# 5.14: Solutions

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## Discussion Questions

1. A business providing a service holds no inventory for resale. Thus, a business that sells goods must match the cost of the goods sold with the revenue the sales generate. The Income Statement will show this, as well as the Gross Profit (also known as Gross Margin)—the difference between Sales and Cost of Goods Sold. A service business Income Statement would not show these items.
2. Gross Profit is the result of deducting Cost of Goods Sold from Sales (or Net Sales). For example, if a car is sold for $16,000 but cost$12,000, the Gross Profit calculation would be

### EXERCISE 5–6

1. The income statement is as follows:
 Smith Corp. Income Statement Year Ended June 30, 2015 Sales $72,000 Less: Sales returns and allowances 2,000 Net sales$70,000 Cost of goods sold 50,000 Gross profit $20,000 Operating expenses: Selling expenses: Advertising expense$1,500 Commissions expense 4,000 Delivery expense 500 Rent expense - store 1,500 Sales salaries expense 2,000 Total selling expenses $9,500 General and administrative expenses: Depreciation expense - equipment 500 Insurance expense 1,000 Office salaries expense 3,000 Rent expense - office 1,000 Total general and administrative expenses 5,500 Total operating expenses 15,000 Income before income tax expense 5,000 Income tax expense 1,000 Net income$4,000
2. The gross profit percentage, rounded to two decimal places, is 28.57% calculated as 100 × (20,000/70,000).

### EXERCISE 5–7

 Inventory, opening balance $10,000$ 53,000 $561,800$ 168,540 50,562 Plus: purchases 30,000 159,000 1,685,400 1,011,240 606,744 Total goods available for sale 40,000 212,000 2,247,200 1,179,780 657,306 Less: ending inventory 15,000 79,500 842,700 556,180 100,000 Cost of goods sold 25,000 132,500 1,404,500 623,600 557,306 Sales 55,000 240,000 1,600,000 900,000 700,000 Less: cost of goods sold 25,000 132,500 1,404,500 623,600 557,306 Gross profit 30,000 107,500 195,500 276,400 142,694 Less: operating expenses 12,000 63,600 275,000 250,000 145,000 Net income/(loss) 18,000 43,900 (79,500) 26,400 (2,306) Gross profit/sales (%) 54.55% 44.79% 12.22% 30.71% 0

### EXERCISE 5–8

1. Closing entries:
 General Journal Date Account/Explanation F Debit Credit June 30 Sales 72,000 Income Summary 72,000 (to close credit balance temporary accounts) 30 Income Summary 68,000 Sales Returns and Allowances 2,000 Cost of Goods Sold 50,000 Advertising Expense 1,500 Commissions Expense 4,000 Delivery Expense 500 Rent Expense – Store 1,500 Sales Salaries Expense 2,000 Depreciation Expense – Equipment 500 Insurance Expense 1,000 Office Salaries Expense 3,000 Rent Expense – Office 1,000 Income Tax Expense 1,000 (to close debit balance temporary accounts) 30 Income Summary 4,000 Retained Earnings 4,000 (to close balance in Income Summary to Retained Earnings) 30 Retained Earnings 2,000 Dividends 2,000 (to close Dividends to Retained Earnings)

