ANSWERS TO QUESTIONS FOR GROUP LEARNING

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ANSWERS TO QUESTIONS FOR GROUP LEARNING

Q5-1 A merchandising business has a major revenue reduction called cost of goods sold. The computation of cost of goods sold results in an income statement that contains information not found on an income statement for a service business.

Q5-2 No, the authors do not agree. Cost of goods sold is made up of several items over which management can exercise control. Some examples are:

• Losses in inventory from spoilage, theft, or simply misplacing items cause an increase in cost of goods sold. Management can strengthen internal control over inventories to reduce these losses.

• Cost of purchases increases the cost of goods sold. If management can cause merchandise items to be purchased at lower costs (quantity discounts, seasonal purchases, or requiring competitive bidding by suppliers), the cost of goods sold will be reduced.

• Transportation In is also a cost of goods sold. Careful planning of purchases to place orders in time to avoid higher-cost fast delivery will reduce cost of goods sold.

• Cash discounts reduce the cost of goods sold. Careful planning (possibly combined with the use of the net price method of recording purchases) should allow a company to take advantage of cash discounts offered.

Q5-3 Sales discounts are an incentive to customers to pay their bills earlier than the normal 30 days allowed. If customers pay earlier, there is a reduced chance of loss by some customers’ later inability to pay. Yes, management really wants customers to take advantage of sales discounts; a collected account will not become a bad debt loss.

Q5-4 A cash discount is the granting of a deduction from the selling price for payment within a limited period of time based on specific agreements between buyer and seller. A trade discount is a percentage reduction from a list price. Unlike a cash

Accounting for a

Merchandising Business 5

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Q5-5 Under the periodic inventory system, the cost of goods sold and the ending inventory balance are determined at the end of each accounting period. Under the perpetual inventory system, the cost of goods sold and inventory balance on hand are determined as each sale is recorded. As a result, a continuous record of cost of goods sold and inventory on hand is produced under a perpetual inventory system.

Q5-6 Under the periodic inventory system, cost of goods sold is computed by subtracting the ending inventory valuation from total goods available for sale.

Since goods lost by shoplifting are not in the ending inventory, the computation leads to the assumption that they have been sold. Thus, shoplifting increases cost of goods sold.

Q5-7 Management needs to know the amount of cost of goods sold; debits to the Purchases account should reflect only items that affect that figure. If purchases of supplies, postage stamps, and other items to be used in operations were debited to Purchases, the cost of goods sold would be incorrectly inflated. Also, information needed to control specific expenses would be buried in the Purchases account.

Q5-8 Measures of efficiency and effectiveness of the purchasing function and the payments function are reflected in these contra accounts. Managerial control is strengthened when management has accumulated information about purchases discounts and purchases returns and allowances.

Q5-9 When a company in Pittsburgh sells to a company in Williamsport F.O.B.

destination, the title to the goods transfers when the goods arrive at the buyer in Williamsport. The F.O.B. terms determine ownership. F 0.8. destination indicates that title transfers at the destination. F 0.8. shipping point indicates that title transfers when the seller turns the goods over to a common carrier at the shipping point. Unless otherwise stated, freight costs are the responsibility of the owner during shipment. In this case, the seller is the owner and is therefore responsible for paying the transportation costs.

Q5-10 Under a periodic inventory system, the beginning inventory figure appears in the end-of-period unadjusted trial balance because no journal entries have been made to the inventory account during the accounting period.

Q5-11 Sales Discounts, Purchases, Transportation In, Sales Returns and Allowances, and Merchandise inventory have debit balances. Sales, Purchases Discounts, and Purchases Returns and Allowances have credit balances.

Q5-12 Selling expenses are directly related to the sales function. Such items as sales salaries, advertising expenses, or delivery expenses can be considered as direct expenses of making sales. General and administrative expenses are those that would be found in a business whether or not sales are made. Such items as office

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supplies expense, salaries of accounting employees, or property tax expense are examples. They also support the sales function, but not solely and directly.

Operating expenses are those incurred in the primary revenue-producing activities of the business. Expenses such as financing costs (interest expense) or losses on disposal of assets are not incurred in the primary revenue-producing efforts and are classified as “other expenses.”

Q5-13 All elements that make up the cost of goods sold are found in the Income Statement columns of the work sheet.

Q5-14 The multiple-step income statement provides detailed information and subtotals for each of its major sections:- sales revenue, cost of goods sold, selling expenses, general and administrative expenses, and other revenues and expenses. Under the single-step form, the total expenses are deducted from the total revenues in one step.

Q5-15 It may give a feeling of false security if management sees a balance accumulating in the Purchases Discounts account. Although this is an indication that some discounts are being taken, it does not show how many. More important to management is knowledge of lost discount opportunities. The -net price method of recording discounts allows practice of management by exception; a balance in the Purchases Discounts Lost account is an indication that something is wrong.

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E5-16 Journalizing Sales Transactions LG 2

GENERAL JOURNAL 2007

Feb. 4 Accounts Receivable 1,470

Sales 1,400

Sales Tax Payable 70

Sold merchandise on account to South Company.

