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CHAPTER 6
MERCHANDISING ACTIVITIES
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief
Exercises
B
...
6
...
Ex
...
2
B
...
6
...
Ex
...
4
B
...
6
...
Ex
...
6

B
...
6
...
Ex
...
8
B
...
6
...
Ex
...
10
B
...
6
...
1
6
...
3
6
...
5
6
...
7
6
...
9
6
...
11
6
...
13

Topic
Computation of gross profit
Accounts receivable subsidiary
ledger
Perpetual inventory system computation of income
Periodic inventory system inventory balance during year
Periodic inventory system determine cost of goods sold
Periodic inventory system working backwards through the
COGS section
Periodic inventory system - closing
process
Benefit of taking a purchase
discount
Sales returns and allowances
Special journals
Ethics, fraud, and corporate
governance
Topic
You as a student
Effects of basic merchandising
transactions
Understanding inventory cost flows
Perpetual inventory systems
Evaluating performance
Taking a physical inventory
Periodic inventory systems
Relationships within periodic
inventory systems
Selecting an inventory system
Cash discounts
Evaluating performance
Comparison of inventory
systems
Periodic inventory system

Learning
Objectives
2, 8
7

Analysis
Analysis

2, 3, 8

Analysis

2, 4, 8

Analysis

2, 4, 8

Analysis

2, 4, 8

Analysis

2, 4

Analysis

6

Analysis

6
7
8

Analysis
Analysis
Communication, judgment

Learning
Objectives
1, 6
1

Skills
Analysis, communication,
Analysis

Skills

2, 5, 8

Analysis, communication

3, 8
6, 8
3
4
4

Analysis, communication
Analysis, communication,
Analysis, communication
Analysis, communication
Analysis

5, 8
6
8
3–5

Communication, judgment
Analysis
Analysis, communication,
Analysis, communication

4, 5

Analysis, communication,

© The McGraw-Hill Companies, Inc
...
14
6
...
1 A,B
6
...
3 A,B
6
...
5 A,B
6
...
7 A,B
6
...
1
Selecting an inventory system
6
...
3
Evaluating inventory systems
6
...
5
Real World: GAP Exploring an
annual report (Internet)

Learning
Objectives
8
8
Learning
Objectives
1, 3, 8
1-3, 6, 8

Skills
Analysis, communication
Analysis, communication,

Skills
Analysis, communication
Analysis, communication

8
3, 6
3, 6
2, 3, 6

Analysis, communication
Analysis, communication
Analysis, communication,
Analysis, communication

1, 3, 6

Analysis, communication,

1–8

Analysis, communication,
judgment

5
4, 8
3–5, 7
8
8

Communication, judgment
Analysis, communication,
Communication, judgment
Communication, judgment
Communication, research,
technology

© The McGraw-Hill Companies, Inc
...
2)

DESCRIPTIONS OF PROBLEMS AND
CRITICAL THINKING CASES
Below are brief descriptions of each problem and case
...
The time estimates
assume use of the partially filled-in working papers
...
1 A,B

Claypool Hardware/Big Oak Lumber
Introduction to both perpetual inventory systems and financial
statement analysis
...


35 Medium

6
...
Using this income
statement, they are asked to compute the company’s gross profit
margin, evaluate customer satisfaction, interpret the meaning of
several accounts, and identify the accounts in the store’s operating
cycle
...
3 A,B

Knauss Supermarkets/Jill's Department Store
Illustrates performance evaluation of a merchandising company using
changes in net sales, sales per square foot of selling space, and
comparable store sales
...
4 A,B

Lamprino Appliance/Mary's TV
A straightforward comparison of the net cost and gross invoice price
methods of recording purchases of merchandise
...
5 A,B

Siogo Shoes and Sole Mates/Hip Pants and Sleek
A comprehensive problem on merchandising transactions
...


30 Strong

6
...
The problem requires the
errors to be corrected both assuming that the books remain open and
assuming that the books have already been closed
...
, 2012
Overview Desc
...
7 A,B

Genuine Accessories/Computer Resources
A problem that requires students to calculate gross profit under an
accrual-based system and under a cash-based system, and to explain
the difference between the two computations
...


30 Strong

6
...
Closely parallels the Demonstration Problem
...
, 2012
Overview Desc
...
2)

Critical Thinking Cases
6
...
Leads to an open-ended discussion
of why different types of businesses maintain different types of inventory
systems
...


35 Medium

6
...
Having determined the amount of loss,
they then are asked to evaluate the economic benefit of hiring a security
guard
...
3 Group Assignment - Evaluating an Inventory System
Students are to visit two local businesses to gain an understanding of the
inventory systems in use
...


No time estimate

6
...


20 Medium

6
...

Internet
Visit the home page of Gap, Inc
...


25 Easy

© The McGraw-Hill Companies, Inc
...
of Prob & Cases

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1
...
The cost
of goods sold represents the original cost to the seller of the merchandise it sells
...
Green Bay Company is not necessarily more profitable than New England Company
...
For a merchandising company
(or manufacturer) to earn a net income, its gross profit must exceed its expenses (including
nonoperating items)
...

However, if Green Bay’s operating expenses (and nonoperating items) exceed those of
New England by more than $70,000, New England is the more profitable company
...
General ledger accounts show the total amounts of various assets, liabilities, revenue, and
expenses
...
This detail is
provided in subsidiary ledgers
...