## Problems

### PROBLEM 5–1

1. The Salem Corp. general journal is as follows:
 General Journal Date Account/Explanation F Debit Credit Jul. 2 Cash 5,000 Share Capital 5,000 To record the issue of common shares. 2 Merchandise Inventory 3,500 Accounts Payable 3,500 To record Purchases on credit 2/10, n/30, from Blic Pens, Ltd. 2 Accounts Receivable 2,000 Sales 2,000 To record sale to Spellman Chair Rentals, Inc.; terms 2/10, n/30. Cost of Goods Sold 1,200 Merchandise Inventory 1,200 To record the cost of sales. 3 Rent Expense 500 Cash 500 To record July rent payment. 5 Equipment 1,000 Cash 1,000 To record purchase of equipment. 8 Cash 200 Sales 200 To record cash sale to Ethan Matthews Furniture Ltd. Cost of Goods Sold 120 Merchandise Inventory 120 To record the cost of sales. 8 Merchandise Inventory 2,000 Accounts Payable 2,000 To record purchase of merchandise inventory; terms 2/15, n/30, from Shaw Distributors, Inc. 9 Cash 1,960 Sales Discount 40 Accounts Receivable 2,000 To record receipt of amount due from Spellman Chair Rentals, Inc. less the discount.
 General Journal Date Account/Explanation F Debit Credit 10 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment to Blic Pens Ltd. less the discount. 10 Merchandise Inventory 200 Accounts Payable 200 To record purchase of merchandise inventory from Peel Products, Inc.; terms n/30. Jul. 15 Accounts Receivable 2,000 Sales 2,000 To record sale to Eagle Products Corp. 2/10, n/30. Cost of Goods Sold 1,300 Merchandise Inventory 1,300 To record the cost of sales. 15 Merchandise Inventory 1,500 Accounts Payable 1,500 To record purchase of merchandise inventory from Bevan Door, Inc.; terms 2/10, n/30. 15 Accounts Payable 100 Merchandise Inventory 100 To record credit memo from Shaw Distributors, Inc. 16 Sales Returns and Allowances 200 Accounts Receivable 200 To record return of defective items sold to Eagle Products Corp.; inventory scrapped. 20 Accounts Receivable 3,500 Sales 3,500 To record sale to Aspen Promotions, Ltd. 2/10, n/30. Cost of Goods Sold 2,700 Merchandise Inventory 2,700 To record the cost of sales. 20 Accounts Payable 950 Cash 931 Merchandise Inventory 19 To record payment of half of the amount due to Shaw Distributors, Inc. less memo and less discount. 24 Cash 882 Sales Discounts 18 Accounts Receivable 900 To record receipt of half of the amount due from Eagle Products Corp.; 2,000 − 200 return = 1,800/2 = 900. 24 Accounts Payable 1,500 Cash 1,470 Merchandise Inventory 30 To record payment made to Bevan Door, Inc. less discount.
 General Journal Date Account/Explanation F Debit Credit 26 Accounts Receivable 600 Sales 600 To record sale to Longbeach Sales, Ltd. for terms 2/10, n/30. Cost of Goods Sold 400 Merchandise Inventory 400 To record the cost of sales. Jul. 26 Merchandise Inventory 800 Accounts Payable 800 To record purchase from Silverman Co. for terms 2/10, n/30. 31 Merchandise Inventory 350 Cash 350 To record payment to Speedy Transport Co. for July transport of inventory to warehouse.
2. The unadjusted ending balance in merchandise inventory is as follows:
 Merchandise Inventory 2-Jul 3,500 1,200 2-Jul 8-Jul 2,000 120 8-Jul 10-Jul 200 70 10-Jul 15-Jul 1,500 1,300 15-Jul 26-Jul 800 100 15-Jul 31-Jul 350 2,700 20-Jul 19 20-Jul 30 24-Jul 400 26-Jul Unadj. Bal. 2,411
3. The general journal entry is as follows:

