Solutions to Exercises- Chap 6

SOLUTIONS TO EXERCISES

Ex. 6–1 a. You are at a significant disadvantage if no information is available about how many of each type of shirt were (1) ordered, (2) sold at full price, (3) sold at the discounted price, and (4) donated to the orphanage. It would be almost impossible to make optimal decisions without this sales information.

b. The first step in the process would be to attempt to forecast the sales of shirts for each concert, both at the concert and on the next school day. To forecast sales, you could examine the relationship between sales of each type of shirt and attendance at the concert at which it was sold. By using this relationship in conjunction with the forecasts of ticket sales this year, you could estimate sales of each type of shirt, both at the concert and on the next school day.

In making your decisions, consideration would also have to be given to the relationship between the cost of the shirts and their discounted price. If the cost of the shirts is greater than their discounted price, the optimal decision is to order only enough to meet the estimated demand at full price on the night of the concert. On the other hand, if the cost of the shirts is less than the discounted price, the optimal decision is to order enough shirts to meet the estimated demand on both the night of the concert and the next school day.

c. To assist the person performing the task next year, you would want to maintain records for each concert of (1) the number of each type of shirt purchased, (2) the number of shirts sold at the concert, (3) the number of shirts sold on the next day on campus, and (4) the number of shirts donated to the orphanage. In addition, you would want to make a record of the attendance at each concert.

Ex. 6–2 Income Statement Balance Sheet

Trans-action

NetSales

Cost ofGoods Sold

All OtherExpenses

= NetIncome

Assets = Liabilities + Owners’Equity

a.b.c.d.e.

NEI

NENENE

NENEI

NEI

NENENENENE

NEID

NED

IID

NED

INENENENE

NEID

NED

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Ex. 6–3Transaction

SubsidiaryLedger

Effect upon SubsidiaryAccount Balance

a.

b.c.d.

e.f.

g.h.

InvAPAPInvARInvARAPInvInvInvAR

IncreaseIncreaseDecreaseDecreaseIncreaseDecreaseDecreaseDecreaseDecreaseIncreaseIncreaseDecrease

Ex. 6–4 a. Jan. 2 Inventory............................................................................ 106,000Accounts Payable (McNamer Supply)................. 106,000

To record purchase of merchandise on credit.

Jan. 3 Cash..................................................................................... 98,000Sales......................................................................... 98,000

Sale of merchandise for cash.

Cost of Goods Sold............................................................. 75,000Inventory................................................................ 75,000

To reduce inventory by cost of goods sold.

b. The balance of the Inventory account on January 3 was $1,231,000. The starting balance of $1.2 million on January 1 was increased by the $106,000 cost of merchandise purchased on January 2 and decreased by the $75,000 cost of goods sold on January 3 ($1,200,000 + $106,000 $75,000 = $1,231,000).

Ex. 6–5 a. The change in net sales provides an overall measure of the effectiveness of the company in generating revenue. A major limitation of this measure is that sales may have changed largely because of the opening of new stores, the closing of unprofitable ones, or as a result of a shift to merchandise with significantly different gross profit margins. Thus, an increase in net sales is not always “good,” and a decrease is not always “bad.”

The change in comparable store sales represents the increase or decrease in the same stores from one period to the next. This statistic provides a better measure of the effectiveness of the company’s marketing strategies because it is not affected by changes in the total number of stores.

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b. Sears’ performance is quite favorable from the standpoint of the overall increase in revenue and the increase in comparable store sales. It indicates that the company’s marketing strategies were effective at existing stores and that the company also is opening new locations.

Broadway’s performance was not as good. Overall, the company’s net sales decreased. The company, however, was moderately effective in increasing sales at comparable stores. Taken together, it would appear that Broadway reduced the number of stores, but was more effective at generating sales at its remaining locations. (Note: Broadway subsequently was acquired by Macy’s.)

