Prepare the trading and profit and loss accounts in the general ledger

Contents

Introduction

Procedure for posting to general ledger accounts

Preparing financial reports for management

Sales returns and purchases returns

Discounts allowed

Discounts received

Feedback to activities

This learning guide is based on the following resource(s):
Textbook
Duncan A (2006) Introductory Accounting, National Core Accounting Publications, Bondi
Note
A new edition of this textbook was being published at the same time as this resource.
Where possible, we have provided a second Key to resources to this new edition.

Key to resources

Resource / Textbook (2006 edition)
1 / Chapter 16 ‘Closing entries’, sections 16.1 to 16.6
2 / Chapter 16, section 16.7, p498
3 / Chapter 16, section 16.7, p499
Resource / Textbook (2007 edition)
1 / Chapter 14 ‘Closing entries’, sections 14.1 to 14.6
2 / Chapter 14, section 14.7, pp 448 – 450 (periodic inventory)
3 / Chapter 14, section 14.7, pp 451 – 453 (perpetual inventory)

Introduction

After the balance day adjustments have been prepared in the general journal, they are posted to their respective accounts in the general ledger.

Procedure for posting to general ledger accounts

Net profit or loss is then found in the general ledger with the following procedure:

1Open a trading account in the general ledger and find gross profit by transferring salesand cost of goods sold.

2Transfer gross profit to the profit and loss account and transfer all incomeandexpense accounts to the profit and loss account to find net profit or loss.

3Transfer the balance of the profit and loss account representing net profit or loss to the capital account.

4Transfer the balance of the drawings account to the capital account.

After the completion of these steps the accounts with balances in the general ledger will be assets, liabilities and owner’s equity(capital). These accounts will be used to prepare the balance sheet. All income and expense accounts will have been transferred to trading and profit and loss accounts and finally are reflected in the capital account as the net profit or loss.

/ Now go to Resource 1
The Key to resources is located at the beginning of this learning guide.

Note the closing journal entries in the example for Strategic Enterprises. This example, however, is for periodic inventory. Note that the closing inventory of $160000 is brought to account under the periodic inventory method.

The main focus in your studies is on perpetual inventory. The following comprehensive example for In Sufficient is based on perpetual inventory.

Example

The trial balance of In Sufficient as at 30 June 20x7 disclosed:

$ / $
Inventory / 30600
Accounts receivable / 10800
Bank / 22400
Plant and equipment / 182600
Accumulated depreciation – plant and equipment / 33000
Accounts payable / 10200
GST clearing account / 6000
Drawings / 22600
Capital / 228400
Sales / 349000
Commission income / 400
Cost of goods sold / 267000
Advertising / 11800
General salaries / 51800
Electricity and phone / 18800
General expenses / 6400
Discount allowed / 2200
627000 / 627000
Balance day adjustments are required for: / $
General salaries due not paid / 1200
Advertising paid in advance / 1600
Bad debt (including GST) to be written off / 1100
Commission income due—not received / 300
Depreciation charge for year—plant and equipment / 34200
Required

(a)Prepare general journal entries for the balance day adjustments.

(b)Open the general ledger.

(c)Post the balance day adjustments to the general ledger.

(d)Prepare closing general journal entries.

(e)Post the closing general journal entries to the general ledger.

(f)Extract an adjusted trial balance.

Solution

Balance day adjustment general journal entries

General journal of
In Sufficient

Date / Account / Folio / Debit $ / Credit $
20x7
June 30 / General salaries / 1 200
Expenses accrued / 1 200
Salaries due – not paid
Expenses prepaid / 1 600
Advertising / 1 600
Advertising paid in advance
Bad debts / 1 000
GST clearing account / 100
Accounts receivable control / 1 100
Bad debt written off
Income accrued / 300
Commission income / 300
Income due – not received
Depreciation – Plant andequipment / 34 200
Accumulated depreciation – Plant and equipment / 34 200
Depreciation charge for year

General ledger – In Sufficient

Inventory

20x7
June 30 / Balance / 30 600

Bank

20x7
June 30 / Balance / 22 400

Accumulated depreciation – Plant andequipment

20x7
June 30 / Balance / 33 000
Dep – Plant and equipment / 34 200
67 200

GST clearing account

20x7 / 20x7
June 30 / Account receivable / 100 / June 30 / Balance / 6 000
Balance c/d / 5 900
6 000 / 6 000
Balance b/d / 5 900

