Adjusting & Closing for Merchandisers
🎯 Learning Objectives
- Understand the adjusting and closing process for merchandisers
- Prepare adjusting entries for inventory shrinkage
- Record closing entries for sales accounts
- Calculate cost of goods sold under periodic inventory systems
- Close temporary accounts at period-end
- Prepare post-closing trial balance
📚 Background & Principles
The closing process ensures that temporary accounts with debit balances are reduced to zero at the end of an accounting period, and that real (permanent) accounts are transferred to retained earnings.
Key temporary accounts to close include sales accounts (revenue, returns, allowances, discounts) and certain contra accounts like inventory shrinkage adjustment.
🔑 Key Concepts
Journal entries made at the end of an accounting period to update account balances for items not yet recorded (accruals, deferrals, estimates).
Journal entries that transfer balances from temporary accounts (revenues, expenses) to permanent accounts (retained earnings) and reset temporary accounts to zero for the new period.
Accounts that are reset to zero at the end of each accounting period. Include revenues, expenses, and dividends.
Accounts that are not reset to zero and whose balances carry forward to future periods. Include assets, liabilities, equity, and contra accounts.
Difference between book inventory and physical count. Adjusted as COGS expense and reduces inventory.
Trial balance prepared after adjusting and closing entries, showing only permanent account balances. Used to prepare financial statements.
🔍 Deep Dive
Explore adjusting and closing concepts at different levels of depth:
🟢 Foundational Level
Understanding basic adjusting and closing principles.
The Mystery of Shrinkage
Analogy: The Missing Cookies
Imagine you have a cookie jar. Your computer says there are 100 cookies inside.
At end of year, you open jar and count only 95 cookies.
Maybe 5 broke (Damage) or someone took them (Theft). This is Shrinkage.
You can't sell ghosts. You must lower the computer count to match reality.
Debit Cost of Goods Sold | Credit Inventory
🟡 Standard Level
Detailed closing entries and sales account closure.
Merchandising Closing Entries
The closing process includes closing sales accounts (revenues and their contra accounts) to properly calculate net income.
Gross Sales = Sales (credit balance)
Debit Sales (reduces to zero), Credit Income Summary (closes revenue)
Debit Sales Returns, Sales Allowances, Sales Discounts (all reduce to zero)
Debit Income Summary (reduce to zero), Credit each expense account (reduces to zero)
Debit Income Summary (transfer net income), Credit Retained Earnings (permanent)
All temporary accounts now have zero balances. Net income is properly reflected in Retained Earnings.
Why Sales Returns and Allowances are Temporary
Sales Returns and Allowances have debit balances (reduce gross sales). They must be closed each period because they only reflect current period activity.
These accounts normally have debit balances (reductions to revenue). Closing them transfers their balances to Income Summary.
Debit Income Summary (for total contra account balances), Credit Sales Returns, Sales Allowances, Sales Discounts (resets to zero)
🔴 Advanced Level
Complex closing scenarios and post-closing trial balance preparation.
Inventory Shrinkage Analysis
Scenario: Physical inventory count shows 98,000 units but book inventory shows 100,000. Cost per unit is $50. How to record?
Shrinkage = 100,000 - 98,000 = 2,000 units
Cost of shrinkage = 2,000 × $50 = $100,000
Debit Cost of Goods Sold $100,000 (expense), Credit Inventory $100,000 (reduce book inventory to match physical count)
Inventory account now reflects physical reality. COGS increased by shrinkage expense. Net income reduced.
Post-Closing Trial Balance Structure
The post-closing trial balance lists only permanent account balances after all temporary accounts are closed.
Assets: Cash, Accounts Receivable, Inventory, PPE
Liabilities: Accounts Payable, Notes Payable, Long-term Debt
Equity: Common Stock, Retained Earnings, Accumulated Depreciation, Dividends, Treasury Stock
Sales, Sales Returns, Sales Allowances, Sales Discounts, COGS, and all expense accounts
Post-closing trial balance is the foundation for preparing Balance Sheet and Income Statement with accurate permanent account balances.
🎨 Interactive: Shrinkage Calculator
Calculate the adjustment needed when book inventory doesn't match physical count.
🚫 Common Misconceptions & Professional Tips
✅ Reality: Closing entries are MANDATORY under accrual accounting. Without closing, temporary accounts would accumulate incorrect balances, causing misleading financial statements.
✅ Reality: Both revenue AND expense accounts must be closed. Net income must be transferred to Retained Earnings after considering ALL temporary account balances.
✅ Reality: Only temporary accounts (revenues, expenses, dividends) are closed. Permanent accounts (assets, liabilities, equity) are NOT reset—their balances carry forward.
🧠 Memory Aids & Quick Reference
1. Close revenues to Income Summary (debit)
2. Close expenses to Income Summary (credit)
3. Close Income Summary to Retained Earnings (debit)
Result: All temporary accounts = zero
Revenues, expenses, dividends. Closed each period, start at zero next period.
Assets, liabilities, equity, contra accounts. Balances carry forward to next period.
Updates for accruals, deferrals, estimates. Made before financial statements.
Transfer temporary account balances to Retained Earnings. Reset temporary accounts to zero for new period.
📖 Glossary
Journal entries at period-end to update accounts for unrecorded items (accruals, deferrals, estimates).
Journal entries that transfer balances from temporary accounts (revenues, expenses) to permanent accounts and reset temporary accounts to zero.
Accounts that are reset to zero at the end of each accounting period. Include revenues, expenses, and dividends.
Accounts whose balances carry forward to future periods. Include assets, liabilities, equity, and contra accounts.
Temporary account used during closing process to aggregate all revenues and expenses, facilitating transfer to Retained Earnings.
Trial balance prepared after adjusting and closing entries, showing only permanent account balances. Used to prepare financial statements.
Cumulative net income retained in the business rather than distributed to shareholders. Equals total revenues minus total expenses and dividends.
Difference between book inventory and physical count due to theft, damage, loss, or errors. Adjusted as COGS expense.
Accounts with credit balances that reduce gross sales. Include Sales Returns, Sales Allowances, and Sales Discounts.
Expense account representing cost of inventory sold during a period. Beginning Inventory + Purchases - Ending Inventory.
🎯 Final Knowledge Check
Test your understanding of Adjusting & Closing for Merchandisers:
Question 1: Which of the following is a temporary account that must be closed each period?
Question 2: When closing revenue accounts, what is the closing entry?
Question 3: What is the purpose of a post-closing trial balance?