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:

Merchandise Inventory Jan. 1 Dec. 31 Beginning Balance 52,800 Dec. 31 Ending Balance 48,300
Effect B

52,800
Effect A

Income Summary Dec. 31 52,800 Dec. 31 48,300

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 Debit Credit 29,410 42,400 52,800 17,400 2,600 1,840 4,500 20,260 Adjustments Debit Credit Income Statement Debit Credit Balance Sheet Debit Credit 29,410 42,400 48,300 11,600 1,060 636 4,500 20,260

Account Name Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Store Supplies Office Supplies Land Building Accumulated Depreciation, Building Office Equipment Accumulated

52,800 (a) 5,800 (b) 1,540 (c) 1,204

48,300

5,650 8,600 2,800

(d) 2,600 8,600 (e) 2,200

8,250 5,000

Depreciation, Office Equipment Accounts Payable Common Stock Retained Earnings Dividends Sales Sales Returns and Allowances Sales Discounts Purchases Purchases Returns and Allowances Purchases Discounts Freight-In Sales Salaries Expense Freight-Out Expense Advertising Expense Office Salaries Expense Insurance Expense, Selling Insurance Expense, General Store Supplies Expense Office Supplies Expense Depreciation Expense, Building Depreciation Expense, Office Equipment Income Taxes Expense Income Taxes Payable Net Income

25,683 50,000 68,352 20,000 246,350 2,750 4,275 126,400 5,640 2,136 8,236 22,500 5,740 10,000 26,900 406,611 8,236 22,500 5,740 10,000 26,900 406,611 (a) 1,600 (a) 4,200 (b) 1,540 (c) 1,204 (d) 2,600 (e) 2,200 (f) 5,000 18,344 (f) 5,000 18,344 1,600 4,200 1,540 1,204 2,600 2,200 5,000 277,945 24,481 302,426 302,426 302,426 186,766 186,766 2,750 4,275 126,400 5,640 2,136 246,350 20,000

25,683 50,000 68,352

5,000 162,285 24,481 186,766

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.

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.

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 Post. Ref.

Page 10

Date 20xx Dec.

Description Closing entries: Income Summary Merchandise Inventory Sales Returns and Allowances Sales Discounts Purchases Freight-In Sales Salaries Expense Freight-Out Expense Advertising Expense Office Salaries Expense Insurance Expense, Selling Insurance Expense, General Store Supplies Expense Office Supplies Expense Depreciation Expense, Building Depreciation Expense, Office Equipment Income Taxes Expense To close temporary expense and revenue accounts with debit balances and to remove the beginning inventory Merchandise Inventory Sales Purchases Returns and Allowances Purchases Discounts Income Summary To close temporary expense and revenue accounts with credit balances and to establish the ending inventory Income Summary Retained Earnings To close the Income Summary account Retained Earnings Dividends To close the Dividends account

Debit

Credit

31

277,945 52,800 2,750 4,275 126,400 8,236 22,500 5,740 10,000 26,900 1,600 4,200 1,540 1,204 2,600 2,200 5,000

31

48,300 246,350 5,640 2,136 302,426

31

24,481 24,481

31

20,000 20,000

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 balancesSales, Purchases Returns and Allowances, and Purchases Discountsand 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 Debit Credit 29,410 42,400 48,300 17,400 2,600 1,840 4,500 20,260 5,650 Adjustments Debit Credit Income Statement Debit Credit Balance Sheet Debit Credit 29,410 42,400 48,300 11,600 1,060 636 4,500 20,260 8,250

Account Name Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Store Supplies Office Supplies Land Building Accumulated Depreciation,

(a) 5,800 (b) 1,540 (c) 1,204

(d) 2,600

Building Office Equipment Accumulated Depreciation, Office Equipment Accounts Payable Common Stock Retained Earnings Dividends Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold Freight-In Sales Salaries Expense Freight-Out Expense Advertising Expense Office Salaries Expense Insurance Expense, Selling Insurance Expense, General Store Supplies Expense Office Supplies Expense Depreciation Expense, Building Depreciation Expense, Office Equipment Income Taxes Expense Income Taxes Payable Net Income

8,600

8,600

2,800 25,683 50,000 68,352 20,000 246,350 2,750 4,275 123,124 8,236 22,500 5,740 10,000 26,900 398,835

(e) 2,200

5,000 25,683 50,000 68,352 20,000 246,350 2,750 4,275 122,124 8,236 22,500 5,740 10,000 26,900

398,835 (a) 1,600 (a) 4,200 (b) 1,540 (c) 1,204 (d) 2,600 (e) 2,200 (f) 5,000 18,344 (f) 5,000 18,344 1,600 4,200 1,540 1,204 2,600 2,200 5,000 221,869 24,481 246,350 246,350 246,350 186,766 186,766 5,000 162,285 24,481 186,766

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.

Exhibit 4 System

Closing Entries for Flanagan Fashions Corporation: Periodic Inventory

General Journal Post. Ref.

Page 10

Date 20xx Dec.

Description Closing entries: Income Summary Sales Returns and Allowances Sales Discounts Cost of Goods Sold Purchases Freight-In Sales Salaries Expense Freight-Out Expense Advertising Expense Office Salaries Expense Insurance Expense, Selling Insurance Expense, General Store Supplies Expense Office Supplies Expense Depreciation Expense, Building Depreciation Expense, Office Equipment Income Taxes Expense To close temporary expense and revenue accounts with debit balances Sales Income Summary To close temporary revenue account with credit balance Income Summary Retained Earnings To close the Income Summary account Retained Earnings Dividends To close the Dividends account

Debit

Credit

31

221,869 2,750 4,275 123,124 126,400 8,236 22,500 5,740 10,000 26,900 1,600 4,200 1,540 1,204 2,600 2,200 5,000

31

246,350 246,350

31

24,481 24,481

31

20,000 20,000

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.

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 Davids Music Store, Inc., at the end of its annual accounting period: Davids Music Store, Inc. Trial Balance November 30, 20xx Cash Accounts Receivable Merchandise Inventory Store Supplies Prepaid Insurance Store Equipment Accumulated DepreciationStore Equipment Accounts Payable Common Stock Retained Earnings Dividends Sales Sales Returns and Allowances Purchases Purchases Returns and Allowances Purchases Discounts Freight-In Sales Salaries Expense Rent Expense Other Selling Expenses Utilities Expense $ 18,075 27,840 88,350 5,733 4,800 111,600 $ 46,800 36,900 30,000 95,982 36,000 306,750 2,961 189,600 58,965 4,068 6,783 64,050 10,800 7,842 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.

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 Marjies Party Costumes Corporation at the end of its annual accounting period: Marjies Party Costumes Corporation Trial Balance June 30, 20xx Cash Accounts Receivable Merchandise Inventory Store Supplies Prepaid Insurance Store Equipment Accumulated DepreciationStore Equipment Accounts Payable Common Stock Retained Earnings Dividends Sales Sales Returns and Allowances Cost of Goods Sold Freight-In Sales Salaries Expense Rent Expense Other Selling Expenses Utilities Expense $ 7,050 24,830 88,900 3,800 4,800 151,300 $ 25,500 38,950 50,000 111,350 24,000 475,250 4, 690 231,840 10,400 64,600 48,000 32,910 3,930 $701,050

$701,050

Required 1. Enter the trial balance for Marjies 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

payable, $650; accrued utilities expense, $100; and estimated income taxes expense, $20,000. 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 closing entries.