FABM1

Fundamentals of Accountancy,
Business and Management
ABM Department

Coverage: 3 weeks

ICI PROPERTY
NOT FOR SALE

Printed in 2021
Adjusting Entries (Step 5)
Lesson 11
Lesson Overview

Topics covered:
I. Prepayments
II. Deferrals
III. Accrued Expenses
IV. Accrued Income
V. Bad Debts/Doubtful Accounts/Uncollectible Accounts
VI. Depreciation

Learning Objectives:
At the end of this lesson, you are expected to
1. Define adjusting journal entries and know their importance.
2. Make the required adjusting journal entries.
Assessment:
Activity- Adjusting Journal Entries
 Adjusting Journal Entries are entries used to update
the
accounts prior to the preparation of Financial
Statements
because they affect more than one accounting period.
Transactions are apportioned properly between the
accounting periods affected. The accounts affected are
adjusted so that there will be no overstatement or
understatement of balance sheet items and income
statement item. According to the accrual principle, income
is recognized at the time it is actually earned and expense
is recognized at the time it is actually incurred or used.
Thus, a receipt of cash does not necessarily mean a
recognition of an income, and payment of cash does not
necessarily men recognition of an expense.

An example of this is the cash received from a customer for the reservation of a hotel room for two
weeks. The receipt of cash from the customer does not necessarily mean that income should be
recognized. The receipt of cash should be recognized mere as a liability in the forms of service to be
rendered. It is only after the customer has checked in to the hotel for his/her two-week stay can the
advance payment be considered as income because the service has already been rendered.

Prepayments- are expenses already paid but not yet incurred or used.
Following are the accounts subjected to adjustments:

The Alternative Method in Recording Prepayments

1. Asset Method

Journal entry upon payment Adjusting Journal Entry

Prepaid Expense xxx Expense xxx Cash xxx Prepaid Expense xxx

Note: The amount on the adjusting journal entry represents the expired or used portion of the prepayment
1

2. Expense Method

Journal entry upon payment Adjusting Journal Entry

Expense xxx Prepaid Expense xxx Cash xxx Expense xxx Paid Expense To record unexpired
expense

Example 1

On April 30, 2016, X Co. paid 36,000 worth of insurance premium for two years. Give the Adjusting
journal entry on June 30, 2016. Use asset and expense method.

Asset Method

Journal Entry upon payment on April 30, 2016 Adjusting Journal Entry June 30, 2016

Prepaid Insurance 36,000 Insurance Expense 3,000 Cash 36,000 Prepaid Insurance 3,000 Paid
two-year insurance To record the expired insurance
premium represents insurance premium
Computation for two years or 24 months. Divide P36,
000 by 24 to get the monthly premium.
The P36, 000 amount of insurance Then, multiply it by 2 months
 representing the premium from May 1 to premium on April 30, you debited the asset
June 30, 2016. account Prepaid Insurance representing 24
months’ insurance. On June 30, the P36, 000
P36, 000/24 x 2 = P3, 000 Prepaid Insurance is not totally asset since it
includes the 2-month expired portion (May 1 to
P3, 000 is therefore the expired
June 30). Hence, an adjusting entry is necessary
insurance from May 1 to June 30,
to recognize the insurance expense for 2 months
by debiting it and decreasing the balance of
2016. Example 2 Prepaid Insurance by crediting it from May 1 to
June 30, 2016.
Analysis:
When you paid 36,000 for the two-year insurance

On September 1, 2016, X Co. paid a one-year advance rent for P 30,000. Give the Adjusting Journal Entry
on Dec. 31, 2016.

Journal Entry upon payment on September 1 Adjusting Journal Entry December 31, 2016

Prepaid Rent 30,000 Rent expense 10, 000 Cash 30, 000 Prepaid Rent 10, 000 Paid rent for one
year To record expired rent
Analysis:
Computation When you paid P30, 000 for the one-year rent in
The P30, 000 amount of rent represents advance on September 1, you debited the asset
one-year or 12-month rent. Divide P30, account Prepaid rent representing 12 months’ rent.
000 by 12 to get the monthly rent. Then On December 31, the end of the accounting
period, the P30, 000 Prepaid Rent is not totally
multiply it by 4 months representing the
asset since it includes the 4 months used portion
rent from September1 to December 31,
(September 1 to December 31). Hence, an
2016.
adjusting entry is necessary to recognize the rent
P30, 000/12 x 4 = P10, 000 expenses for 4 months by debiting it and
decreasing the balance of Prepaid Rent by
P10, 000 is therefore the expired/used rent crediting it.
from September 30 to December 31, 2016.

2
Example 3

Supplies account showed a balance of P4, 000. Supplies used during the year amounted to P2, 300. Give
the adjusting journal entry on Dec. 31, 2016.

Adjusting Journal Entry at end of the accounting period December 31, 2016

Supplies expense 2, 300

Supplies 2, 300
To record supplies expense used for the year
Analysis:
Computation
The asset account Supplies showed a balanced of
There is no computation necessary because the p2, P4, 000 at the beginning of the year. Supplies used
300 supplies used during the year was already during the year amounted to P2, 300. This should
given in the problem. be recorded as expense by debiting Supplies
Expense and crediting the assets account Supplies
Example 4 to decrease in balance.

Supplies account on January 1, 2016, showed a balance of P8, 000. On December 2016, supplies on hand
amounted to P3, 500.

