CHAPTER FIVE Accounting for the Sale of Goods - Saints Business

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Introduction to Financial Accounting Second Edition (Revised) Based on International Financial Reporting Standards David Annand

CHAPTER FIVE Accounting for the Sale of Goods CHAPTER FIVE / Accounting for the Sale of Goods

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Copyright © 2016 Estate of Henry Dauderis Published by Valley Educational Services Ltd. 4910C – 58 St., Athabasca AB T9S 1L5 ISBN 978-0-9953266-4-4 Printed and bound in Canada by Athabasca University Library and Archives Canada Cataloguing in Publication Annand, David, 1954– This textbook is licensed under a Creative Commons License, Attribution–Non-commercial–Share Alike 4.0 Canada: see www.creativecommons.org. This material may be reproduced for non-commercial purposes and changes may be used by others provided that credit is given to the author. To obtain permission for uses beyond those outlined in the Creative Commons license, please contact David Annand at [email protected] Latest version available at http://business.athabascau.ca/faculty/david-annand-edd/ Please forward suggested changes to [email protected] Version 2.2 December 31, 2016

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CHAPTER FIVE Accounting for the Sale of Goods To this point, examples of business operations have involved the sale of services. This chapter introduces business operations based on the purchase and resale of goods. For example, Canadian Tire and Walmart each purchase and resell goods—such businesses are known as merchandizers. The accounting transactions for merchandizing companies differ from those of service-based businesses. Chapter 5 covers accounting for transactions of sales of goods on credit and related cash collections by merchandizing firms, and transactions involving purchases and payments for goods sold in the normal course of business activities.

Chapter 5 Learning Objectives LO1 – Describe merchandizing and explain the financial statement components of sales, cost of goods sold, merchandize inventory, and gross profit; differentiate between the perpetual and periodic inventory systems. LO2 – Analyze and record purchase transactions for a merchandizer. LO3 – Analyze and record sales transactions for a merchandizer. LO4 – Record adjustments to merchandize inventory. LO5 – Explain and prepare a classified multiple-step income statement for a merchandizer. LO6 – Explain the closing process for a merchandizer. LO7 – (Appendix) Explain and identify the entries to record purchase and sales transactions in a periodic inventory system.

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A.

The Basics of Merchandizing

LO1 - Describe merchandizing and explain the financial statement components of sales, cost of goods sold, merchandize inventory, and gross profit; differentiate between the perpetual and periodic inventory systems.

A merchandizing company, or merchandizer, differs in several basic ways from a company that provides services. First, a merchandizer purchases and then sells goods whereas a service company sells services. For example, a car dealership is a merchandizer that sells cars while an airline is a service company that sells air travel. Because merchandizing involves the purchase and then the resale of goods, an expense called cost of goods sold results. Cost of goods sold is the purchase price of items that are then re-sold to customers. For example, the cost of goods sold for a car dealership would be the cost of the cars purchased from the manufacturer. A service company does not have an expense called cost of goods sold since it does not sell physical items. As a result, the income statement for a merchandizer includes different details. A merchandizing income statement highlights cost of goods sold by showing the difference between sales revenue and cost of goods sold, which is called gross profit or gross margin. The basic income statement differences between a service business and a merchandizer are illustrated in Figure 5-1. Service Company Revenues

Merchandizing Company Sales Less: Cost of Goods Sold Equals: Gross Profit Less: Other Expenses Equals: Net Income

Less: Expenses Equals: Net Income

Figure 5-1 Differences Between the Income Statements of Service and Merchandizing Companies Assume that Excel Cars Corporation decides to go into the business of buying used vehicles from a supplier and reselling these to customers. If Excel purchases a vehicle for $2,000 and then sells it for $3,000, the gross profit would be $1,000, as follows: Sales $ 3,000 Cost of goods sold 2,000 Gross profit $ 1,000 The word “gross” is used by accountants to indicate that other expenses incurred in running the business must still be deducted from this amount before net income is calculated. In other words, gross profit represents the amount of sales revenue that remains to pay expenses after the cost of the goods sold is deducted.

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A gross profit percentage can be calculated to express the relationship of gross profit to sales. The sale of the vehicle that cost $3,000 results in a 33.3% gross profit percentage ($1,000/3,000). That is, for every $1 of sales, the company has $.33 left to cover other expenses after deducting cost of goods sold. Readers of financial statements use this percentage as a means to evaluate the performance of one company against other companies in the same industry, or in the same company from year to year. Small fluctuations in the gross profit percentage can have significant effects on the financial performance of a company because the amount of sales and cost of goods sold are often very large in comparison to other income statement items. Another difference between a service company and a merchandizer relates to the statement of financial position. Since a merchandizer purchases goods for resale, goods held for resale by a merchandizer are called merchandize inventory and are reported as an asset on the statement of financial position. A service company would not normally have merchandize inventory. Inventory Systems There are two ways that inventory is managed: the perpetual inventory system or periodic inventory system. This chapter focuses on the perpetual system. In a perpetual inventory system, the Merchandize Inventory and Cost Of Goods Sold accounts in the general ledger are updated immediately when a purchase or sale of goods occurs. When merchandize inventory is purchased, the cost is debited to the Merchandize Inventory account. As inventory is sold to customers, the cost of the inventory sold is removed from the Merchandize Inventory account and debited to the Cost Of Goods Sold account. Under a perpetual system, the detailed composition of merchanides inventory – item description, number of items, cost per item, and total cost – is known at any time. However, a physical count is still performed at the end of the accounting period to determine and adjust for differences between the actual inventory on hand and the Merchandize Inventory account balance in the general ledger. Some businesses will use a periodic inventory system instead. The purchase of merchandize inventory is debited to a temporary account called Purchases in the general ledger. At the end of the accounting period, inventory is counted, the Merchandize Inventory account is updated, and cost of goods sold is calculated. In a periodic inventory system, the real-time balances in Merchandize Inventory and Cost Of Goods Sold accounts are not known. The entry to record this difference

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is discussed later in this chapter. The periodic system is discussed in greater detail in the appendix to this chapter.

B.

The Purchase and Payment of Merchandize Using the Perpetual Inventory Method

LO2 – Analyze and record purchase transactions for a merchandizer.

As introduced in Chapter 3, a company’s operating cycle includes purchases on account or on credit and is highlighted in Figure 5–2.

Inventory sold to customer. Accounts receivable result. Cash is collected from customer

Figure 5–2 Purchase and Payment Portion of the Operating Cycle Recording the Purchase of Merchandize Inventory When merchandize inventory is purchased, the cost is recorded in a Merchandize Inventory general ledger account. An account payable results when the merchandize inventory is acquired but will not be paid in cash until a later date. For example, recall the vehicle purchased on account by Excel Cars Corporation for $2,000. Assume this was purchased on May 2, 2018. The journal entry and general ledger T-account effects would be as follows:

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General Journal Entry May 2 Merchandize Inventory Accounts Payable To record purchase of vehicle.

General Ledger Effect

150 2,000 210

2,000

Merch. Inventory 2,000 Accounts Payable 2,000

In addition to the purchase of merchandize inventory, there are other activities that affect the Merchandize Inventory account. For instance, merchandize may occasionally be returned to a supplier or damaged in transit, or discounts may be earned for prompt cash payment. These transactions result in the reduction of amounts due to the supplier and thus the costs of inventory. The purchase of merchandize inventory may also involve the payment of transportation and handling costs. These are all costs necessary to prepare inventory for sale, and all such costs are included in the Merchandize Inventory account. These costs are discussed in the following sections. Purchase Returns and Allowances Assume that the vehicle purchased by Excel turned out to be the wrong colour. The supplier was contacted on May 3 and agreed to reduce the price by $300 to $1,700. This is an example of a purchase returns and allowances adjustment. The amount of the allowance, or reduction, is recorded as via journal entry as a credit to the Merchandize Inventory account. The entry and related T-account effects are:

May 3 Accounts Payable

Merchandize Inventory

210 300

150

300

Accounts Payable 2,000 300 1,700 Merch. Inventory 2,000 300 1,700

To record reduction in account payable: vehicle wrong colour. Note that the cost of the vehicle has been reduced to $1,700 ($2,000 – 300) as has the amount owing to the supplier.

