{"id":1694,"date":"2015-07-16T01:14:53","date_gmt":"2015-07-16T01:14:53","guid":{"rendered":"https:\/\/courses.candelalearning.com\/finaccountingxmaster\/?post_type=chapter&p=1694"},"modified":"2017-08-22T19:46:50","modified_gmt":"2017-08-22T19:46:50","slug":"adjusting-entries-for-a-merchandising-company","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/clinton-finaccounting\/chapter\/adjusting-entries-for-a-merchandising-company\/","title":{"raw":"Adjusting Entries for a Merchandising Company","rendered":"Adjusting Entries for a Merchandising Company"},"content":{"raw":"Remember this?\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Accounting Cycle\u00a0\u00a0<\/strong><\/td>\r\n<\/tr>\r\n
1.\u00a0 Analyze Transactions<\/td>\r\n5.\u00a0 Prepare Adjusting Journal Entries<\/td>\r\n9.\u00a0 Prepare Closing Entries<\/td>\r\n<\/tr>\r\n
2.\u00a0 Prepare Journal Entries<\/td>\r\n6.\u00a0 Post Adjusting Journal Entries<\/td>\r\n10.\u00a0 Post Closing Entries<\/td>\r\n<\/tr>\r\n
3.\u00a0 Post journal Entries<\/td>\r\n7.\u00a0 Prepare Adjusted Trial Balance<\/td>\r\n11. Prepare Post-Closing Trial Balance<\/td>\r\n<\/tr>\r\n
4.\u00a0 Prepare Unadjusted Trial Balance<\/td>\r\n8.\u00a0 Prepare Financial Statements<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nWe learned how the accounting cycle applies to a service company but guess what?\u00a0 The same accounting cycle applies to any business.\u00a0 We spent the last section discussing the journal entries for sales and purchase transactions.\u00a0 Now we will look how the remaining steps are used in a merchandising company.\u00a0 Those wonderful adjusting entries we learned in previous sections still apply.\r\n

Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded because it is either more convenient to wait until the end of the period to record the activity, or because no source document concerning that activity has yet come to the accountant\u2019s attention.\u00a0 Additionally, periodic reporting and the matching principle necessitate the preparation of adjusting entries. <\/i>Remember, the matching principle indicates that expenses have to be matched with revenues as long as it is reasonable to do so. \u00a0To follow this principle, adjusting entries are journal entries made at the end of an accounting period or at any time financial statements are to be prepared to bring about a proper matching<\/i> of revenues and expenses.<\/p>\r\n

Each adjusting entry has a dual purpose: (1) to make the income statement report the proper revenue or expense and (2) to make the balance sheet report the proper asset or liability. Thus, every adjusting entry affects at least one income statement account and one balance sheet account<\/strong>.\u00a0 Adjusting entries fall into two broad classes:\u00a0accrued (meaning to grow or accumulate) items and deferred (meaning to postpone or delay) items.\u00a0 The entries can be further divided into accrued revenue, accrued expenses, unearned revenue and prepaid expenses.<\/p>\r\n

For a merchandising company, Merchandise Inventory falls under the prepaid expense category since we purchase inventory in advance of using (selling) it.\u00a0 We record it as an asset (merchandise inventory) and record an expense (cost of goods sold) as it is used.\u00a0 The adjusting journal entry we do depends on the inventory method BUT each begins with a physical inventory.<\/p>\r\n

A physical inventory is typically taken once a year and means the actual amount of inventory items is counted by hand.\u00a0 The physical inventory is used to calculate the amount of the adjustment.<\/p>\r\n\r\n

