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Chapter 4: Q4-12E (page 211)

A retail company recently completed a physical count of ending merchandise inventory to use in preparing adjusting entries. In determining the cost of the counted inventory, company employees failed to consider that $3,000 of incoming goods had been shipped by a supplier on December 31 under an FOB shipping point agreement. These goods had been recorded in Merchandise Inventory as a purchase, but they were not included in the physical count because they were in transit.

a. Explain how this overlooked fact impacts the company’s balance sheet and income statement.

b. Indicate whether this overlooked fact results in an overstatement, understatement, or no effect on the following separate ratios: return on assets, debt ratio, current ratio, and acid-test ratio.

Short Answer

Expert verified

Answer

  1. Thecurrent assets, total assets, equity, and net income will be understated.

Return on assets and the current ratio will decline, whereas the quick ratio will remain unaffected and the debt ratio will increase.

Step by step solution

01

Step-by-Step SolutionStep 1: Definition of Inventory Shrinkage

The amount of inventory reported in the balance sheet, but which does not exist in the physical count is known as inventory shrinkage. Business entities incur loss due to such shrinkage.

02

Impact on the balance sheet and income statement

There will be a difference between actual and physical inventory because the inventory of $3,000 is in transit and is reported on the balance sheet. Such difference will be reported as inventory shrinkage in the accounting books as the cost of goods sold will understate the net income, equity, current assets, and total assets.

03

Impact on ratios

  1. Return on the asset will decline because the numerator and denominator used to calculate the ratio will decline.
  2. Debt ratio will increase because of a decrease in the value of total assets.
  3. Current ratio will also decrease due to a decrease in the inventory of the business entity.
  4. Quick ratio will not be affected because inventory is not included in the quick ratio calculation.

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Most popular questions from this chapter

Refer to QS 4-8 and prepare journal entries to record each of the merchandising transactions assuming that the company records purchases using the gross method and a periodic inventory system.

Prepare journal entries to record the following merchandising transactions of Menards, which applies the perpetual inventory system and gross method. (Hint: It will help to identify each receivable and payable; for example, record the purchase on July 3 in Accounts Payable—OLB.)

July 3 Purchased merchandise from OLB Corp. for \(15,000 under credit terms of 1∕10, n∕30, FOB destination, invoice dated July 3.

7 Sold merchandise to Brill Co. for \)11,500 under credit terms of 2∕10, n∕60, FOB destination, invoice dated July 7. The merchandise had cost \(7,750.

10 Purchased merchandise from Rupert Co. for \)14,200 under credit terms of 1∕10, n∕45, FOB shipping point, invoice dated July 10.

11 Paid \(300 cash for shipping charges related to the July 7 sale to Brill Co.

12 Brill returned merchandise from the July 7 sale that had cost Menards \)1,450 and been sold for \(2,000. The merchandise was restored to inventory.

14 After negotiations with Rupert Co. concerning problems with the merchandise purchased on July 10, Menards received a credit memorandum from Rupert granting a price reduction of \)1,200.

15 At OLB’s request, Menards paid \(200 cash for freight charges on the July 3 purchase, reducing the amount owed to OLB.

17 Received balance due from Brill Co. for the July 7 sale less the return on July 12.

20 Paid the amount due Rupert Co. for the July 10 purchase less the price reduction granted on July 14.

21 Sold merchandise to Brown for \)11,000 under credit terms of 1∕10, n∕30, FOB shipping point, invoice dated July 21. The merchandise had cost \(7,000.

24 Brown requested a price reduction on the July 21 sale because the merchandise did not meet specifications. Menards sent Brown a credit memorandum for \)1,000 toward the $11,000 invoice to resolve the issue.

30 Received Brown’s cash payment for the amount due from the July 21 sale less the price allowance from July 24.

31 Paid OLB Corp. the amount due from the July 3 purchase.

BTN 4-9 Samsung (Samsung.com), Apple, and Google are competitors in the global marketplace. Key comparative figures for each company follow.

Net sales

Cost of sales

Samsung

W200,653,482

W123,482,118

Apple

\(233,715

\)140,089

Google

\(74,989

\)28,164

* Millions of Korean won for Samsung.

* Millions of dollars for Apple and Google.

Required

1. Rank the three companies (highest to lowest) based on the gross margin ratio.

2. Which of the companies uses a multiple-step income statement format? (These companies’ income statements are in Appendix A.)

BTN 4-6 Official Brands’s general ledger and supplementary records at the end of its current period reveal the following.

Sales, gross

\(600,000

Merchandise inventory

\)98,000

Sales return and allowances

20,000

Invoice cost of merchandise purchases

360,000

Sales discount

13,000

Purchase discount received

9,000

Cost of transportation-in

22,000

Purchase return and allowances

11,000

Operating expenses

50,000

Merchandise inventory (end of period)

84,000

Required

1. Each member of the team is to assume responsibility for computing one of the following items. You are not to duplicate your teammates’ work. Get any necessary amounts to compute your item from the appropriate teammate. Each member is to explain his or her computation to the team in preparation for reporting to the class.

  1. Net sales d. Gross profit
  2. Total cost of merchandise purchases e. Net income
  3. Cost of good sold

2. Check your net income with the instructor. If correct, proceed to step

3. Assume that a physical inventory count finds that actual ending inventory is $76,000. Discuss how this affects previously computed amounts in step 1.

Valley Company’s adjusted trial balance on August 31, 2017, its fiscal year-end, follows.

Debit

Credit

Merchandise inventory

\(41,000

Other (noninventory) assets

130,400

Total liabilities

\)25,000

Common stock

10,000

Retained earnings

94,550

Dividends

8,000

Sales

225,600

Sales discount

2,250

Sales return and allowances

12,000

Cost of goods sold

74,500

Sales salaries expenses

32,000

Rent expenses – selling space

8,000

Store supplies expenses

1,500

Advertising expenses

13,000

Office salaries expenses

28,500

Rent expenses – office space

3,600

Office supplies expenses

400

Total

\(355,150

\)355,150

On August 31, 2016, merchandise inventory was \(25,400. Supplementary records of merchandising activities for the year ended August 31, 2017, reveal the following itemized costs.

Invoice cost of merchandise purchased

\)92,000

Purchase discount received

2,000

Purchase return and allowances

4,500

Cost of transportation-in

4,600

Required

1. Compute the company’s net sales for the year.

2. Compute the company’s total cost of merchandise purchased for the year.

3. Prepare a multiple-step income statement that includes separate categories for net sales, cost of goods sold, selling expenses, and general and administrative expenses.

4. Prepare a single-step income statement that includes these expense categories: cost of goods sold, selling expenses, and general and administrative expenses.
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