Ex. 6–6 a. The reason why an actual physical count is likely to indicate a smaller inventory than does the perpetual inventory records is inventory shrinkage—the normal loss of inventory through theft, breakage, and spoilage.

b. Cost of Goods Sold.............................................................................. 4,000Inventory.................................................................................. 4,000

To reduce inventory to the quantities reflected in the year-end physical count.

c. Both portions of the preceding entry should be posted to the general ledger. In addition, the reduction in inventory should be posted to the inventory ledger accounts in which the shortages were determined to exist.

Ex. 6–7 a. The amounts of beginning and ending inventory were determined by taking complete physical inventories at (or near) the ends of year 1 and year 2. “Taking a complete physical inventory” means physically counting the number of units of each product on hand and then determining the cost of this inventory by reference to per-unit purchase costs. (The inventory at the end of year 1 serves as the “beginning inventory” for year 2.)

b. Computation of the cost of goods sold during year 2:Inventory (December 31, year 1)...........................................................................Add: Purchases.......................................................................................................Cost of goods available for sale during year 2......................................................Less: Inventory (December 31, year 2).................................................................Cost of goods sold....................................................................................................

$ 2,800 30,200

33,000 3,000 $ 30,000

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c. Year 2Dec. 31 Cost of Goods Sold............................................................. 33,000

Inventory (Dec. 31, year 1).................................... 2,800Purchases................................................................ 30,200

To close those temporary accounts that contribute to the cost of goods sold for the year.

31 Inventory (Dec. 31, year 2)................................................ 3,000Cost of Goods Sold................................................. 3,000

To remove from the Cost of Goods Sold account the cost of merchandise still on hand at year-end.

d. BOSTON BAIT SHOPPartial Income Statement

For the Year Ended December 31, Year 2

Net sales...................................................................................................................Less: Cost of goods sold..........................................................................................Gross profit..............................................................................................................

$ 79,600 30,000 $ 49,600

e. Because the business is small, management probably has decided that the benefits of maintaining a perpetual inventory system are not worth the cost. Furthermore, determining a cost of goods sold figure at the point of sale for live bait (e.g., a dozen minnows) may be difficult, if not impossible.

Ex. 6–8Net

SalesBeginningInventory

NetPurchases

EndingInventory

Cost ofGoodsSold

GrossProfit Expenses

NetIncome

or (Loss)

a.b.c.d.e.

240,000480,000630,000810,000531,000

 76,000 72,000207,000261,000156,000

104,000272,000400,500450,000393,000

 35,200 80,000166,500135,000153,000

144,800264,000441,000576,000396,000

 95,200216,000189,000234,000135,000

 72,000196,000148,500270,000150,000

23,20020,00040,500

(36,000)(15,000)

Ex. 6–9 We cannot provide a specific answer to Exercise 6–9, as the exercise focuses upon local business entities selected by the students. However, the following points should be addressed in students’ answers.

Students favoring perpetual inventory systems should explain (1) management’s need for timely information about inventory levels and/or sales of specific products, and (2) why it is practical for the business to maintain such a system.

Students preferring a periodic system should explain why such a system can meet the needs of the business and/or why it would be impractical for the business to utilize a perpetual system.

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Ex. 6–10 a. Entries in the accounts of Golf World:

Accounts Receivable (Mulligans)....................................................... 10,000Sales.......................................................................................... 10,000

Sold merchandise on account to Mulligans.

Cost of Goods Sold.............................................................................. 6,500Inventory.................................................................................. 6,500

To recognize cost of goods sold relating to sale to Mulligans.

Cash...................................................................................................... 9,900Sales Discounts.................................................................................... 100

Accounts Receivable (Mulligans)........................................... 10,000To record collection of account receivable from Mulligans, less 1% cash discount.

b. Entries in the accounts of Mulligans:

Inventory.............................................................................................. 9,900Accounts Payable (Golf World)............................................. 9,900

Purchased merchandise from Golf World (net cost, $10,000 99% = $9,900).

