College Accounting - MCCChorowitk/documents/Chapter15.pdf · Accounting for a Merchandising Business. 1 Prepare a single-step and multiple-step income statement for a merchandising

College Accounting

Heintz & Parry20th Edition

Chapter 15

Financial Statements

and Year-End

Accounting for a

Merchandising

Business

1

Prepare a single-step and

multiple-step income

statement for a

merchandising business.

INCOME STATEMENT

• Purpose: To summarize the results of

operations

• Shows:

– The sources of revenue

– Types of expenses

– The amount of net income or loss for

the period

• Two forms:

– Single step

– Multiple step

©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Let’s look at a single-stepincome statement.

Northern Micro

Income Statement

For Year Ended December 31, 20--


Revenues:

Net sales

Interest revenue

$212,800

8,000

900

All the revenue sourcesare listed and totaled.

Rent revenue

Subscriptions revenue 10,000

Total revenues $231,700

Northern Micro

Income Statement



Revenues:

Net sales

Interest revenue

$212,800

8,000

900

Cost of goods sold is listedwith all the other expenses.

Rent revenue



Expenses:

Cost of goods sold $111,500

Northern Micro

Income Statement



Revenues:

Net sales

Interest revenue

$212,800

8,000

900

Rent revenue



Expenses:

Cost of goods sold $111,500

Wages expense 42,450Advertising expense 2,500

Bank credit card expense 1,500Rent expense

Supplies expense

20,000

1,400

Telephone expense 3,500Utilities expense 12,000

Northern Micro

Income Statement



Expenses are totaled and subtractedfrom revenues to determine

net income or loss.

Bank credit card expense

Rent expense

Supplies expense

Telephone expense

Utilities expense

1,500

20,000

1,400

3,500

12,000

Insurance expense

Depreciation expense—building

Depreciation expense—store equipment

Miscellaneous expense

Interest expense

Total expenses

1,800

4,000

3,000

2,250

3,150

209,050

Net income $ 22,650


It is called single-step because expenses(including cost of goods sold) are

subtracted from revenues in ONE stepto determine net income or loss.


Rent expense

Supplies expense

Telephone expense

Utilities expense

1,500

20,000

1,400

3,500

12,000

Insurance expense

Depreciation expense—building

Depreciation expense—store equipment


Interest expense

Total expenses

1,800

4,000

3,000

2,250

3,150

209,050

Net income $ 22,650


Now let’s look at amultiple-step incomestatement for the same company.

Northern Micro

Income Statement



Revenue from sales:

Sales

Less sales R & A

Net sales

$214,000

1,200

$212,800

Gross sales (less any returns, allowances,or discounts) is shown first. The other

revenues are listed at the end ofthe statement.

Northern Micro

Income Statement



Revenue from sales:

Sales

Less sales R & A

Net sales

$214,000

1,200

$212,800

Cost of goods gold:

Merch. inv., Jan. 1, 20-- $ 26,000

Purchases $105,000

Less: Purchases R & A $ 800

Purchases disc. 1,000

Net purchases

1,800

$103,200

Add freight-in 300

Cost of goods pur. 103,500

Goods avail. for sale $129,500

Less M. I., Dec. 31, 20-- 18,000

Cost of goods sold 111,500

Northern Micro

Income Statement



Less M. I., Dec. 31, 20--

Goods avail. for sale

Cost of goods sold

$129,500

18,000

111,500

Gross profit

Cost of goods sold is computedand subtracted from net sales

to arrive at gross profit.

$101,300


Less M. I., Dec. 31, 20--Goods avail. for sale

Cost of goods sold

$129,500

18,000

111,500

Gross profit $101,300

Operating expenses:

Wages expense

Advertising expense


Rent expense

Supplies expense

Telephone expense

Utilities expense

Insurance expense

Deprec. exp.—building

Deprec. exp.—store eq.


Total oper. expenses 94,400

Income from operations $ 6,900

$ 42,450

2,500

1,500

20,000

1,400

3,500

12,000

1,800

4,000

3,000

2,250

Operating expenses arelisted, totaled, and subtracted from

gross profitto compute

income from operations.


