financial accounting tools for business decision making 6e solution manual chapter 5

In addition, cost of goods sold is deducted from sales revenue to determine gross profit, before operating and other expenses similar to both types of companies are deducted or other rev

CHAPTER 5

Merchandising Operations

ASSIGNMENT CLASSIFICATION TABLE

Brief Exercises Exercises

A Problems

B

1 Identify the differences

between service and

2B, 3B, 4B, 5B

2B, 3B, 4B, 5B

1, 3, 7

5 Calculate the gross profit

margin and profit margin

18, 19, 20, 10, 11 6, 9, 10,

11

8A, 9A, 10A, *14A

8B, 9B, 10B, *14B

1, 2, 3,

4, 6, 7

6 Prepare entries for

purchases and sales

under a periodic

inventory system and

calculate cost of goods

sold (Appendix 5A)

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Difficulty Level

Time Allotted (min.)

4A Record and post purchase and sales transactions;

prepare trial balance

7A Record and post adjusting entries; prepare adjusted

trial balance and financial statements

*13A Record and post purchase and sales transactions;

prepare trial balance

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Problem

Difficulty Level

Time Allotted (min.)

4B Record and post purchase and sales transactions;

prepare trial balance

7B Record and post adjusting entries; prepare adjusted

trial balance and financial statements

Moderate 35-45

8B Calculate profitability ratios and comment Moderate 15-20

*13B Record and post purchase and sales transactions;

prepare trial balance

2 (a) The income measurement process of a merchandising company is the same as the

service company in that profit is arrived at by deducting expenses from revenues (b) The income measurement process of a merchandising company differs from that of

a service company in that its revenue is derived from sales revenue, not service revenue In addition, cost of goods sold is deducted from sales revenue to determine gross profit, before operating and other expenses similar to both types of companies are deducted (or other revenues are added)

3 The company needs to compare the cost of the detailed record keeping required in a perpetual inventory system to the benefits of having the additional information about the inventory One of the benefits of a perpetual inventory system is the ability to answer questions from customers about merchandise availability In a used clothing business, this may not be of much benefit unless each inventory item is unique Another benefit is the monitoring of inventory quantities in order to avoid running out of stock Again, this may not be of benefit since the company does not order recurring or similar merchandise, and may not have a supplier to order from But if the company is selling used clothing on consignment it will need to track each item in order to determine which consignor to pay when an item is sold

The company should carefully determine the cost of the detailed record keeping required, in particular for a new company A perpetual inventory system requires more record keeping and therefore is more expensive to use For example, a perpetual inventory system usually requires an investment in a point of sale system that is integrated with the inventory system

4 A physical count is an important control feature By using a perpetual inventory system,

a company knows what should be on hand Performing a physical count and checking it

Answers to Questions (Continued)

6 (a) The value of the purchase discount to Butler Roofing is $100.00 ($10,000 × 1%) (b) Failing to take advantage of the discount terms, is like paying the supplier an extra

$100 in order to settle a $9,900 invoice 20 days later This works out to 1.01% [$100

÷ $9,900] every 20 days On an annual basis this amounts to 18.4% [($100 ÷

$9,900 × (365 ÷ 20)]

7 The company should record the sale as revenue in June, when it is sold to a customer The merchandise purchased should be recorded as an asset, merchandise inventory, in April It should be recorded as cost of goods sold (an expense) in June when the inventory is sold and the revenue is recognized This is necessary in order to match the cost with the related revenue

8 (a) FOB shipping point means that the goods are placed free on board by the seller at

the point of shipping The buyer pays the freight costs from the point of shipping to the buyer’s destination because title passes at shipping point FOB destination means the goods are delivered by the seller to their destination where the title passes The seller pays for shipping to the buyer’s destination

(b) FOB shipping point will result in a debit to the Merchandise Inventory account by the buyer because title has transferred at shipping point and the inventory is now owned

by the buyer FOB destination will result in a debit to Freight Out by the seller because they are paying for the freight

