Accounting chapter 14 on your own

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4. Begin a work sheet for a merchandising business.

5. Plan work sheet adjustments for merchandise inventory, supplies, prepaid expenses, uncollect- ible accounts, and depreciation.

6. Calculate federal income tax and plan the work sheet adjustment for federal income tax.

7. Complete a work sheet for a merchandising business.

After studying Chapter 14, you will be able to:

1. Define accounting terms related to distribut- ing dividends and preparing a work sheet for a merchandising business.

2. Identify accounting concepts and practices related to distributing dividends and preparing a work sheet for a merchandising business.

3. Journalize the declaration and payment of a dividend.

C H A P T E R 1 4 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

O B J E C T I V E S

K E Y T E R M S

• retained earnings • dividends • board of directors • declaring a dividend • merchandise inventory • uncollectible accounts

• allowance method of recording losses from uncollectible accounts

• book value • book value of accounts

receivable • current assets • plant assets

• depreciation expense • estimated salvage value • straight-line method of

depreciation • accumulated

depreciation • book value of a plant

asset

www.C21accounting.com Point Your Browser( )

402

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Finding Stock Prices Many company web sites give

a history of the stock prices

for the company’s stock. Go to

the homepage for a company

of your choice. Look under a

heading such as “About Us”

or “Investor Relations” to find

information about the price of

the company’s stock.

Instructions

1. Find the closing stock price

from the previous day’s

trading.

2. Find the highest price for

which the stock sold on

the previous day.

3. Find the lowest price for

which the stock sold on

the previous day.

A C C O U N T I N G I N T H E R E A L W O R L D

I N T E R N E T A C T I V I T Y

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Lowe’s

Lowe’s—the Good Neighbor Welcome to the neighborhood! That’s the reaction Lowe’s wants when

it opens a store in your neighborhood. Lowe’s is working to make home

improvement more convenient for its customers. By providing the right

products at the right price, whether in local stores or at Lowes.com, the com-

pany seeks to make it easy for its customers to improve the quality and value

of their homes.

Lowe’s is also investing in its community. The company provides relief

supplies to victims of natural disasters, financial support for Habitat for

Humanity, and educational grants to K-12 public

education systems.

Community involvement is impor-

tant to the employees at Lowe’s.

The company encourages vol-

unteerism through Lowe’s

Heroes, a program focused

on home safety. Looking

out for your neighbor—

that’s what being a good

neighbor is all about.

Critical Thinking

1. Beyond having quality products at a fair price, how do Lowe’s and

other home improvement companies assist customers to improve

their homes?

2. How should Lowe’s account for a donation of lumber to a Habitat for

Humanity house?

Source: www.lowes.com

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Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

L E S S O N

14-1 Distributing Corporate Earnings to Stockholders

Management decisions about future business operations are often based on financial information. This informa- tion shows whether a profit is being made or a loss is being incurred. Profit or loss information helps an owner or manager determine future changes. Financial information is also needed to prepare required tax reports. Hobby Shack uses a fiscal year that begins on January 1 and ends on December 31. Therefore, Hobby Shack sum- marizes its financial information on December 31 of each year.

F I N A N C I A L I N F O R M AT I O N

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A company that believes one of

its employees is stealing may

obtain the services of a Cer-

tified Fraud Examiner (CFE).

The CFE is trained to examine

accounting records and obtain

other evidence related to the

alleged theft. CFEs often serve

as expert witnesses in court. The

Code of Professional Ethics of the

Association of Certified Fraud Examin-

ers provides its members with guidance on

how to serve as an expert witness. The Code states that

the CFE should obtain evidence that provides a reason-

able basis for his or her opinion. However, the CFE should

never express an opinion on the guilt or innocence of any

person.

Instructions Access the ACFE Code of Professional Ethics of the Associa-

tion of Certified Fraud Examiners at www.cfenet.com. Cit-

ing the section, what other advice does the Code provide

a CFE when serving as an expert witness?

He’s Gui l t y !

C H A R A C T E R C O U N T S

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404 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

A corporation’s ownership is divided into units. Each unit of ownership in a corporation is known as a share of stock. An owner of one or more shares of a corporation is known as a stockholder. Each stockholder is an owner of a corporation. Owners’ equity accounts for a corporation normally are listed under a major chart of accounts division titled Stockholders’ Equity. Most corporations have many stockholders. It is not practical to have a separate owner’s equity account for each stockholder. Instead, a single owners’ equity account, titled Capital Stock, is used for the investment of all owners. A second stockholders’ equity account is used to record a corporation’s earnings. Net income increases a corpo- ration’s total stockholders’ equity. Some income may be

retained by a corporation for business expansion. An amount earned by a corporation and not yet distributed to stockholders is called retained earnings. Retained Earn- ings is the title of the account used to record a corpora- tion’s earnings. Some income may be given to stockholders as a return on their investments. A third stockholders’ equity account is used to record the distribution of a corporation’s earn- ings to stockholders. Earnings distributed to stockholders are called dividends. A corporation’s dividend account is a temporary account similar to a proprietorship’s draw- ing account. Each time a dividend is declared, an account titled Dividends is debited. At the end of each fiscal period, the balance in the dividends account is closed to Retained Earnings.

