Similarly, income is sometimes received in advance to cover services which have not yet been rendered, or rendered only in part, as when rent is received in advance to cover a given number of months, some of which belong to the next fiscal period. Consequently, only a part of this income applies to the current period, the balance being deferred to later periods.
For these reasons certain asset accounts need to be adjusted and certain liability accounts must be opened to bring the ledger into accord with the actual condition of things and show the true financial status of the business. The entries required for this purpose are called “adjustment entries” to distinguish them from the closing or summarizing entries to be described later in this chapter.
First in importance among the adjusting entries are those required to show the correct value of the stock-in-trade, the fixed assets, and the accounts receivable. Whether the merchandise items are kept in one or several accounts, the value of the stock on hand is not shown at any given time during the fiscal period. Goods have been purchased at one price and sold at another, and no record of the value of the merchandise inventory on hand is available. Similarly, no current record has been made of the depreciation of buildings, furniture, fixtures, or other equipment, nor has any provision been made for the accounts receivable that may prove uncollectible.
Basis of Adjustment Entries.—These items, then, merchandise, asset depreciation, bad debts, prepaid and accrued expenses and income, are the occasion of the adjustment entries. An inventory is required to find the value of the stock-in-trade; an appraisal is made of the depreciating assets to determine the amount of depreciation for the current period; and proper consideration must be given to the prepaid and accrued income and expense items for the period under review. The following illustrations are concerned with the several classes of adjustment entries. The detail of the account is not shown in each case, but only the balance.
Adjusting and Closing the Merchandise Records.—Unlike the method shown in the debit and credit schedule for merchandise in [Chapter XIII], the modern practice is to keep the merchandise record by means of the separate accounts used in the profit and loss statement, viz., Merchandise Inventory, Purchases, Inward Freight and Cartage, Returned Purchases, Purchases Rebates and Allowances, Sales, Returned Sales, and Sales Rebates and Allowances. It should be understood that this detailed record of merchandise transactions is preferable to the single merchandise account only because it gives more information. The detailed record does not in any way maintain a sharper separation of the asset and income elements of the merchandise transactions than does the single merchandise account. It does, however, make immediately available information as to volume of business, purchases, returns, and so forth—items which in any well-managed business are watched carefully. These detailed accounts taken together comprise the merchandise record and are equivalent to the single merchandise account.
It is apparent from a consideration of the single merchandise account that at any given time it includes these three items: (1) the net cost of the total goods to be accounted for; (2) the decrease in the asset merchandise brought about by sale; and (3) the profit on the goods sold. In order to bring about the separation of the merchandise records into the two elements (a) goods still on hand, that is, the asset element, and (b) the profit on goods sold, that is, the income element, it is necessary to bring the detailed accounts together for the purpose of summarization. This summarization is accomplished in much the same way as in the profit and loss statement. The net amount of sales and the net cost of goods sold are determined and set up against each other in order to indicate the gross profit. In arriving at the cost of goods sold it is necessary to bring together the opening inventory, the purchases, the inward freight and cartage, and from their sum to subtract the purchase returns, the purchase rebates and allowances, and the final inventory. How this is accomplished in the ledger is explained by an illustration, in which the adjustments or transfers between accounts are traced by means of cross-index letters.
Assume the following facts: Goods on hand January 1, 19—, $10,125.67; purchases for six months $47,897.42; inward freight and cartage $560.25; returned purchases $2,125.40; purchase rebates and allowances $267.92; sales $65,283.21; returned sales $3,924.83; sales rebates and allowances $392.48; and goods on hand June 30, 19—, $11,267.40. Each of these items appears as the first entry on the proper side of its account, and is distinguished by not being marked with a bracketed letter. The items comprise the ledger record previous to summarization at the close of the fiscal period.
| Merchandise Inventory | |||
| 19— | 19— | ||
| Jan. 1 | 10,125.67 | June 30 Purchases (B) | 10,125.67 |
| June 30 (E) | 11,267.40 | ||
| Purchases | |||
| 19— | 19— | ||
| June 30 (Total purchases) | 47,897.42 | June 30 Returned Purchases (C) | 2,125.40 |
| Inward Freight and Cartage (A) | 560.25 | Pur. Rebates & Allow (D) | 267.92 |
| Mdse. Inventory, Jan. 1 (B) | 10,125.67 | Inventory, June 30 (E) | 11,267.40 |
| Profit & Loss (F) | 44,922.62 | ||
| 58,583.34 | 58,583.34 | ||
| Inward Freight and Cartage | |||
| 19— | 19— | ||
| June 30 (Total) | 560.25 | June 30 Purchases (A) | 560.25 |
| Returned Purchases | |||
| 19— | 19— | ||
| June 30 Purchases (C) | 2,125.40 | June 30 (Total) | 2,125.40 |
| Purchases Rebates and Allowances | |||
| 19— | 19— | ||
| June 30 Purchases (D) | 267.92 | June 30 (Total) | 267.92 |
| Sales | |||
| 19— | 19— | ||
| June 30 Returned Sales (G) | 3,924.83 | June 30 (Total) | 65,283.21 |
| Sales Rebates & Allow (H) | 392.48 | ||
| Profit & Loss (I) | 60,965.90 | ||
| 65,283.21 | 65,283.21 | ||