Chapter Five: Receivables

Introduction:

A large portion of all business transactions are

credit transactions.
One way of extending credit is by acceptance
of a promissory note, a contract in which one
person (the maker) promises to pay another
person (the payee), a specific sum of money at a
specific time, with or without interest.
 Cont..d
Most of the companies sell goods and services on
credit in order to earn more profits.
Receivables represent claims for money, goods,
services, and non-cash assets from other firms.
 Receivables may be current or non-current
depending on the expected collection date.
 Classification of Receivable
Receivable are the second most liquid assets next to
cash.
The term receivables refer to amounts due from
individuals and companies.
Receivables are claims that are expected to be
collected in cash.
The management of receivables is a very important
activity for any company that sells goods or services
on credit.
 Cont...d
To reflect important differences among
receivables, they are frequently classified as:
1. Accounts receivable,
2. Notes receivable, and
3. Other receivables.
1. Accounts Receivable
 Accounts receivable are amounts customers
owe on account. They result from the sale of
goods and services.
 Companies generally expect to collect accounts
receivable within 30 to 60 days.
They are usually the most significant type of claim
held by a company.
 Cont.…d
These receivables are supported by sales
invoices or other documents rather than
any formal written promises.
Such Account Receivables are normally
expected to be collected within relatively
short period, such as 30 or 60 days.
They are classified on the balance sheet as a
current asset.
 2. Note Receivable
Notes receivable represent claims for which formal
instruments of credit are issued as evidence of the
debt.

The credit instrument normally requires the debtor

to pay interest and extends for time periods of 60–90
days or longer.

Notes and accounts receivable that result from sales

transactions are often called trade receivables.
 [Link] Receivables
Other receivables include non trade receivables.
Non-trade Receivable arise from many other
sources, such as advance to employees, interest
receivables, rent receivables and loan to affiliated
companies.
Difference between Accounts and Notes Receivables
To mention few of the differences between Accounts
receivable and notes receivables
Notes receivable is more liquid than accounts receivable in
that it can be readily transferred to a bank or other financial
agency in exchange for cash.
 Cont...d
 The due date of note receivable is relatively longer than
accounts receivables.
 Note receivables is stronger legal claim than accounts
receivable
 Notes receivable is a written agreement supported by a
promissory while accounts receivable is oral agreement.
 Receivables that are expected to be collected within one
year are reported as current asset on the balance sheet.
 If collection is expected beyond one year, they are
classified as non-current.
 Characteristics of Notes Receivable
1. A promissory note is a written promise to pay a
specified amount of money, usually with interest,
either on demand or at a definite future date.
Characteristics of a promissory note are as follows :
 The maker is the party making the promise to
pay.
 The payee is the party to whom the note is
payable.
 The face amount is the amount the note is
written for on its face.
 Cont.…d
The issuance date is the date a note is issued.
The due date or maturity date is the date the
note is to be paid.
The term of a note is the amount of time
between the issuance and due dates.
The interest rate is that rate of interest that
must be paid on the face amount for the term of
the note.
Discounted period, is the time between the date
of the transfer and the due date of the note.
 Computing maturity and interest
Maturity Date and Period:
The maturity date of a note is the day the note (principal and
interest) must be repaid.
Maturity value:
The amount that is due at the maturity or due date is called the
maturity value.
The maturity value of a note is the sum of the face amount and
the interest.
MV= FV + I
Where MV =maturity value
FV=face value
I= interest
 The period of a note is the time from the note’s (contract)
date to its maturity date. Many notes mature in less than a full
year, and the period they cover is often expressed in days.
When the time of a note is expressed in days, its maturity date is
the specified number of days after the note’s date.
 Cont.…d
Interest Computation:
Interest is the cost of borrowing money for the
borrower or, alternatively, the profit from lending money
for the lender. Unless otherwise stated, the rate of interest on
a note is the rate charged for the use of the principal for one
year.
The formula for computing interest on a note is shown
below:
Interest = Principals of the note x Annual Interest Rate x
Time expressed in fraction of year
 Cont. …d
To illustrate the formula, the interest on a
Br. 10,000, 12%, 60 day note is computed
as:-
Interest
= Br. 10,000 X 12% X 60/360
= 200
N.B. To simplify interest computations for notes
with periods expressed in days, it is common to
treat a year as having 360 days.
 Accounting for Notes receivable

A promissory note may be received by a company from a

customer to replace an account receivable. In such cases, the
promissory note is recorded as a note receivable.

