CHAPTER 7 COMPLETION OF THE ACCOUNTING CYCLE FOR A MERCHANDISING BUSINESS After studying this chapter, you should be able to: & . Know the methods of ‘accounting for uncollectible receivables Learn the additional adjusting entries prepared for merchandising business. 3. Determine the number of days past due for uncollectible receivables 4. Prepare financial statements for merchandising companies. 5. Complete the accounting cycle for a merchandising firm. The Accounting Cycle The accounting cycle discussed in the service type of business is also applied to the other types of business like the merchandising and manufacturing businesses. To be able to complete the cycle for the merchandising business, two other adjustments will be discussed, these are adjusting entry for Merchandise Inventory and adjustment to take up provision for uncollectible accounts or bad debts. A more thorough discussion for uncollectible accounts is made in this chapter Merchandise Inventory Most businesses rely on the actual count of goods on hand at the end of an accounting period to determine ending inventory and, indirectly, the cost of goods sold. The procedure for determining the merchandise inventory under the periodic inventory method can be summarized as follows: 1... Make a physical count of merchandise on hand at the end of the accounting period. 2. Multiply the quantity of each type of merchandise by its unit cost. 3. Add the resulting costs of each type of merchandise to obtain a total. This amount is the ending merchandise inventory. 259 Scanned with CamScanneree reread Ses cou a met f A ods sold. The ending inve; of ending ermine cost of go D i tory of i tong ventory of te Det accountng Period. Entiest goods ais the been counting period to remove the balance of the Dbeginn:, 3 cone periine end often balance of the ending inventory of the current. Petiog, made at the @ 1. ni by the following two adjusting entries: ap! i Saas ye [ xe [-— Le handle Tnventory = i To close the beginning inventory. [Merchandise Inventory = aE Income Summar = ra ending inventory. ACCOUNTING FOR, UNCOLLECTIBLE ACCOUNTS When a company sells merchandise and services on account, a portion of the claims against customers ordinarily Proves to be uncollectible, This is usually the case regardless of care used in granting credit and the efficiency of the collection procedures employed, Uncollectible Accounts expense, _ doubtful accounts expense, or bad debts expense is an operating expense incurred of failure to collect receivables, because There are several reasons why an account or a Note becomes uncollectible, like bankruptcy of the debtor, discontinuance of the debtor’s business, disappearance of the debtor, failure of repeated attempts to collect and the barring collection by the Statute of worthlessness of the Teceivables, There are two generally accepted methods of accounting for receivable thought to be uncollectible: (1) the direct write-off method, and (2) the allowance or reserve method. Both conform to acceptable accounting practice, when used in 260 Scanned with CamScannerThe Direct Write-Off Method its eae write-off method is used by small businesses who sell most of relation to its total evict ° cash basis. The amount of its receivable is small in collection procedures are aderna ‘He ©Tedit period is short, and the credit and minor in relation to its re fama Hence, the loss from uncollectible account is In such situations, it is sati : lectible aecount until satisfactory to defer recognition of loss from om me CO ven vinePetiod in which a receivable is actually written " ‘ an account bel lectil ‘under the direct write-off method is illustrated below, Ys “© B® Uncolietibie Uncollectible Account Expense 1,500 Accounts Receivable (Oscar Bueno) 1,500 The uncollectible account is the re: ibilit i i ae ‘sponsibility of the credit and collection department within the general administrative cea Thus, uncollectible account expense is usually reported in the income statement as a general or administrative expense. Sometimes, accounts that have been written-off are collected later. If the recovery is in the same fiscal year as the write-off, the earlier entry is reversed to reinstate the account. The receipt of cash and the credit to the receivable account are then recorded in the usual manner, To illustrate, assume that the aecount of O. Bueno, that was written-off above is collected in the same fiscal year. The entries to reinstate that account and to record the collection are as follows: Accounts Receivable (Oscar Bueno) 1,500 Uncollectible Account Expense 1,500 To reinstate account written- off during the year. Cash 1,500 Accounts Receivable ( OscarBueno) 1,500 To record the collection from O. Bueno These two entries can be combined into a single entry debiting Cash and crediting Uncollectible Account Expense. However, it is preferable to record the recovery in the customer’s account so that the information will be available for eredit purposes in the future: 261 Scanned with CamScanneritten-off in prior year ig collecteg in Fre Other f Wy be reinstate “Recovery of Uncollectible Accoung, such as the end of th, units account weeyear, it MAY t at © Year ig - account ° credit balanee in such suction from Uncollectible Acco ee and have little effect on it it Jed