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Chapter 6
statements { the Closing Progress

Pad
Financial

The Worksheet
-
Used for three major end -
of -

period activities :

Journalizinq adjusting entries ( covered in Chapter 5)

Preparing financial statements

Journalizinq closing entries

101 .
Prepare financial statements with the aid of a worksheet
Order of Preparing Financial Statements
1. Income statement

2. Statement of Owner 's Equity

3. Balance Sheet

Income Statement Preparation

.

Heading should contain 3 lines :

company name

-
statement title

> period ended or last date in the period

-
Dollar signs used at top of columns

.
Revenues are shown first

Expenses are shown next ,

listed in either

↳ Account number

↳
Descending order by dollar amount

single rulings indicate addition or subtraction

Expenses are totaled

-
Net income is computed last

statement of owner's Equity Preparation

-

The statement starts with the capital account balance as of the beginning of the accounting period
>
Capital from the work sheet may not be the beginning capital account balance .
It is the
beginning
balance plus any additional investments

↳ Since Mitch made no additional investments this period , we can use the capital account
 balance from the worksheet
-
Instead of showing revenue increasing and expenses
decreasing the owner 's equity ,
this statement uses

the net effect ( net income 1 loss ) from the income

statement
-

The drawing account tells us the amount of assets

Mitch has withdrawn from the business for

personal use

Forms of Balance sheets

-

Report Form
↳ Liabilities and owner 's equity sections are shown BEWW the assets

↳ This is the form you will see from now on in this text

'

Account Form
↳ Assets section is on the LEFT and liabilities and
,
owner 's equity sections are on the RIGHT

↳ This is the form chapters

you saw in 2 v5

Classified Balance Sheet

.
Similar items are grouped together
.
Assets are classified as :

↳ Current Assets

↳
Property . Plant .
and Equipment
.
↳ any;µie, are classified a, ,

↳ Current liabilities
↳ Long -
Term Liabilities

Current Assets
'

Assets ( including cash ) that will be converted into cash or consumed within one year or the

normal operating cycle , whichever is longer

↳ Cash ↳ Accounts Receivable ↳ Supplies ↳ Prepaid Insurance

OPERATING CYCLE

| µÉ F)
Purchase
⇐☒
for cash { ' ☒
cash Receivables
ferries
 Proper ,
Plant .
4 Equipment

µ
-

Assets that are expected to serve the business for many years

-
Also called plant assets or long -
term assets

④ Land , Buildings , Equipment

current liabilities
-
Liabilities that are due within one year or the normal operating cycle of the business ,

whichever is longer
-

They will be paid with current assets

⑧ Accounts payable , wages payable

long -
Term liabilities
.

Obligations that are not expected to be paid within a

year and do not require the use of current

assets
.
Also called long -
term debt

④ A mortgage on an office building

Balance Sheet Preparation

-

Current Assets are listed first

-

Property , Plant .
{ equipment includes the long term assets -

AND their related accumulated depreciation accounts

-

Current ( or short term ) liabilities

-
are shown first

-
The capital amount does not show net income or drawing
-

Balance sheet MUST balance

Additional Investments by Owner

•

Additional Investments by the owner during the accounting period :

↳
Appear in the general ledger capital account

↳ Are part of the amount reported in the unadjusted

trial balance on the worksheet

↳ Must be shown the statement of

separately in

owner 's equity

 102 Journalize & post closing

Pwd
. entries
Permanent Accounts
-
All accounts reported on the balance sheet :

↳ Assets

↳ Liabilities

↳
Capital Accounts
-
Contain the results of all transactions since the business started

.
These accounts are NOT CLOSED

Temporary Accounts
-
Accumulate information for a specific accounting period
-
All accounts not on the balance sheet :

↳ Revenues

↳ Expenses
↳
Drawing
-

These accounts are CLOSED

The Closing Process

-

Gives temporary accounts zero balances so they are prepared to accumulate new information for the next

accounting period
.
The Income summary account is used to aid in the closing process
.
There are four basic steps in the closing process

closing Process steps

'

step 1 : Close Revenue Accounts to Income summary

↳ Revenues have credit balances and increase owner's equity
↳ Revenue accounts are debited to create zero balances
↳ Income summary is credited for the total revenues

step 2 : Close Expense Accounts to Income summary

↳
Expenses have debit balances and reduce owner 's equity
↳ Expense accounts are credited to create zero balances
↳ Income
summary is debited for the total of the expenses
•

step 3 : close Income summary to the owner 's capital Account

↳ Balance in Income summary represents the net income ( credit balance) or net loss ( debit balance )

↳ Net income -
debit Income summary ,
credit owner 's capital
 pod
↳ Net loss -
debit owner 's capital credit
.
Income summary
-

step 4 : close Drawing to the owner 's capital Account

↳ Drawing has a debit balance and reduces owner 's equity
↳ Drawing is credited to zero it out

↳ Owner 's capital account is debited

Closing Net Income vs . Net Loss

Closing Entries in T Account Form

 Journali zing Closing Entries

-
To actually change the ledger
accounts the
closing entries must
,

be journalized and posted to the

general ledger

103 .
Prepare a post closing trial
-
balance

Post Closing
-
Trial Balance
'

Prepared after posting closing entries

-
To prove the equality of the debit and credit

balances in the general ledger accounts

-

Only accounts that remain open are listed

( permanent accounts )

104 .
List { describe the steps in the accounting cycle

µ
steps in the Accounting cycle
-

During Accounting Period

STEP 1 :
Analyze source documents

step , : yourname +he transactions

STEP 3 : Post to the general ledger accounts

.

End of Accounting Period

STEP 4 : Prepare a trial balance

STEP 5 : Determine and prepare needed adjustments on the work sheet

STEP 6 : complete end of

- -

period work sheet

STEP 7 Journal ize and post adjusting entries
:

STEP 8 :
Prepare income statement ,
statement of owner 's equity and
,
balance sheet

STEP 9 : Journal ize and post closing entries

STEP 10 :
Prepare post -

closing trial balance

rod
Chapter 7 Accounting for Cash

Cash
Includes :

Currency Coins , Checking accounts ,

checks received from customers . Money orders & bank cashier 's checks

Because cash plays such a central role in operating a business ,

it must be carefully managed & controlled

what is Internal control ?

-

A system of policies and procedures designed to ensure proper accounting for transactions
-
Good internal control for cash transactions includes :
-
All cash received should be deposited DAILY in a bank
-
All disbursements , except for payments from petty cash ,
should be made by CHECK

101 . Describe how to open { use a checking account

Opening a checking Account
-

Each person authorized to sign checks must complete { sign a signature card
-
This card is used to verify the depositor 's signature on
any banking transactions
.
Card also includes Taxpayer Indication Number LTIN )
-
Social security number ( for individuals )
-

Employer Identification Number LEIN ) → businesses , trusts , estates

Making Deposits
-
A deposit ticket is a form showing a detailed listing of items being deposited
-

Currency , coins , { checks are listed separately

-
Each check can be identified by its ABA

Endorsements
-

Each check being deposited must be endorsed by the payee ( the party to whom the check is payable )
-

The endorsement consists of stamping or

writing the payee 's name & sometimes other information on

µÑ
the back of the check
.
Businesses commonly use a rubber stamp to endorse checks for deposit

TYPES OF ENDORSEMENTS
. Blank Endorsement

• Restrictive Endorsement
 Automated Teller Machines ( ATM )
-
Each depositor has a plastic card & a personal identification number ( PLN )

.
Most ATMs are on a system that allows non customers to use their ATMs

-
It is important for the depositor to keep an
accounting record of ATM withdrawals & deposits

writing checks
.
It is a document ordering a bank to pay cash from a depositor 's account
.
There are three parties to every check :

-
Drawer :
the depositor who orders the bank to pay the cash
-
Drawee : the bank on which the check is drawn
-

Payee : the person being paid the cash

-
Business checks often have a check stub ; otherwise ,
a check register is used

steps in Preparing a check

.

Complete the check stub or register

-
Enter the date ,
payee name , and amount on the check
.
Authorized signer signs the check

Bank statement

pod
-
A statement of account issued by a bank to each depositor once a month ,
it shows :

-
the balance at the BEGINNING of the period
-

deposits and other amounts ADDED during the period

-

checks and other amounts SUBTRACTED during the period

-
the balance at the END of the period
-

Sent with the bank statement :

"
Cancelled checks
"
-

,
imaged sheets of check faces , or a
listing of checks
-

Any other forms representing items added to or subtracted from the account

102 .
Prepare a bank reconciliation and related journals
Book v. s .
Bank Balances

On any given day , the balance in the cash account is unlikely to be the same as that the bank's
•

on

books

-
this difference can be due to errors ,
but it usually is caused by timing
-
transactions generally are recorded by the business at a time that is different from when
 the bank records them
-

we need to prepare a bank reconciliation when that happens

Differences Between Bank and Book Balances

.
Deposits in transit

↳
Deposits that have not reached the bank or been recorded by the bank before the statement is prepared
.

Outstanding checks
↳ Checks that have been issued but have not been is
presented to the bank for payment before the statement

prepared
service charges
-

↳ Bank
charges for services such as check printing and processing
-

Collections
↳ Collections of promising notes or charge accounts made by the bank on behalf of the depositor
.
Not sufficient funds IN SF ) checks

↳ Checks deposited but not paid because the drawer did not have sufficient funds

-
Errors

↳ Errors made in recording cash transactions

by the bank or
by the depositor

steps in Preparing Bank Reconciliation

step 1 :
Identify deposits in transit { any related errors

step 2 :
Identify outstanding checks and any related errors

step 3 :
Identify additional reconciling items

step 1 step 2

Compare the bank statement with -

Compare cancelled checks with bank statement { accounting
.
last month 's deposits in transit records

deposits listed in the

accounting records .
Check mark the stub or accounting record to indicate that the

individual deposit amounts in the check has cleared

accounting
•

records -
Checks written but not cleared are
outstanding checks

pad
step 3
-

Compare any additions { deductions on the bank statement that are not

deposits or checks with the accounting records

 Bank Reconciliation Journal Entries
-

Only two kinds of items appearing on a bank reconciliation require journal entries

→ Errors in the depositor's books

→ Bank additions { deductions that do not already appear in the books

.
All items in the book balance section of the reconciliation require a journal entry
-

Bank Reconciliation General Journal Entry # I ~ 4 . Ppt slides 32 ~ 35 -

Electronic Banking
.
Deposits } payments can be made with electronic funds transfer ( EFT ) ,
using a computer rather than

paper checks

.
Businesses are making increase use of EFT :

→
Employee wages
→ Bills from suppliers

→ Payments from customers

→ Fund transfers

-
When EFT is used .
accounting records must be correctly updated

103 Establish
. { use a petty cash fund
The Petty Cash Fund
A fund set up to pay for small ( petty ) items with cash
•

→ check for very small amounts are inconvenient and inefficient

-
To establish the fund :

→ A check is written to the petty cash custodian for the amount to be set aside in the fund

→ The custodian chases the check and places the money in a

petty cash box

.
The custodian should be the only person authorized to make payments from the fund

I Petty Cash Fund Example

Paid
. Ppt slide 39 -
40 :

Petty Cash Payment Records

-
A special multi -
column record that supplements the regular accounting records

.
Provides a record of each petty cash payment

→ Broken down by account

→ Used to prepare the replenishment journal entry

 Replenishing the Petty Cash Fund
-
Replenish Petty Cash

→ whenever the fund runs low

→ At end of accounting period

To replenish the fund debits are made to appropriate expense accounts and cash is credited
-

→
Only if the amount of the fund itself is being changed would there be a debit or credit to Petty cash

-
Because the petty cash payments record is not a
journal , no
posting is done from this record

→ A separate must be made in the journal to replenish the fund

entry

Petty
-

-
Cash Replenishment Example , ppt slides 43 -44 :

Petty Cash Voucher :

prepared for every payment from the petty cash fund

104 Establish .
change fund
a and use the Cash Short Over account

change Fund
'
A supply of currency coins kept in the cash register or cash drawer

→ Allows businesses to make change when customers pay in cash

.
At the end of the day ,
cash received during the day is deposited
→ change fund is held back for use the next day

I Change Fund Example , ppt slides 47 -

48 .

