Chapter 5, Problem 5APSA

To determine

Concept Introduction:

Adjusting entries: Adjustment entries are like the journal entries only and are basic for accounting. They are made in the closing period to adjust the expenses and incomes in the period in which they occurred. To show the true and fair financial position, it is essential to pass the adjustment entries. This includes the adjustments for the depreciation expense, inventory shrinkage expense and prepaid expenses.. They can be termed as the closing entries as well from the accounting perspective.

Multiple-step income statement: It is one of the most commonly used methods to derive the net income as it uses multiple subtractions under multiple heads. It gives more and appropriate information to the users of the financial statement.

Single-step income statement: It is one of the simple methods to derive the net income as it uses just one subtraction. It takes all the revenues together and deducts all the expenses in one shot without bifurcating them under different heads.

Current ratio: It is also known as the working capital ratio and it is an efficiency ratio used to compute the company’s ability to pay current liabilities or short term liabilities out of its current assets. It covers all the current assets including inventory and prepaid expenses.

Acid test ratio: It is also known as the liquidity ratio and it is used to compute the ability of a company to pay its immediate liabilities out of its current assets. Current assets exclude inventory and prepaid expenses.

Gross margin ratio: It depicts the margin that a business is earning from its operating activities in terms of percentage of net sales.

To Prepare/Determine:

1. Adjusting journal entries at year end for the given merchandise activities.
2. Multiple-step income statement for fiscal year 2017.
3. Single-step income statement for fiscal year 2017.
4. The different ratios like current ratio, acid- test ratio and gross margin ratio.

Explanation of Solution

1. Adjusting journal entries-

S. No.	Particulars	Debit	Credit
a	Store supplies expense	$4,050
	To Store supplies account		$4,050
b	Insurance expense account	$1,400
	To Prepaid insurance account		$1,400
c	Depreciation expense account- Store equipment	$1,525
	To Accumulated Dep- Store equipment		$1,525
D	Inventory shrinkage expense account	$1,600
	To Inventory account		$1,600

2. The multiple-step income statement-

Income Statement of Nelson company
Sales Revenue:
Gross Sales	$111,950
Less: Sales discount	$(2,000)
Less: Sales returns and allowances	$(2,200)
Net sales		$107,750
Less: COGS		$38,400
Less: Inventory shrinkage expense		$1,600
Gross Profit		$67,750
Operating Expenses
Selling Expenses:
Depreciation expense- Store equipment	$1,525
Advertising expense	$9,800
Store supplies expense	$4,050
Administrative expenses:
Salaries expense	$35,000
Insurance expense	$1,400
Rent expense	$15,000
Total Operating expense		$66,775
Net income		$975

3. The single-step income statement-

Income Statement of Nelson company
Revenue:
Sales Revenue	$107,750
Expenses
COGS	$38,400
Inventory shrinkage expense	$1,600
Depreciation expense- Store equipment	$1,525
Advertising expense	$9,800
Salaries expense	$35,000
Insurance expense	$1,400
Rent expense	$15,000
Store supplies expense	$4,050
Net Income	$975

4. The current ratio, acid test ratio and gross margin ratio

$\begin{array}{l}Current Ratio=Current assets÷Current liabilities\\ =(\$1,000+\$10,900+\$1,750+\$1,000)÷\$10,000\\ =1.46\\ \\ Acidtestratio=(C.A.-Inventory-\mathrm{Pr}epaid\exp enses)÷Current liabilities\\ =(\$1,000+\$1,750)÷\$10,000\\ =0.27\\ \\ Gross M\arg in ratio=Gross \mathrm{Pr}ofit÷Net sales\times 100\\ =\$67,750÷\$107,750\times 100\\ =62.88\%\end{array}$