Mark Krilanovich
©November 22, 2008
ACCT 110
DETAILS
Chapter 11a: How to Prepare the Worksheet
The Big Picture
1. Chapters 9 and 10 introduced ten new accounts (see p. Ch. 9b and Ch. 10b).
Chapter 11 now shows us how to adjust them onto a Worksheet, and introduces
using that Worksheet to produce Financial Statements.
2. Chapter 11 mentions several payroll accounts covered in Chapters 7 and 8. (Don't
worry about them.)
3. Pages 365-370 of Chapter 10 introduced the new accounts "Merchandise
Inventory" and "Cost of Goods Sold." Chapter 11 now delves deeply into them,
from the simpler perspective of the "Periodic Inventory System." (Definitions of
the Periodic and Perpetual Systems are on the bottom of p. 404.)
4. The text almost implies that "Beginning (Merchandise) Inventory" and "Ending
(Merchandise) Inventory" are two separate accounts. In truth, the only account is
"Merchandise Inventory." "Beginning Inventory" and "Ending Inventory" are the
balances of that account at the beginning and ending of the accounting period.
5. In a few places, the text talks about the beginning and ending of the month, but
most places more correctly talk about the beginning and end of the year.
6. The title of Chapter 11 includes the term "Merchandise Company," and the text
often talks about "Art's Wholesale Clothing Co.," which is simply the name of a
wholesale merchandise company.
7. Chapter 10 often viewed one transaction from the perspective of two companies:
the buyer and the seller of the same item. Chapter 11 considers only one
company, which buys goods and later sells them.
8. Chapter 12 will tie together many ideas we've studied separately.
These are some new concepts (you must memorize these formulas):
1. "Cost of Goods Sold" ("CoGS") means "The cost to us of merchandise we
purchased from our supplier, and we later sold to our customers." (I.e., the word
"Cost" applies to the time we purchased from our supplier, but the word "Sold"
applies to the time we sold to our customer.)
2. "Unearned Revenue" is money that we haven't yet earned, but will. It's money paid
us in advance of goods or services, like a deposit. It is a Liabillity.
3. Net Purchases = (gross) Purchases - Purchases Returns & Allowances
- Purchase Discounts.
4. Cost of Goods Available for Sale = Beginning Inventory + Net Purchases
needed
+ Freight-In.
for the
5. Cost of Goods Sold = Beginning Inventory + Net Purchases + Freight-In
Income
- Ending Inventory. Statement
6. Net Sales = (gross) Sales - Sales Returns & Allowances - Sales Discounts.
7. Gross Profit = Net Sales - Cost of Goods Sold.
8. Net Income = Gross Profit - Operating Expenses.
©2008 by Mark Krilanovich
Memorize either these formulas, or the diagrams on page 3.
ACCT 110, Chapter 11, page 2
Chapter 11b: The New Accounts
Definitions and Characteristics of the New Accounts:
account name
category
normal balance
when and how this account is used
Unearned Rent
Liability
credit
This is one kind of "Unearned Revenue" (revenue we will earn, but
haven't yet). When we rent space to a customer and they give us their
"Prepaid Rent" (p. 121), we hold their deposit in this account. This is
our liability, because we owe them that much occupancy. As their rent
comes due, we move one month's rent to our "Rental Income" account.
Rental Income
Revenue
credit
Revenue we earn by renting space to customers. This account increases
when a customer's rent comes due, coming from our Unearned Rent.
Mortgage Payable
Liability
credit
The amount we owe on mortgage(s). Chapter 12 will cover this.
Interest Expense
other Expense
debit
The cost of our borrowing money. Chapter 12 will cover this more.
Petty Cash
Asset
debit
Chapter 6 covered this.
Payroll liabilities
Liability
credit
Chapters 7 and 8 covered this.
Payroll Tax Expense
Expense
debit
Chapter 8 (p. 279) covered this.
Merchandise Inventory
Asset
debit
This is the value of all our merchandise. This account doesn't change
during the accounting period, only at the end of the accounting period.
Beginning Inventory
This is the balance of the Merchandise Inventory account at the
beginning of the accounting period.
Ending Inventory
At the end of the accounting period, we take a physical count of our
merchandise on hand, which we haven't sold. We compute its collective
original cost to us (p. 390), and that's our Ending Inventory balance.