4
...
In a company using a perpetual inventory system,
shrinkage is measured and accounted for by taking a physical inventory and adjusting the
accounting records to reflect the actual quantities on hand
...
In a perpetual inventory system, ledger accounts for inventory and the cost of goods sold
are kept perpetually up-to-date
...
When sales occur, Cost of Goods Sold is debited and Inventory is credited for
the cost of the merchandise sold
...

In a periodic inventory system , up-to-date records are not maintained either for inventory
or for the cost of goods sold
...
Purchases are recorded in a Purchases account, and no entries are made to
record the cost of individual sales transactions
...

6
...
A perpetual inventory system requires an entry updating the
inventory records as each item of merchandise is sold
...
For example, perpetual inventory systems were used in auto dealerships and
jewelry stores, but not in supermarkets
...
These terminals “read” identification codes attached to each item of
merchandise; the computer then looks up both the sales price and the cost of the
merchandise in computer-based files and records the sale instantly
...
, 2012
Q1-6

7
...


A general journal is capable of recording any type of business transaction
...
In addition, the person maintaining the journal must have sufficient
background in accounting to correctly interpret all types of accounting transactions
...


b
...
As the journal is used only in
recording one type of transaction, the person maintaining the journal usually does not
require an extensive background in accounting
...

Special journals are used to record transactions that occur frequently
...


8
...

In most well-managed companies, management has a policy of taking all available cash
discounts
...
If this balance becomes significant, management
will take corrective action to assure that the company does take advantage of future discount
opportunities
...
The freight charges should not be charged to delivery expense
...
Freight charges
on inbound shipments are part of the cost of acquiring the inventory, not an expense of the
current period
...

10
...
Paying 50 days earlier and taking the discount saves
4%
...
2%)
...
The financial statements would not include sales tax expense because sales taxes are not an
expense of the business entity
...
Until the taxes have been sent to the
governmental authorities, a liability for sales taxes payable does appear in the balance sheet of
the business
...
)

© The McGraw-Hill Companies, Inc
...
To sellers, the “cost” of offering cash discounts is the resulting reduction in revenue
...

Buyers, however, incur a cost when discounts are lost, not when they are taken
...
This is accomplished by
initially recording the account payable to the supplier at net cost—that is, net of any allowable
cash discounts
...

13
...
It may be computed for the company as a whole (the overall gross profit
margin), for specific sales departments, and for individual products
...
In a manufacturing company, management often is able
to increase margins by reducing the cost of manufacturing the merchandise that the company
sells
...
Even companies that use a perpetual inventory system will generally complete a physical count
of their merchandise inventory at least once a year to compare their actual physical inventory
with what the perpetual inventory records indicate should be on hand
...
This difference is referred to as
"shrink(age)" in the retail industry - one of the truly great euphemisms of all time -and is a
closely watched performance metric by management in the retail industry
...
An inventory subsidiary ledger is maintained under a perpetual inventory system but not under
a periodic inventory system
...
Under a periodic inventory system, the actual physical
quantity of inventory items on hand is only determined at the time that a physical inventory
count is taken, typically once a year
...
, 2012
Q12-15

SOLUTIONS TO BRIEF EXERCISES
B
...
1

Office Today's gross profit is $160 million ($800 million - $640 million)
...
Office Today's gross profit
should provide the company with the ability to cover other expenses and to provide a
return to its shareholders
...
Ex
...
2 The accounts receivable balance in the general ledger should be $850, the total of the
customer accounts with debit balances
...

B
...
6
...

B
...
6
...
Under a periodic inventory system,
the inventory account balance on the balance sheet is only updated when a physical
inventory count is taken, which generally only occurs on a yearly basis
...
The inventory account balance is generally stated at the cost of the inventory
items purchased, whereas the $400,000 of sales is recorded at the retail price at which
the goods are sold
...
Ex
...
5 The cost of goods sold for Murphy Co
...
Add the purchases of $600,000 to
the beginning inventory of $300,000, and then subtract the $250,000 of ending
inventory
...
Ex 6
...
purchased $600,000 of goods during the year
...

Goods available for sale either existed at the beginning of the year - beginning
inventory - or were purchased during the year - purchases
...


© The McGraw-Hill Companies, Inc
...
1-6

B
...
7

Cost of Goods Sold…………………………………
Inventory (beginning balance)……………
Purchases…………………………………
...


330,000

Inventory (ending balance)………………………
...

To reduce the balance of the Cost of Goods Sold
account by the cost of merchandise still on hand at
year-end
...

Cost of Goods Sold………………………
...


300,000

80,000
250,000

30,000

300,000

B
...
6
...
's equivalent annual rate of return by always paying its bills within the
discount period, and thereby receiving a 1% cash discount on the amount of its
purchases, is 18
...


B
...
6
...

Accounts Receivable (or Cash)…………
...


2,000
2,000

B
...
10

Examples of special journals include: sales journal, cash receipts journal, cash
payments journal, purchases journal, and payroll journal
...
Ex 6
...
Your cooperation with the controller's scheme to
overstate income will expose you to severe civil and criminal penalties,
notwithstanding the potential damage to your reputation and the unethical course of
action that the controller is asking you to pursue
...
Failing this, you might avail yourself of the "hotline" that
all public companies are required to maintain to provide an anonymous mechanism
for employees to report concerns about improper accounting practices
...