S T O C K H O L D E R S ’ E Q U I T Y A C C O U N T S U S E D B Y A C O R P O R AT I O N

(3000) STOCKHOLDERS’ EQUITY

3110 Capital Stock 3120 Retained Earnings 3130 Dividends 3140 Income Summary

R E M E M B E R

Dividends is a temporary account that is closed to

Retained Earnings at the end of the fiscal period.

PHOTOGRAPHER’S CHOICE RF/GETTY IMAGES

Distributing Corporate Earnings to Stockholders Lesson 14-1 405

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D E C L A R I N G A D I V I D E N D

A group of persons elected by the stockholders to manage a corporation is called a board of directors. Dividends can be distributed to stockholders only by formal action of a corporation’s board of directors. [CONCEPT: Busi- ness Entity] Action by a board of directors to distribute corporate earnings to stockholders is called declaring a dividend. Dividends normally are declared on one date and paid on a later date. If a board of directors declares a dividend, the corporation is then obligated to pay the dividend. The dividend is a liability that must be recorded in the corpo- ration’s accounts. Hobby Shack declares dividends each March 15, June 15, September 15, and December 15. The dividends are then paid on the 15th of the following month. The stockholders’ equity account, Dividends, has a nor- mal debit balance and is increased by a $5,000.00 debit. Dividends Payable is credited for $5,000.00 to show the increase in this liability account.

December 15. Hobby Shack’s board of directors declared a quarterly dividend of $2.00 per share; capital stock issued is 2,500 shares;

total dividend, $5,000.00. Date of payment is January 15. Memorandum No. 79.

GENERAL JOURNAL PAGE 14

1

2

1

2

DATE ACCOUNT TITLE DEBIT CREDIT

Dec. 20--

15 Dividends Dividends Payable

DOC. NO.

POST. REF.

50 0 0 00 50 0 0 00

M79

3. Memorandum Number2. Account Debited 4. Amount Debited

5. Account Credited 6. Amount Credited1. Date

1

2 3 4

5 6

Dividends

Dividends Payable

3/15 Decl. 6/15 Decl. 9/15 Decl. 12/15 Decl.

5,000.00 5,000.00 5,000.00 5,000.00

4/15 Paid 7/15 Paid 10/15 Paid

5,000.00 5,000.00 5,000.00

3/15 Decl. 6/15 Decl. 9/15 Decl. 12/15 Decl.

5,000.00 5,000.00 5,000.00 5,000.00

Number of Shares Outstanding

2,500

Quarterly Dividend per Share

$2.00

Total Quarterly Dividend $5,000.00

�

�

�

�

1 Write the date, 20--, Dec. 15, in the Date column.

2 Write the title of the account debited, Dividends, in the Account Title column.

3 Write the memorandum number, M79, in the Doc. No. column.

4 Write the debit amount, $5,000.00, in the Debit column.

5 Write the title of the account credited, Dividends Payable, on the next line of the Account Title column, indented about 1 centimeter.

6 Write the credit amount, $5,000.00, in the Credit column.

S T E P S JOURNALIZING DECLARING A DIVIDEND

406 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

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P AY I N G A D I V I D E N D

Hobby Shack issues one check for the amount of the total dividend to be paid. This check is deposited in a special dividend checking account. A separate check for each stockholder is drawn on this special account. The special account avoids a large number of cash payments journal entries and also reserves cash specifically for pay- ing dividends. A check is often made payable to an agent, such as a bank. The agent then handles the details of sending divi- dend checks to individual stockholders.

January 15. Paid cash for quarterly dividend declared December 15, $5,000.00. Check No. 379.

When this entry is posted, the dividends payable account has a zero balance.

CASH PAYMENTS JOURNAL PAGE 25 1 2 3 4

1

2

1

2

DATE ACCOUNT TITLE PURCHASES DISCOUNT

CREDIT

CASH CREDIT

Jan. 20--

15 Dividends Payable

CK. NO.

POST. REF.

GENERAL

DEBIT CREDIT

5 0 0 0 00 5 0 0 0 00

5

ACCOUNTS PAYABLE

DEBIT

379

3. Check Number 4. Debit Dividends Payable

5. Credit Cash

2

3 4

2. Account Title

1. Date

1 5

Dividends Payable

Cash

4/15 Paid 7/15 Paid 10/15 Paid 1/15 Paid

5,000.00 5,000.00 5,000.00 5,000.00

3/15 Decl. 6/15 Decl. 9/15 Decl. 12/15 Decl.

5,000.00 5,000.00 5,000.00 5,000.00

1/15 Paid 5,000.00

1 Write the date, 20--, Jan. 15, in the Date column.

2 Write the account title, Dividends Payable, in the Account Title column.

3 Write the check number, 379, in the Ck. No. column.

4 Write the debit amount, $5,000.00, in the General Debit column.

5 Write the credit amount, $5,000.00, in the Cash Credit column.

S T E P S JOURNALIZING THE PAYMENT OF DIVIDENDS

F O R YO U R I N F O R M AT I O N

F Y I

Dividends are declared on one date and paid on a later date. Only

stockholders owning the stock on the date of record specified by the board of directors receive the

dividend. Stockholders owning the stock on the date of record receive

the entire dividend, regardless of how long they have owned the stock.

