This is Part 4 in our Merchandising Operations series and we'll be
discussing Adjusting and Closing entries for Merchandising Companies. So the first
thing we'll look at is adjusting the accounts. Specifically we're going to
talk about adjusting inventory. So there's a couple of reasons we may need
to adjust inventory. The first one is due to shrinkage. Now recall is talking about
periodic and perpetual inventory. So no matter which method you use, even if
you're using a perpetual method, you're still going to want to take a periodic
inventory count. And when you do that you may find that your physical count does
not equal the count that's currently on your books, and this can be due to
shrinkage. Things can walk out the store due to your employees stealing from you
or customers stealing from you. Also, there could be error, or there could be
damaged goods. So there are several things that can cause shrinkage.
We have to adjust our inventory to account for this because we no longer have that
inventory on hand, however, we did pay for that inventory. So if it disappears, or
walks out the door, we need to expense it. So if we count our inventory, and it's
different from what's on the books, we will need to increase our cost of goods
sold and decrease our inventory by the difference.
Let's look at closing. Now this should be kind of a review for you, but in addition
to what we already know, we're going to be including those contra- revenue
accounts that we talked about earlier in an earlier part to the series. So I
always close my entries, or put my closing entries in the same order every
time that way I don't get confused. So I always close my revenues first. And I
always use an income summary to close my revenues. So you close your revenues to
the income summary. Remember that revenues carry a credit balance. To get
rid of the credit balance you would debit your revenue account and you would
credit the income summary. That would be the closing entry for revenues. Expenses,
we've talked about before, but now we're adding those contra- revenues. Remember
expenses carry debit balances also our contra- revenue accounts carry debit
balances because they're contra- revenues. So we want to close all those
accounts with debit balances. Those will also close to income summary - so to
close a debit balance, we would credit expenses, and our contra- revenues and
when we we would debit the income summary.
Once we've closed our revenues and expenses we do not want to keep an
income summary. You want to close that account out. Remember the income summary
is a temporary account, and it's only used during the closing process. So once
we've closed revenue expenses to the income summary, we will get our balance
in the income summary. And remember if we have a credit balance in the income
summary, that's net income because revenues exceed expenses and the contra-
revenues. If we have a debit balance in our income summary, that would indicate
we have a net loss. So once we close the income summary, we will close our
dividends to retained earnings. Remember dividends is not an expense account, it
just reduces your retained earnings.
So there's an illustration of the income summary T-Account.
So notice we closed our revenues , closed our expenses, closed our contra-revenues
to the income summary. And remember if you have a credit balance in the income
summary, its net income. If you have a debit balance, it's net loss. You will not
have a debit and a credit balance don't get confused by the T-Account that I
have here. You will have one or the other balances here. You'll have a net income
balance, a credit, or a net loss balance, a debit. Let's look at an example.
Candy Creations' accounts at June 30th included these adjustments. They had
inventory of 5600, cost of goods sold $41,200, sales
revenue of $86, 900, sales discounts of $900,
and sales returns and allowances of $1400. The physical count of
inventory on hand added up to $5,400. This is the only
adjustment needed. So what we have here is on our books we show our inventory to
be 5600, but when we did a periodic count we only found 5400.
So we have shrinkage there, we need we need to take care of that. So we
have to come up with an entry to show this adjustment. Now remember we've paid
for that inventory, so we need to expense. It it's not there anymore, we can't sell
it. So we need to expense it. So to journalize the adjustment, we would
increase our cost of goods sold with a debit for the$200 and
decrease our inventory for the $200.
Now journalize the closing entries for the appropriate accounts. So again the
first accounts we closed are the sales revenue accounts. Sales revenue was
$86,900. Sales revenue carries a credit balance, so we
will debit sales revenue to get rid of it, and we close it to the income summary
with a credit of $86,900. Next we want to close our
expenses, and our contra-revenues. We had one expense, it was cost of goods
sold, and we had two contra- revenues. We had sales discounts and sales returns
and allowances. So those all carry debit balances. To get rid of them we would
credit those accounts. We're closing them to the income summary. So we have to
debit the income summary for the total. The total of cost of goods sold and our
to contra- revenues was $43,700. Now we
need to close our income summary to retain earnings. Well we can look at our
numbers here, and I can see that even without a T-Account, that my income
summary has a credit balance of $86,900 and a debit
balance of $43,700. So I know that I'm gonna have a
net income because my credits outweigh my debits. So it's going to carry a
credit balance. So to get rid of that credit balance in the income summary, I'm
going to need to debit the income summary for that balance, which as we can
see here, the income summary has a credit balance of $43,200.
To get rid of that, I need to debit the income summary for
$43,200, and I will credit retained earnings for
$43,200.
Now I will point out that you need to take special note to cost of goods sold
here. They tell me in the problem that cost of goods sold is $41,200,
but here I'm closing cost of goods sold of $41,400.
Remember the first entry we made was a shrinkage
adjustment. We had to expense $200 of inventory that had disappeared, so that
brought my balance of cost of goods sold to $41,400.
Now let's compute Candy Creations gross profit. So recall your
gross profit income statement. We start with our sales revenue of $86,900,
then we need to subtract our contra- revenues to
get our net sales. So here we'll have net sales of $84,600,
then we subtract out the balance in our cost of goods sold
account, which was $41,400. Don't forget about
the shrinkage adjustment, and that will give us gross profit of $43,200.