1

AEACC 1
FINANCIAL ACCOUNTING AND REPORTING

MODULE
MIDTERM COVERAGE

QUALITY POLICY STATEMENT

Jose Rizal Memorial State University, a believer of holistic human development, excellence and quality service,
provides quality training and development to students. It shall commit to provide adequate, suitable and relevant
sources and services with continuing quality management system for clients and customers’ satisfaction through an
efficient and effective quality system which conforms with national and international statutory and regulatory
requirements.

COURSE DESCRIPTION

This is an introductory course in financial accounting will develop students’ appreciation of accounting as
a language of business and an understanding of basic accounting concepts and principles that will help them analyze
business transactions. This course equips the learners with a thorough review of accounting: analysis of business
transactions, accounting equation, journalizing, posting, generation of trial balance, adjusting entries, financial
statements of a merchandising concern and an introductory of a manufacturing business. This course also covers
accounting for the formation and operation of partnership and corporation.

Program Outcomes Addressed by the Course

BSA01. Resolve business issues and problems, with a global and strategic perspective using knowledge and technical
proficiency in the areas of financial accounting and reporting, cost accounting and management, accounting
and control, taxation, and accounting information system.
BSA02. Conduct accountancy research through independent studies of relevant literature and appropriate use of
accounting theory and methodologies.
BSA03. Employ technology as a business tool in capturing financial and non-financial information, generating
reports and making decisions.
BSA04. Apply knowledge and skills to successfully respond to various types of assessments; and (including
professional licensure and certifications).
BSA05. Confidently maintain a commitment to good corporate citizenship, social responsibility and ethical practice
in performing functions as an accountant.

Course Learning Outcomes

At the end of the course, the students should be able to:

1. Demonstrate dynamism needed in various situations to apply the attributes of the VMGO.
2. Complete the accounting cycle and prepare financial statements of a merchandising entity.
3. Determine the different accounting concepts and principles used in the preparation and presentation of
financial statements of a manufacturing entity.
4. Use the concepts and principles relating to the making of financial statements of partnership and
corporation.
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1
INTRODUCTION TO
MERCHANDISING BUSINESS
MODULE
Introduction

A merchandising business is one that buys and sells goods without changing their physical form. The
business, therefore could be a buyer at one hand and a seller on the other hand. Basically, there are two
major activities that are involved in a merchandising business, these are buying and selling activities.

Operating Cycle of Servicing and Merchandising Business Compared

The diagram below shows the comparison of the service and trading business’ operating cycle.

THE OPERATING CYCLE OF A BUSINESS

Servicing Business Merchandising Business

CASH CASH

Phase 1:
Buy Phase 3: Collect
merchandise from customer
Phase 1:
Phase 2: Collect
Render service
from customer
to customers
Phase 2: Sell to
customer on
account

INCOME STATEMENT

MERCHANDISING CONCERN
SERVICE CONCERN
NET SALES
SERVICE INCOME OR REVENUE Minus
Minus COST OF SALES

EXPENSES Equals
GROSS PROFIT
Equals
Minus
EXPENSES
PROFIT
Equals
PROFIT

Income Statemen under Service Concern follows the “Single Step” form wherein Service Revenue is
deducted by Operating Expense to arrive at Profit while the Merchandising business follows the “Multiple
Step” form wherein there are various steps needed before we arrive at profit.
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INVENTORY SYSTEMS
Inventories are accounted for using either of the following inventory systems:
1. Periodic inventory system; or
2. Perpetual inventory system

PERIODIC INVENTORY SYSTEM

The periodic system uses an occasional physical count to measure the level of inventory and the cost of
goods sold (COGS). Merchandise purchases are recorded in the purchases account. The inventory account
and the cost of goods sold account are updated at the end of a set period—this could be once a month, once
a quarter, or once a year. Cost of goods sold is an important accounting metric, which, when subtracted
from revenue, shows a company's gross margin.

Cost of goods sold under the periodic inventory system is calculated as follows:

Beginning Balance of Inventory + Cost of Inventory Purchases - Cost of Ending Inventory = Cost of Goods
Sold

Since businesses often carry products in the thousands, performing a physical count can be difficult and
time-consuming. Imagine owning an office supply store and trying to count and record every ballpoint pen
in stock. Now multiply that for an office supply chain. For these reasons, many companies perform a
physical count only once a quarter or even once a year. For companies under a periodic system, this means
that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.
(Source: [Link]

PERPETUAL INVENTORY SYSTEM

By contrast, the perpetual system keeps track of inventory balances continuously, with updates made
automatically whenever a product is received or sold. Purchases and returns are immediately recorded in
the inventory account. As long as there is no theft or damage, the inventory account balance should be
accurate. The cost of goods sold account is also updated continuously as each sale is made. Perpetual
inventory systems use digital technology to track inventory in real time using updates sent electronically to
central databases.
(Source: [Link]

Major Business Activities of a Merchandising Business

The two major activities of a merchandising business are (1) purchasing activities and (2) selling activities.

Purchasing Activities

This refers to the buying, procurement or acquisition of finished products intended for sale. In accordance
with the historical cost principle, the cost of the product acquired includes the purchase price plus all other
incidental costs related to the acquisition of the product.

Generally, a purchase is perfected upon delivery of the merchandise bought by the buyer, except when there
is an agreement to the contrary.

The common account titles used are:

Purchases – used to describe the products that have been purchased and intended for sale. This
account is debited when merchandise are purchased either in cash or on credit.

Freight-In (Transportation-in) – the account used to record the shipping costs incurred on
purchases of inventory under the periodic system. It is debited for the freight and handling charges
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of merchandise purchased by the buyer or customer and shipped via land, sea and air transportation.
Freight-in is added to Purchases to arrive at the net purchases in periodic inventory system.

Purchase Returns and Allowances – this account is credited for merchandise purchased either in
cash or on credit that were returned to the supplier for reason of bad order or does not fit to the
description of the merchandise ordered and were not replaced due to non-availability of stocks of
merchandise by the supplier. Purchase returns and allowances is deducted to Purchases to compute
for net purchases in periodic inventory system.

Purchase Discounts – this account is credited when there is discount availed from a supplier for
early payment or merchandise purchased on credit. Purchase discounts is deducted to Purchases to
get the net purchases in periodic inventory system.

Selling Activities

“Selling” pertains to the act of transferring the title of ownership over the merchandise from the seller to
the buyer for a consideration either in money or any other thing of value. As a general rule, a sale is
perfected upon delivery of the thing sold.

The selling activities are based on the revenue principle that revenue is recognized when realized or
realizable and earned. It means that when the business is engaged in trading, revenue should be recorded.
In selling, a trader usually adds markup to the cost of the product he purchased. This markup is commonly
called the “gross profit” that will cover the business operating expenses and the residual amount would
either be net income or loss.

The following account titles are commonly used:

Sales – include both cash sales and credit sales. This account is credited for merchandise that are
sold either in cash or on credit. Sales is a revenue account.

Sales Returns and Allowances – used when some items of merchandise sold are returned by the
customer because the items delivered are defective or do not comply with the order’s specification.
To document the acceptance of return, the seller would issue a credit memo. The sales returns and
allowances account is a contra-revenue account, thus, it is deducted from sales account to arrive at
net sales. It has a normal credit balance.

Sales Discounts – The cash discount on sales of merchandise is described by the account title “sales
discounts” which is generally effected in the books of accounts when the buyer pays within the
discount period. It reduces the sales price of merchandise delivered to the buyer. It is treated as a
contra-revenue account against sales, thus, it has a normal credit balance.

Freight-Out (Transportation-out) – refers to the account title for transportation cost incurred by
the seller in transporting the merchandise to the buyer. This account has a normal balance of debit
and treated as a selling expense account under the operating expense caption of the income
statement.

Other Account Titles Used

Asset Account

Merchandise Inventory, End – this refers to the unsold merchandise at the end of the accounting
period as determined by physical counting or inventory taking. The normal balance of the account
is a debit.

Cost Account

Cost of Goods Sold - refers to the direct costs of producing the goods sold by a company. This
amount includes the cost of the materials and labor directly used to create the good. It excludes
indirect expenses, such as distribution costs and sales force costs. Cost of goods sold is also referred
to as "cost of sales."
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Merchandise Inventory, Beginning – refers to merchandise inventory at the beginning of the

period. The account is usually credited in the adjustment. This is used to compute for Cost of Goods
Sold under the periodic inventory system.

Note: There is only one (1) account for merchandise inventory in the General Ledger under both periodic and
perpetual inventory system. Under periodic, being an asset or cost can only be identified by indicating
merchandise inventory, end or merchandise inventory, beginning.

Illustration: Periodic vs. Perpetual (Journal Entries)

PERIODIC System PERPETUAL System

1. To record for purchased goods/merchandise
Purchases xx Merchandise Inventory xx
Cash/Accounts Payable xx Cash/Accounts Payable xx

2. To record for freight charges on merchandise purchased

Freight-in xx Merchandise Inventory xx
Cash/Accounts Payable xx Cash/Accounts Payable xx

3. To record for goods/merchandise returned to supplier

Cash/Accounts Payable xx Cash/Accounts Payable xx
Purchase Returns and Allowances xx Merchandise Inventory xx

4. To record for discount availed for early payment of merchandise purchased on credit
Accounts Payable xx Accounts Payable xx
Cash xx Cash xx
Purchase Discounts xx Merchandise Inventory xx

5. To record for sales to customers

Cash/Accounts Receivable xx Cash/Accounts Receivable xx
Sales xx Sales xx

Cost of Goods Sold xx

No Entry Merchandise Inventory xx

6. To record for goods/merchandise returned by the customer

Sales Returns and Allowances xx Sales Returns and Allowances xx
Cash/Accounts Receivable xx Cash/Accounts Receivable xx

Merchandise Inventory xx
No Entry Cost of Goods Sold xx

7. To record for discount given to customer for early collection of account

Cash xx
Sales Discounts xx
Same Journal Entry
Accounts Receivable xx

8. To record for freight charges on merchandise sold

Freight-out xx
Cash/Accounts Payable xx Same Journal Entry

Note: Under the Perpetual Inventory System, Merchandise Inventory account was used to record for purchases,
freight-in, purchase returns and allowances, and purchase discounts.

For sales transaction, a second journal entry was made to update records on outflow of merchandise or goods
which is not present in the periodic inventory system. Merchandise inventory account was credited to decrease
the inventory recorded and Cost of Goods Sold was debited to increase the volume of merchandise sold.
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For sales returns and allowances, Merchandise Inventory was debited to record the increase of inventory as a
result of goods returned by the customer and a credit to Cost of Goods Sold as a decrease to goods sold. This
second journal entry does not exist in the periodic inventory system.

However, for sales discounts, there is no second journal entry under the perpetual system since discounts does
not affect the flow of merchandise but only the amount of cash to be collected from the customer. Thus, it has
the same journal entry as with periodic system.

Moreover, under the perpetual inventory system, the use of stock cards is a must. There is a continuous updating
of the ins and outs in the stock card every time there are purchases and sale of merchandise. The quantity and
amounts in the stock cards are being filled-up throughout the accounting period or even the whole year round.
It facilitates a better control since it provides information of merchandise inventory on hand.

Merchandise Inventory account under Perpetual Inventory System as an Asset with the following debit and
credit postings:

Merchandise Inventory
1. To record purchases 1. To record purchase returns and allowances
2. To record freight-in 2. To record purchase discounts
3. To record actual cost of merchandise returned 3. To record actual cost of goods sold
by customer 4. Excess of stock card against actual inventory
4. Excess of actual inventory against stock card

Summary:
PERPETUAL System PERIODIC System
• All increases and decreases in inventory • Increases and decreases in inventory
are recorded in the “Merchandise during the period are recorded in the
Inventory” account. “purchases”, “freight-in”, “purchase
returns and allowances”, and “purchase
discounts” accounts, as appropriate.

• “Cost of Goods Sold” is debited when • “Cost of Goods Sold” is not recorded.
inventory is sold and credited for sales
returns.

• Physical count is performed only to check • Physical count is necessary to determine

the accuracy of the ledger balances. the balances of inventory on hand and cost
of goods sold.

• Does not require the use of any formula to • Requires the use of the following formula
determine cost of goods sold because this when determining cost of goods sold:
information is readily available from the
ledger. Beginning Inventory Px
Add: Net Purchases:
Purchases Px
Freight-in x
Purchase Returns & Allowances (x)
Purchase Discount (x) x
Total Goods Available for Sale Px
Less: Ending Inventory (x)
Cost of Goods Sold Px

TRADE DISCOUNT VS. CASH DISCOUNT

Trade discount is referred to as a discount, given by the seller to the buyer at the time of purchase of goods,
as a deduction in the list price of the quantity sold. The trade discount is used by the sellers to attract more
customers and increase the quantity sales. There is no record maintained in the books of both the buyer
and seller for such a discount.
(Source: [Link]

The following are examples of catalogue prices with trade discounts:

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Product List Price Terms Items to purchase

1 P200,000 30, n/30 5 to 10 items
2 P200,000 30, 10, n/30 More than 10 to 20 items
3 P200,000 30, 10, 2/15, n/30 More than 20 items

The meaning of the pricing symbols stated is as follows:

P200,000 – the list price. It is the suggested retail price.

30 – thirty percent (30%). It is the first trade discount deductible from the list price of P200,000.

10 – ten percent (10%). It is the second trade discount deductible from the balance net of the first
discount.

2/15 – two percent (2%) cash discount is given based on the invoice price if paid within fifteen (15)
days.

2/15, EOM – two percent (2%) cash discount is given based on the invoice price if paid within
fifteen (15) days from the end of the month.

n/30 – if not paid within 15 days, net amount (n) without the 2% discount must be paid within 30
days.

