Financial Accounting Study Guide: Inventory, Income Statements, and Merchandising

Q1. Calculate net purchases and cost of goods purchased for Gallant Company using a periodic inventory system.

Background

Topic: Periodic Inventory System

This question tests your understanding of how to compute net purchases and cost of goods purchased under the periodic inventory system, using purchase-related accounts.

Key Terms and Formulas:

• Purchases: Total merchandise bought for resale.

• Purchase Returns and Allowances: Reductions in purchases due to returned or damaged goods.

• Purchase Discounts: Discounts received for early payment.

• Freight-In: Shipping costs incurred to bring inventory to the company.

$\text{Net Purchases} = \text{Purchases} - \text{Purchase Returns and Allowances} - \text{Purchase Discounts}$

$\text{Cost of Goods Purchased} = \text{Net Purchases} + \text{Freight-In}$

Step-by-Step Guidance

1. Start by identifying the amounts for Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In.

2. Calculate Net Purchases by subtracting Purchase Returns and Allowances and Purchase Discounts from Purchases.

3. Add Freight-In to Net Purchases to determine the Cost of Goods Purchased.

4. Set up the equations with the provided values, but stop before computing the final numbers.

Try solving on your own before revealing the answer!

Final Answer:

Net Purchases: $450,000 - 13,000 - 8,000 = $429,000$

Cost of Goods Purchased: $429,000 + 16,000 = $445,000$

Gallant Company's net purchases are $429,000 and cost of goods purchased is $445,000.

Q2. Determine cost of goods sold and gross profit for Gallant Company, given inventory and net sales information.

Background

Topic: Merchandising Operations – Income Measurement

This question tests your ability to calculate cost of goods sold (COGS) and gross profit using inventory balances and net sales.

Key Terms and Formulas:

• Beginning Inventory: Inventory at the start of the period.

• Ending Inventory: Inventory at the end of the period.

• Cost of Goods Purchased: From Q1.

• Net Sales: Total sales minus returns, allowances, and discounts.

• Gross Profit: Net sales minus COGS.

$\text{Cost of Goods Sold} = \text{Beginning Inventory} + \text{Cost of Goods Purchased} - \text{Ending Inventory}$

$\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$

Step-by-Step Guidance

1. Identify the values for beginning inventory, ending inventory, cost of goods purchased (from Q1), and net sales.

2. Set up the COGS formula using these values.

3. Once you have COGS, set up the gross profit formula.

4. Plug in the numbers but stop before calculating the final values.

Try solving on your own before revealing the answer!

Final Answer:

Cost of Goods Sold: $60,000 + 445,000 - 90,000 = $415,000$

Gross Profit: $730,000 - 415,000 = $315,000$

Gallant Company's cost of goods sold is $415,000 and gross profit is $315,000.

Q3. Prepare journal entries for purchase and sales transactions between Vareen and Harrah Companies (perpetual inventory system).

Background

Topic: Perpetual Inventory System – Journal Entries

This question tests your ability to record purchase, freight, returns, and payment transactions under the perpetual inventory system for both buyer and seller.

Key Terms and Formulas:

• FOB Shipping Point: Buyer pays freight and takes ownership at shipping point.

• Purchase Discount: Reduction for early payment (3/10, n/30 means 3% discount if paid within 10 days).

• Perpetual Inventory System: Inventory and COGS updated continuously.

Step-by-Step Guidance

1. For Vareen Company:

   • Record the purchase of merchandise on account.

   • Record payment of freight costs.

   • Record return of damaged goods.

   • Record payment to Harrah, including purchase discount.

2. For Harrah Company:

   • Record the sale to Vareen (including COGS entry).

   • Record return of goods from Vareen.

   • Record receipt of payment, including sales discount.

3. Set up the journal entries for each event, but stop before writing the final debit and credit amounts.

Try solving on your own before revealing the answer!

Final Answer:

All journal entries for both Vareen and Harrah Companies are shown below, with correct debits and credits for each transaction, including purchase, freight, returns, discounts, and COGS.

