Chapter 4, Problem 2PSA

Preparing journal entries for merchandising activities - perpetual system P1 P2
Prepare journal entries to record the following merchandising transactions of Lowe’s, which uses the perpetual inventory system and the gross method. Hint: It will help to identify each receivable and payable; for example, record the purchase on August 1 in Accounts Payable-Aron. Aug.
1 Purchased merchandise from Aron Company for $7,500 under credit terms of $1/10,\text{n}/30,\text{FOB}$ destination, invoice dated August 1.
5 Sold merchandise to Baird Corp. for $5,200 under credit terms of $2/10,\text{n}/60,\text{FOB}$ destination, invoice dated August 5. The merchandise had cost $4,000.
8 Purchased merchandise from Waters Corporation for $5,400 under credit terms of $1/10,\text{n}/45,$ FOB shipping point, invoice dated August 8.
9. Paid $125 cash for shipping charges related to the August 5 sale to Baird Corp.
10 Baird returned merchandise from the August 5 sale that had cost Lowe’s $400 and was sold for $600. The merchandise was restored to inventory.
12 After negotiations with Waters Corporation concerning problems with the purchases on August 8, Lowe’s received a price reduction from Waters of $400 off the $5,400 of goods purchased. Lowe’s debited accounts payable for $400.
14 At Aron’s request, Lowe’s paid $200 cash for freight charges on the August 1 purchase, reducing the amount owed (accounts payable) to Aron.
15 Received balance due from Baird Corp. for the August 5 sale less the return on August 10.
18 Paid the amount due Waters Corporation for the August 8 purchase less the price allowance from August 12.
19 Sold merchandise to Tux Co. for $4,800 under credit terms of $n/10,$ FOB shipping point, invoice dated August 19. The merchandise had cost $2,400.
22 Tux requested a price reduction on the August 19 sale because the merchandise did not meet specifications. Lowe’s gave a price reduction (allowance) of $500 to Tux and credited Tux’s accounts receivable for that amount.
29 Received Tux’s cash payment for the amount due from the August 19 sale less the price allowance from August 22.
30 Paid Aron Company the amount due from the August 1 purchase.
Check Aug. 9, Dr. Delivery Expense, $125
Aug. $18,\text{Cr}$ . Cash, $4,950
Aug. 29, Dr. Cash, $4,300

To determine

Journal Entry:

It means recording of financial data related to business transactions in a journal in a manner so that debit equals credit. They provide an audit trail to the auditor and a means to analyze the effects of transactions to an organization’s financial health.

Rules of Journal Entry:

To increase the balance of account one needs to debit assets, expenses, losses and credit all the liabilities, revenues and gains including capital. To decrease the balance of account credit all assets, expenses, losses and debit all liabilities, revenues and gains including capital.

Perpetual Inventory System:

It is an inventory system wherein the accounts related to inventory are updated on each purchase and sale happening. Quantities of inventory are updated on continuous basis. This can be done by integrating the inventory system to order entry and to the retail sale point of system.

Gross Method:

Under this method, all the purchases are recorded in the books of account without taking into account the trade discount, returns and allowances. The purchases are to be recorded at full cost.

To prepare: Journal entries in the books of Company L.

Explanation of Solution

Purchased merchandise inventory worth $7,500.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 1	Merchandise Inventory		7,500
	Account payable			7,500
	(To record merchandise inventory purchased on credit)

Table (1)

• Merchandise inventory account is an asset account. Since, there is purchase of merchandise inventory, so asset account is to be increased. Therefore, merchandise inventory account to be debited.
• Account payable is a liability account. Since, payment is to be made for purchases on account, so liability is to be increased. Therefore, account payable account is credited.

