CHAPTER 6 ACQUISITIONS AND PAYMENT: INVENTORY AND LIABILITIES

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1 CHAPTER 6 ACQUISITIONS AND PAYMENT: INVENTORY AND LIABILITIES Acquiring Merchandise for Sale Purchases (pp ) Purchase Discounts When a company takes advantage of a purchase discount, it reduces the cost of inventory. Under a perpetual inventory system (discussed below) the credit for purchase discounts is made to the Inventory account. Under a periodic inventory system (also discussed below) the credit is made to a Purchase discounts account. To illustrate, assume that you purchase $10,000 worth of inventory on January 5, 2001 with credit terms 2/10, n/30. The purchase is paid for on January 12 th. Journal entries would be as follows: 1/5/2001 Inventory or Purchases $10,000 Accounts payable $10,000 To record the purchase of inventory, terms 2/10, n/30 1/12/2001 Accounts payable $10,000 Inventory or Purchase discounts $ 200 Cash 9,800 To record the payment of the 1/5/2001 $10,000 purchase less the discount of $200 ($10,000 x 2%) Purchase returns and Purchase allowances Purchase returns and purchase allowances are accounted for much like discounts the account used depends upon whether you are using a perpetual or periodic inventory system. With a perpetual system Inventory is credited. Under a periodic system, the credit would be to Purchase returns and allowances. To illustrate, assume you return $150 of defective merchandise that you have not paid for yet. The journal entry would be as follows: Accounts payable $150 Inventory or Purchase returns and allowances $150 To record the return of $150 of defective merchandise 18

2 Freight-In When goods are shipped (FOB) shipping point, the freight cost increases the total inventory cost. Once again, under a perpetual system a company will increase Inventory while under a periodic system a separate Freight-in account will be maintained. To illustrate, assume you receive a bill for $85 to cover the shipping cost of merchandise purchased FOB shipping point. The journal entry would be as follows: To record the shipping cost of inventory. Inventory or Freight-in $85 Accounts payable or Cash $85 Example of Cost Flow Assumptions and Timing of Record Keeping Perpetual Inventory (pp ) When a company uses a perpetual inventory system, all inventory purchases are debited to the Inventory account. When a sale is made, two journal entries are required, one to record the sale and the other to reduce the inventory and record the cost of goods sold. For example, the January 8 th sale and January 16 th purchase for Phil s Photo Shop using a perpetual inventory system would be as follows: 1/8/2001 Sales $60 Cash or Accounts receivable $60 Cost of goods sold $30 Inventory $30 To record the sale of three cameras sales price $20 each, cost $10 each 1/16/2001 Inventory $60 Cash or Accounts payable $60 To record the purchase of 5 cameras at $12 each Periodic Inventory (pp ) When a company uses a periodic inventory system, all inventory purchases are debited to the Purchases account. It is a temporary account that is used to accumulate the cost of inventory purchased during the period. When a sale is made, only one journal entries is required to record the sale. Cost of goods sold is calculated at the end of the period. The January 8 th sale and January 16 th purchase for Phil s Photo Shop using a periodic inventory system would be as follows: 19

3 1/8/2001 Sales $60 Cash or Accounts receivable $60 To record the sale of three cameras at $20 each 1/16/2001 Purchases $60 Cash or Accounts payable $60 To record the purchase of five cameras at $12 each Conclusions About Inventory Cost Flow Assumptions (p. 222) Jones Saddle Company had the following transactions during August 2002 purchased 30 $20 per unit on August 10, 2002 purchased 20 $21 per unit on August 15, 2002 purchased 20 $23 per unit on August 15, 2002 sold 35 $30 per unit on August 30, 2002 STUDY BREAK 6-2 (p. 222) SEE HOW YOU RE DOING Prepare journal entries to record the purchases assuming that Jones Saddle Company uses a perpetual inventory system. Prepare the journal entries to record the sale using (1) FIFO, (2) LIFO, and (3) Weighted Average. Inventory and Cost of Goods Sold in Merchandising Operations Adjustments and Closing under a Perpetual Inventory System When a company maintains a perpetual inventory system, the current inventory balance and cost of goods sold are maintained at all times. A physical inventory count at the end of the year is needed to verify the inventory balance and identify shrinkage. The following is what typical inventory and cost of goods sold accounts would look like before the adjustment and closing process when using a perpetual system.: Inventory Cost of goods sold BB $7,500 $372 Purchase discounts BB $0 Purchases 26, Purchase returns and allowances Freight-in 2,395 27,435 Cost of goods sold 12/31 Unadjusted balance $8,403 12/1-12/31 27,435 20