© The McGraw-Hill Companies, Inc
...
7-11

SOLUTIONS TO EXERCISES
Ex 6
...
Option #2 enables the band to have the least possible amount of cash invested in
inventory at any given time throughout the basketball season
...
Thus, a combination of
options #2 and #3 will result in the shortest operating cycle
...
Option #1 results in the band having an excessive amount invested in inventory early
in the season
...
Thus, a combination of options #1
and #4 will result in the longest operating cycle
...
Option #1
Advantages : A 5% purchase discount applies to the purchase
...

The band must pay in advance for an entire season of inventory
...

Option #2
Advantages : T-shirts are ordered only when inventory levels become depleted
...
Ordering
shirts as needed reduces the risk of purchasing too many or too few
...

Option #3
Advantages : Cash is collected immediately
...
The band receives 100% of all sales
proceeds
...

Option #4
Advantages : Control over cash receipts and inventory is maintained by the bookstore
...

Disadvantages : The bookstore earns a 6% sales commission, meaning the band
receives only 94% of the total proceeds
...
Thus, the band may experience difficulty in paying for
the inventory it purchases
...
, 2012
E6
...
2

Income Statement
Trans- Net - Cost of - All Other =
Net
action Sales Goods Sold Expenses
Income
a
...

c
...

e
...
3
a
...
2 billion - $132 million)
b
...


The company’s low gross profit margin of 11% reflects the intense levels of price
competition in the personal computing industry
...

With gross profit being only eleven cents of every sales dollar, it is essential that these
retailers control other expenses (such advertising expense, wages expense, and insurance
expense) in order to remain profitable
...


PC Connection uses a perpetual inventory system for several reasons: (1) its inventory
has a relatively high unit cost, (2) its sales volume is extremely high, as evidenced by its
$1
...


© The McGraw-Hill Companies, Inc
...
2,3

Ex
...
4
a
...


Beginning inventory +

$

c
...

Thus, immediately prior to recording inventory shrinkage, the Cost of Goods Sold
account had a debit balance of $10,990,000 ($11,000,000 computed in part a minus
$10,000), whereas the Merchandise Inventory account had a debit balance of
$4,960,000 ($4,950,000 computed in part b plus $10,000)
...
6
...
The change in net sales provides an overall measure of the effectiveness of the
company in generating revenue
...
Thus, an increase in net sales is not always “good,” and a decrease
is not always “bad
...
Increasing margins often mean that a company’s net sales growth
is outpacing its growth in the cost of goods sold
...
A declining gross profit rate, on the other hand, may indicate
weakening customer demand or intensified price competition
...
By factoring
out the effects of opening new stores (and/or closing existing stores), this statistic
provides a better measure of marketing strategy effectiveness and revenue
growth
...
Both Wal-Mart and Target reported very small increases in net sales, likely reflecting
the effects of the severe economic recession of 2009
...
The decline in comparable store net sales was approximately three times as
large for Target as for Wal-Mart
...


© The McGraw-Hill Companies, Inc
...
4,5

Ex
...
6

a
...

b
...


4,000

c
...
In
addition, the reduction in inventory should be posted to the inventory subsidiary
ledger accounts in which the shortages were determined to exist
...
6
...
The amounts of beginning and ending inventory were determined by taking
complete physical inventories at (or near) the ends of year 1 and year 2
...
(The inventory at the end of year 1 serves as the “beginning
inventory” for year 2
...
Computation of the cost of goods sold during year 2:
Inventory (December 31, year 1) ……………………………………………… $ 2,800
30,200
Add: Purchases …………………………………………………………………
33,000
Cost of goods available for sale during year 2 ………………………………
3,000
Less: Inventory (December 31, year 2) ………………………………………
Cost of goods sold ……………………………………………………………… $ 30,000
c
...
31

31

d
...
31, year 1) ……………
Purchases ………………………………
To close those temporary accounts that
contribute to the cost of goods sold for the
year
...
31, year 2) ………………………
Cost of Goods Sold ………………………
To remove from the Cost of Goods Sold
account the cost of merchandise still on hand
at year-end
...
Because the business is small, management probably has decided that the benefits of
maintaining a perpetual inventory system are not worth the cost
...
g
...


© The McGraw-Hill Companies, Inc
...
6,7

Ex
...
8

a
...

c
...

e
...
6
...
It is not uncommon for companies in the same industry to report similar gross profit
percentages
...
This particular
industry is extremely competitive with respect to pricing strategies
...
g
...

b
...
Advances
in technology have made it possible for even these retailers to account for their
inventories using perpetual inventory systems
...


© The McGraw-Hill Companies, Inc
...
8,9

Ex
...
10

a
...


10,000
10,000

Cost of Goods Sold ……………………………………………
Inventory ………………………………………………
To recognize cost of goods sold relating to sale to
Mulligans
...


9,900
100

b
...