7 Accounts Receivable 2,000

Sales 2,000

Sold merchandise on account to Crankfast Company.

9 Sales Returns and Allowances 600

Accounts Receivable 600

Unsatisfactory merchandise

was returned by Crankfast Company.

15 Cash 1,372

Sales Discounts 28

Accounts Receivable 1,400

Received payment from Crankfast Company less 2% discount.

22 Cash 1,470

Received payment from South Company.

SOLUTIONS TO EXERCISES

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E5-17 Journalizing Purchases Transactions LG4

Apr. 5 Purchases 2,000

Accounts Payable 2,000

Purchased merchandise on account from Plains Company, F.O.B shipping point, 2/10, n/30.

7 Purchases 1,000

Purchased merchandise on account from Growers, Inc., F.O.B. destination, 1/10, n/30.

9 Transportation In 100

Cash 100

Paid freight on purchase from Plains Company.

10 Accounts Payable 200

Purchases Returns and Allowances 200

Returned spoiled goods to Growers, Inc.

14 Accounts Payable 2,000

Purchases Discounts 40

Cash 1,960

Paid for merchandise purchased from Plains Company less 2 % discount.

Cash 800

Paid for merchandise purchased from Growers, Inc.

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E5-18 Trade Discounts LG2

Apr. 8 Accounts Receivable 14,400

Sales 14,400*

Sold merchandise to Texas Supply.

*Invoice price = $20,000 x 0.80 x 0.90 = $14,400.

17 Cash 14,256

Sales Discounts 144

Received payment from Texas Supply less 1 % discount.

E5-19 Sales Discounts: Partial Payment LG2

Jun.10 Accounts Receivable 22,000

Sales 22,000

Sold merchandise to Jean Stubs, 2/10, n/30

20 Cash 14,700

Sales Discounts 300

Accounts Receivable 15,000*

Received partial payment from Jean Stubs less 2 % discount.

*Let X = Accounts Receivable credit. Then:

X - .02X = $14,700 0.98X = $14,700

X = $14,700 ÷ 0.98

= $15,000

Jul. 8 Cash 7,000

Received balance from Jean Stubs.

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E5-20 Computation of Net Sales, Net Purchases, Cost of Goods Sold, and Gross LG 2, 4 Margin on Sales

THOMAS COMPANY Partial income Statement

For the Month Ended January 31, 2007

Gross sales revenue $ 18,000

Deduct: Sales returns and

allowances $ 200

Sales discounts 100 300

Net sales revenue $ 17,700 (a)

Cost of goods sold:

Merchandise inventory,

January 1 $ 1,900

Purchases $ 5,600

Transportation in 400

Gross delivered cost of

purchases $ 6,000

Deduct: Purchases returns

and allowances $ 400

Purchases discounts 300 700

Net cost of purchases 5,300 (b)

Cost of goods

available for sale $ 7,200

Deduct: Merchandise inventory,

January 31 2,000

Cost of goods sold 5,200 (c)

Gross margin on sales $ 12,500 (d)

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E5-21 Calculation of Gross Sales LG 4, 5

ROSMAN COMPANY Income Statement For the (period) Ended (date)

Gross sales revenue $ 50,500 (c)

Cost of goods sold:

Merchandise inventory, beginning $ 6,000

Net cost of purchases 31,000

Cost of goods available for sale $ 37,000

Merchandise inventory, ending 5,000

Cost of goods sold 32,000

Gross margin on sales $ 18,500 (b)

Total operating expenses 15,000

Net operating margin $ 3,500 (a)

Other revenues 500

Net income $ 4,000

Computations:

a. Net operating margin = $4,000 ! $500 = $3,500.

b. Gross margin on sales = $3,500 + $15,000 = $18,500.

c. Gross sales revenue = $18,300 + $32,000 = $50,500.

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Inventories in the Work Sheet (Instructor to choose approach) Inventory treated as closing entries: Account Title

Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. 5,000 12,000 20,000 5,000 12,000 20,00020,00017,000

5,000 12,000 17,000 Inventory treated as adjusting entries: Account Title

Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. 5,000 12,000 20,000(b) 17,000 (a) 20,000

(a) 20,000 (b) 17,000

5,000 12,000 17,000 20,00017,00020,00017,000

5,000 12,000 17,000

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E5-23 Determination of Missing Income Statement Amounts LG5

Kona Company

Gross delivered cost of purchases = Purchases + Transportation in = $32,000.

Net cost of purchases = Gross delivered cost of purchases ! Purchases returns and allowances ! Purchases discounts = $29,000.

Cost of goods available for sale = Net cost of purchases + Merchandise inventory, beginning = $33,000.

Cost of goods sold = Cost of goods available for sale ! Merchandise inventory, ending = $30,000.

Gross margin on sales = Sales ! Cost of goods sold = $20,000.

Total operating expenses = Gross margin on sales ! Net operating margin =

$11,000.

Net income before income taxes = Net operating margin + Other revenue ! Other expenses = $7,000.