4 A physical count of inventory calculates an ending inventory value of $8,255, indicating shrinkage of $148. The Inventory and Cost of goods sold accounts must be adjusted for the shrinkage and the Cost of goods sold account must be closed to Income summary, just like all other expense accounts: 12/31 Cost of goods sold $148 Inventory $148 To record inventory shrinkage 12/31 Income summary $27,583 Cost of goods sold $27,583 To close costs of goods sold ($27,435 sales + $148 shrinkage) After these two entries are posted, the Inventory account will contain the correct ending balance of $8,255 ($8,403 - $148) and the Cost of goods sold account will be reset to $0. Adjustments and Closing under a Periodic Inventory System Under a periodic system, the same company would have the following T-accounts and balances before adjustments and closing: Inventory Purchases Freight-in BB $7,500 BB $0 BB $0 12/1-12/31 26,580 12/1-12/31 2,395 Purchase discounts Purchase returns and allowances $0 BB $0 BB /1-12/ /1-12/31 Remember that under a periodic system, no Cost of goods sold account is maintained. 21

5 Under the periodic system, since cost of goods sold is not recorded at each sale, it must be calculated at the end of each year as follows: Beginning inventory + Purchases +Freight-in -Purchase discounts -Purchase returns and allowances = Goods available for sale - Ending inventory (from physical count) = Cost of goods sold In a periodic system, shrinkage is automatically absorbed into cost of goods sold. Closing the temporary accounts and updating the Inventory balance transfers the cost of goods sold to Income summary. The closing entries under a periodic system are as follows. 12/31 Inventory (ending, per physical count) $8,255 Purchase discounts 372 Purchase returns and allowances 265 Income summary $8,892 To close temporary accounts and establish the ending inventory balance 12/31 Income summary $36,475 Inventory (beginning balance) $ 7,500 Purchases 26,580 Freight-in 2,395 To close temporary accounts and the beginning inventory balance Note that the difference between the debit made to income summary in the second entry ($36,475) and the credit made to income summary in the first entry ($8,255) is $27,583, the amount of cost of goods sold. Valuing Inventory: Lower-of-Cost-or-Market (pp ) The journal entry to record the inventory write down would be as follows: To record the LCM valuation Loss on inventory write-down $5,000 Inventory $5,000 22

6 Paying for Acquisitions: Liabilities Acquisition of Human Resources and Payroll Liabilities (pp ) Following the Risky Company example in the textbook: $500 gross salary, 20% ($100) withheld for income taxes, Social Security taxes at 6.2% ($31.00), and Medicare taxes at 1.45% ($7.25), the journal entry to record payroll would be as follows: To record salary expense and payroll deductions Salary expense $ Income taxes payable $ Social security taxes payable Medicare taxes payable 7.25 Cash When Risky Company pays the government the taxes withheld, they must match the Social Security and Medicare amounts. The journal entry to record the payment of the taxes is as follows: Payroll tax expense $ Income taxes payable Social security taxes payable Medicare taxes payable 7.25 Cash $ To record payroll tax expense and payment of taxes Sandy earned $1,500 at her job at Paula s Bookstore during February. Sandy has 20% of her gross pay withheld for income taxes, 6.2% withheld for Social Security (FICA) taxes, and 1.45% withheld for Medicare taxes. Prepare the required payroll journal entries assuming that Paula's bookstore will not submit the taxes to the government until next month. STUDY BREAK 6-6 (p. 232) SEE HOW YOU RE DOING 23

