Chapter 8, Problem 3COP

Recording Daily and Adjusting Entries Using FIFO in a Perpetual Inventory System (Chapters 3, 4, 6, 7, and 8)

One Trick Pony (OTP) incorporated and began operations near the end of the year, resulting in the following post-closing balances at December 31:

The following information is relevant to the first month of operations in the following year:

• • OTP will sell inventory at $145 per unit. OTP’s January 1 inventory balance consists of 35 units at a total cost of $2,800. OTP’s policy is to use the FIFO method, recorded using a perpetual inventory system.
• • In December, OTP received a $4,350 payment for 30 units OTP is to deliver in January; this obligation was recorded in Deferred Revenue. Rent of $1,300 was unpaid and recorded in Accounts Payable at December 31.
• • OTP’s note payable matures in three years, and accrues interest at a 10% annual rate.

January Transactions

1. a. Included in OTP’s January 1 Accounts Receivable balance is a $1,500 balance due from Jeff Letrotski. Jeff is having cash flow problems and cannot pay the $1,500 balance at this time. On 01/01, OTP arranges with Jeff to convert the $1,500 balance to a six-month note, at 12% annual interest. Jeff signs the promissory note, which indicates the principal and all interest will be due and payable to OTP on July 1 of this year.
2. b. OTP paid a $500 insurance premium on 01/02, covering the month of January; the payment is recorded directly as an expense.
3. c. OTP purchased an additional 150 units of inventory from a supplier on account on 01/05 at a total cost of $9,000, with terms n/30.
4. d. OTP paid a courier $300 cash on 01/05 for same-day delivery of the 150 units of inventory.
5. e. The 30 units that OTP’s customer paid for in advance in December are delivered to the customer on 01/06.
6. f. On 01/07, OTP received a purchase allowance of $1,350 on account, and then paid the amount necessary to settle the balance owed to the supplier for the 1/05 purchase of inventory (in c).
7. g. Sales of 40 units of inventory occurring during the period of 01/07–01/10 are recorded on 01/10. The sales terms are n/30.
8. h. Collected payments on 01/14 from sales to customers recorded on 01/10.
9. i. OTP paid the first 2 weeks’ wages to the employees on 01/16. The total paid is $2,200.
10. j. Wrote off a $1,000 customer’s account balance on 01/18. OTP uses the allowance method, not the direct write-off method.
11. k. Paid $2,600 on 01/19 for December and January rent. See the earlier bullets regarding the December portion. The January portion will expire soon, so it is charged directly to expense.
12. l. OTP recovered $400 cash on 01/26 from the customer whose account had previously been written off on 01/18.
13. m. An unrecorded $400 utility bill for January arrived on 01/27. It is due on 02/15 and will be paid then.
14. n. Sales of 65 units of inventory during the period of 01/10–01/28, with terms n/30, are recorded on 01/28.
15. o. Of the sales recorded on 01/28, 15 units are returned to OTP on 01/30. The inventory is not damaged and can be resold. OTP charges sales returns directly against Sales Revenue.
16. p. On 01/31, OTP records the $2,200 employee salary that is owed but will be paid February 1.
17. q. OTP uses the aging method to estimate and adjust for uncollectible accounts on 01/31. All of OTP’s accounts receivable fall into a single aging category, for which 8% is estimated to be uncollectible. (Update the balances of both relevant accounts prior to determining the appropriate adjustment, and round your calculation to the nearest dollar.)
18. r. Accrue interest for January on the note payable on 01/31.
19. s. Accrue interest for January on Jeff Letrotski’s note on 0 1/3 1 (see a).

Required:

1. 1. Prepare all January journal entries and adjusting entries for items (a)–(s).
2. 2. If you are completing this problem manually, set up T-accounts using the December 31 balances as the beginning balances, post the journal entries from requirement 1, and prepare an adjusted trial balance at January 31. If you are completing this problem in Connect using the general ledger tool, this requirement will be completed automatically using your previous answers.
3. 3. Prepare an income statement, statement of retained earnings, and classified balance sheet at the end of January.
4. 4. For the month ended January 31, indicate the (i) gross profit percentage (rounded to one decimal place), (ii) number of units in ending inventory, and (iii) cost per unit of ending inventory (include dollars and cents).
5. 5. If OTP had used the percentage of sales method (using 2% of Net Sales) rather than the aging method, what amounts would OTC’s January financial statements have reported for (i) Bad Debt Expense and (ii) Accounts Receivable, net?
6. 6. If OTP had used LIFO rather than FIFO, what amount would OTC have reported for Cost of Goods Sold on 01/10?