Sales

20x7 / 20x7
June 30 / Trading / 349 000 / June 30 / Balance / 349 000

Cost of goods sold

20x7 / 20x7
June 30 / Balance / 267 000 / June 30 / Trading / 267 000

General salaries

20x7 / 20x7
June 30 / Balance / 51 800 / June 30 / Profit and loss / 53 000
Expenses accrued / 1 200
53 000 / 53 000

Accounts receivable

20x7 / 20x7
June 30 / Balance / 10 800 / June 30 / Bad debts / 1 100
Balance c/d / 9 700
10 080 / 10 080
20x7 Jul 1 / Balance b/d / 9 700

Plant and equipment

20x7
June 30 / Balance / 182 600

Accounts payable

20x7
June 30 / Balance / 10 200

Capital

20x7 / 20x7
June 30 / Profit and loss / 43 100 / June 30 / Balance / 228 400
Drawings / 22 600
Balance c/d / 162 700
228 400 / 228 400
20x7 July 1 / Balance b/d / 162 700

Drawings

20x7 / 20x7
June 30 / Balance / 22 600 / June 30 / Capital / 22 600

Commission income

20x7 / 20x7
June 30 / Profit and loss / 700 / June 30 / Balance / 400
Profit and loss / 300
700 / 700

Advertising

20x7 / 20x7
June 30 / Balance / 11 800 / June 30 / Expenses prepaid / 1 600
Profit and loss / 10 200
11 800 / 11 800

Electricity andtelephone

20x7 / 20x7
June 30 / Balance / 18 800 / June 30 / Profit and loss / 18 800

General expenses

20x7 / 20x7
June 30 / Balance / 6 400 / June 30 / Profit and loss / 6 400

Expenses accrued

20x7
June 30 / General salaries / 1 200

Bad debts

20x7 / 20x7
June 30 / Accounts receivable / 1 000 / June 30 / Profit and loss / 1 000

Depreciation – Plantandequipment

20x7
June 30 / Accumulated depr
Plant and equipment / 34 200 / 20x7
June 30 / Profit and loss / 34 200

Discount allowed

20x7 / 20x7
June 30 / Balance / 2 200 / June 30 / Profit and loss / 2 200

Expenses prepaid

20x7
June 30 / Advertising / 1 600

Income accrued

20x7
June 30 / Commission income / 300

Trading account

20x7 / 20x7
June 30 / Cost of goods sold / 267 000 / June 30 / Sales / 349 000
Profit andloss account / 82 000
349 000 / 349 000

Profit andloss account

20x7 / 20x7
June 30 / Advertising / 10 200 / June 30 / Trading account / 82 000
General salaries / 53 000 / Commission income / 700
Electricity and phone / 18 800 / Capital account / 43 100
General expenses / 6 400
Discount allowed / 2 200
Bad debts / 1 000
Depreciation plant and equipment / 34 200
125 800 / 125 800

Closing general journal entries

General journal of In Sufficient

Date / Account / Folio / Debit $ / Credit $
20x7June 30 / Sales / 349 000
Trading account / 349 000
Balance transferred
Trading account / 267 000
Cost of goods sold / 267 000
Balance transferred
Trading account / 82 000
Profit and loss / 82 000
Gross profittransferred
Commission income / 700
Profit and loss account / 700
Balance transferred
Profit and loss account / 125 800
Advertising / 10 200
General salaries / 53 000
Electricity and phone / 18 800
General expenses / 6 400
Discount allowed / 2 200
Bad debts / 1 000
Depreciation plant and equipment / 34 200
Balance transferred
Capital / 43 100
Profit and loss account / 43 100
Net loss transferred
Capital / 22 600
Drawings / 22 600
Balance transferred
In Sufficient
Adjustedtrial balance as at 30 June 20x7
Debit $ / Credit $
Inventory / 30 600
Accounts receivable / 9 700
Bank / 22 400
Plant and equipment / 182 600
Accumulated depreciation – plant and equipment / 67 200
Accounts payable / 10 200
GST clearing account / 5 900
Capital / 162 700
Expenses accrued / 1 200
Expenses prepaid / 1 600
Income accrued / 300
247 200 / 247 200
Commentary

1The balance day adjustments have affected expense and income balances. In addition two asset accounts (expenses prepaid and income accrued) and one liability account (expenses accrued) have been introduced.