Cash short and Over

-
Mistakes making change lead to errors

.
Actual cash is compared to the daily sales total

→ Too much cash cash Over

→ Too little cash cash short

paid
-
Cash short over account used for recording differences

> Debit Balance Expense

> Credit Balance Revenue

[ Cash short { Over Example . ppt slides 51 ~ 54 I

 Chapter 8 Payroll Accounting
We must know the differences between :

salary us .
Wages
Contractor us .
Employee

lol Distinguish differences between

.
Employees { Contractors
Employees us .
Independent contractors
Work under the control and direction of an
employer ( Employees )
-

Perform services for a fee and do not work under the control of the ( Contractors )
company
.

Government laws & regulations for employees are much more complicated
.

→ Taxes must be deducted

→ Payroll records must be maintained ( clock in { out )

→ Numerous reports must be filed ( contractors only have to file one in V. 5. A)

102 .
Calculate employee earnings { deductions
Employee earnings { deductions
-
3 steps to determine how much to
pay an
employee
→ calculate total earnings

→ determine the amount of deductions

→ subtract deductions from total earnings to compute net

pay

salaries us .
Wages
•
For administrative or managerial services .
For skilled and unskilled labor

-
bi -

weekly . monthly ,
or
annually .
hours ,
weeks ,
or units

paid
Computing Total Earnings
-
a record must be kept of the time worked ( clock in { out )

→ Time cards , plastic cards . badges w/ magnetic strips or barcodes

The hours worked multiplied by the rate of pay to determine total

are
earnings
-
 Deductions from Total Earnings
.
Three categories : -
Gross pay less Deductions = Net pay

→ Federal → Take home

pay
-

→
Employee
→
Voluntary
Federal Income Tax withholding
-
Required by federal law

Applied toward the payment of the employee 's federal income tax
.
Amount withheld determined by
→ Total earnings

→ Marital status

→ No .
of
withholding allowances claimed

→ Length of the pay period

withholding Allowances
-
Exempt a specific dollar amount of an employee's gross pay from federal income tax withholding
-

Computed on Form W -
4

→ Based on the marital status { the number of allowances claimed

Employee FICA Tax withholding

-
Includes amount for :

→ Social Security ( Provides pension { disability benefits )

→ Medicare ( Provides health insurance )

Required by Federal Insurance Contributions Act ( HCA )

Pµ
.
Tax rates are set by Congress
→ social security 16.2% )

→ Medicare 11.45%1

.
Rate, { amount, change frequent,,

Voluntary Deductions
-
Deductions that are optional and depend on specific agreements between the employee { employer
→ U.s.
Savings bond purchases
→ Health insurance premiums

→ credit union deposits → charitable contributions

 Computing Net Pay
Gross Pay Total Earnings
GROSS PAY DEDUCTIONS PAY
-

=
NET

103 Describe .
{ prepare payroll records
Payroll Records
•
Should provide the following information on each employee :

↳ Name
,
address , occupation ,
social security number , marital status .
{ number of withholding allowances

↳ Gross amount of earnings ,

date of payment period covered by
,
each payroll
↳ Gross amount of earnings accumulated for the year

µN
↳ Amounts of taxes & other items withheld

•
Three types of payroll records :

↳
payroll register
↳ Payroll check ( or record of direct deposit ) with earnings statement attached
↳
Employee earning record

Payroll Register
•
a form used to assemble the data required at the end of each payroll period
.
since marital status & number of allowances are used to compute withholding taxes , they are recorded on

the payroll register

.

earnings for this period are shown .

categorized by regular & overtime earnings

Paying Employees
'
Employees should be paid by check or by direct deposit
↳ These methods provide better internal accounting control than payment
↳ when direct deposit is used , payment is deposited directly by the employer into the
employee 's bank account

using EFT

The employer furnishes an earnings statement to each employee along with his or her paycheck or after a direct

deposit has been made

Employee Earnings Record

•
a separate earnings record is maintained for each employee
. information comes from the
payroll register
↳ These records are automatically generated { updated in computerized systems
-

employer need this info to prepare several reports

 104 Account for
. Employee earnings { deductions
Journal i zing Payroll
•
Journal entries must be made to record the payroll expenses & liabilities

-
The payroll register is the source for the journal entries

↳ Gross
pay is debited to
wage Expense
↳ Each deduction is recorded in a separate liability account
↳ Net pay is credited to cash

Accounts involved in Payroll Accounting

-

Wages { Salaries Expense Debited for Gross Pay

Pod
-

Employee Federal Tax Payable

.
social security { Medicare Taxes Payable
.
other deductions

Payroll Record Keeping Methods

-

. Manual system

↳ The same info is recorded several times

↳ Can be very inefficient

Payroll processing center

↳ A business that sells payroll record -

keeping services

↳ Their fees can be much less than the cost to an employer of handling payroll internally
. Electronic system

↳
performs all payroll -

keeping { prepares payroll checks or EFT records

Chapter 9 Employer taxes 4 reports
101 Describe 4 calculate
.
employer payroll taxes
EMPLOYER PAYROLL TAXES

In addition to the gross pay for each employee the employer must pay payroll taxes :
-

→ FICA ( Federal Insurance Contributions Act )

→ FUTA ( Federal Unemployment Tax Act )

→ SUTA ( State Unemployment Tax Act )

•
These taxes add substantially to the cost of having employees

EMPLOYER FICA TAXES

Both the employee { employer must pay FICA Taxes

-

→ Each pays an equal share

-
Socia Security = 6. zoo on maximum earnings of $128, 400

-
Medicare =
1. 45 % on ALL earnings
.
The amount on earnings subject to social security tax is obtained from the payroll register
SELF EMPLOYMENT TAXES
-

.
Paid by individuals who own & run their own business if they earn net self -

employment income of $400 or more

→ They do not receive salary or

wages from the business ,
but they do have earnings in the form of the business

net income ( self -

employment income )

→ self -

employment tax is contribution to the FICA program

.
self -

employment tax rates are double the Social Security & Medicare taxes

→ self -

employment individuals pay both the employer & the employee share of FICA taxes

EMPLOYER FUTA TAX

-
levied only on employers (they have to )

→ not deducted from employee 's earnings

Funds the combined federal state unemployment compensation programs

.
Current rate is 6.0 % applied to maximum earnings of $7,000 for each employee

W
→ Employers are allowed a credit of up to 5.4 00 for participation in state unemployment programs

Effective rate is %
→
usually 0.6

-
also calculated from information in the Payroll Register
.

•
EMPLOYER SUTA

Levied on employers

Tax funds used to pay

Tax rates
TAX

{ unemployment
in most states

unemployment benefits

benefits vary among the states

Pod
Most states have to to workers
.
an experience rating system to encourage employers provide regular employment

→ If an employer has very few former employees receiving unemployment compensation the employer qualifies ,
for

a lower state unemployment tax rate

→ Full federal credit of 5.4 00 is still allowed even if employer pays a lower state rate

102 Account for employer payroll taxes

.

STEPS NEEDED TO PREPARE JOURNAL ENTRY

1 : Obtain the total earnings { taxable earnings amounts from the Earnings Total and Taxable Earnings columns of the payroll register

2 :
Compute the amount of employer Social Security tax by multiplying the Social Security taxable earnings by 6.2%

3: Compute the amount of employer Medicare tax by multiplying total earnings by 1.45%
0.6 %
4: Compute the amount of FUTA tax by multiplying the Unemployment Taxable earnings by

5: Compute the amount of SUTA tax by multiplying the Unemployment Taxable earnings by 5.4 00

6: Prepare the appropriate journal entry using the amounts computed in steps 2- 5

JOURNALRING PAYROLL TAXES

-
A journal entry is needed to record the expense } liabilities for payroll taxes

Usually debit all expense to one account

Credit separate accounts for each of tax

-

type liability
ACCOUNTS USED IN PAYROLL TAX ACCOUNTING

Payroll Taxes Expense

→ social security ,
Medicare , FUTA ,
{ SUTA taxes imposed on the employer are expenses of doing business

Social security { Medicare Taxes Payable

→ credited when taxes imposed on employer or withheld from employees

→ Debited when paid

•
FUTA Tax Payable

→ credited when taxes imposed on employer

→ Debited when paid

•
SUTA Tax Payable

→ credited when taxes imposed on employer

→ Debited when paid

103 Describe
.
employer reporting { payment responsibilities
EMPLOYER PAYROLL } PAYMENT RESPONSIBILITY AREAS

1. Federal income tax withholding { social security { Medicare Taxes

2. FUTA Taxes

3. SUTA Taxes

4. Employee wage } Tax statement 1 Form W 2) -

5. Summary of employee wages & taxes 1 Form W 3) -

6. Employment eligibility verification ( Form 1- 9)

FEDERAL INCOME TAX WITHHOLDING { SOCIAL SECURITY & MEDICARE TAXES

-
3 important aspects of employer reporting { payment responsibilities

→ Determining when payments are due

→ Use of electronic funds transfer ( EFT ) to make federal tax deposits

→ Use of Form 941 . Employer's Quarterly Federal Tax Return

LOOKBACK PERIOD

.
The four quarters beginning July 1 ,
two years ago ,
{ ending June 30 , one year ago
" "
-

Large amounts of payroll taxes in the lookback period require frequent future deposits

MAKING FEDERAL TAX DEPOSITS

Deposits must be made using EFT

-
Use Electronic Federal Tax Payment system ( EFTPS )
→ an electronic funds transfer system designed for making federal tax deposits
-

Each deposit requires a journal entry

Deposits include both the employer imposed taxes & employee 's withholding

FORM 941

Employer 's Quarterly Federal Tax Return

-

µN
→ Must be filed with the IRS ( Internal Revenue service ) at the end of the month following each calendar quarter

'

Due April 30 , July 31 , October 31 ,

and January 31

→
Reports the following taxes for the quarter :

employee federal income tax *new

Employee Social Security and Medicare taxes withheld

Employer Social Security and Medicare taxes

 FUTA TAXES

.
calculated quarterly

Deposit is due end of the month

following the close of the quarter

→ A deposit is required only when the accumulated liability exceeds $500

liability is $500 or less , amount is added to amount to be deposited for next quarter

→ Deposited using EFTPS

FORM 940

-
Annual report of federal unemployment tax

.
Balance due paid using EFTPS or Form 940 -

V 1 if $500 or less )

SUTA TAXES

Deposits usually required on a quarterly basis

Forms required vary by state

WAGE AND TAX STATEMENT ( FORM W 2) -

.
Given to each employee by January 31

→ shows the total amount of wages paid and taxes withheld during the preceding taxable year

→ Prepared from the employee earnings record

→ Multiple copies are needed for the following purposes :

Copy A Employer sends to Social Security Administration

Copy B Employee files with federal income tax return

Copy C Employee retains for his or her own records

Copy 1
Employer sends to state . city ,
or local tax department
.

Copy 2 Employee files with state city , ,

or local income tax return

TRANSMITTAL OF WAGE AND TAX STATEMENTS ( FORM W 3) -

M
-

Sent by employers with Copy A of Forms W 2 to the Social -

Security Administration

.
Due by Feb 28
.

following the end of each taxable year

.
Summarizes employee earnings and tax information presented on Forms w -
2 for the year

EMPLOYMENT ELIGIBLE VERIFICATION

Every employee hired after Nov . 6 ,

1986 , must complete FORM 1- 9 ( E E V ) . .