Adjusting Journal Entry at end of the accounting period December 31, 2016

Supplies expense 4, 500

 Supplies 4, 500
To record the supplies used for the year.
Analysis:
Computation
On January 1, 2016, the asset account Supplies has
Supplies at the beginning of the year is P8, 000. At a balance of P8, 000. At the end of the year, the
the end of the year, the remaining balance is P3, balance of the asset account Supplies decreased to
500. The difference represents the supplies used P3, 500. The difference represents the supplies
during the year. used during the year. You will have to recognize
the used supplies as an expense by debiting
P8, 000- P3, 500= P4, 500 Supplies Expense and decrease the asset account
Supplies by crediting it.

Deferrals

Unearned or deferred income is income already received but not yet

earned. The Alternative Method in Recording Deferrals

1. Liability Method

Journal entry upon receipt of cash Adjusting Journal Entry

Cash xxx Unearned Income xxx Unearned Income xxx Income xxx Received cash for services
to be rendered To record earned portion of the liability

Note: The amount on the adjusting journal entry is the earned portion of the amount initially received

2. Income Method

Journal entry upon receipt of cash Adjusting Journal Entry

Cash xxx Income xxx

Income xxx Unearned Income xxx Received cash for services to be rendered To record
income not yet earned

Example 1

On August 1, Dr. Yee received P90, 000 for dental fees to be rendered in the next 6 months. Give the
adjusting Journal entry at the end of Sept.

Journal entry upon receipt of cash on August 1 Adjusting Journal Entry on September 30

Cash 90,000 Unearned Dental Fees 30,000 Unearned Dental Fees 90,000 Dental Fees 30,000 Received
cash for dental services to be rendered To record dental fees earned

P30, 000 is therefore the dental fees earned from

Computation
August 1 to September 30, 2016.
The P90, 000 amount of cash received represents
Example 2
6-month dental services to be rendered. Divide
Analysis:
P90,000 by 6 to get the monthly dental fee.
Multiply the result by 2. When the P90, 000 was received on August 1 for
the 6- month dental services paid in advance, cash
P90, 000/6 X 2 =30,000
 was debited and the liability account Unearned adjusting entry is necessary to recognize the earned
Dental Fees was credited representing 6 months of portion of the initially
unearned fees. On September 30, the P90, 000 recorded Unearned Dental Fees by crediting Dental
Unearned Dental Fees is not totally a liability Fees and debiting Unearned Dental Fees to
account since it includes the 2-month dental fees decrease the liability.
earned (August I to September 30). Hence, an

On December 1, 2016, Petit Co. received P48, 000 amount of advanced rentals for 6 months. Give the
Adjusting Journal Entry on December 31, 2016.

Journal entry upon receipt of cash on December 1 Adjusting Journal Entry on September 30

Cash 48,000 Unearned Rent Income 8,000 Unearned Rent Income 48,000 Rent Income 8,000
Received cash for dental services to be rendered To record rent earned for the month
debited cash and credited the liability account
Unearned Rent Income for the 6 month rent. On
Computation December 31, which is the end of the accounting
The 48,000 cash you received represents six period the P48,000 amount of Unearned Rent
months of rent. Divide P48, 000 by 6 to get the Income is not totally a liability account since it
monthly rent. Then, multiply it by 1 month includes the 1-month rent earned (December l to
representing the rent from Dec 1 to Dec. 31, 2016. December 31). Hence, an adjusting entry is
necessary to recognize the earned portion of the
48, 000/6 x 1 = P8, 000 initially recorded Unearned Rent Income by
Analysis: crediting Rent income and debiting Unearned Rent
Income to decrease the liability.
When you received P48, 000 for the six-month rent
paid to you in advance on December 1, you

4
Accruals
Accrued expenses are expenses already incurred or used, but not yet paid.

Adjusting Journal Entry at end of the accounting period

Expense xxx
Expense Payable xxx
To record unpaid expenses

Example 1

The company received a PLDT bill in the amount of 9,800 on Dec. 26, 2016. The company intends to pay
on January 8, 2017

Adjusting Journal Entry at end of the accounting period

Utilities Expense 9, 800

Utilities Payable 9, 800
To record unpaid utilities for the month
Analysis: This is liability on the part of the company because the PLDT bill is for the December but
the company has not yet paid for it. Hence, a liability on the part of the company should be recognized
at the end of the accounting period.

Example 2

Unpaid salaries at the end of December 31, 2016 amounted to 18,800.

Adjusting Journal Entry at end of the accounting period

Salaries Expense 18, 800

Salaries Payable 18, 800
To record unpaid salaries at year end

Analysis: This is a liability on the part or the company because the e employees have already worked
for this but the company has not paid their salaries. Hence, a liability on the part of the company
should be recognized at the end of the accounting period.

Accrued income is income already earned but not yet received

Adjusting Journal Entry at end of the accounting period

Income receivable xxx

Income xxx
To record interest income earned

Example

A one-year, 6 % note receivable in the amount of P200, 000 was received on January 1 2016. The interest
and the principal are payable on maturity date. Give the Adjusting Journal Entry on June 30, 2016.
note has already earned half-year interest on
Adjusting Journal Entry on June 30, 2016
June 30, 2016 in the amount of P6, 000
Interest receivable 6, 000 although this interest has not yet been
Interest Income 6, 000 To record interest =P200, 000 x 6% x ½ year
income earned 5
= P200, 000 x 0.06x ½
Computation = P6, 000
The interest for 6 months is P6, 000.
Interest = Principal Rate x Time received. Hence, an Adjusting Journal Entry is
Analysis: necessary to recognize the interest earned on
the notes receivable for 6 months, that is, from
The note receivable bears interest at 6% per
January 1 to June 30, 2016.
annum. This interest will be received after
one year on January 1, 2017. However, the

Bad debts/ doubtful accounts are losses due to uncollectible accounts.