9 In a perpetual inventory system, purchase returns are credited to the Merchandise Inventory because the items purchased have been returned to the vendor and are no longer available to be sold to customers Sales returns are not debited directly to the Sales account because this would not provide information about the goods returned This information can be useful in making decisions Debiting returns directly to sales may also cause problems in comparing sales for different periods

10 (a) A quantity discount gives a reduction in the price according to the volume of the

purchase A purchase discount is offered by a seller to a buyer for early payment of

an invoice When the buyer pays the invoice within the discount period, the amount

of the discount decreases the Merchandise Inventory account A sales discount is the same as a purchase discount but from the seller’s point of view

(b) Quantity discounts are not recorded or accounted for separately but become part of the recorded sales price When collected within the discount period, the seller records the discount as a debit to the Sales Discounts account, which is a contra revenue account to Sales Buyers record purchase discounts when taken as a credit

to Merchandise Inventory under the perpetual system or Purchase Discounts when using the periodic system

Answers to Questions (Continued)

11 If the inventory is not resaleable, it cannot be included in inventory since it cannot be

resold and it has no value The cost remains in cost of goods sold since it is a cost of doing business If the inventory is resaleable, it still has value to the company In this case, the inventory is debited to inventory again and the cost of goods sold is credited

12 By shipping more product than was ordered, customers will be annoyed with Agnew

Inc and there will be damage done to customer relationships Goods that are returned will cost additional freight charges Annoyed customers could possibly refuse the whole order which will result in a lost sale It is not an ethical tactic to implement this procedure as the objective is obviously to manipulate sales results and boost profit in the current year

13 In a single-step income statement, all data are classified into two categories: (1)

revenues and (2) expenses It is referred to as a single-step income statement because only a single step—subtracting expenses from revenues—is needed to determine profit before income tax A multiple-step income statement requires several steps to determine profit before income tax First, cost of goods sold is deducted from sales to determine gross profit Operating expenses are then deducted to calculate profit from operations Finally, other revenues and expenses are added or deducted to determine profit before income tax The deduction of income tax to calculate profit (loss) is the same under both formats In addition, both formats produce the same profit amount for the period

14 Shoppers Drug Mart uses a multiple-step income statement

15 (a) When classifying expenses by their nature, they are reported in accordance with

their natural classification (for example, salaries, deprecation, and so on) When classifying expenses by their function, they are reported according to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling)

(b) It does not matter whether a single-step or multiple-step income statement is prepared, expenses must be classified either by nature or by function

16 Because the Katz Group is a private enterprise, it can follow Accounting Standards for

Private Enterprises (ASPE) Companies following ASPE can classify their expenses in whatever manner is useful to them Shoppers, which follows IFRS must classify its expenses by their nature or their function

Answers to Questions (Continued)

18 The difference between gross profit margin and profit margin is that the gross profit

margin measures the amount by which the selling price exceeds the cost of goods sold while the profit margin measures the extent to which sales cover all expenses (including the cost of goods sold)

19 Factors affecting a company’s gross profit margin include the selling price and the cost

of the merchandise Recall that gross profit = net sales − cost of goods sold Selling products with a higher price or “mark-up” or selling products with a lower cost would result in an increased gross profit margin Selling products with a lower price (perhaps dues to increased competition that results in lower selling prices) or selling products with a higher cost (perhaps due to price increases from suppliers and shippers) would result in a lower gross profit margin

*21

*22 Periodic System

Cost of Goods Sold = Beginning Inventory + Cost of Goods Purchased (Purchases – Purchase Discounts – Purchase Returns and Allowances + Freight In) – Ending Inventory

Ending inventory as well as cost of goods sold for the period, is calculated at the end

of period

Perpetual System

Cost of Goods Sold = the cost of the item(s) sold

Cost of goods sold is calculated at the time of each sale and recorded as an increase (debit) to the Cost of Goods Sold account and a decrease (credit) to the Merchandise Inventory account

