Chapter 6, Problem 6.21E

Complete the accounting cycle using Inventory transactions (LO6-2.6-3. 6-5.6-6. 6-7)

On January 1, 2018, the general ledger of Big Blast Fireworks includes the following account balances:

Accounts	Debit	Credit
Cash	$ 21,900
Accounts Receivable	36,500
Allowance for Uncollectible Accounts Inventory	30,000	$ 3,100
Land Accounts Payable	61,600	32,400
Notes Payable (8%. due in 3 years)		30,000
Common Stock		56,000
Retained Earnings		28,500
Totals	$150,000	$150,000

The $30,000 beginning balance of inventory consists of 300 units, each costing $100. During January 2018, Big Blast Fireworks had the following inventory transactions:

January    3    Purchase 1,200 units for $126,000 on account ($105 each).

January    8    Purchase 1,300 units for $143,000 on account ($110 each).

January    12    Purchase 1,400 units for $161,000 on account ($115 each).

January    15    Return 100 of the units purchased on January 12 because of defects.

January    19    Sell 4,000 units on account for $600,000. The cost of the units sold is determined using a FIFO perpetual inventory system.

January    22    Receive $380,000 from customers on accounts receivable.

January    24    Pay $410,000 to inventory suppliers on accounts payable.

January    27    Write off accounts receivable as uncollectible, $2,500.

January    31    Pay cash for salaries during January, $128,000.

Required:

1.    Record each of the transactions listed above, assuming a FIFO perpetual inventory system.

2.    Record adjusting entries on January 31.

  a.    At the end of January, the company estimates that the remaining units of inventory are expected to sell in February for only $100 each.

  b.    At the end of January, S4.000 of accounts receivable are past due, and the company estimates that 40% of these accounts will not be collected. Of the remaining accounts receivable, the company estimates that 4% will not be collected.

  c.    Accrued interest expense on notes payable for January. Interest is expected to be paid each December 31.

  d.    Accrued income taxes at the end of January are $12,300.

3.    Prepare an adjusted trial balance as of January 31, 2018, after updating beginning balances (above) for transactions during January-(Requirement 1) and adjusting entries at the end of January (Requirement 2).

4.    Prepare a multiple-step income statement for the period ended January 31, 2018.

5.    Prepare a classified balance sheet as of January 31, 2018.

6.    Record closing entries.

7.    Analyze how well Big Blast Fireworks' manages its inventory:

  a.    Calculate the inventory turnover ratio for the month of January. If the industry average of the inventory turnover ratio for the month of January is 18.5 times. Is the company managing its inventory more or less efficiently than other companies in the same industry?

  b.    Calculate the gross profit ratio for the month of January. If the industry average gross profit ratio is 33%, is the company more or less profitable per dollar of sales than other companies in the same industry?

  c.    Used together, what might the inventory turnover ratio and gross profit ratio suggest about Big Blast Fireworks' business strategy? Is the company's strategy to sell a higher volume of less expensive items or does the company appear to be selling a lower volume of more expensive items?

To determine

To record: Each transactions of Company BBF, assuming a FIFO perpetual inventory system.

Explanation of Solution

Perpetual Inventory System:

Perpetual Inventory System refers to the inventory system that maintains the detailed records of every inventory transactions related to purchases, and sales on a continuous basis. It shows the exact on-hand-inventory at any point of time.

Record the journal entries of Company BFF, assuming a FIFO perpetual inventory system:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
January 3	Merchandised Inventory		126,000
	Accounts Payable			126,000
	(To record the purchase of inventories on account)
January 8	Merchandised Inventory		143,000
	Accounts Payable			143,000
	(To record the purchase of inventories on account)
January 12	Merchandised Inventory		161,000
	Accounts Payable			161,000
	(To record the purchase of inventories on account)
January 15	Accounts Payable		11,500
	Merchandised Inventory (1)			11,500
	(To record the return of defective inventories)
January 19	Accounts Receivable		600,000
	Sales Revenue			600,000
	(To record the sales on account)
January 19	Cost of Goods Sold Table (2)		437,000
	Merchandised Inventory			437,000
	(To record the cost of goods sold)
January 22	Cash		580,000
	Accounts receivable			580,000
	(To record the cash received on account)
January 24	Accounts Payable		410,000
	Cash			410,000
	(To record the payment of inventory supplies on account)
January 27	Allowance for uncollectible accounts		2,500
	Accounts receivable			2,500
	(To record the write off accounts receivable as uncollectible)
January 31	Salaries expense		128,000
	Cash			128,000
	(To record the payment made to salaries)

