Chapter 10 - Accounting of a Merchandising Business PDF

Fundamentals of Accounting, Business, and Management Chapter 10 Accounting Cycle of a Merchandising Business Chapter 10 Accounting Cycle of a Merchandising Business Introduction A merchandising business is one that buys and sells goods without changing...

Fundamentals of Accounting, Business, and Management Chapter 10 Accounting Cycle of a Merchandising Business Chapter 10 Accounting Cycle of a Merchandising Business Introduction A merchandising business is one that buys and sells goods without changing their physical form. Also, we will discuss some concepts that are applicable to a merchandising business but not to a service business Specific Objectives At the end of the lesson, the students should be able to: - Explain the inventory system of merchandising business. - Describe the nature of transactions in a merchandising business. - Record transactions of a merchandising business in the general and special journal INVENTORY The main difference between merchandising business and a service business is that a merchandising business necessarily holds inventory of physical goods for sale. Inventory refers to the goods that a merchandising business is purchased and primarily intended for resale, normally in their original form and without any further processing. Inventory System Inventories are accounted for using either of the following inventory system: 1. Perpetual inventory system 2. Periodic inventory system Perpetual Inventory System In layman’s term the word “perpetual” means continuing forever (or “tuloy tuloy” or “walang hanggan” in Filipino). The perpetual inventory system is called as such because under this system, the Inventory account (or Merchandise inventory account) is updated each time a purchase or sale is made. Thus, the Inventory account shows a continuing or running balance of the goods on hand. The perpetual inventory system is commonly used for inventories that are specifically identifiable and relatively high valued, such as cars, machineries, furniture and heavy equipment. Periodic Inventory System In layman’s term the word “periodic” means occurring or recurring at regular intervals (or “pana-panahon” in Filipino). The periodic inventory system is called as such because under this system the Inventory account (or Merchandise inventory account) is updated only when a physical count is performed. Thus, the amount of inventory and cost of goods sold are determined only periodically. The quantity counted is then multiplied by the unit cost to get the balance of the Inventory account. This amount is then used to compute for the Cost of goods sold which is the residual amount in the formula below. Beginning inventory Ᵽ xx Add: Net purchase xx__ Total Goods Available for Sale (xx) Less: Ending inventory (physical count) (xx)_ Cost of Goods Sold Ᵽxx__ Net purchases is computed as follows: Purchases Ᵽxx Add: Freight-in xx Less: Purchase returns (xx) Less: Purchase discounts (xx)__ Net purchases Pxx_ Ø Purchases – the account used to record purchases of inventory under the periodic system. Ø Freight – in (Transportation-in) – the account use to record the shipping costs incurred on purchases of inventory under the periodic system. Ø Purchase returns – the account used to record returns of purchased goods to the supplier. Ø Purchase discounts - the account used to record cash discounts availed on the purchased of goods. Example 1: At the start of the day, you have 1 apple. During the day you purchased 5 apples. If at the end of the day, you have 2 apples left, how many apples have you sold? Answer : 4 apples sold (1 +5 – 2 = 4) OR Beginning inventory (in units) 1 apple Add: Net purchases (in units) 5 apples_ Total goods available for sale (in units) 6 apples Less: Ending inventory (in units) (2 apples)_ Cost of goods sold (in units) 4 apple Example 2: At the start of the day, you have 1 apple costing