BTN 4-4 You are the financial officer for Music Plus, a retailer that sells goods for home entertainment needs. The business owner, Vic Velakturi, recently reviewed the annual financial statements you prepared and sent you an e-mail stating that he thinks you overstated net income. He explains that although he has invested a great deal in security, he is sure shoplifting and other forms of inventory shrinkage have occurred, but he does not see any deduction for shrinkage on the income statement. The store uses a perpetual inventory system.
Prepare a brief memorandum that responds to the owner’s concerns.
Inventory shrinkage is not deducted from the income statement because a perpetual inventory system is applied in the business, and external auditors are also satisfied with the inventory control.
Statements that summarize all the financial transactions in a fiscal year are known as financial statements. It reports revenue, expenses, resources, and liabilities.
To: Business Owner
From: Financial Officer
Subject: Reason for not including shrinkage in the income statement.
This memorandum concerns the overstatement of net income and inventory shrinkage. The company has implemented a perpetual inventory system for recording the inventory, and under this system, the inventory balance is updated after each sale and purchase. Also, the company is reconciling the balance through a physical inspection of the inventory. Any identified difference is corrected immediately, and therefore, there is no chance of error.
Also, the auditors of the business entity are satisfied with the control over the inventory system. There is no space for inventory shrinkage, and therefore, it has not been included in the income statement as deduction.
The following supplementary records summarize Tesla Company’s merchandising activities for year 2017 (it uses a perpetual inventory system). Set up T-accounts for Merchandise Inventory and Cost of Goods Sold. Then record the summarized activities in those T-accounts and compute account balances.
Cost of merchandise sold to customer in sales transaction
Merchandise inventory, December 31, 2016
Invoice cost of merchandise purchase, gross amount
Shrinkage determined on December 31, 2017
Cost of transportation in
Cost of merchandise returned by customer and restored to inventory
Purchase discount received
Purchase return and allowances
Use the data for Valley Company in Problem 4-3A to complete the following requirements.
1. Prepare closing entries as of August 31, 2017 (the perpetual inventory system is used).
2. In prior years, the company experienced a 4% returns and allowance rate on its sales, which means approximately 4% of its gross sales were eventually returned outright or caused the company to grant allowances to customers. Compute the ratio of sales returns and allowances divided by gross sales. How does this year’s ratio compare to the 4% ratio in prior years?
Chico Company allows its customers to return merchandise within 30 days of purchase.
a. Prepare the December 31, 2017, year-end adjusting journal entry for estimated future sales returns and allowances (revenue side).
b. Prepare the December 31, 2017, year-end adjusting journal entry for estimated future inventory returns and allowances (cost side).
c. Prepare January 3, 2018, journal entry(ies) to record the merchandise returned.
Compute net sales, gross profit, and the gross margin ratio for each separate case a through d. Interpret the gross margin ratio for case a.
Sales return and allowances
Cost of goods sold
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