Problem 22 - Accounting

Question

Journalize entries for the following related transactions of Westcoast Diagnostic Company: a. Purchased \(\$ 25,000\) of merchandise from Presidio Co. on account, terms \(2 / 10, n / 30\). b. Paid the amount owed on the invoice within the discount period. c. Discovered that \(\$ 5,000\) of the merchandise was defective and returned items, receiving credit. d. Purchased \(\$ 4,000\) of merchandise from Presidio Co. on account, terms \(\mathrm{n} / 30\). e. Received a check for the balance owed from the return in (c), after deducting for the purchase in (d).

Step-by-Step Solution

Answer

Westcoast's final cash payment after adjustments is $1,000.

Step 1: Record the Initial Purchase

Westcoast Diagnostic Company purchases $25,000 of merchandise on account. The terms are 2/10, n/30, which means they will get a 2% discount if they pay within 10 days. Journal Entry: - Debit Merchandise Inventory: $25,000 - Credit Accounts Payable: $25,000.

Step 2: Payment within Discount Period

Westcoast pays the owed $25,000 within the 10-day discount period. They receive a 2% discount. Discount Calculation: - Discount: $25,000 * 0.02 = $500 - Payment Amount: $25,000 - $500 = $24,500. Journal Entry: - Debit Accounts Payable: $25,000 - Credit Cash: $24,500 - Credit Merchandise Inventory (Discount): $500.

Step 3: Return Defective Merchandise

Westcoast returns defective merchandise valued at $5,000 and receives a credit for it. Journal Entry: - Debit Accounts Payable: $5,000 - Credit Merchandise Inventory: $5,000.

Step 4: Record Additional Purchase

Westcoast purchases another $4,000 of merchandise on account with terms n/30 (no discount). Journal Entry: - Debit Merchandise Inventory: $4,000 - Credit Accounts Payable: $4,000.

Step 5: Account for Settlement with Presidio

Westcoast settles the balance with Presidio. They should offset $5,000 credit from the return against the new purchase of $4,000. Calculation: - Accounts Payable (initial): $5,000 (Return) - $4,000 (New Purchase) = $1,000 credit balance. Journal Entry: - Debit Accounts Payable: $4,000 - Credit Cash: $1,000 (returned balance).

Key Concepts

Understanding Accounts Payable

Accounts payable is an essential part of a company's financials, representing the money a company owes to its suppliers for goods or services purchased on credit. In simple terms, when a business buys merchandise, like Westcoast Diagnostic Company did from Presidio Co., it doesn't pay immediately. Instead, it records the amount owed as a liability called "accounts payable."

• Liabilities: Accounts payable fall under current liabilities on the balance sheet and indicate the company's obligations that are due within a year.
• Recording: When recording journal entries, an increase in accounts payable is credited (adding to the liability), while a payment or return decreases it, which is debited (reducing the liability).
• Payment Terms: Terms like 'n/30' denote that the full invoice amount is due within 30 days, while '2/10, n/30' offers a discount if paid within 10 days.

This framework helps businesses manage their cash flow effectively without needing immediate cash payouts, thus optimizing operational liquidity.

The Role of Merchandise Inventory

Merchandise inventory plays a crucial role in any retail or wholesale business, acting as the goods available for sale to customers. It affects both the balance sheet and income statement, reflecting potential earnings and inventory levels.
For Westcoast Diagnostic Company, when merchandise is purchased, it is initially recorded at cost under merchandise inventory.

• Asset Classification: It's considered a current asset because it is expected to be sold, consumed, or converted to cash within a year.
• Purchasing and Resale: Buying inventory increases the merchandise inventory account (debit), while any items sold decrease it upon customer purchase.
• Inventory Management: Effective inventory management ensures that there is enough stock to meet customer demand without overstocking, which ties up capital.

Adjusting entries, like for a purchase return, involves a credit which decreases the inventory's value. This method keeps financial books accurate and reflects true stock value.

Cash Discount Mechanics

Cash discounts are incentives offered by sellers to encourage buyers to pay off their accounts payable earlier. It's also known as a "prompt payment discount." Westcoast Diagnostic Company, for example, benefited from such a discount by paying within the discount period.

• Discount Terms: The terms '2/10, n/30' mean the buyer gets a 2% reduction in price if the invoice is paid within 10 days, otherwise, the full amount is due in 30 days.
• Accounting Treatment: When the discount is utilized, the discount amount is deducted from the total payable, and savings are credited to the merchandise inventory account in the books.
• Cash Optimization: Taking advantage of cash discounts improves cash flow and reduces costs, as it lowers the total expenditure on inventory.

Utilizing cash discounts can significantly improve a company's financial efficiency by optimizing the use of cash and reducing debts earlier than scheduled.

Handling Defective Merchandise Returns

Handling returns of defective merchandise is crucial for maintaining quality standards and financial integrity. In business, returns like those made by Westcoast for defective items ensure that companies don't pay for unsatisfactory goods.

• Return Policies: Companies may return defective products to suppliers for a refund or credit, which helps maintain quality control.
• Journal Entry Process: For accounting purposes, returning merchandise results in reversing part of the original transaction. This is done by debiting accounts payable and crediting merchandise inventory, thereby adjusting both the liability and asset accounts.
• Impact on Supplier Relations: Promptly returning defective merchandise helps maintain good relationships with suppliers by communicating issues and resolving them efficiently.

Returns are a routine part of business, helping companies ensure they only pay for usable, quality inventory, which reflects in accurate financial statements.