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Purchase Discounts Purchase discounts affect the purchase price of merchandize if payment is made within a time period specified in the supplier’s invoice. For example, if the terms on the $2,000 invoice for one vehicle received by Excel indicates “1/15, n45”, this means that the $2,000 must be paid within 45 days (‘n’ = net). However, if cash payment is made by Excel within 15 days, the purchase price will be reduced by 1%. Assuming the amount is paid within 15 days, the supplier’s terms entitle Excel to deduct $17 [($2,000 - $300) = $1,700 x 1% = $17]. The payment to the supplier if payment was made on May 9 would be recorded as: Accounts Payable 1,700 May 9 Accounts Payable 210 1,700 1,700 Merch. Inventory 2,000 300 Merchandize Inventory 150 17 17 1,683 Cash Cash 101 1,683 1,683 To record payment on account in full and purchases discount applied. The cost of the vehicle in Excel’s inventory records is now $1,683 ($2,000 – 300 – 17). If payment is made after the discount period, $2,700 of cash is paid and the entry would be: Accounts Payable 1,700 Cash 1,700 To record payment on account; no purchase discount applied. In this case, the Merchandize Inventory account is not affected. The cost of the vehicle in the general ledger remains at $1,700. Trade discounts are similar to purchase discounts. A supplier advertizes a list price which is the normal selling price of its goods to merchandizers. Trade discounts are given by suppliers to merchandizers that buy a large quantity of goods. For instance, assume a supplier offers a 10% trade discount on purchases of 1,000 units or

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more where the list price is $1/unit. If Beta Merchandizer Corp. buys 1,000 units on account, the entry in Beta’s records would be: Merchandize Inventory 900 Accounts Payable 900 To record purchase of cups; 5% trade discount applied (1,000 x $1 x 95% = $900) Note that just the net amount (list price less trade discount) is recorded. Transportation Costs to transport goods from the supplier to the seller must also be considered when recording the cost of merchandize inventory. The shipping terms on the invoice identify the point at which ownership of the inventory transfers from the supplier to the purchaser. When the terms are FOB shipping point, ownership transfers at the ‘shipping point’ so the purchaser is responsible for transportation costs. FOB destination indicates that ownership transfers at the ‘destination point’ so the seller is responsible for transportation costs. FOB is the abbreviation for “free on board.” Assume that Excel’s supplier sells with terms of FOB shipping point indicating that transportation costs are Excel’s responsibility. If the cost of shipping is $125 and this amount was paid in cash to the truck driver at time of delivery on May 9, the entry would be:

May 9 Merchandize Inventory

Merch. Inventory 2,000 300 17 125 1,808

150 125

Cash Cash 101 To record freight on vehicle purchased.

125

125

The cost of the vehicle in the Excel Merchandize Inventory account is now $1,808. It is important to note that Excel’s transportation costs to deliver goods to customers are recorded as delivery expenses that do not affect the Merchandize Inventory account.

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The next section describes how the sale of merchandize is recorded as well as the related costs of items sold.

C.

Merchandize Inventory: Sales and Collection Using the Perpetual Inventory System

LO3 – Analyze and record sales transactions for a merchandizer.

In addition to purchases on account, a merchandizing company’s operating cycle includes the sale of merchandize inventory on account or on credit as highlighted in Figure 5–3.

Cash payment to supplier is made. A liability is incurred. Inventory is purchased.

Figure 5–3 Sales and Collection Portion of the Operating Cycle There are some slight recording differences when revenue is earned in a merchandizing company. These are discussed below. Recording the Sale of Merchandize Inventory The sale of merchandize inventory is recorded with two entries: 1. recording the sale by debiting Cash or Accounts Receivable and crediting Sales, and 2. recording the cost of the sale by debiting Cost of Goods Sold and crediting Merchandize Inventory. Assume the vehicle purchased by Excel is sold on May 15 for $3,000 on account. Recall that the cost of this vehicle in the Excel Merchandize Inventory account is $1,808, as shown below.

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The entries to record the sale of the merchandize inventory are: May 15 Accounts Receivable

Accounts Receivable 3,000

110 3,000

Sales Sales

500

3,000

3,000

Costs are transferred to Cost of Goods Sold the income Cost of Goods Sold 570 1,808 1,808 statement from the statement Merch. Inventory of financial 1,808 position at the Merchandize Inventory 150 1,808 1,808 same time the -0sale is To record sale of vehicle. recorded. The first part of the entry records the sales revenue. The second part is required to reduce the Merchandize Inventory account and transfer the cost of the merchandize sold to the Cost of Goods Sold account, and then to the income statement. The part of the entry ensures that both the Merchandize Inventory and Cost of Goods Sold accounts in the general ledger are up to date. Sales Returns and Allowances When merchandize inventory that has been sold is returned to the merchandizer by the customer, a sales return and allowance is recorded. For example, assume some damage occurs to the car sold by Excel while it is being delivered to the customer on May 17. Excel would give the customer a sales allowance by agreeing to reduce the amount owing by, say, $100. The entry is:

May 17 Sales Returns and Allowances

508 100

Sales Ret. & Allow. 100

Accounts Receivable 3,000 Accounts Receivable 110 100 100 2,900 To record customer allowance for damage to vehicle during delivery. Accounts receivable is credited because the original sale was made on account and has not yet been paid. The amount owing from the

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customer is reduced to $2,900. If the $2,900 had already been paid, a credit would be made to Cash and $100 refunded to the customer. The Sales Returns and Allowances account is a contra revenue account, meaning it is deducted from Sales when preparing the income statement. If goods are returned by a customer, a sales return occurs. The related sales and cost of goods sold recorded on the income statement are reversed and the goods are returned to inventory. For example, assume Max Corporation sells a plastic container for $3 that it purchased for $1. The dual entry at the time of sale would be: Accounts Receivable Sales Cost of Goods Sold Merchandize Inventory To record sale of plastic container.

3 3 1 1

If the container is returned, the journal entry would reverse the original entry, except that Sales Returns and Allowances would be debited instead of the Sales account: Sales Returns and Allowances Accounts Receivable Merchandize Inventory Cost of Goods Sold To record return of plastic container.

3 3 1 1

Use of a Sales Returns and Allowances contra account allows management to track the amount of returned and damaged items for their information purposes. Sales Discounts Another contra revenue account, Sales Discounts, records reductions in sales amounts when a customer pays within a certain time period. For example, assume Excel Cars Corporation offers sales terms of “2/10, n30.” This means that the amount owed must be paid by the customer within 30 days (‘n’ = net); however, if the customer chooses to pay within 10 days, a 2% discount may be deducted from the amount owing. Consider the sale of the vehicle for $2,900 ($3,000 less the $100 allowance for damage). Payment within 10 days entitles the customer to a $58 discount ($2,900 x 2% = $58). If payment is made on May 21

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and therefore within the discount period, Excel receives $2,842 cash ($2,900 - 58) and prepares the following entry: May 21 Cash

Sales Discounts

101

2,842

509

58

Cash 2,842 Sales Discounts 58

Accounts Receivable 2,900 Accounts Receivable 110 2,900 2,900 -0To record payment on account and sales discount applied. This entry reduces the accounts receivable amount to zero which is the desired result. If payment is not made within the discount period, the customer pays the full amount owing of $2,900. The Sales Allowances and Sales Discounts contra accounts are deducted from sales on the income statement to arrive at net sales. Cost of goods sold is deducted from net sales. If Excel purchased and sold only this one vehicle, the partial income statement for the period from January 1 to May 31 would show: Excel Cars Corporation Partial Income Statement For the Five Month Period Ended May 31, 2018 Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit

$3,000 $100 58

158 2,842 1,808 1,034

As was the case for Sales Returns and Allowances, the balance in the Sales Discounts account is deducted from Sales on the income statement to arrive at Net Sales. Merchandizers often report only the net sales amount on the income statement. Details from sales returns and allowances, and sales discounts, are often omitted because they are immaterial in amount relative to total sales. However, separate general ledger accounts for each of sales returns and allowances, and

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sales discounts, are useful in helping management identify potential problems that require investigation.

D.

Adjustments to Merchandize Inventory Using the Perpetual Inventory System

LO4 – Record adjustments to merchandize inventory.

In the simple example above, Excel did not have any merchandize inventory on hand at either the start of the year or at the end of May. It purchased and sold one vehicle during the month. Now assume that Excel Cars Corporation purchased five vehicles from its supplier for $2,000 each on June 2, 2018. The company sold three of these for $3,000 each on June 16. On June 30, ending inventory would consist of two vehicles valued at $2,000 each, or $4,000 in total. (Note that inventory is valued at cost, not estimated selling price.) Assume there are no applicable transportation, purchase allowances or discounts expenditures. The journal entry to record the purchase of the vehicles on June 2 would be:

June 2

Merchandize Inventory

150

Accounts Payable

210

10,000

10,000

Merch Inventory -010,000 10,000 Accounts Payable -010,000 10,000

To record purchase of five vehicles.

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The summary journal entry to record the sale of the vehicles on June 16 would be:

June 16 Accounts Receivable

Sales

Cost of Goods Sold

110

9,000

500

570

9,000

6,000

Accounts Receivable -09,000 9,000 Sales 3,000 9,000 12,000 Cost of Goods Sold 1,808 6,000 7,808

Merch. Inventory 10,000 Merchandize Inventory 550 6,000 6,000 4,000 To record sale of three vehicles and related cost of goods sold. Assume the purchases and sales of vehicles in May and June were the only activity of the company during its fiscal year ended December 31, 2018, and the only opening general ledger account balances were Cash - $5,000 and Share Capital - $5,000. After the May and June transactions are recorded, the general ledger T-accounts would appear as follows:

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Cash 5,000 1,6833 7 2,842 1254 6,034 Accounts Rec. 3,000 1006 9 9,000 2,9007 9,000 5

Merchandize Inv. 1 2,000 3002 4 125 173 1,808 1,8085 -08 10,000 6,0009 4,000

Accounts Payable 2 300 2,0001 3 1,700 10,0008 10,000

Share Capital 5,000

Sales 3,0005 9,0009 12,000 Sales Ret. & Allow. 6 100 Sales Discounts 7 58

Cost of Goods Sold 5 1,808 9 6,000 7,808

Summary of transactions 1 Purchased one vehicle on credit, May 2 2 Adjustment by supplier for wrong colour 3 Paid supplier May 9; purchase discount taken 4 Paid transportation costs 5 Sold one vehicle on May 15 6 Customer credited for delivery damage May 17 7 Payment received from customer on May 21; sales discount applied 8 Purchased five vehicles on credit, June 2 9 Sold three vehicles on June 16

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At the end of the fiscal year, an unadjusted trial balance would be prepared based on this information, as follows: Excel Cars Corporation Unadjusted Trial Balance December 31, 2018 Account No.