→ To document that each employee is authorized to work in the United States

→ Not filed with any government agency

→ Must be retained by the employer and made available for inspection if requested by the Department of Homeland Security

or the Department of labor

 '
104 Describe and account for workers
.
compensation insurance
'

WORKERS COMPENSATION INSURANCE EXAMPLE 1

.
Lockwood Co expects its payroll for the year to be $210,000
.

'
.
Lockwood 's workers compensation insurance rate is 0.200

. Estimated Payroll ✗ Rate =

Estimated Insurance Premium

→ $210 , 000 ✗ 0.002 = $420

'

WORKERS COMPENSATION INSURANCE EXAMPLE 2

.
Lockwood 's actual payroll of the year is $220,000

.
what adjustment is required ?
→ Actual Payroll ✗ Rate =
Estimated Insurance Premium

$220,000 ✗ 0.002 = 440

-
420 premium paid previously
$20 additional premium due
'

WORKERS COMPENSATION INSURANCE EXAMPLE 3

.
What if Lockwood 's actual payroll had been $205,000 instead

→ Actual Payroll ✗ Rate =

Estimated Insurance Premium

$205 ,
000 ✗ 0.002 = 410
-
4W premium paid
( lo ) refund due

Paul
 CHAPTER / ACCOUNTING FOR SALES { CASH RECEIPTS

LOL DESCRIBE MERCHANDISE SALES TRANSACTIONS

.

MERCHANDISING BUSINESS

-
Purchases merchandise from vendors suppliers and sells that merchandise to customers

A sale is a transfer of merchandise from one business or individual to another in exchange for cash or a
promise to pay cash

RETAILER

Sells to final consumers

.
Evidence of a retail sale :

→ cash register receipt given to customer

→ cash register tape summary sent to accounting

→ sales ticket

One copy of the sales ticket is the customer and the other
given to copy is sent to accounting
-

WHOLESALER
↳ SALES TICKET EXAMPLE
.
Purchases merchandise from the manufacturer

.
sells to retailers WHOLESALE SALES TRANSACTION PROCESS

" "
→ Usually on account

•
A sales invoice is generated for each sale :

→ One copy is sent to the customer as a bill for the merchandise

→ One is sent to accounting to record the sale → SALES INVOICE

→ One is shipped with the merchandise

CREDIT MEMORANDUM

•
Issued by the seller indicating the customer's accounts receivable account has been credited for the amount of a:

→ sales return

.
Merchandise returned for a refund

→ sales allowance

•
Price reduction granted by the seller because of defects or other problems with the merchandise
↳ CREDIT MEMORANDUM
-
One
copy of the credit memo is sent to the customer

One copy is sent to

-

accounting
 102 DESCRIBE AND USE MERCHANDISE SALES ACCOUNTS
.

MERCHANDISE SALES ACCOUNTS

To account for merchandise sales transactions ,

we will use five new accounts :

→ Sales

→ Sales Tax Payable

→ sales Returns { Payable

→
Customer Refunds Payable

→ sales Discounts

The position of these accounts in the accounting equation { their normal balances are shown on the next slide

SALES ACCOUNT

.
A revenue account used to record sales of merchandise

.
Is credited for the selling price of merchandise sold during the period

.
If a $100 sale is made for cash the .
following entry is made :

→ DR cash $100

→ CR sales $100

.
If the same sale is made an account use this
.
entry :

→ DR Accounts Receivable Customer Name $100

→ CR sales $100

→ sales account is credited . even though company has not yet been paid

SALES TAX PAYABLE ACCOUNT

-
A liability account used to record the taxes collected on sales and owed to the taxing authority

Most states require retailers to collect sales tax on sales to final consumers

.
Credited when taxes are collected on sales made I owned to tax authority )

Debits made to the account :

→ when merchandise is returned by customers

→ when funds are remitted to tax authority

.
If a cash sale for $100 plus 500 sales tax ( 5% ✗ $100 $5 ) occurs
=
, the following entry is made :

.
If a credit sale for $100 plus 500 sales tax ( 5% ✗ $100 $5 )
=
occurs ,
the following entry is made :
 SALES RETURNS AND ALLOWANCES ACCOUNT

-
A contra -
revenue account used to record sales returns and sales allowances

-
Has a debit balance

•
shown as a deduction from sales on the income statement

.
This account is debited rather than sales so that the business can more
readily keep track of this
activity

.
Refer to the credit memo
previously shown

.
The entry for the return of a
riding helmet is shown below

→ sales Returns and Allowances is debited for the amount of the sale ,
excluding the sales tax

SALES RETURNS AND ALLOWANCES SUBSEQUENT YEAR

Timing differences occur between periods when customers return merchandise sold in one fiscal year in a subsequent fiscal year
-

-
An estimate of returns to be made in the future should be recorded as an adjusting entry at
year end

SALES DISCOUNTS ACCOUNT

-
A contra -
revenue account used to record discounts given to customers who buy merchandise on account

→ Businesses offer cash discounts to encourage prompt payment

→
Prompt collection of accounts receivable reduces risk that receivables will become an collectible

.
Has a debit balance

Reported as a deduction from sales on the income statement

↳ TYPICAL CREDIT TERMS

SALES DISCOUNT JOURNAL ENTRY

If merchandise is sold for $100 with credit terms of 2 10 ,

net 30 and cash is received within the discount period two entries
, ,
are made :
 103 DESCRIBE AND USE THE ACCOUNTS RECEIVABLE LEDGER
.

JOURNALRING SALES

.
Assume the following sales transactions occurred during April :

→
Apr 4 . Sale No . 133C on account to Enrico Lorenzo , $1 , 520 plus $176 sales tax

→ Apr . 10 Sale No 134C .

on account to Brenda Myers $440 plus $22
,
sales tax

→ Apr . 18 Sale No 105 D . on account to Edith Walton ,

$980 plus $49 sales tax

→ Apr . 21 Sale No 20213 . on account to Wilma Lutz .

$620 plus $31 sales tax

→ Apr 24 Sale No 162A

. . on account to Heidi Schnitzer ,
$1 ,
600 plus $80 sales tax

GENERAL JOURNAL ENTRY &

POSTING TO THE GENERAL LEDGER

In the general ledger account :

→
step 2 : Enter the date of the transaction

→
Step 2 : Enter the amount of the transaction

→ step 3 : Enter the new balance

→
step 4 : Enter the journal page number

-
In the journal :

→ step 5 : Enter the ledger account number in the PR column

ACCOUNTS RECEIVABLE LEDGER

. A separate subsidiary ledger

.
contains an individual accounts receivable account for each customer

.
Each customer assigned an account number

-
A summary accounts receivable account maintained in the
general ledger is the controlling account

POSTING FROM GENERAL JOURNAL TO THE ACCOUNTS RECEIVABLE LEDGER

-
In the accounts receivable ledger account :

→
step 2 : Enter the date of the transaction

→ step 2: Enter the amount of the transaction

→
step 3 : Enter the new balance

→ step 4 : Enter the journal page number

In the journal :

→
step 5 : Enter a slash ( ) followed by a check mark (V ) in the PR column

RELATIONSHIPS TO REMEMBER

Entries in the and accounts receivable Ledger

general journal are posted to the general ledger
-

.
After the posting of the accounts receivable ledger and the general ledger is completed :

→ Total of the accounts receivable ledger balances should equal the Accounts Receivable balance in the general ledger

Accounts Receivable ledger is detailed of the info that is summarized in Accounts Receivable in the general ledger
→ a
listing same
 BANK CREDIT CARD SALES

-
similar to cash sales cash is available to business as soon as an electronic deposit is made at days end

Credit card makes electronic deposit to merchandiser's bank account for gross amount of credit card sales less processing fee
company a
.

•
Fee is based on the gross amount of sale ,
including sales tax
-
On a sale of $100 plus sales tax of $5 the credit card fee at 400 would be $4.20
.

→ 4% ✗ $105 $4.20=

-
Journal entry shown →

JOURNAL121 NG CASH RECEIPTS

-
Assume the following cash receipts transactions related to sales occurred during April :

→ Apr . 14 Received cash on account from Enrico Lorenzo for sale No 133C .
.
$1,596

→ Apr . 20 Received cash on account from Brenda Myers for sale No . 134C , $462

→
Apr 28 . Received cash on account from Edith Walton for sale No 105 D $1.029 .
,

→
Apr .
30 Cash sales for the month are $3 . 600 plus tax of $180

→
Apr .
30 Bank credit sales for the month are $22.500 plus tax of $1.125

Bank credit card expenses on these sales are $900

104 PREPARE A SCHEDULE OF ACCOUNTS RECEIVABLE

.

SCHEDULE OF ACCOUNTS RECEIVABLE

Prepared to verify that the sum of the accounts receivable ledger balances equals the Accounts Receivable balance

-
An alphabetical or numerical listing of customer accounts and their balances

Usually prepared at the end of the month

The total calculated in the schedule is compared with the balance in Accounts Receivable in the general ledger

FINDING ACCOUNTS RECEIVABLE ERRORS

-
If the total on the schedule of accounts receivable and the Accounts Receivable balance do not agree :

→
step 1: verify the total of the schedule

→ step 2 :
verify the postings to the accounts receivable ledger

step 3 Verify the to Accounts Receivable in the general ledge

→ :
postings
 CHAPTER I 1 ACCOUNTING FOR PURCHASES AND CASH PAYMENTS

101 DEFINE MERCHANDISE PURCHASES TRANSACTIONS

.

PURCHASES
" "
•

In a merchandising business , purchases refers to merchandise acquired for resale

→ Must be items for RESALE (company )

.
Procedures and documents vary .
depending on the nature and size of the business

" "
i
can be made on account or for cash

PURCHASING PROCESS DOCUMENTS

PURCHASE REQUISITION

.
A form used to request the purchase of merchandise or other property

.
Can be prepared by any authorized person

.
Three -

part form

→ copy 1 to purchasing department

→
copy 2 to accounting department

→
copy 3 kept by the department that prepared the requisition

PURCHASE ORDER

-
A written order to buy goods from a specific vendor ( supplier )

The purchasing department reviews and approves the purchase requisition and prepares a purchase order

→ One copy is sent to the vendor to order the goods

→ One copy is sent to the accounting department

→ One copy is kept in the purchasing department

→ copies may also be sent to the receiving area and to the department initiating the purchase requisition

RECEIVING REPORT

Prepared by the receiver ( in receiving department )

.
Indicates what has been received

.
Can be a separate form or can be created from the vendor 's purchase invoice

PURCHASE INVOICE

Prepared by the seller as a bill for the merchandise shipped

→ seller calls it a sales invoice

→
Buyer calls it a purchase invoice
-

Before payment is made the .

accounting department compares the purchase invoice with the :

→ Purchase requisition

→ Purchase order

→
Receiving report

Checking all documents is an example of exercising proper internal control

CASH DISCOUNTS

.
Available if the bill is paid within the discount period

→ The buyer calls it a purchase discount

→ The seller calls it a sales account

TRADE DISCOUNTS

.
Offered by manufacturers and wholesalers

.
A reduction from the list or catalog price offered to different classes of customers

.
Trace discounts represent a reduction in the price of the merchandise

→ should not be entered in the accounts of either the seller or the buyer

.
The buyer and seller both record the transaction at the NET amount ( after the trade discount)

→ If there is both a cash and a trade discount .

