Problem 32 - Accounting

Question

On May 31, 2010, the balances of the accounts appearing in the ledger of Champion Interiors Company, a furniture wholesaler, are as follows: \(\begin{array}{lrlr}\text { Accumulated Depr.-Building } & \$ 30,460 & \text { Notes Payable } & \$ 24,000 \\ \text { Administrative Expenses } & 65,300 & \text { Salaries Payable } & 680 \\ \text { Building } & 55,680 & \text { Sales } & 313,540 \\ \text { Cash } & 8,840 & \text { Sales Discounts } & 18,000 \\ \text { Cost of Merchandise Sold } & 188,000 & \text { Sales Returns and Allow. } & 12,000 \\ \text { Interest Expense } & 1,920 & \text { Sales Tax Payable } & 4,900 \\ \text { Jessica Duerr, Capital } & 141,155 & \text { Selling Expenses } & 124,000 \\ \text { Jessica Duerr, Drawing } & 7,950 & \text { Store Supplies } & 4,580 \\ \text { Merchandise Inventory } & 26,000 & \text { Store Supplies Expenses } & 2,465\end{array}\) Prepare the May 31, 2010, closing entries for Champion Interiors Company.

Step-by-Step Solution

Answer

Champion Interiors ends with a net loss of $98,145 after closing entries are made.

Step 1: Identify Temporary Accounts

Identify the temporary accounts that need to be closed. These accounts include Revenue accounts (Sales), Expense accounts (Administrative Expenses, Cost of Merchandise Sold, Interest Expense, Selling Expenses, Store Supplies Expenses), and drawing accounts (Jessica Duerr, Drawing).

Step 2: Close Revenue Accounts

Transfer the balance of the Sales revenue account to the Income Summary account. The entry would be: Debit Sales for $313,540 and Credit Income Summary for $313,540.

Step 3: Close Expense Accounts

Transfer all the expenses to the Income Summary account. Prepare the following entries: - Debit Income Summary for $65,300 and Credit Administrative Expenses for $65,300. - Debit Income Summary for $188,000 and Credit Cost of Merchandise Sold for $188,000. - Debit Income Summary for $1,920 and Credit Interest Expense for $1,920. - Debit Income Summary for $124,000 and Credit Selling Expenses for $124,000. - Debit Income Summary for $2,465 and Credit Store Supplies Expenses for $2,465.

Step 4: Transfer Sales Discounts and Returns

Transfer Sales Discounts and Sales Returns and Allowances to Income Summary. Prepare the entries: - Debit Income Summary for $18,000 and Credit Sales Discounts for $18,000. - Debit Income Summary for $12,000 and Credit Sales Returns and Allowances for $12,000.

Step 5: Calculate and Close Income Summary

Calculate the net income or net loss by finding the difference between total revenues and total expenses. Close the Income Summary to the Capital account: - Total Revenue: $313,540 - Total Expenses: $411,685 (sum of all expenses, discounts, and returns transferred above) - Net Loss: $98,145 (since Expenses > Revenues, $411,685 - $313,540) Debit Jessica Duerr, Capital for $98,145 and Credit Income Summary for $98,145 to close it.

Step 6: Close Drawing Account

Transfer the Drawing account balance to the Capital account by Debiting Jessica Duerr, Capital for $7,950 and Crediting Jessica Duerr, Drawing for $7,950.

Key Concepts

Temporary Accounts

Temporary accounts are pivotal in managing a company’s finances, as they track the flow of financial activity during a specific accounting period. At the end of each period, these accounts need to be closed to start the new period afresh. This process ensures that the activity from one period doesn’t carry over into the next. Temporary accounts are primarily made up of revenue, expense, and drawing accounts. Each of these accounts plays a vital role in determining the company's financial performance over the period.

To better understand, think of temporary accounts as a clean slate that resets every period. They help in capturing the performance and activity effectively, allowing for accurate financial reporting. This resetting process involves closing entries, which directly affects the company's capital as it incorporates the net results from these temporary accounts.

Income Summary

The Income Summary account is a useful tool in the closing process, acting as a middle point between the temporary accounts and the permanent Capital account. It is where all the revenue and expense balances initially converge.

During the closing process, all revenue balances are transferred to the Income Summary, accumulating the company’s total revenue over the period. Conversely, all expense balances are deducted from the Income Summary, resulting in a net income or net loss for the period. This step is crucial because it summarizes operational performance in a single account before affecting the company’s capital.

Once the net result (either profit or loss) is calculated in the Income Summary, it’s transferred to the Capital account, indicating an increase or decrease in the owner's equity. This seamless process ensures that the company's financial health is clearly depicted at the period's end.

Revenue and Expense Accounts

Revenue and expense accounts are essential in capturing the financial activity within a company during a specific period. Revenue accounts, such as sales, reflect the inflow of economic benefits gained by selling goods or services. On the other hand, expense accounts, such as administrative expenses and selling expenses, represent outflows of economic resources incurred while generating those revenues.

• Revenue Accounts: Records income from sales of goods or services.
• Expense Accounts: Tracks outgoing money spent on operational costs.

These accounts collectively allow a company to measure its profitability. At the end of an accounting period, these accounts are closed to reset the company's records. By transferring their balances to the Income Summary, the company can ensure that they reflect only the current period's activity, maintaining clarity and helping in the accurate preparation of financial statements.

Capital and Drawing Accounts

Capital and Drawing accounts represent an owner's investment in and withdrawal from the business, respectively. The Capital account reflects the owner's stake in the business after all accounts are settled. It is increased by revenues and decreased by expenses and withdrawals (drawings).

The Drawing account records the amounts that the owner withdraws for personal use during the period. At the period end, this account needs to be closed out to the Capital account to adjust the owner’s equity accurately.

• Capital Account: Shows owner's investment and adjusts for net results and drawings.
• Drawing Account: Records withdrawals by the owner and reduces the owner's equity.

Properly managing these accounts is vital for understanding the net effect transactions have on an owner’s equity position. At the end of each period, the closing entries process helps in maintaining the correct capital balance accounting for all profits, losses, and personal withdrawals.