1. Prepare adjusting journal entries to reflect each of the folowing. a. store s
ID: 2371441 • Letter: 1
Question
1. Prepare adjusting journal entries to reflect each of the folowing.
a. store supplies still available at fiscal year-end amount to $3,300.
b. Expired insurance, an administrative expense, for the fiscal year is $3,300
c.Depreciation expense on store equiptment, a selling expense, is $2,800 for the fiscal year.
d. To estimate shrinkage, a hysical count of ending merchandise inventory is taken. It shows $22,200 of inventory is still available at fiscal year-end.
2. Prepare a multiple-step income statement for fiscal year 2011.
3. Prepare a single-step income statement for fiscal year 2011
4. Compute the current ratio, acid-test ratio, and gross margin ratio as of October 31, 2011.
Explanation / Answer
Aug. 1 Purchased merchandise from Abilene Company for $6,000 under credit terms of 1/10, n/30, FOB destination, invoice dated August 1.4 At Abilene's request, Stone paid $100 cash for freight charges on the August 1 purchase, reducing the amount owed to Abilene.
5 Sold merchandise to Lux Corp. for $4,200 under credit terms of 2/10, n/60, FOB destination, invoice dated August 5. The merchandise had cost $3,000.
8 Purchased merchandise from Welch Corporation for $5,300 under credit terms of 1/10, n/45, FOB shipping point, invoice dated August 8. The invoice showed that at Stone’s request, Welch paid the $240 shipping charges and added that amount to the bill. (Hint: Discounts are not applied to freight and shipping charges.)
9 Paid $120 cash for shipping charges related to the August 5 sale to Lux Corp.
10 Lux returned merchandise from the August 5 sale that had cost Stone $500 and been sold for $700. The merchandise was restored to inventory.
12 After negotiations with Welch Corporation concerning problems with the merchandise purchased on August 8, Stone received a credit memorandum from Welch granting a price reduction of $800.
15 Received balance due from Lux Corp. for the August 5 sale less the return on August 10.
18 Paid the amount due to Welch Corporation for the August 8 purchase less the price reduction granted.
19 Sold merchandise to Trax Co. for $3,600 under credit terms of 1/10, n/30, FOB shipping point, invoice dated August 19. The merchandise had cost $2,500.
22 Trax requested a price reduction on the August 19 sale because the merchandise did not meet specifications. Stone sent Trax a $600 credit memorandum to resolve the issue.
29 Received Trax's cash payment for the amount due from the August 19 sale.
30 Paid Abilene Company the amount due from the August 1 purchase.
Prepare journal entries to record the above merchandising transactions of Stone Company, which applies the perpetual inventory system. (Identify each receivable and payable; for example, record the purchase on August 1 in Accounts Payable—Abilene.)
Aug 1
Debit Inventory $6,000
Credit Accounts Payable - Abilene $6,000
Aug 4
Debit Inventory $100
Credit Cash $100
Aug 5
Debit Accounts Receivable - Lux $4,200
Debit Cost of Goods Sold $3,000
Credit Sales $4,200
Credit Inventory $3,000
Aug 8
Debit Inventory $5,540 [$5,300 + $240]
Credit Accounts Payable - Welch $5,540
Aug 9
Debit Delivery Expense $120
Credit Cash $120
Aug 10
Debit Sales Returns and Allowances $700
Debit Inventory $500
Credit Accounts Receivable - Lux $700
Credit Cost of Goods Sold $500
Aug 12
Debit Accounts Payable - Welch $800
Credit Inventory $800
Aug 15
Debit Cash $3,430
Debit Sales Discounts $70 [$3,500 x 2%]
Credit Accounts Receivable - Lux $3,500 [$4,200 - $700]
Aug 18
Debit Accounts Payable - Welch $4,740 [$5,300 + 240 - $800]
Credit Inventory $45 [($5,300 - $800) x 1%]
Credit Cash $4,695
Aug 19
Debit Accounts Receivable - Trax $3,600
Debit Cost of Goods Sold $2,500
Credit Sales $3,600
Credit Inventory $2,500
Aug 22
Debit Sales Returns and Allowances $600
Credit Accounts Receivable - Trax $600
Aug 29
Debit Cash $2,970
Debit Sales Discounts $30 [($3,600 - $600) x 1%]
Credit Accounts Receivable - Trax $3,000 [$3,600 - $600]
Aug 30
Debit Accounts Payable - Abilene $6,000
Credit Cash $6,000
Income statements come with various monikers. The most commonly used are "statement of income," "statement of earnings," "statement of operations" and "statement of operating results." Many professionals still use the term "P&L," which stands for profit and loss statement, but this term is seldom found in print these days. In addition, the terms "profits," "earnings" and "income" all mean the same thing and are used interchangeably.