Accounts Payable (Golf World) ………………………………
Cash ……………………………………………………
Paid account payable to Golf World within the discount
period
...
Entry by Mulligans if discount not taken:
Accounts Payable (Golf World) ………………………………
Purchase Discounts Lost ………………………………………
Cash ……………………………………………………
To record payment of account payable to Golf World and
loss of purchase discount due to failure to pay within
discount period
...
, 2012
E6
...
6
...
Dollar figures are stated in billions except for sales per square foot of selling space:

Net sales
Cost of goods sold
Gross profit
Gross profit margin (rate)
Sales per square foot of selling
space
Computations:
(1) $63
...
278 = $17
...
3 - $17
...
7
(3) $63,300 / 79 = $801
...
3 - $19
...
0
(5) $7
...
3 = 26
...
7

Walgreen
Company
$63
...
7 (2)
$17
...
8%
$801
...
3
$19
...
0 (4)
26
...
7 (6)

b
...

Walgreen's gross profit is $17
...
8% of net sales), whereas Rite Aid's
gross profit is only $7 billion (26
...
A larger gross profit better
enables Walgreen's to absorb the other expenses of running the business, and many
of these expenses may be similar between Walgreen and Rite Aid
...


© The McGraw-Hill Companies, Inc
...
11

Ex
...
12 a
...


117,000

Cost of Goods Sold …………………………………………
Inventory ……………………………………………
To record cost of telescope sold to Central State
University
...


50,000

117,000

90,000

50,000

b
...
31 ………………………………………
Deduct: Cost of goods sold ………………………………
Add: Cost of merchandise purchased ……………………
Inventory at Jan
...
Cash …………………………………………………………
Sales …………………………………………………
To record sale of telescope to Central State University
for cash
...
Terms, net 30 days
...
Cost of goods sold:
Inventory, Jan
...
7 (per part b ) ……………………
Cost of goods sold ………………………………………

117,000

50,000

$ 250,000
50,000
$ 300,000
210,000
$ 90,000

e
...


© The McGraw-Hill Companies, Inc
...
12

Ex
...
13
a
...


$6,240
74,400
$80,640
4,560
$76,080

b
...
Also,
“management” seems to consist of the owners, who may be in the store every day and
therefore do not need an inventory ledger to know what merchandise is in inventory
...

c
...
This
information is used in quarterly reports to stockholders, reports to corporate
management, and monthly reports measuring the profitability of the individual sales
departments
...

Also, a store such as Sears uses point-of-sale terminals to simplify the processing of sales
transactions
...


Ex
...
14
Revenues (4 x $1,200)……………………………………………………
...

Other expenses……………………………………………………………
...

16,000
Other cash expenses……………………………………………………………
1,000
($12,200)
Net loss (cash basis)………………………………………………………
...
Under a cash-basis system, the purchase of merchandise is charged to expense at
the time the merchandise is purchased
...
If a
business is building its inventory balance, net income is often higher than cash flow from
operations (similar to computing income under a cash-basis system)
...
, 2012
E6
...
6
...
All of the following figures are shown in million’s (except percentages):
Year Ended
Jan
...
1
2009
2010
(1) Net sales
$66,176
$71,288
(2) Gross profit (margin)
22,412
23,990
Gross profit percentage (2)  (1)

33
...
7%

Feb
...
6%

b
...
Although management wants to improve the gross margin, Home
Depot faces a serious competitor in Lowe's, likely constraining its ability to raise
margins
...
The recession had a particularly hard effect on the
construction industry, including vendors to that industry
...
, 2012
E6
...
1A
CLAYPOOL HARDWARE

35 Minutes, Medium

a
...


(1)
5 Accounts receivable (Bemidji Construction)
Sales
Sold merchandise on account
...

9 Inventory
Accounts Payable (Owatonna Tool Co
...

Dec
...


13,390

9 Accounts Payable (Owatonna Tool
...
)
Cash
Paid account payable to supplier
...

Inventory per accounting records
Inventory per physical count
Adjustment for inventory shrinkage

1,710

3,800

1,710

$
$

183,790
182,080
1,710

b
...
31
Add: Shrinkage adjustment at Dec
...
, 2012
P6
...
1A
CLAYPOOL HARDWARE (concluded)
c
...
The following data
support these conclusions:
Claypool
Industry
Hardware
Average
Difference
Annual sales ……………………………
...
Claypool’s sales were above the industry average, and it earned $77,968 more gross
profit than the “average” store of its size
...

To have a higher-than-average cost of goods sold and still earn a much larger-thanaverage amount of gross profit, Claypool must be able to charge substantially higher
sales prices than most hardware stores
...
Thus, the remote location appears to
insulate it from competition and allow it to operate more profitably than hardware stores
with nearby competitors
...
, 2012
P6
...
2)

15 Minutes, Easy

PROBLEM 6
...

HENDRY'S BOUTIQUE
Income Statement
For the Year Ended December 31, 2011
Sales
Less: Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Other expenses:
Purchase discounts lost
Utilities expense
Office supply expense
Depreciation expense: office equipment
Rent expense
Insurance expense
Salaries expense
Income before income taxes expense
Income tax expense
Net income

b
...


Sales returns and allowances amount to only 1
...
Thus, it
appears that customers are relatively satisfied with their purchases
...


The use of the Purchase Discounts Lost account indicates that the store records
purchases net of any purchase discounts
...


e
...
When the store
submits this amount to the proper tax authorities, the liability will be removed
...


f
...


© The McGraw-Hill Companies, Inc
...
2A

20 Minutes, Medium

PROBLEM 6
...


1
...

