Under a perpetual inventory system, when goods are purchased for resale by a company

Practice Multiple-Choice Questions

(LO1) Which of the following statements about a periodic inventory system is true?
Companies determine cost of goods sold only at the end of the accounting period.
Companies continuously maintain detailed records of the cost of each inventory purchase and sale.
The periodic system provides better control over inventories than a perpetual system.
The increased use of computerized systems has increased the use of the periodic system.
(LO2) Under a perpetual inventory system, when goods are purchased for resale by a company:
purchases on account are debited to Inventory.
purchases on account are debited to Purchases.
purchase returns are debited to Purchase Returns and Allowances.
freight costs are debited to Freight-Out.
(LO3) Which sales accounts normally have a debit balance?
Sales Discounts.
Sales Returns and Allowances.
Both (a) and (b).
Neither (a) nor (b).
(LO3) A company makes a credit sale of $750 on June 13, terms 2/10, n/30, on which it grants a return of $50 on June 16. What amount is received as payment in full on June 23?
$700.
$686.
$685.
$650.
(LO3) To record the sale of goods for cash in a perpetual inventory system:
only one journal entry is necessary to record cost of goods sold and reduction of inventory.
only one journal entry is necessary to record the receipt of cash and the sales revenue.
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.
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.
(LO4) Gross profit will result if:
operating expenses are less than net income.
net sales are greater than operating expenses.
net sales are greater than cost of goods sold.
operating expenses are greater than cost of goods sold.
(LO4) If net sales are $400,000, cost of goods sold is $310,000, and operating expenses are $60,000, what is the gross profit?
$30,000.
$90,000.
$340,000.
$400,000.
(LO4) The multiple-step income statement for a merchandising company shows each of these features except:
gross profit.
cost of goods sold.
a sales section.
an investing activities section.
(LO5) If beginning inventory is $60,000, cost of goods purchased is $380,000, and ending inventory is $50,000, what is cost of goods sold under a periodic system?
$390,000.
$370,000.
$330,000.
$420,000.
(LO5) Bufford Corporation had reported the following amounts at December 31, 2022: sales revenue $184,000, ending inventory $11,600, beginning inventory $17,200, purchases $60,400, purchase discounts $3,000, purchase returns and allowances $1,100, freight-in $600, and freight-out $900. Calculate the cost of goods available for sale.
$69,400.
$74,100.
$56,900.
$197,700.
(LO6) Which of the following would affect the gross profit rate? (Assume sales remains constant.)
An increase in advertising expense.
A decrease in depreciation expense.
An increase in cost of goods sold.
A decrease in insurance expense.
(LO6) The gross profit rate is equal to:
net income divided by sales.
cost of goods sold divided by sales.
net sales minus cost of goods sold, divided by net sales.
sales minus cost of goods sold, divided by cost of goods sold.
(LO6) During the year ended December 31, 2022, Bjornstad Corporation had the following results: net sales $267,000, cost of goods sold $107,000, net income $92,400, operating expenses $55,400, and net cash provided by operating activities $108,950. What was the company’s profit margin?
40%.
60%.
5%.
6%.
(LO6) A quality of earnings ratio:
is computed as net income divided by net cash provided by operating activities.
that is less than 1 indicates that a company might be using aggressive accounting tactics.
that is greater than 1 indicates that a company might be using aggressive accounting tactics.
is computed as net cash provided by operating activities divided by total assets.

*15. (LO 7) When goods are purchased for resale by a company using a periodic inventory system:

purchases on account are debited to Inventory.
purchases on account are debited to Purchases.
purchase returns are debited to Purchase Returns and Allowances.
freight costs are debited to Purchases.

Solutions

a.Under the periodic inventory system, cost of goods sold is determined only at the end of the accounting period. The other choices are incorrect because (b) detailed records of the cost of each inventory purchase and sale are maintained continuously when a perpetual, not periodic, system is used; (c) the perpetual system provides better control over inventories than a periodic system; and (d) the increased use of computerized systems has increased the use of the perpetual, not periodic, system.
a.Under a perpetual inventory system, purchases on account are debited to the Inventory account. Choices (b) and (c) are incorrect because Purchases and Purchase Returns and Allowances are not used in a perpetual inventory system. Choice (d) is incorrect because freight costs incurred for purchased goods are debited to the Inventory account, not the Freight-Out account.
c.Both Sales Discounts and Sales Returns and Allowances normally have a debit balance. Choices (a) and (b) are both correct, but (c) is the better answer. Choice (d) is incorrect as both (a) and (b) are correct.
b.The full amount of $686 is paid within 10 days of the purchase {($750 − $50) − [($750 − $50) × 2%]}. The other choices are incorrect because (a) does not consider the discount of $14; (c) the amount of the discount is based upon the amount after the return is granted ($700 × 2%), not the amount before the return of merchandise ($750 × 2%); and (d) does not constitute payment in full on June 23.
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. The other choices are incorrect because (a) only considers the recognition of the expense and ignores the revenue, (b) only considers the recognition of revenue and leaves out the expense or cost of merchandise sold, and (d) the receipt of cash and sales revenue, not reduction of inventory, are paired together, and the cost of goods sold and reduction of inventory, not sales revenue, are paired together.
c.Gross profit will result if net sales are greater than cost of goods sold. The other choices are incorrect because (a) operating expenses and net income are not used in the computation of gross profit; (b) gross profit results when net sales are greater than cost of goods sold, not operating expenses; and (d) gross profit results when net sales, not operating expenses, are greater than cost of goods sold.
b.Gross profit = Net sales ($400,000) − Cost of goods sold ($310,000) = $90,000, not (a) $30,000, (c) $340,000, or (d) $400,000.
d.An investing activities section appears on the statement of cash flows, not on a multiple-step income statement. Choices (a) gross profit, (b) cost of goods sold, and (c) a sales section are all features of a multiple-step income statement.
a.Beginning inventory ($60,000) + Cost of goods purchased ($380,000) − Ending inventory ($50,000) = Cost of goods sold ($390,000), not (b) $370,000, (c) $330,000, or (d) $420,000.
b.Beginning inventory ($17,200) + Purchases ($60,400) − Purchases discounts ($3,000) − Purchase returns and allowances ($1,100) + Freight-in ($600) = Cost of goods available for sale ($74,100). The other choices are therefore incorrect.
c.Gross profit rate = Gross profit ÷ Net sales. Therefore, any changes in sale revenue, sales returns and allowances, sales discounts, or cost of goods sold will affect the ratio. Changes in (a) advertising expense, (b) depreciation expense, or (d) insurance expense will not affect the computation of the gross profit rate.
c.Gross profit rate = Gross profit (Net sales − Cost of goods sold) ÷ Net sales. The other choices are therefore incorrect.
d.Net income ($92,400) ÷ Net sales ($267,000) = Profit margin of 34.6%, not (a) 40%, (b) 60%, or (c) 20.5%.
b.A quality of earnings ratio that is less than 1 indicates that a company might be using aggressive accounting tactics. The other choices are incorrect because (a) Quality of earnings = Net cash provided by operating activities ÷ Net income, not vice versa; (c) a ratio that is significantly greater than 1 suggests that a company is using conservative accounting techniques, and (d) Quality of earnings = Net cash provided by operating activities ÷ Net income (not Total assets).

*15. b. Purchases for resale are debited to the Purchases account. The other choices are incorrect because (a) purchases on account are debited to Purchases, not Inventory; (c) Purchase Returns and Allowances are always credited; and (d) freight costs are debited to Freight-In, not Purchases.

Practice Brief Exercises

(LO1, 4) Presented below are the components in determining cost of goods sold for (a) Frazier Company, (b) Todd Company, and (c) Abreu Enterprises. Determine the missing amounts.

Compute the missing amounts in determining cost of goods sold.

	Beginning Inventory	Purchases	Cost of Goods Available for Sale	Ending Inventory	Cost of Goods Sold
a.	$120,000	$150,000	?	?	$160,000
b.	$ 50,000	?	$125,000	$45,000	?
c.	?	$220,000	$330,000	$61,000	?

