Chapter 7, Problem 4P

1 (a)

To determine

Prepare the journal entries to record the purchase and payment using gross price method.

Explanation of Solution

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

Gross price method: Under gross price method, sales and purchases of inventory are recorded at the full invoice price (gross amount) without the deduction of discounts.

Journalize the transactions of Company EC:

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
April 11	Purchases		$30,000
	Accounts payable			$30,000
	(To record the purchase of inventory of $30,000 on account, credit terms of $2/10,\text{n}/30$ )
April 21	Accounts payable		$30,000
	Purchases discounts (1)			$600
	Cash (2)			$29,400
	(To record the payment for  inventory  within the discount period)

Table (1)

April 11: To record the purchase of inventory of $30,000 on account, credit terms of$2/10,\text{n}/30$:

Purchases account is an expense and it is decreased the equity value by $30,000. Therefore, debit purchase account with $30,000.

Accounts payable is a liability and it is increased by $30,000. Therefore, credit accounts payable account with $30,000.

April 21: To record the payment for inventory within the discount period:

Accounts Payable is a liability and it is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $30,000.

Purchases discount is a contra expense account to Purchase account and will have a normal credit balance. Therefore, Purchase discount account is credited with $600.

Cash is an asset and it is decreased because cash is paid for credit purchases. Therefore, credit Cash account with $29,400.

Working Note 1: Compute the discount on purchases.

Credit terms: The credit terms are $2/15,\text{n}/60$. Company N makes payment for the inventory purchased within the discount period. Hence, the Company N is entitled to discount of 2%.

$\begin{array}{c}\text{Discount on purchases}=\text{Purchases}\times \text{Discount rate}\\ =\$30,000\times \frac{2}{100}\\ =\$30,000\times \frac{2}{100}\\ =\$600\end{array}$

Working Note 2: Compute the cash paid to accounts payable (suppliers).

$\begin{array}{c}\text{Cash paid to accounts payable}=\text{Purchases}-\text{Discount onpurchases}\\ =\$30,000-\$600\left(1\right)\\ =\$29,400\end{array}$

1 (b)

To determine

Prepare the journal entries to record the purchase and payment using net price method.

Explanation of Solution

Net price method: Under net price method, sales and purchases of inventory are recorded at the net invoice price which means the discounts are deducted from the gross invoice price.

Journalize the transactions of Company EC:

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
April 11	Purchases  (3)		$29,400
	Accounts payable			$29,400
	(To record the purchase of inventory of $30,000 on account, credit terms of $2/10,\text{n}/30$ )
April 21	Accounts payable		$29,400
	Cash			$29,400
	(To record the payment for Inventory within the discount period)

Table (2)

April 11: To record the purchase of inventory of $30,000 on account, credit terms of$2/10,\text{n}/30$:

Purchases account is an expense and it is decreased the equity value by $29,400. Therefore, debit purchase account with $29,400.

Accounts payable is a liability and it is increased by $29,400. Therefore, credit accounts payable account with $29,400.

April 21: To record the payment for inventory within the discount period:

Accounts Payable is a liability and is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $29,400.

Cash is an asset and it is reduced because amount is paid for credit purchases. Therefore, credit Cash account with $29,400.

Working Note 3: Compute the net price of purchases.

Credit terms: The terms are $2/15,\text{n}/60$. Company EC makes payment for the Inventory purchased within the discount period. Hence, the merchandising company is entitled to discount of 2%.

$\begin{array}{c}\text{Net invoice price}=\text{Gross Invoice price}-\left(\text{Invoice price}\times \text{Discount rate}\right)\\ =\$30,000-\left(\$30,000\times \frac{2}{100}\right)\\ =\$30,000-\$600\\ =\$29,400\end{array}$

2.

To determine

Compute the income that would be recognized by Company EC if it sells half of the inventory for $20,000 during April.

Explanation of Solution

Income: This is the amount earned from operations of a business. The operating activities are sale of goods and services, and rent revenue.

Compute income.

Computation of income
Particulars	Under gross price method	Under net price method
Sales	$20,000	$20,000
Less: Cost of goods sold $\left(\$30,000-\$600\right)\times 50\%$	($14,700)	($14,700)
Income	$5,300	$5,300

Table (3)

Thus, the income of $5,300 would be recognized by Company EC during the month of April.

3.

To determine

Journalize the purchase and payment transaction under each method if the Company makes payment on April 30.

Explanation of Solution

Gross price method: Under gross price method, sales and purchases of inventory are recorded at the full invoice price (gross amount) without the deduction of discounts.

Journalize the transactions of Company N:

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
April 11	Purchase		$30,000
	Accounts payable			$30,000
	(To record the purchase of inventory of $30,000 on account, credit terms of $2/10,\text{n}/30$ )
April 30	Accounts payable		$30,000
	Cash			$30,000
	(To record the payment for  inventory  after the discount period)

Table (4)

April 11: To record the purchase of inventory of $30,000 on account, credit terms of$2/10,\text{n}/30$:

Purchases account is an expense and it is decreased the equity value by $30,000. Therefore, debit purchase account with $30,000.

Accounts payable is a liability and it is increased by $30,000. Therefore, credit accounts payable account with $30,000.

April 30: To record the payment for inventory after the discount period:

Accounts Payable is a liability and is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $30,000.

Cash is an asset and it is reduced because cash is paid for credit purchases. Therefore, credit Cash account with $30,000.

Net price method: Under net price method, sales and purchases of inventory are recorded at the net invoice price which means the discounts are deducted from the gross invoice price.

Journalize the transactions of Company N:

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
April 11	Inventory  (3)		$29,400
	Accounts payable			$29,400
	(To record the purchase of inventory of $30,000 on account, credit terms of$2/10,\text{n}/30$)
April 30	Accounts payable		$29,400
	Purchase discount lost		$600
	Cash			$30,000
	(To record the payment for Inventory after the discount period)

Table (5)

April 11: To record the purchase of inventory of $30,000 on account, credit terms of$2/10,\text{n}/30$:

Purchases account is an expense and it is decreased the equity value by $29,400. Therefore, debit purchase account with $29,400.

Accounts payable is a liability and it is increased by $29,400. Therefore, credit accounts payable account with $29,400.

April 30: To record the payment for Inventory after the discount period:

Accounts Payable is a liability and is decreased because the cash has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $29,400.

Purchases discount lost is a component of retained earnings and it decreases the retained earnings.  Therefore, Purchase discount lost account is debited with $600.

Cash is an asset and it is reduced because amount is paid for credit purchases. Therefore, credit Cash account with $30,000.

4.

To determine

Compute the net income that would be recognized by Company EC if it sells half of the inventory for $20,000 during April.

Explanation of Solution

Compute income.

Computation of income
Particulars	Under gross price method (Value of inventory is $30,000)	Under net price method (Value of inventory is $29,400)
Sales	$20,000	$20,000
Less: Cost of goods sold $\left(\text{Value of inventory}\right)\times 50\%$	($15,000)	($14,700)
Less: Purchase discounts		($600)
Income	$5,000	$4,700

Table (6)

Thus, under gross price method income of $5,000 and in net price method, income of $4,700 would be recognized by Company EC during the month of April.

5.

To determine

Explain the differences in income computed in requirement 4 under two methods.

Explanation of Solution

The major reason for the difference is due to the treatment of discount under two methods. In net price method, the discount loss is treated as an expense and in gross method the discount is included in inventory and is not expensed till the inventories are sold.