Financial Accounting chapter 05

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Chapter 5Accounting for Accounting for Merchandising Merchandising OperationsOperationsFinancial Accounting, IFRS

EditionWeygandt Kimmel Kieso

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1. Identify the differences between service and merchandising companies.

2. Explain the recording of purchases under a perpetual inventory system.

3. Explain the recording of sales revenues under a perpetual inventory system.

4. Explain the steps in the accounting cycle for a merchandising company.

5. Prepare an income statement for a merchandiser.6. Explain the computation and importance of gross

profit.

Study ObjectivesStudy Objectives

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Forms of Forms of Financial Financial StatementsStatements

Accounting for Merchandising Accounting for Merchandising OperationsOperations

Freight Freight costscostsPurchase Purchase returns returns and and allowancesallowancesPurchase Purchase discountsdiscountsSummary of Summary of purchasing purchasing transactiotransactionsns

MerchandisinMerchandisingg

OperationsOperations

Recording Recording Purchases Purchases

of of MerchandiseMerchandise

Recording Recording Sales of Sales of

MerchandiseMerchandise

Completing Completing the the

Accounting Accounting CycleCycle

Operating Operating cyclescyclesFlow of Flow of costs—costs—perpetual perpetual and and periodic periodic inventory inventory systemssystems

Sales Sales returns returns and and allowancesallowancesSales Sales discountsdiscounts

Adjusting Adjusting entriesentriesClosing Closing entriesentriesSummary of Summary of merchandisimerchandising entriesng entries

Income Income statementstatementClassified Classified statement of statement of financial financial positionposition

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Merchandising OperationsMerchandising Operations

SO 1 Identify the differences between service and merchandising companies.SO 1 Identify the differences between service and merchandising companies.

Merchandising CompaniesMerchandising CompaniesBuy and Sell GoodsBuy and Sell Goods

Wholesaler

Retailer Consumer

The primary source of revenues is referred to as sales revenue or sales.

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Income MeasurementIncome Measurement

Illustration 5-1

Cost of goods sold is the total cost of

merchandise sold during the period.

Not used in a Service

business.

Net Income (Loss)

Less

Less=

=

SalesRevenue

Cost of Goods Sold

Gross Profit

Operating Expenses


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The operating cycle of a merchandising company ordinarily is longer than that of a service company.

Illustration 5-2



Operating Cycle

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Flow of CostsIllustration

5-3

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Perpetual System 1. Purchases increase Merchandise Inventory.2. Freight costs, Purchase Returns and Allowances

and Purchase Discounts are included in Merchandise Inventory.

3. Cost of Goods Sold is increased and Merchandise Inventory is decreased for each sale.

4. Physical count done to verify Merchandise Inventory balance.

The perpetual inventory system provides a continuous record of Merchandise Inventory and Cost of Goods

Sold.SO 1 Identify the differences between service and merchandising companies.SO 1 Identify the differences between service and merchandising companies.


Flow of Costs

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1. Purchases of merchandise increase Purchases.2. Ending Inventory determined by physical count.3. Calculation of Cost of Goods Sold:

Beginning inventory

$ 100,000Add: Purchases, net

+ 800,000Goods available for sale

900,000Less: Ending inventory

- 125,000Cost of goods sold

$ 775,000



Flow of CostsPeriodic System

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Answers on notes page

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Made using cash or credit (on account).Normally recorded when goods are received.Purchase invoice should support each credit purchase.

Recording Purchases of MerchandiseRecording Purchases of Merchandise

SO 2 Explain the recording of purchases under a perpetual inventory system.SO 2 Explain the recording of purchases under a perpetual inventory system.

Illustration 5-5

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Under the perpetual inventory system, companies record in the Merchandise Inventory account the purchase of goods they intend to sell.

Illustration:Illustration: From INVOICE NO. 731 (Illustration 5-5) record the journal entry Sauk Stereo would make to record its purchase from PW Audio Supply.

Merchandise inventory 3,800May 4Accounts payable

3,800



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Illustration 5-6

Seller places goods Free On Board the carrier, and buyer pays freight costs.