Oahu Company

Purchases = Gross delivered cost of purchases ! Transportation in = $27,000.

Net cost of purchases = Cost of goods available for sale ! Merchandise inventory, beginning = $28,000.

Purchases discounts = Gross delivered cost of purchases ! Net cost of purchases

! Purchases returns and allowances = $1,500.

Cost of goods sold = Cost of goods available for sale ! Merchandise inventory, ending = $30,000.

Sales = Gross margin on sales + Cost of goods sold = $55,000.

Total operating expenses = Gross margin on sales ! Net operating margin = $8,000.

Other revenue = Net income before income taxes ! Net operating margin + Other expenses = $2,000.

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E5-23 (continued) Hilo Company

Cost of goods available for sale = Cost of goods sold + Merchandise inventory, ending = $47,000.

Merchandise inventory, beginning = Cost of goods available for sale ! Net cost of purchases = $8,000.

Gross delivered cost of purchases = Net cost of purchases + Purchases returns and allowances + Purchases discounts = $45,000.

Transportation in = Gross delivered cost of purchases ! Purchases = $5,000.

Net operating margin = Net income before income taxes + Other expenses ! Other revenues = $14,000.

Gross margin on sales = Net operating margin + Total operating expenses =

$29,000.

Sales = Gross margin on sales + Cost of goods sold = $70,000.

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E5-24 Multiple-step Income Statement LG5

PARIS COMPANY Income Statement

For the Year Ended December 31, 2007

Deduct: Sales returns and

allowances $ 700

Sales discounts 1,300 2,000

Net sales revenue $ 58,000

Cost of goods sold:

Merchandise inventory, January 1 $ 4,000

Purchases $ 20,000

Transportation in 1,000

Gross delivered cost of purchases $ 21,000 Deduct: Purchases returns

and allowances $ 1,400

Purchases discounts 1,600 3,000

December 31 3,000

Gross margin on sales $ 39,000

Operating expenses:

Selling expenses $ 15,000

General and administrative expenses 10,000

Net operating margin $ 14,000

Other revenues $ 800

Other expenses 1,000 (200)

Net income before income taxes $ 13,800

Income tax expense 4,000

Net income $ 9,800

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E5-25 Closing Entries LG7

GENERAL JOURNAL Closing Entries 2007

Dec. 31 Merchandise Inventory 3,000

Sales 60,000

Other Revenues 800

Purchases Returns and Allowances 1,400

Purchases Discounts 1,600

Income Summary 66,800

To enter the ending inventory and close revenue accounts and credit balance merchandise accounts.

31 Income Summary 57,000

Merchandise Inventory 4,000

Sales Returns and Allowances 700

Sales Discounts 1,300

Purchases 20,000

Transportation In 1,000

Selling Expenses 15,000

General and Administrative Expenses 10,000

Other Expenses 1,000

Income Tax Expense 4,000

To close beginning inventory, expense accounts, and debit balance merchandise accounts.

Retained Earnings 9,800

To transfer net income to retained earnings.

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E5-25 (continued)

Instructor Note: If inventory was treated as adjusting entries, the adjusting entries for inventory and the closing entries would be as follows: Dec. 31

GENERAL JOURNAL Adjusting Entries 2007

Dec. 31 lncome Summary 4,000

To transfer the beginning inventory balance to income summary.

31 Merchandise Inventory 3,000

To establish the ending inventory balance in merchandise inventory.

Closing Entries

Dec. 31 Sales 60,000

Other Revenues 800

To close revenue accounts and credit balance merchandise accounts.

Sales Returns and Allowances 700

Purchases 20,000

Selling Expenses 15,000

General and Administrative Expenses 10,000

Other Expenses 1,000

To close expense accounts and debit balance merchandise accounts.

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E5-25 (continued)

Dec. 31 Income Summary 9,800

E5-26 Recordkeeping of Purchases: Net Price Method LG 8

1. GENERAL JOURNAL

Jun. 5 Purchases 8,820

Purchased $9,000 of merchandise, terms 2/10, n/30.

Jul. 1 Accounts Payable 8,820

Purchases Discounts Lost 180

Cash 9,000

Payment of account.

2.

No, the net cost of purchases is lower under the net price method, as follows:

Net Gross

Price Method Price Method

Purchases account $ 8,820 $ 9,000

Purchases discount 0 0

Net cost of purchases $ 8,820 $ 9,000

As can be seen from the above, the net cost of purchases would be the same under both methods only if all cash discounts are taken. The Purchases Discounts Lost account is disclosed in the income statement under other expenses. Net income would be the same.

3.

Some advantages of the gross price method are:

a. Amount of discounts taken is collected in a separate account.

b. Statements from creditors agree with accounts payable amounts in the accounts payable subsidiary ledger.

c. There is a saving in clerical costs.

d. No end-of-period adjusting entry is required to record lapsed discounts.

However, Linda Company desires to take advantage of a/I purchases discounts.

Assuming these discounts to be significant, the ability to monitor this practice with the net price method probably outweighs the advantages of the gross price method for Linda Company.