3
...

Change in net sales per square foot …
...


6% (1)
(1
...
8%) (5)

8% (2)
(2
...
5%) (6)

($5,495  $5,184)  $5,184 = 6%
($5,184  $4,800)  $4,800 = 8%
[($5,495  11
...
1)]  ($5,184  11
...
1%)
[($5,184  11
...
0)]  ($4,800  10
...
7%)
($10
...
0)  $11
...
8%)
($11
...
4)  $11
...
5%)

While Knauss has increased its overall revenue from sales, several of the statistics indicate
problems
...
This indicates a downward trend in sales at existing stores
...
As a result, management should reevaluate its marketing strategies
...
, 2012
P6
...
4A
LAMPRINO APPLIANCE

30 Minutes, Medium

a
...

## Cash

2,940
2,940

450

Sales
Sold 1 Mitsu TV for cash
...


450

294
294

## Accounts Payable (Mitsu Industries)
Cash
Paid account within discount period
...


3,000

## Cash

2,940

3,000

450

Sales
Sold 1 Mitsu TV for cash
...


450

300
300

## Accounts Payable (Mitsu Industries)
Cash
Purchase Discounts Taken
Paid account payable, less 2%
...

(1)
July

(2)
July

3,000

## Accounts Payable (Mitsu Industries)
Purchase Discounts Lost
Cash
Made payment after discount period had expired
...


3,000

© The McGraw-Hill Companies, Inc
...
4A

2,940
60

3,000

3,000

PROBLEM 6
...


The net cost method provides more useful information for evaluating the company's
efficiency in paying its bills
...

Under the gross method, the liability is not recorded at the lowest price at which it can be
settled
...


© The McGraw-Hill Companies, Inc
...
4A (p
...
5A
SIOGO SHOES AND SOLE MATES

30 Minutes, Strong

General Journal

a
...


Journal entries by Siogo Shoes:
9 Accounts Receivable (Sole Mates)
Sales
Sold merchandise on account; terms, 1/10, n/30
...
X $60/pr
...

## Sales Returns & Allowances
Accounts Receivable (Sole Mates)
Customer returned merchandise (10 pr
...

## Inventory
Cost of Goods sold
Reduce cost of goods sold for cost of merchandise
returned (10 pr
...

## Cash
Sales Discount
Accounts Receivable (Sole Mates)
Collected amount due, less $1,000 return and less
1% cash discount on remaining $9,000 balance
...

Feb
...
1/10, n/30
...


9,900
9,900

## Transportation-in
Cash
Paid transportation charge on inbound shipment
...
(Net cost,
$99 per pair x 10 pairs = $990
...
, 2012
P6
...
5A
SIOGO SHOES AND SOLE MATES (concluded)
General Journal
Feb
...


## Accounts Payable (Siogo Shoes)
Cash
Paid within discount period balance owed to
Siogo Shoes ($9,900 - $990 = $8,910)
...
Sole Mates should take advantage of 1/10, n/30 purchase discounts, even if it must
borrow money for a short period of time at an annual rate of 11%
...
At an interest rate
of 11% per year, the bank charges only 0
...
6%)
...


© The McGraw-Hill Companies, Inc
...
5A (p
...
6A
KING ENTERPRISES

60 Minutes, Strong

a
...

Entries Recorded by the Accounting Clerk
Jan
...

Payment for books received on December 15th of
prior year
...
27 No entry since no cash receipt or payment was involved
...
30 No entry since no cash receipt or payment was involved
...
10 Accounts Payable………………………………
...

Payment for books received on December 15th of
prior year
...
27 Inventory………………………………………
...

Purchase of $20,000 of books net of the purchase
discount
...
30 Accounts Receivable………………………………
Sales………………………………………
...


30,000

Dec
...

Record cost of books sold
...
1
...
2
...


a
...


Accounts payable is understated by $9,800 ($19,600 - $9,800)
...
4
...


a
...

b
...


Cost of goods sold is understated by $24,500
...


© The McGraw-Hill Companies, Inc
...
6A

PROBLEM 6
...


The journal entry to correct the accounting clerk's errors is (assuming that King's books
have yet to be closed for the year)
...

Cost of goods sold…………………………………
...

Inventory…………………………………
...


30,000
14,700
9,800

The journal entry to correct the accounting clerk's errors is (assuming that King's books
have been closed for the year)
...

Accounts payable…………………………
...


30,000
24,500

30,000
14,700
9,800
5,500

The journal entry to correct the accounting clerk's errors assuming that the ending
inventory balance has been adjusted based on a physical inventory (and assuming that
King's books have been closed for the year) is:
Accounts receivable…………………………………
Accounts payable…………………………
Retained earnings………………………
...
, 2012
P6
...
2)

30,000
9,800
20,200

PROBLEM 6
...


Sales ($300,000 + $750,000)
Cost of goods sold ($200,000 + $500,000)
Gross profit

$ 1,050,000
(700,000)
$
350,000

b
...


$

(400,000)
(400,000)

The difference between the $350,000 of gross profit under accrual accounting and the
negative $400,000 gross profit under a cash-basis system reflects the balances in the
accounts receivable, inventory, and accounts payable accounts for Genuine Accessories
...
The inventory
balance is $1,200,000 ($400,000 - $200,000 + $600,000 - $500,000 + $900,000)
...