Ᵽ10. During the day you purchased 5 apples for Ᵽ10 each. You returned 1 apple to the supplier because it was rotten. If at the end of the day, you have 2 apples left, how much is your cost of goods sold? Solutions: Beginning inventory (1 apple x Ᵽ10) Ᵽ10 Purchases (5 apples x Ᵽ10) P50 Freight-in - Purchase returns (1 apple x Ᵽ10) (10) Purchase discounts -___ Net purchases 40 Total goods available for sale 50 Ending inventory (2 apples x Ᵽ10) (20) Cost of goods sold Ᵽ30 Illustration: Perpetual vs. Periodic (Journal Entries) Perpetual system Periodic system 1. You purchased goods with Ᵽ10,000 on account. Inventory 10,000 Purchases 10,000 Accounts payable 10,000 Accounts payable 10,000 2. You paid shipping costs of Ᵽ1,000 on the purchase above. Inventory 1,000 Freight-in 1,000 Cash 1,000 Cash 1,000 3. You returned damaged goods worth Ᵽ2,000 to the supplier. Accounts payable 2,000 Accounts payable 2,000 Inventory 2,000 Purchase returns 2,000 4. You sold goods costing Ᵽ5,000 for Ᵽ20,000 on account. Accounts Accounts receivable 20,000 receivable 20,000 Sales 20,000 Sales 20,000 Cost of goods sold 5,000 No entry Inventory 5,000 5. A customer returned goods with sale price Ᵽ800 and cost of Ᵽ200. Sales returns 800 Sales return 800 Accounts receivable 800 Accounts receivable 800 Inventory 200 No entry Cost of goods sold 200 Under the perpetual inventory system, the balances of inventory on hand and cost of goods sold are readily determinable from the ledger. See T-accounts below:  Inventory beg, balance - (1) Purchases 10,000 2,000 (3) Purchase returns (2) Freight-in 1,000 5,000 (4) Costs of goods sold (5) Sales return 200 4,200 ending balance Cost of goods sold (4) Cost of goods sold 5,000 200 (5) Sales return 4,800 ending balance Gross Profit Gross profit (gross income, gross margin, or sales profit) is simply “Net sales minus Cost of goods Sold”. Net Sales Ᵽxx Less: Cost of Goods Sold (xx) Gross profit Ᵽxx Gross profit represents the profit a business earns after deducting the costs directly associated with making the product or providing a service but before deducting other expenses. Profit (or Net profit) is different from gross profit. Profit is the amount derived after deducting all expenses from the gross profit. This is illustrated below: Net sales Ᵽxx Gross profit = Net sales minus Cost of Goods Sold (xx) COGS Gross Profit xx Rent expense (xx) Depreciation expense (xx) Profit = Net sales minus Salaries expense, etc. (xx) all expenses Profit (Net Profit) Ᵽxx Net sales is Total sales minus Sales returns and discounts. This is shown in the formula below: Sales Ᵽxx Less: Sales returns (xx) Less: Sales discounts (xx) Net sales Ᵽxx Ø Sales – include both cash sales and credit sales Ø Sales returns - the account used to record goods returned by customers. Ø Sales discounts – the account used to record cash discounts given to customers.  Illustration 1: Perpetual inventory system The records of your business show the following information on December 31, 2019. Account titles Debit Credit Sales Ᵽ70,000 Sales discounts Ᵽ5,000 Sales returns 10,000 Cost of goods sold 30,000 Rent expense 5,000 Supplies expense 1,000 Depreciation expense 2,000 Salaries expense 7,000 Requirements : Prepare the income statement for the period. Solution: Your Business Income Statement For the period ended December 31, 2019 Sales Ᵽ70,000 Sales discounts (5,000) Sales returns (10,000) Net sales 55,000 Cost of goods sold (30,000) Gross profit 25,000 Rent expense (5,000) Supplies expense (1,000) Depreciation expense (2,000) Salaries expense (7,000) Profit Ᵽ10,000 Illustration 2 : Periodic inventory system You have a bar. At opening time, you have 50 bottles of a beverage with a unit cost of Ᵽ20 each. During business hours, you had your supplier deliver to you 10 cases of the beverage. Each case contains 24 bottles with a unit cost of Ᵽ20 each. At closing time, you have 2 cases and 4 bottles of the beverage