Chapter 05 Solution of fundamental of financial accouting by EDMONDS (4th edition)

ANSWERS TO QUESTIONS - CHAPTER 5

1. The term “inventory” includes a supply of goods that is available or in the process of being available for sale to customers. Inventory also includes stores of goods that are used in the process of operating the business. Some examples of inventory include items that are available for sale to customers, i.e., computers at a computer sales store. It also includes goods in the process of being manufactured, i.e., computer components for a computer manufacturer. Inventory also includes stock of office supplies and operating supplies, i.e., stamps, paper, envelopes, paper bags, and plastic bags.

2. Merchandise inventory is finished goods that are held for sale to customers. The term “inventory” is more broad and includes stocks of supplies for use in the business operations. Costs that are included in “merchandise inventory” include the cost of the product, transportation-in costs, packaging costs, transit insurance, etc.

3. Product costs are costs associated with goods for resale, usually inventory costs. Period costs are costs that are not directly traceable to products, for example, operating expenses.

4. Cost of goods available for sale is the total of inventory on hand at the beginning of the period plus inventory purchased during the period.

5. The cost of the items that have not been sold are allocated to merchandise inventory (asset) and are shown on the balance sheet. The cost of the items that have been sold are allocated to cost of goods sold (expense) and are shown on the income statement.

6. Period costs are expensed in the period they are incurred or used. Product costs are expensed in the period in which the inventory is sold.

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7. Net Sales $600,000Cost of Goods Sold (375,000)Gross Margin $225,000

Cost of Goods Available for Sale$450,000Cost of Goods Sold (375,000)Ending Merchandise Inventory$ 75,000

8. Under a perpetual inventory system, the balance in the inventory account is increased each time goods are purchased and decreased each time goods are sold. Under the periodic inventory system, the inventory balance is adjusted only at the end of the period. The major advantage of the perpetual system is the inventory account will reflect changes to inventory on a continual basis. The primary advantage of the periodic method is recording efficiency. It is not necessary to increase and decrease inventory when goods are bought and sold.

A physical inventory should be taken regardless of the method used. When using the periodic method, it is necessary to take a physical count in order to adjust the inventory account to the correct balance and record the cost of the goods sold. A physical count is necessary under the perpetual method in order to adjust the balance of the inventory account for items that have been lost, stolen, or damaged.

9. a. Assets increase, stockholders’ equity increases - The balance sheet, statement of cash flows, and statement of changes in stockholders’ equity are affected.

b. Assets increase, stockholders’ equity increases - This is similar to an acquisition of cash capital from the owner except that inventory and not cash is increased. The balance sheet and statement of changes in stockholders’ equity are affected. The statement of cash flows is not affected.

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c. This is an asset exchange and total assets would not change. The balance sheet and statement of cash flows are affected.

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d. Assets both increase and decrease (cash increases, inventory decreases) and stockholders’ equity both increases and decreases (revenue is increased and cost of goods sold is increased). The balance sheet, income statement, statement of changes in stockholders’ equity, and statement of cash flows are affected.

10. Assets would both increase and decrease (cash increases by $20,000 and inventory decreases by $12,000) and stockholders’ equity both increases and decreases (revenue is increased by $20,000 and cost of goods sold is increased by $12,000). All four financial statements are affected.

11. Shipping cost of goods shipped F.O.B. shipping point will be paid by the buyer of the goods.

12. Transportation-in is the cost of freight and shipping charges on goods purchased. It is a product cost because it is a part of the cost of the goods purchased.

13. The $80 transportation-in is a product cost and is debited to the Merchandise Inventory account. The $135 transportation-out is a period cost and is debited to the expense account Transportation-out.

14. When allowances are granted it is usually because the customer received inferior or damaged merchandise. When granting an allowance, the seller does not take back the goods and saves the cost of shipping and replacing the product. In addition, it saves time in handling the problem.

15. 2/10, n/30 means that a 2% discount may be taken off of the selling price if payment is made within ten days of the invoice date. If the discount is not taken, the amount of the invoice is due in 30 days.

16. If the $5,000 is for the purchase of inventory, this is an asset exchange in that inventory is increased and cash is decreased. A $5,000 payment for commissions is an asset

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use transaction; assets are decreased and stockholders’ equity is decreased (commissions expense is increased).

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17. Cash discounts are offered to customers to encourage prompt payment.

18. Transportation-out is the freight or shipping cost on goods sold. It is a period cost.

19. Purchase returns refer to the situation where the buyer of the goods returns them. Sales returns refer to the situation where goods sold by the seller are returned to the seller. Generally a sales return on the seller's books is a purchase return on the buyer's books. Sales returns cause an increase in assets (inventory) to the seller as previously sold merchandise is returned. Stockholders’ equity is increased as cost of goods sold is reduced by the original cost of the goods. A sales return will also cause a reduction of cash or accounts receivable as money must be refunded or credit given on accounts receivable. Stockholders’ equity will decrease by a corresponding reduction in revenue. The net effect of a sales return is to decrease assets and decrease stockholders’ equity. Purchase returns are either an asset exchange or asset use. Either cash is increased or accounts payable is decreased and merchandise inventory is decreased.

20. Net sales is gross sales less sales returns and allowances

and less sales discounts.

21. The multistep income statement provides more information on the results of various business activities. For example, net income from operations is computed separately from other gains and losses. Also, any unusual items are reported separately from normal operating activities. The single-step income statement shows a single comparison of total revenues with total expenses.

22. When using the periodic method of accounting for inventory, the schedule of cost of goods sold is prepared to determine the dollar amount of the cost of sales. It is generally used only for internal reporting purposes.

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23. The periodic inventory system does not separate the cost of lost, damaged, or stolen merchandise from the cost of goods sold. This system fails to provide management with information necessary to make decisions on controlling such inventory losses.

24. Common size income statements covering several accounting periods help management identify changes and trends in various operating costs relative to sales. For example, net income may be increasing from year-to-year, yet may be declining as a percentage of sales. Comparison of common size income statements over several years will help management identify which expenses have been rising disproportionately with sales and take corrective action.

25. The return on sales ratio is the amount of net income generated per dollar of sales. The ratio is computed by dividing net income by net sales.

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Note to Instructors: In this chapter the term “net sales” is used in the income statement for all exercises and problems using the perpetual method since any sales discounts, returns and allowances will be reflected in the balance to the Sales Revenue account.

SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 5

EXERCISE 5-1Aa.

Darwin ConsultingIncome Statement

For the Year Ended 20XX

RevenueConsulting Revenue $12,00

0

ExpensesSalaries Expense (7,200)

Net Income $4,800

Darwin Consulting Balance Sheet

As of the End of the Year 20XX

AssetsCash $14,80

0Total Assets $14,80

0

LiabilitiesNotes Payable $10,000

Total Liabilities $10,000

Stockholders’ EquityRetained Earnings 4,800

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Total Stockholders’ Equity 4,800

Total Liab. and Stockholders’ Equity

$14,800

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EXERCISE 5-1A a. (cont.)

Darwin ConsultingStatement of Cash Flows

For Year Ended 20XX

Cash Flows From Operating Activities:

Inflow from Revenue $12,000Outflow for Salaries (7,200)

Net Cash Flow from Operating Activ.

$ 4,800

Cash Flows From Investing Activities

-0-

Cash Flows From Financing Activities:

Inflow from Loan 10,000Net Cash Flow from Financing Activ.

10,000

Net Increase in Cash 14,800Plus: Beginning Cash Balance -0-Ending Cash Balance $14,800

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University Book MartIncome Statement

For the Year Ended 20XX

Net Sales $12,000

Cost of Goods Sold (6,500)

Gross Margin 5,500

ExpensesOperating Expenses (700)

Net Income $4,800

University Book MartBalance Sheet

As of the End of the Year 20XX

AssetsCash $13,050Merchandise Inventory 1,750

Total Assets $14,800






$14,800

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EXERCISE 5-1Aa. (cont.)

University Book MartStatement of Cash Flows

For Year Ended 20XX


Inflow from Revenue $12,000Outflow for Inventory (8,250)Outflow for Operating Expense (700)

Net Cash Flow from Operating Activities

$3,050


-0-


Inflow from Loan 10,000Net Cash Flow from Financing Activities

10,000


b. Darwin Consulting is a service business and has service revenue and expenses. Notice that University Book Mart is a merchandising business and has sales, cost of goods sold (with the calculation of gross margin), and operating expenses.

c. The only difference in the balance sheets of the two businesses is in the type of assets each owns. Darwin’s only asset is cash, while University Book Mart has both cash and inventory.

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d. The cash flows from operating activities section of the statement of cash flow is different for the two businesses. Darwin only had cash outflow for the salaries of $7,200, while University Book Mart had a cash outflow for both the purchase of inventory and the payment of operating expenses. Darwin has a larger ending cash balance because part of University Book Mart’s assets is in inventory.

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EXERCISE 5-2Aa.

Hope Jackson MerchandisingGeneral Journal, 2006

Date Account Titles Debit Credit

1. Cash 25,000Common Stock 25,000

2. Merchandise Inventory 22,000Cash 22,000

3a. Cash 24,000Sales Revenue 24,000

3b. Cost of Goods Sold 17,000Merchandise Inventory 17,000

b.T-Accounts

Assets = Stockholders’ Equity

Cash Common Stock1. 25,000 2.22,000 1. 25,0003a.24,000

Bal.25,000

Bal.27,000

Sales RevenueMerchandise

Inventory3a.24,000

2. 22,000 3b.17,000

Bal.24,000

Bal.5,000Cost of Goods Sold

3b.17,000Bal.17,000

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EXERCISE 5-2A (cont.)c.

Hope Jackson MerchandisingIncome Statement

For the Year Ended December 31, 2006

Net Sales $24,000


Gross Margin 7,000

Operating Expenses -0-

Operating Income $ 7,000

d. Total assets: $32,000 (Cash $27,000 + Inventory $5,000).

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EXERCISE 5-3A a.Stonebrook Merchandising Co. Effect of Events on the Financial Statements

Events Balance Sheet Income StatementStatement ofCash Flows

Assets Liab. Stkholders’ Equity Rev. Exp. Net Inc.Cash A. Rec. Mdse. Inv. A. Pay. C. Stk.Ret. Ear.

Beg. Bal. 48,000 NA NA NA 48,000 NA NA NA NA NA1. Pur. Inv.

NA NA 50,000 50,000 NA NA NA NA NA NA

2. Sold Inv.

NA 56,000 NA NA NA 56,000 56,000 NA 56,000 NA

3. Inv. Cost

NA NA (36,000) NA NA (36,000) NA 36,000 (36,000) NA

4. Pd. AP (30,000) NA NA (30,000) NA NA NA NA NA (30,000) OA5. Coll. AR 40,000 (40,000) NA NA NA NA NA NA NA 40,000 OA6. Pd. Exp. (8,000) NA NA NA NA (8,000) NA 8,000 (8,000) (8,000) OA

End. Bal. 50,000 16,000 14,000 20,000 48,000 12,000 56,000 44,000 12,000 2,000 NC

b. $16,000

c. $20,000

d. Sales $56,000Cost of Goods Sold (36,000 ) Gross Margin 20,000Operating Exp. (8,000)Net Income $12,000

e. Cash Flows From Operating Activities:Inflow from Customers $40,000Outflow for Inventory (30,000)Outflow for Expenses (8,000)

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Net Cash Flow from Operating Activities $ 2,000

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EXERCISE 5-3A (cont.)

f. Net income is $12,000 and net cash flow from operating activities is only $2,000, a difference of $10,000. Revenue earned amounted to $56,000 but only $40,000 was collected. Expenses actually incurred amounted to $44,000, but only $38,000 of the expense was paid for. $16,000 more revenue was earned than collected, and $6,000 more expense was incurred than paid. This accounts for the $10,000 difference in net income and cash flow from operating activities.

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EXERCISE 5-4Aa.

Mary’s Beauty SupplyGeneral Journal for 2006






4. Advertising Expense 600Cash 600

b.T-Accounts


Cash Common Stock Sales Revenue1. 10,000 2. 7,000 1. 10,000 3a. 7,8003a. 7,800 4. 600 Bal.

10,000Bal.7,800

Bal.10,200

Cost of Goods Sold

Mdse. Inventory 3b. 5,2002. 7,000 3b.

5,200Bal. 5,200

Bal.1,800Advertising

Expense

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4. 600Bal. 600

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Mary’s Beauty SupplyTrial Balance

December 31, 2006

Account Titles Debit Credit

Cash $10,200Merchandise Inventory 1,800Common Stock $10,000Sales Revenue 7,800Cost of Goods Sold 5,200Advertising Expense 600

Totals $17,800 $17,800

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EXERCISE 5-5A

a. buyerb. sellerc. buyerd. seller

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EXERCISE 5-6Aa.

The Gift ShopGeneral Journal for 2003


1. Merchandise Inventory 5,500Accounts Payable 5,500

2. Merchandise Inventory 250Cash 250

3. Accounts Payable 800Merchandise Inventory 800




6. Transportation-out 200Cash 200

7. Accounts Payable 4,000Cash 4,000

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EXERCISE 5-6A (cont.)b.