As part of adjusting journal entries at the end of the accounting period,
we move Beginning Inventory out of the Mechandise Inventory account
into Income Summary, and move Ending Inventory into the Merchandise
Inventory account to begin the next accounting period.
Note: Table 11.1 on page 395 gives more information about all new account titles.
©2008 by Mark Krilanovich
ACCT 110, Chapter 11, page 3
Chapter 11c: The New Accounts
Making Year-End Adjustments on the Worksheet with the New Accounts:
Unearned Rent; when we receive advance payment from a customer for their future rent, we do this:
Debit Cash for the amount of money our rental customer gave us.
Credit Unearned Rent for the same amount.
Rental Income; when our customer's rent comes due (e.g., on the last day of the month), we do this:
Debit Unearned Rent by the amount of one month of our customer's rent.
Credit Rental Income by the same amount.
Merchandise Inventory; at the end of the accounting period, we do these two transactions:
1. Credit Merchandise Inventory by the amount in the Merchandise Inventory account (out with the old inventory).
Debit Income Summary by the same amount.
2. Debit Merchandise Inventory by the amount on the Ending Inventory sheet (in with the new inventory).
Credit Income Summary by the same amount.
Note: The above debit and credit to Income Summary remain separate across the worksheet; we don't combine them,
because we'll need them separate in Chapter 12 to prepare the formal Income Statement. Be patient to see why.
Diagrams that Illustrate Formulas for the Income Statement:
Beginning Inventory
- Ending
Inventory
Gross Purchases
+ Net Purch
- Purch Ret.
- Purch Disc.
= COGS
+ Freight-In
Cost Of Goods Sold ("COGS") =
Begin Inven - End Inven + Net Purch + Freight-In
Gross Sales
- Sales Ret.
Net Sales
Gross Profit
- COGS
- Operating
Expenses
= Net Income
- Sales Disc.
= Net Purch
= Net Sales
= Gross Profit
Net Purchases = Gross Purch Purch Returns - Purch Discounts
Net Sales = Gross Sales - Sales
Returns - Sales Discounts
Gross Profit = Net Sales - COGS
Net Income = Gross Profit - Op Expense
I'm a colorful guy.
(c)2008 by Mark Krilanovich
ACCT 110, Chapter 11, page 4
Chapter 11d: How to Adjust Merchandise Inventory
Using the "Income Summary" Account
Assume our merchandise business has an accounting period from Jan. 1 through
Dec. 31. On Jan. 1 (a holiday when our store is closed), we have a Merchandise
Inventory of $19,000. This is how our T-accounts look:
Merchandise Inventory
BB Jan. 1; $19,000
Income Summary
Doesn't exist now, because it's a
temporary account, and lived only
long enough for us to do last years'
year-end adjustments and closing.
On Dec. 31, we close our store and take a hand count of the merchandise in it.
We find that we own $4000 worth of merchandise. Now our T-accounts (for the
moment) look like this:
Merchandise Inventory
BB Jan. 1; $19,000
Income Summary
Doesn't exist.
EB Dec. 31; $4,000
How can we get from the first pair of T-accounts to the second? By the unique
two-step process of crediting out the old Inventory balance, and then debiting
in the new balance, like below left. Of course, we must match that credit and
debit with an equal debit and credit somewhere else. We do those in the Income
Summary account, because the beginning and ending Merchandise Inventory
balances will later help us compute our income. Thus, our T-accounts now look
like this:
Merchandise Inventory
BB Jan. 1; $19,000 $19,000 Out
Income Summary
matches Out $19,000 $4,000 matches In
In $4,000
EB Dec. 31; $4,000
After we complete the year-end closing process, Dec. 31's ending balance of
$4000 will, the next day, be the beginning balance on Jan. 1 of the new year.
©2008 by Mark Krilanovich
ACCT 110, Chapter 11, page 5
Chapter 11e: Worksheet Including Adjustments for Inventory
A Picture View
Worksheet for George Washington Cherry Trees, Year Ending Dec. 31, 1762
Account Title
("ALORE" order)
Assets
Liabilities
Owner's
Equity
Revenue
Expenses
Merchandise Inventory
Cash
Accounts Receivable
Trial Balance
Dr.
