Accounting Principles 7th Canadian Edition, Volume 1 Solution

Accounting Principles 7th Canadian Edition, Volume 1 Solution

CHAPTER 5

Accounting for Merchandising Operations

ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives Questions Brief Exercises Exercises Problems Set A Problems Set B 1. Describe the differences between service and merchandising companies. 1, 2, 3, 4 1, 2 1, 2, 5, 6 1 1 2. Prepare entries for purchases under a perpetual inventory system. 5, 6, 7, 8, 9, 11, 12 3, 4, 5, 2, 3, 5, 6, 7 2, 3, 4, 5 2, 3, 4, 5 3. Prepare entries for sales under a perpetual inventory system. 7, 10, 11, 12, 13, 14 6, 7, 8 2, 4, 5, 6, 7 2, 3, 4, 5 2, 3, 4, 5 4. Perform the steps in the accounting cycle for a merchandising company. 15, 16, 17 9, 10 2, 8, 10 6, 7 6, 7 5. Prepare single-step and multiple-step income statements. 18, 19, 20, 21, 11, 12 2, 9, 10, 11 5, 6, 7 5, 6, 7 6. Calculate the gross profit margin and profit margin. 22, 23 13 2, 11, 12 6, 8 6, 8 *7. Prepare the entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A) *24, *25, *26 * 14, *15, *16 *13, *14, *15, *16 *9, *10, *11, *12, *13 *9, *10, *11, *12, *13 *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the Appendices to each chapter. ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Identify problems and recommend inventory system. Moderate 20-30 2A Record and post inventory transactions – perpetual system. Moderate 30-40 3A Record inventory transactions– perpetual system. Moderate 20-30 4A Record inventory transactions and post to inventory account – perpetual system. Moderate 30-40 5A Record and post inventory transactions – perpetual system. Prepare partial income statement. Moderate 50-60 6A Prepare adjusting and closing entries and single-step income statement – perpetual system. Calculate ratios. Moderate 40-50 7A Prepare adjusting and closing entries and financial statements – perpetual system. Moderate 50-60 8A Calculate ratios and comment. Moderate 20-25 *9A Record inventory transactions – periodic system. Moderate 30-40 *10A Record inventory transactions – periodic system. Moderate 30-40 *11A Record and post inventory transactions – periodic system. Prepare partial income statement. Moderate 60-70 *12A Prepare correct multiple-step income statement, statement of owner’s equity and classified balance sheet – periodic system. Moderate 60-70 *13A Prepare financial statements and closing entries – periodic system. Moderate 60-70 1B Identify problems and recommend inventory system. Moderate 20-30 2B Record and post inventory transactions – perpetual system. Moderate 30-40 3B Record inventory transactions – perpetual system. Moderate 20-30 4B Record inventory transactions and post to inventory account – perpetual system. Moderate 30-40 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description Difficulty Level Time Allotted (min.) 5B Record and post inventory transactions – perpetual system. Prepare partial income statement. Moderate 50-60 6B Prepare adjusting and closing entries and single-step income statement – perpetual system. Calculate ratios. Moderate 40-50 7B Prepare adjusting and closing entries, single-step and multiple step income statements – perpetual system. Moderate 50-60 8B Calculate ratios and comment. Moderate 20-25 *9B Record inventory transactions – periodic system. Moderate 30-40 *10B Record inventory transactions – periodic system. Moderate 30-40 *11B Record and post inventory transactions – periodic system. Prepare partial income statement. Moderate 60-70 *12B Prepare correct multiple-step income statement, statement of owner’s equity and classified balance sheet – periodic system. Moderate 60-70 *13B Prepare financial statements and closing entries – periodic system. Moderate 60-70 BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Material Learning Objective Knowledge Comprehension Application Analysis Synthesis Evaluation 1. Describe the differences between service and merchandising companies. E5-2 Q5-1 Q5-2 Q5-3 Q5-4 E5-1 P5-1A P5-1B BE5-1 BE5-2 E5-5 E5-6 2. Prepare entries for purchases under a perpetual inventory system. Q5-5 Q5-8 E5-2 Q5-6 Q5-7 Q5-9 Q5-11 BE5-3 BE5-4 BE5-5 E5-3 E5-5 E5-6 E5-7 P5-2A P5-3A P5-4A P5-5A P5-2B P5-3B P5-4B P5-5B 3. Prepare entries for sales under a perpetual inventory system. Q5-12 E5-2 Q5-7 