Accounts Payable (Golf World)......................................................... 9,900Cash.......................................................................................... 9,900

Paid account payable to Golf World within the discount period.

c. Entry by Mulligans if discount not taken:

Accounts Payable (Golf World)......................................................... 9,900Purchase Discounts Lost..................................................................... 100

Cash.......................................................................................... 10,000To record payment of account payable to Golf World and loss of purchase discount for failure to pay within discount period.

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Ex. 6–11 a. Kmart Nordstrom Toys “R” Us

Net salesCost of goods soldGross profitGross profit rate

$31,43724,390

7,047a

22.4%b

$4,453c

 3,082 1,37130.8%d

$9,232 6,407f

 2,825e

30.6%

Computations:a$31,437 $24,390 = $7,047b$7,047 (from a) $31,437 = 22.4%c$3,082 + $1,371 = $4,453d$1,371 $4,453 (from c) = 30.8%e$9,232 30.6% = $2,825f$9,232 $2,825 (from e) = $6,407

b. The relative sales volumes and profit margins of Kmart and Toys “R” Us are what one might expect. Kmart is one of the nation’s largest mass merchandisers. It sells many types of everyday merchandise (including toys). Thus, it must compete on a basis of price with other mass merchandisers such as Wal-Mart, Sears, and J.C. Penney. Its gross profit is developed by selling a high volume of merchandise at minimal margins.

Toys “R” Us is a big company, but it sells only toys. It logically has a much lower sales volume than one of the country’s largest sellers of general merchandise. Toys “R” Us also has very few large-scale competitors. Most of the competition comes from small toy stores which, because of their low sales volumes, need high margins to survive. Therefore, Toys “R” Us faces less price competition than Kmart. It competes effectively with its smaller competitors by offering a bigger selection and having greater name recognition. In purchasing merchandise, Toys “R” Us also may receive larger volume discounts than its competitors. Lower purchase costs contribute to higher gross profit margins.

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Ex. 6–12 a.

Cash...................................................................................................... 117,000Sales.......................................................................................... 117,000

To record sale of telescope to Central State University for cash.

Cost of Goods Sold.............................................................................. 90,000Inventory.................................................................................. 90,000

To record cost of telescope sold to Central State University.

Inventory.............................................................................................. 50,000Accounts Payable (Lunar Optics).......................................... 50,000

To record purchase of merchandise on account from Lunar Optics, net 30 days.

b. Computation of inventory at January 7:

Inventory at Dec. 31......................................................................... $250,000 Deduct: Cost of goods sold.............................................................. (90,000) Add: Cost of merchandise purchased............................................ 50,000 Inventory at Jan. 7........................................................................... $210,000

c. Cash...................................................................................................... 117,000Sales.......................................................................................... 117,000

To record sale of telescope to Central State University for cash.

Purchases............................................................................................. 50,000Accounts Payable (Lunar Optics).......................................... 50,000

To record purchase of merchandise on account from Lunar Optics. Terms, net 30 days.

d. Cost of goods sold:

Inventory, Jan. 1............................................................................... $250,000 Purchases.......................................................................................... 50,000 Cost of goods available for sale....................................................... $300,000 Less: Inventory, Jan. 7 (per part b)................................................ 210,000 Cost of goods sold.......................................................................... $ 90,000

e. The company would probably use a perpetual inventory system because it sells merchandise with a high unit cost and has a relatively small number of sales transactions.

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Ex. 6–13

a. Computation of the cost of goods sold:Beginning inventory............................................................................................................. $ 6,240Add: Purchases..................................................................................................................... 74,400 Cost of goods available for sale........................................................................................... $80,640Less: Ending inventory........................................................................................................ 4,560 Cost of goods sold................................................................................................................. $ 76,080

b. Mountain Mabel’s appears to be a very small business that probably has no external reporting obligations (other than in the owners’ annual income tax return). Also, “management” seems to consist of the owners, who may be in the store every day and therefore do not need an inventory ledger to know what merchandise is in inventory. In a situation such as this, the additional record—keeping required to maintain a perpetual inventory system simply may not be worthwhile.

c. A larger business, such as a Sears store, needs to have up-to-date information as to the cost and quantity of merchandise in inventory and also the cost of goods sold. This information is used in quarterly reports to stockholders, reports to corporate management, and monthly reports measuring the profitability of the individual sales departments. In addition, information about the quantities of specific products sold and the quantities currently on hand is needed for such daily decisions as: (1) when to reorder specific products, (2) how much merchandise to order, and (3) which products to advertise in special sales.

