Friday, July 11, 2014
GROSS PROFIT METHOD
ON THIS POST, I WILL DISCUSS, GROSS PROFIT METHOD AND RETAIL INVENTORYMETHOD OF DETERMINING THE INVENTORY AMOUNT.
THE GROSS PROFIT METHOD OF ESTIMATING INVENTORY COST IS BASED ON AN ASSUMED RELATIONSHIP OF GROSS PROFIT AND SALES. A GROSS PROFIT RATIO IS APPLIED TO SALES AMOUNT TO DETERMINE THE GROSS PROFIT AND FINALLY THE COST OF SALES .
ON THE OTHER HAND GIVEN THE AMOUNT OF COST OF SALES , YOU CAN DETERMINE THE VALUE OF INVENTORY BY COMPUTING FOR THE GOODS AVAILABLE FOR SALE( BEG INV. + PURCHASE) LESS THIS COST OF SALES , THEN YOU GET THE ESTIMATED INVENTORY.
BEG INV. 3,000
PURCHASE 4,000
AVAILABLE FOR SALE 7,000
LESS: COST OF SALES 3,000
estimated inventory end 4,000
take note that you can compute this cost of sales by way of knowing the gross profit percentage and finally the cost of sales percentage.
Example:1 GROSS PROFIT AS PERCENTAGE OF SALES ( MARK UP ON SALES).
When we say mark up on sales, that means the gross profit is a certain percent of SALES AMOUNT.
assume a sales of 100,000, the company applies 40% gross profit on sales , therefore:
sales 100,000 100%
cost of sales 60,000 60%
gross profit 40,000 40%
so assuming the available goods for sale is 85,000, the estimated inventory would be:
available for sales 85,000
less cost of sales 60,000
estimated inventory 25,000
example 2 GROSS PROFIT AS PERCENTAGE OF COST ( MARK UP ON COST) When we say mark up on cost , that means the gross profit is a certain percent of COST OF THE PRODUCT.
EXAMPLE: A PRODUCT COSTING 100.00 AND SAID TO HAVE PRICED 20% MARK UP ON COST , IT DOES NOT MEAN THAT 20% IS THE GROSS PROFIT PERCENTAGE AGAINST SALES AMOUNT BECAUSE THE 20% IS BASED ON THE COST AND NOT ON THE SALES PRICE. SO, THE SELLING PRICE OF 100.00 IS 120.00 ( 100.00 X 20% =20 MARK UP + 100.00). IF GET THE PERCENTAGE OF GROSS PROFIT OF 20.00 VS. 120.00 IS NOT 20% BUT 16.67%.
When a product is said to have a gross profit ratio of say 40% based on cost. That means the base is the cost of the product , and this cost is of course the 100% because this is where the 40% was based , NOW CONSIDERING THAT IN THE ORDINARY COMPUTATION OF GROSS PROFIT IT IS THE SALES AMOUNT THAT IS BEING USED AS THE BASE OF GROSS PROFIT PERCENTAGE , RATIO. NOW IF THE COST IS 100% AND THE GROSS PROFIT IS 40%, THEREFORE MATHEMATICALLY THE SALES PERCENTAGE RATIO IS 140%
Assume sales is 100,000 and gross profit ratio is 60% of cost .If sales are made at a gross profit based on cost then to get the gross profit ratio is.
sales ? %
cost of sales ( 100%)
gross profit 40%
since , mathematically, cost is deducted from sales to arrive at gross profit, in the above example , using a work back approach, the sales percentage ratio is 140% , arrived by 40% + 100% is 140%, therefore in making the normal reading of gross profit percentage ratio , you have to divide 40% with 140% to get the gross profit percentage based on SALES PRICES which is 28.57%.
sales 140%
cost ( 100%)
gross profit 40% 40% divide 140% = 28.57%
since the sales amount is given, and the cost amount is not given, and it says the gross profit is 40% of cost, then to get the gross profit amount and its percentage to sales , and also the cost amount and percent to sales , you have to divide the 100,000 by 140% to get the cost amount of 71,430.00
sales 100,000 100%
cost of sales 71,430 71.43%
gross profit 28,570 28.57%
so if the product cost is 71,430.00 , adding 40% to it is 28,570 ( round off diff.) but basing the 28,570 on sales amount , it is 28.57%.
so, when the problem says the gross profit is said to be a certain percent of cost, to be able to get the gross profit percentage against sales , all you have to do is divide the gross profit percent against the sum total percentage of gross profit and cost of sales percentage.
TO BE ABLE TO ESTIMATE THE ENDING INVENTORY USING THAT COST OF SALES, ALL YOU HAVE TO DO IS , OBTAIN THE GOODS AVAILABLE FOR SALES LESS THIS COST OF SALES = ESTIMATED INVENTORY COST.
