EXERCISES. 248 Chapter 5

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1 248 Chapter 5 EXERCISES When the instructions for any exercise or problem call for the preparation of an income statement, use the multistep format unless otherwise indicated. EXERCISE 5 1 Comparing a Merchandising Company with a Service Company The following information is available for two different types of businesses for the accounting period. Davis Company is a service business that provides accounting services to small businesses. Campus Dive Shop Inc. is a merchandising business that sells diving gear to college students. Data for Davis Company 1. Borrowed $20,000 from the bank to start the business. 2. Provided $15,000 of services to customers and collected $15,000 cash. 3. Paid salary expense of $10,000. Data for Campus Dive Shop Inc. 1. Borrowed $20,000 from the bank to start the business. 2. Purchased $12,500 inventory for cash. 3. Inventory costing $8,200 was sold for $15,000 cash. 4. Paid $1,800 cash for operating expenses. a. Prepare an income statement, balance sheet, and cash flow statement for each of the companies. b. What is different about the income statement of the two businesses? c. What is different about the balance sheets of the two businesses? d. How are the cash flow statements different for the two businesses?

2 Accounting for Merchandising Business 249 EXERCISE 5 2 Effect of Inventory Transactions on Journals, Ledgers, and Financial Statements: Perpetual Method Don Jones started a small merchandising business in The business experienced the following events during its first year of operation. Assume that Jones uses the perpetual inventory method. 1. Acquired $20,000 cash from the issue of common shares. 2. Purchased inventory for $15,000 cash. 3. Sold inventory costing $10,000 for $16,000 cash. a. Record the events in general journal format. b. Post the entries to T-accounts. c. Prepare an income statement for d. What is the amount of net cash flow from operating activities for 2005? EXERCISE 5 3 Effect of Inventory Transactions on the Income Statement and Statement: Perpetual Method During 2005, Bond Merchandising Company purchased $30,000 of inventory on account. Bond sold inventory on account that cost $25,000 for $35,000. Cash payments on accounts payable were $20,000. There was $22,000 cash collected from accounts receivable. Bond also paid $7,000 cash for operating expenses. Assume that Bond started the accounting period with $28,000 in cash and common shares. a. Identify the events described in the preceding paragraph and record them in a horizontal statements model like the following one: Assets Liab. Equity Rev. Exp. Net Inc. Cash Accts. Rec. Inv. A. Pay. C. Sh. Ret. Earn. b. What is the balance of accounts receivable at the end of 2005? c. What is the balance of accounts payable at the end of 2005? d. What are the amounts of gross margin and net income for 2005? e. Determine the amount of net cash flow from operating activities. f. Explain why net income and retained earnings are the same for Bond. Normally would these amounts be the same? Why or why not? Statement 28,000 NA NA NA 28,000 NA NA NA NA NA EXERCISE 5 4 Recording Inventory Transactions in the General Journal and Posting Entries to T-Accounts: Perpetual Method Clark s Clothing Centre Inc. experienced the following events during 2004: 1. Acquired $7,000 cash from the issue of common shares. 2. Purchased inventory for $4,000 cash. 3. Sold inventory costing $3,000 for $4,500 cash. 4. Paid $400 for advertising expense. L.O. 5 a. Record the general journal entries for the preceding transactions. b. Post each of the entries to T-accounts. c. Prepare a trial balance to prove the equality of debits and credits. EXERCISE 5 5 Understanding the Freight Terms FOB Shipping Point and FOB Destination Point L.O. 6 For each of the following events, indicate whether the freight terms are FOB destination or FOB shipping point. a. Sold merchandise and paid the freight costs. b. Purchased merchandise and paid the freight costs. c. Sold merchandise and the buyer paid the freight costs. d. Purchased merchandise and the seller paid the freight costs.