Seller places goods Free On Board to the

buyer’s place of business, and seller pays freight costs.


Freight Costs – Terms of – Terms of SaleSale

Freight costs incurred by the seller are an operating expense. SO 2SO 2

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Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company €150 for freight charges, the entry on Sauk Stereo’s books is:Merchandise inventory 150May 6

Cash 150



Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been:Freight-out (or Delivery Expense)

150May 4

Cash 150

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Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.

Purchase Returns and Allowances


Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was

for cash.

May choose to keep the merchandise if the seller will

grant an allowance (deduction) from the

purchase price.

Purchase Return Purchase Allowance


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In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: a. Purchases b. Purchase Returns c. Purchase Allowance d. Merchandise Inventory

QuestionQuestion



Answer on notes page

In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting: a. Purchases b. Purchase Returns c. Purchase Allowance d. Merchandise Inventory

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Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing €300.

Accounts payable 300May 8Merchandise inventory 300

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Credit terms may permit buyer to claim a cash discount for prompt payment.Advantages:

Purchaser saves money.Seller shortens the operating cycle.

Purchase Discounts


Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.” 2% cash discount if payment is made within 10 days.


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Purchase Discount Terms


2% discount if paid within 10 days,

otherwise net amount due within 30 days.

1% discount if paid

within first 10 days of next month.

2/10, n/30 1/10 EOM

Net amount due within

the first 10 days of the next month.

n/10 EOM


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Merchandise Inventory 70

Accounts payable 3,500May 14



Illustration: Assume Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less purchase returns and allowances of €300) on May 14, the last day of the discount period. Prepare the journal entry Sauk makes to record its May 14 payment.

Cash 3,430

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Accounts payable 3,500June 3


Cash 3,500


Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of €3,500 on June 3, the journal entry would be:

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Should discounts be taken when offered?

Purchase Discounts


Example: 2% for 20 days = Annual rate of 36.5% (365/20 = 18.25 twenty-day periods x 2% = 36.5%)

Passing up the discount offered equates to paying an interest rate of 2% on the use of $3,500 for 20 days.


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M erchandise InventoryDebit Credit

€3,800 8th - Return

€300

Balance

4th - Purchase

€3,5803,580

70 14th - Discount


Summary of Purchasing Transactions

1506th – Freight-in

IllustrationIllustration


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Made for cash or credit (on account).Normally recorded when earned, usually when goods transfer from seller to buyer.Sales invoice should support each credit sale.

Recording Sales of MerchandiseRecording Sales of Merchandise

SO 3 Explain the recording of sales revenues under SO 3 Explain the recording of sales revenues under a perpetual inventory system.a perpetual inventory system.

Illustration 5-5

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Two Journal Entries to Record a Sale

Cash or Accounts receivableXXXSales XXX



#1

Cost of goods sold XXXMerchandise inventory XXX

#2

Selling

Price

Cost

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Accounts receivable 3,800May 4Sales

3,800

Illustration: Assume PW Audio Supply records its May 4 sale of €3,800 to Sauk Stereo (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply €2,400.

Cost of goods sold 2,4004Merchandise inventory

2,400

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“Flipside” of purchase returns and allowances.Contra-revenue account (debit).Sales not reduced (debited) because: would obscure importance of sales

returns and allowances as a percentage of sales.

could distort comparisons between total sales in different accounting periods.

Sales Returns and Allowances



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Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a €300 selling price (assume a €140 cost). Assume the goods were not defective.



Sales returns and allowances 300May 8Accounts receivable

300Merchandise inventory 1408

Cost of goods sold140

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Illustration: Assume the returned goods were defective and had a scrap value of €50, PW Audio would make the following entries:



Sales returns and allowances 300May 8Accounts receivable

300Merchandise inventory 508

Cost of goods sold50

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The cost of goods sold is determined and recorded each time a sale occurs in: a. periodic inventory system only. b. a perpetual inventory system only. c. both a periodic and perpetual

inventory system. d. neither a periodic nor perpetual

inventory system.