Answers to Questions (Continued)

*23 The calculation of cost of goods sold is shown in detail in the income statement of a

company using the periodic system In a perpetual system, it is one line and amount only

Periodic System

Cost of Goods Sold =

1 Add the cost of goods purchased (where the cost of goods purchased is equal to purchases less purchases discounts and purchases returns and allowances plus freight in) to the cost of goods on hand at the beginning of the period (beginning inventory) The result is the cost of goods available for sale

2 Subtract the cost of goods on hand at the end of the period (ending inventory) from the cost of goods available for sale The result is the cost of goods sold

Perpetual System

Cost of Goods Sold = one number, which is the total of cost of goods sold as previously determined and recorded for all sales

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 5-1

(a) The company with the most efficient operating cycle is Company A as it uses the

fewest number of days in its cycle to obtain cash

(b) The company which is most likely a service company is Company A as it does not

have to manufacture or deliver inventory and consequently takes the fewest number of days to obtain cash Company C, with the highest number of days in its operating cycle is likely the manufacturing company and the merchandising company would be

in the middle (Company B) with neither the highest nor the lowest number of days in its operating cycle

[5] Income tax expense = $35 – $26 = $9

(b) Company A is the service company, since it has no cost of goods sold Company B is

the merchandising company, since it has cost of goods sold

BRIEF EXERCISE 5-3

Merchandise Inventory Beginning Balance 25,000

12,000 Purchase returns 4,400 Purchase discounts

93,000 Cost of goods sold Ending Balance 18,000

Purchases Merchandise Inventory 100,000

Accounts Payable 100,000 Purchase Accounts Payable 12,000

Returns Merchandise Inventory 12,000 Purchase Accounts Payable ($100,000 – $12,000) 88,000

Discounts Merchandise Inventory ($88,000 × 5%) 4,400

Cash 83,600 Freight In Merchandise Inventory 2,400

Accounts Payable 2,400 Cost of Cost of Goods Sold 93,000

Sales Merchandise Inventory 93,000

BRIEF EXERCISE 5-4

Pocras Corporation (Buyer):

Aug 24 Merchandise Inventory 900

Accounts Payable 900 Wydell Inc (Seller):

Less: Cost of goods sold 320,000 Gross profit $250,000 (c) Gross profit $250,000

Less: Administrative expenses $100,000

Selling expenses 25,000 125,000 Profit from operations $125,000

(d) Profit from operations $125,000

Add: Other revenues $20,000

Less: Other expenses (30,000) (10,000) Profit before income tax $115,000 (e) Profit before income tax $115,000

Less: Income tax expense 25,000 Profit $ 90,000

BRIEF EXERCISE 5-8

As the name suggests, numerous steps are required in determining profit in a multiple-step statement

BRIEF EXERCISE 5-9

(a) The company is using a multiple-step form of income statement

(b) The company is classifying its expenses by their function, they are reported according

to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling)

(b) The Modder Corporation’s gross profit margin increased significantly in 2015 indicating

an increase in the percentage mark-up, or a reduction in the cost of goods sold, or both On the other hand, in 2015, the company’s profit margin had dropped significantly The decrease in profit margin indicates that in spite of an increase in gross profit, the increase operating expenses overtook this increase in gross profit, leaving a decline in profit margin

(b) The Canadian Tire Corporation’s gross profit margin increased marginally in 2012

indicating a slight increase in the percentage mark-up it has been able to command, or

a lowering of the costs of goods sold, or both On the other hand, the profit margin decreased slightly in 2012 This decrease is due to operating expenses or interest or income tax expense increasing at a greater pace than the increase in gross profit

*BRIEF EXERCISE 5-14

(a) Sales $750,000

Less: Sales returns and allowances $75,000

Sales discounts 25,000 100,000 Net Sales $650,000 (b) Purchases $425,000

Less: Purchase returns and allowances $11,000

Purchase discounts 9,000 20,000 Net purchases $405,000

(c) Net purchases $405,000

Add: Freight in 10,000 Cost of goods purchased $415,000 (d) Beginning merchandise inventory $ 60,000