3 250 Chapter 5 EXERCISE 5 6 Effect of Purchase Returns and Allowances and Freight Costs on the Journal, Ledger, and Financial Statements: Perpetual System The trial balance for Vanity Gift Shops Co. as of January 1, 2005 follows: Account Titles Debit Credit Cash $32,000 Inventory 12,000 Common Shares $40,000 Retained Earnings 4,000 Total $44,000 $44,000 The following events affected the company during the 2005 accounting period: 1. Purchased merchandise on account that cost $22, Purchased goods FOB shipping point with freight cost of $1,000 cash. 3. Returned $3,200 of damaged merchandise for credit on account. 4. Agreed to keep other damaged merchandise for which the company received a $1,400 allowance. 5. Sold merchandise that cost $16,000 for $31,000 cash. 6. Delivered merchandise to customers under terms FOB destination with freight costs amounting to $800 cash. 7. Paid $15,000 on the merchandise purchased in Event 1. a. Record the events in general journal format. b. Open general ledger T-accounts with the appropriate beginning balances, and post the journal entries to the T-accounts. c. Prepare an income statement, balance sheet, and cash flow statement. (Assume that closing entries have been made.) d. Explain why a difference does or does not exist between net income and net cash flow from operating activities. L.O. 2, 5 EXERCISE 5 7 Accounting for Product Costs: Perpetual Inventory Method Which of the following would be debited to the Inventory account for a merchandising business using the perpetual inventory method? a. Purchase of inventory. b. Allowance received for damaged inventory. c. Transportation-in. d. Cash discount given on goods sold. e. Transportation-out. f. Purchase of office supplies. L.O. 2, 3, 5 EXERCISE 5 8 Effect of Product Cost and Period Cost: Horizontal Statements Model Action Nature Goods Inc. experienced the following events for the 2004 accounting period: 1. Acquired $10,000 cash from the issue of common shares. 2. Purchased $56,000 of inventory on account. 3. Received goods purchased in Event 2 FOB shipping point; freight cost of $600 paid in cash. 4. Sold inventory on account that cost $33,000 for $57, Paid freight cost on the goods sold in Event 5 of $420. The goods were shipped FOB destination. Cash was paid for the freight cost. 6. Customer in Event 4 returned $2,000 worth of goods that had a cost of $1, Collected $47,000 cash from accounts receivable. 8. Paid $40,000 cash on accounts payable. 9. Paid $1,100 for advertising expense. 10. Paid $2,000 cash for insurance expense. a. Which of these events result in period (selling and administrative) costs? Which result in product costs? If neither, label the transaction NA.

4 Accounting for Merchandising Business 251 b. Record each event in a horizontal statements model like the following one. The first event is recorded as an example. Assets Liab. Equity Rev. Exp. Net Inc. Statement Cash Accts. Rec. Inv. A. Pay. C. Sh. Ret. Earn. 10,000 NA NA NA 10,000 NA NA NA NA 10,000 FA EXERCISE 5 9 Cash Discounts and Purchase Returns On April 6, 2008, Wang Exotics Ltd. purchased $3,100 of merchandise from Exchange Emporium, terms 2/10, n/45. On April 8, Wang returned $600 of the merchandise to the Exchange Emporium for credit. Wang paid cash for the merchandise on April 15, L.O. 6 a. What is the amount that Wang must pay the Exchange Emporium on April 15? b. Prepare the journal entries for these events. c. How much must Wang pay for the merchandise purchased if the payment is not made until April 20? d. Why would Wang want to pay for the merchandise by April 15? EXERCISE 5 10 Effect of Sales Returns and Allowances and Freight Costs on the Journal, Ledger, and Financial Statements: Perpetual Method Smart Company began the 2004 accounting period with $7,000 cash, $38,000 inventory, $25,000 common shares, and $20,000 retained earnings. During 2004, Smart experienced the following events: 1. Sold merchandise costing $32,000 for $50,000 on account to Mitchell s Furniture Store. 2. Delivered the goods to Mitchell under terms FOB destination. Freight costs were $500 cash. 3. Received returned damaged goods from Mitchell. The goods cost Smart $3,000 and were sold to Mitchell for $4, Granted Mitchell a $2,000 allowance for other damaged goods that Mitchell agreed to keep. 5. Collected partial payment of $30,000 cash from accounts receivable., 6 a. Record the events in general journal format. b. Open general ledger T-accounts with the appropriate beginning balances and post the journal entries to the T-accounts. c. Prepare an income statement, balance sheet, and cash flow statement. d. Why would Mitchell agree to keep the damaged goods? Who benefits more? EXERCISE 5 11 Effect of Cash Discounts on the Journal, Ledger, and Financial Statements: Perpetual Method Nelson Sand & Gravel Inc. was started in 2006 and experienced the following accounting events during its first year of operation: 1. Started business when it acquired $15,000 cash from the issue of common shares. 2. Purchased merchandise costing $9,000 on account, terms 2/10, n/ Paid off the account payable within the discount period. 4. Sold inventory on account that cost $5,000 for $7,500. Credit terms were 1/20, n/ Collected cash from the account receivable within the discount period. 6. Paid $1,900 cash for operating expenses. L.O. 5, 6 a. Record the transactions in general journal format. b. Open general ledger T-accounts, and post the journal entries to the T-accounts. c. Record the events in a horizontal statements model like the following one. Assets Liab. Equity Rev. Exp. Net Inc. Cash Accts. Rec. Inv. A. Pay. C. Sh. Ret. Earn. Statement