Adjusting Journal Entry at the end of the accounting period
Bad Debts Expense xxx
Allowance for Bad Debts xxx OR
To record estimated uncollectible accounts

Doubtful Accounts Expense xxx

Allowance for Doubtful Accounts xxx OR
To record estimated uncollectible accounts

Uncollectible Accounts Expense xxx

Allowance for Uncollectible Accounts xxx
To record estimated uncollectible accounts

Example 1

Accounts Receivable shows a balance of 100,000. It is estimated that 8% of this is uncollectible. Give the
adjusting journal entry on December 31, 2016 for the provision of the estimated uncollectible account.
Bad Debts Expense 8, 000
Allowance for Bad Debts 8, 000
To record estimated uncollectible accounts
Computation:

100,000 x 0.08 =8,000

 Example 2

Accounts receivable shows a balance of 100,000. It is estimated that 8% of this is uncollectible.

Allowance for Bad Debts per general ledger has a balance of 1,000. Give the adjusting journal entry on
December 31, 2016 for the provision of the estimated uncollectible account.

Bad Debts Expense 7, 000

Allowance for Bad Debts 7, 000
To record estimated uncollectible accounts
Note: The required allowance for doubtful accounts is P8, 000 (100,000 x 8%). However, per general ledger, the
allowance for doubtful accounts already shows a balance of 1,000. An adjusting journal entry to bring the balance
of the allowance for doubtful accounts to the required balance of P8, 000 is necessary. This can be best illustrated
by the T-accounts.

Allowance for Doubtful Accounts

1, 000 Balance before adjustments

7, 000 Adjusting Journal Entry
8, 000 Required Balance (end)

Depreciation expense is the allocation of plant asset cost over its estimated useful life.
This is the expense allotted for the wear and tear of property, plant, and equipment due to
passage of time.

The following are the three factors considered in computing the depreciation
expense: 1. Cost is the purchase price of the depreciable asset.

2. Salvage value is the estimated value of the asset at the end of its useful life.
6
3. Estimated useful life, as the name connotes, is not an exact measurement but merely an estimation of
the number of years an asset can be useful to the entity.

The formula for computing for annual depreciation is as follows:

Cost P xxx
Less: Salvage Value xxx
Depreciable cost P xxx
Divided by: Estimated Useful Life xxx
Annual Depreciation P xxx

The process of recording depreciation expenses does not directly charge depreciation to the asset
account. The charge is recorded in a contra-asset account called accumulated depreciation. The balance
of the accumulated depreciation is deducted from the cost of the asset to get the carrying value of the
asset.

Example

On June 1, a building with an estimated useful life of 30 years finished construction on 2016. The cost of
the building is 4.8 million pesos with an estimated salvage value of P300, 000.

Give the Adjusting Journal Entry on December 31, 2016 to record the depreciation of the

building. Adjusting Journal Entry on Dec. 31, 2016

Depreciation Expense 87, 500

Accumulated Depreciation 87, 500
To record depreciation expense for the building

Computation
Cost P4, 800, 000 Less: Salvage Value 300, 000 Depreciation P 150, 000 Divide by: Number of
Depreciable cost P4, 500, 000 Divided by: Months/year 12 months
Estimated Useful Life 30 years Annual Monthly Depreciation P 12,500 (June-Dec) x 7
months Depreciation Expense P 87,500 Note: What you have gotten is the annual depreciation.
Since the building was completed on June 1, you will
have to apportion the annual depreciation of P150, 000
by dividing it by 12 to get the monthly depreciation.
Multiplying it by 7 months, you get the deprecation of
the building from June 1 to Dec. 31, 2016.
ASSESSMENT:

Mini Task: 1-Adjusting Entries

Activity: Give the adjusting journal entries on Dec. 31, 2016. Show your computation for each problem in
good form.

1. Workers' salaries for the six-day week is P4, 800, payable every Saturday. December 31 is a
Thursday.
2. On November 15, Moringa Co. issued a 90-day, P120, 000, 10% note. Record the interest due on
the note at the end of December 31.
3. Accounts Receivable has a balance of 78,000. It is estimated that 3% of this will be uncollectible.
4. Accounts Receivable and its corresponding allowance have balances of 229,000 and P5,000,
respectively. It is estimated that 7.5% of this will be uncollectible.
5. On October 31, 2010, a building with an estimated useful life of 20 years finished construction on
2016. The cost of the building is 20 million pesos with an estimated salvage value of P1,500, 000.

Adjusted Trial Balance (Step 6)

Lesson 10
Lesson Overview

Topics covered:
I. Worksheet

Learning Objectives:

At the end of this lesson, you are expected to be able to prepare an adjusted trial balance using a
worksheet.

Assessment:
There is no assessment for this lesson.