left. Your sale price for each bottle beverage is Ᵽ70. Requirement: Prepare a “Statement of Goods Sold and Gross Profit”. Solution: The “Statement of Cost of Goods Sold and Gross Profit” is similar to the “Income Statement. However, the Statement of Cost of Goods Sold and Gross Profit ends with the gross profit, meaning it does not show information about the other expenses. Using our previous formula, let us compute for the cost of goods sold: In In units pesos (bottles) Beginning inventory (50bottles x Ᵽ20) 50 Ᵽ1,000 Add: Net (10 cases x 24 bottles x purchase Ᵽ20) 240 4,800 Total goods available for sale 290 5,800 (2 cases x 24 bottles) + (4 bottles) x Less: Ending inventory Ᵽ20 (52) (1,040) Cost of goods sold 238 Ᵽ4,760 Statement of Cost of Goods Sold and Gross Profit Your Bar Statement of Cost of goods sold and Gross profit For the period ended December 31, 2019 Sales Ᵽ16,660 Cost of goods sold: Beginning inventory Ᵽ1,000 Add: Net purchases 4,800 Total goods available for sale 5,800 Less: Ending inventory (1,040) (4,760) Gross profit Ᵽ11,900 T –ACCOUNTS ANALYSIS  Most accounting problems can be solved much easier using T-accounts analysis than formulas. In this section, we will solve for common accounting problems regarding inventory using T-accounts. The beg. Balance is placed on the Cost of goods sold is placed on the debit side because “Inventory” is an credit side because the goods sold asset, and assets have a nominal decrease the balance of inventory; debit balance. i.e., debit and credit means minus. Inventory beg. balance xx Net purchases xx xx Costs of goods sold xx ending balance The ending balance is placed Net purchases is placed on the on the credit side (opposite of debit side because purchases the beg. Balance) in order to increase the balance of inventory, facilitate the “squeezing” the i.e., debit and debit means add. amounts. The sum of the amounts on the debit side of the T-account must be equal to the sum of the amounts on the credit side. Case #1: Ending inventory Inventory, beg. Ᵽ40,000; Net purchases, Ᵽ180,000; Cost of goods sold, Ᵽ200,000. How much is the ending inventory? Solution: Step 1: Place the given information on the T-account. Inventory beg, balance 40,000 Net Purchases 180,000 200,000 Costs of goods sold ? ending balance \ Step 2: Squeeze for the missing amount.  Inventory beg, balance 40,000 Net Purchases 180,000 200,000 Costs of goods sold 20,000 ending balance 40,000 Debit + 180,000 Debit – 200,000 Credit = 20,000 Case #2: Cost of goods sold Inventory, beg. Ᵽ60,000; Net purchase, Ᵽ270,000; Inventory, end. Ᵽ90,000. How much is the cost of goods sold? Solution: Inventory beg, balance 60,000 Net Purchases 270,000 240,000 COGS (squeeze) 90,000 ending balance 60,000 Debit + 270,000 Debit – 90,000 Credit = 240,000 Case #3. Net purchases Inventory, beg. Ᵽ40,000; Cost of goods sold, Ᵽ200,000; Inventory, end. Ᵽ20,000. How much is the net purchases? Solution: Inventory beg, balance 40,000 Net Purchases (squeeze) 180,000 200,000 COGS 20,000 ending balance Case #4: Inventory, beg. Net purchases, Ᵽ270,000; Cost of goods sold, Ᵽ240,000; Inventory, end. Ᵽ90,000. How much is the beginning inventory? Solution: Inventory beg. (squeeze) 60,000 Net Purchases 270,000 240,000 COGS 90,000 ending balance Case #5: Total goods available for sale Net purchases, Ᵽ270,000; Cost of goods sold, Ᵽ240,000; Inventory, end. Ᵽ90,000. How much is the total goods available for sale? Solution:  Inventory beg. Balance irrelevant Net Purchases 270,000 240,000 COGS 90,000 ending balance Ᵽ240,000 COGS + Ᵽ90,000 Inventory, end. = Ᵽ330,000 TGAS The Accounting Cycle of a Merchandising Business Steps in the Accounting Cycle: 1. Identifying and analyzing 2. Journalizing 3. Posting 4. Unadjusted trial balance 5. Adjusting entries 6. Adjusted trial balance (and/or worksheet) 7. Financial statements 8. Closing entries 9. Post-closing trial balance 10. Reversing entries Illustration 1: PERPETUAL INVENTORY SYSTEM You opened a souvenir store called “BINI Souvenir” November 1, 2018. The following were transactions during the period: Nov. Transactions 1 Provided Ᵽ50,000 cash as initial investment to the business. 