Account Title

101 110 150 210 320 500 508 509 570

Cash Accounts Receivable Merchandize Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold

Account Balance Debit Credit $ 6,034 9,000 4,000 $ 10,000 5,000 12,000 100 58 7,808 $27,000 $27,000

Shrinkage There is one adjusting entry that may need to be made at year-end related to merchandize inventory. Usually, a physical count of inventory is conducted at the fiscal year-end. Costs are attached to these items and all are totalled. This total is then compared to the Merchandize Inventory account balance. These should agree, unless inventory has been lost for some reason. This discrepancy is called shrinkage. Theft and deterioration of goods held for re-sale are the most common examples of shrinkage. Assume that one of the two vehicles remaining on Excel’s vehicle lot is stolen prior to the year-end and that this has (somehow) gone unnoticed by staff. A physical count at December 31 would reveal one vehicle on hand. This vehicle would be traced to the related purchase invoice and valued at $2,000. Comparing this amount to the balance in the Merchandize Inventory account would reveal a discrepancy of $2,000 ($4,000 – 2,000), and the theft would be revealed. This ability to compare accounting records with actual items on hand can be a valuable means for management to safeguard assets of the company, especially when there are thousands of goods purchased for resale. The system alerts managers to possible shrinkage problems.

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At the year-end, the loss of one vehicle must be reflected in the accounting records. The following adjusting entry would be made:

Dec. 31 Cost of Goods Sold

570

2,000

Cost of Goods Sold 1,808 6,000 2,000 9,808

Merch. Inventory 10,000 6,000 4,000 Merchandize Inv. 550 2,000 2,000 2,000 To adjust merchandize inventory to physical count at year-end: vehicle stolen Generally, shrinkage is recorded as part of cost of goods sold. If the amounts are abnormally large, however, a separate general ledger account can be maintained called, say, Inventory Shrinkage. The amount is still combined with cost of goods sold and not disclosed separately on the income statement, as it is considered information to be used only internally (to spur investment in the protection of physical inventory, for instance). However, it does provide information to management about the cost of shrinkage and may alert them to the need to provide better physical protection for inventory assets.

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As there are no more adjustments at year-end in this example, an adjusted trial balance is prepared, as follows: Excel Cars Corporation Adjusted Trial Balance December 31, 2018 Acct. No. 101 110 150 210 320 500 508 509 570

Account Cash Accounts Receivable Merchandize Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold

Account Balance Debit Credit $ 6,034 9,000 2,000 $ 10,000 5,000 12,000 100 58 9,808 $27,000 $27,000

The financial statements for the year ended December 31 would be prepared from this information, as follows: Excel Cars Corporation Income Statement For the Year Ended December 31, 2018 Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit and net income

$12,000 $100 58

158 11,842 9,808 $ 2,034

In this case, sales consists of four vehicles sold for $3,000 each, or $12,000 in total. Cost of goods sold of $9,808 consists of four vehicles that were originally purchased for $2,000 each, or $8,000 in total, plus transportation costs of $125 and the loss of one vehicle ($2,000), less a purchase allowance of $300 and a purchase discount of $17 related to the May sale ($8,000 + 125 + 2,000 – 300 – 17 = $9,808). Gross profit therefore equals $2,034. Since there are no other expenses, net income is also $2,034.

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The statement of changes in equity would show: Excel Cars Corporation Statement of Changes in Equity For the Year Ended December 31, 2018

Balance at January 1, 2018 Net income Balance at December 31, 2018

Share capital $5,000 $5,000

Retained earnings $ -02,034 $2,034

Total equity $5,000 2,034 $7,034

The statement of financial position at year-end would show: Excel Cars Corporation Statement of Financial Position At December 31, 2018 Assets Current assets Cash Accounts receivable Merchandize inventory Total assets

$ 6,034 9,000 2,000 $17,034

Liabilities Accounts payable

$10,000

Shareholders’ Equity Share capital $5,000 Retained earnings 2,034 Total liabilities and shareholders’ equity

7,034 $17,034

The one vehicle remaining in inventory at December 31 is valued at $2,000. This is the amount that remains in the Merchandize Inventory general ledger account, verified by physical count at year-end. It is appropriately shown as an asset on the statement of financial position at December 31.

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E.

Merchandizing Income Statement

LO5 – Explain and prepare a classified multiple-step income statement for a merchandizer.

Businesses are required to show expenses on the income statement based on either the nature or the function of the expense. The nature of an expense is determined by its basic characteristics (what it is). For example, when expenses are listed on the income statement as interest, depreciation, income taxes, or salaries, this identifies the nature of each expense. In contrast, the function of an expense describes the grouping of expenses based on their purpose (what they relate to). For example, an income statement that shows cost of goods sold, selling expenses, and general and administrative expenses has grouped expenses by their function. When expenses are grouped by function, additional information must be disclosed to show the nature of expenses within each group. Full disclosure is the generally accepted accounting principle that requires financial statements to report all relevant information about the operations and financial position of the entity. Information that is relevant but not included in the body of the statements is provided in the notes to the financial statements. A merchandizing income statement can be prepared in different formats. For this course, only one format will be used—the classified multiple-step format. This format is generally used only for internal reporting because of its detail. Most external financial statement users would find this detail excessive and distracting. An example of a classified multiple-step income statement is shown below using assumed data for XYZ Inc. for its month ended December 31, 2017.

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XYZ Inc. Income Statement Month Ended December 31, 2017

These are nature categories.

These are not part of ordinary operations.

Sales Less: Sales discounts Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses These are function Selling categories. Sales salaries Rent, store Advertizing Total selling General and administrative Office salaries Rent, office Supplies Insurance Total general and administrative Total operating expenses expenses Income from operations Other revenues (expenses) Rent revenue Interest expense Income before income taxes Income taxes Net income

$100,000 $1,000 500

1,500 98,500 50,000 48,500

$11,000 12,000 5,000 28,000 9,000 3,000 2,500 1,000 15,500 43,500 5,000 12,000 (1,500)

10,500 15,500 2,000 $13,500

Notice that the classified multiple-step income statement shows expenses by both function and nature. The broad categories that show expenses by function include operating expenses, selling expenses, general and administrative expenses, and income taxes. Within each category, the nature of expenses is disclosed including sales salaries, advertizing, depreciation, supplies, and insurance. Notice that Rent Expense has been divided between two groupings because it applies to both selling (store) and general (office) expenses. The normal operating activity for XYZ Inc. is merchandizing. Revenues and expenses that are not part of normal operating activities are listed under Other Revenues and Expenses. XYZ Inc. shows Rent Revenue under Other Revenues and Expenses because this type of revenue is 182

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not part of its merchandizing operations. Interest earned, dividends earned, and gains on the sale of property, plant, and equipment are more examples of other revenues not related to merchandizing operations. XYZ Inc. deducts interest expense under Other Revenues and Expenses. Interest expense does not result from operating activities; it is a financing activity because it is associated with the borrowing of money. Other examples of non-operating expenses include losses on the sale of property, plant, and equipment. Finally, income taxes expense is deducted. Income tax is a government levy, and considered unrelated to normal business operations.

F.

Closing Entries for a Merchandizer Using the Perpetual Inventory System

LO6 – Explain the closing process for a merchandizer.

The process of recording closing entries for service companies was illustrated in Chapter 3. The closing procedure for merchandizing companies is the same as for service companies—all income statement accounts are transferred to the Income Summary account, the Income Summary is closed to Retained Earnings, and Dividends are closed to Retained Earnings. When preparing closing entries for a merchandizer, the income statement accounts unique for merchandizers need to be considered— Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. Sales is a revenue account so has a normal credit balance. To close Sales, it must be debited with a corresponding credit to the income summary. Sales Discounts and Sales Returns and Allowances are both contra revenue accounts so each has a normal debit balance. Cost of Goods Sold has a normal debit balance because it is an expense. To close these debit balance accounts, a credit is required with a corresponding debit to the income summary. All accounts listed in the income statement columns are transferred to the income summary account, and then the income summary is closed to retained earnings. The same three-step process is used, as shown in chapter 3, as applied to the financial information of Excel Cars Corporation for the year ended December 31, 2018:

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Entry 1 All income statement accounts with credit balances are debited to bring them to zero. Their balances are transferred to the income summary account. (a) Dec. 31

Sales 150 12,000 Income Summary 360 12,000 To close all income statement accounts with credit balances to the income summary.

