Chapter 4, Problem 26AP

a.

To determine

Assuming the perpetual inventory system, indicate the effect of events on the financial statements by placing a ‘+’ for increase and ‘–’ for decrease, and indicate the events as AS (asset source), or AU (asset use), or AE (asset exchange), or CE (claims exchange).

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.

Effect of events on the financial statements for Company R:

Table (1)

Description:

• 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.

b.

To determine

Journalize the inventory transactions in the books of Company R, assuming the perpetual inventory system.

Explanation of Solution

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 R.

Transaction 1a:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			5,200
			Accounts Payable			5,200
		(Record purchase of merchandise on account)

Table (2)

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 1b:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			190
			Cash			190
		(Record purchase of merchandise for cash)

Table (3)

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 2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Payable			400
			Merchandise Inventory			400
		(Record merchandise purchased on account returned)

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 merchandise purchased is returned, asset value decreased, and a decrease in asset is credited.

Transaction 3a:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Payable			48
			Merchandise Inventory			48
		(Record purchase discount received for merchandise purchased on account)

Table (5)

Description:

• Accounts Payable is a liability account. Since sales discount is received, 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 by receiving discount, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute purchase discount.

$\begin{array}{c}\text{Purchase discount = }\left\{\begin{array}{l}\left(\text{Purchases–Purchase returns}\right)\text{×}\\ \text{Purchase discount percentage}\end{array}\right\}\\ \text{= }\left(\text{\$5,200–\$400}\right)\text{×1\%}\\ \text{= \$4,800×1\%}\\ \text{= \$48}\end{array}$ (1)

Transaction 3b:

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 (6)

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.

Working Notes:

Compute cash paid.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\text{Purchases–}\\ \text{Purchase returns–}\\ \text{Purchase discount}\end{array}\right\}\\ \text{= }\left(\text{\$5,200–\$400–\$48}\right)\\ \text{= \$4,752}\end{array}$

Note: Refer to Equation (1) for computation of purchase discount.

Transaction 4a:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Accounts Receivable			12,100
			Sales Revenue			12,100
		(Record merchandise sold on account)

Table (7)

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.

Transaction 4b:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cost of Goods Sold			6,800
			Merchandise Inventory			6,800
		(Record cost incurred for goods sold)

Table (8)

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 5a:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Sales Revenue			1,680
			Accounts Receivable			1,680
		(Record merchandise sold on account returned)

Table (9)

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.

Transaction 5b:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Merchandise Inventory			900
			Cost of Goods Sold			900
		(Record cost incurred on merchandise sold being reduced for the goods returned)

Table (10)

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 6:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Transportation-out			140
			Cash			140
		(Record freight charges on goods sold)

Table (11)

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 7a:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Sales Revenue			242
			Accounts Receivable			242
		(Record allowance granted  on damaged merchandise sold on account)

Table (12)

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.

Working Notes:

Compute sales discount.

$\begin{array}{c}\text{Sales discount = }\left\{\begin{array}{l}\text{Accounts receivable×}\\ \text{Sales discount percentage}\end{array}\right\}\\ \text{= \$12,100×2\%}\\ \text{= \$242}\end{array}$ (2)

Transaction 7b:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cash			11,858
			Accounts Receivable			11,858
		(Record cash collected in part, on merchandise sold on account)

Table (13)

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.

Working Notes:

Compute cash received.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\text{Accounts receivable–}\\ \text{Sales discount}\end{array}\right\}\\ \text{= }\left(\text{\$12,100–\$242}\right)\\ \text{= \$11,858}\end{array}$

Note: Refer to Equation (2) for computation of sales discount.

Transaction 8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cash			8,500
			Land			7,000
			Gain from Sale of Land			1,500
		(Record sale of land)

Table (14)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Land is an asset account. Since land is sold, asset account decreased, and a decrease in asset is credited.
• Gain from Sale of Land is a revenue account. Since gains and revenues increase equity, and an increase in equity is credited, Gain on Sale of Land account is credited.

Transaction 9:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Interest Receivable			600
			Interest Revenue			600
		(Record accrued interest income)

Table (15)

Description:

• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since gains and revenues increase equity, and an increase in equity is credited, Interest Revenue account is credited.