When a note is received from a customer to apply on

account, the facts are recorded by debiting the notes
receivables account and crediting accounts receivable
controlling account and the account of the customer from
whom the note received.
N/R…………………….xx
A/R……………………xxx
Interest Bearing Notes Receivable
If the note received from a customer on account is
interest bearing, interest must be recorded as
appropriated.
Recording the honoured and dishonoured note
A note is honoured when its maker pays in full at
its maturity date.
For each interest bearing note, the amount due at
maturity is the face value of the note plus interest for
the length of time specified on the note.
If the maker of a note fails to pay the note on the
due date, the note is a dishonored note receivable.
 Cont.…d
The balance of the Notes Receivable account normally
includes only those notes that have not matured.
When a note is dishonoured, we therefore remove the
amount of this note from the Notes Receivable account
and charge it back to an Accounts Receivable from its
maker.
 Con….
 A company that holds a dishonoured note transfers the
face amount of the note plus any interest due back to an
accounts receivable account.
Assume for instance Nile Co., holds a Br.1000, 12%, 30-day
note of Ato Alemu. At maturity, Alemu dishonoured the
note. Nile Co. records this dishonouring of its N/R, on
Oct. 25, as follows:
Oct.25, A/R---------------1010
N/R-----------------------1000
Int. Rev. -----------------10
To record dishonoured note & interest of 1000 X 12% X 30/360 =10
 Discounting Notes Receivable
Most promissory notes are negotiable that is
they may be transferred to another (usually to a
bank) in exchange for cash.

The original payee (receiver) of the note transfers

legal title by endorsing the note.

The maker of the note must pay its face amount

plus any interest specified to the endorsee(Bank)
when the latter presents the note for payments on
its date.
Computing the Proceeding of Discounted Notes
Receivable:
The amount which endorser (payee) receives up on the
transfer of a note is called Proceeds of a note. The
amount of the proceeds is determined by deducting the
discounts amount from the maturity value of a note.
The discount is the endorsee (usually bank’s)
compensation for advancing money to the
endorser and for waiting until the maturity date
to be repaired.
Discount is accounted as interest expense by
the business that pays it and interest revenue by
the business which receives it or
 Cont.…d
Discounted is computed on the maturity value of
the note for the period that the endorsee (the bank)
must hold the note.
This period, called the discounted period, is the time
between the date of the transfer and the due date
of the note. Thus, the amount of the proceeds paid
to the endorser is the excess of the maturity value
over the discount.
Generally, in discounting notes receivable the following
steps could be followed.
Determine the maturity value of the note:
Maturity Value = Face Value (Principal) + Interest
Determine the amount of the discount:
Discount amount = Maturity Value X Discount rate X Discount Period

Determine the proceeds:

Proceeds= Maturity Value – Discount Amount
Example 1: Assume that a 90 day, 12%, Br 27,000 note receivable
from TZ Share Company dated April 8 is discounted at the payee’s
bank on May 3 at the rate of 14%.
The data used in determining the effect of the transactions are as follow.
Face value of the note Br 27,000
Interest on note (Br 27,000 X 0.12X 90/360 810
Maturity Value of the note due July 7 Br 27,810.00
Discount on Maturity at 14%
65 days from May 3 to July 7 (27,810 X 65/360 X 0.14) (702.98)
Proceeds Br 27,107.02
May Cash 27.107.02
3 Notes Receivable 27,000
Interest Revenue 107.02
 Cont.…d
When the proceeds from the discounting a note
receivable are less than the face value, then the
excess of face value over the proceeds is recorded
as interest expense.
Whether there is interest income or interest
expense for the endorser of a note depends on the
length of the discount period and the difference
between the interest rate and the discount rate.
 Accounts Receivable
Three accounting issues associated with accounts
receivable are:
Recognizing accounts receivable.
Valuing and Disposing of accounts receivable.
Account Receivable is a claim against a customer for
services rendered or goods sold on credit.
Recognizing accounts receivable is relatively straightforward.
A service organization records a receivable when it
provides service on account.
A merchandiser records accounts receivable at the point of
sale of merchandise on account. When a merchandiser
sells goods, it increases (debits) Accounts Receivable and
increases (credits) Sales Revenue.
The seller may offer terms that encourage early payment by providing a discount.
Sales returns also reduce receivables. The buyer might find some of the goods
unacceptable and choose to return the unwanted goods.
Valuing Accounts Receivable
When a company directly grants credit to its customers, it expects that
some customers will not pay what they promised. The accounts of
these customers are uncollectible accounts Expense, commonly
called bad debts expense or Doubtful Accounts Expense.
The total amount of uncollectible accounts is an expense of selling on
credit.
There is no general rule for when an account becomes
uncollectible. Some indications
that an account may be uncollectible include the following:
1. The receivable is past due.
2. The customer does not respond to the company’s attempts to collect.
3. The customer files for bankruptcy.
4. The customer closes its business.
5. The company cannot locate the customer.
 Cont…d
There is no general rule for when an account becomes
uncollectible. Some indications that an account may be
uncollectible include the following:
1. The receivable is past due.
2. The customer does not respond to the company’s attempts to
collect.
3. The customer files for bankruptcy.
4. The customer closes its business.
5. The company cannot locate the customer.
Two methods are used in accounting for uncollectible accounts:
[Link] direct write-off method or the direct-charge-off method,
2. The allowance method.
1) Direct Write-Off Method for Uncollectible Accounts, which
recognize the expense only when specific accounts are
believed to be worthless.
 Under the direct write-off method, when a company determines
a particular account to be uncollectible, it charges the loss to
Bad Debts Expense.
Example