BEG INV. 80,000
PURCHASE 40,000
AVAILABLE FOR SALE 120,000 available 120,000
LESS: COST OF SALES 71,430 INV. END ( 48,570)
ENDING INVENTORY 48,570 COST OF SALES 71,430
THIS METHOD OF INVENTORY VALUATION IS VALUABLE ESPECIALLY WHEN IT IS IMPOSSIBLE OR DIFFICULT TO UNDERTAKE PHYSICAL INVENTORY COUNTING BECAUSE OF LOSS OR DESTRUCTION OF GOODS.
EXAMPLE assume in oct 31, 2001a fire destroyed the inventory . :
inventory dec 31, 2000 329,500.
payments of purchases based on check issued in 2001 1,015,000.00
unpaid suppliers invoices beginning jan 2001 260,000.00
balance of accts.payable according to suppliers at the time of fire 315,000.00
bank deposits from jan to oct 31, 1,505,000.00
accts. receivable dec 31, 2000 328,000.00
accts receivable oct 31, 2001 275,000.00
gross profit percentage 2000 24% 1999, 23%, 1998 25%, 1997 28%
based on the above the inventory at thetime of fire could be as ff:
what is still unknown here is the amount sales made jan to oct . Now since there is a beginning accounts receivable dec 31,2000 and there is also a collections made during the year up to oct, and the ending receivable , by reconstructing IN T ACCOUNTS , you can compute for the sales amount.
Having sales amount you can compute the cost of sales percentage because you simply compute the average gross profit for the 4 year period .
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RETAIL INVENTORY METHOD
when this method is maintained , the purchases is valued at cost and at retail price. a cost percentage is computed by dividing the goods available for sale at cost against the goods available for sale at retail price . this cost percentage can be applied to the ending inventory at RETAIL to get the inventory at cost.
As you maybe aware, the immediately available figure for a product is its RETAIL OR SELLING PRICE because this is the figure that must be shown to the buyer of your products. The purchase cost of those products is not always given or identified at a click of the finger unlike the retail price, especially when a company is handling multiple or varied line of products. HENCE , to easily compute for the ending inventory cost, without resorting to a perpetual or counting of inventories , a cost ratio of the product against its selling price is established and use this ratio to compute for inventory cost.
at cost retail
beg 100 200
purchases 200 400
available for sale 300 600 300 divide 600 is 50% this the ratio of cost vs. retail
to be able to determine the inventory at retail , the following procedure:
available for sale at retail 600
sales made out of this available at retail (400)
REMAINING INVENTORY at retail 200
sales 400
beg. inventory retail 200
purchases retail 400
available for sale retail 600
Less: inventory retail ( 200) ( 400 ) cost of sales at retail
inventory at cost therefore is 200 x 50% = 100
Use of this retail inventory method offers the ff advantages .
1. no need physical count of inventory at interim period
2. when physical inventory is taken for financial statement preparation, of course since each item has a retail pricing easily available therefore inventory at retail can easily computed without having to dig up records of its cost and it will just be multiplied by the cost ratio vs retail price to get the INVENTORY AT COST.
THE ACCOUNTING ENTRIES IS SIMILAR TO A PERIODIC METHOD OF INVENTORY.
Purchases 200
accts. payable 200
accts receivable 400
sales 400
cost of sales 100
beg inv 100
cost of sales 200
purchases 200
end inve. 100
cost of sales 100
the net cost of sales of the above is 200. so the following computation
beg inve. 100
purchases 200
available 300
less: ending inv. 100
= COST OF SALES 200
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EXERCISES 1. on august 15,1996 , a hurricane damage the entire inventory .
inventory jan 1 375,000
purchases jan 1 aug 15 1,385,000
cash sales jan 1 aug 15 225,000
collection jan 1 augs 15 2,115,000
accounts receivable jan 1 175,000
accts receivable aug 15 265,000
salvage value of inventory 5,000
gross profit percent on sales 32%
COMPUTE THE INVENTORY LOSS.
1. DETERMINE SALE AMOUNT:
Accts receivable beg 175,000
less collection (2,115,000)
accts. rec. end 265,000
SALES AMOUNT 2,205,000
2. DETERMINE COST OF SALES:
SALES 2,205,000 X (100% -32 % ) = 1,499,400
3 DETERMINE GOODS AVAILABLE FOR SALE
BEG INV 375,000
PURCHASES 1,385,000
TOTAL 1,760,000
4 DETERMINE INVENTORY:
TOTAL AVAILABLE FOR SALE 1,760,000
LESS: COST OF SALES 1,499,400
ENDING INVENTORY 260,600 L
LESS SALVAGE VALUE 5,000
ACTUAL INVENTORY LOSS 255,600
4. TO PROVE:
SALES 2,205,000
COST OF SALES:
AVAILABLE FOR SALES 1,760,000
LESS ENDING INV. 260,600 1,499,400 68%
GROSS PROFIT 705,600 32%
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IF IN CASE THE SALES, THE RECEIVABLE , INVENTORY , THE COST OF SALES IS UNKNOWN, TRY TO MAKE A T ACCOUNTS FOR THEM AND PUT THE AVAILABLE FIGURES OR THE GIVEN FIGURES THEN COMPUTE THE UNKNOWN FIGURE by simple mathematical computation :
EXAMPLE :
accts. receivable accts receivable
____dr___________________cr_______ dr cr
beg bal 1,000 : beg 100
sales 3,000 : collection ? coll 50
end balance 200 : sales ?
end bal 80
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MARKUPS AND MARKDOWN - CONVENTIONAL RETAIL
In the previous discussion , it was assumed there were no changes in retail prices. Frequently , retail prices do change .
the following terms are used in retail method.
