Emergency Remote Learning

Module III
SUMMER 2020

Prepared by:

Wee Lu Gee D. Amora, CPA

Accountancy Department

AE 101
FINANCIAL ACCOUNTING & REPORTING
COURSE PLAN

Module 1 Accounting Fundamentals

Lesson 1: Introduction to Accounting
Lesson 2: Accounting Concepts and Principles
Lesson 3: The Accounting Equation
Lesson 4: Types of Major Accounts

Module 2 Accounting for Service Business

Lesson 1: Books of Accounts and Double-Entry System
Lesson 2: Accounting Cycle: Analysis to Unadjusted Trial
Balance
Lesson 3: Accounting Cycle: Adjustments to FS Preparation

Module 3 Accounting for Merchandising Business

Lesson 1: Inventory Systems
Lesson 2: Special Journals
Lesson 3: Accounting Cycle

Midterm Examination

Module 4 Accounting for Partnership

Lesson 1: Formation
Lesson 2: Operations
Lesson 3: Dissolution
Lesson 4: Liquidation

Module 5 Accounting for Corporation

Lesson 1: Components of Equity
Lesson 2: Dividends

Final Examination

FACILITATOR/TUTOR AND TUTORIALS

You are free to work on each module at your convenient time, in your own pace.
However, you are expected to finish one Module each week. You need not worry because
you are not alone in your journey through this course. Your teacher will be available
online to guide and assist you from 2pm to 3pm, Tuesdays and Thursdays. Please
make sure you utilize this opportunity to raise questions so difficult concepts may be
clarified. Just make sure you have read the course materials very well so you will be able
to identify the issues that need to be sorted out with your teacher during the scheduled
tutorial time.
 MODULE 3
ACCOUNTING FOR MERCHANDISING BUSINESS

Faithful with Little, Joyful in Much

How God Meets Us in the Small Things

Immediately after sending the text message I was confronted by a moral dilemma.
Honestly, I felt a little silly at the triviality of it. I was running late to a meeting and said I
would only be five minutes late. But that wasn’t the truth. Having driven the same route
on a weekly basis, I knew exactly how long it would take. It would take me fifteen
minutes. So why did I send a message knowing it was wrong?

We are called to obey God — even in the small things.

Circumstances test our integrity every day. It often seems easier to lie about a situation
than to tell the truth. My coworkers won’t care if it’s not an exact estimation. Surely,
they’ll give a little extra measure of grace knowing I’m a little later than anticipated.
What’s a few additional minutes? Stretching the truth in this situation isn’t really that big
of a deal.

In fact, the world would have us think that these sorts of things are not only acceptable,
but necessary. If we knowingly deceive, saying, “No, officer, I don’t know how fast I was
going” — we are told that it is less likely we get a traffic ticket. It seems as though it was
just an innocent mistake. If we’re drawn into that popular TV show that looks a little
risqué, we’re not really committing an egregious sin. It’s just a small indulgence that
keeps you relevant and culturally up-to-date. Or so we tell ourselves.

But Song of Solomon 2:15 tells us that it is “the little foxes that spoil the vineyards.”
Little areas of our life feel so minuscule and unimportant. It’s easy to dismiss these things
as inconsequential, if not petty, in the grand scope of things. Undoubtedly, following
God’s ways is certainly about obedience in bigger things, but it is also about choosing to
submit to his will in the little details. 
Source: https://www.desiringgod.org/articles/faithful-with-little-joyful-in-much

Devotional Question:
Why do faithfulness in small things matter?
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 Essential Question:
Accountants generally handle financial records. How do you prepare yourself as early
as now in becoming a CPA with integrity?
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For this module, the objective is for you to understand and appreciate the accounting for
service business. Specifically, you will:

a. Understand the concepts and distinguish periodic inventory system and

perpetual inventory system;
b. Identify the different special journals and determine the purpose of each;
c. Prepare the Statement of Cost of Goods Sold and Income Statement of a
merchandising business; and
d. Complete the accounting cycle of a merchandising business.

Now that you have already understood the objective of this module, try to evaluate
yourself as to how much have you already learned about accounting for merchandising
business by taking the pre-assessment that follows.

