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1. (a) Disagree. The steps in the accounting cycle are the same for both a merchandising companyand a service company.
(b) The measurement of income is conceptually the same. In both types of companies, netincome (or loss) results from the matching of expenses with revenues.
2. The normal operating cycle for a merchandising company is likely to be longer than in a servicecompany because inventory must first be purchased and sold, and then the receivables must becollected.
3. (a) The components of revenues and expenses differ as follows:
Merchandising ServiceRevenuesExpenses
SalesCost of Goods Sold and Operating
Fees, Rents, etc.Operating (only)
(b) The income measurement process is as follows:
SalesRevenue
LessCost ofGoodsSold
EqualsGrossProfit
LessOperatingExpenses
EqualsNet
Income
4. Income measurement for a merchandising company differs from a service company as follows:(a) sales are the primary source of revenue and (b) expenses are divided into two maincategories: cost of goods sold and operating expenses.
5. In a perpetual inventory system, cost of goods sold is determined each time a sale occurs.
6. The letters FOB mean Free on Board. FOB shipping point means that goods are placed free onboard the carrier by the seller. The buyer then pays the freight and debits Merchandise Inventory.FOB destination means that the goods are placed free on board to the buyer’s place of business.Thus, the seller pays the freight and debits Freight-out.
7. Credit terms of 2/10, n/30 mean that a 2% cash discount may be taken if payment is made within10 days of the invoice date; otherwise, the invoice price, less any returns, is due 30 days from theinvoice date.
8. July 24 Accounts Payable ($2,000 – $200).......................................................... 1,800Merchandise Inventory ($1,800 X 2%)........................................... 36Cash ($1,800 – $36) .......................................................................... 1,764
9. Agree. In accordance with the revenue recognition principle, sales revenues are generally con-sidered to be earned when the goods are transferred from the seller to the buyer; that is, whenthe exchange transaction occurs. The earning of revenue is not dependent on the collection ofcredit sales.
10. (a) The primary source documents are: (1) cash sales—cash register tapes and (2) credit sales—sales invoice.
(2) Income Summary......................................................................................... 145,000Cost of Goods Sold ............................................................................ 145,000
14. Of the merchandising accounts, only Merchandise Inventory will appear in the post-closing trialbalance.
15. Sales revenues......................................................................................................................... $105,000Cost of goods sold ................................................................................................................... 70,000Gross profit ................................................................................................................................ $ 35,000
Gross profit rate: $35,000 ÷ $105,000 = 33.3%
16. Gross profit ................................................................................................................................ ¥370,000Less: Net income .................................................................................................................... 240,000Operating expenses ................................................................................................................ ¥130,000
17. There are three distinguishing features in the income statement of a merchandising company:(1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit.
*18. (a) The operating activities part of the income statement has three sections: sales revenues,cost of goods sold, and operating expenses.
(b) The nonoperating activities part consists of other income (interest revenue, gain from saleof equipment) and expense (casualty losses, loss from strikes).
*19.Accounts Added/Deducted
Purchase Returns and AllowancesPurchase DiscountsFreight-in
DeductedDeductedAdded
*20. July 24 Accounts Payable ($3,000 – $200).............................................................. 2,800Purchase Discounts ($2,800 X 2%).................................................... 56Cash ($2,800 – $56) .............................................................................. 2,744
*21. The columns are:(a) Merchandise Inventory—Trial Balance (Dr.), Adjusted Trial Balance (Dr.), and Statement of
Financial Position (Dr.).(b) Cost of Goods Sold—Trial Balance (Dr.), Adjusted Trial Balance (Dr.), and Income
Gordon CompanyAccounts Receivable ................................................. 780
Sales ....................................................................... 780Cost of Goods Sold .................................................... 520
Income Summary.................................................................. 107,000Cost of Goods Sold..................................................... 105,000Sales Discounts ........................................................... 2,000
Net purchases......................................................................... W431,000Add: Freight-in ...................................................................... 16,000Cost of goods purchased ................................................... W447,000
*BRIEF EXERCISE 5-11
Net sales................................................................................... W630,000Beginning inventory ............................................................. W 60,000Add: Cost of goods purchased*...................................... 447,000Cost of goods available for sale....................................... 507,000Ending inventory ................................................................... 90,000Cost of goods sold................................................................ 417,000Gross profit ............................................................................. W213,000
(d) Cost of goods sold: Trial balance debit column, Adjusted trial balancedebit column, Income statement debit column.