1. original retail price - the initial sales price, arrived at adding markup called INITIAL MARKUP
2. additional markups- increases that raise sales price above the original price
3. mark up cancellation - decrease in additional mark up that do not reduce sales price below original
4. net markups - additional markups less markup cancellation
5. markdowns - decrease that reduce sales price from the original
6. markdown cancellation - decrease in markdown that do not raise the sales price above original
7. net markdowns -markdowns less markdown cancellation
EXAMPLE:
cost retail
original 4 6 the 2 is 50%markup on cost
add'l markup 1.50 increase the original price
NEW PRICE 7.50
markup cancellation .50 reduce the orig. markup of 1.50
NEW PRICE 7.00
NET MARKUP IS 1.50 LESS .50 =1.00
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
ORIGINAL 6.00
markdowns 1.00 reduce below original of 6
NEW PRICE 5.00 below original
mark down cancellation .25 the 1.00 decrease it to.75 instead
NEW PRICE 5.25
NET MARKDOWN IS 1.00 LESS .25 = .75
Retail inventory results will vary depending on whether net markdowsn are used in computing the cost percentage. When applying retail method , NET MARKUP are added to GOODS AVAILABLE FOR SALES AT RETAIL ,before calculating the cost percentage, net markdowsn , however are not deducted in arriving at the percentage. this method is CONVENTIONAL RETAIL INVENTORY METHOD.
EXAMPLE
COST RETAIL
BEGINNING INVENTORY 8,600 14,000
PURCHASES 72,100 110,000
ADDITIONAL MARK UP 13,000
MARKUP CANCELLATION ( 2,500)
GOODS AVAILABLE FOR SALE 80,700 134,500
LESS: SALES 108,000
MARKDOWN 4,800
MARKDOWN CANCEL ( 800) 112,000
ending inventory at retail 22,500
cost percentage ( 80,700 divide 134,500) = 60%
inventory end at cost 60% x 22,500 = 13,500
YOU MAY ASK WHY THE ADDITIONAL MARK UP IS ADDED TO AVAILABLE FOR SALE, IT IT IS BECAUSE , THE SALES AMOUNT THAT WILL BE DEDUCTED INCLUDES THAT MARK UP . SO IF YOU WILL NOT ADD THE ADDITIONAL MARK UP TO THE AVAILABLE FOR SALE THE RESULTING INVENTORY AT RETAIL WILL BE UNDERSTATED
USING THE ABOVE EXAMPLE.
THE AVAILABLE FOR SALE WOULD BE 124,000
LESS : SALES 112,000
ENDING INVENTORY 12,000
ON THE OTHER HAND IF INSTEAD OF THE NET MARK UP IS ADDED TO THE AVAILABLE FOR SALE , THE NET MARKDOWNS WERE ADDED TO THE AVAILABLE FOR SALE, THE COST PERCENTAGE WILL BE HIGHER BECAUSE THE AVAILABLE FOR SALE WILL BECOME LOWER.
BUT THE SALES AMOUNT TO BE DEDUCTED FROM THAT AVAILABLE FOR SALE TO ARRIVE AT INVENTORY AT RETAIL WOULD NOT INCLUDE THE NET MARKDOWN ,BECAUSE IT WAS ALREADY ADDED TO THE AVAILABLE FOR SALE, THUS BRINGING THE SAME INVENTORY AT RETAIL .
GOODS AVAILABLE FOR SALES 134,500
DEDUCT NET MARKDOWN 4,000
GOODS AVAILABLE FOR SALE 130,500
LESS: SALES WITHOUT MARK DOWN 108,000
ENDING INV 22,500
COST PERCENTAGE WILL BECOME HIGHER BECAUSE THE NET MARKDOWN WILL BE DEDUCTED TO THE AVAILABLE FOR SALE .
80,700 DIVIDE 130,500 = 61.48% X 22,500 = 13,914.00
Wednesday, July 9, 2014
INSTALLMENT SALES ACCOUNTING
IN SOME CASES , THERE ARE CIRCUMSTANCES SURROUNDING A REVENUE TRANSACTIONS SUCH THAT CONSIDERABLE UNCERTAINTY OF FULL COLLECTION WOULD EXISTS SIMPLY BECAUSE OF THE INSTALLMENT SALES WHICH NORMALLY HAS A VERY LONG COLLECTION TERMS . THIS SITUATION CAN OCCUR IF THE SALES IS UNUSUAL IN NATURE OR SALES TO CUSTOMERS WHERE IN CASE OF DEFAULT OF THIS CUSTOMER , A LITTLE COST OR PENALTY IS CHARGED.
