Buy Now, Vote Later
Have you ever shopped for outdoor gear at an REI (Recreational Equipment Incorporated) store? If so, you might have been surprised if a salesclerk asked if you were a member. A member? What do you mean a member? You soon realize that REI might not be your typical store. In fact, there's a lot about REI that makes it different.
REI is a consumer cooperative, or “co-op” for short. To figure out what that means, consider this quote from the company's annual report:
As a cooperative, the Company is owned by its members. Each member is entitled to one vote in the election of the Company's Board of Directors. Since January 1, 2008, the nonrefundable, nontransferable, one-time membership fee has been $20 dollars. As of December 31, 2010, there were approximately 10.8 million members.
Voting rights? Now that's something you don't get from shopping at Wal-Mart. REI members get other benefits as well, including sharing in the company's profits through a dividend at the end of the year, which can be used for purchases at REI stores during the next two years. The more you spend, the bigger your dividend.
Since REI is a co-op, you might wonder whether management's incentives might be a little different. For example, is management still concerned about making a profit? The answer is yes, as it ensures the long-term viability of the company. At the same time, REI's members want the company to be run efficiently, so that prices remain low. In order for its members to evaluate just how well management is doing, REI publishes an audited annual report, just like publicly traded companies do. So, while profit maximization might not be the ultimate goal for REI, the accounting and reporting issues are similar to those of a typical corporation.
How well is this business model working for REI? Well, it has consistently been rated as one of the best places to work in the United States. It was ranked 8th on Fortune's 2012 list. Also, REI had sustainable business practices long before social responsibility became popular at other companies. The CEO's Stewardship Report states “we reduced the absolute amount of energy we use despite opening four new stores and growing our business; we grew the amount of FSC-certified paper we use to 58.4 percent of our total paper footprint—including our cash register receipt paper; we facilitated 2.2 million volunteer hours and we provided $3.7 million to more than 330 conservation and recreation nonprofits.”
Scan Learning Objectives
Read Feature Story
Read Preview
Read text and answer DO IT! p. 225 p. 229 p. 232 p. 237
Work Comprehensive DO IT! p. 238
Review Summary of Learning Objectives
Answer Self-Test Questions
Complete Assignments
Go to WileyPLUS for practice and tutorials
Read A Look at IFRS p. 271
After studying this chapter, you should be able to:
[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] Distinguish between a multiple-step and a single-step income statement.
So, while REI, like other retailers, closely monitors its financial results, it also strives to succeed in other areas. And, with over 10 million votes at stake, REI's management knows that it has to deliver.
Preview of Chapter 5
Merchandising is one of the largest and most influential industries in the United States. It is likely that a number of you will work for a merchandiser. Therefore, understanding the financial statements of merchandising companies is important. In this chapter, you will learn the basics about reporting merchandising transactions. In addition, you will learn how to prepare and analyze a commonly used form of the income statement—the multiple-step income statement. The content and organization of the chapter are as follows.
Merchandising Operations
REI, Wal-Mart, and Amazon.com are called merchandising companies because they buy and sell merchandise rather than perform services as their primary source of revenue. Merchandising companies that purchase and sell directly to consumers are called retailers. Merchandising companies that sell to retailers are known as wholesalers. For example, retailer Walgreens might buy goods from wholesaler McKesson. Retailer Office Depot might buy office supplies from wholesaler United Stationers. The primary source of revenues for merchandising companies is the sale of merchandise, often referred to simply as sales revenue or sales. A merchandising company has two categories of expenses: cost of goods sold and operating expenses.
Cost of goods sold is the total cost of merchandise sold during the period. This expense is directly related to the revenue recognized from the sale of goods. Illustration 5-1 shows the income measurement process for a merchandising company. The items in the two blue boxes are unique to a merchandising company; they are not used by a service company.
Illustration 5-1
Income measurement process for a merchandising company
Operating Cycles
The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase of merchandise inventory and its eventual sale lengthen the cycle. Illustration 5-2 shows the operating cycle of a service company.
Illustration 5-2
Operating cycle for a service company
Illustration 5-3 shows the operating cycle of a merchandising company.
Illustration 5-3
Operating cycle for a merchandising company
Note that the added asset account for a merchandising company is the Inventory account. Companies report inventory as a current asset on the balance sheet.
Flow of Costs
The flow of costs for a merchandising company is as follows. Beginning inventory plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold. Those goods that are not sold by the end of the accounting period represent ending inventory. Illustration 5-4 describes these relationships. Companies use one of two systems to account for inventory: a perpetual inventory system or a periodic inventory system.
PERPETUAL SYSTEM
In a perpetual inventory system, companies keep detailed records of the cost of each inventory purchase and sale. These records continuously—perpetually—show the inventory that should be on hand for every item. For example, a Ford dealership has separate inventory records for each automobile, truck, and van on its lot and showroom floor. Similarly, a Kroger grocery store uses bar codes and optical scanners to keep a daily running record of every box of cereal and every jar of jelly that it buys and sells. Under a perpetual inventory system, a company determines the cost of goods sold each time a sale occurs.
Helpful Hint For control purposes, companies take a physical inventory count under the perpetual system, even though it is not needed to determine cost of goods sold.
PERIODIC SYSTEM
In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting period—that is, periodically. At that point, the company takes a physical inventory count to determine the cost of goods on hand.
To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:
1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.
Illustration 5-5 graphically compares the sequence of activities and the timing of the cost of goods sold computation under the two inventory systems.
Illustration 5-5
Comparing perpetual and periodic inventory systems
ADVANTAGES OF THE PERPETUAL SYSTEM
Companies that sell merchandise with high unit values, such as automobiles, furniture, and major home appliances, have traditionally used perpetual systems. The growing use of computers and electronic scanners has enabled many more companies to install perpetual inventory systems. The perpetual inventory system is so named because the accounting records continuously—perpetually—show the quantity and cost of the inventory that should be on hand at any time.
A perpetual inventory system provides better control over inventories than a periodic system. Since the inventory records show the quantities that should be on hand, the company can count the goods at any time to see whether the amount of goods actually on hand agrees with the inventory records. If shortages are uncovered, the company can investigate immediately. Although a perpetual inventory system requires additional clerical work and additional cost to maintain the subsidiary records, a computerized system can minimize this cost. Much of Amazon.com's success is attributed to its sophisticated inventory system.
Some businesses find it either unnecessary or uneconomical to invest in a sophisticated, computerized perpetual inventory system such as Amazon's. Many small merchandising businesses find that basic computerized accounting packages provide some of the essential benefits of a perpetual inventory system. Also, managers of some small businesses still find that they can control their merchandise and manage day-to-day operations using a periodic inventory system.
Because of the widespread use of the perpetual inventory system, we illustrate it in this chapter. Appendix 5B describes the journal entries for the periodic system.
INVESTOR INSIGHT
Morrow Snowboards Improves Its Stock Appeal 
Investors are often eager to invest in a company that has a hot new product. However, when snowboard-maker Morrow Snowboards, Inc. issued shares of stock to the public for the first time, some investors expressed reluctance to invest in Morrow because of a number of accounting control problems. To reduce investor concerns, Morrow implemented a perpetual inventory system to improve its control over inventory. In addition, it stated that it would perform a physical inventory count every quarter until it felt that the perpetual inventory system was reliable.
If a perpetual system keeps track of inventory on a daily basis, why do companies ever need to do a physical count? (See page 270.)
Recording Purchases of Merchandise
Companies purchase inventory using cash or credit (on account). They normally record purchases when they receive the goods from the seller. Every purchase should be supported by business documents that provide written evidence of the transaction. Each cash purchase should be supported by a canceled check or a cash register receipt indicating the items purchased and amounts paid. Companies record cash purchases by an increase in Inventory and a decrease in Cash.
A purchase invoice should support each credit purchase. This invoice indicates the total purchase price and other relevant information. However, the purchaser does not prepare a separate purchase invoice. Instead, the purchaser uses as a purchase invoice a copy of the sales invoice sent by the seller. In Illustration 5-6 (page 222), for example, Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply (the seller).
Sauk Stereo makes the following journal entry to record its purchase from PW Audio Supply. The entry increases (debits) Inventory and increases (credits) Accounts Payable.
Illustration 5-6
Sales invoice used as purchase invoice by Sauk Stereo
Helpful Hint To better understand the contents of this invoice, identify these items:
1. Seller
2. Invoice date
3. Purchaser
4. Salesperson
5. Credit terms
6. Freight terms
7. Goods sold: catalog number, description, quantity, price per unit
8. Total invoice amount
Under the perpetual inventory system, companies record purchases of merchandise for sale in the Inventory account. Thus, REI would increase (debit) Inventory for clothing, sporting goods, and anything else purchased for resale to customers.
Not all purchases are debited to Inventory, however. Companies record purchases of assets acquired for use and not for resale, such as supplies, equipment, and similar items, as increases to specific asset accounts rather than to Inventory. For example, to record the purchase of materials used to make shelf signs or for cash register receipt paper, REI would increase (debit) Supplies.
Freight Costs
The sales agreement should indicate who—the seller or the buyer—is to pay for transporting the goods to the buyer's place of business. When a common carrier such as a railroad, trucking company, or airline transports the goods, the carrier prepares a freight bill in accord with the sales agreement.
Freight terms are expressed as either FOB shipping point or FOB destination. The letters FOB mean free on board. Thus, FOB shipping point means that the seller places the goods free on board the carrier, and the buyer pays the freight costs. Conversely, FOB destination means that the seller places the goods free on board to the buyer's place of business, and the seller pays the freight. For example, the sales invoice in Illustration 5-6 indicates FOB shipping point. Thus, the buyer (Sauk Stereo) pays the freight charges. Illustration 5-7 (on the next page) illustrates these shipping terms.
Illustration 5-7
Shipping terms
FREIGHT COSTS INCURRED BY THE BUYER
When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory. Therefore, the buyer debits (increases) the Inventory account. For example, if Sauk Stereo (the buyer) pays Public Carrier Co. $150 for freight charges on May 6, the entry on Sauk Stereo's books is:
Thus, any freight costs incurred by the buyer are part of the cost of merchandise purchased. The reason: Inventory cost should include all costs to acquire the inventory, including freight necessary to deliver the goods to the buyer. Companies recognize these costs as cost of goods sold when inventory is sold.
FREIGHT COSTS INCURRED BY THE SELLER
In contrast, freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. These costs increase an expense account titled Freight-Out (sometimes called Delivery Expense). For example, if the freight terms on the invoice in Illustration 5-6 had required PW Audio Supply (the seller) to pay the freight charges, the entry by PW Audio Supply would be:
When the seller pays the freight charges, the seller will usually establish a higher invoice price for the goods to cover the shipping expense.
Purchase Returns and Allowances
A purchaser may be dissatisfied with the merchandise received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser's specifications. In such cases, the purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. This transaction is known as a purchase return. Alternatively, the purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) from the purchase price. This transaction is known as a purchase allowance.
Assume that Sauk Stereo returned goods costing $300 to PW Audio Supply on May 8. The following entry by Sauk Stereo for the returned merchandise decreases (debits) Accounts Payable and decreases (credits) Inventory.
Because Sauk Stereo increased Inventory when the goods were received, Inventory is decreased when Sauk Stereo returns the goods.
Suppose instead that Sauk Stereo chose to keep the goods after being granted a $50 allowance (reduction in price). It would reduce (debit) Accounts Payable and reduce (credit) Inventory for $50.
Purchase Discounts
The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. This incentive offers advantages to both parties. The purchaser saves money, and the seller is able to shorten the operating cycle by converting the accounts receivable into cash.
Helpful Hint The term net in “net 30” means the remaining amount due after subtracting any sales returns and allowances and partial payments.
Credit terms specify the amount of the cash discount and time period in which it is offered. They also indicate the time period in which the purchaser is expected to pay the full invoice price. In the sales invoice in Illustration 5-6 (page 222), credit terms are 2/10, n/30, which is read “two-ten, net thirty.” This means that the buyer may take a 2% cash discount on the invoice price, less (“net of”) any returns or allowances, if payment is made within 10 days of the invoice date (the discount period). Otherwise, the invoice price, less any returns or allowances, is due 30 days from the invoice date.
Alternatively, the discount period may extend to a specified number of days following the month in which the sale occurs. For example, 1/10 EOM (end of month) means that a 1% discount is available if the invoice is paid within the first 10 days of the next month.
When the seller elects not to offer a cash discount for prompt payment, credit terms will specify only the maximum time period for paying the balance due. For example, the invoice may state the time period as n/30, n/60, or n/10 EOM. This means, respectively, that the buyer must pay the net amount in 30 days, 60 days, or within the first 10 days of the next month.