If Wonji co. uses a direct write-off method and determines on Feb.
20,it can’t collect from a customer Home Co. br.500. the entry to
write-off customer account is as follows:
Feb. Uncollectible account expense 500
A/R Home Co. 500
(T o write-off Uncollectible Accounts)
 Cont.…d
Sometimes an account previously written of is later
collected. This can be due to factors such as continual
collection efforts or the good fortune of a customer.
If the account of Home Co. that was written-off directly to
Bad Debit Expense is later collected in full, the following
two entries record this recovery.
Mar. 5 - A/R- Home Co. 500
(Uncollectible Accounts Expense) 500
To reinstate account
Mar. 5 - Cash 500
A/R- Home Co. 500
(To record full payment of account)
 Cont...d
2) Allowance Method for Valuing Accounts Receivable:
The allowance method of accounting for bad debts
involves estimating uncollectible accounts at the end of
each period. This provides better matching on the income
statement.
It also ensures that companies state receivables on
the balance sheet at their cash (net) realizable
value.
Cash (net) realizable value is the net amount the
company expects to receive in cash. It excludes
amounts that the company estimates it will not
collect.
Thus, this method reduces receivables in the
balance sheet by the amount of estimated
uncollectible receivables.
 cont…d
The Allowance method of Accounting for uncollectible:-
(A)The reduction of the value of the receivables to the amount of
cash expected to be realized from them in the future and
(B) The allocation to the current period of the expected expense
resulting from such reductions.
The allowance method estimates bad debt expense at the
end of each accountig period and records it through an
adjusting entry. Eg: on December 31 assume the A/R
account has a balance of Br. 50,000 and based on careful
study of the experience of other companies, Nile Co.
estimates that a total of Br. 2000 will be uncollectible.
This estimated expense is recorded through the following
adjusting entry.
Dec. 31 Uncollectible Accounts Expense 2000
Allowance for Doubtful Accounts 2000
To record estimated bad debts
 Cont…d
The amount Br. 2000 is an estimated reduction in A/R,
but it cannot be credited to specific customer
accounts or to the A/R controlling account. Instead, a
contra asset account entitled Allowance for Doubtful
Accounts is credited.
As with all periodic adjustments the above entry
serves two purposes. First, it reduces the value of the
receivable to the amount of cash expected to be
realized in the future.
This amount, which is Br. 48,000 (Br. 50,000 – Br.
2,000), is called the Net Realizable value of the
receivables. Second, the adjusting entry matches the
Br. 2000 expense of uncollectibles account with the
related revenues of the period.
 Write-off to the Allowance Account
 When specific accounts are identified as
uncollectible, they are written-off against the
Allowance for Doubtful Accounts
Allowance for Doubtful Accounts XX
A/R XX
To write-off uncollectible accounts .
 Cont.….d
Assume after spending some time trying to collect from Shalla Co., Nile Co. decides that
Shalla’s Br. 200 accounts receivable is uncollectible and makes the following entry to writ-it
off.
Jan. 25 Allowance for Doubtful Accounts 200
A/R-Shalla Co. 200
To write-off uncollectible accounts.