The Gift ShopT-Accounts

Assets = Liabilities + Stockholders’ Equity

Cash Accounts Payable Common StockBal.8,000 3. 800 1. 5,500 Bal.

10,0005a. 7,750 2. 250 4. 350

6. 200 7. 4,000 Retained Earnings7. 4,000 Bal. 350 Bal. 1,000

Bal.11,300

Sales RevenueMdse. Inventory 5a. 7,750

Bal.3,000 Bal. 7,7501. 5,500 3. 8002. 250 4. 350 Cost of Goods

Sold5b. 4,000

5b. 4,000

Bal.3,600 Bal.4,000

Transportation-out

6. 200Bal. 200

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The Gift ShopIncome Statement


Net Sales $7,750


Gross Margin 3,750

Operating ExpensesTransportation-out (200)

Operating Income $3,550

The Gift ShopStatement of Cash Flows



Inflow from Customers $7,750Outflow for Merchandise

Inventory(4,250)

Outflow for Expenses (200)Net Cash Flow from Operating Activities

$ 3,300


-0-

Cash Flows From Financing Activities

-0-

Net Change in Cash 3,300Plus: Beginning Cash Balance 8,000Ending Cash Balance $11,300

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d. The difference between net income and net cash flow from operating activities is caused by the shop not selling all of the inventory that it purchased during the period. The cash payment for inventory is included in the statement of cash flows, but only the portion of that payment allocated to goods actually sold is included on the income statement.

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EXERCISE 5-7A

Transaction Debited to Inventory

1. Purchase of inventory Yes2. Allowance for damaged inventory

No

3. Transportation-out No4. Purchase discount No5. Transportation-in Yes6. Purchase computer No

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EXERCISE 5-8Aa.Transaction

Period Costs

Product Costs

Not Applicable

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

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Turner Company Horizontal Statements Model for 2003

Balance Sheet Income Statement Statement of

Assets = Liab. + Stkholders’ Equity

Rev. Exp. =Net Inc. Cash Flows

Cash + A. Rec. + Mdse. Inv.

= A. Pay. +C. Stk.+Ret. Ear.

1. Stock 2,500 + NA + NA = NA +2,500 + NA NA NA = NA 2,500 FA 2. Pur Inv.

NA + NA + 14,000 14,000 + NA + NA NA NA = NA NA

3. Freight (150)+ NA + 150 = NA + NA + NA NA NA = NA (150)OA

4. Ret. Inv.

NA + NA + (600) = (600) + NA + NA NA NA = NA NA

5. Sold Inv.

NA + 14,350 + NA = NA + NA + 14,350 14,350

NA =14,350 NA

5. Cost NA + NA + (8,250) = NA + NA + (8,250) NA 8,250 = (8,250) NA 6. Pd. Frt. (60)+ NA + NA = NA + NA + (60) NA 60 = (60) (60)

OA 7. Coll. AR

11,750 +(11,750)

+ NA = NA + NA + NA NA NA = NA 11,750 OA

8. Pd. AP (10,000)

+ NA + NA =(10,000)

+ NA + NA NA NA = NA (10,000)OA

9. Pd. Exp.

(275)+ NA + NA = NA + NA + (275) NA 275 = (275) (275)OA

10. Pd. Exp.

(500)+ NA + NA = NA + NA + (500) NA 500 = (500) (500)OA

End. Bal. 3,265 + 2,600 + 5,300 = 3,400 +2,500 + 5,265 14,350

9,085 = 5,265 3,265 NC

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EXERCISE 5-9A

a. Purchase $12,400Less, return (2,400 ) Gross due (subject of the discount)10,000Discount percentage x2 % Amount of discount $ 200

Gross amount due $10,000Less, discount ( 200 ) Net amount due $ 9,800

b.Event Account title Debit Credit

Pur. Merchandise Inventory 12,400Accounts Payable 12,400

Return Accounts Payable 2,400Merchandise Inventory 2,400

Payment

Accounts Payable 200

Merchandise Inventory 200Accounts Payable 9,800

Cash 9,800

c. $10,000; he would not be eligible for the discount.

d. The Glass Exchange would be willing to give a discount for prompt payment of the account. The quicker The Glass Exchange can convert accounts receivable into cash, the quicker the company can pay its debts or buy additional inventory.

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EXERCISE 5-10Aa.

Upton CompanyGeneral Journal for 2002


1a. Accounts Receivable 90,800Sales Revenue 90,800


2. Transportation-out 2,600Cash 2,600

3a. Sales Revenue 8,800Accounts Receivable 8,800

3b. Merchandise Inventory 5,600Cost of Goods Sold 5,600

4. Sales Revenue 3,400Accounts Receivable 3,400

5. Cash 56,000Accounts Receivable 56,000

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Upton CompanyT-Accounts for 2002


Cash Common Stock Retained EarningsBal.

13,000Bal.40,000

Bal.43,000

5. 56,000 2. 2,600Bal.

66,400Sales Revenue

3a. 8,800 1a.90,800

Accounts Receivable

4. 3,400

1a.90,800 3a.8,800 Bal.78,600

4. 3,4005.56,000

Cost of Goods Sold

Bal.22,600

1b.60,400

3b.5,600

Bal.54,800

Mdse. InventoryBal.70,000

1b.60,400

Transportation-out

3b. 5,600 2. 2,600Bal.

15,200Bal. 2,600

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Upton CompanyFinancial Statements


Income Statement

Net Sales $78,600


Gross Margin 23,800

Operating ExpensesTransportation-out (2,600)


Balance Sheet

AssetsCash

$66,400Accounts Receivable 22,600Merchandise Inventory 15,200


Liabilities $ -0-

Stockholders’ EquityCommon Stock

$40,000Retained Earnings 64,200


Total Liabilities and Stockholders’ Equity

$104,200

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EXERCISE 5-10A c. (cont.)

Upton CompanyFinancial Statements


Statement of Cash Flows


Inflow from Customers $56,000Outflow for Expenses (2,600)


$53,400


-0-


-0-


0

d. Upton Company would grant an allowance to Jones for several reasons. First, Jones already has the goods and if he keeps them it will save the expense of a return. If the goods are damaged, then Upton will either have to repair the merchandise or sell them to another customer at a reduced price. Also, assuming Jones can sell the goods, he already has them in stock and will not have to wait on another shipment. Also, he is getting the goods at a reduced price. This arrangement can benefit both buyer and seller.

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EXERCISE 5-11Aa.

Stone SalesGeneral Journal for 2005




3a. Accounts Payable 720Merchandise Inventory 720

3b. Accounts Payable 35,280Cash 35,280



5a. Sales Revenue 300Accounts Receivable 300

5b. Cash 29,700Accounts Receivable 29,700

6. Operating Expenses 7,600Cash 7,600

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Stone SalesT-Accounts for 2005


Cash Accounts Payable Common Stock1. 60,000 3b.

35,2803a. 720 2.

36,0001. 60,000

5b.29,700

6. 7,600 3b.35,280

Bal.60,000

Bal.46,820

Bal. -0-

Sales RevenueAccounts

Receivable5a. 300 4a.30,000

4a.30,000

5a. 300 Bal.29,700

5b.29,700

Bal. -0-Cost of Goods Sold

Mdse. Inventory 4b.20,000

2. 36,000 3a. 720 Bal.20,000

4b.20,000

Bal.15,280

Operating Expenses

6. 7,600Bal. 7,600

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Stone Sales Horizontal Statements Model for 2005


Income Statement Statement of

Cash + A. Rec. + M. Inv. = A. Pay. +C. Stk.+ Ret. Ear

Rev. Exp. = Net Inc.

Cash Flows

1. Stock 60,000 + NA + NA = NA +60,000

+ NA NA NA = NA 60,000 FA

2. Pur. Inv.

NA + NA + 36,000 =36,000 + NA + NA NA NA = NA NA

3a. Disc. NA + NA + (720) = (720)+ NA + NA NA NA = NA NA 3b. Pd. AP (35,280

)+ NA + NA = (35,28

0)+ NA + NA NA NA = NA (35,280)

OA 4a. Sold Inv.

NA +30,000 + NA = NA + NA +30,000 30,000

NA =30,000 NA

4b. Cost NA + NA + (20,000)

= NA + NA +(20,000)

NA 20,000=(20,000)

NA

5a. AR Disc.

NA + (300) + NA = NA + NA + (300) (300) NA = (300) NA

5b. Coll. AR

29,700 +(29,700)


6. Pd. Exp. (7,600) + NA + NA = NA + NA + (7,600) NA 7,600 =(7,600) (7,600) OA

End. Bal. 46,820 + -0- +15,280 = -0-+60,000

+ 2,100 29,700

27,600= 2,100 46,820 NC

d. Gross Margin:Net Sales $29,700Cost of Goods Sold (20,000)Gross Margin $ 9,700

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Net Income:Gross Margin $9,700Less: Operating Expenses (7,600)Net Income $2,100 or see Net Income column above.

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e. Cash discounts are given to encourage prompt payment of accounts receivable. Many times the discount cost is less than the cost of obtaining cash externally (loan).

f. Stone Sales will get a 2% discount if the account is paid within 10 days; if the discount is not taken, the full amount of the invoice is due in 30 days.

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EXERCISE 5-12Aa.

Retail Sales CompanyGeneral Journal for 2004






4. Accounts Payable 1,000Merchandise Inventory 1,000








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Retail Sales CompanyGeneral Journal for 2004


9. Selling and Administrative Expenses

3,200

Cash 3,200


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Retail Sales CompanyT-Accounts for 2004


Cash Accounts Payable Common StockBal.15,000

4. 1,000 1.30,000

Bal.20,000

7b.21,560

2. 500 5. 200

8b.14,256

8a. 144 Retained Earnings

9. 3,200 8b.14,256

Bal. 5,000

10.14,400

10.14,400

Bal.4,204

Bal. -0- Sales Revenue

6a. 4,000 3a.26,000

Accounts Receivable

7a. 440

3a.26,000

6a. 4,000 Bal.21,560

7a. 440 7b.21,560

Cost of Goods Sold

Bal. -0- 3b.

17,0006b. 2,400

Bal.14,600


1. 30,000 3b.17,000

Selling & Adm. Exp.

2. 500 4. 1,000 9. 3,2006b. 2,400 5. 200 Bal. 3,200

8a. 144

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Bal.24,556

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Retail Sales CompanyTrial Balance

December 31, 2004

Cash $ 4,204Merchandise Inventory 24,556Common Stock $20,000Retained Earnings 5,000Sales Revenue 21,560Cost of Goods Sold 14,600Selling and Administrative Expenses

3,200

Totals $46,560 $46,560

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EXERCISE 5-12A (cont.)d.

Retail Sales CompanyFinancial Statements


Income Statement

Net Sales $21,560


Gross Margin 6,960

Operating ExpensesSelling and Administrative

Expenses(3,200)


Balance Sheet

AssetsCash $

4,204Merchandise Inventory 24,556


Liabilities $ -0-





$28,760

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EXERCISE 5-12A d. (cont.)

Retail Sales CompanyFinancial Statements




Inflow from Customers $21,560Outflow for Inventory (29,156)Outflow for Expenses (3,200)


$(10,796)


-0-


-0-

Net Change in Cash (10,796)Plus: Beginning Cash Balance 15,000Ending Cash Balance $ 4,204

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EXERCISE 5-13Aa.

Burk MerchandisingT-Accounts for 2002


Cash Common Stock Sales Revenue1. 80,000 2.

56,000 1.

80,0003a.68,400

3a.68,400 Bal.80,000

Bal.68,400

Bal.92,400

Cost of Goods SoldMdse. Inventory 3b.

43,0002. 56,000 3b.

43,0004. 1,400

Bal.13,000

Bal.44,400

4. 1,400 (13,000 11,600)Bal.11,600

b.Burk MerchandisingIncome Statement

For Year Ended December 31, 2002

Net Sales $68,400


Gross Margin 24,000


Net Income $24,000

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EXERCISE 5-13A b. (cont.)

Burk MerchandisingBalance Sheet

As of December 31, 2002



Liabilities $ -0-

Stockholders’ EquityCommon Stock $80,000Retained Earnings 24,000


Total Liab. And Stockholders’ Equity

$104,000

c. Lost, stolen, or damaged inventory may not have been accounted for. When management discovers differences in the book balance of the inventory and the physical count of the inventory, adjusting entries are made to the books to reduce the inventory account to its actual balance. For control purposes, it is important for management to know the amount of lost or damaged inventory.

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EXERCISE 5-14A

EventNo.

EventType

Assets

= Liab. + S. Equity

Rev.

Exp.

= Net Inc.