Pre-Assessment (via flexiquiz.com or fb group quiz)

A. Determine if the statement is true or false. If false, identify what makes it incorrect.
1. Under the periodic inventory system, the “Purchases” account is just a temporary account
while in perpetual inventory system, it maintains the “Inventory” account which is a
permanent account. T F
2. Physical count on year-end is applicable only in periodic inventory system. T F
3. When special journals are used, the General Journal is no longer applicable. T F
4. One of the major differences of a merchandising business’ income statement compared
to a service business’ income statement is the “Cost of Sales” or “Cost of Goods Sold”
section. T F
5. The accounting cycle of merchandising business is just the same with that of a service
business. T F
 Lesson 1: Inventory Systems

To recall, a merchandising business is one that buys and sells goods without changing
their physical forms. The main difference between a merchandising business and a
service business is that a merchandising business necessarily holds inventory of physical
goods for sale.

In this context, inventory simply refers to the goods that a merchandising business has
purchased and primarily intended for resale, normally in their original form and without
any further processing. Inventories are accounted for using either perpetual or periodic
inventory system.

Income Statement: Service vs. Merchandising

Service Merchandising
Income Statement Income Statement

Service Revenues Net Sales

minus
Cost of Sales
minus equals
Gross Profit
add or minus
Expenses Other income or Expenses
equals equals
Profit Profit

In a merchandising business, Net Sales arise from the sale of goods while Cost of Sales or
Cost of Goods Sold represents the cost of inventory the entity has sold to customers. The
difference between net sales and cost of sales is called Gross Profit. Then, other
operating income is added and operating expenses are deducted from gross profit to
arrive at Operating Profit. Finance costs, e.g. interest expense, are considered to arrive at
profit before tax.

Source Documents
Recall the source documents presented in Module 2 and determine the description of the
following:
1. Sales invoice 5. Deposit slips
2. Bill of lading 6. Check
3. Statement of account 7. Purchase requisition
4. Official receipt 8. Purchase order
9. Receiving report 10. Credit memorandum

Terms of Transactions
 Some businesses give discounts for prompt payment such as cash discounts. Cash
discounts is designated by such notation as “2/10” which means that the buyer may
avail of 2% discount if the invoice is paid within 10 days from then invoice date. In
this case, ten days is called the discount period. If you are the buyer, you call this
discount a purchase discount. If you are the seller, you call this a sales discount.

Illustration:
Last June 11, 2020, you purchased five gallons of alcohol worth P3,000 from a supplier
who offers 3/15, n/45 credit term. How much will you pay if you plan to settle the
account within the discount period? Also, when will the discount period end?
Invoice price P
150,000
Multiply: Discount rate 3
%
Cash discount/Purchase discount P 4,500

Invoice price P
150,000
Less: Purchase discount 4,50
0
Net price P
145,500

Alternative solution: P150,000 x (100% minus 3%) = P150,000 x 97% = P145,500.

Discount period will end fifteen days from June 11 and that is June 26, 2020.

 Trade discounts encourage the buyers to purchase products because of markdowns

from the list price. The one you commonly see at the department store during Mall
Sale is a common example of this. Do not trade discount with cash discounts.
Observe that the mall is offering you a discounted branded jeans to encourage you to
buy the product. Whereas, cash discount is offered when you already purchased the
product for to induce early payment. Moreover, there is no “Trade Discount” account
in your accounting records simply because this is not to be recorded. Instead, subtract
first the trade discount from the list price so you will get the invoice price. That
invoice price is the one to be recorded in your books.

Illustration:
Gaisano Mall quoted a list price of P1,000 for selected Nike shoes with a trade discount
of 20%. If you purchased 5 pairs of shoes, what would be the invoice price?
List price (P1,000 x 5) P 5,000
Less: Trade discount (P5,000 x 1,000
20%)
Invoice Price P 4,000
Drill 1:
Personal Collection, Inc. is celebrating its 25th Anniversary. In line with this, they are
offering a 20%, 10% trade discount on all PC products and a 1/15, n/30 credit term. As
an avid Personal Collection buyer, you purchased five dozens of Check bath soap with a
list price of P6,000, and ten pieces of one-liter Sof fabric conditioner worth P2,800. What
is the total invoice price? How much will you pay if you settle your account within the
discount period?

 When merchandise is shipped by a common carrier – a trucking entity or an airline –

the carrier prepares a freight bill in accordance with the instructions of the party
making the shipping arrangements. The freight bill designates which party shoulders
the costs, whether the shipment is freight prepaid or freight collect.

Freight bills usually show whether the shipping terms are FOB shipping point or FOB
destination. F.O.B. is an abbreviation for “free on board.”