When the buyer pays an invoice within the discount period, the amount of the discount decreases Inventory. Why? Because companies record inventory at cost and, by paying within the discount period, the buyer has reduced its cost. To illustrate, 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. The cash discount is $70 ($3,500 × 2%), and Sauk Stereo pays $3,430 ($3,500 − $70). The entry Sauk Stereo makes to record its May 14 payment decreases (debits) Accounts Payable by the amount of the gross invoice price, reduces (credits) Inventory by the $70 discount, and reduces (credits) Cash by the net amount owed.
If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, it would debit Accounts Payable and credit Cash for $3,500 each.
A merchandising company usually should take all available discounts. Passing up the discount may be viewed as paying interest for use of the money. For example, passing up the discount offered by PW Audio Supply would be comparable to Sauk Stereo paying an interest rate of 2% for the use of $3,500 for 20 days. This is the equivalent of an annual interest rate of approximately 36.5% (2% × 365/20). Obviously, it would be better for Sauk Stereo to borrow at prevailing bank interest rates of 6% to 10% than to lose the discount.
Summary of Purchasing Transactions
The following T-account (with transaction descriptions in red) provides a summary of the effect of the previous transactions on Inventory. Sauk Stereo originally purchased $3,800 worth of inventory for resale. It then returned $300 of goods. It paid $150 in freight charges, and finally, it received a $70 discount off the balance owed because it paid within the discount period. This results in a balance in Inventory of $3,580.
DO IT!
Purchase Transactions
On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200. Record the transactions on the books of De La Hoya Company.
Action Plan
Purchaser records goods at cost.
When goods are returned, purchaser reduces Inventory.
Solution
Related exercise material: BE5-2, BE5-4, E5-2, E5-3, E5-4, and DO IT! 5-1.
Recording Sales of Merchandise
In accordance with the revenue recognition principle, companies record sales revenue when the performance obligation is satisfied. Typically, the performance obligation is satisfied when the goods transfer from the seller to the buyer. At this point, the sales transaction is complete and the sales price established.
Sales may be made on credit or for cash. A business document should support every sales transaction, to provide written evidence of the sale. Cash register documents provide evidence of cash sales. A sales invoice, like the one shown in Illustration 5-6 (page 222), provides support for a credit sale. The original copy of the invoice goes to the customer, and the seller keeps a copy for use in recording the sale. The invoice shows the date of sale, customer name, total sales price, and other relevant information.
The seller makes two entries for each sale. The first entry records the sale: The seller increases (debits) Cash (or Accounts Receivable, if a credit sale) and also increases (credits) Sales Revenue. The second entry records the cost of the merchandise sold: The seller increases (debits) Cost of Goods Sold and also decreases (credits) Inventory for the cost of those goods. As a result, the Inventory account will show at all times the amount of inventory that should be on hand.
To illustrate a credit sales transaction, PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo (see Illustration 5-6) as follows (assume the merchandise cost PW Audio Supply $2,400).
For internal decision-making purposes, merchandising companies may use more than one sales account. For example, PW Audio Supply may decide to keep separate sales accounts for its sales of TV sets, DVD recorders, and microwave ovens. REI might use separate accounts for camping gear, children's clothing, and ski equipment—or it might have even more narrowly defined accounts. By using separate sales accounts for major product lines, rather than a single combined sales account, company management can more closely monitor sales trends and respond more strategically to changes in sales patterns. For example, if TV sales are increasing while microwave oven sales are decreasing, PW Audio Supply might reevaluate both its advertising and pricing policies on these items to ensure they are optimal.
On its income statement presented to outside investors, a merchandising company normally would provide only a single sales figure—the sum of all of its individual sales accounts. This is done for two reasons. First, providing detail on all of its individual sales accounts would add considerable length to its income statement. Second, companies do not want their competitors to know the details of their operating results. However, Microsoft recently expanded its disclosure of revenue from three to five types. The reason: The additional categories enabled financial statement users to better evaluate the growth of the company's consumer and Internet businesses.
Ethics Note
Many companies are trying to improve the quality of their financial reporting. For example, General Electric now provides more detail on its revenues and operating profits.
ANATOMY OF A FRAUD1
Holly Harmon was a cashier at a national superstore for only a short while when she began stealing merchandise using three methods. Under the first method, her husband or friends took UPC labels from cheaper items and put them on more expensive items. Holly then scanned the goods at the register. Using the second method Holly scanned an item at the register but then voided the sale and left the merchandise in the shopping cart. A third approach was to put goods into large plastic containers. She scanned the plastic containers but not the goods within them. One day, Holly did not call in sick or show up for work. In such instances, the company reviews past surveillance tapes to look for suspicious activity by employees. This enabled the store to observe the thefts and to identify the participants.
Total take: $12,000
THE MISSING CONTROLS
Human resource controls. A background check would have revealed Holly's previous criminal record. She would not have been hired as a cashier.
Physical controls. Software can flag high numbers of voided transactions or a high number of sales of low-priced goods. Random comparisons of video records with cash register records can ensure that the goods reported as sold on the register are the same goods that are shown being purchased on the video recording. Finally, employees should be aware that they are being monitored.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 251–259.
At the end of “Anatomy of a Fraud” stories, which describe some recent real-world frauds, we discuss the missing control activity that would likely have prevented or uncovered the fraud.
Sales Returns and Allowances
We now look at the “flip side” of purchase returns and allowances, which the seller records as sales returns and allowances. These are transactions where the seller either accepts goods back from the buyer (a return) or grants a reduction in the purchase price (an allowance) so the buyer will keep the goods. PW Audio Supply's entries to record credit for returned goods involve (1) an increase (debit) in Sales Returns and Allowances (a contra account to Sales Revenue) and a decrease (credit) in Accounts Receivable at the $300 selling price, and (2) an increase (debit) in Inventory (assume a $140 cost) and a decrease (credit) in Cost of Goods Sold, as shown below (assuming that the goods were not defective).
If Sauk Stereo returns goods because they are damaged or defective, then PW Audio Supply's entry to Inventory and Cost of Goods Sold should be for the fair value of the returned goods, rather than their cost. For example, if the returned goods were defective and had a fair value of $50, PW Audio Supply would debit Inventory for $50 and credit Cost of Goods Sold for $50.
What happens if the goods are not returned but the seller grants the buyer an allowance by reducing the purchase price? In this case, the seller debits Sales Returns and Allowances and credits Accounts Receivable for the amount of the allowance. An allowance has no impact on Inventory or Cost of Goods Sold.
As mentioned above, Sales Returns and Allowances is a contra revenue account to Sales Revenue. This means that it is offset against a revenue account on the income statement. The normal balance of Sales Returns and Allowances is a debit. Companies use a contra account, instead of debiting Sales Revenue, to disclose in the accounts and in the income statement the amount of sales returns and allowances. Disclosure of this information is important to management. Excessive returns and allowances may suggest problems—inferior merchandise, inefficiencies in filling orders, errors in billing customers, or delivery or shipment mistakes. Moreover, a decrease (debit) recorded directly to Sales Revenue would obscure the relative importance of sales returns and allowances as a percentage of sales. It also could distort comparisons between total sales in different accounting periods.
ACCOUNTING ACROSS THE ORGANIZATION 
Should Costco Change Its Return Policy?
In most industries, sales returns are relatively minor. But returns of consumer electronics can really take a bite out of profits. Recently, the marketing executives at Costco Wholesale Corp. faced a difficult decision. Costco has always prided itself on its generous return policy. Most goods have had an unlimited grace period for returns. A new policy will require that certain electronics must be returned within 90 days of their purchase. The reason? The cost of returned products such as high-definition TVs, computers, and iPods cut an estimated 8¢ per share off Costco's earnings per share, which was $2.30.
Source: Kris Hudson, “Costco Tightens Policy on Returning Electronics,” Wall Street Journal (February 27, 2007), p. B4.
If a company expects significant returns, what are the implications for revenue recognition? (See page 270.)
Sales Discounts
As mentioned in our discussion of purchase transactions, the seller may offer the customer a cash discount—called by the seller a sales discount—for the prompt payment of the balance due. Like a purchase discount, a sales discount is based on the invoice price less returns and allowances, if any. The seller increases (debits) the Sales Discounts account for discounts that are taken. For example, PW Audio Supply makes the following entry to record the cash receipt on May 14 from Sauk Stereo within the discount period.
Like Sales Returns and Allowances, Sales Discounts is a contra revenue account to Sales Revenue. Its normal balance is a debit. PW Audio Supply uses this account, instead of debiting Sales Revenue, to disclose the amount of cash discounts taken by customers. If Sauk Stereo does not take the discount, PW Audio Supply increases (debits) Cash for $3,500 and decreases (credits) Accounts Receivable for the same amount at the date of collection.
The following T-accounts summarize the three sales-related transactions and show their combined effect on net sales.
PEOPLE, PLANET, AND PROFIT INSIGHT 
Selling Green
Here is a question an executive of PepsiCo was asked: Should PepsiCo market green? The executive indicated that the company should, as he believes it's the No. 1 thing consumers all over the world care about. Here are some of his thoughts on this issue:
“Sun Chips are part of the food business I run. It's a ‘healthy snack.’ We decided that Sun Chips, if it's a healthy snack, should be made in facilities that have a net-zero footprint. In other words, I want off the electric grid everywhere we make Sun Chips. We did that. Sun Chips should be made in a facility that puts back more water than it uses. It does that. And we partnered with our suppliers and came out with the world's first compostable chip package.
Now, there was an issue with this package: It was louder than the New York subway, louder than jet engines taking off. What would a company that's committed to green do: walk away or stay committed? If your people are passionate, they're going to fix it for you as long as you stay committed. Six months later, the compostable bag has half the noise of our current package.
So the view today is: we should market green, we should be proud to do it … it has to be a 360-degree process, both internal and external. And if you do that, you can monetize environmental sustainability for the shareholders.”
Source: “Four Problems—and Solutions,” Wall Street Journal (March 7, 2011), p. R2.
What is meant by “monetize environmental sustainability” for shareholders? (See page 270.)
DO IT!
Sales Transactions
On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200 and a fair value of $30. Record the transactions on the books of Junot Diaz Company.
Action Plan
Seller records both the sale and the cost of goods sold at the time of the sale.
When goods are returned, the seller records the return in a contra account, Sales Returns and Allowances, and reduces Accounts Receivable.
Any goods returned increase Inventory and reduce Cost of Goods Sold. Defective or damaged inventory is recorded at fair value (scrap value).
Solution
Related exercise material: BE5-2, BE5-3, E5-3, E5-4, E5-5, and DO IT! 5-2.
Completing the Accounting Cycle
Up to this point, we have illustrated the basic entries for transactions relating to purchases and sales in a perpetual inventory system. Now we consider the remaining steps in the accounting cycle for a merchandising company. Each of the required steps described in Chapter 4 for service companies apply to merchandising companies. Appendix 5A to this chapter shows use of a worksheet by a merchandiser (an optional step).
Adjusting Entries
A merchandising company generally has the same types of adjusting entries as a service company. However, a merchandiser using a perpetual system will require one additional adjustment to make the records agree with the actual inventory on hand. Here's why: At the end of each period, for control purposes, a merchandising company that uses a perpetual system will take a physical count of its goods on hand. The company's unadjusted balance in Inventory usually does not agree with the actual amount of inventory on hand. The perpetual inventory records may be incorrect due to recording errors, theft, or waste. Thus, the company needs to adjust the perpetual records to make the recorded inventory amount agree with the inventory on hand. This involves adjusting Inventory and Cost of Goods Sold.
For example, suppose that PW Audio Supply has an unadjusted balance of $40,500 in Inventory. Through a physical count, PW Audio Supply determines that its actual merchandise inventory at year-end is $40,000. The company would make an adjusting entry as follows.
Closing Entries
A merchandising company, like a service company, closes to Income Summary all accounts that affect net income. In journalizing, the company credits all temporary accounts with debit balances, and debits all temporary accounts with credit balances, as shown below for PW Audio Supply. Note that PW Audio Supply closes Cost of Goods Sold to Income Summary.
Helpful Hint The easiest way to prepare the first two closing entries is to identify the temporary accounts by their balances and then prepare one entry for the credits and one for the debits.
After PW Audio Supply has posted the closing entries, all temporary accounts have zero balances. Also, Owner's Capital has a balance that is carried over to the next period.
Summary of Merchandising Entries
Illustration 5-8 summarizes the entries for the merchandising accounts using a perpetual inventory system.
Illustration 5-8
Daily recurring and adjusting and closing entries
DO IT!
Closing Entries
The trial balance of Celine's Sports Wear Shop at December 31 shows Inventory $25,000, Sales Revenue $162,400, Sales Returns and Allowances $4,800, Sales Discounts $3,600, Cost of Goods Sold $110,000, Rent Revenue $6,000, Freight-Out $1,800, Rent Expense $8,800, and Salaries and Wages Expense $22,000. Prepare the closing entries for the above accounts.
Action Plan
Close all temporary accounts with credit balances to Income Summary by debiting these accounts.
Close all temporary accounts with debit balances, except drawings, to Income Summary by crediting these accounts.