Review QuestionReview Question


SO 3 Explain the recording of sales revenues under SO 3 Explain the recording of sales revenues under a perpetual inventory system.a perpetual inventory system.Answer on notes page

The cost of goods sold is determined and recorded each time a sale occurs in: a. periodic inventory system only. b. a perpetual inventory system only. c. both a periodic and perpetual

inventory system. d. neither a periodic nor perpetual

inventory system.

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Answers on notes page

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Offered to customers to promote prompt payment.“Flipside” of purchase discount.Contra-revenue account (debit).

Sales Discount



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Cash 3,430May 14

Accounts receivable3,500

Sales discounts 70

* [(€3,800 – €300) X 2%]

*

Illustration: Assume Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less purchase returns and allowances of €300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.

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Generally the same as a service company.

One additional adjustment to make the records agree with the actual inventory on hand.Involves adjusting Merchandise Inventory and Cost of Goods Sold.

Adjusting Entries

Completing the Accounting CycleCompleting the Accounting Cycle

SO 4 Explain the steps in the accounting cycle for a merchandising company.SO 4 Explain the steps in the accounting cycle for a merchandising company.

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SO 4 Explain the steps in the accounting cycle for a merchandising company.SO 4 Explain the steps in the accounting cycle for a merchandising company.

Illustration: Suppose that PW Audio Supply has an unadjusted balance of €40,500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is €40,000. The company would make an adjusting entry as follows.

Cost of goods sold 500Merchandise inventory

500

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Closing Entries

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Primary source for evaluating a company’s performance.

Format designed to differentiate between the various sources of income and expense.

Income Statement

Forms of Financial StatementsForms of Financial Statements

SO 5 Prepare an income statement for a merchandiser.SO 5 Prepare an income statement for a merchandiser.

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Illustration 5-13

Income Statement Presentation of Sales


SO 5 Prepare an income statement for a merchandiser.SO 5 Prepare an income statement for a merchandiser.

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SO 6 Explain the computation and importance of gross profit.SO 6 Explain the computation and importance of gross profit.

Illustration 5-13

Illustration 5-10

Gross Profit


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SO 5 Distinguish between a multiple-step and a single-step income statement.SO 5 Distinguish between a multiple-step and a single-step income statement.

Illustration 5-13

Operating Expenses

IFRS allows presentation by nature and presentation by function.

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Other Other Income and Income and ExpenseExpense

SO 5SO 5Illustration

5-13

Various revenues and gains and expenses andlosses that are unrelated to the company’s main line of operations.

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Interest Interest ExpenseExpense

SO 5SO 5Illustration

5-13

Interest expense, if material, must be disclosed on the face of the income statement.

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SO 6 Explain the computation and importance of gross profit.SO 6 Explain the computation and importance of gross profit.

Comprehensive IncomeComprehensive Income


Includes certain adjustments to pension plan assets, gains and losses on foreign currency translation, and unrealized gains and losses on certain types of investments.

Reported in a combined statement of net income and comprehensive income, or in a separate schedule that reports only comprehensive income.

Illustration 5-14

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The multiple-step income statement for a merchandiser shows each of the following features except: a. gross profit. b. cost of goods sold. c. a sales revenue section.d. investing activities section.

Review QuestionReview Question



The multiple-step income statement for a merchandiser shows each of the following features except: a. gross profit. b. cost of goods sold. c. a sales revenue section.d. investing activities section.

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Illustration 5-15

Classified Statement of Financial Position


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Indicate in which financial statement (IncomeStatement, IS; Statement of Financial Position, SFP;



or Retained Earnings Statement, RES) and under what classification each of the following would be reported.Accounts Payable SFP Current liabilitiesAccounts Receivable SFP Current assetsAccumulated Depreciation SFP Property, plant, and equipmentAdvertising Expense IS Operating expensesDepreciation Expense IS Operating expensesDividends RES Deduction sectionCash SFP Current assets

Accounts Payable Accounts Receivable Accumulated DepreciationAdvertising Expense Depreciation Expense Dividends Cash

