1 Web Appendix A The Merchandising Work Sheet and Closing Entries This appendix shows how to prepare the work sheet and closing entries for merchandising companies. The work sheet for a merchandising company is basically the same as for a service company (for an example, see the work sheet for Treadle Website Design in the Supplement to Chapter 3). However, it includes the additional accounts needed to handle merchandising transactions. The treatment of these accounts differs depending on whether a company uses the periodic or the perpetual inventory system. The Periodic Inventory System When a merchandising company uses the periodic inventory system, the accounts generally include Sales, Sales Returns and Allowances, Sales Discounts, Purchases, Purchases Returns and Allowances, Purchases Discounts, Freight-In, and Merchandise Inventory. Except for Merchandise Inventory, these accounts are treated in much the same way as revenue and expense accounts for a service company. They are transferred to the Income Summary account in the closing process. On the work sheet, they are extended to the Income Statement columns. Merchandise Inventory requires special treatment under the periodic inventory system because purchases of merchandise are accumulated in the Purchases account. No entries are made to the Merchandise Inventory account during the accounting period. Its balance at the end of the period, before adjusting and closing entries, is the same as it was at the beginning of the period. Thus, its balance at the end of the period represents beginning merchandise inventory. Remember also that the cost of goods sold is determined by adding beginning merchandise inventory to net cost of purchases and then subtracting ending merchandise inventory. The objectives of handling merchandise inventory in the closing entries at the end of the period are to (1) remove the beginning balance from the Merchandise Inventory account, (2) enter the ending balance into the Merchandise Inventory account, and (3) enter the beginning inventory as a debit and the ending inventory as a credit to the Income Summary account to calculate net income. The following T accounts show how these objectives can be met:
2 Merchandise Inventory Jan. 1 Beginning Balance 52,800 Dec ,800 Dec. 31 Ending Balance 48,300 Effect B Effect A Income Summary Dec ,800 Dec ,300 In this example, merchandise inventory was $52,800 at the beginning of the year and $48,300 at the end of the year. Effect A removes the $52,800 from Merchandise Inventory, leaving a zero balance, and transfers it to Income Summary. In Income Summary, the $52,800 is in effect added to net purchases because, like expenses, the balance of the Purchases account is debited to Income Summary in a closing entry. Effect B establishes the ending balance of Merchandise Inventory, $48,300, and enters it as a credit in the Income Summary account. The credit entry in Income Summary has the effect of deducting the ending inventory from goods available for sale because both purchases and beginning inventory are entered on the debit side. In other words, beginning merchandise inventory and purchases are debits to Income Summary, and ending merchandise inventory is a credit to Income Summary. The discussion that follows is based on the work sheet shown in Exhibit 1 for Flanagan Fashions Corporation, a merchandising company. Exhibit 1 Work Sheet for a Merchandising Concern: Periodic Inventory System Flanagan Fashions Corporation Work Sheet For the Year Ended December 31, 20xx Trial Balance Adjustments Income Statement Balance Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Cash 29,410 29,410 Accounts Receivable 42,400 42,400 Merchandise Inventory 52,800 52,800 48,300 48,300 Prepaid Insurance 17,400 (a) 5,800 11,600 Store Supplies 2,600 (b) 1,540 1,060 Office Supplies 1,840 (c) 1, Land 4,500 4,500 Building 20,260 20,260 Accumulated Depreciation, Building 5,650 (d) 2,600 8,250 Office Equipment 8,600 8,600 Accumulated 2,800 (e) 2,200 5,000
3 Depreciation, Office Equipment Accounts Payable 25,683 25,683 Common Stock 50,000 50,000 Retained Earnings 68,352 68,352 Dividends 20,000 20,000 Sales 246, ,350 Sales Returns and Allowances 2,750 2,750 Sales Discounts 4,275 4,275 Purchases 126, ,400 Purchases Returns and Allowances 5,640 5,640 Purchases Discounts 2,136 2,136 Freight-In 8,236 8,236 Sales Salaries Expense 22,500 22,500 Freight-Out Expense 5,740 5,740 Advertising Expense 10,000 10,000 Office Salaries Expense 26,900 26, , ,611 Insurance Expense, Selling (a) 1,600 1,600 Insurance Expense, General (a) 4,200 4,200 Store Supplies Expense (b) 1,540 1,540 Office Supplies Expense (c) 1,204 1,204 Depreciation Expense, Building (d) 2,600 2,600 Depreciation Expense, Office Equipment (e) 2,200 2,200 Income Taxes Expense (f) 5,000 5,000 Income Taxes Payable (f) 5,000 5,000 18,344 18, , , , ,285 Net Income 24,481 24, , , , ,766 Trial Balance Columns The first step in the preparation of the work sheet is to enter the balances from the ledger accounts into the Trial Balance columns. This procedure is the same as the one used in preparing a work sheet for a service company. Adjustments Columns The adjusting entries are entered in the Adjustments columns just as they are for a service company. No adjusting entry is made for merchandise inventory. After the adjusting entries are entered on the work sheet, the columns are totaled to prove that total debits equal total credits.