To determine

Prepare the journal entries and adjusting entries for items (a) to (s).

Explanation of Solution

Accounts receivable: Accounts receivable refers to the amounts to be received within a short period from customers upon the sale of goods and services on account. In other words, accounts receivable are amounts customers owe to the business. Accounts receivable is an asset of a business.

Prepare the journal entries and adjusting entries for items (a) to (s).

	Date	Account Title and Explanation	Debit	Credit
a.	January 1	Note receivable	$1,500
		Account receivable		$1,500
		(To record the acceptance of note)
b.	January 2	Insurance expense	$500
		Cash		$500
		(To record the insurance expense )
c.	January 5	Inventory	$9,000
		Accounts payable		$9,000
		(To record the purchase of inventory on account)
d.	January 5	Inventory	$300
		Cash		$300
		(To record the purchase of inventory for cash)
e.	January 6	Deferred revenue $\left(\$145\text{ per unit}\times \text{30 units}\right)$	$4,350
		Sales revenue		$4,350
		(To record the earned deferred revenue)
	January 6	Cost of goods sold $\left(\frac{\$2,800}{\text{35 units}}\times 30\text{ units delivered}\right)$	$2,400
		Sales revenue		$2,400
		(To record the cost of goods sold)
f.	January 7	Accounts payable	$9,000
		Cash $\left(\$9,000-\$1,350\right)$		$7,650
		Inventory		$1350
		(To record the settlement of payables)
g.	January 10	Accounts receivable	$5,800
		Sales revenue $\left(\$145\text{ per unit}\times \text{40 units}\right)$		$5,800
		(To record the sales provided on account)
	January 10	Cost of goods sold $\left\{\begin{array}{l}\left(\$80\times 5\text{ units}\right)+\\ \left(\frac{\left(\$9,000+\$300-\$1,350\right)}{\text{150 units}}\times 35\text{ units}\right)\end{array}\right\}$	$2,255
		Sales revenue		$2,255
		(To record the cost of goods sold)
h.	January 14	Cash	$5,800
		Accounts receivable $\left(\$9,000\times 2\%\right)$		$5,800
		(To record the collection of cash on account)
i.	January 16	Salaries and Wages expense	$2,200
		Cash		$2,200
		(To record the salaries and wages expense)
j.	January 18	Allowance for doubtful accounts	$1,000
		Accounts receivable		$1,000
		(To record the write off)
k.	January 19	Accounts payable	$1,300
		Rent expense	$1,300
		Cash		$2,600
		(To record the payment of rent expense and accounts payable)
l.	January 26	Accounts receivable	$400
		Allowance for doubtful accounts		$400
		(To reverse the written off bad debt)
	January 26	Cash	$400
		Accounts receivable		$400
		(To record the collection of cash on account)
m.	January 27	Utilities expense	$400
		Accounts payable		$400
		(To record the accrued utilities expense)
n.	January 28	Accounts receivable	$9,425
		Sales revenue $\left(\$145\text{ per unit}\times 65\text{ units}\right)$		$9,425
		(To record the sales provided on account)
	January 28	Cost of goods sold $\left\{\frac{\left(\$9,000+\$300-\$1,350\right)}{\text{150 units}}\times 65\text{ units}\right\}$	$3,445
		Sales revenue		$3,445
		(To record the cost of goods sold)
o.	January 30	Sales returns and allowances	$2,175
		Accounts receivable $\left(\$145\text{ per unit}\times 15\text{ units}\right)$		$2,175
		(To record the sales returns)
	January 30	Inventory	$795
		Cost of goods sold $\left(\frac{\$3,445}{\text{65units}}\times 15\text{units}\right)$		$795
		(To record the cost of goods sold)
p.	January 31	Salaries and Wages expense	$2,200
		Salaries and Wages payable		$2,200
		(To record the salaries and wages expense)
q.	January 31	Bad debt expense (1)	$852
		Allowance for doubtful accounts		$852
		(To record the bad debt expense)
r.	January 31	Interest expense $\left(\$15,000\times 0.10\times \frac{1}{12}\right)$	$125
		Interest payable		$125
		(To record the interest expense)
s.	January 31	Interest receivable $\left(\$1,500\times 0.12\times \frac{1}{12}\right)$	$15
		Interest revenue		$15
		(To record the interest revenue)

Table (1)

Working note (1):

Step 1: Prepare T-account for accounts receivable.

