Advanced Accounting. Chapter 4: Financial Reporting for a Departmentalized Business

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1 Advanced Accounting Chapter 4: Financial Reporting for a Departmentalized Business Financial statements are used to summarize financial info and then are used to evaluate the financial position and progress of the business Accounting Period Cycle: concept that states that changes in financial info are reported for a specific period of time in the form of financial statements the time period is based on the needs of the business Section 1: Interim Departmental Statement of Gross Profit A departmentalized business usually prepares reports about how well each department is doing EX. Departmental Statement of Gross Profit Provides revenue and cost info for each department A review of this info might be needed for: Change merchandise selling prices Change suppliers of merchandise Add, delete, or change products Discontinue a department Gross profit info shows changes between costs and selling prices Often will prepare this statement monthly even if the fiscal period is longer called an interim departmental statement of gross profits b/c not for whole fiscal period, just a part of it To prepare an interim statement, both beginning and ending inventory amounts are needed Periodic (physical) inventory count actual merchandise Perpetual inventory continuously kept based on purchases and sales requires a good computer system When a perpetual inventory is not kept and a monthly periodic inventory is not practical, a business may estimate merchandise inventory Gross profit method of estimating an inventory: estimating inventory by using the previous year s percentage of gross profit on operations Prepare an estimated merchandise inventory sheet Get the beginning inventory, January 1, from the general ledger Determine net purchases to date (purchases purchases discounts purchases returns and allowances) Add lines 1 and 2 to determine the merchandise available for sale Determine net sales to date (sales sales discount sales returns and allowances) Calculate the estimated gross profit by multiplying line 4 by the estimated gross profit from the previous year

2 Calculate the estimated cost of merchandise sold by subtracting line 5 from line 4 Calculate the estimated ending inventory by subtracting line 6 from line 3 this estimate is used on the interim departmental statement of gross profit Data on an Interim Departmental Statement of Gross Profit is organized into three sections: operating revenue, cost of merchandise sold, gross profit on operations To help managers analyze financial info, relationships between items in a financial statement are calculated Four basic components are included in every sales dollar: Cost of merchandise sold Gross profit on operations Total operating expenses Net income before federal income tax Each department in a merchandising business has a merchandise inventory account and an income summary account The cost of merchandise sold is a large cost for all merchandising businesses Both the cost of merchandise sold percentage and the gross profit percentage use net sales in the denominator of the equation Gross profit on operation must be large enough o cover total operating expenses and produce a new income For component percentages to be useful, a business must know acceptable levels of performance know from business historical records and industry performance standards Interim financial statements provide information for periods of time less than a year such as months, quarters, or semiannual periods. Section 2: Preparing a Work Sheet for a Departmentalized Business Businesses prepare Schedules of Accounts Receivable and Accounts Payable periodically to show the current balances of individual accounts in comparison to the controlling accounts Accounts Receivable and Accounts Payable in the general ledger The balances of the schedules must match its respective controlling account Work Sheet: form used to summaries the general ledger information needed to prepare financial statements Trial Balance: proving on the work sheet that debits equal credits

3 List general ledger accounts (even those with no balances) in the account title column and record the account balances in the appropriate debit/credit column After all accounts and balances are entered, add the debits and credits and prove equality Some general ledger accounts are not current and need to have adjustments made to them Questions to determine the adjustment needed What is the balance of the account needing adjusted? What should the balance be of this account? What must be done to correct the account balance? What adjustment is made? What account to be debited and what account to be credited Must label the adjustments in the order they are made with small letters in ( ) Uncollectible Accounts Expense: debit Uncollectible Accounts Expense and credit Allowance for Uncollectible Accounts. Total sales on account x Percentage = Estimated Uncollectible Accounts Expense Merchandise Inventory Adjustments: must use the respective department categories Merchandise Inventory and Income Summary o If ending balance should be smaller, credit Merchandise Inventory and debit Income Summary o If ending balance should be larger, debit Merchandise Inventory and credit Income Summary Supplies Expense: debit Supplies Expense and credit Supplies to decrease the amount of supplies in inventory for each of the types of supplies it is an operating expense Prepaid Insurance: debit Insurance expense and credit Prepaid Insurance to account for the use of the insurance asset throughout the year Depreciation Expense: debit Depreciation Expense type of equipment and credit Accumulated Depreciation type of equipment o Assets depreciate or lose value over time because of use and newer models available o It is an operating expense and is an estimate because do not know the actual decrease until the equipment is sold or disposed of. Federal Income Tax Expense: debit Federal Income Tax Expense and credit Federal Income Tax Payable o Estimate amount due and make quarterly payments if going to owe more than $500 a year. o Actual income tax is calculated at the end of the year and an adjustment is made