Table (1)

Working note:

Determine the amount of defective inventory:

$\begin{array}{c}\begin{array}{l}\text{Amount of defective}\\ \text{inventory}\end{array}\}\text{= Number of units returned×Rate of each units}\\ \text{=\$115}\times \text{100 Units}\\ \text{=\$11,500}\end{array}$ (1)

Determine the amount of cost of goods sold:

Particulars	Number of units	Rate per unit ($)	Total cost ($)
Beginning balance	300	100	30,000
Purchase on January 3	1,200	105	126,000
Purchase on January 8	1,300	110	143,000
Purchase on January 12	1,200	115	138,000
Cost of goods sold			437,000

Table (2)

To determine

To record: The adjusting entries on January 31.

Explanation of Solution

Adjusting entries:

Adjusting entries refers to the entries that are made at the end of an accounting period in accordance with revenue recognition principle, and expenses recognition principle.  The purpose of adjusting entries is to adjust the revenue, and the expenses during the period in which they actually occurs.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
(a)	Cost of Goods Sold		1,500
January 31	Merchandised Inventory (2)			1,500
	(To record the adjustment made in the cost of goods sold)
(b)	Bad debts expenses		3,000
January 31	Allowance for uncollectible accounts (3)			3,000
	(To record the adjustment in uncollectible accounts)
(c)	Interest expense (6)		200
January 31	Interest Payable			200
	To record the accrued interest expense)
(d)	Income tax Expense		12,300
January 31	Income tax Payable			12,300
	(To record the accrued income taxes)

Table (3)

Working notes:

Determine the amount of merchandise inventory:

$\begin{array}{c}\text{Merchandise inventory = Units remaining×}\left[\begin{array}{l}\text{Rate per unit in}\\ \text{January}-\text{Rate expected }\\ \text{to be sold in february}\end{array}\right]\\ \text{=100Units×}\left[\text{\$115}-\text{\$100}\right]\\ \text{=\$1,500}\end{array}$ (2)

Determine the allowance for uncollectible accounts:

$\begin{array}{c}\begin{array}{l}\text{Allowance for }\\ \text{uncollectible accounts }\end{array}\}\text{=}\left[\begin{array}{l}\text{40\% on Accounts receivable +}\\ \text{ 4\% on remaining receivable (5)}\\ -\text{Uncollectible accounts (4)}\end{array}\right]\\ \text{=}\left(\text{\$4,000×}\frac{\text{40}}{\text{100}}\right)\text{+}\left(\text{\$50,000×}\frac{\text{4}}{\text{100}}\right)-\text{600}\\ \text{=\$1,600 + \$2,000}-\text{600}\\ \text{=\$3,000}\end{array}$ (3)

Determine the amount of uncollectible accounts:

$\begin{array}{c}\text{Uncollectible accounts =}\left[\begin{array}{l}\text{Allowance for uncollectible accounts}\\ -\text{Write off uncollectible accounts}\end{array}\right]\\ =\$3,100-\$2,500\\ =\$600\end{array}$ (4)

Determine the amount of remaining receivables:

$\begin{array}{c}\text{Accounts}\text{receivable =}\left[\begin{array}{l}\text{Beginning balance + receivable}\\ \text{ on 19th}-\text{receivable on 22}-\text{write}\\ \text{ off receivables }-\text{accounts receivable due}\end{array}\right]\\ =\left[\begin{array}{l}\$36,500+\$600,000-\\ \$580,000-\$2,500-\$4,000\end{array}\right]\\ =\$50,000\end{array}$ (5)

Determine the amount of interest expenses:

$\begin{array}{c}\text{Interest expenses = 8\% on Notes payble due }\\ \text{=}\left(\text{\$30,000×}\frac{\text{8}}{\text{100}}\text{×}\frac{\text{1}}{\text{12}}\right)\\ =\$200\end{array}$ (6)

To determine

To prepare: An adjusted trail balance as of January 31, 2018.