Cash Flow

1. AE + NA NA NA NA NA OA2. AS + + NA NA NA NA NA3a. AS + NA + + NA + + OA3b. AU NA NA + NA4a. AS + NA + + NA + NA4b. AU NA NA + NA5. AU NA NA NA NA NA6. AU NA NA + OA7. AU NA NA NA NA OA8. AE + NA NA NA NA NA + OA9. AE + NA NA NA NA NA + OA10. AU NA NA + OA

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EXERCISE 5-15A

Beginning Mdse. Inventory

$ 1,050

Plus: Merchandise Purchased

5,250

Goods Available for Sale 6,300

Less: Ending Mdse. Inventory

(2,200)

Cost of Goods Sold $ 4,100

a. Goods Available for Sale$6,300

b. Cost of Goods Sold$4,100

c. Merchandise Inventory on year-end balance sheet $2,200

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EXERCISE 5-16A

Single-Step Income Statement:

Quick FoodsIncome Statement

Net Sales Revenue $ 400

ExpensesCost of Goods Sold $225Advertising Expense 100Interest Expense 35Salaries Expense 65Supplies Expense 28

Total Expenses (453)

Net Income (Loss) $ (53)

Multistep Income Statement:

Quick FoodsIncome Statement

Net Sales Revenue $ 400

Cost of Goods Sold (225)

Gross Margin 175

Operating ExpensesAdvertising Expense $100Salaries Expense 65Supplies Expense 28

Total Operating Expenses (193)Operating Income (Loss) (18)

Interest Expense (35)Net Income (Loss) $ (53)

EXERCISE 5-17A

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a.Valley Retailers

Schedule of Cost of Goods Sold

Beginning Merchandise Inventory $ 24,900Plus: Purchases 306,400Plus: Transportation-in 2,160Less: Purchase Returns and Allowances

(9,600)

Cost of Goods Available for Sale 323,860Less: Ending Merchandise Inventory (29,300)

Cost of Goods Sold $294,560

b.Valley Retailers

Income StatementFor Year Ended 20XX

Net Sales Revenue* $673,630


Gross Margin 379,070

Operating Expenses (51,400)

Net Income $327,670

*Sales, $680,000 Sales Returns and Allow., $6,370 = Net Sales, $673,630

5-54

EXERCISE 5-18Aa.

Joy Gift ShopGeneral Journal for 2007



2. Merchandise Inventory 2,500Common Stock 2,500

3. Purchases 43,500Accounts Payable 43,500

4. Advertising Expense 2,750Cash 2,750

5. Cash 77,500Sales Revenue 77,500

6. Salaries Expense 8,000Cash 8,000


8 adj. Cost of Goods Sold* 39,000Merchandise Inventory (Ending)

7,000

Purchases 43,500Merchandise Inventory

(ownercontribution)

2,500

*Cost of Goods Sold Calculation:Beginning Merchandise Inventory$ -0-Owner Contribution 2,500Purchases 43,500Goods Available for Sale 46,000Less: Ending Merchandise Inventory ( 7,000 ) Cost of Goods Sold $39,000

5-55


Joy Gift ShopT-Accounts for 2007


Cash Accounts Payable Common Stock1. 33,500 4. 2,750 7. 35,000 3. 43,500 1. 33,5005. 77,500 6. 8,000 Bal.8,500 2. 2,500

7. 35,000 Bal.36,000

Bal.65,250


Inventory5. 77,500

2. 2,500 8. 2,500 Bal.77,500

8. 7,000Bal. 7,000 Cost of Goods Sold

8. 39,000Bal.39,000

Purchases3. 43,500 8. 43,500Bal. -0-

Advertising Expense4. 2,750Bal. 2,750

Salaries Expense6. 8,000Bal. 8,000

5-56


Joy Gift ShopFinancial Statements


Income Statement

Sales Revenue $77,500


Gross Margin 38,500

Operating ExpensesAdvertising Expense $2,750Salaries Expense 8,000

Total Operating Expenses

(10,750)


Statement of Changes in Stockholders’ Equity

Beginning Common Stock

$ -0-

Plus: Stock Issued 36,000Ending Common Stock $36,000

Beginning Retained Earnings

-0-

Plus: Net Income 27,750Ending Retained Earnings

27,750

Total Stockholders’ Equity

$63,750

5-57

EXERCISE 5-18A c. (cont.)

Joy Gift ShopFinancial Statements

Balance Sheet As of December 31, 2007



LiabilitiesAccounts Payable $ 8,500




$72,250

Statement of Cash FlowsFor the Year Ended December 31, 2007




$31,750


-0-


Inflow from Stock Issue 33,500

5-58

Net Change in Cash 65,250Plus: Beginning Cash Balance -0-Ending Cash Balance $65,250

5-59

EXERCISE 5-18A (cont.)d.

Joy Gift ShopGeneral Journal


Closing Entries

cl Sales Revenue 77,500Retained Earnings 77,500

cl Retained Earnings 49,750Cost of Goods Sold 39,000Advertising Expense 2,750Salaries Expense 8,000

5-60

EXERCISE 5-18A d. (cont.)

Joy Gift ShopT-Accounts


Cash Accounts Payable Common StockBal.

65,250Bal. 8,500 Bal.

36,000

Retained EarningsMerchandise

Inventorycl 49,750 cl 77,500

Bal. 7,000 Bal.27,750

Sales RevenueBal.77,500

cl 77,500Bal. -0-

Cost of Goods SoldBal.

39,000cl 39,000

Bal. -0-

Advertising ExpenseBal. 2,750

cl 2,750Bal. -0-

Salaries ExpenseBal. 8,000

cl 8,000Bal. -0-

5-61

EXERCISE 5-18A (cont.)e.

Joy Gift ShopAfter Closing Trial BalanceAs of December 31, 2007


Cash $65,250Merchandise Inventory 7,000Accounts Payable $ 8,500Common Stock 36,000Retained Earnings 27,750

Totals $72,250 $72,250

f. Less recordkeeping is usually required when the periodic method is used. There is no requirement to remove the cost of items from inventory when the goods are sold. The cost is accounted for at the end of the year when goods still on hand are counted and the adjustment is made.

g. Capital acquired from the stockholders does not have to be cash. In this problem, one of the stockholders contributed inventory to the business in exchange for stock. This amount is shown as stock issued on the statement of changes in stockholders’ equity, but since it was not a cash contribution, it does not show up on the statement of cash flows.

5-62

EXERCISE 5-19Aa.

Al’s SailsGeneral Journal for 2008


1. Cash 25,000Notes Payable 25,000






6. Interest Expense* 1,750Interest Payable 1,750

*$25,000 x 7% = $1,750.

5-63


Al’s SailsT-Accounts


Cash Notes Payable Sales Revenue1. 25,000 2.

20,0001. 25,000 3a.

17,0004. 7,000 5. 2,500 Bal.

25,000Bal.17,000

Bal.9,500Interest Payable Cost of Goods Sold

Accounts Receivable

6. 1,750 3b. 9,000

3a.17,000

4. 7,000 Bal.1,750

Bal. 9,000

Bal.10,000

Operating Expenses

Mdse. Inventory 5. 2,5002. 20,000 3b. 9,000 Bal. 2,500Bal.11,000

Interest Expense6. 1,750Bal. 1,750

c.Al’s Sails

Income Statement For the Year Ended December 31, 2008

Net Sales $17,000


Gross Margin 8,000

5-64


Net Income from Operations 5,500

Interest Expense (1,750)

Net Income $ 3,750

5-65


Al’s SailsFinancial Statements


AssetsCash $ 9,500Accounts Receivable 10,000Merchandise Inventory 11,000


LiabilitiesNotes Payable $25,000Interest Payable 1,750





$30,500

Statement of Cash FlowsFor the Year Ending December 31, 2008


Inflow from Customers $ 7,000Outflow for Inventory (20,000)Outflow for Expenses (2,500)


$(15,500)


-0-


Cash Inflow from Loan 25,000

5-66

Net Change in Cash 9,500Plus: Beginning Cash Balance -0-Ending Cash Balance $ 9,500


d. Al will not be able to repay half of his loan. He only collected $7,000 of the amount that was sold. In addition, he paid $2,500 in operating expenses. His ending cash balance is only $9,500. He may be able to pay the interest due on the loan and pay some on the principal, especially if he can collect some more of the accounts receivable. However, he must keep enough cash on hand to purchase additional inventory if he plans to continue in business.

5-67

EXERCISE 5-20A

a. 50 days; Kay will have to pay within 10 days if she takes the discount, but will have 60 days to pay if she does not take the discount.

b. Assuming she has no other cash, Kay would have to borrow the invoice amount less the discount or $260,000 x .98 = $254,800.

c. Interest cost for 50 days: 254,800 x 7% x 50/365 = $2,443.29.Total that would have to be repaid: $254,800 + $2,443.29 = $257,243.29.Savings by borrowing to pay the invoice within 10 days: $260,000 $257,243.29 = $2,756.71.

Memo:It would be most cost effective for Kay to borrow the money in order to pay the invoice within the discount period. Kay would be incurring interest for a period of 50 days at a cost of $2,443.29. However, she would save $5,200 by paying within the discount period. The net savings to Amy would be $2,756.71.

5-68

SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 5

PROBLEM 5-21AT-accounts are provided for the instructor’s use:

Mackey Company T-Accounts 2007, 2008, and 2009


Cash Common Stock Retained Earnings200720,000 9,800 2007

20,0002007 2,350

14,100 4,600 Bal. 2,350Bal. 19,700 2008 1,8002008 17,500 12,000 Bal. 4,150

6,200 2009 3,600Bal. 19,000 Bal. 7,7502009

26,00018,500

7,400 Sales RevenueBal. 19,100 cl 14,100 2007 14,100

Bal. -0-Merchandise Inv. cl 17,500 2008 17,500

2007 9,800 7,150 Bal. -0-Bal. 2,650 cl 26,000 200926,000200812,000 9,500 Bal. -0-Bal. 5,150200918,500 15,000Bal. 8,650 Cost of Goods Sold

2007 7,150 cl 7,150Bal. -0-2008 9,500 cl 9,500Bal. -0-2009

15,000cl 15,000

Bal. -0-

Selling and Adm. Exp.2007 4,600 cl 4,600Bal. -0-2008 6,200 cl 6,200Bal. -0-2009

7,400cl 7,400

5-69

Bal. -0-

5-70

PROBLEM 5-21A (cont.)

Mackey CompanyFinancial Statements

Income Statements

2007 2008 2009

Net Sales $14,100 $17,500

$26,000

Cost of Goods Sold (7,150) (9,500) (15,000)

Gross Margin 6,950 8,000 11,000

Operating ExpensesSelling and Admin.

Expense(4,600) (6,200) (7,400)

Operating Income $ 2,350 $ 1,800

$ 3,600

Balance Sheets

AssetsCash $19,700 $19,000 $19,100Merchandise Inventory 2,650 5,150 8,650

Total Assets $22,350 $24,150 $27,750

Liabilities $ -0- $ -0-

$ -0-

Stockholders’ EquityCommon Stock 20,000 20,000 20,000Retained Earnings 2,350 4,150 7,750

Total Stockholders’ Equity 22,350 24,150 27,750Total Liab. and Stkholders’ Equity

$22,350 $24,150 $27,750

5-71

PROBLEM 5-22A

Event Product Costs

Period Costs

a.

b.

c.

d.

e.

f.

g.

h.

i.

j.

PROBLEM 5-23A

Event Freight Costs Paid

Period/Product

a. $ -0- NA

b. $ -0- NA

c. $190 Product

d. $100 Period

5-72

PROBLEM 5-24Aa.

Doss Heater CompanyEffect of Transactions on Financial Statements Using Horizontal Statements Model

Balance Sheet Income Statement Statement of Date Assets = Liab. + Stockholders’

EquityRev. Exp. = Net

Inc.Cash Flows

Cash + Acct. Rec.

+ Inv. = Acct. Pay.

+ C. Stk. + Ret. Earn.

9/1 30,000 + NA + NA = NA + 30,000 + NA NA NA = NA 30,000 FA 9/1 NA + NA +18,000 = 18,000 + NA + NA NA NA = NA NA 9/5 (800) + NA + 800 = NA + NA + NA NA NA = NA (800) OA 9/8a. NA + 8,800 + NA = NA + NA + 8,800 8,800 NA = 8,800 NA 9/8b. NA + NA + (4,500)= NA + NA + (4,500) NA 4,500 = (4,500) NA 9/8 NA + NA + (900)= (900) + NA + NA NA NA = NA NA 9/10a.

NA + NA + (171)= (171) + NA + NA NA NA = NA NA

9/10b.

(8,379) + NA + NA = (8,379) + NA + NA NA NA = NA (8,379) OA

9/15 8,800 + (8,800) + NA = NA + NA + NA NA NA = NA 8,800 OA 9/30 (8,550) + NA + NA = (8,550) + NA + NA NA NA = NA (8,550) OA 9/30 (1,720) + NA + NA = NA + NA + (1,720) NA 1,720 = (1,720) (1,720) OA

Tot. 19,351 + -0- +13,229 = -0- + 30,000 + 2,580 8,800 6,220 = 2,580 19,351 NC

5-73

PROBLEM 5-24A (cont.)b.

