Merchandising Operations

Wal-Mart (USA), Carrefour (FRA), and Tesco (GBR) are called merchandising companies because they buy and sell merchandise rather than perform services as their primary source of revenue. Merchandising companies that purchase and sell directly to consumers are called retailers. Merchandising companies that sell to retailers are known as wholesalers. For example, retailer Walgreens (USA) might buy goods from wholesaler Grupo Casa SA de CV (MEX); retailer Office Depot (USA) might buy office supplies from wholesaler Corporate Express (NLD). The primary source of revenues for merchandising companies is the sale of merchandise, often referred to simply as sales revenue or sales. A merchandising company has two categories of expenses: cost of goods sold and operating expenses.

Cost of goods sold is the total cost of merchandise sold during the period. This expense is directly related to the revenue recognized from the sale of goods. Illustration 5-1 shows the income measurement process for a merchandising company. The items in the two blue boxes are unique to a merchandising company; they are not used by a service company.

Illustration 5-1 Income measurement process for a merchandising company

Operating Cycles

The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase of merchandise inventory and its eventual sale lengthen the cycle. Illustration 5-2 shows the operating cycle of a service company.

Illustration 5-2 Operating cycle for a service company

Illustration 5-3 shows the operating cycle of a merchandising company.

Illustration 5-3 Operating cycle for a merchandising company

Note that the added asset account for a merchandising company is the Inventory account. Companies report inventory as a current asset on the statement of financial position.

Flow of Costs

The flow of costs for a merchandising company is as follows: Beginning inventory plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold. Those goods that are not sold by the end of the accounting period represent ending inventory. Illustration 5-4 describes these relationships.

Illustration 5-4 Flow of costs

Companies use one of two systems to account for inventory: a perpetual inventory system or a periodic inventory system.

PERPETUAL SYSTEM

In a perpetual inventory system, companies keep detailed records of the cost of each inventory purchase and sale. These records continuously—perpetually—show the inventory that should be on hand for every item. For example, a Toyota (JPN) dealership has separate inventory records for each automobile, truck, and van on its lot and showroom floor. Similarly, a Morrisons (GBR) grocery store uses bar codes and optical scanners to keep a daily running record of every box of cereal and every jar of jelly that it buys and sells. Under a perpetual inventory system, a company determines the cost of goods sold each time a sale occurs.

PERIODIC SYSTEM

In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting period—that is, periodically. At that point, the company takes a physical inventory count to determine the cost of goods on hand.

To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:

1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.

Illustration 5-5 graphically compares the sequence of activities and the timing of the cost of goods sold computation under the two inventory systems.

Illustration 5-5 Comparing perpetual and periodic inventory systems

ADDITIONAL CONSIDERATIONS

Companies that sell merchandise with high unit values, such as automobiles, furniture, and major home appliances, have traditionally used perpetual systems. The growing use of computers and electronic scanners has enabled many more companies to install perpetual inventory systems. The perpetual inventory system is so named because the accounting records continuously—perpetually—show the quantity and cost of the inventory that should be on hand at any time.

A perpetual inventory system provides better control over inventories than a periodic system. Since the inventory records show the quantities that should be on hand, the company can count the goods at any time to see whether the amount of goods actually on hand agrees with the inventory records. If shortages are uncovered, the company can investigate immediately. Although a perpetual inventory system requires additional clerical work and additional cost to maintain the subsidiary records, a computerized system can minimize this cost.

Some businesses find it either unnecessary or uneconomical to invest in a computerized perpetual inventory system. Many small merchandising businesses, in particular, find that a perpetual inventory system costs more than it is worth. Managers of these businesses can control their merchandise and manage day-to-day operations using a periodic inventory system.

Because the perpetual inventory system is growing in popularity and use, we illustrate it in this chapter. Appendix 5A describes the journal entries for the periodic system.

Recording Purchases of Merchandise

Companies purchase inventory using cash or credit (on account). They normally record purchases when they receive the goods from the seller. Business documents provide written evidence of the transaction. A canceled check or a cash register receipt, for example, indicates the items purchased and amounts paid for each cash purchase. Companies record cash purchases by an increase in Inventory and a decrease in Cash.

A purchase invoice should support each credit purchase. This invoice indicates the total purchase price and other relevant information. However, the purchaser does not prepare a separate purchase invoice. Instead, the purchaser uses as a purchase invoice a copy of the sales invoice sent by the seller. In Illustration 5-6 (page 216), for example, Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller).

Sauk Stereo makes the following journal entry to record its purchase from PW Audio Supply. The entry increases (debits) Inventory and increases (credits) Accounts Payable.

Under the perpetual inventory system, companies record purchases of merchandise for sale in the Inventory account. Thus, Carrefour would increase (debit) Inventory for clothing, sporting goods, and anything else purchased for resale to customers.

Not all purchases are debited to Inventory, however. Companies record purchases of assets acquired for use and not for resale, such as supplies, equipment, and similar items, as increases to specific asset accounts rather than to Inventory. For example, to record the purchase of materials used to make shelf signs or for cash register receipt paper, Carrefour would increase Supplies.

Freight Costs

The sales agreement should indicate who—the seller or the buyer—is to pay for transporting the goods to the buyer's place of business. When a common carrier such as a railroad, trucking company, or airline transports the goods, the carrier prepares a freight bill in accord with the sales agreement.

Illustration 5-6 Sales invoice used as purchase invoice by Sauk Stereo

Freight terms are expressed as either FOB shipping point or FOB destination. The letters FOB mean free on board. Thus, FOB shipping point means that the seller places the goods free on board the carrier, and the buyer pays the freight costs. Conversely, FOB destination means that the seller places the goods free on board to the buyer's place of business, and the seller pays the freight. For example, the sales invoice in Illustration 5-6 indicates FOB shipping point. Thus, the buyer (Sauk Stereo) pays the freight charges. Illustration 5-7 illustrates these shipping terms.

Illustration 5-7 Shipping terms

FREIGHT COSTS INCURRED BY THE BUYER

When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory. Therefore, the buyer debits (increases) the account Inventory. For example, if upon delivery of the goods on May 6, Sauk Stereo (the buyer) pays Acme Freight Company €150 for freight charges, the entry on Sauk Stereo's books is:

Thus, any freight costs incurred by the buyer are part of the cost of merchandise purchased. The reason: Inventory cost should include all costs to acquire the inventory, including freight necessary to deliver the goods to the buyer. Companies recognize these costs as cost of goods sold when the inventory is sold.

FREIGHT COSTS INCURRED BY THE SELLER

In contrast, freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. These costs increase an expense account titled Freight-Out or Delivery Expense. If the freight terms on the invoice had required PW Audio Supply (the seller) to pay the freight charges, the entry by PW Audio Supply would be:

When the seller pays the freight charges, it will usually establish a higher invoice price for the goods to cover the shipping expense.

Purchase Returns and Allowances

A purchaser may be dissatisfied with the merchandise received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser's specifications. In such cases, the purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. This transaction is known as a purchase return. Alternatively, the purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) from the purchase price. This transaction is known as a purchase allowance.

Assume that on May 8 Sauk Stereo returned goods costing €300 to PW Audio Supply. The following entry by Sauk Stereo for the returned merchandise decreases (debits) Accounts Payable and decreases (credits) Inventory.

Because Sauk Stereo increased Inventory when the goods were received, Inventory is decreased when Sauk Stereo returns the goods (or when it is granted an allowance).

Suppose instead that Sauk Stereo chose to keep the goods after being granted a €50 allowance (reduction in price). It would reduce (debit) Accounts Payable and reduce (credit) Inventory for €50.

Purchase Discounts

The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. This incentive offers advantages to both parties: The purchaser saves money, and the seller shortens the operating cycle by more quickly converting the accounts receivable into cash.

Credit terms specify the amount of the cash discount and time period in which it is offered. They also indicate the time period in which the purchaser is expected to pay the full invoice price. In the sales invoice in Illustration 5-6 (page 216), credit terms are 2/10, n/30, which is read “two-ten, net thirty.” This means that the buyer may take a 2% cash discount on the invoice price less (“net of”) any returns or allowances, if payment is made within 10 days of the invoice date (the discount period). Otherwise, the invoice price, less any returns or allowances, is due 30 days from the invoice date.

Alternatively, the discount period may extend to a specified number of days following the month in which the sale occurs. For example, 1/10 EOM (end of month) means that a 1% discount is available if the invoice is paid within the first 10 days of the next month.

When the seller elects not to offer a cash discount for prompt payment, credit terms will specify only the maximum time period for paying the balance due. For example, the invoice may state the time period as n/30, n/60, or n/10 EOM. This means, respectively, that the buyer must pay the net amount in 30 days, 60 days, or within the first 10 days of the next month.

When the buyer pays an invoice within the discount period, the amount of the discount decreases Inventory. Why? Because companies record inventory at cost and, by paying within the discount period, the merchandiser has reduced that cost. To illustrate, assume Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less purchase returns and allowances of €300) on May 14, the last day of the discount period. The cash discount is €70 (€3,500 × 2%), and Sauk Stereo pays €3,430 (€3,500 − €70). The entry Sauk Stereo makes to record its May 14 payment decreases (debits) Accounts Payable by the amount of the gross invoice price, reduces (credits) Inventory by the €70 discount, and reduces (credits) Cash by the net amount owed.

If Sauk Stereo failed to take the discount, and instead made full payment of €3,500 on June 3, it would debit Accounts Payable and credit Cash for €3,500 each.

A merchandising company usually should take all available discounts. Passing up the discount may be viewed as paying interest for use of the money. For example, passing up the discount offered by PW Audio Supply would be comparable to Sauk Stereo paying an interest rate of 2% for the use of €3,500 for 20 days. This is the equivalent of an annual interest rate of approximately 36.5% (2% × 365/20). Obviously, it would be better for Sauk Stereo to borrow at prevailing bank interest rates of 6% to 10% than to lose the discount.

Summary of Purchasing Transactions

The following T-account (with transaction descriptions in blue) provides a summary of the effect of the previous transactions on Inventory. Sauk Stereo originally purchased €3,800 worth of inventory for resale. It then returned €300 of goods. It paid €150 in freight charges, and finally, it received a €70 discount off the balance owed because it paid within the discount period. This results in a balance in Inventory of €3,580.

Recording Sales of Merchandise

In accordance with the revenue recognition principle, companies record sales revenue when the performance obligation is satisfied. Typically, the performance obligation is satisfied when the goods transfer from the seller to the buyer. At this point, the sales transaction is complete and the sales price established.

Sales may be made on credit or for cash. A business document should support every sales transaction, to provide written evidence of the sale. Cash register tapes provide evidence of cash sales. A sales invoice, like the one shown in Illustration 5-6 (page 216), provides support for a credit sale. The original copy of the invoice goes to the customer, and the seller keeps a copy for use in recording the sale. The invoice shows the date of sale, customer name, total sales price, and other relevant information.