Note two aspects of this entry and its related accounts

Before Write-off After Write-off
A/R 50,000 49,800
Less Allowance for D. a/cs 2,000 1,800
NRV 48,000 48,000
Neither total assets nor net income are affected by the Write-off of a specific account. But
both total assets and net income are affected by the recognized bad debts expense for the year
in the adjusting entry.
 Recovery of Uncollectible Accounts
 When a customer fails to pay and the account is
written-off as uncollectibles, his or her credit
standing is jeopardized.
 To help restore credit standing, a customer may
later choose to voluntarily pay all or part of the
amount owed.
 A company makes two entries when collecting an
account previously written-off.
 The first is to reverse the original write-off and
reinstate the customer’s account. For example,
assume the amount written-of in the preceding
entry is later collected on February 15
 Cont.….d
On Feb. 15- The entries to record this recovery are:
Feb. 15- A/R Shalla Co. 200
Allowance for Doubtful Accounts 200
To reinstate accounts previously written-off
Feb. 15- Cash 200
A/R-Shalla Co. 200
To record full payment of account
 Allowance for Doubtful Account is a contra asset
account and the amount to be deducted from
Accounts Receivable to determine their
expected realizable value.
 Uncollectible account expense (bad debt
expense) is reported on the income statement
either selling expense or general expense,
depending upon the department responsible.
 Example
To illustrate, assume that a 90-day, 12%, Br. 20,000 N/R
from Hiwot Co. dated Jan.1, 20x2 is discounted at the
payee’s bank on February 12, 20x2 at the discount rate of
15%. The steps to determine the proceeds (the amount to be
received by the payee from the bank upon discounting) are
as follows:
[Link] the maturity date & maturity value.
[Link] the discount period
[Link] the Bank Discount amount
[Link] proceed
[Link] the necessary journal entry at the date of
discount.
Step1 – Determine the maturity date & maturity value.
MD = April –1 & MV = FV + I = 20,000 + [20,000 X 12% X 90/360] = 20,600
Step 2 – Determine the Bank Discount (Bank discount is an interest that is charged by the bank
and is computed based on the maturity value of the note for the discount period.
Discount Period is the time the bank must hold the note) before it becomes due.
Bank Discount = MV X DR X DP where MV = Maturity value (20,600)
DR = Discount Rate (15%)
Discount = 20,600 X 15% X 48/360 DP = Discount period (from February12 to April 1)
= 412
Step 3- Determine proceed (proceed is the amount of cash paid to the endorser after deducting
discount)
I.e. proceed = MV – D
= 20,600 – 412 = 20188
Step 4 – Record the necessary journal entry at the date of discount. (Here, record interest
revenue which is the excess of proceeds from the face value or record interest expense when
the proceed is less than the face value of the note)
Feb 12. Cash---------------------------------20,188
N/R -----------------------------------------20,000
I. Rev. --------------------------------------188.00
Discounted Br. 20,000, 90-day, 12% note at 15%
The length of the discount period and the difference between the interest rate and the discount
rate determine whether interest expense or interest revenue will result from discounting.
 Example
Naol Clinic received a 120-day, 6% note for
$40,000, dated March 14 from a patient on
account.
a. Determine the due date of the note.
b. Determine the maturity value of the note.
c. Journalize the entry to record the receipt of the
payment of the note at maturity.
 example
Same Day Surgery Center received a 120-day,
6% note for $40,000, dated March 14 from a
patient on account.
a. Determine the due date of the note.
b. Determine the maturity value of the note.
c. Journalize the entry to record the receipt of the
payment of the note at maturity.
1. What is the maturity value of a 90-
day, 12% note for $10,000?
A. $8,800 C. $10,300 B. $10,000 D. $11,200
2. What is the due date of a $12,000,
90-day, 8% note receivable dated
August 5?
A. October 31 C. November 3 B. November 2 D.
November 4
3. When a note receivable is dishonored,
Accounts Receivable is debited for what
amount?
•The face value of the note B. The maturity value of the note
C. The maturity value of the note less accrued Interest D. The
maturity value of the note plus accrued interest
4. Give two examples of other receivables.
 Cont.…d
5. Northrop Supply Company received a 30-day,
6% note for $40,000, dated September 23 from a
customer on account.
a. Determine the due date of the note.
b. Determine the maturity value of the note.
c. Journalize the entry to record the receipt of the
payment of the note at maturity.
 Accounting For Merchandising Businesses
 In the preceding chapters we have illustrated the
accounting cycle for organizations that render
services to their customers.
 Merchandising companies, in contrast, earn their
revenue by selling goods.
 A business that buys and resells goods is called
Merchandising Business.
 The goods that a merchandising company sells to its
customers are called inventory (or merchandise).
Merchandising companies include both retailers and
wholesalers. These companies purchase readymade
or ready to sell goods and get all earning or revenue
by selling them.
 Cont…d
 Merchandise consists of products, also called goods that a
company acquires to resell to customers.
 A merchandiser earns net income by buying and selling
merchandise.
 Merchandisers are often identified as either wholesalers or
retailers.
 A wholesaler is an intermediary that buys products from
manufacturers or other wholesalers and sells them to
retailers or other wholesalers.
 A retailer is an intermediary that buys products from
manufacturers or wholesalers and sells them to consumers.
Many retailers sell both products and services.
 Cont…d
Merchandising enterprises commonly use the
procedures described below. However, these
procedures may very from business to business. For
Example:
Purchases and sells may be made for cash or on
credit basis
Different arrangement may be made for making
payment on accounts.
Policies for the return of merchandising may
differ and
Policies for the payment of transportation costs
may also vary
 Accounting For Purchases and Sales of Merchandise

Purchases of merchandise are usually identified in

the ledger as purchases.
A merchandising business can accumulate in the
purchases account the cost of all merchandise
purchased for resale during the accounting period.
The cost of merchandise purchased is recorded by

debiting an account called “PURCHASES”.