The adjusted trial balance is prepared to show updated balances after adjusting entries have been
made. The adjusted trial balance is completed to ensure that the period ending financial statements will be
accurate and in balance. In addition, an adjusted trial balance is used to prepare closing entries. We’ll
explain more about what an adjusted trial balance is, and what the difference is between a trial balance
and an adjusted trial balance. An adjusted trial balance is prepared by creating a series of journal entries
that are designed to account for any transactions that have not yet been completed. These items include
payroll expenses, prepaid expenses, and depreciation expenses.

Here are the steps used to prepare an adjusted trial balance:

1. Run an unadjusted trial balance. This provides an initial summary of your general ledger
 accounts prior to entering any adjusting entries.
2. Make any adjusting entries that are needed. Adjusting entries can include adjustments for
prepayments, interest and depreciation expense, and payroll accruals.
3. Run the adjusted trial balance. You can ensure that the entries have posted correctly by
comparing the initial trial balance totals with the adjusted trial balance totals.

Illustrative Problem:
Assume the unadjusted Trial Balance of XYZ Accounting Services.
XYZ ACCOUNTING SERVICES
Unadjusted Trial Balance
For the period ended Dec. 31, 2006

Account Title Debit Credit

Cash 68,000

Accounts receivable 15,000

Office Equipment 40,000

Accounts payable 15,000

XYZ, Capital 100,000

Professional fees 20,000

Salaries and wages 6,000

Supplies expense 5,000

Utilities expense 1,000

135,000 135,000

8
Assume also that the following adjustments were determined at the end of the
period: 1. Salaries amounting to P1,500 are not yet paid and not yet recorded.

2. Unpaid electricity bill amounting to P500 is not yet recorded.

3. Estimated amount of P300 of the account receivable is expected not to be collected anymore.
4. The cost of the office equipment is to be allocated over its 5 years useful life as depreciation expense.
The usage for this period is ½ year.

5. Unrecorded P5,000 cash as personal withdrawal by Mr. XYZ.

6. At the end of the period, P3,000 worth of supplies is found still unused.

The adjusting entries would be:

GENERAL JOURNAL

Date Account Titles and Explanation PR Debit Credit

12/31/06

(1) Salaries and wages 1,500

Accrued salaries and wages 1,500

To record unpaid salaries

 (2) Utilities expense 500

Accrued utilities expense 500

To record unpaid utilities

(3) Bad debts expense 300

Allowance for bad debts 300

To record doubtful accounts

(4) Depreciation expense 4,000

Accumulated Depreciation- Office Equipment 4,000

To record provision for depreciation,

computed as follows:

Annual depreciation (40,000/5) P 8,000

Multiplied by usage in the period 1/2

Depreciation expense P 4,000

(5) XYZ, Drawing 5,000

Cash 5,000

To record owner’s personal withdrawal

(6) Prepaid Supplies 3,000

Supplies expense 3,000

To record unused supplies

Posting of Adjustments

After journalizing the adjustments in the general journal, they should be posted to the general
ledger to effect updates and correction of the ledger accounts. The posting of adjustments should be made
to affect correct closing entries and post-closing trial balances.

9
Preparation of the Adjusted Trial Balance
XYZ ACCOUNTING SERVICES
Adjusted Trial Balance
For the period ended Dec. 31, 2006

Account Title Debit Credit

Cash 63,000

Accounts receivable 15,000

Allowance for bad debts 300

Prepaid Supplies 3,000

Office Equipment 40,000

Accumulated Depreciation- Office Equipment 4,000

Accounts payable 15,000

Accrued salaries and wages 1,500

Accrued utilities payable 500

XYZ, Capital 100,000

XYZ, Drawing 5,000

Professional fees 20,000

Salaries and wages 7,500

Depreciation expense 4,000

Supplies expense 2,000

Utilities expense 1,500

Bad debts expense 300

141,300 141,300

Steps in Preparing the Worksheet

The following are the steps in the preparation of the worksheet.
1. Write the heading on the top center of the paper covering the necessary data as follows:
∙ Name of business
∙ Name of Working Paper
∙ Period covered

2. Copy the account titles and the balances of the trial balance in the unadjusted trial balance columns.
Total the amounts to check their accuracy. Total debits should equal total credits.

3. Input data in Adjustment column.

∙ Enter the adjustments in the proper adjustments column writing the number or letter of each
adjustment accordingly before each debit or credit amount. Accounts which are not listed
in the unadjusted trial balance are added under the accounts column.
 ∙ After all adjustments have been entered, total the pair of adjustments column to prove the
equality of debits and credits.
∙ For merchandise inventory, end, this will be included in the closing entries when nominal
accounts are closed.

4. Compute each account's adjusted balance by extending the amounts from the pre adjusted trial
balance to the adjusted trial balance plus or minus the adjustments.
∙ For accounts with a debit balance in the unadjusted trial balance and a debit entry in the
adjustments column, add the two debit amounts.
∙ For accounts with a credit balance in the unadjusted trial balance and a credit entry in the
adjustments column, add the two credit amounts.
10
∙ For accounts with a debit balance in the unadjusted trial balance and a credit entry in the
adjustments column, subtract the credit amount from the debit amount.
∙ For accounts with a credit balance in the unadjusted trial balance and a debit entry in the
adjustments column, subtract the debit amount from the credit amount.