Add: Cost of goods purchased 415,000Cost of goods available for sale 475,000Less: Ending merchandise inventory 100,000 Cost of goods sold $375,000

(e) Net sales $650,000

Less: Cost of goods sold 375,000 Gross profit $275,000

*BRIEF EXERCISE 5-15

(a) Cost of goods sold

Beginning merchandise inventory $105,000 Purchases $195,000

Less: Purchase returns and allowances $ 6,600

Purchase discounts 20,400 27,000 Net purchases 168,000

Add: Freight In 5,250

Cost of goods purchased 173,250 Cost of goods available for sale 278,250 Ending merchandise inventory 120,000 Cost of goods sold $158,250

(b) There would be no difference in the remainder of the income statement for Halifax

Limited whether the periodic or perpetual inventory systems were used

*BRIEF EXERCISE 5-16

Dec 31 Merchandise Inventory (ending) 24,000

Cost of Goods Sold 271,000*

Purchase Discounts 4,000

Merchandise Inventory (beginning) 30,000 Purchases 262,000 Freight In 7,000

* Cost of goods sold = Beginning inventory + Purchases − Purchase discounts − Purchase returns and allowances + Freight in – Ending inventory

Cost of goods sold = $30,000 + $262,000 − $4,000 + $7,000 – $24,000 =

$271,000

SOLUTIONS TO EXERCISES

EXERCISE 5-1

(a) Toys’ R Us, Inc is a retailer, Fasken Martineau Dumoulin LLP is a service firm, and

Atlantic Grocery Distributors Ltd is a wholesaler

(b) The operating cycle of these three businesses will be different The longest operating

cycle will be experienced by the retailer, as the sales of merchandise will be the slowest The organization with the shortest operating cycle will be the law firm that does not sell inventory The third company, the distributing wholesaler, will have an operating cycle between that of the retailer and the service firm because its inventory

is more likely to sell faster

EXERCISE 5-2

–$3,430 –$70

6 Asset

Expense

Accounts Receivable

Cost of Goods Sold

Sales Returns and Allowances Merchandise Inventory

Receivable

–$6,000

EXERCISE 5-3

(a)

Sept 2 Merchandise Inventory (75 × $20) 1,500

Accounts Payable 1,500

10 Accounts Payable 40

Merchandise Inventory 40

11 Accounts Receivable (26 × $30) 780

Sales 780

Cost of Goods Sold (26 × $20) 520

Merchandise Inventory 520

14 Sales Returns and Allowances 30

Accounts Receivable 30

Merchandise Inventory 20

Cost of Goods Sold 20

21 Accounts Receivable (30 × $30) 900

Sales 900

Cost of Goods Sold (30 × $20) 600

Merchandise Inventory 600

29 Accounts Payable ($1,500 – $40) 1,460 Cash 1,460 30 Cash ($900 – $9) 891

Sales Discounts ($900 × 1%) 9

Accounts Receivable 900

Number of calculators at September 30: 10 + 75 – 2 – 26 + 1 – 30 = 28

Cost of calculators at September 30: 28 × $20 = $560

Cost of Goods Sold 650

8 Accounts Payable 1,200

Merchandise Inventory 1,200

11 Accounts Payable ($18,000 – $1,200) 16,800

Merchandise Inventory [($18,000 – $1,200) × 2%] 336 Cash ($16,800 – $336) 16,464 (c) Sales $18,000

Less: Sales returns and allowances $1,200

Sales discounts 336 1,536 Net sales 16,464 Cost of goods sold ($10,000 – $650) 9,350 Gross profit $7,114

EXERCISE 5-7

Accounts payable Statement of financial position Current liabilities

Accounts receivable Statement of financial position Current assets

Accumulated depreciation Statement of financial position Property, plant, and equipment

(contra account)