Two basic formats for the income statement are used in financial reporting presentations - the multi-step and the single-step. These are illustrated below in two simplistic examples:
Multi-Step Format Single-Step Format Net Sales Net Sales Cost of Sales Materials and Production Gross Income* Marketing and Administrative Selling, General and Administrative Expenses(SG&A) Research and Development Expenses (R&D) Operating Income* Other Income & Expenses Other Income & Expenses Pretax Income Pretax Income* Taxes Taxes Net Income Net Income (after tax)* --
In the multi-step income statement, four measures of profitability (*) are revealed at four critical junctions in a company's operations - gross, operating, pretax and after tax. In the single-step presentation, the gross and operating income figures are not stated; nevertheless, they can be calculated from the data provided.
Tutorials: An Introduction To Fundamental Analysis
In the single-step method, sales minus materials and production equal gross income. And, by subtracting marketing and administrative and R&D expenses from gross income, we get the operating income figure. If you are a do-it-yourselfer, you'll have to do the math; however, if you use investment research data, the number crunching is done for you.
One last general observation: Investors must remind themselves that the income statementrecognizes revenues when they are realized (i.e., when goods are shipped, services rendered and expenses incurred). With accrual accounting, the flow of accounting events through the income statement doesn't necessarily coincide with the actual receipt and disbursement of cash. The income statement measures profitability, not cash flow.
Income Statement Accounts (Multi-Step Format)
- Net Sales (a.k.a. sales or revenue): These all refer to the value of a company's sales of goods and services to its customers. Even though a company's "bottom line" (its net income) gets most of the attention from investors, the "top line" is where the revenue or income process begins. Also, in the long run, profit margins on a company"s existing products tend to eventually reach a maximum that is difficult on which to improve. Thus, companies typically can grow no faster than their revenues.
- Cost of Sales (a.k.a. cost of goods (or products) sold (COGS), and cost of services): For a manufacturer, cost of sales is the expense incurred for raw materials, labor and manufacturing overhead used in the production of its goods. While it may be stated separately, depreciationexpense belongs in the cost of sales. For wholesalers and retailers, the cost of sales is essentially the purchase cost of merchandise used for resale. For service-related businesses, cost of sales represents the cost of services rendered or cost of revenues.
- Gross Profit (a.k.a. gross income or gross margin): A company's gross profit does more than simply represent the difference between net sales and the cost of sales. Gross profit provides the resources to cover all of the company's other expenses. Obviously, the greater and more stable a company's gross margin, the greater potential there is for positive bottom line (net income) results.
- Selling, General and Administrative Expenses: Often referred to as SG&A, this account comprises a company's operational expenses. Financial analysts generally assume that management exercises a great deal of control over this expense category. The trend of SG&A expenses, as a percentage of sales, is watched closely to detect signs, both positive and negative, of managerial efficiency.
- Operating Income: Deducting SG&A from a company's gross profit produces operating income. This figure represents a company's earnings from its normal operations before any so-called non-operating income and/or costs such as interest expense, taxes and special items. Income at the operating level, which is viewed as more reliable, is often used by financial analysts rather than net income as a measure of profitability.