the cash discount applies to the net amount after deducting the trade discount

102 DESCRIBE . { USE MERCHANDISE PURCHASES ACCOUNTS { COMPUTE

GROSS PROFIT
MERCHANDISE PURCHASE ACCOUNTS

.
Purchases

.
Purchases Returns and Allowances

Freight -
In

PURCHASES ALUOVNT

.
Used to record the cost of merchandise purchased

-
The account is debited when merchandise is purchased

.
The account is credited only during the closing process

PURCHASE EXAMPLE

-
Made $100 purchase for cash

→ Debit Purchases

→ Credit cash

.
If purchase was made on account :

→ Debit Purchases

→ Credit Accounts Payable / Vendor

 PURCHASES RETURNS AND ALLOWANCES ACCOUNT

-
A contra -

purchases ( or contra cost ) account used to record purchases returns and purchases allowances
-

→ Normal balance is a credit balance

.
Credited for the amount of returns and allowances

→ The account is debited only during the closing process

PURCHASES RETURNS AND ALLOWANCES EXAMPLE

.
Merchandise purchased on account for $200 is detective and is returned to the supplier

.
Accounts payable is debited specific vendor is identified

-
Purchases Returns and Allowances is credited

→ Account shown as a deduction from the Purchases account on the income statement

.
Assume that the same merchandise is retained , but the supplier grants a price reduction of $45 because of the defects

Accounts Payable is debited to reflect the price reduction

-
Purchases Returns and Allowances is credited

PURCHASES DISCOUNTS ACCOUNT

-
A contra purchases account used to record cash discounts allowed
-
on purchases

.
The account is credited for the discount granted by the vendor for prompt payment

.
The account is debited during the closing process

PURCHASE DISCOUNT EXAMPLE

.
Merchandise is purchased for $100 on account with credit terms 2110 ,
net 130 and
, payment is made within the discount period

Accounts Payable is debited for the entire amount of the purchase

.
Cash is credited for the actual amount paid ,
$98 ( $100 -

$2 discount )

.
Purchase Discounts is credited for the discount amount $2 ( $100 ✗ 2%7 .

FREIGHT IN AltoUNT-

-
An adjunct purchases-
account used to record transportation charges on merchandise purchases

.
Account is debited for transportation charges
.
Account is credited during the closing process

TRANSPORTATION CHARGES

Expressed in FOB ( free on board ) terms

-

FOB shipping point

→
Buyer pays for transportation charges ; buyer owns item as soon as it is shipped

→
Freight charges are either listed separately on purchase invoice or sent as a
separate freight bill

FOB destination

→ seller pays for transportation charges ; seller owns item in til it is delivered

→ Freight charges do not appear on purchase invoice

FREIGHT EXAMPLE

.
Merchandise was purchased on account for $400 plus freight charges of $38

-
Purchases is debited only for the cost of the merchandise

Freight -

In is debited for the transportation costs

.
Accounts Payable is credited for the entire purchase price ( merchandise +
freight )

.
If the freight charges were on a separate bill from the transportation company

.
Purchases is debited for the cost of the merchandise

.
Accounts Payable is credited for the amount due to the supplier

.
A separate journal entry is made to record the freight charges
.
Accounts Payable is credited but the vendor is the transportation company
,

COMPUTATION OF GROSS PROFIT

Gross profit ( also called gross margin )

→ Difference between net sales and cost of goods sold

•
Cost of goods sold ( also called cost of merchandise sold )

→ Difference between the goods available for sale and the ending inventory

→ Indicates the cost of the goods sold during the period

-
STEP 1 :
Compute net sales

→ NET SALES = SALES -

SALES RETURNS AND ALLOWANCES -
SALES DISCOUNTS

→ This is the price charged to customers for the merchandise

STEP 2 : compute goods available for sale

 → GOODS AVAILABLE FOR SALE =
BEGINNING INVENTORY + COST OF GOODS PURCHASED

→ This is the cost of All the goods that were offered for sale

-
STEP 3 : compute cost of goods sold ( ( OGS )

→ COGS = GOODS AVAILABLE FOR SALE -

ENDING INVENTORY

-
Out of the $129 500 for merchandise available to sell
. ,

$18.000 was not sold lending inventory )

-
$111 .
500 of merchandise was sold

-
STEP 4 :
compute gross profit

→ GROSS PROFIT = NET SALES -

COST OF GOODS SOLD

-
Merchandise was sold for $87 800
.
more than its cost

103 DESCRIBE AND USE THE ACCOUNTS PAYABLE LEDGER

.

ACCOUNTS PAYABLE LEDGER

-
A separate subsidiary ledger
-
Contains an individual account payable for each supplier

.
Often numbered

Filed either alphabetically or numerically

Summary accounts payable account maintained in the general ledger is the controlling account

PURCHASES EXAMPLE DATA PURCHASES ENTERED IN GENERAL JOURNAL

POSTING PURCHASES TO THE GENERAL LEDGER

.
In the ledger account : -

In the journal

→ STEP 2 : Enter the date of the transaction → step 5 : Enter a slash (1)

→ STEP 2: Enter the amount of the transaction followed by a check mark C)

→ STEP 3 : Enter the new balance in the PR column

→ STEP 4 : Enter the journal page number

 POSTING PURCHASE RETURNS

.
Assume that on May 4 . Sunflower cycle returns $200 of merchandise

to Raus Designs Inc ,

.

→ These goods were part of a purchase made on April 23

.
The $200 debit is posted to the accounts payable controlling account and

to the subsidiary ledger account for Rans Designs

.
Purchases Returns and Allowances is posted in the normal manner

POSTING CASH PAYMENTS

Assume sunflower cycle made the following two payments on account during the month of April :

→ April 10 Paid Ace wheelworks $4.800 for purchases made on account

→
April 24 Paid Gunnar
Cycles $8.700 less discount of 1% for purchases made on account

CASH PAYMENTS ENTERED IN A GENERAL JOURNAL POSTING CASH PAYMENTS

104 PREPARE A SCHEDULE OF ACCOUNTS PAYABLE

.

SCHEDULE OF AllOVNTS PAYABLE

Prepared to verify that the sum of the accounts payable ledger balances equals the Accounts Payable balance

An alphabetical or numerical listing of supplier accounts and their balances

Usually prepared at the end of the month

.
The total calculated in the schedule is compared with the balance in Accounts Payable in the general ledger
 FINDING ACCOUNTS PAYABLE ERRORS

-
If the total on the schedule of accounts payable and the Accounts Payable balance do not agree :

→ step 2: verify the total of the schedule

→
step 2 :
Verify the postings to the accounts payable ledger

→ step 3: verify the postings to Accounts Payable in the general ledger

CHAPTER 11 APPENDIX
THE NET PRICE METHOD OF RECORDING PURCHASES
-

LOL DESCRIBE THE NET PRICE METHOD OF RECORDING PURCHASES

.
-

METHODS OF RECORDING PURCHASES

Gross Price Method

-

→ Purchases are recorded at the gross amount , regardless of available cash discounts

→ Method used previously in this chapter

-
Net Price Method
-

→ Purchases are recorded at the net amount . assuming that all available cash discounts will be taken

102 RECORD PURCHASES AND CASH

. PAYMENTS USING THE NET PRICE METHOD
-

COMPARING METHODS OF RECORDING PURCHASES

Purchased $100 of merchandise on account with credit terms of 2/10 net / 30

, ,

.
Gross price method records the purchase
-
as $100

→ Discount if taken will be recorded at the time of payment

. ,

.
Net price method records the purchase at the net amount of $98
-

→
Assumption is made that ALL discounts will be taken

Payment is made within the discount period

-
Gross price method
-
$2 discount credited to Purchases Discounts

. Net price method

-
$2 discount is not recorded

Payment is made after the discount period

Gross price method Discount period is missed no record is missed

-
-

. .

" "

$2 discount is recorded as lost

PURCHASES DISCOUNTS LOST ACCOUNT

.
A temporary owner 's equity account used to record cash discounts lost on purchases

Reported as an expense on the income statement

•
A balance represents a finance charge for postponing the payment for merchandise
 CHAPTER 12 SPECIAL JOURNALS

LOL DESCRIBE EXPLAIN THE PURPOSE OF AND IDENTITY TRANSACTIONS

.
. .

RECORDED IN SPECIAL JOURNAL'S

SPECIAL JOURNALS EXPLAINED

Designed for recording only certain kinds of transactions

Can be created for almost any type of transaction

save time journali zing and posting transactions

→ Transactions are entered on a single line

→ summaries of column totals are posted periodically

.
A general journal is still needed for some transactions

→
Adjusting and closing entries

→ Transactions that occur infrequently

102 DESCRIBE AND USE THE SALES JOURNAL

.

SALES TRANSACTIONS SALES ENTERED IN GENERAL JOURNAL

SALES JOURNAL

-
These transactions can be recorded more efficiently by using a sales journal

.
Used to record only sales of merchandise on account

-
A sale is recorded in the sales journal by entering the following information :

→ Date

→ Sale number

→ Customer ( to whom sold )

→ Dollar amounts

.
There is no need to enter any
general ledger account titles ,
since they appear in the column headings
 POSTING THE SALES JOURNAL

.
In the sales journal :

→ step 1 Total the

: amount columns . verify that the total of the debit column equals the total of the credit columns and rule the columns
,

.
In the ledger account :

→ step 2 : Enter the date of the transaction in the Date column

→ step 3 Enter the amount of the debit

: or credit in the Debit or

credit column

→ step 4 Enter : the new balance in the Balance column under

Debit or credit

" "
→ step 5 : Enter the initial S and the journal page number in

the Posting Reference column

-
In the sales journal :

→ step 6 : Enter the ledger account number immediately below the

column totals for each account that is posted

POSTING FROM THE SALES JOURNAL TO THE ACCOUNTS RECEIVABLE LEDGER

.
Accounts receivable ledger is posted daily so that current information is available for

each customer at all times

→ In the accounts receivable ledger account :

Step 1 : Enter the date of the transaction in the Date column

Step 2 : Enter the amount of the debit or credit in the Debit or credit

column

Step 3 : Enter the new balance in the Balance column

" "
.

step 4 Enter the initial

: S and the journal page number in the

Posting Reference column

→ In the sales journal

.
Step 5 : Enter a check mark ( V ) in the
Posting Reference column of the

journal for each transaction that is posted

103 DESCRIBE AND USE THE CASH RECEIPTS JOURNAL

.

CASH RECEIPTS JOURNAL

.
Used to record only cash receipt transactions

.
Includes separate columns for frequently used accounts such ,
as :

→ Accounts Receivable Credit → General Credit

→ Sales credit → Bank Credit Card Expense Debit

→ Sales Tax Payable Credit → Cash Debit

 CASH RECEIPTS JOURNAL

-
The Account Credited column is
I
→ Used to identify the customer name for any collection on account

→ Used to enter the appropriate account name whenever the General credit column is used

→ Left blank if the entry is for cash sales or bank credit card sales

CASH RECEIPTS JOURNAL POSTING

-
On a daily basis the amounts in the General Credit column
. are posted

.
At the end of the month .
the other columns are totaled

-
Each column total ( except the General credit column ) is posted at the end of the month

Postings to the subsidiary accounts receivable ledger are made daily

→ POSTING TO THE GENERAL LEDGER → POSTING TO THE ACCOUNTS RECEIVABLE LEDGER

104 DESCRIBE AND USE THE PURCHASES JOURNAL

.

PURCHASES JOURNAL

.
Used to record only purchases of merchandise on account

→ cash purchases would be recorded in the cash payments journal

. There are two types of formats :

→ single column
-

.
Purchases Debit / Accounts Payable Credit

→ Three column

.
Purchases Debit .

Freight -
In Debit '

Accounts Payable Credit

 → POSTING TO THE GENERAL LEDGER → POSTING TO THE ACCOUNTS RECEIVABLE LEDGER

105 DESCRIBE AND USE THE CASH PAYMENTS JOURNAL

.