Also, a store such as Sears uses point-of-sale terminals to simplify the processing of sales transactions. These terminals permit the maintenance of perpetual inventory records at very little cost and with no special effort required of accounting personnel.

Ex. 6–14

a. All of the following figures are shown in 000’s:1999 1998 1997

(1) Net sales $396,750 $388,659 $375,594(2) Gross profit (margin) 204,189 201,042 187,281

Gross profit percentage (2) (1) 51.5% 51.7% 49.9%

b. Trends in sales and gross profit include:1. The company reported its twenty-third consecutive year of record sales.2. Gross profit increased by 7.3% from 1997 to 1998, and by 1.6% from 1998 to 1999.

c. Management seems somewhat optimistic about trends in the company’s sales and gross profit statistics. In Management’s Letter to the Shareholders, the following points are made:1. The company is encouraged by the continued growth in its niche brands.2. The company has reported its twenty-third year of record sales.3. The company’s cost of goods sold increased only slightly in 1999 due to slight inflationary

pressures on major ingredient costs. The cost of minor ingredients and packaging remained stable throughout the year.

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SOLUTIONS TO PROBLEMS

35 Minutes, Medium PROBLEM 6–1CLAYPOOL HARDWARE

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PROBLEM 6–1CLAYPOOL HARDWARE (concluded)

c. Claypool seems quite able to pass its extra transportation costs on to its customers and, in fact, enjoys a significant financial benefit from its remote mountain location. The following data support these conclusions:

ClaypoolHardware

IndustryAverage Difference

Annual sales...........................................................Gross profit...........................................................Gross profit rate....................................................

$1,024,900327,968

32% (2)

$1,000,000250,000 (1)

25%

$24,90077,968

+7%

(1) $1,000,000 sales 25% = $250,000(2) $327,968 gross profit $1,024,900 net sales = 32%

Claypool earned a gross profit rate of 32%, which is significantly higher than the industry average. Claypool’s sales were almost equal to the industry average, but it earned $77,968 more gross profit than the “average” store of its size. This higher gross profit was earned even though its cost of goods sold was $18,000 to $20,000 higher than the industry average because of the additional transportation charges.

To have a higher-than-average cost of goods sold and still earn a much larger-than-average amount of gross profit, Claypool must be able to charge substantially higher sales prices than most hardware stores. Presumably, the company could not charge such prices in a highly competitive environment. Thus, the remote location appears to insulate it from competition and allow it to operate more profitably than hardware stores with nearby competitors.

The key question in the company’s future is whether there is enough growth in the area to support another store. If a second store opens, Claypool may face competition and have to cut its prices. If there is not sufficient business to support two stores, however, Claypool has a “captive market,” which will enable it to continue charging premium prices and earning high (gross) profits. (No information is provided in the problem about operating expenses, but with nearly $78,000 more gross profit than the average store of its size, Claypool should be able to earn a net income that is well above average.)

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35 Minutes, Medium PROBLEM 6–2OFFICE SOLUTIONS

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PROBLEM 6–2OFFICE SOLUTIONS (continued)

b.

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PROBLEM 6–2OFFICE SOLUTIONS (concluded)

c. Eight. The quantity of units on hand at any date may be determined from the inventory subsidiary ledger.

d. An inventory subsidiary ledger indicates the quantities, unit costs, and total costs of the units of product purchased, sold, and currently on hand. In addition, the subsidiary ledger accounts usually indicate the location of units in stock, the minimum and maximum quantities desired in inventory, and the names of the major suppliers. Management uses this information to determine which products are selling quickly and which are selling slowly and in setting sales prices. Accounting personnel use the unit cost data in recording the cost of goods sold. Sales personnel refer to this ledger to determine the quantities and location of goods on hand. Employees responsible for purchasing merchandise use the data in this ledger to determine when specific products should be reordered, the quantities to order, and the names of the principal suppliers.

