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

I. Learning objectives

After completing this session, students should be able to1. 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) 500Cash 500

Taking a physical inventory/or make an estimate at the end of the period200 Yuan of supplies is left.Office supplies (memo pads) expense 300

Office supplies (memo pads) 3002. Adjustments for merchandise inventory

(1) Inventory systemsA. 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

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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 Cost of goods sold + - + - Beginning bal. 2000 400 400 2000

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 inventoryBeginning 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 today’s 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 periodMerchandise inventory Income summary

Beginning bal. 2000 adjusting 2000 2000 3600 Ending 3600

3. 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 Unearned sales revenue + - - + 600 600

(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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