Doss Heater CompanyGeneral Journal, September 2009


Sept. 1 Cash 30,000Common Stock 30,000

Sept. 1 Merchandise Inventory 18,000Accounts Payable 18,000

Sept. 5 Merchandise Inventory 800Cash 800

Sept. 8a. Accounts Receivable 8,800Sales Revenue 8,800

Sept. 8b.

Cost of Goods Sold 4,500

Merchandise Inventory 4,500

Sept. 8 Accounts Payable 900Merchandise Inventory 900

Sept. 10a.


Merchandise Inventory 171Sept. 10b.

Accounts Payable 8,379

Cash 8,379

Sept. 15 Cash 8,800Accounts Receivable 8,800

Sept. 30 Accounts Payable 8,550Cash 8,550

Sept. 30 Selling and Admin. Expense 1,720Cash 1,720

5-74

PROBLEM 5-24A (cont.)c.

Doss Heater CompanyT-Accounts, September 2009


Cash Accounts Payable Common Stock9/1 30,000 9/5 800 9/1

18,0009/1 30,000

9/15 8,800 9/10b. 8,379 9/8 9009/30 8,550 9/10a. 171 Sales Revenue9/30 1,720 9/10b.

8,3799/8a.8,800

Bal. 19,351 9/30 8,550 Bal. 8,800Bal. -0-

Accounts Receivable Cost of Goods Sold9/8a. 8,800 9/15 8,800 9/8b. 4,500Bal. -0- Bal. 4,500

Merchandise Inventory Selling & Adm. Expense

9/1 18,000 9/8b. 4,500 9/30 1,7209/5 800 9/8 900 Bal. 1,720

9/10a. 171Bal. 13,229

5-75

PROBLEM 5-24A (cont.)d. & e.

Doss Heater CompanyFinancial Statements

For the Month Ended September 30, 2009

Income Statement

Net Sales $8,800


Gross Margin 4,300

Operating ExpensesSelling and Adm. Expense (1,720)



Cash Flows From Oper. Activities:

Inflow from Customers $8,800Outflow for Inventory

(17,729)Outflow for Selling and Adm.

Exp.(1,720)

Net Cash Flow from Operating Act.

$(10,649)


-0-

Cash Flows From Fin. Activities:

Inflow from Stock Issue 30,000Net Cash Flow from Financing Act.

30,000

Net Change in Cash 19,351Plus: Beginning Cash Balance -0-

5-76

Ending Cash Balance $ 19,351

f. The difference between net income and net cash flow from operating activities [$2,580 ($10,649) = $13,229] is due entirely to unsold inventory that has already been paid for.

5-77

PROBLEM 5-25Aa.

W. Coyle CompanyEffect of Events on the Financial Statements for 2005

Event Event


No. Type Assets = Liab. + S. Equity

Rev. Exp. = Net Inc. Cash Flows

1a. AS + + NA NA NA NA NA1b. AE + NA NA NA NA NA OA2. AU NA NA NA NA NA3a. Disc.

AU NA NA NA NA NA

3b. Pay.

AU NA NA NA NA OA

4a. Sale

AS + NA + + NA + NA

4b. Cost

AU NA NA + NA

5a. Ret AU NA NA OA5b. Ret.

AS + NA + NA + NA

6. AU NA NA + OA7a. Disc.

AU NA NA NA

7b. Coll.

AE + NA NA NA NA NA + OA

8. AU NA NA + NA

5-78

PROBLEM 5-25A (cont.)b. & c,

W. Coyle Company General Journal


1a. Merchandise Inventory 2,200Accounts Payable 2,200

1b. Merchandise Inventory 110Cash 110






5a. Sales Revenue 710Cash 710

5b. Merchandise Inventory 400Cost of Goods Sold 400




8. Cost of Goods Sold (Inventory Loss)

520

Merchandise Inventory 520

5-79


W. Coyle CompanyT-Accounts for 2005



4,300 1b.

110 2. 200 1a.

2,200 Bal.

10,000

7b. 5,390 3b.

1,980 3a. 20

5a.

710 3b. 1,980

6. 60 Bal. -0- Retained EarningsBal.

6,830 Bal.

3,300

cl 3,180 cl 4,680 Bal.

4,800

Mdse. InventoryBal.

9,000 Sales Revenue

1a. 2,200 2. 200 5a. 710 4a. 5,5001b. 110

3a.20 7a. 110

5b. 400 4b.

3,000 Bal.

4,680

Bal.

8,490 cl 4,680

8. 520 Bal.

-0-

Bal.

7,970

Cost of Goods Sold4b. 3,000

Accounts Receivable

8. 520 5b. 400

4a. 5,500 7a.

110 Bal. 3,120

7b. 5,390 cl 3,120Bal.

-0- Bal. -0-

Transportation-out6. 60Bal. 60

cl 60Bal. -0-

5-80

5-81

PROBLEM 5-25Ad.

W. Coyle CompanyFinancial Statements


Income Statement

Net Sales $4,680


Gross Margin 1,560




Beginning Common Stock $10,000Plus: Stock Issued -0-Ending Common Stock $10,000


3,300

Plus: Net Income 1,500Ending Retained Earnings 4,800

Total Stockholders’ Equity $14,800

5-82

PROBLEM 5-25A d. (cont.)

W. Coyle CompanyFinancial Statements


AssetsCash $ 6,830Merchandise Inventory 7,970


Liabilities $ -0-




$14,800



Inflow from Customers $4,680Outflow for Inventory (2,090)Outflow for Expenses (60)


$2,530


-0-


-0-

Net Change in Cash 2,530

5-83

Plus: Beginning Cash Balance 4,300Ending Cash Balance $6,830

5-84

PROBLEM 5-25A (cont.)e.Date Account Titles Debit Credit

Closing Entries

Dec. 31

Sales Revenue 4,680

Retained Earnings 4,680

Dec. 31


Cost of Goods Sold 3,120Transportation-out 60

See T-Accounts in part c. for closing entries.

W. Coyle CompanyAfter Closing Trial Balance

December 31, 2005


Cash $ 6,830Merchandise Inventory 7,970Common Stock $10,000Retained Earnings 4,800

Totals $14,800 $14,800

5-85

PROBLEM 5-26Aa.

Pittman Sales Co.Schedule of Cost of Goods Sold

Beginning Merchandise Inventory

$ 18,000

Purchases 130,000Purchase Returns and Allowances

(2,700)

Transportation-in 5,500Cost of Goods Available for Sale

150,800

Less: Ending Merchandise Inventory

(20,100)


5-86


Pittman Sales Co.Income Statement


RevenueSales Revenue $290,000Sales Returns and

Allowances(8,000)

Sales Discounts (13,500)Net Sales $268,500



Operating ExpensesMiscellaneous Expense 800Transportation-out 10,800Advertising Expense 12,800Salaries Expense 53,000Rent Expense 14,000Depreciation Expense 3,000

Total Operating Expenses (94,400)

Operating Income 43,400

Non-Operating ItemsInterest Expense (5,000)

Net Income Before Income Tax

38,400

Income Taxes (10,700)

Net Income $ 27,700

5-87


Pittman Sales Co.Income Statement



Allowances(8,000)

Sales Discounts (13,500)Net Sales $268,500

Operating ExpensesCost of Goods Sold 130,700Miscellaneous Expense 800Transportation-out 10,800Advertising Expense 12,800Salaries Expense 53,000Rent Expense 14,000Depreciation Expense 3,000Interest Expense 5,000Income Taxes 10,700

Total Expenses (240,800)

Net Income $ 27,700

5-88

PROBLEM 5-27Aa.

Horner Home ProductsGeneral Journal, 2005

Event Account Titles Debit Credit

1a. Land 8,000Cash 8,000

1b. Building 45,000Cash 5,000Notes Payable 40,000


3. Transportation-in 230Cash 230

4. Accounts Payable 2,000Purchase Returns and

Allow.2,000


6. Accounts Receivable 50,000Sales Revenue 50,000

7a. Accounts Payable 420Purchase Discounts 420


8. Selling Expenses 1,200Cash 1,200

9a. Sales Discounts 350Accounts Receivable 350

9b. Cash ($35,000 $350 + $12,000)

46,650

Accounts Receivable 46,650

5-89

PROBLEM 5-27A a. (cont.)

Horner Home ProductsGeneral Journal, 2005


10. Interest Expense ($40,000 x 8%)

3,200

Cash 3,200

11. Notes Payable 2,000Cash 2,000

12. Depreciation Expense1 1,125Accumulated Depreciation 1,125

13. Cost of Goods Sold2 50,810Purchase Discounts 420Purchase Returns and Allowances

2,000

Purchases 23,000Transportation-in 230Merchandise Inventory

($60,000 $30,000)30,000

1$45,000 40 = $1,125 per year.2Cost of Goods Sold: Beginning Merchandise Inventory

$60,000Purchases 23,000Transportation-in 230Purchase Ret. and Allow. (2,000)Purchase Discounts (420)Cost of Goods Available 80,810Less: Ending Merchandise Inventory

(30,000)Cost of Goods Sold $50,810

5-90


Horner Home Products


14,000 1a.

8,000 4. 2,000 Bal.

5,000 Bal.

50,000

5. 27,000 1b.

5,000 7a. 420 2. 23,000

9b. 46,650 3. 230 7b.

20,580 Retained Earnings

7b.

20,580 Bal.

5,000 Bal.

8,000

8. 1,200 10.

3,200 Notes Payable Sales Revenue

11.

2,000 11. 2,000 Bal.

20,000 5. 27,000

Bal.

47,440 1b. 40,000 6. 50,000

Bal.

58,000 Bal.

77,000

Accounts ReceivableBal.

9,000 9a.

350 Sales Discounts

6. 50,000 9b.

46,650 9a.

350

Bal.

12,000

PurchasesMerchandise

Inventory2. 23,000 13. 23,000

Bal.

60,000 13.

30,000 Bal.

-0-

Bal.

30,000

Purchase Returns & Allow.

Building 13.

2,000 4. 2,000

1b. 45,000 Bal.

-0-

Bal.

45,000

Purchase DiscountsAccumulated Depr. 13

.420 7a. 420

12.

1,125 Bal.

-0-

Bal. 1,125

5-91

Transportation-inLand 3. 230 13. 230

1a. 8,000 Bal.

-0-

Bal.

8,000

Cost of Goods Sold13.

50,810

Interest Expense10.

3,200

Selling Expenses8. 1,200

Depreciation Expense12.

1,125


Horner Home ProductsSchedule of Cost of Goods Sold

Beginning Mdse. Inventory 1/1/2005

$60,000

Purchases 23,000Purchase Discounts (420)Purchase Returns and Allow. (2,000)Transportation-in 230Cost of Goods Available for Sale

$80,810

Ending Merchandise Inventory (30,000)Cost of Goods Sold $50,810

5-92

PROBLEM 5-27A c. (cont.)

Horner Home ProductsFinancial Statements


Income Statement

RevenueSales Revenue $77,000Sales Discounts (350)

Net Sales $76,650


Gross Margin 25,840

Operating ExpensesSelling Expenses 1,200Depreciation Expense 1,125

Total Operating Expense (2,325)


Non-Operating ExpenseInterest Expense (3,200)

Net Income $20,315




8,000



5-93


Horner Home ProductsBalance Sheet


AssetsCash $47,440Accounts Receivable 12,000Merchandise Inventory 30,000Building $45,000Accumulated

Depreciation(1,125) 43,875

Land 8,000Total Assets $141,31

5

LiabilitiesAccounts Payable $ 5,000Notes Payable 58,000

Total Liabilities $ 63,000

Stockholders’ EquityCommon Stock 50,000Retained Earnings 28,315

Total Stockholders’ Equity

78,315

Total Liab. and Stk. Equity

$141,315

5-94


Horner Home ProductsStatement of Cash Flows





$48,440

Cash Flows From Investing Activities:

Outflow for Purchase of Bldg. and Land

(13,000)

Net Cash Flow from Investing Activities

(13,000)


Outflow for Loan Payment (2,000)Net Cash Flow from Financing Activities

(2,000)


0

5-95

PROBLEM 5-28A

Marcy CompanyCommon Size Income Statements

2001 % 2002 %

Net Sales $302,900 100 $370,500 100Cost of Goods Sold (217,400) (72) (264,700) (71)Gross Margin 85,500 28 105,800 29

Operating ExpensesSelling and Adm. Exp. (40,800) (13) (58,210) (16)

Net Income $ 44,700 15 $ 47,590 13

Based on the common size income statements, the claims made by the president appear to be true. The dollar amount of the sales increased from $302,900 to $370,500, an increase of 22%, and the gross margin percentage actually increased slightly. This means the company is selling the goods at approximately the same markup as the year before. The fact that operating expenses increased by 43% indicates the company did spend more on advertising. The increase in operating expenses did cause the percentage of net income to sales to fall from 15% to 13%. Profits increased overall from $44,700 to $47,590 from 2001 to 2002.