7 Summary Problem: Tom's Wear Faces New Challenges in May Transaction 1 Pays $300 cash for an insurance premium. Coverage starts May 15th. 5/1/2001 Prepaid insurance $300 Cash $300 To record the purchase of insurance Transaction 2 Collects $7,900 on accounts receivable. 5/10/2001 Cash $7,900 Accounts receivable $7,900 To record the collection of accounts receivable Transaction 3 Pays accounts payable of $4,000. 5/12/2001 Accounts payable $4,000 Cash $4,000 To record payment on account Transaction 4 Purchased 1,100 T-shirts at $4.00 each on account. 5/14/2001 Inventory $4,400 Accounts payable $4,400 To record the purchase of 1,100 T-shirts at $4 on account Transaction 5 Agrees to sell school system 900 each. Collects cash of $9,900 in advance. Half the shirts will be delivered by May 30 and the other half in June. 5/15/2001 Cash $9,900 Unearned revenue $9,900 To record the collection of sales revenue in advance Transaction 6 Sells 800 shirts for $11 each on account. 24

8 4/15/2001 Accounts receivable $8,800 Sales $8,800 To record the sale of 800 T-shirts on account 4/15/2001 Cost of goods sold $3,200 Inventory $3,200 To record the expense cost of goods sold and reduce the inventory by 800 x $4. Transaction 7 Hires Web designers to start a Web page - $200 for design and $50 per month maintenance, 6 months paid in advance. A full month's fee is being charged in May. 5/21/2001 Prepaid Web services $300 Misc. operating expenses 200 Cash $500 To record payment for Web page setup and maintenance Transaction 8 Purchase 1,000 shirts at $4.20 each on account. 5/30/2001 Inventory $4,200 Accounts payable $4,200 To record the purchase of 1,000 shirts on account Transaction 9 Repays the 3-month note issued on March 1st, with interest 5/31/2001 Short-term notes payable $3,000 Interest payable $60 Interest expense $30 Cash $3,090 To record the repayment of the March 1 note, with interest Adjustment 1 Record insurance expense for May - $25 for the first half of the month (beginning prepaid insurance) and $50 for the second half of the month ($100 month beginning May 15). 5/31/2001 Insurance expense $75 Prepaid insurance $75 To record insurance expense for May 25

9 Adjustment 2 Record rent expense of $1,200 for the month of May. 5/31/2001 Rent expense $1,200 Prepaid rent $1,200 To record rent expense for May Adjustment 3 Record Web services expense for May. 5/31/2001 Misc. operating expenses $50 Prepaid Web service $50 To record Web maintenance services for May Adjustment 4 Record depreciation expense for the van - 6,000 miles x $ /31/2001 Depreciation expense $870 Accum. dep. - Van $870 To record May depreciation expense on the van Adjustment 5 Record the $100 monthly depreciation expense on the computer. 5/31/2001 Depreciation expense $100 Accum. dep. - Computer $100 To record May depreciation expense on the computer Adjustment 6 Half of the shirts were delivered to the school. Reclassify half of the unearned revenue as earned and record the cost of goods sold. 5/31/2001 Unearned revenue $4,950 Sales $4,950 To record delivery of half of the shirts to the school 5/31/2001 Cost of goods sold $1,800 Inventory $1,800 To record the expense cost of goods sold and reduce the inventory by 450 x $4 Adjustment 7 Accrue Sam Cubbie's $1,000 salary for May, including the employer portion of payroll taxes (Social security 6.2%; Medicare 1.45%) and Withholding tax 20%. 26

10 5/31/2001 Salary expense $1,000 Employer's payroll tax expense 77 Payroll taxes withheld $277 Other payables 77 Salaries payable 723 To record the accrual of Sam Cubbie's salary, withholding, and payroll taxes Adjustment 8 Accrue interest expense on the van note. 5/31/2001 Interest expense $250 Interest payable $250 To record the interest expense on the van for May 27

11 T-accounts for Tom's Wear with May journal entries and adjustments Accounts Cash receivable Inventory Prepaid insurance Prepaid rent BB $3,295 $300 1 BB $8,000 $7,900 2 BB $1,100 $3,200 6b BB $25 $75 Adj-1 5 $1,800 $1,200 Adj-2 2 7,900 4, a 8, ,400 1,800 Adj ,900 4, , , ,900 4,700 $8,805 Prepaid Web Equipment - service Computer Acc dep - Computer Equipment - Van Acc dep - Van 7 $300 $50 Adj-3 BB $4,000 $200 BB BB $30,000 $725 BB 100 Adj Adj ,000 30, ,595 Payroll taxes Accounts payable Interest payable Unearned revenue withheld Other payables 3 $4,000 $4,000 BB $310 BB Adj-6 $4,950 $9,900 5 $277 Adj-7 $77 Adj-7 4, Adj-8 4, , Short-term notes Long-term notes Salaries payable payable payable Common stock Retained earnings $723 Adj-7 9 $3,000 $3,000 BB $30,000 BB $5,000 BB $4,985 BB ,000 5,000 4,985 28