The seller makes two entries for each sale. The first entry records the sale: The seller increases (debits) Cash (or Accounts Receivable, if a credit sale), and also increases (credits) Sales Revenue. The second entry records the cost of the merchandise sold: The seller increases (debits) Cost of Goods Sold, and also decreases (credits) Inventory for the cost of those goods. As a result, the Inventory account will show at all times the amount of inventory that should be on hand.

To illustrate a credit sales transaction, PW Audio Supply records its May 4 sale of €3,800 to Sauk Stereo (see Illustration 5-6) as follows (assume the merchandise cost PW Audio Supply €2,400).

For internal decision-making purposes, merchandising companies may use more than one sales account. For example, PW Audio Supply may decide to keep separate sales accounts for its sales of TV sets, DVD recorders, and microwave ovens. Carrefour might use separate accounts for sporting goods, children's clothing, and hardware—or it might have even more narrowly defined accounts. By using separate sales accounts for major product lines, rather than a single combined sales account, company management can more closely monitor sales trends and respond more strategically to changes in sales patterns. For example, if TV sales are increasing while microwave oven sales are decreasing, PW Audio Supply might reevaluate both its advertising and pricing policies on these items to ensure they are optimal.

On its income statement presented to outside investors, a merchandising company normally would provide only a single sales figure—the sum of all of its individual sales accounts. This is done for two reasons. First, providing detail on all of its individual sales accounts would add considerable length to its income statement. Second, most companies do not want their competitors to know the details of their operating results. However, Microsoft (USA) recently expanded its disclosure of revenue from three to five types. The reason: The additional categories will better enable financial statement users to evaluate the growth of the company's consumer and Internet businesses.

At the end of “Anatomy of a Fraud” stories, which describe some recent real-world frauds, we discuss the missing internal control activity that would likely have prevented or uncovered the fraud.

Sales Returns and Allowances

We now look at the “flipside” of purchase returns and allowances, which the seller records as sales returns and allowances. These are transactions where the seller either accepts goods back from the buyer (a return) or grants a reduction in the purchase price (an allowance) so the buyer will keep the goods. PW Audio Supply's entries to record credit for returned goods involve (1) an increase (debit) in Sales Returns and Allowances (a contra account to Sales Revenue) and a decrease (credit) in Accounts Receivable at the €300 selling price, and (2) an increase (debit) in Inventory (assume a €140 cost) and a decrease (credit) in Cost of Goods Sold, as shown below (assuming that the goods were not defective).

If Sauk Stereo returns goods because they are damaged or defective, then PW Audio Supply's entry to Inventory and Cost of Goods Sold should be for the fair value of the returned goods, rather than their cost. For example, if the returned goods were defective and had a fair value of €50, PW Audio Supply would debit Inventory for €50, and would credit Cost of Goods Sold for €50.

What happens if the goods are not returned but the seller grants the buyer an allowance by reducing the purchase price? In this case, the seller debits Sales Returns and Allowances and credits Accounts Receivable for the amount of the allowance.

As mentioned above, Sales Returns and Allowances is a contra revenue account to Sales Revenue. The normal balance of Sales Returns and Allowances is a debit. Companies use a contra account, instead of debiting Sales Revenue, to disclose in the accounts and in the income statement the amount of sales returns and allowances. Disclosure of this information is important to management: Excessive returns and allowances may suggest problems—inferior merchandise, inefficiencies in filling orders, errors in billing customers, or delivery or shipment mistakes. Moreover, a decrease (debit) recorded directly to Sales Revenue would obscure the relative importance of sales returns and allowances as a percentage of sales. It also could distort comparisons between total sales in different accounting periods.

Sales Discounts

As mentioned in our discussion of purchase transactions, the seller may offer the customer a cash discount—called by the seller a sales discount—for the prompt payment of the balance due. Like a purchase discount, a sales discount is based on the invoice price less returns and allowances, if any. The seller increases (debits) the Sales Discounts account for discounts that are taken. For example, PW Audio Supply makes the following entry to record the cash receipt on May 14 from Sauk Stereo within the discount period.

Like Sales Returns and Allowances, Sales Discounts is a contra revenue account to Sales Revenue. Its normal balance is a debit. PW Audio Supply uses this account, instead of debiting Sales Revenue, to disclose the amount of cash discounts taken by customers. If Sauk Stereo does not take the discount, PW Audio Supply increases (debits) Cash for €3,500 and decreases (credits) Accounts Receivable for the same amount at the date of collection.

The following T-accounts summarize the three sales-related transactions and show their combined effect on net sales.

Completing the Accounting Cycle

Up to this point, we have illustrated the basic entries for transactions relating to purchases and sales in a perpetual inventory system. Now we consider the remaining steps in the accounting cycle for a merchandising company. Each of the required steps described in Chapter 4 for service companies apply to merchandising companies. Appendix 5B to this chapter shows use of a worksheet by a merchandiser (an optional step).

Adjusting Entries

A merchandising company generally has the same types of adjusting entries as a service company. However, a merchandiser using a perpetual system will require one additional adjustment to make the records agree with the actual inventory on hand. Here's why: At the end of each period, for control purposes, a merchandising company that uses a perpetual system will take a physical count of its goods on hand. The company's unadjusted balance in Inventory usually does not agree with the actual amount of inventory on hand. The perpetual inventory records may be incorrect due to recording errors, theft, or waste. Thus, the company needs to adjust the perpetual records to make the recorded inventory amount agree with the inventory on hand. This involves adjusting Inventory and Cost of Goods Sold.

For example, suppose that PW Audio Supply has an unadjusted balance of €40,500 in Inventory. Through a physical count, PW Audio Supply determines that its actual merchandise inventory at year-end is €40,000. The company would make an adjusting entry as follows.

Closing Entries

A merchandising company, like a service company, closes to Income Summary all accounts that affect net income. In journalizing, the company credits all temporary accounts with debit balances, and debits all temporary accounts with credit balances, as shown below for PW Audio Supply, using assumed data. Note that PW Audio Supply closes Cost of Goods Sold to Income Summary.

After PW Audio Supply has posted the closing entries, all temporary accounts have zero balances. Also, Retained Earnings has a balance that is carried over to the next period.

Summary of Merchandising Entries

Illustration 5-8 summarizes the entries for the merchandising accounts using a perpetual inventory system.

Illustration 5-8 Daily recurring and adjusting and closing entries

Forms of Financial Statements

Merchandising companies widely use the classified statement of financial position introduced in Chapter 4. This section explains an income statement used by merchandisers.

Income Statement

The income statement is a primary source of information for evaluating a company's performance. The format is designed to differentiate between the various sources of income and expense.

Income Statement Presentation of Sales

The income statement begins by presenting sales revenue. It then deducts contra revenue accounts—sales returns and allowances, and sales discounts—to arrive at net sales. Illustration 5-9 presents the sales revenues section for PW Audio Supply, using assumed data.

Illustration 5-9 Computation of net sales

This presentation discloses the key data about the company's principal revenue-producing activities.

GROSS PROFIT

From Illustration 5-1, you learned that companies deduct cost of goods sold from sales revenue in order to determine gross profit. For this computation, companies use net sales (which takes into consideration Sales Returns and Allowances and Sales Discounts) as the amount of sales revenue. On the basis of the sales data in Illustration 5-9 (net sales of €460,000) and cost of goods sold under the perpetual inventory system (assume €316,000), PW Audio Supply's gross profit is €144,000, computed as follows.

Illustration 5-10 Computation of gross profit

We also can express a company's gross profit as a percentage, called the gross profit rate. To do so, we divide the amount of gross profit by net sales. For PW Audio Supply, the gross profit rate is 31.3%, computed as follows.

Illustration 5-11 Gross profit rate formula and computation

Analysts generally consider the gross profit rate to be more useful than the gross profit amount. The rate expresses a more meaningful (qualitative) relationship between net sales and gross profit. For example, a gross profit of €1,000,000 may sound impressive. But if it is the result of a gross profit rate of only 7%, when others in the industry get 20%, it is not so impressive. The gross profit rate tells how much of each euro of sales go to gross profit.

Gross profit represents the merchandising profit of a company. It is not a measure of the overall profitability, because operating expenses are not yet deducted. But managers and other interested parties closely watch the amount and trend of gross profit. They compare current gross profit with amounts reported in past periods. They also compare the company's gross profit rate with rates of competitors and with industry averages. Such comparisons provide information about the effectiveness of a company's purchasing function and the soundness of its pricing policies.

OPERATING EXPENSES

Operating expenses are the next component in the income statement of a merchandising company. They are the expenses incurred in the process of earning sales revenue. Many of these expenses are similar in merchandising and service companies. At PW Audio Supply, operating expenses were €114,000. This €114,000 includes costs that were incurred for salaries, utilities, advertising, depreciation, freight-out, and insurance. The presentation of operating expenses is shown in Illustration 5-12 (page 228).

Illustration 5-12 Operating expenses

Illustration 5-12 provides an opportunity to discuss two different presentation formats allowed by IFRS: presentation by nature and presentation by function. Presentation by nature provides very detailed information, with numerous line items, that reveal the nature of costs incurred by the company. In Illustration 5-12, the detailed information regarding costs incurred for salaries and wages, utilities, advertising, depreciation, freight-out, and insurance demonstrates presentation by nature.

Presentation by function aggregates costs into groupings based on the primary functional activities in which the company engages. For example, at PW Audio Supply, operating expenses are those costs incurred to perform the operating functions of a merchandising business. If PW Audio Supply chose to present strictly by function, it would present its operating expenses as a single line item of €114,000. However, if a presentation by function is used, IFRS requires disclosure of additional details regarding the nature of certain expenses that were included in the functional grouping. For example, depreciation and salary and wage costs are items specifically required to be disclosed.

Illustration 5-12 combines both a presentation by function and by nature to present operating expenses. It uses a functional grouping of operating expenses but also presents in detail the nature of the costs included in that functional grouping. In your homework, you should use this approach.

OTHER INCOME AND EXPENSE

Other income and expense consists of various revenues and gains and expenses and losses that are unrelated to the company's main line of operations. Illustration 5-13 lists examples of each.

Illustration 5-13 Examples of other income and expense

Merchandising companies report other income and expense in the income statement immediately after the company's primary operating activities. Illustration 5-14 shows this presentation for PW Audio Supply.

Illustration 5-14 Income statement

INTEREST EXPENSE

Financing activities, which result in interest expense, represent distinctly different types of cost to a business. In evaluating the performance of a business, it is important to monitor its interest expense. As a consequence, interest expense, if material, must be disclosed on the face of the income statement. PW Audio Supply incurred interest expense of €1,800. Illustration 5-14 presents a complete income statement for PW Audio Supply. Use this format when preparing your homework.

