Financial Accounting - Lesson 6.1 - Service vs Merchandisers

Summary

In this lesson, Patrick introduces the basics of merchandising operations, focusing on the differences between service companies, merchandisers, and manufacturers from an accounting perspective. He explains how merchandisers manage inventory, including how it is recorded as an asset when purchased and expensed as cost of goods sold when sold to customers. Patrick provides real-world examples, such as Target and Southwest Airlines, to illustrate these concepts. The video also outlines key accounting statements like the balance sheet and income statement, highlighting how inventory impacts a merchandiser’s financial reporting.

Takeaways

• 😀 Merchandising companies buy goods from manufacturers and sell them to customers, unlike service companies that offer services as their main revenue source.
• 😀 Inventory is a key asset for merchandising companies, representing goods that are bought to be resold, while service companies typically don't deal with inventory.
• 😀 The core difference between service companies and merchandisers is the presence of inventory, which is used to generate revenue in merchandising operations.
• 😀 The cost of inventory is not expensed until the goods are sold, following the matching principle in accounting, which ensures expenses are recorded in the same period as the related revenue.
• 😀 COGS (Cost of Goods Sold) represents the expense of inventory items sold to customers. It is recorded when the item is sold, not when it is purchased.
• 😀 Service companies generate revenue by providing services, while merchandising companies earn revenue from selling inventory.
• 😀 Merchandising companies use a balance sheet that includes inventory as an asset, whereas service companies do not have inventory.
• 😀 A merchandising company's income statement includes a section for COGS, which reflects the cost of inventory sold during the period, resulting in gross profit after subtracting COGS from revenue.
• 😀 The key financial difference between service and merchandising companies lies in the income statement, where merchandisers account for the cost of inventory sold and service companies only show service revenues and operating expenses.
• 😀 The process of inventory turning from an asset to an expense happens when the goods are sold, ensuring accurate financial reporting and adherence to accrual accounting principles.
• 😀 Even though some companies may overlap categories (e.g., Southwest Airlines), merchandising companies focus on buying and selling goods for profit, while service companies are primarily service-oriented.

Q & A

What is the main difference between service companies and merchandising companies?

The main difference is that service companies provide services to generate revenue, while merchandising companies sell goods (inventory) that they have purchased from other vendors.

What are the three categories of companies discussed in the video?

The three categories are: Service Companies, Merchandising Companies, and Manufacturers. Service companies provide services, merchandising companies sell goods they buy from others, and manufacturers produce goods from raw materials.

Can you give an example of a service company?

An example of a service company is Southwest Airlines, which provides transportation services rather than physical goods.

What role does inventory play in merchandising companies?

Inventory in merchandising companies refers to the goods they purchase from vendors to sell to customers. It is considered an asset on the balance sheet until sold.

What is the difference between inventory and supplies in merchandising companies?

Inventory is goods that a company sells to customers, while supplies are items used in daily operations, such as pens or paper, and are not sold to customers.

When is inventory expensed in merchandising companies?

Inventory is not expensed when it is purchased. Instead, it is expensed as **Cost of Goods Sold (COGS)** when the inventory is sold to customers.

What is the matching principle in accounting, and how does it apply to inventory?

The matching principle in accounting requires that expenses be recognized in the same period as the revenues they generate. In merchandising companies, inventory is initially recorded as an asset and only expensed (as COGS) when it is sold.

What is the difference between a balance sheet for a service company and a merchandising company?

A service company's balance sheet will show assets like cash, accounts receivable, and supplies but not inventory. A merchandising company's balance sheet will include inventory as a current asset along with other items like cash and accounts receivable.

What does the income statement for a merchandising company include that a service company’s income statement does not?

A merchandising company’s income statement includes **Cost of Goods Sold (COGS)**, which reflects the cost of inventory sold to customers. Service companies do not have COGS because they do not sell physical goods.

How is gross profit calculated in merchandising companies?

Gross profit in merchandising companies is calculated by subtracting **Cost of Goods Sold (COGS)** from **Revenue**. This shows the profit made after accounting for the cost of inventory sold.

Why is inventory considered an asset for merchandising companies?

Inventory is considered an asset because it provides future benefits to the company. When the inventory is sold, it generates revenue, which typically exceeds the initial purchase cost, leading to a profit.