Solution

a. Cost of goods available for sale = $120,000 + $150,000 = $270,000

Ending inventory = $270,000 − $160,000 = $110,000

b. Purchases = $125,000 − $50,000 = $75,000

Cost of goods sold = $125,000 − $45,000 = $80,000

c. Beginning inventory = $330,000 − $220,000 = $110,000

Cost of goods sold = $330,000 − $61,000 = $269,000

(LO2) Prepare the journal entries to record the following transactions on Robertson Company’s books using a perpetual inventory system.

Journalize purchase transactions.

a. On March 2, Melky Company sold $800,000 of merchandise to Robertson Company, terms 2/10, n/30.
b. On March 6, Robertson Company returned $100,000 of the merchandise purchased on March 2.
c. On March 12, Robertson Company paid the balance due to Melky Company.

Solution

a.	Inventory	800,000
	Accounts Payable		800,000
b.	Accounts Payable	100,000
	Inventory		100,000
c.	Accounts Payable ($800,000 − $100,000)	700,000
	Inventory ($700,000 × 2%)		14,000
	Cash ($700,000 − $14,000)		686,000

(LO3) Prepare the journal entries to record the following transactions on Wendel Company’s books using a perpetual inventory system.

Journalize sales transactions.

a. On March 2, Wendel Company sold $700,000 of merchandise to Krista Company, terms 2/10, n/30. The cost of the merchandise sold was $460,000.
b. On March 6, Krista Company returned $80,000 of the merchandise purchased on March 2. The cost of the merchandise returned was $54,000.
c. On March 12, Wendel Company received the balance due from Krista Company.

Solution

a.	March 2	Accounts Receivable	700,000
		Sales Revenue		700,000
	2	Cost of Goods Sold	460,000
		Inventory		460,000
b.	6	Sales Returns and Allowances	80,000
		Accounts Receivable		80,000
	6	Inventory	54,000
		Cost of Goods Sold		54,000
c.	12	Cash ($620,000 − $12,400)	607,600
		Sales Discounts ($620,000 × 2%)	12,400
		Accounts Receivable ($700,000 − $80,000)		620,000

(LO4, 6) Assume Yoan Company has the following reported amounts: Sales revenue $400,000, Sales discounts $10,000, Cost of goods sold $234,000, and Operating expenses $60,000. 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 sales, gross profit, income from operations, and gross profit rate.

Solution

a. Net sales = $400,000 − $10,000 = $390,000
b. Gross profit = $390,000 − $234,000 = $156,000
c. Income from operations = $156,000 − $60,000 = $96,000
d. Gross profit rate = $156,000 ÷ $390,000 = 40%

Practice Exercises

(LO2, 3) On June 10, Vareen Company purchased $8,000 of merchandise from Harrah Company, FOB shipping point, terms 3/10, n/30. Vareen pays the freight costs of $400 on June 11. Damaged goods totaling $300 are returned to Harrah for credit on June 12. The fair value of these goods is $70. On June 19, Vareen pays Harrah Company in full, less the purchase discount. Both companies use a perpetual inventory system.

Prepare purchase and sales entries.

Instructions

Prepare separate entries for each transaction on the books of Vareen Company.
Prepare separate entries for each transaction for Harrah Company. The merchandise purchased by Vareen on June 10 had cost Harrah $4,800.

Solution

June 10	Inventory	8,000
	Accounts Payable		8,000
11	Inventory	400
	Cash		400
12	Accounts Payable	300
	Inventory		300
19	Accounts Payable ($8,000 − $300)	7,700
	Inventory ($7,700 × 3%)		231
	Cash ($7,700 − $231)		7,469

June 10	Accounts Receivable	8,000
	Sales Revenue		8,000
	Cost of Goods Sold	4,800
	Inventory		4,800
12	Sales Returns and Allowances	300
	Accounts Receivable		300
	Inventory	70
	Cost of Goods Sold		70
19	Cash ($7,700 − $231)	7,469
	Sales Discounts ($7,700 × 3%)	231
	Accounts Receivable ($8,000 − $300)		7,700

(LO4) In its income statement for the year ended December 31, 2022, Marten Company reported the following condensed data.

Prepare multiple-step and single-step income statements.

Interest expense	$ 70,000	Net sales	$2,200,000
Operating expenses	725,000	Interest revenue	25,000
Cost of goods sold	1,300,000	Loss on disposal of plant assets	17,000
		Income tax expense	10,000

Instructions

Prepare a multiple-step income statement.
Prepare a single-step income statement.

Solution

Marten Company Income Statement For the Year Ended December 31, 2022
Net sales		$2,200,000
Cost of goods sold		1,300,000
Gross profit		900,000
Operating expenses		725,000
Income from operations		175,000
Other revenues and gains
Interest revenue		25,000
Other expenses and losses
Interest expense	$70,000
Loss on disposal of plant assets	17,000	(87,000)
Income before income taxes		113,000
Income tax expense		10,000
Net income		$ 103,000

Marten Company Income Statement For the Year Ended December 31, 2022
Revenues
Net sales		$2,200,000
Interest revenue		25,000
Total revenues		2,225,000
Expenses
Cost of goods sold	$1,300,000
Operating expenses	725,000
Interest expense	70,000
Loss on disposal of plant assets	17,000
Income tax expense	10,000
Total expenses		2,122,000
Net income		$ 103,000

Practice Problem

(LO 4) The adjusted trial balance for the year ended December 31, 2022, for Dykstra Company is shown below.

Prepare a multiple-step income statement.

Dykstra Company Adjusted Trial Balance For the Year Ended December 31, 2022
	Debit	Credit
Cash	$ 14,500
Accounts Receivable	11,100
Inventory	29,000
Prepaid Insurance	2,500
Equipment	95,000
Accumulated Depreciation—Equipment		$ 18,000
Notes Payable		25,000
Accounts Payable		10,600
Common Stock		70,000
Retained Earnings		11,000
Dividends	12,000
Sales Revenue		536,800
Sales Returns and Allowances	6,700
Sales Discounts	5,000
Cost of Goods Sold	363,400
Freight-Out	7,600
Advertising Expense	12,000
Salaries and Wages Expense	56,000
Utilities Expense	18,000
Rent Expense	24,000
Depreciation Expense	9,000
Insurance Expense	4,500
Interest Expense	3,600
Interest Revenue		2,500
	$673,900	$673,900

Instructions

Prepare a multiple-step income statement for Dykstra Company. Assume a tax rate of 30%.

Solution

Dykstra Company Income Statement For the Year Ended December 31, 2022
Sales
Sales revenue		$536,800
Less: Sales returns and allowances	$ 6,700
Sales discounts	5,000	11,700
Net sales		525,100
Cost of goods sold		363,400
Gross profit		161,700
Operating expenses
Salaries and wages expense	56,000
Rent expense	24,000
Utilities expense	18,000
Advertising expense	12,000
Depreciation expense	9,000
Freight-out	7,600
Insurance expense	4,500
Total operating expenses		131,100
Income from operations		30,600
Other revenues and gains
Interest revenue		2,500
Other expenses and losses
Interest expense		3,600
Income before income taxes		29,500
Income tax expense		8,850
Net income		$ 20,650