12 Cost of goods Misc. operating Employer's payroll Revenue sold Depreciation expense expenses tax expense $8,800 6a 6b $3,200 Adj-4 $870 7 $200 Adj-7 $77 4,950 Adj-6 Adj-6 1,800 Adj Adj ,750 5, Insurance expense Rent expense Interest expense Salary expense Adj-1 $75 Adj-2 $1,200 9 $30 Adj-7 $1,000 Adj ,200 1,

13 Tom's Wear, Inc. Adjusted Trial Balance May 31, 2001 Debits Credits Cash $8,805 Accounts receivable 8,900 Inventory 4,700 Prepaid insurance 250 Prepaid rent 600 Prepaid Web service 250 Equipment - Computer 4,000 Accumulated depreciation - Computer $300 Equipment - Van 30,000 Accumulated depreciation - Van 1,595 Accounts payable 4,200 Interest payable 500 Unearned revenue 4,950 Payroll taxes withheld 277 Other payables 77 Salaries payable 723 Long-term notes payable 30,000 Common stock 5,000 Retained earnings 4,985 Sales 13,750 Cost of goods sold 5,000 Depreciation expense 970 Other operating expense 250 Employer's payroll tax expense 77 Insurance expense 75 Rent expense 1,200 Interest expense 280 Salary expense 1,000 Totals $66,357 $66,357 30

14 Journal Entries for Study Break Questions Date Debit Credit Study Break 6-2 8/10/2001 Inventory $600 Cash or Accounts payable $600 To record the purchase of 30 $20 each 8/15/2001 Inventory $420 Cash or Accounts payable $420 To record the purchase of 20 $21 each 8/21/2001 Inventory $700 Cash or Accounts payable $700 To record the purchase of 20 $35 each 8/30/2001 Sales $1,050 Cash or Accounts receivable $1,050 Cost of goods sold $705 Inventory $705 To record the sale of 35 $30 each, using FIFO 8/30/2001 Sales $1,050 Cash or Accounts receivable $1,050 Cost of goods sold $775 Inventory $775 To record the sale of 35 $30 each, using LIFO 8/30/2001 Sales $1,050 Cash or Accounts receivable $1,050 Cost of goods sold $740 Inventory $740 To record the sale of 35 $30 each, using weighted average Study Break 6-6 Salary expense $1, Income taxes payable $ Social security taxes payable Medicare taxes payable Cash To record salary expense and payroll deductions 31

15 Payroll tax expense $ Social security taxes payable Me dicare taxes payable T o record employer payroll tax expense. Short Exercises SE6-11 The Woods Company purchased 500 electric saws from the Jordan's Equipment Company. Each electric saw cost $300. The saws are to be sold for $650 each. Woods paid $1,550 for freight and $280 for insurance while the saws were in transit. Woods Company also hired two more salespeople for a cost of $4,000 per month. Give the journal entry for the purchase of inventory. Assume the company uses perpetual record keeping for inventory. Date Account Debit Credit SE6-21 Tone Company acquired 4,000 transformers from the Ochoa Company. Each transformer cost $100. Tone will sell them for $125 each. Tone paid $950 for freight and $200 for insurance while the transformers were in transit. Tone Company paid $900 to advertise the transformers in a local real estate magazine. Give the journal entry for the purchase of inventory. Assume the company uses perpetual record keeping for inventory. Date Account Debit Credit SE6-7 The Hawking Company's records reported the following at the end of the fiscal year: Beginning inventory $ 40,000 Ending inventory 28,500 Cost of goods sold 280,000 A physical count showed that the ending inventory was actually $26,000. What is the journal entry needed to correct the accounting records? 32