Freight terms Who shoulders the Who actually pays

transportation cost? the shipper?
FOB Destination, Freight Prepaid Seller Seller
FOB Shipping Point, Freight Collect Buyer Buyer
FOB Destination, Freight Collect Seller Buyer
FOB Shipping Point, Freight Prepaid Buyer Seller

Question: If a typhoon damaged the product/goods in transit, who must bear the loss?
Answer: The one who shoulders the transportation cost also shoulders the loss.

If you are the buyer and you shoulder the transportation cost, you recognize a
“Transportation In” or “Freight In” account. This account forms part in your net
purchases reflected in the income statement. However, if you are the seller and you
shoulder the transportation cost, you recognize a “Transportation Out,” “Freight Out,” or
“Delivery expense” account. This account forms part in your operating expenses,
specifically a distribution or selling expense.

Illustrations: (Journal entries are prepared using the periodic inventory system.)
On May 2020, Spongebob Co., whose business is located at Pacific Ocean, sold
merchandise worth P100,000, on account, to Patrick Co. who is located at Mediterranean
Sea. Squidward Inc., the shipping company, bills P12,000 freight cost on the
merchandise. Spongebob and Patrick agreed on an “FOB Destination, Freight Prepaid”
shipping term.
 Spongebob Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Accounts Receivable 100,000
Sales 100,000
To record sale on account.

Transportation Out 12,000

Cash 12,000
To record freight out of merchandise sold.

Patrick Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Purchases 100,000
Accounts payable 100,000
To record purchase on account.

Observe that Spongebob, the seller, shoulders and pays the freight cost. Now, assuming
that the term is “FOB Shipping Point, Freight Collect.”

Spongebob Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Accounts Receivable 100,000
Sales 100,000
To record sale on account.

Patrick Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Purchases 100,000
Accounts payable 100,000
To record purchase on account.

Freight In 12,000
Cash 12,000
To record freight cost of merchandise bought.
This time, Patrick, the buyer, shoulders and pays the freight charges. The Freight In
account is added to Purchases account in computing the Net Purchases of the period.
Now, assuming that the term is “FOB Destination, Freight Collect.”

Spongebob Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Accounts Receivable 88,000
Transportation Out 12,000
Sales 100,000
To record sale on account and freight cost.

Patrick Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Purchases 100,000
Accounts payable 88,000
Cash 12,000
To record purchase on account.

Observe that although Spongebob is to shoulder the freight, Patrick is the one who paid it
(see a credit of cash P12,000 in Patrick’s books). So, instead of having a receivable of
P100,000 from Patrick, it will now be just P88,000 because Patrick paid the obligation of
Spongebob to the shipping company (kumbaga, gitaplan ni Patrick). Patrick, on the other
hand, instead of having a liability of P100,000, it will now be just P88,000. Notice that
the “Sales” and “Purchases” amount is not affected by the shipping terms. It will always
be equal to the cost of the merchandise. Now lastly, assuming that the term is “FOB
Shipping Point, Freight Prepaid.”

Spongebob Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Accounts Receivable 112,000
Sales 100,000
Cash 12,000
To record sale on account.
 Patrick Company
General Journal
2020 Account Titles and Explanation P.R. Debit Credit
May Purchases 100,000
Freight In 12,000
Accounts payable 112,000
To record purchase on account and freight cost.

This time, Patrick, the buyer, must shoulder the freight but Spongebob, the seller, is the
one who paid the shipping company (si Spongebob napud nitapal). So instead of having
just a P100,000 receivable, the P12,000 freight will become an additional receivable,
which on Patrick’s point of view is an additional payable.

In the preceding illustrations, note also that the “Accounts Payable” of the buyer is equal
to the “Accounts receivable” of the seller.

Now that you have an overview of a merchandising business, pause for a while and
breathe. Absorb, absorb, and absorb. If there are concepts that are not clear yet, do not go
on to the next topic without going back to that concept and analysing them again and
again. But if all is already clear to you now, then congratulations! You may now proceed
to next level.

Perpetual Inventory System

In layman’s term, the word “perpetual” means continuing forever (‘tuloy-tuloy’). The
perpetual inventory system is called as such because under this system, the “Inventory”
or “Merchandise Inventory” account is updated each time a purchase or sale is made.
Thus, the inventory account shows a continuing or running balance of the goods on hand.