Transaction 10:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Cost of Goods Sold			600
			Merchandise Inventory			600
		(Record inventory loss or shrinkage)

Table (16)

Description:

• Cost of Goods Sold is an expense account. Loss of inventory is identified after evaluating the physical count and the recorded inventory. 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 lost, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate loss of inventory.

Step 1: Compute value of inventory as per records.

Merchandise Inventory
Beginning balance	$15,000	Accounts payable	$400
Accounts payable	5,200	Accounts payable	48
Cash	190	Cost of goods sold	6,800
Cost of goods sold	900
Total	21,290	Total	7,248
Balance	$14,042

Table (17)

Step 2: Compute inventory loss or shrinkage.

$\begin{array}{c}\begin{array}{l}\text{Inventory }\\ \text{shrinkage}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Balance in Merchandise Inventory account – }\\ \text{Physical count of inventory}\end{array}\right\}\\ \text{= \$14,042 – \$13,400}\\ \text{= \$642}\end{array}$

Note: Refer to Table (17) for computation of balance of Merchandise Inventory account.

b.

To determine

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

Explanation of Solution

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

Cash
Beginning balance	$6,900	Merchandise inventory	$190
Accounts receivable	11,858	Accounts payable	4,752
Land	7,000	Sales revenue	1,680
Gain on sale of land	1,500	Transportation-out	140
Total	27,258	Total	6,762
Balance	$20,496

Table (18)

Accounts Receivable
Sales revenue	$12,100	Sales revenue	$242
		Cash	11,858
Total	12,100	Total	12,100
Balance	$0

Table (19)

Interest Receivable
Interest revenue	$600
Total	600	Total	$0
Balance	$600

Table (20)

Merchandise Inventory
Beginning balance	$15,000	Accounts payable	$400
Accounts payable	5,200	Accounts payable	48
Cash	190	Cost of goods sold	6,800
Cost of goods sold	900
Total	21,290	Total	7,248
Balance	$14,042
		Cost of goods sold	642
Total	14,042	Total	642
Balance	$13,400

Table (21)

Land
Beginning balance	$7,000	Cash	$7,000
Total	7,000	Total	$7,000
Balance	$0

Table (22)

Accounts Payable
Merchandise inventory	$400	Merchandise inventory	$5,200
Merchandise inventory	48
Cash	4,752
Total	5,200	Total	5,200
		Balance	$0

Table (23)

Common Stock
		Beginning balance	$15,000
Total	$0	Total	15,000
		Balance	$15,000

Table (24)

Retained Earnings
		Beginning balance	$13,900
Total	$0	Total	13,900
		Balance	$13,900

Table (25)

Sales Revenue
Cash	$1,680	Accounts receivable	$12,100
Accounts receivable	242
Total	$1,922	Total	12,100
		Balance	$10,178

Table (26)

Cost of Goods Sold
Merchandise inventory	$6,800	Merchandise inventory	$900
Merchandise inventory	642
Total	7,442	Total	900
Balance	$6,542

Table (27)

Transportation-out
Cash	$140
Total	140	Total	$0
Balance	$140

Table (28)

Interest Revenue
		Interest receivable	$600
Total	$0	Total	600
		Balance	$600

Table (29)

Gain from Sale of Land
		Cash	$1,500
Total	$0	Total	1,500
		Balance	$1,500

Table (30)

d.

To determine

Prepare a multistep income statement, statement of stockholders’ equity, balance sheet, and statement of cash flows for Company R, based on the account balances derived in Part (c).

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, Year 2.

Company R
Income Statement
For the Year Ended December 31, Year 2
Sales	$12,100
Sales returns	(1,680)
Sales discounts	(242)
Net sales		$10,178
Cost of goods sold		(6,542)
Gross margin		3,636
Operating expenses:
Transportation-out		(140)
Operating income		3,496
Non-operating items:
Interest revenue	600
Gain on sale of land	1,500	2,100
Net income		$5,596

Table (31)

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, Year 2.

Company R
Statement of Stockholders’ Equity
For the Year Ended December 31, Year 2
Beginning common stock	$15,000
Stock issued	0
Ending common stock		$15,000
Beginning retained earnings	$13,900
Net income	5,596
Ending retained earnings		19,496
Total stockholders’ equity		$34,496

Table (32)

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, Year 2.

