Chapter-06-solutions-financial-accounting

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Chapter 06 Solutions – Financial Accounting

Mba-hrm (Riphah International University)

Studocu is not sponsored or endorsed by any college or university

Chapter 06 Solutions – Financial Accounting

Mba-hrm (Riphah International University)

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Brief

Exercises

B. Ex. 6.1

B. Ex. 6.2

B. Ex. 6.3 Analysis

B. Ex. 6.4

B. Ex. 6.5 Analysis

B. Ex. 6.6

B. Ex. 6.7

B. Ex. 6.8

B. Ex. 6.9

B. Ex. 6.10

B. Ex. 6.11

6.1 1, 6

6.2 1

6.3 2, 5, 8

6.4 3, 8

6.5 Evaluatin

g

p

erformanc

e

6, 8

6.6 3

6.7 4

6.8 4

6.9 5, 8

6.10 Cash discounts 6

6.11 Evaluating performance 8

6.12 3–5

6.13 Periodic inventory system 4, 5

Comparison of inventory

systems

Analysis, communication

Analysis, communication, judgment

Analysis

Communication, judgment

Analysis, communication, judgment

Analysis

Relationships within periodic

inventory systems

Selectin

g

an inventor

y

s

y

ste

m

Analysis, communication, judgment

Analysis, communication

OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL

THINKING CASES

Accounts receivable subsidiary

ledger

Perpetual inventory system –

computation of income

Periodic inventory system –

determine cost of goods sold

2, 3, 8

Periodic inventory system –

inventory balance during year

2, 4, 8 Analysis

2, 4, 8

Computation of gross profit

Special journals 7 Analysis

8 Communication, judgmentEthics, fraud, and corporate

governance

6 Analysis

Sales returns and allowances 6 Analysis

Benefit of taking a purchase

discount

2, 4, 8 Analysis

Periodic inventory system – closing

process

2, 4 Analysis

Periodic inventory system –

working backwards through the

COGS section

2, 8 Analysis

7 Analysis

Learning

To

p

ic Ob

j

ectives Skills

Analysis, communication

Effects of basic merchandising

transactions

Analysis, communication, judgment

Exercises

Understanding inventory cost flows

Ob

j

ectives

Perpetual inventory systems

To

p

ic

Taking a physical inventory

Periodic inventor

y

s

y

stem

s

CHAPTER 6

MERCHANDISING ACTIVITIE

S

Analysis, communication

Skills

You as a student

Analysis

Learnin

g

Overview

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6.14 8

6.15 Using an annual report 8

Problems

Sets A, B

6.1 A,B 1, 3, 8

6.2 A,B 1-3, 6, 8

and interpretation

6.3 A,B 8

6.4 A,B 3, 6

6.5 A,B 3, 6

6.6 A,B 2, 3, 6

6.7 A,B 1, 3, 6

6.8 A,B 1–8

6.1 5

6.2 4, 8

6.3 3–5, 7

6.4 8

& corporate governance)

6.5 8

6.6 8

annual report (Internet) technology

Learning

Ob

j

ectives

Exercises Topic Objectives

To

p

ic

Skills

Learning

Analysis, communication

Analysis, communication, judgment

Trend analysis

Analysis, communication

Income statement preparation

Net cost and gross price methods

Merchandising transactions

Analysts’ evaluation of

company (Business Week)

Evaluating inventory systems

Manipulating income (Ethics, fraud

Real World: CVS Corporation Analysis, communication

Communication, judgment

Critical Thinkin

g

Cases

Real World: GAP Exploring an Communication, research,

Communication, judgment

Selecting an inventory system Communication, judgment

A cost-benefit analysis Analysis, communication, judgment

Analysis, communication, judgment

A comprehensive problem

Analysis, communication, judgment

Difference between income and

cash flows

Analysis, communication

Skills

Evaluating profitability

Analysis, communication, judgment

Correcting Errors – Recording of

Merchandisin

g

Transactions

Accrual Accounting, Cash Flow,

and Fair Value

Overview (p. 2)

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DESCRIPTIONS OF PROBLEMS AND

CRITICAL THINKING CASE

S

Problems (Sets A and B)

35 Medium

6.2 A,B 15 Easy

6.3 A,B 20 Medium

6.4 A,B

6.5 A,B 30 Strong

6.6 A,B 45 Strong

A problem that requires students to evaluate the effects of accounting

errors on various balance sheet and income statement accounts and to

prepare journal entries to correct the errors. The problem requires the

errors to be corrected both assuming that the books remain open and

assuming that the books have already been closed.

Below are brief descriptions of each problem and case. These descriptions are accompanied by the

estimated time (in minutes) required for completion and by a difficulty rating. The time estimates

assume use of the partially filled-in working papers.

