Chapter 4, Problem 12AE

a.

To determine

Journalize the inventory transactions for Shop TA, assuming the perpetual inventory system.

Explanation of Solution

Perpetual inventory system: The method or system of maintaining, recording, and adjusting the inventory perpetually throughout the year, is referred to as perpetual inventory system.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Journalize the inventory transactions in the books of Shop TA.

Transaction 1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			15,000
			Accounts Payable			15,000
		(Record purchase of merchandise on account)

Table (1)

Description:

• Merchandise Inventory is an asset account. Since merchandise is purchased, asset value increased, and an increase in asset is debited.
• Accounts Payable is a liability account. Since amount owed increased, liability increased, and an increase in liability is credited.

Transaction 2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			800
			Cash			800
		(Record freight charges on goods purchased)

Table (2)

Description:

• Merchandise Inventory is an asset account. Since merchandise is purchased, asset value increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 3:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Payable			2,600
			Merchandise Inventory			2,600
		(Record merchandise purchased on account returned)

Table (3)

Description:

• Accounts Payable is a liability account. Since amount owed decreased, liability decreased, and a decrease in liability is debited.
• Merchandise Inventory is an asset account. Since merchandise purchased is returned, asset value decreased, and a decrease in asset is credited.

Transaction 4:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Payable			1,100
			Merchandise Inventory			1,100
		(Record allowance received for merchandise purchased on account)

Table (4)

Description:

• Accounts Payable is a liability account. Since amount owed decreased, liability decreased, and a decrease in liability is debited.
• Merchandise Inventory is an asset account. Since cost of merchandise purchased is reduced as purchase allowance, asset value decreased, and a decrease in asset is credited.

Transaction 5:

For recognizing sales revenue:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cash			31,000
			Sales Revenue			31,000
		(Record sale of merchandise)

Table (5)

Description:

• Cash is an asset account. The amount is increased because cash is received, and an increase in asset is debited.
• Sales Revenue is a revenue account. Since gains and revenues increase equity, and an increase in equity is credited, Sales Revenue account is credited.

For recognizing cost of goods sold:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cost of Goods Sold			15,000
			Merchandise Inventory			15,000
		(Record cost incurred on goods sold)

Table (6)

Description:

• Cost of Goods Sold is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Cost of Goods Sold account is debited.
• Merchandise Inventory is an asset account. Since merchandise is sold, asset value decreased, and a decrease in asset is credited.

Transaction 6:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Transportation-out			500
			Cash			500
		(Record freight charges on goods sold)

Table (7)

Description:

• Transportation-out is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Transportation-out account is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 7:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Payable			8,000
			Cash			8,000
		(Record cash paid for merchandise purchased on account)

Table (8)

Description:

• Accounts Payable is a liability account. Since amount owed is paid, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Operating Expenses			9,000
			Cash			9,000
		(Record cash paid for operating expenses)

Table (9)

Description:

• Operating Expenses is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Operating Expenses account is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

b.

To determine

Post the beginning balances into T-accounts, and post the journal entries prepared in Part (a) into T-accounts.

Explanation of Solution

T-account: The condensed form of a ledger is referred to as T-account. The left-hand side of this account is known as debit, and the right hand side is known as credit.

Post the journal entries prepared in Part (a) into T-accounts.

Cash
Beginning balance	$16,000	Merchandise inventory	$800
Sales revenue	31,000	Transportation-out	500
		Accounts payable	8,000
		Operating expenses	9,000
Total	47,000	Total	18,300
Balance	$28,700

Table (10)

Merchandise Inventory
Beginning balance	$8,000	Accounts payable	$2,600
Accounts payable	15,000	Accounts payable	1,100
Cash	800	Cost of goods sold	15,000
Total	23,800	Total	18,700
Balance	$5,100

Table (11)

Accounts Payable
Merchandise inventory	$2,600	Merchandise inventory	$15,000
Merchandise inventory	1,100
Cash	8,000
Total	11,700	Total	15,000
		Balance	$3,300

Table (12)

Common Stock
		Beginning balance	$20,000
Total	$0	Total	20,000
		Balance	$20,000

Table (13)

Retained Earnings
		Beginning balance	$4,000
Total	$0	Total	4,000
		Balance	$4,000

Table (14)

Sales Revenue
		Cash	$31,000
Total	$0	Total	31,000
		Balance	$31,000

Table (15)

Cost of Goods Sold
Merchandise inventory	$15,000
Total	15,000	Total	$0
Balance	$15,000

Table (16)

Transportation-out
Cash	$500
Total	500	Total	$0
Balance	$500

Table (17)

Operating Expenses
Cash	$9,000
Total	9,000	Total	$0
Balance	$9,000

Table (18)

c.

To determine

Prepare a multistep income statement, balance sheet, and statement of cash flows for Shop TA based on the account balances derived in Part (b).

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 Shop TA for the year ended December 31, Year 2.

Shop TA
Income Statement
For the Year Ended December 31, Year 2
Net sales	$31,000
Cost of goods sold	(15,000)
Gross margin	16,000
Operating expenses	(9,000)
Transportation-out	(500)
Net income	$6,500

Table (19)

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 Shop TA as at December 31, Year 2.

Shop TA
Balance Sheet
December 31, Year 2
Assets
Cash	$28,700
Merchandise inventory	5,100
Total assets		$33,800
Liabilities
Accounts payables		$3,300
Stockholders’ equity
Common stock	20,000
Retained earnings	10,500
Total stockholders’ equity		30,500
Total liabilities and stockholders’ equity		$33,800

Table (20)

Working Notes:

Prepare statement of retained earnings for Shop TA for the year ended December 31, Year 2.

Shop TA
Statement of Retained Earnings
For the Year Ended December 31, Year 2
Retained earnings, December 31, Year 1	$4,000
Add: Net income	6,500
	10,500
Less: Dividends	(0)
Retained earnings, December 31, Year 2	$10,500

Table (21)

Note: Refer to Table (19) for value and computation of net income.

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities. Ending cash balance computed in balance sheet is required in statement of cash flows. Operating activities include cash inflows and outflows from business operations. Investing activities includes cash inflows and cash outflows from purchase and sale of land or equipment, or investments. Financing activities includes cash inflows and outflows from issuance of common stock and debt, payment of debt and dividends.

Prepare the statement of cash flows for Shop TA for the year ended December 31, Year 2.

Shop TA
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash flows from operating activities:
Cash inflow from customers	$31,000
Cash outflow for inventory	(8,800)
Cash outflow for expenses	(9,500)
Net cash flow from operating activities		$12,700
Cash flows from investing activities		0
Cash flows from financing activities		0
Net change in cash		12,700
Add: Beginning cash balance		16,000
Ending cash balance		$28,700

Table (22)

d.

To determine

Provide reasons for the difference in net income and cash flow from operating activities.

Explanation of Solution

Reason: In general, net income includes all the cash and non-cash operating activities, but cash flow from operating activities includes only cash operating activities. In the given case, net income value is different from net cash flow from operating activities. The main reason for this difference is that the merchandise which was sold by the company, is different from the amount paid for inventory bought on account.