MERCHANDISING BUSINESS

The activities of a service business differ from that of a merchandising business. A service
business earns revenue by rendering services to customers or clients. The revenue activities of a
merchandising business involve the buying and selling of goods or merchandise to its customers.
However, except for the merchandise related accounts, the accounting cycle for both types of
business activities are the same. Because of the differences in their revenue activities, the
general format of the condensed statements of comprehensive income of service and
merchandising companies are illustrated below:

Service Business Merchandising Business

Service Revenue P xxx Sales P xxx
Less Operating Expenses xxx Less Cost of Merchandise Sold xxx
Net Income xxx Gross Profit xxx
Less Operating Expenses xxx
Net Income xxx

INVENTORY SYSTEMS

The two main types of inventory systems are the periodic inventory system and the
perpetual inventory system. Companies that sell goods of low unit value or inexpensive items use
the periodic inventory system. The periodic system relies upon the physical count of the
inventory to determine the ending inventory balance. Merchandise bought intended for sale are
recorded in the Purchases account. The balance in the Purchases account is then added to the
beginning balance of the inventory account to arrive at the cost of merchandise available for sale.
When a physical inventory count is done, the amount of the ending inventory balance will then be
deducted from the cost of merchandise available for sale to arrive at the cost of merchandise
sold. Sale of merchandise is recorded in a revenue account, Sales. However, the cost is not
recorded.

Under the perpetual inventory system, purchases and sale of merchandise is recorded in
the Merchandise Inventory account and the Cost of the Merchandise sold account. This system is
used by companies that sell goods of high unit value like automobiles, jewelry, and other large
home appliances. The business keeps track of its cost of merchandise sold on a continuous basis,
thus, at any given time, there is an estimate of the company’s inventory level. At the end of the
accounting period, an actual count is taken on the number of units still on hand and is compared
with the records showing the ending inventory balance.

VALUE ADDED TAX

Value Added Tax (VAT) is a type of sales tax which is levied on the consumption on the
sale of goods, services or properties, as well as goods imported in the Philippines.

A 12% value added tax rate is levied on goods and is recorded as a separate account in
recording the sale and purchase transactions. It is an indirect tax that is passed on to the buyer

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and is added to the selling price. The amount paid by the customer, known as the invoice price,
will include the selling price and the 12% value added tax.

Output Vat refers to the value added tax the seller passed on to the buyer and is classified
as a liability account. Input Vat refers to the value added tax the buyer paid on the purchase. The
excess of output tax over input tax is the Value added tax due and payable to the Bureau of
Internal Revenue and is to be remitted by the company within 25 days of the following month.

The following transactions illustrate the accounting for value added tax using the periodic
system:

Mar 5 A Company sold merchandise to B Company for cash, P 22,400 vat inclusive.

A Company B Company
Cash 22,400 Purchases 20,000
Sales 20,000 Input tax 2,400
Output tax 2,400 Cash 22,400

Mar 6 A Company sold merchandise to X Company, P 28,000 vat inclusive.

A Company X Company
Accounts Receivable 28,000 Purchases 25,000
Sales 25,000 Input tax 3,000
Output tax 3,000 Accounts Payable 28,000

Mar 9 A Company issued a credit memorandum to X Company for defective merchandise

returned sold on March 6, invoice price P 2,800

A Company X Company
Sales returns and allowances 2,500 Accounts Payable 2,800
Output tax 300 Purchase ret. and allow. 2,500
Accounts Receivable 2,800 Input tax 300

Mar 15 A Company collected amount due from X Company

A Company X Company
Cash 25,200 Accounts Payable 25,200
Accounts Receivable 25,200 Cash 25,200

SPECIAL JOURNALS

We have used the general journal to record all types of business transactions. However,
as the transactions of a company increase, there is a need to change to a more efficient and
timesaving manner. Accountants have developed an accounting system for an orderly and
effective processing of data. They have developed special journals. Each special journal records
one particular type of transaction that occurs frequently, such as sales on account, cash receipts,
purchases on account, or cash disbursements.

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The special journals are designed to systematize the original recording of major recurring types of
transactions. The number and format of the special journals actually used in a company depend
primarily on the nature of the company’s business transactions. The special journals illustrated on
this chapter are the sales, cash receipts, purchases, cash disbursements journals.

 The Sales Journal is used to record all sales of merchandise on account (on credit).
 The Cash Receipts Journal is used to record all inflows or receipts of cash into the
business.
 The Purchases Journal is used to record all purchases of merchandise and other items on
account (on credit).
 The Cash Payments Journal is used to record all payments (or outflows) of cash by the
business.