account, tare he ent as a dedus fi ror te income re likely to be relatively minor Suck amounts are = . owance or Reserve Metho The A. cee direct write-off method is simple and convenient, thig =i Pern the matching of current es With relnen meth, does not La receivables at theit net Tealizable Value. The aj Uowaner ee : ane debts adheres to these Principles by rowan me adr Sle alice ti te acae id uncollectible. The allowance ie doubtful acco alo eda izable value, . receivable to its net real : The estimated ex] fiom UNcollectible ac, unts is Tecorded ag an adjusting entry at the end of an accounting Period ag follows: Doubtful Accounts Expense AX Wowance for Done, Accounts XK To take 4“? provision for uncollectible Acounts, The Allowan, for Dow ‘isa tra asset acco) that is deducted from the b:; ‘ance of the accounts Teceivable at the end of the periog, Teduction annot be all, the individual accounts in the subsidiary Jedger and; therefore, should be to the “ontrolling @ecount in the general I When the alloy ‘Count inclu Provision for do unts and Rotes, the allowance is di rom the to Notes Receivab} counts ivable, 269 r Scanned with CamScanne!Writing-off Uncollectible CeO er the Allowanc '8-off Uncollectible A, unt Under the Al ce tf lo Method When positive evi evidence is avail worthlessness of an account, the <°, ee Sonceming the partial or complete account is written off as follows: Allowance for Doi ub tpl A Axx Accounts Receivable ae To write-off’ uncollectible account. Ne account ame ae allowance method, the debit is to a contra asset is already recorded by nore, 8COUnt. The reason is that, bad debts expense The expense was, thst, adjusting entry when the allowance was established. necessarily in the period ieetn in the period when the sale was made, not direct write-off method. en the account becomes uncollectible, as with the When an account that has been charged to the allowance account is subsequently collected, the account should saad to, foo anentry that is just the reverse of the write-off entry. As was pointed out earlier, the purpose of the reinstatement is to provide information that will be useful in re-establishing the customer’s credit. The following entries would be made at the time of collection. Accounts Receivable XX Allowance for Doubtful Accounts XX To reinstate account previously written-off. Cash XX Accounts Receivable xX To record the collection. Estimating Uncollectible Accounts Based on Trade Receivables Instead of using sales data, many businesses base their estimate on an analysis of trade receivable accounts at the end of the period. The estimate of _ uncollectible accounts at the end of an accounting period is based on past experience and forecasts of the future. Scanned with CamScannerbts may be based on the Accounts Receivable balancg is del The estimated bad j @ ingle rate is applied to outstanding accounts receivable og Panes f Accounts Reeeivable is made \ere econ i cas ed according to how long they remain Outstanding Thi ies Aging of Accounts Receivable, ig Percent of Accounts Receivable Method i i is multiplied by the total o 4 Under this method, a single rate is m t accounts Precuivabe and the product represents the estimated inca it balance of P 4,000 before adjustment, The company estimates that 50, fomomnie Accounts receivable will be uncollectible. The adjusting entry jg. Uncollectible Accounts Expense 5,000 Allowance > for Uncollectible Accounts 6, To record the estimated wncollectibte accounts, Computation: Required ending balance of allowance for uncollectible accounts at Dec, 31, (5% of P 200,000) P10,000 Less: credit balance of allowance before adjustment 4,000 Uncollectible Accounts Expense to be recorded P__6,000 4 i ents APES be town ste eons tt P 6000. Ri se tement amounted to ‘Owance for Bad bts of P 10,000 win Prese: i Balance Sheet as follows: a a Accounts Receivable P 200,000 Less: Allowance for Bad Debts 10,000 Net Realizable Value P190,000 If in the Preceding example, the Allowance for B; it balance before adjustment, the adjusting entry wea ey nla bie debit Uncollectibie Accounts Expens, re 1 Allowance fop Uncollectibje Accounts “~ 000 264 Scanned with CamScannerComputation: Required ending balance of Allowance for Uneollectible Accounts (5% x P 200,000 P 10,000 Add: debit balance of allowance before : , adjustment 4,000 Unicollectible accounts expense to be recorded P_ 14,000 Aging of Accounts Receivable Method The aging of accounts receivable is the process of listing each accounts receivable according to the due date of the account. An aging schedule is prepared by classifying each receivable by its due date. The number of days an account is past due is determined from the due date of the account to the date the aging schedule is prepared: To illustrate, assume that the Blue Ridge Company is preparing an aging schedule as of December 31, 2015. The accounts receivable for Aaron was due on July 20, 2015. As of December 31, 2015, Aaron’s account is 164 days past due, as shown below: Number of days due in July 11 days ‘Number of days past due in August 31 days Number of days past due in September 30 days ‘Number of days past due in October =| 31 days Number of days past due in November 30 days [Number of days past due in December 31 days Total number of days past due 164 days_| After the number of days past due has been determined for each account, ain aging schediile is prépated as show on the next page: ‘Account | Notyet | 1-30 | 31-60 | 61-90 | 91-180 Customer | Balance | __due da days days | __ days Aaron 'P40,000 P 40,000 Benitez | 60,000 |P 60,000 | _ [ Castro 20,000 P 20,000 David 50,000 P_ 50,000 | Elio 30,000 30,000 Total 200,000 | P 60,000 | P30,000_| P 20,000 | P_50,000 | P_40,000 265 Scanned with CamScanneree | columns to determine yy. the = ae by adding "class is multiplied by the mpleted Each age ; ing schedule is CONN class. d then the sum are addeq +, sree uch a est tage uneolectb aso ible account: get the total estima Estimated Uncollectible Accounts Percent _ Amount ___ Accom _.s G Balance. P 600 ! 