Company R
Balance Sheet
December 31, Year 2
Assets
Cash	$20,496
Accounts receivable	13,400
Merchandise inventory	600
Total assets		$34,496
Liabilities		$0
Stockholders’ equity
Common stock	15,000
Retained earnings	19,494
Total stockholders’ equity		34,496
Total liabilities and stockholders’ equity		$34,496

Table (33)

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 R for the year ended December 31, Year 2.

Company R
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash flows from operating activities:
Cash inflow from customers	$10,178
Cash outflow for inventory	(4,942)
Cash outflow for expenses	(140)
Net cash flow from operating activities		$5,096
Cash flows from investing activities:
Cash inflow from sale of land		8,500
Cash flows from financing activities		0
Net change in cash		13,596
Add: Beginning cash balance		6,900
Ending cash balance		$20,496

Table (34)

e.

To determine

Prepare closing entries at the end of Year 2, post the closing entries into T-accounts, and prepare post-closing trial balance of Company R as on December 31, Year 2.

Explanation of Solution

Closing entries: The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Prepare closing entries at the end of Year 1 for Company R.

Closing revenues:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Sales Revenue			10,178
		Interest Revenue			600
		Gain from Sale of Land			1,500
			Retained Earnings			12,278
		(Record revenues being closed to Retained Earnings account)

Table (35)

Description:

• Sales Revenue, Interest Revenue, and Gain from Sale of Land are revenue accounts. Since revenues are closed to Retained Earnings account, the accounts are cancelled by debiting to reverse its effect.
• Retained Earnings is a stockholders’ equity account. Since revenues are transferred to the account, the value increased, and an increase in equity is credited.

Closing expenses:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 2
		Retained Earnings			6,682
			Cost of Goods Sold			6,542
			Transportation-out			140
		(Record expenses being closed to Retained Earnings account)

Table (36)

Description:

• Retained Earnings is a stockholders’ equity account. Since expenses are transferred to the account, the value decreased, and a decrease in equity is debited.
• Cost of Goods Sold and Transportation-out are expenses accounts. Since expenses are closed to Retained Earnings account, the accounts are cancelled by crediting to reverse the effect.

Post the entries into T-accounts.

Cash
Balance	$20,496

Table (37)

Interest Receivable
Balance	$600

Table (38)

Merchandise Inventory
Balance	$13,400

Table (39)

Common Stock
		Balance	$15,000

Table (40)

Retained Earnings
		Beginning balance	$13,900
Total	$0	Total	13,900
		Balance	$13,900
Cost of goods sold	6,542	Sales revenue	10,178
Transportation-out	140	Interest revenue	600
		Gain from sale of land	1,500
Total	6,682	Total	26,178
		Balance	$19,496

Table (41)

Sales Revenue
Cash	$1,680	Accounts receivable	$12,100
Accounts receivable	242
Total	$1,922	Total	12,100
		Balance	$10,178
Retained earnings	10,178
Total	10,178	Total	10,178
		Balance	$0

Table (41)

Cost of Goods Sold
Merchandise inventory	$6,800	Merchandise inventory	$900
Merchandise inventory	642
Total	7,442	Total	900
Balance	$6,542
		Retained earnings	6,542
Total	6,542	Total	6,542
Balance	$0

Table (42)

Transportation-out
Cash	$140
Total	140	Total	$0
Balance	$140
		Retained earnings	140
Total	140	Total	140
Balance	$0

Table (43)

Interest Revenue
		Interest receivable	$600
Total	$0	Total	600
		Balance	$600
Retained earnings	600
Total	600	Total	600
		Balance	$0

Table (44)

Gain from Sale of Land
		Cash	$1,500
Total	$0	Total	1,500
		Balance	$1,500
Retained earnings	1,500
Total	1,500	Total	1,500
		Balance	$0

Table (45)

Post-closing trial balance: Post-closing trial balance is a summary of all the asset, liability, and equity accounts and their balances, after the closing entries are prepared. So, post-closing trial balance reports the balances of permanent accounts only.

Prepare post-closing trial balance for Company R as of December 31, Year 2.

Company R
Post-Closing Trial Balance
December 31, Year 2
Account Titles	Debit ($)	Credit ($)
Cash	$20,496
Merchandise Inventory	13,400
Interest receivable	600
Common Stock		$15,000
Retained earnings		19,496
Total	$34,496	$34,496

Table (46)