Accounting theory and practice, Volume 1 (of 3)

by Roy B. Kester

During the year, sales amounted to $33,000; purchases to $25,000; selling expenses to $3,500; and general administrative expenses to $2,025. It is estimated that of outstanding accounts $350 are uncollectible; that furniture and fixtures have depreciated in value $45. Merchandise inventory shows $5,000 on hand. Gibson drew $1,000 during the year.

The first thing necessary is to make the adjustments on account of depreciation, bad debts estimate, and present inventory. These adjustment entries are made in the Journal as follows:

19—
Sept. 30	Depreciation	20	45.00
	Depreciation Reserve Furniture and Fixtures	6		45.00
	To bring on the books the expense due to estimated depreciation and to effect the proper valuation of Furniture and Fixtures.
	Bad Debts	21	350.00
	Reserve for Doubtful Accounts	3		350.00
	To bring on the books the expense due to estimated loss from uncollectible accounts.
	Purchases	16	4,000.00
	Merchandise Inventory	4		4,000.00
	To transfer the goods on hand at the beginning of the year to Purchases.
	Merchandise Inventory	4	5,000.00
	Purchases	16		5,000.00
	To transfer the inventory of merchandise now on hand to Merchandise Inventory account.

The first two entries, when posted, will bring on the book valuation accounts for furniture and fixtures and accounts receivable, and will set up the expense accounts, Depreciation and Bad Debts. The third Journal entry, when posted, will transfer the goods on hand at the beginning of the year so that they can be added to the Purchases made during the year. In this connection it will be remembered that the sum of these two items, old inventory plus purchases during the year, constitutes the primary factor of “cost of goods to be accounted for.” The fourth entry shows the asset Merchandise now on hand and, by its credit to Purchases, effects a subtraction from Purchases, so that the balance of Purchases, $24,000, shows the “cost of goods sold.”

The books are now adjusted and ready for summarization by means of the Profit and Loss account. The following Journal entries, transferring all temporary proprietorship items to the Profit and Loss account, will effect the closing operation:

19—
Sept. 30	Sales	15	33,000.00
	Profit and Loss	14		33,000.00
	To close.
	Profit and Loss	14	29,920.00
	Purchases	16		24,000.00
	Selling Expense	18		3,500.00
	General Administrative Expense	19		2,025.00
	Bad Debts	21		350.00
	Depreciation	20		45.00
	To close.			29,920.00
	Profit and Loss	14	3,080.00
	Jack Gibson, Personal	11		3,080.00
	To transfer net profit for the year.
	Jack Gibson, Personal	11	2,080.00
	Jack Gibson, Capital	10		2,080.00
	To transfer the portion of the year’s net gain left in the business.

The first entry transfers the sales income to the credit of Profit and Loss. The second entry charges the Profit and Loss account with the cost of goods sold and all other expenses for the fiscal year. When the posting has been completed up to this point, the balance of the Profit and Loss account shows a net gain of $3,080, which, belonging to the proprietor, is transferred to the credit of his personal account, as shown by the third entry. He has drawn against prospective profits to the extent of $1,000, leaving $2,080 of profit remaining in the business as an addition to his permanent investment. Hence, this balance is transferred to Gibson’s capital account by the fourth entry.

Objection to the Direct Ledger Method of Adjusting and Closing the Books.—These adjustment and closing transactions are sometimes recorded directly in the ledger without first entering them in the Journal. Usually this is not satisfactory because it does not show in one place a complete record of all the adjustment and closing summaries necessary at the close of a fiscal period. These summaries are matters of sufficient concern to the business to warrant their entry in the Journal where full and complete explanations can be given. The more complex entries often needed to adjust and close the books of a business where numerous income and expense accounts are kept, follow the same general principles as those discussed above. Adjusting and closing entries are given fuller treatment in Chapters [XXVII] and [XXVIII].

The two illustrations given above cover certain types of Journal entries which are of a more difficult character than the customary purchases, sales, and cash entries. A keen analysis is often required to formulate the debits and credits of these entries, and the explanatory matter should be worded with sufficient care to render them intelligible even after the immediate interest in them has been lost and their recording ink has become “cold.”

Entries Affecting Several Journals.—Transactions sometimes require entry in two or more journals. A basic principle of bookkeeping is that there should be no duplication of entry in the various journals. A transaction that can be completely entered in one journal should not be entered in any other journal. The one exception to this principle is made in the case of an investment transaction, as explained on [page 171]. Sometimes, however, there may be a conflict of places of entry, as in the case of cash purchases and sales, already explained, where entry is made in both journals in order to allow each journal to perform its proper function. Two examples will illustrate the proper method of handling such transactions.