5-96

SOLUTIONS TO EXERCISES SERIES B - CHAPTER 5

EXERCISE 5-1Ba.

Davis CPAsIncome Statement

For the Period Ended 20XX

RevenueConsulting Revenue $15,00

0

ExpensesSalaries Expenses (10,000

)

Net Income $5,000

Davis CPAs Balance Sheet

As of the End of the Period 20XX

AssetsCash $25,00

0Total Assets $25,00

0






$25,000

5-97

EXERCISE 5-1B a. (cont.)

Davis CPAsStatement of Cash FlowsFor Period Ended 20XX


Inflow from Revenue $15,000Outflow for Salaries (10,000)

Net Cash Flow from Operating Activ.

$ 5,000


-0-


Inflow from Loan 20,000Net Cash Flow from Financing Activ.

20,000


5-98


Campus Dive ShopIncome Statement

For the Period Ended 20XX

Net Sales Revenue $15,000


Gross Margin 6,800

ExpensesOperating Expense (1,800)

Net Income $5,000

Campus Dive ShopBalance Sheet

As of the End of the Period 20XX








$25,000

5-99

EXERCISE 5-1Ba. (cont.)

Campus Dive ShopStatement of Cash FlowsFor Period Ended 20XX


Inflow from Revenue $15,000Outflow for Inventory (12,500)Outflow for Expense (1,800)


$ 700


-0-


Inflow from Loan 20,000Net Cash Flow from Financing Activities

20,000

Net Increase in Cash 20,700Plus: Beginning Cash Balance -0-Net Increase in Cash $20,700

b. Campus Dive Shop is a merchandising business and has inventory and cost of goods sold, product costs. Davis is a service company and does not have product costs.

c. Davis is a service company and sells a service not a product. Consequently, it does not have cost of goods sold or gross margin. It only has selling and administrative expense (period expense).

d. The only asset that Davis has is Cash. Campus Dive Shop has two assets, cash and inventory. Davis does not sell a product and does not have any inventory. Campus Dive

5-100

Shop sells products and must carry inventory available for sale to customers.

5-101

EXERCISE 5-2Ba.

Don Jones MerchandisingGeneral Journal, 2005






b.T-Accounts


Cash Common Stock1. 20,000 2.15,000 1. 20,0003a.16,000

Bal.20,000

Bal.21,000


Inventory3a.16,000

2. 15,000 3b.10,000

Bal.16,000

Bal. 5,000Cost of Goods Sold

3b.10,000Bal.10,000

5-102

EXERCISE 5-2B (cont.)c.

Don Jones MerchandisingIncome Statement


Net Sales $16,000


Gross Margin 6,000


Net Income $ 6,000

d.


Inflow from Customers $16,000Outflow for Inventory (15,000)


$ 1,000

5-103

EXERCISE 5-3Ba.

Bond Merchandising Co. Effect of Events on the Financial Statements

Events Balance Sheet Income Statement Statement of



Cash + A. Rec. + Mdse. Inv.

= A. Pay. +C. Stk.+Ret. Ear.

Beg. Bal. 28,000 + NA + NA = NA + 28,000

+ NA NA NA = NA NA

1. Pur. Inv.

NA + NA + 30,000 =30,000 + NA + NA NA NA = NA NA

2. Sold Inv.

NA +35,000 + NA = NA + NA +35,000 35,000

NA =35,000 NA

3. Inv. Cost

NA + NA +(25,000) = NA + NA + (25,000)

NA 25,000 =(25,000)

NA

4. Pd. AP (20,000)

+ NA + NA =(20,000)

+ NA + NA NA NA = NA (20,000)OA

5. Coll. AR

22,000 +(22,000)


6. Pd. Exp.

(7,000)+ NA + NA = NA + NA + (7,000) NA 7,000 = (7,000) (7,000) OA

End. Bal. 23,000 +13,000 + 5,000 =10,000 + 28,000

+ 3,000 35,000

32,000 = 3,000 (5,000) NC

b. $13,000

c. $10,000

d. Sales $35,000Cost of Goods Sold (25,000 )

5-104

Gross Margin 10,000Operating Exp. (7,000)Net Income $ 3,000

e. Cash Flows From Operating Activities:Inflow from Customers $22,000Outflow for Inventory (20,000)Outflow for Expenses (7,000)

Net Cash Flow from Operating Activities$ (5,000 )

5-105

EXERCISE 5-3B (cont.)

f. Ending retained earnings and net income are the same in this problem because this is the first year of operations and no dividends were paid. Ending Retained Earnings is calculated as follows: Beginning Retained Earnings + Net Income Dividends = Ending Retained Earnings.

5-106

EXERCISE 5-4Ba.

Clark’s Clothing CenterGeneral Journal for 2004






4. Advertising Expense 400Cash 400

b.T-Accounts


Cash Common Stock Sales Revenue1. 7,000 2. 4,000 1. 7,000 3a. 4,5003a. 4,500 4. 400 Bal.7,000 Bal.4,500Bal.7,100

Cost of Goods Sold

Mdse. Inventory 3b. 3,0002. 4,000 3b.

3,000Bal. 3,000

Bal.1,000Advertising

Expense4. 400Bal. 400

5-107

5-108


Clark’s Clothing CenterTrial Balance

December 31, 2004


Cash $ 7,100Merchandise Inventory 1,000Common Stock $ 7,000Sales Revenue 4,500Cost of Goods Sold 3,000Advertising Expense 400

Totals $11,500 $11,500

5-109

EXERCISE 5-5B

a. FOB destinationb. FOB shipping pointc. FOB shipping pointd. FOB destination

5-110

EXERCISE 5-6Ba.

Vanity Gift ShopGeneral Journal for 2005










5-111

EXERCISE 5-6B (cont.)b.

Vanity Gift ShopT-Accounts



3. 3,200 1.22,000

Bal.40,000

5a.31,000

2. 1,000 4. 1,400

6. 800 7.15,000

Retained Earnings

7.15,000

Bal. 2,400

Bal. 4,000

Bal.46,200

Sales RevenueMdse. Inventory 5a.

31,000Bal.12,000

Bal.31,000

1. 22,000 3. 3,2002. 1,000 4. 1,400 Cost of Goods

Sold5b.16,000

5b. 16,000

Bal.14,400

Bal.16,000

Transportation-out

6. 800Bal. 800

5-112


Vanity Gift ShopFinancial Statements


Income Statement

Net Sales $31,000


Gross Margin 15,000



Balance Sheet



LiabilitiesAccounts Payable $ 2,400




$60,600

5-113

EXERCISE 5-6B c. (cont.)

Vanity Gift ShopFinancial Statements






$14,200


-0-


-0-


0

d. The fact that net income and net cash flow from operating activities is the same in this problem is coincidence. Revenue is $31,000 and all is cash, so the amounts of revenue and cash from revenue are the same. But since not all of the inventory was sold and not all of the accounts payable was paid, it is coincidence that the amount of inventory sold and the amount of accounts payable paid of $15,000 plus freight of $1,000 are both $16,000.

5-114

EXERCISE 5-7B

Transaction Debited to Inventory

1. Purchase of inventory Yes2. Allowance for damaged inventory

No

3. Transportation-in Yes4. Cash Discount on Goods Sold

No

5. Transportation-out No6. Purchase of office supplies No

5-115

EXERCISE 5-8Ba.Transaction

Period Costs

Product Costs

Not Applicable

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

5-116


Action Nature Goods Horizontal Statements Model for 2004



Rev. Exp. =Net Inc. Cash Flows

Cash + A. Rec. + Inv. = A. Pay. +C. Stk.+Ret. Ear.

1. Stock 10,000 + NA + NA = NA +10,000


2. Pur Inv. NA + NA + 56,000 56,000 + NA + NA NA NA = NA NA 3. Freight (600)+ NA + 600 = NA + NA + NA NA NA = NA (600)

OA 4. Sold Inv. NA + 57,400 + NA = NA + NA + 57,400 57,400 NA =57,400 NA 4. Cost NA + NA + (33,00

0)= NA + NA +(33,000

)NA 33,000 =(33,000

)NA

5. Pd. Frt. (420)+ NA + NA = NA + NA + (420) NA 420 = (420) (420)OA

6. Ret. Sale NA + (2,000)+ NA = NA + NA + (2,000) (2,000)

NA = (2,000) NA

6. Ret. Inv. NA + NA + 1,400 = NA + NA + 1,400 NA (1,400)= 1,400 NA 7. Coll. AR 47,000 +(47,000

)+ NA = NA + NA + NA NA NA = NA 47,000 OA

8. Pd. AP (40,000)

+ NA + NA =(40,000)

+ NA + NA NA NA = NA (40,000)OA

9. Pd. Exp. (1,100)+ NA + NA = NA + NA + (1,100) NA 1,100 = (1,100) (1,100)OA

10. Pd. Exp.

(2,000)+ NA + NA = NA + NA + (2,000) NA 2,000 = (2,000) (2,000)OA

End. Bal. 12,880 + 8,400 + 25,000 =16,000 +10,00 + 20,280 55,400 35,120 =20,280 12,880 NC

5-117

0

5-118

EXERCISE 5-9B

a. Purchase $3,100Less, return ( 600 ) Gross due (subject to the discount)2,500Discount percentage x2 % Amount of discount $ 50

Gross amount due $2,500Less, discount ( 50 ) Net amount due $2,450

b.Event Account title Debit Credit

Pur. Merchandise Inventory 3,100Accounts Payable 3,100

Return Accounts Payable 600Merchandise Inventory 600

Payment

Accounts Payable 50

Merchandise Inventory 50Accounts Payable 2,450

Cash 2,450

c. $2,500; he would not be eligible for the discount.

d. Wang would be willing to pay within the discount period in order to take advantage of the discount. Taking the discount will reduce the cost of the merchandise by $50. While this does not seem like a large savings, if the rate is annualized the savings is considerable. A 2% discount for paying within 10 days, or 35 days before the total amount would be due, amounts to a savings of $1.42857 per day ($50 35 days). Even if Wang borrowed the $2,450 at a 10% interest rate, the cost of borrowing would only be $23.49 ($2,450 x 10% x 35/365) or $.67 per day. Wang

5-119

would still save $.758 per day, even if the company had to borrow the funds to pay early.

5-120

EXERCISE 5-10Ba.

Smart CompanyGeneral Journal for 2004







4. Sales Revenue 2,000Accounts Receivable 2,000


5-121


Smart CompanyT-Accounts for 2004


Cash Common Stock Retained EarningsBal. 7,000 Bal.

25,000Bal.20,000

5. 30,000 2. 500Bal.

36,500Sales Revenue

3a. 4,000 1a.50,000

Accounts Receivable

4. 2,000

1a.50,000 3a.4,000 Bal.44,000

4. 2,0005.30,000

Cost of Goods Sold

Bal.14,000

1b.32,000

3b.3,000

Bal.29,000


1b.32,000

Transportation-out

3b. 3,000 2. 500Bal. 9,000 Bal. 500

5-122


Smart CompanyFinancial Statements


Income Statement

Net Sales $44,000


Gross Margin 15,000



Balance Sheet

AssetsCash

$36,500Accounts Receivable 14,000Merchandise Inventory 9,000


Liabilities $ -0-





$59,500

5-123


Smart CompanyFinancial Statements




Inflow from Customers $30,000Outflow for Expenses (500)


$29,500


-0-


-0-


0

d. Mitchell may agree to keep the damaged goods for several reasons. First, Mitchell already has the goods and, assuming the goods can be sold, will not have to wait on another shipment. Also, Mitchell is getting the goods at a reduced price. Smart benefits because he does not have to pay for the shipping cost of the returned goods and any repair cost in order to sell them to another customer. This arrangement can benefit both buyer and seller.

5-124

EXERCISE 5-11Ba.

Nelson Sand & GravelGeneral Journal for 2006










6. Operating Expense 1,900Cash 1,900

5-125


Nelson Sand & GravelT-Accounts for 2006


Cash Accounts Payable Common Stock1. 15,000 3b.8,820 3a. 180 2. 9,000 1. 15,0005b. 7,425 6. 1,900 3b. 8,820 Bal.

15,000Bal.11,705

Bal. -0-

Sales RevenueAccounts

Receivable5a. 75 4a. 7,500

4a. 7,500 5a. 75 Bal. 7,4255b. 7,425

Bal. -0-Cost of Goods Sold

Mdse. Inventory 4b. 5,0002. 9,000 3a. 180 Bal. 5,000

4b.5,000

Bal.3,820 Operating Expense6. 1,900Bal. 1,900

5-126


Nelson Sand & Gravel Horizontal Statements Model for 2006

Assets = Liab. + Stk. Equity Income Statement Statement of

Cash + A. Rec. + Inv. = A. Pay. +C. Stk.+ Ret. Ear


Cash Flows

1. Stock 15,000 + NA + NA = NA +15,000


2. Pur. Inv.

NA + NA + 9,000 = 9,000 + NA + NA NA NA = NA NA

3a. Disc. NA + NA + (180) = (180)+ NA + NA NA NA = NA NA 3b. Pd. AP (8,820) + NA + NA = (8,820)+ NA + NA NA NA = NA (8,820) OA 4a. Sold Inv.