WileyPLUS

Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

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

Questions

a.“The steps in the accounting cycle for a merchandising company differ from the steps in the accounting cycle for a service company.” Do you agree or disagree?
Is the measurement of net income in a merchandising company conceptually the same as in a service company? Explain.
How do the components of revenues and expenses differ between a merchandising company and a service company?
Maria Lopez, CEO of Sales Bin Stores, is considering a recommendation made by both the company’s purchasing manager and director of finance that the company should invest in a sophisticated new perpetual inventory system to replace its periodic system. Explain the primary difference between the two systems, and discuss the potential benefits of a perpetual inventory system.
a.Explain the income measurement process in a merchandising company.
How does income measurement differ between a merchandising company and a service company?
Waymon Co. has net sales of $100,000, cost of goods sold of $70,000, and operating expenses of $18,000. What is its gross profit?
Masie Ascot believes revenues from credit sales may be recorded before they are collected in cash. Do you agree? Explain.
a.What is the primary source document for recording (1) cash sales and (2) credit sales?
Using XXs for amounts, give the journal entry for each of the transactions in part (a), assuming perpetual inventory.
A credit sale is made on July 10 for $900, terms 1/15, n/30. On July 12, the purchaser returns $100 of goods for credit. Give the journal entry on July 19 to record the receipt of the balance due within the discount period.
As the end of Smyle Company’s fiscal year approached, it became clear that the company had considerable excess inventory. Marvin Ross, the head of marketing and sales, ordered salespeople to “add 20% more units to each order that you ship. The customers can always ship the extra back next period if they decide they don’t want it. We’ve got to do it to meet this year’s sales goal.” Discuss the accounting implications of Marvin’s action.
To encourage bookstores to buy a broader range of book titles and to discourage price discounting, the publishing industry allows bookstores to return unsold books to the publisher. This results in very significant returns each year. To ensure proper recognition of revenues, how should publishing companies account for these returns?
Goods costing $1,900 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, the purchaser receives a $300 credit from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period.
Scribe Company reports net sales of $800,000, gross profit of $560,000, and net income of $230,000. What are its operating expenses?
Mai Company has always provided its customers with payment terms of 1/10, n/30. Members of its sale force have commented that competitors are offering customers 2/10, n/45. Explain what these terms mean, and discuss the implications to Mai of switching its payment terms to those of its competitors.
In its year-end earnings announcement press release, Ransome Corp. announced that its earnings increased by $15 million relative to the previous year. This represented a 20% increase. Inspection of its income statement reveals that the company reported a $20 million gain under “Other revenues and gains” from the sale of one of its factories. Discuss the implications of this gain from the perspective of a potential investor.
Identify the distinguishing features of an income statement for a merchandising company.
Why is the normal operating cycle for a merchandising company likely to be longer than for a service company?
What title does Appleuse for gross profit? By how much did its total gross profit change, and in what direction, for the year ended September 30, 2017?
What merchandising account(s) will appear in the post-closing trial balance?
What types of businesses are most likely to use a perpetual inventory system?
Identify the accounts that are added to or deducted from purchases to determine the cost of goods purchased under a periodic system. For each account, indicate (a) whether it is added or deducted, and (b) its normal balance.
In the following cases, use a periodic inventory system to identify the item(s) designated by the letters Xand Y.
Purchases − X− Y = Net purchases.
Cost of goods purchased − Net purchases = X.
Beginning inventory + X= Cost of goods available for sale.
Cost of goods available for sale − Cost of goods sold = X.
What two ratios measure factors that affect profitability?
What factors affect a company’s gross profit rate—that is, what can cause the gross profit rate to increase and what can cause it to decrease?
Earl Massey, director of marketing, wants to reduce the selling price of his company’s products by 15% to increase market share. He says, “I know this will reduce our gross profit rate, but the increased number of units sold will make up for the lost margin.” Before this action is taken, what other factors does the company need to consider?
Mark Coney is considering investing in Wiggles Pet Food Company. Wiggles’ net income increased considerably during the most recent year even though many other companies in the same industry reported disappointing earnings. Mark wants to know whether the company’s earnings provide a reasonable depiction of its results. What initial step can Mark take to help determine whether he needs to investigate further?

*26. On July 15, a company purchases on account goods costing $1,900, with credit terms of 2/10, n/30. On July 18, the company receives a $400 credit memo 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.

*27. What are the steps to record an end of period adjustment for credit sales with returns and allowances?

*28. What treatment do Allowance for Sales Returns and Allowances and the Estimated Inventory Returns receive in the financial statements?

Brief Exercises

BE5.1 (LO 1), AP Presented below are the components in determining cost of goods sold. Determine the missing amounts.

Compute missing amounts in determining cost of goods sold.

Beginning Inventory	Purchases	Cost of Goods Available for Sale	Ending Inventory	Cost of Goods Sold
$80,000	$100,000	(a)	(b)	$120,000
$50,000	(c)	$115,000	$35,000	(d)
(e)	$110,000	$160,000	$29,000	(f)

BE5.2 (LO 1, 4), AP Presented here are the components in Salas Company’s income statement. Determine the missing amounts.

Compute missing amounts in determining net income.

Sales Revenue	Cost of Goods Sold	Gross Profit	Operating Expenses	Net Income
$ 71,200	(a)	$ 30,000	(b)	$12,100
$108,000	$70,000	(c)	(d)	$29,500
(e)	$71,900	$109,600	$46,200	(f)

BE5.3 (LO 2, 3), AP Rita Company buys merchandise on account from Linus Company. The selling price of the goods is $900 and the cost of the goods sold is $590. Both companies use perpetual inventory systems. Journalize the transactions on the books of both companies.

Journalize perpetual inventory entries.

BE5.4 (LO 3), AP Prepare the journal entries to record the following transactions on Borst Company’s books using a perpetual inventory system.

Journalize sales transactions.

On March 2, Borst Company sold $800,000 of merchandise to McLeena Company on account, terms 2/10, n/30. The cost of the merchandise sold was $540,000.
On March 6, McLeena Company returned $140,000 of the merchandise purchased on March 2. The cost of the merchandise returned was $94,000.
On March 12, Borst Company received the balance due from McLeena Company.

BE5.5 (LO 2), AP From the information in BE5.4, prepare the journal entries to record these transactions on McLeena Company’s books under a perpetual inventory system.

Journalize purchase transactions.

BE5.6 (LO 4), AP Barto Company provides this information for the month ended October 31, 2022: sales on credit $300,000, cash sales $150,000, sales discounts $5,000, and sales returns and allowances $19,000. Prepare the sales section of the multiple-step income statement based on this information.

Prepare sales section of income statement.

BE5.7 (LO 4), AP The following information is available for Rancid Corp. for the year ended December 31, 2022.

Prepare multiple-step income statement.

Other revenues and gains	$ 22,600	Sales revenue	$752,000
Other expenses and losses	3,400	Operating expenses	216,000
Cost of goods sold	286,000	Sales returns and allowances	10,000
Sales discounts	3,600

Prepare a multiple-step income statement for Rancid Corp. The company has a tax rate of 25%.

BE5.8 (LO 4), AP Explain where each of these items would appear on a multiple-step income statement: gain on disposal of plant assets, cost of goods sold, depreciation expense, and sales returns and allowances.

Identify placement of items on a multiple-step income statement.

BE5.9 (LO 4), AP The following information relates to Karen Weigel Inc. for the year 2022.

Prepare a comprehensive income statement.

Retained earnings, January 1, 2022	$48,000	Advertising expense	$ 1,800
Dividends during 2022	5,000	Rent expense	10,400
Service revenue	62,500	Utilities expense	3,100
Salaries and wages expense	28,000	Other comprehensive income (net of tax)	400

After analyzing the data, (a) compute net income and (b) prepare a comprehensive income statement for the year ending December 31, 2022.

BE5.10 (LO 5), AP Silas Company sold goods with a total selling price of $800,000 during the year. It purchased goods for $380,000 and had beginning inventory of $67,000. A count of its ending inventory determined that goods on hand was $50,000. What was its cost of goods sold?

Determine cost of goods sold using basic periodic formula.

BE5.11 (LO 5), AP Assume that Spacey Company uses a periodic inventory system and has these account balances: Purchases $404,000, Purchase Returns and Allowances $13,000, Purchase Discounts $9,000, and Freight-In $16,000. Determine net purchases and cost of goods purchased.

Compute net purchases and cost of goods purchased.

BE5.12 (LO 5), AP Assume the same information as in BE5.11 and also that Spacey Company has beginning inventory of $60,000, ending inventory of $90,000, and net sales of $612,000. Determine the amounts to be reported for cost of goods sold and gross profit.

Compute cost of goods sold and gross profit.

BE5.13 (LO 6), AP Dublin Corporation reported net sales of $250,000, cost of goods sold of $150,000, operating expenses of $50,000, net income of $32,500, beginning total assets of $520,000, and ending total assets of $600,000. Calculate each of the following values and explain what they mean: (a) profit margin and (b) gross profit rate.

Calculate profitability ratios.

BE5.14 (LO 6), AP Garten Corporation reported net sales $800,000, cost of goods sold $520,000, operating expenses $210,000, and net income $68,000. Calculate the following values and explain what they mean: (a) profit margin and (b) gross profit rate.