Illustration
On April 2, Barn Company sold merchandise to Burn Company at a list price of P100,000; trade discount
– 25, 10; 2/10, n/30. The computation of the invoice price would be:

List Price P100,000

Less: First trade discount (P100,000 x 25%) 25,000
Balance net of first trade discount P75,000
Less: Second trade discount (P75,000 x 10%) 7,500
Invoice Price P67,500

Other computation:

List Price P100,000

Multiplied by percentage less of first trade discount x 75%
Balance net of first trade discount P75,000
Multiplied by percentage less of second trade discount x 90%
Invoice Price P67,500

The appropriate journal entries would be – Periodic Inventory System:

• Books of Barn Company (Seller)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 2 Accounts Receivable 67,500
Sales 67,500
Sales on account. Terms: 25, 10; 2/10, n/30
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• Books of Burn Company (Buyer)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 2 Purchases 67,500
Accounts Payable 67,500
Purchases on account. Terms: 25, 10; 2/10,
n/30

Note:
1. There is no trade discount journalized in either of the books of the seller and the buyer.
2. Trade discounts are not recognized for accounting purposes because they are primarily used to establish
pricing policy.
3. The amount to b recognized in the books of accounts should be the invoice price and not the list price.

Cash Discount is referred to as a discount, allowed to customers by the seller at the time of making the
payment of purchases, as a reduction in the invoice price of the commodity. A cash discount is used by the
sellers to facilitate a prompt payment and thereby to avoid the credit risk. Both the buyers and sellers keep
a proper record of such discount in their books of accounts. Therefore, unlike trade discounts, cash discounts
are recorded in the books of the entity. It can either be a purchase discount (on the buyer’s viewpoint) or
a sales discount (on the seller’s viewpoint).
(Source: [Link]

Illustration
Based on the illustration above, assume that Burn Company paid within 10 days. The computation of actual
cash payment to the Barn Company would be:

Invoice Price P67,500

Less: Cash discount (P67,500 x 2%) 1,350
Actual cash payment P66,150

The appropriate journal entries would be – Periodic Inventory System:

• Books of Burn Company (Buyer)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 12 Accounts Payable 67,500
Cash 66,150
Purchase discounts 1,350
Payment within discount period

• Books of Barn Company (Seller)

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Apr 12 Cash 66,150
Sales discounts 1,350
Accounts Receivable 67,500
Collection within discount period

Note:
1. Purchase discounts and sales discounts are recorded since payment/collection was made within discount
period.
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2. If payment or collection is beyond the discount period given, journal entries in the books of the buyer shall
consist of a debit to Accounts Payable for P67,500 and a credit to Cash also for P67,500. In the books of
the seller, a debit of Cash for P67,500 shall be recorded and a credit to Accounts Receivable for the same
amount.

CREDIT MEMORANDUM AND DEBIT MEMORANDUM

Credit Memorandum is taken from the viewpoint of the seller or supplier who is the creditor. Since the
merchandise sold on account was recorded by the seller/supplier as a debit to Accounts Receivable in its
book, the merchandise returned by the buyer will be recorded as a credit to the same account to effect
reduction of Accounts Receivable. Hence, the document issued to is called as credit memorandum.

Debit Memorandum on the other hand is taken from the viewpoint of the buyer/customer who is the
debtor. Since the merchandise bought on account was recorded by the buyer/customer as a credit to
Accounts Payable in its book, the merchandise returned by the buyer/customer will be recorded as a debit
to the same account to effect the reduction of Accounts Payable.

Illustration
Seller or Supplier’s Book Buyer or Customer’s Book
Upon sale of merchandise: Upon purchase of merchandise:
Accounts Receivable xx Purchases xx
Sales xx Accounts Payable xx

Credit Memorandum Debit Memorandum

We credit your account for the return of We debit your account for the return
merchandise sold on account. of merchandise purchased on
account.
Supplier/Creditor
Customer/Debtor

Seller or Supplier’s Book Buyer or Customer’s Book

Upon return of the merchandise sold: Upon return of the merchandise purchased:
Sales Returns & Allowances xx Accounts Payable xx
Accounts Receivable xx Purchase Returns & Allowances xx

ILLUSTRATIVE PROBLEM - 1
Tinda Han Department Store has just opened its new accounting period. The opening journal entry has been
prepared as follows:

Cash 980,000
Accounts Receivable 65,000
Merchandise Inventory 1,010,000
Store Equipment 300,000
Accumulated Depreciation 50,000
Accounts Payable 350,000
Notes Payable 400,000
T. Han, Capital 1,555,000
#
The transactions for the month of January 2020:

Jan. 1 - Sold merchandise on account to M. Ceniza Trading, P800,000; terms 5/15, n/30.
5 - Sold merchandise on account to V. Bacani, P500,000. Term: 2/10, n/30.
8 - Bought merchandise on account from N. Napila, P10,000. Term: 3/10, n/30. Paid
P100 for freight.
9 - Paid rental for the month, P15,000.
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10 - Paid half of the notes payable.

15 - Collected the account of Jan. 5.
17 - Collected the account of Jan. 1.
18 - Paid the account of January 8.
21 - Sold merchandise for cash, P150,000 to Ace Co.; terms 10, 5/20, n/30. Paid
P2,000 for the freight.
23 - Tinda Han withdrew P70,000 cash from her business for personal use.
24 - Received returns from Ace Co. because of poor quality merchandise, P18,000.
25 - Purchased merchandise from Hark on account, P19,000; terms 2/20, n/30. Paid
freight costs of P1,000.
26 - Returned to Hark merchandise with a selling price of P2,500 due to bad order.
28 - Tinda Han invested additional P50,000 cash to be utilized in the normal
operations of the business.
30 - Paid salaries to store employees, P150,000.
31 - Actual inventory through physical count, P45,400.

(Assume that cost of sales is 70% of the selling price.)

Comparative Journal Entries

PERIODIC System PERPETUAL System
Jan 1 Accounts Receivable 800,000 Accounts Receivable 800,000
Sales 800,000 Sales 800,000

Cost of Goods Sold 560,000

Merchandise Inventory 560,000
*(800,000 x 70% = 560,000)

5 Accounts Receivable 500,000 Accounts Receivable 500,000

Sales 500,000 Sales 500,000

Cost of Goods Sold 350,000

Merchandise Inventory 350,000
*(500,000 x 70% = 350,000)

8 Purchases 10,000 Merchandise Inventory 10,000

Accounts Payable 10,000 Accounts Payable 10,000

Freight-in 100 Merchandise Inventory 100

Cash 100 Cash 100

9 Rent Expense 15,000 Rent Expense 15,000

Cash 15,000 Cash 15,000

10 Notes Payable 200,000 Notes Payable 200,000

Cash 200,000 Cash 200,000

15 Cash 490,000 Cash 490,000

Sales Discount 10,000 Sales Discount 10,000
Accounts Receivable 500,000 Accounts Receivable 500,000
*Account was collected within the given
10-day discount period thus a cash
discount shall be computed (500,000 x
2% = 10,000)

17 Cash 800,000 Cash 800,000

Accounts Receivable 800,000 Accounts Receivable 800,000
*Account was collected beyond the 15-
day discount period.

18 Accounts Payable 10,000 Accounts Payable 10,000

Cash 9,700 Cash 9,700
Purchase Discount 300 Merchandise Inventory 300
*Account was paid within the 10-day
discount period thus a cash discount
shall be computed (10,000 x 3% = 300)
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21 Cash 135,000 Cash 135,000

Sales 135,000 Sales 135,000
*Amount is net of the trade discount
given (150,000 x 90% = 135,000) Cost of Goods Sold 94,500
Merchandise Inventory 94,500
Freight-out 2,000 *(135,000 x 70% = 94,500)
Cash 2,000
Freight-out 2,000
Cash 2,000

23 T. Han, Drawing 70,000 T. Han, Drawing 70,000

Cash 70,000 Cash 70,000

24 Sales Returns and Allowances 18,000 Sales Returns and Allowances 18,000
Cash 18,000 Cash 18,000

Merchandise Inventory 12,600

Cost of Goods Sold 12,600
*(18,000 x 70% = 12,600)

25 Purchases 19,000 Merchandise Inventory 19,000

Accounts Payable 19,000 Accounts Payable 19,000

Freight-in 1,000 Merchandise Inventory 1,000

Cash 1,000 Cash 1,000

26 Accounts Payable 2,500 Accounts Payable 2,500

Purchase Returns & Allowances 2,500 Merchandise Inventory 2,500

28 Cash 50,000 Cash 50,000

T. Han, Capital 50,000 T. Han, Capital 50,000

30 Salaries Expense 150,000 Salaries Expense 150,000

Cash 150,000 Cash 150,000

31 Merchandise Inventory, End 45,400 *No journal entry since the balance for
Income & Expense Summary 45,400 Merchandise Inventory is the same as with
*Inventory at the end was set-up based the actual physical count
on the actual physical counting.
Merchandise Inventory
Jan 1 1,010,000 Jan 1 560,000
8 10,000 5 350,000
8 100 18 300
24 12,600 21 94,500
25 19,000 26 2,500
25 1,000
1,052,700 1,007,300
45,400
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COMPARATIVE INCOME STATEMENT

PERIODIC Inventory System

Tinda Han Department Store
Income Statement
For the month ended January 31, 2020

Net Sales:
Sales P1,435,000
Sales Returns & Allowances (18,000)
Sales Discounts (10,000) P1,407,000
Cost of Goods Sold:
Beg. Inventory P1,010,000
Net Purchases:
Purchases P29,000
Freight-in 1,100
Purchase Returns & Allowances (2,500)
Purchase Discounts (300) 27,300
Ending Inventory (45,400) (991,900)
Gross Profit P415,100
Operating Expenses:
Rent Expense P15,000
Freight-out 2,000
Salaries Expense 150,000 (167,000)
Net Profit P248,100

PERPETUAL Inventory System

Tinda Han Department Store
Income Statement
For the month ended January 31, 2020

Net Sales:
Sales P1,435,000
Sales Returns & Allowances (18,000)
Sales Discounts (10,000) P1,407,000
Cost of Goods Sold (991,900)
Gross Profit P415,100
Operating Expenses:
Rent Expense P15,000
Freight-out 2,000
Salaries Expense 150,000 (167,000)
Net Profit P248,100

Notes:
1. Under the periodic system, account titles such as purchases, freight-in, purchase returns and allowances,
and purchase discounts were used. Thus, a physical count of the ending inventory is needed since
merchandise inventory account has no real-time update. Moreover, the cost of goods sold is computed
using the following formula:

Beginning Inventory Px
Add: Net Purchases:
Purchases Px
Freight-in x
Purchase Returns & Allowances (x)
Purchase Discount (x) x
Total Goods Available for Sale Px
Less: Ending Inventory (x)
Cost of Goods Sold Px

2. Under the perpetual system, there is no need to compute for cost of goods sold since the account is updated
for every sale and return transaction. Likewise, Merchandise Inventory account also has an updated
balance.
3. Regardless of the inventory system used, cost of goods sold and net profit/income would still be the same.
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Under the Perpetual inventory system, if the ending balance of the Merchandise Inventory account is the
same as with the physical or actual count of inventory, then no journal entry shall be made. Problem will
arise if the Merchandise Inventory account end balance and the physical count differs. Thus, a journal entry
shall be recorded to equate the two amounts in accordance to the actual/physical count.

Assumption:
Using the above illustrative problem, assuming the actual inventory through physical count is P40,000.

Comparative Journal Entries

PERIODIC System PERPETUAL System
31 Merchandise Inventory, end 40,000 Inventory short or over 5,400
Income and Expense Summary 40,000 Merchandise Inventory 5,400
*Inventory at the end was set-up based *(45,400 – 40,000 = 5,400)
on the actual physical counting.

COMPARATIVE INCOME STATEMENT

PERIODIC Inventory System

Tinda Han Department Store
Income Statement
For the month ended January 31, 2020

Net Sales:
Sales P1,435,000
Sales Returns & Allowances (18,000)
Sales Discounts (10,000) P1,407,000
Cost of Goods Sold:
Beg. Inventory P1,010,000
Net Purchases:
Purchases P29,000
Freight-in 1,100
Purchase Returns & Allowances (2,500)
Purchase Discounts (300) 27,300
Ending Inventory (40,000) (997,300)
Gross Profit P409,700
Operating Expenses:
Rent Expense P15,000
Freight-out 2,000
Salaries Expense 150,000 (167,000)
Net Profit P242,700

PERPETUAL Inventory System

Tinda Han Department Store
Income Statement
For the month ended January 31, 2020

Net Sales:
Sales P1,435,000
Sales Returns & Allowances (18,000)
Sales Discounts (10,000) P1,407,000
Cost of Goods Sold: (adjusted)
Cost of Goods Sold P991,900
Inventory Short or Over 5,400 (997,300)
Gross Profit P409,700
Operating Expenses:
Rent Expense P15,000
Freight-out 2,000
Salaries Expense 150,000 (167,000)
Net Profit P242,700
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Notes:
1. Under the perpetual inventory system, adjustment shall be made if the Merchandise Inventory balance and
actual physical count differs. The Inventory Short or Over account shall be used to equate both amounts
following the actual physical count. This account is an adjustment to the Cost of Goods Sold (COGS) for
which a debit of it can increase COGS and a credit of the same account decreases COGS.
2. In the above assumption, Merchandise Inventory has an ending balance of P45,400 while the actual
physical count is P40,000 having a difference of P5,400. Since the actual count should be followed,
Merchandise Inventory is credited by P5,400 and the adjustment account, Inventory Short or Over, is
debited. Furthermore, a debit to Inventory Short or Over increases the Cost of Goods Sold.
3. Still, the COGS and Net Profit of both inventory systems have the same amounts.

GROSS METHOD vs. NET METHOD OF RECORDING CASH DISCOUNTS

The issue in accounting is whether or not there would be a journal entry to be made for cash discount not
taken. The journal entry for cash discount not taken depends on whether the method used in recording is
gross method or net method.

The cost measured under the net method represents the cash equivalent price on the date of payment and
therefore the theoretically correct historical cost. However, in practice, most entities record purchases at
gross invoice amount.