Perpetual Inventory Method<\/h3>\r\nUnder the perpetual inventory method, we compare the physical inventory count value to the unadjusted trial balance amount for inventory.\u00a0 If there is a difference (there almost always is for a variety of reasons including theft, damage, waste, or error), an adjusting entry must be made.\u00a0 If the physical inventory is less than the unadjusted trial balance inventory amount, we call this an inventory shortage<\/strong>.\u00a0 This is the most common reason for an adjusting journal entry.\r\n\r\nhttps:\/\/youtu.be\/YVVFrXptzTw\r\n\r\nThe video showed an example of an inventory shortage.\u00a0 Let's look at another example.\u00a0 Our company has an unadjusted trial balance in inventory of $45,000 and $150,000 in cost of goods sold.\u00a0 The physical inventory count came to $43,000.\u00a0 We have a difference in inventory\u00a0of $2,000 ($45,000 unadjusted inventory - $43,000 physical count) that needs to be recorded.\u00a0 We want to reduce our inventory and increase our expense account Cost of Goods Sold.\u00a0 The journal entry would be:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Account<\/strong><\/td>\r\nDebit<\/strong><\/td>\r\nCredit<\/strong><\/td>\r\n<\/tr>\r\n
Cost of goods sold<\/td>\r\n\u00a02,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0 \u00a0 Merchandise Inventory<\/td>\r\n<\/td>\r\n2,000<\/td>\r\n<\/tr>\r\n
To adjust inventory to match the physical count.<\/em>\u00a0<\/em>\u00a0<\/em><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nWhen we post this adjusting journal entry, you can see the ending inventory balance matches the physical inventory count and cost of good sold has been increased.\r\n\r\n\r\n\r\n\r\n\r\n
Account: Merchandise Inventory\u00a0 <\/strong><\/td>\r\n\u00a0 Debit\u00a0 <\/strong><\/td>\r\n\u00a0Credit\u00a0 <\/strong><\/td>\r\n\u00a0 Balance\u00a0 <\/strong><\/td>\r\n<\/tr>\r\n
Unadjusted Balance<\/td>\r\n<\/td>\r\n<\/td>\r\n45,000<\/td>\r\n<\/tr>\r\n
Adjust for shortage<\/td>\r\n<\/td>\r\n2,000<\/td>\r\n43,000<\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n \r\n\r\n\r\n\r\n\r\n\r\n
Account: Cost of goods sold<\/strong><\/td>\r\nDebit<\/strong><\/td>\r\nCredit<\/strong><\/td>\r\nBalance<\/strong><\/td>\r\n<\/tr>\r\n
Unadjusted Balance<\/td>\r\n<\/td>\r\n<\/td>\r\n150,000<\/td>\r\n<\/tr>\r\n
Adjust for shortage<\/td>\r\n2,000<\/td>\r\n<\/td>\r\n152,000<\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nOn the rare occasion when the physical inventory count is more than the unadjusted inventory balance, we increase (debit)\u00a0inventory and decrease (credit) cost of goods sold for the difference.\r\n

Periodic Inventory Method<\/h3>\r\nUnder the periodic inventory method, we do not record any purchase or sales transactions directly into the inventory account.\u00a0 The unadjusted trial balance for inventory represents last period's ending balance and includes nothing from the current period.\u00a0 We have not record any cost of goods sold during the period either.\u00a0 We will use the physical inventory count as our ending inventory balance and use this to calculate the amount of the adjustment needed.\r\n\r\nhttps:\/\/youtu.be\/jgd0HuRHFoY\r\n\r\nTo determine the cost of goods sold, a company must know:<\/span>\r\n
    \r\n \t
  • Beginning inventory (cost of goods on hand at the beginning of the period).<\/span><\/li>\r\n \t
  • Net cost of purchases during the period (purchases + transportation in - purchase discounts - purchase returns and allowances)<\/span><\/li>\r\n \t
  • Ending inventory (cost of unsold goods at the end of the period).<\/span><\/li>\r\n<\/ul>\r\n

    To illustrate, Hanlon Food Store had the following unadjusted trial balance amounts:<\/p>\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    \u00a0Trial Balance Accounts<\/strong><\/td>\r\nDebit<\/strong><\/td>\r\nCredit<\/strong><\/td>\r\n<\/tr>\r\n
    Merchandise Inventory<\/td>\r\n24,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    Purchases<\/td>\r\n167,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    Purchase discounts<\/td>\r\n<\/td>\r\n3,000<\/td>\r\n<\/tr>\r\n
    Purchase returns and allowances<\/td>\r\n<\/td>\r\n8,000<\/td>\r\n<\/tr>\r\n
    Transportation In<\/td>\r\n10,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n