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25.5% ' 100 × $14,847,000,000⁽

$58,247,000,000 *$73,094,000,000 ! $58,247,000,000 E5-27 Analyzing the Home Depot

LG 9

1. Net sales have increased significantly from $58,247,000,000 in 2002 to

$73,094,000,000 in 2004.

2. The percent increase in net sales is:

3. Home Depot was able to reduce cost of goods sold as a percent of net sales from 68.9% in 2002 to 66.6% in 2004. The result is a gross profit margin of 33.4% in 2004 the highest for the three years. This is favorable. The increase in the gross margin percent could have been caused by a combination of (1) increased sales prices, (2) reduced cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the increase in the gross margin percent.

4. Operating expenses increased as a percent of net sales increased from 21.1%

in 2002 to 22.6% in 2004. This trend is unfavorable.

5. Other expenses and revenues have remained relatively insignificant over the three-year period.

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P5-28 Use of Merchandising Accounts LG 2, 4

GENERAL JOURNAL Page 24

2007

Feb. 4 Purchases 3,600

Purchase at n/30, F.O.B.

shipping point from Mankato Company.

Cash 150

Freight cost of February 4 purchase.

Returned incorrect model to Mankato Company.

8 Accounts Receivable 2,000

Sales 2,000

Sale at 2/10, n/30, F.O.B.

shipping point to Susan Sexton.

18 Cash 1,960

Sales Discounts 40

Collection with discount taken from Susan Sexton.

SOLUTIONS TO PROBLEMS

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P5-28 (continued)

Feb. 19 Accounts Receivable 1,500

Sales 1,500

Sale at 2/10, n/30, F.O.B.

destination to Dale Karn.

19 Transportation Out Expense 200

Cash 200

Delivery of merchandise sold F.O.B. destination.

20 Sales Returns and Allowances 100

Accounts Receivable 100

Credit for defective item from Dale Karn.

28 Cash 1,372

Sales Discounts 28

Collection with discount taken from Dale Karn.

Mar. 5 Accounts Payable 2,600

Cash 2,600

Payment in full to Mankato Company.

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P5-29 Partial Income Statement LG 4

MO COMPANY Partial Income Statement

For the Year Ended September 30, 2007

Deduct; Sales discounts 5,000

Net safes revenue $ 695,000

Cost of goods sold:

October 1, 2006 $ 27,000

Purchases $ 360,000

Gross delivered cost of purchases $ 368,000 Deduct: Purchases returns and

allowances $ 7,000

September 30, 2007 30,000

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P5-30 lncome Statement and Closing Entries LG 5, 7

Requirement 1.

RUSS CROW COMPANY Income Statement

Deduct: Sales returns and allowances $ 4,000

Cost of goods sold:

Merchandise inventory, January 1, 2007 $ 27,000

Purchases $ 410,000

allowances $ 6,000

December 31, 2007 24,000

Operating expenses:

Selling expenses:

Sales salaries expense $ 166,000

Advertising expense 12,000

Transportation out expense 4,000

Total selling expenses $ 182,000

General and administrative expenses:

Administrative salaries expense $ 32,000

Office supplies expense 5,000

Depreciation expense—office equipment 2,000 Total general and administrative

expense 39,000

Other expenses:

Interest expense $ 8,500

Other revenues:

Interest revenue 1,500 7,000

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Requirement 2 (closing approach).

2007

Sales 670,000

Interest Revenue 1,500

To record the ending inventory and to close the revenue and credit balance merchandise accounts.

Sales Returns and Allowances 4,000

Purchases 410,000

Sales Salaries Expense 166,000

Advertising Expense 12,000

Transportation Out Expense 4,000

Administrative Salaries Expense 32,000

Office Supplies Expense 5,000

Depreciation Expense—Office

Equipment 2,000

Interest Expense 8,500

To close the beginning inventory, the expenses, and the debit balance merchandise accounts.

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Requirement 2 (adjusting approach)

Adjusting Entries 2007

To record the ending inventory.

To remove the beginning inventory.

Closing Entries

Dec. 31 Sales 670,000

Interest Revenue 1,500

To close the revenue and credit balance merchandise accounts.

Sales Returns and Allowances 4,000

Purchases 410,000

Advertising Expense 12,000

Transportation Out Expense 4,000

Administrative Salaries Expense 32,000

Office Supplies Expense 5,000

Depreciation Expense—Office

Equipment 2,000

To close the expenses and the

debit balance merchandise accounts.

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P5-30 Requirement 2 (adjusting approach) (continued)

P5-31 Journalizing Transactions for a Retail Store LG 2-5

Requirement 1.

2007

Jan. 6 Purchases 501 3,600

Accounts Payable 201 3,600

To record purchase from Columbia Supply, 1/10, n/30, F.O.B. destination. List price

$5,000, trade discount: 20%, 10%.

7 Purchases 501 3,000

Accounts Payable 201 3,000

To record purchase from Warner Entertainment, 2/10, n/30,

F.O.B. shipping point.