5 252 Chapter 5 d. What is the amount of gross margin for the period? What is the net income for the period? e. Why would Nelson sell merchandise with the terms 1/20, n/30? f. What do the terms 2/10, n/30 mean to Nelson?, 6 EXERCISE 5 12 Effect of Inventory Transactions on the Financial Statements: Comprehensive Exercise With Sales and Purchase Returns and Discounts Macomb Merchandise Company had the following balances in its accounts on January 1, 2006: Cash $20,000 Merchandise Inventory 15,000 Common Shares 25,000 Retained Earnings 10,000 Macomb experienced the following events during 2006: 1. Purchased merchandise inventory on account for $45,000, terms 2/10, n/ Paid freight of $600 on the merchandise purchased. 3. Sold merchandise inventory that cost $23,000 for $42,000 on account, terms 1/10, n/ Returned $1,500 of damaged merchandise purchased in Event Agreed to keep other merchandise that was slightly damaged and was granted an allowance of $ The customer in Event 3 returned $6,000 of merchandise that had a cost of $3, Collected the balance of accounts receivable within the discount period. 8. Paid for one-half of the merchandise in Event 1 within the discount period. 9. Paid $4,300 cash for selling and administrative expenses. 10. Paid the balance of accounts payable (not within the discount period). a. Record each of these events in general journal format. b. Open general ledger T-accounts. Post the beginning balances and the events to the accounts. c. Prepare a trial balance. d. Prepare an income statement, balance sheet (assume closing entries have been made), and a cash flow statement., 9 EXERCISE 5 13 Effect of Inventory Losses: Perpetual Method Carroll Traders experienced the following events during its first year of operation: 1. Started the business when it acquired $20,000 cash from the issue of common shares. 2. Paid $14,000 cash to purchase inventory. 3. Sold inventory costing $10,750 for $17,100 cash. 4. Physically counted inventory; had inventory of $2,900 on hand at the end of the accounting period. a. Open appropriate ledger T-accounts, and record the events in the accounts. b. Prepare an income statement and balance sheet. c. If all purchases and sales of merchandise are reflected as increases or decreases to the merchandise inventory account, why is it necessary for management to even bother to take a physical count of goods on hand (ending inventory) at the end of the year? EXERCISE 5 14 Determining the Effect of Inventory Transactions on the Accounting Equation: Perpetual Method Marshall Company experienced the following events: 1. Purchased merchandise inventory on account. 2. Purchased merchandise inventory for cash. 3. Sold merchandise inventory on account. Label the revenue recognition 3a and the expense recognition 3b. 4. Returned merchandise purchased on account. 5. Sold merchandise inventory for cash. Label the revenue recognition 5a and the expense recognition 5b. 6. Paid cash on accounts payable within the discount period. 7. Paid cash for selling and administrative expenses. 8. Collected cash from accounts receivable. Label 8a as discount and 8b for cash received. 9. Paid cash for transportation-out. 10. Paid cash for transportation-in.

