Chapter 4, Problem 5E

To determine

Journal Entry:

It means record of financial data related to business transactions in a journal in a manner so that debit equals credit. It provides 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 and losses and debit all liabilities, revenues and gains including capital.

Perpetual Inventory System:

The inventory system in which the inventory accounts are updated on every single purchase or sale in inventory. 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.

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

Answer to Problem 5E

Solution:

Journal entries in the books of Company A:

Purchased merchandise on account worth $20,000.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 3	Merchandise Inventory		20,000
	Cash			20,000
	(To record purchase of merchandise inventory for cash)

Explanation of Solution

▪ Inventory is an asset account. Since the Inventory is purchased, the value of assets is increased. So, debit the Inventory account.

▪ Cash is an asset account. Since cash is paid for purchase of inventory, it is to be reduced. Therefore, credit cash account.

Working note:

Calculation of purchase cost:

$\begin{array}{c}\text{Purchase}\text{cost}=\text{Number}\text{of}\text{units}\times \text{Unit}\text{cost}\text{per}\text{unit}\\ =2,000\times \$10\\ =\$20,000\end{array}$

Sold 1,500 units of inventory for $14 on account:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 5	Account Receivable		21,000
	Sales			21,000
	(To record sales made on account)

• 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.

Working Note:

Calculation of amount of sales:

$\begin{array}{c}\text{Sales}=\text{Number}\text{of}\text{units}\text{sold}\times \text{Sales}\text{price}\text{per}\text{unit}\\ =1,500\times \$14\\ =\$21,000\end{array}$

Record cost of sold goods on May 5.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 5	Cost of goods sold		15,000
	Merchandise inventory			15,000
	(To record cost of goods sold)

• Cost of goods sold account is an expense account. Since expense is to be increased, expense is 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.

Working note:

Calculation of cost of goods sold:

$\begin{array}{c}\text{Cost}\text{of}\text{goods}\text{sold}=\text{Number}\text{of}\text{units}\text{sold}\times \text{Cost}\text{price}\text{per}\text{unit}\\ =1,500\times \$10\\ =\$15,000\end{array}$

Company B returns 200 units because they were unfit as per its needs:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 7	Sales return and allowances		2,800
	Account receivable			2,800
	(To record sales return)

• 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 account receivable is to be credited.

Working Note:

Calculation of sales return and allowances:

$\begin{array}{c}\text{Sales}\text{return}\text{and}\text{allowances}=\text{Number}\text{of}\text{units}\text{returned}\times \text{Sale}\text{price}\text{per}\text{unit}\\ =200\times \$14\\ =\$2,800\end{array}$

Record cost of goods returned.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 7	Cost of goods sold		2,000
	Merchandise inventory			2,000
	(To record cost of goods sold)

• Cost of goods sold account is an expense account. Since expense is to be increased, expense is 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.

Working note:

Calculation of cost of goods sold:

$\begin{array}{c}\text{Cost}\text{of}\text{goods}\text{sold}=\text{Number}\text{of}\text{units}\text{sold}\times \text{Cost}\text{price}\text{per}\text{unit}\\ =200\times \$10\\ =\$2,000\end{array}$

Company B discovered scuffed units and gave credit memorandum to Company A.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 8	Sales return and allowances		600
	Account receivable			600
	(To record sales return)

• 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 account receivable account is to be credited.

Company B found 100 units of wrong color. So, returns 40 units because they were unfit as per its needs:

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 15	Sales return and allowances		680
	Account receivable			680
	(To record sales return)

• 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 account receivable is to be credited.

Working Note:

Calculation of sales return and allowances:

$\begin{array}{c}\text{Sales}\text{return}\text{and}\text{allowances}=\left(\begin{array}{l}\left(\text{Number}\text{of}\text{units}\text{returned}\times \text{Sale}\text{price}\text{per}\text{unit}\right)\\ +\text{Compensation}\end{array}\right)\\ =\left(40\times \$14\right)+\$120\\ =\$560+\$120\\ =\$680\end{array}$

Record cost of goods returned.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
May 15	Cost of goods sold		400
	Merchandise inventory			400
	(To record cost of goods sold)

• Cost of goods sold account is an expense account. Since expense is to be increased, expense is 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.

Working note:

Calculation of cost of goods sold:

$\begin{array}{c}\text{Cost}\text{of}\text{goods}\text{sold}=\text{Number}\text{of}\text{units}\text{sold}\times \text{Cost}\text{price}\text{per}\text{unit}\\ =40\times \$10\\ =\$400\end{array}$