Entry 2 All income statement accounts with debit balances are credited to bring them to zero. Their balances are transferred to the income summary account. (b) Dec. 31

Income Summary 360 9,966 Cost of Goods Sold 570 9,808 Sales Returns and Allow. 508 100 Sales Discounts 509 58 To close all income statement accounts with credit balances to income summary.

Entry 3 The Income Summary account is closed to the Retained Earnings account. The effect is to transfer temporary (income statement) account balances in the income summary totalling $4,034 to the permanent (statement of financial position) account, Retained Earnings. Dec. 31

184

(c) Income Summary 360 2,034 Retained Earnings 340 2,034 To close income summary account to retained earnings.

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After these closing entries are posted, the general ledger T-accounts would appear as follows: Cash 5,000 1,6833 7 2,842 1254 6,034

Accounts Rec. 3,000 1006 9 9,000 2,9007 9,000 5

Accounts Payable 2 300 2,0001 3 1,700 10,0008 10,000 The balance in the Income Summary is transferred to Retained Earnings.

Merchandize Inventory 1 2,000 3002 4 125 173 1,808 1,8085 -08 10,000 6,0009 4,000 2,000 2,000

Share Capital 5,000

Sales 3,0005 9,0009 12,000

Retained Earnings 2,034c

a

Income Summary b 9,966 12,000a c 2,034 -0-

Sales Ret. & Allow. 6 100 100b -0-

12,000 -0-

Sales Discounts 7 58 58b -0-

Adjusting entry for inventory shrinkage

Cost of Goods Sold 5 1,808 9 6,000 7,808 2,000 9,808 9,808b -0-

All income statement accounts and the income summary account are reduced to zero and net income for the year of $2,034 is transferred to retained earnings.

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185

Appendix: The Periodic Inventory System LO7 – Explain and identify the entries to record purchase and sales transactions in a periodic inventory system.

The perpetual inventory system maintains a continuous, real-time balance in both Merchandize Inventory, a statement of financial position account, and Cost of Goods Sold, an income statement account. As a result, the Merchandize inventory general ledger account balance should always equal the value of physical inventory on hand at any point in time. Additionally, the Cost of goods sold general ledger account balance should always equal the total cost of merchandize inventory sold for the accounting period. The accounts should perpetually agree; hence the name. An alternate system is considered below, called the periodic inventory system. Description of the Periodic Inventory System The periodic inventory system does not maintain a constantly-updated merchandize inventory balance. Instead, ending inventory is determined by a physical count and valued at the end of an accounting period. The change in inventory is recorded only periodically. Additionally, a Cost of goods sold account is not maintained in a periodic system. Instead, cost of goods sold is calculated at the end of the accounting period. When goods are purchased using the periodic inventory system, the cost of merchandize is recorded in a Purchases account in the general ledger, rather than in the Merchandize Inventory account as is done under the perpetual inventory system. The Purchases account is an income statement account that accumulates the cost of merchandize acquired for resale. Recall that Excel purchased a vehicle on account from its supplier on May 2 for $2,000. The journal entry and general ledger T-account effects using the periodic inventory system would be as follows:

May 2

Purchases

550

Accounts Payable 210 To record purchase of vehicle.

Purchases 2,000

2,000

2,000

Accounts Payable 2,000

Other types of activities related to the purchase of merchandize, like allowances for damaged items, purchase discounts, and transportation and handling charges, are not recorded in the Merchandize Inventory

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account either. Rather, they are recorded in special income statement accounts. Accounting for each type of transaction is explained below. Purchase returns and Allowances Recall that the price of the vehicle purchased on May 2 was reduced from $2,000 to $1,700 because it was the wrong colour. Under the periodic inventory system, the amount of the reduction is accumulated in a separate Purchase returns and Allowances, an income statement account. Excel would record the transaction as follows:

May 3

Accounts Payable

210

300

Accounts Payable 2,000 300

Purch. Ret. & Allows. Purch. Ret. and Allow.558 300 300 To record reduction in account payable: vehicle damaged. The Purchase returns and Allowances amount of $300 is deducted from Purchases when calculating cost of goods sold on the income statement. It is a contra account. Purchase discounts Another contra account, Purchase discounts, accumulates reductions in the purchase price of merchandize if payment is made within a time period specified in the supplier’s invoice. Recall that if amount owing on the vehicle is paid within 15 days, the supplier’s terms entitle Excel to deduct $17 [($2,000 - 300) = $1,700 x 1% = $17]. Under the periodic inventory system, the $1,683 cash payment to the supplier on May 9 is recorded as follows:

May 9

Accounts Payable

Purchase discounts

210

559

1,700

Accounts Payable 1,700 1,700 Purchase discounts 17 17

Cash Cash 101 1,683 1,683 To record payment on account in full and purchases discount applied.

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187

The discount of $17 is deducted when calculating cost of goods sold on the income statement. Transportation Under the perpetual inventory system, the cost of transporting the vehicle to Excel’s premises was added to the Merchandize Inventory account on the statement of financial position. Under the periodic inventory system, a Transportation-in account is used to accumulate freight charges on merchandize purchased for re-sale. Like the Purchases and Purchase discounts accounts, this is also an income statement account which is used to calculate cost of goods sold directly on the income statement. Recall the cost of shipping the vehicle is $125 and it is paid in cash to the truck driver. Payment would be recorded as follows: May 9

Transportation-In

560

Transportation-In 125

125

Cash Cash 101 125 To record transportation costs on vehicle.

125

The vehicle is then sold for $3,000 on May 15. A $100 allowance is granted for damage to the vehicle during delivery. A $58 sales discount is granted because the customer paid the balance owing to Excel within the discount period. The sales transactions are recorded in the same manner under both the perpetual and periodic inventory systems. The summary of these transactions is: May 15 May 17 May 21

Accounts Receivable Sales Sales Ret. and Allowances Accounts Receivable Cash Sales Discounts Accounts Receivable

110 500 508 110 101 509 110

3,000 3,000 100 100 2,842 58 2,900

Note, however, that there is no entry made to adjust Merchandize Inventory and cost of goods sold when recording the May 15 sales. This is different from the perpetual inventory system. There have been no entries made to the Merchandize Inventory account to date using the periodic inventory system. 188

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The same transactions also occur in June as described earlier. Five vehicles are purchased for $2,000 each, or $10,000 in total. The entry to record the purchase of the vehicles is:

June 2

Purchases

Accounts Payable

550

Purchases 2,000 10,000 12,000

10,000

210

10,000

Accounts Payable -010,000 10,000

Three vehicles are sold during June for $3,000 each, or $9,000 in total. The entry to record the sale of the vehicles is:

June 16 Accounts Receivable

110

Accounts Receivable -09,000 9,000

9,000

Sales Sales

500

9,000

3,000 9,000 12,000

Again, note that there are no adjustments to the Merchandize Inventory or Cost of Goods Sold accounts in the general ledger at this point, unlike the perpetual inventory system. After the June transactions are recorded, the general ledger T-accounts would appear as follows:

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189

Cash 5,000 1,6833 7 2,842 1254 6,034

Accounts Payable 2 300 2,0001 3 1,700 10,0008 10,000

Share Capital 5,000

Accounts Rec. 3,000 1006 9 9,000 2,9007 9,000

3,0005 9,0009 12,000 Sales Ret. & Allow. 6 100

5

Merchandize Inventory -0-

Sales

Using the periodic . inventory system, no transactions are recorded during the year in the Merchandize Inventory account. Purchases are recorded in a separate general ledger account.

Sales Discounts 7 58

Purchases 2,000 9 10,000 12,000 1

Purch. Ret. & Allows. 3002 Purchase Discounts 173 Transportation-In 4 125

Summary of transactions Purchased one vehicle on credit, May 2 2 Adjustment by supplier for wrong colour 3 Paid supplier May 9; purchase discount taken 4 Paid transportation costs 5 Sold one vehicle on May 15 6 Customer credited for delivery damage May 17 7 Payment received from customer on May 21; sales discount applied 8 Purchased five vehicles on credit, June 2 9 Sold three vehicles on June 16 1

Assume again that no other transactions occur during the year. When financial statements are prepared at December 31, a physical count of

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inventory is taken. Purchase invoices are referenced to determine the value of the items counted. The resulting amount is inserted into the income statement to determine the cost of goods sold for the year. In the case of Excel, a physical count should show that there is one vehicle left on the lot. Referring to the purchase documents, this vehicle would be valued at its purchase price - $2,000. The value of ending inventory would thus be calculated as $2,000. This information is inserted directly into the income statement of Excel for the year ended December 31, 2018. Combined with the information in the general ledger T-accounts, the income statement would show: Excel Cars Corporation Income Statement For the Year Ended December 31, 2018 Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold: Opening inventory Purchases Transportation-in Less: Purchase returns and allow. Purchase discounts Cost of goods available for sale Less: Ending inventory Cost of goods sold Gross profit and net income

$12,000 $100 58

-012,000 125 (300) (17) 11,808 (2,000)

158 11,842 Ending inventory is counted and valued. The total amount is inserted into the income statement to determine cost of goods sold.