Q5-10 Q5-11 Q5-13 Q5-14 BE5-6 BE5-7 BE5-8 E5-4 E5-5 E5-6 E5-7 P5-2A P5-3A P5-4A P5-5A P5-2B P5-3B P5-4B P5-5B 4. Perform the steps in the accounting cycle for a merchandising company. E5-2 Q5-17 Q5-15 Q5-16 BE5-9 BE5-10 E5-6 E5-7 E5-8 E5-10 P5-6A P5-7A P5-6B P5-7B BLOOM’S TAXONOMY TABLE (Continued) Learning Objective Knowledge Comprehension Application Analysis Synthesis Evaluation 5. Prepare single-step and multiple-step income statements. Q5-18 Q5-19 E5-2 Q5-20 Q5-21 BE5-11 BE5-12 E5-9 E5-10 E5-11 P5-5A P5-6A P5-7A P5-5B P5-6B P5-7B 6. Calculate the gross profit margin and profit margin. E5-2 Q5-22 Q5-23 BE5-13 BE5-14 E5-11 P5-6A P5-6B E5-12 P5-8A P5-8B *7. Prepare the entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A) *Q5-24 *Q5-25 *Q5-26 *BE5-14 *BE5-15 *BE5-16 *E5-13 *E5-14 *E5-15 *E5-16 *P5-9A *P5-10A *P5-11A *P5-12A *P5-13A *P5-9B *P5-10B *P5-11B *P5-12B *P5-13B Broadening Your Perspective Santé Smoothie Saga Cumulative Coverage Chapters 2-5 BYP5-3 BYP5-1 BYP5-2 BYP5-4 BYP5-5 ANSWERS TO QUESTIONS 1. Profit for a merchandising company is determined principally by the gross profit created by the difference between sales revenue and cost of goods sold. Service companies will have service revenue or service fees earned as their primary source of revenue. Service companies do not have an expense comparable to cost of goods sold. Both types of companies will have operating expenses such as advertising expense, depreciation expense, insurance expense, rent expense, and salaries expense. 2. A “perpetual” inventory system reflects changes for inventory purchases and sales on a “perpetual” or continuous basis. The company keeps detailed records of quantity and cost of inventory on hand for every item. When inventory is sold, the cost of goods sold is recorded as part of the sale transaction and the Merchandise Inventory account is decreased. A “periodic” inventory system does not keep detailed records of inventory on hand throughout the period. Cost of goods sold and ending inventory are determined at the end of the “period”, usually by an inventory count. When inventory is sold, the cost of goods sold is not recorded and the Merchandise Inventory account is not decreased. 3. A physical count is an important control feature. With a perpetual inventory system a company knows what should be on hand, but there still could be errors in the record keeping or shortages in stock. By performing a physical count and comparing it to the perpetual inventory records, an error or shortage can be detected. If an error or shortage is found, it is important to adjust the accounting records to reflect actual quantities on hand. 4. The benefits of the perpetual inventory system are that it continuously—perpetually—shows the quantity and cost of the inventory purchased, sold, and on hand. Under a perpetual inventory system, the cost of goods sold and reduction in inventory are recorded each time a sale occurs. A perpetual inventory system gives stronger internal control over inventories compared with a periodic system. Another benefit of a perpetual inventory system is that it makes it easier to answer questions from customers about merchandise availability. Management can also maintain optimum inventory levels and avoid running out of stock. In a periodic system the number of items on hand cannot be determined without physically examining the inventory. A perpetual inventory system requires more record keeping and therefore is more expensive to use than a periodic system. For example, a perpetual inventory system usually requires an investment in a point-of-sale system that is integrated with the inventory system. In a periodic system, this not required. QUESTIONS (Continued) 5. A subsidiary ledger is a group of accounts that share a common characteristic (for example, all inventory accounts). The subsidiary ledger frees the general ledger from the details of individual balances. In addition to having one for inventory, it is very common to have subsidiary ledgers for accounts receivable (to track individual customer balances), accounts payable (to track individual creditor balances), and payroll (to track individual employee pay records). 