Advanced Accounting
Chapter 4: Financial Reporting for a Departmentalized Business
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Financial statements are used to summarize financial info and then are
used to evaluate the financial position and progress of the business
Accounting Period Cycle: concept that states that changes in financial
info are reported for a specific period of time in the form of financial
statements – the time period is based on the needs of the business
Section 1: Interim Departmental Statement of Gross Profit
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A departmentalized business usually prepares reports about how well each
department is doing – EX. Departmental Statement of Gross Profit
Provides revenue and cost info for each department
A review of this info might be needed for:
• Change merchandise selling prices
• Change suppliers of merchandise
• Add, delete, or change products
• Discontinue a department
Gross profit info shows changes between costs and selling prices
Often will prepare this statement monthly even if the fiscal period is
longer – called an interim departmental statement of gross profits b/c not
for whole fiscal period, just a part of it
To prepare an interim statement, both beginning and ending inventory
amounts are needed
Periodic (physical) inventory – count actual merchandise
Perpetual inventory – continuously kept based on purchases and sales –
requires a good computer system
When a perpetual inventory is not kept and a monthly periodic inventory
is not practical, a business may estimate merchandise inventory
Gross profit method of estimating an inventory: estimating inventory by
using the previous year’s percentage of gross profit on operations
Prepare an estimated merchandise inventory sheet
• Get the beginning inventory, January 1, from the general ledger
• Determine net purchases to date (purchases – purchases discounts
– purchases returns and allowances)
• Add lines 1 and 2 to determine the merchandise available for sale
• Determine net sales to date (sales – sales discount – sales returns
and allowances)
• Calculate the estimated gross profit by multiplying line 4 by the
estimated gross profit from the previous year
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Calculate the estimated cost of merchandise sold by subtracting
line 5 from line 4
Calculate the estimated ending inventory by subtracting line 6 from
line 3 – this estimate is used on the interim departmental
statement of gross profit
Data on an Interim Departmental Statement of Gross Profit is organized
into three sections: operating revenue, cost of merchandise sold, gross
profit on operations
To help managers analyze financial info, relationships between items in a
financial statement are calculated
Four basic components are included in every sales dollar:
• Cost of merchandise sold
• Gross profit on operations
• Total operating expenses
• Net income before federal income tax
Each department in a merchandising business has a merchandise
inventory account and an income summary account
The cost of merchandise sold is a large cost for all merchandising
businesses
Both the cost of merchandise sold percentage and the gross profit
percentage use net sales in the denominator of the equation
Gross profit on operation must be large enough o cover total operating
expenses and produce a new income
For component percentages to be useful, a business must know
acceptable levels of performance – know from business’ historical records
and industry performance standards
Interim financial statements provide information for periods of time less
than a year such as months, quarters, or semiannual periods.
Section 2: Preparing a Work Sheet for a Departmentalized Business
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Businesses prepare Schedules of Accounts Receivable and Accounts
Payable periodically to show the current balances of individual accounts in
comparison to the controlling accounts – Accounts Receivable and
Accounts Payable in the general ledger
The balances of the schedules must match its respective controlling
account
Work Sheet: form used to summaries the general ledger information
needed to prepare financial statements
Trial Balance: proving on the work sheet that debits equal credits
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List general ledger accounts (even those with no balances) in the account
title column and record the account balances in the appropriate
debit/credit column
After all accounts and balances are entered, add the debits and credits
and prove equality
Some general ledger accounts are not current and need to have
adjustments made to them
Questions to determine the adjustment needed
• What is the balance of the account needing adjusted?
• What should the balance be of this account?
• What must be done to correct the account balance?
• What adjustment is made? What account to be debited and what
account to be credited
Must label the adjustments in the order they are made with small letters
in ( )
Uncollectible Accounts Expense: debit Uncollectible Accounts Expense and
credit Allowance for Uncollectible Accounts. Total sales on account x
Percentage = Estimated Uncollectible Accounts Expense
Merchandise Inventory Adjustments: must use the respective department
categories Merchandise Inventory and Income Summary
o If ending balance should be smaller, credit Merchandise Inventory
and debit Income Summary
o If ending balance should be larger, debit Merchandise Inventory
and credit Income Summary
Supplies Expense: debit Supplies Expense and credit Supplies to decrease
the amount of supplies in inventory for each of the types of supplies – it is
an operating expense
Prepaid Insurance: debit Insurance expense and credit Prepaid Insurance
to account for the use of the insurance asset throughout the year
Depreciation Expense: debit Depreciation Expense – type of equipment
and credit Accumulated Depreciation – type of equipment
o Assets depreciate or lose value over time because of use and
newer models available
o It is an operating expense and is an estimate because do not know
the actual decrease until the equipment is sold or disposed of.