Total each column of the adjusted trial balance to check the accuracy of the extensions. and prove
the equality of the debits and credits.
Account Balance in Adjustment What to do
the Unadjusted Trial
Balance

Debit Debit Add the two amounts

Debit Credit Subtract the credit amount from

the debit amount

Credit Credit Add the two amounts

Credit Debit Subtract the debit amount from

the credit amount

5. From the adjusted trial balances, extend the balances of the Asset, Liability, and Owner's Equity
accounts to the appropriate columns of the Balance Sheet and the adjusted balances of Income and
Expense accounts to the appropriate columns of the Income Statement. The sales account presents
the revenue account to be extended to the credit column of the income statement while the sales
discount and sales returns and allowances are extended to the debit column. The beginning
inventory and purchases accounts including freight-in are considered as cost accounts. Hence,
they should be extended to the debit column of the income statement while the purchase returns
and allowances accounts are extended to the credit column Applying the direct extension method,
extend the ending inventory to the credit column of the income statement and debit column of the
balance sheet. The beginning inventory and ending inventory firm part of the Cost of Sales section
of the income statement.

6. Total the Balance Sheet columns and the Income Statement columns. The difference between the
Income Statement column totals and the Balance Sheet column totals should be the same.
Otherwise, review your work for error or errors. This difference represents either the net income
or net loss When the credit total of the income statement exceeds the debit total, the difference is
a net income. When the debit total of the income statement exceeds the credit total, the difference
is a net loss.

7. Write the difference as a balancing figure on the income statement and on the balance sheet. Write
"Net Income" or "Net Lows under the account titles column depending on the result of operations.
For Net Income, write the amount under the debit column of the Income Statement and credit
column of the Balance Sheet. For Net Loss, write the amount under the credit column of the
Income Statement and debit column of the Balance Sheet.
8. Double rule the totals of the last four columns. See sample worksheet on the following pages for
illustration.

11

s
 12
Financial Statements (Step 7)
Lesson 11
Lesson Overview

Topics covered:
II. Statement of Comprehensive Income
III. Statement of Changes in Equity
IV. Statement of Financial Position
V. Statement of Cash Flows

Learning Objectives:
At the end of this lesson, you are expected to:
1. Classify the types of financial statements
2. Identify the typical accounts used in financial statements
Assessment:

Activity- Financial Statements

Essentially, the purpose of financial statements is to report a variety of seemingly complex

information such that the end-users will be able to make sense of the given information. From a practical
standpoint, financial statements will give the users a way to read, understand, interpret, and analyze
economic transactions translated into financial records. The key product or the end product of the
accounting process is a set of documents called the financial statements comprised of the following:

1. Statement of Financial Position or Balance Sheet

Shows the financial condition/ position of a business as of a given period. It consists of

the assets, liabilities, and capital. The two main balance sheet formats are the account format
and the report format. The account format lists assets on the left side and liabilities and equity
on the right side of the statement. The report format lists liabilities and equity directly below
assets on the same page.
ALBERTO’S INC.
Statement of Financial Position
December 31, 2017

ASSETS LIABILITIES AND OWNER’S EQUITY

Current Assets Current Liabilities

Cash and Cash Equivalents P6 500 Accounts Payable P 350

 Accounts Receivable 750 Notes Payable 1 300

Inventories 800 Total Current Liabilities 1 650

Total Current Assets 8 050 Noncurrent Liabilities

Long –Term Debt 800

Total Liabilities 2 450

Net Fixed Assets Owner’s Equity

Plant and Equipment 9 600 Common Stocks 4 000

(Net of Depreciation) (500 000 shares)

Additional Paid-in 3 500

Capital

Retained Earnings 7 700

Total Owner’s Equity 15 200

Total Assets P17 650 Total Liabilities and P17 650

Owner’s Equity

Table 1- The composition of a statement of financial position in account format

13

ALBERTO’S INC.
Statement of Financial Position
December 31, 2017

ASSETS

Current Assets

Cash and Cash Equivalents P6 500

Accounts Receivable 750

Inventories 800

Total Current Assets 8 050

Net Fixed Assets

Plant and Equipment 9 600

(Net of Depreciation)

Total Assets P17 650

LIABILITIES AND OWNER’S EQUITY

Current Liabilities

Accounts Payable P 350

Notes Payable 1 300

 Total Current Liabilities 1 650

Noncurrent Liabilities

Long –Term Debt 800

Total Liabilities 2 450

Owner’s Equity

Common Stocks 4 000

(500 000 shares)

Additional Paid-in Capital 3 500

Retained Earnings 7 700

Total Owner’s Equity 15 200

Total Liabilities and Owner’s Equity P17 650

Table 2 The composition of a statement of financial position in report format

2. Income Statement or Statement of Comprehensive Income.

The Income Statement shows the result of operations for a given period. It consists of the
revenue, cost, and expenses.
The statement of comprehensive income consists of the revenue, cost, and expenses and
also contains components of other comprehensive income (including reclassification adjustments)
as follows: changes in revaluation surplus, gains and losses on benefit plans, gains and losses from
investments in equity instruments, finance costs, share of associates, and joint ventures under the
equity method, tax expense, gain or loss from discontinued operations, gain or loss on realization
of assets from discontinued operations, gain or loss from foreign operations, and all other
operating and financial events affecting the owner's equity in the business.
Internati0onal Accounting Standards I defines Total Comprehensive Income as the
"change in equity during a period resulting from transactions and other events. other than those
changes resulting from transactions with owners in their capacity as owners.
For purposes of lessons in single proprietorship, the activities will consist of the usual revenue,
cost, expense, and transactions with owners in their capacity as owners. Hence, the Income
Statement will be used to show the results of operations since there is no activity beyond the
regular profit and loss items.

