Chapter 5 Discussion Question's

Question 1

How does the income statement prepared for a company that sells goods differ from that prepared for a service business?

Answer 1

In a service-based business, no inventory is held for resale. Unlike businesses selling goods, the income statement of a service business does not include items like Cost of Goods Sold or Gross Profit.

Question 2

How is gross profit calculated? What relationships do the gross profit and gross profit percentage calculations express? Explain, using an example.

Answer 2

Gross Profit is the result of deducting Cost of Goods Sold from Sales. For example, if a car is sold for $16,000 but cost $12,000, the Gross Profit calculation would be $4,000. The Gross Profit percentage is $4,000/16,000 or 25 per cent. That means for every $1 of Sales, the business earns $0.25 on average to cover expenses.

Question 3

What are some common types of transactions that are recorded in the merchandise Inventory account?

Answer 3

Purchases, purchase discounts, returns to suppliers, transportation costs, and adjustments for inventory shrinkage.

Question 4

Contrast and explain the sales and collection cycle and the purchase and payment cycle.

Answer 4

The sales and collection cycle begins with a sale, leading to the creation of an Account Receivable. Once cash is collected, the Account Receivable is cleared. If merchandise is returned, Sales Returns and Allowances reduce the Account Receivable. Discounts may be offered for prompt payments, recorded as Sales Discounts to accelerate collections.

Question 5

What contra accounts are used in conjunction with sales? What are their functions?

Answer 5

Contra accounts used with sales are Sales Returns and Allowances and Sales Discounts. They adjust sales revenue for returns, allowances, and discounts, ensuring a more accurate net sales representation.

Question 6

(Appendix) Compare the perpetual and periodic inventory systems. What are some advantages of each?

Answer 6

In a perpetual inventory system, the balances in Merchandise Inventory and Cost of Goods Sold are updated with each transaction involving purchases and sales, ensuring that account balances are always known in real-time. In contrast, a periodic inventory system only updates these balances after an inventory count is performed, meaning account balances are not known and must be estimated until the count. Perpetual is more accurate while Periodic is cheaper and easier to implement.