For Vareen:

• June 10: Debit Inventory $8,000; Credit Accounts Payable $8,000

• June 11: Debit Inventory $400; Credit Cash $400

• June 12: Debit Accounts Payable $300; Credit Inventory $300

• June 19: Debit Accounts Payable $7,700; Credit Cash $7,469; Credit Inventory $231

For Harrah:

• June 10: Debit Accounts Receivable $8,000; Credit Sales Revenue $8,000; Debit Cost of Goods Sold $4,800; Credit Inventory $4,800

• June 12: Debit Sales Returns and Allowances $300; Credit Accounts Receivable $300; Debit Inventory $180; Credit Cost of Goods Sold $180

• June 19: Debit Cash $7,469; Debit Sales Discounts $231; Credit Accounts Receivable $7,700

Q4. Prepare a multiple-step income statement for Falcetto Company for the year ended December 31, 2019.

Background

Topic: Income Statement Preparation

This question tests your ability to organize account balances into a multiple-step income statement, separating operating and non-operating items.

Key Terms and Formulas:

• Multiple-Step Income Statement: Separates operating revenues/expenses from non-operating items.

• Gross Profit: Sales revenue minus COGS.

• Operating Income: Gross profit minus operating expenses.

• Non-operating Items: Interest, gains/losses, etc.

Step-by-Step Guidance

1. Calculate net sales: Sales Revenue minus Sales Returns and Allowances and Sales Discounts.

2. Compute gross profit: Net sales minus Cost of Goods Sold.

3. List operating expenses: Add up selling and administrative expenses.

4. Subtract operating expenses from gross profit to get income from operations.

5. Include non-operating items: Interest revenue and expense.

6. Set up the statement format, but stop before filling in the final totals.

Try solving on your own before revealing the answer!

Final Answer:

Falcetto Company's multiple-step income statement:

• Net Sales: $525,100

• Gross Profit: $161,700

• Total Operating Expenses: $141,700

• Income from Operations: $20,000

• Other Revenues and Expenses: Interest Revenue $2,500, Interest Expense $3,600

• Net Income: $18,900

The statement properly separates operating and non-operating items.

Q5. Prepare condensed income statements for Family Department Store under Dana's changes, Eric's ideas, and both; recommend the best option.

Background

Topic: Decision-Making and Income Statement Analysis

This question tests your ability to analyze proposed changes to sales, COGS, and expenses, and to prepare and compare condensed income statements.

Key Terms and Formulas:

• Gross Profit Rate: Gross profit divided by net sales.

• Operating Expenses: Selling and administrative expenses.

• Net Income: Gross profit minus operating expenses.

Step-by-Step Guidance

1. For Dana's changes:

   • Calculate new net sales (increase by 6%).

   • Apply new gross profit rate (24%) to net sales to find gross profit.

   • Subtract unchanged operating expenses to find net income.

2. For Eric's ideas:

   • Keep net sales unchanged.

   • Calculate new selling expenses (reduce salaries, add commission, reduce delivery expenses).

   • Subtract new operating expenses from gross profit to find net income.

3. For both sets of changes:

   • Apply Dana's net sales and gross profit rate.

   • Apply Eric's reduced operating expenses.

4. Set up the condensed income statements for each scenario, but stop before computing the final net income.

Try solving on your own before revealing the answer!

Final Answer:

Condensed income statements:

• Dana's changes: Net income $52,000

• Eric's ideas: Net income $49,000

• Both: Net income $74,000

Recommendation: Implement both sets of changes for maximum net income. Combining increased gross profit rate and reduced operating expenses yields the best result.

Q6. Record the adjusting entry for Litwin Company when actual inventory is less than perpetual records.

Background

Topic: Inventory Adjustments – Perpetual System

This question tests your ability to record an adjusting entry when physical inventory count is less than the recorded amount.

Key Terms and Formulas:

• Inventory Shrinkage: Loss of inventory due to theft, damage, or error.

• Adjusting Entry: Updates records to match physical count.

Step-by-Step Guidance

1. Calculate the difference between recorded inventory and actual inventory.

2. Determine which accounts to debit and credit (usually debit Cost of Goods Sold, credit Inventory).

3. Set up the journal entry, but stop before writing the final amounts.

Try solving on your own before revealing the answer!

Final Answer:

Adjusting entry:

• Debit Cost of Goods Sold $2,300

• Credit Inventory $2,300

This entry records the shrinkage and adjusts inventory to the correct amount.

Q7. Compute net sales, gross profit, income from operations, and gross profit rate for Kader Company.

Background

Topic: Merchandising Profitability

This question tests your ability to calculate key profitability metrics for a merchandising company.

Key Terms and Formulas:

• Net Sales: Sales revenue minus returns and allowances.

• Gross Profit: Net sales minus COGS.

