Chapter 6, Problem 3PA

Recording Sales with Discounts and Returns and Analyzing Gross Profit Percentage

Hair World Inc. is a wholesaler of hair supplies. Hair World uses a perpetual inventory system. The following transactions (summarized) have been selected for analysis:

Required:

1. 1. Compute Net Sales and Gross Profit for Hair World. No additional sales returns/allowances are expected.
2. 2. Compute the gross profit percentage (using the formula shown in this chapter and rounding to one decimal place).
3. 3. Prepare journal entries to record transactions (a)–(e).
4. 4. Hair World is considering a contract to sell merchandise to a hair salon chain for $15,000. This merchandise will cost Hair World $10,000. Would this contract increase (or decrease) Hair World’s dollars of gross profit and its gross profit percentage?

To determine

Calculate the sales revenue and gross profit of Incorporation H.

Explanation of Solution

Sales revenue:

Sales revenue is the amount received by the company from the sale of goods and services during day-to-day operations of the company within specified period of time.

Gross Profit:

Gross Profit is the difference between the net sales, and the cost of goods sold. Gross profit usually appears on the income statement of the company.

Calculate the sales revenue and gross profit of Incorporation H as follows:

Particulars	Amount($)
Sales Revenue (1)	61,200
Less: Sales Returns and Allowances(2)	(760)
Net Sales	60,440
Less: Cost of Goods Sold (3)	33,187
Gross Profit	27,253

Table (1)

Working note 1:

Calculate the value of sales revenue:

$\begin{array}{c}\text{Sales}\text{revenue=}\left(\begin{array}{l}\text{Sale}\text{of}\text{merchandise}\text{for}\text{cash+}\\ \text{Sale}\text{of}\text{merchandise}\text{on}\text{account}\end{array}\right)\\ \text{=\$51,200 + \$10,000}\\ \text{=\$61,200}\end{array}$

Working note 2:

Calculate the sales returns and allowances:

$\begin{array}{c}\text{Sales}\text{returns}\text{and}\text{allowances=}\left(\text{Merchandise}\text{returned + Partial}\text{allowance}\right)\\ \text{=\$600 + \$160}\\ \text{=\$760}\end{array}$

Working note 3:

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost}\text{of}\text{goods}\text{sold=}\left(\begin{array}{l}\left[\begin{array}{l}\text{Cost}\text{of}\text{merchandise}-\text{Original}\\ \text{cost}\text{of}\text{returned}\text{merchandise}\end{array}\right]+\\ \text{Original}\text{cost}\text{of}\text{merchandise}\text{sold}\end{array}\right)\\ \text{=}\left(\text{\$28,797}-\text{\$360}\right)\text{+\$4,750}\\ \text{=\$33,187}\end{array}$

Conclusion

Therefore, the net sales and gross profit of Incorporation H are $60,440 and $27,253 respectively.

To determine

Calculate the gross profit percentage of Incorporation H.

Explanation of Solution

Gross Profit Percentage:

Gross profit is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a percentage of net sales. Gross Profit is the difference between the net sales revenue, and the cost of goods sold. It can be calculated by dividing gross profit and net sales.

Calculate the gross profit percentage of Incorporation H as follows:

$\begin{array}{c}\text{Gross}\text{profit}\text{percentage=}\frac{\text{Gross}\text{profit}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$27,153}}{\text{\$60,440}}\text{×100}\\ \text{=45}\text{.1\%}\end{array}$

Conclusion

Therefore, the gross profit percentage of Incorporation H is 45.1%.

To determine

Prepare journal entries to record the transaction from (a) to (e).

Explanation of Solution

Journal Entry:

Journal entry is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Prepare journal entries to record the transaction from (a) to (e) as follows:

a. Record the sales revenue and cost of goods sold:

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Cash	51,200
	Sales Revenue		51,200
	(To record the sales revenue received in cash )

Table (2)

• Cash is an asset and it increases the value of assets. Therefore, debit cash by $51,200.
• Sales revenue is component of stockholders’ equity and it increases the value of stockholder’s equity. Therefore, credit sales revenue by $51,200.

