the directions in Step 2 above, answer the other questions for this task. Discuss your overall findings in the space below.

Attachments

Solution Preview

Please see the attached files. File No. 2 had the same tables as the file no. 1 so that information is not there. File number 2 needed a write up summary which is there.

To: Jan Waters, Controller
From:
Subject: Accounting for Inventory of Possible Online Bookstore

Which accounts are affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
Balance sheet_- current assets inventory/accounts payable increase
Income statement - cogs no effect
Decrease no effect

When the inventory is purchased, it is recorded as an asset. Since it is on credit, the accounts payable account will be credited

How is the balance sheet affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
Current assets inventory increase
Retain earning this is not affected increase
Inventory increase
Liabilities - accounts payable increase

There is effect on only two accounts - inventory and accounts payable. Retained earnings will be affected when the inventory is sold

How is the income statement affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Account affected Increase or decrease?
COGS - no effect decrease

When inventory is purchased there is no effect on the income statement

How is the statement of cash flows (using the direct method) affected when a company purchases merchandise for resale? (Assume the merchandise is purchased on account and will be paid for at a future date.)
Operating activities (list event) Cash inflow, cash outflow, or no change?
Inventory No change

There is no effect since the inventory is on credit and so the event will not be listed on the statement of cash flows
How are the numerator and denominator of ...

Solution Summary

The solution explains the effect of inventory purchase on financial statements and the given ratios

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