6. Disagree. Sales taxes include the federal Goods and Services Tax (GST), the Provincial Sales Tax (PST), and the Harmonized Sales Tax (HST) (which is a combination of GST and PST). GST and HST are paid by merchandising companies on inventory purchases. Companies conducting business in provinces that are subject to PST do not pay PST on merchandise purchased for resale. PST is paid by the final customer only. 7. The letters FOB mean free on board. FOB shipping point means that the goods are placed on a carrier (such as a truck or train) by the seller, and the buyer pays the freight costs. Ownership transfers to the buyer as soon as the goods are placed on the carrier. FOB destination means that the goods are shipped to the buyer’s place of business, and the seller pays the freight. Ownership transfers to the buyers when the goods are delivered to the buyer’s place of business. Freight costs paid on inventory purchases are added to the cost of the inventory. Freight costs paid on sales are recorded as an expense such as Freight Out or Delivery Expense. 8. Purchase returns occur when goods purchased for resale are returned to a supplier. If the merchandise does not correspond to what was ordered or the quantity shipped is in excess of quantities ordered, goods are shipped back to the supplier for credit. In this case, the Merchandise Inventory account is reduced (credited) and the Accounts Payable account is reduced (debited) for the cost amount of the goods returned. In the case of a purchase allowance, the merchandise is not returned. Purchase allowances are granted by suppliers when the product has some defect or deficiency when received by the buyer. An amount is negotiated to reduce the purchase price of the goods and an allowance is granted by the supplier. In this case the Merchandise Inventory account is reduced (credited) and the Accounts Payable account is reduced (debited) for the reduction in the purchase price. QUESTIONS (Continued) 9. Fukushima Company should take advantage of the discount offered. The bank rate of 7.25% is an annual rate which is equivalent to 0.4% for 20 days (7.25% × 20/365). Since 0.4% cost of borrowing is less than 1% saved by paying 10 days after the purchase—20 days before the final due date—it is advantageous to borrow and pay within the discount period. Another way to explain the advantage is to convert the discount to an annual rate. In order to obtain the 1% discount the company must pay 20 days ahead of the final due date (30 days – 10 days = 20 days). The effective annual interest rate of doing this is 18.25% (1% × 365/20). Since the 18.25% savings is greater than the 7.25% rate on the bank loan, the company should borrow from the bank and take advantage of the discount. 10. The company needs to record a credit to Sales for $75 and to debit Cost of Goods Sold for $50 instead of the $25 credit to Gross Profit. Recording the sales and cost of goods sold in separate accounts allows the company and users of financial information to do ratio analysis to measure the company’s profitability and it allows management to analyze trends and variances in both revenues and expenses separately. A debit will also be recorded for $75 of cash received and a credit will be recorded for $50 of inventory that was sold. 11. A quantity discount gives a reduction in price according to the volume of the purchase—in other words, the larger the number of items purchased, the larger the discount. Quantity discounts are not the same as purchase discounts, which are offered to customers for early payment of the balance due. Purchase discounts are noted on the invoice by the use of credit terms that specify the amount and time period for the purchase discount. Quantity discounts are not recorded or accounted for separately, whereas purchase discounts are recorded separately. When an invoice is paid within the discount period, the Merchandise Inventory account will be reduced by the amount of the discount because inventory is recorded at cost. By paying within the discount period, a company reduces the cost of its inventory. A sales discount is the counterpart of the purchase discount. A purchase discount is a discount taken by the purchaser, and a sales discount is the discount offered by the seller. When the invoice is paid within the discount period, the discount is recorded in a separate contra revenue account called Sales Discount. QUESTIONS (Continued) 12. By using separate sales accounts for major product lines, management can monitor sales trends more closely and respond more strategically to changes in sales patterns and manage inventory. For example, a car dealership that sells cars and car parts would want to be able to track car sales separately from parts sales. This would allow managing these two segments of the business separately and possibly apply different strategies to increase sales. For internal reporting purposes the sales amounts would be reported separately as it is meaningful to managers in both segments of the business. For distribution of information to outsiders, sales would be grouped into a single amount. This ensures that the financial information is simple and easy to understand. It also protects the business from revealing detailed information that could be used against it if the information fell into the hands of competitors. 13. Disagree with Geoff’s advice. Sales returns are not debited directly to the Sales account because this would not provide information on the amount of sales returns and allowances. This information is important to management as it may suggest inferior merchandise, errors in billing, or incorrect sales techniques. Debiting returns directly to sales may also cause problems in comparing sales for different periods. Geoff may be suggesting this to hide the volume of returns associated with his sales if many of the sales returns are from his customers. Raymond should record the sales returns in a separate contra account in order to have better information to manage the company. 14. A sales allowance occurs when the buyer keeps the merchandise, but the sales price is adjusted. This may happen because the purchaser is dissatisfied because the goods are damaged, of inferior quality, or do not meet the purchaser’s specifications. Since the goods are not returned, the Merchandise Inventory account cannot be debited. The transaction is recorded as a reduction to Accounts Receivable or Cash and a debit to Sales Returns and Allowances. When goods are returned and are in saleable condition, they are available to be resold to another customer. A journal entry will debit Merchandise Inventory and credit Cost of Goods Sold for the same amount as the original cost of the inventory. If the goods are damaged and cannot be resold, the transaction is recorded in the same way as a sales allowance; there is no entry to Merchandise Inventory or Cost of Goods Sold. Since the items are damaged they do not represent assets to the company and cannot be returned to the Merchandise Inventory account. QUESTIONS (Continued) 15. Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service enterprise. The types of transactions are different, but the steps in the accounting cycle are the same. 16. This difference could be the result of errors in the perpetual inventory records, or because of errors in the annual physical inventory count. An adjustment at the end of the period will be necessary to correctly reflect the actual inventory on hand at year end. If the dollar value of actual inventory on hand is greater than what is reflected in the perpetual inventory records, the difference will be an increase (debit) to Merchandise Inventory and a decrease (credit) to Cost of Goods Sold. 17. The additional accounts that must be closed for a merchandising company using a perpetual inventory system are Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, and Freight Out. The Sales account is debited to close it to the Income Summary account. The remaining accounts have normal debit balances and are credited when closed to Income Summary. 18. The single-step income statement differs from the multiple-step income statement in that (1) all data are classified into two categories: revenues and expenses; and (2) only one step, subtracting total expenses from total revenues, is required in determining profit (or loss). A multiple step income statement includes three main steps: (1) cost of goods sold is subtracted from sales to determine gross profit (2) operating expenses are subtracted from gross profit to determine profit from operations, and (3) non-operating expenses are subtracted from (and non-operating revenues are added to) profit from operations to determine profit. QUESTIONS (Continued) 19. Net sales is calculated by deducting the contra revenue accounts, Sales Returns and Allowances and Sales Discounts, from Sales. Gross profit is calculated by subtracting cost of goods sold from net sales. Profit from operations is calculated by subtracting operating expenses from gross profit. Profit is calculated by subtracting non-operating expenses from (or adding non-operating revenues to) profit from operations. Only merchandising companies show net sales and gross profit; service companies would show service revenues. Profit from operations is used by both merchandising and service companies as both of these types of companies may have non-operating revenues or expenses. 20. Interest expense is a non-operating expense because it relates to how a company’s operations are financed, so it is not an expense related to main operating activities. 21. Yes, it is possible for profit from operations and profit to be the same. This would occur if the company has no non-operating expenses or revenues. If companies do not have non-operating expenses or revenues, the profit from operations is referred to as profit. 22. Operating expenses are those expenses related to the main activity or main operations of the business. Recurring expenses of different types are incurred to generate the revenue from providing goods or services. Non-operating expenses have more to do with how the business is financed or how much cash it has available to invest and generate additional revenues beyond its main source of revenue from operations. If a business is partly financed with debt, it will have interest expense. If a company has excess cash, it can earn revenue from investments, including interest revenue. The multiple-step income statement highlights the non-operating expenses and presents them separately so that income from operations can be reported. This is not the case when the single-step income statement format is used. 23. Gross profit is calculated as the difference between net sales revenue and cost of goods sold and is expressed in dollars. Gross profit margin represents gross profit expressed as a percentage of net sales. The gross profit margin allows the company to compare its results with past periods, competitors, and industry averages. It shows the relative relationship between net sales and gross profit. QUESTIONS (Continued) *24. In a periodic inventory system, purchases are debited to the Purchases account. Purchase returns and allowances, purchase discounts, and freight in are also recorded in separate accounts. In a perpetual inventory system, purchases, purchase returns and allowances, purchase discounts, and freight in are recorded directly to the Merchandise Inventory account. In a perpetual system, cost of goods sold and inventory are updated as each sale occurs. This does not happen in a periodic system. *25. To arrive at the cost of goods purchased using the periodic system, purchase discounts and purchase returns (contra accounts to purchases) are deducted from the account Purchases. Freight in, on the other hand, is added to Purchases. *26. The purpose of these entries is to update the Merchandise Inventory account to the correct ending balance (i.e., adjust for the change between the beginning and ending inventories). SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a) & (b) Company A Cost of goods sold = $227,500 ($350,000-$122,500) Profit = $17,500 ($122,500-$105,000) (c) & (d) Company B Gross profit = $367,500 ($735,000-$367,500) Operating expenses = $294,000 ($367,500-$73,500) (e) & (f) Company C Gross Profit = $210,000 ($525,000-$315,000) Profit = $94,500 ($210,000-$115,500) (g) & (h) Company D Sales = $495,000 ($346,500+$148,500) Loss = $(39,600) ($148,500-$188,100) BRIEF EXERCISE 5-2 (1) (a) Cost of goods available for sale = $250,000 + $170,000 = $420,000. (b) Cost of goods sold = $420,000 – $50,000 = $370,000 (2) (c) Cost of goods available for sale = $108,000 + $70,000 = $178,000. (d) Ending inventory = $178,000 – $90,000 = $88,000. (3) (e) Purchases = $130,000 – $75,000 = $55,000. (f) Ending inventory = $130,000 – $38,000 = $92,000. (4) (g) Beginning inventory = $95,000 – $75,000 = $20,000. (h) Cost of goods sold = $95,000 – $45,000 = $50,000. BRIEF EXERCISE 5-3 (a) Mar. 16 Merchandise Inventory 