9,808 $ 2,034

Net income remains the same under either the perpetual or periodic inventory system ($2,034). The periodic method is simpler to use than the perpetual inventory system, and is often used by small businesses because the costs of inventory recordkeeping are reduced. However, a perpetual inventory system enables management to compare inventory records to actual goods on hand at a period end to determine if any shrinkage has occurred. This security feature is not present with the periodic inventory system. The extra costs of recordkeeping using a perpetual inventory system are offset by the added control over a high-value asset like inventory, especially when there are thousands of items that a business may buy for re-sale each year and where shrinkage can be a significant issue.

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191

Closing Entries – Periodic Inventory System The process of closing the general ledger temporary accounts to retained earnings at the end of an accounting year is the same under the perpetual or periodic system, with one exception. Under the periodic system, an entry must be made in the Merchandize Inventory account to adjust this balance to the amount of inventory counted and valued at year-end. Otherwise, the steps are the same: Entry 1 All income statement accounts with credit balances are debited to bring them to zero. Their balances are transferred to the income summary account. At the same time, the ending inventory balance ($2,000 in this case) is debited to the Merchandize Inventory account. Dec. 31

(a) Merchandize Inv. (ending) 150 2,000 Sales 500 12,000 Purchase Ret. and Allow. 558 300 Purchase Discounts 559 17 Income Summary 360 14,317 To close all income statement accounts with credit balances to income summary and record ending inventory balance in Merchandize Inventory account.

Entry 2 All income statement accounts with debit balances are credited to bring them to zero. Their balances are transferred to the Income Summary account. At the same time, the opening inventory balance (zero in this case) is credited to the Merchandize Inventory account:

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(b) Dec. 31

Income Summary 360 12,283 Merch. Inv. (opening) 150 -0Sales Return and Allows. 508 100 Sales Discounts 509 58 Purchases 550 12,000 Transportation-In 560 125 To close all income statement accounts with credit balances to income summary and remove opening inventory from the Merchandize Inventory account.

The combined effect of entries 1 and 2 on the Merchandize Inventory account is to adjust it to the actual ending balance at December 31 of $2,000. At the end of this process, the account will show:

Jan. 1

Dec. 31

Opening balance Add: Ending inventory (closing entry posted) Less: Opening inventory (closing entry posted) Ending balance

Merchandize Inventory -02,000 -02,000

Entry 3 The income summary account is closed to the Retained Earnings account. The effect is to transfer temporary account balances in the income summary totalling $2,034 to the permanent general ledger account, Retained Earnings. Dec. 31

(c) Income Summary 360 2,034 Retained Earnings 340 2,034 To close the Income Summary account to the Retained Earnings account.

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193

After these closing entries are posted, the general ledger T-accounts would appear as follows: Cash 3 5,000 1,683 7 4 2,842 125 6,034

Accounts Payable 2 1 300 2,000 3 8 1,700 10,000 10,000

Share Capital 5,000

Retained Earnings c 2,034

Accounts Rec. 6 3,000 100 9 7 9,000 2,900 9,000 5

Merchandize Inventory -0a 2,000 b -02,000

Income Summary b a 12,283 14,317 c 2,034 -0-

Sales 5

a

3,000 9 9,000 12,000 12,000 -0-

Sales Ret. & Allow. 6 100 b 100 -0Sales Discounts 7 58 b

58 -0-

Purchases 2,000 9 10,000 12,000 b 12,000 -01

Purch. Ret. & Allows. 2 300 a 300 -0Purchase Discounts 3 17 a 17 -0Transportation-In 4 125 b 125 -0-

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Opening Inventory Under the periodic inventory system, the ending inventory of one accounting time period becomes the opening inventory of the next accounting time period. Opening inventory is added to purchases each period and ending inventory is deducted to calculate cost of goods sold. Assume that Excel Cars Corporation had the following transactions in 2019, its next accounting year: Opening inventory Plus: Purchases Less: Sales Equals ending inventory

1 vehicle at $2,000 6 vehicles at $2,000 each (5) vehicles at $3,000 each 2 vehicles at $2,000 each

Journal entries are omitted in this example. The gross profit and net income calculations disclosed on the income statement for 2018 and 2019 are shown below. Note that the ending inventory at December 31, 2018 becomes the opening inventory at January 1, 2019. Excel Cars Corporation Income Statement For the Year Ended December 31, 2019

Sales Less: Sales returns and allowances Sales discounts Net sales

2018 $12,000 (100) (58) 11,842

2019 $15,000 -0-015,000

Cost of goods sold Opening inventory Purchases Transportation-in Less: Purchase returns and allow. Purchase discounts Cost of goods available for sale Less: ending inventory Cost of goods sold Gross profit and net income

-012,000 125 (300) (17) 11,808 (2,000) 9,808 $ 2,034

2,000 12,000 -0-0-014,000 (4,000) 10,000 $ 5,000

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Ending inventory for 2018 becomes the opening inventory for 2019.

195

In 2019, seven vehicles are available for sale – one remaining from 2018 and now included as opening inventory at January 1, 2019 plus six purchased in 2019. Cost of goods available for sale therefore equals $14,000 for the 2019 fiscal year (7 x $2,000). Two vehicles are not sold so are shown as ending inventory at December 31, 2019. Their total cost of $4,000 is deducted from cost of goods available for sale to arrive at cost of goods sold for 2019 of $10,000. As was done on 2018, ending inventory amounts would be determined by counting the vehicles on the lot at December 31, 2019 and determining from purchase invoices how much was paid for these. The interrelationship of inventory disclosed in the income statement and statement of financial position using the periodic inventory system can be illustrated as follows: Excel Car Corporation Income Statement For the Year Ended December 31, 2019 Sales Cost of goods sold Opening inventory (Jan. 1, 2019) Cost of goods purchased Cost of goods available Less: Ending inventory (Dec. 31) Cost of goods sold Gross profit and net income

$15,000 $2,000 12,000 14,000 (4,000)

Excel Car Corporation Statement of Financial Position At December 31 2018 Assets Cash $A,000 Accounts receivable B,000 Merchandize inventory 2,000

196

10,000 $ 5,000

2019 $C,000 D,000 4,000

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Closing entries for 2019 would be prepared using the same process as previously described. Entry 1 Dec. 31

(a) Merchandize Inv. (ending) 150 4,000 Sales 500 15,000 Income Summary 360 19,000 To close all income statement accounts with credit balances to the income summary and record ending inventory balance.

Entry 2 Dec. 31

(b) Income Summary 360 14,000 Merch. Inv. (opening) 150 2,000 Purchases 550 12,000 To close all income statement accounts with credit balances to the income summary and remove opening inventory from the Merchandize Inventory account.

The combined effect of entries 1 and 2 on the Merchandize Inventory account is to adjust it to the actual ending balance at December 31, 2019 of $4,000. At the end of this process, the Merchandize Inventory account in the general ledger will show:

Jan. 1

Dec. 31

Opening balance Add: Ending Inventory (closing entry posted) Less: Opening Inventory (closing entry posted) Ending balance

Merchandize Inventory 2,000 4,000 2,000 4,000

The usual entry is made to close the Income Summary account to the Retained Earnings account. Entry 3 (c) Dec. 31

Income Summary 360 5,000 Retained Earnings 340 5,000 To close the Income Summary account to the Retained Earnings account.

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197

Summary of Chapter 5 Learning Objectives LO1 – Describe merchandizing and explain the financial statement components of sales, cost of goods sold, merchandize inventory, and gross profit; differentiate between the perpetual and periodic inventory systems. Merchandizers buy and resell products. Merchandize inventory, an asset, is purchased from suppliers and resold to customers to generate sales revenue. The cost of the merchandize inventory sold is an expense called cost of goods sold. The profit realized on the sale of merchandize inventory before considering any other expenses is called gross profit. Gross profit may be expressed as a dollar amount or as a percentage. To track merchandize inventory and cost of goods sold in real time, a perpetual inventory system is used; the balance in each of Merchandize Inventory and Cost of Goods Sold is always up-to-date. In a periodic inventory system, a physical count of the inventory must be performed in order to determine the balance in Merchandize Inventory and Cost of Goods Sold. LO2 – Analyze and record purchase transactions for a merchandizer. In a perpetual inventory system, a merchandizer debits Merchandize Inventory regarding the purchase of merchandize for resale from a supplier. Any purchase returns and allowances or purchase discounts are credited to Merchandize Inventory as they occur to keep the accounts up-to-date. LO3 – Analyze and record sales transactions for a merchandizer. In a perpetual inventory system, a merchandizer records two entries at the time of sale: one to record the sale and a second to record the cost of the sale. Sales returns that are returned to inventory also require to entries: one to reverse the sale by debiting a sales returns and allowances account and a second to restore the merchandize to inventory by debiting Merchandize Inventory and crediting Cost of Goods Sold. Sales returns not restored to inventory as well as sales allowances are recorded with one entry: debit sales returns and allowances and credit cash or accounts receivable. Sales discounts are recorded when a credit customer submits their payment within the discount period specified.