1 Acquired equipment for Ᵽ36,000 cash. The equipment has a useful life of 4 years. 1 Paid a one-year insurance premium of Ᵽ12,000. (Use asset method) 12 Purchased inventory costing Ᵽ15,000 for cash. 14 Sold goods for Ᵽ15,000 cash. The cost of sales is Ᵽ2,000. Dec. Transactions 1 Sold goods with sale price of Ᵽ12, 000 in exchange for a Ᵽ12,000, 10%, one-year note receivable. Principal and interest are due at maturity. The cost of sales is Ᵽ1,500. 5 Purchased inventory for Ᵽ2,000 on account. 26 Sold goods for Ᵽ17,000 on account. The cost of sales is Ᵽ3,000. 27 Paid Ᵽ1,000 account payable. 29 Collected Ᵽ10,000 account receivable. Requirement: Complete the accounting cycle Solutions:  Step 1& 2: Identifying and Journalizing The transactions are recorded in the journal as follows: November transactions: Date Account titles Debit Credit 2018 Nov. 1 Cash 50,000 Owner's equity 50,000 to record the owner's investment to the business 1 Equipment 36,000 Cash 36,000 to record the acquisition of equipment for cash 1 Prepaid insurance 12,000 Cash 12,000 to record the prepayment of insurance 12 Inventory 15,000 Cash 15,000 to record the acquisition of inventory for cash 14 Cash 15,000 Sales 15,000 to record cash sales Cost of goods sold 2,000 Inventory 2,000 to record the cost of inventory sold as expense December transaction  Date Account titles Debit Credit 2018 Dec. 1 Notes receivable 12,000 Sales 12,000 to record sale in exchange for note Cost of goods sold 1,500 Inventory 1,500 to record the cost of inventory sold as expense 5 Inventory 2,000 Accounts payable 2,000 to record the acquisition of inventory on account 26 Accounts receivable 17,000 Sales 17,000 to record on sale on account Cost of goods sold 3,000 Inventory 3,000 to record the cost of inventory sold as expense 27 Accounts payable 1,000 Cash 1,000 to record the payment of account payable 29 Cash 10,000 Accounts receivable 10,000 to record the collection of account receivable Step 3: Posting The journal entries are posted to the ledger as follows: ASSETS Cash Inventory Nov. 1 50,000 Nov. 1 36,000 Nov. 12 15,000 Nov. 14 2,000 14 15,000 1 12,000 Dec. 5 2,000 Dec. 1 1,500 Dec. 29 10,000 12 15,000 26 3,000 Dec. 27 1,000 17,000 6,500 75,000 64,000 Balance 10,500 Balance 11,000  Accounts receivable Notes receivable Dec. 26 17,000 Dec. 29 10,000 Dec. 1 12,000 Balance 7,000 Balance 12,000 Prepaid insurance Equipment Nov. 1 12,000 Nov. 1 36,000 Balance 12,000 Balance 36,000 LIABILITIES Accounts payable Dec. 27 1,000 Dec. 5 2,000 Balance 1,000 EQUITY Owner's equity Nov. 1 50,000 Balance 50,000 INCOME EXPENSES Sales Cost of goods sold Nov. 14 15,000 Nov. 14 2,000 Dec. 1 12,000 Dec. 1 1,500 26 17,000 26 3,000 Balance 44,000 Balance 6,500 Step 4: Unadjusted trial balance  BINI Souvenir Unadjusted Trial Balance December 31, 2018 Accounts Debit Credit Cash Ᵽ11,000 Accounts receivable 7,000 Notes receivable 12,000 Inventory 10,500 Prepaid insurance 12,000 Equipment 36,000 Accounts payable Ᵽ1,000 Owner's equity 50,000 Sales 44,000 Cost of sales 6,500 Totals Ᵽ95,000 Ᵽ95,000 Step 5: Adjusting entries Additional information: The following information was identified on December 31, 2018. a. The total account receivable, Ᵽ1,000 is doubtful of collection. b. Salaries earned by employees during the period but were not yet paid amounted to Ᵽ10,000. AJE #1: Interest income. i = Prt P = Ᵽ12,000 r = 10% t= 1 month (Dec. 1 to Dec. 31, 2018) over 12 months in a year or (1/12) Interest = (12,000 x 10% x 1/12) = 100 The Adjusting entry for the accrued interest income is as follows: Dec. 31, 2018 Interest receivable 100 Interest income 100 to accrue interest income earned but not yet collected AJE #2: Salaries expense The