Chapter 4, Problem 3GLP

To determine

General Ledger:

General ledger includes all the accounts for recording of various transactions in relation to income, expenses, assets, liabilities, owner’s equity. It is backbone of any accounting software.

Adjusting Entries:

Adjusting entries are the accounting entries which are made at the end of an accounting period to change the closing balances of various general ledger accounts. They are made to align the reported results and financial position of the business in accordance with the accounting framework, such as GAAP or IFRS.

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 Margin Ratio:

It means the ratio of gross profit earned to net sales. Formula to compute it:

  $\text{Gross}\text{margin}\text{ratio}=\frac{\text{Gross}\text{profit}}{\text{Net}\text{sales}}$

Current ratio:

It is ratio which gives idea about the ability of company to pay it liabilities. Formula to compute it:

  $\text{Current}\text{ratio}=\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}$

Acid Test ratio:

It measures the ability of company to use cash or its liquid assets or paying off current liabilities. Formula to compute it:

  $\text{Acid}\text{test}\text{ratio}=\frac{\text{Current}\text{assets}-\left(\text{Stock}+\text{Prepaid}\text{expenses}\right)}{\text{Current}\text{liabilities}}$

1.

To prepare: Adjusting entries.

Explanation of Solution

Physical count of Store supplies at the year end shows $1,750 still available but store supplies listed shows $5,800.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Supplies expense		4,050
	Store supplies			4,050
	(To record supplies consumed)

Table (1)

• Supplies expense account is an expense account. Since Supplies expense is increased, expense is to be increased. So, debit the Supplies expense account.
• Store supplies account is an asset account. Since inventory is shrinked, so it is to be reduced. Therefore, Store supplies account is to be credited.

Working notes:

Computation of inventory shrinkage,

  $\begin{array}{c}\text{Supplies Used}=\text{Supplies}\text{listed}-\text{Supplies}\text{still}\text{available}\\ =\$5,800-\$1,750\\ =\$4,050\end{array}$

Prepaid selling expenses worth $1,400 have expired:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Insurance expense		1,400
	Prepaid insurance expense			1,400
	(To record expired prepaid insurance expense)

Table (2)

• Insurance expense is an expense account. Since insurance expense is increased, expense is to be increased. So, debit the insurance expense account.
• Prepaid insurance expense is an asset account. Since prepaid insurance expense have expired resulting a decrease in asset, so asset is to be decreased. Therefore prepaid insurance expense account is credited.

Depreciation expense worth $1,525 is to be recorded:

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Depreciation expense		1,525
	Store equipment			1,525
	(To record depreciation expense)

Table (3)

• Depreciation expense is an expense account. Since depreciation expense is to be recorded, expense is to be increased. So, debit the depreciation expense account.
• Store equipment is an asset account. Since, depreciation expense is to be recorded resulting a decrease in asset, so asset is to be decreased. Therefore Store equipment account is credited.

Physical count of merchandise inventory at the year end shows $10,900 still available but merchandise inventory listed shows $12,500.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 31	Cost of goods sold		1,600
	Merchandise inventory			1,600
	(To record inventory shrinkage cost)

Table (4)

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

Working notes:

Computation of inventory shrinkage,

  $\begin{array}{c}\text{Inventory}\text{shrinkage}=\text{Inventory}\text{listed}-\text{Inventory}\text{still}\text{available}\\ =\$12,500-\$10,900\\ =\$1,600\end{array}$

2.

To determine

To prepare: Multi step income statement.

Explanation of Solution

Multi Step Income Statement

Company N
Multi step Income Statement
For the Year Ended January 31,
Particulars	Amount($)	Amount($)
Sales Revenue		111,950
Less: Sales Returns and Allowances	(2,200)
Sales discount	(2,000)	(4,200)
Net Sales		107,750
Less: Cost of Goods Sold		(40,000)
Gross Profit		67,750
Less: Selling expenses
Advertising expense	(9,800)	(9,800)
		57,950
Less: General and admin Expenses
Store supply expense	(4,050)
Rent expense	(15,000)
Insurance expense	(1,400)
Depreciation	(1,525)
Salaries	(35,000)	(56,975)
Net income		975

Table (5)

Hence, net income of Company N is $975.