Explanation of Solution

Adjusted trial balance:

Adjusted trial balance is a summary of all the ledger accounts, and it contains the balances of all the accounts after the adjustment entries are journalized, and posted.

An adjusted trail balance as of January 31, 2018 is prepared as follows:

Company BBF
Adjusted Trial Balance
January 31, 2018
Particulars	Debit ($)	Credit ($)
Cash (7)	$63,900
Accounts Receivable (8)	54,000
Inventory (9)	10,000
Land	61,600
Allowance for Uncollectible Accounts (11)		$3,600
Accounts Payable (10)		40,900
Interest Payable		200
Income Tax Payable		12,300
Notes Payable		30,000
Common Stock		56,000
Retained Earnings		28,500
Sales Revenue		600,000
Cost of Goods Sold	438,500
Salaries Expense	128,000
Bad Debt Expense	3,000
Interest Expense	200
Income Tax Expense	12,300
Totals	$771,500	$771,500

Table (4)

Working note:

Determine the amount of cash:

$\begin{array}{c}\text{Cash = }\left[\begin{array}{l}\text{Beginning balance + Cash }\\ \text{received on 22}-\text{Cash payments}\\ \text{made on 24th and 31st}\end{array}\right]\\ =\$21,900+\$580,000-\$410,000-128,000\\ =\$63,900\end{array}$ (7)

Determine the amount of accounts receivable:

$\begin{array}{c}\text{Accounts}\text{receivable =}\left[\begin{array}{l}\text{Beginning balance + receivable}\\ \text{ on 19th}-\text{receivable on 22}-\text{write}\\ \text{ off receivables }-\text{accounts receivable due}\end{array}\right]\\ =\left[\$36,500+\$600,000-\$580,000-\$2,500\right]\\ =\$54,000\end{array}$ (8)

Determine the amount of inventory:

$\begin{array}{c}\text{Inventory =}\left[\begin{array}{l}\text{Beginning balance +Purchase of }\\ \text{inventories on account}-\text{sale of inventories}\end{array}\right]\\ \text{=}\left[\begin{array}{l}\text{\$30,000+\$126,000+\$143,000}-\\ \text{\$161,000}-\text{\$437,000}-\text{11,500}-1,500\end{array}\right]\\ \text{=\$10,000}\end{array}$ (9)

Determine the amount of accounts Payable:

$\begin{array}{c}\text{Accounts}\text{Payable =}\left[\text{Beginning balance +Accounts payable due}-\text{Payments made}\right]\\ \text{=}\left[\begin{array}{l}\text{\$32,400+\$126,000+\$143,000}\\ -\text{\$161,000}-\text{\$410,000}-11,500\end{array}\right]\\ \text{=\$40,900}\end{array}$ (10)

Determine the amount of uncollectible accounts:

$\begin{array}{c}\text{Uncollectible accounts =}\left[\begin{array}{l}\text{Allowance for uncollectible accounts}\\ -\text{Write off uncollectible accounts+adjsuting entry}\end{array}\right]\\ =\$3,100-\$2,500+\$3,000\\ =\$3,600\end{array}$ (11)

Conclusion

The debit column and credit column of the unadjusted trial balance are agreed, both having balance of $771,500.

To determine

To prepare: A multiple-step income statement for the period ended January 31, 2018.