Solution
Related exercise material: BE5-5, BE5-6, E5-6, E5-7, E5-8, and DO IT! 5-3.
Forms of Financial Statements
Merchandising companies widely use the classified balance sheet introduced in Chapter 4 and one of two forms for the income statement. This section explains the use of these financial statements by merchandisers.
Multiple-Step Income Statement
The multiple-step income statement is so named because it shows several steps in determining net income. Two of these steps relate to the company's principal operating activities. A multiple-step statement also distinguishes between operating and nonoperating activities. Finally, the statement also highlights intermediate components of income and shows subgroupings of expenses.
INCOME STATEMENT PRESENTATION OF SALES
The multiple-step income statement begins by presenting sales revenue. It then deducts contra revenue accounts—sales returns and allowances, and sales discounts—from sales revenue to arrive at net sales. Illustration 5-9 presents the sales revenues section for PW Audio Supply, using assumed data.
Illustration 5-9
Computation of net sales
GROSS PROFIT
From Illustration 5-1, you learned that companies deduct cost of goods sold from sales revenue to determine gross profit. For this computation, companies use net sales (which takes into consideration Sales Returns and Allowances and Sales Discounts) as the amount of sales revenue. On the basis of the sales data in Illustration 5-9 (net sales of $460,000) and cost of goods sold under the perpetual inventory system (assume $316,000), PW Audio Supply's gross profit is $144,000, computed as follows.
Alternative Terminology Gross profit is sometimes referred to as gross margin.
illustration 5-10
Computation of gross profit
We also can express a company's gross profit as a percentage, called the gross profit rate. To do so, we divide the amount of gross profit by net sales. For PW Audio Supply, the gross profit rate is 31.3%, computed as follows.
Illustration 5-11
Gross profit rate formula and computation
Analysts generally consider the gross profit rate to be more useful than the gross profit amount. The rate expresses a more meaningful (qualitative) relationship between net sales and gross profit. For example, a gross profit of $1,000,000 may sound impressive. But if it is the result of a gross profit rate of only 7%, it is not so impressive. The gross profit rate tells how many cents of each sales dollar go to gross profit.
Gross profit represents the merchandising profit of a company. It is not a measure of the overall profitability because operating expenses are not yet deducted. But managers and other interested parties closely watch the amount and trend of gross profit. They compare current gross profit with amounts reported in past periods. They also compare the company's gross profit rate with rates of competitors and with industry averages. Such comparisons provide information about the effectiveness of a company's purchasing function and the soundness of its pricing policies.
OPERATING EXPENSES AND NET INCOME
Operating expenses are the next component in measuring net income for a merchandising company. They are the expenses incurred in the process of earning sales revenue. These expenses are similar in merchandising and service companies. At PW Audio Supply, operating expenses were $114,000. The company determines its net income by subtracting operating expenses from gross profit. Thus, net income is $30,000, as shown below.
Illustration 5-12
Operating expenses in computing net income
The net income amount is the so-called “bottom line” of a company's income statement.
NONOPERATING ACTIVITIES
Nonoperating activities consist of various revenues and expenses and gains and losses that are unrelated to the company's main line of operations. When nonoperating items are included, the label “Income from operations” (or “Operating income”) precedes them. This label clearly identifies the results of the company's normal operations, an amount determined by subtracting cost of goods sold and operating expenses from net sales. The results of nonoperating activities are shown in the categories “Other revenues and gains” and “Other expenses and losses.” Illustration 5-13 lists examples of each.
Illustration 5-13
Other items of nonoperating activities
Ethics Note
Companies manage earnings in various ways. ConAgra Foods recorded a non-recurring gain for $186 million from the sale of Pilgrim's Pride stock to help meet an earnings projection for the quarter.
Merchandising companies report the nonoperating activities in the income statement immediately after the company's operating activities. Illustration 5-14 shows these sections for PW Audio Supply, using assumed data.
The distinction between operating and nonoperating activities is crucial to many external users of financial data. These users view operating income as sustainable and many nonoperating activities as non-recurring. Therefore, when forecasting next year's income, analysts put the most weight on this year's operating income, and less weight on this year's nonoperating activities.
Illustration 5-14
Multiple-step income statement
ETHICS INSIGHT 
Disclosing More Details
After Enron, increased investor criticism and regulator scrutiny forced many companies to improve the clarity of their financial disclosures. For example, IBM began providing more detail regarding its “Other gains and losses.” It had previously included these items in its selling, general, and administrative expenses, with little disclosure.
Disclosing other gains and losses in a separate line item on the income statement will not have any effect on bottom-line income. However, analysts complained that burying these details in the selling, general, and administrative expense line reduced their ability to fully understand how well IBM was performing. For example, previously if IBM sold off one of its buildings at a gain, it would include this gain in the selling, general and administrative expense line item, thus reducing that expense. This made it appear that the company had done a better job of controlling operating expenses than it actually had.
As another example, when eBay recently sold the remainder of its investment in Skype to Microsoft, it reported a gain in “Other revenues and gains” of $1.7 billion. Since eBay's total income from operations was $2.4 billion, it was very important that the gain from the Skype sale not be buried in operating income.
Why have investors and analysts demanded more accuracy in isolating “Other gains and losses” from operating items? (See page 270.)
Single-Step Income Statement
Another income statement format is the single-step income statement. The statement is so named because only one step—subtracting total expenses from total revenues—is required in determining net income.
In a single-step statement, all data are classified into two categories: (1) revenues, which include both operating revenues and other revenues and gains; and (2) expenses, which include cost of goods sold, operating expenses, and other expenses and losses. Illustration 5-15 shows a single-step statement for PW Audio Supply.
Illustration 5-15
Single-step income statement
There are two primary reasons for using the single-step format. (1) A company does not realize any type of profit or income until total revenues exceed total expenses, so it makes sense to divide the statement into these two categories. (2) The format is simpler and easier to read. For homework problems, however, you should use the single-step format only when specifically instructed to do so.
Classified Balance Sheet
In the balance sheet, merchandising companies report inventory as a current asset immediately below accounts receivable. Recall from Chapter 4 that companies generally list current asset items in the order of their closeness to cash (liquidity). Inventory is less close to cash than accounts receivable because the goods must first be sold and then collection made from the customer. Illustration 5-16 presents the assets section of a classified balance sheet for PW Audio Supply.
Illustration 5-16
Assets section of a classified balance sheet
Helpful Hint The $40,000 is the cost of the inventory on hand, not its expected selling price.
Financial Statement Classifications
You are presented with the following list of accounts from the adjusted trial balance for merchandiser Gorman Company. Indicate in which financial statement and under what classification each of the following would be reported.
| Accounts Payable | Interest Payable |
| Accounts Receivable | Inventory |
| Accumulated Depreciation—Buildings | Land |
| Accumulated Depreciation—Equipment | Notes Payable (due in 3 years) |
| Advertising Expense | Owner's Capital (beginning balance) |
| Buildings | Owner's Drawings |
| Cash | Property Taxes Payable |
| Depreciation Expense | Salaries and Wages Expense |
| Equipment | Salaries and Wages Payable |
| Freight-Out | Sales Returns and Allowances |
| Gain on Disposal of Plant Assets | Sales Revenue |
| Insurance Expense | Utilities Expense |
| Interest Expense |
Action Plan
Review the major sections of the income statement: sales revenues, cost of goods sold, operating expenses, other revenues and gains, and other expenses and losses.
Add net income and investments to beginning capital and deduct drawings to arrive at ending capital in the owner's equity statement.
Review the major sections of the balance sheet, income statement, and owner's equity statement.
Solution
Related exercise material: BE5-7, BE5-8, BE5-9, E5-9, E5-10, E5-12, E5-13, E5-14, and DO IT! 5-4.
The adjusted trial balance columns of Falcetto Company's worksheet for the year ended December 31, 2014, are as follows.
Action Plan
Remember that the key components of the income statement are net sales, cost of goods sold, gross profit, total operating expenses, and net income (loss). Report these components in the right-hand column of the income statement.
Put nonoperating items after income from operations.
Instructions
Prepare a multiple-step income statement for Falcetto Company.
Solution to Comprehensive DO IT!
SUMMARY OF LEARNING OBJECTIVES
1 Identify the differences between service and merchandising companies. Because of inventory, a merchandising company has sales revenue, cost of goods sold, and gross profit. To account for inventory, a merchandising company must choose between a perpetual and a periodic inventory system.
2 Explain the recording of purchases under a perpetual inventory system. The company debits the Inventory account for all purchases of merchandise and freight-in, and credits it for purchase discounts and purchase returns and allowances.
3 Explain the recording of sales revenues under a perpetual inventory system. When a merchandising company sells inventory, it debits Accounts Receivable (or Cash) and credits Sales Revenue for the selling price of the merchandise. At the same time, it debits Cost of Goods Sold and credits Inventory for the cost of the inventory items sold. Sales Returns and Allowances and Sales Discounts are debited and are contra revenue accounts.
4 Explain the steps in the accounting cycle for a merchandising company. Each of the required steps in the accounting cycle for a service company applies to a merchandising company. A worksheet is again an optional step. Under a perpetual inventory system, the company must adjust the Inventory account to agree with the physical count.
5 Distinguish between a multiple-step and a single-step income statement. A multiple-step income statement shows numerous steps in determining net income, including nonoperating activities sections. A single-step income statement classifies all data under two categories, revenues or expenses, and determines net income in one step.
GLOSSARY
Contra revenue account An account that is offset against a revenue account on the income statement. (p. 228).
Cost of goods sold The total cost of merchandise sold during the period. (p. 218).
FOB destination Freight terms indicating that the seller places the goods free on board to the buyer's place of business, and the seller pays the freight. (p. 222).
FOB shipping point Freight terms indicating that the seller places goods free on board the carrier, and the buyer pays the freight costs. (p. 222).
Gross profit The excess of net sales over the cost of goods sold. (p. 233).
Gross profit rate Gross profit expressed as a percentage, by dividing the amount of gross profit by net sales. (p. 233).
Income from operations Income from a company's principal operating activity; determined by subtracting cost of goods sold and operating expenses from net sales. (p. 234).
Multiple-step income statement An income statement that shows several steps in determining net income. (p. 232).
Net sales Sales revenue less sales returns and allowances and less sales discounts. (p. 233).
Nonoperating activities Various revenues, expenses, gains, and losses that are unrelated to a company's main line of operations. (p. 234).
Operating expenses Expenses incurred in the process of earning sales revenue. (p. 234).
Other expenses and losses A nonoperating-activities section of the income statement that shows expenses and losses unrelated to the company's main line of operations. (p. 234).
Other revenues and gains A nonoperating-activities section of the income statement that shows revenues and gains unrelated to the company's main line of operations. (p. 234).
Periodic inventory system An inventory system under which the company does not keep detailed inventory records throughout the accounting period but determines the cost of goods sold only at the end of an accounting period. (p. 220).
Perpetual inventory system An inventory system under which the company keeps detailed records of the cost of each inventory purchase and sale, and the records continuously show the inventory that should be on hand. (p. 219).
Purchase allowance A deduction made to the selling price of merchandise, granted by the seller so that the buyer will keep the merchandise. (p. 223).
Purchase discount A cash discount claimed by a buyer for prompt payment of a balance due. (p. 224).
Purchase invoice A document that supports each credit purchase. (p. 221).
Purchase return A return of goods from the buyer to the seller for a cash or credit refund. (p. 223).
Sales discount A reduction given by a seller for prompt payment of a credit sale. (p. 228).
Sales invoice A document that supports each credit sale.(p. 226).
Sales returns and allowances Purchase returns and allowances from the seller's perspective. See Purchase return and Purchase allowance, above. (p. 227).
Sales revenue (Sales) The primary source of revenue in a merchandising company. (p. 218).
Single-step income statement An income statement that shows only one step in determining net income. (p. 236).
APPENDIX 5A Worksheet for a Merchandising Company—Perpetual Inventory
Using a Worksheet
As indicated in Chapter 4, a worksheet enables companies to prepare financial statements before they journalize and post adjusting entries. The steps in preparing a worksheet for a merchandising company are the same as for a service company (see pages 163–165). Illustration 5A-1 shows the worksheet for PW Audio Supply (excluding nonoperating items). The unique accounts for a merchandiser using a perpetual inventory system are in red.
Illustration 5A-1
Worksheet for merchandising company—perpetual inventory system
TRIAL BALANCE COLUMNS
Data for the trial balance come from the ledger balances of PW Audio Supply at December 31. The amount shown for Inventory, $40,500, is the year-end inventory amount from the perpetual inventory system.
ADJUSTMENTS COLUMNS
A merchandising company generally has the same types of adjustments as a service company. As you see in the worksheet, adjustments (b), (c), and (d) are for insurance, depreciation, and salaries. Pioneer Advertising Agency, as illustrated in Chapters 3 and 4, also had these adjustments. Adjustment (a) was required to adjust the perpetual inventory carrying amount to the actual count.
