Chapter 4, Problem 22AE

a.

To determine

Journalize the inventory transactions in the books of Shop B, assuming the periodic inventory system.

Explanation of Solution

Periodic inventory system: The method or system of recording the transactions related to inventory occasionally or periodically is referred to as periodic inventory system.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Journalize the inventory transactions in the books of Shop B.

Transaction 1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Cash			35,000
			Common Stock			35,000
		(Record issuance of common stock)

Table (1)

Description:

• Cash is an asset account. The amount is increased because cash is received, and an increase in asset is debited.
• Common Stock is a stockholders’ equity account. Since stock is issued, equity amount increased, and an increase in equity is credited.

Transaction 2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Merchandise Inventory			9,600
			Common Stock			9,600
		(Record purchase of merchandise in exchange for common stock)

Table (2)

Description:

• Merchandise Inventory is an asset account. Since merchandise is contributed by the owner, asset value increased, and an increase in asset is debited.
• Common Stock is a stockholders’ equity account. Since stock is issued, equity amount increased, and an increase in equity is credited.

Transaction 3:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Purchases			85,000
			Accounts Payable			85,000
		(Record purchase of merchandise on account)

Table (3)

Description:

• Purchases is an expense account. Since merchandise is purchased, expense value increased. An increase in expenses decreases equity, and a decrease in equity is debited.
• Accounts Payable is a liability account. Since amount owed increased, liability increased, and an increase in liability is credited.

Transaction 4:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Advertising Expense			2,800
			Cash			2,800
		(Record payment of advertising expense )

Table (4)

Description:

• Advertising Expense is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Advertising Expense account is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 5:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Cash			165,000
			Sales Revenue			165,000
		(Record sale of merchandise)

Table (5)

Description:

• Cash is an asset account. The amount is increased because cash is received, and an increase in asset is debited.
• Sales Revenue is a revenue account. Since gains and revenues increase equity, and an increase in equity is credited, Sales Revenue account is credited.

Transaction 6:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Salaries Expense			28,000
			Cash			28,000
		(Record payment of salaries expense )

Table (6)

Description:

• Salaries Expense is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Salaries Expense account is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 7:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Accounts Payable			65,000
			Cash			65,000
		(Record cash paid for merchandise purchased on account)

Table (7)

Description:

• Accounts Payable is a liability account. Since amount owed is paid, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Transaction 8:

For recognizing cost of goods sold:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Cost of Goods Sold			66,100
		Merchandise Inventory			28,500
			Purchases			85,000
			Merchandise Inventory			9,600
		(Record cost incurred on goods sold)

Table (8)

Description:

• Cost of Goods Sold is an expense account. Since losses and expenses decrease equity and a decrease in equity is debited, Cost of Goods Sold account is debited.
• Merchandise Inventory is an asset account. The merchandise which is remained at the end of year, after the purchases and sales, is recorded. So asset value increased, and an increase in asset is debited.
• Purchases is an expense account. Since merchandise of $85,000, purchased is sold, Purchases account is cancelled by crediting the account, to reverse its effect.
• Merchandise Inventory is an asset account. Since merchandise of $9,600, contributed by the owner is sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute cost of goods sold.

Cost of Goods Sold
Beginning inventory balance	$0
Owner contribution	9,600
Inventory purchases during the period	85,000
Cost of goods available for sale	94,600
Less: Ending inventory	(28,500)
Cost of goods sold	$66,100

Table (9)

b.

To determine

Post the beginning balances into T-accounts, and post the journal entries prepared in Part (a) into T-accounts.

Explanation of Solution

T-account: The condensed form of a ledger is referred to as T-account. The left-hand side of this account is known as debit, and the right hand side is known as credit.

Post the journal entries prepared in Part (a) into T-accounts.

