ANSWERS TO QUESTIONS FOR GROUP LEARNING

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1 Accounting for a 5 Merchandising Business ANSWERS TO QUESTIONS FOR GROUP LEARNING Q5-1 A merchandising business has a major revenue reduction called cost of goods sold. The computation of cost of goods sold results in an income statement that contains information not found on an income statement for a service business. Q5-2 No, the authors do not agree. Cost of goods sold is made up of several items over which management can exercise control. Some examples are: Losses in inventory from spoilage, theft, or simply misplacing items cause an increase in cost of goods sold. Management can strengthen internal control over inventories to reduce these losses. Cost of purchases increases the cost of goods sold. If management can cause merchandise items to be purchased at lower costs (quantity discounts, seasonal purchases, or requiring competitive bidding by suppliers), the cost of goods sold will be reduced. Transportation In is also a cost of goods sold. Careful planning of purchases to place orders in time to avoid higher-cost fast delivery will reduce cost of goods sold. Cash discounts reduce the cost of goods sold. Careful planning (possibly combined with the use of the net price method of recording purchases) should allow a company to take advantage of cash discounts offered. Q5-3 Sales discounts are an incentive to customers to pay their bills earlier than the normal 30 days allowed. If customers pay earlier, there is a reduced chance of loss by some customers later inability to pay. Yes, management really wants customers to take advantage of sales discounts; a collected account will not become a bad debt loss. Q5-4 A cash discount is the granting of a deduction from the selling price for payment within a limited period of time based on specific agreements between buyer and seller. A trade discount is a percentage reduction from a list price. Unlike a cash discount, it is not related to the time of payment. 5-1

2 Q5-5 Under the periodic inventory system, the cost of goods sold and the ending inventory balance are determined at the end of each accounting period. Under the perpetual inventory system, the cost of goods sold and inventory balance on hand are determined as each sale is recorded. As a result, a continuous record of cost of goods sold and inventory on hand is produced under a perpetual inventory system. Q5-6 Under the periodic inventory system, cost of goods sold is computed by subtracting the ending inventory valuation from total goods available for sale. Since goods lost by shoplifting are not in the ending inventory, the computation leads to the assumption that they have been sold. Thus, shoplifting increases cost of goods sold. Q5-7 Management needs to know the amount of cost of goods sold; debits to the Purchases account should reflect only items that affect that figure. If purchases of supplies, postage stamps, and other items to be used in operations were debited to Purchases, the cost of goods sold would be incorrectly inflated. Also, information needed to control specific expenses would be buried in the Purchases account. Q5-8 Measures of efficiency and effectiveness of the purchasing function and the payments function are reflected in these contra accounts. Managerial control is strengthened when management has accumulated information about purchases discounts and purchases returns and allowances. Q5-9 When a company in Pittsburgh sells to a company in Williamsport F.O.B. destination, the title to the goods transfers when the goods arrive at the buyer in Williamsport. The F.O.B. terms determine ownership. F 0.8. destination indicates that title transfers at the destination. F 0.8. shipping point indicates that title transfers when the seller turns the goods over to a common carrier at the shipping point. Unless otherwise stated, freight costs are the responsibility of the owner during shipment. In this case, the seller is the owner and is therefore responsible for paying the transportation costs. Q5-10 Under a periodic inventory system, the beginning inventory figure appears in the end-of-period unadjusted trial balance because no journal entries have been made to the inventory account during the accounting period. Q5-11 Sales Discounts, Purchases, Transportation In, Sales Returns and Allowances, and Merchandise inventory have debit balances. Sales, Purchases Discounts, and Purchases Returns and Allowances have credit balances. Q5-12 Selling expenses are directly related to the sales function. Such items as sales salaries, advertising expenses, or delivery expenses can be considered as direct expenses of making sales. General and administrative expenses are those that would be found in a business whether or not sales are made. Such items as office 5-2

3 supplies expense, salaries of accounting employees, or property tax expense are examples. They also support the sales function, but not solely and directly. Operating expenses are those incurred in the primary revenue-producing activities of the business. Expenses such as financing costs (interest expense) or losses on disposal of assets are not incurred in the primary revenue-producing efforts and are classified as other expenses. Q5-13 All elements that make up the cost of goods sold are found in the Income Statement columns of the work sheet. Q5-14 The multiple-step income statement provides detailed information and subtotals for each of its major sections:- sales revenue, cost of goods sold, selling expenses, general and administrative expenses, and other revenues and expenses. Under the single-step form, the total expenses are deducted from the total revenues in one step. Q5-15 It may give a feeling of false security if management sees a balance accumulating in the Purchases Discounts account. Although this is an indication that some discounts are being taken, it does not show how many. More important to management is knowledge of lost discount opportunities. The -net price method of recording discounts allows practice of management by exception; a balance in the Purchases Discounts Lost account is an indication that something is wrong. 5-3

4 SOLUTIONS TO EXERCISES E5-16 Journalizing Sales Transactions LG 2 GENERAL JOURNAL Feb. 4 Accounts Receivable 1,470 Sales 1,400 Sales Tax Payable 70 Sold merchandise on account to South Company. 7 Accounts Receivable 2,000 Sales 2,000 Sold merchandise on account to Crankfast Company. 9 Sales Returns and Allowances 600 Accounts Receivable 600 Unsatisfactory merchandise was returned by Crankfast Company. 15 Cash 1,372 Sales Discounts 28 Accounts Receivable 1,400 Received payment from Crankfast Company less 2% discount. 22 Cash 1,470 Accounts Receivable 1,470 Received payment from South Company. 5-4

