Question

Mastery Problem: Accounting for Retail Businesses

Merchandising Transactions

You are working as a summer intern for AAA Auditing, Inc. You have been asked to help resolve discrepancies noted in the audit for Dolfin Corporation, a retailer of specialty aquarium supplies.

As a retail company, Dolfin Corporation uses the perpetual inventory system. To prepare for this assignment, you have been asked to review your knowledge of sales and purchase transactions by completing the following table.

Consider the effect of each transaction on the three accounts listed, and identify which accounts are debited or credited. If not affected by the transaction, select "No Effect".

		Inventory		Estimated Returns Inventory		Cost of Goods Sold
Purchase of merchandise for resale		credit or debit or no effect		credit or debit or no effect		credit or debit or no effect
Cash sale of merchandise		c or d or NE		c or d or NE		c or d or NE
Customer returns		c or d or NE		c or d or nE		c or d or NE
Yearly estimate for customer returns		c or d or NE		c or d or NE		c or d or NE
Freight paid for merchandise purchased FOB shipping point		c or d or NE		c or d or NE		c or d or NE
Return of merchandise purchased for resale		c or d or NE		c or d or NE		c or d or NE
Freight paid for sales with FOB destination		c or d or NE		c or d or NE		c or d or NE
Sale on account		c or d or NE		c or d or NE		c or d or NE
Customer payment on account		c or d or NE		c or d or NE		c or d or NE
Payment of service fee for processing credit card sales		c or d or NE		c or d or NE		c or d or NE

Auditing Observations

After going through the accounting records of Dolfin Corporation in detail, the auditor made a list of observations. You have been asked to review the effect of these observations.

For each observation, identify which items on the income statement are overstated or understated. If not affected by the observation, select the "No Effect".

Observations		Sales		Cost of Goods Sold		Gross Profit		Operating Expenses		Operating Income
While the company accountant was on vacation, the cost of each sale was not recorded for sales transactions.
All freight costs were charged to Delivery Expense regardless of the terms of sale.
Customer returns and allowances were sometimes debited to Estimated Returns Inventory and credited to Sales.
Office supplies expense was included in administrative expenses.
Sales tax collected on each sale was credited to Cost of Goods Sold.
Inventory shrinkage was credited to Miscellaneous Selling Expense.
Credit card processing fees were debited to Cost of Goods Sold.

Income Statement

The accountant for Dolfin Corporation prepared the following income statement. The auditor has asked you to use this statement to provide additional information to Dolfin Corporation on the Final Questions.

Dolfin Corporation Income Statement For the Year Ended December 31, 20Y8
Sales			$317,340
Expenses:
Cost of goods sold	$215,791
Selling expenses	41,254
Administrative expenses	34,907
Interest expense	275
Total expenses			(292,227)
Net income			$25,113

Final Questions

The auditor has asked you to prepare additional information about Dolfin Corporation’s results for last year. Use the data shown on the income statement in your computations.

1. Compute the operating expenses for Dolfin Corporation.
$

2. Compute the gross profit for Dolfin Corporation.
$

3. Compute the operating income for Dolfin Corporation.
$

Answer 1

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AAA Auditing Inc.	Inventory	Estimated Returns Inventory	Cost of Goods sold	Reason
Purchase of merchandise for resale	Debit	No Effect	No Effect	Purchase of merchandise will increase inventory in books. No impact in Estimated Returns Inventory as it is not a return from customer. Impact on Cost of Goods sold will be when merchandise is sold so no impact now.
Cash sales of merchandise	Credit	No Effect	Debit	Inventory will reduce and cost of goods sold will be debited because it’s a sale of merchandise.
Customer Returns	No Effect	Debit	Credit	No impact on inventory. Estimated Returns Inventory will increase as it is a return from customer. Cost of Goods sold will decrease.
Yearly estimate for Customer Returns	No Effect	Debit	Credit	No impact on inventory. Estimated Returns Inventory will increase as it is a return from customer. Cost of Goods sold will decrease.
Freight paid for merchandise purchased FOB Shipping point	No Effect	No Effect	Debit	Cost of Goods sold will increase because freight is part of cost of inventory.
Return of merchandise purchased for resale	Credit	No Effect	No Effect	Return of merchandise will decrease inventory.
Freight paid for sales with FOB destination	No Effect	No Effect	No Effect	Freight paid for sales is a part of cost of sales.
Sales on Account	Credit	No Effect	Debit	Inventory will reduce and cost of goods sold will be debited because it’s a sale of merchandise.
Customer payment on Account	No Effect	No Effect	No Effect	Customer payment will affect accounts receivable and cash account.
Payment of service fee for processing credit card sales	No Effect	No Effect	No Effect	Payment of service fee for processing credit card sales is a type of financial expense and will not impact inventory in any way.
Dolfin Corporation
Observations	Sales	Cost of Goods Sold	Gross Profit	Operating Expenses	Operating Income
While the company accountant was on vacation, the cost of each sale was not recorded for sales transactions.	No effect	Understated	Overstated	No effect	No effect
All freight costs were charged to Delivery Expense regardless of the terms of sale.	No effect	Understated	Overstated	No effect	No effect
Customer returns and allowances were sometimes debited to Estimated Returns Inventory and credited to Sales.	Overstated	Understated	No effect	No effect	No effect
Office supplies expense was included in administrative expenses.	No effect	No effect	No effect	No effect	No effect
Sales tax collected on each sale was credited to Cost of Goods Sold.	No effect	Understated	Overstated	No effect	No effect
Inventory shrinkage was credited to Miscellaneous Selling Expense.	No effect	Understated	Overstated	Overstated	No effect
Credit card processing fees were debited to Cost of Goods Sold.	No effect	Overstated	Understated	No effect	No effect
1. Compute the operating expenses for Dolfin Corporation
Selling expenses	41,254.00
Administrative expenses	34,907.00
Operating expenses	76,161.00
2. Compute the gross profit for Dolfin Corporation
Sales	317,340.00
Less: Cost of goods sold	215,791.00
Gross Profit	101,549.00
3. Compute the operating income for Dolfin Corporation
Sales	317,340.00
Less: Cost of goods sold	215,791.00
Gross Profit	101,549.00
Less: Operating expenses
Selling expenses	41,254.00
Administrative expenses	34,907.00
Operating income	25,388.00