Moreover, record called “stock cards” and “stock ledger card” are maintained under this
system, from which the quantities and balances of goods on hand and goods sold can be
determined at any given point of time without the need of performing a physical count of
inventories.

When an entity uses the perpetual inventory system, the ending inventory should
reconcile with the actual physical count at the end of the period assuming that no theft,
spoilage, or error has occurred.

The perpetual inventory system is commonly used for inventories that are specifically
identified and are relatively high valued, such as cars, machineries, furniture and heavy
equipment.

Periodic Inventory System

In layman’s term, the word “periodic” means occurring or recurring at regular intervals
(or ‘pan-panahon’). The periodic inventory system is called as such because under this
system, the “Inventory” or “Merchandise Inventory” account is updated only when a
physical count is performed. Thus, the amounts of inventory and cost of goods sold are
determined only periodically.

Under this system, the business does not maintain records hat show the running balances
of inventory on hand and cost of goods sold at any given point of time. To determine this
information, a physical count of the quantity of goods on hand must be performed
periodically (e.g., on a daily, weekly, monthly, or annual basis).

Perpetual vs. Periodic Inventory Systems

Assume that the beginning inventory for the year is P250,000. Assuming the transactions
(nos. 1 to 7) were the only transactions for the entire year, the balance in the inventory
account at year-end under the periodic inventory system is P250,000 (beginning
inventory). The year-end balance in the inventory account under the perpetual inventory
system is P248,186.

At year-end, the physical count is taken, and it revealed that the inventory on hand is only
P248,036. The year-end journal entries (nos. 8 to 10) are then made to bring the
inventory account into agreement with the amount of the physical inventory. When
posted to the general ledger, both the periodic and perpetual inventory systems result in
the same ending inventory amount, P248,036.

1. Sold merchandise on account costing P8,000 for P50,000; terms were 2/10, n/30.

Periodic Inventory System Perpetual Inventory System

Accounts receivable 10,000 Accounts receivable 10,000
Sales 10,000 Sales 10,000

Cost of Sales 8,000

Inventory 8,000

2. Customer returned merchandise costing P400 that had been sold on account for P500
(part of the P10,000 sale in number 1).

Periodic Inventory System Perpetual Inventory System

Sales returns and allowances 500 Sales returns and allowances 500
Accounts receivable 500 Accounts receivable 500

Inventory 400
Cost of sales 400

3. Received payment from customer for merchandise sold above (cash discount =
P9,500 x 2% = P190).

Cash 9,310 Cash 9,310

Sales discount 190 Sales discount 190
Acccounts receivable 9,500 Acccounts receivable 9,500
4. Purchased on account merchandise for resale for P6,000; terms were 2/10, n/30
(purchases recorded at invoice price).

Purchases 6,000 Inventory 6,000

Accounts payable 6,000 Accounts payable 6,000

5. Paid P200 freight on the P6,000 purchase; terms were FOB shipping point, freight
collect.

Transportation in 200 Inventory 200

Cash 200 Cash 200

6. Returned merchandise costing P300 (part of the P6,000 purchase).

Accounts payable 300 Accounts payable 300

Purchase returns and allowances 300 Inventory 300

7. Paid for merchandise purchased, refer to no. 4 (cash discount taken = P5,700 x 2% =
P114).

Accounts payable 5,700 Accounts payable 5,700

Purchase discounts 114 Inventory 114
Cash 5,586 Cash 5,586

8. To transfer the beginning inventory balance to the Income Summary account (part of
the closing entries under the periodic inventory system):

Income Summary 250,000

No entry required
Inventory 250,000

9. To record the ending inventory balance (part of the closing entries under the periodic
inventory system):

Inventory 248,036
No entry required.
Income Summary 248,036

10. To adjust the ending perpetual inventory balance for the shrinkage during the year:

Shrinkage already effected Cost of sales 150

in the no. 9 entry Inventory 150

Lesson 2: Special Journals

Special Journals
These are journals of original entry other than the general journal that are designed for
recording specific types of transactions of a similar nature. Most entities use the
following special journals:

Journal Specific Transactions Recorded

Sales journal Sales of merchandise on account
Cash receipts journal Receipts of cash
Purchases journal Credit purchases of merchandise and other items
Cash disbursements journal Payments of cash
General journal Entries that do not fit in the other journals

Cash receipts are usually recorded in the cash receipts journal rather than in the sales
journal because cash is best controlled when all routine cash receipts are recorded in one
journal. Similarly, an entity can increase control over cash disbursements by recording
cash purchases of merchandise or other items in the cash disbursements journal rather
than in the purchases journal.