Distributing Corporate Earnings to Stockholders Lesson 14-1 407

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E n d o f L e s s o n

REVIEW A U D I T Y O U R U N D E R S T A N D I N G

1. Under what major chart of accounts division are the owners’ equity accounts for a corporation normally listed?

2. How many accounts are kept for the investment of all owners of a corporation?

3. What account does a corporation use to record earnings not yet distrib- uted to stockholders?

4. What action is required before a corporation can distribute income to its stockholders?

W O R K T O G E T H E R 1 4  1

Journalizing dividends

Journals are given in the Working Papers. Your instructor will guide you through the following examples.

Coastal Aquatics completed the following transactions during December of the current year and January of the next year.

Transactions: Dec. 15. The board of directors declared a dividend of $3.00 per share; capital stock issued is 1,750 shares. M162. Jan. 15. Paid cash for dividend declared December 15. C687.

1. Use page 14 of a general journal. Journalize the dividend declared on December 15.

2. Use page 21 of a cash payments journal. Journalize payment of the dividend on January 15.

O N Y O U R O W N 1 4  1

Journalizing dividends

Journals are given in the Working Papers. Work this problem independently.

Sonoma Treasures completed the following transactions during December of the current year and January of the next year.

Transactions: Dec. 15. The board of directors declared a dividend of $1.00 per share; capital stock issued is 21,000 shares.

M321. Jan. 15. Paid cash for dividend declared December 15. C721.

1. Use page 22 of a general journal. Journalize the dividend declared on December 15.

2. Use page 24 of a cash payments journal. Journalize payment of the dividend.

retained earnings

dividends

board of directors

declaring a dividend

T E R M S R E V I E W

408 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

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L E S S O N

14-2

Beginning an 8-Column Work Sheet for a Merchandising Business

A columnar accounting form on which the financial information needed to prepare financial statements is summarized is known as a work sheet. A work sheet is used to plan adjustments and summarize the information nec-

essary to prepare financial statements. The steps used to prepare a work sheet are similar for proprietorships and corporations.

To prepare a work sheet, a trial balance is first entered in the Trial Balance columns. All general ledger accounts and balances are listed in the same order as they appear in the general ledger. Trial Balance columns are totaled to prove equality of debits and credits. The worksheet for Hobby Shack is different from the work sheet completed for TechKnow in Chapter 6. Unlike

E N T E R I N G A T R I A L B A L A N C E O N A W O R K S H E E T

a service business, a merchandising business will have an account for merchandise inventory. A corporation’s accounts are similar to those of a proprietorship except for the capital stock, retained earnings, dividends, and federal income tax accounts.

Some general ledger accounts need to be brought up to date before financial statements are prepared. Accounts are brought up to date by planning and entering adjust- ments on a work sheet. Adjustments are planned in the Adjustments columns of a work sheet. Adjustments recorded on a work sheet are for planning purposes only. The general ledger account balances are not changed until entries are journalized and posted. Journal entries made to bring general ledger accounts up to date are known as adjusting entries. Hobby Shack’s adjustments for supplies and prepaid insurance are the same as those for TechKnow described in Chapter 6. Hobby Shack also makes adjustments to these accounts: (1) Merchandise Inventory, (2) Uncollect- ible Accounts Expense, (3) Depreciation Expense, and (4) Federal Income Tax Expense.

P L A N N I N G A D J U S T M E N T S O N A W O R K S H E E T

The adjustment for merchandise inventory is unique to a merchandising business. Adjustments for uncollect- ible accounts expense and depreciation expense could also be made by a service business. The adjustment for federal income tax is unique to corporations. This adjustment is not made for a proprietorship because taxes are paid by the owner, not the business.

S P O T L I G H T

Small businesses represent approximately 99 percent of

employers, employ nearly 50 percent of non-government employees,

and are responsible for about two-thirds to three-quarters of net new jobs, according to the Office of Advocacy of the U.S.

Small Business Administration.

S M A L L B U S I N E S S

Beginning an 8-Column Work Sheet for a Merchandising Business Lesson 14-2 409

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R E C O R D I N G A T R I A L B A L A N C E O N A W O R K S H E E T

TRIAL BALANCE ACCOUNT TITLE DEBIT CREDIT

1 2

Hobby Shack, Inc.

Work Sheet

For Year Ended December 31, 20--

Cash

Petty Cash

Accounts Receivable

Allow. for Uncoll. Accts.

Merchandise Inventory

Supplies—Office

Supplies—Store

Prepaid Insurance

Office Equipment

Acc. Depr.—Office Equipment

Store Equipment

Acc. Depr.—Store Equipment

Accounts Payable

Federal Income Tax Payable

Insurance Expense

Miscellaneous Expense

Payroll Taxes Expense

Rent Expense

Salary Expense

Supplies Expense—Office

Supplies Expense—Store

Uncollectible Accounts Expense

Utilities Expense

Federal Income Tax Expense

1

2

3

4

5

6

7

8

9

10

11

12

13

14

40

41

42

43

44

45

46

47

48

49

50

29 0 8 0 28 3 0 0 00

14 6 9 8 40

140 4 8 0 00 3 4 8 0 00 3 9 4 4 00 5 8 0 0 00

35 8 6 4 50

40 8 4 9 50

2 5 6 4 90 9 1 0 5 00

18 0 0 0 00 104 5 2 5 00

3 8 2 0 00 18 0 0 0 00

670 8 6 1 59

1 2 7 52

6 4 9 7 00

5 0 6 9 00 11 5 8 3 03

670 8 6 1 59

ACCOUNT NO. 1110

DATE ITEM DEBIT CREDIT BALANCE

Dec. 20--

1 31 31

Balance

POST. REF.

