Chapter 6, Problem 6.1CC

(1)

To determine

To prepare: Journal entries for the transactionsin the books of NG Spa

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 entry for the inventory sold on account, on August 2.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
August	2	Accounts Receivable			1,000
			Sales Revenue			1,000
		(To record revenue earned on account for the goods sold)

Table (1)

Description:

• Accounts Receivable is an asset account. Since amount to be received has increased, asset account increased, and an increase in asset is debited.
• Sales Revenue is a revenue account. Since revenues increase equity, equity value is increased. An increase in equity is credited.

Prepare journal entry for the cost of goods sold, on August 2.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	2	Cost of Goods Sold			650
			Inventory			650
		(To record cost of inventory sold)

Table (2)

Description:

• Cost of Goods Sold is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Inventory is an asset account. Since inventory is sold, and the cost of inventory sold is transferred to Cost of Goods Sold account, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the inventory sold on account, on August 3.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
August	3	Accounts Receivable			500
			Sales Revenue			500
		(To record revenue earned on account for the goods sold)

Table (3)

Description:

• Accounts Receivable is an asset account. Since amount to be received has increased, asset account increased, and an increase in asset is debited.
• Sales Revenue is a revenue account. Since revenues increase equity, equity value is increased. An increase in equity is credited.

Prepare journal entry for the cost of goods sold, on August 3.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	3	Cost of Goods Sold			400
			Inventory			400
		(To record cost of inventory sold)

Table (4)

Description:

• Cost of Goods Sold is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Inventory is an asset account. Since inventory is sold, and the cost of inventory sold is transferred to Cost of Goods Sold account, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the goods returned on August 6.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	6	Sales Returns and Allowances			100
			Accounts Receivable			100
		(To record sales returns)

Table (5)

Description:

• Sales Returns and Allowances is a contra-revenue account, and contra-revenue accounts decrease the equity value, and a decrease in equity is debited.
• Accounts Receivable is an asset account. Since inventory is returned, amount to be received has decreased, asset account decreased, and a decrease in asset is credited.

Note: Sales returns value is $100 $\left(\text{\$500÷5 items}\right)$, being 1 item returned out of the 5 items purchased for $500.

Prepare journal entry for the cost of goods returned on August 6.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	6	Inventory			80
			Cost of Goods Sold			80
		(To record cost of goods returned)

Table (6)

Description:

• Inventory is an asset account. Since inventory sold is returned, and the inventory value increased. Hence, asset value is increased, and an increase in asset is debited.
• Cost of Goods Sold is an expense account. Since expenses decreased, equity value is increased, and an increase in equity is credited.

Note: Cost of goods sold value is $80 $\left(\text{\$400÷5 items}\right)$, being 1 item returned out of the 5 items cost for $400.

Prepare journal entry for the cash collected, on August 10.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
August	10	Cash			980
		Sales Discounts			20
			Accounts Receivable			1,000
		(To record cash received for sales on account)

Table (7)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Sales Discounts is a contra-revenue account, and contra-revenue accounts decrease the equity value, and a decrease in equity is debited.
• Accounts Receivable is an asset account. Since amount to be received has decreased, asset account decreased, and a decrease in asset is credited.

Working Notes:

Compute sales discount value.

$\begin{array}{c}\text{Sales discounts = }\left\{\begin{array}{l}\left(\text{Sales revenue–Sales returns and allowances}\right)\text{ ×}\\ \text{ Discount percentage}\end{array}\right\}\\ \text{= }\left(\text{\$1,000–\$0}\right)\text{×2\%}\\ \text{= \$20}\end{array}$

Prepare journal entry for the inventory sold on account, on August 20.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
August	20	Accounts Receivable			300
			Sales Revenue			300
		(To record revenue earned on account for the goods sold)

Table (8)

Description:

• Accounts Receivable is an asset account. Since amount to be received has increased, asset account increased, and an increase in asset is debited.
• Sales Revenue is a revenue account. Since revenues increase equity, equity value is increased. An increase in equity is credited.

Prepare journal entry for the cost of goods sold, on August 20.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	20	Cost of Goods Sold			96
			Inventory			96
		(To record cost of inventory sold)

Table (9)

Description:

• Cost of Goods Sold is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Inventory is an asset account. Since inventory is sold, and the cost of inventory sold is transferred to Cost of Goods Sold account, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the cash collected, on August22.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
August	22	Cash			400
			Accounts Receivable			400
		(To record cash received for sales on account)

Table (10)

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. Since amount to be received has decreased, asset account decreased, and a decrease in asset is credited.

(2)

To determine

The net sales, cost of goods sold, and gross profit percentage for NG Spa

Explanation of Solution

Sales revenue: The amount of price of merchandise sold during a certain period is referred to as sales revenue. Net sales is 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.

Determine the net sales for NG Spa.

Details	Amount ($)
Sales revenue from S World	$1,000
Sales revenue from R Cosmetics	500
Sales revenue from MW	300
Total sales revenue	1,800
Less: Sales returns and allowances	(100)
Less: Sales discounts	(20)
Net sales	$1,680

Table (11)

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

Determine the cost of goods sold for NG Spa.

Details	Amount ($)
Cost of goods sold from S World	$650
Cost of goods sold from R Cosmetics	400
Cost of goods sold from sales returns	(80)
Cost of goods sold from MW	96
Cost of goods sold	$1,066

Table (12)

Gross profit percentage: 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.

Formula to compute gross profit percentage:

$\begin{array}{c}\text{Gross profit percentage }\text{= }\frac{\text{Gross profit}}{\text{Net sales}}\\ \text{=}\frac{\text{Net sales – Cost of goods sold}}{\text{Net sales}}\end{array}$

Determine gross profit percentage, if net sales is $1,680, and cost of goods sold is $1,066.

$\begin{array}{c}\text{Gross profit percentage }\text{= }\frac{\text{Gross profit}}{\text{Net sales}}\\ \text{=}\frac{\text{Net sales – Cost of goods sold}}{\text{Net sales}}\\ =\frac{\$1,680–\$1,066}{\$1,680}\\ =36.5\%\end{array}$

Gross profit represents the business profit earned from purchase and sale of merchandise. Gross profit percentage of 36.5% denotes that $0.365 of gross profit is obtained from the sale of one dollar of merchandise.