CASH PAYMENTS JOURNAL

-
Used to record only cash payments transactions

Every transaction in the journal will involve a credit to the cash account

.
Columns are set up in the journal for those accounts most frequently affected by cash payments transactions

.
Five types of cash payments transactions are as follows :

→
Payment of an expense ( April 2)

→ Cash purchase ( April 4)

→ Payment of an account payable ( April 10 and 24 )

→ Payment of a note payable ( April 14 )

→ withdrawal by the owner ( April 22 )

-
General Debit column is provided for debits to any other accounts affected by cash payments transactions

.
For good internal control over cash payments ,
all payments ( except out of petty cash ) should be made by check ; therefore the cash , payments journal

also includes a check Number column

CASH PAYMENTS JOURNAL POSTING

-
On a daily basis the amounts in the General Debit column
,
are posted

.
At the end of the month ,
the columns are totaled .
the equality of debits and credits is verified ,
and the totals are posted to the general ledger

→ POSTING TO THE GENERAL LEDGER → POSTING TO THE ACCOUNTS RECEIVABLE LEDGER

 CHAPTER 13 ACCOUNTING FOR MERCHANDISE INVENTORY

LOI EXPLAIN THE IMPACT OF MERCHANDISE INVENTORY ON FINANCIAL

.

STATEMENTS

put
IMPACT OF MERCHANDISE INVENTORY ON FINANCIAL STATEMENTS

Errors in inventory will cause errors on the :

-
Income statement

•
statement of owner 's equity

.
Balance sheet

→ since this year 's ending inventory becomes next year 's beginning inventory financial statements for the following year will also contain errors
,

EFFECT OF INVENTORY ERRORS

Understanding the ending inventory has the

following effects :

.
Cost of goods sold overstated

-
Net income understated

Capital understated

•
Assets understated

Overstating the ending inventory has the following effects

-
Cost of goods sold understated

.
Net income overstated
↳ INVENTORY ERRORS ON NET INCOME EFFECTS
.

Capital overstated

.
Assets overstated

102 DESCRIBE THE TWO PRINCIPAL SYSTEMS OF ACCOUNTING FOR

.

MERCHANDISE INVENTORY THE PERIODIC SYSTEM AND THE PERPETUAL

never ending
SYSTEM
TYPES OF INVENTORY SYSTEMS

-
Periodic Inventory system

.
Merchandise inventory account balance = most recent physical inventory

.
Purchases account used for all merchandise purchases

-
Merchandise inventory and cost of goods sold are only computed at the end of the accounting period (adjusting entry required )

Perpetual Inventory System

-
Merchandise inventory account reflects current inventory

-
Purchases are debited to Merchandise Inventory and cost of goods sold
.
are credited to Merchandise Inventory

.
No need for end of year adjustments
- -
 pad
↳ INVENTORY SYSTEM JOURNAL ENTRIES

103 COMPUTE THE COSTS ALLOCATED TO THE ENDING INVENTORY AND COST OF
.

GOODS SOLD USING DIFFERENT INVENTORY METHODS

KEY CONCEPTS

To determine the cost of goods sold and ending inventory ,

it is important to understand

Purpose of a
physical inventory
INVENTORY SHEET
.
specific calculations used under the periodic and perpetual systems
f)
-
Role of the lower of cost
- - -
or -
market rule

TAKING A PHYSICAL INVENTORY

Counting the goods on hand at the end of period

.
Periodic system

.
Used to allocate merchandise costs between sold and unsold goods

Perpetual system

Compared to the accounting records to determine if the amount of merchandise actually held agrees with what is reported in the accounting records

Frequently done after regular business hours

.
Some companies even close for a few days to take inventory

The ideal time to count the goods is when the quantity on hand is at its lowest level

.
A fiscal year that starts and ends when inventory is normally at its lowest level is known as a natural business year

PHYSICAL INVENTORY SPECIAL CONSIDERATIONS

'
Goods held for sale on consignment

Consigned good remain property of shipper ( consignor )

-
Should NOT be included in inventory of company holding goods ( consignee )

Good in transit

Shipped FOB shipping point

-
BUYER pays for shipping

-
Goods belong to buyer when shipped

Shipped FOB destination

 Pad
•
Goods belong to seller until received by buyer

INVENTORY COST COMPONENTS

Proper cost must be assigned to the inventory ( after counting )

-
Cost means ALL necessary and reasonable costs incurred to get the goods to the buyer 's place of business

-
Cost components of inventory can include :

Purchase price

Delivery costs ( freight -

in )

.
Insurance

storage fees

COMPUTING COST OF INVENTORY

.
Identical items are purchased at different times and at different costs per unit

. Of the goods available for sale .

how do we decide which units were sold and which units remain on the shelf ?

•
Four inventory methods generally accepted :

Specific identification

.
First -
in .
first out CFIFO )
-

weighted -

average

-
Last in
-

. first -
out ( UFO )

-
Methods can be applied under periodic or perpetual inventory systems

SPECIFIC IDENTIFICATION

To use specific identification inventory items must

↳ INVENTORY COSTING
.

EXAMPLE DATA
-
Be physically different from each other ( works of art )

Have serial numbers ( cars computers ) ,

.
Cost is determined from supplier 's invoice

and
-

Usually practical only for businesses in which sales volume is relatively low
inventory unit value is relatively high

COMPUTING COST OF GOODS SOLD USING THE SPECIFIC IDENTIFICATION METHOD

.
The identity of the 200 printers sold is as follows

.
30 of the beginning inventory were sold

.
50 from the 1st purchase were sold

.
60 from the 2nd purchase were sold

.
60 from the 2nd purchase were sold

.
60 from the 3rd purchase were sold ↳ COMPUTING COST OF GOODS SOLD USING THE SPECIFIC IDENTIFICATION METHOD
-
Cost of goods sold = Total cost of 200 printers sold
 -
PERIODIC INVENTORY SYSTEM

Assumes that the first

Therefore the latest

,
FIRST

goods purchased were

goods purchased
-
IN

the first

remain in
. FIRST OUT IF 11=0 )
-

goods sold

inventory
put
-
Whenever possible ,
a business will attempt to sell the older goods first

( before they become obsolete )

Example Grocery
: stores . bakeries .
computer dealers
↳ FIFO INVENTORY METHOD
.
FIFO often follows the movement of goods

PERIODIC INVENTORY SYSTEM WEIGHTED AVERAGE METHOD

-

Computes an
average cost per unit using the following formula :
-

-
Total cost of units available for sale divided by the total number of units available for sale

COMPUTING COST OF GOODS SOLD USING THE WEIGHTED -

AVERAGE METHOD

-
lost of goods sold 200 units @ $66 $13,200
=

Ending inventory 50 units @ $66 =3 . 300

.
One of the advantages of the weighted -

average method is its simplicity

.
Calculate the average cost

.
Cost of units available for sale divided by number of units

PERIODIC INVENTORY SYSTEM LAST IN -

.
FIRST OUT ( UFO ) METHOD
-

.
Assumes that the sales in the period were made from the most recently purchased goods

.
Earliest goods purchased remain in inventory

.
Justifications for this method include :

Physical movement of goods in some businesses is actually last -

in .
first out
-

-
Matches the most current cost of items purchased against the current sales revenue

.
Results in lower net income .
and therefore lower income tax when prices .
are rising

↳ UFO INVENTORY METHOD

 pad
PHYSICAL FLOWS AND COST FLOWS

Only the specific identification method will necessarily reflect cost flows that match physical flows of goods

-
Assumed cost flows ( FIFO weighted average
,
-
.
and UFO ) methods do not have to reflect actual physical movement of goods

Any one of these methods could be used under any set of physical flow conditions

COMPARISON OF INVENTORY METHODS

•
Goods available for sale is the same for all four methods

Ending inventory and cost of goods sold differ with each method

.
Gross profit differs with each method

-
when prices are rising ( as with the printers ) . FIFO results in the largest gross profit

.
UFO results in the smallest gross profit therefore .
creating the smallest tax liability

.
when selecting the inventory method to be used by a business . Keep in mind :

The Internal Revenue Service requires the use of the same inventory method for tax and financial reporting purposes

-
The physical flow of the inventory does not need to match the flow assumed by the inventory method

.
The consistency principle requires that the same accounting methods be followed from period to period

↳ COMPARISON OF INVENTORY METHODS

PERPETUAL INVENTORY SYSTEM

.
A continuous record is maintained for the quantities and costs of goods on hand at all times

.
Much easier to handle with computerized systems

.
The balance of the Merchandise Inventory account at any time shows the cost of goods that should be on hand

.
Merchandise Inventory account at any time shows the cost of goods that should be on hand

.
A subsidiary ledger is maintained with an account for each type of merchandise

-
Goods sold usually are assigned cost an either a FIFO . moving average
-

,
or UFO basis

A) PERPETUAL INVENTORY RECORD :

FIFO METHOD
 Dad
CONSERVATION PRINCIPLE

.
when in doubt ,
a lower asset value and net income measure should be used

.
If an asset increases in value while being held .
no formal entry of the gain is made on the books until the asset is sold

.
If an asset decreases in value while being held .
an entry is made to recognize the loss

.
We should never anticipate gains but .
we should always anticipate and account for losses

LOWER OF - -
COST -
OR -
MARKET METHOD

-
If the value of inventory declines while it is being held .
the loss should be recognized in the period of the decline

Purpose of the lower of - -

cost -
or -
market method is to :

Recognize such losses on the income statement

Report the lower inventory valuation on the balance sheet

.
Cost means dollar amount calculated using one of the four inventory costing methods

.
Market mean current cost to replace the inventory

Price in the market in which goods are purchased by the business

-
NOT the price in the market in which goods are normally sold by the business

.
Method assumes that a decline in the purchase ( replacement ) price is accompanied by a decline in the selling price is accompanied by a decline in

the selling price and thus signals a decline in the value of the inventory

Is LOWER -
OF -
COST -
OR MARKET METHOD
-

.
Two ways to calculate the lower of cost -
-
or market :

Applied to Total Inventory

.
The lower of all items at their cost OR all items at their market value

Applied to Each Item

-
Each Item is evaluated individually

lower amount l cost or market ) is determined for each item

-
Assume we use the total inventory method

.
Journal entry needed to reduce Merchandise Inventory to $23 .
500

.
Reduction in value is an expense

↳ LOWER -
OF -
COST -
OR -
MARKET METHOD
 pod
104 ESTIMATE THE ENDING INVENTORY AND COST OF GOODS SOLD BY
.

USING THE GROSS PROFIT AND RETAIL INVENTORY METHODS

ESTIMATING INVENTORY

Estimating inventory is not a problem for businesses using the perpetual inventory method

.
Unverified amounts are generally reliable estimates and can be used for interim monthly or
quarterly financial statements

.
Businesses using the periodic inventory method must use other methods to estimate ending inventory and cost of goods sold

.
Two generally accepted methods :

•
Gross profit method

.
Retail inventory method

GROSS PROFIT METHOD OF ESTIMATING INVENTORY

.
A business's normal gross profit ( net sales cost of goods sold ) is used to estimate the cost of goods sold and ending inventory

-
Calculation is appropriate only if the firm's normal gross profit as a percentage of net sales has been relatively stable over time

Example data :

Inventory start .
of period $80,000

-
Net purchases ,
first month $70,000

.
Net sales first month
,
$ 110 , 000

Normal gross profit percentage of sales 40%

as a
↳
.