4 Omission of Adjusted Trial Balance Columns These two columns, which appear in the work sheet for a service company, can be omitted. They are optional and are used when there are many adjusting entries to record. When only a few adjusting entries are required, as is the case for Flanagan Fashions, these columns are not necessary and can be omitted to save time. Income Statement and Balance Sheet Columns After the Trial Balance columns have been totaled, the adjustments entered, and the equality of the columns proved, the balances are extended to the Income Statement and Balance Sheet columns. As on the work sheet for a service company, you begin with the Cash account at the top of the sheet and move sequentially down, one account at a time, entering each account balance in the correct Income Statement or Balance Sheet column. The problem extension here is in the Merchandise Inventory row. The beginning inventory balance of $52,800 (which is already in the trial balance) is extended to the debit column of the Income Statement columns, as shown in Exhibit 1. This procedure has the effect of adding beginning inventory to net purchases because the Purchases account is also in the debit column of the Income Statement columns. The ending inventory balance of $48,300 (which is determined by the physical inventory and is not in the trial balance) is then inserted in the credit column of the Income Statement columns. This procedure has the effect of subtracting the ending inventory from goods available for sale in order to calculate the cost of goods sold. Finally, the ending merchandise inventory ($48,300) is inserted in the debit side of the Balance Sheet columns because it will appear on the balance sheet. After all the items have been extended in the correct columns, the four columns are totaled. The net income or net loss is the difference between the debit and credit Income Statement columns. In this case, Flanagan Fashions Corporation has earned a net income of $24,481, which is extended to the credit side of the Balance Sheet columns. The four columns are then added to prove that total debits equal total credits. Adjusting Entries The adjusting entries from the work sheet are now entered into the general journal and posted to the ledger. The procedure is the same as for a service company.