Calculate profitability ratios.

BE5.15 (LO 6), C Cabo Corporation reported net income of $346,000, cash of $67,800, and net cash provided by operating activities of $221,200. What does this suggest about the quality of the company’s earnings? What further steps should be taken?

Evaluate quality of earnings.

*BE5.16 (LO 7), AP Prepare the journal entries to record these transactions on Kimble Company’s books using a periodic inventory system.

Journalize purchase transactions.

On March 2, Kimble Company purchased $800,000 of merchandise from Poe Company, terms 2/10, n/30.
On March 6, Kimble Company returned $95,000 of the merchandise purchased on March 2.
On March 12, Kimble Company paid the balance due to Poe Company.

*BE5.17 (LO 8), AP At December 31, 2022, Familla Corporation estimates that goods with a selling price of $1,400 and a cost of $650 that were sold on account during the current period will be returned during the next accounting period. Record the entry or entries required to adjust for this information.

Record entry for estimated sales returns.

DO IT! Exercises

DO IT! 5.1 (LO 1), C Indicate whether the following statements are true or false. If false, indicate how to correct the statement.

Answer general questions about merchandisers.

1. A merchandising company reports gross profit but a service company does not.
2. Under a periodic inventory system, a company determines the cost of goods sold each time a sale occurs.
3. A service company is likely to use accounts receivable but a merchandising company is not likely to do so.
4. Under a periodic inventory system, the cost of goods on hand at the beginning of the accounting period plus the cost of goods purchased less the cost of goods on hand at the end of the accounting period equals cost of goods sold.

DO IT! 5.2 (LO 2), AP On October 5, Iverson Company buys merchandise on account from Lasse Company. The selling price of the goods is $5,000, and the cost to Lasse Company is $3,000. On October 8, Iverson returns defective goods with a selling price of $640 and a scrap value of $240. Record the transactions of Iverson Company, assuming a perpetual approach.

Record transactions of purchasing company.

DO IT! 5.3 (LO 3), AP Assume information similar to that in DO IT! 5.2. That is: On October 5, Iverson Company buys merchandise on account from Lasse Company. The selling price of the goods is $5,000, and the cost to Lasse Company is $3,000. On October 8, Iverson returns defective goods with a selling price of $640 and a scrap value of $240. Record the transactions on the books of Lasse Company, assuming a perpetual approach.

Record transactions of selling company.

DO IT! 5.4 (LO 4), AP The following information is available for Berlin Corp. for the year ended December 31, 2022:

Prepare multiple-step income statement and comprehensive income statement.

Other revenues and gains	$ 12,700	Sales revenue	$592,000
Other expenses and losses	13,300	Operating expenses	186,000
Cost of goods sold	156,000	Sales returns and allowances	40,000
Other comprehensive income	5,400

Prepare a multiple-step income statement for Berlin Corp. and comprehensive income statement. The company has a tax rate of 30%. This rate also applies to the other comprehensive income.

DO IT! 5.5 (LO 5), AP Clean Lake Corporation’s accounting records show the following at year-end December 31, 2022:

Determine cost of goods sold using periodic system.

Purchase Discounts	$ 5,900	Beginning Inventory	$31,720
Freight-In	8,400	Ending Inventory	27,950
Freight-Out	11,100	Purchase Returns and Allowances	3,600
Purchases	162,500

Assuming that Clean Lake Corporation uses the periodic system, compute (a) cost of goods purchased and (b) cost of goods sold.

DO IT! 5.6 (LO 6), AN Owen Wise, Inc. reported the following in its 2022 and 2021 income statements.

Compute and analyze profitability ratios.

	2022	2021
Net sales	$150,000	$120,000
Cost of goods sold	90,000	72,000
Operating expenses	32,000	16,000
Income tax expense	18,000	10,000
Net income	$ 10,000	$ 22,000

Determine the company’s gross profit rate and profit margin for both years. Discuss the cause for changes in the ratios.

Exercises

E5.1 (LO 1), C Mr. Etemadi has prepared the following list of statements about service companies and merchandisers.

Answer general questions about 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.

E5.2 (LO 2), AP This information relates to Rice Co.

Journalize purchase transactions.

1. On April 5, purchased merchandise on account from Jax Company for $28,000, terms 2/10, n/30.
2. On April 6, paid freight costs of $700 on merchandise purchased from Jax.
3. On April 7, purchased equipment on account for $30,000.
4. On April 8, returned $3,600 of April 5 merchandise to Jax Company.
5. On April 15, paid the amount due to Jax Company in full.

Instructions

Prepare the journal entries to record the transactions listed above on Rice Co.’s books. Rice Co. uses a perpetual inventory system.
Assume that Rice Co. paid the balance due to Jax Company on May 4 instead of April 15. Prepare the journal entry to record this payment.

E5.3 (LO 2, 3), AP Assume that on September 1, Office Depot had an inventory that included a variety of calculators. The company uses a perpetual inventory system. During September, these transactions occurred.

Journalize perpetual inventory entries.

Sept. 6	Purchased calculators from Dragoo Co. at a total cost of $1,650, on account, terms n/30.
9	Paid freight of $50 on calculators purchased from Dragoo Co.
10	Returned calculators to Dragoo Co. for $66 credit because they did not meet specifications.
12	Sold calculators costing $520 for $690 to Fryer Book Store, on account, terms n/30.
14	Granted credit of $45 to Fryer Book Store for the return of one calculator that was not ordered. The calculator cost $34.
20	Sold calculators costing $570 for $760 to Heasley Card Shop, on account, terms n/30.

Instructions

Journalize the September transactions.

E5.4 (LO 3), AP The following transactions are for Alonzo Company.

Journalize sales transactions.

1. On December 3, Alonzo Company sold $500,000 of merchandise to Arte Co., on account, terms 1/10, n/30. The cost of the merchandise sold was $330,000.
2. On December 8, Arte Co. was granted an allowance of $25,000 for merchandise purchased on December 3.
3. On December 13, Alonzo Company received the balance due from Arte Co.

Instructions

Prepare the journal entries to record these transactions on the books of Alonzo Company. Alonzo uses a perpetual inventory system.
Assume that Alonzo Company received the balance due from Arte 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.

E5.5 (LO 2, 3), AP On June 10, Pais Company purchased $9,000 of merchandise from McGiver Company, on account, terms 3/10, n/30. Pais pays the freight costs of $400 on June 11. Goods totaling $600 are returned to McGiver for credit on June 12. On June 19, Pais Company pays McGiver Company in full, less the purchase discount. Both companies use a perpetual inventory system.

Journalize perpetual inventory entries.

Instructions

Prepare separate entries for each transaction on the books of Pais Company.
Prepare separate entries for each transaction for McGiver Company. The merchandise purchased by Pais on June 10 cost McGiver $5,000, and the goods returned cost McGiver $310.

E5.6 (LO 4), AP The adjusted trial balance of Doqe Company shows these data pertaining to sales at the end of its fiscal year, October 31, 2022: Sales Revenue $900,000, Freight-Out $14,000, Sales Returns and Allowances $22,000, and Sales Discounts $13,500.

Prepare sales section of income statement.

Instructions

Prepare the sales section of the income statement.

E5.7 (LO 4, 6), AP Presented below is information for Lieu Co. for the month of January 2022.

Prepare an income statement, a comprehensive income statement, and calculate profitability ratios.

Cost of goods sold	$212,000	Rent expense	$ 32,000
Freight-out	7,000	Sales discounts	8,000
Insurance expense	12,000	Sales returns and allowances	20,000
Salaries and wages expense	60,000	Sales revenue	370,000
Income tax expense	5,000	Other comprehensive income (net of $400 tax)	2,000

Instructions

Prepare an income statement using the format presented in Illustration 5.12.
Prepare a comprehensive income statement.
Calculate the profit margin and the gross profit rate.

E5.8 (LO 4, 6), AP Financial information is presented here for two companies.

Compute missing amounts and calculate profitability ratios.

