Merchandising, Adjusting, and Closing

1. Closing Entries: A Review

You may recall that a closing entry is an entry made at the end of an accounting period that is used to close out a temporary account. Closing entries are entered into the general journal, and then posted to the general ledger.

As mentioned in the definition, the accounts that get closed are the temporary accounts, which comprise revenues and expenses, as well as owner drawings. Within a merchandising company, there are some unique revenue accounts that are going to be closed and hence have closing entries. These are the sales discounts and sales returns and allowances, which will be closed in addition to the sales account.

On the expense side, there are purchases that need to be closed out, as well as purchase discounts, purchase returns and allowances, and freight-in. These are all of the accounts on the expense side, unique to a merchandising company, that will also be closed out with accompanying closing entries, in addition to operating expenses.

The purpose of closing the accounting system is essentially to serve as a reset button. All of the temporary, period-based accounts are closed to ensure accurate reporting, so that a merchandiser can hit reset for the next period.

Closing the accounting system also allow a merchandiser to track activity for a specific period, and then transfer net income or loss into cumulative equity. Then, those temporary accounts are reopened for the following period, again, to report activity for that one specific period.

2. Closing Procedure: A Review

Temporary account groups are closed by processing netting journal entries on their unnatural balance side. Now, netting refers to looking at the total balance of the account, whether it's debit or credit, and recording a closing entry for that amount to the opposite side.

EXAMPLE

Suppose you have an account with a current debit balance. Through netting, you would book an entry for that same amount to the opposite side, credit, so that the account nets to zero.

The REDI method refers to the following process :

Revenues: First, close out the revenues.
Expenses: Next, close out the expenses.
Drawings: This is the other type of temporary account that needs to be closed out. Close the owner drawings accounts.
Income Summary: Close out the revenues, expenses, and drawings to the income summary, which in turn gets closed to the retained earnings.

3. Closing Entries: Example

Now let's look at some closing entries specific to a merchandising company. Remember, these entries are in addition to the regular closing entries mentioned above--the revenues and operating expenses. These are the additional closing entries that a merchandising company would need to make: sales returns and allowances, as well as sales discounts.

• Sales returns and allowances and sales discounts must be closed out with a credit. This means that they have a natural debit balance, which makes sense because they are actually a reduction of sales, which has a natural credit balance.
• Purchases are closed out with a credit, because they are an expense, so naturally have a debit balance.
• Purchase returns and allowances, as well as purchase discounts, are closed out with debits, because they have a natural credit balance--again, because they reduce the purchases that were made.
• Freight-in in the last entry needed to close out. Freight-in, because it's an expense that is incurred, is closed out with a credit, because it has a natural debit balance.