5 Closing Entries Exhibit 2 shows the closing entries for Flanagan Fashions Corporation. Exhibit 2 System Closing Entries for Flanagan Fashions Corporation: Periodic Inventory General Journal Page 10 Date Description Post. Ref. Debit Credit 20xx Closing entries: Dec. 31 Income Summary 277,945 Merchandise Inventory 52,800 Sales Returns and Allowances 2,750 Sales Discounts 4,275 Purchases 126,400 Freight-In 8,236 Sales Salaries Expense 22,500 Freight-Out Expense 5,740 Advertising Expense 10,000 Office Salaries Expense 26,900 Insurance Expense, Selling 1,600 Insurance Expense, General 4,200 Store Supplies Expense 1,540 Office Supplies Expense 1,204 Depreciation Expense, Building 2,600 Depreciation Expense, Office Equipment 2,200 Income Taxes Expense 5,000 To close temporary expense and revenue accounts with debit balances and to remove the beginning inventory 31 Merchandise Inventory 48,300 Sales 246,350 Purchases Returns and Allowances 5,640 Purchases Discounts 2,136 Income Summary 302,426 To close temporary expense and revenue accounts with credit balances and to establish the ending inventory 31 Income Summary 24,481 Retained Earnings 24,481 To close the Income Summary account 31 Retained Earnings 20,000 Dividends 20,000 To close the Dividends account
6 Notice that Merchandise Inventory is credited for the amount of beginning inventory ($52,800) in the first entry and debited for the amount of the ending inventory ($48,300) in the second entry. Otherwise, these closing entries are like those for a service company except that the merchandising accounts also must be closed to Income Summary. All income statement accounts with debit balances, including the merchandising accounts of Sales Returns and Allowances, Sales Discounts, Purchases, and Freight-In, and beginning Merchandise Inventory are credited in the first entry. The total of these accounts ($277,945) equals the total of the debit column in the Income Statement columns of the work sheet. All income statement accounts with credit balances Sales, Purchases Returns and Allowances, and Purchases Discounts and ending Merchandise Inventory are debited in the second entry. The total of these accounts ($302,426) equals the total of the Income Statement credit column in the work sheet. The third entry closes the Income Summary account and transfers net income to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The Perpetual Inventory System Exhibit 3 shows how the work sheet for Flanagan Fashions Corporation would appear if the company used the perpetual inventory system. Exhibit 3 Work Sheet for a Merchandising Concern: Perpetual Inventory System Flanagan Fashions Corporation Work Sheet For the Year Ended December 31, 20xx Trial Balance Adjustments Income Statement Balance Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Cash 29,410 29,410 Accounts Receivable 42,400 42,400 Merchandise Inventory 48,300 48,300 Prepaid Insurance 17,400 (a) 5,800 11,600 Store Supplies 2,600 (b) 1,540 1,060 Office Supplies 1,840 (c) 1, Land 4,500 4,500 Building 20,260 20,260 Accumulated Depreciation, 5,650 (d) 2,600 8,250
7 Building Office Equipment 8,600 8,600 Accumulated Depreciation, Office Equipment 2,800 (e) 2,200 5,000 Accounts Payable 25,683 25,683 Common Stock 50,000 50,000 Retained Earnings 68,352 68,352 Dividends 20,000 20,000 Sales 246, ,350 Sales Returns and Allowances 2,750 2,750 Sales Discounts 4,275 4,275 Cost of Goods Sold 123, ,124 Freight-In 8,236 8,236 Sales Salaries Expense 22,500 22,500 Freight-Out Expense 5,740 5,740 Advertising Expense 10,000 10,000 Office Salaries Expense 26,900 26, , ,835 Insurance Expense, Selling (a) 1,600 1,600 Insurance Expense, General (a) 4,200 4,200 Store Supplies Expense (b) 1,540 1,540 Office Supplies Expense (c) 1,204 1,204 Depreciation Expense, Building (d) 2,600 2,600 Depreciation Expense, Office Equipment (e) 2,200 2,200 Income Taxes Expense (f) 5,000 5,000 Income Taxes Payable (f) 5,000 5,000 18,344 18, , , , ,285 Net Income 24,481 24, , , , ,766 Under this system, purchases of merchandise are recorded directly in the Merchandise Inventory account, and costs are transferred from the Merchandise Inventory account to the Cost of Goods Sold account as merchandise is sold. Thus, the Merchandise Inventory account is up to date at the end of the accounting period and is not involved in the closing process. Note that the ending merchandise inventory in Exhibit 3 is $48,300 in both the Trial Balance and the Balance Sheet columns. Exhibit 4 shows the closing entries for Flanagan Fashions under the perpetual inventory system.