	Yoste Company	Noone Company
Sales revenue	$90,000	(d)
Sales returns and allowances	(a)	$ 5,000
Net sales	84,000	100,000
Cost of goods sold	58,000	(e)
Gross profit	(b)	40,000
Operating expenses	14,380	(f)
Net income	(c)	17,000

Instructions

Fill in the missing amounts. Show all computations.
Calculate the profit margin and the gross profit rate for each company.
Discuss your findings in part (b).

E5.9 (LO 4, 6), AP In its income statement for the year ended December 31, 2022, Darren Company reported the following condensed data.

Prepare multiple-step income statement and calculate profitability ratios.

Salaries and wages expense	$465,000	Loss on disposal of plant assets	$ 83,500
Cost of goods sold	987,000	Sales revenue	2,210,000
Interest expense	71,000	Income tax expense	25,000
Interest revenue	65,000	Sales discounts	160,000
Depreciation expense	310,000	Utilities expense	110,000

Instructions

Prepare a multiple-step income statement.
Calculate the profit margin and gross profit rate.
In 2021, Darren had a profit margin of 5%. Is the decline in 2022 a cause for concern? (Ignore income tax effects.)

E5.10 (LO 4, 6), AP Suppose in its income statement for the year ended June 30, 2022, The Clorox Company reported the following condensed data (dollars in millions).

Prepare multiple-step income statement and calculate profitability ratios.

Salaries and wages expense	$ 460	Research and development expense	$ 114
Depreciation expense	90
Sales revenue	5,730	Income tax expense	276
Interest expense	161	Loss on disposal of plant assets	46
Advertising expense	499	Cost of goods sold	3,104
Sales returns and allowances	280	Rent expense	105
		Utilities expense	60

Instructions

Prepare a multiple-step income statement.
Calculate the gross profit rate and the profit margin and explain what each means.
Assume the marketing department has presented a plan to increase advertising expenses by $340 million. It expects this plan to result in an increase in both net sales and cost of goods sold of 25%. (Hint:Increase both sales revenue and sales returns and allowances by 25%.) Redo parts (a) and (b) and discuss whether this plan has merit. (Assume a tax rate of 34%, and round all amounts to whole dollars.)

E5.11 (LO 4), AP In its income statement for the year ended December 31, 2022, Laine Inc. reported the following condensed data.

Prepare an income statement and comprehensive income statement.

Operating expenses	$ 725,000	Interest revenue	$ 33,000
Cost of goods sold	1,256,000	Loss on disposal of plant assets	17,000
Interest expense	70,000	Net sales	2,200,000
Income tax expense	47,000	Other comprehensive income (net of $1,200 tax)	8,300

Instructions

Prepare a multiple-step income statement.
Prepare a comprehensive income statement.

E5.12 (LO 4), AP The following selected accounts from the Blue Door Corporation’s general ledger are presented below for the year ended December 31, 2022:

Prepare a multiple-step income statement.

Advertising expense	$ 55,000	Interest revenue	$ 30,000
Common stock	250,000	Inventory	67,000
Cost of goods sold	1,085,000	Rent revenue	24,000
Depreciation expense	125,000	Retained earnings	535,000
Dividends	150,000	Salaries and wages expense	675,000
Freight-out	25,000	Sales discounts	8,500
Income tax expense	70,000	Sales returns and allowances	41,000
Insurance expense	15,000
Interest expense	70,000	Sales revenue	2,400,000

Instructions

Prepare a multiple-step income statement.

E5.13 (LO 5), AP The trial balance of Mendez Company at the end of its fiscal year, August 31, 2022, includes these accounts: Beginning Inventory $18,700, Purchases $154,000, Sales Revenue $190,000, Freight-In $8,000, Sales Returns and Allowances $3,000, Freight-Out $1,000, and Purchase Returns and Allowances $5,000. The ending inventory is $21,000.

Prepare cost of goods sold section using periodic system.

Instructions

Prepare a cost of goods sold section (periodic system) for the year ending August 31, 2022.

E5.14 (LO 5), AP Below is a series of cost of goods sold sections for companies B, M, O, and S.

Prepare cost of goods sold section using periodic system.

	B	M	O	S
Beginning inventory	$ 250	$ 120	$ 700	$ (j)
Purchases	1,500	1,080	(g)	43,590
Purchase returns and allowances	80	(d)	290	(k)
Net purchases	(a)	1,040	7,410	42,290
Freight-in	130	(e)	(h)	2,240
Cost of goods purchased	(b)	1,230	8,050	(l)
Cost of goods available for sale	1,800	1,350	(i)	49,530
Ending inventory	310	(f)	1,150	6,230
Cost of goods sold	(c)	1,230	7,600	43,300

Instructions

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

E5.15 (LO 6), C Dorsett Corporation reported sales revenue of $257,000, net income of $45,300, cash of $9,300, and net cash provided by operating activities of $23,200. Accounts receivable have increased at three times the rate of sales during the last 3 years.

Evaluate quality of earnings.

Instructions

Explain what is meant by high quality of earnings.
Evaluate the quality of the company’s earnings. Discuss your findings.
What factors might have contributed to the company’s quality of earnings?

*E5.16 (LO 7), AP This information relates to Alfie Co.

Journalize purchase transactions.

1. On April 5, purchased merchandise from Bach Company for $27,000, on account, terms 2/10, n/30.
2. On April 6, paid freight costs of $1,200 on merchandise purchased from Bach Company.
3. On April 7, purchased equipment on account for $30,000.
4. On April 8, returned $3,600 of the April 5 merchandise to Bach Company.
5. On April 15, paid the amount due to Bach Company in full.

Instructions

Prepare the journal entries to record these transactions on the books of Alfie Co. using a periodic inventory system.
Assume that Alfie Co. paid the balance due to Bach Company on May 4 instead of April 15. Prepare the journal entry to record this payment.

*E5.17 (LO 8), AP At December 31, 2022, Highland Corporation estimates that goods with a selling price of $4,700 and a cost of $1,870 that were sold on account during the current period will be returned during the next accounting period. On January 17, 2023, the goods were returned as estimated. The customer had not paid for the goods by the time of the return.

Record entry for estimated sales returns.

Instructions

Record the entry or entries required to adjust for this information, as well as the subsequent return.

Problems: Set A

P5.1A (LO 2, 3, 4, 6), AP Winters Hardware Store completed the following merchandising transactions in the month of May. At the beginning of May, Winters’ ledger showed Cash of $8,000 and Common Stock of $8,000.

Journalize, post, and prepare partial income statement, and calculate ratios.

May 1	Purchased merchandise on account from Black Wholesale Supply for $8,000, terms 1/10, n/30.
2	Sold merchandise on account for $4,400, terms 2/10, n/30. The cost of the merchandise sold was $3,300.
5	Received credit from Black Wholesale Supply for merchandise returned $200.
9	Received collections in full, less discounts, from customers billed on May 2.
10	Paid Black Wholesale Supply in full, less discount.
11	Purchased supplies for cash $900.
12	Purchased merchandise for cash $3,100.
15	Received $230 refund for return of poor-quality merchandise from supplier on cash purchase.
17	Purchased merchandise on account from Wilhelm Distributors for $2,500, terms 2/10, n/30.
19	Paid freight on May 17 purchase $250.
24	Sold merchandise for cash $5,500. The cost of the merchandise sold was $4,100.
25	Purchased merchandise on account from Clasps Inc. for $800, terms 3/10, n/30.
27	Paid Wilhelm Distributors in full, less discount.
29	Made refunds to cash customers for returned merchandise $124. The returned merchandise had cost $90.
31	Sold merchandise on account for $1,280, terms n/30. The cost of the merchandise sold was $830.

Winters Hardware’s chart of accounts includes Cash, Accounts Receivable, Inventory, Supplies, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold.

Instructions

Journalize the transactions using a perpetual inventory system.
Post the transactions to T-accounts. Be sure to enter the beginning cash and common stock balances.
Prepare an income statement through gross profit for the month of May 2022.

Gross profit

$2,828

Calculate the profit margin and the gross profit rate. (Assume operating expenses were $1,400.)

P5.2A (LO 2, 3), AP Powell Warehouse distributes hardback books to retail stores and extends credit terms of 2/10, n/30 to all of its customers. During the month of June, the following merchandising transactions occurred.