15,000 Accounts Payable 15,000 18 Accounts Payable 750 Merchandise Inventory 750 25 Accounts Payable ($15,000 – $750) 14,250 Merchandise Inventory ($14,250 × 2%) 285 Cash 13,965 (b) Date Assets Liabilities Owner’s Equity Mar. 16 Inventory + $15,000 Accounts Payable + $15,000 NE 18 Inventory – $750 Accounts Payable – $750 NE 25 Inventory – $285 Accounts Payable – $14,250 NE Cash – $13,965 BRIEF EXERCISE 5-4 Jan. 2 Merchandise Inventory 20,000 Accounts Payable 20,000 Jan. 4 Merchandise Inventory 215 Cash 215 Jan. 6 Accounts Payable 1,500 Merchandise Inventory 1,500 Feb. 1 Accounts Payable 18,500 Cash 18,500 BRIEF EXERCISE 5-5 Mar. 12 Merchandise Inventory 25,000 Accounts Payable 25,000 13 No entry required. 14 Accounts Payable 2,000 Merchandise Inventory 2,000 21 Accounts Payable ($25,000 – $2,000) 23,000 Merchandise Inventory ($23,000 × 2%) 460 Cash 22,540 BRIEF EXERCISE 5-6 (a) Mar. 16 Accounts Receivable 15,000 Sales 15,000 Cost of Goods Sold 8,700 Merchandise Inventory 8,700 17 Freight Out 170 Cash 170 18 Sales Returns and Allowances 750 Accounts Receivable 750 25 Cash ($14,250 – $285) 13,965 Sales Discounts ($14,250 × 2%) 285 Accounts Receivable ($15,000 – $750) 14,250 (b) Date Assets Liabilities Owner’s Equity Mar. 16 Accounts Receivable + $15,000 NE + $15,000 16 Merchandise Inventory – $8,700 NE – $8,700 17 Cash – $170 NE – $170 18 Accounts Receivable – $750 NE – $750 25 Cash + $13,965 NE – $285 Accounts Receivable – $14,250 BRIEF EXERCISE 5-7 Jan. 2 Accounts Receivable 20,000 Sales 20,000 Cost of Goods Sold 7,900 Merchandise Inventory 7,900 4 No entry required. 6 Sales Returns and Allowances 1,500 Accounts Receivable 1,500 Merchandise Inventory 590 Cost of Goods Sold 590 Feb. 1 Cash ($20,000 – $1,500) 18,500 Accounts Receivable 18,500 BRIEF EXERCISE 5-8 Mar. 12 Accounts Receivable 25,000 Sales 25,000 Cost of Goods Sold 13,250 Merchandise Inventory 13,250 13 Freight Out 265 Cash 265 14 Sales Returns and Allowances 2,000 Accounts Receivable 2,000 22 Cash ($23,000 – $460) 22,540 Sales Discounts ($23,000 × 2%) 460 Accounts Receivable 23,000 BRIEF EXERCISE 5-9 Cost of Goods Sold 1,900 Merchandise Inventory ($98,000 – $96,100) 1,900 BRIEF EXERCISE 5-10 Sept. 30 Sales 218,750 Income Summary 218,750 30 Income Summary 171,000 Sales Returns and Allowances 3,150 Sales Discounts 950 Cost of Goods Sold 125,000 Freight Out 1,900 Salaries Expense 40,000 Merchandise Inventory and Supplies are balance sheet (permanent) accounts and are not closed. BRIEF EXERCISE 5-11 NELSON COMPANY Income Statement For the Month Ended October 31, 2017 Sales* $375,000 Less: Sales returns and allowances $11,000 Sales discounts 5,000 16,000 Net sales $359,000 * ($280,000 + $95,000) BRIEF EXERCISE 5-12 (a) Net sales = $539,000 ($561,000 – $5,500 – $16,500) (b) Gross profit = $154,000 ($539,000 – $385,000) (c) Operating expenses = $115,500 ($13,200 + $3,300 + $44,000 + $55,000) (d) Profit from operations $38,500 ($154,000 – $115,500) (e) Profit = $36,300 ($38,500 + $8,800 – $11,000) BRIEF EXERCISE 5-13 2017 Gross profit margin = 36.84% [($950,000 – $600,000) ÷ $950,000] Profit margin = 7.37% [$70,000 ÷ $950,000] 2016 Gross profit margin = 37.50% [($800,000 – $500,000) ÷ $800,000] Profit margin = 8.13% [$65,000 ÷ $800,000] GS Retail’s profitability has deteriorated since both its gross profit margin and its profit margin have decreased from the previous year. *BRIEF EXERCISE 5-14 Feb. 5 Purchases 12,000 Accounts Payable 12,000 6 Freight In 110 Cash 110 8 Accounts Payable 1,000 Purchase Returns and Allowances 1,000 11 Accounts Payable ($12,000 − $1,000) 11,000 Purchases Discounts ($11,000 × 2%) 220 Cash ($11,000 – $220) 10,780 *BRIEF EXERCISE 5-15 Feb. 5 Accounts Receivable 12,000 Sales 12,000 6 No entry required. 8 Sales Returns and Allowances 1,000 Accounts Receivable 1,000 11 Cash ($11,000 – $220) 10,780 Sales Discounts ($11,000 × 2%) 220 Accounts Receivable 11,000 *BRIEF EXERCISE 5-16 Cost of goods sold Merchandise inventory, beginning $ 51,000 Purchases $340,000 Less: Purchase discounts $6,800 Purchase returns and allowances 9,350 16,150 Net purchases 323,850 Add: Freight in 13,600 Cost of goods purchased 337,450 Cost of goods available for sale 388,450 Merchandise inventory, ending 68,000 Cost of goods sold $320,450 Note: Freight out is not included; it is an operating expense.