COMPREHENSIVE INCOME

Chapter 1 discussed the fair value principle. IFRS requires companies to mark the recorded values of certain types of assets and liabilities to their fair values at the end of each reporting period. In some instances, the unrealized gains or losses that result from adjusting recorded amounts to fair value are included in net income. However, in other cases, these unrealized gains and losses are not included in net income. Instead, these excluded items are reported as part of a more inclusive earnings measure, called comprehensive income. Examples of such items include certain adjustments to pension plan assets, gains and losses on foreign currency translation, and unrealized gains and losses on certain types of investments. Items that are excluded from net income, but included in comprehensive income, are either reported in a combined statement of net income and comprehensive income, or in a separate schedule that reports only comprehensive income. Illustration 5-15 (page 230) shows how comprehensive income is appended to the bottom of the income statement, after net income, when a combined approach is used.

Illustration 5-15 Combined statement of net income and comprehensive income

Classified Statement of Financial Position

In the statement of financial position, merchandising companies report inventory as a current asset immediately above accounts receivable. Recall from Chapter 4 that companies generally list current asset items in the reverse order of their closeness to cash (liquidity). Inventory is less close to cash than accounts receivable because the goods must first be sold and then collection made from the customer. Illustration 5-16 presents the assets section of a classified statement of financial position for PW Audio Supply.

Illustration 5-16 Assets section of a classified statement of financial position

SUMMARY OF LEARNING OBJECTIVES

1 Identify the differences between service and merchandising companies. Because of inventory, a merchandising company has sales revenue, cost of goods sold, and gross profit. To account for inventory, a merchandising company must choose between a perpetual and a periodic inventory system.

2 Explain the recording of purchases under a perpetual inventory system. The company debits the Inventory account for all purchases of merchandise and freight-in, and credits it for purchase discounts and purchase returns and allowances.

3 Explain the recording of sales revenues under a perpetual inventory system. When a merchandising company sells inventory, it debits Accounts Receivable (or Cash), and credits Sales Revenue for the selling price of the merchandise. At the same time, it debits Cost of Goods Sold and credits Inventory for the cost of the inventory items sold. Sales returns and allowances and sales discounts are debited.

4 Explain the steps in the accounting cycle for a merchandising company. Each of the required steps in the accounting cycle for a service company applies to a merchandising company. A worksheet is again an optional step. Under a perpetual inventory system, the company must adjust the Inventory account to agree with the physical count.

5 Prepare an income statement for a merchandiser. The income statement usually has the following components: sales revenues, cost of goods sold, gross profit, operating expenses, other income and expense, and interest expense.

GLOSSARY

Comprehensive income An income measure that includes gains and losses that are excluded from the determination of net income. (p. 229).

Contra revenue account An account that is offset against a revenue account on the income statement. (p. 221).

Cost of goods sold The total cost of merchandise sold during the period. (p. 212).

FOB destination Freight terms indicating that the seller places the goods free on board to the buyer's place of business, and the seller pays the freight. (p. 216).

FOB shipping point Freight terms indicating that the seller places goods free on board the carrier, and the buyer pays the freight costs. (p. 216).

Gross profit The excess of net sales over the cost of goods sold. (p. 227).

Gross profit rate Gross profit expressed as a percentage, by dividing the amount of gross profit by net sales. (p. 227).

Net sales Sales less sales returns and allowances and less sales discounts. (p. 226).

Operating expenses Expenses incurred in the process of earning sales revenues. (p. 227).

Periodic inventory system An inventory system under which the company does not keep detailed inventory records throughout the accounting period but determines the cost of goods sold only at the end of an accounting period. (p. 214).

Perpetual inventory system An inventory system under which the company keeps detailed records of the cost of each inventory purchase and sale, and the records continuously show the inventory that should be on hand. (p. 213).

Purchase allowance A deduction made to the selling price of merchandise, granted by the seller so that the buyer will keep the merchandise. (p. 217).

Purchase discount A cash discount claimed by a buyer for prompt payment of a balance due. (p. 218).

Purchase invoice A document that supports each credit purchase. (p. 215).

Purchase return A return of goods from the buyer to the seller for a cash or credit refund. (p. 217).

Sales discount A reduction given by a seller for prompt payment of a credit sale. (p. 222).

Sales invoice A document that supports each credit sale. (p. 219).

Sales returns and allowances Purchase returns and allowances from the seller's perspective. See Purchase return and Purchase allowance, above. (p. 221).

Sales revenue (Sales) The primary source of revenue in a merchandising company. (p. 212).

APPENDIX 5A PERIODIC INVENTORY SYSTEM

As described in this chapter, companies may use one of two basic systems of accounting for inventories: (1) the perpetual inventory system or (2) the periodic inventory system. In the chapter, we focused on the characteristics of the perpetual inventory system. In this appendix, we discuss and illustrate the periodic inventory system. One key difference between the two systems is the point at which the company computes cost of goods sold. For a visual reminder of this difference, refer back to Illustration 5-5 (page 214).

Determining Cost of Goods Sold Under a Periodic System

Determining cost of goods sold is different when a periodic inventory system is used rather than a perpetual system. As you have seen, a company using a perpetual system makes an entry to record cost of goods sold and to reduce inventory each time a sale is made. A company using a periodic system does not determine cost of goods sold until the end of the period. At the end of the period the company performs a count to determine the ending balance of inventory. It then calculates cost of goods sold by subtracting ending inventory from the goods available for sale. Goods available for sale is the sum of beginning inventory plus purchases, as shown in Illustration 5A-1.

Illustration 5A-1 Basic formula for cost of goods sold using the periodic system

Another difference between the two approaches is that the perpetual system directly adjusts the Inventory account for any transaction that affects inventory (such as freight costs, returns, and discounts). The periodic system does not do this. Instead, it creates different accounts for purchases, freight costs, returns, and discounts. These various accounts are shown in Illustration 5A-2, which presents the calculation of cost of goods sold for PW Audio Supply using the periodic approach.

Illustration 5A-2 Cost of goods sold for a merchandiser using a periodic inventory system

Note that the basic elements from Illustration 5A-1 are highlighted in Illustration 5A-2. You will learn more in Chapter 6 about how to determine cost of goods sold using the periodic system.

The use of the periodic inventory system does not affect the form of presentation in the statement of financial position. As under the perpetual system, a company reports inventory in the current assets section.

Recording Merchandise Transactions

In a periodic inventory system, companies record revenues from the sale of merchandise when sales are made, just as in a perpetual system. Unlike the perpetual system, however, companies do not attempt on the date of sale to record the cost of the merchandise sold. Instead, they take a physical inventory count at the end of the period to determine (1) the cost of the merchandise then on hand and (2) the cost of the goods sold during the period. And, under a periodic system, companies record purchases of merchandise in the Purchases account rather than the Inventory account. Also, in a periodic system, purchase returns and allowances, purchase discounts, and freight costs on purchases are recorded in separate accounts.

To illustrate the recording of merchandise transactions under a periodic inventory system, we will use purchase/sale transactions between PW Audio Supply, Inc. and Sauk Stereo, as illustrated for the perpetual inventory system in this chapter.

Recording Purchases of Merchandise

On the basis of the sales invoice (Illustration 5-6, shown on page 216) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the €3,800 purchase as follows.

Purchases is a temporary account whose normal balance is a debit.

FREIGHT COSTS

When the purchaser directly incurs the freight costs, it debits the account Freight-In (or Transportation-In). For example, if Sauk Stereo pays Acme Freight Company €150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk Stereo's books is:

Like Purchases, Freight-In is a temporary account whose normal balance is a debit. Freight-In is part of cost of goods purchased. The reason is that cost of goods purchased should include any freight charges necessary to bring the goods to the purchaser. Freight costs are not subject to a purchase discount. Purchase discounts apply only to the invoice cost of the merchandise.

PURCHASE RETURNS AND ALLOWANCES

Sauk Stereo returns €300 of goods to PW Audio Supply and prepares the following entry to recognize the return.

Purchase Returns and Allowances is a temporary account whose normal balance is a credit.

PURCHASE DISCOUNTS

On May 14, Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio Supply for payment within 10 days. Sauk Stereo records the payment and discount as follows.

Purchase Discounts is a temporary account whose normal balance is a credit.

Recording Sales of Merchandise

The seller, PW Audio Supply, records the sale of €3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-6, page 216) as follows.

SALES RETURNS AND ALLOWANCES

To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the €300 sales return as follows.

SALES DISCOUNTS

On May 14, PW Audio Supply receives payment of €3,430 on account from Sauk Stereo. PW Audio Supply honors the 2% cash discount and records the payment of Sauk Stereo's account receivable in full as follows.

COMPARISON OF ENTRIES—PERPETUAL VS. PERIODIC

Illustration 5A-3 summarizes the periodic inventory entries shown in this appendix and compares them to the perpetual-system entries from the chapter. Entries that differ in the two systems are shown in color.

Illustration 5A-3 Comparison of entries for perpetual and periodic inventory systems

SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 5A

6 Explain the recording of purchases and sales of inventory under a periodic inventory system. In recording purchases under a periodic system, companies must make entries for (a) cash and credit purchases, (b) purchase returns and allowances, (c) purchase discounts, and (d) freight costs. In recording sales, companies must make entries for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales discounts.

APPENDIX 5B WORKSHEET FOR A MERCHANDISING COMPANY

Using a Worksheet

As indicated in Chapter 4, a worksheet enables companies to prepare financial statements before they journalize and post adjusting entries. The steps in preparing a worksheet for a merchandising company are the same as for a service company (see pages 159–161). Illustration 5B-1 (page 238) shows the worksheet for PW Audio Supply (excluding non-operating items). The unique accounts for a merchandiser using a perpetual inventory system are in boldface letters and in red.

Illustration 5B-1 Worksheet for merchandising company

TRIAL BALANCE COLUMNS

Data for the trial balance come from the ledger balances of PW Audio Supply at December 31. The amount shown for Inventory, €40,500, is the year-end inventory amount from the perpetual inventory system.

ADJUSTMENTS COLUMNS

A merchandising company generally has the same types of adjustments as a service company. As you see in the worksheet, adjustments (b), (c), and (d) are for insurance, depreciation, and salaries. Pioneer Advertising Agency Inc. as illustrated in Chapters 3 and 4, also had these adjustments. Adjustment (a) was required to adjust the perpetual inventory carrying amount to the actual count.

After PW Audio Supply enters all adjustments data on the worksheet, it establishes the equality of the adjustments column totals. It then extends the balances in all accounts to the adjusted trial balance columns.

ADJUSTED TRIAL BALANCE

The adjusted trial balance shows the balance of all accounts after adjustment at the end of the accounting period.

INCOME STATEMENT COLUMNS

Next, the merchandising company transfers the accounts and balances that affect the income statement from the adjusted trial balance columns to the income statement columns. PW Audio Supply shows sales of €480,000 in the credit column. It shows the contra revenue accounts Sales Returns and Allowances €12,000 and Sales Discounts €8,000 in the debit column. The difference of €460,000 is the net sales shown on the income statement (Illustration 5-14, page 229).