• Income from Operations: Gross profit minus operating expenses.

• Gross Profit Rate: Gross profit divided by net sales.

$\text{Net Sales} = \text{Sales Revenue} - \text{Sales Returns and Allowances}$

$\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$

$\text{Income from Operations} = \text{Gross Profit} - \text{Operating Expenses}$

$\text{Gross Profit Rate} = \frac{\text{Gross Profit}}{\text{Net Sales}} \times 100$

Step-by-Step Guidance

1. Calculate net sales by subtracting sales returns and allowances from sales revenue.

2. Compute gross profit by subtracting COGS from net sales.

3. Find income from operations by subtracting operating expenses from gross profit.

4. Set up the formula for gross profit rate, but stop before calculating the final percentage.

Try solving on your own before revealing the answer!

Final Answer:

Net Sales: $495,000

Gross Profit: $165,000

Income from Operations: $55,000

Gross Profit Rate: 33.3%

These metrics show Kader Company's profitability for the period.

Q8. Prepare closing entries for Hudson Company to Income Summary.

Background

Topic: Closing Entries – Merchandising Company

This question tests your ability to close revenue and expense accounts to Income Summary at period end.

Key Terms and Formulas:

• Closing Entries: Transfer balances from temporary accounts to Income Summary.

• Income Summary: Temporary account used during closing process.

Step-by-Step Guidance

1. Identify which accounts need to be closed (Sales Revenue, Sales Discounts, COGS).

2. Prepare entries to close each account to Income Summary.

3. Set up the journal entries, but stop before writing the final debit and credit amounts.

Try solving on your own before revealing the answer!

Final Answer:

Closing entries:

• Debit Sales Revenue $195,000; Credit Income Summary $195,000

• Debit Income Summary $2,000; Credit Sales Discounts $2,000

• Debit Income Summary $117,000; Credit Cost of Goods Sold $117,000

These entries close the temporary accounts to Income Summary.

Q9. Prepare the sales section of the income statement for Arndt Company for October 2019.

Background

Topic: Income Statement – Sales Section

This question tests your ability to present the sales section of an income statement, including sales discounts and returns.

Key Terms and Formulas:

• Sales Revenue: Total sales (cash and credit).

• Sales Discounts: Reductions for early payment.

• Sales Returns and Allowances: Reductions for returned or damaged goods.

• Net Sales: Sales revenue minus discounts and returns.

$\text{Net Sales} = \text{Total Sales} - \text{Sales Discounts} - \text{Sales Returns and Allowances}$

Step-by-Step Guidance

1. Add up sales on credit and cash sales to get total sales revenue.

2. Subtract sales discounts and sales returns and allowances from total sales to get net sales.

3. Set up the sales section format, but stop before calculating the final net sales amount.

Try solving on your own before revealing the answer!

Final Answer:

Sales Section:

• Sales Revenue: $380,000

• Less: Sales Discounts $5,000

• Less: Sales Returns and Allowances $11,000

• Net Sales: $364,000

This section shows the calculation of net sales for the month.

Q10. Explain where each item appears on a multiple-step and single-step income statement: (a) gain on sale of equipment, (b) interest expense, (c) casualty loss from vandalism, (d) cost of goods sold.

Background

Topic: Income Statement Presentation

This question tests your understanding of how various items are classified and presented on different types of income statements.

Key Terms and Formulas:

• Multiple-Step Income Statement: Separates operating and non-operating items.

• Single-Step Income Statement: All revenues and gains grouped together; all expenses and losses grouped together.

Step-by-Step Guidance

1. For each item, determine if it is operating or non-operating.

2. Identify its placement on a multiple-step income statement (e.g., other revenues and expenses, operating expenses, COGS).

3. Identify its placement on a single-step income statement (e.g., revenues/gains or expenses/losses).

4. Set up the explanations for each item, but stop before giving the final placement details.

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Final Answer:

• (a) Gain on sale of equipment: Multiple-step – Other revenues and gains; Single-step – Included in total revenues/gains.

• (b) Interest expense: Multiple-step – Other expenses and losses; Single-step – Included in total expenses/losses.

• (c) Casualty loss from vandalism: Multiple-step – Other expenses and losses; Single-step – Included in total expenses/losses.

• (d) Cost of goods sold: Multiple-step – Deducted from net sales to compute gross profit; Single-step – Included in total expenses/losses.

Each item is classified according to its nature and the statement format.