Chapter 4, Problem 2PSB

To determine

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, and 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 the 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.

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. T

he purchases are to be recorded at full cost.

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

Explanation of Solution

Purchased merchandise inventory worth $7,500.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 3	Merchandise Inventory		15,000
	Account payable			15,000
	(To record merchandise inventory purchased on credit)

Table (1)

• 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.

Sold Merchandise inventory on account for $11,500:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 7	Account receivable		11,500
	Sales			11,500
	(To record sales made on account)

Table (2)

• 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($)	Credit($)
July 7	Cost of goods sold		7,750
	Merchandise inventory			7,750
	(To record cost of goods sold)

Table (3)

• 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.

Purchased merchandise inventory worth $14,200.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 10	Merchandise inventory		14,200
	Account payable			14,200
	(To record merchandise inventory purchased on credit)

Table (4)

• 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, accounts payable account is credited.

Paid $300 cash for shipping charges:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 11	Merchandise inventory		300
	Cash			300
	(To record shipping charges paid) by buyer)

Table (5)

• 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.

Company M received the goods worth $2,000 back and restores them:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 12	Sales return and allowances		2,000
	Account receivable			2,000
	(To record sales return)

Table (6)

• 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, accounts receivable is to be credited.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 12	Merchandise inventory		1,450
	Cost of goods sold			1,450
	(To record cost of goods sold)

Table (7)

• 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 M received price reduction for purchase of goods from Company R $1,200:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 14	Account payable		1,200
	Merchandise inventory			1,200
	(To record price reduction worth $1,200)

Table (8)

• 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.

Paid $200 cash for shipping charges reducing the amount owed to Company O:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 15	Account payable		200
	Cash			200
	(To record shipping charges paid by buyer)

Table (9)

• Account payable is a liability account. Since, the amount of freight is paid and value of liability is to be decreased. So, debit the account payable account.
• Cash is an asset account. Since, the cash is paid, the value of assets is decreased. So, credit the cash account.

Received cash from customer:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 17	Cash		9,310
	Sales discount		190
	Account receivable			9,500
	(To record final payment received from Company A)

Table (10)

• Cash is an 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 notes:

Computation of account receivables,

  $\begin{array}{c}\text{Account}\text{receivables}=\text{Sales}-\text{Sales}\text{return}\\ =\$11,500-\$2,000\\ =\$9,500\end{array}$

Computation of sales discount,

  $\begin{array}{c}\text{Sales}\text{Discount}=\text{Account}\text{recievable}\times \text{Rate}\text{of}\text{Discount}\\ =\$9,500\times 2\%\\ =\$190\end{array}$

Computation of cash to be received,

  $\begin{array}{c}\text{Cash}=\text{Account}\text{recievable}-\text{Sales}\text{discount}\\ =\$9,500-\$190\\ =\$9,310\end{array}$

Company M makes final payment to Company R:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 20	Account payable		13,000
	Merchandise inventory			130
	Cash			12,870
	(To record cash payment made for merchandise inventory )

Table (11)

• 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 notes:

Computation of accounts payable,

  $\begin{array}{c}\text{Account}\text{payables}=\text{Purchase}-\text{Credit}\text{memorandum}\\ =\$14,200-\$1,200\\ =\$13,000\end{array}$

Computation of merchandise inventory,

  $\begin{array}{c}\text{Discount}\text{amount}=\text{Account}\text{payables}\times \text{Discount}\text{rate}\\ =\$13,000\times 1\%\\ =\$130\end{array}$

Computation of cash to be paid,

  $\begin{array}{c}\text{Cash}=\text{Account}\text{payable}-\text{Discount}\\ =\$13,000-\$130\\ =\$12,870\end{array}$

Sold Merchandise inventory on account for $11,000:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 21	Account receivable		11,000
	Sales			11,000
	(To record sales made on account)

Table (12)

• 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($)	Credit($)
July 21	Cost of goods sold		7,000
	Merchandise inventory			7,000
	(To record cost of goods sold)

Table (13)

• 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 M gave price reduction for purchase of goods from Company B $1,000:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 24	Merchandise inventory		1,000
	Account receivable			1,000
	(To record price reduction worth $1,000)

Table (14)

• Merchandise inventory is an asset account. Since, it is returned to the seller, the value of asset is to be increased. So, debit the merchandise inventory account.
• Account receivable is an asset account. Since, price reduction is given so asset is to be decreased. Therefore, account receivable account is credited.

Received cash from customer:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 30	Cash		9,900
	Sales discount		100
	Account receivable			10,000
	(To record final payment received from Company A)

Table (15)

• Cash is an asset account. Since, payment is received in cash, so it is to be increased. Therefore, cash account is credited.
• 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 notes:

Computation of account receivables,

  $\begin{array}{c}\text{Account}\text{receivables}=\text{Sales}-\text{Price}\text{Reduction}\\ =\$11,000-\$1,000\\ =\$10,000\end{array}$

Computation of sales discount,

  $\begin{array}{c}\text{Sales}\text{Discount}=\text{Account}\text{recievable}\times \text{Rate}\text{of}\text{Discount}\\ =\$10,000\times 1\%\\ =\$100\end{array}$

Computation of cash to be received,

  $\begin{array}{c}\text{Cash}=\text{Account}\text{recievable}-\text{Sales}\text{discount}\\ =\$10,000-\$100\\ =\$9,900\end{array}$

Company M makes final payment to Company O:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 31	Account payable		14,800
	Cash			14,800
	(To record cash payment made for merchandise inventory )

Table (16)

• Account payable is a liability account. Since, payment is to be made for account payable which 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.

Working note:

Computation of accounts payable,

  $\begin{array}{c}\text{Accounts}\text{payable}=\text{Purchase}-\text{Freight}\\ =\$15,000-\$200\\ =\$14,800\end{array}$