Finally, the company totals all the credits in the income statement column and compares those totals to the total of the debits in the income statement column. If the credits exceed the debits, the company has net income. PW Audio Supply has net income of €30,000. If the debits exceed the credits, the company would report a net loss.

STATEMENT OF FINANCIAL POSITION COLUMNS

The major difference between the statements of financial position of a service company and a merchandiser is inventory. PW Audio Supply shows the ending inventory amount of €40,000 in the statement of financial position debit column. The information to prepare the retained earnings statement is also found in these columns. That is, the retained earnings beginning balance is €33,000. The dividends are €15,000. Net income results when the total of the debit column exceeds the total of the credit column in the statement of financial position columns. A net loss results when the total of the credits exceeds the total of the debit balances.

SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 5B

7 Prepare a worksheet for a merchandising company. The steps in preparing a worksheet for a merchandising company are the same as for a service company. The unique accounts for a merchandiser are Inventory, Sales Revenue, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold.

Self-Test, Brief Exercises, Exercises, Problem Set A, and many more components are available for practice in WileyPLUS.

*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

SELF-TEST QUESTIONS

Answers are on page 259.

1. Gross profit will result if:   (LO 1)

   (a) operating expenses are less than net income.

   (b) sales revenues are greater than operating expenses.

   (c) sales revenues are greater than cost of goods sold.

   (d) operating expenses are greater than cost of goods sold.

2. Under a perpetual inventory system, when goods are purchased for resale by a company:   (LO 2)

   (a) purchases on account are debited to Inventory.

   (b) purchases on account are debited to Purchases.

   (c) purchase returns are debited to Purchase Returns and Allowances.

   (d) freight costs are debited to Freight-Out.

3. The sales accounts that normally have a debit balance are:   (LO 3)

   (a) Sales Discounts.

   (b) Sales Returns and Allowances.

   (c) Both (a) and (b).

   (d) Neither (a) nor (b).

4. A credit sale of NT$7,500 is made on June 13, terms 2/10, net/30. A return of NT$500 is granted on June 16. The amount received as payment in full on June 23 is:   (LO 3)

   (a) NT$7,000.

   (b) NT$6,860.

   (c) NT$6,850.

   (d) NT$6,500.

5. Which of the following accounts will normally appear in the ledger of a merchandising company that uses a perpetual inventory system?   (LO 2)

   (a) Purchases.

   (b) Freight-In.

   (c) Cost of Goods Sold.

   (d) Purchase Discounts.

6. To record the sale of goods for cash in a perpetual inventory system:   (LO 3)

   (a) only one journal entry is necessary to record cost of goods sold and reduction of inventory.

   (b) only one journal entry is necessary to record the receipt of cash and the sales revenue.

   (c) two journal entries are necessary: one to record the receipt of cash and sales revenue, and one to record the cost of goods sold and reduction of inventory.

   (d) two journal entries are necessary: one to record the receipt of cash and reduction of inventory, and one to record the cost of goods sold and sales revenue.

7. The steps in the accounting cycle for a merchandising company are the same as those in a service company except:   (LO 4)

   (a) an additional adjusting journal entry for inventory may be needed in a merchandising company.

   (b) closing journal entries are not required for a merchandising company.

   (c) a post-closing trial balance is not required for a merchandising company.

   (d) an income statement is required for a merchandising company.

8. The income statement for a merchandising company shows each of the following features except:   (LO 5)

   (a) gross profit.

   (b) cost of goods sold.

   (c) a sales revenue section.

   (d) investing activities section.

9. If sales revenues are €400,000, cost of goods sold is €310,000, and operating expenses are €60,000, the gross profit is:   (LO 5)

   (a) €30,000.

   (b) €90,000.

   (c) €340,000.

   (d) €400,000.

10. * In determining cost of goods sold using a periodic system:   (LO 6)

    (a) purchase discounts are deducted from net purchases.

    (b) freight-out is added to net purchases.

    (c) purchase returns and allowances are deducted from net purchases.

    (d) freight-in is added to net purchases.

11. * If beginning inventory is HK$600,000, cost of goods purchased is HK$3,800,000, and ending inventory is HK$500,000, cost of goods sold is:   (LO 6)

    (a) HK$3,900,000.

    (b) HK$3,700,000.

    (c) HK$3,300,000.

    (d) HK$4,200,000.

12. * When goods are purchased for resale by a company using a periodic inventory system:   (LO 6)

    (a) purchases on account are debited to Inventory.

    (b) purchases on account are debited to Purchases.

    (c) purchase returns are debited to Purchase Returns and Allowances.

    (d) freight costs are debited to Purchases.

13. * In a worksheet, Inventory is shown in the following columns:   (LO 7)

    (a) adjusted trial balance debit and statement of financial position debit.

    (b) income statement debit and statement of financial position debit.

    (c) income statement credit and statement of financial position debit.

    (d) income statement credit and adjusted trial balance debit.

Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

QUESTIONS

1. (a) “The steps in the accounting cycle for a merchandising company are different from the accounting cycle for a service company.” Do you agree or disagree?
   (b) Is the measurement of net income for a merchandising company conceptually the same as for a service company? Explain.
2. Why is the normal operating cycle for a merchandising company likely to be longer than for a service company?
3. (a) How do the components of revenues and expenses differ between merchandising and service companies? (b) Explain the income measurement process in a merchandising company.
4. How does income measurement differ between a merchandising and a service company?
5. When is cost of goods sold determined in a perpetual inventory system?
6. Distinguish between FOB shipping point and FOB destination. Identify the freight terms that will result in a debit to Inventory by the buyer and a debit to Freight-Out by the seller.
7. Explain the meaning of the credit terms 2/10, n/30.
8. Goods costing $2,500 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit memo is received from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period using a perpetual inventory system.
9. Karen Lloyd believes revenues from credit sales may be earned before they are collected in cash. Do you agree? Explain.
10. (a) What is the primary source document for recording (1) cash sales, (2) credit sales. (b) Using XXs for amounts, give the journal entry for each of the transactions in part (a).
11. A credit sale is made on July 10 for $700, terms 2/10, n/30. On July 12, $100 of goods are returned for credit. Give the journal entry on July 19 to record the receipt of the balance due within the discount period.
12. Explain why the Inventory account will usually require adjustment at year-end.
13. Prepare the closing entries for the Sales Revenue account, assuming a balance of €180,000 and the Cost of Goods Sold account with a €125,000 balance.
14. What merchandising account(s) will appear in the post-closing trial balance?
15. Regis Co. has sales revenue of $109,000, cost of goods sold of $70,000, and operating expenses of $23,000. What is its gross profit and its gross profit rate?
16. Kim Ho Company reports net sales of ¥800,000, gross profit of ¥570,000, and net income of ¥240,000. What are its operating expenses?
17. Identify the distinguishing features of an income statement for a merchandising company.
18. Identify the sections of an income statement that relate to (a) operating activities, and (b) non-operating activities.
19. * Identify the accounts that are added to or deducted from Purchases to determine the cost of goods purchased. For each account, indicate whether it is added or deducted.
20. * Goods costing $2,000 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit was received from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period, assuming a periodic inventory system.
21. * Indicate the columns of the worksheet in which (a) inventory and (b) cost of goods sold will be shown.

BRIEF EXERCISES

Compute missing amounts in determining net income.   (LO 1)

BE5-1 Presented below are the components in Clearwater Company's income statement. Determine the missing amounts.

Journalize perpetual inventory entries.   (LO 2, 3)

BE5-2 Giovanni Company buys merchandise on account from Gordon Company. The selling price of the goods is $780, and the cost of the goods is $560. Both companies use perpetual inventory systems. Journalize the transaction on the books of both companies.

Journalize sales transactions.   (LO 3)

BE5-3 Prepare the journal entries to record the following transactions on Benson Company's books using a perpetual inventory system.

(a) On March 2, Benson Company sold $800,000 of merchandise to Edgebrook Company, terms 2/10, n/30. The cost of the merchandise sold was $620,000.

(b) On March 6, Edgebrook Company returned $120,000 of the merchandise purchased on March 2. The cost of the returned merchandise was $90,000.

(c) On March 12, Benson Company received the balance due from Edgebrook Company.

Journalize purchase transactions.   (LO 2)

BE5-4 From the information in BE5-3, prepare the journal entries to record these transactions on Edgebrook Company's books under a perpetual inventory system.

Prepare adjusting entry for merchandise inventory.   (LO 4)

BE5-5 At year-end, the perpetual inventory records of Federer Company showed merchandise inventory of CHF98,000. The company determined, however, that its actual inventory on hand was CHF94,600. Record the necessary adjusting entry.

Prepare closing entries for accounts.   (LO 4)

BE5-6 Orlaida Company has the following account balances: Sales Revenue $192,000, Sales Discounts $2,000, Cost of Goods Sold $105,000, and Inventory $40,000. Prepare the entries to record the closing of these items to Income Summary.

Prepare sales revenues section of income statement.   (LO 5)

BE5-7 Yangtze Company provides the following information for the month ended October 31, 2014 (amounts in Chinese yuan): sales on credit ¥280,000, cash sales ¥100,000, sales discounts ¥5,000, sales returns and allowances ¥18,000. Prepare the sales revenues section of the income statement based on this information.

Explain presentation in an income statement.   (LO 5)

BE5-8 Explain where each of the following items would appear on an income statement: (a) gain on sale of equipment, (b) interest expense, (c) casualty loss from vandalism, (d) cost of goods sold, and (e) depreciation expense.

Compute net sales, gross profit, income from operations, and gross profit rate.   (LO 5)

BE5-9 Assume Jose Company has the following reported amounts: Sales revenue $506,000, Sales returns and allowances $13,000, Cost of goods sold $330,000, Operating expenses $110,000. Compute the following: (a) net sales, (b) gross profit, (c) income from operations, and (d) gross profit rate. (Round to one decimal place.)

Compute net purchases and cost of goods purchased.   (LO 6)

*BE5-10 Assume that Kowloon Company uses a periodic inventory system and has these account balances (in thousands): Purchases 430,000; Purchase Returns and Allowances 13,000; Purchase Discounts 8,000; and Freight-In 16,000. Determine net purchases and cost of goods purchased.

Compute cost of goods sold and gross profit.   (LO 6)

*BE5-11 Assume the same information as in BE5-10 and also that Kowloon Company has beginning inventory (in thousands) of 60,000, ending inventory of 90,000, and net sales of 680,000. Determine the amounts to be reported for cost of goods sold and gross profit.

Journalize purchase transactions.   (LO 6)

*BE5-12 Prepare the journal entries to record these transactions on Huntington Company's books using a periodic inventory system.

(a) On March 2, Huntington Company purchased $900,000 of merchandise from Saunder Company, terms 2/10, n/30.

(b) On March 6, Huntington Company returned $184,000 of the merchandise purchased on March 2.

(c) On March 12, Huntington Company paid the balance due to Saunder Company.