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LO4 – Record adjustments to merchandize inventory. A physical count of merchandize inventory is performed and the total compared to the general ledger balance of Merchandize Inventory. Discrepancies are recorded as an adjusting entry that debits cost of goods sold and credits Merchandize Inventory. LO5 – Explain and prepare a classified multiple-step income statement for a merchandizer. A classified multiple-step income statement for a merchandizer is for internal use because of the detail provided. Sales, less sales returns and allowances and sales discounts, results in net sales. Net sales less cost of goods sold equals gross profit. Expenses are shown based on both their function and nature. The functional or group headings are: operating expenses, selling expenses, and general and administrative expenses. Within each grouping, the nature of expenses is detailed including: depreciation, salaries, advertizing, wages, and insurance. A specific expense can be divided between groupings. LO6 – Explain the closing process for a merchandizer. The steps in preparing closing entries for a merchandizer are the same as for a service company. The difference is that a merchandizer will need to close income statement accounts unique to merchandizing such as: Sales, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold. LO7 – (Appendix) Explain and identify the entries to record purchase and sales transactions in a periodic inventory system. A periodic inventory system maintains a Merchandize Inventory account but does not have a Cost of Goods Sold account. The Merchandize Inventory account is updated at the end of the accounting period as a result of a physical inventory count. Because a merchandizer using a period system does not use a Merchandize Inventory account to record purchase or sales transactions during the accounting period, it maintains accounts that are different than under a perpetual system, namely, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Transportation-in.

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199

200

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A S S I G N M E N T

M A T E R I A L S

Concept Self-check 1. How does the income statement prepared for a company that sells goods differ from that prepared for a service business? 2. How is gross profit calculated? What relationships do the gross profit and gross profit percentage calculations express? Explain, using an example. 3. What is a perpetual inventory system? 4. How is the purchase of merchandize inventory on credit recorded in a perpetual system? 5. How is a purchase return recorded in a perpetual system? 6. What does the credit term of “1/15, n30” mean? 7. How is a purchase discount recorded in a perpetual system? 8. How is the sale of merchandize inventory on credit recorded in a perpetual system? 9. How is a sales return recorded in a perpetual system? 10. What is a sales discount and how is it recorded in a perpetual inventory system? 11. Why does merchandize inventory need to be adjusted at the end of the accounting period and how is this done in a perpetual inventory system? 12. What types of transactions affect merchandize inventory in a perpetual inventory system? 13. How are the closing entries for a merchandizer using a perpetual inventory system different than for a service company? 14. When reporting expenses on multi-step income statement, how is the function of an expense reported? The nature of an expense? 15. On a classified multiple-step income statement, what is reported under the heading ‘Other revenues and expenses’ and why? 16. (Appendix) Compare the perpetual and periodic inventory systems. What are some advantages of each? 17. (Appendix) What contra accounts are used in conjunction with purchases using the periodic inventory system? 18. (Appendix) How is cost of goods available for sale calculated using the periodic inventory system? 19. (Appendix) How is cost of goods sold calculated using the periodic inventory system?

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201

20. (Appendix) Explain how ending inventory is recorded in the accounts of a business that sells goods using a periodic inventory system.

Comprehension Problems

CP 5–1 Consider the following information of Jones Corporation over four years:

Sales Cost of goods sold Gross profit Gross profit percentage

2021

2020

$10,000 ? 2,500 ?

$9,000 6,840 ? ?

2019

2018

$ ? $7,000 6,160 ? 1,840 ? ? 22%

Required: 1. Calculate the missing amounts for each year. 2. What does this information indicate about the company?

CP 5–2 Reber Corp. uses the perpetual inventory system. Its transactions during July 2018 are as follows: July 6 Purchased $600 of merchandize on account (for credit) from Hobson Corporation for terms 1/10, net 30 9 Returned $200 of defective merchandize 15 Paid the amount owing to Hobson. Required: Prepare journal entries to record the above transactions. Include general ledger account numbers and brief descriptions.

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CP 5–3 Boucher Corporation uses the perpetual inventory system. Its transactions during June 2017 are as follows: June 1 Boucher purchased $1,200 of merchandize inventory from a supplier for terms 1/10, n 60. 3 Boucher sold all of the inventory purchased on June 1 for $1,500 on credit to Wright Inc. for terms 2/10, net 30. 8 Wright returned $800 of defective merchandize purchased June 3 (cost to Boucher: $600). 13 Boucher received payment from Wright Inc. for the balance owed. Required: Prepare journal entries to record the above transactions. Include general ledger account numbers and brief descriptions.

CP 5–4 Horne Inc. and Sperling Renovations Ltd. both sell goods and use the perpetual inventory system. The company had $3,000 of merchandize inventory at the start of its fiscal year, January 1, 2018. During the year, the company had only the following transactions: May Horne sold $4,000 of merchandize on account to Sperling 5 Renovations Ltd. for terms 2/10, net 30. Cost of merchandize to Horne from its supplier was $2,500. 7 Sperling returned $500 of merchandize; Horne issued a credit memo. (Cost of merchandize to Horne was $300) 15 Horne received the amount due from Sperling Renovations Ltd. A physical count and valuation of merchandize inventory at May 31, the fiscal year-end, showed $700 of goods on hand. Required: Prepare journal entries to record the above transactions and adjustment(include general ledger account numbers and brief descriptions): 1. In the records of Horne Inc. 2. In the records of Sperling Renovations Ltd.

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203

CP 5–5 The following information is taken from the records of Smith Corp. at June 30, 2018, the fiscal year-end: Advertizing expense $ 1,500 Commissions expense 4,000 Cost of goods sold 50,000 Delivery expense 1,000 Insurance expense 1,000 Rent expense 2,500 Salaries expense 5,000 Sales (gross) 72,000 Sales returns and allowances 2,000 Required: 1. Prepare a classified income statement. Assume all expenses not related to cost of goods sold are selling expenses. 2. Compute gross profit percentage.

CP 5–6 Refer to the information in CP 5-5. Required: Prepare all closing entries. Include general ledger account numbers as shown in the chapter – for example, Cost of Goods Sold: 570. Include a brief description for each entry.

CP 5–7 (Appendix) Consider the information for each of the following four companies. A Opening inventory Purchases Transportation-in Cost of goods available Ending inventory Cost of goods sold

B

$ ? 1,415 25 1,940 340 ?

$ 184 ? 6 534 200 ?

C $ 112 840 15 ? 135 ?

D $ 750 5,860 ? 6,620 ? 5,740

Required: Calculate the missing amounts.

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CP 5–8 (Appendix) Consider the following information: Opening inventory Purchases Purchase discounts Purchase returns and allowances Transportation-in

$ 375 2,930 5 20 105

Ending inventory amounts to $440. Required: Calculate cost of goods sold.

CP 5–9 (Appendix) The following information is taken from the records of four different companies in the same industry: Sales Opening inventory Purchases Cost of goods available Less: Ending inventory Cost of goods sold Gross profit Gross profit percentage

A $ 300 ? 240 320 ? ? $ 100 ?

B $ 150 40 ? ? (60) 100 $ ? ?

C $

? 40 ? 260 (60) 200 $ 100 ?

D $ 90 12 63 ? (15) 60 $ ? ?

Required: 1. Calculate the missing amounts. 2. Which company seems to be performing best? Why?

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205

CP 5–10 (Appendix) The following balances are taken from the records of Mohan Corp. at December 31, 2018, its first year–end: Transportation-in Delivery expense Sales Purchases Sales returns and allowances Purchase returns and allowances Sales Discounts Purchase discounts Interest expense

$

500 1,200 25,000 20,000 2,000 1,000 400 300 4,000

The inventory at December 31, 2018 amounted to $7,900. Required: 1. Calculate the gross profit. 2. What is the gross profit percentage?

CP 5–11 (Appendix) The following information is taken from the records of O’Donnell Corp. at June 30, 2018, its fiscal year-end: Advertizing expense Commissions expense Delivery expense Insurance expense Opening inventory Purchases Purchase returns and allowances Rent expense Salaries expense Sales (gross) Sales returns and allowances Transportation-in

$ 1,500 4,000 1,000 1,000 6,000 35,000 2,000 2,500 5,000 72,000 2,000 1,000

The merchandize inventory at June 30, 2018 amounted to $10,000. Required: 1. Prepare a classified income statement. Assume all expenses not related to cost of goods sold are selling expenses. 2. Compute gross profit percentage.

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CP 5–12 (Appendix) Refer to the information in CP 5-11. Required: Prepare all closing entries. Include general ledger account numbers as shown in the chapter – for example, Purchases: 550. Include brief descriptions for each entry.

CP 5–13 (Appendix) Sherman Stores Ltd. had the following transactions: Oct. 8 12

Purchased $2,800 of merchandize on account from Morris Wholesalers Corp. for terms 1/10, net 30 Received a credit memo from Morris Wholesalers Corp. for $800 of defective merchandize included in the October 8 purchase and subsequently returned to Morris.

Additional Information: Morris Wholesalers Corp. uses the periodic inventory system. Required: 1. Prepare journal entries in the records of Sherman, assuming that it paid the amount due on a. October 8 b. October 25. 2. Prepare journal entries in the records of Morris Wholesalers Corp., assuming that it received payment on a. October 18 b. October 25. Omit general ledger account numbers and descriptions from the journal entries.