37 1 8 0 80 36 3 6 0 52

DEBIT CREDIT

2 8 2 6 0 00 6 5 4 4 0 80 2 9 0 8 0 28

ACCOUNT Cash

�

CR12 CP24

1. Account Titles

1 2

3. Total, prove and rule the debit and credit columns.

2. Account Balances

3

1 Write the title of each general ledger account in the work sheet’s Account Title column in the same order they appear in the general ledger. All accounts are listed regardless of whether there is a balance or not. Listing all accounts reduces the possibility of overlooking an account that needs to be brought up to date.

2 Write the balance of each account in the appropriate work sheet’s Trial Balance Debit or Credit column. The amounts are taken from the general ledger accounts.

3 Total, prove, and rule the Trial Balance Debit and Credit columns of the work sheet.

S T E P S RECORDING A TRIAL BALANCE ON A WORK SHEET

410 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

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A N A LY Z I N G A N D R E C O R D I N G S U P P L I E S A D J U S T M E N T S

The balance of Supplies—Office in the trial balance, $3,480.00, is the cost of office supplies on hand at the beginning of the year plus the office supplies purchased during the year. The supplies on hand on December 31 are counted and determined to be $750.00. The differ- ence is the value of office supplies used during the year, which is an expense. Likewise, the balance of Supplies—Store in the trial balance, $3,944.00, is the cost of store supplies on hand at the beginning of the year plus the store supplies purchased during the year. The value of store supplies on hand on December 31 is determined to be $1,034.00.

Analyzing Supplies Adjustments Four questions are asked to analyze the adjustments for the supplies accounts.

1. What is the balance of the Supplies accounts? Supplies—Office, $3,480.00 Supplies—Store, $3,944.00

2. What should the balance be for these accounts? Supplies—Office, $750.00 Supplies—Store, $1,034.00

3. What must be done to correct the account balances? Decrease Supplies—Office, $2,730.00 ($3,480.00 � 750.00) Decrease Supplies—Store, $2,910.00 ($3,944.00 � 1,034.00)

4. What adjustment is made? Debit: Supplies Expense—Office, $2,730.00 Supplies Expense—Store, $2,910.00 Credit: Supplies—Office, $2,730.00 Supplies—Store, $2,910.00

The supplies adjustments are shown in the T accounts. The December 31 balance shown in faded type is the bal- ance before the adjustments.

Supplies Expense—Office

Adj. (a) 2,730.00

Supplies—Office

Dec. 31 Bal. 3,480.00 (Adj. Bal. 750.00)

Adj. (a) 2,730.00

Supplies Expense—Store

Adj. (b) 2,910.00

Supplies—Store

Dec. 31 Bal. 3,944.00 (Adj Bal. 1,034.00)

Adj. (b) 2,910.00

HOLA IM AGES/GETTY IMAGES

Beginning an 8-Column Work Sheet for a Merchandising Business Lesson 14-2 411

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R E C O R D I N G S U P P L I E S A D J U S T M E N T S O N A W O R K S H E E T

6

7

45

46

ACCOUNT TITLE TRIAL BALANCE

DEBIT CREDIT

ADJUSTMENTS

DEBIT CREDIT

Supplies—Office Supplies—Store

Supplies Expense—Office Supplies Expense—Store

1. Debits

2. Credits3. Labels

34 8 0 00 39 4 4 00

2 7 3 0 00 2 9 1 0 00

(a)

(b)

2 7 3 0 00 2 9 1 0 00

(a)

(b)

1 2 3 4

1

23

3

1 Write the debit amounts in the Adjustments Debit column on the lines with the appropriate account titles: $2,730.00 with Supplies Expense—Office and $2,910.00 with Supplies Expense—Store.

2 Write the credit amounts in the Adjustments Credit column on the lines with the appropriate account titles: $2,730.00 with Supplies—Office and $2,910.00 with Supplies—Store.

3 Label the two parts of the Supplies—Office adjustment with a small letter a in parentheses, (a). Label the two parts of the Supplies—Store adjustment with a small letter b in parentheses, (b).

S T E P S RECORDING WORK SHEET ADJUSTMENTS FOR SUPPLIES

DIG

ITAL VISION/GETTY IMAGES

412 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

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A N A LY Z I N G A N D R E C O R D I N G A P R E P A I D I N S U R A N C E A D J U S T M E N T

Insurance premiums are debited to a prepaid insurance account when paid. During the year, Hobby Shack paid $5,800.00 of insurance premiums.