Identify worksheet columns for selected accounts.   (LO 7)

*BE5-13 Presented below is the format of the worksheet presented in the chapter.

Indicate where the following items will appear on the worksheet: (a) Cash, (b) Inventory, (c) Sales revenue, and (d) Cost of goods sold.

Example:

Cash: Trial balance debit column; Adjusted trial balance debit column; and Statement of financial position debit column.

DO IT! REVIEW

Record transactions of purchasing company.   (LO 2)

5-1 On October 5, Gibson Company buys merchandise on account from Quincy Company. The selling price of the goods is $4,700, and the cost to Quincy Company is $3,100. On October 8, Gibson returns defective goods with a selling price of $650 and a fair value of $160. Record the transactions on the books of Gibson Company.

Record transactions of selling company.   (LO 3)

5-2 Assume information similar to that in 5-1. That is: On October 5, Gibson Company buys merchandise on account from Quincy Company. The selling price of the goods is $4,700, and the cost to Quincy Company is $3,100. On October 8, Gibson returns defective goods with a selling price of $650 and a fair value of $160. Record the transactions on the books of Quincy Company.

Prepare closing entries for a merchandising company.   (LO 4)

5-3 The trial balance of Alagoas's Boutique at December 31 shows Inventory R$21,000, Sales Revenue R$156,000, Sales Returns and Allowances R$4,000, Sales Discounts R$3,000, Cost of Goods Sold R$92,400, Interest Revenue R$3,000, Freight-Out R$1,900, Utilities Expense R$7,400, and Salaries and Wages Expense R$19,500. Prepare the closing entries for Alagoas.

Classify financial statement accounts.   (LO 5)

5-4 Dorothea Company is preparing its income statement, retained earnings statement, and classified statement of financial position. Using the column heads Account, Financial Statement, and Classification, indicate in which financial statement and under what classification each of the following would be reported.

EXERCISES

Answer general questions about merchandisers.   (LO 1)

E5-1 Mr. Soukup has prepared the following list of statements about service companies and merchandisers.

1. Measuring net income for a merchandiser is conceptually the same as for a service company.
2. For a merchandiser, sales less operating expenses is called gross profit.
3. For a merchandiser, the primary source of revenues is the sale of inventory.
4. Sales salaries and wages is an example of an operating expense.
5. The operating cycle of a merchandiser is the same as that of a service company.
6. In a perpetual inventory system, no detailed inventory records of goods on hand are maintained.
7. In a periodic inventory system, the cost of goods sold is determined only at the end of the accounting period.
8. A periodic inventory system provides better control over inventories than a perpetual system.

Instructions

Identify each statement as true or false. If false, indicate how to correct the statement.

Journalize purchase transactions.   (LO 2)

E5-2 Information related to Duffy Co. is presented below.

1. On April 5, purchased merchandise from Thomas Company for $25,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of $900 on merchandise purchased from Thomas.
3. On April 7, purchased equipment on account for $26,000.
4. On April 8, returned damaged merchandise to Thomas Company and was granted a $2,600 credit for returned merchandise.
5. On April 15, paid the amount due to Thomas Company in full.

Instructions

(a) Prepare the journal entries to record these transactions on the books of Duffy Co. under a perpetual inventory system.

(b) Assume that Duffy Co. paid the balance due to Thomas Company on May 4 instead of April 15. Prepare the journal entry to record this payment.

Journalize perpetual inventory entries.   (LO 2, 3)

E5-3 On September 1, Roshek Office Supply had an inventory of 30 calculators at a cost of €22 each. The company uses a perpetual inventory system. During September, the following transactions occurred.

Sept.  6	Purchased 90 calculators at €20 each from Harlow Co., terms 2/10, n/30.
9	Paid freight of €180 on calculators purchased from Harlow Co.
10	Returned 3 calculators to Harlow Co. for €66 credit (including freight) because they did not meet specifications.
12	Sold 26 calculators costing €22 (including freight) for €33 each to Village Book Store, terms n/30.
14	Granted credit of €33 to Village Book Store for the return of one calculator that was not ordered.
20	Sold 40 calculators costing €22 for €32 each to Holiday Card Shop, terms n/30.

Instructions

Journalize the September transactions.

Prepare purchase and sale entries.   (LO 2, 3)

E5-4 On June 10, Rebecca Company purchased $7,600 of merchandise from Clinton Company, FOB shipping point, terms 2/10, n/30. Rebecca pays the freight costs of $400 on June 11. Damaged goods totaling $300 are returned to Clinton for credit on June 12. The fair value of these goods is $70. On June 19, Rebecca pays Clinton Company in full, less the purchase discount. Both companies use a perpetual inventory system.

Instructions

(a) Prepare separate entries for each transaction on the books of Rebecca Company.

(b) Prepare separate entries for each transaction for Clinton Company. The merchandise purchased by Rebecca on June 10 had cost Clinton $4,300.

Journalize sales transactions.   (LO 3)

E5-5 Presented below are transactions related to Li Company.

1. On December 3, Li Company sold HK$570,000 of merchandise to South China Co., terms 1/10, n/30, FOB shipping point. The cost of the merchandise sold was HK$364,800.
2. On December 8, South China Co. was granted an allowance of HK$20,000 for merchandise purchased on December 3.
3. On December 13, Li Company received the balance due from South China Co.

Instructions

(a) Prepare the journal entries to record these transactions on the books of Li Company using a perpetual inventory system.

(b) Assume that Li Company received the balance due from South China Co. on January 2 of the following year instead of December 13. Prepare the journal entry to record the receipt of payment on January 2.

Prepare sales revenues section and closing entries.   (LO 4, 5)

E5-6 The adjusted trial balance of Mendoza Company shows the following data pertaining to sales at the end of its fiscal year October 31, 2014: Sales Revenue $820,000, Freight-Out $16,000, Sales Returns and Allowances $28,000, and Sales Discounts $13,000.

Instructions

(a) Prepare the sales revenues section of the income statement.

(b) Prepare separate closing entries for (1) sales, and (2) the contra accounts to sales.

Prepare adjusting and closing entries.   (LO 4)

E5-7 Hezir Company had the following account balances at year-end: Cost of Goods Sold 60,000; Inventory 15,000; Operating Expenses 29,000; Sales Revenue 115,000; Sales Discounts 1,300; and Sales Returns and Allowances 1,700. A physical count of inventory determines that merchandise inventory on hand is 13,600.

Instructions

(a) Prepare the adjusting entry necessary as a result of the physical count.

(b) Prepare closing entries.

Prepare adjusting and closing entries.   (LO 4)

E5-8 Presented below is information related to Taylor Co. for the month of January 2014.

Ending inventory per perpetual records	$   21,600
Ending inventory actually on hand	21,000
Cost of goods sold	208,000
Freight-out	7,000
Insurance expense	$   12,000
Rent expense	20,000
Salaries and wages expense	59,000
Sales discounts	8,000
Sales returns and allowances	13,000
Sales revenue	378,000

Instructions

(a) Prepare the necessary adjusting entry for inventory.

(b) Prepare the necessary closing entries.

Prepare an income statement.   (LO 5)

E5-9 Presented below is information for Bach Company for the month of March 2014.

Cost of goods sold	£212,000
Freight-out	9,000
Insurance expense	6,000
Salaries and wages expense	58,000
Rent expense	£ 32,000
Sales discounts	6,600
Sales returns and allowances	13,000
Sales revenue	380,000

Instructions

(a) Prepare an income statement.

(b) Compute the gross profit rate.

Prepare an income statement.   (LO 5)

E5-10 In its income statement for the year ended December 31, 2014, Michael Company reported the following condensed data.

Operating expenses	€    725,000
Cost of goods sold	1,256,000
Interest expense	70,000
Interest revenue	€     33,000
Loss on disposal of plant assets	17,000
Net sales	2,200,000

Instructions

Prepare an income statement.

Prepare correcting entries for sales and purchases.   (LO 2, 3)

E5-11 An inexperienced accountant for Gulliver Company made the following errors in recording merchandising transactions.

1. A $175 refund to a customer for faulty merchandise was debited to Sales Revenue $175 and credited to Cash $175.
2. A $150 credit purchase of supplies was debited to Inventory $150 and credited to Cash $150.
3. A $215 sales discount was debited to Sales Revenue.
4. A cash payment of $20 for freight on merchandise purchases was debited to Freight-Out $200 and credited to Cash $200.

Instructions

Prepare separate correcting entries for each error, assuming that the incorrect entry is not reversed. (Omit explanations.)

Compute various income measures.   (LO 5)

E5-12 In 2014, Endeaver Company had net sales of $860,000 and cost of goods sold of $533,200. Operating expenses were $221,000, and interest expense was $7,000.

Instructions

(a) Compute Endeaver's gross profit.

(b) Compute the gross profit rate. Why is this rate computed by financial statement users?

(c) What is Endeaver's income from operations and net income?

(d) In what section of its classified statement of financial position should Endeaver report merchandise inventory?

Compute missing amounts and compute gross profit rate.   (LO 5)

E5-13 Presented below is financial information for two different companies (amounts in thousands).

Instructions

(a) Determine the missing amounts on the previous page.

(b) Determine the gross profit rates on the previous page. (Round to one decimal place.)

Compute missing amounts.   (LO 5)

E5-14 Financial information is presented below for three different companies.

Instructions

Determine the missing amounts.

Prepare cost of goods sold section.   (LO 6)

*E5-15 The trial balance of Biju Company at the end of its fiscal year, August 31, 2014, includes these accounts (amounts in thousands): Inventory Rp17,200; Purchases Rp149,000; Sales Revenue Rp190,000; Freight-In Rp5,000; Sales Returns and Allowances Rp3,000; Freight-Out Rp1,000; and Purchase Returns and Allowances Rp6,000. The ending inventory is Rp14,000.

Instructions

Prepare a cost of goods sold section for the year ending August 31 (periodic inventory).

Compute various income statement items.   (LO 6)

*E5-16 On January 1, 2014, Clover Corporation had inventory of $50,000. At December 31, 2014, Clover had the following account balances.

Freight-in	$  4,000
Purchases	509,000
Purchase discounts	6,000
Purchase returns and allowances	8,000
Sales revenue	840,000
Sales discounts	7,000
Sales returns and allowances	11,000

At December 31, 2014, Clover determines that its ending inventory is $60,000.

Instructions

(a) Compute Clover's 2014 gross profit.

(b) Compute Clover's 2014 operating expenses if net income is $130,000 and there are no non-operating activities.

Compute missing amounts for cost of goods sold section.   (LO 6)

*E5-17 Below is a series of cost of goods sold sections for companies Alpha, Beta, Chi, and Decca.

Instructions

Fill in the lettered blanks to complete the cost of goods sold sections.

Journalize purchase transactions.   (LO 6)

*E5-18 This information relates to Olaf Co.