    The unadjusted trial balance amount for inventory represents the ending inventory from last period. In our first adjusting entry, we will close the purchase related accounts into inventory to reflect the inventory transactions for this period.\u00a0 Remember, to close means to make the balance zero and we do this by entering an entry opposite from the balance in the trial balance.<\/em><\/p>\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    Account<\/strong><\/td>\r\n\u00a0 Debit\u00a0 <\/strong><\/td>\r\n\u00a0Credit\u00a0 <\/strong><\/td>\r\n<\/tr>\r\n
    Merchandise Inventory<\/td>\r\n166,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    Purchase discounts<\/td>\r\n3,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    Purchase returns and allowances<\/td>\r\n8,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    \u00a0 \u00a0 Purchases<\/td>\r\n<\/td>\r\n167,000<\/td>\r\n<\/tr>\r\n
    \u00a0 \u00a0 Transportation In<\/td>\r\n<\/td>\r\n10,000<\/td>\r\n<\/tr>\r\n
    To close net purchases into inventory.<\/em>\u00a0<\/em>\u00a0<\/em><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n

    Next we can look at recording cost of goods sold.\u00a0 The beginning inventory is the unadjusted trial balance amount of $24,000.\u00a0 The net cost of purchases for the year\u00a0is $ 166,000 (calculated as Purchases $167,000 + Transportation In $10,000 - Purchase discounts $3,000 - Purchase returns and allowances $8,000).\u00a0\u00a0On\u00a0December 31, the physical count of merchandise inventory was $ 31,000, meaning that this amount was left unsold. We calculate cost of goods sold as follows:<\/p>\r\n

    Beg. Inventory $24,000 + Net Purchases $166,000 - Ending inventory count $31,000 = $159,000 cost of goods sold<\/p>\r\n

    The second adjusting journal\u00a0would increase (debit) cost of goods sold and decrease (credit)\u00a0inventory for the calculated amount of cost of goods sold and would look like:<\/p>\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    Account<\/strong><\/td>\r\nDebit<\/strong><\/td>\r\nCredit<\/strong><\/td>\r\n<\/tr>\r\n
    Cost of goods sold<\/td>\r\n\u00a0159,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    \u00a0 \u00a0 Merchandise Inventory<\/td>\r\n<\/td>\r\n\u00a0 159,000<\/td>\r\n<\/tr>\r\n
    To record cost of goods sold for the period.<\/em>\u00a0<\/em>\u00a0<\/em><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n

    Next we would post these adjusting journal entries.\u00a0 We will look at the\u00a0how the merchandise inventory account changes based on these transactions.\u00a0 The physical inventory count of $31,000 should match the\u00a0reported ending inventory balance.\u00a0<\/span><\/p>\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    Account: Merchandise Inventory<\/strong><\/td>\r\nDebit<\/strong><\/td>\r\nCredit<\/strong><\/td>\r\nBalance<\/strong><\/td>\r\n<\/tr>\r\n
    Unadjusted Balance<\/td>\r\n<\/td>\r\n<\/td>\r\n24,000<\/td>\r\n<\/tr>\r\n
    (1) Close net purchases<\/td>\r\n166,000<\/td>\r\n<\/td>\r\n190,000<\/td>\r\n<\/tr>\r\n
    (2) \u00a0 Record cost of goods sold<\/td>\r\n<\/td>\r\n159,000<\/td>\r\n31,000<\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNotice how the ending inventory balance equals physical inventory of $31,000 (unadjusted balance $24,000 + net purchases $166,000 - cost of goods sold $159,000).\r\n