UNDER THIS CIRCUMSTANCES, WHERE UNCERTAINTY OF COLLECTION SUGGEST THAT REVENUE RECOGNITION SHOULD BE BASED ON THE ACTUAL COLLECTION RATHER THAN THE TIME OF SALE.
THERE ARE APPROACHES THAT REVENUE RECOGNITION DEPENDS ON COLLECTION.
1. INSTALLMENT SALES
2. COST RECOVERY METHOD
3. CASH METHOD.
INSTALLMENT SALES METHOD
ACCOUNTING FOR INSTALLMENT SALES METHOD IS WHERE AT THE TIME OF SALE the following entry is made. ( IF USING PERPETUAL INVENTORY METHOD)
THIS IS THE REGULAR ENTRY:
INSTALLMENT ACCOUNTS RECEIVABLE 50,000
INSTALLMENT SALES 50,000
to record sales made on installment.
COST OF INSTALLMENT SALES 25,000
INVENTORY ( USING PERPETUAL) 25,000
to record the cost of the sales made. this is based on qty sold x the cost of the product.
CASH 10,000
INSTALLMENT ACCTS. RECEIVABLE 10,000
to record collection
NOW CONSIDERING THAT IN INSTALLMENT SALES METHOD , THE INSTALLMENT SALES ACCOUNT IS NOT CONSIDERED A REVENUE YET, AND EVEN THE COST OF SALES FOR INSTALLMENT SALES this two accounts are REVERSED.at the end of the period. THEREFORE THE CREDIT ENTRY ON THE SALES AND THE DEBIT ENTRY ON COST OF INSTALLMENT SALES NEED TO BE REVERSED . OF COURSE IF ONLY THESE ACCOUNT WILL BE THE ONE TO BE REVERSED , THERE IS A DIFFERENCE IN AMOUNT BECAUSE THE DEBIT IS BIGGER THAN THE COST OF SALES WHICH IS CREDITED, THAT DIFFERENCE IS ACTUALLY THE GROSS PROFIT , HENCE , AN ACCOUNT NAME "" deferred gross profit " is to be credited. and will not be a nominal accounts but a REAL ACCOUNTS OR BALANCE SHEET account .
NOW YOU MAY ASK, HOW TO COMPUTE FOR THE ACTUAL REVENUE OR ACTUAL GROSS PROFIT THAT WILL BE REFLECTED ON THE PROFIT AND LOSS. BECAUSE THE FACT IS THE GROSS PROFIT WAS TRANSFERRED TO THE BALANCE SHEET.
IN INSTALLMENT ACCOUNTING , THE RECOGNITION OF THE REVENUE IS BASED ON THE AMOUNT OF COLLECTION OF THAT SALES MADE MULTIPLY BY THE GROSS PROFIT RATIO OF THAT SALES MADE . BUT SINCE THE GROSS PROFIT WAS CLASSIFIED AS BALANCE SHEET ACCOUNT, IT IS NECESSARY THAT WHEN A COLLECTION IS MADE, THE EQUIVALENT GROSS PROFIT OF THAT COLLECTION USING THE GROSS PROFIT RATIO WILL BE TRANSFERRED BACK TO THE PROFIT AND LOSS UNDER THE ACCOUNT NAME " realized gross profit. , that means if the SALES was totally collected the deferred or the unrealized gross profit will become zero.
that means revenue is recognized in the profit and loss depending on the amount of collection multiplied by the gross profit ratio. ( COLLECTIONS X GROSS PROFIT = realized gross profit)
if that is the case. the balance of the unrealized or deferred gross profit if divided by the gross profit ratio will be equal to the INSTALLMENT SALES RECEIVABLE BALANCE ( deferred gross profit divide gross profit ratio = RECEIVABLE ) or installment receivable multiplied by the gross profit is the deferred gross profit appearing on the balance sheet.( RECEIVABLE X GROSS PROFIT RATIO = DEFERRED GROSS PROFIT )
or the realized gross profit for a particular period divide by the gross profit ratio is equal to the amount of collections made on the sales. ( REALIZED GROSS PROFIT DIVIDE BY gross profit ratio = COLLECTIONS )
NOW HOW DO YOU COMPUTE FOR THE GROSS PROFIT RATIO.
WHEN YOU ARE ENGAGING IN SELLING A PRODUCT , YOU PURCHASE THAT PRODUCT FROM OTHER SOURCES FOR RESALE . WHEN YOU ARE TO SELL THAT PRODUCT , YOU MUST ADD A CERTAIN AMOUNT FROM THE COST OF THE PRODUCT TO ARRIVE AT THE SELLING PRICE.
THE AMOUNT THAT YOU WILL ADD ON THAT COST OF THE PRODUCT IS DEPENDING ON HOW MUCH YOU WANT TO HAVE A GROSS PROFIT AND THAT GROSS PROFIT WILL ANSWER FOR THE OPERATING COST AND YOUR NEEDED NET PROFIT.