6 Accounting for Merchandising Business 253 Identify each event as asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE). Also explain how each event affects the financial statements by placing a for increase, for decrease, or NA for not affected under each of the components in the following statements model. Assume the company uses the perpetual inventory system. The first event is recorded as an example. Event No. Event Type Assets Liab. Equity Rev. Exp. Net Inc. Statement 1 AS NA NA NA NA NA EXERCISE 5 15 Effect of Inventory Transactions on the Income Statement and Balance Sheet: Periodic Method Nat Briscoe owns Nat s Sporting Goods. At the beginning of the year, Nat s had $4,200 in inventory. During the year, Nat s purchased inventory that cost $21,000. At the end of the year, inventory on hand amounted to $8,800. L.O. 12 Calculate the following: a. Cost of goods available for sale during the year. b. Cost of goods sold for the year. c. Amount of inventory Nat s would report on the year-end balance sheet. EXERCISE 5 16 Single-Step and Multistep Income Statements The following information was taken from the accounts of Neighbourhood Market, a small grocery store. The accounts are listed in alphabetical order, and all have normal balances. L.O. 7 Accounts Payable $ 600 Accounts Receivable Accumulated Amortization Advertising Expense Cash Common Shares Cost of Goods Sold Interest Expense Merchandise Inventory Prepaid Rent Retained Earnings ,020 Sales Revenue ,600 Salaries Expense Supplies Expense Prepare an income statement using the multistep approach. EXERCISE 5 17 Determining Cost of Goods Sold: Periodic Method Hill Antiques uses the periodic inventory system to account for its inventory transactions. The following account titles and balances were drawn from Hill s records: beginning balance in inventory, $12,000; purchases, $150,000; purchase returns and allowances, $5,000; sales, $400,000; sales returns and allowances, $3,000; freight-in, $1,000; and operating expenses, $26,000. A physical count indicated that $15,000 of merchandise was on hand at the end of the accounting period. L.O. 8 a. Prepare a schedule of cost of goods sold. b. Prepare a multistep income statement. EXERCISE 5 18 Basic Transactions: Periodic System, Single Cycle The following transactions apply to Kay s Specialties Shop for L.O. 12

7 254 Chapter 5 1. Acquired $70,000 cash from the issue of common shares. 2. Acquired $8,000 of gift merchandise from Kay Pierce, the owner, who had acquired the merchandise prior to opening the shop. Issued common shares to Kay in exchange for the merchandise. 3. Purchased $90,000 of inventory on account. 4. Paid $6,000 for radio ads. 5. Sold inventory for $160,000 cash. 6. Paid $20,000 in salary to a part-time salesperson. 7. Paid $75,000 on accounts payable (see Event 3). 8. Physically counted inventory, which indicated that $20,000 of inventory was on hand at the end of the accounting period. a. Record each of these transactions in general journal form using the periodic method. b. Post each of the transactions to ledger T-accounts. c. Prepare an income statement, statement of shareholders equity, balance sheet, and cash flow statement for d. Prepare the necessary closing entries at the end of 2005, and post them to the appropriate T-accounts. e. Prepare a post-closing trial balance. f. Discuss an advantage of using the periodic method instead of the perpetual method. g. Why is the common shares balance on the statement of shareholders equity different from the cash inflow from issuing shares in the cash flow from financing activities section of the cash flow statement?, 11 EXERCISE 5 19 Determining Cost of Financing Inventory On January 1, 2006, Jay Woo started a small home appliance merchandising business that he named J s Appliances. J s uses the perpetual system. The company experienced the following events during the first year of operation: 1. Started the business when Jay borrowed $100,000 by issuing a one-year note dated January 1, The note had a 7 percent annual rate of interest. 2. Paid $80,000 cash to purchase inventory. 3. Sold appliances that cost $36,000 for $68,000 on account. 4. Collected $28,000 cash from accounts receivable. 5. Paid $10,000 for operating expenses. 6. Recognized accrued interest on the note payable on December 31. a. Record the transactions in general journal format. b. Open general ledger T-accounts, and post the journal entries to the T-accounts. c. Prepare an income statement, balance sheet, and cash flow statement. (Assume that year-end closing entries have been made.) L.O. 6, 11 EXERCISE 5 20 Financing Inventory and Cash Discounts Larry Braun came to you for advice. He has just purchased a large amount of inventory with the terms 1/10, n/45. The amount of the invoice is $65,000. He is currently short on cash but has good credit and so can borrow the money at the appropriate time to take advantage of the discount. The annual interest rate is 7 percent if he decides to borrow the money. Braun is sure he will have the necessary cash by the due date of the invoice (but not by the discount date). a. For how long would Braun need to borrow the money to take advantage of the discount? b. How much money would Braun need to borrow? c. What action would you recommend Braun take? Explain.

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