Chapter 5, Problem 5AP

1.

To determine

Journalize adjusting entries of Company N.

Explanation of Solution

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

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Record the adjusting entries of Company N.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
a.	Store supplies expense (1)		4,050
	Store supplies			4,050
	(To record store supplies expense)
b.	Insurance expenses		1,400
	Prepaid expenses			1,400
	(To record prepaid selling expenses)
c.	Depreciation expense - Store equipment		1,525
	Accumulated Depreciation - Store equipment			1,525
	(To record depreciation expenses)
d.	Cost of goods sold		1,600
	Merchandise inventory (2)			1,600
	(To record the inventory shrinkage)

Table (1)

a. To record store supplies expense:

• Store supplies expense is an expense account and it is increased. Therefore, debit office supplies expense with $4,050.
• Store supplies are an asset account and it is decreased. Therefore, credit office supplies with $4,050.

b. To record prepaid insurance expenses:

• Insurance expense is an expense account and it is increased. Therefore, it is debited with $1,400.
• Prepaid expense is an asset account and it is decreased. Therefore, credit prepaid selling expense with $1,400.

c. To record depreciation expenses:

• Depreciation expense is an expense account and it is increased. Therefore, it is debited with $1,525.
• Prepaid expense is an asset account and it is decreased. Therefore, credit prepaid selling expense with $1,525.

d. To record the shrinkage of inventory:

• Cost of goods sold is an expense and they are increased. Thus, it is debited with $1,600.
• Inventory is an asset account, and they are increased. Hence, debit the inventory returns estimated account by $1,600.

Working Note:

Compute the Store supplies expense.

…… (1)

Compute the shrinkage of inventory.

…… (2)

2.

To determine

Prepare the multi-step income statement of Company N for the year ended January 31.

Explanation of Solution

Multi-step income statement: The income statement represented in multi-steps with several subtotals, to report the income from principal operations, and separate the other expenses and revenues which affect net income, is referred to as multi-step income statement.

Prepare the income statement of Company N for the year ended January 31.

Company N
Statement of Income
For the year ended January 31
Particulars	Amount	Amount
Sales		$111,950
Less:  Sales discounts	$2,000
Sales returns and allowances	$2,200	($4,200)
Net sales		$1,07,750
Less: Cost of goods sold (2)		($40,000)
Gross profit		$67,750
Expenses
Selling expenses
Depreciation expense—Store equipment	$1,525
Sales salaries expense $\left(\$35,000\times 1/2\right)$	$17,500
Rent expense—Selling space $\left(\$15,000\times 1/2\right)$	$7,500
Store supplies expense (1)	$4,050
Advertising expense	$9,800
Total selling expenses	$40,375
General and administrative expenses
Insurance expense	$1,400
Office salaries expense $\left(\$35,000\times 1/2\right)$	$17,500
Rent expense—Office space $\left(\$15,000\times 1/2\right)$	$7,500
Total general and administrative expenses	$26,400
Total expenses		($66,775)
Net income		$975

Table (2)

Thus, the net income of Company N for the year ended January 31, 2017 is $975.

3.

To determine

Prepare the single-step income statement of Company N for the year ended December 31.

Explanation of Solution

Single-step income statement:  This statement displays the total revenues as one line item from which the total expenses including cost of goods sold is subtracted to arrive at the net profit /net loss for the period.

Prepare the income statement of Company N for the year ended January 31.

Company N
Statement of Income
For the year ended January 31
Particulars	Amount	Amount
Net sales		$107,750
Less: Expenses
Cost of goods sold (2)	$40,000
Selling expenses (Refer Table (2))	$40,375
General and administrative expense (Refer Table (2))	$26,400
Total expenses		($1,06,775)
Net income		$975

Table (3)

Thus, the net income of Company N for the year ended January 31 is $975.

4.

To determine

Compute current ratio, acid-test ratio and gross margin ratio.

Explanation of Solution

Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. Current ratio is calculated by using the formula:

  $\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

Acid test ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

  $\text{Acid test ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Gross margin ratio: The percentage of gross profit generated by every dollar of net sales is referred to as gross margin ratio. This ratio measures the profitability of a company by quantifying the amount of income earned from sales revenue generated after cost of goods sold are paid. The higher the ratio, the more ability to cover operating expenses. It is calculated by using the formula:

$\text{Gross margin ratio}=\frac{\text{Net sales}-\text{Cost of goods sold}}{\text{Net sales}}$

Compute current ratio, acid test ratio and gross margin ratio of Company N.

Computation of ratios
Particulars	Amount
Cash	$1,000
Merchandise inventory (2)	$10,900
Store supplies (1)	$1,750
Prepaid insurance	$1,000
Total current assets (A)	$14,650
Current liabilities (B)	$10,000
Current ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	1.47
Quick assets (Cash) (C)	$1,000
Current liabilities (D)	$10,000
Acid-test ratio $\left(\text{C}\right)÷\left(\text{D}\right)$	0.10
Net Sales (E)	$107,750
Less: Cost of Goods Sold (2)	($40,000)
Gross margin (F)	$67,750
Gross margin ratio $\left(\text{F}\right)÷\left(\text{E}\right)$	0.63 or 63%

Table (4)

The current ratio, acid- test ratio and gross margin ratio of Company N is 1.47, 0.10 and 0.63 or 63% respectively.