    Summary<\/h3>\r\nThe perpetual inventory method has ONE additional adjusting entry at the end of the period.\u00a0 This entry compares the physical count of inventory to the inventory balance on the unadjusted trial balance and adjusts for any difference.\u00a0 The difference is recorded into cost of goods sold and inventory.\r\n\r\nThe periodic inventory methods has TWO additional adjusting entries at the end of the period.\u00a0 The first entry closes the purchase accounts (purchases, transportation in, purchase discounts, and purchase returns and allowances) into inventory by increasing inventory.\u00a0 The second entry records cost of goods sold for the period calculated as beginning inventory (unadjusted trial balance amount)\u00a0+ net purchases - ending inventory (physical inventory account) from the inventory account.\r\n\r\n ","rendered":"

    Remember this?<\/p>\n\n\n\n\n\n\n\n
    Accounting Cycle\u00a0\u00a0<\/strong><\/td>\n<\/tr>\n
    1.\u00a0 Analyze Transactions<\/td>\n5.\u00a0 Prepare Adjusting Journal Entries<\/td>\n9.\u00a0 Prepare Closing Entries<\/td>\n<\/tr>\n
    2.\u00a0 Prepare Journal Entries<\/td>\n6.\u00a0 Post Adjusting Journal Entries<\/td>\n10.\u00a0 Post Closing Entries<\/td>\n<\/tr>\n
    3.\u00a0 Post journal Entries<\/td>\n7.\u00a0 Prepare Adjusted Trial Balance<\/td>\n11. Prepare Post-Closing Trial Balance<\/td>\n<\/tr>\n
    4.\u00a0 Prepare Unadjusted Trial Balance<\/td>\n8.\u00a0 Prepare Financial Statements<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    We learned how the accounting cycle applies to a service company but guess what?\u00a0 The same accounting cycle applies to any business.\u00a0 We spent the last section discussing the journal entries for sales and purchase transactions.\u00a0 Now we will look how the remaining steps are used in a merchandising company.\u00a0 Those wonderful adjusting entries we learned in previous sections still apply.<\/p>\n

    Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded because it is either more convenient to wait until the end of the period to record the activity, or because no source document concerning that activity has yet come to the accountant\u2019s attention.\u00a0 Additionally, periodic reporting and the matching principle necessitate the preparation of adjusting entries. <\/i>Remember, the matching principle indicates that expenses have to be matched with revenues as long as it is reasonable to do so. \u00a0To follow this principle, adjusting entries are journal entries made at the end of an accounting period or at any time financial statements are to be prepared to bring about a proper matching<\/i> of revenues and expenses.<\/p>\n

    Each adjusting entry has a dual purpose: (1) to make the income statement report the proper revenue or expense and (2) to make the balance sheet report the proper asset or liability. Thus, every adjusting entry affects at least one income statement account and one balance sheet account<\/strong>.\u00a0 Adjusting entries fall into two broad classes:\u00a0accrued (meaning to grow or accumulate) items and deferred (meaning to postpone or delay) items.\u00a0 The entries can be further divided into accrued revenue, accrued expenses, unearned revenue and prepaid expenses.<\/p>\n

    For a merchandising company, Merchandise Inventory falls under the prepaid expense category since we purchase inventory in advance of using (selling) it.\u00a0 We record it as an asset (merchandise inventory) and record an expense (cost of goods sold) as it is used.\u00a0 The adjusting journal entry we do depends on the inventory method BUT each begins with a physical inventory.<\/p>\n

    A physical inventory is typically taken once a year and means the actual amount of inventory items is counted by hand.\u00a0 The physical inventory is used to calculate the amount of the adjustment.<\/p>\n

    Perpetual Inventory Method<\/h3>\n

    Under the perpetual inventory method, we compare the physical inventory count value to the unadjusted trial balance amount for inventory.\u00a0 If there is a difference (there almost always is for a variety of reasons including theft, damage, waste, or error), an adjusting entry must be made.\u00a0 If the physical inventory is less than the unadjusted trial balance inventory amount, we call this an inventory shortage<\/strong>.\u00a0 This is the most common reason for an adjusting journal entry.<\/p>\n