SOLUTIONS FOR DO IT! REVIEW EXERCISES
DO IT! 5-1
Oct. 5 Merchandise Inventory ................................................. 5,000Accounts Payable ................................................... 5,000 (To record goods purchased on account)
Oct. 8 Accounts Payable........................................................... 700Merchandise Inventory .......................................... 700 (To record return of defective goods)
DO IT! 5-2
Oct. 5 Accounts Receivable..................................................... 5,000Sales............................................................................. 5,000 (To record credit sales)
Cost of Goods Sold........................................................ 3,000Merchandise Inventory ......................................... 3,000 (To record cost of goods sold on account)
Oct. 8 Sales Returns and Allowances .................................. 700Accounts Receivable ............................................. 700 (To record credit granted for receipt of returned goods)
Merchandise Inventory.................................................. 250Cost of Goods Sold ................................................ 250 (To record scrap value of goods returned)
Income Summary ..................................................... 141,000 (To close accounts with credit balances)
Income Summary ............................................................ 126,800Cost of Goods Sold ................................................. 92,400Sales Returns and Allowances............................ 4,000Sales Discounts........................................................ 3,000Freight-out.................................................................. 1,500Utilities Expense....................................................... 7,400Salaries Expense...................................................... 18,500 (To close accounts with debit balances)
Accounts Payable Statement of Financial Position Current liabilitiesAccounts Receivable Statement of Financial Position Current assetsAccumulatedDepreciation— Office Building
Statement of Financial Position Property, plant, and equipment
Cash Statement of Financial Position Current assetsCasualty Loss from Vandalism
Income Statement Other income andexpense
Cost of Goods Sold Income Statement Cost of goods soldDelivery Equipment Statement of Financial Position Property, plant, and
equipmentDepreciation Expense Income Statement Operating expensesDividends Retained Earnings Statement Deduction sectionFreight-out Income Statement Operating expensesInsurance Expense Income Statement Operating expensesInterest Payable Statement of Financial Position Current liabilitiesLand Statement of Financial Position Property, plant, and
equipmentMerchandise Inventory Statement of Financial Position Current assetsNotes Payable (due in 5 years)
Statement of Financial Position Non-current liabilities
Property Tax Payable Statement of Financial Position Current liabilitiesSalaries Expense Income Statement Operating expensesSalaries Payable Statement of Financial Position Current liabilitiesSales Returns and Allowances
Income Statement Sales revenues
Sales Income Statement Sales revenuesShare Capital—Ordinary Statement of Financial Position EquityUnearned Rent Statement of Financial Position Current liabilityUtilities Expense Income Statement Operating expensesWarehouse Statement of Financial Position Property, plant, and
Income Summary ........................................................... 92,800Cost of Goods Sold (TL60,000 + TL900)........ 60,900Operating Expenses............................................. 29,000Sales Returns and Allowances......................... 1,700Sales Discounts..................................................... 1,200
Income Summary (TL108,000 – TL92,800) ............. 15,200Retained Earnings................................................. 15,200
For the Year Ended December 31, 2011 Net sales...................................................... €2,312,000Cost of goods sold .................................. 1,289,000Gross profit ................................................ 1,023,000Operating expenses ................................ 925,000Income from operations......................... 98,000Other income and expense
Interest revenue............................... € 28,000Loss on sale of equipment........... (10,000) 18,000
(b) $360,000/$900,000 = 40%. The gross profit rate is generally considered tobe more useful than the gross profit amount. The rate expresses a moremeaningful (qualitative) relationship between net sales and gross profit.The gross profit rate tells how many of each sales dollar go to grossprofit. The trend of the gross profit rate is closely watched by financialstatement users, and is compared with rates of competitors and withindustry averages. Such comparisons provide information about theeffectiveness of a company’s purchasing function and the soundness ofits pricing policies.
(c) Income from operations is $130,000 ($360,000 – $230,000), and net incomeis $119,000 ($130,000 – $11,000).
(d) Merchandise inventory is reported as a current asset immediately belowprepaid expenses.