THE AMOUNT YOU ADD IS THE GROSS PROFIT OF THAT PRODUCT. DIVIDING THAT AMOUNT YOU ADDED OR THE GROSS PROFIT AGAINST THE SELLING PRICE IS THE GROSS PROFIT RATIO. DIVIDING THE COST OF THE PRODUCT AGAINST THE SELLING PRICE IS THE COST OF SALES RATIO.
NOW, IT WOULD BE IMPRACTICAL THAT EVERYTIME YOU PURCHASE A PRODUCT , YOU WILL THINK OF HOW MUCH YOU HAVE TO ADD TO ARRIVE AT SELLING PRICE. THEREFORE YOU HAVE SET A COST OF SALES RATIO AGAINST THE SELLING PRICE SO THAT EVERYTIME YOU PURCHASED A PRODUCT YOU JUST DIVIDE YOU COST TO THIS COST RATIO TO ARRIVE AT SELLING PRICE., IT'S AUTOMATIC NOW THAT THE COST LESS THE SELLING PRICE IS YOUR GROSS PROFIT , SO GROSS PROFIT DIVIDE SALES PRICE IS YOUR GROSS PROFIT RATIO.
EXAMPLE
PURCHASED COST 3,300.00 AND YOU KNOW THAT YOUR COST RATIO IS 80%, SO DIVIDE 3,300.00 BY 80%, YOU GET 4,125.00 AS SELLING PRICE.
SELL PRICE 4,125
COST 3,300 80%
GROSS PROFIT 825 20%
This deferred gross profit account though a non assets accounts , can be presented as a contra accounts of INSTALLMENT ACCOUNTS RECEIVABLE or can be presented as a DEFERRED ACOUNT ON THE LIABILITIES SIDE . The following are pro forma journal entries and adjusting entry:
1. SALES ON INSTALLMENT
INSTALLMENT ACCTS. REC 50,000
INSTALLMNET SALES 50,000
2. COST OF THE PRODUCT at 20% mark up on sales price.
COST OF SALES ON INSTALLMENT 10,000
INVENTORY( perpetual)SHIPMENTS( periodic) 10,000
3. EXPENSES OF THE COMPNAY
SELLING AND GEN . EXP 1,000
CASH OR ACCTS. PAY 1,000
4. COLLECTIONS
CASH 20,000
INSTALLMENT REC. 2011 5,000
INST. RECE 2012 10,000
INST RECE 2013 5,000
5. CLOSING OF INSTALLMENT SALE ACCOUNT AND COST OF SALES AND SET UP OF DEFERRED GROSS PROFIT. FOR SALES THIS PERIOD.
INST. SALES 50,000
COST OF SALES INST. 10,000
DEFERRED GROSS PROFIT 40,000
6. TO RECOGNIZE THE REALIZED GROSS PROFIT BASED ON COLLECTION X GROSS PROFIT RATIO
DEFERRED GROSS PROFIT 2013 1,000
DEF. GROSS PROFIT 2012 2,000
DEF. GROSS PRFIT 2011 1,500
REALIZED GROSS PROFIT 4,500
7. CLOSING ENTRIES( PERPETUAL INV. METHOD) PERIODIC
REALIZED GROSS PROFIT 4,500 cost of sales/inst(inc/exp). xxx
SELLING AND GEN EXP 1,000 inv. beg xxx
INCOME EXP SUMM 3,500 close beg inv
inc.exps summ xxx
purchases xxx
close purch.
INV. END XXX
inc. exp summ xxx
set up inv. end
realized g.p. xxx
shipments xxx
expenses xxx
inc.exp summ xxxx
LET ME GIVE YOU AN EXAMPLE OF INSTALLMENT SALE METHOD
TAKE NOTE THAT THE PRE TRIAL BALANCE WOULD SHOW YOU THE INSTALLMENT SALES ACCOUNT AND THE COST OF INSTALLMENT SALES ACCOUNT OF THE CURRENT PERIOD BECAUSE THE CLOSING OF THAT ACCOUNTS ARE MADE AS PART OF THE ADJUSTING JOURNAL ENTRIES
THE DEFERRED GROSS PROFIT AND THE INSTALLMENT ACCTS. RECEIVABLE OF PREVIOUS SHALL BE INDICATED IN THE BALANCE SHEET WITH INDICATION OF WHAT YEAR IT WAS JOURNALIZED
ILLUSTRATIVE EXAMPLE..