Technically, the gross method violates the matching principle because discounts are recorded only when
taken or when cash is paid rather than when purchases that give rise to the discounts are made. Despite its
theoretical shortcomings, the gross method is supported on practical grounds. It is more convenient than
the net method from a bookkeeping standpoint.

Under the asset recognition principle, the net method is the current GAAP. Purchase discount loss, being
avoidable cost, should not be included in the cost of the asset. Asset should be recognized net of discount.

Illustration
Assume that Go Enterprises sold merchandise to Wang Company at gross sales of P200,000, terms: 2/10,
n/30. The journal entries would be

Books of Go Enterprises (Seller)

1. To record credit sales

Gross Method Net Method

Accounts Receivable 200,000 Accounts Receivable 196,000
Sales 200,000 Sales 196,000
*(200,000 x 98% = 196,000)

Note: Unlike the gross method, the net method initially records the sales reduced by the cash discount even if no
actual collection has been made yet. The recording, however, does not reflect the sales discount account in the
books of accounts.

2. If collection is made within the discount period

Gross Method Net Method

Cash 196,000 Cash 196,000
Sales Discounts 4,000 Accounts Receivable 196,000
Accounts Receivable 200,000

Note: The gross method records only the cash discount when actual collection was made within the discount period.
 15

3. If collection is made after the discount period.

Gross Method Net Method

Cash 200,000 Cash 200,000
Accounts Receivable 200,000 Accounts Receivable 196,000
Sales discounts forfeited 4,000

Note: Sales discount forfeited shall be treated as other operating income in the income statement. Therefore, net profit
is the same for both gross and net methods.

Books of Wang Company (Buyer)

1. To record purchases on account

Gross Method Net Method

Purchases 200,000 Purchases 196,000
Accounts Payable 200,000 Accounts Payable 196,000
*(200,000 x 98% = 196,000)

2. If payment is made within the discount period.

Gross Method Net Method

Accounts Payable 200,000 Accounts Payable 196,000
Cash 196,000 Cash 196,000
Purchase Discounts 4,000

3. If payment is made after the discount period.

Gross Method Net Method

Accounts Payable 200,000 Accounts Payable 196,000
Cash 200,000 Purchase Discount Lost 4,000
Cash 200,000

Note: The purchase discount lost account shall be treated as other operating expense (loss) in the income statement.
Therefore, net profit is the same for both gross and net methods.

ILLUSTRATIVE PROBLEM – 2

Consider the following transactions of Maayo Company in the month of May 2020: (Assume that cost of
sales is 60% of the invoice price)

May 6 Sold merchandise on account, P500,000. Terms: 10; 5/15, n/30.

8 Purchased merchandise on account, P200,000; terms: 20; 3/15, n/30.
12 Sold P400,000. Terms: 3/10, n/30.
17 Collected sales for May 12.
19 Purchased goods on account, P300,000. Terms: 20; 10; 5/10, n/30.
20 Paid for the May 8 purchases.
22 Collected the account on May 6.
31 Paid for account purchases on May 19
 16

A. GROSS METHOD

Comparative Journal Entries

PERIODIC System PERPETUAL System
May 6 Accounts Receivable 450,000 Accounts Receivable 450,000
Sales 450,000 Sales 450,000
*(500,000 x 90% = 450,000)
net of the 10% trade discount Cost of Goods Sold 270,000
Merchandise Inventory 270,000
*(450,000 x 60% = 270,000)

8 Purchases 160,000 Merchandise Inventory 160,000

Accounts Payable 160,000 Accounts Payable 160,000
*(200,000 x 80% = 160,000)
net of the 20% trade discount

12 Accounts Receivable 400,000 Accounts Receivable 400,000

Sales 400,000 Sales 400,000

Cost of Goods Sold 240,000

Merchandise Inventory 240,000
*(400,000 x 60% = 240,000)

17 Cash 388,000
Sales Discount 12,000
Accounts Receivable 400,000
SAME JOURNAL ENTRY
*(400,000 x 3% = 12,000)
Collected within discount period

19 Purchases 216,000 Merchandise Inventory 216,000

Accounts Payable 216,000 Accounts Payable 216,000
*(300,000 x 80% x 90% = 216,000)
net of the 20% and 10% trade discounts

20 Accounts Payable 160,000 Accounts Payable 160,000

Cash 155,200 Cash 155,200
Purchase Discount 4,800 Merchandise Inventory 4,800
*(160,000 x 3% = 4,800)
Paid within discount period

22 Cash 450,000
Accounts Receivable 450,000 SAME JOURNAL ENTRY
Collected beyond discount period

31 Accounts Payable 216,000

Cash 216,000 SAME JOURNAL ENTRY
Paid beyond discount period

B. NET METHOD

Comparative Journal Entries

PERIODIC System PERPETUAL System
May 6 Accounts Receivable 427,500 Accounts Receivable 427,500
Sales 427,500 Sales 427,500
*(500,000 x 90% x 95% = 427,500)
net of the 10% trade discount & 5% cash Cost of Goods Sold 270,000
discount Merchandise Inventory 270,000
*(500,000 x 90% =450,000 x 60% = 270,00)
COGS not affected with cash discounts

8 Purchases 155,200 Merchandise Inventory 155,200

Accounts Payable 155,200 Accounts Payable 155,200
*(200,000 x 80% x 97% = 155,200)
net of the 20% trade discount and 3%
cash discount

12 Accounts Receivable 388,000 Accounts Receivable 388,000

Sales 388,000 Sales 388,000
*(400,000 x .97% = 388,000)
 17

net of the 3% cash discount Cost of Goods Sold 240,000

Merchandise Inventory 240,000
*(400,000 x 60% = 240,000)

17 Cash 388,000
Accounts Receivable 388,000
SAME JOURNAL ENTRY
Collected within discount period

19 Purchases 205,200 Merchandise Inventory 205,200

Accounts Payable 205,200 Accounts Payable 205,200
*(300,000 x 80% x 90% x 95% = 205,200)
net of the 20% and 10% trade discounts
and 5% cash discount

20 Accounts Payable 155,200

Cash 155,200
SAME JOURNAL ENTRY
Paid within discount period

22 Cash 450,000
Accounts Receivable 427,500
Sales discount forfeited 22,500 SAME JOURNAL ENTRY
Collected beyond discount period

31 Accounts Payable 205,200 Accounts Payable 205,200

Purchase discount lost 10,800 Merchandise Inventory 10,800
Cash 216,000 Cash 216,000
Paid beyond discount period Paid beyond discount period

Observations:
1. Under the periodic inventory system, regardless of what method used (gross or net) it would still have
the same net profit. For illustration purposes, let us assume that the ending inventory is P50,000.

GROSS METHOD NET METHOD

Net Sales: Net Sales:

Sales P850,000 Sales P815,500
Sales Discounts (12,000) P838,000 Cost of Goods Sold:
Cost of Goods Sold: Purchases P360,400
Net Purchases: End. Inventory (50,000) (310,400)
Purchases P376,000 Gross Profit P505,100
Purchase Discount (4,800) Other Operating Income/Expense:
TGAS P371,200 Sales discount forfeited 22,500
End. Inventory (50,000) (321,200) Purchase discount lost (10,800)
Net Profit P516,800 Net Profit P516,800

2. Under the perpetual inventory system, regardless of what method used (gross or net) it would still have
the same net profit and Merchandise Inventory balance. For illustration purposes, let us assume that the
beginning balance for Merchandise Inventory is P500,000.

GROSS METHOD NET METHOD

Merchandise Inventory Merchandise Inventory

1) 500,000 1) 500,000
8) 160,000 270,000 6) 8) 155,200 270,000 6)
19) 216,000 240,000 12) 19) 205,200 240,000 12)
4,800 20) 31) 10,800
876,000 514,800 871,200 510,000
361,200 361,200

GROSS METHOD NET METHOD

Net Sales: Net Sales:

Sales P850,000 Sales P815,500
Sales Discounts (12,000) P838,000 Cost of Goods Sold (510,000)
Cost of Goods Sold (510,000) Gross Profit P305,500
Net Profit P328,000 Other Operating Income:
Sales discount forfeited 22,500
Net Profit P328,000
 18

Transportation Costs:
F.O.B. SHIPPING POINT vs. F.O.B. DESTINATION

An accounting question may arise as to whom between the seller and the buyer should be responsible to
shoulder and pay the transportation costs. This will depend on the terms, whether FOB Shipping Point or
FOB Destination. FOB means free on board.

F.O.B. Shipping Point

Under FOB shipping point, ownership of goods is transferred to the buyer upon shipment. Consequently,
the buyer becomes responsible for the cost of transportation because he practically owned the merchandise
while in transit.

Illustration
Metro Enterprises purchased P100,000 worth of merchandise from Central Company with terms of
2/10, n/30, FOB Shipping Point. ABC Express transported the products and collected P5,000 as
transportation fee. The related journal entries would be:
(Assuming gross method was used to record for cash discounts)

Central Company (Seller) Metro Enterprises (Buyer)

Accounts Receivable 100,000 Purchases 100,000
Sales 100,000 Accounts Payable 100,000

Freight-in 5,000
Cash 5,000

Note: Only the buyer shall record for “freight-in”, because the contract is FOB shipping point; the buyer owns the
goods upon shipment. The seller, on the other hand, will not record “freight-out” because he does not own the
merchandise while in transit.

F.O.B. Destination

Under FOB destination, ownership of goods is transferred to the buyer only upon reaching the specified
place of destination or upon receipt of the goods to the buyer at the point of destination. Consequently, the
seller still owns the products transported which makes him responsible for the cost of transportation while
the products are still in transit.

Illustration
Using the previous illustration, but with terms of FOB destination.
(Assuming gross method was used to record for cash discounts)

Central Company (Seller) Metro Enterprises (Buyer)

Accounts Receivable 100,000 Purchases 100,000
Sales 100,000 Accounts Payable 100,000

Freight-out 5,000
Cash 5,000

Note: Only the seller effected a transportation entry, “freight-out”, because the contract is FOB destination – the seller
owns the goods while in transit. The buyer will not have an entry for “freight-in” because he acquires ownership
only when the goods have reached the point of destination.

FREIGHT PREPAID vs. FREIGHT COLLECT

Another problem regarding accounting for transportation is when the seller makes the actual transportation
payment although the agreement in the contract of sale is FOB Shipping Point. Likewise, this complex
problem also occurs when the buyer pays the actual transportation payment even though the agreement in
the contract of sale is FOB Destination.
 19

Freight Prepaid

This term means that the actual payment of transportation cost shall be made by the seller to the common
carrier. If the contract of sale is FOB Shipping Point, Freight Prepaid, the obligation of the buyer is
increased by the amount of transportation cost paid by the seller on his behalf.

Illustration
Pally Tan Store sold P50,000 worth of merchandise to Barley Bazaar. The terms of sales contract
are 2/10, n/30; FOB shipping point; freight prepaid, P2,500. The related journal entries would be:
(Assuming gross method was used to record for cash discounts)

Pally Tan Store (Seller) Barley Bazaar (Buyer)

Accounts Receivable 52,500 Purchases 50,000
Sales 50,000 Freight-in 2,500
Cash 2,500 Accounts Payable 52,500

Note:
1. The terms for transportation was FOB shipping point thus the buyer should pay for the freight cost since
ownership of the goods has transferred to the buyer upon shipment. However, it was done under “freight
prepaid” meaning the actual payment was made by the seller.
2. Since it was under FOB shipping point, the buyer should record “freight-in” in its books. Because of
freight prepaid, actual payment was made by seller therefore a credit to cash can be seen in its books. On
the other hand, the buyer shall record a payable account in relation to the freight paid by the seller which
should be shouldered by the him.

Sales price per invoice P50,000

Add: Transportation cost paid on behalf of the buyer 2,500
Total accounts receivable P52,500

Freight Collect

This term means that the buyer shall make the actual payment of transportation cost to the common carrier,
such that whenever the contract of sale is FOB Destination, Freight Collect, the accounts payable by the
buyer is reduced by the cost of transportation because the buyer paid the shipment cost on behalf of the
seller.

Illustration
Pally Tan Store sold P50,000 worth of merchandise to Barley Bazaar. The terms of sales contract
are 2/10, n/30; FOB destination; freight collect, P2,500. The related journal entries would be:
(Assuming gross method was used to record for cash discounts)

Pally Tan Store (Seller) Barley Bazaar (Buyer)

Accounts Receivable 47,500 Purchases 50,000
Freight-out 2,500 Cash 2,500
Sales 50,000 Accounts Payable 47,500

Notes:
1. The terms for transportation was FOB destination thus the seller should pay for the freight cost since
ownership of the goods will only transfer to the buyer upon receipt of the goods to the buyer at the point
of destination. However, it was done under “freight collect” meaning the actual payment was made by the
buyer.
2. Since it was under FOB destination, the seller should record “freight-out” in its books. Because of freight
collect, actual payment was made by buyer therefore a credit to cash can be seen in its books. On the other
hand, the seller should decrease its receivable due to the payment of freight done or shouldered by the
buyer.

Purchase price invoice P50,000

Less: Transportation cost paid in behalf of the seller (2,500)
Remaining accounts payable P47,500
 20

Based on the above illustrations, it could be inferred that there is no increase or decrease in accounts
receivable or accounts payable if the agreement is

1. FOB Shipping Point; Freight Collect, and

2. FOB Destination; Freight Prepaid

The following table summarizes the common terms used in transporting products and their corresponding
effects:

Summary of Transportation Terms

Actual payor of Effect on claims or

Transportation Terms Expense of transportation cost obligation
FOB Shipping Point, Freight Prepaid Buyer Seller Increase
FOB Shipping Point, Freight Collect Buyer Buyer No effect
FOB Destination, Freight Prepaid Seller Seller No effect
FOB Destination, Freight Collect Seller Buyer Decrease

ILLUSTRATIVE PROBLEM – 3

The account balances of Encore Marketing are as follows, as of February 28, 2020:

Debit Credit
Cash P100,000 Accounts payable P50,000
Accounts receivable 400,000 Notes payable 200,000
Merchandise inventory 490,000 E. Capital 805,000
Prepaid supplies 5,000 Allowance for bad debts 20,000
E, Drawings 80,000

Transactions for the month of March 2020:

March 1 Purchases on account, P580,000; terms: 2/20; n/30. FOB shipping point,
freight prepaid, P1,800.
2 Sold merchandise on account, P650,000; terms: 10; 5/15, n/30. FOB
shipping point, freight prepaid, P20,000.
15 Paid 15th month salary, P150,000.
16 Collected sales on March 2.
20 Paid purchases made on March 1.
22 Sold goods for cash to various customers, P400,000.
23 Received sales returns, P20,000 from various customers.
26 Sold goods on account, P500,000. FOB destination, freight collect,
P30,000.
31 Purchased goods on account P100,000. FOB destination, freight prepaid,
P10,000.

