Completing the Accounting Cycle for a Merchandising Company Chapter 12 Completing the Accounting Cycle for a Merchandising Company

Accrued Adjustments If accrued expenses are unrecorded: Expenses & liabilities understated Net income & Owner’s Equity overstated If accrued revenues are not recorded: Revenue, net income, assets and owner’s equity all understated If unearned revenue unrecorded: Revenue, net income, owner’s equity all overstated Liabilities understated

Bad Debts Some debtors (A/R) do not pay on time or at all The amount should be recorded as an expense in the period of the matching revenue GAAP: matching principle

Bad Debts Estimate an amount deemed uncollectible based on past experience Dr Bad Debts Expense 2000 CR Allowance for Doubtful Accounts* 2000 Use a contra account to A/R to show correct balance owing on balance sheet: Accounts Receivable 52000 Less: Allowance for Doubtful Accounts 2000 50000

Estimating Bad Debts Expense Income Statement Method: % of net sales E.g., 1% of $90 000 Dr Bad Debts Expense 900 Cr Allowance for Doubtful Accounts 900

Estimating Bad Debts Expense Balance Sheet Method: Based on age of accounts The longer the amount outstanding the greater likelihood it’s uncollectible “age analysis” Consider existing balance in the Allowance account

Estimating Bad Debts Expense Balance Sheet Method: Estimated $3000 uncollectible Allowance account has credit balance $500 Adjusting entry: dr Bad Debts Expense 2500 cr Allowance for Doubtful Accounts 2500 Assume Allowance account had $300 debit balance: dr Bad Debts Expense 3300 cr Allowance for Doubtful Accounts 3300

Bad Debts Write off: when debt proves uncollectible dr Allowance for Doubtful Accounts 500 cr A/R 500 Recovery: dr A/R 500 cr Allowance for Doubtful Accounts 500 dr Cash 500

Accrued Interest Money is borrowed with a bank loan and interest owing but not paid at period end Loan taken out at October 1st for six months at 7% rate dr Cash 5000 cr Bank Loan 5000 Period end at December 31st: dr Interest Expense 87.50 cr Interest Payable 87.50 I=PRT=5000x0.07x3/12

Accrued Salaries Period ends in between pay weeks, need to record salaries earned and owing E.g., regular $50000 two week salary for ten days is not due for another week: dr Salaries Expense 25000 cr Salaries Payable 25000 One week later into new period: dr Salaries Payable 25000 cr Cash 50000

Unearned Revenue Cash received in advance of performance of service or sale E.g., Three months of services are prepaid on December 1 for $1200 dr Cash 1200 cr Unearned Revenue (liability) 1200 period ends on December 31: dr Unearned Revenue 400 cr Revenue 400

Classified Balance Sheet

Income Statement

Adjusting Entries Journalize all entries indicated in adjusting entry columns on worksheet Inventory update (periodic) Transfer opening inventory from trial balance debit column to income statement debit column Ending inventory is placed in income statement credit column and balance sheet debit column Closing entry process updates inventory in ledger

Closing Entries Debit all income statement “credit” balance accounts, credit income summary Credit all income statement “debit’ balance accounts, debit income summary Close income summary and credit (income) or debit (loss) capital Debit capital and credit drawings

Post-closing trial balance Checks accuracy of ledger at year end

Other Issues Expenses often separated into selling (advertising, delivery, salespeople salary) and administrative (office supplies, maintenance, office salaries) Accrued revenues and expense adjusting entries often reversed on first day of new period to allow regular entries (e.g., wages to occur) Perpetual system simpler due to updated inventory figure requiring no or minor adjustment