20 Minutes, Medium PROBLEM 6–3KNAUSS SUPERMARKETS

2001–2002 2000–2001

a. 1.2.3.

Change in net sales.....................................................Change in net sales per square foot..........................Change in comparable store sales.............................

6% (1)(1%) (3)

(1.8%) (5)

8% (2)(2.7%) (4)(3.5%) (6)

(1) ($5,495 $5,194) $5,184 = 6%(2) ($5,184 $4,800) $4,800 = 8%(3) [($5,495 11.9) ($5,184 11.1)] ($5,184 11.1) = (1%)(4) [($5,184 11.1) ($4,800 10.0)] ($4,800 10.0) = (2.7%)(5) ($10.8 $11.0) $11.0 = (1.8%)(6) ($11.0 $11.4) $11.4 = (3.5%)

b. While Knauss has increased its overall revenue from sales, several of the statistics indicate problems. Both sales per square foot of selling space and comparable store sales have declined for the last two years. This indicates a downward trend in sales at existing stores. It is apparent that the increase in overall net sales must have resulted from adding new stores. As a result, management should reevaluate its marketing strategies.

30 Minutes, Medium PROBLEM 6–4LAMPRINO APPLIANCE

PROBLEM 6–4LAMPRINO APPLIANCE (concluded)

c. The net cost method provides more useful information for evaluating the company’s efficiency in paying its bills. This method clearly indicates the lowest price that the company may pay, and separately records any additional costs incurred as purchase discounts lost.

Under the gross price method, the liability is not recorded at the lowest price at which it can be settled. Hence, management is not made aware of available discounts that were not taken.

30 Minutes, Strong PROBLEM 6–5SIOGO SHOES AND SOLE MATES

PROBLEM 6–5SIOGO SHOES AND SOLE MATES (concluded)

c. Yes. Sole Mates should take advantage of 1/10, n/30 purchase discounts, even if it must borrow money for a short period of time at an annual rate of 11%. By taking advantage of the discount, the company saves 1% by making payment 20 days early. At an interest rate of 11% per year, the bank charges only 0.6% interest over a 20-day period (11% 20365 = 0.6%). Thus, the cost of passing up the discount is greater than the cost of short-term borrowing.

40 Minutes, Strong PROBLEM 6–6CPI

Parts a, c, g, and h follow; parts b, d, e, and f are on the next page.

a. The operating cycle of a merchandising company consists of purchasing merchandise, selling that merchandise to customers (often on account), and collecting the sales proceeds from these customers. The assets and liabilities involved in this cycle include cash, accounts receivable, inventory, and accounts payable.

c. In the January 2 entry, the $24,250 debit to the Inventory controlling account should be allocated among—and posted to—the appropriate product accounts in the inventory subsidiary ledger. The information posted should include the cost and quantities of each type of merchandise purchased. In addition, the credit portion of this entry should be posted to the Sharp account in CPI’s accounts payable subsidiary ledger.

In the first entry on January 6, the debit to the Accounts Receivable controlling account should be posted to the Pace Corporation account in CPI’s accounts receivable ledger.

In the final entry, the credit to the Inventory controlling account should be allocated among the thirty products sold and posted to the appropriate accounts in the inventory ledger.

g. CPI probably would use a perpetual inventory system. The items in its inventory have a high per-unit cost. Therefore, management will want to know the costs of the individual products included in specific sales transactions, and also will want to keep track of the items in stock. The company also has a computer-based accounting system, a full-time accountant, and a low volume of transactions. This combination of factors eliminates the potential difficulties of maintaining a perpetual system.

h. Computation of profit margin on January 6 sales transaction:

Gross profit = Sales price - Cost of goods sold= $10,000 $6,100= $3,900

Gross profit margin = Dollar gross profit Sales revenue= $3,900 $10,000= 39%

PROBLEM 6–6CPI (concluded)