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Worksheet for E5-10 E5-10 on page: 263 The trial balance of Sanchez Company at the end of its fiscal year, August 31, 2014, includes these accounts: Beginning Inventory $18,700; Purchases $154,000; Sales Revenue $190,000; Freight-In $8,000; Sales Returns and Allowances $3,000; Freight-Out $1,000; and Purchase Returns and Allowances $5,000. The ending inventory is $21,000. Instructions Prepare a cost of goods sold section (periodic system) for the year ending August 31, 2014. (Refer to page 231 - Flow of Cost Illustration 5-3; Pages 246 - 247; Illustration 5-13 on page 246; and the \"Do It!\" Demonstration. Refer to illustration 5-12 and 5-13 on page 246 & 247 to format your answer to this problem) Beginning Inventory Purchases Sales Revenue Freight-In Sales Returns and Allowances Freight-Out Purchase Returns and Allowances Ending Inventory $ $18,700 $154,000 $190,000 $8,000 $5,000 $1000 $5,000 $21,000 Solution ART CENTER CORP. Income Statement For the Year Ended December 31, 2014 Sales Sales revenue $462,000 Sales discounts 20,000 Net sales 442,000 Cost of goods sold 147,000 Gross profit 295,000 Operating expenses 187,000 Income from operations 108,000 Other revenues and gains $8,000 Other expenses and losses 3,000 5,000 Income before income taxes 113,000 Income tax expense 28,250 Net income $ 84,750 Related exercise material: BE5-5, BE5-6, 5-3, and E5-5. DETERMINING COST OF GOODS SOLD UNDER A PERIODIC SYSTEM Determining cost of goods sold is different when a periodic inventory system is used rather than a perpetual system. As you have seen, a company using a perpetual system makes an entry to record cost of goods sold and to reduce inventory each time a sale is made. A company using a periodic system does not determine cost of goods sold until the end of the period. At the end of the period, the company performs a count to determine the ending balance of inventory. It then calculates cost of goods sold by subtracting ending inventory from the goods available for sale. Goods available for sale is the sum of beginning inventory plus purchases, as shown in Illustration 5-12. LEARNING OBJECTIVE 5 Determine cost of goods sold under a periodic system. Illustration 5-12: Basic formula for cost of goods sold using the periodic system Beginning Inventory + Cost of Goods Purchased Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold Another difference between the two approaches is that the perpetual system directly adjusts the Inventory account for any transaction that affects inventory (such as freight costs, purchase returns, and purchase discounts). The periodic system does not do this. Instead, it creates different accounts for purchases, freight costs, purchase returns, and purchase discounts. These various accounts are shown in Illustration 5-13 (page 247), which presents the calculation of cost of goods sold for PW Audio Supply using the periodic approach. Note that the basic elements from Illustration 5-12 are highlighted in Illustration 5-13. You will learn more in Chapter 6 about how to determine cost of goods sold using the periodic system. The use of the periodic inventory system does not affect the form of presentation in the balance sheet. As under the perpetual system, a company reports inventory in the current assets section. Appendix 5A provides further detail on the use of the periodic system. Illustration 5-13: Cost of goods sold for a merchandiser using a periodic inventory system PW AUDIO SUPPLY, INC. Cost of Goods Sold For the Year Ended December 31, 2014 Cost of goods sold Inventory, January 1 $ 36,000 Purchases $325,000 Less: Purchase returns and allowances $10,400 Purchase discounts 6,800 17,200 Net purchases 307,800 Add: Freight-in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 356,000 Inventory, December 31 40,000 Cost of goods sold $316,000 Helpful Hint The far right column identifies the primary items that make up cost of goods sold of $316,000. The middle column explains cost of goods purchased of $320,000. The left column reports contra purchase items of $17,200. COST OF GOODS SOLD-PERIODIC SYSTEM Aerosmith Company's accounting records show the following at the year-end December 31, 2014. Purchase Discounts $ 3,400 Freight-In 6,100 Purchases 162,500 Beginning Inventory 18,000 Ending Inventory 20,000 Purchase Returns and Allowances 5,200 Assuming that Aerosmith Company uses the periodic system, compute (a) cost of goods purchased and (b) cost of goods sold. Action Plan To determine cost of goods purchased, adjust purchases for returns, discounts, and freight-in. To determine cost of goods sold, add cost of goods purchased to beginning inventory, and subtract ending inventory. Solution (a) Cost of goods purchased equals $ 160,000 colon Purchase ; ; Purchase returns and allowances ; ; Purchase discounts ; plus ; Freight-in ; $ 162,500 ; ; $ 5,200 ; ; $ 3,400 ; plus ; $ 6,100 ; equals $ 160,000 ; (b) Cost of goods sold equals $ 158,000 colon Beginning inventory ; plus ; Cost of goods purchased ; ; Ending inventory ; $ 18,000 ; plus ; $ 160,000 ; ; $ 20,000 ; equals $ 158,000 ; Related exercise material: BE5-7, BE5-8, BE5-9, 5-4, E5-10, and E5-11. Evaluating Profitability GROSS PROFIT RATE A company's gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales. This is referred to as the gross profit rate. For PW Audio Supply, the gross profit rate is 31.3% ($ 144,000 $ 460,000). LEARNING OBJECTIVE 6 Explain the factors affecting profitability. Analysts generally consider the gross profit rate to be more informative than the gross profit amount because it expresses a more meaningful (qualitative) relationship between gross profit and net sales. For example, a gross profit amount of $1,000,000 may sound impressive. But if it was the result of sales of $100,000,000, the company's gross profit rate was only 1%. A 1% gross profit rate is acceptable in very few industries. Illustration 5-14 (page 248) demonstrates that gross profit rates differ greatly across industries. Illustration 5-14: Gross profit rate by industry Sanchez Company cost of goods sold section for the year ending August 31, 2014 Beginning inventory Purchases Less: Purchase Returns and Allowances Cost of goods available for sale Less: Ending inventory Cost of goods sold $18,700 $154,000 $ 5,000 $149,000 $167,700 $ 21,000 $146,700