After PW Audio Supply enters all adjustments data on the worksheet, it establishes the equality of the adjustments column totals. It then extends the balances in all accounts to the adjusted trial balance columns.
ADJUSTED TRIAL BALANCE
The adjusted trial balance shows the balance of all accounts after adjustment at the end of the accounting period.
INCOME STATEMENT COLUMNS
Next, the merchandising company transfers the accounts and balances that affect the income statement from the adjusted trial balance columns to the income statement columns. PW Audio Supply shows Sales Revenue of $480,000 in the credit column. It shows the contra revenue accounts Sales Returns and Allowances $12,000 and Sales Discounts $8,000 in the debit column. The difference of $460,000 is the net sales shown on the income statement (Illustration 5-14, page 235).
Finally, the company totals all the credits in the income statement column and compares those totals to the total of the debits in the income statement column. If the credits exceed the debits, the company has net income. PW Audio Supply has net income of $30,000. If the debits exceed the credits, the company would report a net loss.
BALANCE SHEET COLUMNS
The major difference between the balance sheets of a service company and a merchandiser is inventory. PW Audio Supply shows the ending inventory amount of $40,000 in the balance sheet debit column. The information to prepare the owner's equity statement is also found in these columns. That is, the Owner's Capital account is $83,000. Owner's Drawings are $15,000. Net income results when the total of the debit column exceeds the total of the credit column in the balance sheet columns. A net loss results when the total of the credits exceeds the total of the debit balances.
SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 5A
6 Prepare a worksheet for a merchandising company. The steps in preparing a worksheet for a merchandising company are the same as for a service company. The unique accounts for a merchandiser are Inventory, Sales Revenue, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold.
APPENDIX 5B Periodic Inventory System
As described in this chapter, companies may use one of two basic systems of accounting for inventories: (1) the perpetual inventory system or (2) the periodic inventory system. In the chapter, we focused on the characteristics of the perpetual inventory system. In this appendix, we discuss and illustrate the periodic inventory system. One key difference between the two systems is the point at which the company computes cost of goods sold. For a visual reminder of this difference, refer back to Illustration 5-5 (on page 220).
Explain the recording of purchases and sales of inventory under a periodic inventory system.
Determining Cost of Goods Sold Under a Periodic System
Determining cost of goods sold is different when a periodic inventory system is used rather than a perpetual system. As you have seen, a company using a perpetual system makes an entry to record cost of goods sold and to reduce inventory each time a sale is made. A company using a periodic system does not determine cost of goods sold until the end of the period. At the end of the period, the company performs a count to determine the ending balance of inventory. It then calculates cost of goods sold by subtracting ending inventory from the goods available for sale. Goods available for sale is the sum of beginning inventory plus purchases, as shown in Illustration 5B-1.
Illustration 5B-1
Basic formula for cost of goods sold using the periodic system
Another difference between the two approaches is that the perpetual system directly adjusts the Inventory account for any transaction that affects inventory (such as freight costs, returns, and discounts). The periodic system does not do this. Instead, it creates different accounts for purchases, freight costs, returns, and discounts. These various accounts are shown in Illustration 5B-2, which presents the calculation of cost of goods sold for PW Audio Supply using the periodic approach.
Illustration 5B-2
Cost of goods sold for a merchandiser using a periodic inventory system
Helpful Hint The far right column identifies the primary items that make up cost of goods sold of $316,000. The middle column explains cost of goods purchased of $320,000. The left column reports contra purchase items of $17,200.
Note that the basic elements from Illustration 5B-1 are highlighted in Illustration 5B-2. You will learn more in Chapter 6 about how to determine cost of goods sold using the periodic system.
The use of the periodic inventory system does not affect the form of presentation in the balance sheet. As under the perpetual system, a company reports inventory in the current assets section.
Recording Merchandise Transactions
In a periodic inventory system, companies record revenues from the sale of merchandise when sales are made, just as in a perpetual system. Unlike the perpetual system, however, companies do not attempt on the date of sale to record the cost of the merchandise sold. Instead, they take a physical inventory count at the end of the period to determine (1) the cost of the merchandise then on hand and (2) the cost of the goods sold during the period. And, under a periodic system, companies record purchases of merchandise in the Purchases account rather than the Inventory account. Also, in a periodic system, purchase returns and allowances, purchase discounts, and freight costs on purchases are recorded in separate accounts.
To illustrate the recording of merchandise transactions under a periodic inventory system, we will use purchase/sale transactions between PW Audio Supply and Sauk Stereo, as illustrated for the perpetual inventory system in this chapter.
Recording Purchases of Merchandise
On the basis of the sales invoice (Illustration 5-6, shown on page 222) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows.
Helpful Hint Be careful not to debit purchases of equipment or supplies to a Purchases account.
Purchases is a temporary account whose normal balance is a debit.
FREIGHT COSTS
When the purchaser directly incurs the freight costs, it debits the account Freight-In (or Transportation-In). For example, if Sauk Stereo pays Public Carrier Co. $150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk Stereo's books is:
Alternative Terminology Freight-In is also called Transportation-In.
Like Purchases, Freight-In is a temporary account whose normal balance is a debit. Freight-In is part of cost of goods purchased. The reason is that cost of goods purchased should include any freight charges necessary to bring the goods to the purchaser. Freight costs are not subject to a purchase discount. Purchase discounts apply only to the invoice cost of the merchandise.
PURCHASE RETURNS AND ALLOWANCES
Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return.
Purchase Returns and Allowances is a temporary account whose normal balance is a credit.
PURCHASE DISCOUNTS
On May 14, Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio Supply for payment within 10 days. Sauk Stereo records the payment and discount as follows.
Purchase Discounts is a temporary account whose normal balance is a credit.
Recording Sales of Merchandise
The seller, PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-6, page 222) as follows.
SALES RETURNS AND ALLOWANCES
To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows.
SALES DISCOUNTS
On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio Supply honors the 2% cash discount and records the payment of Sauk Stereo's account receivable in full as follows.
COMPARISON OF ENTRIES—PERPETUAL VS. PERIODIC
Illustration 5B-3 summarizes the periodic inventory entries shown in this appendix and compares them to the perpetual-system entries from the chapter. Entries that differ in the two systems are shown in color.
Illustration 5B-3
Comparison of entries for perpetual and periodic inventory systems
Journalizing and Posting Closing Entries
For a merchandising company, like a service company, all accounts that affect the determination of net income are closed to Income Summary. Data for the preparation of closing entries may be obtained from the income statement columns of the worksheet. In journalizing, all debit column amounts are credited, and all credit columns amounts are debited. To close the merchandise inventory in a periodic inventory system:
1. The beginning inventory balance is debited to Income Summary and credited to Inventory.
2. The ending inventory balance is debited to Inventory and credited to Income Summary.
The two entries for PW Audio Supply are:
After posting, the Inventory and Income Summary accounts will show the following.
Illustration 5B-4
Posting closing entries for merchandise inventory
Often, the closing of inventory is included with other closing entries, as shown below for PW Audio Supply.
Helpful Hint Except for merchandise inventory, the easiest way to prepare the first two closing entries is to identify the temporary accounts by their balances and then prepare one entry for the credits and one for the debits.
Helpful Hint Close inventory with other accounts in homework problems unless stated otherwise.
After the closing entries are posted, all temporary accounts have zero balances. In addition, Owner's Capital has a credit balance of $98,000: beginning balance + net income − drawings ($83,000 + $30,000 − $15,000).
Using a Worksheet
As indicated in Chapter 4, a worksheet enables companies to prepare financial statements before journalizing and posting adjusting entries. The steps in preparing a worksheet for a merchandising company are the same as they are for a service company (see pages 163–165).
TRIAL BALANCE COLUMNS
Data for the trial balance come from the ledger balances of PW Audio Supply at December 31. The amount shown for Inventory, $36,000, is the beginning inventory amount from the periodic inventory system.
ADJUSTMENTS COLUMNS
A merchandising company generally has the same types of adjustments as a service company. As you see in the worksheet in Illustration 5B-5, adjustments (a), (b), and (c) are for insurance, depreciation, and salaries and wages. These adjustments were also required for Pioneer Advertising Agency, as illustrated in Chapters 3 and 4. The unique accounts for a merchandiser using a periodic inventory system are shown in capital red letters. Note, however, that the worksheet excludes nonoperating items.
After all adjustment data are entered on the worksheet, the equality of the adjustment column totals is established. The balances in all accounts are then extended to the adjusted trial balance columns.
Illustration 5B-5
Worksheet for merchandising company—periodic inventory system
INCOME STATEMENT COLUMNS
Next, PW Audio Supply transfers the accounts and balances that affect the income statement from the adjusted trial balance columns to the income statements columns. The company shows Sales Revenue of $480,000 in the credit column. It shows the contra revenue accounts, Sales Returns and Allowances of $12,000 and Sales Discounts of $8,000 in the debit column. The difference of $460,000 is the net sales shown on the income statement (Illustration 5-9, page 233). Similarly, Purchases of $325,000 and Freight-In of $12,200 are extended to the debit column. The contra purchase accounts, Purchase Returns and Allowances of $10,400 and Purchase Discounts of $6,800, are extended to the credit columns.
The worksheet procedures for the Inventory account merit specific comment. The procedures are:
1. The beginning balance, $36,000, is extended from the adjusted trial balance column to the income statement debit column. From there it can be added in reporting cost of goods available for sale in the income statement.
2. The ending inventory, $40,000, is added to the worksheet by an income statement credit and a balance sheet debit. The credit makes it possible to deduct ending inventory from the cost of goods available for sale in the income statement to determine cost of goods sold. The debit means the ending inventory can be reported as an asset on the balance sheet.
These two procedures are specifically illustrated below:
Illustration 5B-6
Worksheet procedures for inventories
The computation for cost of goods sold, taken from the income statement column in Illustration 5B-5, is as follows.
Illustration 5B-7
Computation of cost of goods sold from worksheet columns
Helpful Hint In a periodic system, cost of goods sold is a computation—it is not a separate account with a balance.
Finally, PW Audio Supply totals all the credits in the income statement column and compares these totals to the total of the debits in the income statement column. If the credits exceed the debits, the company has net income. PW Audio Supply has net income of $30,000. If the debits exceed the credits, the company would report a net loss.
BALANCE SHEET COLUMNS
The major difference between the balance sheets of a service company and a merchandising company is inventory. PW Audio Supply shows ending inventory of $40,000 in the balance sheet debit column. The information to prepare the owner's equity statement is also found in these columns. That is, the Owner's Capital account is $83,000. Owner's Drawings are $15,000. Net income results when the total of the debit column exceeds the total of the credit column in the balance sheet columns. A net loss results when the total of the credits exceeds the total of the debit balances.
SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 5B
7 Explain the recording of purchases and sales of inventory under a periodic inventory system. In recording purchases under a periodic system, companies must make entries for (a) cash and credit purchases, (b) purchase returns and allowances, (c) purchase discounts, and (d) freight costs. In recording sales, companies must make entries for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales discounts.
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more components are available for practice in WileyPLUS.
*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.
SELF-TEST QUESTIONS
Answers are on page 271.
(LO 1)
1. Gross profit will result if:
(a) operating expenses are less than net income.
(b) sales revenues are greater than operating expenses.
(c) sales revenues are greater than cost of goods sold.
(d) operating expenses are greater than cost of goods sold.
(LO 2)
2. Under a perpetual inventory system, when goods are purchased for resale by a company:
(a) purchases on account are debited to Inventory.
(b) purchases on account are debited to Purchases.
(c) purchase returns are debited to Purchase Returns and Allowances.
(d) freight costs are debited to Freight-Out.
(LO 3)
3. The sales accounts that normally have a debit balance are:
(a) Sales Discounts.
(b) Sales Returns and Allowances.
(c) Both (a) and (b).
(d) Neither (a) nor (b).
(LO 3)
4. A credit sale of $750 is made on June 13, terms 2/10, net/30. A return of $50 is granted on June 16. The amount received as payment in full on June 23 is:
(a) $700.
(b) $686.
(c) $685.
(d) $650.
(LO 2)
5. Which of the following accounts will normally appear in the ledger of a merchandising company that uses a perpetual inventory system?
(a) Purchases.
(b) Freight-In.
(c) Cost of Goods Sold.
(d) Purchase Discounts.
(LO 3)
6. To record the sale of goods for cash in a perpetual inventory system:
(a) only one journal entry is necessary to record cost of goods sold and reduction of inventory.
(b) only one journal entry is necessary to record the receipt of cash and the sales revenue.
(c) two journal entries are necessary: one to record the receipt of cash and sales revenue, and one to record the cost of goods sold and reduction of inventory.
(d) two journal entries are necessary: one to record the receipt of cash and reduction of inventory, and one to record the cost of goods sold and sales revenue.
(LO 4)
7. The steps in the accounting cycle for a merchandising company are the same as those in a service company except:
(a) an additional adjusting journal entry for inventory may be needed in a merchandising company.
(b) closing journal entries are not required for a merchandising company.