5 E5-17 Journalizing Purchases Transactions LG4 GENERAL JOURNAL Apr. 5 Purchases 2,000 Accounts Payable 2,000 Purchased merchandise on account from Plains Company, F.O.B shipping point, 2/10, n/30. 7 Purchases 1,000 Accounts Payable 1,000 Purchased merchandise on account from Growers, Inc., F.O.B. destination, 1/10, n/30. 9 Transportation In 100 Cash 100 Paid freight on purchase from Plains Company. 10 Accounts Payable 200 Purchases Returns and Allowances 200 Returned spoiled goods to Growers, Inc. 14 Accounts Payable 2,000 Purchases Discounts 40 Cash 1,960 Paid for merchandise purchased from Plains Company less 2 % discount. 25 Accounts Payable 800 Cash 800 Paid for merchandise purchased from Growers, Inc. 5-5

6 E5-18 Trade Discounts LG2 GENERAL JOURNAL Apr. 8 Accounts Receivable 14,400 Sales 14,400* Sold merchandise to Texas Supply. *Invoice price = $20,000 x 0.80 x 0.90 = $14, Cash 14,256 Sales Discounts 144 Accounts Receivable 14,400 Received payment from Texas Supply less 1 % discount. E5-19 Sales Discounts: Partial Payment LG2 GENERAL JOURNAL Jun.10 Accounts Receivable 22,000 Sales 22,000 Sold merchandise to Jean Stubs, 2/10, n/30 20 Cash 14,700 Sales Discounts 300 Accounts Receivable 15,000* Received partial payment from Jean Stubs less 2 % discount. *Let X = Accounts Receivable credit. Then: X -.02X = $14, X = $14,700 X = $14, = $15,000 Jul. 8 Cash 7,000 Accounts Receivable 7,000 Received balance from Jean Stubs. 5-6

7 E5-20 Computation of Net Sales, Net Purchases, Cost of Goods Sold, and Gross LG 2, 4 Margin on Sales THOMAS COMPANY Partial income Statement For the Month Ended January 31, Gross sales revenue $ 18,000 Deduct: Sales returns and allowances $ 200 Sales discounts Net sales revenue $ 17,700 (a) Cost of goods sold: Merchandise inventory, January 1 $ 1,900 Purchases $ 5,600 Transportation in 400 Gross delivered cost of purchases $ 6,000 Deduct: Purchases returns and allowances $ 400 Purchases discounts Net cost of purchases 5,300 (b) Cost of goods available for sale $ 7,200 Deduct: Merchandise inventory, January 31 2,000 Cost of goods sold 5,200 (c) Gross margin on sales $ 12,500 (d) 5-7

8 E5-21 Calculation of Gross Sales LG 4, 5 ROSMAN COMPANY Income Statement For the (period) Ended (date) Gross sales revenue $ 50,500 (c) Cost of goods sold: Merchandise inventory, beginning $ 6,000 Net cost of purchases 31,000 Cost of goods available for sale $ 37,000 Merchandise inventory, ending 5,000 Cost of goods sold 32,000 Gross margin on sales $ 18,500 (b) Total operating expenses 15,000 Net operating margin $ 3,500 (a) Other revenues 500 Net income $ 4,000 Computations: a. Net operating margin = $4,000! $500 = $3,500. b. Gross margin on sales = $3,500 + $15,000 = $18,500. c. Gross sales revenue = $18,300 + $32,000 = $50,

9 E5-22 Inventories in the Work Sheet (Instructor to choose approach) LG 7, A1 1. Inventory treated as closing entries: Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash Accounts Receivable Merchandise Inventory 5,000 12,000 20,000 5,000 12,000 20,000 20,000 17,000 5,000 12,000 17, Inventory treated as adjusting entries: Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Title Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash Accounts Receivable Merchandise Inventory 5,000 12,000 20,000 (b) 17,000 (a) 20,000 5,000 12,000 17,000 5,000 12,000 17,000 Income Summary (a) 20,000 (b) 17,000 20,000 17,000 20,000 17,

10 E5-23 Determination of Missing Income Statement Amounts LG5 Kona Company Gross delivered cost of purchases = Purchases + Transportation in = $32,000. Net cost of purchases = Gross delivered cost of purchases! Purchases returns and allowances! Purchases discounts = $29,000. Cost of goods available for sale = Net cost of purchases + Merchandise inventory, beginning = $33,000. Cost of goods sold = Cost of goods available for sale! Merchandise inventory, ending = $30,000. Gross margin on sales = Sales! Cost of goods sold = $20,000. Total operating expenses = Gross margin on sales! Net operating margin = $11,000. Net income before income taxes = Net operating margin + Other revenue! Other expenses = $7,000. Oahu Company Purchases = Gross delivered cost of purchases! Transportation in = $27,000. Net cost of purchases = Cost of goods available for sale! Merchandise inventory, beginning = $28,000. Purchases discounts = Gross delivered cost of purchases! Net cost of purchases! Purchases returns and allowances = $1,500. Cost of goods sold = Cost of goods available for sale! Merchandise inventory, ending = $30,000. Sales = Gross margin on sales + Cost of goods sold = $55,000. Total operating expenses = Gross margin on sales! Net operating margin = $8,000. Other revenue = Net income before income taxes! Net operating margin + Other expenses = $2,

11 E5-23 (continued) Hilo Company Cost of goods available for sale = Cost of goods sold + Merchandise inventory, ending = $47,000. Merchandise inventory, beginning = Cost of goods available for sale! Net cost of purchases = $8,000. Gross delivered cost of purchases = Net cost of purchases + Purchases returns and allowances + Purchases discounts = $45,000. Transportation in = Gross delivered cost of purchases! Purchases = $5,000. Net operating margin = Net income before income taxes + Other expenses! Other revenues = $14,000. Gross margin on sales = Net operating margin + Total operating expenses = $29,000. Sales = Gross margin on sales + Cost of goods sold = $70,

