Exercises: Unit 6



➢  Sales discounts and sales returns and allowances are deducted from sales on the income statement to arrive at net sales. Why not deduct these directly from the Sales account by debiting Sales each time a sales discount, return, or allowance occurs?

➢  What useful purpose does the Purchases account serve?

➢  What type of an expense is delivery expense? Where is this expense reported in the income statement?

➢  How does the accountant arrive at the total dollar amount of the inventory after taking a physical inventory?

➢  How is cost of goods sold determined under periodic inventory procedure?

➢  If the cost of goods available for sale and the cost of the ending inventory are known, what other amount appearing on the income statement can be calculated?

➢  What are the major sections in a multi-step income statement for a merchandising company, and in what order do these sections appear?

➢  What is gross margin? Why might management be interested in the percentage of gross margin to net sales?

➢  How are adjusting entries different under perpetual and periodic inventory methods?

➢  After closing entries are posted to the ledger, which types of accounts have balances? Why?


Exercise 1 (periodic) Cramer Company uses periodic inventory procedure. Determine the cost of goods sold for the company assuming purchases during the period were $ 40,000, transportation-in was $ 300, purchase returns and allowances were $ 1,000, beginning inventory was $ 25,000, purchase discounts were $ 2,000, and ending inventory was $ 13,000.

Exercise 2 In each case, use the following information to calculate the missing information:

  Case 1 Case 2 Case 3
Gross sales $ 640,000 $ ? $ ?
Sales discounts ? 25,600 19,200
Sales returns and allowances 19,200 44,800 32,000
Net sales 608,000 1,209,600  ?
Merchandise inventory, January 1 256,000 384,000
Purchases 384,000 768,000  
Purchase discounts 7,680 13,440 12,800
Purchase returns and allowances 24,320 31,360 32,000
Net purchases 352,000 672,000
Transportation-in 25,600 38,400 32,000
Net cost of purchases 377,600 761,600 ?
Cost of goods available for sale ? 1,081,600 1,088,000
Merchandise inventory, December 31 ? 384,000 448,000
Cost of goods sold 320,000 ? 640,000
Gross margin  ? 512,000 320,000

Exercise 3 In each of the following equations supply the missing term(s):

  1. Net sales = Gross sales – (______________________ + Sales returns and allowances).
  2. Cost of goods sold = Beginning inventory + Net cost of purchases – ________ ________.
  3. Gross margin = ________ ________ – Cost of goods sold.
  4. Income from operations = __________ _________ – Operating expenses.
  5. Net income = Income from operations + _________ ________ – ________ ________.

Exercise 4 (periodic) A partial trial balance is presented below.  The ending physical count of inventory is $96. Prepare the 2 adjusting entries required under the periodic inventory method.

 Trial Balance 
  Debit Credit
Merchandise Inventory 120  
Sales   S40
Sales Discounts 18  
Sales Returns and Allowances 45  
Purchases 600  
Purchase Discounts   12
Purchase Returns and Allowances   24
Transportation-In 36  

Exercise 5 (perpetual) Under the perpetual inventory method, prepare the adjusting entry for inventory if ending merchandise inventory is $101,000 and the physical count of inventory is $96,000.


Problem 1  (periodic) The following data are for Leone Lumber Company:

Leone Lumber Company  
Trial Balance  
As of December 31  
Debit Credit
Cash                70,640
Accounts Receivable              159,520
Merchandise Inventory,  January 1              285,200
Supplies on Hand                  5,360
Prepaid Insurance                  4,800
Prepaid Rent                57,600
Equipment                88,000
Accumulated Depreciation—Equipment                  17,600
Accounts Payable                102,800
Capital Stock                200,000
Retained Earnings,  January 1                219,640
Sales            1,122,360
Sales Returns and Allowances                  5,160
Interest Revenue                      1,000
Purchases              500,840
Purchases Returns and Allowances                      4,040
Transportation-In                  7,840
Advertising Expense                78,000
Sales Salaries Expense              138,400
Office Salaries Expense                80,800
Officers’ Salaries Expense              160,000
Utilities Expense                  4,800
Legal and Accounting Expense                10,000
Interest Expense                      600
Miscellaneous Administrative Expense                  9,880
TOTALS          1,667,440            1,667,440
  • A total of $3,400 of the prepaid insurance has expired.
  • An inventory of supplies showed that $1,700 are still on hand.
  • Prepaid rent expired during the year is $ 50,600.
  • Depreciation expense on store equipment is $8,800.
  • Accrued sales salaries are $4,000.
  • Accrued office salaries are $3,000.
  • Merchandise inventory on hand is $350,000.