14
Depreciation expense 4, 000
XYZ ACCOUNTING SERVICES
Statement of Financial Performance Supplies expense 2, 000
December 31, 2017
Utilities expense 1, 500

Professional Fees: P20, 000 Bad debts expense 300

Less: Operating Expenses: Bank charges 500 15,800

Salaries and wages P 7, Net Income: P 4, 200

500
 DDD Merchandising Company Selling Expenses 350,000
Statement of Financial Performance
December 31, 2017 Administrative Expenses 200,000

General Expenses 365,000

Sales P1,950,000
Total Operating Expenses 915,000
Less: Cost of goods sold 913,000
Net Income: P 122,000
Gross Profit 1,037,000

Less: Operating Expenses

3. Statement of Changes in Owner's Equity or Statement of Owner's Equity

Shows the changes in the capital or owner's equity as a result of additional investment or
withdrawals by the owner, plus or minus the net income or net loss for the year.
XYZ ACCOUNTING SERVICES
Statement of Financial Position
December 31, 2017

XYZ, Capital- beginning P100, 000

Add: Net Income 4, 200

Totals P104, 200

Less: XYZ, Drawing 5, 000

XYZ, Capital-ending P 99, 200

4. Statement of Cash Flows

Summarizes the cash receipts and cash disbursements for the accounting period. It
summarizes the cash activities of the business by classifying cash inflows (receipts) and cash
outflows (payments) into operating, investing, and financing activities. It shows the net increase
or decrease of cash in a given period and the cash balance at the end of the period. This allows
management to assess the business' ability to generate cash and project future cash flows.
Cash flow from operating activities refers to money generated from the regular
activities of the firm such as production, selling of goods, or provision of services to customers. It
also includes changes in working capital which is obtained using the equation, Current
Assets-Current Liabilities. Changes in inventory, short-term debt, accounts receivable, and
accounts payable affect the flow of cash from operating activities.
Cash flow from investing activities refers to the change in a firm's cash position
resulting from investments made, including money spent on plant and equipment. Finance
managers and other industry experts review the statement of cash flows by part and as a whole.
For instance, the firm might show an overall negative cash flow but if there was a huge investment
made on machineries and equipment, it may mean that the company invested heavily but cash
flow from operations may still be positive.
15

Cash flow from financing activities refers to changes in the company's cash position due
to the activities of the firm such as raising capital or repayment of debt-adding loans, debt
restructuring, deferment of payments, and issuance of new stocks in the financial market. These
financing activities are of high importance to analysts. If a company relies on debt quite often, it
 might have a problem in terms of liquidity, or the ability to satisfy its obligations when they
become due.
ABC ACCOUNTING SERVICES
Cash Flow Statement
December 31, 2017

Operating Activities

Cash receipt from professional income P50, 000

Cash payments of:

Taxes and Licenses (P2, 000)

Transportation (2, 000) ( 4, 000)

Net cash from operations P46, 000

Investing Activity

Cash payment of equipment (P10, 000)

Financing Activities

Owner’s investment P15,000

Owner’s Drawing (P1, 000)

Owner’s Withdrawal (P30, 000) (P16, 000)

Net increase in cash P20, 000

Add: cash beginning -0-

Cash end of year P20, 000

Relationships of Financial Statements

The basic financial statements complement each other because they are taken from related
transactions.
The cash flows statements
reveal that not all
service income has been collected
so even if there was an
operating net income of P41,000,
the cash flows from
operations have a negative cash of
P34,000. This is because
the cash flow statement reports only
cash activities
affecting operations while the
statement of comprehensive
income reports the results of
operation comprising both
cash and noncash items
(collectibles and unpaid expenses).
The ending cash balance of the cash flow statement must
be equal to the amount of cash in the Statement of Financial
Position. In this case, both have P176,000. The net income
of P41,000 will increase owner's equity so it was added to
the statement of changes in the owner's equity which was
 originally P200,000. Hence the total amount of owners’
equity is P241,000. This amount is also forwarded to the
equity section of the Statement of Financial Position.

16
ASSESSMENT
Mini Task 2: Presented below is the Adjusted Trial Balance of Anime World Gallery.

Anime World Gallery

Trial Balance
May 31, 2016

Cash P373,660
Accounts Receivable 70,000
Allowance for Bad Debts P1,500 Art Supplies 5,400 Prepaid Rent 6,000
Prepaid Insurance 8,100 Office Equipment 180,000 Accumulated Depreciation
- Office Equipment 5,000 Furniture and Fixture 40,000
Accumulated Depreciation - Furniture & Fixture 1,000 Accounts Payable
32,200 Notes Payable 100,000 Utilities Payable 4,500 Unearned Painting
Revenue 80,000 Ong. Capital 300,000 Ong. Drawing 18,000
Painting Revenue 210,000 Salaries Expense 4,000 Utilities Expense 5,040
Insurance Expense 2,700
Rent Expense 12,000
Art Supplies Expense 1,800
Depreciation Expense 6,000
Bad Debts Expense 1,500
P734,200 P734,200

Required: Prepare the following

1. Income Statement/Comprehensive Income
2. Statement of Changes in Owner’s Equity
3. Statement of Financial Position/ Balance Sheet in report form.