Step 2: Determine the desired ending balance for allowance for doubtful accounts.

$\begin{array}{c}\begin{array}{l}\text{Desired ending balance for}\\ \text{allowance for doubtful accounts}\end{array}\}=\left[\begin{array}{l}\text{Ending balance of accounts receivable}\times \\ \text{8\% of receivable}\end{array}\right]\\ =\$14,400\times \frac{8}{100}\\ =\$1,152\end{array}$

Step 3: Now, determine the bad debt expense to be reported on January 31 using T-account for allowance for doubtful accounts.

To determine

Set up T-account and post the journal entries, and prepare adjusted trial balance.

Explanation of Solution

Adjusted trial balance: Adjusted trial balance is that statement which contains complete list of accounts with their adjusted balances, after all relevant adjustments have been made. This statement is prepared at the end of every financial period.

Set up T-account and post the journal entries as follows:

Prepare adjusted trial balance for Company OTP as follows:

Company OTP
Adjusted trial balance
January 31
Account Titles	Debit	Credit
Cash	$11,570
Accounts Receivable	14,400
Allowance for Doubtful Accounts		$1,152
Inventory	3,445
Note Receivable	1,500
Interest Receivable	15
Deferred Revenue		0
Accounts Payable		400
Salaries and Wages Payable		2,200
Interest Payable		125
Note Payable		15,000
Common Stock		5,000
Retained Earnings		4,520
Sales Revenue		17,400
Cost of Goods Sold	7,305
Salaries and Wages Expense	4,400
Rent Expense	1,300
Bad Debt Expense	852
Insurance Expense	500
Utilities Expense	400
Interest Expense	125
Interest Revenue		15
Totals	$45,812	$45,812

Table (2)

To determine

Prepare an income statement, retained earnings statement and classified balance sheet for the month ended January 31.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare an income statement for Company OTP as follows:

Company OTP
Income Statement
For the Month Ended January 31
Particulars	Amount
Sales Revenue	$17,400
Less: Cost of Goods Sold	7,305
Gross Profit	10,095
Less: Salaries and Wages Expense	4,400
Rent Expense	1,300
Bad Debt Expense	852
Insurance Expense	500
Utilities Expense	400
Income from Operations	2,643
Less: Interest Revenue (Expense), net	110
Net Income	$2,533

Table (3)

Statement of Retained Earnings: Statement of retained earnings shows, the changes in the retained earnings, and the income left in the company after payment of the dividends, for the accounting period.

Prepare the statement of retained earnings for Company OTP as follows:

Company OTP
Statement of Retained Earnings
For the Month Ended January 31
Particulars	Amount
Balance, January 1	$ 4,520
Add: Net Income	2,533
Less: Dividends	0
Balance, December 31	$ 7,053

Table (4)

Classified balance sheet: The main elements of balance sheet assets, liabilities, and stockholders’ equity are categorized or classified further into sections, and sub-sections in a classified balance sheet. Assets are further classified as current assets, long-term investments, property, plant, and equipment (PPE), and intangible assets. Liabilities are classified into two sections current and long-term. Stockholders’ equity comprises of common stock and retained earnings. Thus, the classified balance sheet includes all the elements under different sections.

Prepare classified balance sheet for Company OTP as follows:

Company OTP
Balance Sheet
At December 31
Assets	Amount
Current Assets:
Cash	$11,570
Accounts Receivable	14,400
Less: Allowance for Doubtful Accounts	-1,152
Inventory	3,445
Note Receivable	1,500
Interest Receivable	15
Total Assets	$29,778
Liabilities and Stockholders’ Equity	Amount
Liabilities
Current Liabilities:
Accounts Payable	$400
Salaries and Wages Payable	2,200
Interest Payable	125
Total Current Liabilities	2,725
Note Payable	15,000
Total Liabilities (a)	17,725
Stockholders’ Equity
Common Stock	5,000
Retained Earnings	7,053
Total Stockholders’ Equity (b)	12,053
Total Liabilities and Stockholders’ Equity $\left(\text{a}+\text{b}\right)$	$29,778

Table (5)

To determine

Calculate the following:

1. i. The gross profit percentage.
2. ii. The number of units in ending inventory.
3. iii. Cost per unit of ending inventory.