16 Date Account Debit Credit Exercises E6-1 The Ribbon Company began operations on May 1. The following transactions took place in the month of May. a. Cash purchases of merchandise during May were $300,000. b. Purchases of merchandise on account during May were $400,000. c. The cost of freight to deliver the merchandise to Ribbon Company was $25,000, paid in cash by Ribbon during May. d. Ribbon returned $22,000 of merchandise purchased in part a. to the supplier for a full refund. e. The store manager's salary was $3,000 for the month. Assume Ribbon Company uses periodic record keeping for inventory. Give the journal entry for each transaction described above. a. Transaction Account Debit Credit b. c. d. e. 33

17 E6-3 For each of the following situations, give the journal entry that the purchasing company would record for the inventory purchase (including the cost of the freight, where applicable). Assume any freight charges are paid in cash at the time of receipt. Then, record the payment to the vendor for each purchase. Assume the company uses periodic record keeping. Assume discounts are recorded only when the payment is actually made and the purchase discount is taken. a. Invoice price of goods is $5,000. Purchase terms are 2/10, n/30 and the invoice is paid in the week of receipt. The shipping terms are FOB shipping point, and the shipping costs amount to $200. b. Invoice price of goods is $3,000. Purchase terms are 4/10, n/30 and the invoice is paid in the week of receipt. The shipping terms are FOB destination, and the shipping costs amount to $250. c. Invoice price of goods is $2,500. Purchase terms are 2/10, n/30 and the invoice is paid 15 days after receipt. The shipping terms are FOB shipping point, and the shipping costs amount to $250. d. Invoice price of goods is $9,000. Purchase terms are 3/10, n/30 and the invoice is paid in the week of receipt. The shipping terms are FOB destination, and the shipping costs amount to $200. Transaction Account Debit Credit a. purchase payment b. purchase payment c. purchase payment 34

18 d. purchase payment E6-16 F or a specific accounting period, a company has gross payroll of $ 20,000, federal income tax withheld of $4,000, and FICA (social security) taxes withheld of $1,600. Give the journal entry(s) to record the salary expense for the period. Include any related employer expenses. Date Account Debit Credit Problems Set A P6 1A The Battier Company made the following purchases in March of the current year: March 2 Purchased $5,000 of merchandise, terms 1/10, n/30, FOB shipping point. March 5 Purchased $2,000 of merchandise, terms 2/15, n/45, FOB shipping point. March 10 Purchased $4,000 of merchandise, terms 3/5, n/15, FOB destination. Required: Record the journal entries for each purchase. In each case, the freight charges are $350 and are paid in cash. Assume Battier Company records purchases at the full invoice amount, and records purchase discounts only when the payment to the vendor is made and the discount is taken. The company uses perpetual record keeping for inventory. 35

19 Date Account Debit Credit P6 5A The For Fish Company sells commercial fish tanks. The compan y began 2002 with 10,000 units of inventory on hand. These units cost $150 each. The following transactions related to the company's merchandise inventory occurred during the first quarter of 2002: January 20 Purchase 5,000 units for $160 each February 18 Purchase 6,000 units for $170 each March 28 Purchase 4,000 units for $180 each Total Purchases 15,000 units The costs shown include all related inventory costs. During the quarter ending March 31, 2002, sales in units totaled 17,000 units, leaving 8,000 units in ending inventory. The company uses a periodic recordkeeping system. Required: Give the journal entry required at March 31 to record the cost of goods sold for the quarter using: a. FIFO b. LIFO c. Weighted average 36

20 Date Account Debit Credit a. b. c. P6 8A Cheny Company buys and then resells a single product. The product is a commodity and is subject to rather severe cost fluctuations. Following is information concerning Cheny's inventory activity during the month of June 2003: June units on hand, $3,010 June 4 Sold 200 units June 6 Purchased 500 $11 per unit June 10 Purchased 200 $9 per unit June 15 Sold 300 units June 20 Purchased 150 $6 per unit June 25 Sold 400 units June 29 Purchased 50 $8 per unit Cheny uses a perpetual, FIFO inventory system. Required: Assume Cheny sold each unit for $20 per unit. Give the journal entries to record the sales and reduction in inventory if appropriate: June 4 Date Account Debit Credit June 15 37

21 June 25 38