Chapter 6, Problem 5PB

a.

To determine

Prepare the journal entry to record the transactions for Company HP using gross invoice method.

Explanation of Solution

Gross invoice method: In gross invoice method, the companies will record the purchase of the inventory at total invoice price. 

Prepare the journal entry to record the sale of merchandise on account:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 12	Accounts receivable (Company S)	18,000
	Sales		18,000
	(To record the sale made to Company S on account)

Table (1)

• Accounts receivable is an asset account and it is increased. Therefore, debit accounts receivable with $18,000.
• Sale is a revenue account and it increases the stockholders’ equity account. Therefore, credit sales account with $18,000.

Prepare the journal entry to record the cost of goods sold:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 12	Cost of goods sold $\left(300\text{Pairs}\times \text{\$20 per pairs}\right)$	6,000
	Inventory		6,000
	(To record the cost of goods sold)

Table (2)

• Cost of goods sold is an expense account and it decreases the stockholders’ equity. Therefore, debit cost of goods sold with $6,000.
• Inventory is an asset account and it is decreased. Therefore, credit inventory with $6,000.

Prepare the journal entry to record the delivery expenses:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 15	Delivery expense	25
	Cash		25
	(To record the cost of goods sold)

Table (3)

• Delivery expense is an expense account and it decreases the stockholders’ equity. Therefore, debit delivery expense with $25.
• Cash is an asset account and it is decreased. Therefore, credit cash with $25.

Prepare the journal entry to record the sales return from Company S:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 16	Sales returns and allowances $\left(\$60\text{Per unit}\times 4\text{Unit}\right)$	240
	Accounts receivable		240
	(To record the sales returns and allowances from Company S)

Table (3)

• Sales returns and allowance are the contra-revenue account which decreases the amount of revenue. Therefore, debit sales discounts with $240.
• Accounts receivable is an asset account and it is decreased. Therefore, credit accounts receivable account with $240.

Prepare the journal entry to record the cost of goods sold for the returned goods:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 16	Inventory $\left(\$20\text{Per pair}\times \text{4pairs}\right)$	80
	Cost of goods sold		80
	(To record the reduction in the cost of goods sold for the returned goods)

Table (4)

• Inventory is an asset account and it is increased. Therefore, debit inventory account with $80.
• Cost of goods sold is an expense account and it is decreased. Therefore, credit cost of goods sold with $80.

Prepare the journal entry to record the collection of accounts receivable within the discount period:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 22	Cash	17,582.40
	Sales discount $\left(\$17,760\times 1\%\right)$	177.60
	Accounts receivable (Company S)		17,760
	(To record the collection of accounts receivable from Company SM)

Table (4)

• Cash is an asset account and it is increased. Therefore, debit inventory account with $17,582.40.
• Sales discount is an expense account and it decreases the stockholder’s equity. Therefore, debit sales discount with $177.60.
• Accounts receivable is an asset account and it is decreased. Therefore, credit accounts receivables with $17,760.

b.

To determine

Prepare the journal entries to record the transactions for Company S using net cost method.

Explanation of Solution

Net cost method: In net cost method, the companies will record the purchase of inventory at net cost which is calculated by deducting the available discount from the invoice price.

Prepare the journal entry to record the purchase of inventory on account:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 12	Inventory	17,820
	Accounts payable (Company HP)		17,820
	(To record the purchase made from Company HP)

Table (4)

Working note:

Calculate the amount of accounts payable:

$\begin{array}{c}\text{Net cost per unit=Purchase price}-\left(\text{Purchase price}\times \text{Discount rate}\right)\\ =\$60-\left(\$60\times 1\%\right)\\ =\$59.40\end{array}$

$\begin{array}{c}\text{Accounts payable to Company HP=Number of pair pants }\times \text{Net cost per unit}\\ \text{=300}\times \text{\$59}\text{.4}\\ \text{=\$17,820}\end{array}$

• Inventory is an asset account and it is increased. Therefore, debit inventory account with $17,820.
• Accounts payable is a liability account and it is increased. Therefore, credit accounts payable with $17,820.

Prepare the journal entry to record the transportation charge in in bound:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 15	Transportation in	25
	Cash		25
	(To record the transportation charge in bound)

Table (5)

• Transportation charge is an expense account and it decreases the stockholders’ equity. Therefore, debit transportation charge with $25.
• Cash is an asset and it is decreased. Therefore, credit cash account with $25.

Prepare the journal entry to record the return of goods:

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 16	Accounts payable (Company HP)	237.60
	Inventory $\left(\$59.40\text{Per unit}\times \text{4Pairs}\right)$		237.60
	(To record the returned goods)

Table (5)

• Accounts payable is a liability account and it is decreased. Therefore, debit accounts payable with $237.60.
• Inventory is an asset account and it is decreased. Therefore, credit inventory account with $237.60.

Prepare the journal entry to record the payment made within the discount period.

Date	Accounts title and explanation	Debit ($)	Credit ($)
October 22	Accounts payable (Company HP)	17,582.40
	Cash $\left(\$17,820-\$237.60\right)$		17,582.40
	(To record the payment made with in discount period)

Table (5)

• Accounts payable is a liability account and it is decreased. Therefore, debit accounts payable with $17,582.40.
• Cash is an asset account and it is decreased. Therefore, credit cash account with $17,582.40.

c.

To determine

Explain whether Company S should take the advantage of cash discount even if it borrow money at the annual rate of 12 percent.

Answer to Problem 5PB

Yes, Company SM must take the advantage of 1/1,n/30 purchase discount.

Explanation of Solution

Company S is borrowing money from the bank at the rate of 12%. If the Company S takes the advantage of cash discount, then the company can save 1% by making the payment within the 20days. The bank is charging 11% per year for the loan borrowed by Company S. hence, the bank charges nearly 0.66% $\left(12\%\times \frac{20\text{Days}}{365\text{Days}}\right)$ for the 20days period. Since, the cost of passing up the cash discount is larger than the cost of short-term borrowing; Company S should take the advantage of cash discount.