17

Closing Entries (Step 8)

Lesson 12
 Lesson Overview

Topics covered:
I. Steps in Closing the Nominal Accounts

Learning Objectives:
At the end of this lesson, you are expected to
1. Understand the objectives of closing entries
2. Prepare the closing entries

Assessment:
There is no assessment for this lesson.

The closing entries update the owner's capital account at the end of the period. They also eliminate the
balances of the nominal accounts to ready them for the next accounting period.

To close a temporary account, an entry is made to make its balance become zero. Closing transfers the
balances of the temporary accounts to the capital account. The Income Summary, considered to be a
summary account, is used to close the income and expense accounts.

Anime World Gallery

Trial Balance
May 31, 2016

Cash P373,660
Accounts Receivable 70,000
Allowance for Bad Debts P1,500 Art Supplies 5,400
Prepaid Rent 6,000
Prepaid Insurance 8,100
Office Equipment 180,000
Accumulated Depreciation - Office Equipment 5,000 Furniture and Fixture
40,000
Accumulated Depreciation - Furniture & Fixture 1,000
Accounts Payable 32,200 Notes Payable 100,000 Utilities Payable 4,500
Unearned Painting Revenue 80,000 Ong. Capital 300,000 Ong. Drawing 18,000
Painting Revenue 210,000 Salaries Expense 4,000
Utilities Expense 5,040
Insurance Expense 2,700
Rent Expense 12,000
Art Supplies Expense 1,800
Depreciation Expense 6,000
Bad Debts Expense 1,500
P734,200 P734,200

18
STEPS IN CLOSING THE ACCOUNT

1. Close the income accounts.

Since income accounts have normal credit balances, each revenue account will have to be
debited in the amount of its balance to bring their balances to zero. The credit is made to the
income summary account.

2016
May 31 Painting Revenue 210,000
Income Summary 210,000
To close income accounts.

2. Close the expense accounts.

 Expense accounts have normal debit balances, each of these will have to be credited to
close this account. Thus, a compound entry is ended considering the number of expense accounts.
The total of all expense accounts is then debited to income summary. The entry to close the
expense accounts of Anime World Gallery.

2016
May 31 Income Summary 33,040
Salaries Expense 4,000
Utilities Expense 5,040
Insurance Expense 2,700
Rent Expense 12,000
Art Supplies Expense 1,800
Depreciation Expense 6,000
Bad Debts Expense 1,500
To close the expense accounts.

3. Close the income summary to capital

Notice that after posting the entries involving the income and expense accounts, the
balance of the income summary account is exactly the net income or not loss for the period. A
credit balance indicates a net income and a debit balance indicates a net loss. Regardless of
whether the business yields a net income or a net loss, the income summary account must be
closed to the capital account. For Anime World Gallery, the entry is:

2016
May 31 Income Summary 176,960
Ong, Capital 176,960
To close income summary to capital.

Note: The balancing figure of the income summary account to be closed to capital is the net
income or net loss of the business. In the case of Anime World Gallery, P176.960 in the amount
of net income

4. Close the drawing account

The drawing account represents the amount withdrawn by the owner either in cash and
non-cash assets for personal use. It is for this reason that the debit balance of the drawing account
should be closed to capital. The following entry is an illustration using Anime World Gallery

2016
May 31 Ong, Capital 18,000
Ong, Drawing 18,000
To close the drawing account to capital.

19

Post-Closing Trial Balance (Step 9)

Lesson 13

Lesson Overview

Topics covered:
I. Post-Closing Trial Balance

Learning Objectives:

At the end of this lesson, you are expected to

1. Prepare the Post-Closing Trial Balance

 Assessment:

Activity- Closing Entries and Post-Closing Trial Balance

The post-closing trial balance is prepared from the general ledger accounts after the closing
entries have been posted. This is necessary to ensure that these entries have been correctly posted. This
will also test the equality of the accounts.

The post-closing trial balance confirms the equality of the debits and credits. It contains only
balance sheet items such as assets, liabilities, and ending capital because all the income and expense
accounts as well as the drawing account all have zero balances as a result of the closing entries.

The following is an illustration of the post-closing trial balance of Anime World Gallery:

Anime World Gallery

Post-Closing Trial Balance
May 31, 2016

Cash P373,660
Accounts Receivable 70,000
Allowance for Bad Debts P1,500 Art Supplies 5,400
Prepaid Rent 6,000
Prepaid Insurance 8,100
Office Equipment 180,000
Accumulated Depreciation - Office Equipment 5,000 Furniture and Fixture
40,000
Accumulated Depreciation - Furniture & Fixture 1,000 Accounts Payable
32,200 Notes Payable 100,000 Utilities Payable 4,500 Unearned Painting
Revenue 80,000
Ong. Capital 458,960 P683,160 P683,160

Explanation:

1. The May 2 credit of P300,000 is the beginning capital.

2. The May 31 credit of P176,960 is the 3rd closing entry where the income summary was closed
to capital.
3. The May 31 debit of P18,000 is last closing entry where the drawing account was closed to
capital.
4. The ending balance of P458,900 is the balance of Ong, Capital in the post-closing trial balance
after the income summary and the drawing amount were closed to capital.
20
ASSESSMENT: Prepare the Closing entries and post-closing Trial Balance.