1. On April 5, purchased merchandise from DeVito Company for €18,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of €820 on merchandise purchased from DeVito Company.
3. On April 7, purchased equipment on account for €30,000.
4. On April 8, returned some of April 5 merchandise, which cost €2,800, to DeVito Company.
5. On April 15, paid the amount due to DeVito Company in full.

Instructions

(a) Prepare the journal entries to record these transactions on the books of Olaf Co. using a periodic inventory system.

(b) Assume that Olaf Co. paid the balance due to DeVito Company on May 4 instead of April 15. Prepare the journal entry to record this payment.

Journalize purchase transactions.   (LO 6)

*E5-19 Presented below is information related to Chile Co.

1. On April 5, purchased merchandise from Graham Company for $16,000, terms 2/10, net/30, FOB shipping point.
2. On April 6, paid freight costs of $800 on merchandise purchased from Graham.
3. On April 7, purchased equipment on account from Reed Mfg. Co. for $27,000.
4. On April 8, returned merchandise, which cost $4,000, to Graham Company.
5. On April 15, paid the amount due to Graham Company in full.

Instructions

(a) Prepare the journal entries to record these transactions on the books of Chile Co. using a periodic inventory system.

(b) Assume that Chile Co. paid the balance due to Graham Company on May 4 instead of April 15. Prepare the journal entry to record this payment.

Complete worksheet.   (LO 7)

*E5-20 Presented below are selected accounts for Higley Company as reported in the worksheet at the end of May 2014.

Instructions

Complete the worksheet by extending amounts reported in the adjusted trial balance to the appropriate columns in the worksheet. Do not total individual columns.

Prepare a worksheet.   (LO 7)

*E5-21 The trial balance columns of the worksheet for Barbosa Company at June 30, 2014, are as follows.

Other data:

Operating expenses incurred on account, but not yet recorded, total R$1,500.

Instructions

Enter the trial balance on a worksheet and complete the worksheet.

PROBLEMS: SET A

Journalize purchase and sales transactions under a perpetual inventory system.   (LO 2, 3)

P5-1A Ready-Set-Go Co. distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of its customers. At the end of June, Ready-Set-Go's inventory consisted of suitcases costing $1,200. During the month of July, the following merchandising transactions occurred.

July  1	Purchased suitcases on account for $1,500 from Trunk Manufacturers, FOB destination, terms 2/10, n/30. The appropriate party also made a cash payment of $100 for freight on this date.
3	Sold suitcases on account to Satchel World for $2,200. The cost of suitcases sold is $1,400.
9	Paid Trunk Manufacturers in full.
12	Received payment in full from Satchel World.
17	Sold suitcases on account to Lady GoGo for $1,400. The cost of the suitcases sold was $1,010.
18	Purchased suitcases on account for $1,900 from Holiday Manufacturers, FOB shipping point, terms 1/10, n/30. The appropriate party also made a cash payment of $125 for freight on this date.
20	Received $300 credit (including freight) for suitcases returned to Holiday Manufacturers.
21	Received payment in full from Lady GoGo.
22	Sold suitcases on account to Vagabond for $2,250. The cost of suitcases sold was $1,350.
30	Paid Holiday Manufacturers in full.
31	Granted Vagabond $200 credit for suitcases returned costing $120.

Ready-Set-Go's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.

Instructions

Journalize the transactions for the month of July for Ready-Set-Go using a perpetual inventory system.

Journalize, post, and prepare a partial income statement.   (LO 2, 3, 5)

P5-2A Vree Distributing Company completed the following merchandising transactions in the month of April. At the beginning of April, the ledger of Vree showed Cash of €8,000 and Share Capital—Ordinary of €8,000.

Apr.  2	Purchased merchandise on account from Walker Supply Co. €6,200, terms 1/10, n/30.
4	Sold merchandise on account €5,500, FOB destination, terms 1/10, n/30. The cost of the merchandise sold was €3,400.
5	Paid €240 freight on April 4 sale.
6	Received credit from Walker Supply Co. for merchandise returned €500.
11	Paid Walker Supply Co. in full, less discount.
13	Received collections in full, less discounts, from customers billed on April 4.
14	Purchased merchandise for cash €3,800.
16	Received refund from supplier for returned goods on cash purchase of April 14, €500.
18	Purchased merchandise from Benjamin Distributors €4,500, FOB shipping point, terms 2/10, n/30.
20	Paid freight on April 18 purchase €160.
23	Sold merchandise for cash €7,400. The merchandise sold had a cost of €4,120.
26	Purchased merchandise for cash €2,300.
27	Paid Benjamin Distributors in full, less discount.
29	Made refunds to cash customers for defective merchandise €90. The returned merchandise had a fair value of €30.
30	Sold merchandise on account €3,400, terms n/30. The cost of the merchandise sold was €1,900.

Vree Distributing Company's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 311 Share Capital—Ordinary, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, No. 505 Cost of Goods Sold, and No. 644 Freight-Out.

Instructions

(a) Journalize the transactions using a perpetual inventory system.

(b) Enter the beginning cash and share capital—ordinary balances, and post the transactions. (Use J1 for the journal reference.)

(c) Gross profit €6,765

(c) Prepare the income statement through gross profit for the month of April 2014.

Prepare financial statements and adjusting and closing entries.   (LO 4, 5)

P5-3A Starz Department Store is located near the Towne Shopping Mall. At the end of the company's calendar year on December 31, 2014, the following accounts appeared in two of its trial balances.

Instructions

(a) Net income $128,500

Retained earnings $169,100

Total assets $456,100

(a) Prepare an income statement, a retained earnings statement, and a classified statement of financial position. $16,000 of the mortgage payable is due for payment next year.

(b) Journalize the adjusting entries that were made.

(c) Journalize the closing entries that are necessary.

Journalize, post, and prepare a trial balance.   (LO 2, 3, 4)

P5-4A J. Zheng, a former professional tennis star, operates Zheng's Tennis Shop at the Yalong River Resort. At the beginning of the current season, the ledger of Zheng's Tennis Shop showed Cash ¥2,200, Inventory ¥1,800, and Share Capital—Ordinary ¥4,000. The following transactions were completed during April.

Apr.   4	Purchased racquets and balls from Jay-Mac Co. ¥760, FOB shipping point, terms 2/10, n/30.
6	Paid freight on purchase from Jay-Mac Co. ¥40.
8	Sold merchandise to members ¥1,150, terms n/30. The merchandise sold had a cost of ¥790.
10	Received credit of ¥60 from Jay-Mac Co. for a racquet that was returned.
11	Purchased tennis shoes from Li Sports for cash, ¥420.
13	Paid Jay-Mac Co. in full.
14	Purchased tennis shirts and shorts from Everett Sportswear ¥800, FOB shipping point, terms 3/10, n/60.
15	Received cash refund of ¥50 from Li Sports for damaged merchandise that was returned.
17	Paid freight on Everett Sportswear purchase ¥30.
18	Sold merchandise to members ¥980, terms n/30. The cost of the merchandise sold was ¥520.
20	Received ¥600 in cash from members in settlement of their accounts.
Apr. 21	Paid Everett Sportswear in full.
27	Granted an allowance of ¥40 to members for tennis clothing that did not fit properly.
30	Received cash payments on account from members, ¥820.

The chart of accounts for the tennis shop includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 311 Share Capital—Ordinary, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.

Instructions

(a) Journalize the April transactions using a perpetual inventory system.

(b) Enter the beginning balances in the ledger accounts and post the April transactions. (Use J1 for the journal reference.)

(c) Total debits ¥6,130

(c) Prepare a trial balance on April 30, 2014.

Determine cost of goods sold and gross profit under periodic approach.   (LO 6)

*P5-5A At the end of Apex Department Store's fiscal year on December 31, 2014, these accounts appeared in its adjusted trial balance.

Freight-In	$    5,600
Inventory	40,500
Purchases	442,000
Purchase Discounts	12,000
Purchase Returns and Allowances	6,400
Sales Revenue	718,000
Sales Returns and Allowances	18,000

Additional facts:

1. Merchandise inventory on December 31, 2014, is $65,000.
2. Apex Department Store uses a periodic system.

Instructions

Prepare an income statement through gross profit for the year ended December 31, 2014.

Gross profit $295,300

Calculate missing amounts and assess profitability.   (LO 6)

*P5-6A Valerie Fons operates a retail clothing operation. She purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011–2014.

Instructions

(a) 2013 $146,600

(a) Calculate cost of goods sold for each of the 2012, 2013, and 2014 fiscal years.

(b) Calculate the gross profit for each of the 2012, 2013, and 2014 fiscal years.

(c) 2013 Ending accts payable $15,000

(c) Calculate the ending balance of accounts payable for each of the 2012, 2013, and 2014 fiscal years.

(d) Sales declined in fiscal 2014. Does that mean that profitability, as measured by the gross profit rate, necessarily also declined? Explain, calculating the gross profit rate for each fiscal year to help support your answer. (Round to one decimal place.)

Journalize, post, and prepare trial balance and partial income statement using periodic approach.   (LO 6)

*P5-7A At the beginning of the current season, the ledger of Village Tennis Shop showed Cash CHF2,500; Inventory CHF1,700; and Share Capital—Ordinary CHF4,200. The following transactions were completed during April.

Apr.  4	Purchased racquets and balls from Hingis Co. CHF860, terms 3/10, n/30.
6	Paid freight on Hingis Co. purchase CHF74.
8	Sold merchandise to members CHF900, terms n/30.
10	Received credit of CHF60 from Hingis Co. for a racquet that was returned.
Apr. 11	Purchased tennis shoes from Volker Sports for cash CHF300.
13	Paid Hingis Co. in full.
14	Purchased tennis shirts and shorts from Linzey Sportswear CHF700, terms 2/10, n/60.
15	Received cash refund of CHF50 from Volker Sports for damaged merchandise that was returned.
17	Paid freight on Linzey Sportswear purchase CHF30.
18	Sold merchandise to members CHF1,200, terms n/30.
20	Received CHF500 in cash from members in settlement of their accounts.
21	Paid Linzey Sportswear in full.
27	Granted an allowance of CHF25 to members for tennis clothing that did not fit properly.
30	Received cash payments on account from members CHF620.

The chart of accounts for the tennis shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Share Capital—Ordinary, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In.

Instructions

(a) Journalize the April transactions using a periodic inventory system.

(b) Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.

(c) Tot. trial balance CHF6,448

(c) Prepare a trial balance on April 30, 2014.

(d) Gross profit CHF855

(d) Prepare an income statement through gross profit, assuming inventory on hand at April 30 is CHF2,296.

Complete accounting cycle beginning with a worksheet.   (LO 4, 5, 7)

*P5-8A The trial balance of Mr. Rosiak Fashion Center contained the following accounts at November 30, the end of the company's fiscal year.

Adjustment data:

1. Supplies on hand totaled $2,100.
2. Depreciation is $11,500 on the equipment.
3. Interest of $4,000 is accrued on notes payable at November 30.
4. Inventory actually on hand is $44,520.