Increases in operating current asset accounts (e
...
, accounts receivable and inventory)
result in cash-based metrics of income being below accrual income, whereas increases in
operating current liability accounts (e
...
, account payable) result in cash-based metrics of
income being above accrual income
...

d
...


300,000
300,000

A wholesaler might determine the fair value of its ending inventory by reference to recent
sales prices of inventory items, assuming that these sales took place reasonably close to
year-end
...
, 2012
P6
...
8A
CPI

Parts a, f, and g follow; parts b, c, d, and e are on the next page
...


The operating cycle of a merchandising company consists of purchasing merchandise,
selling that merchandise to customers (often on account), and collecting the sales proceeds
from these customers
...


f
...
The items in its inventory have a
high per-unit cost
...
The company also has a computer-based accounting system, a full-time
accountant, and a low volume of transactions
...


g
...
, 2012
P6
...
8A
CPI (concluded)
b
...
Net cost, $25,000, less 3%
...

6 Cost of Goods Sold
Inventory
To record the cost of merchandise sold to Pace
Corporation
...


6,100
6,100

Computation of inventory at January 6:
Inventory at Dec
...
2011
Add: Merchandise purchased on Jan
...
6
Inventory at close of business on Jan
...
Net cost, $25,000, less 3%
...


6 Accounts Receivable (Pace Corporation)
Sales
Sale on account; terms, 5/10, n/90
...


Computation of cost of goods sold:
Inventory (Dec
...
6-per part c)
Cost of goods sold

© The McGraw-Hill Companies, Inc
...
8A (p
...
1B
BIG OAK LUMBER

35 Minutes, Medium

a
...


19,700

## Cost of Good Sold
Inventory
To record the cost of goods sold relating to the
sales of merchandise to Hard Hat Construction
...

May

3,700
3,700

## Cash

19,700

Accounts Receivable
Collected accounts receivable
...


3,700

## Cost of Goods Sold
Inventory
To adjust inventory records to reflect the results
of the year-end physical count
...

BIG OAK LUMBER
Partial Income Statement
For the Year Ended December 31, 20__
Net sales
Cost of goods sold (1)
Gross profit
(1) Cost of goods sold prior to adjustment at Dec
...
31
Cost of goods sold (adjusted balance)

© The McGraw-Hill Companies, Inc
...
1B

$
$
$
$

1,422,000
723,500
698,500
721,000
2,500
723,500

PROBLEM 6
...


Big Oak seems quite able to pass its extra transportation costs on to its customers and, in
fact, enjoys a significant financial benefit from its remote location
...

$1,422,000
$1,000,000
$422,000
Gross profit ………………………………
698,500
220,000 (1)
478,500
Gross profit rate …………………………
49
...
1%
( 1) $1,000,000 sales  22% = $220,000
(2) $698,500 gross profit  $1,422,000 net sales = 49
...
1%, which is significantly higher than the industry
average
...
This higher gross profit was
earned even though its cost of goods sold was $8,000 to $18,000 higher than the industry
average because of the additional transportation charges
...
Presumably, the company could not charge such
prices in a highly competitive environment
...


© The McGraw-Hill Companies, Inc
...
1B(p
...
2B
HARRY'S HABERDASHERY

a
...


$

$

400
7,000
900
4,700
10,000
1,500
150,000
$
$

384,000
4,000
380,000
157,630
222,370

174,500
47,870
13,900
33,970

Gross profit  Net sales = gross profit margin
Using the figures from the income statement prepared in part a, the store’s gross profit
margin is computed as follows: $222,370  $380,000 = 59%

c
...
Thus, it
appears that customers are relatively satisfied with their purchases ($4,000 ÷ $384,000 =
1%)
...


The use of the Purchase Discounts Lost account indicates that the store records
purchases net of any purchase discounts
...


e
...
When the store
submits this amount to the proper tax authorities, the liability will be removed
...


f
...
Cash, Accounts Receivable, and
Merchandise Inventory are the accounts that comprise the store's operating cycle
...
, 2012
P6
...
3B
JILL'S DEPARTMENT STORES
2010-2011

a
...
9% (1)
(
...
9%) (5)

8
...
2%) (4)
(3
...


1
...

3
...
9%
($8,810 - $8,140) ÷ $8,140 = 8
...
0) - ($8,810 ÷ 5
...
7) = (0
...
7) - ($8,140 ÷ 5
...
1) = (3
...
2 - $72
...
3 = (2
...
3 - $75
...
0 = (3
...
Both sales per square foot of selling space and comparable store sales have
declined
...
It is apparent that
the increase in overall net sales must have resulted from adding new stores
...


© The McGraw-Hill Companies, Inc
...
3B

PROBLEM 6
...

General Journal
Date
(1)
Mar
...

## Cash

2,744
2,744

1,200

Sales
Sold 2 Whosa TVs for cash
...


1,200

686
686

## Accounts Payable (Whosa Industries)
Cash
Paid account within discount period
...


2,800

## Cash

(2)
Mar
...

## Cost of Goods Sold
Inventory
To record cost of TVs sold
...

b
...


(2)
Apr
...