(c) a post-closing trial balance is not required for a merchandising company.
(d) a multiple-step income statement is required for a merchandising company.
(LO 5)
8. The multiple-step income statement for a merchandising company shows each of the following features except:
(a) gross profit.
(b) cost of goods sold.
(c) a sales revenue section.
(d) an investing activities section.
(LO 5)
9. If sales revenues are $400,000, cost of goods sold is $310,000, and operating expenses are $60,000, the gross profit is:
(a) $30,000.
(b) $90,000.
(c) $340,000.
(d) $400,000.
(LO 5)
10. A single-step income statement:
(a) reports gross profit.
(b) does not report cost of goods sold.
(c) reports sales revenues and “Other revenues and gains” in the revenues section of the income statement.
(d) reports operating income separately.
(LO 5)
11. Which of the following appears on both a single-step and a multiple-step income statement?
(a) Inventory.
(b) Gross profit.
(c) Income from operations.
(d) Cost of goods sold.
*12. In a worksheet using a perpetual inventory system, Inventory is shown in the following columns:
(a) adjusted trial balance debit and balance sheet debit.
(b) income statement debit and balance sheet debit.
(c) income statement credit and balance sheet debit.
(d) income statement credit and adjusted trial balance debit.
(LO 7)
*13. In determining cost of goods sold in a periodic system:
(a) purchase discounts are deducted from net purchases.
(b) freight-out is added to net purchases.
(c) purchase returns and allowances are deducted from net purchases.
(d) freight-in is added to net purchases.
(LO 7)
*14. If beginning inventory is $60,000, cost of goods purchased is $380,000, and ending inventory is $50,000, cost of goods sold is:
(a) $390,000.
(b) $370,000.
(c) $330,000.
(d) $420,000.
(LO 7)
* 15. When goods are purchased for resale by a company using a periodic inventory system:
(a) purchases on account are debited to Inventory.
(b) purchases on account are debited to Purchases.
(c) purchase returns are debited to Purchase Returns and Allowances.
(d) freight costs are debited to Purchases.
Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.
QUESTIONS
1. (a) “The steps in the accounting cycle for a merchandising company are different from the accounting cycle for a service company.” Do you agree or disagree? (b) Is the measurement of net income for a merchandising company conceptually the same as for a service company? Explain.
2. Why is the normal operating cycle for a merchandising company likely to be longer than for a service company?
3. (a) How do the components of revenues and expenses differ between merchandising and service companies? (b) Explain the income measurement process in a merchandising company.
4. How does income measurement differ between a merchandising and a service company?
5. When is cost of goods sold determined in a perpetual inventory system?
6. Distinguish between FOB shipping point and FOB destination. Identify the freight terms that will result in a debit to Inventory by the buyer and a debit to Freight-Out by the seller.
7. Explain the meaning of the credit terms 2/10, n/30.
8. Goods costing $2,000 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit memo is received from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period using a perpetual inventory system.
9. Ming Xu believes revenues from credit sales may be recorded before they are collected in cash. Do you agree? Explain.
10. (a) What is the primary source document for recording (1) cash sales, (2) credit sales. (b) Using XXs for amounts, give the journal entry for each of the transactions in part (a).
11. A credit sale is made on July 10 for $900, terms 2/10, n/30. On July 12, $100 of goods are returned for credit. Give the journal entry on July 19 to record the receipt of the balance due within the discount period.
12. Explain why the Inventory account will usually require adjustment at year-end.
13. Prepare the closing entries for the Sales Revenue account, assuming a balance of $200,000 and the Cost of Goods Sold account with a $145,000 balance.
14. What merchandising account(s) will appear in the post-closing trial balance?
15. Minnick Co. has sales revenue of $105,000, cost of goods sold of $70,000, and operating expenses of $20,000. What is its gross profit and its gross profit rate?
16. Paul Scott Company reports net sales of $800,000, gross profit of $370,000, and net income of $240,000. What are its operating expenses?
17. Identify the distinguishing features of an income statement for a merchandising company.
18. Identify the sections of a multiple-step income statement that relate to (a) operating activities, and (b) nonoperating activities.
19. How does the single-step form of income statement differ from the multiple-step form?
20. Determine Apple's gross profit rate for 2011 and 2010. Indicate whether it increased or decreased from 2010 to 2011.
*21. Indicate the columns of the worksheet in a perpetual system in which (a) inventory and (b) cost of goods sold will be shown.
*22. Identify the accounts that are added to or deducted from Purchases in a periodic system to determine the cost of goods purchased. For each account, indicate whether it is added or deducted.
*23. Goods costing $3,000 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit was received from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period, assuming a periodic inventory system.
BRIEF EXERCISES
BE5-1 Presented below are the components in Gates Company's income statement. Determine the missing amounts.
Compute missing amounts in determining net income.
(LO 1)
BE5-2 Radomir Company buys merchandise on account from Lemke Company. The selling price of the goods is $780, and the cost of the goods is $470. Both companies use perpetual inventory systems. Journalize the transaction on the books of both companies.
Journalize perpetual inventory entries.
(LO 2, 3)
Journalize sales transactions.
(LO 3)
BE5-3 Prepare the journal entries to record the following transactions on Kwang Company's books using a perpetual inventory system.
(a) On March 2, Kwang Company sold $900,000 of merchandise to Sensat Company, terms 2/10, n/30. The cost of the merchandise sold was $620,000.
(b) On March 6, Sensat Company returned $90,000 of the merchandise purchased on March 2. The cost of the returned merchandise was $62,000.
(c) On March 12, Kwang Company received the balance due from Sensat Company.
BE5-4 From the information in BE5-3, prepare the journal entries to record these transactions on Sensat Company's books under a perpetual inventory system.
Journalize purchase transactions.
(LO 2)
BE5-5 At year-end, the perpetual inventory records of Litwin Company showed merchandise inventory of $98,000. The company determined, however, that its actual inventory on hand was $95,700. Record the necessary adjusting entry.
Prepare adjusting entry for inventory.
(LO 4)
BE5-6 Hudson Company has the following account balances: Sales Revenue $195,000, Sales Discounts $2,000, Cost of Goods Sold $117,000, and Inventory $40,000. Prepare the entries to record the closing of these items to Income Summary.
Prepare closing entries for accounts.
(LO 4)
BE5-7 Arndt Company provides the following information for the month ended October 31, 2014: sales on credit $280,000, cash sales $100,000, sales discounts $5,000, and sales returns and allowances $11,000. Prepare the sales revenues section of the income statement based on this information.
Prepare sales revenues section of income statement.
(LO 5)
BE5-8 
Explain where each of the following items would appear on (1) a multiple-step income statement, and on (2) a single-step income statement: (a) gain on sale of equipment, (b) interest expense, (c) casualty loss from vandalism, and (d) cost of goods sold.
Contrast presentation in multiple-step and single-step income statements.
(LO 5)
BE5-9 Assume Kader Company has the following reported amounts: Sales revenue $510,000, Sales returns and allowances $15,000, Cost of goods sold $330,000, and Operating expenses $110,000. Compute the following: (a) net sales, (b) gross profit, (c) income from operations, and (d) gross profit rate. (Round to one decimal place.)
Compute net sales, gross profit, income from operations, and gross profit rate.
(LO 5)
*BE5-10 Presented below is the format of the worksheet using the perpetual inventory system presented in Appendix 5A.
Identify worksheet columns for selected accounts.
(LO 6)
Indicate where the following items will appear on the worksheet: (a) Cash, (b) Inventory, (c) Sales revenue, and (d) Cost of goods sold.
Example:
Cash: Trial balance debit column; Adjusted trial balance debit column; and Balance sheet debit column.
*BE5-11 Assume that Gallant Company uses a periodic inventory system and has these account balances: Purchases $450,000; Purchase Returns and Allowances $13,000; Purchase Discounts $8,000; and Freight-In $16,000. Determine net purchases and cost of goods purchased.
Compute net purchases and cost of goods purchased.
(LO 7)
*BE5-12 Assume the same information as in BE5-11 and also that Gallant Company has beginning inventory of $60,000, ending inventory of $90,000, and net sales of $730,000. Determine the amounts to be reported for cost of goods sold and gross profit.
Compute cost of goods sold and gross profit.
(LO 7)
*BE5-13 Prepare the journal entries to record these transactions on Nimmer Company's books using a periodic inventory system.
(a) On March 2, Nimmer Company purchased $900,000 of merchandise from Sen Company, terms 2/10, n/30.
(b) On March 6, Nimmer Company returned $130,000 of the merchandise purchased on March 2.
(c) On March 12, Nimmer Company paid the balance due to Sen Company.
Journalize purchase transactions.
(LO 7)
*BE5-14 A. Hall Company has the following merchandise account balances: Sales Revenue $180,000, Sales Discounts $2,000, Purchases $120,000, and Purchases Returns and Allowances $30,000. In addition, it has a beginning inventory of $40,000 and an ending inventory of $30,000. Prepare the entries to record the closing of these items to Income Summary using the periodic inventory system.
Prepare closing entries for merchandise accounts.
(LO 7)
*BE5-15 Presented below is the format of the worksheet using the periodic inventory system presented in Appendix 5B.
Identify worksheet columns for selected accounts
(LO 7)
Indicate where the following items will appear on the worksheet: (a) cash, (b) beginning inventory, (c) accounts payable, (d) ending inventory.
Example
Cash: Trial balance debit column; Adjustment trial balance debit column; and Balance sheet debit column.
DO IT! Review
DO IT! 5-1 On October 5, Loomis Company buys merchandise on account from Brooke Company. The selling price of the goods is $5,000, and the cost to Brooke Company is $3,100. On October 8, Loomis returns defective goods with a selling price of $650 and a fair value of $100. Record the transactions on the books of Loomis Company.
Record transactions of purchasing company.
(LO 2)
DO IT! 5-2 Assume information similar to that in DO IT! 5-1: On October 5, Loomis Company buys merchandise on account from Brooke Company. The selling price of the goods is $5,000, and the cost to Brooke Company is $3,100. On October 8, Loomis returns defective goods with a selling price of $650 and a fair value of $100. Record the transactions on the books of Brooke Company.
Record transactions of selling company.
(LO 3)
DO IT! 5-3 The trial balance of Optique Boutique at December 31 shows Inventory $21,000, Sales Revenue $156,000, Sales Returns and Allowances $4,000, Sales Discounts $3,000, Cost of Goods Sold $92,400, Interest Revenue $5,000, Freight-Out $1,500, Utilities Expense $7,400, and Salaries and Wages Expense $19,500. Prepare the closing entries for Optique.
Prepare closing entries for a merchandising company.
(LO 4)
DO IT! 5-4 Estes Company is preparing its multiple-step income statement, owner's equity statement, and classified balance sheet. Using the column heads Account, Financial Statement, and Classification, indicate in which financial statement and under what classification each of the following would be reported.
Classify financial statement accounts.
(LO 5)
EXERCISES
E5-1 Mr. Etemadi has prepared the following list of statements about service companies and merchandisers.
1. Measuring net income for a merchandiser is conceptually the same as for a service company.
2. For a merchandiser, sales less operating expenses is called gross profit.
3. For a merchandiser, the primary source of revenues is the sale of inventory.
4. Sales salaries and wages is an example of an operating expense.
5. The operating cycle of a merchandiser is the same as that of a service company.
6. In a perpetual inventory system, no detailed inventory records of goods on hand are maintained.
7. In a periodic inventory system, the cost of goods sold is determined only at the end of the accounting period.
8. A periodic inventory system provides better control over inventories than a perpetual system.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Answer general questions about merchandisers.
(LO 1)
E5-2 Information related to Harwick Co. is presented below.
1. On April 5, purchased merchandise from Botham Company for $23,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of $900 on merchandise purchased from Botham.
3. On April 7, purchased equipment on account for $26,000.
4. On April 8, returned damaged merchandise to Botham Company and was granted a $3,000 credit for returned merchandise.
5. On April 15, paid the amount due to Botham Company in full.
Instructions
(a) Prepare the journal entries to record these transactions on the books of Harwick Co. under a perpetual inventory system.
(b) Assume that Harwick Co. paid the balance due to Botham Company on May 4 instead of April 15. Prepare the journal entry to record this payment.
Journalize purchase transactions.
(LO 2)
E5-3 On September 1, Boylan Office Supply had an inventory of 30 calculators at a cost of $18 each. The company uses a perpetual inventory system. During September, the following transactions occurred.
Journalize perpetual inventory entries.
(LO 2, 3)
| Sept. | 6 | Purchased with cash 80 calculators at $20 each from Guthrie. |
| 9 | Paid freight of $80 on calculators purchased from Guthrie Co. | |
| 10 | Returned 3 calculators to Guthrie Co. for $63 credit (including freight) because they did not meet specifications. | |
| 12 | Sold 26 calculators costing $21 (including freight) for $31 each to Lee Book Store, terms n/30. | |
| 14 | Granted credit of $31 to Lee Book Store for the return of one calculator that was not ordered. | |
| 20 | Sold 30 calculators costing $21 for $32 each to Orr's Card Shop, terms n/30. |
Instructions Journalize the September transactions.