Journalize purchase and sale transactions under a perpetual system.

June 1	Purchased books on account for $1,040 (including freight) from Catlin Publishers, terms 2/10, n/30.
3	Sold books on account to Garfunkel Bookstore for $1,200. The cost of the merchandise sold was $720.
6	Received $40 credit for books returned to Catlin Publishers.
9	Paid Catlin Publishers in full.
15	Received payment in full from Garfunkel Bookstore.
17	Sold books on account to Bell Tower for $1,200. The cost of the merchandise sold was $730.
20	Purchased books on account for $720 from Priceless Book Publishers, terms 1/15, n/30.
24	Received payment in full from Bell Tower.
26	Paid Priceless Book Publishers in full.
28	Sold books on account to General Bookstore for $1,300. The cost of the merchandise sold was $780.
30	Granted General Bookstore $130 credit for books returned costing $80.

Instructions

Journalize the transactions for the month of June for Powell Warehouse, using a perpetual inventory system.

P5.3A (LO 2, 3, 4), AP At the beginning of the current season on April 1, the ledger of Granite Hills Pro Shop showed Cash $2,500, Inventory $3,500, and Common Stock $6,000. The following transactions were completed during April 2022.

Journalize, post, and prepare trial balance and partial income statement.

Apr. 5	Purchased golf bags, clubs, and balls on account from Arnie Co. $1,500, terms 3/10, n/60.
7	Paid freight on Arnie purchase $80.
9	Received credit from Arnie Co. for merchandise returned $200.
10	Sold merchandise on account to members $1,340, terms n/30. The merchandise sold had a cost of $820.
12	Purchased golf shoes, sweaters, and other accessories on account from Woods Sportswear $830, terms 1/10, n/30.
14	Paid Arnie Co. in full.
17	Received credit from Woods Sportswear for merchandise returned $30.
20	Made sales on account to members $810, terms n/30. The cost of the merchandise sold was $550.
21	Paid Woods Sportswear in full.
27	Granted an allowance to members for clothing that did not fit properly $80.
30	Received payments on account from members $1,220.

The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Common Stock, Sales Revenue, Sales Returns and Allowances, and Cost of Goods Sold.

Instructions

Journalize the April transactions using a perpetual inventory system.
Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.
Prepare a trial balance on April 30, 2022.

Tot. trial balance

$8,150

Prepare an income statement through gross profit for the month of April 2022.

Gross profit

$ 700

P5.4A (LO 4, 6), AP Wolford Department Store is located in midtown Metropolis. During the past several years, net income has been declining because suburban shopping centers have been attracting business away from city areas. At the end of the company’s fiscal year on November 30, 2022, these accounts appeared in its adjusted trial balance.

Prepare financial statements and calculate profitability ratios.

Accounts Payable	$ 26,800
Accounts Receivable	17,200
Accumulated Depreciation—Equipment	68,000
Cash	8,000
Common Stock	35,000
Cost of Goods Sold	614,300
Freight-Out	6,200
Equipment	157,000
Depreciation Expense	13,500
Dividends	12,000
Gain on Disposal of Plant Assets	2,000
Income Tax Expense	10,000
Insurance Expense	9,000
Interest Expense	5,000
Inventory	26,200
Notes Payable	43,500
Prepaid Insurance	6,000
Advertising Expense	33,500
Rent Expense	34,000
Retained Earnings	14,200
Salaries and Wages Expense	117,000
Salaries and Wages Payable	6,000
Sales Returns and Allowances	20,000
Sales Revenue	904,000
Utilities Expense	10,600

Additional data: Notes payable are due in 2026.

Instructions

Prepare a multiple-step income statement, a retained earnings statement, and a classified balance sheet.

Net income	$ 32,900
Tot. assets	$146,400

Calculate the profit margin and the gross profit rate.
The vice president of marketing and the director of human resources have developed a proposal whereby the company would compensate the sales force on a strictly commission basis. Given the increased incentive, they expect net sales to increase by 15%. As a result, they estimate that gross profit will increase by $40,443 and expenses by $58,600. Compute the expected new net income. (Hint:You do not need to prepare an income statement.) Then, compute the revised profit margin and gross profit rate. Comment on the effect that this plan would have on net income and on the ratios, and evaluate the merit of this proposal. (Ignore income tax effects.)

P5.5A (LO 4), AP An inexperienced accountant prepared this condensed income statement for Simon Company, a retail firm that has been in business for a number of years.

Prepare a correct multiple-step income statement.

Simon Company Income Statement For the Year Ended December 31, 2022
Revenues
Net sales	$850,000
Other revenues	22,000
	872,000
Cost of goods sold	555,000
Gross profit	317,000
Operating expenses
Selling expenses	109,000
Administrative expenses	103,000
	212,000
Net earnings	$105,000

As an experienced, knowledgeable accountant, you review the statement and determine that the following steps were taken by the accountant to compute the amounts presented in the income statement.

1. Net sales, as presented, consist of sales $911,000, less freight-out on merchandise sold $33,000, and sales returns and allowances $28,000.
2. Other revenues, as presented, consist of sales discounts $18,000 and rent revenue $4,000.
3. Selling expenses, as presented, consist of salespersons’ salaries $80,000, depreciation on equipment $10,000, advertising $13,000, and sales commissions $6,000. The commissions represent commissions paid. At December 31, $3,000 of commissions have been earned by salespersons but have not been paid. All compensation should be recorded as Salaries and Wages Expense.
4. Administrative expenses, as presented, consist of office salaries $47,000, dividends $18,000, utilities $12,000, interest expense $2,000, and rent expense $24,000, which includes prepayments totaling $6,000 for the first quarter of 2023.

Instructions

Evaluate the steps taken by the inexperienced accountant so you can identify corrections that need to be made. Then, prepare a correct detailed multiple-step income statement. (Assume a 25% tax rate.)

Net income

$67,500

P5.6A (LO 4), AP The trial balance of People’s Choice Wholesale Company contained the following accounts shown at December 31, the end of the company’s fiscal year.

Journalize, post, and prepare adjusted trial balance and financial statements.

People’s Choice Wholesale Company Trial Balance December 31, 2022
	Debit	Credit
Cash	$ 31,400
Accounts Receivable	37,600
Inventory	70,000
Land	92,000
Buildings	200,000
Accumulated Depreciation—Buildings		$ 60,000
Equipment	83,500
Accumulated Depreciation—Equipment		40,500
Notes Payable		54,700
Accounts Payable		17,500
Common Stock		160,000
Retained Earnings		67,200
Dividends	10,000
Sales Revenue		922,100
Sales Discounts	6,000
Cost of Goods Sold	709,900
Salaries and Wages Expense	51,300
Utilities Expense	11,400
Maintenance and Repairs Expense	8,900
Advertising Expense	5,200
Insurance Expense	4,800
	$1,322,000	$1,322,000

Adjustment data:

1. Depreciation is $8,000 on buildings and $7,000 on equipment. (Both are operating expenses.)
2. Interest of $4,500 is due and unpaid on notes payable at December 31.
3. Income tax due and unpaid at December 31 is $24,000.

Other data: $15,000 of the notes payable are payable next year.

Instructions

Journalize the adjusting entries.
Create T-accounts for all accounts used in part (a). Enter the trial balance amounts into the T-accounts and post the adjusting entries.
Prepare an adjusted trial balance.

Tot. trial balance

$1,365,500

Prepare a multiple-step income statement and a retained earnings statement for the year, and a classified balance sheet at December 31, 2022.

Net income	$ 81,100
Tot. assets	$ 399,000

P5.7A (LO 4, 5), AP At the end of Oates Department Store’s fiscal year on November 30, 2022, these accounts appeared in its adjusted trial balance.

Determine cost of goods sold and gross profit under a periodic system.

Freight-In	$ 5,060
Inventory (beginning)	41,300
Purchases	613,000
Purchase Discounts	7,000
Purchase Returns and Allowances	6,760
Sales Revenue	902,000
Sales Returns and Allowances	20,000

Additional facts:

1. Inventory on November 30, 2022, is $36,200.
2. Note that Oates Department Store uses a periodic system.

Instructions

Prepare an income statement through gross profit for the year ended November 30, 2022.