2,744
56

6 Accounts Payable (Whosa Industries)
Cash
Made payment after discount period had expired
...
, 2012
P6
...
4B
MARY'S TV (concluded)
c
...
This method clearly indicates the lowest price that the
company may pay, and separately records any additional costs incurred as purchase
discounts lost
...
Hence, management is not made aware of available discounts that were not taken
...
, 2012
P6
...
2)

PROBLEM 6
...

Oct
...

## Cost of Goods Sold
Inventory

18,000
18,000

6,000
6,000

To record cost of merchandise sold (300 pr
...


## Delivery Expense
Cash
Paid delivery charges on outbound shipment
...
X $60/pr
...
X $20/pr
...
60)
...

Oct
...
40
177
...

Net cost, $59
...

## Transportation-in
Cash
Paid transportation charge on inbound shipment
...
(Net cost,
$59
...
60)
...
, 2012
P6
...
60
237
...
5B
HIP PANTS AND SLEEK (concluded)
General Journal
Oct

c
...
60 = $17,582
...


17,582
...
40

Yes
...
By taking advantage of the
discount, the company saves 1% by making payment 20 days early
...
66% interest over a 20 day period (12% x 20/365 =
0
...
Thus, the cost of passing up the discount is greater than the cost of short-term
borrowing
...
, 2012
P6
...
2)

PROBLEM 6
...


The easiest way for a student to solve this problem is to record the journal entries that the
accounting clerk made and to compare them with the journal entries that should have been
made
...
7 Inventory……………………………………………
Cash………………………………………
...


4,900
4,900

Dec
...

Dec
...

Entries that Should Have Been Recorded by the Accounting Clerk
Jan
...

Cash………………………………………
...


4,900
4,900

Dec
...

Purchase of $10,000 of furniture net of the purchase
discount
...
26 Accounts Receivable…………………………………
...


15,000

Dec
...

Inventory…………………………………
...


12,250

9,800

15,000

12,250

a
...


a
...


Inventory is overstated by $7,350 ($9,800 - $12,250 - $4,900)
...
3
...


a
...


Sales is understated by $15,000
...
5
...


Based on a comparison of the above entries, accounts receivable is understated by
$15,000
...

Net income is understated by $2,750 ($15,000 - $12,250)
...
, 2012
P6
...
6B
QUEEN ENTERPRISES (concluded)
c
...

Accounts receivable………………………………
...

Sales………………………………………
...

Accounts payable…………………………

d
...

Accounts receivable…………………………………
Inventory…………………………………
...


e
...

Retained earnings…………………………

© The McGraw-Hill Companies, Inc
...
6B(p
...
7B
COMPUTER RESOURCES

30 Minutes, Strong

a
...


c
...
The accounts
receivable balance is $100,000
...
The accounts payable balance is $300,000 ($100,000 + $200,000)
...
g
...
g
...
Therefore, Computer Resources moves from an
accrual gross profit of $50,000 to a cash-based breakeven amount as follows:
$50,000 (accrual-based gross profit) - $100,000 (increase in AR) - $250,000 (increase in
inventory ) + $300,000 (increase in accounts payable) = $0 (cash-based gross profit)
...


Inventory…………………………………………………
Revaluation of Inventory to Market Value
...


125,000
125,000

A retailer might determine the fair value of its ending inventory by reference to recent
sales prices of inventory items, assuming that these sales took place reasonably close to
year-end
...
, 2012
P6
...
8B
SUI

Parts a, c, g, and h follow; parts b, d, e, and f are on the next page
...


The operating cycle of a merchandising company consists of purchasing merchandise,
selling that merchandise to customers (often on account), and collecting the sales proceeds
from these customers
...


c
...
The information posted should include the cost and quantities of
each type of merchandise purchased
...
account in SUI's accounts payable subsidiary ledger
...

In the final entry, the credit to the Inventory control account should be allocated
among the thirty products sold and posted to the appropriate accounts in the inventory
ledger
...


SUI probably would use a perpetual inventory system
...
Therefore, management will want to know the costs of the individual
products included in specific sales transactions, and also will want to keep track of the items
in stock
...
This combination of factors eliminates the
potential difficulties of maintaining a perpetual system
...


Computation of profit margin on January 10 sales transaction:
Gross profit

Gross profit margin

=
=
=

Sales price - Cost of goods sold
$28,000  $10,000
$18,000

=
=
=

Dollar gross profit  Sales revenue
$18,000  $28,000
64
...
, 2012
P6
...
8B
SUI (concluded)
b
...


38,800
38,800

## Accounts Receivable (Air Corporation)
Sales
Sale on account; terms, 5/10, n/90
...

d
...

Inventory at Dec
...
5
Less: Cost of goods sold on Jan
...
10

Journal entries assuming use of a periodic system
2012
Jan
5 Purchases
Accounts payable (Double)
Purchased merchandise on account; terms, 3/10,
n/60
...