Sold Merchandise inventory on account for $5,200.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 5	Account Receivable		5,200
	Sales			5,200
	(To record sales made on account)

Table (2)

• Account receivable is an asset account. Since payment is to be received, so asset is to be increased. Therefore, account receivable account is debited.
• Sales are a revenue account. Since sales is made, so it needs to be increased. Therefore, sales account is to be credited.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 5	Cost of goods sold		4,000
	Merchandise inventory			4,000
	(To record cost of goods sold)

Table (3)

• Cost of goods sold account is an expense account. Since goods are being sold, expense is to increased. Therefore, Cost of goods sold account is debited.
• Merchandise inventory account is an asset account. Since inventory is being sold, so it is to be reduced. Therefore, merchandise inventory account is to be credited.

Purchased merchandise inventory worth $5,400.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 8	Merchandise Inventory		5,400
	Account payable			5,400
	(To record merchandise inventory purchased on credit)

Table (4)

• Merchandise inventory account is an asset account. Since there is purchase of merchandise inventory, so asset account is to be increased. Therefore, merchandise inventory account to be debited.
• Account payable is a liability account. Since payment is to be made for purchases on account, so liability is to be increased. Therefore account payable account is credited.

Paid $125 cash for shipping charges:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 9	Merchandise Inventory		125
	Cash			125
	(To record shipping charges paid by buyer)

Table (5)

• Merchandise inventory is an asset account. Since the amount of freight is added up in the merchandise inventory value, the value of assets is increased. So, debit the merchandise inventory account.
• Cash is an asset account. Since the cash is paid, the value of assets is decreased. So, credit the cash account.

Company L received the goods worth $600 back and restores them:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 10	Sales return and allowances		600
	Account receivable			600
	(To record sales return)

Table (6)

• Sales return and allowances account is an expense account. Since Company A is receiving the sales return so it needs to be increased, so expense account is to be increased. Therefore, sales return and allowances account is to be debited.
• Account receivable is an asset account. Since account receivable is getting reduced because of sales return so asset is to be reduced. Therefore account receivable is to be credited.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 10	Merchandise inventory		400
	Cost of goods sold			400
	(To record cost of goods sold)

Table (7)

• Merchandise inventory account is an asset account. Since inventory is being received, so asset is to be increased. Therefore, merchandise inventory account is to be debited.
• Cost of goods sold account is an expense account. Since goods are being returned, expense is to be reduced. Therefore, cost of goods sold account is credited.

Company L received price reduction for purchase of goods from Company W $400:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 12	Account payable		400
	Merchandise Inventory			400
	(To record price reduction worth $400)

Table (8)

• Account payable is a liability account. Since the Inventory which was purchased on credit is returned, this reduces the liability to be paid. So, debit the accounts payable account.
• Merchandise Inventory is an asset account. Since it is returned to the seller , the value of asset is to be reduced. So credit the Merchandise inventory account.

Paid $200 cash for shipping charges reducing the amount owed to Company A:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 14	Account payable		200
	Cash			200
	(To record shipping charges paid by buyer)

Table (9)

• Account payable is a liability account. Since the amount of freight is paid and value of liability is to be decreased. So, debit the account payable account.
• Cash is an asset account. Since the cash is paid, the value of assets is decreased. So, credit the cash account.

Received cash from customer:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 15	Cash		4,508
	Sales discount		92
	Account receivable			4,600
	(To record final payment received from Company A)

Table (10)

• Cash is an asset account. Since, payment is received in cash, so it is to be increased. Therefore cash account is credited.
• Sales discount is an expense account. Since, an expense is getting increased, so it requires a debit in the entry. Therefore sales discount is debited.
• Account receivable is an asset account. Since account receivable is getting recovered for cash, so it is to be reduced. Therefore, account receivable is credited.