Less M. I., Dec. 31, 20--Goods avail. for sale

Cost of goods sold

$129,500

18,000

111,500

Gross profit $101,300

Operating expenses:

Wages expense

Advertising expense


Rent expense

Supplies expense

Telephone expense

Utilities expense

Insurance expense

Deprec. exp.—building

Deprec. exp.—store eq.


Total oper. expenses 94,400

Income from operations $ 6,900

$ 42,450

2,500

1,500

20,000

1,400

3,500

12,000

1,800

4,000

3,000

2,250

Operating expenses canbe divided into

subcategories of selling expenses and

general expenses.

SELLING EXPENSES

• Expenses directly associated with selling

activities

• Examples:

– Sales Salaries Expense

– Sales Commissions Expense

– Advertising Expense

– Bank Credit Card Expense

– Delivery Expense

– Depreciation Expense—Store

Equipment and Fixtures

GENERAL EXPENSES

• Expenses associated with administrative, office,

or general operating activities

• Examples:

– Rent Expense

– Office Salaries Expense

– Office Supplies Expense

– Telephone Expense

– Utilities Expense

– Insurance Expense

– Depreciation Expense—Office Equipment


Other revenues:

Income from operations

Interest revenue

$ 6,900

$ 900Rent revenue

Other revenues are added andOther expenses are subtracted

to arrive at net income.

8,000Subscriptions revenue

10,000Total other revenue

$ 18,900Other expenses:

Interest expense 3,150 15,750

Net income $ 22,650

2

Prepare a statement of

owner’s equity.

THE STATEMENT OF OWNER’S

EQUITY

• Purpose: Summarizes all changes in the

owner’s equity during the period

• Sources needed to prepare statement:

– Work sheet

– General ledger capital account

• Includes:

– Beginning and ending capital balances

– Investments and withdrawals by the

owner

– Net income or loss


Let’s look at the statement of owner’s equity

for Northern Micro.

Northern Micro

Statement of Owner’s Equity



Beginning capital and investmentsare found in the general ledger

capital account.

Gary L. Fishel, capital, January 1, 20--

Add additional investments

Total investment

$104,400

10,000

$114,400

Northern Micro




Net income is found on the work sheetand on the income statement.



Total investment

$104,400

10,000

$114,400

Net income for the year $22,650

Northern Micro




Withdrawals, from the work sheet,are subtracted from net income todetermine the increase in capital

for this period.



Total investment

$104,400

10,000

$114,400


Less withdrawals for the year 20,000

Increase in capital 2,650

Northern Micro




The ending capital is computed.



Total investment

$104,400

10,000

$114,400


Less withdrawals for the year 20,000

Increase in capital 2,650

$117,050Gary L. Fishel, capital, December 31, 20--

Northern Micro



3

Prepare a classified

balance sheet.


Let’s look atNorthern Micro’s

classified balance sheet.

Northern Micro

Balance Sheet

December 31, 20--


Assets

Current assets:

Northern Micro

Balance Sheet

December 31, 20--

CURRENT ASSETS

• Include cash and other assets which are:

– Expected to be converted into cash, or

– Consumed within one year or the normal operating cycle of the business, whichever is longer

• Examples:

– Cash, receivables, merchandise inventory, and prepaid expenses

• Listed in order of liquidity

– The most liquid are shown first

OPERATING CYCLE

• The length of time generally required for a

business to:

– Buy inventory

– Sell it

– Collect the cash

• Generally, it is less than one year


Assets

Current assets:

Cash

Accounts receivable

Merchandise inventory

Supplies

Prepaid insurance

Total current assets

$20,000

15,000

18,000

400

600

$54,000

Merchandise Inventory is a current assetthat is unique to merchandising businesses.

Northern Micro

Balance Sheet

December 31, 20--

PROPERTY, PLANT, AND

EQUIPMENT

• Assets that are expected to be used:

– For more than one year

– In the operation of a business

• Examples:

– Land, buildings, office equipment, store

equipment, and delivery equipment

• Assets with the longer lives are listed first


Assets

Current assets:

Cash

Accounts receivable

Merchandise inventory

Supplies

Prepaid insurance


$20,000

15,000

18,000

400

600

$ 54,000

Property, plant, and equipment:

Building

Less accum. deprec.—building

Store equipment

Less accum. deprec.—store eq.

Total prop., plant., & equip.