Ᵽ10,000 unpaid salaries are accrued as follows: Dec. 31, 2018 Salaries expense 10,000 Salaries payable 10,000 to accrue salaries expense incurred but not yet paid AJE #3: Depreciation expense The annual depreciation expense is computed as follows: Cost Ᵽ36,000 Divide by: Useful life 4 Annual depreciation expense Ᵽ9,000 However, since the equipment has only been used for 2 months in 2018 (Nov. 1 to Dec. 31, recognized. This is computed as follows: Annual depreciation Ᵽ9,000 Multiply by: 2/12 Depreciation expense Ᵽ1,500 The adjusting entry as follows: Dec. 31, 2018 Depreciation expense 1,500 Accumulated depreciation 1,500 to record depreciation expense for the period The carrying amount of the equipment on December 31, 2018 is determined as follows: Equipment Ᵽ36,000 Accumulated depreciation (1,500) Equipment – net Ᵽ34, 500 AJE #4: Bad debts expense The adjusting entry to recognize the Ᵽ1,000 uncollectible account is as follows: Dec. 31, 2018 Bad debts expense 1,000 Allowance for bad debts 1,000 to record bad debts expense for the period The carrying amount of accounts receivable on December 31, 2018 is determined as follows: Accounts receivable Ᵽ7,000 Allowance for bad debts (1,000) Accounts receivable – net Ᵽ6,000 AJE #5: Prepaid insurance / Insurance expense Previous transaction: Nov. 1 Paid a one-year insurance premium of Ᵽ12,000. Year-end analysis: Expired portion (Insurance expense): 2 mos. – Nov.1 to Dec. 31, 2018 (12,000 x 2/12) = Ᵽ2,000 Ᵽ12,000 1-year insurance prepaid on November 1, 2018 Unexpired portion (Prepaid insurance): 10 mos. – Jan.1 to Oct. 31, 2019 (12,000 x 10/12) = Ᵽ10,000 The adjusting entry to record the used up portion of the prepaid insurance as expense is as follows: Dec. 31, 2018 Insurance expense 2,000 Prepaid insurance 2,000 to record insurance expense Step 6: Adjusted trial balance (Worksheet) The adjustments are placed on the worksheet as follow  BINI Souvenir Worksheet For the two months ended December 31, 2018 Unadjusted Trial Adjusted Trial Accounts Balance Adjustments Balance Debit Credit Debit Credit Debit Credit Cash Ᵽ11,000 Ᵽ11,000 Accounts receivable 7,000 7,000 Notes receivable 12,000 12,000 Inventory 10,500 10,500 Prepaid insurance 12,000 Ᵽ2,000 10,000 Equipment 36,000 36,000 Accounts payable Ᵽ1,000 Ᵽ1,000 Owner's equity 50,000 50,000 Sales 44,000 44,000 Cost of goods sold 6,500 6,500 Total Ᵽ95,000 Ᵽ95,000 Adjustments Interest receivable Ᵽ100 100 Interest income 100 100 Salaries expense 10,000 10,000 Salaries payable 10,000 10,000 Depreciation expense 1,500 1,500 Accumulated depreciation 1,500 1,500 Bad debts expense 1,000 1,000 Allowance for bad debts 1,000 1,000 Insurance expense 2,000 2,000 Totals Ᵽ14,600 Ᵽ14,600 Ᵽ107,600 Ᵽ107,600 Step 7; Financial Statements The income statement and balance sheet columns of the worksheet are completed as follows  BINI Souvenir Worksheet For the two months ended December 31, 2018 Unadjusted Trial Adjusted Trial Accounts Balance Adjustments Balance Income Statement Balance Sheet Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Ᵽ11,000 Ᵽ11,000 Ᵽ11,000 Accounts receivable 7,000 7,000 7,000 Notes receivable 12,000 12,000 12,000 Inventory 10,500 10,500 10,500 Prepaid insurance 12,000 Ᵽ2,000 10,000 10,000 Equipment 36,000 36,000 36,000 Accounts payable Ᵽ1,000 Ᵽ1,000 Ᵽ1,000 Owner's equity 50,000 50,000 50,000 Sales 44,000 44,000 Ᵽ44,000 Cost of goods sold 6,500 6,500 Ᵽ6,500 Total Ᵽ95,000 Ᵽ95,000 Adjustments Interest receivable Ᵽ100 100 100 Interest income 100 100 100 Salaries expense 10,000 10,000 10,000 Salaries payable 10,000 10,000 10,000 Depreciation expense 1,500 1,500 1,500 Accumulated 1,500 depreciation 1,500 1,500 Bad debts expense 1,000 1,000 1,000 Allowance for bad debts 1,000 1,000 1,000 Insurance expense 2,000 2,000 2,000 Totals Ᵽ14,600 Ᵽ14,600 Ᵽ107,600 Ᵽ107,600 21,000 44,100 86,600 63,500 23,100 23,100 Ᵽ44,100 Ᵽ44,100 Ᵽ86,600 Ᵽ86,600 Step 8: Closing entry Closing entry #1: Income summary  Dec. 31, 2018 Sales 44,000 Interest income 100 Cost of goods sold 6,500 Salaries expense 10,000 Depreciation expense 1,500 Bad debts expense 1,000 Insurance expense 2,000 Income summary (squeeze) 23,100 to close income and expense accounts to income summary Closing entry #2: Income summary closed to Equity Dec. 31, 2018 Incomesummary 23,100 Owner's equity 23,100 to close the income summary to equity Step 9: post-closing trial balance The worksheet is completed.  