6.1 A,B Claypool Hardware/Big Oak Lumber

Hendry’s Boutique/Harry’s Haberdashery

Knauss Supermarkets/Jill’s Department Store

Introduction to both perpetual inventory systems and financial

statement analysis. After making journal entries for merchandising

transactions, students are asked to compare the company’s gross

profit rate with the industry average and draw conclusions.

Siogo Shoes and Sole Mates/Hip Pants and Sleek

Lamprino Appliance/Mary’s TV

Students prepare an income statement for a small retail store using

information from an adjusted trial balance. Using this income

statement, they are asked to compute the company’s gross profit

margin, evaluate customer satisfaction, interpret the meaning of

several accounts, and identify the accounts in the store’s operating

cycle.

Illustrates performance evaluation of a merchandising company using

changes in net sales, sales per square foot of selling space, and

comparable store sales.

King Enterprises/Queen Enterprises

30 Medium

A comprehensive problem on merchandising transactions. Also asks

students to evaluate whether it is worthwhile to take advantage of a

1/10, n/30 cash discount.

A straightforward comparison of the net cost and gross invoice price

methods of recording purchases of merchandise.

Overview Desc.

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Problems (continued)

6.7 A,B 30 Strong

6.8 A,B 40 Strong

Genuine Accessories/Computer Resources

CPI/SUI

A comprehensive problem addressing every learning objective in the

chapter. Closely parallels the Demonstration Problem .

A problem that requires students to calculate gross profit under an

accrual-based system and under a cash-based system, and to explain

the difference between the two computations. Also, students are

introduced to fair value accounting, and are required to prepare a

journal entry to revalue inventory (for loan evaluation purposes) to

fair value.

Overview Desc. (p.2)

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Critical Thinking Cases

Selecting an Inventory System

A Cost-Benefit Analysis

Group Assignment – Evaluating an Inventory System

6.4 Manipulating Income 20 Medium

Ethics, Fraud & Corporate Governance

CVS Is Riding High for Now 15 Medium

Business Week

Exploring the Annual Report of GAP, Inc.

Internet

Students must react to a supervisor’s request to alter financial records in

order to improve the appearance of the company’s financial performance.

6.6 25 Easy

6.5

Students are asked to discuss why prescription drug plans may reduce the

gross margin of CVS, a giant drug store chain.

Visit the home page of Gap, Inc., and gather financial information to

evaluate sales performance.

25 Medium

35 Medium

6.3 No time estimate

Students are to visit two local businesses to gain an understanding of the

inventory systems in use. They are then asked to evaluate those systems in

terms of the information needs and resources of the businesses.

6.2

6.1

Students are asked the type of inventory system they would expect to find

in various types of business operations. Leads to an open-ended discussion

of why different types of businesses maintain different types of inventory

systems. A very practical assignment.

Using the company’s markup policy, students are asked to determine the

amount of shrinkage loss included in the cost of goods sold in a business

using a periodic inventory system. Having determined the amount of loss,

they then are asked to evaluate the economic benefit of hiring a security

guard.

Desc. of Prob & Cases

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1.

2.

3.

4.

5.

6.

7.

8.

Inventory shrinkage refers to the decrease (shrinkage) in inventory resulting from such

factors as theft, breakage, and spoilage. In a company using a perpetual inventory system,

shrinkage is measured and accounted for by taking a physical inventory and adjusting the

accounting records to reflect the actual quantities on hand.

In a perpetual inventory system, ledger accounts for inventory and the cost of goods sold are

kept perpetually up-to-date. The Inventory account is debited whenever goods are purchased.

When sales occur, Cost of Goods Sold is debited and Inventory is credited for the cost of the

merchandise sold. An inventory subsidiary ledger is maintained showing the cost and

quantity of every type of product in the inventory.

The operating cycle of a business is the sequence of transactions by which the company

normally generates its revenue and its cash receipts from customers. In a merchandising

company, this cycle includes: (1) purchasing merchandise; (2) selling merchandise, often on

account; and (3) collecting accounts receivable from customers.

Both wholesalers and retailers are merchandising companies and, therefore, buy their

inventory in a ready-to-sell condition. Wholesalers, however, buy large quantities of

merchandise directly from manufacturers and then sell this merchandise in smaller quantities

to many different retailers. Wholesalers usually operate from a central location and do not

sell directly to the final consumer. Retailers, in contrast, buy from wholesalers and then resell

the merchandise to the final consumer.

General ledger accounts show the total amounts of various assets, liabilities, revenue, and

expenses. While these total amounts are used in financial statements, company personnel

need more detailed information about the items comprising these totals. This detail is

provided in subsidiary ledgers. Subsidiary ledgers are needed to show the amounts

receivable from individual customers, the amounts owed to individual creditors, and the

quantities and costs of the specific products in inventory.