EXERCISE 5-13
(a) (*missing amount)
a. Sales....................................................................................... PY 90,000)*Sales returns....................................................................... (6,000)Net sales ............................................................................... PY 84,000)
b. Net sales ............................................................................... PY 84,000)Cost of goods sold............................................................ (56,000)
e. Net sales................................................................................ PY 100,000)*Cost of goods sold ............................................................ 58,500)Gross profit .......................................................................... PY 41,500
(b) Net sales............................................................................ $ 81,000Cost of goods sold ........................................................ 56,000Gross profit ...................................................................... $ 25,000*
(c) and (d)Gross profit ...................................................................... $ 25,000Operating expenses ...................................................... 15,000Income from operations (c)......................................... $ 10,000*Other expenses and losses ........................................ 4,000Net income (d) ................................................................. $ 6,000*
(j) Net sales ............................................................................ $132,000Cost of goods sold......................................................... 108,000*Gross profit....................................................................... $ 24,000
(k) and (l)Gross profit...................................................................... $ 24,000Operating expenses...................................................... 18,000Income from operations (k) ........................................ $ 6,000*Other expenses and losses (l)................................... 1,000*Net income....................................................................... $ 5,000
EXERCISE 5-15
Inventory, September 1, 2010......................................... Rp 17,200Purchases ............................................................................. Rp 149,000Less: Purchase returns and allowances ................... 2,000Net Purchases ..................................................................... 147,000Add: Freight-in ................................................................... 4,000Cost of goods purchased ................................................ 151,000Cost of goods available for sale.................................... 168,200Inventory, August 31, 2011.............................................. 25,000
Cost of goods sold ................................................... Rp143,200
(a) Sales ............................................................... $800,000Less: Sales returns and allowances...... $ 10,000
Sales discounts ............................. 5,000 15,000Net sales........................................................ 785,000Cost of goods sold
Inventory, January 1 ........................... 50,000Purchases .............................................. $500,000Less: Purch. rets. and alls. ............. 2,000
Purch. discounts .................... 6,000Net purchases....................................... 492,000Add: Freight-in...................................... 4,000Cost of goods available for sale..... 546,000Inventory, December 31..................... 60,000
Cost of goods sold...................... 486,000Gross profit............................................ $299,000
(b) Gross profit $299,000 – Operating expenses = Net income $130,000.Operating expenses = $169,000.
Cost of goods sold ............................................................. 11,990Gross profit ........................................................................... € 3,465
For the Year Ended December 31, 2011 Retained earnings, January 1 ................................................................. $60,000Add: Net income........................................................................................ 30,100
90,100Less: Dividends.......................................................................................... 28,000Retained earnings, December 31........................................................... $62,100
MAINE DEPARTMENT STOREStatement of Financial Position
December 31, 2011
AssetsProperty, plant, and equipment
Building ........................................................ $190,000Less: Accumulated depreciation—
building ........................................... 52,500 $137,500Equipment ................................................... 110,000Less: Accumulated depreciation—
Cost of goods soldInventory, January 1................... $ 40,500Purchases ...................................... $447,000Less: Purchase returns
and allowances ............... $ 6,400Purchase discounts ...... 12,000 18,400
Net purchases............................... 428,600Add: Freight-in ............................ 5,600Cost of goods purchased........... 434,200Cost of goods available
for sale .................................... 474,700Inventory, December 31 ............ 75,000
Cost of goods sold.............. 399,700Gross profit ........................................... $310,300
Cost of goods sold:Beginning inventoryPlus: PurchasesCost of goods availableLess: Ending inventoryCost of goods sold
$ 13,000 146,000 159,000 11,300$147,700
$ 11,300 145,000 156,300 14,700$141,600
$ 14,700 129,000 143,700 12,200$131,500
(b)2009 2010 2011
SalesLess: CGSGross profit
$225,700 147,700$ 78,000
$227,600 141,600$ 86,000
$219,500 131,500$ 88,000
(c)2009 2010 2011
Beginning accounts payablePlus: PurchasesLess: Payments to suppliersEnding accounts payable
$ 20,000 146,000 135,000$ 31,000
$ 31,000 145,000 161,000$ 15,000
$ 15,000 129,000 127,000$ 17,000
(d) Gross profit rate 134.6% 237.8% 340.1%
1$78,000 ÷$225,700
2$86,000 ÷$227,600
3$88,000 ÷$219,500
No. Even though sales declined in 2011 from each of the two prior years,the gross profit rate increased. This means that cost of goods solddeclined more than sales did, reflecting better purchasing power or controlof costs. Therefore, in spite of declining sales, profitability, as measured bythe gross profit rate, actually improved.