Although we use all these four special journals, the General Journal is still needed. The General
Journal is used to record all transactions that cannot be recorded in any one of the special
journals. All five of these journals are books of original entry. If a transaction is recorded in the
journal, it is posted to the ledger and made part of the accounting records. Therefore, if a
transaction is recorded in a special journal, it should not be recorded in the general journal
because this would record the transaction twice.

Since the journal entries are posted to the ledger accounts, the posting reference column in the
ledger should indicate the source of the posting. The following abbreviations are used for the five
journals:

Journal Transactions Abbreviation

Sales Journal Merchandise sold on account S
Cash Receipts Journal Cash receipts from all sources CR
Purchases Journal Merchandise and other items purchased on account P
Cash Payments Journal Cash payments for various purposes CD
General Journal Any transaction that is not included in the special G
journals.

CONTROL ACCOUNTS AND SUBSIDIARY LEDGERS

A control account is an account in the general ledger that shows the total balance of all
the subsidiary accounts related to it. An example of a control account is the general ledger
Accounts Receivable account, which summarizes all of the amounts owed to the company.

The subsidiary ledger accounts show the details supporting the related general ledger
control account balance. The company may use subsidiary accounts for receivables to send out
customer statements. They may use the subsidiary accounts for payables to determine the
amount payable to each supplier. These accounts are normally arranged alphabetically by the
name of the customer or supplier. The sum of the subsidiary accounts in a subsidiary ledger
should agree with the balance in the related general ledger control account when the company
prepares the financial statements.

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 A subsidiary ledger, then, is a group of related accounts showing the details of the
balance of a general ledger control account. The subsidiary ledger is separated from the general
ledger in order to relieve the general ledger of a mass of details and thereby shorten the general
ledger trial balance. Also, having separate ledger promotes a division of labor.

SCHEDULE OF ACCOUNTS PAYABLE

A schedule of accounts payable is prepared to make certain that the total of the balances
in the subsidiary ledger accounts agrees with the control account.

SCHEDULE OF ACCOUNTS RECEIVABLE

A schedule of accounts receivable is prepared to ensure that the total of the balances in
the subsidiary ledger account agrees with the control account. This schedule is merely a listing of
open account balances.

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 EXERCISES

1-1 On December 31, 2019, Jag Company had total assets of P 640,000 and total liabilities of
P180,000. During 2020, the company had total revenues of P 560,000 and total expenses of
P 460,000. Also during 2020, the owner withdrew P 60,000. On December 31, 2020, total assets
were P 840,000.

_________________ 1. Compute the owner’s equity on December 31, 2019

_________________ 2. Compute the net income for the year 2020.
_________________ 3. Compute the total liabilities on December 31, 2020.
_________________ 4. Compute the owner’s equity on December 31, 2020.

1-2 On March 1, 2020, Anthony Davis started his business, Davis Laundry Services, by investing
cash of P 140,000. During the month, he earned service revenue on account, P 100,000. He
also paid utilities expenses amounting to P 7,000; wages of P 20,000 and rent expense for the
month of P 12,000. He later collected partially the account of customers amounting to
P 30,000. At the end of the month, he received a bill for advertising for the month of March
payable in April, amounting to P 10,000.

_________________ 5. Compute the owner’s equity on March 31, 2020

_________________ 6. Compute the total assets on March 31, 2020
_________________ 7. Compute the total liabilities on March 31, 2020.
_________________ 8. Compute the net income for the month of March 2020

1-3 During the current year, the assets of Clipper’s Company increased by P 232,000 and the
liabilities decreased by P 54,000. If the owner’s equity in the business is P 620,000 at the
end of the year, how much is the owner’s equity at the beginning of the year?

1-4 The balance sheet of Miami Company shows owner’s equity of P 680,000, which is equal to
2/3 of the amount of total assets. What is the amount of total assets? Total liabilities?

1-5 The following data relates to Warriors Company:

Withdrawals by the owner P 56,000

Total revenues during the year 308,000
Owner’s equity, January 1 220,000
Additional investments 94,000
Total expenses during the year 232,000

How much is the owner’s equity at the end of the year?

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1-6 Given are the following selected data of Thunder Repair Service Company
Revenue from professional services rendered for cash P 490,000
Revenue from professional services rendered on account 160,000
Additional investment by the owner 104,000
Cash collected from account customers 230,000
Operating expenses incurred on account 48,000
Operating expenses incurred for cash 140,000
Cash withdrawn by the owner 76,000

Compute for the net income of the company.