NA + 7,500 + NA = NA + NA + 7,500 7,500 NA = 7,500 NA

4b. Cost NA + NA + (5,000) = NA + NA + (5,000) NA 5,000 =(5,000) NA 5a. AR Disc.

NA + (75) + NA = NA + NA + (75) (75) NA = (75) NA

5b. Coll. AR

7,425 + (7,425) + NA = NA + NA + NA NA NA = NA 7,425 OA

6. Pd. Exp. (1,900) + NA + NA = NA + NA + (1,900) NA 1,900 =(1,900) (1,900) OA

End. Bal. 11,705 + -0- + 3,820 = -0-+15,000

+ 525 7,425 6,900 = 525 11,705 NC

d. Gross Margin:Net Sales $7,425Cost of Goods Sold (5,000)Gross Margin $2,425

Net Income:

5-127

Gross Margin $2,425Less: Operating Expense (1,900)Net Income $ 525 or see Net Income column above.

5-128

EXERCISE 5-11B (cont.)

e. Cash discounts are given to encourage prompt payment of accounts receivable. A faster collection of accounts receivable will give Nelson cash faster and allow Nelson to pay its bills quicker. Many times the discount cost is less than the cost of obtaining cash externally (loan).

f. Nelson Sand & Gravel will give a 2% discount to the purchaser if the account is paid within 10 days; if the discount is not taken, the full amount of the invoice is due in 30 days.

5-129

EXERCISE 5-12Ba.

Macomb Merchandise CompanyGeneral Journal for 2006














5-130


Macomb Merchandise CompanyGeneral Journal for 2006


9. Selling and Administrative Expenses

4,300

Cash 4,300


5-131


Macomb Merchandise CompanyT-Accounts for 2006



4. 1,500 1.45,000

Bal.25,000

7b.35,640

2. 600 5. 500

8b.21,070

8a. 430 Retained Earnings

9. 4,300 8b.21,070

Bal.10,000

10.21,500

10.21,500

Bal.8,170

Bal. -0- Sales Revenue

6a. 6,000 3a.42,000

Accounts Receivable

7a. 360

3a.42,000

6a. 6,000

Bal.35,640

7a. 360 7b.35,640

Cost of Goods Sold

Bal. -0- 3b.

23,0006b. 3,400

Bal.19,600


1. 45,000 3b.23,000

Selling & Adm. Exp.

2. 600 4. 1,500 9. 4,3006b. 3,400 5. 500 Bal. 4,300

8a. 430

5-132

Bal.38,570

5-133


Macomb Merchandise CompanyTrial Balance

December 31, 2006

Cash $ 8,170Merchandise Inventory 38,570Common Stock $25,000Retained Earnings 10,000Sales Revenue 35,640Cost of Goods Sold 19,600Selling and Administrative Expenses

4,300

Totals $70,640 $70,640

5-134

EXERCISE 5-12B (cont.)d.

Macomb Merchandise CompanyFinancial Statements


Income Statement

Net Sales $35,640


Gross Margin 16,040

Operating ExpensesSelling and Administrative

Expenses(4,300)


Balance Sheet

AssetsCash $

8,170Merchandise Inventory 38,570


Liabilities $ -0-





$46,740

5-135

EXERCISE 5-12B d. (cont.)

Macomb Merchandise CompanyFinancial Statements






$(11,830)


-0-


-0-

Net Change in Cash (11,830)Plus: Beginning Cash Balance 20,000Ending Cash Balance $ 8,170

5-136

EXERCISE 5-13Ba.

Carroll TradersT-Accounts for 2005


Cash Common Stock Sales Revenue1. 20,000 2.

14,000 1.

20,0003a.17,100

3a.17,100 Bal.20,000

Bal.17,100

Bal.23,100

Cost of Goods SoldMdse. Inventory 3b.

10,7502. 14,000 3b.

10,7504. 350

Bal. 3,250 Bal.11,100

4. 350Bal. 2,900

b.Carroll Traders

Income Statement For Year Ended December 31, 2005

Net Sales $17,100


Gross Margin 6,000

Operating Expense -0-

Operating Income $ 6,000

5-137

EXERCISE 5-13B b. (cont.)

Carroll TradersBalance Sheet




Liabilities $ -0-




$26,000

c. Even though all of the purchases and cost of goods sold are recorded when goods are purchased or sold, management still must take a physical inventory to verify the book amount. Also, any adjustment will reflect the amount of lost, broken or spoiled goods for the period.

5-138

EXERCISE 5-14B

EventNo.

EventType

Assets

= Liab.

+ S. Equity

Rev.

Exp.

= Net Inc.

Cash Flow

1. AS + + NA NA NA NA NA2. AE + NA NA NA NA NA OA3a. AS + NA + + NA + NA3b. AU NA NA + NA4. AU NA NA NA NA NA5a. AS + NA + + NA + + OA5b. AU NA NA + NA6a. AU NA NA NA NA NA6b. AU NA NA NA NA OA7. AU NA NA + OA8a. AU NA NA NA8b. AE +/ NA NA NA NA NA + OA9. AU NA NA + OA10. AE + NA NA NA NA NA OA

5-139

EXERCISE 5-15B

Beginning Mdse. Inventory

$ 4,200

Plus: Merchandise Purchased

21,000

Total Available for Sale 25,200

Less: Ending Mdse. Inventory

(8,800)


a. Goods Available for Sale $25,200

b. Cost of Goods Sold $16,400

c. Merchandise Inventory on year-end balance sheet $8,800

5-140

EXERCISE 5-16B

Single-Step Income Statement:

Neighborhood MarketIncome Statement

Net Sales $1,600

ExpensesCost of Goods Sold $900Advertising Expense 400Interest Expense 140Salaries Expense 260Supplies Expense 110


Net Income (Loss) $(210)

Multistep Income Statement:

Neighborhood MarketIncome Statement

Net Sales $1,600

Cost of Goods Sold (900)

Gross Margin 700

Operating ExpensesAdvertising Expense $400Salaries Expense 260Supplies Expense 110

Total Operating Expenses (770)Operating Income (Loss) (70)

Interest Expense (140)Net Income (Loss) $(210)

EXERCISE 5-17B

5-141

a.Hill Antiques

Schedule of Cost of Goods Sold

Beginning Merchandise Inventory $ 12,000Plus: Purchases 150,000Plus: Transportation-in 1,000Less: Purchase Returns and Allowances

(5,000)

Cost of Goods Available for Sale 158,000Less: Ending Merchandise Inventory (15,000)


b.Hill Antiques

Income StatementFor Period Ended 20XX

RevenueNet Sales Revenue* $397,00

0




Net Income $228,000

*Sales, $400,000 Sales Returns and Allow., $3,000 = Net Sales, $397,000

5-142

EXERCISE 5-18Ba.

Kay’s Specialties ShopGeneral Journal for 2005



2. Merchandise Inventory 8,000Common Stock 8,000


4. Advertising Expense 6,000Cash 6,000


6. Salaries Expense 20,000Cash 20,000


8 adj. Cost of Goods Sold* 78,000Merchandise Inventory (Ending)

20,000

Purchases 90,000Merchandise Inventory

(ownercontribution)

8,000

*Cost of Goods Sold Calculation:Beginning Merchandise Inventory$ -0-Owner Contribution 8,000Purchases 90,000Goods Available for Sale 98,000Less: Ending Merchandise Inventory(20,000 ) Cost of Goods Sold $78,000

5-143


Kay’s Specialties ShopT-Accounts for 2005


Cash Accounts Payable Common Stock1. 70,000 4. 6,000 7. 75,000 3. 90,000 1. 70,0005. 160,000 6. 20,000 Bal.

15,0002. 8,000

7. 75,000 Bal.78,000

Bal.129,000


Inventory5. 160,000

2. 8,000 8. 8,000 Bal.160,000

8. 20,000Bal.

20,000Cost of Goods Sold

8. 78,000Bal.78,000

Purchases3. 90,000 8. 90,000Bal. -0-

Advertising Expense4. 6,000Bal. 6,000

Salaries Expense6. 20,000Bal.20,000

5-144


Kay’s Specialties ShopFinancial Statements


Income Statement

Net Sales $160,000


Gross Margin 82,000

Operating ExpensesAdvertising Expense $ 6,000Salaries Expense 20,000

Total Operating Expenses

(26,000)


5-145


Kay’s Specialties ShopFinancial Statements


AssetsCash $129,00

0Merchandise Inventory 20,000


LiabilitiesAccounts Payable $15,000




$149,000



Inflow from Customers $160,000

Outflow for Inventory (75,000)Outflow for Expenses (26,000)


$59,000


-0-

Cash Flows From Financing

5-146

ActivitiesInflow from Stock Issue 70,000

Net Change in Cash 129,000Plus: Beginning Cash Balance -0-Ending Cash Balance $129,00

0

5-147

EXERCISE 5-18B (cont.)d.

Kay’s Specialties ShopGeneral Journal


Closing Entries

cl Sales Revenue 160,000Retained Earnings 160,000

cl Retained Earnings 104,000Cost of Goods Sold 78,000Advertising Expense 6,000Salaries Expense 20,000

5-148

EXERCISE 5-18B d. (cont.)

Kay’s Specialties ShopT-Accounts



129,000Bal.

15,000Bal.78,000

Retained EarningsMerchandise

Inventorycl104,000 cl 160,000

Bal.20,000

Bal.56,000

Sales RevenueBal.160,000

cl160,000Bal. -0-

Cost of Goods SoldBal.

78,000cl 78,000

Bal. -0-

Advertising ExpenseBal. 6,000

cl 6,000Bal. -0-

Salaries ExpenseBal.

20,000cl 20,000

Bal. -0-

5-149

EXERCISE 5-18B (cont.)e.

Kay’s Specialties ShopAfter Closing Trial BalanceAs of December 31, 2005


Cash $129,000Merchandise Inventory 20,000Accounts Payable $ 15,000Common Stock 78,000Retained Earnings 56,000

Totals $149,000 $149,000

f. A business that may use the periodic method would be small retailers that do not have the necessary computer equipment to be able to record the cost of goods as they are sold. Also, it may be more cost effective for a business with small amounts of inventory to use the periodic method.

g. Owners may contribute many types of assets to a business in exchange for stock in the business. For instance, an owner may contribute automobiles, office equipment, land, building or other similar assets that are personally owned in exchange for stock in a corporation.

5-150

EXERCISE 5-19Ba.

J’s AppliancesGeneral Journal for 2006


1. Cash 100,000Notes Payable 100,000






6. Interest Expense* 7,000Interest Payable 7,000

*$100,000 x 7% = $7,000

5-151


J’s AppliancesT-Accounts


Cash Notes Payable Sales Revenue1.

100,000

2.80,000

1.100,000

3a.68,000

4. 28,000 5.10,000

Bal.100,000

Bal.68,000

Bal.38,000

Interest Payable Cost of Goods Sold

Accounts Receivable

6. 7,000 3b.36,000

3a.68,000

4.28,000

Bal. 7,000 Bal.36,000

Bal.40,000

Operating Expenses

Mdse. Inventory 5. 10,0002. 80,000 3b.

36,000Bal.

10,000Bal.44,000

Interest Expense6. 7,000Bal. 7,000

c.J’s Appliances

Income Statement For the Year Ended December 31, 2006

Net Sales $68,000

5-152


Gross Margin 32,000



Interest Expense (7,000)

Net Income $15,000

5-153


J’s AppliancesFinancial Statements


AssetsCash $38,000Accounts Receivable 40,000Merchandise Inventory 44,000



0Interest Payable 7,000





$122,000





$(62,000)


-0-

5-154


Cash Inflow from Loan 100,000

Net Change in Cash 38,000Plus: Beginning Cash Balance -0-Ending Cash Balance $

38,000

EXERCISE 5-20B

a. 35 days; Braun will have to pay within 10 days if he takes the discount, but will have 45 days to pay if he does not take the discount.

b. Assuming he has no other cash, Braun would have to borrow the invoice amount less the discount or $65,000 x .98 = $63,700.

c. Interest cost for 35 days: 63,700 x 8% x 35/365 = $488.66.Total that would have to be repaid: $63,700 + $488.66 = $64,188.66.Savings by borrowing to pay the invoice within 10 days: $65,000 $64,188.66 = $811.34.

Memo:It would be most cost effective for Braun to borrow the money in order to pay the invoice within the discount period. Braun would be incurring interest for a period of 35 days at a cost of $488.66. However, he would save $1,300 ($65,000 x .02) by paying within the discount period. The net savings to Braun would be $811.34.

5-155

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 5

PROBLEM 5-21BT-accounts are provided for the instructor’s use:

Flower Company T-Accounts 2002, 2003, and 2004


Cash Common Stock Retained Earnings200280,000 60,000 2002

80,0002002 8,000

102,000 40,000 Bal. 8,000Bal. 82,000 2003 16,0002003

146,00090,000 Bal. 24,000

52,000 2004 8,000Bal. 86,000 Bal. 32,0002004

220,000130,000

72,000 Sales RevenueBal.