Requirements:
1. Journalize the above transactions using (a) periodic method and (b) perpetual method. For
illustration purposes, let us use gross method to record for cash discounts. (Assume that cost of
sales is 70% of the invoice price)
2. Post transactions in the general ledger
3. Prepare an unadjusted trial balance

Comparative Journal Entries

PERIODIC System PERPETUAL System
Mar 1 Purchases 580,000 Merchandise Inventory 581,800
Freight-in 1,800 Accounts Payable 581,800
Accounts Payable 581,800
 21

2 Accounts Receivable 605,000 Accounts Receivable 605,000

Cash 20,000 Cash 20,000
Sales 585,000 Sales 585,000
*(650,000 x 90% =585,000)
net of 10% trade discount Cost of Goods Sold 409,500
Merchandise Inventory 409,500
*(585,000 x 70% = 409,500)

15 Salaries Expense 150,000

Cash 150,000 SAME JOURNAL ENTRY

16 Cash 575,750
Sales Discount 29,250
Accounts Receivable 605,000 SAME JOURNAL ENTRY
*(585,000 x 5% = 29,250)

20 Accounts Payable 581,800 Accounts Payable 581,800

Cash 570,200 Cash 570,200
Purchase Discount 11,600 Merchandise Inventory 11,600
*(580,000 x 2% = 11,600)

22 Cash 400,000 Cash 400,000

Sales 400,000 Sales 400,000

Cost of Goods Sold 280,000

Merchandise Inventory 280,000
*(400,000 x 70% = 280,000)

23 Sales Returns 20,000 Sales Returns 20,000

Cash 20,000 Cash 20,000

Merchandise Inventory 14,000

Cost of Goods Sold 14,000
*(20,000 x 70% = 14,000)

26 Accounts Receivable 470,000 Accounts Receivable 470,000

Freight-out 30,000 Freight-out 30,000
Sales 500,000 Sales 500,000

Cost of Goods Sold 350,000

Merchandise Inventory 350,000
*(500,000 x 70% = 350,000)

31 Purchases 100,000 Merchandise Inventory 100,000

Accounts Payable 100,000 Accounts Payable 100,000

Notes:
a. March 1 transaction:
Periodic: The shipping term was FOB shipping point; therefore, the buyer is responsible
for the freight charge. That is why a debit of “freight-in” can be seen in the books
of the company since in this transaction the company was the purchaser or buyer.
However, the actual payment of freight was done by the seller (freight prepaid).
Thus, the accounts payable account was increased by P1,800 to signify an
additional liability of the buyer on the freight cost paid by the seller of its behalf.

Perpetual: Both amounts of purchases and freight-in are lumped in the merchandise
inventory account.

b. Mach 2 transaction:
Periodic: This transaction was subject to a 10% trade discount. The sales to be recorded
should be net of the trade discount given. Moreover, the sale was made under
FOB shipping point, thus, the buyer should record “freight-in” in its books.
Meanwhile, freight prepaid was applied. Meaning, the seller paid for the freight
which should be the expense of the buyer. Thus, a credit to cash was recorded
and the receivable account was increased equivalent to the freight cost paid.

Perpetual: A second journal entry was made to record for the cost of the goods sold.

c. March 16 transaction:
 22

Collection was made within the discount period given. Therefore, the customer
is entitled to a cash discount. Sales of P585,000 times 5% cash discount equal to
a sales discount of P29,250. The accounts receivable credited is inclusive of the
freight cost paid by the seller.

d. March 20 transaction:
Periodic: Payment was made within discount period. Hence, the entity is entitled to a cash
discount. Purchases of P580,000 times 2% cash discount equal to a purchase
discount of P11,600. The accounts payable debited is inclusive of the freight cost
paid by the seller.

Perpetual: Instead of purchase discount, merchandise inventory account was used.

e. March 26 transaction:
The shipping term was FOB destination therefore any shipping cost should be
the expense of the seller. The entity should record for “freight-out”. However, it
was done under freight collect. Meaning, the buyer paid the shipping cost on the
seller’s behalf. Instead of having a receivable of P500,000, the remaining
receivable now would be P470,000 (less of the shipping cost paid by the buyer
which should be the expense of the seller).

f. March 31 transaction:
The shipping term was FOB destination thus the seller is responsible for any
shipping cost. In the seller’s books, there should be a debit to “freight-out”.
Moreover, the terms of shipment were under freight prepaid for which the seller
made the actual payment. There shall be no effect on the payable account since
all terms were on the seller’s viewpoint.

PERPETUAL INVENTORY SYSTEM

GENERAL LEDGER

Account: CASH Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 100,000 - 100,000 -
2 Paid freight on goods sold 20,000 - 80,000 -
15 Paid salaries 50,000 - 30,000 -
16 Collection of credit sales 575,750 - 605,750 -
20 Paid purchases on account 570,200 - 35,550 -
22 Collection of cash sales 400,000 - 435,550 -
23 Received sales returns 20,000 - 415,550 -

Account: ACCOUNTS RECEIVABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 400,000 - 400,000 -
2 Credit sales 605,000 - 1,005,000 -
16 Collection of credit sales 605,000 - 400,000 -
26 Credit sales 470,000 - 870,000 -

Account: ALLOWANCE FOR BAD DEBTS Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 20,000 - 20,000 -

Account: MERCHANDISE INVENTORY Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 490,000 - 490,000 -
 23

Account: PREPAID SUPPLIES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 5,000 - 5,000 -

Account: ACCOUNTS PAYABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 50,000 - 50,000 -
1 Purchases on account 581,800 - 631,800 -
20 Paid account purchases 581,800 - 50,000 -
31 Purchases on account 100,000 - 150,000 -

Account: NOTES PAYABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 200,000 - 200,000 -

Account: E. CAPITAL Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 805,000 - 805,000 -

Account: E. DRAWINGS Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 80,000 - 80,000 -

Account: SALES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 2 Credit sales 585,000 - 585,000 -
22 Cash sales 400,000 - 985,000 -
26 Credit sales 500,000 1,485,000 -

Account: SALES DISCOUNT Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 16 Collection of credit sales 29,250 - 29,250 -

Account: SALES RETURNS & ALLOWANCES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 23 Received sales returns 20,000 - 20,000 -

Account: PURCHASES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Purchases on account 580,000 - 580,000 -
31 Purchases on account 100,000 - 680,000 -

Account: FREIGHT-IN Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Freight on purchases 1,800 - 1,800 -

Account: PURCHASE DISCOUNT Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 20 Payment of account purchases 11,600 - 11,600 -
 24

Account: FREIGHT-OUT Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 26 Freight on sales 30,000 - 30,000 -

Account: SALARIES EXPENSE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 15 Payment of salaries 50,000 - 50,000 -

ENCORE MARKETING
Unadjusted Trial Balance
March 31, 2020

Account Titles Folio Debit Credit

Cash P415,550
Accounts Receivable 870,000
Allowance for Bad Debts P20,000
Merchandise Inventory 490,000
Prepaid Supplies 5,000
Accounts Payable 150,000
Notes Payable 200,000
E. Capital 805,000
E. Drawings 80,000
Sales 1,485,000
Sales Discount 29,250
Sales Returns & Allowances 20,000
Purchases 680,000
Freight-in 1,800
Purchase Discount 11,600
Freight-out 30,000
Salaries Expense 50,000
Total P2,671,600 P2,671,600

PERPETUAL INVENTORY SYSTEM

GENERAL LEDGER

Account: CASH Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 100,000 - 100,000 -
2 Paid freight on goods sold 20,000 - 80,000 -
15 Paid salaries 50,000 - 30,000 -
16 Collection of credit sales 575,750 - 605,750 -
20 Paid purchases on account 570,200 - 35,550 -
22 Collection of cash sales 400,000 - 435,550 -
23 Received sales returns 20,000 - 415,550 -

Account: ACCOUNTS RECEIVABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 400,000 - 400,000 -
2 Credit sales 605,000 - 1,005,000 -
16 Collection of credit sales 605,000 - 400,000 -
26 Credit sales 470,000 - 870,000 -

Account: ALLOWANCE FOR BAD DEBTS Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 20,000 - 20,000 -
 25

Account: MERCHANDISE INVENTORY Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 490,000 - 490,000 -
1 Purchases on account 581,800 - 1,071,800 -
2 Credit sales 409,500 - 662,300 -
20 Purchase discount availed 11,600 - 650,700 -
22 Cash sales 280,000 - 370,700 -
23 Received sales returns 14,000 - 384,700 -
26 Sales on account 350,000 - 34,700
31 Purchases on account 100,000 - 134,700

Account: PREPAID SUPPLIES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 5,000 - 5,000 -

Account: ACCOUNTS PAYABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 50,000 - 50,000 -
1 Purchases on account 581,800 - 631,800 -
20 Paid account purchases 581,800 - 50,000 -
31 Purchases on account 100,000 - 150,000 -

Account: NOTES PAYABLE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 200,000 - 200,000 -

Account: E. CAPITAL Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 805,000 - 805,000 -

Account: E. DRAWINGS Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 1 Beg. balance 80,000 - 80,000 -

Account: SALES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 2 Credit sales 585,000 - 585,000 -
22 Cash sales 400,000 - 985,000 -
26 Credit sales 500,000 1,485,000 -

Account: SALES DISCOUNT Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 16 Collection of credit sales 29,250 - 29,250 -

Account: SALES RETURNS & ALLOWANCES Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 23 Received sales returns 20,000 - 20,000 -

Account: COST OF GOODS SOLD Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 2 Credit sales 409,500 - 409,500 -
22 Cash sales 280,000 - 689,500 -
 26

23 Received sales returns 14,000 - 675,500 -

26 Credit sales 350,000 - 1,025,500 -

Account: FREIGHT-OUT Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 26 Freight on sales 30,000 - 30,000 -

Account: SALARIES EXPENSE Account No.

Post.
2020 Explanation DEBIT CREDIT BALANCE
Ref.
Mar 15 Payment of salaries 50,000 - 50,000 -

ENCORE MARKETING
Unadjusted Trial Balance
March 31, 2020

Account Titles Folio Debit Credit

Cash P415,550
Accounts Receivable 870,000
Allowance for Bad Debts P20,000
Merchandise Inventory 134,700
Prepaid Supplies 5,000
Accounts Payable 150,000
Notes Payable 200,000
E. Capital 805,000
E. Drawings 80,000
Sales 1,485,000
Sales Discount 29,250
Sales Returns & Allowances 20,000
Cost of Goods Sold 1,025,500
Freight-out 30,000
Salaries Expense 50,000
Total P2,660,000 P2,660,000
 27

ACCOUNTING FOR VALUE-ADDED TAX

(Source: Fundamentals of Accounting 2016 ed by Rafael M. Lopez, Jr.)

VAT is not entirely a new concept of business taxation but is just another form of tax levied on a wide
range of goods and service. Specifically, it means “tax on the value-added” by every seller to purchase of
goods and services.

The approval of R.A. 9337 No. 14-2005, removes the VAT exemption of several formerly, exempt section
of our economy. Thus, the burden of taxation is now shared more equitably. The approval has increased
VAT from 10% to 12% effective February 2006.

The difference between our Output Tax, the tax on our sales and Input Tax, the tax on our purchases is our
VAT Payable which will then be remitted to the Bureau of Internal Revenue within 25 days after the end of
each month.

Input Tax and Prepaid Tax are presented in the Current Asset section of the Balance Sheet while Output
Tax and Vat Payable are presented in the Current Liability section of the Balance Sheet.

The revenue regulation also emphasizes that VAT Input/Output should be shown separately in the invoices.

PURCHASING ACTIVITY

Application of VAT on Purchases and Related Accounts

FOR CASH PURCHASES

1. Bought merchandise for cash from P. Tao Grocery, P100,000 plus 12% VAT.

Journal Entry:
Purchases 100,000
Input Tax 12,000
Cash in Bank 112,000

Note:
The actual cost of merchandise purchased was P100,000. However, our supplier added 12% VAT to the cost
of what we purchased which is P12,000 (P100,000 x 12% = P12,000). Thus, we pay P112,000 (P100,000 +
P12,000). The amount of P12,000 which our supplier added to the cost of our purchases is called Input Tax. It
has a normal balance of debit because it is an Asset.

FOR ACCOUNT PURCHASES

2. Bought merchandise on account from J. Alegado Mall, P75,000 plus 12% VAT. Term: 2/10, n/30.

Journal Entry:
Purchases 75,000
Input Tax 9,000
Accounts Payable 84,000

RETURN OF MERCHANDISE PURCHASED IN CASH

3. Return P5,000 cost of merchandise bought for cash from P. Tao Grocery for not conforming with
order and was not replaced. VAT is 12%.

Journal Entry:
Cash in Bank 5,600
Purchase Returns and Allowances 5,000
Input Tax 600
 28

Note:
When we returned the P5,000 cost of what we purchased because there was no replacement, we should also
remove the 12% VAT therefrom. Since Input Tax has a normal balance of a debit, it is also being credited by
P600 to effect the decrease (P5,000 x 12% = P600).

RETURN OF MERCHANDISE PURCHASED ON ACCOUNT

4. Return P10,000 cost of merchandise bought on account from J. Alegado Mall for not conforming
with the order and was not replaced. VAT is 12%.