Cash
Common stock	$35,000	Advertising expense	$2,800
Sales revenue	165,000	Salaries expense	28,000
		Accounts payable	65,000
Total	200,000	Total	95,800
Balance	$104,200

Table (10)

Merchandise Inventory
Common stock	$9,600	Cost of goods sold	$9,600
Purchases	28,500
Total	38,100	Total	9,600
Balance	$28,500

Table (11)

Accounts Payable
Cash	$65,000	Purchases	$85,000
Total	65,000	Total	85,000
		Balance	$20,000

Table (12)

Common Stock
		Cash	$35,000
		Merchandise inventory	9,600
Total	$0	Total	44,600
		Balance	$44,600

Table (13)

Sales Revenue
		Cash	$165,000
Total	$0	Total	165,000
		Balance	$165,000

Table (14)

Cost of Goods Sold
Purchases	$85,000	Merchandise inventory	$28,500
Merchandise inventory	9,600
Total	94,600	Total	28,500
Balance	$66,100

Table (15)

Purchases
Accounts payable	$85,000	Merchandise inventory	$28,500
Merchandise inventory	9,600	Cost of goods sold	66,100
Total	94,600	Total	94,600
Balance	$0

Table (16)

Advertising Expense
Cash	$2,800
Total	2,800	Total	$0
Balance	$2,800

Table (17)

Salaries Expense
Cash	$28,000
Total	28,000	Total	$0
Balance	$28,000

Table (18)

c.

To determine

Prepare an income statement, statement of stockholders’ equity, balance sheet, and statement of cash flows for Shop B based on the account balances derived in Part (b).

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare an income statement for Shop B for the year ended December 31, Year 1.

Shop B
Income Statement
For the Year Ended December 31, Year 1
Sales revenue		$165,000
Cost of goods sold		(66,100)
Gross margin		98,900
Operating expenses:
Advertising expense	$2,800
Salaries expense	28,000
Total operating expenses		(30,800)
Net income		$68,100

Table (19)

Statement of stockholders’ equity: The statement which reports the changes in stock, paid-in capital, retained earnings, and treasury stock, during the year is referred to as statement of stockholders’ equity.

Prepare a statement of stockholders’ equity for Shop B for the year ended December 31, Year 1.

Shop B
Statement of Stockholders’ Equity
For the Year Ended December 31, Year 1
Beginning common stock	$0
Stock issued	44,600
Ending common stock		$44,600
Beginning retained earnings	$0
Net income	68,100
Ending retained earnings		68,100
Total stockholders’ equity		$112,700

Table (20)

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Prepare the balance sheet for Shop B as at December 31, Year 1.

Shop B
Balance Sheet
December 31, Year 1
Assets
Cash	$104,200
Merchandise inventory	28,500
Total assets		$132,700
Liabilities
Accounts payables		$20,000
Stockholders’ equity
Common stock	44,600
Retained earnings	68,100
Total stockholders’ equity		112,700
Total liabilities and stockholders’ equity		$132,700

Table (21)

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities. Ending cash balance computed in balance sheet is required in statement of cash flows. Operating activities include cash inflows and outflows from business operations. Investing activities includes cash inflows and cash outflows from purchase and sale of land or equipment, or investments. Financing activities includes cash inflows and outflows from issuance of common stock and debt, payment of debt and dividends.

Prepare the statement of cash flows for Shop B for the year ended December 31, Year 1.

Shop B
Statement of Cash Flows
For the Year Ended December 31, Year 1
Cash flows from operating activities:
Cash inflow from customers	$165,000
Cash outflow for inventory	(65,000)
Cash outflow for expenses	(30,800)
Net cash flow from operating activities		$69,200
Cash flows from investing activities		0
Cash flows from financing activities:
Cash inflow from stock issue		35,000
Net change in cash		104,200
Add: Beginning cash balance		0
Ending cash balance		$104,200

Table (22)

d.

To determine

Prepare closing entries at the end of Year 1 and post the entries into T-accounts.

Explanation of Solution

Closing entries: The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Prepare closing entries at the end of Year 1 for Shop B.

