Chapter 3, Problem 26P

Comprehensive cycle problem: Perpetual system

At the beginning of 2018, the Redd Company had the following balances in its accounts:

During 2018, the company experienced the following events:

1. Purchased inventory that cost $15,200 on account from Ross Company under terms 1/10, n/30. The merchandise was delivered FOB shipping point. Freight costs of $200 were paid in cash.

2. Returned $800 of the inventory that it had purchased because the inventory was damaged in transit. The seller agreed to pay the return freight cost.

3. Paid the amount due on its account payable to Ross Company within the cash discount period.

4. Sold inventory that had cost $18,000 for $32,000 on account, under terms 2/10, n/45.

5. Received merchandise returned from a customer. The merchandise originally cost $800 and was sold to the customer for $1,500 cash. The customer was paid $1,500 cash for the returned merchandise.

6. Delivered goods FOB destination in Event 4. Freight costs of $140 were paid in cash.

7. Collected the amount due on the account receivable within the discount period.

8. Took a physical count indicating that $21,100 of inventory was on hand at the end of the accounting period.

Required

a. Identify these events as asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE).

b. Record each event in a statements model like the following one.

c. Prepare a multistep income statement, a statement of changes in stockholders’ equity, a balance sheet, and a statement of cash flows.

To determine

Identify the events as asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE).

Explanation of Solution

Identify the events as asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE).

Event No.	Event type
1a.	AS
1b.	AE
2.	AU
3.	AU
4a.	AS
4b.	AU
5a.	AU
5b.	AS
6.	AU
7.	AU
8.	AU

Table (1)

• Asset source: All the transactions which increase assets either by borrowing from creditors (increase liabilities), or by earning operating revenues (increase in stockholders’ equity) are referred to as asset source transactions.
• Asset use: All the transactions which decrease assets either by paying off liabilities (decrease in liabilities), or by paying operating expenses (decrease in stockholders’ equity) are referred to as asset use transactions.
• Asset exchange: All the transactions which increase assets and decrease assets simultaneously, with no effect on the total assets value are referred to as asset exchange transactions.
• Claims exchange: All the transactions which include exchange of liabilities for equity are referred to as claims exchange transactions.

To determine

Record each event in a statements model.

Explanation of Solution

Horizontal statements model: The model that represents all the financial statements, balance sheet, income statement, and statement of cash flows in one table in a horizontal form, is referred to as, horizontal statements model.

Record each event in a statements model.

Table (2)

Working Note:

(1) Compute purchase discount.

$\begin{array}{c}\text{Purchase discount = }\left\{\begin{array}{l}\left(\text{Purchases–Purchase returns}\right)\text{×}\\ \text{Purchase discount percentage}\end{array}\right\}\\ \text{= }\left(\text{\$15,200–\$800}\right)\text{×1\%}\\ \text{= \$14,400×1\%}\\ \text{= \$144}\end{array}$

(2)  Compute the cash paid for inventory purchased.

$\begin{array}{c}\text{Cash paid for inventory = }\left\{\begin{array}{l}\text{Purchases}–\text{Purchase returns}–\\ \text{Purchase discount}\end{array}\right\}\\ \text{= \$15,200}–\text{\$800}–\text{\$144}\left(1\right)\\ \text{= \$14,256}\end{array}$

(3) Compute sales discount.

$\begin{array}{c}\text{Sales discount = Accounts receivable}\times \text{Sales discount percentage}\\ \text{= \$32,000}\times \text{2\%}\\ \text{= \$640}\end{array}$

(4) Compute cash received.

$\begin{array}{c}\text{Cash received from customers = Sales}–\text{Sales discount}\\ \text{= \$}32,000–\text{\$640}\left(3\right)\\ \text{= \$31,360}\end{array}$

To determine

Prepare a multistep income statement, statement of stockholders’ equity, balance sheet, and statement of cash flows for Company R.

Explanation of Solution

Multi-step income statement: The income statement represented in multi-steps with several subtotals, to report the income from principal operations, and separate the other expenses and revenues which affect net income, is referred to as multi-step income statement.

Prepare a multistep income statement for Company R for the year ended December 31, 2018.

Company R
Income Statement
For the Year Ended December 31, 2018
Net sales		$29,860
Cost of goods sold (5)		($18,356)
Gross margin		$11,504
Operating expenses:
Transportation-out		($140)
Net income		$11,364

Table (3)

  Working Note:

    (5) Determine the amount of cost of goods sold.

    $\begin{array}{c}\text{Cost of goods sold}=\left(\begin{array}{l}\text{Cost of }\\ \text{inventory sold}\end{array}\right)+\left(\begin{array}{l}\text{Shrinkage of}\\ \text{ inventory}\end{array}\right)-\left(\begin{array}{l}\text{Cost of inventory }\\ \text{returned from }\\ \text{customers}\end{array}\right)\\ \text{=\$18,000}+\text{\$1,156}-\text{\$800}\\ \text{=\$18,356}\end{array}$

Statement of stockholders’ equity: The statement which reports the changes in stock, paid-in capital, retained earnings, and treasury stock, during the year is referred to as statement of stockholders’ equity.

Prepare a statement of stockholders’ equity for Company R for the year ended December 31, 2018.

Company R
Statement of Stockholders’ Equity
For the Year Ended December 31, 2018
Beginning common stock	$30,000
Add: Stock issued	$0
Ending common stock		$30,000
Beginning retained earnings	$11,900
Add: Net income	$11,364
Ending retained earnings		$23,264
Total stockholders’ equity		$53,264

Table (4)

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Prepare the balance sheet for Company R as at December 31, 2018.

Company R
Balance Sheet
December 31, 2018
Assets
Cash	$32,164
Merchandise inventory	$21,100
Total assets		$53,264
Liabilities		$0
Stockholders’ equity
Common stock	$30,000
Retained earnings	$23,264
Total stockholders’ equity		$53,264
Total liabilities and stockholders’ equity		$53,264

Table (5)

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash and the result of these transactions is reported as ending balance of cash at the end of reported period.

Prepare the statement of cash flows for Company R for the year ended December 31, 2018.

Company R
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Inflow from customers (6)	$29,860
Outflow for inventory (7)	($14,456)
Outflow for expenses	($140)
Net cash flow from operating activities		$15,624
Cash flows from investing activities		$0
Cash flows from financing activities		$0
Net change in cash		$15,624
Add: Beginning cash balance		$16,900
Ending cash balance		$31,164

Table (6)

Working note:

(6) Determine the cash inflow from customers.

$\begin{array}{c}\text{Inflow from customers = }\left(\begin{array}{l}\text{Cash received }\\ \text{from customers }\end{array}\right)–\left(\begin{array}{l}\text{Increase in }\\ \text{accounts receivable}\end{array}\right)\\ \text{= \$31,360}\left(7\right)–\text{\$1,500}\left(5\text{a}\right)\\ \text{= \$29,860}\end{array}$

(7) Determine the cash outflow for inventory.

$\begin{array}{c}\text{Outflow for inventory = }\left(\begin{array}{l}\text{Freight paid }\\ \text{for inventory }\end{array}\right)+\left(\begin{array}{l}\text{Cash paid to }\\ \text{accounts payable}\end{array}\right)\\ \text{= \$200}\left(\text{1b}\right)+\text{\$14,256}\left(3\right)\\ \text{= \$14,456}\end{array}$