2The closing general journal entries have closed off all the income and expense accounts, after the balance day adjustments, to trading and profit and loss accounts.

3The balance of profit and loss account (a loss in this case) and drawings have been transferred to the capital account.

4Thenthe accounts left open in the general ledger with balances make up the adjusted trial balance. The accounts are assets, liabilities and owner’s equity (capital).

/ Activity 1

Note: Feedback to all activities isprovided at the end of this document.

The trial balance of Jack Straw as at 30 June 20x8 disclosed:

$ / $
Inventory / 58565
Accounts receivable / 18245
Cash at bank / 11200
Petty cash / 1000
Land and buildings / 239941
Accumulated depreciation buildings / 2600
Motor vehicles / 25400
Accounts payable / 9280
GST clearing / 8102
Rent income / 4275
Sales / 329643
Cost of goods sold / 195875
Advertising / 2862
Office salaries / 38915
Rates and taxes / 8052
Light and power / 10329
Office cleaning / 5293
Bad debts / 909
Drawings / 17314
Capital / 280000
633900 / 633900

Balance day adjustments are required for:

  • additional bad debt to be written off—$165 including GST
  • allowance for doubtful debts of 5% to be created after the bad debt write-off
  • rent income received in advance is $575
  • depreciation of buildings of $2600 and of motor vehicles of $5080 is to be provided.

Required

(a)General journal entries for the balance day adjustments

(b)The trading and profit and loss accounts as they would appear in the general ledger

(c)An adjusted trial balance after the balance day adjustments and the transfer of drawings and net profit or loss to the capital account

/ Activity 2

The trial balance of Jim Gillett as at 30 June 20x7 disclosed:

$ / $
Inventory / 49570
Accounts receivable / 16660
Allowance for doubtful debts / 330
Cash at bank / 4970
Land and buildings / 198000
Accumulated depreciation – Buildings / 3100
Motor vehicles / 27900
Accounts payable / 6780
GST clearing / 2370
Commission income / 2380
Sales / 309860
Cost of goods sold / 178630
Cartage outwards / 3410
Salaries and wages / 43920
Insurance / 6450
Light and power / 10330
Telephone and Internet / 2570
Bank charges / 170
Drawings / 15200
Capital / 232960
557780 / 557780

Balance day adjustments are required for:

  • commission income due, not received $370
  • bad debt to be written off $660 including GST
  • allowance for doubtful debts to be adjusted to 3% of accounts receivable(after bad debt write-off)
  • holiday pay to be provided $880
  • a physical stocktake revealed inventory on hand $49470
  • depreciation buildings $3100 and motor vehicles $5580 to be provided.

Required

(a)General journal entries for the balance day adjustments

(b)The trading and profit and loss accounts as they would appear in the general ledger

(c)An adjusted trial balance after the balance day adjustments and thetransfer of drawings and net profit to the capital account

Preparing financial reports for management

The two key financial reports for management are the income statement and the balance sheet. There is another financial report—the statement of cash flows—however, that statement will be the subject of future studies.

Income statement

The income statement is prepared from the details in the general ledger for the trading account and profit and loss account. The income statement restates the information in the trading and profit and loss accounts and puts that information into a format more useful to management. It shows the results of the business operations for a given period. Recall that the following steps occurred for the preparation of the trading account and profit and loss account.

1Balance day adjustments are recorded in the general journal.

2The balance day adjustments are posted into the general ledger.

3Closing general journal entries are recorded in the general journal.

4The closing general journal entries are posted to the general ledger, including the trading and profit and loss accounts.

5Net profit or loss is transferred to the capital account from the profit and loss account.

