Chapter 4, Problem 5PSB

To determine

Adjusting Entries:

The accounting entries which are made at the end of an accounting period to change the closing balances of various general ledger accounts. They are made to align the reported results and financial position of the business in accordance with the accounting framework, such as GAAP or IFRS.

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:

The inventory system in which the inventory accounts are updated on each purchase or sale in inventory. 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 margin ratio:

It means the ratio of gross profit earned to net sales. Formula to compute it:

  $\text{Gross}\text{Margin}\text{Ratio}=\frac{\text{Gross}\text{Profit}}{\text{Net}\text{Sales}}$

Current ratio:

It is ratio which gives idea about the ability of company to pay it liabilities. Formula to compute it:

  $\begin{array}{c}\text{Current}\text{ratio}=\frac{\text{Current}\text{Assets}}{\text{Current}\text{liabilities}}\\ \end{array}$

Acid Test ratio:

It measures the ability of company to use cash or its liquid assets or paying off current liabilities. Formula to compute it:

  $\text{Acid}\text{test}\text{Ratio}=\frac{\text{Current}\text{assets}\text{-}\left(\text{Stock+Prepaid}\text{expenses}\right)}{\text{Current}\text{Liabilities}}$

1.

To prepare: Adjusting entries.

Explanation of Solution

(a)

Physical count of Store supplies at the year end shows $3,700 still available but Store supplies listed shows $9,700.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Supplies expense		6,000
	Store supplies			6,000
	(To record supplies consumed during the period)

Table (1)

• Supplies expense account is an expense account. Since Supplies expense is increased, expense is to be increased. So, debit the Supplies expense account.
• Store supplies account is an asset account. Since inventory is shrinked, so it is to be reduced. Therefore, Store supplies account is to be credited.

Working note:

Computation of Inventory shrinkage,

  $\begin{array}{c}\text{Supplies Expense}=\text{Supply}\text{listed}-\text{Supply}\text{still}\text{available}\\ =\$9,700-\$3,700\\ =\$6,000\end{array}$

(b)

Prepaid selling expenses worth $1,400 have expired:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Insurance expense		2,800
	Prepaid insurance expense			2,800
	(To record expired prepaid selling expense)

Table (2)

• Insurance expense is an expense account. Since Insurance expense is increased, expense is to be increased. So, debit the Insurance expense account.
• Prepaid insurance expense is an asset account. Since Prepaid insurance expense have expired resulting a decrease in asset, so asset is to be decreased. Therefore Prepaid insurance expense account is credited.

(c)

Depreciation expense worth $3,000 is to be recorded:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Depreciation expense		3,000
	Store equipment			3,000
	(To record depreciation on office equipment)

Table (3)

• Depreciation expense is an expense account. Since Depreciation expense is to be recorded, expense is to be increased. So, debit the Depreciation expense account.
• Store equipment is an asset account. Since,Depreciation expense is to be recorded resulting a decrease in asset, so asset is to be decreased. Therefore Store equipment account is credited.

(d)

Physical count of merchandise inventory at the year end shows $21,300 still available but merchandise inventory listed shows $24,000.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Cost of goods sold		2,700
	Merchandise inventory			2,700
	(To record inventory shrinkage cost)

Table (4)

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

Working note:

Computation of Inventory shrinkage,

  $\begin{array}{c}\text{Inventory}\text{shrinkage}=\text{Inventory}\text{listed}-\text{Inventory}\text{still}\text{available}\\ =\$24,000-\$21,300\\ =\$2,700\end{array}$

2.

To determine

To prepare: Multi step Income Statement.

Explanation of Solution

Company F
Multi step Income Statement
For the Year Ended December 31,2017
Particulars	Amount($)	Amount($)
Sales Revenue		227,100
Less: Sales Returns and Allowances	(5,000)
Sales discount	(1,000)	(6,000)
Net Sales		221,100
Less: Cost of Goods Sold		(78,500)
Gross Profit		142,600
Less: Operating expenses
Selling expenses
Advertising expense	(17,800)
General and admin Expenses
Store supply expense	(6,000)
Rent expense	(26,000)
Insurance expense	(2,800)
Depreciation	(3,000)
Salaries	(63,000)
	(100,800)
Total other revenues and gains		118,600
Net income		24,000

Table (5)

Hence, Net income of Company F is $24,000

3.

To determine

To prepare: Single step Income Statement.

Explanation of Solution

Company F
Single Step Income Statement
Particulars	Amount($)	Amount($)
Net Sales		221,100
Less: Expenses
Cost of goods sold	(78,500)
Selling expenses	(17,800)
General and admin Expenses	(100,800)	(197,100)
Net income		24,000

Table (6)

Hence, Net income of Company F is $24,000

4.

To determine

To Compute: Current and Acid test ratio and Gross margin ratio.

Explanation of Solution

Given,

Cash is $7,400.

Merchandise inventory is $21,300.

Store supplies are $3,700.

Prepaid asset is $3,800.

Current liabilities are $18,000.

Formula to compute Current ratio: $\begin{array}{c}\text{Current}\text{ratio}=\frac{\text{Current}\text{Assets}}{\text{Current}\text{liabilities}}\\ \end{array}$

Substitute current assets by $36,200 and current liabilities by$18,000.

  $\begin{array}{c}\text{Current}\text{ratio}=\frac{\$36,200}{\$18,000}\\ =2.01\end{array}$

Working notes:

Computation of Current Assets,

  $\begin{array}{c}\text{Current}\text{assets}=\text{Cash}+\text{Inventory}+\text{store}\text{supplies}+\text{Prepaid}\text{insurance}\\ =7,400+21,300+3,700+3,800\\ =\$36,200\end{array}$

Calculated,

Current assets are $36,200.

Merchandise inventory is $21,300.

Store supplies are $3,700.

Prepaid asset is $3,800.

Current liabilities are $18,000.

Formula to compute Acid test ratio: $\text{Acid}\text{test}\text{Ratio}=\frac{\text{Current}\text{assets}\text{-}\left(\text{Stock+Prepaid}\text{expenses}\right)}{\text{Current}\text{Liabilities}}$

Substitute current assets by $36,200, stock by (21,300+3,700)25,000, prepaid expenses by $3,800 and current liabilities by$18,000.

  $\begin{array}{c}\text{Current}\text{ratio}=\frac{\$36,200-\left(25,000+3,800\right)}{\$18,000}\\ =\frac{\$36,200-\$28,800}{\$18,000}\\ =\frac{\$7,400}{\$18,000}\\ =0.41\end{array}$

Gross profit is $142,600. (From part 2)

Net sales is $221,100. (From part 2)

Formula to compute Gross margin ratio:

  $\text{Gross}\text{Margin}\text{Ratio}=\frac{\text{Gross}\text{Profit}}{\text{Net}\text{Sales}}$

Substitute Gross profit by $142,600 and Net sales by $221,100.

  $\begin{array}{c}\text{Gross}\text{margin}\text{ratio}=\frac{\$142,600}{\$221,100}\\ =64.50\%\end{array}$

Hence, Gross Margin ratio of Company F is 64.50%, Current ratio is 2.01, Acid test ratio is 0.41.