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Kabankalan Catholic College College Department Kabankalan City, Negros Occidental – 6111 – Philippines Tel. No. 4712-479 – Telefax No. 4712-462 COMPLETING THE CYCLE OF MERCHANDISING BUSINESS In the periodic inventory system, purchases of merchandise are accumulated in the purchases account. During the accounting period, no entry is made to the merchandise inventory account such that its balance at the end of the period, before adjusting and closing entries, is the same as the beginning inventory. With no perpetual record of the cost of sales during the period, the only way to obtain the cost of the ending inventory is to make a physical count. It should be noted that the ending inventory amount is needed in the computation of the cost of sales. The steps involved in the physical count follows: a. All merchandise owned by the entity is counted. b. The quantity counted is multiplied by the cost per unit for each inventory item. c. The cost of various items are needed to determine the total cost of inventory. A reliable physical count is very significant because ending inventory amount affects both the income statement and the balance sheet. For example, an understatement of ending inventory in the 2019 income statement will cause an overstatement of cost of sales. In effect, gross profit and profit will be understated. The understatement of ending inventory in the current period means that the beginning inventory of the next period will also be understated. As a result of this error or omission, the current assets and the owner’s equity in the 2019 balance sheet would be understated. In summary, an error in valuing ending inventory will translate into one inaccurate balance sheet and two income statements. MERCHANDISE INVENTORY AT THE END OF THE PERIOD At the end of the period, entries are made to reflect in the inventory account the ending balance. The objectives of these entries are as follows: a. To remove the beginning balance from the merchandise inventory account and to transfer it to income summary; b. To enter the ending balance in the merchandise inventory account and to establish it in the income summary. Illustration: Merchandise Inventory

Jan. 1

Beginning Balance

528,00 0

Dec. 31

Effect B (Ending Balance)

483,00 0

Effect A

Income Summary 528,00 0 Dec. 31

Dec. 31

Dec. 31

Effect A (Beginning Balance)

528,00 0

Effect B

483,00 0

1

THIS MODULE IS A PROPERTY OF KABANKALAN CATHOLIC COLLEGE-COLLEGE DEPARTMENT. UNAUTHORIZED DISTRIBUTION AND REPRODUCTION OF THIS MATERIAL IS STRICTLY PROHIBITED.

Kabankalan Catholic College College Department Kabankalan City, Negros Occidental – 6111 – Philippines Tel. No. 4712-479 – Telefax No. 4712-462

In this example, merchandise inventory was Ᵽ528,000 at the beginning of the year and Ᵽ483,000 at the end year. Effect A removed the Ᵽ528,000 from the merchandise inventory account and transferred it to income summary. In income summary, the Ᵽ528,000 is in effect added to net cost of purchases because, like expenses, the balance of the purchases account is debited to income summary by a closing entry. Effect B established the ending balance of merchandise inventory of Ᵽ483,000 and entered it as a credit in the income summary account. The credit entry in income summary has the effect of deducting the ending inventory from goods available for sale because both purchases and beginning inventory are entered on the debit side. To summarize, beginning merchandise inventory and purchases are debits to income summary; while ending merchandise inventory is a credit to income summary. THE ADJSUTING ENTRY METHOD Using the adjusting entry method, the two entries indicated by effects A and B which are prepared at the time the other adjusting entries are made follow: Dec. 31

Income Summary Merchandise inventory, Beginning To remove beginning balance of merchandise inventory and transfer it to income summary.

528,000 528,000

Dec. 31

Merchandise inventory, End Income Summary To establish ending balance of merchandise inventory and deduct it from goods available for sale in income summary.

483,000 483,000

THE CLOSING ENTRY METHOD The closing entry method makes the debit and the credit to merchandise inventory by including them among the closing entries as follows: Dec. 31

Dec. 31

Income Summary Merchandise Inventory, Beginning Temporary Accounts with Debit Balances To close temporary accounts with debit balances and to remove beginning inventory

xxx

Merchandise Inventory, End Temporary Accounts with Credit Balances Income Summary To close temporary accounts with credit balances and to establish ending inventory.

483,000 xxx

528,000 xxx

xxx

Notice that in both methods, merchandise inventory is credited for the beginning balance and debited for the ending balance and that the opposite entries are made to income summary. 2 THIS MODULE IS A PROPERTY OF KABANKALAN CATHOLIC COLLEGE-COLLEGE DEPARTMENT.

UNAUTHORIZED DISTRIBUTION AND REPRODUCTION OF THIS MATERIAL IS STRICTLY PROHIBITED.

Kabankalan Catholic College College Department Kabankalan City, Negros Occidental – 6111 – Philippines Tel. No. 4712-479 – Telefax No. 4712-462

PREPARING THE WORKSHEET The worksheet of a merchandising business is the same as that of a service business except that it has to deal with the new accounts related to merchandising transactions. These accounts include sales, sales returns and allowances, sales discounts, purchases, purchases returns and allowances, purchase discounts, transportation in, merchandise inventory and transportation out. Trial Balance Column – the first step in the preparation of the worksheet is to enter the balances from the ledger accounts into the trial balance columns. Adjustment Columns – under the closing entry method of handling merchandise inventory, the adjusting entries are entered in the adjustments columns in the same way that they were for service entries. No adjusting entry is made for merchandise inventory because the closing entry method was used. After the adjusting entries are entered in the worksheet, the trial balance columns and adjustment columns are totaled to prove the equality of the debits and credits. Omission of Adjusted Trial Balance Columns – these two columns are used when there are many adjusting entries to be considered. When only a few adjusting entries are required, as in this case, these columns are not necessary and may be omitted. Income Statement and Balance Sheet Columns – after the trial balance columns have been totaled, the adjustments entered, and the equality of the columns proved, the balances are extended to the statement columns. Each account balance is entered in the proper column of the income statement or balance sheet. PREPARING FINANCIAL STATEMENTS Income Statement The statement may be prepared by referring to the income statement columns of the worksheet. An enterprise should present an analysis of expense using a classification based on either the nature of expenses or their function within the entity, whichever provides information that is reliable and more relevant. Entities are encouraged to present the analysis of expenses on the face of the income statement. Nature of Expense Method Expenses are aggregated or combined in the income statement according to their nature and are not reallocated among various functions within the entity. This method is simple to apply in many smaller enterprises because no allocation of operating expenses between functional classifications is necessary. Function of Expense Method This method, also referred to as the “cost of sales” method, classifies expenses according to their function as part of cost of sales, distribution or selling, administrative, and other operating activities. This presentation often provides information that is more relevant to users than the nature of expense method but the allocation of costs to functions can be arbitrary and involves considerable judgment. This method provides multiple classifications and intermediate differences to highlight significant relationships.

3 THIS MODULE IS A PROPERTY OF KABANKALAN CATHOLIC COLLEGE-COLLEGE DEPARTMENT.

UNAUTHORIZED DISTRIBUTION AND REPRODUCTION OF THIS MATERIAL IS STRICTLY PROHIBITED....