9 Advertising Expense. 616 200

Cash 101 200

To record payment for advertising.

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P5-31 Requirement 1 (continued)

Jan. 10 Accounts Payable 201 432

Purchases Returns and

Allowances 503 432

To record return of $600 list price of merchandise to Columbia Supply.

12 Transportation In 502 100

Cash 101 100

To record freight charges on purchase from Warner Entertainment.

15 Cash 101 5,200

Sales 401 5,200

To record cash sales for first half of month.

15 Accounts Receivable 111 2,000

Sales 401 2,000

To record sales on account for first half of month.

17 Accounts Payable 201 3,000

Purchases Discounts 504 60

Cash 101 2,940

To record payment to Warner Entertainment less discount.

18 Sales Returns and Allowances 402 100

Accounts Receivable 111 100

To record return of merchandise.

20 Delivery Expense 621 200

Cash 101 200

To record payment of delivery expense.

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Jan. 24 Cash 101 1,372

Sales Discounts 403 28

Accounts Receivable 111 1,400

To record collection from customers less discount.

27 Utilities Expense 625 300

Accounts Payable 201 300

To record receipt of utilities bill.

28 Sales Wages Expense 602 400

Office Wages Expense 703 200

Cash 101 600

To record payment of wages for the month.

30 Cash 101 5,000

Sales 401 5,000

To record cash sales for the second half of the month.

30 Accounts Receivable 111 1,000

Sales 401 1,000

To record sales on account for the second half of the month.

31 Income Tax Expense 901 600

Income Taxes Payable 215 600

To record estimated income taxes.

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P5-31 (continued) Requirement 2.

GENERAL LEDGER

Cash Acct. No. 117

Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 1

9 12 15 17 20 24 28 30

Balance

J1 J1 J1 J1 J1 J1 J1 J1

5,200

1,372 5,000

200 100 2,940 200 600

5,000 4,800 4,700 9,900 6,960 6,760 8,132 7,532 12,532

Accounts Receivable Acct. No. 111 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 15

18 24 30

J1 J1 J1 J1

2,000

1,000

100 1,400

2,000 1,900 500 1,500

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Accounts Payable Acct. No. 201 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 6

7 10 17 27

J1 J1 J1 J1 J1

432 3,000

3,600 3,000

300

3,600 6,600 6,168 3,168 3,468

Income Taxes Payable Acct. No. 215 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 31 J1 600 600

Sales Acct. No. 401

Jan. 15

15 30 30

J1 J1 J1 J1

5,200 2,000 5,000 1,000

5,200 7,200 12,200 13,200

Sales Returns and Allowances Acct. No. 402 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 18 Balance J1 100 100

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Sales Discounts Acct. No. 403 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 24 J1 28 28

Purchases Acct. No. 501

Jan. 6

7

J1 J1

3,600 3,000

3,600 6,600

Transportation In Acct. No. 502 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 9 J1 100 100

Purchases Returns and Allowances Acct. No. 503 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 10 J1 432 432

Purchases Discounts Acct. No. 504 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 17 J1 60 60

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Sales Wages Expense Acct. No. 602 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 28 J1 400 400

Advertising Expense Acct. No. 616 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 9 J1 200 200

Delivery Expense Acct. No. 621 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 20 J1 200 200

Utilities Expense Acct. No. 625 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 27 J1 300 300

Office Wages Expense Acct. No. 703 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 28 J1 200 200

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Income Tax Expense Acct. No. 901 Balance Date Explanation PR Debit Credit Debit Credit 2007

Jan. 31 J1 600 600

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POP MUSIC COMPANY Income Statement

For the Month Ended January 31, 2007

Deduct: Sales returns and allowances $ 100

Sales discounts 28 128

Cost of goods sold:

Purchases $6,600

Gross delivered cost of purchases $6,700 Deduct: Purchases returns and

allowances $ 432

January 31, 2007 3,000

Operating expenses:

Selling expenses:

Sales wages expense $ 400

Advertising expense 200

Delivery expense 200

Utilities expense 300

General and administrative expense:

Office wages expense 200

Net income before income taxes 4,564

Income tax expense 600

Net Income $ 3,964

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Completion of Work sheet, Preparation of Statements, Adjusting and Closing Entries closing entries in this solution version.) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, 2007 Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. 21,000 40,000 15,000 30,000 150,000 2,000 5,000 196,000 4,000 40,000 20,000 16,000 7,000 546,000

40,000 30,000 10,000 3,000 60,000 38,000 352,000 3,000 10,000 546,000

(e)2,000 (d)1,500 (d)1,500

(a)27,000 (b)12,000 (e)2,000

21,000 40,000 15,000 3,000 150,000 2,000 5,000 196,000 4,000 41,500 21,500 16,000 7,000