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or Retained Earnings Statement, RES) and under what classification each of the following would be reported.Freight-out IS Operating expensesGain on Sale of Equipment IS Other income and expenseInsurance Expense IS Operating expensesInterest Expense IS Interest expenseInterest Payable SFP Current liabilitiesLand SFP Property, plant, and equipmentMerchandise Inventory SFP Current assets

Freight-out Gain on Sale of Equipment Insurance Expense Interest Expense Interest Payable Land Merchandise Inventory

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or Retained Earnings Statement, RES) and under what classification each of the following would be reported.Notes Payable SFP Non-current liabilitiesOffice Building SFP Property, plant, and equipmentProperty Tax Payable SFP Current liabilitiesSalaries Expense IS Operating expensesSalaries Payable SFP Current liabilitiesSales Returns and Allowances IS Sales revenuesShare Capital—Ordinary SFP Equity

Notes Payable Office Building Property Tax Payable Salaries Expense Salaries Payable Sales Returns and AllowancesShare Capital—Ordinary

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or Retained Earnings Statement, RES) and under what classification each of the following would be reported.Store Equipment SFP Property, plant, and equipmentSales Revenue IS Sales revenuesUtilities Expense IS Operating expenses

Store Equipment Sales Revenue Utilities Expense

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Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic system.

Inventories are defined in IAS 2 as held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services. The definition under GAAP is essentially the same.

Accounting for Merchandising Operations

Understanding U.S. GAAPUnderstanding U.S. GAAP

Key Key DifferencesDifferences

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As noted in the chapter, under IFRS companies must classify expenses by either nature or by function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional expense method on the income statement, disclosure by nature is required in the notes to the financial statements. In contrast, under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions such as administration, distribution, and manufacturing.




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Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach although the approach used is similar to that referred to as a multiple-step statement under GAAP.

IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.




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Looking to the Looking to the FutureFuture


The IASB and FASB are working on a project that would rework the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. Finally, this approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature.


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Periodic SystemSeparate accounts used to record purchases, freight costs, returns, and discounts.Company does not maintain a running account of changes in inventory.Ending inventory determined by physical count.

SO 7 Explain the recording of purchases and sales of SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.inventory under a periodic inventory system.

Periodic Inventory SystemPeriodic Inventory System

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Calculation of Cost of Goods Sold Illustration

5A-1


Periodic Inventory SystemPeriodic Inventory System

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Illustration:Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the €3,800 purchase as follows.

Purchases 3,800May 4Accounts payable

3,800

Recording Purchases under Periodic SystemRecording Purchases under Periodic System

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Illustration:Illustration: If Sauk pays Acme Freight Company €150for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is:

Freight-in (Transportation-in) 150May 6Cash

150

Freight CostsFreight Costs


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Illustration:Illustration: Sauk Stereo returns €300 of goods to PW Audio Supply and prepares the following entry to recognize the return.

Accounts payable 300May 8Purchase returns and allowances

300

Purchase Returns and Purchase Returns and AllowancesAllowances


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Illustration:Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. SaukStereo records the payment and discount as follows. Accounts payable 3,500May 14

Purchase discounts 70

Purchase DiscountsPurchase Discounts

Cash 3,430


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No entry is recorded for cost of goods sold at the time of the sale under a periodic system.


Illustration:Illustration: PW Audio Supply, records the sale of €3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows.

Accounts receivable 3,800May 4Sales

3,800

Recording Sales under Periodic SystemRecording Sales under Periodic System

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Illustration:Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the €300 sales return as follows.

Sales returns and allowances300May 4Accounts receivable

300

Sales Returns and AllowancesSales Returns and Allowances


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Illustration:Illustration: On May 14, PW Audio Supply receives payment of €3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows.

Sales DiscountsSales Discounts

Cash 3,430May 14

Accounts receivable3,500

Sales discounts 70


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Illustration 5A-2

Comparison of Entries-Perpetual vs. Periodic Comparison of Entries-Perpetual vs. Periodic

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Illustration 5A-2

Comparison of Entries-Perpetual vs. Periodic Comparison of Entries-Perpetual vs. Periodic

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Illustration 5B-1

SO 8SO 8

Worksheet for a Merchandising Company Worksheet for a Merchandising Company

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