Land $10,000

$90,000

20,000 70,000

$50,000

18,000 32,000

112,000

Northern Micro

Balance Sheet

December 31, 20--



Property, plant, and equipment:

Land

Building

Less accum. deprec.—building

Store equipment

Less accum. deprec.—store eq.

Total prop., plant., & equip.

$ 54,000

$10,000

$90,000

20,000 70,000

$50,000

18,000 32,000

112,000

Total assets $166,000



Liabilities

Current liabilities:

CURRENT LIABILITIES

• Obligations that are due within one year or

the normal operating cycle, whichever is

longer

• Require the use of current assets

• Examples:

– Notes Payable, Accounts Payable,

Wages Payable, Sales Tax Payable,

Unearned Subscriptions Revenue, and

the current portion of Mortgage Payable



Liabilities


Notes payable

Accounts payable

Wages payable

Sales tax payable

Unearned subscriptions revenue

Mortgage pay. (current portion)

Total current liabilities

$ 5,000

10,000

450

1,500

2,000

500

$19,450

LONG-TERM LIABILITIES

• Obligations that will extend beyond one

year or the normal operating cycle,

whichever is longer

• Mortgage payable is a common long-term

liability

– Used to reflect an obligation that is

secured by a mortgage on certain

property



Liabilities


Notes payable

Accounts payable

Wages payable

Sales tax payable




$ 5,000

10,000

450

1,500

2,000

500

$19,450

Long-term liabilities:

Mortgage payable

Less current portion

Total liabilities

$30,000

500 29,500

$ 48,950

OWNER’S EQUITY

• Accounts are determined by the type of

organization:

– A sole proprietorship reports one

owner’s equity account



Liabilities


Notes payable

Accounts payable

Wages payable

Sales tax payable




$ 5,000

10,000

450

1,500

2,000

500

$19,450

Long-term liabilities:

Mortgage payable

Less current portion

Total liabilities

$30,000

500 29,500

$ 48,950

Owner’s Equity

Gary L. Fishel, capital 117,050

Total liabilities and owner’s equity $166,000

4

Compute standard financial

ratios.

FINANCIAL STATEMENT ANALYSIS

• Evaluate the financial condition of a

business:

– Used by management and creditors

• Two types:

– Balance sheet analysis

– Interstatement analysis

BALANCE SHEET ANALYSIS

• Uses only the information on the balance

sheet

• Includes calculating:

– Working capital

– Current ratio

– Quick ratio

WORKING CAPITAL

FORMULA:

The amount of capital the business has available for current operations.

CURRENT

ASSETS

CURRENT

LIABILITIES–

WORKING CAPITAL

FORMULA:

EXAMPLE: Northern Micro has current assets of $54,000 and current liabilities of $19,450.

CURRENT

ASSETS

CURRENT

LIABILITIES

$54,000 $19,450

WORKING

CAPITAL

$34,550

–

–

=

=

CURRENT RATIO

FORMULA:

CURRENT

ASSETS

CURRENT

LIABILITIES

CURRENT RATIO

EXAMPLE: Let’s look at the current ratio for Northern Micro.

CURRENT

ASSETS

CURRENT

LIABILITIES

$54,000

$19,4502.8 to 1= =

CURRENT RATIO

• Measures a firm’s ability to pay its current liabilities

• ―Rule of thumb‖ = 2 to 1

• Many companies operate successfully with a current ratio of 1.5 to 1

• It is better to compare an individual company to industry averages

CURRENT RATIO

EXAMPLE: Let’s look at the current ratio for Northern Micro.

CURRENT

ASSETS

CURRENT

LIABILITIES

$54,000

$19,4502.8 to 1= =

Northern Microhas a very good

current ratio!

QUICK RATIO

• Gives a more defined picture of a firm’s

ability to pay its current liabilities

• ―Rule of thumb‖ = 1 to 1

• Many businesses operate successfully

with a quick ratio of 0.6 to 1

QUICK RATIO

FORMULA:

QUICK

ASSETS

CURRENT

LIABILITIES

QUICK ASSETS

• Cash and all other assets that can be converted into cash quickly

• Examples:

– Accounts receivable and temporary investments

• Northern Micro has $35,000 of quick assets

– $20,000 in cash and $15,000 in accounts receivable

=

BALANCE SHEET ANALYSIS

QUICK RATIO

FORMULA:

QUICK

ASSETS

CURRENT

LIABILITIES

$35,000

$19,4501.8 to 1

Quick assets aremore than adequate

to meet currentobligations.