52,000 30,000 10,000 1,000 60,000 38,000 352,000 3,000 12,000

15,000 5,000 196,000 4,000 41,500 21,500 16,000 7,000

12,000 352,000 3,000 12,000

21,000 40,000 12,000 3,000 150,000 2,000

52,000 30,000 10,000 1,000 60,000 38,000

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P5-32Requirement 1 (closing approach) (continued) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, 2007 Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. Store Sup. Exp. Dep. Exp.—S.E. Int. Exp. Int. Pay. Sal. Pay. Income Tax Expense Income Taxes Payable Totals Net Income Totals

(a)27,000 (b)12,000 (c)1,000 (f)10,000 55,000

(c)1,000 (d)3,000 (f)10,000 55,000

27,000 12,000 1,000 10,000 572,000

1,000 3,000 10,000 572,000

27,000 12,000 1,000 10,000 356,000 23,000 379,000

379,000 379,000 228,000 228,000

1,000 3,000 10,000 205,000 23,000 228,000

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(continued) adjusting entries in this solution version.) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, 2007 Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. 21,000 40,000 15,000 30,000 150,000 2,000 5,000 196,000 4,000 40,000 20,000 16,000 7,000 546,000

40,000 30,000 10,000 3,000 60,000 38,000 352,000 3,000 10,000 546,000

(a)12,000 (g)2,000 (f)1,500 (f)1,500

(b)15,000 (c)27,000 (d)12,000 (g)2,000

21,000 40,000 12,000 3,000 150,000 2,000 5,000 196,000 4,000 41,500 21,500 16,000 7,000

52,000 30,000 10,000 1,000 60,000 38,000 352,000 3,000 12,000

5,000 196,000 4,000 41,500 21,500 16,000 7,000

352,000 3,000 12,000

21,000 40,000 12,000 3,000 150,000 2,000

52,000 30,000 10,000 1,000 60,000 38,000

(35)

Requirement 1 (adjusting approach) (continued) MACROSOFT COMPANY Work Sheet For the Year Ended December 31, 2007 Trial BalanceAdjustmentsAdjusted Trial BalanceIncome StatementBalance Sheet Account TitlesDr.Cr.Dr.Cr.Dr.Cr.Dr.Cr.Dr.Cr. Totals Totals

(b)15,000 (c)27,000 (d)12,000 (e)1,000 (h)10,000 82,000

(a)12,000 (e)1,000 (f)3,000 (h)10,000 82,000

15,000 27,000 12,000 1,000 10,000 584,000

12,000 1,000 3,000 10,000 584,000

15,000 27,000 12,000 1,000 10,000 356,000 23,000 379,000

12,000 379,000 379,000

228,000 228,000

1,000 3,000 10,000 205,000 23,000 228,000

(36)

Requirement 2.

MACROSOFT COMPANY Income Statement

Deduct: Sales discounts 5,000

Cost of goods sold:

January 1, 2007 $ 15,000

Purchases $196,000

Gross delivered cost of purchases $200,000

Deduct: Purchases discounts 3,000

December 31, 2007 12,000

Operating expenses:

Selling expenses:

Store supplies expense 27,000

Depreciation expense—

store equipment 12,000

Total selling expense $ 80,500

General and administrative expense:

Office salary expense $ 21,500

Rent expense 16,000

Utilities expense 7,000

Total general and administrative

expense 44,500

Total operating expense 125,000

Other revenue:

Rental revenue $ 12,000

Other expense:

Interest expense 1,000 11,000

Net income $ 23,000

(37)

MACROSOFT COMPANY Statement of Owners’ Equity For the Year Ended December 31, 2007

Common stock, December 31, 2007 $ 60,000

Retained earnings, January 1, 2007 $ 38,000

Add: Net income 23,000

Deduct: Dividends (2,000)

Retained earnings, December 31, 2007 59,000

Total owners’ equity, December 31, 2007 $ 119,000

MACROSOFT COMPANY Balance Sheet December 31, 2007

Assets Current assets

Cash $ 21,000

Accounts receivable 40,000

Merchandise inventory 12,000

Store supplies 3,000

Total current assets $ 76,000

Property, plant, and equipment

Store equipment $150,000

Accumulated depreciation 52,000

Total property, plant, and equipment 98,000

Total assets $ 174,000

Liabilities Current liabilities

Accounts payable $ 30,000

Notes payable 10,000

Unearned revenue 1,000

Salaries payable 3,000

Interest payable 1,000

Income taxes payable 10,000

Total current liabilities $ 55,000

Owners’ Equity

Common stock $ 60,000

Retained earnings 59,000

Total owners’ equity 119,000

(38)

Requirement 3 (closing approach).

Dec. 31 Store Supplies Expense 27,000

Store Supplies 27,000

To record store supplies used.

31 Depreciation Expense—Store Equipment 12,000

Accumulated Depreciation— 12,000

Store Equipment

To record depreciation on store equipment.

31 Interest Expense 1,000

Interest Payable 1,000

To accrue interest on note payable.

31 Sales Salaries Expense 1,500

Office Salaries Expense 1,500

Salaries Payable 3,000

To accrue salaries expense.

31 Unearned Rent 2,000

Rent Revenue 2,000

To record net revenue earned.

31 Income Tax Expense 10,000

Income Taxes Payable 10,000

To record estimated income tax expense.

