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 Beginning Balance 52,800 Dec. 31 52,800
Dec. 31 Ending Balance 48,300 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

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) 1,204 636
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
 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 246,350 246,350
Sales Returns and
Allowances 2,750 2,750
Sales Discounts 4,275 4,275
Purchases 126,400 126,400
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 26,900
406,611 406,611
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 18,344 277,945 302,426 186,766 162,285
Net Income 24,481 24,481
302,426 302,426 186,766 186,766

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 Closing Entries for Flanagan Fashions Corporation: Periodic Inventory

System

General Journal Page 10

Post.
Date Description 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
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) 1,204 636
Land 4,500 4,500
Building 20,260 20,260
Accumulated
Depreciation, 5,650 (d) 2,600 8,250
 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 246,350 246,350
Sales Returns and
Allowances 2,750 2,750
Sales Discounts 4,275 4,275
Cost of Goods Sold 123,124 122,124
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 26,900
398,835 398,835
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 18,344 221,869 246,350 186,766 162,285
Net Income 24,481 24,481
246,350 246,350 186,766 186,766

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 Page 10

Post.
Date Description 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.
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.
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
 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.