Prepare the following:

  1. The adjusting entries required under the periodic inventory method.
  2. A multi-step income statement showing the detailed calculation of cost of goods sold. The only selling expenses are sales salaries, advertising, supplies, and depreciation expense—equipment.
  3. A statement of retained earnings.
  4. The required closing entries.

Problem 2 (perpetual) The following data are for Bayer Lamp Company: 

Bayer Lamp Company   
Trial Balance   
   December 31
Account Title Debits Credits
Cash $ 228,800
Accounts Receivable 193,200
Merchandise Inventory 222,000
Prepaid Insurance 11,600
Land 240,000
Building 440,000
Accumulated Depreciation – Building $ 132,000
Store Fixtures 222,400
Accumulated Depreciation – Store Fixtures 44,480
Accounts Payable 151,600
Common Stock 400,000
Retained Earnings, January 1 480,720
Sales 2,206,000
Sales Discounts 14,800
Sales Returns and Allowances 8,000
Interest Revenue 1,600
Cost of Goods Sold 1,209,200
Advertising Expense 48,000
Sales Salaries Expense 256,000
Office Salaries Expense 296,000
Delivery Expense 18,400
Interest Expense 8,000
 Totals $ 3,416,400 $ 3,416,400
  • Depreciation expense on the store building is $8,800.
  • Depreciation expense on the store fixtures is $22,240.
  • Accrued sales salaries are $5,600.
  • Insurance expired for the year is $10,000.
  • Cost of merchandise inventory on hand December 31 is $221,000.

Prepare the following:

  1. The required adjusting journal entries under the perpetual inventory method.
  2. A multi-step income statement. The only administrative expenses are office salaries and insurance. The building depreciation is on the store building.
  3. A statement of retained earnings.
  4. The required closing entries.

Comprehensive problems

Alternate problem 1 (perpetual) Gardner Company engaged in the following transactions in June, the company’s first month of operations:

June 1 Stockholders invested $ 384,000 cash and $ 144,000 of merchandise inventory in the business in exchange for capital stock.

3 Merchandise was purchased on account, $ 192,000; terms 2/10, n/30, FOB shipping point.

4 Paid height on the June 3 purchase, $ 5,280.

7 Merchandise was purchased on account, $ 96,000; terms 2/10, n/30, FOB destination.

10 Sold merchandise on account, $ 230,400; terms 2/10, n/30, FOB shipping point.

11 Returned $ 28,800 of the merchandise purchased on June 3.

12 Paid the amount due on the purchase of June 3.

13 Sold merchandise on account, $ 240,000; terms 2/10, n/30, FOB destination.

14 Paid height on sale of June 13, $ 14,400.

20 Paid the amount due on the purchase of June 7.

21 $ 48,000 of the goods sold on June 13 were returned for credit.

22 Received the amount due on sale of June 13.

25 Received the amount due on sale of June 10.

29 Paid rent for the administration building for June, $ 19,200.

30 Paid sales salaries of $ 57,600 for June.

30 Purchased merchandise on account, $ 48,000; terms 2/10, n/30, FOB destination.

  1. Prepare journal entries for the transactions using the perpetual inventory method.
  2. Post the journal entries to the proper ledger accounts.
  3. Prepare an adjusting entry for inventory (if needed).  The physical inventory on June 30 was $288,000.
  4. Prepare an adjusted trial balance as of June 30.
  5. Prepare a multi-step income statement for the month ended June 30.
  6. Prepare a statement of retained earnings.
  7. Prepare a classified balance sheet.
  8. Prepare the required closing entries.

Alternate problem 2 (periodic) Organized on May 1, Noah Cabinet Company engaged in the following transactions:

May 1 The stockholders invested $ 900,000 in this new business by purchasing capital stock.

1 Purchased merchandise on account from String Company, $ 46,800; terms n/60, FOB shipping point, freight collect.

3 Sold merchandise for cash, $ 28,800.

6 Paid transportation charges on May 1 purchase, $ 1,440 cash.

7 Returned $ 3,600 of merchandise to String Company due to improper size.

10 Requested and received an allowance of $ 1,800 from String Company for improper quality of certain items.

14 Sold merchandise on account to Texas Company, $ 18,000; terms 2/20, n/30, FOB shipping point, freight collect.

16 Issued cash refund for return of merchandise relating to sale made on May 3, $ 180.

18 Purchased merchandise on account from Tan Company invoiced at $ 28,800; terms 2/15, n/30, FOB shipping point, freight collect.