Closing Entries

Sales 352,000

Rent Revenue 12,000

To record the ending inventory and to close the revenue and credit balance merchandising accounts.

(39)

P5-32 Requirement 3 (closing approach) (continued)

Purchases 196,000

Stores Supplies Expense 27,000

Depreciation Expense—

Store Equipment 12,000

Rent Expense 16,000

Utilities Expense 7,000

To close the beginning inventory, the expense, and debit balance merchandise accounts.

31 Retained Earnings 2,000

Dividends 2,000

To close dividends to retained earnings.

Requirement 3 (adjusting approach).

To establish ending inventory.

To remove beginning inventory.

(40)

Dec. 31 Store Supplies Expense 27,000

Store Supplies 27,000

To record store supplies used.

31 Depreciation Expense—Store Equipment 12,000 Accumulated Depreciation—

To record depreciation on store equipment.

31 Interest Expense 1,000

Interest Payable 1,000

To accrue interest on note payable.

31 Sales Salaries Expense 1,500

Salaries Payable 3,000

To accrue salaries expense.

31 Unearned Rent 2,000

Rent Revenue 2,000

To record rent earned.

31 Income Tax Expense 10,000

Income Taxes Payable 10,000

To record estimated income tax expense.

Closing Entries

Dec. 31 Sales 352,000

Rent Revenue 12,000

Income Summary . 367,000

To close revenue and credit balance merchandising accounts.

(41)

Purchases 196,000

Stores Supplies Expense 27,000

Depreciation Expense—

Rent Expense 16,000

Utilities Expense 7,000

To close expenses and debit balance merchandising accounts.

31 Retained Earnings 2,000

Dividends 2,000

To close dividends to retained earnings.

(42)

P5-33 Recording Purchases Net of Discount LG 8

Requirement 1a.

Jul. 2 Purchases 1,000

Purchase at 2/10, n/30, F.O.B.

Destination from Goss Company.

3 Purchases 600

Accounts Payable 600

Shipping point from Willi Company.

Cash 30

Freight charges on F.O.B. shipping point shipment.

Return of defective merchandise to Willi Company.

Cash 980

Purchases Discounts 20

Payment of account to Goss Company.

Cash 550

Payment of account to Willi Company.

(43)

FONZ COMPANY Partial Income Statement For the Month Ended July 31, 2007 Cost of goods sold:

Merchandise inventory, July 1, 2007 $ 300

Purchases $1,600

Gross delivered cost of

purchases $1,630

Deduct: Purchases returns and

allowances $ 50

Cost of goods available for sale $1,860

July 31, 2007 400

Cost of goods sold $1,460

Requirement 2a.

Jul. 2 Purchases 980

destination from Goss Company.

3 Purchases 588

shipping point from Willi Company.

Cash 30

Freight charges on F.O.B. shipping point shipment.

Return of defective merchandise to Willi Company.

Cash 980

(44)

P5-33 Requirement 2a (continued)

Jul. 31 Accounts Payable 539

Purchases Discounts Lost 11

Cash 550

Payment of account to Willi Company.

Requirement 2b.

FONZ COMPANY Partial Income Statement For the Month Ended July 31, 2007 Cost of goods sold:

Merchandise inventory, July 1, 2007 $ 300

Purchases $ 1,568

allowances 49

Net cost of purchases $ 1,549

Cost of goods available for sale 1,849

July 31, 2007 400

Cost of goods sold $ 1,449*

*Note that the difference between the two methods is equal to purchases discounts lost.

Requirement 3.

Under the net price method, purchases discounts lost are classified as “other expenses”

on the income statement.

(45)

5.3% ' 100 × $474,000,000*

$8,934,000,000 *$9,408,000,000 ! $8,934,000,000

4.5% ' 100 × $73,500,000*

$1,624,300,000 *$1,697,800,000 ! $1,624,300,000

15.4% ' 100 × $5,002,800,000*

$32,505,400,000 *$37,508,200,000 ! $32,505,400,000

15.1% ' 100 × $4,006,300,000*

$26,588,000,000 *$30,594,300,000 ! $26,588,000,000 P5-34 Analyzing Limited Brands and The Talbot’s

LB 9

1. For fiscal 2004, net sales for Limited Brands are more than five times the amount for Talbot’s. Net sales for both companies have increased in 2004.

2. The percent increase in net sales is:

Limited Brands

Talbot’s

3. For both companies, the cost of goods sold percent increased in 2004. In 2004, the cost of goods sold percent for Limited Brands is lower than for Talbot’s. The result is that Limited Brands has a higher gross profit margin. This is favorable for Limited Brands. The higher gross margin percent for Limited Brands could be caused by a combination of (1) increased sales prices, (2) reduced cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the increase in the gross margin percent.

4. Operating expenses as a percent of sales decreased for both companies in 2004.

This is favorable.