Federal Income Tax Expense: debit Federal Income Tax Expense and
credit Federal Income Tax Payable
o Estimate amount due and make quarterly payments if going to owe
more than $500 a year.
o Actual income tax is calculated at the end of the year and an
adjustment is made
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After all adjustments have been entered on the work sheet, the
Adjustments columns are totaled and checked for equality and are doubleruled
The asset, liability, and stockholders’ equity account balances are
extended to the Balance Sheet columns of a work sheet
o The totals of the two columns are out of balance because going to
indicate an increase or decrease in stockholders’ equity
The balances of all revenue, cost, and expense accounts are extended to
the Income Statement columns on a work sheet
o The accounts that are to be adjusted must be
o The difference between the two Income Statement columns
indicates Net Income or Net Loss for a fiscal period
o If credit column is larger have a net income
o If debit column is larger have a net loss
Record Net Income after Federal Income Tax at the bottom of the work
sheet
After the net income or loss amount is recorded, total the balance sheet
and income statement columns to prove respective equality
Section 3: Financial Statements for a Departmentalized Business
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Financial statements are prepared to report the financial progress and
condition of a business
Statements commonly prepared at the end of the fiscal period
• Departmental statement of gross profit (DSGP)
• Income statement (IS)
• Statement of stockholders’ equity (SSE)
• Balance sheet (BS)
DSGP is similar to the interim departmental statement of gross profit – the
difference is that the annual statement uses the actual ending periodic
inventories
Info needed to complete the DSGP is from the Trial Balance, Income
Statement and Balance Sheet columns of the work sheet
Component percentages for the total cost of merchandise sold and gross
profit on operations are calculated. Also calculated for individual
departments
An analysis of the annual DSGP indicates either acceptable or
unacceptable levels of performance
If performance not acceptable steps need to be taken to improve the
performance
Component percentages are usually carried to one decimal place
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IS is a financial statement showing the revenue and expenses for a fiscal
period
Data used to prepare an IS is from the work sheet
On an IS component percentages are analyzed for total operating
expenses, net income before and after income tax, and federal income tax
Analyze the percentages in comparison to previous performance and
industry standards
Component percentages are shown in a separate column on the IS
Percentages for total gross profit on operations and total cost of
merchandise sold are obtained from the departmental statement of gross
profit
Calculating Component Percentage
• Divide total operating expenses by net sales to determine the total
operating expense percentage
• Divide net income before federal income tax by net sales to
determine the total net income before federal income tax
percentage
• Divided federal income tax by net sales to determine the federal
income tax percentage
• Divide net income after federal income tax by net sales to
determine the net income after federal income tax percentage
SSE is a financial statement that shows changed in a corporations’
ownership for a fiscal period
SSE has 2 major sections
• Capital stock which represents total shares of ownership in a
corporation
• Retained earnings which is the amount earned by a corporation
and not yet distributed to stockholders
Find capital stock info from the previous year’s SSE and the capital stock
account
Find retained earnings from previous year’s SSE and the dividend line and
the net income after federal income tax line on the work sheet
BS is a financial statement that reports assets, liabilities, and owner’s
equity on a specific date
Data for the BS comes from the Balance Sheet columns of the work sheet
and the SSE
Section 4: End-of-Period Work for a Departmentalized Business
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Adjusting entries: journal entries recorded to update general ledger
accounts at the end of the fiscal period
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At the end of the fiscal period, the temporary account balances are
transferred to an income summary account
Journalize adjusting entries: center the words Adjusting Entries in the
account title line of a new general journal page and then record the
adjusting entries from the work sheet in alphabetical order
Closing Entries: journal entries used to prepare temporary accounts for a
new fiscal period
1. Closing entry for income statement accounts with credit balances
a. Departmental income summary accounts (those with credit
balances), the revenue accounts (sales), and the contra cost
accounts (purchases discounts and returns and allowances)
2. Closing entry for income statement accounts with debit balances
a. Departmental income summary accounts (those with debit
balances), the contra revenue accounts (sales discounts and
returns and allowances), the cost accounts (purchases), and
expense accounts
3. Closing entry to record net income (net loss) in the retained earnings
account and to close the income summary account
a. Income Summary – General account balances is equal to the net
income (or loss) for the fiscal period
b. Corporation’s net income is recorded in the retained earnings
account
c. After the entry is recorded, Income Summary has a zero balance
and the net income has been credited to Retained Earnings
4. Closing entry for the dividends account
a. The debit balance of a dividends account is the total amount of
dividends declared during a fiscal period.
b. Dividends decrease the earnings that a corporation retains so it is
closed to Retained Earnings
c. After the closing entry, Dividends has a zero balance and Retained
Earnings has been debited for the amount of dividends
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After closing entries have been posted, all temporary accounts have zero
balances and are ready for the new fiscal year.
After adjusting and closing entries are posted, must again prove equality
of debits and credits
Prepare a Post-Closing Trial Balance to prove the equality
Accounting procedures used by a departmentalized merchandising
business are described in chapters 1-4
Same procedures are used from year to year (Consistent Reporting)
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Accounting cycle procedures provide information for preparing interim and
end-of-fiscal-period financial statements (Accounting Period Cycle)
The Accounting Cycle for Departmentalized Business
• Verify source documents for accuracy
• Record entries in journals
• Post journal entries to the ledgers
• Prepare interim departmental statement of gross profit
• Prepare schedules of accounts receivables and payables for the
subsidiary ledger
• Prepare trial balances on the work sheet. Complete the work sheet to
summarize the financial condition of a business
• Prepare financial information from the work sheet and accounting
records
• Journalize and post adjusting and closing entries using info from work
sheet
• Prepare a post-closing trial balance to check equality of debits and
credits in the general ledger. The accounting records for the fiscal
period are complete and ready for the start of the next fiscal period.