Problem 21 - Accounting

Question

Madamé Co., a women's clothing store, purchased \(\$ 10,000\) of merchandise from a supplier on account, terms \(\mathrm{FOB}\) destination, \(2 / 10, \mathrm{n} / 30\). Madamé Co. returned \(\$ 2,500\) of the merchandise, receiving a credit memorandum, and then paid the amount due within the discount period. Journalize Madamé Co.'s entries to record (a) the purchase, (b) the merchandise return, and (c) the payment.

Step-by-Step Solution

Answer

Journal entries: (a) Purchase: Debit Inventory $10,000, Credit AP $10,000. (b) Return: Debit AP $2,500, Credit Inventory $2,500. (c) Payment: Debit AP $7,500, Credit Cash $7,350, Credit Inventory $150.

Step 1: Initial Purchase Entry

When the merchandise is purchased on account, Madamé Co. should record the purchase by debiting the 'Merchandise Inventory' account and crediting the 'Accounts Payable' account. The entries will be: - Debit Merchandise Inventory: $10,000 - Credit Accounts Payable: $10,000 This reflects that Madamé Co. now has more inventory worth $10,000, which was bought on credit.

Step 2: Merchandise Return Entry

Madamé Co. decides to return some of the merchandise. The merchandise return will reduce the inventory and the liability. Therefore, Madamé Co. should: - Debit Accounts Payable: $2,500 - Credit Merchandise Inventory: $2,500 This entry reflects the reduction of both the inventory and the outstanding payable by $2,500 corresponding to the returned merchandise.

Step 3: Payment with Discount Entry

Madamé Co. pays the remaining amount due within the discount period to avail the price reduction. First, calculate the net payable after returns and discount: 1. Total purchase = $10,000 2. Less returns = $2,500 3. Net payable before discount = $7,500 4. Discount = 2% of $7,500 = $150 5. Amount to be paid = $7,500 - $150 = $7,350 Now, journalize the payment: - Debit Accounts Payable: $7,500 - Credit Cash: $7,350 - Credit Merchandise Inventory for Discount: $150 This reflects that the account payable is settled for $7,500, but only $7,350 is paid due to the discount, reducing the inventory cost by $150.

Key Concepts

Merchandise Return

When Madamé Co. returned merchandise worth $2,500, it had to adjust its inventory and accounts payable accordingly. This process is essential because returns involve reducing both the assets and the liabilities. Here's how it works:

• The return was recorded by debiting the 'Accounts Payable' account by $2,500. This means that the liability or the amount owed to the supplier decreases by this value.
• Simultaneously, the 'Merchandise Inventory' account is credited by $2,500, showing that the inventory value is reduced due to the return.

Understanding this transaction is crucial because it highlights the impact returns have on financial statements, reducing both inventory and the corresponding payable amounts.

Accounts Payable

Accounts Payable is a critical concept in accounting, especially in the context of purchase transactions on account. It represents the total amount a company owes to its suppliers for goods or services received on credit. When Madamé Co. purchased merchandise:

• The 'Accounts Payable' account was credited by $10,000 to reflect this liability.
• The subsequent merchandise return and payment with a cash discount require adjustments to the accounts payable balance, decreasing it appropriately.

By tracking accounts payable, businesses like Madamé Co. can ensure timely payments and manage lender relationships effectively. This also helps in maintaining accurate records and securing any discounts available by settling debts early.

Cash Discount

A cash discount is an incentive given to buyers to encourage early payment of invoices. In Madamé Co.’s case, the supplier offered a 2% discount for payments made within 10 days.

• The original purchase amount was $10,000, but after returning $2,500, the amount due was reduced to $7,500.
• Madamé Co. took advantage of the discount, reducing the paid amount further by $150 (2% of $7,500), paying only $7,350.

This discount helps businesses maintain good supplier relations and reduce overall cost – in this case, reducing the actual cash outflow and lowering inventory costs by the discount amount.

Merchandise Inventory

Merchandise Inventory is the account that tracks the cost of goods available for sale. When Madamé Co. made the initial purchase, the inventory was increased by $10,000.
But when merchandise was returned:

• The inventory value decreased by $2,500 to account for the return.
• The cash discount also impacts inventory, as the $150 discount obtained reduces the cost of inventory, improving profitability.

Accurate recording of inventory transactions ensures that financial statements reflect true costs and inventory levels. This precision is crucial for effective inventory and financial management.

Purchase on Account

Purchasing on account involves acquiring goods or services with an agreement to pay the supplier at a later date. For Madamé Co., purchasing $10,000 of merchandise on account:

• Results in a credit to 'Accounts Payable', recognizing that the business has a liability to the supplier.
• Increases 'Merchandise Inventory' by the same amount, reflecting the addition of goods to the store's inventory.

This method of purchasing allows companies to manage cash flows better, preserving liquidity and taking advantage of potential cash discounts for early payment. It is a common business practice that supports efficient business operations and financial flexibility.