1-7 You are given the following data:

December 31, 2019 December 31, 2020

Assets P 520,000 P 670,000
Liabilities ? 300,000

During 2020: Net loss, P 20,000; Additional investment, P 35,000; Drawings, P 60,000

Compute for the beginning balance of liabilities.

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1-8. The following trial balance did not balance.

JERRY WEST, CPA

Trial Balance
December 31, 2020

Debit Credit

Cash 28,400
Accounts receivable 22,310
Supplies 30,000
Office equipment 50,000
Accounts payable 46,600
Jerry West, Capital 90,000
Jerry West, Drawing 8,000
Professional fees 42,660
Salaries expense 24,000
Advertising expense 9,100
Rent expense 4,000
Utilities expense 5,000
Miscellaneous expense 1,000

181,810 179,260

The following errors were detected:

1. Cash received from a customer on account was debited for P 4,700 and Accounts Receivable
was credited for the same amount. The actual collection was for P 7,400.
2. The purchase of a computer on account for P 23,400 was recorded as a debit to supplies for
P 23,400 and a credit to Accounts payable for P 23,400.
3. Services were performed on account to a client for P 8,900. Accounts receivable was debited
for P 8,900 while Professional fees was credited for P 890.
4. A debit posting to Salaries expense of P 6,000 was omitted.
5. A payment on account for P 2,060 was credited to Cash for P 2,060 but debited to Accounts
payable for P 2,600.
6. The withdrawal of P 5,000 cash by the owner for his personal use was debited Salaries
expense.
7. Utilities expense of P 2,500 was posted as a credit rather than a debit.
8. The balance of Advertising expense is P 4,100 but it was listed as P 9,100 on the trial balance.

Required: Prepare a corrected trial balance.

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1-9 Given the following independent cases, answer the following:

1. On June 1, 2020, ABC Company collected a total of P 43,200 as payment in advance of a

one-year subscription contract to a monthly magazine from a client beginning June 1,
2020. Give the entries needed to record (a) the receipt of the subscription fees and (b) to
adjust the accounts on December 31, 2020 using the liability method and the revenue
method.

2. Sincere Company incurs salaries at the rate of P 12,600 per day. It pays the employees
every Saturday for a 6 day work-week. The last payday was January 27. Give the adjusting
entry on January 31.

3. Gonzales and Mendoza, a law firm, performed legal services in late December, 2020 for
clients. The P 42,000 of the services will be billed to the clients in January, 2021. Give the
adjusting entry that is necessary on December 31, 2020 if the financial statements are
prepared at the end of each month.

4. Assume that a company acquires a building on January 1, 2020 at a cost of P 1,410,000.

The building has an estimated useful life of 25 years and an estimated residual value of
P 150,000. What adjusting entry is needed on December 31, 2020 to record the
depreciation for the entire year?

5. Give the adjusting entries needed as of December 31, the last day of the current year. Show
your computations after each entry.
(a) The balance of the supplies account is a debit of P 14,125. The inventory of supplies on
December 31 amounts to P 4,220.

(b) The insurance expense account has a debit balance of P 46,800 which represent a one-
year insurance premium paid in advance on October 1.

(c) The balance of the prepaid rent account is a debit of P 27,000 which represent a 6-
month rent received in advance on October 15.

(d) The taxes expense account includes a debit of P 64,800 which represent an advance
payment of taxes for one year beginning April 30.

(e) The advertising expense account includes a debit of P 111,072 which represent the cost
of an advertising contract to publish the company ad in 52 consecutive issues of weekly
magazine. As of December 31, advertisements had appeared in 32 issues already.

(f) The balance of the equipment account is a debit of P 235,200 which represent the cost
of office equipment purchased at the beginning of the year. This equipment was
estimated to have a life of 15 years with a residual value of P 9,600.

(g) An automobile was acquired on July 1 at a cost of P 720,000. This automobile was
estimated to have a life of 8 years with a residual value of P 90,000.

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6. Give the adjusting entries needed as of December 31, the end of the current fiscal year.
Show your computations after each entry.
(a) The rent revenue account showed a credit balance of P 48,000 which represent a 6-
month rent received in advance from a tenant on October 31.

(b) The balance of the unearned commissions account is a credit of P 35,100 which
represent commissions received in advance for selling one dozen computer sets. As of
December 31, only 5 computer sets were sold.