=

INTERSTATEMENT ANALYSIS

• Provides a comparison of the relationships between selected income statement and balance sheet amounts

• Includes:

– Return on owner’s equity

– Accounts receivable turnover

– Average collection period

– Inventory turnover

– Average days to sell inventory

RETURN ON OWNER’S EQUITY

FORMULA:

NET INCOME

AVERAGE

OWNER’S EQUITY


NET INCOME

AVERAGE

OWNER’S EQUITY

EXAMPLE: Let’s compute the return on owner’s equity for Northern Micro.

$22,650=

AVERAGE OWNER’S EQUITY

FORMULA:

Owner’s Equity

at the Beginning

of the Year

+ Owner’s Equity

at the End of the

Year

2


NET INCOME

AVERAGE

OWNER’S EQUITY


$22,650

($104,400 + $117,050) 2

$110,725=


NET INCOME

AVERAGE

OWNER’S EQUITY


$22,650

$110,72520.5%

This should be compared withprior years and other businessesof comparable nature and size.

= =

ACCOUNTS RECEIVABLE TURNOVER

A measure of the time required to collect cash from customers.

FORMULA:

NET CREDIT SALES

FOR THE PERIOD

AVERAGE ACCOUNTS

RECEIVABLE


EXAMPLE: Net credit sales for Northern Micro are $110,000 and accounts receivable for January 1 and December 31 are $10,000

and $15,000, respectively.

NET CREDIT SALES

FOR THE PERIOD

AVERAGE ACCOUNTS

RECEIVABLE

$110,000

$12,5008.8

($10,000 + $15,000) 2

==


EXAMPLE: Net credit sales for Northern Micro are $110,000 and accounts receivable for January 1 and December 31 are $10,000

and $15,000, respectively.

NET CREDIT SALES

FOR THE PERIOD

AVERAGE ACCOUNTS

RECEIVABLE

$110,000

$12,5008.8==

Indicates the number oftimes accounts receivable

were collected in the accountingperiod. A higher number indicatesthat cash is collected more quickly.

AVERAGE COLLECTION PERIOD

FORMULA:

NUMBER OF DAYS

IN THE YEARRATE OF

TURNOVER

365

8.841.5 days

The number of days credit customers are taking to pay for their purchases.

Comparing the average collection periodwith a business’s credit terms offers an

indication of whether customers arepaying within the terms.

= =

INVENTORY TURNOVER

FORMULA:

Represents the number of times merchandise inventory was turned over

(sold) during the accounting period.

COST OF GOODS SOLD

FOR THE PERIOD

AVERAGE

INVENTORY

INVENTORY TURNOVER

EXAMPLE: Northern Micro’s cost of goods sold was $111,500 for the year and inventory

balances for the beginning and end of the year were $26,000 and $18,000, respectively.

COST OF GOODS SOLD

FOR THE PERIOD

AVERAGE

INVENTORY

$111,500

$22,000

($26,000 + $18,000) 2

5.1= =

INVENTORY TURNOVER

• The higher the rate of inventory turnover,

the smaller the profit required on each

dollar of sales to produce a satisfactory

gross profit

• Grocery stores have high turnover and a

low profit per item

• Jewelry stores need higher profit per item

to offset the low turnover

AVERAGE DAYS TO SELL

INVENTORY

FORMULA:

NUMBER OF DAYS

IN THE YEAR

RATE OF

TURNOVER

Just like theaverage collection

period formula

AVERAGE DAYS TO SELL

INVENTORY

FORMULA:

NUMBER OF DAYS

IN THE YEAR

RATE OF

TURNOVER

365

5.171.6 days

Needs to be compared with prior years,other companies, or its industry.

= =

5

Prepare closing entries for

a merchandising business.

CLOSING ENTRIES

• Similar to closing entries for a service

business

– Additional merchandising accounts also

must be closed

• The easiest way to complete the closing

process is to use a work sheet to prepare

closing entries


DR.CR.ACCOUNT TITLE

Gary L. Fishel, Capital

CR.INCOME STMT.