Journal Entry:
Accounts Payable 11,200
Purchase Returns and Allowances 10,000
Input Tax 1,200

PAYMENT OF ACCOUNT AT A DISCOUNT

5 Payment of account with J. Alegado Mall within the discount period.

Journal Entry:
Accounts Payable 72,800
Purchase Discounts 1,300
Input Tax 156
Cash in Bank 71,344

Note:
The purchase discount availed is P1,300 (P75,000 – P10,000 = P65,000 x 2% = P1,300) and VAT Input Tax
is P156 (P1,300 x 12%).

As a result, Input Tax registers a debit balance of P19,044 (P12,000 + P9,000 – P1,200 – P156 = P19,044) or
it can be gleaned from the T-account below:

Input Tax
1) 12,000 600 3)
2) 9,000 1,200 4)
156 5)
21,000 1,956
P19,044

SELLING ACTIVITIES

Application of VAT on Sales and Related Accounts

FOR SALES ON CASH

1. Sold merchandise for cash to Matero Convenience Center, P190,000 plus 12% VAT.

Journal Entry:
Cash in Bank 212,800
Sales 190,000
Output Tax 22,800

Note:
The actual cost of merchandise sold was P190,000. However, we add 12% VAT to our sales which is P22,800
(P190,000 x 12%). Thus, we collect P212,800 (P190,000 + P22,800). The amount of P22,800 which we add to
our sales is called an “Output Tax”. It has a normal balance of credit being a liability account.
 29

FOR SALES ON ACCOUNT

2. Sold merchandise on account to E. Detoya & Sons, P180,000 plus 12% VAT. Term: 2/10, n/30.

Journal Entry:
Accounts Receivable 201,600
Sales 180,00
Output Tax 21,600

RECEIVED MERCHANDISE SOLD FOR CASH

AND RETURNED BY A CUSTOMER

3. Received P6,000 worth of merchandise returned by Matero Convenience Center due to bad order.
It was not replaced, so it is refunded. VAT is 12%.

Journal Entry:
Sales Returns and Allowances 6,000
Output Tax 720
Cash in Bank 6,720

Note:
When we received the P60,000 worth of merchandise returned by our customer, we also have to remove the
12% VAT therefrom. Since output tax has a normal balance of a credit being a liability, it is also being debited
by P720 to effect the decrease (P6,000 x 12%).

RECEIVED MERCHANDISE SOLD ON ACCOUNT

AND RETURNED BY A CUSTOMER

4. Received P10,000 worth of merchandise returned by E. Detoya & Sons and was not replaced. VAT
is 12%.

Journal Entry:
Sales Returns and Allowances 10,000
Output Tax 1,200
Accounts Receivable 11,200

COLLECTED THE ACCOUNT WITH A DISCOUNT

5 Collected the account of E. Detoya & Sons within the discount period.

Journal Entry:
Cash in Bank 186,592
Sales Discounts 3,400
Output Tax 408
Accounts Receivable 190,400

Note:
The sales discount availed is P3,400 (P180,000 – P10,000 = P170,000 x 12% = P3,400) and Output Tax is
P408 (P3,400 x 12%).

As a result, Output Tax registers a credit balance of P42,072 (P22,800 + P21,600 – P720 – P1,200 – P408) or
it can be gleaned from the T-account below:

Output Tax
3) 720 22,800 1)
4) 1,200 21,600 2)
5) 408
2,328 44,400
P42,072
 30

Closing of the Input Tax Against Output Tax

The Input Tax of P19,044 is closed against the Output Tax of P42,072 and the difference of P23,028 is the VAT Payable. In an
instance wherein Input Tax shows a bigger balance than the Output Tax, the amount of difference is called Prepaid Tax. This is
being brought forward to the next month. No remittance until Output Tax exceeds Input Tax.

Journal Entry:
Output Tax 42,072
Input Tax 19,044
VAT Payable 23,028

Remittance of VAT Payable to the Bureau of Internal Revenue

VAT Payable of P23,028 represents the amount that we should remit to the Bureau of Internal Revenue.

Journal Entry:
VAT Payable 23,028
Cash in Bank 23,028
 31

EXERCISES/PROBLEMS
PROBLEM 1 – 1 PURCHASES OF MERCHANDISE

The following transactions are taken from the records of V Merchandising in July 2020:

July 5 Purchased merchandise with a list price of P40,000 subject to a trade

discount of 20% from C Company. The terms of the sale include
transportation FOB shipping point and credit 2/10, n/30. Freight collect
costs amount to P1,500.

6 Purchased merchandise with a list price of P5,000, trade discount of 15%

from S Company, transportation term FOB shipping point, freight prepaid
amounts to P500, credit terms 2/10, n/30.

7 Purchased merchandise with a list price of P6,000, trade discount of 15

and 10 from A Company, transportation terms FOB shipping point, credit
terms 2/10, n/30. Freight collect costs amount to P1,500.

15 Paid the amount owed to C Company.

16 Paid the amount owed to A Company

31 Paid the amount owed to S Company

Required: Prepare journal entries to record the above transactions using (a) periodic method and (b)
perpetual method.

PROBLEM 1 – 2 JOURNAL ENTRIES – PERIODIC & PERPETUAL

Zacky Tan Co. had a beginning inventory of P6,200. The following transactions occurred during the period:

1. Purchased goods worth P120,000 on account.

2. Paid transportation costs of P12,000 on the purchase above.
3. Returned damaged goods worth P2,400 to the supplier.
4. Sold goods costing P98,400 for P147,600 on account.
5. A customer returned goods with sale price of P10,800 and cost of P7,200.

Required:
1. Provide the journal entries under the Periodic and Perpetual inventory system, respectively.
2. Compute for the cost of goods sold under each of the inventory systems. The physical count of
inventory reveals a balance of P44,600 in ending inventory.

PROBLEM 1 – 3 JOURNAL ENTRIES – PERIODIC & PERPETUAL

Kaya Kho Store completed the following merchandising transactions in the month of May. At the beginning
of May, the ledger of Kaha Kho showed cash of P50,000 and Kho, Capital of P50,000.

May 1 Purchased merchandise on account from Dare amounting to P50,000,

terms 2/10, n/30.
2 Sold merchandise on account P75,000, terms 2/10, n/30.
5 Received credit from Dare for merchandise returned P2,000.
 32

8 Received collections in full, less discounts, from customers billed on May

2.
10 Paid Dare in full, less discount.
11 Purchased supplies for cash P3,000.
13 Purchased merchandise for cash, P25,000.
15 Received return for poor quality merchandise from supplier on cash
purchase P2,000.
17 Purchased merchandise from Hark, P19,000 FOB shipping point, terms
2/10, n/30.
19 Paid freight for May 17 purchases, P500.
24 Sold merchandise for cash, P61,000.
25 Purchased merchandise from Corn, P29,840, FOB destination, terms 2/10,
n/30.
27 Paid Hark in full, less discount.
28 Made refunds to cash customers for defective merchandise, P1,000.
31 Sold merchandise on account, P30,000, terms n/30.

Required:
1. Journalize the transactions using (a) periodic method and (b) perpetual method. (Assume that cost
of sales is 60% of the invoice price.)
2. Prepare income statement for both periodic and perpetual inventory system assuming that the
merchandise inventory end amounts to P20,000 and that there is no beginning inventory.

PROBLEM 1 – 4 ACCOUNTING FOR DISCOUNTS

Complete the missing amount.

2020 Amount Term 2020 Cash Discount Amount Paid

1-05 P100,000 10, 5; n/30 2-04 1) 2)
1-10 P200,000 2/10, 1/30 2-05 3) 4)
1-15 P300,000 1/20, n/30 2-02 5) 6)
1-20 P400,000 1/20; EOM 2-25 7) 8)
1-25 9) 2/10, 1/20 2-12 10) P470,250

PROBLEM 1 – 5 GROSS METHOD vs NET METHOD

Fall Company began operations in the current year. The entity used periodic inventory system.

1. During the year, Fall Company purchased merchandise having a gross invoice of P1,000,000. All
purchases were made under the terms 2/10, n/30.
2. During the year, Fall Company paid for 80% of the merchandise within the discount period.
3. The remaining 20% was paid beyond the discount period.
4. Fall Company sold merchandise for cash of P1,200,000.

Required: Prepare journal entries to record transactions using gross and net method.
 33

PROBLEM 1 – 6 ACCOUNTING FOR TRANSPORTATION COSTS

Afatay Company sold merchandise on account for P500,000. The terms are 3/10, n/30. The related freight
charge amounted to P10,000. The account was collected within the discount period.

Required: Prepare journal entries to record the transactions under the following freight terms:

1. FOB destination and freight collect

2. FOB destination and freight prepaid
3. FOB shipping point and freight collect
4. FOB shipping point and freight prepaid
 34

MODULE

2
MERCHANDISE INVENTORY
and COST OF GOODS SOLD

MERCHANDISE INVENTORY VALUATION

(Source: Intermediate Accounting 1 by Valix et al.)

PAS 2, paragraph 25, expressly provides that the cost of inventories shall be determined using either:

a. First in, First out (FIFO)

b. Weighted average

FIRST IN, FIRST OUT (FIFO)

The FIFO method assumes that “the goods first purchased are first sold” and consequently the goods
remaining in the inventory at the end of the period are those most recently purchased or produced. In other
words, the FIFO is in accordance with the ordinary merchandising procedure that the goods are sold in the
order they are purchased.

The rule is “first come, first sold”.

The inventory is thus expressed n terms of recent or new prices while the cost of goods sold is
representative of earlier or old prices.

Accordingly, in a period of inflation or rising, the FIFO method would result to the highest net income.

However, in a period of deflation or declining prices, the FIFO method would result to the lowest net
income.

Note well that under FIFO – Periodic and FIFO – Perpetual, the inventory costs are the same.

Illustration – FIFO (Periodic/Perpetual)

The following data pertain to an inventory item:

Units Unit cost Total cost Sales (in units)

Jan. 1 Beginning balance 800 200 160,000
8 Sale 500
18 Purchase 700 210 147,000
22 Sale 800
31 Purchase 500 220 110,000

The ending inventory is 700 units.

FIFO

Units Unit cost Total cost

From Jan. 18 Purchase 200 210 42,000
From Jan. 31 Purchase 500 220 110,000
700 152,000 Ending inventory
 35

Cost of Goods Sold

Inventory – January 1 160,000

Purchases (147,000 + 110,000) 257,000
Goods available for sale 417,00
Inventory – January 31 (152,000)
Cost of Goods Sold 265,000

WEIGHTED AVERAGE – PERIODIC

The cost of the beginning inventory plus the total cost of purchases during the period is divided by total
units purchased plus those in the beginning inventory to get weighted average unit cost. Such weighted
average unit cost is then multiplied by the units on hand to derive the inventory value.

In other words, the average unit cost is computed by dividing the total cost of goods available for sale by
the total number of units available for sale.

Formula:

Weighted average Total goods available for sale

=
unit cost Total no. of units available for sale

* Total goods available for sale = Beg. Inventory + Purchases

* Total no. of units available for sale = Beg. Inventory (in units) + Purchases (in units)

Cost of Ending Inventory = Weighted average unit cost x Ending inventory (in units)

Illustration – Weighted Average (Periodic)

The preceding illustrative data are used.

Units Unit cost Total cost

Jan. 1 Beginning balance 800 200 160,000
18 Purchase 700 210 147,000
31 Purchase 500 220 110,000
Total goods available for sale 2,000 417,000

Weighted average unit cost (417,000 / 2,000) 208.50

Ending Inventory cost (700 x 208.50) 145,950

Cost of Goods Sold

Inventory – January 1 160,000

Purchases 257,000
Goods available for sale 417,00
Inventory – January 31 (145,950)
Cost of Goods Sold 271,050

WEIGHTED AVERAGE – PERPETUAL

When used in conjunction with the perpetual system, the weighted average method is popularly known as
the moving average method.

PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis or as each
additional shipment is received depending upon the circumstances of the entity. Under this method, a new
weighted average cost must be computed after purchase and purchase return.
 36

Thus, the total cost of goods available after every purchase and purchase return is divided by the total units
available for sale at this time to get a new weighted average unit cost. Such new weighted average unit cost
is then multiplied by the units on hand to get inventory cost.
This method requires the keeping of inventory stock card in order to monitor the “moving” unit cost after
every purchase.

Illustration – Weighted Average (Perpetual) or Moving Average

The preceding illustrative data are used.

Units Unit cost Total cost

Jan. 1 Beginning balance 800 200 160,000
8 Sale (500) 200 (100,000)
Balance 300 200 60,000
18 Purchase 700 210 147,00
Total 1,000 207 207,000
22 Sale (800) 207 (165,600)
Balance 200 207 41,400
31 Purchase 500 220 110,000
Total 700 216 151,400 Ending Inventory

Notes:
a. Unit cost will only change every purchase and purchase return transaction.
b. Sales and sales return transactions will not affect the unit cost.
c. To compute for the new unit cost, divide total cost with the units available for sale.

Cost of Goods Sold

Cost of goods sold under the moving average method can be computed by adding the cost of sales.

Total cost
Jan. 8 Sale 100,000
22 Sale 165,600
Cost of Goods Sold 265,600

The argument for the weighted average method is that it is relatively easy to apply, especially with
computers. Moreover, the weighted average method produces inventory valuation that approximates
current value if there is a rapid turnover of inventory.

The argument against the weighted average method is that there may be a considerable lag between the
current cost and inventory valuation since the average unit cost involves early purchases.

