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

52,800
Effect A

Effect B

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

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

Trial Balance
Debit
Credit
29,410
42,400
52,800
17,400
2,600
1,840
4,500
20,260

5,650

Adjustments
Debit
Credit

Income Statement
Debit
Credit

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

48,300

Balance Sheet
Debit
Credit
29,410
42,400
48,300
11,600
1,060
636
4,500
20,260

(d) 2,600

8,600

8,250
8,600

2,800

(e) 2,200

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

25,683
50,000
68,352

25,683
50,000
68,352

20,000

20,000
246,350

246,350

2,750
4,275
126,400

2,750
4,275
126,400
5,640
2,136

5,640
2,136

8,236
22,500
5,740
10,000
26,900
406,611

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

8,236
22,500
5,740
10,000
26,900
406,611
(a) 1,600

1,600

(a) 4,200
(b) 1,540

4,200
1,540

(c) 1,204

1,204

(d) 2,600

2,600

(e) 2,200
(f) 5,000

2,200
5,000

18,344

(f) 5,000
18,344

Net Income

277,945
24,481
302,426

302,426

186,766

302,426

186,766

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

Exhibit 2 shows the closing entries for Flanagan Fashions Corporation.

Closing Entries for Flanagan Fashions Corporation: Periodic Inventory

System

General Journal

Date
20xx
Dec.

Description

31

31

31

31

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

Page 10
Post.
Ref.

Debit

Credit

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

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

24,481
24,481

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

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

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

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

(d) 2,600

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

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

8,600

8,600

2,800
25,683
50,000
68,352

(e) 2,200

20,000

20,000
246,350

246,350

2,750
4,275
123,124
8,236
22,500
5,740
10,000
26,900
398,835

2,750
4,275
122,124
8,236
22,500
5,740
10,000
26,900
398,835
(a) 1,600

1,600

(a) 4,200
(b) 1,540

4,200
1,540

(c) 1,204

1,204

(d) 2,600

2,600

(e) 2,200
(f) 5,000

2,200
5,000

18,344
Net Income

5,000
25,683
50,000
68,352

(f) 5,000
18,344

221,869
24,481
246,350

246,350

186,766

246,350

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

Closing Entries for Flanagan Fashions Corporation: Periodic Inventory

System

General Journal

Date
20xx
Dec.

Description

31

31

31

31

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

Page 10
Post.
Ref.

Debit

Credit

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

246,350
246,350

24,481
24,481

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.