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Income Statement

Instructions
a. Prepare an income statement for Hendry’s Boutique dated December 31, 2009.
b. Compute the store’s gross profit margin as a percentage of net sales.
c. Do the store’s customers seem to be satisfied with their purchases? Defend your answer.
d. Explain how you can tell that the business records inventory purchases net of any purchase discounts.
e. The store reports sales taxes payable of $ 3,200 in its adjusted trial balance. Explain why it does not report any sales taxes expense.
f. Which accounts appearing in the store’s adjusted trial balance comprise its operating cycle?

Sales (C) 226,000
Less: Sales returns and allowances (C) 2500
Net sales (C) 223,500
Cost of goods sold (c) 100,575
Gross profit (c) 122925
Purchase discounts (D) 250
Office Supply expense (d) 4120
Depreciation expense(d) 2750
Rent Expense (D) 6100
Insurance Expense (D) 900
Salaries Expense (D) 88095 = (C)102735
Income before income taxes expense (C)20190
Income taxes expense (C) 8190
Net Income (C) 12,000

b. Gross profit 122,925
Net Sales 223,500
Gross profit margin 122925/223500=1

c) The stores customers seem to be satisfied with their purchases. Out of the 226000 worth of sales only 2500 worth of that were sales returns.

Can someone explain d, e and f to me?

There's a lot here that I can't answer because I can't see the information given in the problem. And there's one account that's making a world of difference in how some things would be answered, and I'd have to know how to deal with that account first. But I can answer some things and then tell you where the difficulty lies.

Quote:

a. Prepare an income statement for Hendry’s Boutique dated December 31, 2009.
Sales (C) 226,000
Less: Sales returns and allowances (C) 2500
Net sales (C) 223,500
Cost of goods sold (c) 100,575
Gross profit (c) 122925
Purchase discounts (D) 250
Office Supply expense (d) 4120
Depreciation expense(d) 2750
Rent Expense (D) 6100
Insurance Expense (D) 900
Salaries Expense (D) 88095 = (C)102735
Income before income taxes expense (C)20190
Income taxes expense (C) 8190
Net Income (C) 12,000

First, I can't know whether everything here is right or not since I can't see where you got the information from. I can only check the math, and see if the setup looks right, etc. I can spot two mistakes, but wouldn't know if you have anything else wrong (like missed an account or if your numbers are right, etc).

But before I get to the mistakes, an income statement isn't debits and credits. Every piece of paper that has columns on it isn't debits and credits. In fact, net sales, gross profit, total expense, income before taxes and net income aren't accounts, so they can't have a debit/credit side. Debit and credit mean left and right -- they are literally from Latin words meaning left and right. They refer to the left and right side of accounts. Financial statements are just a reporting of ending balances and are not about sides of accounts. The columns are for organization only.

First error: where did you get the 102,735?

Second error - about that purchases discounts. (As a side note, that account is not a debit. It's a contra expense, a credit.) Is this periodic? If so, you should have a COGS section and the discounts would be in that section. If it's not periodic, then I don't know why you have a purchases discount account. So the only logical thing to me is that it's periodic. In which case, you need a COGS section. Either way, the purchases discounts isn't added with the expenses, cause it's a negative. (If you get a discount, does that not reduce your purchase cost?) The COGS section of a periodic statement would look like part d of your other problem.

If it wasn't mentioned then it's OK. (the way you did net sales, taxes OK, etc.)

Quote:

b. Gross profit 122,925
Net Sales 223,500
Gross profit margin 122925/223500=1

Um.. check your math. Also, always think about whether your answers make sense. You can't know if an answer is exactly correct, but you can know it doesn't make sense to divide 122925 by 223500 and get 1??

Quote:

c. Do the store’s customers seem to be satisfied with their purchases? Defend your answer.
c) The stores customers seem to be satisfied with their purchases. Out of the 226000 worth of sales only 2500 worth of that were sales returns.

I would figure this as a percent of sales. The number 2500 in and of itself has no meaning without looking at it as a percent of (gross) sales.

Quote:

Can someone explain d, e and f to me?

Quote:

d. Explain how you can tell that the business records inventory purchases net of any purchase discounts.

I would have to say I don't quite understand the question. The statement "records inventory purchases net of any purchase discounts" makes me believe they're referring to a method whereby you take the discount off at the time of purchase. That is, rather than taking the discount a the time of payment and crediting it out of inventory, you just take the discount off right from the time of purchase and it never gets recorded at all. It's an assumption that all discounts will get taken. However, I see nothing here that would tell me they are doing this, especially since there's a purchase discounts account. So I don't comprehend the question.

Quote:

e. The store reports sales taxes payable of $ 3,200 in its adjusted trial balance. Explain why it does not report any sales taxes expense.

Think about this: you walk into a store and buy some clothes. You pay sales tax on it. (Unless you're like in Oregon or some place without one, and then it might not make sense.) The company takes the sales tax from you, which they will later turn over to the state. Who does the expense belong to?

Quote:

f. Which accounts appearing in the store’s adjusted trial balance comprise its operating cycle?

The operating cycle is from the time a purchase is made until the time the cash from a sale of inventory is collected. Which accounts do you think would be involved?

Comment on morgaine300's post

morgaine300,
As for the answer of f, should I say that Merchandise inventory, accounts payable, sales taxes payable, sales, sales returns and allowances, cost of goods sold, purchase discounts lost are the accounts comprise the operating cycle then? I didn't include other ordinary asset accounts and expenses accounts like Utilities, office supply. Is that correct?

The operating cycle is equal to the age of inventory plus the collection period.

To calculate the age of inventory you first need to calculate the Inventory Turnover ratio which is: Cost of Goods Sold / Average Invntory. Now you can calculate the age of inventory, which is: 365/ the Inventory Turnover Ratio.

To calculate the collection period you need to first calculate the Accounts Receivable Turnover ratio, which is: Net Credit Sales / Average Accounts Receivable. Now you can calculate the average collection period by: 365/ Accounts Receivable Turnover Ratio.