1% 4 Age Interval P Or 3% 900 ‘ Not yet due 130 das past 26,000 5% 1,000 1 31-60 days past due 50000 8% 4,000 a1 rr 40,000 10% 4,000 181-365 days ralve f 165 days ps —_ Tas P 200,000 P 10,500 The total estimated uncollectible account amounting to P10,500, is the required or desired ending balance of the allowance account after adjustment. Blue Ridge Company’s computation of Bad Debts expense is as follows: Required ending balance of Allowance for Bad Debts (Pls. see computation above) P10, Less: Credit balance of Allowance before adjustment sont Bad Debts Expense to be recorded The adjusting entry to record the estimated uncollectible accounts is: Dec. 31 Bad Debts Expense 6,500 Allowance for bad debts” To take up provision for doubtful ee 01 i . ‘ounts, analysis and cms will be useful to mange the data developed ment for purposes of credit Scanned with CamScannerWork Sheet for a Merchandising Business . All the steps in the preparation of a work sheet in a service business taken up in Chapter 5, ate basically the same steps in a merchandising concem, Both the debit and credit amounts for the account Income Summary are extended to the Adjusted Trial Balance columns or if an cight-column work sheet is prepared, extension will, be directly to the Income Statement columns. Extending both amounts aids in the preparation of the income statement because the debit and credit adjustments representing beginning and ending inventories are reported as part of the cost of merchandise sold. The Purchases, Purchase Returns and Allowances, Purchase ‘Discounts, and Freight-in accounts are extended to the Income Statement columns of the work sheet since they will also become part of the computation of the cost of goods sold. After all adjusted balances of the items have been extended, then the net income or loss cah now be determi ‘ed in the same manner as in a service business. column work sheet of a merchandising business, An illustration of an 8 is presented on page 270. The Green Valley Merchandising, Scanned with CamScannerof Green Valley Merchandising on Decent, ‘al balance js the trit Presented below is a 531, 2015: Green Valley Merchandising Trial Balance December 31, 2015: Debit credit 39,000 Cash 56,250 ‘Accounts Receivable 90,000 Merchandise Inventory 4,850 Prepaid Insurance 2,125 Store Supplies 1,050 Office Supplies 66.000 Store Equipment i Accumulated Depreciation — Store Equipment 20,150 Office Equipment 25,000 ‘Accumulated Depreciation — Office Equipment 8,600 Accounts Payable 33,350 | Uneamed Rent 20,600 Notes Payable (due December 31, 2018) G. Ramos, Capital ; aM ae 20,000 sl Sales Returns and Allowances 457,500 Sales Discount 5,950 Purchases 3,550 Purchase Retums and Allowances 270,000 Purchase Discount 5,050 Transportation In 2.450 Sales Salaries Expense 3,100 : aes Expense 35,700 laneous Selling Expense 12,501 «Office Salaries Expene 200 Rent Expense 2 Miscellaneous Administra ren Interest Expense ive Expense 3,000 Total 825 5,800 £77,500 677,500 Scanned with CamScannerChapter 7= Completion of the A Cycle fur a Marchondtung i The data for year-end adjustments on December. 31, 2015, are as follows: a) Merchandise inventory on December 31 P 98,000 b) Unexpired insurance at the end of the year 2,150 ¢) Supplies on hand on December 31: Store Supplies 650 Office Supplies 375 d) Depreciation for the year: Store Equipment 3,750 Office Equipment 1,900 e) Salaries Payable on December 31: Sales Salaries 1,925 Office Salaries 575 f) Rent earned during the period 10,400 g) 10% of the outstanding Accounts receivable is doubtful of being collected. An eight-column work sheet prepared for The Green Valley Merchandising is presented on the next page. Scanned with CamScanner; Merchandising een valley. rk sheet per 31, 2015 awe Decem! orthe Year Ended . Balance Sheet lace} _Mauretis it it = Ga | alt Tebit_| Bradt 38,000 deco Te — —_ eS 5625, a, et — seo, oso ee 2 i rs iz He ss ay 5a 000 f a750 = i Fits @ 5000 ie = Ts 600, 300 Tess Fo Ht Si Sole |} = Tener Ret 7™s00 i eesti prent 08) 25) owe itd at ame Rao Drei 7.000 Fano 7 eae Soy <—] ato] sao tue ISDH aE ‘Soles Returns and Alowances, 5850 5.950 aa Dist 550 [st Pras 7000 7m000 Parctase Returns od slowances ‘S050 5050. feieiat 2450 l= 2450 Sete leo em a ee am WBS [3725 Tereciton bgerst- Sra Fa Ei) Ser Sige es al art Unssletie Arts Epes OA id Keele rn wi EB25 ia sae Ta FO Hest i : 5 000 | peesatin GpeHienas [ 2700 +2700 | Mesa tinbe ee = 2) 55 a ht a 825 5800 i)ia.400' ay NET ACONE a 3800 fa 481850 ees Tiss) —} o_| ares ae S1550 270 Scanned with CamScanner