Question

Mastery Problem: Accounting for Merchandising Businesses

Merchandising Transactions

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

As a merchandising company, Dolfin Company 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, then use checkmarks to identify which accounts are debited or credited. If none of these accounts is affected by the transaction, check the “No Effect” box.

	Merchandise Inventory		Estimated Returns Inventory		Cost of Merchandise Sold		No Effect
	Debit	Credit	Debit	Credit	Debit	Credit
Customer payment on account
Yearly estimate for customer returns
Freight paid for merchandise purchased FOB shipping point
Return of merchandise purchased for resale
Sale on account
Customer returns
Purchase of merchandise for resale
Freight paid for sales with FOB destination
Payment of service fee for processing credit card sales
Cash sale of merchandise

Auditing Observations

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

For each observation, use checkmarks to identify which items on the income statement are overstated or understated. If none of these items is affected by the observation, check the “No Effect” box.

Observations	Sales		Cost of Merchandise Sold		Gross Profit		Operating Expenses		Income from Operations		No Effect
	Overstated	Understated	Overstated	Understated	Overstated	Understated	Overstated	Understated	Overstated	Understated
Office supplies expense was included in administrative expenses.
Sales tax collected on each sale was credited to Cost of Merchandise Sold.
Credit card processing fees were debited to Cost of Merchandise Sold.
Customer returns and allowances were sometimes debited to Estimated Returns Inventory and credited to Sales.
Inventory shrinkage was credited to Miscellaneous Selling Expense.
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.

Income Statement

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

Dolfin Company

Income Statement

For the Year Ended December 31, 2020

1	Sales		$320,840.00
2	Expenses:
3	Cost of merchandise sold	$218,171.20
4	Selling expenses	41,709.20
5	Administrative expenses	35,292.40
6	Interest expense	275.00
7	Total expenses		295,447.80
8	Net income		$25,392.20

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

1. Compute the operating expenses for Dolfin Company.

2. Compute the gross profit for Dolfin Company.

3. Compute the income from operations for Dolfin Company.

Answer 1