When special journals are used, the general journal is maintained for adjusting, closing
and reversing entries; and for recording transactions that do not fit in other special
journals. Examples of the latter include the recording of purchases returns and
allowances, and sales returns and allowances.

(The succeeding discussion is taken from

https://opentextbc.ca/principlesofaccountingv1openstax/chapter/describe-and-explain-
the-purpose-of-special-journals-and-their-importance-to-stakeholders/)

Describe and Explain the Purpose of Special Journals and Their Importance to
Stakeholders
The larger the business, the greater the likelihood that that business will have a large
volume of transactions that need to be recorded in and processed by the company’s
accounting information system. You’ve learned that each transaction is recorded in the
general journal, which is a chronological listing of transactions. In other words,
transactions are recorded into the general journal as they occur. While this is correct
accounting methodology, it also can create a cumbersome general journal with which to
work and may make finding specific pieces of information very challenging. For
example, assume customer John Smith charged an item for $100 on June 1. In the general
journal, the company would record the following.
This journal entry would be followed by a journal entry for every other transaction the
company had for the remainder of the period. Suppose, on June 27, Mr. Smith asked,
“How much do I owe?” To answer this question, the company would need to review all
of the pages of the general journal for nearly an entire month to find all of the sales
transactions relating to Mr. Smith. And if Mr. Smith said, “I thought I paid part of that
two weeks ago,” the company would have to go through the general journal to find all
payment entries for Mr. Smith. Imagine if there were 1,000 similar credit sales
transactions for the month, each one would be written in the general journal in a similar
fashion, and all other transactions, such as the paying of bills, or the buying of inventory,
would also be recorded, in chronological order, in the general journal. Thus, recording all
transactions to the general journal makes it difficult to find the particular tidbits of
information that are needed for one of our customers, Mr. Smith. The use of special
journal and subsidiary ledgers can make the accounting information system more
effective and allow for certain types of information to be obtained more easily.
Using General Ledger (Control) Accounts
Here is the information from the accounts payable subsidiary ledger:

What should the total be in the Accounts Payable Control Total?

Here is the information from the accounts receivable subsidiary ledger.
What should the total be in the Accounts Receivable Control Total?
Solution
Accounts Payable Control Total is: 1,362 + 4,468 + 8,167 = 13,997
Accounts Receivable Control Total is: 2,250 + 0 + 1,500 + 8,160 = 11,910

Special Journals

Instead of having just one general journal, companies group transactions of the same kind
together and record them in special journals rather than in the general journal. This
makes it easier and more efficient to find a specific type of transaction and speeds up the
process of posting these transactions. In each special journal, all transactions are totaled
at the end of the month, and these totals are posted to the general ledger. In addition,
instead of one person entering all of the transactions in all of the journals, companies
often assign a given special journal’s entries to one person. The relationship between the
special journals, the general journal, and the general ledger can be seen in (Figure).
Special and General. Transaction summaries form the special journals, and all
transactions in the general journal are posted to the general ledger. (attribution: Copyright
Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Most companies have four special journals, but there can be more depending on the
business needs. The four main special journals are the sales journal, purchases
journal, cash disbursements journal, and cash receipts journal. These special journals
were designed because some journal entries occur repeatedly. For example, selling goods
for cash is always a debit to Cash and a credit to Sales recorded in the cash receipts
journal. Likewise, we would record a sale of goods on credit in the sales journal, as a
debit to accounts receivable and a credit to sales. Companies using a perpetual inventory
system also record a second entry for a sale with a debit to cost of goods sold and a credit
to inventory. You can see sample entries in (Figure).
Sales Journal. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA
4.0 license)

Note there is a column to enter the date the transaction took place; a column to indicate
the customer to whom the transaction pertains; an invoice number that should match the
number on the invoice given (in paper or electronically) to the customer; a reference box
that indicates the transaction has been posted to the customer’s account and can include
something as simple as a check mark or a code that links the transaction to other journals
and ledgers; and the last two columns that indicate the accounts and amounts debited and
credited.
Purchases of inventory on credit would be recorded in the purchases journal ((Figure))
with a debit to Merchandise Inventory and a credit to Accounts Payable.
Purchases Journal. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-
SA 4.0 license)

Paying bills is recorded in the cash disbursements journal ((Figure)) and is always a debit
to Accounts Payable (or another payable or expense) and a credit to Cash.
Cash Disbursements Journal. (attribution: Copyright Rice University, OpenStax, under
CC BY-NC-SA 4.0 license)

The receipt of cash from the sale of goods, as payment on accounts receivable or from
other transactions, is recorded in a cash receipts journal ((Figure)) with a debit to cash
and a credit to the source of the cash, whether that is from sales revenue, payment on an
account receivable, or some other account.
Cash Receipts Journal. (attribution: Copyright Rice University, OpenStax, under CC BY-
NC-SA 4.0 license)

(Figure) summarizes the typical transactions in the special journals previously illustrated.

