Chapter 4, Problem 7E

To determine

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.

Journal Entry:

It means recording of financial data related to business transactions in a journal in a manner so that debit equals credit. They provide an audit trail to the auditor and a means to analyze the effects of transactions to an organization’s financial health.

Rules of Journal Entry:

To increase the balance of account one needs to debit assets, expenses, losses and credit all the liabilities, revenues and gains including capital. To decrease the balance of account credit all assets, expenses, losses and debit all liabilities, revenues and gains including capital.

Perpetual Inventory System:

It is an inventory system wherein accounts related to inventory are updated on each purchase and sale activity. 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.

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

Explanation of Solution

Journal entries in the books of Company S.

Purchased merchandise on account worth $40,000

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 11	Merchandise Inventory		40,000
	Account payable			40,000
	(To record purchase of merchandise inventory on account)

• Merchandise Inventory is an asset account. Since the Merchandise Inventory is purchased, the value of assets is increased. So, debit the Merchandise Inventory account.
• 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.

Paid $345 cash for shipping charges:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 11	Merchandise Inventory		345
	Cash			345
	(To record shipping charges paid by buyer)

• Merchandise Inventory is an asset account. Since the amount of freight is added up in the Merchandise inventory value, the value of assets is increased. So, debit the Merchandise Inventory account.
• Cash is an asset account. Since the Cash is paid, the value of assets is decreased. So, credit the Cash account.

Purchase return made to Company T for $1400:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 12	Account payable		1,400
	Merchandise Inventory			1,400
	(To record return of merchandise worth $1400)

• 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.

Company S makes final payment to Company T:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 20	Account payable		38,600
	Merchandise inventory			1,158
	Cash			37,442
	(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:

Calculation of accounts payable,

   $\begin{array}{c}\text{Account}\text{payables}=\text{Invoice}\text{amount}-\text{Purchase return}\\ =\$40,000-\$1,400\\ =\text{\$38,600}\end{array}$

Calculation of merchandise inventory,

   $\begin{array}{c}\text{Merchandise}\text{Inventory}=\text{Account}\text{Payables}\times \text{Discount}\text{Rate}\\ =\$38,600\times 3\%\\ =\$1,158\end{array}$

Calculation of cash paid,

   $\begin{array}{c}\text{Cash}=\text{Account}\text{Payable}-\text{Discount}\\ =\$38,600-\$1,158\\ =\$37,442\end{array}$

Journal entries in the books of Company T.

Sold Merchandise inventory on account for $40,000:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 11	Account receivable		40,000
	Sales			40,000
	(To record sales made on account)

• Account receivable is an asset account. Since payment is to be received, so asset is to be increased. Therefore, account receivable account is debited.
• Sales are a revenue account. Since sales are made, so it needs to be increased. Therefore, sales account is to be credited.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 11	Cost of goods sold		30,000
	Merchandise inventory			30,000
	(To record cost of goods sold)

• Cost of goods sold account is an expense account. Since goods are being sold, expense is to be increased. Therefore, Cost of goods sold account is debited.
• Merchandise inventory account is an asset account. Since inventory is being sold, so it is to be reduced. Therefore, merchandise inventory account is to be credited.

Company S returns units worth $1,400 and Company T restores them:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 12	Sales return and allowances		1,400
	Account receivable			1,400
	(To record sales return)

• Sales return and allowances account is an expense account. Since Company A is receiving the sales return so it needs to be increased, so expense account is to be increased. Therefore, sales return and allowances account is to be debited.
• Account receivable is an asset account. Since account receivable is getting reduced because of sales return so asset is to be reduced. Therefore account receivable is to be credited.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 12	Merchandise inventory		1,050
	Cost of goods sold			1,050
	(To record cost of goods sold)

• Merchandise inventory account is an asset account. Since inventory is being received, so asset is to be increased. Therefore, merchandise inventory account is to be debited.
• Cost of goods sold account is an expense account. Since goods are being returned, expense is to be reduced. Therefore, Cost of goods sold account is credited.

Company T receives final payment from Company S:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 20	Cash		37,442
	Sales discount		1158
	Account receivable			38,600
	(To record final payment received from Company A)

• Cash is a asset account. Since, payment is received in cash, so it is to be increased. Therefore Cash account is credited.
• Sales discount is an expense account. Since, an expense is getting increased, so it requires a debit in the entry. Therefore Sales discount is debited.
• Account receivable is an asset account. Since account receivable is getting recovered for cash, so it is to be reduced. Therefore, Account receivable is credited.

Working note:

Calculation of accounts receivable,

   $\begin{array}{c}\text{Account}\text{Recievable}=\text{Sales}-\text{Sales}\text{Return}\\ =\$40,000-\$1,400\\ =\$38,600\end{array}$

Calculation of sales discount,

   $\begin{array}{c}\text{Sales}\text{Discount}=\text{Account}\text{recievable}\times \text{Rate}\text{of}\text{Discount}\\ =38,600\times 3\%\\ =\$1158\end{array}$

Calculation of cash received,

   $\begin{array}{c}\text{Cash}=\text{Account}\text{Recievable}-\text{Sales}\text{Discount}\\ =\$38,600-\$1,158\\ =\$37,442\end{array}$