My Souvenir Worksheet For the two months ended December 31, 2018 Una djus ted Tri a l Adjus ted Tri a l Pos t-cl os i ng Accounts Ba l a nce Adjus tments Ba l a nce Income Sta tement Ba l a nce Sheet Cl os i ng entri es Ti ra l ba l a nce Debi t Credi t Debi t Credi t Debi t Credi t Debi Credi t Debi t Credi t Debi t Credi t Debi t Credi t Ca s h Ᵽ11,000 Ᵽ11,000 Ᵽ11,000 Accounts recei va bl e 7,000 7,000 7,000 Notes recei va bl e 12,000 12,000 12,000 Inventory 10,500 10,500 10,500 Prepa i d i ns ura nce 12,000 Ᵽ2,000 10,000 10,000 Equi pment 36,000 36,000 36,000 Accounts pa ya bl e Ᵽ1,000 Ᵽ1,000 Ᵽ1,000 Owner's equi ty 50,000 50,000 Ᵽ23,100 73,100 Sa l es 44,000 44,000 Ᵽ44,000 Ᵽ44,000 Cos t of goods s ol d 6,500 6,500 Ᵽ6,500 6,500 Total Ᵽ95,000 Ᵽ95,000 Adjustments Interes t recei va bl e Ᵽ100 100 Interes t i ncome 100 100 100 100 Sa l a ri es expens e 10,000 10,000 10,000 10,000 Sa l a ri es pa ya bl e 10,000 10,000 10,000 Depreci a ti on expens e 1,500 1,500 1,500 1,500 Accumul a ted depreci a ti on 1,500 1,500 1,500 Ba d debts expens e 1,000 1,000 1,000 1,000 Al l owa nce for ba d debts 1,000 1,000 1,000 Ins ura nce expens e 2,000 2,000 2,000 2,000 Totals Ᵽ14,600 Ᵽ14,600 Ᵽ107,600 Ᵽ107,600 21,000 44,100 86,600 63,500 Ᵽ44,100 Ᵽ44,100 Ᵽ86,600 Ᵽ86,600 23,100 23,100 Ᵽ44,100 Ᵽ44,100 Ᵽ86,600 Ᵽ86,600 The Balance sheet and Income statement are prepared as follows: BINI Souvenir Balance Sheet As of December 31, 2018 ASSETS Cash Ᵽ11,000 Accounts receivable 7,000 Allowance for bad debts (1,000) Interest receivable 100 Notes receivable 12,000 Inventory 10,500 Prepaid insurance 10,000 Equipment 36,000 Accumulated depreciation (1,500) TOTAL ASSETS Ᵽ84,100 LIABILITIES Accounts payable Ᵽ1,000 Salaries payable 10,000 TOTAL LIABILITIES 11,000 EQUITY Owner's equity 73,100 TOTAL LIABILITIES AND EQUITY Ᵽ84,100  BINI Souvenir Income Statement For the two months ended December 31, 2018 Sales Ᵽ44,000 Cost of goods sold (6,500) GROSS PROFIT 37,500 Interest income 100 Salaries expense (10,000) Depreciation expense (1,500) Bad debts expense (1,000) Insurance expense (2,000) PROFIT Ᵽ23,100 Illustration 2: PERIODIC INVENTORY SYSTEM The account of James Lynn Trading Co. have the following balances on January 1, 2018 James Lynn Trading Co. Trial Balance January 1, 2018 Accounts Debit Credit Cash Ᵽ50,000 Accounts receivable 120,000 Inventory 30,000 Equipment 200,000 Accumulated depreciation Ᵽ80,000 Accounts payable 20,000 James Lynn, Capital 300,000 Totals Ᵽ400,000 Ᵽ400,000 The following were the transactions during the year. 1. Sales on cash basis amounted to Ᵽ80,000. 2. Sales on account amounted to Ᵽ130,000. 3. Purchases on account amounted to Ᵽ70,000. 4. Freight paid on purchases amounted to Ᵽ5,000.  5. Purchase returns amounted to Ᵽ10,000. 6. Salaries amounted to Ᵽ60,000. 7. Utility bills paid amounted to Ᵽ20,000. 8. Collections of accounts receivable amounted to Ᵽ200,000. 9. Payment of accounts payable amounted to Ᵽ60,000. 