Analyzing a Prepaid Insurance Adjustment Hobby Shack determined that the value of prepaid insur- ance on December 31 is $2,630.00. Therefore, the value of insurance used during the year is $3,170.00 ($5,800.00 � $2,630.00). This difference is the amount of insurance expense for the year. Prepaid Insurance is credited and Insurance Expense is debited at the end of the fiscal period for the value of insurance used. The prepaid insurance adjustment is shown in the T accounts. The December 31 balance shown in faded type is the balance before the adjustment.

1. What is the balance of Prepaid Insurance? $5,800.00

2. What should the balance be for this account? $2,630.00

3. What must be done to correct the account balance? Decrease $3,170.00 ($5,800.00 � $2,630.00)

4. What adjustment is made? Debit Insurance Expense, $3,170.00 Credit Prepaid Insurance, $3,170.00

Insurance Expense

Adj. (c) 3,170.00

Prepaid Insurance

Dec. 31 Bal. 5,800.00 (New Bal. 2,630.00)

Adj. (c) 3,170.00

Recording a Prepaid Insurance Adjustment

8

40

ACCOUNT TITLE TRIAL BALANCE

DEBIT CREDIT

ADJUSTMENTS

DEBIT CREDIT

Prepaid Insurance

Insurance Expense

2. Debit

1. Credit

3. Labels

5 8 0 0 00

3 1 7 0 00(c)

3 1 7 0 00(c)

1 2 3 4

2 3

3 1

1 Enter the amount of insurance used, $3,170.00, in the Adjustments Credit column on the Prepaid Insurance line of the work sheet.

2 Enter the same amount, $3,170.00, in the Adjustments Debit column on the Insurance Expense line of the work sheet.

3 Label the two parts of the adjustment with a small letter c in parentheses, (c).

S T E P S RECORDING WORK SHEET ADJUSTMENTS FOR PREPAID INSURANCE

Beginning an 8-Column Work Sheet for a Merchandising Business Lesson 14-2 413

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E n d o f L e s s o n

REVIEW A U D I T Y O U R U N D E R S T A N D I N G

1. What accounts are used for the adjustment to office supplies?

2. What accounts are used for the adjustment to prepaid insurance?

W O R K T O G E T H E R 1 4  2

Beginning an 8-column work sheet for a merchandising business

A partially completed work sheet for Coastal Aquatics is given in the Working Papers. Four general ledger accounts are shown below. Your instructor will guide you through the following examples.

1. Enter the accounts and account balances on the following lines.

Line Account Account Balance 3 Accounts Receivable $ 15,485.25 13 Accounts Payable 18,482.28 29 Sales 845,828.09 32 Purchases 389,184.01

2. Total, prove, and rule the trial balance.

3. From a physical count of the following, December 31 balances are determined to be:

Supplies—Office $657.15 Supplies—Store 633.11 Prepaid Insurance 800.00

Analyze adjustments that need to be made for the accounts above and enter the adjustments on the work sheet. Label the adjustments (a)–(c). Save your work to complete Work Together 14-3.

O N Y O U R O W N 1 4  2

Beginning an 8-column work sheet for a merchandising business

A partially completed work sheet for Sonoma Treasures is given in the Working Papers. Four general ledger accounts are shown below. Work this problem independently.

1. Enter the accounts and account balances on the following lines.

Line Account Account Balance 8 Prepaid Insurance $ 12,000.00 25 Capital Stock 210,000.00 30 Sales Discount 715.25 43 Rent Expense 30,000.00

2. Total, prove, and rule the trial balance.

3. From a physical count of the following, December 31 balances are determined to be:

Supplies—Office $ 633.61 Supplies—Store 983.36 Prepaid Insurance 3,000.00

Analyze adjustments that need to be made for the accounts above and enter the adjustments on the work sheet. Label the adjustments (a)–(c). Save your work to complete On Your Own 14-3.

414 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

L E S S O N

14-3

Planning and Recording a Merchandise Inventory Adjustment

M E R C H A N D I S E I N V E N T O R Y

In addition to supplies and prepaid insurance, Hobby Shack needs to adjust the merchandise inventory account. Planning the adjustment is similar to the adjustment for supplies. However, the adjusting entry includes a new account. The amount of goods on hand for sale to custom- ers is called merchandise inventory. The general ledger account in which merchandise inventory is recorded is titled Merchandise Inventory. Merchandise Inventory is an asset account with a normal debit balance.

The balance of the merchandise inventory account on December 31, the end of the fiscal year, is the same amount, $140,480.00. The January 1 and December 31 balances are the same because no entries have been made in the account during the fiscal year. The changes in inven- tory resulting from purchases and sales transactions have not been recorded in the merchandise inventory account. During a fiscal period, the amount of merchandise on hand increases each time merchandise is purchased. How- ever, all purchases are recorded in the purchases account. The amount of merchandise on hand decreases each time merchandise is sold. However, all sales are recorded in the sales account. This procedure makes it easier to determine the total purchases and sales during a fiscal period. The merchandise inventory account balance, therefore, must be adjusted to reflect the changes resulting from purchases and sales during a fiscal period.

In cr

ea se

D ecrease

Debit

Merchandise Inventory

Credit

Hobby Shack’s merchandise inventory account on Jan- uary 1, the beginning of the fiscal year, has a debit balance of $140,480.00.