Gary L. Fishel, DrawingIncome SummarySalesSales Returns & Allow.Interest RevenueRent RevenueSubscriptions Revenue

Purchases Ret. & Allow.Purchases Discounts

Purchases

Freight-InWages ExpenseAdvertising Expense

Bank Credit Card ExpenseRent Expense

DR.BALANCE SHEET

1,500

114,40020,000

26,000

1,200900

8,00010,000

105,000800

1,000300

42,4502,500

20,000

3,500

17

Supplies ExpenseTelephone ExpenseUtilities ExpenseInsurance Expense

18192021222324252627282930313233343536

18,000214,000

1,400

12,000

1,800

Entry#1DEBIT – all income statementaccounts with credit balancesCREDIT – Income Summary


CLOSING ENTRIES FOR A MERCHANDISING

BUSINESS

DATE DESCRIPTION PR DEBIT CREDIT

Closing Entries1

2

3

4

5

6

7

8

9

10

11

Dec.20--

31 Sales

Subscriptions Revenue

Interest Revenue

Rent Revenue

Purch. Returns and Allowances

Purchases Discounts

Income Summary

214,000

10,000

900

8,000

800

1,000

234,700


DR.CR.ACCOUNT TITLE

CR.

INCOME STMT.

Sales Returns & Allow.

Purch. Returns & Allow.Purchases Discounts

Purchases

Wages ExpenseAdvertising ExpenseBank Credit Card Exp.Rent Expense

DR.

BALANCE SHEET

1,500

1,200

8001,000

105,000

42,4502,500

20,000

3,500

21


25262728293031323330313233343536

1,400

12,0001,800

Freight-In 300

Depr. Expense–BuildingDepr. Expense–Store Eq.

4,0003,000

Miscellaneous Expense 2,250Interest Expense 3,150

Entry #2DEBIT – Income

SummaryCREDIT – all

income statementaccounts withdebit balances


204,050

1,200

105,000

300

42,450

2,500

1,500

20,000

1,400

3,500

12,000

10

11

12

13

14

15

16

17

18

19

20

2122

2324

25

2627

31 Income Summary

Sales Returns & Allow.

Purchases

Freight-In

Wages Expense

Advertising Expense

Bank Credit Card Exp.

Rent Expense

Supplies Expense

Telephone Expense

Utilities Expense

Insurance Expense 1,800

Depr. Exp.–Building 4,000

Depr. Exp.–Store Eq. 3,000Miscellaneous Expense 2,250

Interest Expense 3,150


DR.CR.ACCOUNT TITLE

Purchases

CR.INCOME STMT.

Purchases Ret. & Allow.Purchases DiscountsFreight-InWages ExpenseAdvertising ExpenseBank Credit Card ExpRent Expense

Telephone ExpenseUtilities Expense

Supplies Expense

Insurance ExpenseDepr. Expense–BuildingDepr. Expense–Store Eq.Miscellaneous ExpenseInterest Expense

DR.

BALANCE SHEET

2,250

105,000800

42,4502,5001,500

20,0001,4003,500

12,0001,8004,0003,000

3,150

22,650

25

Net Income

26272829303132333435363738394041424344

1,000300

230,050

252,700

252,700

252,700

224,000

224,00022,650

201,350

224,000

Entry #3DEBIT – Income Summary

CREDIT – the owner’s capital accountfor the net income amount


20

21

22

23

24

25

26

27

28

29

30

3132

3334

35

3637

Income Summary 22,650

Gary L. Fishel, Capital 22,650

31


DR.CR.ACCOUNT TITLE

Gary L. Fishel, Capital

CR.INCOME STMT.

Gary L. Fishel, DrawingIncome SummarySalesSales Returns & Allow.Interest RevenueRent RevenueSubscriptions Revenue

Purchases Ret. & AllowPurchases Discounts

Purchases

Freight-InWages ExpenseAdvertising ExpenseBank Credit Card ExpenseRent Expense

DR.BALANCE SHEET

1,500

114,40020,000

26,000

1,200900

8,00010,000

105,000800

1,000300

42,4502,500

20,000

3,500

17


18192021222324252627282930313233343536

18,000214,000

1,400

12,000

1,800

Entry # 4DEBIT – the owner’s capital account

CREDIT – the owner’s drawing account


20

21

22

23

24

25

26

27

28

29

30

3132

3334

35

3637

31 Gary L. Fishel, Capital

Gary L. Fishel, Drawing

20,000

20,000

POST-CLOSING TRIAL BALANCE

• A trial balance of the general ledger

accounts taken after the temporary

owner’s equity accounts have been closed

• Purpose: To prove that the general ledger

is in balance at the beginning of a new

accounting period, before any

transactions for the new accounting period

are entered


Northern MicroPost-Closing Trial Balance

December, 31, 20--Account Title Acct # Debit Bal. Credit Bal.