ILLUSTRATIVE PROBLEM – 4

Galie Bog Company had the following transactions relating to inventory during January:

Units Unit cost

Jan. 1 Beginning balance 6,000 150
5 Purchase 2,000 200
10 Sale 4,000
15 Sale 2,000
20 Purchase 2,500 300
25 Purchase 2,000 400
31 Sale 3,000

Determine the ending inventory and cost of goods sold under each of the following costing methods:
1. FIFO
2. Weighted average method – periodic
3. Moving average
 37

Solution:

FIFO
Units
Jan. 1 Beginning balance 6,000
5 Purchase 2,000
10 Sale (4,000)
15 Sale (2,000)
20 Purchase 2,500
25 Purchase 2,000
31 Sale (3,000)
Ending inventory (in units) 3,500

Units Unit cost Total cost

From Jan. 25 Purchase 2,000 400 800,000
From Jan. 20 Purchase 1,500 300 450,000
3,500 1,250,000 Ending inventory

Units Unit cost Total cost

Jan. 5 Purchase 2,000 200 400,000
20 Purchase 2,500 300 750,000
25 Purchase 2,000 400 800,000
Total purchases 6,500 1,950,000

Inventory – January 1 (6,000 x 150) 900,000

Purchases 1,950,000
Goods available for sale 2,850,000
Inventory – January 31 (1,250,000)
Cost of Goods Sold 1,600,000

Weighted Average – Periodic

Weighted average Total goods available for sale

=
unit cost Total no. of units available for sale

(900,000 + 1,950,000)
P228 =
(6,000 + 6,500)

Ending inventory (3,500 units x P228) 798,000

Inventory – January 1 900,000

Purchases 1,950,000
Goods available for sale 2,850,000
Inventory – January 31 (798,000)
Cost of Goods Sold 2,052,000

Moving Average

Units Unit cost Total cost

Jan. 1 Beginning balance 6,000 150 900,000
5 Purchase 2,000 200 400,000
Balance (1,300,000/8,000) 8,000 162.50 1,300,000
10 Sale (4,000) 162.50 (650,000)
Balance 4,000 162.50 650,000
15 Sale (2,000) 162.50 (325,000)
Balance 2,000 162.50 325,000
 38

20 Purchase 2,500 300 750,000

Balance (1,075,000/4,500) 4,500 238.89 1,075,000
25 Purchase 2,000 400 800,000
Balance (1,875,000/6,500) 6,500 288.46 1,875,000
31 Sale (3,000) 288.46 (865,380)
Total 3,500 288.46 1,009,620 Ending Inventory

Total cost
Jan. 10 Sale 650,000
15 Sale 325,000
31 Sale 865,380
Cost of Goods Sold 1,840,380
 39

EXERCISES/PROBLEMS
PROBLEM 2 – 1 INVENTORY VALUATION

Nalou Ca Comapany showed the following information:

Units Unit Cost Total Cost

January 1 Beginning 10,000 40 400,000
31 Sale 5,000
April 1 Purchase 15,000 50 750,000
July 31 Sale 18,000
October 1 Purchase 25,000 60 1,500,000
December 31 Sale 12,000

Required: Compute the cost of ending inventory and cost of goods sold using:
(Round values to two decimal places)
a. FIFO
b. Weighted average
c. Moving average

PROBLEM 2 – 2 COMPUTATIONS

1. The records of a business show the following information: Sales, P724,200; sales discounts,
P10,000; sales returns, P3,600; and freight-in, P5,300. How much is the net sales?

2. The records of a business show the following information: Sales, P426,800; Inventory, beg.
P22,400; Purchases, P220,000; Freight-in, P12,000; Purchase discounts, P4,500; Sales returns,
P21,600; and Purchase returns, P3,000. How much is the net purchases?

3. The records of a business show the following information: Sales, P364,000; Purchases, P252,000;
Freight-in, P11,000; Purchase discounts, P4,900; Sales returns, P12,600; Purchase returns, P3,000;
Inventory, beg. P22,400; and Inventory, end. P15,000. How much is the total goods available for
sale?

4. Use the information in #3 above. How much is the cost of goods sold?

5. Inventory, beg. P33,000; Net purchases, P128,000; Cost of goods sold, P96,000. How much is the
Inventory, end?

6. Inventory, beg. P89,000; Net purchases, P217,000; Cost of goods sold, P154,000. How much is the
Inventory, end?

7. Inventory, beg. P20,000; Net purchases, P176,000; Inventory, end., P90,000. How much is the cost
of goods sold?

8. Inventory, beg. P24,000; Cost of goods sold, P89,000; Inventory, end. P19,000. How much is the
Net purchases?

9. Inventory, end. P62,000; Net purchases, P216,000; Cost of goods sold, P244,000. How much is the
Inventory, beg.?

10. Inventory, end. P148,000; Net purchases, P236,000; Cost of goods sold, P344,000. How much is
the Total Goods Available for Sale?

11. Net purchases, P170,000; Increase in inventory during the year, P40,000. How much is the cost of
goods sold?
 40

12. Net purchases, P170,000; Decrease in inventory during the year, P40,000. How much is the cost
of goods sold?

13. Cost of goods sold, P720,000; Increase in inventory during the year, P80,000. How much is the
net purchases?

14. Inventory, beg. P4,000; Total goods available for sale, P190,000; Cost of goods sold, P169,000.
How much is the change in inventory during the year? Increase (decrease)

15. Total goods available for sale, P71,000; Net purchases, P59,000; Inventory, end., P5,000; How
much is the change in inventory during the year? Increase (decrease)
 41

MODULE

3
COMPLETING THE
ACCOUNTING CYCLE

THE ACCOUNTING CYCLE OF A MERCHANDISING BUSINESS

(Source: Financial Accounting and Reporting by Zeus Vernon B. Millan)

Steps in the Accounting Cycle

1. Identifying and analyzing
2. Journalizing
3. Posting
4. Unadjusted trial balance
5. Adjusting entries
6. Adjusted trial balance (and/or worksheet)
7. Financial statements
8. Closing entries
9. Post-closing trial balance
10. Reversing entries

Journalizing
1. Special Journal - is used to record transactions of a similar nature.
a. Sales Journal - used to record sales on account.
b. Purchases Journal - used to record purchases of inventory on account.
c. Cash Receipts Journal – used to record all transactions involving receipts of cash.
d. Cash Disbursements Journal – used to record all transactions involving payments of
cash.

2. General Journal - All other transactions that cannot be recorded in the special journals are
recorded in the general journal.

Posting to the General and Subsidiary Ledgers

a. General Ledger - contains all the accounts appearing in the trial balance.
b. Subsidiary Ledger - provides a breakdown of the balances of controlling accounts.

Illustration: PERIODIC INVENTORY SYSTEM

The unadjusted trial balance on December 31, 2020 is prepared as follows:

Koleen Company
Unadjusted Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P105,000
Accounts Receivable 50,000
Merchandise Inventory 30,000
Equipment 200,000
Accumulated Depreciation P80,000
Accounts Payable 20,000
Koleen, Capital 300,000
Koleen, Drawings 80,000
 42

Sales 210,000
Purchases 70,000
Freight-in 5,000
Purchase Returns 10,000
Salaries Expense 60,000
Utilities Expense 20,000 ________
Total P620,000 P620,000

Additional information:
a. The annual depreciation on the equipment is P20,000.
b. The physical count of inventory on December 31, 2020 revealed a P60,000 balance of goods on
hand.

Adjusting Entries

AJE #1: Depreciation Expense

The problem states that the annual depreciation is P20,000. The adjusting entry is as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Depreciation Expense 20,000
Accumulated Depreciation 20,000
To record the depreciation expense for the year

AJE #2: Ending Inventory

The problem states that the physical count of inventory on December 31, 2020 revealed a P60,000 balance
of goods on hand. The adjusting entry is as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Merchandise Inventory, end. 60,000
Income and Expense Summary 60,000
To recognize the ending inventory

Notes:
1. The account “Merchandise Inventory, end.” is debited in order to segregate the ending inventory from the
beginning inventory. The credit is recorded in the “Income and Expense Summary” account.

2. In the worksheet, we will label the beginning inventory as “Merchandise Inventory, beg.” This will be closed
later together with “Purchases”, “Freight-in”, “Purchase Returns and Allowances”, and “Purchase discounts”
to the “Income and Expense Summary” account. These are nominal accounts that are closed at the end of the
period.

3. This manner of recording simplifies the adjusting and closing entries for the ending inventory and beginning
inventory.
 43

Adjusted Trial Balance

Koleen Company
Adjusted Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P105,000
Accounts Receivable 50,000
Merchandise Inventory, beg. 30,000
Equipment 200,000
Accumulated Depreciation P100,000
Accounts Payable 20,000
Koleen, Capital 300,000
Koleen, Drawings 80,000
Sales 210,000
Purchases 70,000
Freight-in 5,000
Purchase Returns 10,000
Salaries Expense 60,000
Utilities Expense 20,000
Depreciation Expense 20,000
Merchandise Inventory, end. 60,000
Income and Expense Summary ________ 60,000
Total P700,000 P700,000
 44

Worksheet

Koleen Company
Worksheet
For the year ended December 31, 2020

Unadjusted Trial Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Accounts Balance
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 105,000 105,000 105,000
Accounts Receivable 50,000 50,000 50,000
Merchandise Inventory, beg. 30,000 30,000 30,000
Equipment 200,000 200,000 200,000
Accumulated Depreciation 80,000 20,000 100,000 100,000
Accounts Payable 20,000 20,00 20,000
Koleen, Capital 300,000 300,000 300,000
Koleen, Drawings 80,000 80,000 80,000
Sales 210,000 210,000 210,000
Purchases 70,000 70,000 70,000
Freight-in 5,000 5,000 5,000
Purchase Returns 10,000 10,000 10,000
Salaries Expense 60,000 60,000 60,000
Utilities Expense 20,000 _______ 20,000 20,000
Total 620,000 620,000
Adjustments:
Depreciation Expense 20,000 20,000 20,000
Merchandise Inventory, end 60,000 60,000 60,000
Income and Expense Summary ______ 60,000 _______ 60,000 _______ 60,000 _______ ______
Total 80,000 80,000 700,000 700,000 205,000 280,000 495,000 420,000
Profit 75,000 _______ _______ 75,000
Total 280,000 280,000 495,000 495,000

Notice that “Merchandise Inventory, beg.” and “Income and Expense Summary” ae
The “Merchandise Inventory, end” is extended to the Balance Sheet.
extended to the Income Statement. This is necessary so that the amount of cost of
goods sold is properly reflected in the income statement.
 45

Financial Statements

Koleen Company
Income Statement
For the year ended December 31, 2020

Sales P210,000
Cost of Goods Sold:
Beg. Inventory P30,000
Net Purchases:
Purchases P70,000
Freight-in 5,000
Purchase Returns (10,000) 65,000
Ending Inventory (60,000) (35,000)
Gross Profit P175,000
Operating Expenses:
Salaries Expense P60,000
Utilities Expense 20,000
Depreciation Expense 20,000 (100,000)
Net Profit P75,000

Koleen Company
Statement of Changes in Equity
For the year ended December 31, 2020

Koleen, Capital – beginning P300,000

Add: Net Profit 75,000
Total P375,000
Less: Withdrawals (80,000)
Koleen, Capital - end P295,000

Koleen Company
Balance Sheet
As of December 31, 2020

ASSETS
Current Assets:
Cash P105,000
Accounts Receivable 50,000
Merchandise Inventory 60,000 P215,000
Noncurrent Assets:
Equipment P200,000
Accumulated Depreciation (100,000) 100,000
Total Assets P315,000

LIABILITIES and EQUITY

Liabilities
Accounts Payable P20,000
Equity
Koleen, Capital 295,000
Total Liabilities and Equity P315,000
 46

Closing Entries

Closing Entry #1: Beginning Inventory

The beginning inventory is closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Income and Expense Summary 30,000
Merchandise Inventory, beg. 30,000
To close beginning inventory to income and
expense summary

Closing Entry #2: Income Accounts

The income accounts are closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Sales 210,000
Income and Expense Summary 210,000
To close sales and other related account to
income and expense summary

Closing Entry #3: Cost of Goods Sold Accounts

The cost of goods sold accounts are closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Purchase Returns 10,000
Income and Expense Summary 65,000
Purchases 70,000
Freight-in 5,000
To close cost of goods sold and other related
account to income and expense summary

Closing Entry #4: Expense Accounts

The expense accounts are closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Income and Expense Summary 100,000
Salaries Expense 60,000
Utilities Expense 20,000
Depreciation Expense 20,000
To close expense and other related account to
income and expense summary

Closing Entry #5: Income and Expense Summary closed to Equity

Let us first determine the balance of the “Income and Expense Summary” account before closing it to
owner’s equity:
 47

Income and Expense Summary

60,000 (AJE #2)
(CE #1) 30,000 210,000 (CE #2)
(CE #3) 65,000
(CE #4) 100,000
195,000 270,000
75,000

The income and expense summary is closed to the “Owner’s Capital” account as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Income and Expense Summary 75,000
Koleen, Capital 75,000
To close the income and expense summary to
equity

Closing Entry #6: Drawings account closed to Equity

The “Owner’s drawings” account is closed to the “Owner’s equity” account as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Koleen, Capital 80,000
Koleen, Drawings 80,000
To close the drawings account

Post-Closing Trial Balance

Koleen Company
Post-Closing Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P105,000
Accounts Receivable 50,000
Merchandise Inventory, end 60,000
Equipment 200,000
Accumulated Depreciation P100,000
Accounts Payable 20,000
Koleen, Capital ________ 295,000
Total P415,000 P415,000
 48

Koleen Company
Worksheet
For the year ended December 31, 2020

Unadjusted Trial Adjustments Adjusted Trial Income Statement Balance Sheet Closing Entries Post-Closing Trial
Accounts Balance Balance Balance
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 105,000 105,000 105,000 105,000
Accounts Receivable 50,000 50,000 50,000 50,000
Merchandise Inventory, beg. 30,000 30,000 30,000 30,000
Equipment 200,000 200,000 200,000 200,000
Accumulated Depreciation 80,000 20,000 100,000 100,000 100,000
Accounts Payable 20,000 20,00 20,000 20,000
Koleen, Capital 300,000 300,000 300,000 5,000 295,000
Koleen, Drawings 80,000 80,000 80,000 80,000
Sales 210,000 210,000 210,000 210,000
Purchases 70,000 70,000 70,000 70,000
Freight-in 5,000 5,000 5,000 5,000
Purchase Returns 10,000 10,000 10,000 10,000
Salaries Expense 60,000 60,000 60,000 60,000
Utilities Expense 20,000 ______ 20,000 20,000 20,000
Total 620,000 620,000
Adjustments:
Depreciation Expense 20,000 20,000 20,000 20,000
Merchandise Inventory, end 60,000 60,000 60,000 60,000
Income and Expense Summary ______ 60,000 _______ 60,000 _______ 60,000 _______ ______ 60,000 _______ ______ ______
Total 80,000 80,000 700,000 700,000 205,000 280,000 495,000 420,000 285,000 285,000 415,000 415,000
Profit 75,000 _______ _______ 75,000
Total 280,000 280,000 495,000 495,000
 49