E5-4 On June 10, Tuzun Company purchased $8,000 of merchandise from Epps Company, FOB shipping point, terms 2/10, n/30. Tuzun pays the freight costs of $400 on June 11. Damaged goods totaling $300 are returned to Epps for credit on June 12. The fair value of these goods is $70. On June 19, Tuzun pays Epps Company in full, less the purchase discount. Both companies use a perpetual inventory system.
Instructions
(a) Prepare separate entries for each transaction on the books of Tuzun Company.
(b) Prepare separate entries for each transaction for Epps Company. The merchandise purchased by Tuzun on June 10 had cost Epps $4,800.
Prepare purchase and sale entries.
(LO 2, 3)
E5-5 Presented below are transactions related to Bogner Company.
1. On December 3, Bogner Company sold $570,000 of merchandise to Maris Co., terms 2/10, n/30, FOB shipping point. The cost of the merchandise sold was $350,000.
2. On December 8, Maris Co. was granted an allowance of $20,000 for merchandise purchased on December 3.
3. On December 13, Bogner Company received the balance due from Maris Co.
Instructions
(a) Prepare the journal entries to record these transactions on the books of Bogner Company using a perpetual inventory system.
(b) Assume that Bogner Company received the balance due from Maris Co. on January 2 of the following year instead of December 13. Prepare the journal entry to record the receipt of payment on January 2.
Journalize sales transactions.
(LO 3)
E5-6 The adjusted trial balance of Tsai Company shows the following data pertaining to sales at the end of its fiscal year October 31, 2014: Sales Revenue $820,000, Freight-Out $16,000, Sales Returns and Allowances $25,000, and Sales Discounts $13,000.
Instructions
(a) Prepare the sales revenues section of the income statement.
(b) Prepare separate closing entries for (1) sales revenue, and (2) the contra accounts to sales revenue.
Prepare sales revenues section and closing entries.
(LO 4, 5)
E5-7 Juan Morales Company had the following account balances at year-end: Cost of Goods Sold $60,000; Inventory $15,000; Operating Expenses $29,000; Sales Revenue $115,000; Sales Discounts $1,200; and Sales Returns and Allowances $1,700. A physical count of inventory determines that merchandise inventory on hand is $13,900.
Instructions
(a) Prepare the adjusting entry necessary as a result of the physical count.
(b) Prepare closing entries.
Prepare adjusting and closing entries.
(LO 4)
E5-8 Presented below is information related to Garland Co. for the month of January 2014.
Prepare adjusting and closing entries.
(LO 4)
(a) Prepare the necessary adjusting entry for inventory.
(b) Prepare the necessary closing entries.
E5-9 Presented below is information for Furlow Company for the month of March 2014.
Prepare multiple-step income statement.
(LO 5)
Instructions
(a) Prepare a multiple-step income statement.
(b) Compute the gross profit rate.
E5-10 In its income statement for the year ended December 31, 2014, Lemere Company reported the following condensed data.
Instructions
(a) Prepare a multiple-step income statement.
(b) Prepare a single-step income statement.
Prepare multiple-step and single-step income statements.
(LO 5)
E5-11 An inexperienced accountant for Huang Company made the following errors in recording merchandising transactions.
1. A $195 refund to a customer for faulty merchandise was debited to Sales Revenue $195 and credited to Cash $195.
2. A $180 credit purchase of supplies was debited to Inventory $180 and credited to Cash $180.
3. A $215 sales discount was debited to Sales Revenue.
4. A cash payment of $20 for freight on merchandise purchases was debited to Freight-Out $200 and credited to Cash $200.
Instructions
Prepare separate correcting entries for each error, assuming that the incorrect entry is not reversed. (Omit explanations.)
Prepare correcting entries for sales and purchases.
(LO 2, 3)
E5-12 In 2014, Matt Cruz Company had net sales of $900,000 and cost of goods sold of $522,000. Operating expenses were $225,000, and interest expense was $11,000. Cruz prepares a multiple-step income statement.
Instructions
(a) Compute Cruz's gross profit.
(b) Compute the gross profit rate. Why is this rate computed by financial statement users?
(c) What is Cruz's income from operations and net income?
(d) If Cruz prepared a single-step income statement, what amount would it report for net income?
(e) In what section of its classified balance sheet should Cruz report merchandise inventory?
Compute various income measures.
(LO 5)
E5-13 Presented below is financial information for two different companies.
Instructions
(a) Determine the missing amounts.
(b) Determine the gross profit rates. (Round to one decimal place.)
Compute missing amounts and compute gross profit rate.
(LO 5)
E5-14 Financial information is presented below for three different companies.
Instructions
Determine the missing amounts.
Compute missing amounts.
(LO 5)
*E5-15 Presented below are selected accounts for Salazar Company as reported in the worksheet using a perpetual inventory system at the end of May 2014.
Instructions
Complete the worksheet by extending amounts reported in the adjusted trial balance to the appropriate columns in the worksheet. Do not total individual columns.
Complete worksheet using a perpetual inventory system.
(LO 6)
*E5-16 The trial balance columns of the worksheet using a perpetual inventory system for Marquez Company at June 30, 2014, are as follows.
Other data:
Operating expenses incurred on account, but not yet recorded, total $1,500.
Instructions
Enter the trial balance on a worksheet and complete the worksheet.
Prepare a worksheet using a perpetual inventory system.
(LO 6)
*E5-17 The trial balance of D. Savage Company at the end of its fiscal year, August 31, 2014, includes these accounts: Inventory $17,200; Purchases $149,000; Sales Revenue $190,000; Freight-In $5,000; Sales Returns and Allowances $3,000; Freight-Out $1,000; and Purchase Returns and Allowances $2,000. The ending merchandise inventory is $23,000.
Instructions
Prepare a cost of goods sold section for the year ending August 31 (periodic inventory).
Prepare cost of goods sold section.
(LO 7)
*E5-18 On January 1, 2014, Christel Madan Corporation had inventory of $50,000. At December 31, 2014, Christel Madan had the following account balances.
At December 31, 2014, Christel Madan determines that its ending inventory is $60,000.
Instructions
(a) Compute Christel Madan's 2014 gross profit.
(b) Compute Christel Madan's 2014 operating expenses if net income is $130,000 and there are no nonoperating activities.
Compute various income statement items.
(LO 7)
*E5-19 Below is a series of cost of goods sold sections for companies B, F, L, and R.
Instruction
Fill in the lettered blanks to complete the cost of goods sold sections.
Prepare cost of goods sold section.
(LO 7)
*E5-20 This information relates to Rana Co.
1. On April 5, purchased merchandise from Craig Company for $25,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of $900 on merchandise purchased from Craig Company.
3. On April 7, purchased equipment on account for $30,000.
4. On April 8, returned some of April 5 merchandise, which cost $2,800, to Craig Company.
5. On April 15, paid the amount due to Craig Company in full.
Instructions
(a) Prepare the journal entries to record these transactions on the books of Rana Co. using a periodic inventory system.
(b) Assume that Rana Co. paid the balance due to Craig Company on May 4 instead of April 15. Prepare the journal entry to record this payment.
Journalize purchase transactions.
(LO 7)
*E5-21 Presented below is information related to Lor Co.
1. On April 5, purchased merchandise from Garcia Company for $19,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of $800 on merchandise purchased from Garcia.
3. On April 7, purchased equipment on account from Holifield Mfg. Co. for $23,000.
4. On April 8, returned merchandise, which cost $4,000, to Garcia Company.
5. On April 15, paid the amount due to Garcia Company in full.
Journalize purchase transactions.
(LO 7)
(a) Prepare the journal entries to record these transactions on the books of Lor Co. using a periodic inventory system.
(b) Assume that Lor Co. paid the balance due to Garcia Company on May 4 instead of April 15. Prepare the journal entry to record this payment.
*E5-22 Presented below are selected accounts for B. Midler Company as reported in the worksheet at the end of May 2014. Ending inventory is $75,000.
Instructions
Complete the worksheet by extending amounts reported in the adjustment trial balance to the appropriate columns in the worksheet. The company uses the periodic inventory system.
Complete worksheet.
(LO 7)
EXERCISES: SET B AND CHALLENGE EXERCISES
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.
PROBLEMS: SET A
P5-1A Powell's Book Warehouse distributes hardcover books to retail stores and extends credit terms of 2/10, n/30 to all of its customers. At the end of May, Powell's inventory consisted of books purchased for $1,800. During June, the following merchandising transactions occurred.
Powell's Book Warehouse's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
Journalize the transactions for the month of June for Powell's Book Warehouse using a perpetual inventory system.
Journalize purchase and sales transactions under a perpetual inventory system.
(LO 2, 3)
P5-2A Latona Hardware Store completed the following merchandising transactions in the month of May. At the beginning of May, the ledger of Latona showed Cash of $5,000 and Owner's Capital of $5,000.
| May | 1 | Purchased merchandise on account from Gray's Wholesale Supply $4,200, terms 2/10, n/30. |
| 2 | Sold merchandise on account $2,100, terms 1/10, n/30. The cost of the merchandise sold was $1,300. | |
| 5 | Received credit from Gray's Wholesale Supply for merchandise returned $300. | |
| 9 | Received collections in full, less discounts, from customers billed on sales of $2,100 on May 2. | |
| 10 | Paid Gray's Wholesale Supply in full, less discount. | |
| 11 | Purchased supplies for cash $400. | |
| 12 | Purchased merchandise for cash $1,400. | |
| 15 | Received refund for poor quality merchandise from supplier on cash purchase $150. | |
| 17 | Purchased merchandise from Amland Distributors $1,300, FOB shipping point, terms 2/10, n/30. | |
| 19 | Paid freight on May 17 purchase $130. | |
| 24 | Sold merchandise for cash $3,200. The merchandise sold had a cost of $2,000. | |
| 25 | Purchased merchandise from Horvath, Inc. $620, FOB destination, terms 2/10, n/30. | |
| 27 | Paid Amland Distributors in full, less discount. | |
| 29 | Made refunds to cash customers for defective merchandise $70. The returned merchandise had a fair value of $30. | |
| 31 | Sold merchandise on account $1,000 terms n/30. The cost of the merchandise sold was $560. |
Journalize, post, and prepare a partial income statement.
(LO 2, 3, 5)
Latona Hardware's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 126 Supplies, No. 201 Accounts Payable, No. 301 Owner's Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the transactions using a perpetual inventory system.
(b) Enter the beginning cash and capital balances and post the transactions. (Use J1 for the journal reference.)
(c) Prepare an income statement through gross profit for the month of May 2014.
(c) Gross profit $2.379
P5-3A The Deluxe Store is located in midtown Madison. During the past several years, net income has been declining because of suburban shopping centers. At the end of the company's fiscal year on November 30, 2014, the following accounts appeared in two of its trial balances.
Prepare financial statements and adjusting and closing entries.
(LO 4, 5)
Instructions
(a) Prepare a multiple-step income statement, an owner's equity statement, and a classified balance sheet. Notes payable are due in 2017.
(b) Journalize the adjusting entries that were made.
(c) Journalize the closing entries that are necessary.
(a) Net income $29, 100 Owner's capital $120,800 Total assets $190,000
P5-4A Adam Nichols, a former disc golf star, operates Adam's Discorama. At the beginning of the current season on April 1, the ledger of Adam's Discorama showed Cash $1,800, Inventory $2,500, and Owner's Capital $4,300. The following transactions were completed during April.
| Apr. | 5 | Purchased golf discs, bags, and other inventory on account from Rayford Co. $1,200, FOB shipping point, terms 2/10, n/60. |
| 7 | Paid freight on the Rayford purchase $50. | |
| 9 | Received credit from Rayford Co. for merchandise returned $100. | |
| 10 | Sold merchandise on account for $900, terms n/30. The merchandise sold had a cost of $540. | |
| 12 | Purchased disc golf shirts and other accessories on account from Galaxy Sportswear $670, terms 1/10, n/30. | |
| 14 | Paid Rayford Co. in full, less discount. | |
| 17 | Received credit from Galaxy Sportswear for merchandise returned $70. | |
| 20 | Made sales on account for $610, terms n/30. The cost of the merchandise sold was $370. | |
| 21 | Paid Galaxy Sportswear in full, less discount. | |
| 27 | Granted an allowance to customers for clothing that was flawed $20. | |
| 30 | Received payments on account from customers $900. |
The chart of accounts for the store includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner's Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the April transactions using a perpetual inventory system.
(b) Enter the beginning balances in the ledger accounts and post the April transactions. (Use J1 for the journal reference.)
(c) Prepare a trial balance on April 30, 2014.
Journalize, post, and prepare a trial balance.
(LO 2, 3, 4)
*P5-5A The trial balance of Valdez Fashion Center contained the following accounts at November 30, the end of the company's fiscal year.
