Chapter 4, Problem 23E

To determine

Net Method:

Under this method, all the purchases are recorded in the books of account after taking into account the trade discount, returns and allowances. The purchases are to be recorded at full cost after deducting the discounts and allowances.

Journal Entries:

Journal entries are the transactions of quantitative nature that are made in the books of accounts to record every transaction that happens in the business in the chronological order.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

Perpetual inventory system:

The inventory system in which accounts related to the inventory are updated on each purchase or sale in inventory. Quantities of inventory are updated on continuous basis. This can be done by integrating the inventory system to order entry and to the retail sale point of system.

Gross Method:

Under this method, all the purchases are recorded in the books of account without taking into account the trade discount, returns and allowances. The purchases are to be recorded at full cost.

To prepare: Journal entries in the books of Company P.

Explanation of Solution

Journal entries under gross method:

Purchased merchandise inventory worth $3,000.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 2	Merchandise Inventory		3,000
	Account Payable			3,000
	(To record merchandise inventory purchased on credit)

• Merchandise Inventory account is an asset account. Since there is purchase of merchandise inventory, so asset account is to be increased. Therefore, Merchandise Inventory account is debited.
• Account Payable is a liability account. Since payment is to be made for purchases on account, so liability is to be increased. Therefore, Account Payable account is credited.

Purchase return made by Company P for $500:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 10	Account Payable		500
	Merchandise Inventory			500
	(To record return of merchandise worth $500)

• Account payable is a liability account. Since the Inventory which was purchased on credit is returned, this reduces the liability to be paid. So, debit the Accounts Payable account.
• Merchandise Inventory is an asset account. Since it is returned to the seller, the value of asset is to be reduced. So, credit the Merchandise inventory account.

Purchased merchandise inventory worth $5,400.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 17	Merchandise Inventory		5,400
	Account Payable			5,400
	(To record merchandise inventory purchased on credit)

• Merchandise Inventory account is an asset account. Since there is purchase of merchandise inventory, so asset account is to be increased. Therefore, Merchandise Inventory account is debited.
• Account Payable is a liability account. Since payment is to be made for purchases on account, so liability is to be increased. Therefore, Account payable account is credited.

Cash paid for purchase made on October 17.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 27	Account Payable		5,400
	Merchandise Inventory			108
	Cash			5,292
	(To record cash payment made for merchandise inventory)

• Account payable is a liability account. Since payment is to be made for account payable, this will result in reduction of liability. Therefore, Account payable account is debited.
• Merchandise Inventory account is an asset account. Since, discount is received in making final payment by company S from Company T, Merchandise Inventory is to be reduced. Therefore, Merchandise Inventory account is credited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, Cash account is credited.

Working Note:

Computation of Merchandise Inventory:
   $\begin{array}{c}\text{Discount}=\text{Account}\text{payables}\times \text{Discount}\text{rate}\\ =\$5,400\times 2\%\\ =\$108\end{array}$

Computation of Cash to be paid:
   $\begin{array}{c}\text{Cash}=\text{Account}\text{payable}-\text{Discount}\\ =\$5,400-\$108\\ =\$5,292\end{array}$

Cash payment after the discount the period:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 31	Account Payable		2,500
	Cash			2,500
	(To record payment made for merchandise inventory )

• Account payable is a liability account. Since payment is to be made for account payable, this will result into reduction of liability. Therefore, Account Payable account is debited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, Cash account is credited.

Journal entries by net method:

Purchased merchandise inventory worth $2,940.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 2	Merchandise Inventory		2,940
	Account Payable			2,940
	(To record merchandise inventory purchased on credit)

• Merchandise inventory account is an asset account. Since there is purchase of merchandise inventory, so asset account is to be increased. Therefore, Merchandise Inventory account is debited.
• Account payable is a liability account. Since payment is to be made for purchases on account, so liability is to be increased. Therefore Account payable account is credited.

Working Note:

Computation of merchandise inventory:
   $\begin{array}{c}\text{Merchandise}\text{inventory}=\text{Invoice}\text{value}-\text{Discount}\\ =\$3,000-\$60\\ =\$2,940\end{array}$

Computation of discount amount:
  $\begin{array}{c}\text{Discount}=\text{Invoice}\text{value}\times \text{Rate}\text{of}\text{discount}\\ \text{=\$3,000}\times 2\text{\%}\\ \text{=\$60}\end{array}$

Purchase return made by Company P for $490:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 10	Account Payable		490
	Merchandise Inventory			490
	(To record return of merchandise worth $500)

• Account payable is a liability account. Since the Inventory which was purchased on credit is returned, this reduces the liability to be paid. So, debit the Accounts Payable account.
• Merchandise Inventory is an asset account. Since it is returned to the seller , the value of asset is to be reduced. So credit the Merchandise Inventory account.

Working Note:

Computation of Account payable:
   $\begin{array}{c}\text{Account}\text{payable}=\text{Gross}\text{Purchase}\text{Returm}-\text{Discount}\\ =\$500-2\%\text{of}500\\ =\$500-10\\ =\$490\end{array}$

Purchased merchandise inventory worth $5,292.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 17	Merchandise Inventory		5,292
	Account Payable			5,292
	(To record merchandise inventory purchased on credit)

• Merchandise inventory account is an asset account. Since there is purchase of merchandise inventory, so asset account is to be increased. Therefore, Merchandise inventory account to be debited..
• Account payable is a liability account. Since payment is to be made for purchases on account, so liability is to be increased. Therefore Account payable account is credited.

Working Note:

Computation of Merchandise inventory:
   $\begin{array}{c}\text{Merchandise}\text{inventory}=\text{Invoice}\text{value}-\text{Discount}\\ =\$5,400-\$108\\ =\$5,292\end{array}$

Computation of Discount amount:
   $\begin{array}{c}\text{Discount}=\text{Invoice}\text{value}\times \text{Rate}\text{of}\text{discount}\\ =\$5,400\times 2\%\\ =\$108\end{array}$

Cash paid for October 17 purchase made:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 27	Account Payable		5,292
	Cash			5,292
	(To record cash payment made for merchandise inventory)

• Account payable is a liability account. Since payment is to be made for account payable, this will result in reduction of liability. Therefore, Account Payable account is debited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, Cash account is credited.

Cash payment after the discount the period:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Oct 31	Account Payable		2,450
	Discount Lost		50
	Cash			2,500
	(To record payment made for merchandise inventory )

• Account payable is a liability account. Since payment is to be made for account payable, this will result into reduction of liability. Therefore, Account payable account is debited.
• Discount Lost account is an expense account. Since, discount is lost so expense is increased. Therefore, Discount Lost account is debited.
• Cash account is an asset account. Since, cash is paid so asset is reduced. Therefore, Cash account is credited.

Working Note:

Computation of Account payable:
   $\begin{array}{c}\text{Account}\text{payable}=\text{Gross}\text{Purchase}-\text{Purchase}\text{Return}\\ =\$2,940-\$490\\ =\$2,450\end{array}$

Computation of Cash to be paid:
   $\begin{array}{c}\text{Cash}=\text{Account}\text{Payable}+\text{Discount}\text{lost}\\ =\$2,450+\$50\\ =\$3,000\end{array}$