Working note:

Computation of account receivables,

  $\begin{array}{c}\text{Account}\text{receivables}=\text{Sales}-\text{Sales}\text{Return}\\ =\$5,200-\$600\\ =\$4,600\end{array}$

Computation of sales discount,

  $\begin{array}{c}\text{Sales}\text{Discount}=\text{Account}\text{recievable}\times \text{Rate}\text{of}\text{Discount}\\ =\$4,600\times 2\%\\ =\$92\end{array}$

Computation of cash to be received,

  $\begin{array}{c}\text{Cash}=\text{Account}\text{Recievable}-\text{Sales}\text{Discount}\\ =\$4,600-\$92\\ =\$4,508\end{array}$

Company L makes final payment to Company W:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 18	Account payable		5,000
	Merchandise inventory			50
	Cash			4,950
	(To record cash payment made for merchandise inventory )

Table (11)

• Account payable is a liability account. Since payment is to be made for account payable this will result in reduction of liability. Therefore, account payable account is debited.
• Merchandise Inventory account is an asset account. Since, discount is received in making final payment by Company S from Company T, merchandise inventory is to be reduced. Therefore, merchandise inventory account is credited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, cash account is credited.

Working notes:

Computation of account payables,

  $\begin{array}{c}\text{Account}\text{payables}=\text{Purchase}-\text{Purchase}\text{Return}\\ =\$5,400-\$400\\ =\$5,000\end{array}$

Computation of merchandise inventory,$\begin{array}{c}\text{Discount}\text{amount}=\text{Account}\text{Payables}\times \text{Discount}\text{Rate}\\ =\$5,000\times 1\%\\ =\$50\end{array}$

Computation of cash to be paid,

  $\begin{array}{c}\text{Cash}=\text{Account}\text{payable}-\text{Discount}\\ =\$5,000-\$50\\ =\$4,950\end{array}$

Sold Merchandise inventory on account for $4,800:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 19	Account receivable		4,800
	Sales			4,800
	(To record sales made on account)

Table (12)

• Account receivable is an asset account. Since payment is to be received, so asset is to be increased. Therefore, account receivable account is debited.
• Sales are a revenue account. Since sales are made, so it needs to be increased. Therefore, sales account is to be credited.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 19	Cost of goods sold		2,400
	Merchandise inventory			2,400
	(To record cost of goods sold)

Table (13)

• Cost of goods sold account is an expense account. Since goods are being sold, expense is increased. Therefore, cost of goods sold account is debited.
• Merchandise inventory account is an asset account. Since inventory is being sold, so it is to be reduced. Therefore, merchandise inventory account is to be credited.

Company L received price reduction for purchase of goods from Company W $500:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Aug 22	Account payable		500
	Merchandise Inventory			500
	(To record price reduction worth $500)

Table (14)

• Account payable is a liability account. Since the inventory which was purchased on credit is returned, this reduces the liability to be paid. So, debit the accounts payable account.
• Merchandise inventory is an asset account. Since it is returned to the seller, the value of asset is to be reduced. So credit the merchandise inventory account.

Received cash from customer:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 29	Cash		4,300
	Account receivable			4,300
	(To record final payment received from Company A)

Table (15)

• Cash is a asset account. Since, payment is received in cash, so it is to be increased. Therefore cash account is credited.
• Account receivable is an asset account. Since account receivable is getting recovered for cash, so it is to be reduced. Therefore, account receivable is credited.

Working note:

Computation of account receivables,

  $\begin{array}{c}\text{Account}\text{receivables}=\text{Sales}-\text{Sales}\text{Return}\\ =\$4,800-\$500\\ =\$4,300\end{array}$

Company L makes final payment to Company A:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 30	Account payable		7,300
	Cash			7,300
	(To record cash payment made for merchandise inventory )

Table (16)

• Account payable is a liability account. Since payment is to be made for account payable this will result in reduction of liability. Therefore, account payable account is debited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, cash account is credited.

Working note:

Computation of account payables,

  $\begin{array}{c}\text{Account}\text{payables}=\text{Purchase}-\text{Purchase}\text{return}\\ =\$7,500-\$200\\ =\$7,300\end{array}$