### PROBLEM 5–3

1. The income statement and statement of changes in equity are as follows:
 Acme Automotive Inc. Income Statement Year Ended December 31, 2015 Sales $310,000 Less: Sales returns and allowances$2,900 Sales discounts 1,300 4,200 Net sales $305,800 Cost of goods sold 126,000 Gross profit$179,800 Operating expenses: Selling expenses: Advertising expense $14,000 Commissions expense 29,000 Delivery expense 14,800 Rent expense 19,440 Sales salaries expense 26,400 Total selling expenses$103,640 General and administrative expenses: Depreciation expense $12,000 Insurance expense 10,400 Office supplies expense 3,100 Rent expense 12,960 Telephone expense 1,800 Utilities expense 4,200 Wages expense – office 14,300 Total general and administrative expenses 58,760 Total operating expenses 162,400 Income from operations$17,400 Other revenues and expenses: Rent revenue $19,200 Interest expense (840) 18,360 Income before tax$35,760 Income tax expense 4,200 Net income $31,560  Acme Automotive Inc. Statement of Changes in Equity Year Ended December 31, 2015 Share Capital Retained Earnings Total Equity Opening balance$50,000 $12,440$62,440 Shares issued 20,000 20,000 Net income 31,560 31,560 Dividends (11,000) (11,000) Ending balance $70,000$33,000 $103,000 2. Closing entries:  General Journal Date Account/Explanation F Debit Credit Dec. 31 Sales 310,000 Rent Sales 19,200 Income Summary 329,200 (to close credit balance temporary accounts) 31 Income Summary 297,640 Sales Returns and Allowances 2,900 Sales Discounts 1,300 Cost of Goods Sold 126,000 Advertising Expense 14,000 Commissions Expense 29,000 Delivery Expense 14,800 Rent Expense 32,400 Sales Salaries Expense 26,400 Depreciation Expense 12,000 Insurance Expense 10,400 Office Supplies Expense 3,100 Telephone Expense 1,800 Utilities Expense 4,200 Wages Expense – Office 14,300 Interest Expense 840 Income Tax Expense 4,200 (to close debit balance temporary accounts) 31 Income Summary 31,560 Retained Earnings 31,560 (to close Income Summary to Retained Earnings) 31 Retained Earnings 11,000 Dividends 11,000 (to close Dividends to Retained Earnings) ### PROBLEM 5–4 Answers for the missing boxes are in the colored cells.  Inventory, opening balance 55,000 Plus: purchases 250,000 Plus: sales returns to inventory 100 Plus: purchase shipping costs 500 Less: Purchase returns and allowances 200 Less: Purchase discounts 3,500 3,100 Net purchases 246,900 Total goods available for sale 301,900 Ending inventory, per GL 90,000 Less shrinkage adjustment (90,000−88,500) 1,500 88,500 Cost of goods sold 213,400 Sales 580,000 Less: sales discounts 200 Less: sales returns 200 Less: sales allowances 600 1,000 Net sales 579,000 Gross profit 365,600 Less: operating expenses 250,000 Net income/(loss) 115,600 Gross profit/sales (%) (365,600÷579,000) 63.14% ### PROBLEM 5–5 1.  Turret Retail Ltd. Income Statement For the Year Ended December 31, 2016 Sales$360,000 Less: Sales discounts $3,600 Sales returns and allowances 9,600 13,200 Net sales 346,800 Cost of goods sold 240,000 Gross profit from sales 106,800 Operating expenses Salaries expense 57,000 Insurance expense 5,000 Shop supplies expense 1,000 Depreciation expense 3,200 Rent expense 30,240 Travel expense 2,100 Utilities expense 7,300 Total operating expenses 105,840 Income from operations 960 Other revenue and expenses Rental income 6000 Interest expense 200 5,800 Income before tax 6,760 Income tax expense 2,028 Net income$4,732
2.  General Journal Date Account/Explanation F Debit Credit Dec 31 Rental income 6,000 Sales 360,000 Income summary 366,000 To close temporary revenue accounts. Dec 31 Income summary 108,068 Salaries expense 57,000 Insurance expense 5,000 Shop supplies expense 1,000 Depreciation expense 3,200 Rent expense 30,240 Travel expense 2,100 Utilities expense 7,300 Interest expense 200 Income tax expense 2,028 To close temporary expense accounts. Dec 31 Income Summary 4,732 Retained earnings 4,732 To close income summary to retained earnings. Dec 31 Retained earnings 10,000 Cash dividends 10,000 To close temporary cash dividend account.
3. Gross profit ratio = gross profit/Net sales = $106,800÷346,800 = 30.8% This ratio means that for every$100 of sales, the company has $30.8 left to cover operating expenses after deducting cost of goods sold. This ratio can be compared to other companies in the same industry or to historical trends within the same company. A small fluctuation in the ratio can often cause a large increase/decrease in gross profit, if inventory and sales dollar amounts are often the largest amounts reported on the income statement. ### PROBLEM 5–6 1.  Yuba Yabi Enterprises Ltd. Trial Balance March 31, 2017 Unadjusted Trial Balance Adjustments Adjusted Trial Balance Debit Credit Debit Credit Debit Credit Accounts payable$68,750 $68,750 Accounts receivable$308,000 $308,000 Accrued salaries and benefits payable 26,400$12,000 38,400 Accumulated depreciation, furniture 9,460 9,460 Cash 46,200 46,200 Cash dividends 22,000 22,000 Cost of goods sold 528,000 $7,800 535,800 Advertising expense 9,900 9,900 Bank loan payable (long-term) 88,704 88,704 Depreciation expense 7,040 7,040 Copyright 44,000 44,000 Franchise 66,000 66,000 Furniture 44,000 44,000 Income tax expense – 149,872$$^{*}$$ * 229,481 Income taxes payable 17,600 149,872$$^{*}$$ 247,081 Insurance expense 11,000 5,000 16,000 Interest expense 440 5,600 6,040 Interest payable 1,210 5,600 6,810 Land 308,000 308,000 Merchandise inventory 264,000 7,800 256,200 Prepaid insurance expense 13,200 5,000 8,200 Prepaid advertising expense 8,800 8,800 Rent expense 66,528 66,528 Rental income 13,200 13,200 Retained earnings 265,364 265,364 Salaries expense 125,400 12,000 137,400 Sales 792,000 792,000 Sales discounts 7,920 7,920 Sales returns and allowances 21,120 21,120 Service revenue 495,000 30,000 525,000 Share capital 44,000 44,000 Shop supplies 8,360 8,360 Shop supplies expense 2,200 2,200 Travel expense 4,620 4,620 Unearned service revenue 111,100 30,000 81,100 Utilities expense 16,060 16,060$1,932,788 $1,932,788$210,272 $210,272$2,179,869 $2,179,869 $$^{*}$$ Income tax expense calculation:  Cost of goods sold$535,800 Advertising expense 9,900 Depreciation expense 7,040 Insurance expense 16,000 Interest expense 6,040 Rent expense 66,528 Rental income $13,200 Salaries expense 137,400 Sales 792,000 Sales discounts 7,920 Sales returns and allowances 21,120 Service revenue 525,000 Shop supplies expense 2,200 Travel expense 4,620 Utilities expense 16,060$830,628 $1,330,200 Net income before taxes 499,572 Income taxes @ 30%$149,872 adjusting entry
2.  Turret Retail Ltd. Income Statement For the Year Ended December 31, 2016 Sales $792,000 Less: Sales discounts$7,920 Sales returns and allowances 21,120 29,040 Net sales 762,960 Cost of goods sold 535,800 Gross profit from sales 227,160 Service revenue 525,000 752,160 Operating expenses Salaries expense 137,400 Insurance expense 16,000 Advertising expense 9,900 Shop supplies expense 2,200 Depreciation expense 7,040 Rent expense 66,528 Travel expense 4,620 Utilities expense 16,060 Total operating expenses 259,748 Income from operations 492,412 Other revenue and expenses Rental income 13,200 Interest expense 6,040 7,160 Income before tax 499,572 Income tax expense 149,872 Net income \$349,700

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