Buildings Statement of financial position Property, plant, and equipment

Common shares Statement of financial position Shareholders’ equity

Equipment Statement of financial position Property, plant, and equipment

Interest payable Statement of financial position Current liabilities

Merchandise inventory Statement of financial position Current assets

Mortgage payable Statement of financial position Non-current liabilities

Prepaid insurance Statement of financial position Current assets

Property tax payable Statement of financial position Current liabilities

Salaries payable Statement of financial position Current liabilities

Sales returns and allowances Income statement Revenue (contra account) Unearned revenue Statement of financial position Current liabilities

EXERCISE 5-8

(a)

BLUE DOOR CORPORATION Income Statement (Single-Step) Year Ended December 31, 2015

EXERCISE 5-8 (Continued)

(b)

BLUE DOOR CORPORATION Income Statement (Multiple-Step) Year Ended December 31, 2015

Total operating expenses 895,000

Profit from operations 370,500

Other revenues and expenses

Interest revenue $30,000

Rent revenue 24,000 Interest expense (70,000) (16,000)

Profit before income tax 354,500

Income tax expense 70,000

Profit $ 284,500

(c) The Blue Door Corporation is classifying its expenses by function, which is a method

of classifying expenses by functional areas For smaller companies such as this one, the difference between classification of items on the income statement by function or nature is not significant although if listed by nature, cost of goods sold would typically

be shown in two parts: goods purchased and changes in inventory

*Gross profit [2] $30,250

Gross profit $30,250 Less: Operating expenses 19,500

*Profit from operations [3] $10,750

Profit from operations $10,750 Add: Other revenues 750

*Profit before income tax [4] $11,500

Profit before income tax $11,500 Less: Income tax expense 2,300

*Less: Cost of goods sold [7] 60,000

Gross profit $ 40,000 Gross profit $40,000

*Less: Operating expenses [8] 22,000

Profit from operations $18,000 Profit from operations $18,000 Less: Other expenses 2,000

Total operating expenses 930,000

Profit from operations 2,130,000

Other revenues and expenses

Other expenses 270,000

Profit before income tax 1,860,000

Income tax expense 560,000

EXERCISE 5-11

(in USD millions)

(a) Gross profit margin

(b) While the gross profit margin has been holding steady, with a slight deterioration from

in 2012, the profit margin deteriorated slightly in 2011 and then deteriorated significantly and turned negative in 2012

(c) Profit margin (using profit from operations)

2012: $1,085 ÷ $50,705 = 2.1%

2011: $2,374 ÷ $49,747 = 4.8%

2010: $2,235 ÷ $49,694 = 4.5%

The profit margin using profit from operations has followed the same trend in 2010 and

2012 when compared to profit margin using profit from operations On the other hand, profit margin using profit decreased in 2011 while profit margin using profit from operations increased in 2011 The major element that is in the profit margin ratio but is not in the gross profit margin is operating expenses In 2011, the increased profit margin is likely due to lower operating expenses relative to sales but in 2012, because the profit margin deteriorated so much, it is likely due to increased operating expenses relative to sales

*EXERCISE 5-12

Olaf Corp (Buyer)

(a) Apr 3 Purchases 28,000

(a) Apr 3 Accounts Receivable 28,000

Sales Discounts [($28,000 – $3,500) × 1%] 245

Accounts Receivable ($28,000 – $3,500) 24,500

*EXERCISE 5-13

(a) Duvall Ltd (Seller)

(1) Perpetual Inventory System

June 10 Accounts Receivable 5,000

Sales 5,000 Cost of Goods Sold 3,000

(2) Periodic Inventory System

June 10 Accounts Receivable 5,000

*EXERCISE 5-13 (Continued)

(b) Pele Ltd (Buyer)

