Chapter 6, Problem 1CC

1.

To determine

Prepare journal entries for the given transactions.

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.

Prepare journal entries for the given transactions.

Date	Account Title and Explanation	Debit ($)	Credit ($)
August 2	Cash	450
	Sales revenue (3)		90
	Deferred revenue (4)		360
	(To record the cash received from person V for future sales and services)
	Cost of goods sold	80
	Inventory		80
	(To record cost of goods sold incurred)
August 3	Accounts receivable	500
	Sales Revenue		500
	(To record the goods sold to R cosmetics on account)
	Cost of goods sold	400
	Inventory		400
	(To record cost of goods sold incurred)
August 6	Sales revenue	100
	Accounts receivable (5)		100
	(To record the goods returned from R cosmetics)
	Inventory	80
	Cost of goods sold		80
	(To record the cost of inventory returned)
August 10	Deferred revenue (6)	120
	Service revenue		120
	(To record the service revenue recognized during the year)
August 20	Cash	300
	Sales Revenue		300
	(To record the goods sold to person M in cash)
	Cost of goods sold	96
	Inventory		96
	(To record cost of goods sold incurred)
August 22	Cash (7)	400
	Accounts receivable		400
	(To record the cash received from R cosmetics)

Table (1)

Justification:

For August 2:

• Cash is an asset and it increases the value of assets. Therefore, debit cash by $450
• Sales revenue is component of stockholders’ equity and it increases the value of stockholder’s equity. Therefore, credit sales revenue by $90.
• Deferred revenue is a liability and it increases the value of liability. Therefore, credit deferred revenue by $390.
• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Hence, debit cost of goods sold by $80.
• Inventory is an asset and it decreases the value of assets. Hence, credit inventory by $80.

For August 3:

• Accounts receivable is an asset and it increases the value of asset. Hence, debit the accounts receivable by $500.
• Sales revenue is a component of stock holders’ equity and it increases the value of stockholder’s equity. Hence, credit the sales revenue by $500.
• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Hence, debit cost of goods sold by $400.
• Inventory is an asset and it decreases the value of assets. Hence, credit inventory by $400.

For August 6:

• Sales revenue is a component of stock holders’ equity and it decreases the value of stockholder’s equity. Hence, debit the sales revenue by $100.
• Accounts receivable is an asset and it decreases the value of asset. Hence, credit the accounts receivable by $100.
• Inventory is an asset and it increases the value of assets. Hence, debit inventory by $80.
• Cost of goods sold is a component of stockholders’ equity and it increases the value of stockholder’s equity. Hence, credit cost of goods sold by $80.

For August 10:

• Deferred revenue is a liability and it increases the value of liability. Therefore, credit deferred revenue by $120.
• Service revenue is component of stockholders’ equity and it increases the value of stockholder’s equity. Therefore, credit service revenue by $120.

For August 20:

• Cash is an asset and it increases the value of asset. Hence, debit the accounts receivable by $300.
• Sales revenue is a component of stock holders’ equity and it increases the value of stockholder’s equity. Hence, credit the sales revenue by $300.
• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Hence, debit cost of goods sold by $96.
• Inventory is an asset and it decreases the value of assets. Hence, credit inventory by $96.

For August 22:

• Cash is an asset and it increases the value of asset. Hence, debit the cash account by $400.
• Accounts receivable is an asset and it decreases the value of asset. Hence, credit the accounts receivable by $400.

Working note 1:

Calculate the total amount of selling price:

$\begin{array}{c}\text{Total amount of selling price = }\left(\begin{array}{l}\text{Selling price of basket + }\\ \text{Selling price of services}\end{array}\right)\\ \text{=\$100+\$400}\\ \text{=\$500}\end{array}$

Working note 2:

Calculate the allocation percentage of transaction price.