(c) Total debits $5,810
Complete accounting cycle beginning with a worksheet.
(LO 4, 5, 6)
Adjustment data:
1. Supplies on hand totaled $2,000.
2. Depreciation is $11,500 on the equipment.
3. Interest of $4,000 is accrued on notes payable at November 30.
4. Inventory actually on hand is $44,400.
Instructions
(a) Enter the trial balance on a worksheet, and complete the worksheet.
(b) Prepare a multiple-step income statement and an owner's equity statement for the year, and a classified balance sheet as of November 30, 2014. Notes payable of $20,000 are due in January 2015.
(c) Journalize the adjusting entries.
(d) Journalize the closing entries.
(e) Prepare a post-closing trial balance.
(a) Adj. trial balance $988,200 Net loss $2,200
(b) Gross profit $248,700 Total assets $179,300
*P5-6A At the end of Dayton Department Store's fiscal year on November 30, 2014, these accounts appeared in its adjusted trial balance.
Additional facts:
1. Merchandise inventory on November 30, 2014, is $52,600.
2. Dayton Department Store uses a periodic system.
Determine cost of goods sold and gross profit under periodic approach.
(LO 5, 7)
Instructions
Prepare an income statement through gross profit for the year ended November 30, 2014.
Gross profit $409,100
*P5-7A Alana Inc. operates a retail operation that purchases and sells home entertainment products. The company purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011 through 2014, inclusive.
Instructions
(a) Calculate the missing amounts.
(b) Sales declined over the 3-year fiscal period, 2012–2014. Does that mean that profit-ability necessarily also declined? Explain, computing the gross profit rate and the profit margin for each fiscal year to help support your answer. (Round to one decimal place.)
Calculate missing amounts and assess profitability.
(LO 5, 7)
(c) $4,700
(g) $17,200
(i) $32,700
*P5-8A At the beginning of the current season on April 1, the ledger of Kokott Pro Shop showed Cash $3,000; Inventory $4,000; and Owner's Capital $7,000. These transactions occurred during April 2014.
| Apr. | 5 | Purchased golf bags, clubs, and balls on account from Hogan Co. $1,200, FOB shipping point, terms 2/10, n/60. |
| 7 | Paid freight on Hogan Co. purchases $50. | |
| 9 | Received credit from Hogan Co. for merchandise returned $100. | |
| 10 | Sold merchandise on account to customers $600, terms n/30. | |
| 12 | Purchased golf shoes, sweaters, and other accessories on account from Duffer Sportswear $450, terms 1/10, n/30. | |
| 14 | Paid Hogan Co. in full. | |
| 17 | Received credit from Duffer Sportswear for merchandise returned $50. | |
| 20 | Made sales on account to customers $600, terms n/30. | |
| 21 | Paid Duffer Sportswear in full. | |
| 27 | Granted credit to customers for clothing that had flaws $35. | |
| 30 | Received payments on account from customers $600. |
The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Owner's Capital, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In.
Instructions
(a) Journalize the April transactions using a periodic inventory system.
(b) Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.
(c) Prepare a trial balance on April 30, 2014.
(d) Prepare an income statement through gross profit, assuming merchandise inventory on hand at April 30 is $4,824.
Journalize, post, and prepare trial balance and partial income statement using periodic approach.
(LO 7)
(c) Tot. trial balance $8,376 Gross profit $465
PROBLEMS: SET B
P5-1B Urdan Co. distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of its customers. At the end of June, Urdan's inventory consisted of suitcases costing $1,200. During the month of July, the following merchandising transactions occurred.
| July | 1 | Purchased suitcases on account for $1,800 from Hostad Manufacturers, FOB destination, terms 2/10, n/30. The appropriate party also made a cash payment of $100 for freight on this date. |
| 3 | Sold suitcases on account to Kaye Satchels for $2,000. The cost of suitcases sold is $1,200. | |
| 9 | Paid Hostad Manufacturers in full. | |
| 12 | Received payment in full from Kaye Satchels. | |
| 17 | Sold suitcases on account to The Going Concern for $1,800. The cost of the suitcases sold was $1,080. | |
| 18 | Purchased suitcases on account for $1,900 from Nelson Manufacturers, FOB shipping point, terms 1/10, n/30. The appropriate party also made a cash payment of $125 for freight on this date. | |
| 20 | Received $300 credit (including freight) for suitcases returned to Nelson Manufacturers. | |
| 21 | Received payment in full from The Going Concern. | |
| 22 | Sold suitcases on account to Wopat's for $2,250. The cost of suitcases sold was $1,350. | |
| 30 | Paid Nelson Manufacturers in full. | |
| 31 | Granted Wopat's $200 credit for suitcases returned costing $120. |
Journalize purchase and sales transactions under a perpetual inventory system.
(LO 2, 3)
Urdan's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
Journalize the transactions for the month of July for Urdan using a perpetual inventory system.
P5-2B Rose Distributing Company completed the following merchandising transactions in the month of April. At the beginning of April, the ledger of Rose showed Cash of $9,000 and Owner's Capital of $9,000.
| Apr. | 2 | Purchased merchandise on account from Kwon Supply Co. $6,900, terms 1/10, n/30. |
| 4 | Sold merchandise on account $6,500, FOB destination, terms 1/10, n/30. The cost of the merchandise sold was $3,900. | |
| 5 | Paid $240 freight on April 4 sale. | |
| 6 | Received credit from Kwon Supply Co. for merchandise returned $500. | |
| 11 | Paid Kwon Supply Co. in full, less discount. | |
| 13 | Received collections in full, less discounts, from customers billed on April 4. | |
| 14 | Purchased merchandise for cash $3,800. | |
| 16 | Received refund from supplier for returned goods on cash purchase of April 14, $500. | |
| 18 | Purchased merchandise from Davis Distributors $4,500, FOB shipping point, terms 2/10, n/30. | |
| 20 | Paid freight on April 18 purchase $100. | |
| 23 | Sold merchandise for cash $7,400. The merchandise sold had a cost of $4,120. | |
| 26 | Purchased merchandise for cash $2,300. | |
| 27 | Paid Davis Distributors in full, less discount. | |
| 29 | Made refunds to cash customers for defective merchandise $90. The returned merchandise had a fair value of $30. | |
| 30 | Sold merchandise on account $3,700, terms n/30. The cost of the merchandise sold was $2,800. |
Journalize, post, and prepare a partial income statement.
(LO 2, 3, 5)
Rose Distributing Company's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner's Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, No. 505 Cost of Goods Sold, and No. 644 Freight-Out.
Instructions
(a) Journalize the transactions using a perpetual inventory system.
(b) Enter the beginning cash and capital balances, and post the transactions. (Use J1 for the journal reference.)
(c) Prepare the income statement through gross profit for the month of April 2014.
P5-3B Mackey Department Store is located near the Village Shopping Mall. At the end of the company's calendar year on December 31, 2014, the following accounts appeared in two of its trial balances.
Instructions
(a) Prepare a multiple-step income statement, an owner's equity statement, and a classified balance sheet. $25,000 of the mortgage payable is due for payment next year.
(b) Journalize the adjusting entries that were made.
(c) Journalize the closing entries that are necessary.
(c) Gross profit $6,655
Prepare financial statements and adjusting and closing entries.
(LO 4, 5)
(a) Net income $129,100 Owner's capital $277,700 Total assets $456,100
P5-4B Alex Diaz, a former professional tennis star, operates Diaz Tennis Shop at the Cedar Lake Resort. At the beginning of the current season, the ledger of Diaz Tennis Shop showed Cash $2,500, Inventory $1,700, and Owner's Capital $4,200. The following transactions were completed during April.
| Apr. | 4 | Purchased racquets and balls from Marx Co. $840, FOB shipping point, terms 2/10, n/30. |
| 6 | Paid freight on purchase from Marx Co. $40. | |
| 8 | Sold merchandise to members $1,150, terms n/30. The merchandise sold had a cost of $790. | |
| 10 | Received credit of $40 from Marx Co. for a racquet that was returned. | |
| 11 | Purchased tennis shoes from Rupp Sports for cash, $420. | |
| 13 | Paid Marx Co. in full. | |
| 14 | Purchased tennis shirts and shorts from Hayley's Sportswear $900, FOB shipping point, terms 3/10, n/60. | |
| 15 | Received cash refund of $50 from Rupp Sports for damaged merchandise that was returned. | |
| 17 | Paid freight on Hayley's Sportswear purchase $30. | |
| 18 | Sold merchandise to members $900, terms n/30. The cost of the merchandise sold was $540. | |
| 20 | Received $600 in cash from customers in settlement of their accounts. | |
| 21 | Paid Hayley's Sportswear in full. | |
| 27 | Granted an allowance of $40 to members for tennis clothing that did not fit properly. | |
| 30 | Received cash payments on account from customers, $710. |
Journalize, post, and prepare a trial balance.
(LO 2, 3, 4)
The chart of accounts for the tennis shop includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner's Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the April transactions using a perpetual inventory system.
(b) Enter the beginning balances in the ledger accounts and post the April transactions. (Use J1 for the journal reference.)
(c) Prepare a trial balance on April 30, 2014.
*P5-5B At the end of Roshek Department Store's fiscal year on December 31, 2014, these accounts appeared in its adjusted trial balance.
Additional facts:
1. Merchandise inventory on December 31, 2014, is $65,000.
2. Roshek Department Store uses a periodic system.
Instructions
Prepare an income statement through gross profit for the year ended December 31, 2014.
(c) Total debits $6,250
Determine cost of goods sold and gross profit under periodic approach.
(LO 5, 7)
*P5-6B Val Knight operates a retail clothing operation. She purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011–2014.
Gross profit $304,300
Calculate missing amounts and assess profitability.
(LO 5, 7)
Instructions
(a) Calculate cost of goods sold for each of the 2012, 2013, and 2014 fiscal years.
(b) Calculate the gross profit for each of the 2012, 2013, and 2014 fiscal years.
(c) Calculate the ending balance of accounts payable for each of the 2012, 2013, and 2014 fiscal years.
(d) Sales declined in fiscal 2014. Does that mean that profitability, as measured by the gross profit rate, necessarily also declined? Explain, calculating the gross profit rate for each fiscal year to help support your answer. (Round to one decimal place.)
(a) 2013 $141,600
(c) 2013 Ending accts payable $15,000
*P5-7B At the beginning of the current season, the ledger of Everett Tennis Shop showed Cash $2,500; Inventory $1,700; and Owner's Capital $4,200. The following transactions were completed during April.
Journalize, post, and prepare trial balance and partial income statement using periodic approach.
(LO 7)
The chart of accounts for the tennis shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Owner's Capital, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In.
Instructions
(a) Journalize the April transactions using a periodic inventory system.
(b) Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.
(c) Prepare a trial balance on April 30, 2014.
(d) Prepare an income statement through gross profit, assuming inventory on hand at April 30 is $2,296.
(c) Tot. trial balance $6,225
(d) Gross profit $766
PROBLEMS: SET C
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.
COMPREHENSIVE PROBLEM
CP5 On December 1, 2014, Prosen Distributing Company had the following account balances.
During December, the company completed the following summary transactions.
| Dec. | 6 | Paid $1,600 for salaries and wages due employees, of which $600 is for December and $1,000 is for November salaries and wages payable. |
| 8 | Received $1,900 cash from customers in payment of account (no discount allowed). | |
| 10 | Sold merchandise for cash $6,300. The cost of the merchandise sold was $4,100. | |
| 13 | Purchased merchandise on account from Maglio Co. $9,000, terms 2/10, n/30. | |
| 15 | Purchased supplies for cash $2,000. | |
| 18 | Sold merchandise on account $12,000, terms 3/10, n/30. The cost of the merchandise sold was $8,000. | |
| 20 | Paid salaries and wages $1,800. | |
| 23 | Paid Maglio Co. in full, less discount. | |
| 27 | Received collections in full, less discounts, from customers billed on December 18. |
Adjustment data:
1. Accrued salaries and wages payable $800.
2. Depreciation $200 per month.
3. Supplies on hand $1,500.
(a) Journalize the December transactions using a perpetual inventory system.
(b) Enter the December 1 balances in the ledger T-accounts and post the December transactions. Use Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Sales Revenue, Sales Discounts, and Supplies Expense.
(c) Journalize and post adjusting entries.
(d) Prepare an adjusted trial balance.
(e) Prepare an income statement and an owner's equity statement for December and a classified balance sheet at December 31.
(d) Totals $65,300
(e) Net income $740
CONTINUING COOKIE CHRONICLE
(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 4.)
CCC5 Because Natalie has had such a successful first few months, she is considering other opportunities to develop her business. One opportunity is the sale of fine European mixers. The owner of Kzinski Supply Company has approached Natalie to become the exclusive U.S. distributor of these fine mixers in her state. The current cost of a mixer is approximately $525 (U.S.), and Natalie would sell each one for $1,050. Natalie comes to you for advice on how to account for these mixers.
