Name: Mohammed Uzair Ashfaq

ERP: 18384

Home Assignment 2

Question 1
Fashion house uses perpetual inventory system. At the beginning of the year, inventory amounted to
$50,000. During the year, the company purchased merchandise worth Rs. 230,000 and sold merchandise
costing $245,000. A physical inventory taken at the yearend indicated that shrinkage losses of $ 4,000.
Prior to recording these shrinkage losses, what was the yearend balance in company’s inventory
account?

Answer:

Opening Inventory: $50,000

Add Purchases: $230,000

Subtract Cost of Sales: ($245,000)

ENDING INVENTORY: $ 35,000

Note: Damages ($5000) won’t be incuded since the question asked for yearend balance w/o accounting
for shrinkage loss.

Question 2
Two of the lawn mowers sold by Garden Products Co. are the LawnMaster and the Mark 5. LawnMaster
sells for $250 apiece, which results in a 35% gross profit margin. Each Mark 5 costs Garden Products
$300 and sells for $400. Indicate all correct answers?

a. The dollar amount of gross profit is greater on the sale of a Mark 5 than LawnMaster. - CORRECT
b. The gross profit margin is higher on Mark 5s than on LawnMasters.
c. Garden profits more by selling one Mark 5 than one LawnMaster. - CORRECT
d. Garden profits more by selling $2,000 worth of Mark 5s than $2,000 worth LawnMakers.

Question 3
Outback Sporting Goods purchased merchandise on terms of 4/10, n/60. The company has a line of
credit that enables it to borrow money as needed from Northern Bank at an annual interest rate of 13%.
Should Outback pay its suppliers within the 10 days discount period if it must draw on its credit line to
make early payment? Explain.
Answer:

Yes, the company should make the payment within 10 days to avail the discount. Because if the money
is invested and If x is the rate of return being offered on that investment, in order to meet the discount
amount , x ( for a 50 day investment) would be 50/365* X = 4%  x = 4% * 365/50  x= 29.2%

OR

Suppose the cost of purchase = $ 100

Discount if paid within 10 days = 4% => $ 4
If $ 100 are invested for 50 days return @ 13% per annum = 100 * 13% * 50/365 = $ 1.8
Since earning from investment is lower, it would be better for Outback Sporting goods to take the
discount.

Question 4
A seller generally records sales at the full invoice price, but the buyer often records purchases at net
cost. Explain the logic of the buyer and seller recording transaction at different amounts.

Answer:

In order to give a clear picture of the total sales and in view of the matching principle, seller shows the
actual sale price or total revenue and the discounts as a contra is shown separately. This is because of
the terms of discount. The seller may not be sure whether discount will be utilized and even if it utilized
he may not be sure of the exact date. For example, if discount is utilized after the end of the reporting
period, as per matching principle, its impact should reflect in the next period.

Similarly, based on matching principle, buyers, record the transaction net of discount and if that
discount is not availed within due time, it is expensed.

Question 5
PC Connection is a leading mail order retailer of personal computers. A recent financial report issued by
the company revealed the following information.

Merchandise Inventory at the beginning of the year $69 million

Merchandise Inventory at the end of the year $57 million
Net Sales for the year $1.2 billion
Gross profit margin 11%

a. Compute cost of goods sold for the company.

b. How much inventory did the company purchase?
Answers:

Inventory at the beginning of the year $69 million $69,000,000

Inventory at the end of the year $57 million $57,000,000
Net Sales for the year $1.2 billion $1,200,000,000
Gross profit margin 11% $132,000,000
a. cost of goods sold for the company. $1,068,000,000.00
$57,000,000
+ $1,068,000,000
b.      Purchases - $69,000 $1,056,000,000.00

Question 6
Assume that you were hired by Regis Departmental Store in 2012 to develop and implement a new
credit policy. At the time of your hire, the average collection period for an outstanding receivable was in
excess of 90 days (far greater than the industry average). Thus the primary purpose of the new policy
was to better screen credit applicants in an attempt to improve the quality of the company’s accounts
receivables.

Shown below are the net sales and accounts receivables data for past four years (in thousands)

2015 2014 2013 2102

Sales 17,000 14,580 9,600 9,000
Average Accounts Receivable 1,700 1,620 1,600 1,800

Based on the above data, was the credit policy developed by you was successful. Explain with workings?

Answer:

The policy was effective and the same is reflecting in the increase in receivable turnover. The higher
Turnover of receivable tells that the cycle of receivable turned around faster or more efficiently.
2015 2014 2013 2102
Sales 17,000 14,580 9,600 9,000
Average Accounts Receivable 1,700 1,620 1,600 1,800
Reciebvable turnover (Net Sales/ Avg Accounts Recievable) 10 9 6 5

Question 7
What are lines of credit? From the view point of a short term creditor, why do lines of credit increase a
company’s liquidity? How are the unused portions of these lines presented in financial statements?

Answer:
Lines of credit are agreements with the lender whereby lender agrees to provide loan/ credit facility to a
company subject to certain predefined terms and conditions. Credit line for facilities such as running
finance can be drawn upon by the company to fulfill its day to day requirements if it falls short of its own
cash. The bank is usually liable to extend this credit as per agreement, provided the company satisfies
the agreed terms. Unused portion of these lines of credit generally are disclosed in the notes to the
financial statements

Question 8
What are the advantages to a retailer of making credit sales only to customers who use nationally
recognized credit cards?

1. It gives them a competitive edge over peers who don’t accept credit card.
2. The risk of non-payment is transferred to the credit card issuer, which is usually a bank or a
company with good credit rating. This also reduces the efforts and expense that may be
required for collection.
3. Better credit terms for the merchant. In most cases the cash is provided immediately.
4. Improves the record of sales. It also can serve as a counter check like bank statement is used for
reconciliation of accounts.
5. Credit card companies may issue value added services such as direct transfer of funds to the
merchant’s account within a specified time (usually a claim is submitted by the merchant
through his bank).
6. It also reduces the risk that arises due to cash handling such risk may include robberies,
skimming etc.

Question 9
How does an annual audit by a CA firm provide assurance that a company’s accounts receivables and
notes receivables are fairly presented in a company’s financial statement?
Answer:

1. It will check whether accounting of the receivable is as per principles and best practices. In
particular it will give special considerations to provisions made against doubtful receivables or
write offs in case of bad debts.
2. The CA firm will try to assess whether customers actually purchased items as per disclosed term.
For this it may, on a sampling basis, check invoices or other documentary evidences and also
take confirmation from the customers.
3. The firm will also check internal control mechanisms such as recording, verification and
validation of sales by the company.

Question 10
Coco Cola’s distinctive trade mark is valuable to the company. Why isn’t it listed as an asset on company
financial statements?
Answer:
First, if Coca cola trademark was internally generated, the cost attributable to the trademark would have
been difficult to determine and thus in line with accounting standards, it would have been expensed at
that time. Secondly, if it was purchased, an asset might have been created against it, but considering
that it’s a very old trademark, the same would have been amortized by now.