18 Received a bill for freight charges of $ 900 from Ball Trucking Company on the purchase from Tan Company.

19 Texas Company returned $ 360 of merchandise purchased on May 14.

24 Returned $ 2,880 of defective merchandise to Tan Company. Received full credit.

28 Texas Company remitted balance due on sale of May 14.

31 Paid Tan Company for the purchase of May 18 after adjusting for transaction of May 24.

31 Paid miscellaneous selling expenses of $ 7,200.

31 Paid miscellaneous administrative expenses of $ 10,800.

From the data for Noah Cabinet Company:

  1. Journalize the transactions using the periodic inventory method. Round all amounts to the nearest dollar.
  2. Post the entries to the proper ledger accounts.
  3. Prepare an unadjusted trial balance.
  4. Prepare the adjusting entries required under the periodic inventory method.  The May 31st inventory was $57,600.
  5. Prepare a multi-step income statement for the month ended May 31 showing the detailed cost of goods sold calculation.
  6. Prepare a statement of retained earnings.
  7. Prepare a classified balance sheet.
  8. Prepare the closing entries.

Beyond the numbers—Critical thinking

Business decision case A Candy’s Shirts, Inc., has an opportunity to purchase 40,000 shirts with the logo of her favorite school in January 2009. Candy, who is not currently in business, is considering buying these shirts and then renting a display cart from which to sell these shirts (called a kiosk) in a shopping mall. Based on the following information and estimates, Candy needs to decide if the business would be profitable:

  • Cost of the 40,000 shirts, all of which must be purchased in January 2009, is $ 440,000.
  • Candy thinks it would take two years to sell all of the shirts. She estimates her sales at 25,000 shirts in 2009 and 15,000 shirts in 2010.
  • Rent of the kiosk would be $ 1,500 per month in 2009 and $ 1,600 per month in 2010.
  • Candy can buy some counters on which to display the merchandise for $ 4,000. She could sell the counters for $ 500 at the end of the second year.
  • Candy estimates the cost to decorate her kiosk would be $ 2,500.
  • Candy would hire employees and pay them $ 1 per shirt sold.
  • Candy plans to sell the shirts for $ 17 each.
  • Candy and her husband purchased $ 100,000 of capital stock in the business. Therefore, she plans to borrow $ 400,000 from their family banker. Interest expense on this loan will be $ 52,000 in 2009 and $ 6,500 in 2010. Candy plans to repay $ 300,000 on 2010 January 2, and the remaining $ 100,000 on 2010 July 1
  • Candy needs to rent some storage space because all 40,000 shirts cannot be stored at the kiosk. Storage space costs $ 2,500 per year.
  1. Prepare estimated income statements for 2009 and 2010 for Candy’s business. Does it appear that the business will be profitable?
  2. Will Candy have the cash available to pay the bank loan as she planned?

Business decision case B In the Annual report appendix, refer to the consolidated statements of earnings for The Limited’s most recent three years. Calculate the gross margin percentage and write an explanation of what the results mean for each of the three years.

Annual report analysis C Refer to the consolidated statements of income of The Limited in the Annual report appendix. Identify the 2000, 1999, and 1998 net sales; cost of goods sold; gross profit; selling, administrative, and general expenses; and operating income. Do the results present a favorable trend? Comment on the results.

Ethics case – Writing experience D Based on the ethics case related to World Auto Parts Corporation, respond in writing to the following questions:

  1. Do you agree that the total impact of this practice could be as much as $ 10 million?
  2. Are the small suppliers probably better off going along with the practice?
  3. Is this practice ethical?

Group project E In teams of two or three students, go to the library (or find an annual report at www.sec.gov/edgar.shtml) to locate one merchandising company’s annual report for the most recent year. Calculate the company’s gross margin percentage for each of the most recent three years. As a team, write a memorandum to the instructor showing your calculations and commenting on the results. The heading of the memorandum should contain the date, to whom it is written, from whom, and the subject matter.

Group project F In a team of two or three students, contact a variety of businesses in your area and inquire as to the types of sales discount terms they offer to credit customers and the types of purchase discount terms they are offered by their suppliers. Calculate the approximate annual rate of interest implied in several of the more common discount terms. For instance, the book states that the implied annual rate of interest on terms of 2/10, n/30 is 36 per cent, assuming we use a 360-day year. Present your findings in a written report to your instructor.

Group project G In a team of two or three students, obtain access to several annual reports of companies in different industries (see www.sec.gov/edgar.shtml.) Examine their income statements and identify differences in their formats. Discuss these differences within your group and then present your findings in a report to your instructor.

Using the Internet—A view of the real world

Visit the Fat Brains Toys website at:

http://fatbraintoys.com website

Browse around the site for interesting information. What products do they sell? What journal entries would they make to record sales of these products? Write a report to your instructor summarizing your experience at this site.