A PRE TRIAL BALANCE DEC 31, 2013 APPEARS BELOW
CASH 70,000
INSTALLMENT REC 2013 137,500
INST. REC 2012 30,000
INST. REC 2011 7,500
ACCOUNTS RECEIVBLE 42,500
MDSE INV. BEG 130,000
OTHER ASSETS 120,000
ACCTS PAYABLE 80,000
DEFERRED GROSS PROFIT 2012 112,500
DEF. GROSS PROFIT 2011 24,000
CAPITAL STOCK 212,500
RETAINED EARNINGS 171,000
SALES REGULAR 312,500
INSTALLMENT SALES 800,000
PURCHASES 875,000
COST OF INST. SALES 580,000
COST OF SHIPPED INSTALLMENT GOODS 580,000
EXPENSES 300,000
TOTAL 2,292,500 2,292,500
REQUIRED: 1. CALCULATE THE GROSS PROFIT RATIO OF 2011,2012,2013
2, MAKE THE ADJUSTING ENTRIES, SETTING UP THE DEFERRED GROSS PROFIT AND CLOSING THE INSTALLMENT SALES ACCOUNT AND THE COST OF INSTALLMENT SALES ACCOUNT.
3. PREPARE PROFIT AND LOSS AND BALANCE SHEET.
AS I HAVE EXPLAINED EARLIER ABOVE , BEFORE YOU CAN COMPUTE THE REALIZED GROSS PROFIT ,SO THAT AN ADJUSTING ENTRY CAN BE MADE , YOU MUST KNOW THE GROSS PROFIT RATIO OF THE PRODUCT SOLD, IN THE ABOVE EXAMPLE IT WOULD APPEAR THAT EVERY YEAR THERE IS DIFFERENT GROSS PROFIT RATIO.
ALSO AS EXPLAINED THE BEGINNING BALANCE OF RECEIVABLE AND THE DEFERRED GROSS PROFIT ( even those end of the year before adjustment is also a beginning balance ) IS DIRECTLY RELATED TO EACH OTHER BECAUSE THE RECEIVABLE DECREASES THE SAME AMOUNT OF THE DEFERRED GROSS PROFIT AS A RESULT OF THE COLLECTION MADE AND BEING MULTIPLIED TO THE GROSS PROFIT RATIO TO REDUCE THE DEFERRED GROSS PROFIT. THAT MEANS , IF YOU DIVIDE THE DEFERRED GROSS PROFIT WITH THE COST PROFIT RATIO , THE ANSWER IS THE BEGINNING LAST YEAR OF THE RECEIVABLE AMOUNT.
NOW CONSIDERING THAT THE ABOVE EXAMPLE DID NOT SPECIFY HOW MUCH COLLECTION WAS MADE FOR 2011, 2012, A RECONSTRUCTION OF THE installment receivable account must be made to determine how much collection was made on a particular year..
THE LAST YEAR BALANCES OF INSTALLMENT RECEIVABLE ARE AS FF:
2011 75,000
2012 375,000
IT IS ASSUMED THAT THE ENDING DEFERRED GROSS PROFIT THIS YEAR IS THE LAST YEAR ENDING BALANCE ALSO BECAUSE THAT BALANCE IS BEFORE ADJUSTING ENTRIES.
GROSS PROFIT RATIO IS COMPUTED AS FF::
FOR 2011 DEFERRED GROSS PROFIT 24,000
DIVIDE INST. RECEIVABLE beg 75000
equals 32% gross profit ratio
FOR 2012 deferred gross profit per trial balance 112,500
divide receivable beg. 375,000
equals 30%
FOR 2013
INSTALLMENT SALES AMOUNT 800,000
COST OF INSTALLMENT SALES 580,000
GROSS PROFIT 220,000
220,000 DIVIDE 800,000 EQUALS 27.5%
DIVIDE INSTALLMENT SALES AMOUNT 800,000
THE ADJUSTING JOURNAL ENTRIES.
1. IS TO ADJUST THE DEFERRED GROSS PROFIT FOR 2011, 2012 BY KNOWING THE COLLECTION MADE FOR 2011, 2012 THIS YEAR.. THIS IS HOW TO RECONSTRUCT THE RECEIVABLE TRANSACTIONS SINCE THERE IS NO DATA ON HOW MUCH WAS COLLECTED FOR 2011, 12 .
SINCE THE ENDING RECEIVABLE AND THE BEGINNING RECEIVABLE IS GIVEN , AND THE ENDING BALANCE IS SMALLER THEREFORE THERE IS A CREDIT MADE ON THE RECEIVABLE ACCOUNT WHICH REPRESENT COLLECTION., HENCE THAT REDUCTION IS THE COLLECTION ITSELF.
2011 2012
BEG RECEIVABLE 75,000 375,000
ENDING BALANCE 7,500 30,000
EQUALS COLLECTION 67,500 345,000
FOR 2013
INSTALLMENT SALES MADE 800,000
BALANCE END OF THE YEAR 137,500
EQUALS COLLECTION 662,500
JOURNAL ENTRIES ADJUSTING:
1. INSTALLMENT SALES 800,000
COST OF INSTALLMENT SALES 580,000
DEFERED GROSS PROFIT 2013 220,000
to recognize the deferred gross profit in view of the closing of sales and the cost of sales
2. DEFERRED GROSS PROFIT 2011 ( 67,500 X 32%) 21,600
DEFERRED GROSS PROFIT 2012( 345,000X 30%) 103,500
DEFERRED GROSS PROFIT 2013 ( 662,500 X 27.5%) 182,187.50
REALIZED GROSS PROFIT 307,287.50
to recognize the realized gross profit and reducing the deferred gross profit.