Cost of goods soldInventory, April 1 ........................ CHF1,700Purchases ..................................... CHF1,640Less: Purchase returns
and allowances .............. CHF90Purchase discounts ..... 33 123
Net purchases.............................. 1,517Add: Freight-in ........................... 90Cost of goods purchased ........ 1,607Cost of goods available
for sale ................................... 3,307Inventory, April 30...................... 2,296
Cost of goods sold............. 1,011Gross profit .......................................... CHF 859
Total operating expenses ............... 248,900Loss from operations............................................... (200)Interest expense......................................................... 4,080Net loss ......................................................................... $ (4,280)
TERRY MANNING FASHION CENTERRetained Earnings Statement
For the Year Ended November 30, 2011 Retained earnings, December 1, 2010........................... $30,000Less: Net loss....................................................................... $ 4,280
Dividends................................................................... 12,000 16,280Retained earnings, November 30, 2011........................ $13,720
TERRY MANNING FASHION CENTERStatement of Financial Position
November 30, 2011
AssetsProperty, plant, and equipment
Store equipment .................................... $85,000Accumulated depreciation— store equipment ................................ 31,000 $54,000Delivery equipment............................... 48,000Accumulated depreciation— delivery equipment........................... 11,000 37,000 $ 91,000
Current liabilitiesNotes payable due next year .......................................... 30,000Accounts payable............................................................... 48,500Interest payable................................................................... 4,080 82,580
Total equity and liabilities ....................................................... $197,300
(c) Nov. 30 Store Supplies Expense................................ 3,700Store Supplies......................................... 3,700
Cost of goods sold ............................................................. 3,850Gross profit ........................................................................... $2,269
For the Year Ended November 30, 2011 Retained earnings, December 1, 2010.................................................... £51,700Add: Net income.......................................................................................... 6,600
58,300Less: Dividends............................................................................................ 10,000Retained earnings, November 30, 2011................................................. £48,300
TARP DEPARTMENT STOREStatement of Financial Position
November 30, 2011
AssetsProperty, plant, and equipment
Store equipment ...................................... £100,000Less: Accumulated depreciation—
store equipment ......................... 32,000 £68,000Delivery equipment................................. 46,000Less: Accumulated depreciation—
Cash.....................................................................................Accounts Receivable .....................................................Merchandise Inventory..................................................Share Capital—Ordinary...............................................Sales....................................................................................Sales Returns and Allowances...................................Cost of Goods Sold ........................................................
and allowances............ TL2,700Purchase discounts... 6,300 9,000
Net purchases............................ 576,000Add: Freight-in ......................... 4,500Cost of goods purchased ...... 580,500Cost of goods available
for sale............................ 620,500Inventory, Nov. 30, 2011......... 32,600
Cost of goods sold..... 587,900Gross profit ........................................ TL204,100
(2) A decline in sales does not necessarily mean that profitability declined.Profitability is affected by sales, cost of goods sold, and operatingexpenses. If cost of goods sold or operating expenses decline morethan sales, profitability can increase even when sales decline. However,in this particular case, sales declined with insufficient offsetting costsavings to improve profitability. Therefore, profitability declined forLetterman, Inc.
Cost of goods soldInventory, April 1................................ €4,000Purchases............................................. €1,540Less: Purchase returns
and allowances...................... €140Purchase discounts............. 25 165
Net purchases ..................................... 1,375Add: Freight-in................................... 50Cost of goods purchased.................. 1,425Cost of goods available for sale............................................... 5,425Inventory, April 30.............................. 4,726
Cost of goods sold .................... 699Gross profit .................................................. € 466
(c) Percentage of net income to sales: 2007 (£407 ÷ £4,699) 2008 (£366 ÷ £5,384)
8.7%6.8%
Comment
The percentage of net income to sales declined 21.8% (8.7% to 6.8%) from2007 to 2008. This occurred even though the gross profit rate remainedunchanged at 46.7% from 2007 to 2008.
(b) Because the companys report using different currencies, direct com-parisons of total gross profit, or total operating income are difficult.Comparisons of ratios and percentages can be performed. Nestléreported a higher gross profit rate, while Cadbury experienced a muchbigger percentage increase in operating income.