12 E5-24 Multiple-step Income Statement LG5 PARIS COMPANY Income Statement For the Year Ended December 31, Gross sales revenue $ 60,000 Deduct: Sales returns and allowances $ 700 Sales discounts 1,300 2,000 Net sales revenue $ 58,000 Cost of goods sold: Merchandise inventory, January 1 $ 4,000 Purchases $ 20,000 Transportation in 1,000 Gross delivered cost of purchases $ 21,000 Deduct: Purchases returns and allowances $ 1,400 Purchases discounts 1,600 3,000 Net cost of purchases 18,000 Cost of goods available for sale $ 22,000 Deduct: Merchandise inventory, December 31 3,000 Cost of goods sold 19,000 Gross margin on sales $ 39,000 Operating expenses: Selling expenses $ 15,000 General and administrative expenses 10,000 Total operating expenses 25,000 Net operating margin $ 14,000 Other revenues $ 800 Other expenses 1,000 (200) Net income before income taxes $ 13,800 Income tax expense 4,000 Net income $ 9,

13 E5-25 Closing Entries LG7 GENERAL JOURNAL Closing Entries Dec. 31 Merchandise Inventory 3,000 Sales 60,000 Other Revenues 800 Purchases Returns and Allowances 1,400 Purchases Discounts 1,600 Income Summary 66,800 To enter the ending inventory and close revenue accounts and credit balance merchandise accounts. 31 Income Summary 57,000 Merchandise Inventory 4,000 Sales Returns and Allowances 700 Sales Discounts 1,300 Purchases 20,000 Transportation In 1,000 Selling Expenses 15,000 General and Administrative Expenses 10,000 Other Expenses 1,000 Income Tax Expense 4,000 To close beginning inventory, expense accounts, and debit balance merchandise accounts. 31 Income Summary 9,800 Retained Earnings 9,800 To transfer net income to retained earnings. 5-13

14 E5-25 (continued) Instructor Note: If inventory was treated as adjusting entries, the adjusting entries for inventory and the closing entries would be as follows: Dec. 31 GENERAL JOURNAL Adjusting Entries Dec. 31 lncome Summary 4,000 Merchandise Inventory 4,000 To transfer the beginning inventory balance to income summary. 31 Merchandise Inventory 3,000 Income Summary 3,000 To establish the ending inventory balance in merchandise inventory. Closing Entries Dec. 31 Sales 60,000 Other Revenues 800 Purchases Returns and Allowances 1,400 Purchases Discounts 1,600 Income Summary 63,800 To close revenue accounts and credit balance merchandise accounts. 31 Income Summary 53,000 Sales Returns and Allowances 700 Sales Discounts 1,300 Purchases 20,000 Transportation In 1,000 Selling Expenses 15,000 General and Administrative Expenses 10,000 Other Expenses 1,000 Income Tax Expense 4,000 To close expense accounts and debit balance merchandise accounts. 5-14

15 E5-25 (continued) Dec. 31 Income Summary 9,800 Retained Earnings 9,800 To transfer net income to retained earnings. E5-26 Recordkeeping of Purchases: Net Price Method LG 8 1. GENERAL JOURNAL Jun. 5 Purchases 8,820 Accounts Payable 8,820 Purchased $9,000 of merchandise, terms 2/10, n/30. Jul. 1 Accounts Payable 8,820 Purchases Discounts Lost 180 Cash 9,000 Payment of account. 2. No, the net cost of purchases is lower under the net price method, as follows: Net Gross Price Method Price Method Purchases account $ 8,820 $ 9,000 Purchases discount 0 0 Net cost of purchases $ 8,820 $ 9,000 As can be seen from the above, the net cost of purchases would be the same under both methods only if all cash discounts are taken. The Purchases Discounts Lost account is disclosed in the income statement under other expenses. Net income would be the same. 3. Some advantages of the gross price method are: a. Amount of discounts taken is collected in a separate account. b. Statements from creditors agree with accounts payable amounts in the accounts payable subsidiary ledger. c. There is a saving in clerical costs. d. No end-of-period adjusting entry is required to record lapsed discounts. However, Linda Company desires to take advantage of a/i purchases discounts. Assuming these discounts to be significant, the ability to monitor this practice with the net price method probably outweighs the advantages of the gross price method for Linda Company. 5-15

16 E5-27 Analyzing the Home Depot LG 9 1. Net sales have increased significantly from $58,247,000,000 in 2002 to $73,094,000,000 in The percent increase in net sales is: 25.5% ' 100 $14,847,000,000( $58,247,000,000 *$73,094,000,000! $58,247,000, Home Depot was able to reduce cost of goods sold as a percent of net sales from 68.9% in 2002 to 66.6% in The result is a gross profit margin of 33.4% in 2004 the highest for the three years. This is favorable. The increase in the gross margin percent could have been caused by a combination of (1) increased sales prices, (2) reduced cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the increase in the gross margin percent. 4. Operating expenses increased as a percent of net sales increased from 21.1% in 2002 to 22.6% in This trend is unfavorable. 5. Other expenses and revenues have remained relatively insignificant over the three-year period. 5-16

17 SOLUTIONS TO PROBLEMS P5-28 Use of Merchandising Accounts LG 2, 4 GENERAL JOURNAL Page 24 Feb. 4 Purchases 3,600 Accounts Payable 3,600 Purchase at n/30, F.O.B. shipping point from Mankato Company. 6 Transportation In 150 Cash 150 Freight cost of February 4 purchase. 6 Accounts Payable 1,000 Purchases Returns and Allowances 1,000 Returned incorrect model to Mankato Company. 8 Accounts Receivable 2,000 Sales 2,000 Sale at 2/10, n/30, F.O.B. shipping point to Susan Sexton. 18 Cash 1,960 Sales Discounts 40 Accounts Receivable 2,000 Collection with discount taken from Susan Sexton. 5-17