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207

Problems

P 5–1 Salem Corp. was incorporated on July 2, 2018 to operate a merchandizing business. Salem uses the perpetual inventory system. All its sales on account are made according to the following terms: 2/10, n30. Its transactions during July 2018 are as follows: July 2 2 2 3 5 8 8 9 10 10 15 15 15

16 20 20

208

Issued share capital for $5,000 cash to George Salem, the incorporator and sole shareholder of the corporation Purchased $3,500 merchandize on account from Blic Pens Ltd. for terms 2/10, n30 Sold $2,000 of merchandize on account to Spellman Chair Rentals Inc. (Cost to Salem: $1,200) Paid Sayer Holdings Corp. $500 for July rent Paid Easton Furniture Ltd. $1,000 for equipment Collected $200 for a cash sale made today to Ethan Matthews Furniture Ltd. (Cost: $120) Purchased $2,000 merchandize on account from Shaw Distributors Inc. for terms 2/15, n30 Received the amount due from Spellman Chair Rentals Inc. for the July 2 sale (less discount) Paid Blic Pens Ltd. for the July 2 purchase (less discount) Purchased $200 of merchandize on account from Peel Products Inc. for terms n30 Sold $2,000 of merchandize on account to Eagle Products Corp. (Cost: $1,300) Purchased $1,500 of merchandize on account from Bevan Door Inc. for terms 2/10, n30 Received a memo from Shaw Distributors Inc. to reduce its account payable by $100 for defective merchandize included in the July 8 purchase. Eagle Products Corp. returned $200 of merchandize: reduced related Account Payable. (Cost to Salem: $150) Sold $3,500 of merchandize on account to Aspen Promotions Ltd. (Cost: $2,700) Paid Shaw Distributors Inc. for half the purchase made July 8 (less memo amount, less discount on payment)

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24 24 26 26 31

Received half the amount due from Eagle Products Corp. in partial payment for the July 15 sale (less discount on payment) Paid Bevan Doors Ltd. for the purchase made July 15 (less discount) Sold $600 merchandize on account to Longbeach Sales Ltd. (Cost: $400) Purchased $800 of merchandize on account from Silverman Co. for terms 2/10, n30 Paid Speedy Transport Co. $350 for transportation to Salem’s warehouse during the month (all purchases are fob shipping point).

Required: 1. Prepare journal entries to record the July transactions. Include general ledger account numbers and a brief description. 2. Calculate the ending balance in merchandize inventory. 3. Assume the merchandize inventory is counted at July 31 and assigned a total cost of $2,400. Prepare the July 31 adjusting entry. Show calculations.

P 5–2 Randall Sales Corp. was incorporated on May 1, 2018 to operate a merchandizing business. All its sales on account are made according to the following terms: 2/10, n30. Its transactions during May 2018 are as follows: May 1 1 1 1 1 1 2 2 3

Issued share capital for $2,000 cash to Harry Randall, the incorporator and sole shareholder of the corporation Received $10,000 from the First Chance Bank as a demand bank loan Paid Viva Corp. $1,500 for 3 months’ rent in advance—$500 for each of May, June, and July (recorded as an asset) Paid Avanti Equipment Ltd. $5,000 for equipment Purchased $5,000 of merchandize on account from Renaud Wholesalers Ltd. for terms 2/10, n30 Sold $2,500 of merchandize on account to North Vancouver Distributors. (Cost to Randall: $1,700) Purchased $1,800 of merchandize on account from Lilydale Products Ltd. for terms n30 Sold $2,000 of merchandize on account to Tarrabain Sales Inc. (Cost: $1,400) Collected $500 for a cash sale made today to Smith Weston Ltd.

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209

5 5 6 8

8 9 9 10 11 13 15 15 15 19 19 22 22 24 25 26 27

210

Paid All West Insurance Inc. $1,200 for a 1-year insurance policy, effective May l (recorded as an asset) Sold $1,000 of merchandize on account to Trent Stores Corporation. (Cost: $700) Tarrabain Sales Inc. returned $500 of merchandize: reduced the related Account Payable. (Cost: $300) Received a memo from Renaud Wholesalers Ltd. to reduce its account payable by $300 for defective merchandize included in the May 1 purchase and returned subsequently to Renaud Purchased $2,800 of merchandize on account from Pinegrove Novelties Ltd. for terms 2/15, n30 Received the amount due from North Vancouver Distributors from the May 1 sale (less discount) Paid Renaud Wholesalers Corp. for the May 1 purchase (less discount) Sold $400 of merchandize on account to Eastern Warehouse. (Cost: $250) Received the amount due from Tarrabain Sales Inc. (less the May 6 memo and discount) Paid Fast Delivery Corporation $100 for Transportation-In Purchased $1,500 of merchandize on account from James Bay Distributors Inc. for terms 2/10, n30 Sold $1,500 of merchandize on account to Ransom Outlets Inc. (Cost: $1,100) Paid $500 in commissions to Yvonne Smith, re: sales invoices nos. 1, 2, and 3 Paid Lilydale Products Inc. for the May 2 purchase Purchased $1,200 of merchandize on account from Midlife Stores Corp. for terms 1/10, n30 Purchased $600 of merchandize on account from Speedy Sales Co. for terms n30 Paid to Pinegrove Novelties Inc. for the May 8 purchase (less discount) Paid to In Transit Corporation $150 for Transportation-In (fob shipping point) Sold $900 of merchandize on account to Timmins Centres Ltd. (Cost: $650) Received the amount due from Trent Stores Corporation Paid $200 to Intown Deliveries Ltd. for deliveries made to customers

CHAPTER FIVE / Accounting for the Sale of Goods

28 28

Collected $300 for a cash sale made today to Betty Regal. (Cost: $250) Made a $200 cash purchase from Joe Balla Sales Inc.

28

Sold $900 of merchandize on account to Sault Rapids Corp. . (Cost: $700) 29 Purchased $100 of merchandize on account from Amigos Inc. 29 Paid Intown Deliveries Ltd. $300 for deliveries to customers (debited account 620) 29 Paid Main Force Advertizing Agency $400 for advertizing materials used during May 29 Paid State Hydro $100 for electricity 29 Paid Yvonne Smith $350 commission, re: sales invoices nos. 4, 5, 6, and 7 30 Collected $l,000 on account from Ransom Outlets Inc. 31 Paid Midlife Stores Corp. $700 on account Inventory on hand at May 31 was counted and valued at $6,500. Required: Prepare journal entries to record the May transactions and any month-end adjusting entries needed. Show calculations for shrinkage. Include general ledger account numbers and a brief description for each entry.

P 5–3 The following closing entries were prepared for Whirlybird Products Inc. at December 31, 2018, the end of its fiscal year. Dec. 31

31

31

Sales Income Summary

510 360

37,800

Income Summary Cost of Goods Sold Sales Returns and Allowances Sales Discounts Salaries Expenses

360 570 508 509 656

32,800

Income Summary Retained Earnings

360 340

5,000

CHAPTER FIVE / Accounting for the Sale of Goods

37,800

26,800 690 310 5,000

5,000

211

Required: 1. Post the closing entries to general ledger T-accounts and calculate balances. 2. Calculate gross profit.

P 5–4 Southern Cross Corporation supplies you with the following information applicable to the current year, December 31, 2018. The company uses the perpetual inventory system. Delivery expense Sales Merchandize inventory (Dec. 31) Cost of goods sold Office supplies expense Sales returns and allowances Salaries expense Unused supplies

$ 2,000 100,000 15,000 70,000 7,000 10,000 4,000 5,000

Required: 1. Prepare an income statement. List expenses other than cost of goods sold as other expenses. Assume all accounts have normal balances. 2. Prepare all required closing entries. Include general ledger account numbers and a brief description for each entry.

212

CHAPTER FIVE / Accounting for the Sale of Goods

P 5–5 The following trial balance has been extracted from the records of Acme Automotive Inc. at December 31, 2017, its fiscal year-end. The company uses the perpetual inventory system. Account Cash Accounts receivable Merchandize inventory Unused supplies Equipment Bank loan (due May, 2018) Accounts payable Income taxes payable Share capital Retained earnings Sales Sales returns and allowances Sales discounts Cost of goods sold Advertizing expense Commissions expense Delivery expense Insurance expense Interest expense Office supplies expense Rent expense Telephone expense Utilities expense Income taxes expense

Account Balances Dr. Cr. 750 12,000 56,000 -04,400 5,000 12,540 2,400 2,000 600 100,000 –1,500 500 34,000 1,700 4,800 650 450 600 250 1,950 300 290 2,400 $122,540 $122,540

Required: 1. Prepare adjusting entries, including general ledger account numbers and brief descriptions, for the following: a. $1,000 of sales on account has not been recorded. (Cost to Acme: $700) b. A physical count indicates that $100 of office supplies is still on hand at year-end. c. A telephone bill for $60 owing at December 31 has not yet been recorded. d. A physical count indicates that $53,000 of merchandize inventory is on hand at December 31, 2017. CHAPTER FIVE / Accounting for the Sale of Goods

213

2. Prepare a multi-step income statement and statement of changes in equity for the year ended December 31, 2017, and a classified statement of financial position at December 31. 3. Prepare closing entries.