Allocate the transaction price to the performance obligation
Item	Selling price ($) (A)	Total amount ($) (B) (refer working note 1)	Allocation percentage $\left(\frac{\text{A}}{\text{B}}\times 100\right)$
Basket	$100	$500	20%
Services	$400	$500	80%
Total	$500		100%

Table (2)

Working note (3):

Revenue earned from the basket sale:

$\begin{array}{c}\begin{array}{l}\text{Recognized revenue }\\ \text{from basket sale}\end{array}\}\text{ =}\left(\begin{array}{l}\text{ Bundled price }\times \\ \text{Allocation percentage of basket }\end{array}\right)\\ =\$450\times \frac{20}{100}\text{(refer working note 2)}\\ =\$90\end{array}$

Working note (4):

Revenue earned from the services:

$\begin{array}{c}\begin{array}{l}\text{Recognized revenue }\\ \text{from services}\end{array}\}\text{ =}\left(\begin{array}{l}\text{ Bundled price }\times \\ \text{Allocation percentage of services }\end{array}\right)\\ =\$450\times \frac{80}{100}\text{(refer working note 2)}\\ =\$360\end{array}$

Working note (5):

Calculate the value of sales return.

$\begin{array}{c}\text{Sales return = Value of sales }\times \frac{1}{5}\\ =\$500\times \frac{1}{5}\\ =\$100\end{array}$

Working note (6):

Calculate the value of recognized revenue.

$\begin{array}{c}\text{Recognized revenue = Sales revenue for basket }\times \frac{1}{3}\\ =\$360\times \frac{1}{3}\\ =\$120\end{array}$

Working note (7):

Calculate the value of cash received from R cosmetics.

$\begin{array}{c}\text{Cash received = Sales revenue from bundled item }-\text{Sales return}\\ \text{=\$500}-\$100\\ =\$400\end{array}$

2.

To determine

Calculate the sales revenue, cost of goods sold and gross profit percentage. Explain the meaning of gross profit percentage.

Explanation of Solution

Sales revenue: The amount of price of merchandise sold during a certain period is referred to as sales revenue. Net sales are the sales revenue, net of sales returns, sales allowances, and sales discounts.

Formula to compute net sales:

$\text{Net sales = Sales revenue–Sales returns and allowances–Sales discounts}$

Sales returns and allowances: Sometimes, customers either return goods due to manufacturing defects, or accept to keep the defective goods for a reduction in sale price. That amount of goods returned, or reduced amount in sale price, is referred to as sales returns and allowances. These are recorded as contra-revenue accounts.

Sales discounts: The merchandisers offer a reduction in sales price on initial sales, to accelerate the sale on account payments, by their customers within the sale terms promptly. Such a reduction in sales price is referred to as sales discount. This is recorded as contra-revenue account.

Cost of goods sold: The amount of cost of merchandise sold during a certain period is referred to as cost of goods sold.

Calculate the value of net sales.

Details	Amount ($)
Sales revenue from person V	90
Sales revenue from R Cosmetics	500
Sales revenue from person M	300
Less: Sales return	100
Sales revenue, net	$790

Table (3)

Calculate the cost of goods sold, net.

Details	Amount ($)
Cost of goods sold from person V	$80
Cost of goods sold from R Cosmetics	400
Less: Cost of goods sold returned	(80)
Cost of goods sold from person M	96
Cost of goods sold	$496

Table (4)

Calculate the gross profit percentage, and explain the meaning of gross profit percentage as follows:

$\begin{array}{c}\text{Gross profit percentage }\text{= }\frac{\text{Gross profit}}{\text{Net sales}}\\ \text{=}\frac{\text{Gross profit}}{\text{Net sales}}\\ =\frac{\$294\text{ (8)}}{\$790}\\ =37.2\%\end{array}$

Working note (8):

Calculate the value of gross profit:

Details	Amount ($)
Sales revenue	790
Less: Cost of goods sold	496
Gross profit	$294

Table (5)

Gross profit represents the business profit earned from purchase and sale of merchandise. Gross profit percentage of 37.2% denotes that $0.372 $\left(\$1\times \frac{37.2}{100}\right)$  of gross profit is obtained from the sale of one dollar of merchandise.

The percentage of gross profit generated by every dollar of net sales is referred to as gross profit percentage. The higher the ratio, the more ability to cover operating expenses.