Instructions

(a) Adj. trial balance $981,200

Net loss $1,980

(a) Enter the trial balance on a worksheet, and complete the worksheet.

(b) Gross profit $244,820

Total assets $181,520

(b) Prepare an income statement and a retained earnings statement for the year, and a classified statement of financial position as of November 30, 2014. Notes payable of $6,000 are due in January 2015.

(c) Journalize the adjusting entries.

(d) Journalize the closing entries.

(e) Prepare a post-closing trial balance.

PROBLEMS: SET B

Journalize purchase and sales transactions under a perpetual inventory system.   (LO 2, 3)

P5-1B Book Nook Warehouse distributes hardcover books to retail stores and extends credit terms of 2/10, n/30 to all of its customers. At the end of May, Book Nook's inventory consisted of books purchased for €1,800. During June, the following merchandising transactions occurred.

June  1	Purchased books on account for €1,850 from Phantom Publishers, FOB destination, terms 2/10, n/30. The appropriate party also made a cash payment of €50 for the freight on this date.
3	Sold books on account to Ex Libris for €2,500. The cost of the books sold was €1,440.
6	Received €150 credit for books returned to Phantom Publishers.
9	Paid Phantom Publishers in full, less discount.
15	Received payment in full from Ex Libris.
17	Sold books on account to Bargain Books for €1,800. The cost of the books sold was €1,020.
20	Purchased books on account for €1,500 from Bookem Publishers, FOB destination, terms 2/15, n/30. The appropriate party also made a cash payment of €50 for the freight on this date.
24	Received payment in full from Bargain Books.
26	Paid Bookem Publishers in full, less discount.
28	Sold books on account to Corner Bookstore for €1,300. The cost of the books sold was €850.
30	Granted Corner Bookstore €120 credit for books returned costing €72.

Book Nook Warehouse's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.

Instructions

Journalize the transactions for the month of June for Book Nook Warehouse using a perpetual inventory system.

Journalize, post, and prepare a partial income statement.   (LO 2, 3, 5)

P5-2B Copple Hardware Store completed the following merchandising transactions in the month of May. At the beginning of May, the ledger of Copple showed Cash of $5,000 and Share Capital—Ordinary of $5,000.

May   1	Purchased merchandise on account from Nute's Wholesale Supply $4,200, terms 2/10, n/30.
2	Sold merchandise on account $2,300, terms 1/10, n/30. The cost of the merchandise sold was $1,300.
5	Received credit from Nute's Wholesale Supply for merchandise returned $500.
9	Received collections in full, less discounts, from customers billed on sales of $2,300 on May 2.
10	Paid Nute's Wholesale Supply in full, less discount.
11	Purchased supplies for cash $400.
12	Purchased merchandise for cash $1,400.
15	Received refund for poor quality merchandise from supplier on cash purchase $150.
17	Purchased merchandise from Sherrick Distributors $1,300, FOB shipping point, terms 2/10, n/30.
May 19	Paid freight on May 17 purchase $130.
24	Sold merchandise for cash $3,200. The merchandise sold had a cost of $2,000.
25	Purchased merchandise from Herbert, Inc. $620, FOB destination, terms 2/10, n/30.
27	Paid Sherrick Distributors in full, less discount.
29	Made refunds to cash customers for defective merchandise $90. The returned merchandise had a fair value of $40.
31	Sold merchandise on account $1,000 terms n/30. The cost of the merchandise sold was $560.

Copple Hardware's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 126 Supplies, No. 201 Accounts Payable, No. 311 Share Capital—Ordinary, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.

Instructions

(a) Journalize the transactions using a perpetual inventory system.

(b) Enter the beginning cash and share capital—ordinary balances and post the transactions. (Use J1 for the journal reference.)

(c) Gross profit $2,567

(c) Prepare an income statement through gross profit for the month of May 2014.

Prepare financial statements and adjusting and closing entries.   (LO 4, 5)

P5-3B The Moulton Store is located in midtown Metropolis. During the past several years, net income has been declining because of suburban shopping centers. At the end of the company's fiscal year on November 30, 2014, the following accounts appeared in two of its trial balances.

Instructions

(a) Net income £30,900

Retained earnings £84,600

Total assets £207,300

(a) Prepare an income statement, a retained earnings statement, and a classified statement of financial position. Notes payable are due in 2017.

(b) Journalize the adjusting entries that were made.

(c) Journalize the closing entries that are necessary.

Journalize, post, and prepare a trial balance.   (LO 2, 3, 4)

P5-4B Bill Kokott, a former disc golf star, operates Bill's Discorama. At the beginning of the current season on April 1, the ledger of Bill's Discorama showed Cash $1,850, Inventory $2,150, and Share Capital—Ordinary $4,000. The following transactions were completed during April.

Apr.   5	Purchased golf discs, bags, and other inventory on account from Ellis Co. $1,200, FOB shipping point, terms 2/10, n/60.
7	Paid freight on the Ellis purchase $75.
9	Received credit from Ellis Co. for merchandise returned $100.
10	Sold merchandise on account for $930, terms n/30. The merchandise sold had a cost of $540.
12	Purchased disc golf shirts and other accessories on account from Penguin Sportswear $720, terms 1/10, n/30.
14	Paid Ellis Co. in full, less discount.
17	Received credit from Penguin Sportswear for merchandise returned $120.
20	Made sales on account for $610, terms n/30. The cost of the merchandise sold was $370.
Apr.  21	Paid Penguin Sportswear in full, less discount.
27	Granted an allowance to customers for clothing that was flawed $20.
30	Received payments on account from customers $960.

The chart of accounts for the store includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 311 Share Capital—Ordinary, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.

Instructions

(a) Journalize the April transactions using a perpetual inventory system.

(b) Enter the beginning balances in the ledger accounts and post the April transactions. (Use J1 for the journal reference.)

(c) Total debits $5,540

(c) Prepare a trial balance on April 30, 2014.

Determine cost of goods sold and gross profit under periodic approach.   (LO 6)

*P5-5B At the end of Ilhan Department Store's fiscal year on November 30, 2014, these accounts appeared in its adjusted trial balance.

Freight-In	7,500
Inventory	40,000
Purchases	585,000
Purchase Discounts	5,300
Purchase Returns and Allowances	2,900
Sales Revenue	1,000,000
Sales Returns and Allowances	28,000

Additional facts:

1. Merchandise inventory on November 30, 2014, is 54,600.
2. Ilhan Department Store uses a periodic system.

Instructions

Prepare an income statement through gross profit for the year ended November 30, 2014.

Gross profit 402,300

Calculate missing amounts and assess profitability.   (LO 6)

*P5-6B Psang Inc. operates a retail operation that purchases and sells home entertainment products. The company purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011 through 2014, inclusive.

(c) $6,700

(g) $15,200

(i) $31,700

Instructions

(a) Calculate the missing amounts.

(b) Sales declined over the 3-year fiscal period, 2012–2014. Does that mean that profitability necessarily also declined? Explain, computing the gross profit rate and the profit margin ratio for each fiscal year to help support your answer. (Round to one decimal place.)

Journalize, post, and prepare trial balance and partial income statement using periodic approach.   (LO 6)

*P5-7B At the beginning of the current season on April 1, the ledger of Oosthuizen Pro Shop showed Cash €3,000; Inventory €4,000; and Share Capital—Ordinary €7,000. The following transactions occurred during April 2014.

Apr.  5	Purchased golf bags, clubs, and balls on account from Balata Co. €1,300, FOB shipping point, terms 2/10, n/60.
7	Paid freight on Balata Co. purchases €70.
9	Received credit from Balata Co. for merchandise returned €100.
10	Sold merchandise on account to members €670, terms n/30.
12	Purchased golf shoes, sweaters, and other accessories on account from Arrow Sportswear €450, terms 1/10, n/30.
14	Paid Balata Co. in full.
17	Received credit from Arrow Sportswear for merchandise returned €50.
20	Made sales on account to members €600, terms n/30.
21	Paid Arrow Sportswear in full.
27	Granted credit to members for clothing that had flaws €55.
30	Received payments on account from members €630.

The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Share Capital—Ordinary, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In.

Instructions

(a) Journalize the April transactions using a periodic inventory system.

(b) Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.

(c) Tot. trial balance €8,448

Gross profit €397

(c) Prepare a trial balance on April 30, 2014.

(d) Prepare an income statement through gross profit, assuming merchandise inventory on hand at April 30 is €4,824.

COMPREHENSIVE PROBLEM

CP5 On December 1, 2014, Jurczyk Distributing Company had the following account balances.

During December, the company completed the following summary transactions.

Dec.  6	Paid $1,600 for salaries and wages due employees, of which $600 is for December and $1,000 is for November salaries and wages payable.
8	Received $2,100 cash from customers in payment of account (no discount allowed).
10	Sold merchandise for cash $6,600. The cost of the merchandise sold was $4,100.
13	Purchased merchandise on account from Gong Co. $9,000, terms 2/10, n/30.
15	Purchased supplies for cash $2,000.
18	Sold merchandise on account $12,000, terms 3/10, n/30. The cost of the merchandise sold was $8,400.
20	Paid salaries and wages $1,800.
23	Paid Gong Co. in full, less discount.
27	Received collections in full, less discounts, from customers billed on December 18.

Adjustment data:

1. Accrued salaries and wages payable $800.
2. Depreciation $200 per month.
3. Supplies on hand $1,700.

Instructions

(a) Journalize the December transactions using a perpetual inventory system.

(b) Enter the December 1 balances in the ledger T-accounts and post the December transactions. Use Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Sales Revenue, Sales Discounts, and Supplies Expense.

(c) Journalize and post adjusting entries.

(d) Totals      $65,600

(d) Prepare an adjusted trial balance.

(e) Net income $840

(e) Prepare an income statement and a retained earnings statement for December and a classified statement of financial position at December 31.

CONTINUING COOKIE CHRONICLE

(Note: This is a continuation of the Cookie Chronicle from Chapters 1–4.)

CCC5 Because Natalie has had such a successful first few months, she is considering other opportunities to develop her business. One opportunity is the sale of fine European mixers. The owner of Kzinski Supply Company has approached Natalie to become the exclusive U.S. distributor of these fine mixers in her state. The current cost of a mixer is approximately $575 (U.S.), and Natalie would sell each one for $1,150. Natalie comes to you for advice on how to account for these mixers.

Go to the book's companion website, www.wiley.com/college/weygandt, to see the completion of this problem.

Broadening Your PERSPECTIVE

Financial Reporting and Analysis

Financial Reporting Problem: Samsung Electronics Co., Ltd.

BYP5-1 The financial statements of Samsung are presented in Appendix A at the end of this textbook. The complete annual report, including the notes to the financial statements, is available in the Investor Relations section of the company's website, www.samsung.com.

Instructions

Answer the following questions using Samsung's consolidated income statement.

(a) What was the percentage change in (1) sales and in (2) net income from 2009 to 2010?