P 5–6 (Appendix) Providence Corp. was incorporated on July 2, 2018 to operate a merchandizing business. All its sales on account are made according to the following terms: 2/10, n30. Its transactions during July 2018 are as follows: July 2 2 2 3 5 8 8 9 10 10 15 15 15

16 20 20 24

214

Issued share capital for $5,000 cash to Pam Providence, the incorporator and sole shareholder of the corporation Purchased $3,500 merchandize on account from Blic Pens Ltd. for terms 2/10, n30 Sold merchandize on account to Spellman Chair Rentals Inc. for $2,000 Paid Sayer Holdings Corp. $500 for July rent Paid Easton Furniture Ltd. $1,000 for equipment Collected $200 for a cash sale made today to Ethan Matthews Furniture Ltd. Purchased $2,000 merchandize on account from Shaw Distributors Inc. for terms 2/15, n30 Received the amount due from Spellman Chair Rentals Inc. for the July 2 sale (less discount) Paid Blic Pens Ltd. for the July 2 purchase (less discount) Purchased $200 of merchandize on account from Peel Products Inc. for terms n30 Sold merchandize on account to Eagle Products Corp. for $2,000 Purchased $1,500 of merchandize on account from Bevan Door Inc. for terms 2/10, n30 Received a memo from Shaw Distributors Inc. to reduce its account payable by $100 for defective merchandize included in the July 8 purchase. Eagle Products Corp. returned $200 of merchandize: reduced related Account Payable. Sold merchandize on account to Aspen Promotions Ltd. for $3,500 Paid Shaw Distributors Inc. for half the purchase made July 8 (less memo amount, less discount on payment) Received half the amount due from Eagle Products Corp. in partial payment for the July 15 sale (less discount on payment)

CHAPTER FIVE / Accounting for the Sale of Goods

24 26 26 31

31

Paid Bevan Doors Inc. for the purchase made July 15 (less discount) Sold merchandize on account to Longbeach Sales Ltd. for $600 Purchased $800 of merchandize on account from Silverman Co. for terms 2/10, n30 Paid Speedy Transport Co. $350 for transportation to Salem’s warehouse during the month (all purchases are fob shipping point). Inventory on hand was counted and valued at $2,000

Assume Providence uses the periodic inventory system. Required: Prepare journal entries to record the July transactions.

P 5–7 (Appendix) Robert Sales Corp. was incorporated on May 1, 2018 to operate a merchandizing business. All its sales on account are made according to the following terms: 2/10, n30. Its transactions during May 2018 are as follows: May 1 1 1 1 1 1 2 2 3 5 5 6

Issued share capital for $2,000 cash to Rob Robert, the incorporator and sole shareholder of the corporation Received $10,000 from the First Chance Bank as a demand bank loan Paid Viva Corp. $1,500 for 3 months’ rent in advance—$500 for each of May, June, and July (recorded as an asset) Paid Avanti Equipment Ltd. $5,000 for equipment Purchased $5,000 of merchandize on account from Renaud Wholesalers Ltd. for terms 2/10, n30 Sold merchandize on account to North Vancouver Distributors for $2,500 Purchased $1,800 of merchandize on account from Lilydale Products Ltd. for terms n30 Sold merchandize on account to Tarrabain Sales Inc. for $2,000 Collected $500 for a cash sale made today to Smith Weston Ltd. Paid All West Insurance Inc. $1,200 for a 1-year insurance policy, effective May l (recorded as an asset) Sold merchandize on account to Trent Stores Corporation for $1,000 Tarrabain Sales Inc. returned $500 of merchandize: reduced the related Account Receivable

CHAPTER FIVE / Accounting for the Sale of Goods

215

8

8 9 9 10 11 13 15 15 15 19 19 22 22 24 25 26 27 28 28 28 29 29 29 29 29 30

216

Received a memo from Renaud Wholesalers Ltd. to reduce its account payable by $300 for defective merchandize included in the May 1 purchase and returned subsequently to Renaud Purchased $2,800 of merchandize on account from Pinegrove Novelties Ltd. for terms 2/15, n30 Received the amount due from North Vancouver Distributors from the May 1 sale (less discount) Paid Renaud Wholesalers Corp. for the May 1 purchase (less discount) Sold merchandize on account to Eastern Warehouse for $400 Received the amount due from Tarrabain Sales Inc. (less the May 6 memo and discount) Paid Fast Delivery Corporation $100 for Transportation-In Purchased $1,500 of merchandize on account from James Bay Distributors Inc. for terms 2/10, n30 Sold merchandize on account to Ransom Outlets Inc. for $1,500 Paid $500 in commissions to Yvonne Smith, re: sales invoices nos. 1, 2, and 3 Paid Lilydale Products Inc. for the May 2 purchase Purchased $1,200 of merchandize on account from Midlife Stores Corp. for terms 1/10, n30 Purchased $600 of merchandize on account from Speedy Sales Co. for terms n30 Paid to Pinegrove Novelties Inc. for the May 8 purchase (less discount) Paid to In Transit Corporation $150 for Transportation-In (fob shipping point) Sold merchandize on account to Timmins Centres Ltd. for $900 Received the amount due from Trent Stores Corporation Paid $200 to Intown Deliveries Ltd. for deliveries made to customers Collected $300 for a cash sale made today to Betty Regal Made a $200 cash purchase from Joe Balla Sales Inc. today; issued cheque #11 (debited purchases) Sold merchandize on account to Sault Rapids Corp. for $900 Purchased $100 of merchandize on account from Amigos Inc. Paid Intown Deliveries Ltd. $300 for deliveries to customers (debited account 620) Paid Main Force Advertizing Agency $400 for advertizing materials used during May Paid State Hydro $100 for electricity Paid Yvonne Smith $350 commission, re: sales invoices nos. 4, 5, 6, and 7 Collected $l,000 on account from Ransom Outlets Inc.

CHAPTER FIVE / Accounting for the Sale of Goods

31 31

Paid Midlife Stores Corp. $700 on account Inventory on hand was counted and valued at $5,000

Assume Robert uses the periodic inventory system. Required: Prepare journal entries to record the May transactions and any month-end adjusting entries needed. Include general ledger account numbers and a brief description for each entry.

P 5–8 (Appendix) The following closing entries were prepared for Zenith Products Inc. at December 31, 2018, the end of its fiscal year. Dec. 31

31

Merchandize Inventory Sales Purchase returns and Allowances Purchase discounts Income Summary

6,000 31,000 575 225

Income Summary Merchandize Inventory Sales Returns and Allowances Sales Discounts Purchases Transportation-In Salaries Expenses

32,800

31 Income Summary Retained Earnings

37,800

4,000 690 310 22,500 300 5,000 5,000 5,000

Required: 1. Post the closing entries to general ledger T-accounts and calculate balances. 2. Prepare a classified, partial income statement, showing sales, cost of goods sold calculations, and gross profit.

CHAPTER FIVE / Accounting for the Sale of Goods

217

P 5–9 (Appendix) Northern Lights Corporation supplies you with the following information applicable to the current year, December 31, 2018. Transportation-in Delivery expense Sales Merchandize inventory (Jan. 1) Merchandize inventory (Dec. 31) Purchases Office supplies expense Purchase discounts Purchase returns and allowances Sales returns and allowances Unused supplies

$ 3,000 2,000 100,000 12,000 15,000 70,000 7,000 4,000 6,000 10,000 5,000

Required: 1. Prepare in proper form a classified, partial income statement including sales, cost of goods sold, and gross profit. 2. Prepare closing entries. 3. What is net income for the year?

218

CHAPTER FIVE / Accounting for the Sale of Goods

P 5–10 (Appendix) The following trial balance has been extracted from the records of Tom’s Trucks Inc. at December 31, 2017, its fiscal year-end. Account Cash Accounts receivable Merchandize inventory (Jan. 1, 2017) Prepaid rent Unused supplies Equipment Bank loan (due Dec. 31, 2021) Accounts payable Income taxes payable Share capital Retained earnings Sales Sales returns and allowances Sales discounts Purchases Purchase returns and allowances Purchase discounts Transportation-in Advertizing expense Commissions expense Delivery expense Insurance expense* Interest expense Supplies expense Rent expense* Telephone expense Utilities expense Income taxes expense

Account Balances Debit Credit 750 12,000 56,000 -0-04,400 5,000 12,540 2,400 2,000 600 – 100,000 1,500 500 35,000 1,700 300 1,000 1,700 4,800 650 450 600 250 1,950 300 290 2,400 $124,540 $124,540

*selling expenses Required: 1. Prepare adjusting entries, including general ledger account numbers and a brief description for each entry, for the following: a. A telephone bill for $60 owing at December 31 has not yet been recorded. b. $600 of sales on account has not been recorded.

CHAPTER FIVE / Accounting for the Sale of Goods

219

c. A physical count indicates that $100 of office supplies is still on hand at year-end. d. A physical count indicates that $58,000 of merchandize inventory is on hand at December 31, 2017. 2. Prepare a classified income statement and statement of changes in equity for the year ended December 31, 2017, and a classified statement of financial position at December 31. 3. Prepare all required closing entries. Include general ledger account numbers and a brief description for each entry.

220

CHAPTER FIVE / Accounting for the Sale of Goods

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