 Cont…d
Purchases can be made for cash or on account. The
sale of merchandise during an accounting period
credited to an account called “SALES”.
Merchandises may be sold on cash or may also be
sold on account.
Illustration : Mulu Super Market purchases 2000
cartons of Canned Fish from Century Trading
House at a cost of Br 50 per carton on cash.
Record the transaction for both the buyer and the
seller.
 Cont…d
Illustration : Lucy Cosmo Trading Company
sold merchandises of Br 5,700 on credit to Selam
Cosmetics.
Record the transaction for both parties
Illustration: Assume Ambassel Trading House
purchases 10,000 cartons of Exercises book from
Guna Trading Enterprise for Br 150,000 with dawn
payment of 60%.
Record the transaction in the book’s of the buyer
and the seller.
 Credit Terms, Cash Discounts and Return & Allowances
Credit Terms
The arrangements agreed upon by the buyer and
the seller as to when payments for merchandise are
to be made is called the credit terms.
If the payment is required upon delivery, the
terms are said to be “Cash term” or “Net cash term”.
If the payment is not required upon delivery, the
buyer is allowed a certain period of time for
payment; the term is known as the credit period
 Examples of Credit Period terms:

 n/30 (i.e. net 30 days) – payment will be made or

due within 30 days after the date of the invoice.
 n/EOM (i.e. net end of the month) – the payment
will due by the end of the month in which the
sales was made.
 20/EOM (i.e. 20 end of the month) – Payment is
due 20 days after the end of the month in which
the sales was made
 Purchase Discount
The purchase of goods on credit requires a clear
statement of expected future payments and dates
to avoid misunderstandings. The arrangement
agreed upon by the buyer and seller as to when
payments are to be made are called Credit terms.
Credit terms for a purchase include the amounts
and timing of payments from a buyer to a seller.
 Cash Discounts

As a means of encouraging payment before the end

of the credit period, the seller may offer a discount
for the early payment of cash. Such type of deduction
or discount is known, as a cash discount. It is a
discount for prompt payment made from the invoice
price.
 Cont..d
Illhjstration: A seller may offer a buyer a 2% discount if
payment is received within 10 days of the invoice date. For
this, the term “2/10, n/30” can be used and it means that :
The credit period is net 30 days
The period during which a discount is available is
called the Discount Period i.e. is the first 10 days
The buyer will get a deduction of 2% of the
amount of the invoice if it is paid within the 10 days
of the credit period.
 Cash discounts can be Purchase discount and Sales discount .
 Purchase discount: the cash discount taken by
the buyer for early or prompt payment of an
invoice is called purchase discounts.
 The buyer records purchase discount by crediting
the “PURCHASES DISCOUNTS” account and
they are usually viewed as a deduction from the
amount initially recorded as in purchases.
 Purchase discount account is a contra (offsetting)
account to Purchases account.
 Cont.…d
Sales discounts: the seller refers to the same cash
discounts taken by the buyer as “SALES
DISCOUNT”.
It is recorded by debiting sales discount account and
considered as the amount to be deducted from the
amount sales. Sales discount is a contra sales
account.
 Illustration :
On March 1, 2005 assume Hebesha Trading House
purchased ready made clothes from Kombolcha
Textile Factory on account for Br 600,000; terms
2/10,n/30. Instructions: record the transaction in the
books of both the buyer and the seller assuming that
(A) the Buyer settled the payment within the
discount period, and (B) the Buyer did not settle the
payment within the discount period
 Purchase Return and allowance
 Merchandise purchased from the supplier may be
unsatisfactory, defective or wrong specification.
 In this case the goods may be returned to the supplier
(this is called Returns) or the buyer may requests for
a price reduction or adjustment (this is called
Allowances).
 The buyer sends a debit memo to the supplier to
notify that it is debiting the seller’s account. It is
recorded by crediting “Purchases Return and
Allowances” or “Purchases” account
 The same return and allowance is referred by the
buyer as purchases returns and allowances and by
the seller as sales returns and allowances.
 Cont.…d
Purchase return:
Refers to merchandise a buyer acquires but then
returns to the seller.
A purchases return involves actually returning
merchandise that is damaged or does not meet the
specifications of the order.
Purchase allowance:
Refers to a reduction in the cost of defective or
unacceptable merchandise that a buyer acquires.
When the defective or incorrect merchandise is kept
by the buyer and the vendor makes a price adjustment,
this is a purchases allowance.
 Sales Returns and Allowances (SRA):
The effect of sales return and allowances is a
deduction in sales revenue and a reduction in or
account receivable.
There fore, excessive sales return and allowances
show there is loss in revenue, an additional expense
and customer dissatisfaction. catalog
It is possible to debit the sales account instead of
debiting the sales returns and allowances account.
 Illustration
On July 8, 2005 Global Trading Enterprise sold
merchandises on account to GYB Company Br 40,000
terms 3/10, n/eom. On July 11, GYB Returned Br4000
defective merchandises to Global which is part of the sale of
July 8. On July 17, Global received cash from GYB.
Instruction: record the transactions in the books of the buyer
and the seller.
 Transportation Costs