STOCKBYTE/GETTY IMAGES

Merchandise Inventory

Jan. 1 Bal. 140,480.00

Planning and Recording a Merchandise Inventory Adjustment Lesson 14-3 415

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

A N A LY Z I N G A N D R E C O R D I N G A M E R C H A N D I S E I N V E N T O R Y A D J U S T M E N T

The two accounts used to adjust the merchandise inven- tory are Merchandise Inventory and Income Summary. Before the adjustment, the merchandise inventory account has a January 1 debit balance of $140,480.00. The merchandise inventory account balance, however, is not up-to-date. The actual count of merchandise on Decem- ber 31 shows that the inventory is valued at $124,640.00. Therefore, the merchandise inventory account balance must be adjusted to show the current value of merchan- dise on hand. Most accounts needing adjustment at the end of a fis- cal period have a related temporary account. For example, when the account Prepaid Insurance is adjusted, Insur- ance Expense is the related expense account, a temporary account. Merchandise Inventory, however, does not have a related expense account. Therefore, Income Summary, a temporary account, is used to adjust the merchandise inventory account at the end of a fiscal period. Four questions are asked in analyzing the adjustment for merchandise inventory.

1. What is the balance of Merchandise Inventory? $140,480.00

2. What should the balance be for this account? $124,640.00

3. What must be done to correct the account balance? Decrease $15,840.00

4. What adjustment is made? Debit Income Summary, $15,840.00 Credit Merchandise Inventory, $15,840.00

5

28

ACCOUNT TITLE TRIAL BALANCE

DEBIT CREDIT

ADJUSTMENTS

DEBIT CREDIT

Merchandise Inventory

Income Summary

2. Credit

3. Label

1. Debit

1404 8 0 00

15 8 4 0 00(d)

158 4 0 00(d)

1 2 3 4

1

2 3

Income Summary is debited and Merchandise Inven- tory is credited for $15,840.00. The beginning debit bal- ance of Merchandise Inventory, $140,480.00, minus the adjustment credit amount, $15,840.00, equals the ending debit balance of Merchandise Inventory, $124,640.00.

1 Write the debit amount, $15,840.00, in the Adjustments Debit column on the line with the account title Income Summary.

2 Write the credit amount, $15,840.00, in the Adjustments Credit column on the line with the account title Merchandise Inventory.

3 Label the two parts of this adjustment with a small letter d in parentheses, (d).

S T E P S RECORDING A WORK SHEET ADJUSTMENT FOR MERCHANDISE INVENTORY

Merchandise Inventory

Jan. 1 Bal. 140,480.00 (New Bal. 124,640.00)

Income Summary

Adj. (d) 15,840.00

Adj. (d) 15,840.00

416 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

A N A LY Z I N G A N A D J U S T M E N T W H E N E N D I N G M E R C H A N D I S E I N V E N T O R Y I S G R E AT E R T H A N B E G I N N I N G M E R C H A N D I S E I N V E N T O R Y

If the amount of merchandise inventory on hand is greater than the January 1 balance of Merchandise Inven- tory, opposite entries would be made—debit Merchandise Inventory and credit Income Summary. For example, Ven- able Company’s merchandise inventory account on Janu- ary 1 has a debit balance of $294,700.00. The count of merchandise on December 31 shows that the inventory is valued at $298,900.00. The merchandise on hand is $4,200.00 greater than the January 1 balance of Merchan- dise Inventory. Four questions are asked in analyzing the adjustment for merchandise inventory.

1. What is the balance of Merchandise Inventory? $294,700.00

2. What should the balance be for this account? $298,900.00

3. What must be done to correct the account balance? Increase $4,200.00

4. What adjustment is made? Debit Merchandise Inventory, $4,200.00 Credit Income Summary, $4,200.00

Merchandise Inventory is debited and Income Summary is credited for $4,200.00. The beginning debit balance of Merchandise Inventory, $294,700.00, plus the adjustment debit amount, $4,200.00, equals the ending debit balance of Merchandise Inventory, $298,900.00.

The merchandise inventory adjustment is shown in the T accounts.

R E M E M B E R

When an account that requires adjusting does not have a related expense account, the temporary account

Income Summary is used.

DIGITAL VISION/GETTY IMAGES

Merchandise Inventory

Jan. 1 Bal. 294,700.00 Adj. (d) 4,200.00 (New Bal. 298,900.00)

Income Summary

Adj. (d) 4,200.00

Planning and Recording a Merchandise Inventory Adjustment Lesson 14-3 417

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

E n d o f L e s s o n

REVIEW

T E R M R E V I E W

merchandise inventory

A U D I T Y O U R U N D E R S T A N D I N G

1. In what order should general ledger accounts be listed on a work sheet?

2. What accounts are used for the adjustment for merchandise inventory?

3. What adjusting entry is entered on a work sheet when the ending merchandise inventory is less than the beginning value?

4. When is the temporary account Income Summary used?

W O R K T O G E T H E R 1 4  3

Analyzing and recording an adjustment for merchandise inventory

Use the work sheet from Work Together 14-2. Your instructor will guide you through the following example.

1. From a physical count of merchandise inventory, the December 31 balance is determined to be $234,904.20. Analyze the merchandise inventory adjustment and enter the adjustment on the work sheet. Label the adjust- ment (d). Save your work to complete Work Together 14-4.