(1) Perpetual Inventory System

June 10 Merchandise Inventory 5,000

Accounts Payable 5,000

11 Merchandise Inventory (freight) 250 Cash 250

12 Accounts Payable 500 Merchandise Inventory (returns) 500

19 Accounts Payable ($5,000 – $500) 4,500

Cash ($4,500 – $45) 4,455 (2) Periodic Inventory System

June 10 Purchases 5,000

Accounts Payable 5,000

11 Freight In 250 Cash 250

[8] $2,030 = ($2,300 – $270 [5]) [17] $9,850 = ($1,250 [14] + $8,600 [16]) [9] $1,950 = ($2,300 – $350) [18] $8,350 = ($9,850 [17] – $1,500)

*EXERCISE 5-15

(a)

LIVELY LIMITED Income Statement Year Ended February 28, 2015 Sales revenue

Cost of goods sold

Purchase returns and allowances 20,800

Operating expenses

Other revenues and expenses

(b)

Feb 28 Merchandise Inventory (ending) 79,300

Cost of Goods Sold 196,950

Purchase Returns and Allowances 20,800

Purchase Discounts 39,000

Merchandise Inventory (beginning) 54,600 Purchases 273,000 Freight In 8,450

SOLUTIONS TO PROBLEMS

(a) A company’s operating cycle is the average time it takes to go from cash to cash in producing revenues The operating cycle for a merchandising company covers the period of time between when you purchase your inventory, to when you sell it, and to when you eventually collect the accounts receivable from a sale

The hair salon is having problems paying for its products because it purchases a two month supply, paying for it immediately, with cash flow from the current month’s operations There is an insufficient cash float available to purchase two months of supply at one time, and to pay immediately rather than taking advantage of the 30 day payment period

The hair salon’s inventory is contributing to the problem of reduced cash flow and gross profit because some items have been in stock for a long period of time This further extends the operating cycle for those items

(b) The hair salon should use the perpetual inventory system to help determine which inventory items are out-of-stock and which items are taking a long time to sell By managing what inventory is purchased, fewer markdowns of the selling price will be required, and sales should increase as there will be less chance for a stock-out Finally, the full 30 days should be taken on the terms with your supplier to have more cash on hand when needed

(c) For control reasons, a physical inventory count must always be taken at least once a year, and ideally more often under the perpetual inventory system By using a perpetual inventory system, a company knows what inventory should be on hand Performing a physical count and checking it to the perpetual records is necessary to detect any errors

in record keeping and/or shortages in stock Since the salon staff and customers are resisting the process of scanning products at the time of sale, there might be a tendency for staff not to scan the product, leading to errors in the perpetual inventory record Enforcing the scanning procedure will strengthen internal control over cash receipts as well If staff can avoid scanning product, they may also attempt to avoid recording a cash sale altogether, pocketing the extra cash This theft would lead to unrecorded revenues, explaining the past’s poor gross profit performance of the salon

PROBLEM 5-1A

(a) Phantom Book Warehouse Ltd is a wholesaler Its suppliers are publishers and its

customers are book stores

PROBLEM 5-2A (Continued)

(b) (Continued)

June 25 Sales Returns and Allowances 375

Accounts Receivable 375 Merchandise Inventory (15 × $15) 225

Cost of Goods Sold 225

Merchandise Inventory 20,000

PROBLEM 5-3A

PROBLEM 5-3A (Continued)

(a) (Continued)

Sept 23 No entry necessary

28 Sales Returns and Allowances 10,000

(b)

April 3

Merchandise Inventory

Accounts Payable

4,600

4,600

6 Merchandise Inventory

Cash

120

120

9 Accounts Payable

Merchandise Inventory

200

200

10 Accounts Receivable

Sales

5,020

5,020

Cost of Goods Sold

Merchandise Inventory

2,010

2,010

14 Cash

Accounts Receivable

2,125

2,125

16 Merchandise Inventory

Accounts Payable

1,300

1,300

17 Accounts Payable

Merchandise Inventory

100

100

20 Accounts Receivable

Sales

3,200

3,200

Cost of Goods Sold

Merchandise Inventory

1,285

1,285

PROBLEM 5-4A

PROBLEM 5-4A (Continued)

27

Sales Returns and Allowances