Chapter 3: Adjusting and Closing for Merchandisers

Adjustments and Closing Entries for a Merchandising Company In a merchandising company, adjustments and closing entries are made at the end of an accounting period to ensure accurate financial reporting. Key processes include accounting for inventory shrinkage, adjusting for sales discounts, returns, and allowances, and closing temporary accounts. 1. Adjusting Entries for Merchandisers Merchandising Cost Flow Merchandising costs flow through several stages during the period: • • Beginning Inventory + Net Purchases = Merchandise Available for Sale As goods are sold, their cost is transferred to Cost of Goods Sold (COGS), with the remaining balance becoming Ending Inventory, reported on the balance sheet. At the end of the period, adjustments are made for items such as inventory shrinkage and estimated returns and allowances. Inventory Shrinkage In a perpetual inventory system, shrinkage is the difference between the recorded inventory and the physical count, accounting for losses due to theft, damage, or errors. The adjustment ensures that Merchandise Inventory reflects the actual amount available. For example, Z-Mart's Merchandise Inventory shows $21,250, but the physical count reveals only $21,000. To record the $250 shrinkage, the entry is: • • Debit Cost of Goods Sold $250 Credit Merchandise Inventory $250 Adjustments for Sales Discounts, Returns, and Allowances Adjustments may also be made for expected sales discounts, returns, and allowances. These entries ensure that revenue is recorded at the amount expected to be received. While the detailed entries depend on estimates of future discounts or returns, the adjustment would generally debit Sales Discounts or Sales Returns and Allowances and credit Accounts Receivable. 2. Closing Entries for Merchandisers Closing entries for merchandising companies are similar to those for service companies but involve additional temporary accounts related to merchandising activities, such as Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. These accounts are closed at the end of the period to transfer their balances to Income Summary and prepare for the next period. Steps in Closing Entries: 1. Close Sales (Revenue) Accounts: Since Sales has a normal credit balance, it is closed by debiting the Sales account and crediting Income Summary. o Debit Sales $X o Credit Income Summary $X 2. Close Contra-Revenue and Expense Accounts: Temporary accounts with debit balances, such as Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold, are closed by crediting them and debiting Income Summary. o Debit Income Summary $Y (for the total of all these accounts) o Credit Sales Discounts $A o Credit Sales Returns and Allowances $B o Credit Cost of Goods Sold $C 3. Close Income Summary to Retained Earnings: After transferring revenue and expenses to Income Summary, the net income (or loss) is transferred to Retained Earnings. o If there is a profit:  Debit Income Summary $Z  Credit Retained Earnings $Z o If there is a loss:  Debit Retained Earnings $Z  Credit Income Summary $Z 4. Close Dividends (if any): Finally, Dividends (if applicable) are closed by debiting Retained Earnings and crediting Dividends. o Debit Retained Earnings $D o Credit Dividends $D 3. Example of Recording Shrinkage and Closing Entries a. Recording Inventory Shrinkage: Assume a merchandising company has the following accounts at year-end, and the physical inventory count reveals $656 in inventory. The ledger shows a balance of $700 in Merchandise Inventory. The shrinkage adjustment entry would be: • • Debit Cost of Goods Sold $44 (700 − 656) Credit Merchandise Inventory $44 b. Closing Entries: 1. Close Sales: o Debit Sales $10,000 (for example) Credit Income Summary $10,000 2. Close Contra-Revenue and Expense Accounts: o Debit Income Summary $8,000 o Credit Sales Discounts $200 o Credit Sales Returns and Allowances $300 o Credit Cost of Goods Sold $7,500 3. Close Income Summary to Retained Earnings (assuming net income of $2,000): o Debit Income Summary $2,000 o Credit Retained Earnings $2,000 4. Close Dividends (if dividends of $500 were declared): o Debit Retained Earnings $500 o Credit Dividends $500 o Summary of Key Adjustments and Closing Entries: 1. Adjust for inventory shrinkage to match physical count and records. 2. Close temporary accounts related to sales, discounts, returns, allowances, and COGS. 3. Transfer net income or loss to Retained Earnings. 4. Close dividends (if any) to Retained Earnings.