The terms of agreement between a buyer and seller

include when the ownership of the merchandise
passes to the buyer and which party is to absorb the
cost of delivering the merchandise to the buyer.
There are two most common terms with respect to
this:
 FOB (Free on Board) Shipping Point and
Destination.
 Cont…d

FOB Shipping Point: under this term the seller

places merchandise “Free On Board” at the shipping
point. Thus,
The buyer pays transportation costs
Ownership is transferred at point of shipment
The goods are the property of the buyer after the
point of shipment
Any risk is absorbed by the buyer while the goods
is in transit
 Cont.…d
FOB Destination: under this term the seller places
merchandise “Free On Board” at the buyer’s final
destination by paying the delivery costs. Thus,
The seller pays the transportation costs
Title or ownership to the goods is transferred at
the buyer’s location
The goods are the property of the seller while in
transit
Any risk while the goods in transit is absorbed by
the seller
 Cont.…d
 When merchandise is purchased on terms of FOB
shipping point, the transportation costs paid by
the buyer is debited to Transportation In or
Freight In or Purchases account.
 In some cases, the seller may prepay the
transportation costs and add them to the buyer,
even though the agreement is states that the buyer
bear such costs (i.e. terms FOB shipping point).
This is also debited to the same accounts as
above.
 Cont…d
 When the agreement states that the seller is to
bear the delivery costs (FOB Destination), the
amount paid by the seller for delivery of
merchandise is debited to Transportation Out or
Freight Out or delivery Expense or a similarly
titled account.
 The total of such costs incurred during a period is
reported on the seller’s income statement as a
selling expense and will not be included in the
cost of goods sold.
 Example
on February 1, 2004 RR Trading Company purchased
merchandise on account from KK Company for Br
12,000, terms FOB shipping point 2/10, n/30 and the buyer
paid a transportation cost of Br 100 to XX Transportation
Company. On February 12, RR Company paid cash to KK
Co.
Soln.
 Periodic Reporting and Merchandise Inventory System

1. Periodic Reporting
The sequence of year end procedures may be changed
slightly, but in general the following outline is typical:
1. Prepare a trial balance of the ledger on a worksheet form
2. Review the accounts and gather the data required for the
adjustment
3. Insert the adjustments and complete the work sheet
4. Prepare financial statements from the data in the
worksheet
5. Journalize the adjusting entries and post to the ledger
6. Journalize the closing entries and post to the ledger
7. Prepare a post closing trial balance of the ledger
 Cont…

[Link] Inventory Systems

• The system through which you can determine
CGS and Cost of Ending Inventory is called
inventory system. The two main systems for
accounting for merchandise held for sale are the
periodic inventory system and the perpetual
inventory system.
 The Periodic Inventory System and Determination of Cost of
Merchandise Sold

 The cost of merchandise sold (CMS) is determined as follows:

Merchandise Inventory (Beginning) ............................................xxxxx
Add: Purchases..................................................... xxxxx
Less: Purchase Return & Allow...........................(xxxxx)
Less: PD ............................................................... (xxxxx)
Net Purchases ....................................................... xxxxx
Add: Freight in ..................................................... xxxxx
Cost of merchandise purchased .................................... xxxxx
Cost of Merchandise Available for sales (CMAS)....... xxxxx
Less: Ending Inventory ................................................. (xxxxx)
Cost of Merchandise Sold............................................. xxxxx