104,000cl 102,000 2002

102,000Bal. -0-

Merchandise Inv. cl 146,000 2003146,000

2002 60,000 54,000 Bal. -0-Bal. 6,000 cl 220,000 2004

220,000200390,000 78,000 Bal. -0-Bal. 18,0002004

130,000140,000

Bal. 8,000 Cost of Goods Sold2002

54,000cl 54,000

Bal. -0-2003

78,000cl 78,000

Bal. -0-2004

140,000cl 140,000

Bal. -0-

Selling and Adm. Exp.2002 cl 40,000

5-156

40,000Bal. -0-2003

52,000cl 52,000

Bal. -0-2004

72,000cl 72,000

Bal. -0-

5-157

PROBLEM 5-21B (cont.)

Flower CompanyFinancial Statements

Income Statements

2002 2003 2004

Net Sales $102,000 $146,000

$220,000

Cost of Goods Sold (54,000) (78,000) (140,000)

Gross Margin 48,000 68,000 80,000

Operating ExpensesSelling and Admin.

Expense(40,000) (52,000) (72,000)

Operating Income $ 8,000 $ 16,000 $ 8,000

Balance Sheets

AssetsCash $82,000 $

86,000$104,00

0Merchandise Inventory 6,000 18,000 8,000

Total Assets $88,000 $104,000

$112,000

Liabilities $ -0- $ -0- $ -0-

Stockholders’ EquityCommon Stock 80,000 80,000 80,000Retained Earnings 8,000 24,000 32,000

Total Stockholders’ Equity 88,000 104,000 112,000Total Liab. and Stkholders’ Equity

$88,000 $104,000

$112,000

5-158

PROBLEM 5-22B

Event Product Costs

Period Costs

a.

b.

c.

d.

e.

f.

g.

h.

i.

j.

PROBLEM 5-23B

Event Freight Costs Paid

Period/Product

a. $300 Product

b. $ -0- NA

c. $ -0- NA

d. $500 Period

5-159

PROBLEM 5-24Ba.

The Jewel ShopEffect of Transactions on Financial Statements Using Horizontal Statements Model


Date Assets = Liab. + Stockholders’ Equity


Cash Flows

Cash + Acct. Rec.

+ Inv. = Acct. Pay.

+ C. Stk. + Ret. Earn.

5/1 100,000

+ NA + NA = NA + 100,000

+ NA NA NA = NA 100,000 FA

5/1 NA + NA + 60,000 = 60,000 + NA + NA NA NA = NA NA 5/2 (1,200) + NA + 1,200 = NA + NA + NA NA NA = NA (1,200) OA 5/4a. NA + 74,000 + NA = NA + NA + 74,000 74,00

0 NA =74,000 NA

5/4b. NA + NA + (44,000)

= NA + NA +(44,000) NA 44,000

=(44,000)

NA

5/4 NA + NA + (5,000)= (5,000) + NA + NA NA NA = NA NA 5/10a.

NA + NA + (550)= (550) + NA + NA NA NA = NA NA

5/10b.

(26,950)

+ NA + NA =(26,950) + NA + NA NA NA = NA (26,950) OA

5/13 74,000 +(74,000) + NA = NA + NA + NA NA NA = NA 74,000 OA 5/31 (27,500

)+ NA + NA =(27,500) + NA + NA NA NA = NA (27,500) OA

5/31 (7,800) + NA + NA = NA + NA + (7,800) NA 7,800 = (7,800) (7,800) OA

Tot. 110,550

+ -0- + 11,650 = -0- + 100,000

+ 22,200 74,000

51,800

=22,200 110,550 NC

5-160

PROBLEM 5-24B (cont.)b.

The Jewel ShopGeneral Journal, May 2008


May 1 Cash 100,000Common Stock 100,000

May 1 Merchandise Inventory 60,000Accounts Payable 60,000

May 2 Merchandise Inventory 1,200Cash 1,200

May 4a. Accounts Receivable 74,000Sales Revenue 74,000

May 4b. Cost of Goods Sold 44,000Merchandise Inventory 44,000

May 4 Accounts Payable 5,000Merchandise Inventory 5,000

May 10a.


Merchandise Inventory 550May 10b.

Accounts Payable 26,950

Cash 26,950

May 13 Cash 74,000Accounts Receivable 74,000

May 31 Accounts Payable 27,500Cash 27,500

May 31 Selling and Admin. Expenses

7,800

Cash 7,800

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PROBLEM 5-24B (cont.)c.

The Jewel ShopT-Accounts, May 2008


Cash Accounts Payable Common Stock5/1 100,000 5/2 1,200 5/1

60,0005/1100,000

5/13 74,000 5/10b.26,950

5/4 5,000

5/31 27,500 5/10a. 550 Sales Revenue5/31 7,800 5/10b.

26,9505/4a.74,000

Bal.110,550

5/31 27,500 Bal.74,000

Bal. -0-Accounts Receivable Cost of Goods Sold

5/4a.74,000

5/13 74,000 5/4b.44,000

Bal. -0- Bal. 44,000

Merchandise Inventory Selling & Adm. Expenses

5/1 60,000 5/4b. 44,000 5/31 7,8005/2 1,200 5/4 5,000 Bal. 7,800

5/10a. 550Bal. 11,650

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PROBLEM 5-24B (cont.)d. & e.

The Jewel ShopFinancial Statements

For the Month Ended May 31, 2008

Income Statement

Net Sales $74,000


Gross Margin 30,000

Operating ExpensesSelling and Adm. Expenses (7,800)



Cash Flows From Oper. Activities:

Inflow from Customers $74,000

Outflow for Inventory

(55,650)Outflow for Selling and Adm.

Exp.(7,800)


$10,550


-0-

Cash Flows From Fin. Activities:

Inflow from Stock Issue 100,000Net Cash Flow from Financing Act.

100,000


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Plus: Beginning Cash Balance -0-Ending Cash Balance $110,55

0

f. The difference between net income and net cash flow from operating activities is due entirely to unsold inventory ($22,200 $10,550 = $11,650) that has already been paid for.

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PROBLEM 5-25Ba.

M & M EnterprisesEffect of Events on the Financial Statements for 2006

Event Event


No. Type Assets = Liab. + S. Equity


1a. AS + + NA NA NA NA NA1b. AE + NA NA NA NA NA OA2. AU NA NA NA NA NA3a. Disc.

AU NA NA NA NA NA

3b. Pay.

AU NA NA NA NA OA

4a. Sale

AS + NA + + NA + NA

4b. Cost

AU NA NA + NA

5a. Ret.

AU NA NA OA

5b. Ret.

AS + NA + NA + NA

6. AU NA NA + OA7a. Disc.

AU NA NA NA

7b. Coll.

AE + NA NA NA NA NA + OA

8. AU NA NA + NA

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M & M Enterprises General Journal


1a. Merchandise Inventory 5,600Accounts Payable 5,600

1b. Merchandise Inventory 500Cash 500






5a. Sales Revenue 840Cash 840

5b. Merchandise Inventory 520Cost of Goods Sold 520




8. Cost of Goods Sold (Inventory Loss)

316

Merchandise Inventory 316

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M & M EnterprisesT-Accounts for 2006



8,400 1b.

500 2. 400 1a.

5,600 Bal.

8,000

7b. 8,820 3b.

5,096 3a. 104

5a.

840 3b. 5,096

6. 600 Bal. -0- Retained EarningsBal.

10,184 Bal.

2,400

cl 6,396 cl 7,980 Bal.

3,984

Merchandise Inventory

Bal.

2,000 Sales Revenue

1a. 5,600 2. 400 5a. 840 4a. 9,0001b. 500

3a.104 7a. 180

5b. 520 4b.

6,000 Bal.

7,980

8. 316 cl 7,980Bal.

1,800 Bal.

-0-

Cost of Goods Sold4b. 6,000

Accounts Receivable

8. 316 5b. 520

4a. 9,000 7a.

180 Bal.

5,796

7b. 8,820 cl 5,796Bal.

-0- Bal.

-0-

Transportation-out6. 600Bal.

600

cl 600Bal -0-

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.

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PROBLEM 5-25Bd.

M & M EnterprisesFinancial Statements


Income Statement

Net Sales $7,980


Gross Margin 2,184






2,400



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PROBLEM 5-25B d. (cont.)

M & M EnterprisesFinancial Statements




Liabilities $ -0-

Stockholders’ EquityCommon Stock $ 8,000Retained Earnings 3,984



$11,984





$ 1,784


-0-


-0-


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Plus: Beginning Cash Balance 8,400Ending Cash Balance $10,18

4

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PROBLEM 5-25B (cont.)e.Date Account Titles Debit Credit

Closing Entries

Dec. 31

Sales Revenue 7,980


Dec. 31


Cost of Goods Sold 5,796Transportation-out 600

See T-Accounts in part c. for closing entries.

M & M EnterprisesAfter Closing Trial Balance

December 31, 2006


Cash $10,184Merchandise Inventory 1,800Common Stock $ 8,000Retained Earnings 3,984

Totals $11,984 $11,984

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PROBLEM 5-26Ba.

Martin Farm Co.Schedule of Cost of Goods Sold

Beginning Merchandise Inventory

$ 5,075

Purchases 40,000Purchase Returns and Allowances

(1,450)


45,350

Less: Ending Merchandise Inventory

(4,050)


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Martin Farm Co.Income Statement



Allowances(2,250)

Sales Discounts (405)Net Sales $67,095


Gross Margin 25,795

Operating ExpensesMiscellaneous Expense 400Transportation-out 600Advertising Expense 2,750Salaries Expense 7,900Rent Expense 5,000Depreciation Expense 710

Total Operating Expenses (17,360)


Non-Operating ItemsInterest Expense (360)

Net Income Before Income Tax

8,075

Income Taxes (3,700)

Net Income $ 4,375

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PROBLEM 5-26b (cont.)c.

Martin Farm Co.Income Statement



Allowances(2,250)

Sales Discounts (405)Net Sales $67,095

Operating ExpensesCost of Goods Sold 41,300Miscellaneous Expense 400Transportation-out 600Advertising Expense 2,750Salaries Expense 7,900Rent Expense 5,000Depreciation Expense 710Interest Expense 360Income Taxes 3,700


Net Income $ 4,375

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PROBLEM 5-27Ba.

John’ s JungleGeneral Journal, 2008


1a. Land 20,000Cash 20,000

1b. Building 90,000Cash 10,000Notes Payable 80,000


3. Transportation-in 1,000Cash 1,000

4. Accounts Payable 3,600Purchase Returns and

Allow.3,600


6. Accounts Receivable 120,000Sales Revenue 120,000

7a. Accounts Payable 1,224Purchase Discounts 1,224


8. Selling Expenses 11,600Cash 11,600

9a. Sales Discounts ($50,000 x 2%)

1,000

Accounts Receivable 1,000

9b. Cash ($110,000 $1,000) 109,000Accounts Receivable 109,000

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PROBLEM 5-27B a. (cont.)

John’s JungleGeneral Journal, 2008


10. Interest Expense ($80,000 x 8%)

6,400

Cash 6,400

11. Notes Payable 10,000Cash 10,000

12. Depreciation Expense1 2,250Accumulated Depreciation 2,250

13. Cost of Goods Sold2 144,576Purchase Discounts 1,224Purchase Returns and Allowances

3,600

Purchases 126,000Transportation-in 1,000Merchandise Inventory

($50,000 $27,600)22,400

1$90,000 40 = $2,250 per year.2Cost of Goods Sold:Beginning Merchandise Inventory $ 50,000

Purchases 126,000Transportation-in 1,000Purchase Ret. and Allow.(3,600)Purchase Discounts (1,224 ) Cost of Goods Available172,176Less: Ending Merchandise Inventory

(27,600)Cost of Goods Sold $144,576

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John’s Jungle


26,000 1a. 20,000 4. 3,600 Bal.

4,000 Bal.

37,000

5. 86,000 1b. 10,000 7a. 1,224 2. 126,000

9b. 109,000

3. 1,000 7b.

121,176

Retained Earnings

7b. 121,176

Bal.

4,000 Bal.

33,000

8. 11,600 10. 6,400 Notes Payable Sales Revenue 11. 10,000 11.10,000

Bal.6,000 5. 86,000

Bal.

40,824 1b. 80,000 6. 120,000

Bal.

76,000 Bal.

206,000

Accounts ReceivableBal.

4,000 9a. 1,000 Sales Discounts

6. 120,000

9b. 109,000

9a. 1,000

Bal.

14,000

PurchasesMerchandise Inventory 2. 126,00

0 13.

126,000

Bal.

50,000 13. 22,400 Bal.

-0-

Bal.

27,600

Purchase Returns & Allow.

Building 13. 3,600 4. 3,6001b. 90,000 Bal

.-0-

Bal.