- Interest Expense: This item reflects the costs of a company's borrowings. Sometimes companies record a net figure here for interest expense and interest income from invested funds.
- Pretax Income: Another carefully watched indicator of profitability, earnings garnered before the income tax expense is an important step in the income statement. Numerous and diverse techniques are available to companies to avoid and/or minimize taxes that affect their reported income. Because these actions are not part of a company's business operations, analysts may choose to use pretax income as a more accurate measure of corporate profitability.
- Income Taxes: As stated, the income tax amount has not actually been paid - it is an estimate, or an account that has been created to cover what a company expects to pay.
- Special Items or Extraordinary Expenses: A variety of events can occasion charges against income. They are commonly identified as restructuring charges, unusual or nonrecurring items and discontinued operations. These write-offs are supposed to be one-time events. Investors need to take these special items into account when making inter-annual profit comparisons because they can distort evaluations.
- Net Income (a.k.a. net profit or net earnings): This is the bottom line, which is the most commonly used indicator of a company's profitability. Of course, if expenses exceed income, this account caption will read as a net loss. After the payment of preferred dividends, if any, net income becomes part of a company's equity position as retained earnings. Supplemental data is also presented for net income on the basis of shares outstanding (basic) and the potential conversion of stock options, warrants etc. (diluted).
- Comprehensive Income: The concept of comprehensive income, which is relatively new (1998), takes into consideration the effect of such items as foreign currency translations adjustments, minimum pension liability adjustments and unrealized gains/losses on certain investments in debt and equity. The investment community continues to focus on the net income figure. The aforementioned adjustment items all relate to volatile market and/or economic events that are out of the control of a company's management. Their impact is real when they occur, but they tend to even out over an extended period of time.
Now let's take a look at a sample income statement for company XYZ for FY ending 2008 and 2009 (expenses are in parentheses):
Income Statement For Company XYZ FY 2008 and 2009 (Figures USD) 2008 2009 Net Sales 1,500,000 2,000,000 Cost of Sales (350,000) (375,000) Gross Income 1,150,000 1,625,000 Operating Expenses (SG&A) (235,000) (260,000) Operating Income 915,000 1,365,000 Other Income (Expense) 40,000 60,000 Extraordinary Gain (Loss) - (15,000) Interest Expense (50,000) (50,000) Net Profit Before Taxes (Pretax Income) 905,000 1,360,000 Taxes (300,000) (475,000) Net Income 605,000 885,000
Now that we understand the anatomy of an income statement, we can deduce from the above example that between the years 2008 and 2009, Company XYZ managed to increase sales by about 33%, while reducing its cost of sales from 23% to 19% of sales. Consequently, gross income in 2009 increased significantly, which is a huge plus for the company's profitability. Also, general operating expenses have been kept under strict control, increasing by a modest $25,000. In 2008, the company's operating expenses represented 15.7% of sales, while in 2009 they amounted to only 13%. This is highly favorable in view of the large sales increase.
As a result, the bottom line - net income - for the company in 2009 has increased from $605,000 in 2008 to $885,000 in 2009. The positive inter-annual trends in all the income statement components, both income and expense, have lifted the company's profit margins (net income/net sales) from 40% to 44% - again, highly favorable.
Conclusion
When an investor understands the income and expense components of the income statement, he or she can appreciate what makes a company profitable. In the case of Company XYZ, it experienced a major increase in sales for the period reviewed and was also able to control the expense side of its business. That's a sign of very efficient management.
Multi-Step Format Single-Step Format Net Sales Net Sales Cost of Sales Materials and Production Gross Income* Marketing and Administrative Selling, General and Administrative Expenses(SG&A) Research and Development Expenses (R&D) Operating Income* Other Income & Expenses Other Income & Expenses Pretax Income Pretax Income* Taxes Taxes Net Income Net Income (after tax)* --
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