GROSS PROFIT METHOD STEPS

RETAIL METHOD OF ESTIMATING INVENTORY

.
Used by many retail businesses

Requires keeping records of both the cost and selling

( retail ) prices of all goods purchased

↳ RETAIL INVENTORY METHOD STEPS

 CHAPTER 14 ACCOUNTING FOR MERCHANDISING BUSINESS

LOL PREPARE AN ADJUSTMENT FOR MERCHANDISE INVENT

012µm
.

USING THE PERIODIC INVENTORY

REVIEW OF ENTRIES FOR PURCHASE

WORKSHEET FOR A MERCHANDISING BUSINESS

-
Is similar to a service business work sheet

.
Used to prepare year end adjustments
-

.
Also includes an adjustment to properly report the amount of merchandise inventory held at the end of the accounting period

.
Used to prepare financial statements

ADJUSTMENT FOR MERCHANDISE INVENTORY : PERIODIC INVENTORY SYSTEM

Andy 's Auto Parts had a beginning merchandise inventory of $25,000

.
At the end of the accounting period ,
a physical inventory of the merchandise determined that merchandise costing $27.000 was still on hand

Why is there more

inventory at the END than at the BEGINNING of the
year ?

-
When purchase EXCEED sales , the inventory balance is HIGHER at the end of the year

-
Merchandise Inventory account is NOT changed during the accounting period

-
Merchandise bought during the year is debited to Purchases instead of Merchandise Inventory

-
The COST of merchandise sold is NOT recorded

.
The selling price is credited to the sales account

-
After a
year of purchasing and selling merchandise the merchandise inventory
.
balance is no longer accurate

-
A two -

step adjustment is needed to update the balance of the Merchandise Inventory account

Step 1- The begaining inventory 1$23 .

000 ) is removed by crediting Merchandise Inventory

•
Income summary is debited because this amount is used in the calculation of cost of goods sold and net income

step 2- The ending inventory ( $27.000 ) is entered by debiting Merchandise Inventory

.
Income summary is credited because this amount is also used in the calculation of cost of goods sold and net income

-
Note that the debit and credit adjustments made to Income summary are extended into the Adjusted Trial Balance columns This .
is done because

the individual amounts are needed for the calculation of cost of goods sold on the Income statement C b eggin ing inventory + purchases -

ending

inventory = cost of goods sold )

Steps 3- 5 in the inventory adjustment processes address issued related to customers returning inventory

.
In a
merchandising business ,
it is likely that customers will return some of the merchandise that was purchased
-
The entry made when merchandise is returned during the current period is as follows :
 Dad
-
Debit Sales Returns and Allowances

. Credit Accounts Receivable ( or cash )

. Returned inventory is not debited to the merchandise

inventory account

.
Will be captured in the physical count of the ending inventory ,
if not sold by the end of the year

.
Some of the inventory sold this year is likely to be returned next year

Andy 's estimates that customers will be granted $4,000 in refunds of this
year 's sales next year

Merchandise expected to be returned will have a cost $3.000

-
Customer Refunds Payable must be adjusted to
equal the estimated $4 ,
ooo
liability
•
Has a balance of $2 . 600 before adjustment

Step 3 Make the

following adjustment

ADJUSTMENTS FOR SALES RETURNS AND ALLOWANCES

In steps 4 and 5 ,
we adjust for the estimated inventory to be returned next year

Estimated Returns is of merchandise inventory sold this year but expected to be returned
-

Inventory an asset account that represents the estimated cost ,

next year

.
Is reported as a current asset on the Balance sheet and is often combined with Merchandise Inventory

-
Will be adjusted at the end of each period to
properly reflect the cost of merchandise sold this period ,
but expected to be returned next period

-
Estimated Returns Inventory has a balance of $2,000 before adjustment

-
Account must reflect the required $3,000 balance ,
the cost of the expected returns

Following entries are made :

↳
ADJUSTMENTS FOR ESTIMATED RETURNS INVENTORY

→ CALCULATION OF COST OF GOODS SOLD

 µgf
102 PREPARE AN ADJUSTMENT FOR UNEARNED REVENUE
.

UNEARNED REVENUE

-
Cash received in advance before delivering a product or
performing a service

Reported as a liability on the balance sheet because the company owes the customer the product or service

ADJUSTMENT OF UNEARNED REVENUE

-
Brown County Playhouse sells season tickets

.
Tickets sell for $10 for each day ( 5 plays per season )

.
A maximum of 1,000 seats can be sold for each play

.
Assume that all shows sell out during the first week

-
When season tickets are sold .
Cash is debited and Unearned Ticket Revenue is credited

Following production of the third show ,

financial statements are to be prepared

-
An adjusting entry is needed to recognize the ticket revenue earned for the three shows

-
3 shows ✗ 1,000 tickets for each show = 3,000 tickets

3,000 tickets ✗ $10 per ticket = $30,000

. $30.000 in earned revenue is removed from the unearned account and put into the revenue account

Remaining balance of $20,000 in Unearned Ticket Revenue is reported as a current liability on the balance sheet

→ ENTRIES FOR UNEARNED REVENUE

→ CHART OF ACCOUNTS FOR SUNFLOWER CYCLE

 pad
103 PREPARE A WORKSHEET FOR A MERCHANDISING BUSINESS
.

PREPARING A WORKSHEET FOR A MERCHANDISING BUSINESS

1. Prepare the trial balance

2. Prepare the adjustments

3. Prepare the adjusted trial balance

4. Extend the adjusted trial balance amounts to the Income statement and Balance sheet columns

5. Total the Income statement and Balance sheet columns to compute the net income or net loss

↳ YEAR
-
END ADJUSTMENT DATA FOR SUNFLOWER CYCLE

↳
ADJUSTING ENTRIES FOR SUNFLOWER CYCLE

↳
YEAR END SPREADSHEET FOR SUNFLOWER CYCLE
-
 µ
104 JOURNALREADJUSTING ENTRIES FOR A MERCHANDISING
.

BUSINESS

↳ ADJUSTING ENTRIES FOR SUNFLOWER CYCLE

LO 5 PREPARE ADJUSTING JOURNAL ENTRIES UNDER THE PERPETUAL

.

INVENTORY SYSTEM
ENTRIES UNDER THE PERPETUAL INVENTORY SYSTEM

.
Under the perpetual inventory system ,
the merchandise inventory ,
estimated returns inventory .
cost of goods sold ,
and customer refunds payable

accounts are continually updated throughout the year to reflect → ENTRIES FOR PERIODIC AND PERPETUAL
INVENTORY SYSTEMS
.

Inventory purchases

-
Sales

.
Returns by customers

.
Returns to suppliers

ADJUSTMENTS FOR EXPECTED SALES RETURNS AND ALLOWANCES

.
Under a
perpetual inventory system ,
business has the ability to track the details of inventory transactions since they are updated during the year :

•
Merchandise Inventory

-
Estimated Returns Inventory

.
Cost of goods sold

-
Customer Refunds Payable
 MY
•
Must be adjusted at year end for next year 's estimates

-
it last year 's estimates for refunds and returns inventory were accurate .
the ending balances of Estimated Returns inventory and

customer Refunds payable should approach zero

ADJUSTMENTS FOR INVENTORY SHRINKAGE

Perpetual inventory system does not eliminate the need for taking physical inventories

Perpetual records must be compared with the physical inventory to discover and correct any errors or losses of merchandise from

theft , breakage ,
or
spoilage

.
This is known as inventory shrinkage

.
Differences found between physical count and amount in the perpetual inventory

-
Records must be corrected by an
adjusting entry
.

Differences are recorded in an account called Inventory short and Over

.
Debit balance -
Listed with other expenses on the income statement

.
Credit balance listed with other revenues on the income statement

.
EXAMPLE : A physical inventory shows $3.710 worth of merchandise ,
but the inventory account has a balance of $3,840

-
$130 short
 FINANCIAL STATEMENTS { YEAR END
CHAPTER 15
-

ACCOUNTING FOR A MERCHANDISING BUSINESS

LOL PREPARE A SINGLE
.
-
STEP { MULTIPLE -
STEP INCOME STATEMENT FOR
A MERCHANDISING BUSINESS
INCOME STATEMENT

-
To summarize the results of operations during an
accounting period
-
Shows :

→ sources of revenue

→
types of expenses

→ amount of net income or net loss for the period

-
Two forms :

→
single step -

→
Multiple step -

SINGLE -
STEP INCOME STATEMENT

.
All the revenue sources are listed and totaled

-
Cost of goods sold is listed with all the other expenses
↳ SINGLE -
STEP INCOME STATEMENT
-

Expenses are totaled and subtracted from revenues to determine net income or loss

.
Called a single step -
income statement because expenses ( including cost of goods sold ) are subtracted from

MULTI STEP INCOME

.
Gross sales is shown first less any returns allowances
, . . or discounts

-
Difference is called net sales

-
Other revenues are listed at the end of the statement

Cost of goods sold is computed and subtracted from net sales to arrive at gross profit for gross margin)

Operating expenses are listed totaled and subtracted from gross

. , profit to compute income from operations ( sometimes called operating income )

Operating expenses are directly associated with providing the primary goods and services of the business

Operating expenses can be divided into subcategories of selling expenses and general expenses

SELLING EXPENSES

Expenses directly associated with

.

selling activities
→ Sales salaries Expense

→ Sales Commissions Expense

→ Advertising Expense
→ Bank Credit Card Expense

→
Delivery Expense

→
Depreciation Expense Store Equipment and Fixtures
 GENERAL EXPENSES

Expenses associated with administrative office , ,

or general operating activities

→ Rent Expense

→ Office Salaries Expense

→ Office Supplies Expense

→ Phone Expense

→ Utilities Expense

→ Insurance Expense

→ Depreciation Expense Office Equipment

LOZ PREPARE A STATEMENT OF OWNER 'S EQUITY

.

THE STATEMENT OF OWNER'S EQUITY

.
Summarizes all changes in the owner 's equity during the period

. Sources needed to prepare this statement :

•
worksheet

.
General ledger capital account

-
Includes :

-
Investments and withdrawals

→ Found on worksheet

.
Net income or loss ↳ STATEMENT OF OWNER'S EQUITY

→ Found on income statement

Beginning and ending capital balances

→ Found in general ledger

103 PREPARE A CLASSIFIED BALANCE SHEET

.

CURRENT ASSETS

Include cash and other assets which are :

Expected to be converted into cash

-
Consumed within one
year or the normal operating cycle of the business whichever is
. longer

→ Operating cycle length of time generally required for a business to :

Buy inventory
•

.
Sell it

.
Collect cash

EX Cash
.
receivables merchandise
, inventory prepaid expenses
,
 Listed in order of liquidity the speed with which the convert the asset
company can
•

.
From most liquid to least liquid

.
Cash is the most liquid always listed first

PROPERTY PLANT AND EQUIPMENT

. .

-
Assets that are expected to be used

For more than one

year in the operation of a business
.

Ex land , buildings office equipment

, .
store equipment delivery equipment
.

.
Assets with longer useful lives are listed first

CURRENT LIABILITIES

Obligations that are due within one

year or the normal operating cycle whichever
,
is longer
.
Will require the use of current assets

Ex Notes Payable .
Accounts Payable Wages Payable Sales Tax Payable Unearned Subscriptions Revenue Mortgage
. . . .
Payable

LONG TERM LIABILITIES

-

Obligations that will extend beyond one year or the normal operating cycle ,
or the normal operating cycle ,
whichever is longer
.