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Cost of goods sold	28,797
	Inventory		28,797
	(To record the cost of goods sold incurred during the year)

Table (3)

• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Therefore, debit cost of goods sold by $28,797.
• Inventory is an asset and it decreases the value of asset. Therefore, credit inventory by $28,797.

b. Record the sales return and the cost of inventory used for production.

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Sales revenue	600
	Cash		600
	(To record the sales returns from customer)

Table (4)

• Sales revenue is a component of stockholders’ equity and it increases the value of stockholder’s equity. Therefore, debit sales revenue by $600.
• Cash is an asset and it decreases the value of assets. Therefore, credit cash by $600

.Date	Account Title and Explanation	Debit ($)	Credit ($)
	Inventory	360
	Cost of goods sold		360
	(To record the  cost of inventory return)

Table (5)

• Inventory is an asset and it increases the value of assets. Therefore, debit inventory by $360.
• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Therefore, credit cost of goods sold by $360.

c. Record the sale of merchandise on account:

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Accounts Receivable	10,000
	Sales Revenue		10,000
	(To record the sales revenue received on account)

Table (6)

• Accounts receivable is an asset and it increases the value of assets. Therefore, debit accounts receivable by $10,000.
• Sales revenue is component of stockholders’ equity and it increases the value of stockholder’s equity. Therefore, credit sales revenue by $10,000.

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Cost of goods sold	4,750
	Inventory		4,750
	(To record the  cost of inventory return)

Table (7)

• Cost of goods sold is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Therefore, debit cost of goods sold by $4,750.
• Inventory is an asset and it decreases the value of asset. Therefore, credit inventory by $4,750.

d. Record the cash receipt from customer.

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Cash	5,000
	Accounts Receivable		5,000
	(To record the cash received from customers)

Table (8)

• Cash is an asset and it increases the value of assets. Therefore, debit cash by $5,000.
• Accounts receivable is an asset and it decreases the value of assets. Therefore, credit accounts receivable by $5,000.

e. Record the sales return and allowances:

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Sales revenue	160
	Accounts receivable		160
	(To record the sales returns from customer and allowances )

Table (9)

• Sales revenue is a component of stockholders’ equity and it decreases the value of stockholder’s equity. Therefore, debit sales returns and allowances by $160.
• Accounts receivable is an asset and it decreases the value of assets. Therefore, credit accounts receivable by $160.

To determine

Describe whether the sale of given contract would increase (or decrease) the gross profit and gross profit percentage of Incorporation H.

Explanation of Solution

Describe whether the sales of given contract would increase (or decrease) the gross profit and gross profit percentage of Incorporation H as follows:

In this case, the gross profit percentage is decreased from 45.1% to 42.8% (5), because of the sale of contract.

Working note 4:

Calculate the gross profit from the sale of contract.

$\begin{array}{c}\text{Gross}\text{profit}\text{for}\text{sale}\text{of}\text{contract=}\left(\begin{array}{l}\text{Original}\text{cost}\text{of}\text{merchandise}-\\ \text{Selling}\text{price}\text{of}\text{merchandise}\end{array}\right)\\ \text{=\$15,000}-\text{\$10,000}\\ \text{=\$5,000}\end{array}$

Working note 5:

Calculate the gross profit percentage of Company after the sale of contract.

$\begin{array}{c}\text{Gross}\text{profit}\text{percentage=}\frac{\text{Gross}\text{profit + Gross profit of sales of contract}}{\text{Net}\text{sales + Book value of contract}}\text{×100}\\ \text{=}\frac{\text{\$27,253 + \$5,000 (refer working note 4)}}{\text{\$60,440 + \$15,000}}\text{×100}\\ \text{=}\frac{\$32,253}{\$75,440}\text{×100}\\ \text{=42}\text{.8\%}\end{array}$