It will be noted that some of the adjusting entries are not set up in the adjustment columns in exact accord with the way in which the same items are entered on the ledger, but rather in accord with the use to be made of the particular items in drawing up the periodic statements. The purpose of the columns is not to make the adjustments and summarization in a formal manner as is done in the books, but to gather together all the adjusting data so that a correct separation of the balance sheet and profit and loss items can be made for use in the formal summary entries and in the statements. Thus, instead of transferring the initial inventory to the Purchases account, it is allowed to remain under its own title, because it will be needed as a separate item in drawing up the cost-of-goods-sold section of the profit and loss statement. Similarly, the final inventory is not shown deducted from Purchases, but is set up, debit and credit, in the adjustment columns, opposite the title “Merchandise Inventory—Final,” which is inserted immediately following the account “Merchandise Inventory—Initial.” At the time of summarizing, the debit item goes into the balance sheet, while the credit item goes into profit and loss. This method of handling provides in the profit and loss columns the detailed information needed for the cost-of-goods-sold section of the statement, comprising Initial Inventory, Purchases, In-Freight, Purchases Returns and Allowances, and Final Inventory.
The bad debts adjustment is entered in the adjustment columns as a debit to Bad Debts and a credit to Reserve for Doubtful Accounts. Similarly, the depreciation entry is shown as a debit to Depreciation in detail, the credits going to the various depreciation reserve accounts.
The adjustments covering deferred charges are shown as debits to the “Deferred Charges to Operation” classification in detail, the offsetting credits being to the various expense accounts as shown in the trial balance. These credits in the adjustment column will, when combined with the corresponding debit in the trial balance column, indicate the net amount of the charge to profit and loss. The other classes of adjustment entries follow the same procedure.
After all adjustments have been made, a complete distribution of the items in the trial balance and adjustment columns is made either to the profit and loss or the balance sheet columns. The difference between the profit and loss columns will thus show the net profit or loss for the period and must be transferred to the balance sheet as a vested proprietorship item. Instead of being shown as a definite addition to the proprietor’s capital, the transfer is indicated as the final item on the work sheet, being a debit in the profit and loss columns to balance them, and a credit in the balance sheet columns. This difference, $14,747.12 in our illustration, constitutes the net profit for the period, and when added to the credit side of the balance sheet columns should give a total equal to the total of the debit balance sheet column. This transfer of net profit effects a proof of the accuracy of the work.
When this proof has been secured, the formal profit and loss statement should be drawn up, all of the material for which will be found in the profit and loss columns of the work sheet, where it is arranged in almost the exact order needed for the formal statement. The information for the balance sheet is found similarly in the balance sheet columns, all of the detail being properly grouped but a rearrangement of the order of some items being necessary. Thus, while the detail of the deferred charges to operation has been gathered together in one place in the work sheet, in the formal balance sheet this group of items must appear immediately after the current asset section. [See page 234] for the profit and loss statement and [page 232] for the balance sheet.
It is thus seen that the work sheet provides a convenient method of passing through the trial balance the adjustments necessary to a summarization of the results of the period and of effecting a rough summarization of these results. The work sheet becomes the source of information for the formal statements and a preliminary stage to the adjustment and closing of the books.
The purpose of the formal adjusting entries and the manner of framing them are fully explained in [Chapter XXVIII]. After the information on which they are based is brought together and entered on the work sheet and after the work of summarization has been proven, the adjustment columns of the work sheet are made the source for these entries. The formal adjusting entries as they appear in the journal are given on [page 245]. They should be compared with the debit and credit list for the work sheet as given above and the differences noted.
Need for the Summary Statements.—Before setting up the formal journal entries necessary to adjust and close the books, the balance sheet and statement of profit and loss will be shown. These two periodic statements do not form an integral part of the books of account. They are drawn up periodically and submitted to the proprietor, because the latter does not always have ready access to the books of account and often lacks sufficient knowledge of accounting to interpret correctly the information shown by the journal and ledger. The periodic statements are intended to show the results of the year in a concise, non-technical form, so that a proprietor, even though not versed in the science of accounts, can readily understand them.
The Two Forms of Balance Sheet.—The balance sheet may be arranged in either of two forms. The first form (illustrated on [page 232)] follows the principles already laid down in [Chapter III]. This is called the “report form” and is based on the proprietorship equation when written
Assets - Liabilities = Proprietorship