10. Owner drawings during the year totaled Ᵽ80,000. Additional information: a. The annual depreciation on the equipment is Ᵽ20,000. b. The physical count of inventory on December 31, 2018 revealed a Ᵽ60,000 balance of goods on hand. Requirement: Complete the accounting cycle. Solution: Step 1 & 2: Identifying and analyzing and Journalizing The transactions are recorded in the journal as follows: 1 Cash 80,000 Sales 80,000 to record cash sales 2 Accounts receivable 130,000 Sales 130,000 to record sales on account 3 Purchases 70,000 Accounts payable 70,000 to record the purchases on account 4 Freight-in 5,000 Cash 5,000 to record freight costs incurred on purchases 5 Accounts payable 10,000 Purchase returns 10,000 to record purchase returns 6 Salaries expense 60,000 Cash 60,000 to record payment of salaries 7 Utilities expense 20,000 Cash 20,000 to record payment of utility bills 8 Cash 200,000 Accounts receivable 200,000  to record the collection of accounts receivable 9 Accounts payable 60,000 Cash 60,000 to record payment of accounts payable 10 James Lynn, Drawings 80,000 Cash 80,000 to record withdrawals of owner from the business Step 3: Posting ASSETS Cash Accounts receivable Beg. bal. 50,000 Jan. 4 5,000 Beg,bal. 120,000 Jan. 8 200,000 Jan. 1 80,000 6 60,000 Jan. 2 130,000 8 200,000 7 20,000 250,000 200,000 9 60,000 Balance 50,000 10 80,000 330,000 225,000 Balance 105,000 Inventory Equipment Beg. bal. 30,000 Beg.bal 200,000 Balance 30,000 Balance 200,000 Accumulated depreciation Beg.bal. 80,000 Balance 80,000 LIABILITIES Accounts payable Jan. 5 10,000 Beg.bal. 20,000 9 60,000 3 70,000 70,000 90,000 Balance 20,000 EQUITY  James Lynn, Capital James Lynn, Drawings Beg.bal. 300,000 Jan. 10 80,000 Balance 300,000 Balance 80,000 INCOME Sales Jan. 1 80,000 2 130,000 Balance 210,000 EXPENSES Purchases Freight-in Jan. 3 70,000 Jan. 4 5,000 Balance 70,000 Balance 5,000 Purchase returns Salaries expense Jan. 5 10,000 Jan. 6 60,000 Balance 10,000 Balance 60,000 Utilities expense Jan. 7 20,000 Balance 20,000 Step 4: Unadjusted trial balance James Lynn Trading Co. Unadjusted trial balance December 31, 2018 Accounts Debit Credit Cash Ᵽ105,000 Accounts receivable 50,000 Inventory 30,000 Equipment 200,000 Accumulated depreciation Ᵽ80,000 Accounts payable 20,000 James Lynn, Capital 300,000 James Lynn, Drawings 80,000 Sales 210,000 Purchases 70,000 Freight-in 5,000 Purchase returns 10,000  Salaries expense 60,000 Utilities expense 20,000 Totals Ᵽ620,000 Ᵽ620,000 Step 5: Adjusting entries AJE #1 : Depreciation expense The problem states that the annual depreciation is Ᵽ20,000. Dec. 31, 2018 Depreciation expense 20,000 Accumulated depreciation 20,000 to record the depreciation expense for the year AJE #2: Ending inventory The problem states that the physical count of inventory on December 31, 2018 revealed a Ᵽ60,000 balance of goods on hand. Dec. 31, 2018 Inventory,ending 60,000 Income summary 60,000 to recognize the ending inventory Step 6: Adjusted trial balance (Worksheet)  James Lynn Trading Co. Worksheet For the year ended December 31, 2018 Unadjusted Adjusted trial Accounts trial balance Adjustments balance Debit Credit Debit Credit Debit Credit Cash Ᵽ105,000 Ᵽ105,000 Accounts receivable 50,000 50,000 Inventory, beginning 30,000 30,000 Equipment 200,000 200,000 Accumulated depreciation Ᵽ80,000 Ᵽ20,000 Ᵽ100,000 Accounts payable 20,000 20,000 James Lynn, Capital 300,000 300,000 James Lynn, Drawings 80,000 80,000 Sales 210,000 210,000 Purchases 70,000 70,000 Freight - in 5,000 5,000 Purchase returns 10,000 10,000 Salaries expense 60,000 60,000 Utilities expense 20,000 20,000 Totals Ᵽ620,000 Ᵽ620,000 Adjustments Depreciation expense Ᵽ20,000 20,000 Inventory, ending 60,000 60,000 Income summary 60,000 60,000 Totals Ᵽ80,000 Ᵽ80,000 Ᵽ700,000 Ᵽ700,000 Step 7: Financial Statements The income statement and balance sheet columns of the worksheet are completed as follows:  James Lynn Trading Co. Worksheet For the year ended December 31, 2018 Unadjusted Adjusted trial Accounts trial balance Adjustments balance Income Statement Balance Sheet Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Ᵽ105,000 Ᵽ105,000 Ᵽ105,000 Accounts receivable 50,000 50,000 50,000 Inventory, beginning 30,000 30,000 Ᵽ30,000 Equipment 200,000 200,000 200,000 Accumulated depreciation Ᵽ80,000 Ᵽ20,000 Ᵽ100,000 Ᵽ100,000 Accounts payable 20,000 20,000 20,000 James Lynn, Capital 300,000 300,000 300,000 James Lynn, Drawings 80,000 80,000 