CashAccounts ReceivableMerchandise InventorySuppliesPrepaid InsuranceLandBuildingAccumulated Depreciation—BuildingStore EquipmentAccumulated Depreciation—Store Eq.Notes Payable Accounts PayableWages PayableSales Tax PayableUnearned Subscriptions RevenueMortgage PayableGary L. Fishel, Capital

101122131141145161171

171.1181

181.1201202219231241251311

20,00015,00018,000

400600

10,00090,000

20,00050,000

18,0005,000

10,000450

1,5002,000

204,000117,05030,000

204,000

6

Prepare reversing entries.

REVERSING ENTRIES

• Prepared at the beginning of an

accounting period

• Reverse adjusting entries

• Done to simplify the recording of

transactions in the new accounting period

• Except for the first year of operations, only

adjustments that INCREASED an ASSET

OR LIABILITY account from a zero

balance should be reversed


WHICH ADJUSTING ENTRIES TO

REVERSE?


Adjusting Entries1

2

3

4

5

6

7

8

9

10

11

Dec.20--

31 Income Summary

Merchandise Inventory


Income Summary

Supplies Expense

26,000

26,000

18,000

18,000

1,400

31

31

Supplies 1,400

31 Insurance Expense 1,800

Which of these adjustingentries should be reversed?



REVERSE?


Adjusting Entries1

2

3

4

5

6

7

8

9

10

11

Dec.20--

31 Income Summary



Income Summary

Supplies Expense

26,000

26,000

18,000

18,000

1,400

31

31

Supplies 1,400


Never reverse adjustmentsfor merchandise inventory.



REVERSE?


Adjusting Entries1

2

3

4

5

6

7

8

9

10

11

Dec.20--

31 Income Summary



Income Summary

Supplies Expense

26,000

26,000

18,000

18,000

1,400

31

31

Supplies 1,400


No asset or liability with a zerobalance has been increased.No reversing entry is needed.


1,800

1,800

4,000

4,000

3,000

3,000

450

450

11

12

13

14

15

16

17

18

19

20

21

2223

2425

26

2728

31 Insurance Expense

Prepaid Insurance

Depr. Exp.—Building

Accum. Depr.—Building

Depr. Exp.—Store Eq.

Accum. Depr.—Store Eq.

Wages Expense

Wages Payable

Unearned Subscrip. Rev. 10,000

Subscriptions Revenue 10,000

31

31

31

31



1,800

1,800

4,000

4,000

3,000

3,000

450

450

11

12

13

14

15

16

17

18

19

20

21

2223

2425

26

2728


Prepaid Insurance





Wages Expense

Wages Payable



31

31

31

31

Never reverse adjustmentsfor depreciation.


1,800

1,800

4,000

4,000

3,000

3,000

450

450

11

12

13

14

15

16

17

18

19

20

21

2223

2425

26

2728


Prepaid Insurance





Wages Expense

Wages Payable



31

31

31

31A liability account with a zero balance

has been increased!!!A reversing entry is needed.


1,800

1,800

4,000

4,000

3,000

3,000

450

450

11

12

13

14

15

16

17

18

19

20

21

2223

2425

26

2728


Prepaid Insurance





Wages Expense

Wages Payable

Unearned Subscript. Rev. 10,000


31

31

31

31



REVERSING ENTRY FOR NORTHERN

MICRO


Reversing Entries1

2

3

4

5

6

7

8

9

10

11

Jan.20--

1 Wages Payable

Wages Expense

450

450

Reversing entries are the reverseor opposite of the adjusting entry.

Documents

College Accounting - MCCChorowitk/documents/Chapter15.pdf · Accounting for a Merchandising Business. 1 Prepare a single-step and multiple-step income statement for a merchandising