Question

Lopez Company reports unadjusted first-year merchandise sales of \(100,000 and cost of merchandise sales of \)30,000.

a. Compute gross profit (using the unadjusted numbers above).

b. The company expects future returns and allowances equal to 5% of sales and 5% of cost of sales.

1. Prepare the year-end adjusting entry to record the sales expected to be refunded.

2. Prepare the year-end adjusting entry to record the cost side of sales returns and allowances.

3. Recompute gross profit (using the adjusted numbers from parts 1 and 2).

c. Is Sales Refund Payable an asset, liability, or equity account?

d. Is Inventory Returns Estimated an asset, liability, or equity account?

Short answer

1. Gross profit:$70,000.
2. Recalculated gross profit after return:$66,500.
3. Sales refund payable:Current liability.
4. Inventory return estimated:Current asset.

Step-by-step solution

Step-by-Step SolutionStep 1: Definition of Purchase Returns

When goods purchased by a business entity are returned to a supplier due to defects in the products or due to the wrong product, it is reported as purchase returns.

Gross profit

Particulars	Amount $
Sales	$100,000
Less: Cost of sales	($30,000)
Gross profit	$70,000

Adjusting entries

Date	Accounts and Explanation	Debit $	Credit $
1	Sales return and allowance	5,000
	Sales refund liability		5,000
2	Inventory return estimated	1,500
	Cost of goods sold		1,500

Re-calculation of gross profit:

Particulars	Amount $
Sales	$100,000
Less: Sales return and allowance	(5,000)
Net sales	95,000
Less: Cost of sales	(28,500)
Gross profit	$66,500

Classification of sales refund payable

Sales refund payable is reported as a current liability because it represents the amount to be refunded to a customer for returns. These returns are made within the business entity’s operating period.

Classification of Inventory return estimated

Inventory return estimated is used to restore the goods returned to a business’s inventory because they are not defective, and therefore, it is considered a current asset account.