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Preparing an Income Statement Term review The area of accounting that focuses on reporting information to external users is called financial accounting. The area of accounting that focuses on reporting information to internal users is called managerial accounting. Information needed to prepare the income statement is obtained from the work sheet. A comparison between two components of financial information is called a financial ratio. The calculation and interpretation of a financial ratio is called ratio analysis. Reporting an amount on a financial statement as a percentage of another item on the same financial statement is called vertical analysis. Audit Your Understanding 1. List the four sections of an income statement. // Heading, revenue, expenses, and net income or net loss 2. What is the formula for calculating the total expenses ratio? // Total Expenses divided by Total Sales equals Total Expenses Ratio. 3. What is the formula for calculating the net income ratio? // Net Income divided by Total Sales equals Net Income Ratio. Preparing a Balance Sheet Information needed to prepare the balance sheet is obtained from the work sheet. Audit Your Understanding 1. List the four sections on a balance sheet. // Heading, assets, liabilities, and owner’s equity 2. What is the formula for calculating current capital? // Capital Account Balance plus Net Income (or less Net Loss) less Drawing Account Balance equals Current Capital. Subsidiary Ledgers And Controlling Accounts Terms review Goods that a business purchases to sell are called merchandise. A business that purchases and resells goods is called a merchandising business. A merchandising business that sells to those who use or consume the goods is called a retail merchandising business. A wholesale merchandising business buys and resells merchandise primarily to other merchandising businesses. A corporation is an organization with the legal rights of a person which many persons or other corporations may own. The assets or other financial resources available to a business are called capital. Each unit of ownership in a corporation is called a share of stock. The owner of one or more shares of stock is called a stockholder. The total shares of ownership in a corporation are called capital stock. The articles of incorporation, a legal document that identifies basic characteristics of a corporation, is a part of the application submitted to a state to become a corporation. A state approves the formation of a corporation by issuing a charter, the legal right for a business to conduct operations as a corporation. A business from which merchandise, supplies, or other assets are purchased is called a vendor. A ledger that is summarized in a single general ledger account is called a subsidiary ledger. Accountants often refer to a subsidiary ledger as a subledger. The subsidiary ledger containing vendor accounts is called an accounts payable ledger. An account in a general ledger that summarizes all accounts in a subsidiary ledger is called a controlling account. Audit Your Understanding 1. What is the primary difference between retail and wholesale merchandising businesses? // A retail merchandising business sells to those who use or consume the goods. A wholesale merchandising business buys and resells merchandise primarily to other merchandising businesses. 2. What allows a corporation to own property, incur liabilities, and enter into contracts in its own name? // A corporation, through the rights granted in its charter, has the legal rights of a person. 3. What is the principal difference between the accounting records of proprietorships and corporations? // Proprietorships have a single capital and drawing account for the owner. A corporation has separate capital accounts for the stock issued and for the earnings kept in the business. 4. What is the relationship between a controlling account and a subsidiary ledger? // The sum of the subsidiary ledger accounts is equal to the balance in the general ledger controlling account. 5. What column on a general ledger form is not on an accounts payable ledger form? // Debit Balance Accounting for Merchandise Purchases Term review A list of assets, usually containing the value of individual items, is called an inventory. The goods a business has on hand for sale to customers is called merchandise inventory. An inventory determined by keeping a continuous record of increases, decreases, and the balance on hand of each item of merchandise is called a perpetual inventory. A merchandise inventory evaluated at the end of a fiscal period is called a periodic inventory. When a periodic inventory is conducted by counting, weighing, or measuring items of merchandise on hand, it is called a physical inventory. The amount a business pays for goods it purchases to sell is called cost of merchandise. A form requesting the purchase of merchandise is called a requisition. A form requesting that a vendor sell merchandise to a business is called a purchase order. A journal used to record only one kind of transaction is called a special journal. Businesses typically use five journals: Purchases journal—for all purchases of merchandise on account Cash payments journal—for all cash payments Sales journal—for all sales of merchandise on account Cash receipts journal—for all cash receipts General journal—for all other transactions A transaction in which the items purchased are to be paid for later is called a purchase on account. A purchases journal is a special journal used to record only purchases of merchandise on account. A journal amount column headed with an account title is called a special amount column. An invoice used as a source document for recording a purchase on account transaction is called a purchase invoice. An agreement between a buyer and a seller about payment for merchandise is called the terms of sale. The date by which an invoice must be paid is called the due date. Audit Your Understanding 1. What is the difference between a periodic inventory system and a perpetual inventory system? // With a periodic inventory system, the value of the inventory is determined by a physical count. With a perpetual inventory system, the value of the inventory on hand is determined by a continuous record of increases and decreases. 2. When the perpetual inventory system is used, in what account are purchases recorded? In what account are purchases recorded when the periodic inventory system is used? // In a perpetual inventory system, purchases are recorded in the Merchandise Inventory account. In a periodic inventory system, purchases are recorded in the Purchases account. 3. Identify the four special journals typically used by a business. Purchases journal, cash payments journal, sales journal, cash receipts journal 4. How are special amount columns used in a journal? Special amount columns are used for frequently occurring transactions. 5. Why are there two account titles in the amount column of the purchases journal? All transactions for purchasing merchandise on account involve a debit to Purchases and a credit to Accounts Payable. 6. What is the advantage of having special amount columns in a journal? Using special amount columns eliminates writing general ledger account titles in the Account Title column, which saves time and helps to reduce mistakes. 7. What information is contained on a purchase invoice? // A purchase invoice lists the vendor name and address; the date; the quantity, description, and price of each item; and the total amount of the purchase.