O N Y O U R O W N 1 4  3

Analyzing and recording an adjustment for merchandise inventory

Use the work sheet from On Your Own 14-2. Work this problem independently.

1. From a physical count of merchandise inventory, the December 31 balance is determined to be $261,089.97. Analyze the merchandise inventory adjustment and enter the adjustment on the work sheet. Label the adjust- ment (d). Save your work to complete On Your Own 14-4.

418 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

L E S S O N

14-4

Planning and Recording an Allowance for Uncollectible Accounts Adjustment

A L L O W A N C E M E T H O D O F R E C O R D I N G L O S S E S F R O M U N C O L L E C T I B L E A C C O U N T S

With each sale on account, a business takes a risk that customers will not pay their accounts. Accounts receiv- able that cannot be collected are called uncollectible accounts. This risk is a cost of doing business that should be recorded as an expense in the same accounting period that the revenue is earned. Accurate financial reporting requires that expenses be recorded in the fiscal period in which the expenses contribute to earning revenue. [CON- CEPT: Matching Expenses with Revenue] At the end of a fiscal year, a business does not know which customer accounts will become uncollectible. If a business knew exactly which accounts would become uncollectible, it could credit Accounts Receivable and each customer account for the uncollectible amounts and debit Uncollectible Accounts Expense for the same amounts. To solve this accounting problem, a business can cal- culate and record an estimated amount of uncollectible accounts expense. Estimating uncollectible accounts expense at the end of a fiscal period accomplishes two objectives:

1. It reports a balance sheet amount for Accounts Receiv- able that reflects the amount the business expects to collect in the future.

2. It recognizes the expense of uncollectible accounts in the same period in which the related revenue is recorded.

To record estimated uncollectible accounts, an adjust- ing entry is made affecting two accounts. The estimated amount of uncollectible accounts is debited to Uncollect- ible Accounts Expense and credited to an account titled Allowance for Uncollectible Accounts. An account that reduces a related account is known as a contra account. Allowance for Uncollectible Accounts is a contra account to its related asset account, Accounts Receivable. Crediting the estimated value of uncollectible accounts to a contra account is called the allowance method of recording losses from uncollectible accounts. The dif- ference between an asset’s account balance and its related contra account balance is called book value. The differ- ence between the balance of Accounts Receivable and its contra account, Allowance for Uncollectible Accounts, is called the book value of accounts receivable. The book value of accounts receivable, which is reported on the bal- ance sheet, represents the total amount of accounts receiv- able the business expects to collect in the future. A contra account is usually assigned the next number of the account number sequence after its related account in the chart of accounts. Hobby Shack’s Accounts Receivable account is numbered 1130 and the Allowance for Uncol- lectible Accounts contra account is numbered 1135.

D ecrease

In cr

ea se

In cr

ea se

D ecrease

Debit

Uncollectible Accounts Expense

Credit

In cr

ea se

D ecrease

Debit

Accounts Receivable

Credit Debit

Allowance for Uncollectible Accounts

Credit

Planning and Recording an Allowance for Uncollectible Accounts Adjustment Lesson 14-4 419

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

E S T I M AT I N G U N C O L L E C T I B L E A C C O U N T S E X P E N S E

Many businesses use a percentage of total sales on account to estimate uncollectible accounts expense. Each sale on account represents a risk of loss from an uncollectible account. Therefore, if the estimated percentage of loss is accurate, the amount of uncollectible accounts expense will be accurate regardless of when the actual losses occur. Since a sale on account creates a risk of loss, estimat- ing the percentage of uncollectible accounts expense for the same period matches sales revenue with the related uncollectible accounts expense. [CONCEPT: Matching Expenses with Revenue] Hobby Shack estimates uncollectible accounts expense by calculating a percentage of total sales on account. A review of Hobby Shack’s previous experience in col- lecting sales on account shows that actual uncollectible accounts expense has been about 1% of total sales on

account. The company’s total sales on account for the year is $124,500.00. Thus, Hobby Shack estimates that $1,245.00 of the current fiscal year’s sales on account will eventually be uncollectible.

F Y I

Total Sales on Account

$124,500.00

Percentage

1%

Estimated Uncollectible

Accounts Expense $1,245.00

�

�

�

�

F O R YO U R I N F O R M AT I O N

F Y I

Allowance for Bad Debts and Allowance for Doubtful Accounts

are account titles sometimes used instead of Allowance for

Uncollectible Accounts.

Mention the word “budget” to most peo- ple and many negative thoughts come to mind. However, a budget does not have to be restrictive or inflexible. In fact, a budget may give you more freedom.

A budget is merely a plan that helps you achieve your goals. When getting ready to prepare a budget, you not only

need to gather income and expense data, but you also need to determine and prioritize

your goals. For example, suppose you want to take a trip during spring break, but you also like to

have all the latest clothing styles. If you can’t do both, which is more important to you? No one can answer this

question for you. Financial goals are very personal. One of the major benefits of a budget is that any “left-

over” money you have is used to fund your goals in their order of priority. This may mean that instead of spending money on the latest fashions, you may choose to save it to

fund your spring-break trip—but only because you deter- mined the trip was more important. You are in control, and your budget can change as your goals change.