Types and Purposes of Special Journals

 Journal Name Journal Purpose Account(s) Account(s)
Debited Credited
Sales Journal Sales on credit Accounts Sales, Inventory
Receivable, Cost
of Goods Sold
Purchases Purchases on credit Inventory Accounts Payable
Journal
Cash Paying cash Could be: Cash
Disbursements Accounts Payable,
Journal or other accounts
Cash Receipts Receiving cash Cash Could be:
Journal Sales, Accounts
Receivable, or other
accounts
General Journal Any transaction not Could be: Could be:
covered previously; Depreciation Accumulated
adjusting and closing Expense Depreciation
entries

How will you remember all of this? Remember, “Cash Is King,” so we consider cash
transactions first. If you receive cash, regardless of the source of the transaction, and
even if it is only a part of the transaction, it goes in the cash receipts journal. For
example, if the company made a sale for $1,000 and the customer gave $300 in cash and
promised to pay the remaining balance in the future, the entire transaction would go into
the cash receipts journal, because some cash was received, even if it was only part of a
transaction. You could not split this journal entry between two journals, because each
transaction’s debits must equal the credits or else your journal totals will not balance at
the end of the month. You might consider splitting this transaction into two separate
transactions and considering it a cash sale for $300 and a sale on account for $700, but
that would also be inappropriate. Although the balances in the general ledger accounts
would technically be correct if you did that, this is not the right approach. Good internal
control dictates that this is a single transaction, associated with one invoice number on a
given date, and should be recorded in its entirety in a single journal, which in this case is
the cash receipts journal. If any cash is received, even if it is only a part of the
transaction, the entire transaction is entered in the cash receipts journal. For this example,
the transaction entered in the cash receipts journal would have a debit to cash for $300, a
debit to Accounts Receivable for $700, and a credit to Sales for $1,000.
If you pay cash (usually by writing a check), for any reason, even if it is only a part of the
transaction, the entire transaction is recorded in the cash disbursements journal. For
example, if the company purchased a building for $500,000 and gave a check for
$100,000 as a down payment, the entire transaction would be recorded in the cash
disbursements journal as a credit to cash for $100,000, a credit to mortgage payable for
$400,000, and a debit to buildings for $500,000.
If the transaction does not involve cash, it will be recorded in one of the other special
journals. If it is a credit sale (also known as a sale on account), it is recorded in the sales
journal. If it is a credit purchase (also known as a purchase on account), it is recorded in
the purchases journal. If it is none of the above, it is recorded in the general journal.
Accounting Information Systems

Let’s consider what Gearhead Outfitters’ accounting information system might look

like. What information will company management find important? Likewise, what
information might external users of Gearhead’s financial reports need? Do regulatory
requirements dictate what Gearhead needs to track in its accounting system?
Gearhead will want to know its financial position, results of operations, and cash flows.
Such data will help management make decisions about the company. Likewise, external
users want this data (balance sheet, income statement, and statement of cash flows) to
make decisions such as whether or not to extend credit to Gearhead.
To keep accurate records, company operations must be considered. For example,
inventory is purchased, sales are made, customers are billed, cash is collected, employees
work and need to be paid, and other expenses are incurred. All of these operations
involve different recording processes. Inventory will require a purchases journal. Sales
will require a sales journal, cash receipts journal, and accounts receivable subsidiary
ledger (discussed later) journal. Payroll and other disbursements will require their own
journals to accurately track transactions.
Such journals allow a company to record accounting information and generate financial
statements. The data also provides management with the information needed to make
sound business decisions. For example, subsidiary ledgers, such as the accounts
receivable ledger, provide data about the aging and collectability of receivables. Thus,
the proper design, implementation, and maintenance of the accounting information
system are vital to a company’s sustainability.
What other questions can be answered through the analysis of information gathered by
the accounting information system? Think in terms of the timing of inventory orders and
cash flow needs. Is there nonfinancial information to extract from the accounting system?
An accounting information system should provide the information needed for a business
to meet its goals.