3. cost of sales 130,000
beg. inventory 130,000
to close beg inventory
4. COST OF SALES 875,000
PURCHASES 875,000
to close purchases to cost of sales
5. INVENTORY 150,000
COST OF SALES 150,000
to set up ending inventory
CLOSING ENTRIES.
1. INCOME EXP SUMMARY 855,000
COST OF SALES 855,000
to close cost of sales account
2. REALIZED GROSS PROFIT 307,287.50
SALES 312,500.00
SHIPMENT OF INST. SALES 580,000.00
INCOME EXP. SUMM 1,199,787.50
to close income account
3. INCOME EXP SUMMARY 378,750.00
OPERATING EXPENSES 378,750.00
to close expense account.
4. retained earnings 33962.50
income exp summ 33,962.50
to transfer net loss to retained earnings.
EXERCISES:
1. COMPLE THE FOLLOWING UNKNOWN DATA
1995 1996 1997
installment sales 50,000 80,000 ?
cost of inst. sales ? ? 91,800
gross profit ? ? 28,200
gross profit ratio ? 25% ?
collections 1995 ? 25,000 10,000
1996 20,000 50,000
1997 45,000
realized gross profit 1,100 10,500 ?
Hint: 1. answer first the 1995 unknown.
2. since the realized gross profit in 1996 is given, and the gross profit ratio of 1996 is given then you can compute the realized gross profit of 1996 which is part of the 10,500.
3. since the collection in 1996 for the sales made in 1995, and the realized gross profit in 1996 for 1995 is known already then you can compute for the gross profit ratio in 1995.
4. all the unknown now can be easily computed.
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2. a company has the ff: data
1995 1996 1997
inst. sales 210,000 270,000 350,000
gross profit ratio 25% 29% 27%
required: compute gross profit, cost of sales, realized gross profit, collections.
the collection history confirms that the sales was collected at 10% first year , 40% 2nd year , 30% 3rd year
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.EXERCISE 3
IN JAN 1, 1997 A COMPANY SOLD A PARCEL OF LAND COSTING 85,000 FOR 140,000, 10% DOWNPAYMENT, BALANCE TO PAY ANNUALLY FOR 10 YRS AT 12% INTEREST PAYABLE EVERY END OF DEC.
REQUIRED: HOW MUCH IS THE ANNUAL PAYMENT.
JOURNAL ENTRIES FOR THE FIRST YEAR.
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IN INSTALLMENT SALES , IT WOULD BE COMMON THAT A DEFAULT ON PAYMENT CAN HAPPEN AND REPOSSESSIONS OF THE PRODUCT IS NECESSARY
IN THE BALANCE SHEET , THERE EXIST A RECEIVABLE FOR THAT CUSTOMER AND A DEFERRED GROSS PROFIT FOR THAT PRODUCT. SINCE THE PRODUCT WILL BE REPOSSESSED , THE BALANCE OF THE RECEIVABLE AND THE DEFERRED GROSS PROFIT HAS TO BE CLOSED.
THE DIFFERENCE BETWEEN THE RECEIVABLE AND THE DEFERRED GROSS PROFIT IS ACTUALLY THE COST OF THE PRODUCT ITSELF BECAUSE ANY REDUCTION ON THAT RECEIVABLE DUE TO COLLECTION , THE DEFERRED GROSS PROFIT IS ALSO CORRESPONDING REDUCED BY APPLYING THE PROFIT RATIO ON THAT COLLECTION.
THAT MEANS , IF THAT PRODUCT IS REPOSSESSED , THE RECEIVABLE IS CLOSED AND THE DEFERRED GROSS PROFIT IS CLOSED , THE DIFFERENCE IS THE ORIGINAL COST OF THAT PRODUCT. NOW , CONSIDERING THAT THE PRODUCT UNDERGO DEPRECIATION DUE TO WEAR AND TEAR THAT INVENTORY MAY NOT BE ANYMORE REALISTIC, HENCE A PROPER VALUATION IS NECESSARY, WHERE IS EITHER GAIN OR LOSS MAY OCCUR DUE TO REPOSSESSIONS.
EXAMPLE:
INVENTORY 5,000
DEFERRED GROSS PROFIT 10,,000
INST. RECEIVABLE 15,000
THEREFORE , A PROPER VALUATION ON THE RETURNED PRODUCT IS NEEDED. THE FOLLOWING MAY BE THE BASIS.
1. THE FAIR MARKET VALUE., IF MORE THAN THE COST , HENCE A GAIN, IF LESS, THEN A LOSS ON REPOSSESSIONS
2. THE BOOK VALUE OR THE COST, NO GAIN NOR LOSS
3. RESALE VALUE LESS RECONDITIONING COST PLUS NORMAL PROFIT
4. NO MORE VALUE, A TOTAL LOSS.
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TRADE INS
PRODUCTS BEING TRADED IN AS PART OF PAYMENT FOR THE NEW PRODUCT PURCHASED SHOULD BE RECORDED AT VALUES AFTER RECONDITIONING COST , WILL MAKE THE PRODUCT REALIZE A NORMAL GROSS PROFIT ON IT SSALE.