In summary, wholesalers emphasize distribution of the product to the places (retailers) where

it is needed. Retailers specialize in meeting the needs of their local customers.

The cost of goods sold appears in the income statement of any business that sells

merchandise, but not in the income statement of a business that sells only services. The cost

of goods sold represents the original cost to the seller of the merchandise it sells.

Green Bay Company is not necessarily more profitable than New England Company.

Profitability is measured by net income, not by gross profit. For a merchandising company

(or manufacturer) to earn a net income, its gross profit must exceed its expenses (including

nonoperating items). Green Bay’s gross profit exceeds that of New England by $70,000.

However, if Green Bay’s operating expenses (and nonoperating items) exceed those of New

England by more than $70,000, New England is the more profitable company.

Revenue from sales amounts to $1,070,000 (gross profit, $432,000, plus cost of goods sold,

$638,000). Net income is equal to $42,000 (gross profit, $432,000, minus expenses,

$390,000).

Q1-7

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9.

10.

11. a.

b.

12. A balance arises in the Purchase Discounts Lost account when the company fails to take

advantage of an available cash discount and, therefore, pays more than the net cost of the

merchandise.

In most well-managed companies, management has a policy of taking all available cash

discounts. Therefore, the balance in the Purchase Discounts Lost account represents a cost

arising from failure to adhere to this policy. If this balance becomes significant, management

will take corrective action to assure that the company does take advantage of future discount

opportunities.

8.cont In a periodic inventory system, up-to-date records are not maintained either for inventory or

for the cost of goods sold. The beginning and ending inventory are determined by a physical

count. Purchases are recorded in a Purchases account, and no entries are made to record the

cost of individual sales transactions. Rather, the cost of goods sold is determined by a

computation made at the end of the year (beginning inventory, plus purchases, minus ending

inventory).

(a) $51,500; (b) $65,000; (c) $49,800; (d) $61,600.

Special journals are used to record transactions that occur frequently. A general journal

is still used for recording unusual transactions that do not fit the format of any special

journal.

The statement is correct. A perpetual inventory system requires an entry updating the inventory

records as each item of merchandise is sold. In the days of manual accounting systems, only

businesses that sold a small number of high-cost items could use a perpetual system. For

example, perpetual inventory systems were used in auto dealerships and jewelry stores, but not

in supermarkets.

A general journal is capable of recording any type of business transaction. However,

recording transactions in this type of journal is a relatively slow and cumbersome

p

rocess. In addition, the person maintaining the journal must have sufficient background

in accounting to correctly interpret all types of accounting transactions. Also, because

the journal is used to record all types of transactions, it must remain in the accounting

department, rather than being located “in the field” where a specific type of transaction

occurs.

A special journal is an accounting record or device that is designed for recording one

specific type of transaction in a highly efficient manner. As the journal is used only in

recording one type of transaction, the person maintaining the journal usually does not

require an extensive background in accounting. Also, the journal may be located in the

field where the transactions occur.

Today, point-of-sale terminals have made perpetual inventory systems available to almost

every type of business. These terminals “read” identification codes attached to each item of

merchandise; the computer then looks up both the sales price and the cost of the merchandise

in computer-based files and records the sale instantly.

Q8-12

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14.

15.

16.

17.

18.

This is equivalent to an investment with a rate of return of approximately 29% (4%  36550 =

29.2%).

The financial statements would not include sales tax expense because sales taxes are not an

expense of the business entity. Rather, these taxes are collected from the customer and

forwarded by the business to the state government. Until the taxes have been sent to the

governmental authorities, a liability for sales taxes payable does appear in the balance sheet of

the business. (The entry to record the collection of sales taxes consists of a debit to Cash or

Accounts Receivable and a credit to Sales Taxes Payable.)

13. The freight charges should not be charged to delivery expense. Delivery expense is a selling

expense, matched with (offset against) the sales revenue of the current period. Freight charges on

inbound shipments are part of the cost of acquiring the inventory, not an expense of the current

period. Transportation charges on inbound shipments should be added to the cost of the

purchased merchandise or, as a matter of practical convenience, included in the cost of goods

sold during the period.

Yes; Outback should take advantage of 4/10, n/60 cash discounts even if it must borrow the

money to do so at an annual rate of 13%. Paying 50 days earlier and taking the discount saves

4%.

An increase in net sales normally is viewed as a positive change. But to evaluate a specific

company’s performance, it is necessary to determine the reasons for this change, and the overall

financial impact.

Gross profit margin, also called gross profit rate, is gross profit expressed as a percentage of

net sales revenue. It may be computed for the company as a whole (the overall gross profit

margin), for specific sales departments, and for individual products. Management often may

improve the company’s overall profit margin by raising sales prices or by concentrating sales

efforts on products with higher margins. In a manufacturing company, management often is able

to increase margins by reducing the cost of manufacturing the merchandise that the company

sells.