For the Year Ended December 31, 2011 Net sales [$700,000 + ($700,000 X 6%)]........ $742,000Cost of goods sold ($742,000 X 76%)* ......... 563,920Gross profit ($742,000 X 24%)......................... 178,080Operating expenses
Total operating expenses ............... 120,000Net income............................................................. $ 58,080
**Alternatively: Net sales, $742,000 – gross profit, $178,080.
(2) FEDCO DEPARTMENT STOREIncome Statement
For the Year Ended December 31, 2011 Net sales................................................................. $700,000Cost of goods sold ............................................. 553,000Gross profit ........................................................... 147,000Operating expenses
Net income............................................................. $ 55,000
*$100,000 – $30,000 + ($700,000 X 2%) – ($30,000 X 40%) = $72,000.
(b) Carrie’s proposed changes will increase net income by $31,080. Luke’sproposed changes will reduce operating expenses by $28,000 andresult in a corresponding increase in net income. Thus, if the choice isbetween Carrie’s plan and Luke’s plan, Carrie’s plan should be adopted.While Luke’s plan will increase net income, it may also have an adverseeffect on sales personnel. Under Luke’s plan, sales personnel will betaking a cut of $16,000 in compensation [$60,000 – ($30,000 + $14,000)].
For the Year Ended December 31, 2011 Net sales ........................................................................ $742,000Cost of goods sold..................................................... 563,920Gross profit................................................................... 178,080Operating expenses
Total operating expenses ...................... 92,840Net income.................................................................... $ 85,240
*$72,000 + [2% X ($742,000 – $700,000)] = $72,840.
If both plans are implemented, net income will be $58,240 ($85,240 –$27,000) higher than the 2010 results. This is an increase of over 200%.Given the size of the increase, Luke’s plan to compensate sales person-nel might be modified so that they would not have to take a pay cut.For example, if sales commissions were 3%, the compensation cut wouldbe reduced to $8,580 [$16,000 (from (b)) – $742,000 X (3% – 2%)].
As you know, the financial statements for Surfing USA Co. are prepared inaccordance with international financial reporting standards (IFRS). One ofthese principles is the revenue recognition principle, which provides thatrevenues should be recognized when they are earned.
Typically, sales revenues are earned when the goods are transferred to thebuyer from the seller. At this point, the sales transaction is completed andthe sales price is established. Thus, in the typical situation, revenue on thesurfboard ordered by Flutie is earned at event No. 8, when Flutie picks upthe surfboard.
The circumstances pertaining to this sale may seem to you to be atypicalbecause Flutie has ordered a specific kind of surfboard. From an accountingstandpoint, this would be true only if you could not reasonably expect tosell this surfboard to another customer. In such case, it would be properunder IFRS to recognize sales revenue when you have completed thesurfboard for Flutie.
Whether Flutie makes a down payment with the purchase order is irrelevantin recognizing sales revenue because at this time, you have not done any-thing to earn the revenue. A down payment may be an indication of Flutie’s“good faith.” However, its effect on your financial statements is limited entirelyto recognizing the down payment as unearned revenue.
If you have further questions about the accounting for this sale, please letme know.
(a) Laura McAntee, as a new employee, is placed in a position of res-ponsibility and is pressured by her supervisor to continue an unethicalpractice previously performed by him. The unethical practice is takingundeserved cash discounts. Her dilemma is either follow her boss’sunethical instructions or offend her boss and maybe lose the job shejust assumed.
(b) The stakeholders (affected parties) are:� Laura McAntee, the assistant treasurer.� Danny Feeney, the treasurer.� Dorchester Stores, the company.� Creditors of Dorchester Stores (suppliers).� Mail room employees (those assigned the blame).
(c) Laura’s alternatives:
1. Tell the treasurer (her boss) that she will attempt to take every allow-able cash discount by preparing and mailing checks within thediscount period—the ethical thing to do. This will offend her bossand may jeopardize her continued employment.
2. Join the team and continue the unethical practice of taking undeservedcash discounts.
3. Go over her boss’s head and take the chance of receiving just andreasonable treatment from an officer superior to Danny. The companymay not condone this practice. Laura definitely has a choice, butprobably not without consequence. To continue the practice isdefinitely unethical. If Laura submits to this request, she may beasked to perform other unethical tasks. If Laura stands her groundand refuses to participate in this unethical practice, she probablywon’t be asked to do other unethical things—if she isn’t fired.Maybe nobody has ever challenged Danny’s unethical behavior andhis reaction may be one of respect rather than anger and retribution.Being ethically compromised is no way to start a new job.