$

$

500,000
38,800
(10,000)
528,800

e
...


f
...
31, 2011)
Add: Purchases
Cost of goods available for sale
Less: Inventory (Jan
...
, 2012
P6
...
2)

38,800
38,800

28,000
28,000

$
$
$

500,000
38,800
538,800
528,800
10,000

SOLUTIONS TO CRITICAL THINKING CASES
35 Minutes, Medium

CASE 6
...
The Frontier Shop would probably use a periodic inventory system
...
First, this is a small business that does not have a computerized
accounting system
...
Thus, the only dollar amount recorded at
the time of sale is the sales revenue
...
Finally, this
business does not appear to need an inventory subsidiary ledger, as the owner is likely to
be very knowledgeable as to how quickly various items are selling and the quantity of
each item currently in stock
...

b
...
The primary reason for using a perpetual
system is the high unit cost of the paintings comprising the company’s inventory
...
Also, the low volume of sales transactions—three
or four sales each week—makes the record-keeping burden of maintaining a perpetual system
of virtually no consequence
...
The publicly owned publishing company probably would use a perpetual inventory system
for several reasons
...
The need to carefully control the quantity and location of inventory on hand
suggests the need for an inventory subsidiary ledger
...
The perpetual
inventory system is better suited to the issuance of quarterly (or monthly) financial
statements than is a periodic system
...
The facts suggest that Toys-4-You uses a perpetual inventory system
...
In
fact, this is the principal reason for using point-of-sale terminals
...

Finally, the size of Toys-4-You—86 retail stores—suggests a publicly owned corporation with
quarterly reporting obligations
...
, 2012
Case 6
...
1
SELECTING AN INVENTORY SYSTEM
(concluded)
e
...
Several factors support this
conclusion
...

Next, inventory is not material in this type of business
...
Finally, a person operating an independent ice cream truck probably has no
external reporting responsibilities other than the preparation of annual income tax returns
...

f
...
For one,
management needs to know precisely how many units are on hand at any time in order to
know whether the company can fill the large sales orders it receives from customers
...
Finally, TransComm’s accounting records are maintained on commercial
accounting software
...


© The McGraw-Hill Companies, Inc
...
1(p
...
2
A COST-BENEFIT ANALYSIS

a
...


$
$
$

580,000

$

305,950
274,050

58,000
297,250
355,250
49,300

Loss from inventory "shrinkage" at cost:
Cost of goods sold, per part a
Less: Cost of goods sold excluding any shrinkage losses
(net sales, $580,000 x 50%)
Inventory shrinkage losses for the year, at cost

305,950

$

290,000
15,950

Inventory shrinkage losses for the year, at retail
prices (cost, $15,950 x 200%)

c
...
Thus, hiring the security guard would not be a
profitable strategy
...

Furthermore, not all of the “shrinkage” loss necessarily stems from shoplifting
...
If the security guard
could not eliminate these other types of losses, shrinkage would not be reduced to zero even
after the guard was hired
...
, 2012
Case 6
...
3
GROUP ASSIGNMENT WITH
BUSINESS COMMUNITY
INVOLVEMENT

No specific solution is provided for this group assignment
...
For example, some businesses may maintain perpetual records only in units, others may
enter dollar amounts on a monthly basis, and still others may maintain perpetual records for use
by management, but may use estimating techniques such as the gross profit method or the retail
method in interim financial statements
...
At this point, however, we
consider it useful for students to learn first-hand that accounting systems are tailored to meet
the specific needs of the organization
...
, 2012
Case 6
...
4
MANIPULATING INCOME
ETHICS, FRAUD & CORPORATE GOVERNANCE

20 Minutes, Medium

a
...
You should probably start by
reasoning with your supervisor about why you think what he proposes is not a good thing,
or the right thing, to do
...
Another implication is what will happen in future years should you start down
the "slippery slope" proposed by your supervisor
...
) Once you start
doing things like your supervisor proposes, will you have to continue doing them, perhaps in
greater proportions over time?
Ultimately, you are going to have to decide whether to take the high ground or the low
ground
...
If you have a
mentor or some other person of authority with whom you can confide, you may want to go
to that person with your concerns
...
Even if this means losing your job, you cannot afford to compromise
your own reputation, or put yourself at risk of criminal charges, to help another person who
is trying to artificially improve his own financial wellbeing
...
You
cannot afford to go down with him
...
is a public company, it will be required to
have a "hotline" where employees can confidentially report concerns regarding the
company's accounting practices
...


b
...
For example, an intentional overstatement of ending
inventory for purposes of reducing cost of goods sold and increasing gross profit and net
income will flow into the next accounting period as an overstatement of beginning inventory
...
Specifically, the Year 2 overstatement of
beginning inventory will result in a higher cost of goods sold, low gross profit, and lower net
income in Year 2
...
Will he
expect you to engage in an even greater overstatement of ending inventory to offset the
carryover effect of last year's restatement, plus improve Year 2 performance over Year 1
performance? Will he come up with other schemes to improve the appearance of the
company's performance that will require your cooperation to implement? Once you begin
intentionally distorting financial numbers, you almost always must keep doing so, and often
at more extreme levels, in order to accomplish your objective of obscuring the facts
...
, 2012
Case 6
...
5
EXPLORING THE ANNUAL REPORT OF GAP, INC
...
Our
answers provide only general information about the requirements
...


Financial information available at the company’s home page includes annual reports, proxy
statements, SEC filings, sales and earnings summaries, web casts, news releases, stock
charts, analyst coverage, and more
...


Information pertaining to the company’s performance is found throughout its annual
report in the following sections: (1) 10-Year Selected Financial Data, (2) Management’s
Discussion and Analysis, (3) a discussion of the business and the company's properties in
items 1 and 2 of the 10-K, respectively, and (4) Consolidated Financial Statements
...
, 2012
Case 6

---