To sellers, the “cost” of offering cash discounts is the resulting reduction in revenue. This cost is

measured by initially recording the account receivable from the customer at the full invoice

price and then recording any discounts taken by customers in a separate account (Sales

Discounts).

Buyers, however, incur a cost when discounts are lost, not when they are taken. Therefore,

buyers design their accounting systems to measure any discounts lost. This is accomplished by

initially recording the account payable to the supplier at net cost—that is, net of any allowable

cash discounts. This practice means that any discounts lost must be recorded in a separate

expense account.

The increase in net sales is a good sign, but it does not necessarily mean the company’s

marketing strategies have been successful. This increase might have stemmed entirely from the

opening of new stores, or from inflation. Also, an increase in net sales does not mean that gross

profit has increased. Perhaps this increase in sales stemmed from selling more low-margin

merchandise, in which case, gross profit might even have declined. In that case this would have

been an unsuccessful marketing strategy.

Q13-18

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20. An inventory subsidiary ledger is maintained under a perpetual inventory system but not under a

periodic inventory system. Under a perpetual inventory system, each purchase and sale of

individual inventory items is tracked. Under a periodic inventory system, the actual physical

quantity of inventory items on hand is only determined at the time that a physical inventory

count is taken, typically once a year.

19. Even companies that use a perpetual inventory system will generally complete a physical count

of their merchandise inventory at least once a year to compare their actual physical inventory

with what the perpetual inventory records indicate should be on hand. There are typically

differences between the physical count of inventory and what the perpetual records indicate due

to breakage, spoilage, and employee and customer theft. This difference is referred to as

“shrink(age)” in the retail industry – one of the truly great euphemisms of all time -and is a

closely watched performance metric by management in the retail industry.

Q19-20

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SOLUTIONS TO BRIEF EXERCISES

Office Today’s gross profit is $160 million ($800 million – $640 million). Its gross

profit percentage is 20% ($160 million/$800 million). Office Today’s gross profit

should provide the company with the ability to cover other expenses and to provide a

return to its shareholders.

The accounts receivable balance in the general ledger should be $850, the total of the

customer accounts with debit balances. The two customer accounts with credit

balances would be reclassified as accounts payable.

Alberto & Sons’ gross profit for October is $1,500, the $30 gross profit on each item

($80 selling price – $50 cost) multiplied by the 50 units sold during October.

B. Ex 6.1

B. Ex. 6.2

B. Ex. 6.3

The balance in Neel & Neal’s inventory account at February 1st would be $300,000,

the same balance as of the beginning of the year. Under a periodic inventory system,

the inventory account balance on the balance sheet is only updated when a physical

inventory count is taken, which generally only occurs on a yearly basis. Please note

that the inventory balance cannot be computed by adding the $250,000 of inventory

purchases to the beginning inventory balance, and then subtracting the $400,000 in

sales. The inventory account balance is generally stated at the cost of the inventory

items purchased, whereas the $400,000 of sales is recorded at the retail price at which

the goods are sold.

The cost of goods sold for Murphy Co. is $650,000. Add the purchases of $600,000 to

the beginning inventory of $300,000, and then subtract the $250,000 of ending

inventory.

B. Ex. 6.5

B. Ex 6.6 Yang & Min Inc. purchased $600,000 of goods during the year. Since Yang & Min

had an ending inventory of $200,000 and cost of goods sold of $500,000, we then know

that Yang & Min had goods available for sale of $700,000 (all goods available for sale

are either sold – cost of goods sold – or are still held at the end of the year – inventory).

Goods available for sale either existed at the beginning of the year – beginning

inventory – or were purchased during the year – purchases. Since Yang & Min’s goods

available for sale are $700,000 and its beginning inventory is $100,000 Yang & Min

must have purchased $600,000 of goods during the year.

B. Ex. 6.4

BE6.1-6

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330,000

Inventory (beginning balance)…………… 80,000

Purchases…………………………………. 250,000

30,000

Cost of Goods Sold……………………….. 30,000

300,000

Cost of Goods Sold……………………….. 300,000

To reduce the balance of the Cost of Goods Sold

account by the cost of merchandise still on hand at

year-end.

Income Summary…………………………………..

To close the Cost of Goods Sold account to Income

Summary.

Pag Inc.’s equivalent annual rate of return by always paying its bills within the

discount period, and thereby receiving a 1% cash discount on the amount of its

purchases, is 18.25% (1% x 365/20).

B. Ex. 6.8

Cost of Goods Sold…………………………………

To close the accounts contributing to the cost of

goods sold for the year.

Inventory (ending balance)………………………..

B. Ex 6.7

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