8 Exhibit 4 System Closing Entries for Flanagan Fashions Corporation: Periodic Inventory General Journal Page 10 Date Description Post. Ref. Debit Credit 20xx Closing entries: Dec. 31 Income Summary 221,869 Sales Returns and Allowances 2,750 Sales Discounts 4,275 Cost of Goods Sold 123,124 Purchases 126,400 Freight-In 8,236 Sales Salaries Expense 22,500 Freight-Out Expense 5,740 Advertising Expense 10,000 Office Salaries Expense 26,900 Insurance Expense, Selling 1,600 Insurance Expense, General 4,200 Store Supplies Expense 1,540 Office Supplies Expense 1,204 Depreciation Expense, Building 2,600 Depreciation Expense, Office Equipment 2,200 Income Taxes Expense 5,000 To close temporary expense and revenue accounts with debit balances 31 Sales 246,350 Income Summary 246,350 To close temporary revenue account with credit balance 31 Income Summary 24,481 Retained Earnings 24,481 To close the Income Summary account 31 Retained Earnings 20,000 Dividends 20,000 To close the Dividends account The Cost of Goods Sold account is closed to Income Summary along with the expense accounts because it has a debit balance. There are no entries to the Merchandise Inventory account. Also, there is no Purchases Returns and Allowances account under the perpetual inventory system, and Freight-In is accounted for separately but is combined with Cost of Goods Sold on the income statement.
9 Problems Work Sheet, Financial Statements, and Closing Entries for a Merchandising Company: Periodic Inventory System P 1. The following trial balance is from the ledger of David s Music Store, Inc., at the end of its annual accounting period: David s Music Store, Inc. Trial Balance November 30, 20xx Cash $ 18,075 Accounts Receivable 27,840 Merchandise Inventory 88,350 Store Supplies 5,733 Prepaid Insurance 4,800 Store Equipment 111,600 Accumulated Depreciation Store Equipment $ 46,800 Accounts Payable 36,900 Common Stock 30,000 Retained Earnings 95,982 Dividends 36,000 Sales 306,750 Sales Returns and Allowances 2,961 Purchases 189,600 Purchases Returns and Allowances 58,965 Purchases Discounts 4,068 Freight-In 6,783 Sales Salaries Expense 64,050 Rent Expense 10,800 Other Selling Expenses 7,842 Utilities Expense 5,031 $579,465 $579,465 Required 1. Enter the trial balance on a work sheet, and complete the work sheet using the following information: ending merchandise inventory, $99,681; ending store supplies inventory, $912; unexpired prepaid insurance, $600; estimated depreciation on store equipment, $12,900; sales salaries payable, $240; accrued utilities expense, $450; and estimated income taxes expense, $15,000.
10 2. Prepare an income statement, a statement of retained earnings, and a balance sheet. Sales salaries expense, other selling expenses, store supplies expense, and depreciation on store equipment are selling expenses. 3. From the work sheet, prepare the closing entries. Work Sheet, Financial Statements, and Closing Entries for a Merchandising Company: Perpetual Inventory System P 2. The trial balance that follows is from the ledger of Marjie s Party Costumes Corporation at the end of its annual accounting period: Marjie s Party Costumes Corporation Trial Balance June 30, 20xx Cash $ 7,050 Accounts Receivable 24,830 Merchandise Inventory 88,900 Store Supplies 3,800 Prepaid Insurance 4,800 Store Equipment 151,300 Accumulated Depreciation Store Equipment $ 25,500 Accounts Payable 38,950 Common Stock 50,000 Retained Earnings 111,350 Dividends 24,000 Sales 475,250 Sales Returns and Allowances 4, 690 Cost of Goods Sold 231,840 Freight-In 10,400 Sales Salaries Expense 64,600 Rent Expense 48,000 Other Selling Expenses 32,910 Utilities Expense 3,930 $701,050 $701,050 Required 1. Enter the trial balance for Marjie s Party Costumes on a work sheet, and complete the work sheet using the following information: ending store supplies inventory, $550; expired insurance, $2,400; estimated depreciation on store equipment, $5,000; sales salaries
11 payable, $650; accrued utilities expense, $100; and estimated income taxes expense, $20, Prepare an income statement, a statement of retained earnings, and a balance sheet. Sales salaries expense, other selling expenses, store supplies expense, and depreciation on store equipment are selling expenses. 3. From the work sheet, prepare closing entries.
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