Chapter Eight Adjusting Entries and Work Sheet for a Merchandising Sole Proprietorship I.

Learning objectives

After completing this session, students should be able to 1. Prepare adjusting entries to convert office supplies into expenses; 2. Prepare adjusting entries to update the merchandise inventory account at the end of accounting period; 3. Prepare adjusting entries to convert unearned revenue into revenue; 4. Differentiate periodic inventory system from perpetual inventory system; 5. Complete the work sheet for a merchandising sole proprietorship. II. Lecture Notes 1. Adjustment for office supplies (1) Why make adjustments at the end of accounting period/month? It is not practical to make journal entries every few minutes/every day as the supplies are used. Example: the consumption of chalk, ink or memo pad Only make an estimate or take a physical inventory of the supplies remaining on hand at the end of the period; The missing supplies are assumed to have been used. (2) An illustration Bought memo pads in cash, 500 Yuan Office supplies (memo pads) 500 Cash 500 Taking a physical inventory/or make an estimate at the end of the period 200 Yuan of supplies is left. Office supplies (memo pads) expense 300 Office supplies (memo pads) 300 Adjustments for merchandise inventory (1) Inventory systems A. Perpetual inventory system Purchases of merchandise are recorded by debiting the Merchandise Inventory account. Example: Beginning inventory (books @20 Yuan each) 2 000 Yuan Bought 100 books at 20 Yuan each Merchandise Inventory + Beginning bal. 2000 2000

2.

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 As the goods are sold, two entries are needed: one to recognize the revenue earned, and the second to transfer the cost of the goods out of inventory (into cost of goods sold) Example: Sold 20 books for cash at 25 Yuan each Cash Sales + + 500 500

Merchandise inventory + + Beginning bal. 2000 400 2000

Cost of goods sold 400

The basic characteristic of the perpetual inventory system is that the inventory account is continuously updated for all purchases and sales of merchandise. Taking a physical inventory Beginning inventory + purchases cost of goods sold = Ending inventory Who uses perpetual inventory system? --- Most businesses use perpetual inventory system in accounting for products with a high per-unit cost but low sales volume, such as automobiles, heavy machinery, jewelry, home appliances, electronic equipment, etc. --- Almost all manufacturing companies use perpetual inventory system. --- In the days when all accounting records were maintained by hand, businesses that sold many types of low-cost products could not use this system. (Example: Wal-Mart could not use this system when it kept its accounts by hand) --- With todays point-of-sale terminals and bar-coded merchandise, even high-volume retailers like Wal-Mart and Trust-Mart can use this system. --- Advances in technology (computer-aided accounting) extend the use of perpetual inventory system to more businesses and more types of products. B. Periodic inventory system Acquisition of merchandise is recorded by debiting the Purchase account. Merchandise inventory Purchases + + 2000 2000

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 The merchandise inventory account is brought up to date only at the end of the accounting period when a physical inventory is taken. Beginning inventory + Purchases ending inventory = cost of goods sold Used when the need for current information about inventories and sales does not justify the cost of maintaining a perpetual system. Businesses that sell many low-cost items and have manual accounting systems have to use periodic system. Adjusting the Merchandise Inventory account at the end of the period Merchandise inventory Income summary Beginning bal. 2000 adjusting 2000 Ending 3600 3. 2000 3600

Adjustment for unearned revenue (1) In some instances, customers may pay in advance for services/products to be delivered in later accounting periods. Examples: Football team collects much of its revenue in advance through the sale of season tickets. Health clubs collect in advance by selling long-term membership contracts. In Australia, people may even pay in advance for funeral services Microsoft collects warranty fees in advance for technical support to be rendered in the future period. (2) For accounting purposes, amounts collected in advance do not represent revenue, because these amounts have not yet been earned. (3) When a company collects money in advance from its customers, it has an obligation to render services or deliver products in the future. Therefore, the balance of an unearned revenue account is considered to be a liability. It appears in the liability section of the balance sheet, not in the income statement. Example: (on December 3, 2003) Collected 600 Yuan from students for 30 books to be provided in 30 days. Cash + 600 Unearned sales revenue + 600

(4) When the company renders the services or delivers the products for which customers have paid in advance, it is working off its liabilities these customers and is earning the revenue. (5) At the end of the accounting period, an adjusting entry is made to transfer an appropriate amount from the unearned revenue account a revenue account.
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Example: On December 31, deliver 20 books to the students, with the rest of books to be provided in January. Unearned sales revenue Sales revenue + + Adjusting 400 600 400 Bal. 200 (income (balance sheet) statement) The transfer of unearned revenue to earned revenue is illustrated below.

Value of goods or services To be provided in future Periods

Liabilities Unearned revenue

Balance sheet

Income statement services are provided

Revenue earned

As the goods or

4. 5. 6.

Complete the work sheet for a merchandising business. (p.198-199) Journalizing and posting the adjusting entries (p.200-203 Assignment: Problem 3 (p.206, provide students with one work sheet and one general journal sheet)

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