This expanded discussion illustrates how to prepare a 10-column work sheet using the periodic inventory method. The following discussion can be substituted for the discussion in chapter 3 of the text, which illustrates preparation of a work sheet under the perpetual inventory method.

To facilitate the end-of-period (monthly, quarterly, or annually) accounting and reporting process, a work sheet is often used. A work sheet is a columnar sheet of paper used to adjust the account balances and prepare the financial statements. Use of a work sheet helps the accountant prepare the financial statements on a more timely basis. It is not necessary to delay preparation of the financial statements until the adjusting and closing entries are journalized and posted. The 10-column work sheet shown in Illustration 1 below provides columns for the first trial balance, adjustments, adjusted trial balance, income statement, and balance sheet.

The work sheet does not replace the financial statements. Instead, it is an informal device for accumulating and sorting information needed for the financial statements. Completing the work sheet provides considerable assurance that all of the details related to the end-of-period accounting and statement preparation have been properly brought together.

Adjustments Entered on the Work Sheet

Items (a) through (f) below serve as the basis for the adjusting entries made in the work sheet shown in Illustration 1.

1. Furniture and equipment is depreciated at the rate of 10% per year based on original cost of $67,000.
2. Estimated bad debts, one-quarter of 1% of sales ($400,000).
3. Insurance expired during the year, $360.
4. Interest accrued on notes receivable as of December 31, $800.
5. The Rent Expense account contains $500 rent paid in advance, which is applicable to next year.
6. Property taxes accrued December 31, $2,000.

The adjusting entries shown on the December 31, work sheet are as follows:

(a) Depreciation Expense - Furniture and Equipment 6,700     Accumulated Depreciation - Furniture and Equipment     6,700 (b) Bad Debts Expense 1,000     Allowance for Doubtful Accounts     1,000 (c) Insurance Expense 360     Prepaid Insurance     360 (d) Interest Receivable 800     Interest Revenue     800 (e) Prepaid Rent Expense 500     Rent Expense     500 (f) Property Tax Expense 2,000     Property Tax Payable     2,000

These adjusting entries are transferred to the Adjustments columns of the work sheet, and each may be designated by letter. The accounts that are set up as a result of the adjusting entries and that are not already in the trial balance are listed below the totals of the trial balance, as illustrated on the work sheet. The Adjustments columns are then totaled and balanced.

The illustration does not include in the Adjustments columns the adjustments for cost of goods sold. Although these adjustments are sometimes included in these columns on a 10-column work sheet, this illustration assumes that these entries will be made during the closing process.

Adjusted Trial Balance Columns

The amounts shown in the Trial Balance columns are combined with the Adjustments columns and are extended to the Adjusted Trial Balance columns. For example, the $2,000 shown opposite the Allowance for Doubtful Accounts in the Trial Balance Cr. column is added to the $1,000 in the Adjustments Cr. column. The $3,000 total is then extended to the Adjusted Trial Balance Cr. column. Similarly, the $900 debit opposite Unexpired Insurance is reduced by the $360 credit in the Adjustments column. The result, $540, is shown in the Adjusted Trial Balance Dr. column. The Adjusted Trial Balance debit and credit columns are then totaled and determined to be in balance.

Income Statement and Balance Sheet Columns

All the debit items in the Adjusted Trial Balance columns are extended into the balance sheet or income statement columns to the right. All the credit items in the Adjusted Trial Balance columns are similarly extended.

Note that the January 1 inventory is extended to the Income Statement Dr.column, because beginning inventory will appear as an addition in the cost of goods sold section of the income statement.

Ending Inventory

The December 31 inventory, $40,000, is not in either of the trial balances but is listed as a separate item below the accounts already shown. It is listed in the Balance Sheet Dr. column because it is an asset at the end of the year, and in the Income Statement Cr. column because it will be used as a deduction in the cost of goods sold section of the income statement.

Illustration 1: Use of a Work Sheet

Income Taxes and Net Income

The next step is to total the Income Statement columns; the figure necessary to balance the debit and credit columns is the pretax income or loss for the period. The income before income taxes of $15,640 is shown in the Income Statement Dr. column because the revenue exceeded expenses by that amount.

The federal and state income tax expense and related tax liability are then computed. The company applies an effective rate of 22% to arrive at $3,440. Because the Adjustments columns have been balanced, this adjustment is entered in the Income Statement Dr. column as Income Tax Expense and in the Balance Sheet Cr. column as Income Tax Payable. The following adjusting journal entry is recorded on December 31 and posted to the general ledger as well as entered on the work sheet.

(g) Income Tax Expense 3,440     Income Tax Payable     3,440

Next the Income Statement columns are balanced with the income taxes included. The $12,200 difference between the debit and credit columns in this illustration represents net income. The net income of $12,200 is entered in the Income Statement Dr. column to achieve equality and in the Balance Sheet Cr. column as the increase in retained earnings.

Preparing Financial Statements from a Work Sheet The work sheet provides the information needed for preparation of the financial statements without reference to the ledger or other records. In addition, the data have been sorted into appropriate columns, which facilitates the preparation of the statements. Thus the income statement under the periodic method, prepared from the 10-column work sheet, is shown in Illustration 2

Illustration 2: An Income Statement, Periodic Inventory Method

Note that the balance sheet and statement of retained earnings would be the same as that prepared under the perpetual method (and as illustrated in the text.)