Gross profit

$272,600

P5.8A (LO 4, 5, 6), AN Zhou Inc. operates a retail operation that purchases and sells snowmobiles, among other outdoor products. The company purchases all 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 2020 through 2023, inclusive.

Calculate missing amounts and assess profitability.

	2020	2021	2022	2023
Income Statement Data
Sales revenue		$96,890	$ (e)	$82,220
Cost of goods sold		(a)	28,060	26,490
Gross profit		67,800	59,620	(i)
Operating expenses		63,640	(f)	52,870
Net income		$ (b)	$ 3,510	$ (j)
Balance Sheet Data
Inventory	$13,000	$ (c)	$14,700	$ (k)
Accounts payable	5,800	6,500	4,600	(l)
Additional Information
Purchases of inventory on account		$25,890	$ (g)	$24,050
Cash payments to suppliers		(d)	(h)	24,650

Instructions

Calculate the missing amounts.
The vice presidents of sales, marketing, production, and finance are discussing the company’s results with the CEO. They note that sales declined over the 3-year fiscal period, 2021−2023. Does that mean that profitability necessarily also declined? Explain, computing the gross profit rate and the profit margin for each fiscal year to help support your answer.

*P5.9A (LO 5, 7), AP At the beginning of the current season on April 1, the ledger of Granite Hills Pro Shop showed Cash $2,500, Inventory $3,500, and Common Stock $6,000. The following transactions occurred during April 2022.

Journalize, post, and prepare trial balance and partial income statement under a periodic system.

Apr. 5	Purchased golf bags, clubs, and balls on account from Arnie Co. $1,500, terms 3/10, n/60.
7	Paid freight on Arnie Co. purchases $80.
9	Received credit from Arnie Co. for merchandise returned $200.
10	Sold merchandise on account to members $1,340, terms n/30.
12	Purchased golf shoes, sweaters, and other accessories on account from Woods Sportswear $830, terms 1/10, n/30.
14	Paid Arnie Co. in full.
17	Received credit from Woods Sportswear for merchandise returned $30.
20	Made sales on account to members $810, terms n/30.
21	Paid Woods Sportswear in full.
27	Granted credit to members for clothing that did not fit properly $80.
30	Received payments on account from members $1,220.

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

Instructions

Journalize the April transactions using a periodic inventory system.
Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions.
Prepare a trial balance on April 30, 2022.

Tot. trial balance

$8,427

Prepare an income statement through gross profit, assuming inventory on hand at April 30 is $4,263.

Gross profit

$ 700

Continuing Case

Cookie Creations

(Note: This is a continuation of the Cookie Creations case from Chapters 1 through 4.)

CC5 Because Natalie has had such a successful first few months, she is considering other opportunities to develop her business. One opportunity is to become the exclusive distributor of a line of fine European mixers. Natalie comes to you for advice on how to account for these mixers.

Go to WileyPLUS for complete case details and instructions.

Comprehensive Accounting Cycle Review

ACR5.1 On December 1, 2022, Devine Distributing Company had the following account balances.

	Debit		Credit
Cash	$ 7,200	Accumulated Depreciation—Equipment	$ 2,200
Accounts Receivable	4,600
Inventory	12,000	Accounts Payable	4,500
Supplies	1,200	Salaries and Wages Payable	1,000
Equipment	22,000	Common Stock	15,000
	$47,000	Retained Earnings	24,300
			$47,000

During December, the company completed the following summary transactions.

Dec. 6	Paid $1,600 for salaries due employees, of which $600 is for December and $1,000 is for November salaries payable.
8	Received $1,900 cash from customers in payment of account (no discount allowed).
10	Sold merchandise for cash $6,300. The cost of the merchandise sold was $4,100.
13	Purchased merchandise on account from Hecht 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 $8,000.
20	Paid salaries $1,800.
23	Paid Hecht Co. in full, less discount.
27	Received collections in full, less discounts, from customers billed on December 18.

Adjustment data:

1. Accrued salaries payable $800.
2. Depreciation $200 per month.
3. Supplies on hand $1,500.
4. Income tax due and unpaid at December 31 is $200.

Instructions

Journalize the December transactions using a perpetual inventory system.
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, Supplies Expense, Income Tax Expense, and Income Taxes Payable.
Journalize and post adjusting entries.
Prepare an adjusted trial balance.

Totals

$65,500

Prepare an income statement and a retained earnings statement for December and a classified balance sheet at December 31.

Net income

$540

ACR5.2 On November 1, 2022, IKonk, Inc. had the following account balances. The company uses the perpetual inventory method.

	Debit		Credit
Cash	$ 9,000	Accumulated Depreciation—Equipment	$ 1,000
Accounts Receivable	2,240
Supplies	860	Accounts Payable	3,400
Equipment	25,000	Unearned Service Revenue	4,000
	$37,100	Salaries and Wages Payable	1,700
		Common Stock	20,000
		Retained Earnings	7,000
			$37,100

During November, the following summary transactions were completed.

Nov. 8	Paid $3,550 for salaries due employees, of which $1,850 is for November and $1,700 is for October.
10	Received $1,900 cash from customers in payment of account.
11	Purchased merchandise on account from Dimas Discount Supply for $8,000, terms 2/10, n/30.
12	Sold merchandise on account for $5,500, terms 2/10, n/30. The cost of the merchandise sold was $4,000.
15	Received credit from Dimas Discount Supply for merchandise returned $300.
19	Received collections in full, less discounts, from customers billed on sales of $5,500 on November 12.
20	Paid Dimas Discount Supply in full, less discount.
22	Received $2,300 cash for services performed in November.
25	Purchased equipment on account $5,000.
27	Purchased supplies on account $1,700.
28	Paid creditors $3,000 of accounts payable due.
29	Paid November rent $375.
29	Paid salaries $1,300.
29	Performed services on account and billed customers $700 for those services.
29	Received $675 from customers for services to be performed in the future.

Adjustment data:

1. Supplies on hand are valued at $1,600.
2. Accrued salaries payable are $500.
3. Depreciation for the month is $250.
4. $650 of services related to the unearned service revenue has not been performed by month-end.

Instructions

Enter the November 1 balances in ledger T-accounts.
Journalize the November transactions.
Post to the ledger accounts. You will need to add some accounts.
Journalize and post adjusting entries.
Prepare an adjusted trial balance at November 30.

Tot. adj. trial bal.

$49,025

Prepare a multiple-step income statement and a retained earnings statement for November and a classified balance sheet at November 30.

Tot. assets

$38,430

Journalize and post closing entries.

Expand Your Critical Thinking

Financial Reporting Problem: Apple Inc.

CT5.1 The financial statements for Apple Inc. are presented in Appendix A.

Instructions

Answer these questions using the Statement of Operations.

What was the percentage change in net sales and in net income from the year ended September 24, 2016, to the year ended September 30, 2017?
What was the profit margin in each of the 3 years? (Use “Net Sales.”) Comment on the trend.
What was Apple’s gross profit rate in each of the 3 years? (Use “Net Sales” amounts.) Comment on the trend.

Comparative Analysis Problem: Columbia Sportswear Company vs. VF Corporation

CT5.2 The financial statements of Columbia Sportswear Company are presented in Appendix B. Financial statements of VF Corporation are presented in Appendix C.

Instructions

Based on the information contained in these financial statements, determine the following values for each company.

Profit margin for 2016. (For VF, use “Net Sales.”)
Gross profit for 2016.
Gross profit rate for 2016.
Operating income for 2016.
Percentage change in operating Income from 2015 to 2016. (For Columbia, use Income from operations.)

What conclusions concerning the relative profitability of the two companies can be drawn from these data?

Comparative Analysis Problem: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.

CT5.3 The financial statements of Amazon.com, Inc. are presented in Appendix D. Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E.

Instructions

Based on the information contained in these financial statements, determine the following values for each company.

Profit margin for the most recent year provided. (For Amazon, use “Total net sales.”)
Gross profit for the most recent year provided.
Gross profit rate for the most recent year provided.
Operating income for the most recent year provided.
Percentage change in operating income between the most recent year provided and the prior year.