/ Now go to Resource 2
Look at the income statement shown in the textbook under section 16.7 for WKenny. This income statement is prepared for a business using periodic inventory. If WKenny was using perpetual inventory, the income statement would appear as per the one which follows.
Income statement of WKenny
for year ended 30 June 20x7
Sales (net) / 117900
Less: Cost of goods sold / 62498
Gross profit / 55402
Add: Other operating income / 306
Discount received / 306
Total income / 55708
Less: Operating expenses / 34220
Marketing / 7300
Advertising / 1400
Cartage outwards / 1500
Sales commission / 4400
Administration / 22980
Insurance / 800
Depreciation / 7000
General expenses / 3500
Salaries and wages / 11680
Financial / 3940
Discount allowed / 720
Doubtful debts / 220
Interest on mortgage / 3000
Net profit / 21488

Note: The heading of the income statement is for a given period. Also note particularly the sub-headings under the main heading of ‘operating expenses’. The sub-headings are:

  • marketing (also known as selling and distribution)—includes any expense related to selling goods or services
  • administration (also known as general and administration)—includes all expenses not involved in marketing or finance
  • financial—includes the expenses incurred in obtaining or maintaining funds to operate the business.

Note also that the amounts shown in the income statement include any adjustment required by the balance day adjustments.

/ Activity 3

Prepare a classified income statement from the solution for the previous example for In Sufficient.

Balance sheet

Recall that, after the transfer of net profit or loss from the profit and loss account to the capital account and the transfer of drawings to the capital account, the remaining accounts with balances in the general ledger are assets, liabilities and owner’s equity (capital).

These accounts form the balance sheet. The balance sheet sets out the financial position of the business as at a specified date, hence the heading is as at a given date.

/ Now go to Resource 3
In the balance sheet for WKenny in the textbook, note that the heading should read ‘as at 30 June 20x7’ and not ‘for the year ended’.

The balance day adjustments affecting assets and liabilities, eg accrued salaries and prepaid advertising, are reflected in the balance sheet.

The headings must be in the format shown, that is:

Current assets—cash or assets generally convertible into cash within 12months

Non-current assets—assets to be kept beyond 12 months

Total assets

Current liabilities—liabilities expected to be paid within 12 months

Non-current liabilities—liabilities expected to be paid beyond 12months

Total liabilities

Net assets

Owner’s equity (not capital as shown)

Capital

Add: Profit

Less: Drawings

Note that under owner’s equity the capital account for the period is restated, that is:

Capital
Drawings / xxxx / Opening balance / xxxx
Profit and loss (net profit) / xxxx
/ Activity 4

Prepare a balance sheet from the adjusted trial balance of the previous example for InSufficient.

/ Activity 5

Prepare an income statement and balance sheet from the solution to Activity 1.

/ Activity 6

Nightingale trial balance
as at 30 June 20x7

Debit $ / Credit $
Sales / 98 000
Commission income / 4 000
Cost of goods sold / 37 500
Advertising / 2 000
Discount allowed / 1 500
Discount received / 500
Selling expenses / 2 600
Office wages / 1 750
Stationery / 400
Insurance / 800
Electricity / 800
Cash at bank / 16 000
Accounts receivable / 18 000
Inventory / 22 000
Land / 40 000
Buildings / 80 000
Accumulated depreciation – Buildings / 20 000
Delivery vans / 50 000
Accumulated depreciation – Delivery vans / 10 000
Accounts payable / 6 200
GST clearing account / 7 800
Mortgage – Due 30 June 20x9 / 20 000
Capital – JHopkins / 108 850
Drawings / 2 000
275 350 / 275 350

Additional information

  • Advertising of $400 was prepaid.
  • Office wages owing are $1600.
  • Depreciation on delivery vans was $10 000.
  • Depreciation on building was $6000.
  • Allowance for doubtful debts to be5% of accounts receivable.
  • A physical stocktake disclosed an inventory value of $21 700.