Go to the book's companion website, www.wiley.com/college/weygandt, to see the completion of this problem.
Broadening Your Perspective
Financial Reporting and Analysis
Financial Reporting Problem: Apple Inc.
BYP5-1 The financial statements of Apple Inc. are presented in Appendix A at the end of this textbook. Instructions for accessing and using the company's complete annual report, including the notes to the financial statements, are also provided in Appendix A.
Instructions
Answer the following questions using Apple's Consolidated Statement of Income.
(a) What was the percentage change in (1) sales and in (2) net income from 2009 to 2010 and from 2010 to 2011?
(b) What was the company's gross profit rate in 2009, 2010, and 2011?
(c) What was the company's percentage of net income to net sales in 2009, 2010, and 2011? Comment on any trend in this percentage.
Comparative Analysis Problem:
PepsiCo, Inc. vs. The Coca-Cola Company
BYP5-2 PepsiCo's financial statements are presented in Appendix B. Financial statements of The Coca-Cola Company are presented in Appendix C. Instructions for accessing and using the complete annual reports of PepsiCo and Coca-Cola, including the notes to the financial statements, are also provided in Appendices B and C, respectively.
Instructions
(a) Based on the information contained in these financial statements, determine each of the following for each company.
(1) Gross profit for 2011.
(2) Gross profit rate for 2011.
(3) Operating income for 2011.
(4) Percentage change in operating income from 2010 to 2011.
(b) What conclusions concerning the relative profitability of the two companies can you draw from these data?
Comparative Analysis Problem:
Amazon.com, Inc. vs. Wal-Mart Stores, Inc.
BYP5-3 Amazon.com, Inc.'s financial statements are presented in Appendix D. Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E. (Use Wal-Mart's January 31, 2012, financial statements for comparative purposes.) Instructions for accessing and using the complete annual reports of Amazon and Wal-Mart, including the notes to the financial statements, are also provided in Appendices D and E, respectively.
Instructions
(a) Based on the information contained in these financial statements, determine each of the following for each company. Use Amazon's net product sales to compute gross profit information.
(1) Gross profit for 2011.
(2) Gross profit rate for 2011.
(3) Operating income for 2011.
(4) Percentage change in operating income from 2010 to 2011.
(b) What conclusions concerning the relative profitability of the two companies can you draw from these data?
Real-World Focus
BYP5-4 No financial decision-maker should ever rely solely on the financial information reported in the annual report to make decisions. It is important to keep abreast of financial news. This activity demonstrates how to search for financial news on the Web.
Address: biz.yahoo.com/i, or go to www.wiley.com/college/weygandt
Steps:
1. Type in either PepsiCo or Coca-Cola.
2. Choose News.
3. Select an article that sounds interesting to you.
Instructions
(a) What was the source of the article (e.g., Reuters, Businesswire, PR Newswire)?
(b) Assume that you are a personal financial planner and that one of your clients owns stock in the company. Write a brief memo to your client, summarizing the article and explaining the implications of the article for his or her investment.
Critical Thinking
Decision-Making Across the Organization
BYP5-5 Three years ago, Dana Mann and her brother-in-law Eric Boldt opened Family Department Store. For the first two years, business was good, but the following condensed income results for 2013 were disappointing.
Dana believes the problem lies in the relatively low gross profit rate (gross profit divided by net sales) of 21%. Eric believes the problem is that operating expenses are too high.
Dana thinks the gross profit rate can be improved by making both of the following changes. She does not anticipate that these changes will have any effect on operating expenses.
1. Increase average selling prices by 17%. This increase is expected to lower sales volume so that total sales will increase only 6%.
2. Buy merchandise in larger quantities and take all purchase discounts. These changes are expected to increase the gross profit rate by 3 percentage points.
Eric thinks expenses can be cut by making both of the following changes. He feels that these changes will not have any effect on net sales.
1. Cut 2013 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales.
2. Reduce store deliveries to one day per week rather than twice a week. This change will reduce 2013 delivery expenses of $30,000 by 40%.
Dana and Eric come to you for help in deciding the best way to improve net income.
Instructions
With the class divided into groups, answer the following.
(a) Prepare a condensed income statement for 2014, assuming (1) Dana's changes are implemented and (2) Eric's ideas are adopted.
(b) What is your recommendation to Dana and Eric?
(c) Prepare a condensed income statement for 2014, assuming both sets of proposed changes are made.
Communication Activity
BYP5-6 The following situation is in chronological order.
1. Connor decides to buy a surfboard.
2. He calls Surfing USA Co. to inquire about its surfboards.
3. Two days later, he requests Surfing USA Co. to make a surfboard.
4. Three days later, Surfing USA Co. sends him a purchase order to fill out.
5. He sends back the purchase order.
6. Surfing USA Co. receives the completed purchase order.
7. Surfing USA Co. completes the surfboard.
8. Connor picks up the surfboard.
9. Surfing USA Co. bills Connor.
10. Surfing USA Co. receives payment from Connor.
Instructions
In a memo to the president of Surfing USA Co., answer the following.
(a) When should Surfing USA Co. record the sale?
(b) Suppose that with his purchase order, Connor is required to make a down payment. Would that change your answer?
Ethics Case
BYP5-7 Jacquie Boynton was just hired as the assistant treasurer of Key West Stores. The company is a specialty chain store with nine retail stores concentrated in one metropolitan area. Among other things, the payment of all invoices is centralized in one of the departments Jacquie will manage. Her primary responsibility is to maintain the company's high credit rating by paying all bills when due and to take advantage of all cash discounts.
Phelan Carter, the former assistant treasurer who has been promoted to treasurer, is training Jacquie in her new duties. He instructs Jacquie that she is to continue the practice of preparing all checks “net of discount” and dating the checks the last day of the discount period. “But,” Phelan continues, “we always hold the checks at least 4 days beyond the discount period before mailing them. That way, we get another 4 days of interest on our money. Most of our creditors need our business and don't complain. And, if they scream about our missing the discount period, we blame it on the mail room or the post office. We've only lost one discount out of every hundred we take that way. I think everybody does it. By the way, welcome to our team!”
Instructions
(a) What are the ethical considerations in this case?
(b) Who are the stakeholders that are harmed or benefitted in this situation?
(c) Should Jacquie continue the practice started by Phelan? Does she have any choice?
All About You
BYP5-8 There are many situations in business where it is difficult to determine the proper period in which to record revenue. Suppose that after graduation with a degree in finance, you take a job as a manager at a consumer electronics store called Impact Electronics. The company has expanded rapidly in order to compete with Best Buy. Impact has also begun selling gift cards for its electronic products. The cards are available in any dollar amount and allow the holder of the card to purchase an item for up to 2 years from the time the card is purchased. If the card is not used during that 2 years, it expires.
Instructions
Answer the following questions.
At what point should the revenue from the gift cards be recognized? Should the revenue be recognized at the time the card is sold, or should it be recorded when the card is redeemed? Explain the reasoning to support your answers.
FASB Codification Activity
BYP5-9 If your school has a subscription to the FASB Codification, go to http://aaahq.org/ ascLogin.cfm to log in and prepare responses to the following.
Instructions
(a) Access the glossary (“Master Glossary”) to answer the following:
(1) What is the definition provided for inventory?
(2) What is a customer?
(b) What guidance does the Codification provide concerning reporting inventories above cost?
Answers to Chapter Questions
Answers to Insight and Accounting Across the Organization Questions
p. 221 Morrow Snowboards Improves Its Stock Appeal Q: If a perpetual system keeps track of inventory on a daily basis, why do companies ever need to do a physical count? A: A perpetual system keeps track of all sales and purchases on a continuous basis. This provides a constant record of the number of units in the inventory. However, if employees make errors in recording sales or purchases, or if there is theft, the inventory value will not be correct. As a consequence, all companies do a physical count of inventory at least once a year.
p. 228 Should Costco Change Its Return Policy? Q: If a company expects significant returns, what are the implications for revenue recognition? A: If a company expects significant returns, it should make an adjusting entry at the end of the year, reducing sales by the estimated amount of sales returns. This is necessary so as not to overstate the amount of revenue recognized in the period.
p. 229 Selling Green Q: What is meant by “monetize environmental sustainability” for shareholders? A: By marketing green, not only does PepsiCo help the environment in the long run, but it also leads to long-term profitability as well. In other words, sound sustainability practices are good business and lead to sound financial results.
p. 235 Disclosing More Details Q: Why have investors and analysts demanded more accuracy in isolating “Other gains and losses” from operating items? A: Greater accuracy in the classification of operating versus nonoperating (“Other gains and losses”) items permits investors and analysts to judge the real operating margin, the results of continuing operations, and management's ability to control operating expenses.
Answers to Self-Test Questions
1. c 2. a 3. c 4. b (($750 − $50) × .98) 5. c 6. c 7. a 8. d 9. b ($400,000 – $310,000) 10. c 11. d *12. a *13. d *14. a ($60,000 + $380,000 − $50,000) *15. b
A Look at IFRS
The basic accounting entries for merchandising are the same under both GAAP and IFRS. The income statement is a required statement under both sets of standards. The basic format is similar although some differences do exist.
Key Points
- Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic system.
- Inventories are defined by IFRS 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 providing of services.
- Under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions like administration, distribution, and manufacturing. Under IFRS, companies must classify expenses either by 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.
- 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.
- Under IFRS, revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS results in more transactions affecting equity (other comprehensive income) but not net income.
- IAS 1, “Presentation of Financial Statements,” provides general guidelines for the reporting of income statement information. Subsequently, a number of international standards have been issued that provide additional guidance to issues related to income statement presentation.
- Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such as those on so-called “non-trading securities”) that are not included in the calculation of net income.
- IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.
Looking to the Future
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. For example, the amount of income that is generated by operations would be traceable to the assets and liabilities used to generate the income. 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. The new financial statement format was heavily influenced by suggestions from financial statement analysts.
IFRS Practice
IFRS Self-Test Questions
1. Which of the following would not be included in the definition of inventory under IFRS?
(a) Photocopy paper held for sale by an office-supply store.
(b) Stereo equipment held for sale by an electronics store.
(c) Used office equipment held for sale by the human relations department of a plastics company.
(d) All of the above would meet the definition.
2. Which of the following would not be a line item of a company reporting costs by nature?
(a) Depreciation expense.
(b) Salaries expense.
(c) Interest expense.
(d) Manufacturing expense.
3. Which of the following would not be a line item of a company reporting costs by function?
(a) Administration.
(b) Manufacturing.
(c) Utilities expense.
(d) Distribution.
4. Which of the following statements is false?
(a) IFRS specifically requires use of a multiple-step income statement.
(b) Under IFRS, companies can use either a perpetual or periodic system.
(c) The proposed new format for financial statements was heavily influenced by the suggestions of financial statement analysts.
(d) The new income statement format will try to de-emphasize the focus on the “net income” line item.
5. Under the new format for financial statements being proposed under a joint IASB/FASB project:
(a) all financial statements would adopt headings similar to the current format of the balance sheet.
(b) financial statements would be presented consistent with the way management usually run companies.
(c) companies would be required to report income statement line items by function only.
(d) the amount of detail shown in the income statement would decrease compared to current presentations.
IFRS Exercises
IFRS5-1 Explain the difference between the “nature-of-expense” and “function-of-expense” classifications.
IFRS5-2 For each of the following income statement line items, state whether the item is a “by nature” expense item or a “by function” expense item.
________ Cost of goods sold
________ Depreciation expense
________ Salaries and wages expense
________ Selling expenses
________ Utilities expense
________ Delivery expense
________ General and administrative expenses
IFRS5-3 Matilda Company reported the following amounts (in euros) in 2014: Net income, €150,000; Unrealized gain related to revaluation of buildings, €10,000; and Unrealized loss on non-trading securities, €(35,000). Determine Matilda's total comprehensive income for 2014.
International Financial Reporting Problem: Zetar plc
IFRS5-4 The financial statements of Zetar plc are presented in Appendix F. Instructions for accessing and using the company's complete annual report, including the notes to its financial statements, are also provided in Appendix F.
Instructions
Use Zetar's annual report to answer the following questions.
(a) Does Zetar use a multiple-step or a single-step income statement format? Explain how you made your determination.
(b) Instead of “interest expense,” what label does Zetar use for interest costs that it incurs?
(c) Using the notes to the company's financial statements, explain what each of the following are:
(1) Adjusted results.
(2) One-off items.
Answers to IFRS Self-Test Questions
1. c 2. d 3. c 4. a 5. b
Remember to go back to The Navigator box on the chapter opening page and check off your completed work.
__________
1The “Anatomy of a Fraud” stories in this textbook are adapted from Fraud Casebook: Lessons from the Bad Side of Business, edited by Joseph T. Wells (Hoboken, NJ: John Wiley & Sons, Inc., 2007). Used by permission. The names of some of the people and organizations in the stories are fictitious, but the facts in the stories are true.