Closing revenues:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Sales Revenue			165,000
			Retained Earnings			165,000
		(Record revenues being closed to Retained Earnings account)

Table (23)

Description:

• Sales Revenue is a revenue account. Since revenues are closed to Retained Earnings account, the account is cancelled by debiting to reverse its effect.
• Retained Earnings is a stockholders’ equity account. Since revenues are transferred to the account, the value increased, and an increase in equity is credited.

Closing expenses:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
		Retained Earnings			96,900
			Cost of Goods Sold			66,100
			Advertising Expense			2,800
			Salaries Expense			28,000
		(Record expenses being closed to Retained Earnings account)

Table (24)

Description:

• Retained Earnings is a stockholders’ equity account. Since expenses are transferred to the account, the value decreased, and a decrease in equity is debited.
• Cost of Goods Sold, Advertising Expense, and Salaries Expense are expenses accounts. Since expenses are closed to Retained Earnings account, the accounts are cancelled by crediting to reverse the effect.

Post the entries into T-accounts.

Cash
Balance	$104,200

Table (25)

Merchandise Inventory
Balance	$28,500

Table (26)

Accounts Payable
		Balance	$20,000

Table (27)

Common Stock
		Balance	$44,600

Table (28)

Retained Earnings
Cost of goods sold	$66,100	Sales revenue	$165,000
Advertising expense	2,800
Salaries expense	28,000
Total	96,900	Total	165,000
		Balance	$68,100

Table (29)

Sales Revenue
		Cash	$165,000
Total	$0	Total	165,000
		Balance	$165,000
Retained earnings	$165,000
Total	165,000	Total	165,000
		Balance	$0

Table (30)

Cost of Goods Sold
Purchases	$85,000	Merchandise inventory	$28,500
Merchandise inventory	9,600
Total	94,600	Total	28,500
Balance	$66,100
		Retained earnings	$66,100
Total	66,100	Total	66,100
Balance	$0

Table (31)

Advertising Expense
Cash	$2,800
Total	2,800	Total	$0
Balance	$2,800
		Retained earnings	$2,800
Total	2,800	Total	2,800
Balance	$0

Table (32)

Salaries Expense
Cash	$28,000
Total	28,000	Total	$0
Balance	$28,000
		Retained earnings	$28,000
Total	28,000	Total	28,000
Balance	$0

Table (33)

e.

To determine

Prepare post-closing trial balance for Shop B as of December 31, Year 1, based on the T-accounts prepared in Part (d).

Explanation of Solution

Post-closing trial balance: Post-closing trial balance is a summary of all the asset, liability, and equity accounts and their balances, after the closing entries are prepared. So, post-closing trial balance reports the balances of permanent accounts only.

Prepare post-closing trial balance for Shop B as of December 31, Year 1.

Shop B
Post-Closing Trial Balance
December 31, Year 1
Account Titles	Debit ($)	Credit ($)
Cash	$104,200
Merchandise Inventory	28,500
Accounts payable		$20,000
Common Stock		44,600
Retained earnings		68,100
Total	$132,700	$132,700

Table (34)

Conclusion

Hence, the debit and credit total of post-closing trial balance of Shop B, as at December 31, Year 1 is $132,700.

f.

To determine

Mention the examples of businesses that use periodic and perpetual inventory system.

Explanation of Solution

Businesses that use periodic inventory system: A small business does not require a computer for recording the transactions related to inventory like purchases, sales, and cost of goods sold. This would be cost-effective too. So, small businesses which do not have large inventory transactions use periodic inventory system.

Businesses that use perpetual inventory system: Large and very large businesses require computers to record the numerous transactions related to inventory like purchases, sales, and cost of goods sold. Computerized equipment is required to keep track of the inventory transactions and the businesses can afford the cost of those equipment. So, large businesses which have numerous inventory transactions use perpetual inventory system.

g.

To determine

Mention few assets, other than cash, which can be contributed in exchange for common stock.

Explanation of Solution

Generally, owners contribute the assets in exchange for common stock. Assets like equipment, land, building, and inventory could be contributed in exchange for common stock.