18 P5-28 (continued) Feb. 19 Accounts Receivable 1,500 Sales 1,500 Sale at 2/10, n/30, F.O.B. destination to Dale Karn. 19 Transportation Out Expense 200 Cash 200 Delivery of merchandise sold F.O.B. destination. 20 Sales Returns and Allowances 100 Accounts Receivable 100 Credit for defective item from Dale Karn. 28 Cash 1,372 Sales Discounts 28 Accounts Receivable 1,400 Collection with discount taken from Dale Karn. Mar. 5 Accounts Payable 2,600 Cash 2,600 Payment in full to Mankato Company. 5-18

19 P5-29 Partial Income Statement LG 4 MO COMPANY Partial Income Statement For the Year Ended September 30, Gross sales revenue $ 700,000 Deduct; Sales discounts 5,000 Net safes revenue $ 695,000 Cost of goods sold: Merchandise inventory, October 1, 2006 $ 27,000 Purchases $ 360,000 Transportation in 8,000 Gross delivered cost of purchases $ 368,000 Deduct: Purchases returns and allowances $ 7,000 Purchases discounts 3,000 10,000 Net cost of purchases 358,000 Cost of goods available for sale $ 385,000 Deduct: Merchandise inventory, September 30, 30,000 Cost of goods sold 355,000 Gross margin on sales $ 340,

20 P5-30 lncome Statement and Closing Entries LG 5, 7 Requirement 1. RUSS CROW COMPANY Income Statement For the Year Ended December 31, Gross sales revenue $ 670,000 Deduct: Sales returns and allowances $ 4,000 Sales discounts 11,000 15,000 Net sales revenue $ 655,000 Cost of goods sold: Merchandise inventory, January 1, $ 27,000 Purchases $ 410,000 Transportation in 8,000 Gross delivered cost of purchases $ 418,000 Deduct: Purchases returns and allowances $ 6,000 Purchases discounts 5,000 11,000 Net cost of purchases 407,000 Cost of goods available for sale $ 434,000 Deduct: Merchandise inventory, December 31, 24,000 Cost of goods sold 410,000 Gross margin on sales $ 245,000 Operating expenses: Selling expenses: Sales salaries expense $ 166,000 Advertising expense 12,000 Transportation out expense 4,000 Total selling expenses $ 182,000 General and administrative expenses: Administrative salaries expense $ 32,000 Office supplies expense 5,000 Depreciation expense office equipment 2,000 Total general and administrative expense 39,000 Total operating expenses 221,000 Net operating margin $ 24,000 Other expenses: Interest expense $ 8,500 Other revenues: Interest revenue 1,500 7,000 Net income before income taxes $ 17,000 Income tax expense 5,000 Net income $ 12,

21 P5-30 (continued) Requirement 2 (closing approach). GENERAL JOURNAL Page 1 Dec. 31 Merchandise Inventory 24,000 Sales 670,000 Purchases Returns and Allowances 6,000 Purchases Discounts 5,000 Interest Revenue 1,500 Income Summary 706,500 To record the ending inventory and to close the revenue and credit balance merchandise accounts. 31 Income Summary 694,500 Merchandise Inventory 27,000 Sales Returns and Allowances 4,000 Sales Discounts 11,000 Purchases 410,000 Transportation In 8,000 Sales Salaries Expense 166,000 Advertising Expense 12,000 Transportation Out Expense 4,000 Administrative Salaries Expense 32,000 Office Supplies Expense 5,000 Depreciation Expense Office Equipment 2,000 Interest Expense 8,500 Income Tax Expense 5,000 To close the beginning inventory, the expenses, and the debit balance merchandise accounts. 31 Income Summary 12,000 Retained Earnings 12,000 To transfer net income to retained earnings. 5-21

22 P5-30 (continued) Requirement 2 (adjusting approach) GENERAL JOURNAL Page 1 Adjusting Entries Dec. 31 Merchandise Inventory 24,000 Income Summary 24,000 To record the ending inventory. 31 Income Summary 27,000 Merchandise Inventory 27,000 To remove the beginning inventory. Closing Entries Dec. 31 Sales 670,000 Purchases Returns and Allowances 6,000 Purchases Discounts 5,000 Interest Revenue 1,500 Income Summary 682,500 To close the revenue and credit balance merchandise accounts. 31 Income Summary 667,500 Sales Returns and Allowances 4,000 Sales Discounts 11,000 Purchases 410,000 Transportation In 8,000 Sales Salaries Expense 166,000 Advertising Expense 12,000 Transportation Out Expense 4,000 Administrative Salaries Expense 32,000 Office Supplies Expense 5,000 Depreciation Expense Office Equipment 2,000 Interest Expense 8,500 Income Tax Expense 5,000 To close the expenses and the debit balance merchandise accounts. 5-22

23 P5-30 Requirement 2 (adjusting approach) (continued) Dec. 31 Income Summary 12,000 Retained Earnings 12,000 To transfer net income to retained earnings. P5-31 Journalizing Transactions for a Retail Store LG 2-5 Requirement 1. GENERAL JOURNAL Page 1 Jan. 6 Purchases 501 3,600 Accounts Payable 201 3,600 To record purchase from Columbia Supply, 1/10, n/30, F.O.B. destination. List price $5,000, trade discount: 20%, 10%. 7 Purchases 501 3,000 Accounts Payable 201 3,000 To record purchase from Warner Entertainment, 2/10, n/30, F.O.B. shipping point. 9 Advertising Expense Cash To record payment for advertising. 5-23

24 P5-31 Requirement 1 (continued) Jan. 10 Accounts Payable Purchases Returns and Allowances To record return of $600 list price of merchandise to Columbia Supply. 12 Transportation In Cash To record freight charges on purchase from Warner Entertainment. 15 Cash 101 5,200 Sales 401 5,200 To record cash sales for first half of month. 15 Accounts Receivable 111 2,000 Sales 401 2,000 To record sales on account for first half of month. 17 Accounts Payable 201 3,000 Purchases Discounts Cash 101 2,940 To record payment to Warner Entertainment less discount. 18 Sales Returns and Allowances Accounts Receivable To record return of merchandise. 20 Delivery Expense Cash To record payment of delivery expense. 5-24