Mortgage payable is a common long -

term liability

.
Used to reflect an obligation that is secured by a
mortgage

Mortgage written agreement that lender has right to take over specific property to satisfy a debt if borrower does not repay it

OWNER 'S EQUITY

.
Accounts are determined by the type of organization

-
Sole Proprietorship

Partnership

Corporation

USING A SPREADSHEET TO
PREPARE A REPORT FORM ←-

CLASSIFIED BALANCE SHEET

 104 COMPUTE STANDARD FINANCIAL RATIOS
.

FINANCIAL STATEMENT ANALYSIS

.
Used to evaluate the financial condition and profitability of a business

.
Used by management and creditors

-
Balance sheet analysis

-
Inter statement analysis

BALANCE SHEET ANALYSIS

-
Uses only the information on the balance sheet

Working capital

.
Current ratio

.
Quick ratio

WORKING CAPITAL

.
The amount of capital the business has available for current operations

.
FORMULA : CURRENT ASSETS -
CURRENT LIABILITIES

.
Sunflower cycle has current assets of $127 900 and
.
current liabilities of $34.800

.
WORKING CAPITAL = $127 900 $34 800
,
-
. = $93 , 100

CURRENT RATIO

Measures firm 's ability to its current liabilities

. a
pay
"
"
.
Rule of thumb = 2 to I

Many businesses operate successfully with a current ratio of 1.5 to 1

.
It is better to compare an individual company to industry averages

QUICK ASSETS

.
Cash and all other current assets that can be converted into cash quickly

EX Cash ,
Accounts Receivable Temporary investments
.

QUICK RATIO

.
Gives a more defined picture of a firm 's ability to pay its current liabilities

" "
-
Rule of thumb = I -101

Many businesses operate successfully with a quick ratio of 0.6 to 1

RETURN ON OWNER 'S EQUITY

 ACCOUNTS RECEIVABLE TURNOVER

.
Measure of time required to collect cash from credit customers

" "
-
Indicates number of times accounts receivable turned over
,
or were collected ,
in the accounting period

Higher numbers indicate cash collected more quickly

AVERAGE COLLECTION PERIOD

.
Number of days credit customers are taking to pay for their purchases

Comparing average collection period with business 's credit terms offers an indication of whether customers are
paying within terms

13651 by the rate of number

-
Calculated by dividing the number of days in the
year

ex 365 days ÷ 9. 6 = 38 . 2
days

INVENTORY TURNOVER

Represents the number of times merchandise inventory turned over ( was sold 1
during the accounting period

Higher rate of inventory turnover smaller profit required on each dollar of sales to produce a satisfactory gross profit

Grocery stores have high inventory turnover and a low profit per item

Jewelry stores need a higher profit per item to offset their low inventory turnover

Compare Inventory Turnover rate with :

-
Prior years

.
Other companies

Industry average

AVERAGE DAYS TO SELL INVENTORY

Computed by dividing number of days in a

year 13651 by inventory turnover
-

Requires comparison with prior years ,

other companies ,
or industry averages
EX
365 days ÷ 4.8=7.6 days
 105 PREPARE CLOSING ENTRIES FOR A MERCHANDISING BUSINESS
.

CLOSING ENTRIES

.
Similar to closing entries for a service business

.
Additional merchandising accounts also must be dosed

.
Easiest way to complete closing process use a worksheet to prepare closing entries

↳ THE CLOSING PROCESS

↳ CLOSING ENTRIES FOR A MERCHANDISING BUSINESS

 POST CLOSING TRIAL BALANCE
-

Prepared by taking the balances from the general ledger accounts

-
Should not be prepared from the balances on the spreadsheet

Using general ledger accounts helps ensure that all temporary accounts have been closed properly

.
Proves general ledger is in balance at beginning of new accounting period

↳ POST CLOSING TRIAL BALANCE

-

106 PREPARE REVERSING ENTRIES

.

REVERSING ENTRIES

.
Reverse 1 or
opposites of an adjusting entry

.
Done to simplify recording of transactions in new
accounting period

Prepared at the beginning of the next accounting period

.
What to reverse : Except for the first year of operations ,
reverse all adjusting entries

that increase an asset or liability account from a zero balance

→ WHICH ADJUSTING ENTRIES

TO REVERSE ?

↳ ADJUSTING CLOSING AND REVERSING ENTRIES

. .

FOR WAGES

↳ REVERSING ENTRY FOR SUNFLOWER CYCLE

 Accounting for Accounts Receivable
lol .

Apply the allowance method of anointing for wmollectible accounts

sales on account

customers the
"

account
offering ability to buy
"
-
on increases sales

But some customers do not

pay
.

→ some the accounts receivable will be unuellectible or bad debts

of
Bad debt to collect account receivable
expense from failure
→
expense
=
an

accounts :
Two methods
of accounting for urnollcetible
.

→ allowance method

→ Direct write method

off
-

allowance method

Attempts to
recognize bad debt expense in the same
period that the related credit sales are made
•

Consistent with the

→

matching principle
→
usually regrind under the accrual method
of accounting
Three
step process
-
-
:

of bad debt expense uncountable accounts

Estimate amount at the end
→
step 2 -

or
of each
accounting
period
→
Flip 2- Make
adjusting entry for this estimate

-
Debit -
Bad debt expense

Credit -
Allowance for Doubtful Ancoats
→
step 3
-
In a
subsequent period identify .
and write
off specific uncountable accounts

-
Anoints Receivable is not credited in the
adjusting entry
→ me do not know which specific customers will fail to pay

a contra -
asset account Allowance for
, Doubtful Accounts (also known as Allowance for Unuotlutible Amounts or

allowance Bad Debts ) is credited

for ,

Balance this account is deductedfrom Aments Receivable the balance shut

up
→ on

amount is known the net receivables net realizable value accounts receivable
Remaining
→
as or
of
-
Individual Anoints Receivable balances are written
off
in
subsequent periods as
they become unrollcctible
 and percentage
V02 .

Apply the
percentage of sales of
receivables methods

of estimating uncountable amounts

Uncountable Accounts
Estimating
sales metal
Percentage of
•

Based o n the relationship between amount of credit rules the you and ament
of uncollutible
→

during
accounts

→ Ammer some portion credit rules will not be collected

of

Percentage receivables method

of
•

→ Band o n the
relationship between amount accounts receivable at the end the and amount
of of gun
will be uncountable

the accounts receivable balance

→ Assumes some
portion of existing is unrollulible

Percentage of
sales Method

→ Band on the
relationship between ament
of
aments receivable at the end the
your
and ament will
of
be uncollected

Ammer some portion of accounts receivables balance in uniolhwtible

→ the
existing
Determine % of credit sales muollutible
the
expected to be
•

By looking the company's prior

at credit
→
experience industry averages ,
or
percentages for similar
companies
Ex
During the
prior you , Chris Co .
had total credit sales
of $ zoo ,
ooo ,
and $ 2 , ooo
of
those credit sales had become

unvollectible

lnwollectibhe amounts
→ =
percent uncolleitible
credit sales

$ Zoo ,
ooo
→

$ 2 , ooo

→ Current credit sales are $ 1us ooo

year ,

→ Estimate of current year Bad Rebt

expense
is $ I. zoo ($ 120 . ooo × I /
°

o )

→
Journal Entry is made as
follows :

-
Debit - Bad Debt
Expense $:
1 .
zoo

-
Credit -
Allowance for Doubtful Amounts : $ 1.200

During you total credit $ 130

the
following sales ooo
-
.
are ,

.
Debit -

Allowance
for Doubtful Amounts $ I :
,
too

Credit Amounts Runnable

-

:$ 1 ,
ooo

account and all reduced

→ Allowance amount amounts receivable , ,
subsidiary ledger accounts are

→ Under the allowance method ,

write -

offs affect the balance sheet only

→
Expense of these mnolhetibh accounts wa r
recognized in the adjusting entry in the period of
the related sale
 total credit soles $ 130
Ring the
following you are ooo
-

, ,

Estimate Bad Debt

Expense is $ 1. 3001$ 130.000 I Io )
◦

following yen
✗
of
→

found entry male

→ in as
follow :

Debit Bad Debt

Expense :$ 1,300
-
.

. Credit -
Allowance for Doubtful Amounts : $ 1.300
Allowance
for Doubtful Arrants way home a debit or credit balance or
prior to
adjustment
-

Mound underestimating mwolleilibln anoints

result
overestimating
→
of in

Any balance in allowance for

Doubtful Amounts prior to
adjustment is generally ignored
Percentage of sales method tw current gun's credit roles
focuses on
→

→
any previous balance in the allowance account relates to credit ruler and uncwllutibh anoints from

prior your
-

lf a
large debit expense or credit balance annunciates in allowance account

used for estimates

→ Time to adjust the
percentage
Percentage of Receivables Method

Compute uncollectible anoints as a

percentage of the aments Receivable balance

estimated to tw anoints Receivable balance to delirium estimated but debt

-

Apply tin percentage expense

This not
.

approach is
very precise
then not take into anoint the fact that the older amount the the it will be
→ an in .
gratin chance

mwolleitiblr

had Accounts Receivable balance end the past two years of $ 110 and
Ex
Craft lo . an
average
at the
of ,
ooo
,
average
www.tible amounts of $ 9 , 400 per
year

Average Unuollectible accounts

=
percent uncolleetible
Accounts Receivable balance
→
Average
$ 4. doo
= 4%
$ 10
→
, ooo

→ AIR balance end of current year is $ 120 ,

ooo

Estimate accounts is $ 4. 800 ($ 120 4 /)

°

of uucollcetible
→ ,
ooo ×
o

→
Journal entry is made as follows ( assuming balance in allowance account )
zero
:

Debit Bad Debt

Expense :$ 4. 800
•
-

Credit Allowance for Doubtful anoints $4.800 :

. -

the Receivables
Aging
schedule
prepared details
•

Aging is ,
which :

→ Each customer's account balance and how

long it has been outstanding
Estimated account
"

uncollrctible based the

"
the
percentage age of
→
on

Computer a more precise estimate of bad debt expense

 →
Taken into account that older amounts have greater wuollcctible
a chance
of being
-
Customers and balances a re listed

.
Balances are separated and classified by how
long they have been
outstanding
-

Percentages ,
based o n past experience ,
are
applied to each
category
increases the accounts become older and less
•

Percentage or
likely to be collected

Journal entry is made as follows I

assuming zero
balance in allowance account ) :

Debit Bad Debt

Expense :$ 5. 500
-
-

.
Credit _

allowance for Doubtful Amounts :$ 5 . 500

45 written
-

During the
following year
unuellectible accounts
totaling ,
zoo we re
app
.
Debit -

Allowance
for Doubtful Amounts : $5 . zoo

.
Credit -
Anoints Receivable 1 Customer Nunes : $ 5 , zoo

→ Balance in the allowance account is now a $ 300 credit

End
following year another schedule prepared estimated wmollrctible amount is $5 noo
of aging
-
-

Need a balance
of $ 5, Too but the balance in allowance is
only $300
→
,

→ an
adjustment of $ 5.400 is needed

Percentage of Receivables Points to Remember

.
Allowance for
Doubtful accounts may have a debit or credit balance prior to adjustment
This balance must be considered in the current period
making 's
adjusting entry
→

Method focuses the Accounts Renewable balance at the end the

on
of year
-

That balance contains receivables from the current year and

any remaining from prior
→
years

Total Amounts Receivable balance (

consisting of current andprior year receivables )
is
amazed to determine the
-
 proper allowance account
•

Adjusting entry is made to achieve that balance in the allowance account

Effects of White -

Offs on Financial statements

.
on the income statement

→ No
effect
Bad debt already recognized with adjusting entry in the your expense estimated
expense
→ wa s

-
On the balance sheet

→
no effect overall
→ Write decreases bath asset ( accounts Receivable ) and contra asset 1 Allowance for Doubtful Ancoats )
off
-
-

Recovery of a
Previously Written -

Off amount
A check
for $500 received february 2
from Bill McDonald whose account was written
off
.
war on on
,

January 15
-
Need two journal entries :

Reinstate the auout (reverse the write

off )
→ -

→ Record the collection

 103 .