What conclusions concerning the relative profitability of the two companies can be drawn from these data?

Interpreting Financial Statements

CT5.4 Recently, it was announced that two giant French retailers, Carrefour SA and Promodes SA, would merge. A headline in the Wall Street Journal blared, “French Retailers Create New Wal-Mart Rival.” While Wal-Mart‘s total sales would still exceed those of the combined company, Wal-Mart’s international sales are far less than those of the combined company. This is a serious concern for Wal-Mart, since its primary opportunity for future growth lies outside of the United States.

Below are basic financial data for the combined corporation (in euros) and Wal-Mart (in U.S. dollars) in a recent year. Even though their results are presented in different currencies, by employing ratios we can make some basic comparisons.

	Carrefour (in millions)	Wal-Mart (in millions)
Sales revenue	€70,486	$256,329
Cost of goods sold	54,630	198,747
Net income	1,738	9,054
Total assets	39,063	104,912
Current assets	14,521	34,421
Current liabilities	13,660	37,418
Total liabilities	29,434	61,289

Instructions

Compare the two companies by answering the following.

Calculate the gross profit rate for each of the companies, and discuss their relative abilities to control cost of goods sold.
Calculate the profit margin, and discuss the companies’ relative profitability.
Calculate the current ratio and debt to assets ratio for each of the two companies, and discuss their relative liquidity and solvency.
What concerns might you have in relying on this comparison?

Real-World Focus

CT5.5 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.

Instructions

Search the Internet for an article on either PepsiCo or Coca-Cola that sounds interesting to you and that would be relevant to an investor in these companies, and then answer the following questions.

What was the source of the article (e.g., Reuters, Businesswire, Prnewswire)?
Assume that you are a personal financial planner and that some of your clients own stock in the company. Write a brief memo to these clients summarizing the article and explaining the implications of the article for their investment.

Decision-Making Across the Organization

CT5.6 Three years ago, Karen Suez and her brother-in-law Reece Jones opened Gigasales Department Store. For the first 2 years, business was good, but the following condensed income statement results for 2022 were disappointing.

Gigasales Department Store Income Statement For the Year Ended December 31, 2022
Net sales		$700,000
Cost of goods sold		560,000
Gross profit		140,000
Operating expenses
Selling expenses	$100,000
Administrative expenses	20,000
		120,000
Net income		$ 20,000

Karen believes the problem lies in the relatively low gross profit rate of 20%. Reece believes the problem is that operating expenses are too high.

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

1. Increase average selling prices by 15%; this increase is expected to lower sales volume so that total sales dollars will increase only 4%.
2. Buy merchandise in larger quantities and take all purchase discounts. These changes to selling price and purchasing practices are expected to increase the gross profit rate from its current rate of 20% to a new rate of 25%.

Reece thinks expenses can be cut by making these two changes. He feels that these changes will not have any effect on net sales.

1. Cut 2023 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 2023 delivery expenses of $40,000 by 40%.

Karen and Reece come to you for help in deciding the best way to improve net income.

Instructions

With the class divided into groups, answer the following.

Prepare a condensed income statement for 2023 assuming (1) Karen’s changes are implemented and (2) Reece’s ideas are adopted.
What is your recommendation to Karen and Reece?
Prepare a condensed income statement for 2023 assuming both sets of proposed changes are made.
Discuss the impact that other factors might have. For example, would increasing the quantity of inventory increase costs? Would a salary cut affect employee morale? Would decreased morale affect sales? Would decreased store deliveries decrease customer satisfaction? What other suggestions might be considered?

Communication Activity

CT5.7 The following situation is presented in chronological order.

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

Instructions

In a memo to the president of Surfing Hawaii Co., answer the following questions.

When should Surfing Hawaii Co. record the sale?
Suppose that with his purchase order, Aikan is required to make a down payment. Would that change your answer to part (a)?

Ethics Case

CT5.8 Tabitha Andes was just hired as the assistant treasurer of Southside Stores, a specialty chain store company that has nine retail stores concentrated in one metropolitan area. Among other things, the payment of all invoices is centralized in one of the departments Tabitha 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.

Pete Wilson, the former assistant treasurer who has been promoted to treasurer, is training Tabitha in her new duties. He instructs Tabitha 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,” Pete 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 mailroom 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

What are the ethical considerations in this case?
What stakeholders are harmed or benefited?
Should Tabitha continue the practice started by Pete? Does she have any choice?

All About You

CT5.9 There are many situations in business where it is difficult to determine the proper period in which to record revenue. Suppose that after graduation with a degree in finance, you take a job as a manager at a consumer electronics store called FarWest Electronics. The company has expanded rapidly in order to compete with Best Buy.

FarWest has also begun selling gift cards. The cards are available in any dollar amount and allow the holder of the card to purchase an item for up to 2 years from the time the card is purchased. If the card is not used during those 2 years, it expires.

Instructions

At what point should the revenue from the gift cards be recognized? Include the reasoning to support your answer.

FASB Codification Activity

CT5.10 If your school has a subscription to the FASB Codification, log in and prepare responses to the following.

Access the glossary (“Master Glossary”) to answer the following.
What is the definition provided for inventory?
What is a customer?
What guidance does the Codification provide concerning reporting inventories above cost?

A Look at IFRS

LEARNING OBJECTIVE 9

Compare the accounting for merchandising under GAAP and IFRS.

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

Following are the key similarities and differences between GAAP and IFRS related to inventories.

Similarities

Under both GAAP and IFRS, a company can choose to use either a perpetual or a periodic inventory system.
The definition of inventories is basically the same under GAAP and IFRS.
As indicated above, the basic accounting entries for merchandising are the same under both GAAP and IFRS.
Both GAAP and IFRS require that income statement information be presented for multiple years. For example, IFRS requires that 2 years of income statement information be presented, whereas GAAP requires 3 years.

Differences

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 either by 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 other comprehensive income. The effect of this difference is that the use of IFRS results in more transactions aff ecting other comprehensive income.

IFRS Practice

IFRS Self-Test Questions

Which of the following would notbe included in the definition of inventory under IFRS?
Photocopy paper held for sale by an office-supply store.
Stereo equipment held for sale by an electronics store.
Used office equipment held for sale by the human relations department of a plastics company.
All of the answer choices would meet the definition.
Which of the following would notbe a line item of a company reporting costs by nature?
Depreciation expense.
Salaries expense.
Interest expense.
Manufacturing expense.
Which of the following would notbe a line item of a company reporting costs by function?
Utilities expense.

IFRS Exercises

IFRS5.1 Explain the difference between the “nature-of-expense” and “function-of-expense” classifications.

IFRS5.2 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.

a. Cost of goods sold.
b. Depreciation expense.
c. Salaries and wages expense.
d. Selling expenses.
e. Utilities expense.
f. Delivery expense.
g. General and administrative expenses.

IFRS5.3 Matilda Company reported the following amounts (in euros) in 2022: Net income, €150,000; Unrealized gain related to revaluation of buildings, €10,000; and Unrealized loss on non-trading securities, €(35,000). Determine Matilda’s total comprehensive income for 2022.

International Financial Reporting Problem: Louis Vuitton

IFRS5.4 The financial statements of Louis Vuitton are presented in Appendix F. The complete annual report, including the notes to its financial statements, is available at the company’s website.

Instructions

Use Louis Vuitton’s annual report to answer the following questions.

Does Louis Vuitton use a multiple-step or a single-step income statement format? Explain how you made your determination.
Instead of “interest expense,” what label does Louis Vuitton use for interest costs that it incurs?
Using the notes to the company’s financial statements, determine the following:

Composition of the inventory.
Amount of inventory (gross) before impairment.

Answers to IFRS Self-Test Questions

c 2.d 3. c

_______________

¹ The “Anatomy of a Fraud” stories in this text are adapted from Fraud Casebook: Lessons from the Bad Side of Business, edited by Joseph T. Wells (Hoboken, NJ: John Wiley & Sons, Inc., 2007). Used by permission. The names of some of the people and organizations in the stories are fictitious, but the facts in the stories are true.

Under a perpetual inventory system, when goods are purchased for resale by a company

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