25 P5-31 Requirement 1 (continued) Jan. 24 Cash 101 1,372 Sales Discounts Accounts Receivable 111 1,400 To record collection from customers less discount. 27 Utilities Expense Accounts Payable To record receipt of utilities bill. 28 Sales Wages Expense Office Wages Expense Cash To record payment of wages for the month. 30 Cash 101 5,000 Sales 401 5,000 To record cash sales for the second half of the month. 30 Accounts Receivable 111 1,000 Sales 401 1,000 To record sales on account for the second half of the month. 31 Income Tax Expense Income Taxes Payable To record estimated income taxes. 5-25

26 P5-31 (continued) Requirement 2. GENERAL LEDGER Cash Acct. No. 117 Balance Date Explanation PR Debit Credit Debit Credit Jan Balance J1 J1 J1 J1 J1 J1 J1 J1 5,200 1,372 5, , ,000 4,800 4,700 9,900 6,960 6,760 8,132 7,532 12,532 Accounts Receivable Acct. No. 111 Balance Date Explanation PR Debit Credit Debit Credit Jan J1 J1 J1 J1 2,000 1, ,400 2,000 1, ,

27 P5-31 Requirement 2 (continued) Accounts Payable Acct. No. 201 Balance Date Explanation PR Debit Credit Debit Credit Jan J1 J1 J1 J1 J ,000 3,600 3, ,600 6,600 6,168 3,168 3,468 Income Taxes Payable Acct. No. 215 Balance Date Explanation PR Debit Credit Debit Credit Jan. 31 J Sales Acct. No. 401 Balance Date Explanation PR Debit Credit Debit Credit Jan J1 J1 J1 J1 5,200 2,000 5,000 1,000 5,200 7,200 12,200 13,200 Sales Returns and Allowances Acct. No. 402 Balance Date Explanation PR Debit Credit Debit Credit Jan. 18 Balance J

28 P5-31 Requirement 2 (continued) Sales Discounts Acct. No. 403 Balance Date Explanation PR Debit Credit Debit Credit Jan. 24 J Purchases Acct. No. 501 Balance Date Explanation PR Debit Credit Debit Credit Jan. 6 7 J1 J1 3,600 3,000 3,600 6,600 Transportation In Acct. No. 502 Balance Date Explanation PR Debit Credit Debit Credit Jan. 9 J Purchases Returns and Allowances Acct. No. 503 Balance Date Explanation PR Debit Credit Debit Credit Jan. 10 J Purchases Discounts Acct. No. 504 Balance Date Explanation PR Debit Credit Debit Credit Jan. 17 J

29 P5-31 Requirement 2 (continued) Sales Wages Expense Acct. No. 602 Balance Date Explanation PR Debit Credit Debit Credit Jan. 28 J Advertising Expense Acct. No. 616 Balance Date Explanation PR Debit Credit Debit Credit Jan. 9 J Delivery Expense Acct. No. 621 Balance Date Explanation PR Debit Credit Debit Credit Jan. 20 J Utilities Expense Acct. No. 625 Balance Date Explanation PR Debit Credit Debit Credit Jan. 27 J Office Wages Expense Acct. No. 703 Balance Date Explanation PR Debit Credit Debit Credit Jan. 28 J

30 P5-31 Requirement 2 (continued) Income Tax Expense Acct. No. 901 Balance Date Explanation PR Debit Credit Debit Credit Jan. 31 J

31 P5-31 Requirement 2 (continued) POP MUSIC COMPANY Income Statement For the Month Ended January 31, Gross sales revenue $ 13,200 Deduct: Sales returns and allowances $ 100 Sales discounts Net sales revenue $ 13,072 Cost of goods sold: Merchandise inventory, January 1, $ 4,000 Purchases $6,600 Transportation in 100 Gross delivered cost of purchases $6,700 Deduct: Purchases returns and allowances $432 Purchases discounts Net cost of purchases 6,208 Cost of goods available for sale $10,208 Deduct: Merchandise inventory, January 31, 3,000 Cost of goods sold 7,208 Gross margin on sales $ 5,864 Operating expenses: Selling expenses: Sales wages expense $ 400 Advertising expense 200 Delivery expense 200 Utilities expense 300 Total selling expenses $ 1,100 General and administrative expense: Office wages expense 200 Total operating expenses 1,300 Net income before income taxes 4,564 Income tax expense 600 Net Income $ 3,

32 P5-32 Completion of Work sheet, Preparation of Statements, Adjusting and Closing Entries LG 2, 4-7 Requirement 1. (Instructor note: Inventory treated as closing entries in this solution version.) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash Accts. Rec. Merch. Inv. Store Supp. Store Equip. Accum. Dep. S.E. Acct. Pay. Notes Pay. (2008) Unearned Rent Common Stock Retained Earnings Dividends Sales Sales Disc. Purchases Trans. In Purch. Disc. Sales Sal. Exp. Office Sal. Exp. Rent Exp. Util. Exp. Rent Revenue Totals 21,000 40,000 15,000 30, ,000 2,000 5, ,000 4,000 40,000 20,000 16,000 7, ,000 40,000 30,000 10,000 3,000 60,000 38, ,000 3,000 10, ,000 (e) 2,000 (d) 1,500 (d) 1,500 (a) 27,000 (b) 12,000 (e) 2,000 21,000 40,000 15,000 3, ,000 2,000 5, ,000 4,000 41,500 21,500 16,000 7,000 52,000 30,000 10,000 1,000 60,000 38, ,000 3,000 12,000 15,000 5, ,000 4,000 41,500 21,500 16,000 7,000 12, ,000 3,000 12,000 21,000 40,000 12,000 3, ,000 2,000 52,000 30,000 10,000 1,000 60,000 38,