Illustration: PERPETUAL INVENTORY SYSTEM

The unadjusted trial balance on December 31, 2020 is prepared as follows:

Huber Company
Unadjusted Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P11,000
Accounts Receivable 19,000
Merchandise Inventory 10,500
Prepaid Insurance 12,000
Equipment 36,000
Accounts Payable P1,000
Huber, Capital 55,000
Huber, Drawings 5,000
Sales 44,000
Cost of Goods Sold 6,500 _______
Total P100,000 P100,000

Additional information:
The following information was identified on December 31, 2020:
a. Of the total accounts receivable, P1,000 is doubtful of collection.
b. Salaries earned by employees during the period but were not yet paid amounted to P10,000.
c. Equipment has an estimated useful life of 4 years.
d. One-year insurance premium acquired on November 1, 2020

Adjusting Entries

AJE #1: Bad Debts Expense

The adjusting entry to recognize the P1,000 uncollectible account is as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Bad Debts Expense 1,000
Allowance for Bad Debts 1,000
To record bad debts for the period

AJE #2: Salaries Expense

The P10,000 unpaid salaries are accrued as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Salaries Expense 10,000
Accrued Salaries Payable 10,000
To accrue salaries expense incurred but not yet
paid
 50

AJE #3: Depreciation Expense

The annual depreciation expense is computed as follows:

Cost P36,000
Divided by: Useful life 4
Annual depreciation expense P 9,000

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Depreciation Expense 9,000
Accumulated Depreciation 9,000
To record depreciation expense for the period

The carrying amount of the equipment on December 31, 2020 is determined as follows:

Equipment P36,000
Accumulated Depreciation (9,000)
Carrying Amount P27,000

AJE #4: Prepaid Insurance/Insurance Expense

Expired Portion (Insurance Expense):

2 mons. – Nov. 1 to Dec. 31, 2020
(12,000 x 2/12) = P2,000
P12,000
1-year insurance
prepaid on Nov. 1, 2020 Unexpired Portion (Prepaid Insurance):
10 mons. – Jan. 1 to Oct. 31, 2021
(12,000 x 10/12) = P10,000

The adjusting entry to record the used up portion of the prepaid insurance as expense is as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Insurance Expense 2,000
Prepaid Insurance 2,000
To record insurance expense
 51

Adjusted Trial Balance

Huber Company
Adjusted Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P11,000
Accounts Receivable 19,000
Allowance for Bad Debts P1,000
Merchandise Inventory 10,500
Prepaid Insurance 10,000
Equipment 36,000
Accumulated Depreciation 9,000
Accounts Payable 1,000
Accrued Salaries Payable 10,000
Huber, Capital 55,000
Huber, Drawings 5,000
Sales 44,000
Cost of Goods Sold 6,500
Bad Debts Expense 1,000
Salaries Expense 10,000
Depreciation Expense 9,000
Insurance Expense 2,000
Total P120,000 P120,000
 52

Worksheet

Huber Company
Worksheet
For the year ended December 31, 2020

Unadjusted Trial Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Accounts Balance
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 11,000 11,000 11,000
Accounts Receivable 19,000 19,000 19,000
Merchandise Inventory 10,500 10,500 10,500
Prepaid Insurance 12,000 2,000 10,000 10,000
Equipment 36,000 36,000 36,000
Accounts Payable 1,000 1,000 1,000
Huber, Capital 55,000 55,000 55,000
Huber, Drawings 5,000 5,000 5,000
Sales 44,000 44,000 44,000
Cost of Goods Sold 6,500 ______ 6,500 6,500
Total 100,000 100,000
Adjustments:
Bad Debts Expense 1,000 1,000 1,000
Allowance for Bad Debts 1,000 1,000 1,000
Salaries Expense 10,000 10,000 10,000
Accrued Salaries Payable 10,000 10,000 10,000
Depreciation Expense 9,000 9,000 9,000
Accumulated Depreciation 9,000 9,000 9,000
Insurance Expense 2,000 ______ 2,000 ______ 2,000 ______ ______ ______
Total 22,000 22,000 120,000 120,000 28,500 44,000 91,500 76,000
Profit 15,500 ______ ______ 15,500
Total 44,000 44,000 91,500 91,500
 53

Financial Statements

Huber Company
Income Statement
For the year ended December 31, 2020

Sales P44,000
Cost of Goods Sold: (6,500)
Gross Profit P37,500
Operating Expenses:
Bad Debts Expense P1,000
Salaries Expense 10,000
Depreciation Expense 9,000
Insurance Expense 2,000 (22,000)
Net Profit P15,500

Huber Company
Statement of Changes in Equity
For the year ended December 31, 2020

Huber, Capital – beginning P55,000

Add: Net Profit 15,500
Total P70,500
Less: Withdrawals (5,000)
Huber, Capital - end P65,500

Huber Company
Balance Sheet
As of December 31, 2020

ASSETS
Current Assets:
Cash P11,000
Accounts Receivable 19,000
Allowance for Bad Debts (1,000)
Merchandise Inventory 10,500
Prepaid Insurance 10,000 P49,500
Noncurrent Assets:
Equipment P36,000
Accumulated Depreciation (9,000) 27,000
Total Assets P76,500

LIABILITIES and EQUITY

Liabilities
Accounts Payable P1,000
Accrued Salaries Payable 10,000 P11,000
Equity
Huber, Capital 65,500
Total Liabilities and Equity P76,500
 54

Closing Entries

Closing Entry #1: Income Accounts

The income accounts are closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Sales 44,000
Income and Expense Summary 44,000
To close sales and other related account to
income and expense summary

Closing Entry #2: Expense Accounts

The expense accounts are closed to income and expense summary:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Income and Expense Summary 28,500
Cost of Goods Sold 6,500
Bad Debts Expense 1,000
Salaries Expense 10,000
Depreciation Expense 9,000
Insurance Expense 2,000
To close expense and other related account to
income and expense summary

Closing Entry #3: Income and Expense Summary closed to Equity

Let us first determine the balance of the “Income and Expense Summary” account before closing it to
owner’s equity:
Income and Expense Summary
44,000 (CE #1)
(CE #2) 28,500
15,500

The income and expense summary is closed to the “Owner’s Capital” account as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Income and Expense Summary 15,500
Huber, Capital 15,500
To close the income and expense summary to
equity

Closing Entry #4: Drawings account closed to Equity

The “Owner’s drawings” account is closed to the “Owner’s equity” account as follows:

GENERAL JOURNAL
2020 PARTICULARS Folio DEBIT CREDIT
Dec 31 Huber, Capital 5,000
Huber, Drawings 5,000
To close the drawings account
 55

Post-Closing Trial Balance

Huber Company
Post-Closing Trial Balance
December 31, 2020

Accounts Debit Credit

Cash P11,000
Accounts Receivable 19,000
Allowance for Bad Debts P1,000
Merchandise Inventory 10,500
Prepaid Insurance 10,000
Equipment 36,000
Accumulated Depreciation 9,000
Accounts Payable 1,000
Accrued Salaries Payable 10,000
Huber, Capital _______ 65,500
Total P86,500 P86,500
 56

Huber Company
Worksheet
For the year ended December 31, 2020

Unadjusted Trial Adjustments Adjusted Trial Income Statement Balance Sheet Closing Entries Post-Closing Trial
Accounts Balance Balance Balance
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 11,000 11,000 11,000 11,000
Accounts Receivable 19,000 19,000 19,000 19,000
Merchandise Inventory 10,500 10,500 10,500 10,500
Prepaid Insurance 12,000 2,000 10,000 10,000 10,000
Equipment 36,000 36,000 36,000 36,000
Accounts Payable 1,000 1,000 1,000 1,000
Huber, Capital 55,000 55,000 55,000 10,500 65,500
Huber, Drawings 5,000 5,000 5,000 5,000
Sales 44,000 44,000 44,000 44,000
Cost of Goods Sold 6,500 ______ 6,500 6,500 6,500
Total 100,000 100,000
Adjustments:
Bad Debts Expense 1,000 1,000 1,000 1,000
Allowance for Bad Debts 1,000 1,000 1,000 1,000
Salaries Expense 10,000 10,000 10,000 10,000
Accrued Salaries Payable 10,000 10,000 10,000 10,000
Depreciation Expense 9,000 9,000 9,000 9,000
Accumulated Depreciation 9,000 9,000 9,000 9,000
Insurance Expense 2,000 _____ 2,000 ______ 2,000 ______ ______ ______ ______ 2,000 ______ ______
Total 22,000 22,000 120,000 120,000 28,500 44,000 91,500 76,000 44,000 44,000 86,500 86,500
Profit 15,500 ______ ______ 15,500
Total 44,000 44,000 91,500 91,500
 57

Financial Statements

Investors and financial analysts rely on financial data to analyze the performance of a company and make
predictions about its future direction of the company's stock price. One of the most important resources
of reliable and audited financial data is the annual report, which contains the firm's financial statements.

The financial statements are used by investors, market analysts, and creditors to evaluate a company's
financial health and earnings potential.

Balance Sheet
The balance sheet provides an overview of a company's assets, liabilities, and stockholders' equity as a
snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which is
generally the end of the fiscal year.

The Balance Sheet Formula

Assets = (Liabilities + Owner’s Equity)

The balance sheet of a merchandising business has only slight variations as compared to the balance sheets
of other types of businesses.

At the end of the accounting cycle, all businesses prepare financial statements to communicate information
regarding the financial well-being of the business entity. Merchandising businesses, manufacturers, and
service businesses all prepare an income statement and a balance sheet, and all are very similar. A
merchandising business, however, has a few slight differences in its income statement and balance sheet.

The balance sheet of the merchandising business expands its assets section to include merchandise
inventory and sometimes estimated returns inventory. Merchandise inventory is the merchandise purchased
to be sold to consumers. Merchandise inventory is categorized as a current asset. Estimated returns
inventory is a current asset and is the account used to document the return of merchandise for either
dissatisfaction or damage. Depending on the materiality of estimated returns, sometimes it may be reflected
as a separate account on the balance sheet or it may be part of the inventory account and reflected only in
the notes to the financial statements.

Income Statement

The financial statements of a merchandising business involve a multiple-step income statement which
separates the cost of the goods the business sells from the cost of running the business.

Merchandising businesses use the multiple-step income statement, as it provides more information for
financial statement users on the profits made from the actual merchandise versus the costs of running the
business. With a simplistic format for preparing an income statement, the single-step income
statement shows only revenues less expenses, and does not include gross profit. It contains fewer
subsections or subtotals than the multiple-step income statement, which is an income statement with
sections, subsections, and subtotals, including gross profit, operating income, other income, and other
expenses, as well as net income.

The first step in a multiple-step income statement is to calculate gross profit. To compute gross profit, the
cost of merchandise sold is subtracted from the sales. Revenues from the sale of goods to consumers
are sales and are recorded in the sales account. The cost associated with the goods sold is recorded in an
expense account titled "cost of merchandise sold." Gross profit shows how much profit was made purely
on the merchandise that was sold.

The next step in a multiple-step income statement is operating income. Gross profit is reduced by operating
expenses to arrive at operating income, which is the income earned from normal business operations. To
successfully buy and sell merchandise, most merchandising businesses have a support staff and other
expenses that are necessary to make their business run. Examples include marketing, sales staff, advertising,
purchasing agents, and more.

The final step in a multiple-step income statement is net income. Operating income is adjusted by other
revenues or expenses that do not directly relate to the business's day-to-day operations. These costs are
 58

called nonoperating expenses. Examples include interest expense or income, taxes, lawsuits, or gains and
losses from the sale of investments.

By breaking down the income statement into steps, statement users can now see three key elements: gross
profit, operating income, and net income. This allows for analysis on how much profit is made directly on
the merchandise that is sold, how much is spent on expenses to support the business (operating expenses),
and how much is spent on expenses that do not directly relate to daily operations (nonoperating expenses).

Statement of Changes in Equity

The statement of changes in equity presents an entity’s profit or loss for a reporting period, items of
income and expense recognized in other comprehensive income for the period, the effects of changes in
accounting policies and corrections of errors recognized in the period, and the amounts of investments by,
and dividends and other distributions to, equity investors during the period.

A statement of changes in equity reflects all changes in equity between the beginning and the end of the
reporting period arising from transactions with owners in their capacity as owners (ie owner changes in
equity) reflecting the increase or decrease in net assets in the period. This statement provides a linkage
between the entity’s statement of financial position and its statement of comprehensive income.

Statement of Cash Flows

A statement of cash flows is a component of financial statements summarizing the operating, investing and
financing activities of an entity.

In simple language, the statement of cash flows provides information about the cash receipts and cash
payments of an entity during a period. An entity shall prepare a statement of cash flows and present it as
an integral part of the financial statements for each period for which financial statements are presented.

The primary purpose of a statement of cash flows is to provide relevant information about cash receipts and
cash payments of an entity during a period. Cash flow information is useful in assessing the ability of the
entity to generate cash and cash equivalents. It also enhances the comparability of operating performance
by different entities.

Operating Activities

Operating activities are the cash flows derived primarily from the principal revenue producing
activities of the entity. In other words, operating activities generally result from transactions and
other events that enter into the determination of net income or loss.

Investing Activities

Investing activities are the cash flows derived from the acquisition and disposal of long-term assets
and other investments not included in cash equivalent. As a simple guide, investing activities
include cash flows from transactions involving nonoperating assets.