Apply the direct write -

off method of anointing for muollutible aments

Direct white off Method -

Bad debt not until account is deemed uncollectibee

expire recognized
-

advantages
→
simple to
apply
→
Required for income tax purposes
.

Disadvantages
Violates
matching principle
→

Amount
→
of expense can be
manipulated
Balance sheet does not reflect amount
of Accounts Receivable actually expected to be collected
→

John Lafitte's ament for $ Soo is

judged to be uncountable

made
Following entry :
•

Debit -

Bad Debt Expense $500 :

.
Credit -
Auoutr Receivable IJ .

Lafitte : $500

$500 in the
He
subsequently pays the same
anointing period
•

Reinstate the account (Debit accoutre Receivable Credit Bad Debt

→ -

Expense )
→ Record the collection

If he subsequently pays the $ soo in a

different accounting period
Reinstate the account account ( Unuetbutible Awaits Recovered 1 instead of
→
by crediting a Revenue

Bad Debt Expense

crediting
→ Record the collection
 Accounting for Notes and
Interest
LO1. DESCRIBE A
PROMISSORY NOTE PROMISSORY
NOTES
u A written promise to pay a specific sum at a definite future
date
-
Also called a note
\
Often used when credit is extended for 60 days or more, or when large amounts of money
are involved
Must be signed by the maker of the note: the person or business agreeing to make
: the payment
Must be payable to a specific person or business, known as
the payee
Interest bearing note: one with an explicit interest rate started on the face of the note

i
Non Interest bearing note: one on which no rate of Interest is specified, although the note does include an
interest
component

LO2. CALCULATE INTEREST ON AND DETERMINE THE DUE

DATE OF PROMISSORY NOTE
CALCULATING
INTEREST
3 factors needed for
calculation
I
Principal of the note: the face amount of the note that the maker promised to pay at
maturity
→ This is the amount on which the interest is
calculated
/
Rate of interest: usually expressed as a
percentage
-
Term of the note: months or days from the issue date to the maturity
date
→ Used to calculate Time: the term of the note stated as a fraction of a
year
\ When the term is specified in months, Time is calculated on the basis
of months
\
Time for a three month note is calculated as
follows
→ 3 months divided by 12 months 1
=

4 years
When the term is expressed in days, or when the due date is specified in a note, Time is calculated

:
using the exact
number of days from the issue date of the note to the maturity
date
We use 360 days as a year for
simplicity
- Time for a 92 day note is calculated: 92 /days 360
= I 92
360 year
\
Most banks and business firms and all federal government agencies use 365 days as the
base in computing
daily
interest
✓
Formula
s:
Interest =/ Principal 2500
.
✗ Rate 0.07
)× Time/ 92 =

365 44.11
-

Maturity value Principal Interest 2500

= + I = Principal 2500 %x
+ Rate 7
✗ ITime
)=92 365 2500
+ =

44.11 2544.11
ex $ 2,500,%7 note is due in 90 days
-
Principal Rate Time
✗ ✗ =

Interest
-
$ 2,500 1.7✗ 90
✗ / =360 43.75
interest
Maturity value=$ 2,500
. +$ 43.75
=$ 2,543.75
2544.11
•
$ 2,000, 6 % note is due in 3
months
•

$ 2,000✗ 1.6 ✗ 1=4

3 12 30
interest
. Maturity value=$ 2,000 +4=4 30
2,030
DETERMINING THE DUE
DATE
-
If the term of a note is stated in months, the due date is determined by counting the number of
months
from the date the note was
issued
-
The note is due on the date in the month of maturity that correspond with the date the note
was issued
-
A three month note dated August 10 would be due
November 10
-

If there is no date in the maturity month corresponding to the issue date, the due date is the last
day of the
maturity
month
-
A three month note added January 31 would be due
on April 30
i
Term of the note stated in days: Due date is specified number of days after
issue date
Three step

i.
calculation
-

Step 1: Subtract issue date from number of days in month of

issuance
-

Step 2: Add to result of Step 1 number of days in as many months as possible without
exceeding the time
of the
note
Step 3: Subtract result of Step 2 from the time of the
note
The result is the date of the month the note is
due

NOTES RECEIVABLE TRANSACTION

TYPES
Note received from a customer in exchange for
assets sold
Note received from a customer to extend time for payment of an
account
Note collected at
maturity
-
Note collected at
maturity
- Note renewed at
maturity
Note discounted before
: maturity
Note
dishonored
-
Collection of dishonored
note
NOTES RECEIVED FROM A CUSTOMERS IN EXCHANGE
FOR ASSETS SOLD
On June 1, Linesch Hardware Co. sells an industrial mower to Williams Manufacturing
$ for 8,500 in
exchange for
a 180 day,% 8 note signed by
Williams

NOTE RECEIVED TO EXTEND TIME FOR PAYMENT

.
Accounts receivable customer Michael Putter owes$ 2,000 to Linesch
Hardware Co.
-
To settle this account, Putter signs a 90 day, 7.5 note dated
June 8
/

Why would Linesch want to accept this

note?
The note is formal, written promise to
-

pay
Can be converted to cash at a bank if
→

necessary
-
The note bears
Interest

-
What if Michael Putter gives a check for 250 and a note for 1,750 instead?
-
Journal entry is as
follows:

NOTE COLLECTED AT MATURITY

-
When a note receivable matures, it may be
collected by:
-

The
payee
-

The bank named in the

note
l
A bank where it was left for
collection
-
Putter pays Linesch the
$ 2,000 principal $plus 37.50 interest on the note previously
described

What if the note had been left at Planet Bank for collection
: instead?
Planet Bank
would:
-
Collect the maturity value from Putter1$ )
2,037.50
• Subtract out a service change($ I
15.00
 -
Deposit the remainder in Linesch’ss account
($ )
2,022.50

When the bank makes the collection it notifies the payee that the net amount has been added to the
payee’s
account
\
Bank uses a credit advice for
notification

NOTE RENEWED AT MATURITY

What if Mr Putter paid only the interest due on the note and asked to renew the note?
: Linesch Hardware Co.
would:
Collect the
: Accept
interest
a new note to replace the original note
-
Assume Putter pays
$ 37.50 interest plus
& 500 on the principal and gives a new
% 90 day, $
8 note for
1,500
Linesch makes the following

i
entry:

NOTE DISCOUNTED BEFORE

Business needs cash beforeMATURITY
due date of
a note
Can endorse note and transfer it to a
1

bank
.

Called discounting a note

receivable
-

Bank charge an interest fee called a bank

discount
- Discount Period: Time between date of discounting and due
date of note
I
Difference between maturity value of note and bank discount is called
proceeds
Maturity value Discount
→ -
=

Proceeds
-

Assume the$ 2,000,%7.5 ,90 day note from Putter dated June 8 is discounted at the bank on July 8 %
at a rate of 8
-
Calculating the discount and proceeds is a four step
-

process
< Step 1 Compute the maturity value of the
-

note
.

Face Interest Maturity

1- =

value
-
$ 2,000 $ 37.50 =$ +

2,037.50
~
Step 2 Compute the number of days in the discount period from the discount date to the due date
-
-

-
Step 3 Compute the discount
-

amount
•
Maturity Value Discount Rate Discount Period Discount
_ =

Amount
-
Step 4 Compute the
-

proceeds
r
Maturity Value Discount Amount
-
=

Proceeds

If proceeds from discounting a note are less than the principal value of the note: difference
represents
interest
expense

NOTE DISHONORED
-
Maker of a note does not pay or renew it at
maturity
Note is
: dishonored
Market is still
liable
-
Note loses its legal status as a note
receivable
-
Payee transfers amount due from Notes Receivable to Accounts
Receivable
i Putter dishonors the$ 2,000, %7.5 , 90
day note
Interest, although not paid by maker, is recognized as earned
: by payee
Entire maturity value is devoted to Accounts Receivable in
following entry:

/
If Putter’s note has been discounted at the bank and then was dishonored, the bank will
require the PAYEE
( Linesch) to
pay:
-

$ 2,000
principal
-

$ 37.50 interest
.

.
$ 25 bank
fee
/
Linesch pays the bank, but will try to recover the amount from Putter: journal entry
as follows

COLLECTION OF A DISHONORED NOTE

-
In October 16, Linesch collects from Putter after note has been discounted and
dishonored
•
Putter pays the original maturity value, Bank fee, and additional interest% at 7.4 for the period
since
 dishonoring the note( 40 )
days
Original principal
.

+ Original Interest Bank=$fee

+

2062.50
$ 2062.50✗ 7.5
•
1.x I40 360
=$
17.19
$ 2,052.50
-

-1$ 17.19
=$ 2,079.69

NOTES RECEIVABLE REGISTER

ACCRUED INTEREST RECEIVABLE

<
Revenue should be recognized when it is
earned
Impractical for interest because it is earned day by day
-

-
Note is received and due within a single
accounting period
Interest recorded When note is
-

due
/ Note is received in one period and due in the next
Accrued interest recorded at the end of

:
period

LO4. ACCOUNT FOR NOTES PAYABLE TRANSACTIONS AND

ACCRUED INTEREST
NOTES PAYABLE TRANSACTION TYPES
Note issued to a supplier in exchange for assets
purchased
/
Note issued to a supplier to extend Time for payment of an
account
Note issued as security for cash loan
i Note paid at
maturity
-
Note renewed at v v
maturity

j
 NOTE ISSUED AS SECURITY FOR CASH LOAN
I
Interest bearing
notes
The face value of the note is received in cash
-

-
The maker pays face value plus interest at
maturity
-

Non interest bearing

notes
-

Interest is deducted in advance, which is called

discounting
-
Face value minus interest( the bank account
) is received in cash
-
The maker pays face value at
maturity

>

$ 70 debit to discount on notes payable is an offset to$the 6,000 note

payable
-
Linesch’s liability at this time is only
$ 5,930, which is the proceeds received
from the bank
/
Discount on Notes Payable is a contra liability account
-
Reported as deduction from Notes Payable on the
balance sheet

STATED VS. EFFECTIVE INTEREST RATE

1
Stated rate of interest on interest bearing and discounted notes may be
the same
But real interest rates on the two notes are not the
I

same
-
Interest bearing notes: Linesch obtained
$ 6,000 for 60 days at a cost
$ of 70, exactly
% 7
.
$70 :-& 6,000=1.167-1 for 60 .

days
-
1.167 -1
.
✗
for 360
6 (360--60)=71 .

days
.
Discounted note: Linesch paid
$ 70 for the$ use 5,930 for 60 days: a rate %
of nearly 7.1
/
This Rate is known as the effective rate of
interest
.
$70 :-& 5.930=1.181 for 60 .

days
.
1.18% 6 (360--60)=7.0831 for 360
✗ .

days
 NOTES PAYABLE TRANSACTION TYPES
Note issued to a supplier in exchange for assets
: purchased
Note issued to a supplier to extend Time for payment of an
account
Note issued as security for cash loan
i Note paid at
maturity
\
Note renewed at
maturity ✓

i
s Notes payable
register

ACCRUED INTEREST PAYABLE: INTEREST BEARING

NOTE
-

Issued a$ 900, 60 day,

-1 8 note on
.

may 31
I
Adjusting entry needed on June 30 to record the interest
accrued
-

$900 ✗ 81.
30/360
✗ $6.00 interest
=

ACCRUED INTEREST PAYABLE: NON INTEREST

BEARING NOTE
-

$ 900,60 day, non interest bearing note, discounted at the

bank at 8
.
Original entry to record note debuted Discount on Note $
Payable for 12
- Accrued interest at June 30 is now
$
6.00
\
Part of the discount has turned into
expense