33 P5-32 Requirement 1 (closing approach) (continued) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Store Sup. Exp. Dep. Exp. S.E. Int. Exp. Int. Pay. Sal. Pay. Income Tax Expense Income Taxes Payable Totals Net Income Totals (a) 27,000 (b) 12,000 (c) 1,000 (f) 10,000 55,000 (c) 1,000 (d) 3,000 (f) 10,000 55,000 27,000 12,000 1,000 10, ,000 1,000 3,000 10, ,000 27,000 12,000 1,000 10, ,000 23, , , , , ,000 1,000 3,000 10, ,000 23, ,

34 P5-32 (continued) LG 2, 4-7 Requirement 1. (Instructor note: Inventory treated as adjusting entries in this solution version.) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash Accts. Rec. Merch. Inv. Store Supp. Store Equip. Accum. Dep. S.E. Acct. Pay. Notes Pay. (2008) Unearned Rent Common Stock Retained Earnings Dividends Sales Sales Disc. Purchases Trans. In Purch. Disc. Sales Sal. Exp. Office Sal. Exp. Rent Exp. Util. Exp. Rent Revenue Totals 21,000 40,000 15,000 30, ,000 2,000 5, ,000 4,000 40,000 20,000 16,000 7, ,000 40,000 30,000 10,000 3,000 60,000 38, ,000 3,000 10, ,000 (a)12,000 (g) 2,000 (f) 1,500 (f) 1,500 (b) 15,000 (c) 27,000 (d) 12,000 (g) 2,000 21,000 40,000 12,000 3, ,000 2,000 5, ,000 4,000 41,500 21,500 16,000 7,000 52,000 30,000 10,000 1,000 60,000 38, ,000 3,000 12,000 5, ,000 4,000 41,500 21,500 16,000 7, ,000 3,000 12,000 21,000 40,000 12,000 3, ,000 2,000 52,000 30,000 10,000 1,000 60,000 38,

35 P5-32 Requirement 1 (adjusting approach) (continued) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Income Summ. Store Sup. Exp. Dep. Exp. S.E. Int. Exp. Int. Pay. Sal. Pay. Income Tax Expense Income Taxes Payable Totals Net Income Totals (b) 15,000 (c) 27,000 (d) 12,000 (e) 1,000 (h) 10,000 82,000 (a) 12,000 (e) 1,000 (f) 3,000 (h) 10,000 82,000 15,000 27,000 12,000 1,000 10, ,000 12,000 1,000 3,000 10, ,000 15,000 27,000 12,000 1,000 10, ,000 23, ,000 12, , , , ,000 1,000 3,000 10, ,000 23, ,

36 Requirement 2. MACROSOFT COMPANY Income Statement For the Year Ended December 31, Gross sales revenue $ 352,000 Deduct: Sales discounts 5,000 Net sales revenue $ 347,000 Cost of goods sold: Merchandise inventory, January 1, $ 15,000 Purchases $196,000 Transportation in 4,000 Gross delivered cost of purchases $200,000 Deduct: Purchases discounts 3,000 Net cost of purchases 197,000 Cost of goods available for sale $ 212,000 Merchandise inventory, December 31, 12,000 Cost of goods sold 200,000 Deduct: Gross margin on sales $ 147,000 Operating expenses: Selling expenses: Sales salaries expense $ 41,500 Store supplies expense 27,000 Depreciation expense store equipment 12,000 Total selling expense $ 80,500 General and administrative expense: Office salary expense $ 21,500 Rent expense 16,000 Utilities expense 7,000 Total general and administrative expense 44,500 Total operating expense 125,000 Net operating margin $ 22,000 Other revenue: Rental revenue $ 12,000 Other expense: Interest expense 1,000 11,000 Net income before income taxes $ 33,000 Income tax expense 10,000 Net income $ 23,

37 P5-32 Requirement 2 (continued) MACROSOFT COMPANY Statement of Owners Equity For the Year Ended December 31, Common stock, December 31, $ 60,000 Retained earnings, January 1, $ 38,000 Add: Net income 23,000 Deduct: Dividends (2,000) Retained earnings, December 31, 59,000 Total owners equity, December 31, $ 119,000 MACROSOFT COMPANY Balance Sheet December 31, Assets Current assets Cash $ 21,000 Accounts receivable 40,000 Merchandise inventory 12,000 Store supplies 3,000 Total current assets $ 76,000 Property, plant, and equipment Store equipment $150,000 Accumulated depreciation 52,000 Total property, plant, and equipment 98,000 Total assets $ 174,000 Liabilities Current liabilities Accounts payable $ 30,000 Notes payable 10,000 Unearned revenue 1,000 Salaries payable 3,000 Interest payable 1,000 Income taxes payable 10,000 Total current liabilities $ 55,000 Owners Equity Common stock $ 60,000 Retained earnings 59,000 Total owners equity 119,000 Total liabilities and owners equity $ 174,

38 P5-32 (continued) Requirement 3 (closing approach). GENERAL JOURNAL Page 1 Adjusting Entries Dec. 31 Store Supplies Expense 27,000 Store Supplies 27,000 To record store supplies used. 31 Depreciation Expense Store Equipment 12,000 Accumulated Depreciation 12,000 Store Equipment To record depreciation on store equipment. 31 Interest Expense 1,000 Interest Payable 1,000 To accrue interest on note payable. 31 Sales Salaries Expense 1,500 Office Salaries Expense 1,500 Salaries Payable 3,000 To accrue salaries expense. 31 Unearned Rent 2,000 Rent Revenue 2,000 To record net revenue earned. 31 Income Tax Expense 10,000 Income Taxes Payable 10,000 To record estimated income tax expense. Closing Entries Dec. 31 Merchandise Inventory 12,000 Sales 352,000 Purchases Discounts 3,000 Rent Revenue 12,000 Income Summary 379,000 To record the ending inventory and to close the revenue and credit balance merchandising accounts. 5-38

