Chapter 6, Problem 8BP

a)

To determine

Briefly describe the operating cycle of a merchandising company. Identify the assets and liabilities directly affected by this cycle.

Explanation of Solution

Operating cycle of a merchandising company: Operating cycle is the sequence of activities which includes the purchase goods, selling goods on account, and cash collection as from customers.

• Purchase of goods will decrease the cash and increases the inventory.
• Sale of merchandise will decrease the inventory and increases the accounts receivable.
• Collection of cash from customers will decrease the accounts receivable and increases the cash balance.

b)

To determine

Prepare journal entries to record these transactions, assuming that Incorporation H uses a perpetual inventory system.

Explanation of Solution

Perpetual inventory system: The method or system of maintaining, recording, and adjusting the inventory perpetually throughout the year, is referred to as perpetual inventory system.

Prepare journal entries to record these transactions:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
January 05	Inventory		69,840
	Accounts payable			69,840
	(To record purchases on account)
January 10	Accounts receivable		50,400
	Sales			50,400
	(To record sales on account)
January 10	Cost of goods sold		18,000
	Inventory			18,000
	(To record cost of goods sold)

Table (1)

Record the purchases on account

• Inventory (asset) is increased. Thus, it is debited.
• Accounts payable (liability) is increased. Thus, it is credited.

Record the sales on account:

• Accounts receivable (asset) is increased. Thus, it is debited.
• Sales (increases the equity) is increased. Thus, it is credited.

Record the cost of goods sold:

• Cost of goods sold (decreases the equity) is increased. Thus, it is debited.
• Inventory (asset) is decreased. Thus, it is credited.

c)

To determine

Explain the information in part b that should be posted to subsidiary ledger accounts.

Explanation of Solution

In the first entry (on January 5) entry, $69,840 is debit to the Inventory account should be distributed among 90 products purchased and posted to the proper product accounts in the inventory subsidiary ledger.  The information posted regarding this entry should include the cost and quantities of each type of merchandise purchased. The credit part of this entry should be posted to the Corporation RC account in Incorporation H's accounts payable subsidiary ledger.

In the first entry on January 10, $50,400 is debit to the Accounts Receivable control account should be posted to the Incorporation Hr account in Incorporation H's accounts receivable ledger.

In the second entry on January 10, $18,000 is credit to the Inventory account. It should be allocated among the 45 products sold and posted to the proper accounts in the inventory ledger.

d)

To determine

Compute the balance in the Inventory account at the close of business on January 10.

Explanation of Solution

Compute the balance in the Inventory account at the close of business on January 10:

Beginning Inventory  January 01	$900,000
Add: merchandise purchased on January 05	69,840
Less: Cost of goods sold on January 10	(18,000)
Ending inventory as on January 10	$951,840

Table (2)

Hence, $951,840 is the balance in the Inventory account at the close of business on January 10.

e)

To determine

Prepare journal entries to record the two transactions, assuming that Incorporation H uses a periodic inventory system.

Explanation of Solution

Periodic inventory system: The method or system of recording the transaction related to inventory occasionally or periodically is referred to as periodic inventory system.

Prepare journal entries to record the two transactions:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
January 05	Purchases		69,840
	Accounts payable			69,840
	(To record purchases on account)
January 10	Accounts receivable		50,400
	Sales			50,400
	(To record sales on account)

Table (3)

Record the purchases on account

• Purchase (increases the inventory) is increased. Thus, it is debited.
• Accounts payable (liability) is increased. Thus, it is credited.

Record the sales on account:

• Accounts receivable (asset) is increased. Thus, it is debited.
• Sales (increases the equity) is increased. Thus, it is credited.

f)

To determine

Compute the cost of goods sold for the first week of January assuming use of the periodic system.

Explanation of Solution

Compute the cost of goods sold for the first week of January assuming use of the periodic system:

Beginning Inventory on January 01	$900,000
Add: merchandise purchased on January 05	69,840
Cost of goods available for sale	$969,840
Less: Ending inventory as on January 10	(951,840)
Cost of goods sold on January 10	$18,000

Table (2)

Hence, $18,000 is the cost of goods sold for the first week of January assuming use of the periodic system.

g)

To determine

Find the type of inventory system that Incorporation H would use most likely. Explain the same.

Explanation of Solution

Incorporation H most probably would use a perpetual inventory system. The reason is that the products in its inventory are having high cost per-unit. Thus, the management wants to know the cost of the individual products included in specific sales transactions. Incorporation H wants to keep track of each of the products in stock.

Moreover, Incorporation H has a computer-based accounting system, a full-time accountant, and a low volume of transactions, this will reduces the possible complications of maintaining a perpetual system.

Hence, Incorporation H would use perpetual inventory system most likely.

h)

To determine

Compute the gross profit margin on the January 10 sales transaction.

Explanation of Solution

Gross Profit margin: Gross profit margin ratio is used to determine the percentage of gross profit that is being generated per dollar of revenue or sales.

$\text{Gross profit margin}\text{=}\frac{\text{Gross profit}}{\text{Net Sales Revenue}}\times 100$

Compute the gross profit margin on the January 10 sales transaction:

Gross profit is $32,400 (1) and sales revenue is $50,400.

$\begin{array}{c}\text{Gross profit margin}\text{=}\frac{\text{Gross profit}}{\text{Net Sales Revenue}}\times 100\\ =\frac{\$32,400}{\$50,400}\times 100\\ =64.3\%\end{array}$

Hence, the gross profit margin on the January 10 sales transaction is 64.3%.

Working note:

Calculate the gross profit:

Gross profit is the amount of revenue earned from goods sold over the costs incurred for the goods sold.

$\text{Gross profit = Net sales – Cost of goods sold}$

Net sales are $50,400 and cost of goods sold is $18,000.

$\begin{array}{c}\text{Gross profit = Net sales – Cost of goods sold}\\ \text{=}\text{\$54,000}-\text{\$18,000}\\ =\$32,400\end{array}$

Therefore, gross profit is $32,400.

(1)