(b) What was the company's gross profit rate in 2009 and 2010?

(c) What was the company's percentage of net income to net sales in 2009 and 2010? Comment on any trend in this percentage.

Comparative Analysis Problem: Nestlé S.A. vs. Zetar plc

BYP5-2 Nestlé's financial statements are presented in Appendix B. Financial statements of Zetar are presented in Appendix C.

Instructions

(a) Based on the information contained in these financial statements, determine each of the following for each company.

(1) Gross profit for the most recent fiscal year reported in the appendices.

(2) Gross profit rate for the most recent fiscal year reported in the appendices.

(3) Operating income for the most recent fiscal year reported in the appendices. (Note: Operating income may be described with alternative labels.)

(4) Percentage change in operating income for the most recent fiscal year reported in the appendices.

(b) What conclusions concerning the relative profitability of the two companies can you draw from these data?

Real-World Focus

BYP5-3 No financial decision-maker should ever rely solely on the financial information reported in the annual report to make decisions. It is important to keep abreast of financial news. This activity demonstrates how to search for financial news on the Internet.

Address: biz.yahoo.com/i, or go to www.wiley.com/college/weygandt

Steps

1. Type in either Nestlé or Zetar.
2. Choose News.
3. Select an article that sounds interesting to you.

Instructions

(a) What was the source of the article (e.g., Reuters, Businesswire, PR Newswire)?

(b) Assume that you are a personal financial planner and that one of your clients owns shares in the company. Write a brief memo to your client, summarizing the article and explaining the implications of the article for his or her investment.

Critical Thinking

Decision-Making Across the Organization

BYP5-4 Three years ago, Debbie Sells and her brother-in-law Mike Mooney opened Family Department Store. For the first two years, business was good, but the following condensed income results for 2013 were disappointing.

Debbie believes the problem lies in the relatively low gross profit rate (gross profit divided by net sales) of 21%. Mike believes the problem is that operating expenses are too high.

Debbie thinks the gross profit rate can be improved by making both of the following changes. She does not anticipate that these changes will have any effect on operating expenses.

1. Increase average selling prices by 20%. This increase is expected to lower sales volume so that total sales will increase only 5%.
2. Buy merchandise in larger quantities and take all purchase discounts. These changes are expected to increase the gross profit rate by 3 percentage points.

Mike thinks expenses can be cut by making both of the following changes. He feels that these changes will not have any effect on net sales.

1. Cut 2013 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales.
2. Reduce store deliveries to one day per week rather than twice a week; this change will reduce 2013 delivery expenses of $30,000 by 40%.

Debbie and Mike come to you for help in deciding the best way to improve net income.

Instructions

With the class divided into groups, answer the following.

(a) Prepare a condensed income statement for 2014, assuming (1) Debbie's changes are implemented and (2) Mike's ideas are adopted.

(b) What is your recommendation to Debbie and Mike?

(c) Prepare a condensed income statement for 2014, assuming both sets of proposed changes are made.

Communication Activity

BYP5-5 The following situation is in chronological order.

1. Dexter decides to buy a surfboard.
2. He calls Boardin Co. to inquire about its surfboards.
3. Two days later, he requests Boardin Co. to make a surfboard.
4. Three days later, Boardin Co. sends Dexter a purchase order to fill out.
5. He sends back the purchase order.
6. Boardin Co. receives the completed purchase order.
7. Boardin Co. completes the surfboard.
8. Dexter picks up the surfboard.
9. Boardin Co. bills Dexter.
10. Boardin Co. receives payment from Dexter.

Instructions

In a memo to the president of Boardin Co., answer the following.

(a) When should Boardin Co. record the sale?

(b) Suppose that with his purchase order, Dexter is required to make a down payment. Would that change your answer?

Ethics Case

BYP5-6 Anita Zurbrugg was just hired as the assistant treasurer of Yorktown Stores. The company is a specialty chain store with nine retail stores concentrated in one metropolitan area. Among other things, the payment of all invoices is centralized in one of the departments Anita will manage. Her primary responsibility is to maintain the company's high credit rating by paying all bills when due and to take advantage of all cash discounts.

Chris Dadian, the former assistant treasurer who has been promoted to treasurer, is training Anita in her new duties. He instructs Anita that she is to continue the practice of preparing all checks “net of discount” and dating the checks the last day of the discount period. “But,” Chris continues, “we always hold the checks at least 4 days beyond the discount period before mailing them. That way, we get another 4 days of interest on our money. Most of our creditors need our business and don't complain. And, if they scream about our missing the discount period, we blame it on the mail room or the post office. We've only lost one discount out of every hundred we take that way. I think everybody does it. By the way, welcome to our team!”

Instructions

(a) What are the ethical considerations in this case?

(b) Who are the stakeholders that are harmed or benefitted in this situation?

(c) Should Anita continue the practice started by Chris? Does she have any choice?

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

p. 215 Snowboard Company Improves Its Share Appeal Q: If a perpetual system keeps track of inventory on a daily basis, why do companies ever need to do a physical count? A: A perpetual system keeps track of all sales and purchases on a continuous basis. This provides a constant record of the number of units in the inventory. However, if employees make errors in recording sales or purchases, or if there is theft, the inventory value will not be correct. As a consequence, all companies do a physical count of inventory at least once a year.

p. 222 Should Costco Change Its Return Policy? Q: If a company expects significant returns, what are the implications for revenue recognition? A: If a company expects significant returns, it should make an adjusting entry at the end of the year reducing sales by the estimated amount of sales returns. This is necessary so as not to overstate the amount of revenue recognized in the period.

p. 223 Selling Green Q: What is meant by “monetize environmental sustainability” for shareholders? A: By marketing green, not only does PepsiCo help the environment in the long run, but it also leads to long-term profitability as well. In other words, sound sustainability practices are good business and lead to sound financial results.

p. 230 Online Merchandisers in India Q: What implications do the lack of customer credit cards and the limited transportation system have for Flipkart's profitability? A: Credit card payments reduce many of the costs and complications of payment collection. They also decrease the potential for fraud and theft. The limited transportation system increases the cost of shipping goods to individuals' homes, as well as increasing the likelihood of lost or damaged goods.

Answers to Self-Test Questions

1. c 2. a 3. c 4. b ((NT$7,500 − NT$500) × .98) 5. c 6. c 7. a 8. d 9. b (€400,000 − €310,000) *10. d *11. a (HK$600,000 + HK$3,800,000 − HK$500,000) *12. b *13. a

Another Perspective

The basic accounting entries for merchandising are the same under both GAAP and IFRS. The income statement is a required statement under both sets of standards. The basic format is similar although some differences do exist.

Key Points

• Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic system.
• Inventories are defined by IFRS as held-for-sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the providing of services. The definition under GAAP is essentially the same.
• Under GAAP, companies generally classify income statement items by function. Classification by function leads to descriptions like administration, distribution, and manufacturing. Under IFRS, companies must classify expenses by either nature or by function. Classification by nature leads to descriptions such as the following: salaries, depreciation expense, and utilities expense. If a company uses the functional-expense method on the income statement, disclosure by nature is required in the notes to the financial statements.
• Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach.
• Under IFRS, revaluation of land, buildings, and intangible assets is permitted. The initial gains and losses resulting from this revaluation are reported as adjustments to equity, often referred to as other comprehensive income. The effect of this difference is that the use of IFRS instead of GAAP results in more transactions affecting equity (other comprehensive income) but not net income.
• IAS 1, “Presentation of Financial Statements,” provides general guidelines for the reporting of income statement information. Subsequently, a number of international standards have been issued that provide additional guidance to issues related to income statement presentation. Presented on the next page is the income statement for Wal-Mart Stores, Inc. (USA). The income statement is presented in conformity with GAAP.

  

• Similar to GAAP, comprehensive income under IFRS includes unrealized gains and losses (such as those on non-trading securities) that are not included in the calculation of net income.
• IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.

Looking to the Future

The IASB and FASB are working on a project that would rework the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements. For example, the amount of income that is generated by operations would be traceable to the assets and liabilities used to generate the income. Finally, this approach would also provide detail, beyond that currently seen in most statements (either GAAP or IFRS), by requiring that line items be presented both by function and by nature. The new financial statement format was heavily influenced by suggestions from financial statement analysts.

GAAP Practice

GAAP Self-Test Questions

1. Which of the following would not be included in the definition of inventory under GAAP?

   (a) Photocopy paper held for sale by an office-supply store.

   (b) Stereo equipment held for sale by an electronics store.

   (c) Used office equipment held for sale by the human relations department of a plastics company.

   (d) All of the above would meet the definition.

2. Which of the following would not be a line item of a company reporting costs by nature?

   (a) Depreciation expense.

   (b) Salaries and wages expense.

   (c) Interest expense.

   (d) Manufacturing expense

3. Which of the following would not be a line item of a company reporting costs by function?

   (a) Administration.

   (b) Manufacturing.

   (c) Utilities expense.

   (d) Distribution.

4. Which of the following statements is false?

   (a) GAAP specifically requires use of a multiple-step income statement.

   (b) Under GAAP, companies can use either a perpetual or periodic system.

   (c) The proposed new format for financial statements was heavily influenced by the suggestions of financial statement analysts.

   (d) The new income statement format will try to de-emphasize the focus on the “net income” line item.

5. Under the new format for financial statements being proposed under a joint IASB/FASB project:

   (a) all financial statements would adopt headings similar to the current format of the statement of financial position (balance sheet).

   (b) financial statements would be presented consistent with the way management usually run companies.

   (c) companies would be required to report income statement line items by function only.

   (d) the amount of detail shown in the income statement would decrease compared to current presentations.

GAAP Exercises

GAAP5-1 Explain the difference between the “nature-of-expense” and “function-of-expense” classifications.

GAAP5-2 For each of the following income statement line items, state whether the item is a “by nature” expense item or a “by function” expense item.

• _______ Cost of goods sold
• _______ Depreciation expense
• _______ Salaries and wages expense
• _______ Selling expenses
• _______ Utilities expense
• _______ Delivery expense
• _______ General and administrative expenses

GAAP5-3 Atlantis Company reported the following amounts in 2014: net income, $150,000; unrealized gain related to revaluation of buildings, $10,000; and unrealized loss on non-trading securities, $(35,000). Determine Atlantis's total comprehensive income for 2014.

GAAP Financial Reporting Problem: Tootsie Roll Industries, Inc.

GAAP5-4 The financial statements of Tootsie Roll are presented in Appendix D. The company's complete annual report, including the notes to its financial statements, is available at www.tootsie.com.

Instructions

(Round to one decimal place.)

(a) What was the percentage change in (1) total revenue and in (2) net income from 2008 to 2009 and from 2009 to 2010?

(b) What was the company's gross profit margin rate in 2008, 2009, and 2010?

(c) What was the company's percentage of net income to total revenue in 2008, 2009, and 2010?

Answers to GAAP Self-Test Questions

1. c 2. d 3. c 4. a 5. b

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