39 P5-32 Requirement 3 (closing approach) (continued) Dec. 31 Income Summary 356,000 Merchandise Inventory 15,000 Sales Discounts 5,000 Purchases 196,000 Transportation in 4,000 Sales Salaries Expense 41,500 Stores Supplies Expense 27,000 Depreciation Expense Store Equipment 12,000 Office Salaries Expense 21,500 Rent Expense 16,000 Utilities Expense 7,000 Interest Expense 1,000 Income Tax Expense 10,000 To close the beginning inventory, the expense, and debit balance merchandise accounts. 31 Income Summary 23,000 Retained Earnings 23,000 To transfer net income to retained earnings. 31 Retained Earnings 2,000 Dividends 2,000 To close dividends to retained earnings. Requirement 3 (adjusting approach). GENERAL JOURNAL Page 1 Adjusting Entries Dec. 31 Merchandise Inventory 12,000 Income Summary 12,000 To establish ending inventory. 31 Income Summary 15,000 Merchandise inventory 15,000 To remove beginning inventory. 5-39

40 P5-32 Requirement 3 (adjusting approach) (continued) Dec. 31 Store Supplies Expense 27,000 Store Supplies 27,000 To record store supplies used. 31 Depreciation Expense Store Equipment 12,000 Accumulated Depreciation Store Equipment 12,000 To record depreciation on store equipment. 31 Interest Expense 1,000 Interest Payable 1,000 To accrue interest on note payable. 31 Sales Salaries Expense 1,500 Office Salaries Expense 1,500 Salaries Payable 3,000 To accrue salaries expense. 31 Unearned Rent 2,000 Rent Revenue 2,000 To record rent earned. 31 Income Tax Expense 10,000 Income Taxes Payable 10,000 To record estimated income tax expense. Closing Entries Dec. 31 Sales 352,000 Purchases Discounts 3,000 Rent Revenue 12,000 Income Summary. 367,000 To close revenue and credit balance merchandising accounts. 5-40

41 P5-32 Requirement 3 (adjusting approach) (continued) Dec. 31 Income Summary 341,000 Sales Discounts 5,000 Purchases 196,000 Transportation In 4,000 Sales Salaries Expense 41,500 Stores Supplies Expense 27,000 Depreciation Expense Store Equipment 12,000 Office Salaries Expense 21,500 Rent Expense 16,000 Utilities Expense 7,000 Interest Expense 1,000 Income Tax Expense 10,000 To close expenses and debit balance merchandising accounts. 31 Income Summary 23,000 Retained earnings 23,000 To transfer net income to retained earnings. 31 Retained Earnings 2,000 Dividends 2,000 To close dividends to retained earnings. 5-41

42 P5-33 Recording Purchases Net of Discount LG 8 Requirement 1a. GENERAL JOURNAL Jul. 2 Purchases 1,000 Accounts Payable 1,000 Purchase at 2/10, n/30, F.O.B. Destination from Goss Company. 3 Purchases 600 Accounts Payable 600 Purchase at 2/10, n/30, F.O.B. Shipping point from Willi Company. 4 Transportation In 30 Cash 30 Freight charges on F.O.B. shipping point shipment. 5 Accounts Payable 50 Purchases Returns and Allowances 50 Return of defective merchandise to Willi Company. 11 Accounts Payable 1,000 Cash 980 Purchases Discounts 20 Payment of account to Goss Company. 31 Accounts Payable 550 Cash 550 Payment of account to Willi Company. 5-42

43 P5-33 (continued) FONZ COMPANY Partial Income Statement For the Month Ended July 31, Cost of goods sold: Merchandise inventory, July 1, $ 300 Purchases $1,600 Transportation in 30 Gross delivered cost of purchases $1,630 Deduct: Purchases returns and allowances $ 50 Purchases discounts Net cost of purchases 1,560 Cost of goods available for sale $1,860 Deduct: Merchandise inventory, July 31, 400 Cost of goods sold $1,460 Requirement 2a. GENERAL JOURNAL Jul. 2 Purchases 980 Accounts Payable 980 Purchase at 2/10, n/30, F.O.B. destination from Goss Company. 3 Purchases 588 Accounts Payable 588 Purchase at 2/10, n/30, F.O.B. shipping point from Willi Company. 4 Transportation In 30 Cash 30 Freight charges on F.O.B. shipping point shipment. 5 Accounts Payable 49 Purchases Returns and Allowances 49 Return of defective merchandise to Willi Company. 11 Accounts Payable 980 Cash 980 Payment of account to Goss Company. 5-43

44 P5-33 Requirement 2a (continued) Jul. 31 Accounts Payable 539 Purchases Discounts Lost 11 Cash 550 Payment of account to Willi Company. Requirement 2b. FONZ COMPANY Partial Income Statement For the Month Ended July 31, Cost of goods sold: Merchandise inventory, July 1, $ 300 Purchases $ 1,568 Transportation in 30 Gross delivered cost of purchases $ 1,598 Deduct: Purchases returns and allowances 49 Net cost of purchases $ 1,549 Cost of goods available for sale 1,849 Deduct: Merchandise inventory, July 31, 400 Cost of goods sold $ 1,449* *Note that the difference between the two methods is equal to purchases discounts lost. Requirement 3. Under the net price method, purchases discounts lost are classified as other expenses on the income statement. 5-44