Financing Activities

Financing activities are the cash flows derived from the equity capital and borrowings of the entity.
In other words, financing activities are the cash flows that result from transactions:

a. Between the entity and the owners - equity financing

b. Between the entity and the creditors – debt financing

As a simple guide, financing activities include the cash flows from transactions involving nontrade
liabilities and equity of an entity.
 59

Preparation of the Financial Statements

 60

Reversing Entries

Reversing entries are made on the first day of an accounting period to remove accrual adjusting entries that
were made at the end of the previous accounting period.

Two benefits of using reversing entries are:

• It greatly reduces the chance of double-counting revenues and/or expenses, and
• It allows for more efficient processing of the actual invoices that will be processed in the new
accounting period

The following adjusting entries require reversal:

1. All accruals (accrued income and expense)
2. Prepayment – if original entry uses Expense Method
3. Pre-collection – if original entry uses Income Method
 61

EXERCISES/PROBLEMS

PROBLEM 3 – 1 PERIODIC

Nally Bogg
Chart of Accounts
Account No. Account No.
Cash 100 Sales 400
Accounts Receivable 110
Allowance for Bad Debts 115 Purchases 500
Merchandise Inventory 120
Equipment 130 Salaries Expense 600
Accumulated Depreciation 135 Utilities Expense 610
Depreciation Expense 620
Accounts Payable 200 Bad Debts Expense 630

Bogg, Capital 300

Income and Expense Summary 310

The trial balance of Nally Bogg, a merchandising business, on January 1, 2020 is shown below:

Nally Bogg
Unadjusted Trial Balance
January 1, 2020

Accounts Folio Debit Credit

Cash 100 280,000
Accounts Receivable 110 60,000
Merchandise Inventory 120 140,000
Equipment 130 300,000
Accumulated Depreciation 135 180,000
Accounts Payable 200 100,000
Bogg, Capital 300 _______ 500,000
Total 780,000 780,000

The following were the transactions during the year:

1. Purchased inventories worth P600,000, on account. Nally uses the periodic inventory system.
2. Sold inventories for P1,600,000, on account.
3. Collected P1,490,000 account receivable.
4. Paid P490,000 accounts payable.
5. Paid salaries expense of P820,000.
6. Paid utilities expense of P64,000.

Additional information for year-end adjustments:

• The annual depreciation on the equipment is P30,000.
• Accounts amounting to P3,000 are doubtful of collection.
• Ending inventory per physical count is P180,000.
 62

Instruction:
1. Complete the accounting cycle of a merchandising business using Microsoft Excel.
2. One sheet shall be utilized for each requirement stated below. Requirement is from a to d thus,
the file should have 4 sheets.
3. Sheets shall be renamed according to the requirements. Example: Sheet 1 is named as ‘General
Journal’, sheet 2 is named as ‘General Ledger’ and so on.
4. General Journal should be completed with proper folio indexing.
5. Account numbers and folios should be completed in the General Ledger. Follow the format
below.

Account: _________________________ Account No. _______

Year Particulars Folio DEBIT CREDIT BALANCE

Month Day

6. Trial balances and financial statements should be labeled with adequate headers.
7. The excel file shall be named following the format.

LastName_Periodic
Example: Cruz_Periodic

8. In any case you have a classmate bearing the same Last Name, this format is for you.

LastnameFirstname_Periodic
Example: CruzRoseanne_Periodic

9. Further instructions shall be given as to the submission of the excel file.

Requirements:
a. General Journal
1. Initial journal entries
2. Adjusting entries
3. Closing entries
b. General Ledger
c. Trial Balances
1. Unadjusted Trial Balance
2. Adjusted Trial Balance
3. Post-Closing Trial Balance
d. Financial Statements
1. Income Statement
2. Statement of Changes in Equity
3. Balance Sheet
 63

PROBLEM 3 – 2 PERPETUAL

Lee Bog Ko
Chart of Accounts
Account No. Account No.
Cash 100 Sales 400
Accounts Receivable 110
Allowance for Bad Debts 115 Cost of Goods Sold 500
Merchandise Inventory 120 Salaries Expense 510
Equipment 130 Utilities Expense 520
Accumulated Depreciation 135 Depreciation Expense 530
Bad Debts Expense 540
Accounts Payable 200

Lee, Capital 300

Income and Expense Summary 310

The trial balance of Lee Bog Ko, a merchandising business, on January 1, 2020 is shown below:

Lee Bog Ko
Unadjusted Trial Balance
January 1, 2020

Accounts Folio Debit Credit

Cash 100 280,000
Accounts Receivable 110 60,000
Merchandise Inventory 120 140,000
Equipment 130 300,000
Accumulated Depreciation 135 180,000
Accounts Payable 200 100,000
Lee, Capital 300 _______ 500,000
Total 780,000 780,000

The following were the transactions during the year:

1. Purchased inventories worth P600,000, on account. Mr. Lee uses the perpetual inventory system.
2. Sold inventories costing P560,000 for P1,600,000, on account.
3. Collected P1,490,000 account receivable.
4. Paid P490,000 accounts payable.
5. Paid salaries expense of P820,000.
6. Paid utilities expense of P64,000.

Additional information for year-end adjustments:

• The annual depreciation on the equipment is P30,000.
• Accounts amounting to P3,000 are doubtful of collection.
 64

Instruction:
1. Complete the accounting cycle of a merchandising business using Microsoft Excel.
2. One sheet shall be utilized for each requirement stated below. Requirement is from a to d thus,
the file should have 4 sheets.
3. Sheets shall be renamed according to the requirements. Example: Sheet 1 is named as ‘General
Journal’, sheet 2 is named as ‘General Ledger’ and so on.
4. General Journal should be completed with proper folio indexing.
5. Account numbers and folios should be completed in the General Ledger. Follow the format
below.

Account: _________________________ Account No. _______

Year Particulars Folio DEBIT CREDIT BALANCE

Month Day

6. Trial balances and financial statements should be labeled with adequate headers.
7. The excel file shall be named following the format.

LastName_Perpetual
Example: Cruz_Perpetual

8. In any case you have a classmate bearing the same Last Name, this format is for you.

LastnameFirstname_Perpetual
Example: CruzRoseanne_Perpetual

9. Further instructions shall be given as to the submission of the excel file.

Requirements:
a. General Journal
1. Initial journal entries
2. Adjusting entries
3. Closing entries
b. General Ledger
c. Trial Balances
1. Unadjusted Trial Balance
2. Adjusted Trial Balance
3. Post-Closing Trial Balance
d. Financial Statements
1. Income Statement
2. Statement of Changes in Equity
3. Balance Sheet
 65

MODULE

4
INTRODUCTION TO
MANUFACTURING

INTRODUCTION TO MANUFACTURING
(Source: Basic Accounting Concepts, Principles, Procedures and Applications by Valencia et. al.)

Manufacturing is the processing of raw materials or parts into finished goods through the use of tools,
human labor, machinery, and chemical processing. Large-scale manufacturing allows for the mass
production of goods using assembly line processes and advanced technologies as core assets. Efficient
manufacturing techniques enable manufacturers to take advantage of economies of scale, producing more
units at a lower cost.

Manufacturing is a value-adding process allowing businesses to sell finished products at a higher cost over
the value of the raw materials used. It is often reported on by the conference board, and well examined by
economists.

Manufacturing business is similar to merchandising as far as the selling of goods at marked-up price is
concerned. The main difference lies on the cost of sale.

Under merchandising, the cost of sale pertains to the cost of merchandise purchased including the
transportation cost of bringing in such merchandise to the business place. In manufacturing, however, the
cost of sales involves the conversion of raw materials into finished goods through the application of labor
and various factory costs incidental to the production of products.

Operating Cycle of Manufacturing Business

The diagram below shows the operating cycle of a manufacturing business.

THE OPERATING CYCLE OF MANUFACTURING BUSINESS

CASH
Phase 1: Phase 1:
Buy raw Collect from
materials customers

Phase 2: Processed raw

materials to finished goods Phase 3: Sell finished goods to
(Raw materials + Direct labor customers
+ Factory overhead)

Cost Elements of Manufacturing Business

In the making of finished products, a manufacturing business incurs three types of production costs, (1) Raw Materials, (2) Direct
Labor, and (3) Factory Overhead.

Raw Materials

This production cost accounts the cost of direct raw materials used in the production of products which is the primary physical
substance of the products produced, like cost of wood to produce table products, and cloth to produce pants.
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Direct Labor

It refers to the cost of labor or effort directly utilized in the making of product such as the carpenter’s wages for making the tables
and the tailor’s salary to produce pants.

Factory Overhead

The cost of factory overhead is also called as manufacturing overhead cost. It refers to all indirect materials, indirect labor and
other miscellaneous items used in the making of a product. Examples are used factory supplies, salary of factory supervisor, factory
depreciation, and factory maintenance.

As a rule, if a cost could not be classified as direct raw materials or direct labor, it is classified as factory
overhead.

The following cost can be determined until a product is produced:

1. Manufacturing costs – This is the sum of the three (3) cost elements: direct materials, direct labor
and factory overhead. This id sometimes referred to as production cost or factory cost.

2. Work-in-process – The portion of the total manufacturing costs that pertains to the goods under
process which are not yet 100% completed at the end of the accounting period.

3. Cost of goods manufactured – The portion of the total manufacturing costs pertaining to the work
which is 100% processed and completed, transferred to finished goods.

The ending inventories of each type of business to be reported as part of inventory under the current assets
are compared as follows:

Merchandising Manufacturing

1. Merchandise inventory 1. Finished goods inventory (unsold)

(unsold merchandise at the end of the 2. Work-in-process inventory (incomplete)
period) 3. Raw material inventory (unused)
4. Factory supplies inventory (unused)

PRIME COST and CONVERSION COST

The cost elements of a manufacturing firm could be combined and formed as (1) prime cost and (2)
conversion cost.

1. Prime Cost
- consist of direct materials and direct labor used to make the product. This cost is called
prime cost or direct cost because the primary materials and main labor are combined in
making the product.

2. Conversion Cost
- includes the costs of direct labor and all direct costs. This is called conversion cost
because the direct labor and overhead costs transform the raw materials to finished goods.
Indirect manufacturing cost is also called manufacturing overhead or factory overhead.
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COST OF GOODS MANUFACTURED AND SOLD

The cost of goods manufactured and sold account is generally used to describe the merchandise sold by
a manufacturing business. The schedule of cost of goods manufactured and sold is presented as follows
(all amounts assumed):

Voltaire Manufacturing
Cost of Goods Manufactured and Sold
For the Year Ended December 31, 2020

Raw Materials Used:

Raw Materials, beg. P 70,000
Net Raw Materials Purchases:
Raw Materials Purchases P 200,000
Freight-in 5,000
Purchase Returns & Allowances (2,500)
Purchase Discounts (2,500) 200,000
Raw Materials, end (20,000) P 250,000
Direct Labor 400,000
Factory Overhead 150,000
Total Manufacturing Cost P 800,000
Add: Work in Process, beg. 100,000
Total Cost of Goods in Process P 900,000
Less: Work in Process, end. (150,000)
Total Cost of Goods Manufactured P 750,000
Add: Finished Goods, beg. 50,000
Total Finished Goods Available for Sale P 800,000
Less: Finished Goods, end. (150,000)
Cost of Goods Manufactured and Sold P 650,000

Comparative Cost Flow

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FINANCIAL STATEMENT OF A MANUFACTURING BUSINESS

For illustration purposes, the following amounts are assumed:

Y Manufacturing
Cost of Goods Manufactured and Sold
For the year ended December 31, 2020

Raw Materials Used:

Raw Materials, beg. P200,000
Net Purchases:
Purchases P1,500,000
Freight-in 50,000
Purchase Returns (5,000) 1,545,000
Raw Materials, end (245,000) P1,500,000
Direct Labor 1,000,000
Manufacturing Overhead:
Indirect Labor P350,000
Factory taxes and licenses 75,000
Factory utilities 50,000
Factory supplies 25,000
Depreciation – factory 25,000 525,000
Total Manufacturing Cost P3,025,000
Add: Work in process, beg. 100,000
Total Cost of Goods in Process P3,125,000
Less: Work in process, end (625,000)
Total Cost of Goods Manufactured P2,500,000
Add: Finished Goods, beg. 500,000
Total Finished Goods Available for Sale P3,000,000
Less: Finished Goods, end (250,000)
Cost of Goods Manufactured and Sold P2,750,000

Y Manufacturing
Income Statement Huber Company
For the year ended December 31, 2020 Statement of Changes in Equity
For the year ended December 31, 2020
Sales P4,500,000
Less: Cost of Goods Manufactured & Sold (2,750,000) Y, Capital – beginning P1,800,000
Gross Profit P1,750,000 Add: Net Profit 750,000
Less: Operating Expenses: Total P2,550,000
Selling Expenses P700,000 Less: Withdrawals -
Administrative Expenses 300,000 (1,000,000) Y, Capital - end P2,550,000
Net Profit P750,000

X Manufacturing
Balance Sheet
As of December 31, 2020

ASSETS
Current Assets:
Cash P855,000
Inventories of a
Accounts Receivable 1,350,000
Manufacturing Business:
Inventories:
1. Finished Goods Finished Goods P200,000
Inventory (unsold) Work-in-process 625,000
2. Work-in-process
Raw Materials 245,000
Inventory
Supplies 50,000 1,120,000
(incomplete) Total Current Assets P3,325,000
3. Raw Materials
Inventory (unused)
Noncurrent Assets:
Equipment P1,000,000
4. Supplies (unused)
Accumulated Depreciation (25,000) 975,000
Total Assets P4,300,000

LIABILITIES and EQUITY

Current Liabilities:
Accounts Payable P400,000
Accrued Payroll 350,000 P750,000

Noncurrent Liability:
Mortgage Payable 1,000,000
Total Liabilities P1,750,000

Equity
Y, Capital 2,550,000
Total Liabilities and Equity P4,300,000