P5-35 Analyzing Walgreen and CVS Corporation LG 9

1. For fiscal 2004 net sales for Walgreen are higher than CVS. Net sales for both companies increased in 2004.

2. The percent increase (decrease) in net sales is:

Walgreen

CVS

(46)

3. Cost of goods sold as a percent of sales decreased for both companies in 2004. This is favorable. The lower gross margin percent could be caused by a combination of (1) decreased sales prices, (2) increased cost of goods sold, or (3) a different mix of products sold. From the information shown, we cannot determine the exact reason for the decrease in the gross margin percent.

4. Operating expenses as a percent of net sales increased for both companies in 2004.

This is unfavorable. ln 2004, Walgreens is consistently operating at a higher operating margin than CVS.

(47)

LG 4, 5 Preparing a Multiple-step Income Statement, Statement of Owners’ Equity, and Balance Sheet for a Merchandising Business

Requirement 1.

PARIS HILTON FASHION COMPANY Income Statement

For the Year Ended December 31, 2007 Revenues

Sales $ 225,000

Deduct: Sales returns and allowances $ 4,000

Cost of goods sold:

Purchases $ 99,000

Gross delivered cost of purchases $ 101,500 Deduct: Purchases returns

and allowances $ 600

Purchases discounts 900 1,500

Cost of goods available for use $ 130,000

December 31, 2007 20,000

Deduct: Operating expenses:

Selling expenses:

Advertising expense 37,000

Depreciation expense—store building 7,000

General and administrative expenses:

Office salaries expense $ 15,000

Rent expense—office building 6,000

Office supplies expense 3,000

Total general and

administrative expenses 24,000

Net operating income $ 13,000

Other expenses:

Interest expense $ 5,000

Other revenues:

Interest revenue 1,000 4,000

Net income before income taxes 9,000

SOLUTION TO PRACTICE CASE

(48)

Practice Case (continued) Requirement 2.

PARIS HILTON FASHION COMPANY Statement of Owners' Equity For the Year Ended December 31, 2007

Common stock, December 31, 2007 $ 70,000

Retained earnings, January 1, 2007 $ 39,000

Add: Net income 6,000

Deduct: Dividends (1,000)

Retained earnings, December 31, 2007 44,000

Total owners’ equity, December 31, 2007 $ 114,000

(49)

Practice Case (continued) Requirement 3.

PARIS HILTON FASHION COMPANY Balance Sheet

December 31, 2007 Assets

Current assets

Cash $ 35,000

Accounts receivable 50,000

Office supplies 3,000

Total current assets $108,000

Property, plant, and equipment

Land $ 25,000

Store building $ 80,000

Deduct: Accumulated depreciation 15,000 65,000 Total property, plant, and

equipment 90,000

Total assets $ 198,000

Liabilities Current liabilities

Accounts payable $ 20,000

Salaries payable 1,000

Income taxes payable 3,000

Total current liabilities $ 24,000

Long-term liabilities

Notes payable, due December 2009 60,000

Total liabilities $ 84,000

Owners’ Equity

Common stock $ 70,000

Total owners’ equity 114,000

Total liabilities and owners’ equity $ 198,000

(50)

Improving Profitability

Following is a typical student response to this communications problem; actual responses may vary in content and style but should contain as much of this basic information as possible.

TO: Sam Tees

FROM: Student

SUBJECT: Profitability of Shirts Unlimited

In reviewing the income statement of Tees Unlimited, I have noted several items for your consideration. First, the company is carrying too high a level of inventory. Cost of goods sold for the year 2007 was $33,000. You have $30,000 in merchandise inventory on hand on December 31, 2007. You have almost one year’s inventory on hand at the end of 2007. This represents money that is tied up which you could invest. Consider expanding your store, or at least investing in some interest-bearing securities. Second, sales returns and allowances are 20% of sales. This may indicate unhappy customers. You should investigate why returns are so high and work to reduce this considerably.

Third, the company is purchasing more goods than it is selling in a year. Plan purchases to coincide with actual yearly needs for goods. This will also reduce your level of inventory.

Fourth, purchases returns are also high. You should investigate this. It may be that you need to change suppliers or work with your suppliers to get acceptable merchandise. Fifth, it also appears that you are not taking advantage of cash discounts on purchases, as the income statement does not list any. By paying within the discount period, you can reduce the cost of merchandise.

Predating Sales Transactions

Individual responses to ethical dilemmas will vary. The technical and ethical issues raised in the following response are central to this dilemma; look for them in students answers and be prepared to discuss them with students in class.

The owner’s request will have the effect of transferring sales from 2007 to 2008. This will overstate revenues and income in 2007. It also will overstate assets and owners' equity.

With F.O.B. shipping point terms, the date of shipment determines the sales date. The title to the merchandise passes when the merchandise is shipped.

The back-dating of sales transactions would be unethical. It appears that the owner desires to inflate sales and income for the purpose. of creating a more favorable income statement.

This may improve the conditions of the loan he is negotiating. As the accountant, you have an ethical responsibility not only to the owner but to all users of the financial statements. The bank loan officer is certainly one user of this company’s financial statements. You should

ANSWERS TO QUESTIONS FOR GROUP LEARNING