4 After all adjustments have been entered on the work sheet, the Adjustments columns are totaled and checked for equality and are doubleruled The asset, liability, and stockholders equity account balances are extended to the Balance Sheet columns of a work sheet o The totals of the two columns are out of balance because going to indicate an increase or decrease in stockholders equity The balances of all revenue, cost, and expense accounts are extended to the Income Statement columns on a work sheet o The accounts that are to be adjusted must be o The difference between the two Income Statement columns indicates Net Income or Net Loss for a fiscal period o If credit column is larger have a net income o If debit column is larger have a net loss Record Net Income after Federal Income Tax at the bottom of the work sheet After the net income or loss amount is recorded, total the balance sheet and income statement columns to prove respective equality Section 3: Financial Statements for a Departmentalized Business Financial statements are prepared to report the financial progress and condition of a business Statements commonly prepared at the end of the fiscal period Departmental statement of gross profit (DSGP) Income statement (IS) Statement of stockholders equity (SSE) Balance sheet (BS) DSGP is similar to the interim departmental statement of gross profit the difference is that the annual statement uses the actual ending periodic inventories Info needed to complete the DSGP is from the Trial Balance, Income Statement and Balance Sheet columns of the work sheet Component percentages for the total cost of merchandise sold and gross profit on operations are calculated. Also calculated for individual departments An analysis of the annual DSGP indicates either acceptable or unacceptable levels of performance If performance not acceptable steps need to be taken to improve the performance Component percentages are usually carried to one decimal place

5 IS is a financial statement showing the revenue and expenses for a fiscal period Data used to prepare an IS is from the work sheet On an IS component percentages are analyzed for total operating expenses, net income before and after income tax, and federal income tax Analyze the percentages in comparison to previous performance and industry standards Component percentages are shown in a separate column on the IS Percentages for total gross profit on operations and total cost of merchandise sold are obtained from the departmental statement of gross profit Calculating Component Percentage Divide total operating expenses by net sales to determine the total operating expense percentage Divide net income before federal income tax by net sales to determine the total net income before federal income tax percentage Divided federal income tax by net sales to determine the federal income tax percentage Divide net income after federal income tax by net sales to determine the net income after federal income tax percentage SSE is a financial statement that shows changed in a corporations ownership for a fiscal period SSE has 2 major sections Capital stock which represents total shares of ownership in a corporation Retained earnings which is the amount earned by a corporation and not yet distributed to stockholders Find capital stock info from the previous year s SSE and the capital stock account Find retained earnings from previous year s SSE and the dividend line and the net income after federal income tax line on the work sheet BS is a financial statement that reports assets, liabilities, and owner s equity on a specific date Data for the BS comes from the Balance Sheet columns of the work sheet and the SSE Section 4: End-of-Period Work for a Departmentalized Business Adjusting entries: journal entries recorded to update general ledger accounts at the end of the fiscal period

6 At the end of the fiscal period, the temporary account balances are transferred to an income summary account Journalize adjusting entries: center the words Adjusting Entries in the account title line of a new general journal page and then record the adjusting entries from the work sheet in alphabetical order Closing Entries: journal entries used to prepare temporary accounts for a new fiscal period 1. Closing entry for income statement accounts with credit balances a. Departmental income summary accounts (those with credit balances), the revenue accounts (sales), and the contra cost accounts (purchases discounts and returns and allowances) 2. Closing entry for income statement accounts with debit balances a. Departmental income summary accounts (those with debit balances), the contra revenue accounts (sales discounts and returns and allowances), the cost accounts (purchases), and expense accounts 3. Closing entry to record net income (net loss) in the retained earnings account and to close the income summary account a. Income Summary General account balances is equal to the net income (or loss) for the fiscal period b. Corporation s net income is recorded in the retained earnings account c. After the entry is recorded, Income Summary has a zero balance and the net income has been credited to Retained Earnings 4. Closing entry for the dividends account a. The debit balance of a dividends account is the total amount of dividends declared during a fiscal period. b. Dividends decrease the earnings that a corporation retains so it is closed to Retained Earnings c. After the closing entry, Dividends has a zero balance and Retained Earnings has been debited for the amount of dividends After closing entries have been posted, all temporary accounts have zero balances and are ready for the new fiscal year. After adjusting and closing entries are posted, must again prove equality of debits and credits Prepare a Post-Closing Trial Balance to prove the equality Accounting procedures used by a departmentalized merchandising business are described in chapters 1-4 Same procedures are used from year to year (Consistent Reporting)

7 Accounting cycle procedures provide information for preparing interim and end-of-fiscal-period financial statements (Accounting Period Cycle) The Accounting Cycle for Departmentalized Business Verify source documents for accuracy Record entries in journals Post journal entries to the ledgers Prepare interim departmental statement of gross profit Prepare schedules of accounts receivables and payables for the subsidiary ledger Prepare trial balances on the work sheet. Complete the work sheet to summarize the financial condition of a business Prepare financial information from the work sheet and accounting records Journalize and post adjusting and closing entries using info from work sheet Prepare a post-closing trial balance to check equality of debits and credits in the general ledger. The accounting records for the fiscal period are complete and ready for the start of the next fiscal period.

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