Cr.
ttt
oo
oo
Accounts Payable
Salaries Payable
Owner's Capital
Owner's Withdrawals
Income Summary
Sales (gross)
Sales Returns & Allow.
Sales Discounts
Purchases (gross)
Purchases Ret. & Allow.
Purchases Discounts
Office Supplies Expense
Rent Expense
totals:
Adjustments
Dr.
Cr.
*
ss
(In)
oo
oo
*
Adjust. Trial Bal.
Dr.
Cr.
ttt
(Out)
ss
oo
oo
o
empty.
ooo
o
ttt
ss
ttt
oo
o
copy both
ooo
o
ss
ooo
ttt
oo
copy both
o
oo
o
ooo
ooo
oo
oo
AAA
oo
oo
ooo
o
ooo
ooo
BBB
ooo
ooo
BB B
We copy both the ttt and ss
numbers across to the right
(rather than combining them),
because we'll need them
individually in the Income
Statement column, so that in Ch.
12 we can use them to prepare
the formal Income Statement.
CCC
ss
ooo
Always
ooo
oo
oo
o
o
AAA
oo
oo
empty.
ooo
ooo
C CC
net loss:
totals:
XXX
EEE
FFF
ZZZ
XXX
NNN
XXX
NNN
ZZZ
ZZZ
These two XXX's match, but
differ from ZZZ at the right.
The two NNN's match.
NNN = XXX - EEE.
A template of this form is on my website, www.silcom.com/~mkrilano/worksheet.xls
©2008 by Mark Krilanovich
Balance Sheet
Dr.
Cr.
ss
oo
oo
Always
oo
oo
ooo
Income Stmt.
Dr.
Cr.
These two ZZZ's match, but
differ from XXX at the left.
NNN is Net Income or Net Loss.
NNN = ZZZ - FFF.
ACCT 110, Chapter 11, page 6
Chapter 11f: How to Prepare the Worksheet
Step-by-Step Instructions
1. Account Titles Column:
List all the accounts down the left-most column, in the order they appear in the chart of accounts (preferably "ALORE").
2. Trial Balance Section:
For each account, copy its ending balance from the general ledger (as debit or credit) into the Trial Balance Section.
3. Adjustments Section:
1. Enter the debit and credit adjustments for the familiar accounts (pp. 395-396, D-G), as we learned on pp. 119-125.
2. Enter the debit and credit for Unearned Rent and Rental Income as shown above in Chapter 11c.
3. On the Merchandise Inventory line, copy the original number from Merchandise Inventory in the Trial Balance Section as the
credit, and enter Ending Inventory balance (from the Inventory Sheet) as the debit. (Out with the old, in with the new.)
4. On the Income Summary line, enter the same two numbers as in step #3 reversed, so that old Merchandise Inventory is the
debit, and Ending Inventory balance is the credit.
4. Adjusted Trial Balance Section:
1. For the Income Summary row, copy both the debit and credit entries from the Adjustments to the Adjusted Trial Balance.
2. For every other account, combine the values in the Trial Balance Section with those in the Adjustments Section, and enter
the result. as a debit or credit appropriately, in the Adjusted Trial Balance Section.
5. Income Statement Section:
1. For the Income Summary row, copy both the debit and credit entries from Adjustments to the Income Statement Section.
2. For every account (row) that relates to Income (Revenue, Expenses, and Costs, contra- and otherwise), copy the contents
from the Adjusted Trial Balance Section into the Income Statement Section. (Why? See 6.1 below.)
3. Subtotal the debit half-column, and subtotal the credit half-column.
4. Subtract the smaller subtotal from the larger, yielding either Net Income or Net Loss. Place the result on the next line, below
the smaller subtotal.
5. Total these last two rows, and they will match.
6. Balance Sheet Section:
1. For every account (row) in the Adjusted Trial Balance Column that you didn't copy to the Income Statement Section, copy it
now to the Balance Sheet Section. (Why? It makes Income Statement and Balance Sheet Sections easier to read and total.)
2. Subtotal the debit half-column, and subtotal the credit half-column.
3. Subtract the smaller subtotal from the larger, yielding either Net Income or Net Loss. Place the result on the next line, below
the smaller subtotal. This must match the Net Income calculated in step #3 in the Income Statement Section.
4. Total these last two rows, and they will match, but won't match the totals of the Income Statement Section.
(c)2008 by Mark Krilanovich