Chapter 4, Problem 16AE

a.

To determine

Journalize the inventory transactions in the books of Company PO, 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 Company PO.

Transaction 1:

For recognizing sales revenue:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Receivable			99,500
			Sales Revenue			99,500
		(Record merchandise sold on account)

Table (1)

Description:

• Accounts Receivable is an asset account. The amount is increased because amount to be received increased, 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			58,000
			Merchandise Inventory			58,000
		(Record cost incurred for goods sold)

Table (2)

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 2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Transportation-out			900
			Cash			900
		(Record freight charges on goods sold)

Table (3)

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 3:

For recognizing reduction in sales revenue:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Sales Revenue			5,900
			Accounts Receivable			5,900
		(Record merchandise sold on account returned)

Table (4)

Description:

• Sales Revenue is a revenue account. Since goods sold were returned, revenues decreased, and a decrease in revenues (equity) is debited.
• Accounts Receivable is an asset account. The goods sold were returned, and amount to be received decreased, and a decrease in asset is credited.

For recognizing reduction in cost of goods sold:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			4,000
			Cost of Goods Sold			4,000
		(Record cost incurred on merchandise sold being reduced for the goods returned)

Table (5)

Description:

• Merchandise Inventory is an asset account. Since merchandise sold is returned, asset value increased, and an increase in asset is debited.
• Cost of Goods Sold is an expense account. Since goods sold were returned, expenses decreased, and a decrease in expenses (equity) is credited.

Transaction 4:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Sales Revenue			3,000
			Accounts Receivable			3,000
		(Record allowance granted  on damaged merchandise sold on account)

Table (6)

Description:

• Sales Revenue is a revenue account. Since sale allowance is granted on goods sold, revenues decreased, and a decrease in revenues (equity) is debited.
• Accounts Receivable is an asset account. The sale allowance is granted on goods sold, and amount to be received decreased, and a decrease in asset is credited.

Transaction 5:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cash			81,000
			Accounts Receivable			81,000
		(Record cash collected in part, on merchandise sold on account)

Table (6)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Accounts Receivable is an asset account. The sale allowance is granted on goods sold, and amount to be received 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	$40,000	Transportation-out	$900
Accounts receivable	81,000
Total	121,000	Total	900
Balance	$120,100

Table (7)

Accounts Receivable
Sales revenue	$99,500	Sales revenue	$5,900
		Sales revenue	3,000
		Cash	81,000
Total	99,500	Total	89,900
Balance	$9,600

Table (8)

Merchandise Inventory
Beginning balance	$86,000	Cost of goods sold	$58,000
Cost of goods sold	4,000
Total	90,000	Total	58,000
Balance	$32,000

Table (9)

Common Stock
		Beginning balance	$60,000
Total	$0	Total	60,000
		Balance	$60,000

Table (10)

Retained Earnings
		Beginning balance	$66,000
Total	$0	Total	66,000
		Balance	$66,000

Table (11)

Sales Revenue
Accounts receivable	$5,900	Accounts receivable	$99,500
Accounts receivable	3,000
Total	$8,900	Total	99,500
		Balance	$90,600

Table (12)

Cost of Goods Sold
Merchandise inventory	$58,000	Merchandise inventory	$4,000
Total	58,000	Total	4,000
Balance	$54,000

Table (13)

Transportation-out
Cash	$900
Total	900	Total	$0
Balance	$900

Table (14)

c.

To determine

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

Explanation of Solution

Multistep income statement: The financial statement which reports revenues and expenses from business operations in an expanded form and the result of those operations as net income or net loss for a particular time period is referred to as multistep income statement.

Prepare a multistep income statement for Company PO for the year ended December 31, Year 2.

Company PO
Income Statement
For the Year Ended December 31, Year 2
Net sales	$90,600
Cost of goods sold	(54,000)
Gross margin	36,600
Operating expenses:
Transportation-out	(900)
Net income	$35,700

Table (15)

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 PO as at December 31, Year 2.

Company PO
Balance Sheet
December 31, Year 2
Assets
Cash	$120,100
Accounts receivable	9,600
Merchandise inventory	32,000
Total assets		$161,700
Liabilities		$0
Stockholders’ equity
Common stock	$60,000
Retained earnings	101,700
Total stockholders’ equity		161,700
Total liabilities and stockholders’ equity		$161,700

Table (16)

Working Notes:

Prepare statement of retained earnings for Company PO for the year ended December 31, Year 2.

Company PO
Statement of Retained Earnings
For the Year Ended December 31, Year 2
Retained earnings, December 31, Year 1	$66,000
Add: Net income	35,700
	101,700
Less: Dividends	(0)
Retained earnings, December 31, Year 2	$101,700

Table (17)

Note: Refer to Table (15) 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 Company PO for the year ended December 31, Year 2.

Company PO
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash flows from operating activities:
Cash inflow from customers	$81,000
Cash outflow for expenses	(900)
Net cash flow from operating activities		$80,100
Cash flows from investing activities		0
Cash flows from financing activities		0
Net change in cash		80,100
Add: Beginning cash balance		40,000
Ending cash balance		$120,100

Table (18)

d.

To determine

Give reasons for accepting the allowance granted by Company PO to the buyer, Company PR, on the damaged merchandise.

Explanation of Solution

Allowance: The amount of reduction in sale price granted by the seller to the buyers for the goods returned due to defects or damages in the product, or incorrect sizes, is referred to as allowance granted by seller.

Reasons for accepting damaged goods by the buyer, Company PR: Company PO granted the sale allowance to Company PR for accepting the damaged goods at a reduced price.

In this process, Company PO would save shipping charges and time, for products to be returned, or to repair the defective goods, or to sell those goods to other customers. So, Company PO benefits from this arrangement.