Explanation of Solution

A multiple-step income statement for the period ended January 31, 2018 is prepared as follows:

Income Statement (Multiple-Step)
For the year ended January 31, 2018
Sales revenue	$600,000
Cost of goods sold	438,500
Gross profit		$161,500
Salaries expense	128,000
Bad debt expense	3,000
Total operating expenses		131,000
Operating income		30,500
Interest expense		200
Income before taxes		30,300
Income tax expense		12,300
Net income		$18,000

Table (5)

Conclusion

Therefore, a multiple-step income statement shows a net income of $18,000.

To determine

To prepare: A classified balance sheet as of January 31, 2018.

Explanation of Solution

Classified balance sheet:

This is the financial statement of a company which shows the grouping of similar assets and liabilities under subheadings.

A classified balance sheet as of January 31, 2018is prepared as follows:

Company BBF
Classified Balance Sheet
January 31, 2018
Assets			Liabilities
Cash		$63,900	Accounts payable	$40,900
Accounts receivable	54,000		Interest payable	200
Less: Allowance	-3,600	50,400	Income tax payable	12,300
Inventory		10,000	Total current liabilities	53,400
Total current assets		124,300	Notes payable	30,000
			Total liabilities	83,400
Land		61,600	Stockholders’ Equity
			Common stock	56,000
			Retained earnings	46,500
			Total stockholders’ equity	102,500
Total assets		$185,900	Total liabilities and stockholders’ equity	$185,900

Table (6)

To determine

To record: The closing entries.

Explanation of Solution

Closing entries:

Closing entries are recorded in order to close the temporary accounts such as incomes and expenses by transferring them to the permanent accounts. It is passed at the end of the accounting period, to transfer the final balance.

Closing entry for revenue and expense accounts:

Date	Accounts title and Explanation	Debit ($)	Credit ($)
January 31, 2018	Service Revenue	600,000
	Retained earnings		600,0000
	(To close the revenues  account)
	Retained earnings	582,000
	Cost of goods sold		483,500
	Salaries expenses		128,000
	Bad debt expense		3,000
	Interest expense		200
	Income tax expense		12,300
	(To close the expenses account)

Table (7)

To determine

To calculate: The inventory turnover ratio.

Answer to Problem 6.21E

The inventory turnover is 21.9 Times.

Explanation of Solution

Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the inventory turnover ratio is as follows:

$\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Working note:

The inventory turnover ratio is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$483,500}{\$20,000}\\ =\text{ 21}\text{.9Times}\end{array}$

Calculate the average inventory:

$\begin{array}{c}\text{Average inventory =}\frac{\text{Beginninginventory+endinginventory}}{2}\\ \text{=}\frac{\text{\$30,000+\$10,000}}{\text{2}}\\ \text{= \$20,000}\end{array}$

The inventory turnover ratio is calculated by dividing cost of goods sold by average inventory during the period. The average inventory is calculating by dividing beginning inventory and ending inventory by 2. The inventory turnover ratio is an important measure as to how efficient is the management is good at managing inventory and achieving sales from it.

To determine

To calculate: The gross profit ratio.

Answer to Problem 6.21E

The gross profit ratio is 26.9%.

Explanation of Solution

Gross profit method

This method is use the estimated gross profit for the period to evaluate and ascertain the ending inventory for the period. The gross profit for the period is calculated from the preceding year, which is adjusted for any current period changes in the sales and cost price of the inventory.

Working note:

The gross profit ratio is calculated as follows:

$\begin{array}{c}\text{Gross profit ratio=}\frac{\text{Sales}-\text{Cost of goods sold}}{\text{Net sales}}\\ \text{=}\frac{\text{\$600,000}-\$438,500}{\text{\$600,000}}\\ \text{= 26}\text{.9\%}\end{array}$

To determine

To state: Whether the company sells a higher volume of less expensive item or a lower volume of more expensive items.

Explanation of Solution

From the inventory turnover ratio and the gross profit ratio, it is clear that the Company BB appears to sell a higher volume of less expensive. This is because, the lower price item sell more than high priced items.