AS TO INDUCE A SALES , AN OVERALLOWANCE IS GIVEN ON THE PRODUCT BEING TRADE IN. THIS OVERALLOWANCE AMOUNT MAY BE RECORDED AS A SEPARATE ACCOUNT AND DEDUCT ON THE SALES FIGURE ON TEH PROFIT AND LOSS OR MAYBE APPLIED ON THE SALES FIGURE .
EXAMPLE:
A PRODUCT COSTING 5,000.00 IS SOLD AT 8,000. A USED SIMILAR PRODUCT IS ACCEPTED AS PARTIAL PAYMENT FOR 1,000. THE USED PRODUCT CAN BE RESOLD AT 1,500.00 AFTER REPAIR COST OF 400.00 THE COMPANY WANTS A 20% GROSS PROFIT ON TEH RESALE OF THE USED CAMERA.
IF THAT CAN BE SOLD AT 1500.00
THE MARK UP IS 20% x 1500 ( 300.00)
THEREFORE COST IS 1,200.00
less THE REPAIR COST ( 400.00)
cost to value the trade in 800.00
ACTUAL COST ACCEPT AS TRADE IN 1,000.00
OVER ALLOWANCE 200.00
the entry is :
INVENTORY TRADE IN 800
TRADE IN OVER ALLOWANCE 200
INST. RECE 7,000
INSTALLMENT SALES 8,000
COST OF INST. SALES 5,000
INVENTORY 5,000
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INTEREST ON INSTALLMENT RECEIVABLE
when interest is calculated , the interest revenue should be accounted for separately, that is, each payment received is separated into interest revenue. the interest revenue should be recorded on accrual basis.
EXAMPLE :
On Oct end , a lot is sold costing 200,000.00 for 300,000.00 . a 75,000 down was made and the balance payable in monthly installment with first payment due end nov. payable in 75 months. the monthly installment is 3,000 a month plus 12% interest on the unpaid balance
ENTRIES
CASH 75,000
Notes receivable 225,000
REAL ESTATE 200,000
DEFERRED GROSS PROFIT 100,000
November
Cash 5,250.00
notes rece 3,000
interest income 2,250
dec. 31
cash 5,220.00
notes rec 3,000.00
interest 2,220.00
to record collection in dec. with a principal balance of 222,000 x 1% =2220.00
deferred gross profit 27,000
realized gross profit 27,000
to record the realized gross profit for the collection of 81,000 x .33.333.% mark up
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EXERCISE PROBLEM INSTALLMENT SALES
A TRIAL IS SHOWN BELOW. AS OF DEC 31, 2013
CASH 62,500
INS. REC. 2013 200,000
INST. REC 2012 50,000
INST REC 2011 12,500
ACCTS REC 100,000
INVENTORY 75,000
OTHER ASSETS 130,000
ACCTS PAYABLE 187,500
DEF. GROSS PROFIT 2012 240,000
DEF GROSS PROFIT 2011 56,250
CAPITAL STOCK 250,000
RETAINED EARNINGS 111,250
SALES 480,000
INSTALLMENT SALES 1,250,000
PURCHASES 1,137,500
REPOSSESS INV 25,000
COST OF INSTALLMENT 775,000
SHIPMENTS ON INST. SALES 775,000
LOSS ON REPOSSESS 32,500
EXPENSES 750,000
TOTAL 3,350,000 3,350,000
THE FOLLOWING BEGININNING BALANCES OF SOME ACCOUNTS AS OF DEC 31, 2012 LAST YEAR.
INSTALLMENT RECEIVABLE 2012 600,000
INST. REC. 2011 125,000
DEF. GROSS PROFIT 2012 240,000
DEF. GROSS PROFIT 2011 56,250
THE INVENTORY AS OF DEC 31, 2013 IS 87,500
DURING THE YEAR THERE WAS AN ENTRY WHICH IS INCOMPLETE FOR A REPOSSESSED UNITS.
REPOSSESSED INV. 25,000
LOSS ON REPOSSESSION 32,500
INSTALLMENT RECE 2013 12,500
INSTALLMENT REC 2012 25,000
INSTALLMENT REC 2011 20,000
REQUIRED:
1. compute the gross profit for the three years.
2. correct the wrong entry.
3 make adjusting and closing entries.
4. make PROFIT AND LOSS AND BALANCE SHEET.
NOTE:
When a repossession is made , the corresponding deferred gross profit of the product should also be reversed . Since there is no debit to this account, the balancing account used was loss on repossesion
it would appear that the repossessed units below to 2013, 2012,2011 sales. because all the 3 yrs receivable were credited.
IN determining the the amount of collection , make sure you adjust first the ending balance of the installment receivable because that was reduced because of the entry made out of the repossessions.
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