90,000

Purchase DiscountsAccumulated Depr. 13. 1,224 7a. 1,224

12. 2,250 Bal.

-0-

Bal.

2,250

Transportation-in

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Land 3. 1,000 13. 1,0001a. 20,000 Bal

.-0-

Bal.

20,000

Cost of Goods Sold13. 144,57

6

Interest Expense10. 6,400

Selling Expenses8. 11,600

Depreciation Expense12. 2,250

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John’s JungleSchedule of Cost of Goods Sold

Beginning Inventory 1/1/2008

$50,000

Purchases 126,000Purchase Discounts (1,224)Purchase Returns and Allow.

(3,600)


$172,176

Ending Merchandise Inventory

(27,600)


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PROBLEM 5-27B c. (cont.)

John’s JungleFinancial Statements


Income Statement

RevenueSales Revenue $206,000Sales Discounts (1,000)

Net Sales $205,000


Gross Margin 60,424

Operating ExpensesSelling Expenses 11,600Depreciation Expense 2,250

Total Operating Expense (13,850)


Non-Operating ExpenseInterest Expense (6,400)

Net Income $ 40,174


Beginning Common Stock $37,000Plus: Stock Issued -0-Ending Common Stock $ 37,000


33,000



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5-182

PROBLEM 5-27B c. (cont.)

John’s JungleBalance Sheet


AssetsCash $40,824Accounts Receivable 14,000Merchandise Inventory 27,600Building $90,00

0Accumulated Depreciation (2,250) 87,750Land 20,000


LiabilitiesAccounts Payable $ 4,000Notes Payable 76,000

Total Liabilities $ 80,000

Stockholders’ EquityCommon Stock 37,000Retained Earnings 73,174



$190,174

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PROBLEM 5-27B c. (cont.)John’s Jungle



Inflow from Customers $195,000Outflow for Inventory (122,176

)Outflow for Expenses (18,000)


$54,824

Cash Flows From Investing Activities:

Outflow for Purchase of Bldg. and Land

(30,000)

Net Cash Flow from Investing Activities

(30,000)


Outflow for Loan Payment (10,000)Net Cash Flow from Financing Activities

(10,000)


4

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PROBLEM 5-28B

Madison CompanyCommon Size Income Statements

2002 % 2003 %

Net Sales $74,507 100 $80,000 100Cost of Goods Sold (28,317) (38) (34,400) (43)Gross Margin 46,190 62 45,600 57

Operating ExpensesSelling and Adm. Exp. (43,210) (58) (40,800) (51)

Net Income $ 2,980 4 $ 4,800 6

Based on the common size income statements, the claims made by the president appear to be true. The dollar amount of the sales increased from $74,507 to $80,000, but the gross margin percentage decreased from 62% to 57%. The lower gross margin percentage shows that the company is charging less for its goods compared to the cost of the goods. Operating expenses in 2003 were lower, as a percentage of sales, than in 2002. These factors combined to give the company a higher return-on-sales percentage in 2003.

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ATC 5-1a.(All amounts are in thousands)

Gross Profit Sales = Gross Profit %2000 $5,218 $25,265 = 20.65%2001 $6,443 $31,888 = 20.21%

b.Net Income Sales = Return on

Sales %2000 $1,666 $25,265 = 6.59%2001 $2,177 $31,888 = 6.83%

c. Dell’s gross profit percentage in 2000 was 0.44 points higher than it was in 2001 (20.65% 20.21%). Ignoring taxes, an additional 0.44% of gross profit would have increased Dell’s 2001 net income by just over $140 million. (Sales of $31,888 x .0044 = $140.3)

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ATC 5-2a. (1)Calculate cost of goods sold:

First Quarter

Second Quarter

Third Quarter

FourthQuarter

Sales $1,481,605

$2,260,388

$2,891,237

$774,674

Less gross margin

(561,247) (855,353) (1,107,323)

(295,970)

Cost of goods sold

$ 920,358 1,405,035 $1,783,914

$478,704

Calculate operating expenses:

First Quarter

Second Quarter

Third Quarter

FourthQuarter

Gross margin $561,247 $855,353 $1,107,323

$295,970

Less net income (52,279) (21,138) (43,321) (36,645)Operating expenses

$508,968 $834,215 $1,064,002

$259,325

Multistep income statements

First Quarter

Second Quarter

Third Quarter

FourthQuarter

Sales $1,481,605

$2,260,388

$2,891,237

$774,674

Less Cost of goods sold (920,358) (1,405,035

)(1,783,914

)(478,704)

Gross margin 561,247 855,353 1,107,323 295,970Less operating expenses (508,968) (834,215) (1,064,002

)(259,325)

Net income $ 52,279 $ 21,138 $ 43,321 $ 36,645

a. (2)Gross margin percentage:

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Quarter Gross Margin Sales = Gross margin %

First $561,247 $1,481,605 = 37.88%Second $855,353 $2,260,388 = 37.84%Third $1,107,323 $2,891,237 = 38.30%Fourth $295,970 $774,674 = 38.21%

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ATC 5-2 a. (cont.)

a. (3)Cost of goods sold percentage:Quarter

1 Gross margin %

= Cost of goods sold %

First 1.00 .3788 = 62.12%Second

1.00 .3784 = 62.16%

Third 1.00 .3830 = 61.70%Fourth

1.00 .3821 = 61.79%

b. Some points the students may mention include:The sales increase in the third quarter can be attributed to sales for the Christmas season.Gross margin may drop in the last quarter if the company is trying to increase sales for year end and sell old merchandise.

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ATC 5-3

The correct matching of the four companies with their related financial data can be achieved with only the gross margin percentage ratio, plus other factors. However, on the assumption that many students will compute all the ratios for which there were sufficient data, the return-on-assets and return-on-sales ratios are presented here as well.

(Dollar amounts are in millions.) A B C D

Sales $20,175 $1,688.1 1,668.1$1,161.7

Cost of Goods Sold 14,497 1,063.4 719.6 327.4Gross Margin $ 5,678 $ 624.7 $ 948.5 $ 834.3

Company

RATIO: A B C D

28.1% = 37.0% = 56.9% =

71.8%=

Gross Margin $ 5,678 $ 624.7 $ 948.5

$ 834.3

$20,175 $1,688.1

$1,668.1

$1,161.7

5.2% = 7.1% = 11.4%= 4.3% =

Return-on-Sales $ 1,053 $ 120.2 $190.6 $ 49.5 $20,175

$1,688.1

$1,668.1

$1,161.7

3.7% = 16.1%= 12.2% =

2.9% =

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Return-on-Assets

$ 1,053 $ 120.2 $ 190.6 $ 49.5

$28,464 $ 746.9 $1,568.3

$1,712.3

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ATC 5-3 (cont.)

The four companies relate to the financial information as follows:

Caterpillar is company “A”Dollar Tree is company “B”Tiffany is company “C”Novell is company “D”

It is entirely coincidental that the alphabetical ordering of the companies matches the decreasing magnitude of their respective sales.

Rational for matching companies with financial information:

Dollar Tree can be matched with company “B” data because it is the only company that did not have any accounts receivable. Most students will probably know that discount stores do not usually make sales on account.

Novell can be matched with company “D” due to its high gross margin percentage. The big expense for a software company is the cost of developing programs. Once developed, it is easy and cheap to produce more copies.

There are a couple of clues suggesting that company “A” is Caterpillar and company “C” is Tiffany. First, company “A” is a lot larger company than company “C” in terms of both sales and total assets. Many students will probably expect Caterpillar to be the larger company. Second, once it is determined that the discount retailer, company “B” has a gross margin percentage of 37%, students would expect Tiffany’s gross profit margin to be higher. This would eliminate company “A” from being Tiffany.

It is worth noting that even though the discount store company, Dollar Tree, had a lower gross margin percentage and return-on-sales ratio than Tiffany’s, it still had a higher

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return-on-assets ratio. A company that charges the lowest prices does not necessarily earn the least profit for the amount of assets invested.

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ATC 5-4

a. Gross Margin Percentages:

Richard: 45% ($14,670 ÷ $32,600)Jennifer: 25% ($21,550 ÷ $86,200)

Return-on-Sales Ratios:

Richard: 5% ($1,630 ÷ $32,600)Jennifer: 3% ($2,590 ÷ $86,200)

Both of these ratios, but especially the gross margin percentages, show that Richard is the “high-end retailer.” Richard is obviously marking up the price of merchandise by a greater percentage than Jennifer.

b. Return-on-Equity Ratios:

Richard: 10.1% ($1,630 $16,200)Jennifer: 12.7% ($2,590 $20,400)

From the viewpoint of the owners, Jennifer was more profitable.

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ATC 5-5

a.

Common Size Income Statements

Karen % Patrick %

Sales $1,000,000 100.0 $1,000,000 100.0Cost of Goods Sold (650,000) (65.0) (550,000) (55.0)Gross Margin 350,000 35.0 450,000 45.0

Operating Expenses (250,000) (25.0) (375,000) (37.5)Net Income $ 100,000 10.0 $ 75,000 7.5

b. Karen Company:

Return on assets: $100,000 ÷ $1,200,000 = 8.3%Return on equity: $100,000 ÷ $ 450,000 = 22.2%

Patrick Company:

Return on assets: $75,000 ÷ $1,200,000 = 6.3%Return on equity: $75,000 ÷ $ 300,000 = 25.0%

c. Patrick Co., because it has the higher return-on-equity percentage.

d. Patrick Co. appears to be the high-end retailer because it has the higher gross margin percentage. Karen Co. appears to be the discounter because it has the lower gross margin percentage.

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ATC 5-6

a.This writing assignment tests both analytical and writing skills.

Some of the analytical amounts that should be included are:

For 2005:Sales are overstated by $146,800.Cost of goods sold is overstated by $94,623.Gross profit is overstated by $52,177 ($146,800 $94,623).Net income is overstated by $52,177.Assets are overstated by $52,177.Equity is overstated by $52,177.

For 2006 the opposite result occurs:Sales are understated by $146,800.Cost of goods sold is understated by $94,623.Gross profit is understated by $52,177.Net income is understated by $52,177.

b. The president of the company may want to show a higher net income and higher sales for 2005 for the purpose of making a loan or securing other capital. Also, if the president receives a bonus that is based on net income, delaying the recognition of the sales return will act to increase his 2005 bonus. However, reporting more income in 2005 will increase the amount of income tax paid.

c. Yes, it will violate rules II , IV & V .

d. If this is an indication of the character of the president and consequently the company, you may want to find other employment. Usually, if a person violates one set of rules, then others may also be violated.

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ATC 5-7

a. An immediate write off would result in a $600,000 inventory loss reported under unusual items on the company’s income statement. This loss would be subtracted from income from continuing operations. Accordingly, net income would decline. The write-off would decrease assets (i.e., inventory) and equity (i.e., retained earnings) on the balance sheet. Cash flow would not be affected. These computations ignore the effects resulting from tax savings.

b. Since Ms. Fontanez’s bonus is based on net income, her bonus would be reduced by $30,000 [$600,000 loss in profit x .05 bonus].

c. The loss would be recognized on the 2006 income statement if Ms. Fontanez refused to have it recognized in 2005. This would reduce the new president’s bonus. Even if the loss is not taken in 2005 and the new president can sell the damaged goods at a reduced price, profits would still be adversely affected and his bonus would suffer from an event that happened in the prior period.

d. Given that the damaged inventory is worthless, it would be unethical for Ms. Fontanez to refuse to recognize it in the period the loss was incurred. Fairness would dictate that Ms. Fontanez accept the loss because it occurred in a period under her management control. It was her management team that exposed the company to the risk of self insurance. Funds saved on insurance expense must be weighed against the losses that a company is likely to incur. Not only is the deferral of the loss unethical, it is in violation of GAAP. The willful failure to report a material loss is an act of fraud. Accordingly, Ms. Fontanez and Mr. Smith could face criminal charges if they fail to report the loss in the financial statements.

e. Mr. Smith must refuse to go along with Ms. Fontanez even if it means he loses his job. If he willfully

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participates in fraudulent reporting practices, he may face criminal prosecution. My boss made me do it, is not a valid justification for fraud in the eyes of the law.

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ATC 5-8

NOTE: This solution was accurate as of December 15, 2001. However, the EDGAR database is subject to update at any time, so this solution will likely be “dated” at the time you assign this case to your students.

a.& b. Amounts in millions.

2000 1999 Sales $22,936 $16,323Cost of goods sold 17,342 12,536Gross margin $ 5,594 $ 3,787

Gross margin percentage 24.4% 23.2%

c. Net earnings in 2000 were $1,484. Return on sales was:

$1,484 ÷ $22,936 = 6.5%

d. Total sales in 2000 were $22,936; sales in the USA were $15,487 Domestic operations accounted for 67.5% of sales.

e. These companies are not in the same industry and cannot be compared. You need to compare companies in the same industry to determine which is better managed.

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Documents

Chapter 05 Solution of fundamental of financial accouting by EDMONDS (4th edition)