80,000 Sales 210,000 210,000 Ᵽ210,000 Purchases 70,000 70,000 70,000 Freight - in 5,000 5,000 5,000 Purchase returns 10,000 10,000 10,000 Salaries expense 60,000 60,000 60,000 Utilities expense 20,000 20,000 20,000 Totals Ᵽ620,000 Ᵽ620,000 Adjustments Depreciation expense Ᵽ20,000 20,000 20,000 Inventory, ending 60,000 60,000 60,000 Income summary 60,000 60,000 60,000 Totals Ᵽ80,000 Ᵽ80,000 Ᵽ700,000 Ᵽ700,000 205,000 280,000 495,000 420,000 75,000 75,000 Ᵽ280,000 Ᵽ280,000 Ᵽ495,000 Ᵽ495,000 Cost of goods sold Analysis: Formula: Beginning inventory 30,000 Purchases 70,000 Freight-in 5,000 Purchase returns (10,000) Total goods available for sale 95,000 Ending inventory (60,000) Cost of goods sold 35,000 Income Statement columns of Worksheet: Accounts Income Statement Debit Credit Cost of goods sold Inventory, beg. 30,000 Purchases 70,000 Freight-in 5,000 Purchase returns 10,000 Income summary 60,000 Totals 105,000 70,000 Difference - COGS 35,000 Step 8: Closing entries Closing entry #1: Beginning inventory Dec. 31, 2018 Income summary 30,000 Inventory, beginning 30,000 to close beginning inventory to income summary Closing entry #2: Income summary Dec. 31, 2018 Sales 210,000 Purchase returns 10,000 Purchases 70,000 Freightin 5,000 Salaries expense 60,000 Utilities expense 20,000 Depreciation expense 20,000 Income summary (squeeze) 45,000  to close income and expense accounts to income summary Closing entry #3: Income summary closed to Equity Income summary 60,000 AJE 2 (CI.E.1) 30,000 45,000 (Cl.E. 20 75,000 Balance The income summary is closed to the “Owner’s capital” accounts as follows: Dec. 31, 2018 Income summary 75,000 James Lynn, Capital 75,000 to close income summary to equity Closing entry #4 : Drawings account closed to Equity Dec. 31, 2018 James Lynn, Capital 80,000 James Lynn, Drawings 80,000 to close drawings account Step 9: Post-closing trial balance The worksheet is completed as follows:  James Lynn Trading Co. Worksheet For the year ended December 31, 2018 Unadjusted Adjusted trial Post-closing trial Accounts trial balance Adjustments balance Income Statement Balance Sheet Closing enries balance Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash Ᵽ105,000 Ᵽ105,000 Ᵽ105,000 Ᵽ105,000 Accoounts receivable 50,000 50,000 50,000 50,000 Inventory, beginning 30,000 30,000 Ᵽ30,000 Ᵽ30,000 Equipment 200,000 200,000 200,000 200,000 Accumulated depreciation Ᵽ80,000 Ᵽ20,000 Ᵽ100,000 Ᵽ100,000 Ᵽ100,000 Accoouns payable 20,000 20,000 20,000 20,000 James Lynn, Capital 300,000 300,000 300,000 Ᵽ80,000 75,000 295,000 James Lynn, Drawings 80,000 80,000 80,000 80,000 Sales 210,000 210,000 Ᵽ210,000 210,000 Purchases 70,000 70,000 70,000 70,000 Freight - in 5,000 5,000 5,000 5,000 Purchase returns 10,000 10,000 10,000 10,000 Salaries expense 60,000 60,000 60,000 60,000 Utilities expense 20,000 20,000 20,000 20,000 Totals Ᵽ620,000 Ᵽ620,000 Adjustments Depreciaiton expense Ᵽ20,000 20,000 20,000 20,000 Inventory, ending 60,000 60,000 60,000 60,000 Income summary 60,000 60,000 60,000 105,000 45,000 Totals Ᵽ80,000 Ᵽ80,000 Ᵽ700,000 Ᵽ700,000 205,000 280,000 495,000 420,000 Ᵽ 405,000 Ᵽ 405,000 Ᵽ 415,000 Ᵽ 415,000 75,000 75,000 Ᵽ280,000 Ᵽ280,000 Ᵽ 495,000 Ᵽ 495,000 Format reports:  James Lynn Trading Co. Balance Sheet As of December 31, 2018 ASSETS Cash Ᵽ105,000 Accounts receivable 50,000 Inventory 60,000 Equipment 200,000 Accumulated depreciation (100,000) TOTAL ASSETS Ᵽ315,000 LIABILITIES Accounts payable Ᵽ20,000 EQUITY James Lynn, Capital 295,000 TOTAL LIABILITIES AND EQUITY Ᵽ315,000 James Lynn Trading Co. Income Statement For the year ended December 31, 2018 Sales Ᵽ210,000 Cost of Goods Sold: Inventory, beginning Ᵽ30,000 Purchases 70,000 Freight- in 5,000 Purchase returns (10,000) Total goods available for sale 95,000 Inventory, ending (60,000) (35,000) GROSS PROFIT 175,000 Salaries expense (60,000) Utilities expense (20,000) Depreciation expense (20,000) PROFIT FOR THE YEAR Ᵽ75,000