Explanation of Solution

Gross margin percentage: The percentage of gross profit generated by every dollar of net sales is referred to as gross profit percentage. This ratio measures the profitability of a company by quantifying the amount of income earned from sales revenue generated after cost of goods sold are paid. The higher the ratio, the more ability to cover operating expenses.

1. i. Calculate the gross profit percentage as follows:

$\begin{array}{c}\text{Gross profit percentage = }\frac{\text{Gross profit}}{\text{Net sales}}\times 100\\ =\frac{\$10,095}{\$17,400}\times 100\\ =0.580\times 100\\ =58.01\%\end{array}$

Thus, the gross profit percentage is 58.01%.

1. ii. Calculate the number of units in ending inventory as follows:

Particulars	Number of units
Inventory as of January 1	35
Add: Inventory purchased on January 5	150
Less: Inventory sold on January 6	-30
Less: Inventory sold on January 10	-40
Less: Inventory sold on January 28	-65
Add: Inventory returned on January 30	15
Number of units on hand as of January 31	65

Table (6)

Thus, the number of units in ending inventory as of January 31 is 65 units.

1. iii. Calculate the cost per unit of ending inventory as follows:

$\begin{array}{c}\text{Cost per unit of ending inventory = }\frac{\text{Inventory as of January 31}}{\text{Number of units in ending inventory}}\\ =\frac{\$3,445}{65\text{ units}}\\ \text{=}\text{\$53}\text{per}\text{unit}\end{array}$

Hence, the cost per unit of ending inventory is $53 per unit.

To determine

Calculate the net amount that would be reported by Company OTC for (i) bad debt expense, and (ii) accounts receivable, if it uses percentage of sale method.

Explanation of Solution

Bad debt expense: Bad debt expense is an expense account. The amounts of loss incurred from extending credit to the customers are recorded as bad debt expense. In other words, the estimated uncollectible accounts receivable are known as bad debt expense.

1. i. Calculate the amount of bad debt expense.

$\begin{array}{c}\text{Bad debt expense = Net sales}\times \text{2\% of sales}\\ \text{=\$17,400}\times \text{2\%}\\ =\$348\end{array}$

Therefore, Company OTP would have reported $348 as bad debt expense if it uses percentage of sales method.

1. ii. Calculate the amount of accounts receivable, net.

Step 1: Prepare T-account for allowance for doubtful accounts according calculated bad debts based on percentage of credit sales method.

Allowance for doubtful accounts
		Beginning balance	900
(j)	1,000	(l)	400
		Bad debt expense	348
		Balance	648

Step 2: Calculate the accounts receivable, net.

$\begin{array}{c}\text{Accounts receivable, net =}\left[\begin{array}{l}\text{Accounts receivable}-\\ \text{Allowance for doubtful accounts}\end{array}\right]\\ =\$14,400-\$648\\ =\$13,752\end{array}$

Therefore, Company OTP would have reported $13,752 as accounts receivable, net, if it uses percentage of sales method.

To determine

Calculate the amount of cost of goods sold that would be reported by Company OTC on January 10, if it uses LIFO instead of FIFO.

Explanation of Solution

First-in-First-Out (FIFO): In this method, items purchased initially are sold first. So, the value of the ending inventory consists the recent cost for the remaining unsold items.

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consists the initial cost for the remaining unsold items.

If Company OTP uses LIFO (Last-In First Out) instead of FIFO (First-In First Out), then it would have used the cost of goods that was acquired in recent times to calculate the cost of goods sold.

For January 10, the most recently purchased goods is $9,000 of 150 units on January 5, however the cost of goods sold is changed later due to the cost of freight and purchase discount, which  is calculated as follows:

Cost of goods sold
Particulars	$
Purchase value of goods	$9,000
Add: Freight-in	$300
Less: Purchase discount	–$1,350
Cost of goods sold	$7,950

Table (7)

These 150 units cost is $7,950, and whose cost per unit is $\left(\frac{\$7,950}{150\text{ units}}\right)$ $53.

Thus, at a LIFO unit cost of $53, the 40 units sold on January 10 would have produced a cost of goods sold of $\left(\$53\times 40\text{ units}\right)$$2,120.

Conclusion

Thus, at a LIFO unit cost of $53, the 40 units sold on January 10 would have produced a cost of goods sold of $2,120.