45 P5-34 Analyzing Limited Brands and The Talbot s LB 9 1. For fiscal 2004, net sales for Limited Brands are more than five times the amount for Talbot s. Net sales for both companies have increased in The percent increase in net sales is: Limited Brands 5.3% ' 100 $474,000,000* $8,934,000,000 *$9,408,000,000! $8,934,000,000 Talbot s 4.5% ' 100 $73,500,000* $1,624,300,000 *$1,697,800,000! $1,624,300, For both companies, the cost of goods sold percent increased in In 2004, the cost of goods sold percent for Limited Brands is lower than for Talbot s. The result is that Limited Brands has a higher gross profit margin. This is favorable for Limited Brands. The higher gross margin percent for Limited Brands could be caused by a combination of (1) increased sales prices, (2) reduced cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the increase in the gross margin percent. 4. Operating expenses as a percent of sales decreased for both companies in This is favorable. P5-35 Analyzing Walgreen and CVS Corporation LG 9 1. For fiscal 2004 net sales for Walgreen are higher than CVS. Net sales for both companies increased in The percent increase (decrease) in net sales is: Walgreen 15.4% ' 100 $5,002,800,000* $32,505,400,000 *$37,508,200,000! $32,505,400,000 CVS 15.1% ' 100 $4,006,300,000* $26,588,000,000 *$30,594,300,000! $26,588,000,

46 P5-35 (continued) 3. Cost of goods sold as a percent of sales decreased for both companies in This is favorable. The lower gross margin percent could be caused by a combination of (1) decreased sales prices, (2) increased cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the decrease in the gross margin percent. 4. Operating expenses as a percent of net sales increased for both companies in This is unfavorable. ln 2004, Walgreens is consistently operating at a higher operating margin than CVS. 5-46

47 SOLUTION TO PRACTICE CASE LG 4, 5 Preparing a Multiple-step Income Statement, Statement of Owners Equity, and Balance Sheet for a Merchandising Business Requirement 1. PARIS HILTON FASHION COMPANY Income Statement For the Year Ended December 31, Revenues Sales $ 225,000 Deduct: Sales returns and allowances $ 4,000 Sales discounts 3,000 7,000 Net sales revenue $ 218,000 Cost of goods sold: Merchandise inventory, January 1, $ 30,000 Purchases $ 99,000 Transportation in 2,500 Gross delivered cost of purchases $ 101,500 Deduct: Purchases returns and allowances $ 600 Purchases discounts 900 1,500 Net cost of purchases 100,000 Cost of goods available for use $130,000 Deduct: Merchandise inventory, December 31, 20,000 Cost of goods sold 110,000 Gross margin on sales $ 108,000 Deduct: Operating expenses: Selling expenses: Sales salaries expense $ 27,000 Advertising expense 37,000 Depreciation expense store building 7,000 Total selling expenses $ 71,000 General and administrative expenses: Office salaries expense $ 15,000 Rent expense office building 6,000 Office supplies expense 3,000 Total general and administrative expenses 24,000 Total operating expenses 95,000 Net operating income $ 13,000 Other expenses: Interest expense $ 5,000 Other revenues: Interest revenue 1,000 4,000 Net income before income taxes 9,000 Income tax expense 3,000 Net income $ 6,

48 Practice Case (continued) Requirement 2. PARIS HILTON FASHION COMPANY Statement of Owners' Equity For the Year Ended December 31, Common stock, December 31, $ 70,000 Retained earnings, January 1, $ 39,000 Add: Net income 6,000 Deduct: Dividends (1,000) Retained earnings, December 31, 44,000 Total owners equity, December 31, $ 114,

49 Practice Case (continued) Requirement 3. PARIS HILTON FASHION COMPANY Balance Sheet December 31, Assets Current assets Cash $ 35,000 Accounts receivable 50,000 Merchandise inventory 20,000 Office supplies 3,000 Total current assets $108,000 Property, plant, and equipment Land $ 25,000 Store building $ 80,000 Deduct: Accumulated depreciation 15,000 65,000 Total property, plant, and equipment 90,000 Total assets $ 198,000 Liabilities Current liabilities Accounts payable $ 20,000 Salaries payable 1,000 Income taxes payable 3,000 Total current liabilities $ 24,000 Long-term liabilities Notes payable, due December ,000 Total liabilities $ 84,000 Owners Equity Common stock $ 70,000 Retained earnings 44,000 Total owners equity 114,000 Total liabilities and owners equity $ 198,

50 SOLUTION TO BUSINESS DECISION AND COMMUNICATION PROBLEM Improving Profitability Following is a typical student response to this communications problem; actual responses may vary in content and style but should contain as much of this basic information as possible. TO: FROM: SUBJECT: Sam Tees Student Profitability of Shirts Unlimited In reviewing the income statement of Tees Unlimited, I have noted several items for your consideration. First, the company is carrying too high a level of inventory. Cost of goods sold for the year was $33,000. You have $30,000 in merchandise inventory on hand on December 31,. You have almost one year s inventory on hand at the end of. This represents money that is tied up which you could invest. Consider expanding your store, or at least investing in some interest-bearing securities. Second, sales returns and allowances are 20% of sales. This may indicate unhappy customers. You should investigate why returns are so high and work to reduce this considerably. Third, the company is purchasing more goods than it is selling in a year. Plan purchases to coincide with actual yearly needs for goods. This will also reduce your level of inventory. Fourth, purchases returns are also high. You should investigate this. It may be that you need to change suppliers or work with your suppliers to get acceptable merchandise. Fifth, it also appears that you are not taking advantage of cash discounts on purchases, as the income statement does not list any. By paying within the discount period, you can reduce the cost of merchandise. SOLUTION TO ETHICAL DILEMMA Predating Sales Transactions Individual responses to ethical dilemmas will vary. The technical and ethical issues raised in the following response are central to this dilemma; look for them in students answers and be prepared to discuss them with students in class. The owner s request will have the effect of transferring sales from to This will overstate revenues and income in. It also will overstate assets and owners' equity. With F.O.B. shipping point terms, the date of shipment determines the sales date. The title to the merchandise passes when the merchandise is shipped. The back-dating of sales transactions would be unethical. It appears that the owner desires to inflate sales and income for the purpose. of creating a more favorable income statement. This may improve the conditions of the loan he is negotiating. As the accountant, you have an ethical responsibility not only to the owner but to all users of the financial statements. The bank loan officer is certainly one user of this company s financial statements. You should refuse to alter the dating of the sales transactions. 5-50

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