Required

(a)General journal entries for the balance date adjustments

(b)Closing general journal entries

(c)Trading account

(d)Profit and loss account

(e)Balance sheet

/ Activity 7

Seal and Co.
Trial balance as at 30 June 20x7

Debit $ / Credit $
Capital / 137 900
Drawings / 4 000
Bank / 6 000
Inventory / 17 200
Account receivable / 26 000
Accounts payable / 9 000
GST clearing / 5 000
Land and buildings at cost / 224 000
Fixtures and fittings at cost / 11 000
Office equipment at cost / 22 000
Accumulated dep – Office equipment / 2 300
Motor vehicles at cost / 44 000
Accumulated dep. – Motor vehicles / 5 200
Mortgage on freehold – Due 30 June 20x8 / 108 000
Sales / 472 760
Cost of goods sold / 247 900
Rent income / 5 000
Salaries – Sales / 43 000
Advertising / 4 400
Salaries – Office / 44 000
Insurance / 1 700
Discount allowed / 2 400
Discount received / 2 240
General wages / 46 000
Commission – Sales / 3 000
Telephone / 1 360
Bad debts / 240
Motor vehicle expenses / 4 700
Office expenses / 6 500
753 400 / 753 400

Additional information relating to 30 June 20x7

  • Rent income received in advance $600
  • General wages due and unpaid $1 200
  • Insurance paid in advance $500
  • Depreciation of motor vehicles $8800 and of office equipment $1100
  • Accounts receivable considered doubtful to the extent of 4%
  • Provision for long service leave $5000 (due after 30th June 20x8)

Required

(a)General journal entries for the balance day adjustments

(b)Closing general journal entries

(c)Income statement

(d)Balance sheet

/ Activity 8

Acme Trading
Trial balanceas at 30 June 20x7

Debit $ / Credit $
Capital / 29 956
Drawings / 200
Sales / 7 580
Travelling expenses for sales people / 320
Wages – Sales / 2 400
Inventory / 6 000
Electricity / 600
Cost of goods sold / 1 420
Interest income / 160
Interest expense / 96
Rates / 100
Buildings / 6 000
Accounts receivable / 4 600
Accounts payable / 4 500
GST clearing account / 1 600
Allowance for doubtful debts / 140
Insurance / 200
10%Commonwealth bonds – Due 30th June 20x9 / 2 000
Bank / 1 200
Loan from Blue Rory – Due 30th June 20x9 / 1 200
Machinery / 20 000
$45 136 / $45 136

Additional information

  • Provide for depreciation on machinery of $2000 and buildings of $300.
  • Bad debt is to be written off: $220 including GST.
  • Provision for doubtful debts is to be adjusted to 5% of current trade accounts receivable (after bad debt write-off).
  • Accrued wages at 30th June 20x7 were $70.
  • Insurance paid in advance is $60.
  • Accrued interest income on bonds is $40.

Required

(a)General journal entries for balance day adjustment

(b)Income statement

(c)Balance sheet.

Sales returns and purchases returns

Some businesses will use separate general ledger accounts to record when a business either receives goods back from a customer (sales returns) or returns goods to a supplier (purchase returns). If they do use separate general ledger accounts, these accounts will need to be offset against the original sales general ledger account or purchases general ledger account at the end of the reporting period for the business (usually each year).

The journal entry to offset the balance of the sales returns account to the sales account would be:

Debit Sales
Credit Sales returns

Alternative treatment

You do not need to use separate general ledger accounts for returns. You can simply record them directly in the same general ledger accounts used when goods were sold or purchased (as a reduction to theaccount). So, for sales returns, they can be recorded in the sales account. For purchase returns, it will depend on what inventory method is being used (i.e., the perpetual or the periodic method). If you are using the periodic method, the original purchase would have been recorded as a debit entry in the Purchases account. So the purchase return will be recorded as a credit entry in the purchases account.

However, if you are using the perpetual method, the original purchase would have been recorded as a debit entry in the inventory account. Therefore, the return would be recorded as a credit entry in the inventory account.

To record these returns in the journals, they should be shown as a negative entry under the sales column in the Sales Journal or the inventory column in the purchases journal.

Example

SDJ
Date / Invoice no / Particulars / Fol / Accounts receivable / Sales / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 100024 / North East Wholesalers / 550.00 / 500.00 / 50.00
Mar 18 / C00895 / North East Wholesalers / (55.00) / (50.00) / (5.00)

Discounts allowed

When goods are sold on credit, the customer will pay their account at a later date. In some cases, we may offer a discount to encourage an earlier payment. It is important to record these discounts as part of the receipt transaction. As a result, you will see cash receipt transactions that also include the discount allowed. The cash receipts journal may use a separate column (and general ledger account) to record the discount allowed.