Subsidiary Ledgers

In addition to the four special journals, there are two special ledgers, the accounts
receivable subsidiary ledger and the accounts payable subsidiary ledger. The accounts
receivable subsidiary ledger gives details about each person who owes the company
money, as shown in (Figure). Each colored block represents an individual’s account and
shows only the amount that person owes the company. Notice that the subsidiary ledger
provides the date of the transaction and a reference column to link the transaction to the
same information posted in one of the special journals (or general journal if special
journals are not used)—this reference is usually a code that references the special journal
such as SJ for the sales special journal, as well as the amounts owed in the debit column
and the payments made in the credit column. The amounts owed by all of the individuals,
as indicated in the subsidiary ledger, are added together to form the accounts receivable
control total, and this should equal the Accounts Receivable balance reported in the
 general ledger as shown in (Figure). Key points about the accounts receivable subsidiary
ledger are:

 Accounts Receivable in the general ledger is the total of all of the individual
account totals that are listed in the accounts receivable subsidiary ledger.
 All of the amounts owed to the company in the accounts receivable subsidiary
ledger must equal the amounts in the accounts receivable general ledger account.
Accounts Receivable Subsidiary Ledger. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)

Subsidiary ledgers have to balance and agree with the general ledger. Accountants using
QuickBooks and other accounting systems may not have to perform this step, because in
these systems the subsidiary ledger updates the general ledger automatically. However, a
dishonest person might manipulate accounting records by recording a smaller amount of
cash receipts in the control account than is recorded on the subsidiary ledger cards. The
ethical accountant must be vigilant to ensure that the ledgers remain balanced and that
proper internal controls are in place to ensure the soundness of the accounting system.
The accounts payable subsidiary ledger holds the details about all of the amounts a
company owes to people and/or companies. In the accounts payable subsidiary ledger,
each vendor (the person or company from whom you purchased inventory or other items)
has an account that shows the details of all transactions. Similar to the accounts
receivable subsidiary ledger, the purchases subsidiary journal indicates the date on which
a transaction took place; a reference column used in the same manner as previously
described for accounts receivable subsidiary ledgers; and finally, the subsidiary ledger
shows the amount charged or the amount paid. Following are the transactions for ABC
Inc. and XYZ Inc. The final balance indicated on each subsidiary purchases journal
shows the amount the company owes ABC and XYZ.

If the two amounts are added together, the company owes $305 in total to the two
companies. The $305 is the amount that will show in the Accounts Payable general
ledger account.

Using the Accounts Payable Subsidiary Ledger

Find the balance in each account in the accounts payable subsidiary ledger that follows.
Note that each vendor account has a unique account number or AP No.

Solution
 Key Concepts and Summary

 We use special journals to keep track of similar types of transactions.

 We use special journals to save time because the same types of transactions occur
over and over.
 To decide which special journal to use, first ask, “Is cash involved?” If the answer
is “Yes,” then use either the cash receipts or cash disbursements journal.
 The cash receipts journal always debits cash but can credit almost anything
(primarily sales, Accounts Receivable, or a new loan from the bank).
 The cash disbursements journal always credits cash but can debit almost anything
(Accounts Payable, Notes Payable, sales returns and allowances, telephone expense,
etc.).
 The sales journal always debits Accounts Receivable and always credits Sales. If
the company uses a perpetual inventory method, it also debits cost of goods sold and
credits inventory.
 The purchases journal always debits Purchases (if using the periodic inventory
method) or Inventory (if using the perpetual inventory method) and credits Accounts
Payable.
 We post the monthly balance from each of the special journals to the general
ledger at the end of the month.
 We post from all journals to the subsidiary ledgers daily.
 We use the general journal for transactions that do not fit anywhere else—
generally, for adjusting and closing entries, and can be for sales returns and/or purchase
returns.
 The accounts receivable subsidiary ledger contains all of the details about
individual accounts.
 The total of the accounts receivable subsidiary ledger must equal the total in the
Accounts Receivable general ledger account.
 The accounts payable subsidiary ledger contains all of the details about individual
accounts payable accounts.
 The total of the accounts payable subsidiary ledger must equal the total in the
Accounts Payable general ledger account.