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


For each transaction, think about the journal entry that would be used to record it.

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
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.


Consider the effect of each error on the income statement. Compare what should have been recorded to what was actually done.

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 $318,840
Cost of goods sold $216,811
Selling expenses 41,449
Administrative expenses 35,072
Interest expense 275
Total expenses (293,607)
Net income $25,233

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.
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2. Compute the gross profit for Dolfin Corporation.
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3. Compute the operating income for Dolfin Corporation.
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