3.

To determine

To prepare: Single step income statement.

Explanation of Solution

Single Step Income Statement

Company N
Single Step Income Statement
Particulars	Amount($)	Amount($)
Net Sales		107,750
Less: Expenses
Cost of goods sold	(40,000)
Selling expenses	(9,800)
General and admin Expenses	(56,975)	(106,775)
Net Sales		975

Table (6)

Hence, net income of Company N is $975.

4.

To determine

To Compute: Current and acid test ratio and gross margin ratio.

Explanation of Solution

Gross profit is $67,750. (From part 2)

Net sales is $107,750. (From part 2)

Formula to compute gross margin ratio,

  $\text{Gross}\text{margin}\text{ratio}=\frac{\text{Gross}\text{profit}}{\text{Net}\text{sales}}$

Substitute $67,750 for gross profit and $107,750 for net sales.

  $\begin{array}{c}\text{Gross}\text{margin}\text{ratio}=\frac{\$67,750}{\$107,750}\\ =62.87\%\end{array}$

Given,

Cash is $1,000.

Merchandise inventory is $10,900.

Store supplies are $1,750.

Prepaid asset is $1,000.

Current liabilities are $10,000.

Formula to compute current ratio,$\text{Current}\text{ratio}=\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}$

Substitute $14,650 for current assets and $10,000 for current liabilities.

  $\begin{array}{c}\text{Current}\text{ratio}=\frac{\$14,650}{\$10,000}\\ =1.47\end{array}$

Working notes:

Computation of current assets,

  $\begin{array}{c}\text{Current}\text{assets}=\text{Cash}+\text{Merchandise}\text{inventory}+\text{Store}\text{supplies}+\text{Prepaid}\text{assets}\\ =\$1,000+\$10,900+\$1,750+\$1,000\\ =\$14,650\end{array}$

Calculated,

Current assets are $14,650.

Merchandise inventory is $10,900.

Store supplies are $1,750.

Prepaid asset is $1,000.

Current liabilities are $10,000.

Formula to compute acid test ratio,$\text{Acid}\text{test}\text{ratio}=\frac{\text{Current}\text{assets}-\left(\text{Stock}+\text{Prepaid}\text{expenses}\right)}{\text{Current}\text{liabilities}}$

Substitute $14,650 for current assets, $12,650 $\left(10,900+1,750\right)$ for stock, $1,000 for prepaid expenses and $10,000 for current liabilities.

  $\begin{array}{c}\text{Acid}\text{test}\text{ratio}=\frac{\$14,650-\left(\$12,650+\$1,000\right)}{\$10,000}\\ =0.1\end{array}$

Hence, gross margin ratio of Company N is 62.87%, Current ratio is 1.47, acid test ratio is 0.1.

General ledger:

Supply expense
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Jan 31	Store supply		4,050		4,050

Table (7)

Hence, the ending balance is $4,050.

Store supply
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Feb 1	Opening balance		5,800		5,800
Jan 31	Supply expense			4,050	1,750

Table (8)

Hence, the ending balance is $1,750.

Insurance expense
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Jan 31	Prepaid insurance expense		1,400		1,400

Table (9)

Hence, the ending balance is $1,400.

Prepaid insurance expense
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Feb 1	Opening balance		2,400		2,400
Jan 31	Insurance expense			1,400	1,000

Table (10)

Hence, the ending balance is $1,000.

Depreciation expense
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Jan 31	Store equipment		1,525		1,525

Table (11)

Hence, the ending balance is $1,525.

Store equipment
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Feb 1	Opening balance		42,900		42,900
Jan 31	Depreciation expense			1,525	41,375

Table (12)

Hence, the ending balance is $41,375.

Cost of goods sold
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Jan 31	Merchandise inventory		1,600		1,600

Table (13)

Hence, the ending balance is $1,600.

Merchandise inventory
Date	Account Title and Explanation	Post ref	Debit($)	Credit($)	Balance($)
Feb 1	Opening balance		12,500		12,500
Jan 31	Cost of goods sold			1,600	10,900

Table (14)

Hence, the ending balance is $10,900.