Think of a budget as a flexible spending plan that helps you achieve your goals, and you will be more likely to fol- low your budget and actually be able to take that trip!

Activities

1. One way to gather expense data for your budget is to write down all of your expenses for a period of time. Do this for one week. Try to pick a typical week, and remember to include all expenses. Then categorize what you’ve spent into “needs” and “wants.”

2. Survey five adults. Ask each one if he or she has a bud- get. If that person has a budget, ask if he or she follows it. What does he or she feel are the advantages and disadvantages of having a budget? Summarize your findings in a written report.

Per sonal Budget s

F I N A N C I A L L I T E R A C Y

P H

O T

O :

P H

O T

O D

IS C

/G E

T T

Y IM

A G

E S

420 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

A N A LY Z I N G A N D R E C O R D I N G A N A D J U S T M E N T F O R U N C O L L E C T I B L E A C C O U N T S E X P E N S E

The percentage of total sales on account method of esti- mating uncollectible accounts expense assumes that a portion of every sale on account dollar will become uncollectible. Hobby Shack has estimated that 1% of its $124,500.00 sales on account, or $1,245.00, will eventu- ally become uncollectible. At the end of a fiscal period, an adjustment for uncol- lectible accounts expense is planned on a work sheet. The Allowance for Uncollectible Accounts balance in the Trial Balance Credit column, $127.52, is the allow- ance estimate from the previous fiscal period that has not yet been identified as uncollectible. When the allowance account has a previous credit bal- ance, the amount of the adjustment is added to the previ- ous balance.

This new balance of the allowance account, $1,372.52, is the estimated amount of accounts receivable that will eventually become uncollectible. This amount, subtracted from the accounts receivable account balance, $14,698.40, is the book value of accounts receivable. Notice in the T accounts that Accounts Receivable is not affected by this adjustment. Also notice that Uncollectible Accounts Expense did not have a balance before the adjustment.

3

4

47

ACCOUNT TITLE TRIAL BALANCE

DEBIT CREDIT

ADJUSTMENTS

DEBIT CREDIT

Accounts Receivable Allowance for Uncollectible Accounts

Uncollectible Accounts Expense

1. Credit2. Debit

3. Label

14 6 9 8 40 1 2 7 52

1 2 4 5 00(e)

1 2 4 5 00(e)

1 2 3 4

1

2

3

Accounts Receivable

Dec. 31 Bal. 14,698.40

Uncollectible Accounts Expense

Adj. (e) 1,245.00

Allowance for Uncollectible Accounts

Bal. 127.52 Adj. (e) 1,245.00 (New Bal. 1,372.52)

Accounts Receivable

$14,698.40

Balance of Allowance for Uncollectible

Accounts $1,372.52

Book Value of Accounts

Receivable

$13,325.88

�

�

�

�

Hobby Shack estimates that it will collect $13,325.88 from its outstanding accounts receivable.

1 Enter the estimated uncollectible amount, $1,245.00, in the Adjustments Credit column on the Allowance for Uncollectible Accounts line of the work sheet.

2 Enter the same amount, $1,245.00, in the Adjustments Debit column on the Uncollectible Accounts Expense line of the work sheet.

3 Label the two parts of this adjustment with a small letter e in parentheses, (e).

S T E P S

RECORDING A WORK SHEET ADJUSTMENT FOR UNCOLLECTIBLE ACCOUNTS

Planning and Recording an Allowance for Uncollectible Accounts Adjustment Lesson 14-4 421

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

E n d o f L e s s o n

REVIEW A U D I T Y O U R U N D E R S T A N D I N G

1. Why is an uncollectible account recorded as an expense rather than a reduction in revenue?

2. When do businesses normally estimate the amount of their uncollect- ible accounts expense?

3. What two objectives will be accomplished by recording an estimated amount of uncollectible accounts expense?

4. Why is Allowance for Uncollectible Accounts called a contra account?

5. How is the book value of accounts receivable calculated?

uncollectible accounts

allowance method of recording losses from uncollectible accounts

book value

book value of accounts receivable

T E R M S R E V I E W

W O R K T O G E T H E R 1 4  4

Analyzing and recording an adjustment for uncollectible accounts expense

Use the work sheet from Work Together 14-3. Your instructor will guide you through the following example.

1. Coastal Aquatics estimates uncollectible accounts expense as 0.5% of its total sales on account. During the current year, Coastal Aquatics had sales on account of $424,000.00. Record the uncollectible accounts expense adjustment on the work sheet. Label the adjustment (e). Save your work to complete Work Together 14-5.

O N Y O U R O W N 1 4  4

Analyzing and recording an adjustment for uncollectible accounts expense

Use the work sheet from On Your Own 14-3. Work this problem independently.

1. Sonoma Treasures estimates uncollectible accounts expense as 0.4% of its total sales on account. During the current year, Sonoma Treasures had sales on account of $462,500.00. Record the uncollectible accounts expense adjustment on the work sheet. Label the adjustment (e). Save your work to complete On Your Own 14-5.

422 Chapter 14 Distributing Dividends and Preparing a Work Sheet for a Merchandising Business

Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.