(c) Service fees of P 264,000 were collected for one year in advance on April 1. These are
credited to Unearned Service Fees when received.

(d) Subscriptions income has a credit balance of P 14,040 which represent a one-year
subscription to a monthly magazine received in advance on May 31.

(e) The company pays a total of P 90,000 every Friday for a 5-day work week ending
Friday. Assume that the last day of the year falls on a Wednesday.

(f) The company had rendered services to a client towards the end of December. The bill
for P 14,100 will be sent in January of the following year.

1-10 Prepare the adjusting entries on December 31, 2020, the end of the annual accounting
period, on the following independent data. Show your computations after each entry.

1. The Insurance Expense account had a debit balance on December 31, 2020 of P 72,000
representing premium for a 2-year fire insurance policy effective October 1, 2020.

2. Rent Income was credited for P 58,500 on November 1, 2020 representing 9 months rent
collected in advance.

3. Machinery per general ledger on December 31, 2020 shows a balance of P 558,000.
Machinery acquired during the year was P 78,000 on March 1, 2020. All machinery is to
be depreciated at the rate of 25% per annum.

4. As of December 31, 2020, commissions already earned but not yet collected amounted
to P 18,000.

5. Supplies costing P 18,000 bought during the period was debited to the Supplies account.
Of the amount, P 8,000 were consumed during the year.

6. Unearned Subscriptions account showed a credit balance of P 76,000 per general ledger
on December 31. Of this, 40% had been actually earned during the period.

7. On December 31, 2020 a 60-day, 9% Notes Payable has a balance of P 360,000 per
general ledger. The note was issued on December 5, 2020. No interest has been taken
on this note.

8. Fees Collected in Advance has a balance of P 600,000 of which 60% has been earned.

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 9. Notes Receivable has a balance of P 300,000 received from a customer in settlement of
an open account on November 16, 2020. The note is a 90-day, 12% note. No interest
has been taken on this note.

10. The Prepaid Insurance account has balance of P 105,000 on December 31, 2020. The
balance represented two fire insurance policies acquired during 2020. The first policy,
Policy I for P 60,000 was acquired on March 1, 2020 and the second policy, Policy II was
acquired on August 1, 2020 for P 45,000. Policy I is payment for a 2-year plan while
Policy II is for a one-year plan.

I-11. Compute for the missing items as indicated by a letter below.

Beginning Net Ending Cost of Gross Operating Net

Sales Inventory Purchases Inventory Goods Profit Expenses Income
sold (Net Loss)
175,000 A 85,000 60,000 B 90,000 C 62,000
D 62,000 E 68,000 158,000 110,000 40,000 70,000
280,000 72,000 217,000 F G 100,000 H (51,000)
440,000 90,000 I 110,000 J K 170,000 90,000

A. _________________ G. _________________

B. _________________ H. _________________

C. _________________ I. _________________

D. _________________ J. _________________

E. _________________ K. __________________

F. _________________

1-12. Given the following data, solve for the following:

Debit Credit
Sales P 425,000
Sales returns and allowances P 14,000
Accounts receivable 43,000
Allowance for bad debts 760

1. If the estimate of uncollectibles is made by taking 10% of outstanding accounts

receivable, the amount of the adjustment is _______________________.

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 2. The following accounts were abstracted from Lakers Co.’s unadjusted trial balance at
December 31, 2020.

Debit Credit
Accounts receivable P 700,000
Allowance for bad debts 8,000
Net credit sales P 3,000,000

Lakers estimates that 1% of the gross account receivable will become uncollectible.
After adjustment at December 31, 2020, the Allowance for Bad Debts should have a credit
balance of ___________________.

1-13. The following accounts were found in the ledger of Blondie Company on December 31,
2020:

Debit Credit
Accounts receivable P 356,800
Allowance for bad debts 8,760
Cash Sales P 913,800
Credit Sales 1,851,000

Instructions:

1.) Prepare the adjusting entry to take up the provision for bad debts account on the books
of Blondie Company under each of the following independent assumptions:

a) Analysis indicates that 5%of the outstanding accounts receivable will not be collected.
b) Accounts receivable of P 40,000 will become uncollectible.
c) Accounts receivable of P 10,000 is to be written off, and that the allowance for bad
debts is to be adjusted to 10% of the outstanding accounts receivable.

2.) Show how the Accounts Receivable and the Allowance for Bad Debts would appear on the
December 31, 2020 Statement of Financial Position.

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