MNM Delivery
Trial Balance
December 31, 2016

Cash P 375,000 Accounts Receivable 180,000 Supplies 10,500 Prepaid Insurance

22,500 Furniture and Fixture 187,500
Accumulated Depreciation -. Furniture and Fixture P22,500 Accounts Payable 67,500 Notes
Payable 82,500 MNM Capital 334,500 MNM, Drawing 75,000 Delivery Income 315,750 Rent
Expense 60,000
Salaries Expense 11,250 Utilities Expense 37,500 Advertising Expense 13,500 P897,750 P897,750

Accounting for Merchandising

Lesson 14
Lesson Overview

Topics covered:
I. Nature of a Merchandising Business
 II. Types of Merchandisers
III. Merchandising Operations

Learning Objectives:

At the end of this lesson, you are expected to familiarize oneself with the merchandising

business. Assessment:

Nature of a Merchandising Business

A business engaged in the buying and selling of

merchandise or goods is called a trading or
merchandising firm. While a service type of business
earns income by rendering services to its clients, a
merchandising type of business generates income by
buying and selling goods at a profit. Moreover, a
merchandising business is also different from a
manufacturing business. A manufacturing business
buys raw materials and processes them to become
finished goods for sale. On the other hand, a
merchandising business only buys and sells finished
goods.

21

The merchandiser purchases these goods directly from

the manufacturer or from other merchandise.
Merchandising companies include auto dealerships,
clothing stores, and supermarkets, all of which earn
revenue by selling goods to customers. The operating
cycle of a merchandising business involves three steps:
purchasing merchandise from a supplier, selling the
merchandise to a consumer, and collecting payment.

Types of Merchandisers

∙ Wholesalers- A wholesaler is a person or company who sells products in bulk to various outlets or
retailers for onward sale, either directly or through a middleman. Wholesalers are able to sell their
products for a lower price as they are selling in bulk, which reduces the handling time and costs
involved. They usually provide large quantities of goods, but can take on orders for smaller
quantities as well. The wholesaler may also be the manufacturer or producer of the product, but
they don’t have to be.
∙ Retailers- A retailer is a person or a company who sells products directly to their customers for a
profit. The retailer may be the manufacturer of the product, or may acquire relevant products from
a distributor or a wholesaler. The products they sell will be at a higher price than they would be
from a wholesaler, due to markups.
 Merchandising Operations

Merchandising operations are your purchasing, selling, collecting and payment activities.
Although cyclical in nature, they are ongoing operations designed to improve your cash flow. Efficient
merchandising operations keeps your store well stocked with inventory that your customers want to buy.
Offering attractive credit terms to qualified buyers can increase your sales income. Collecting on your
credit sales and paying your invoices promptly keeps the merchandise operations cycle functioning
smoothly.

Merchandise Purchase Operations

Your merchandise operations start by placing an order with a vendor. When the merchandise
arrives, you enter each item into your inventory accounting system. The merchandise is sorted and placed
in storage until it is needed. Return any damaged or incorrect merchandise to the vendor. If your order is
missing items, contact the vendor to arrange for another delivery or to have the amount deducted from
your invoice total. If you purchase merchandise on credit, enter the vendor’s invoice into your accounts
payable system.

Vendor Payment Operations

You use the money you collect from your cash and credit customers to pay your merchandise
vendors. Keeping track of the invoice due date allows you to lower your merchandise purchase costs by
taking the early payment discount. If you receive damaged merchandise or your purchase order was
incorrectly filled, you want to return the merchandise within the vendor’s deadline to get a full credit for

22
that amount. Run an accounts receivable aging report to make sure you do not fall behind in your vendor
payments.

Merchandise Selling Operations

Each cash and credit sale increases your sales revenue and reduces your inventory. For cash sales,
immediately deduct any sales discount or price markdown from the list price. You receive the cash
payment at the point of sale. Credit customers take your merchandise with them with the understanding
that payment is due at a later date. You enter a sale into each customer’s accounts receivable account. As
merchandise is sold, you take new stock from storage and bring it out for sale. Inspect returned
merchandise and return it to the shelves for resale or set it aside if the item cannot be resold.

Payment Collection Operations

Credit customers receive an invoice listing each purchase they made during the accounting cycle
and the total amount that is due. You can offer your credit customers a discount if they pay their invoices
within a set time. For example, you can allow your customers to take a 2 percent discount off the total
invoice amount if they pay within 10 days of the invoice date. Payments reduce the customer’s accounts
payable account and increase your cash flow. Collection procedures should include running an accounts
receivable aging report so you can better collect overdue amounts from slow-paying or non-paying
customers.

Periodic Inventory Systems in a Merchandising Business

Lesson 15
Lesson Overview

Topics covered:
I. The Periodic System

Learning Objectives:
At the end of this lesson, you are expected to journalize the transactions on the seller’s books under the
periodic inventory system.
Assessment:
Quiz – True or False

Since a merchandising business purchases goods for sale in the ordinary course of its business
operations, the goods acquired form part of the goods available for sale. Thus, the merchandise inventory
is an important factor in the determination of these goods as well as the cost of sales. The two alternative
systems which can be used in recording transactions related to a company's merchandise inventory are the
periodic system and the perpetual system.
23

The Periodic System

For businesses selling goods with different low-priced items, the periodic system maybe a more
appropriate system to use. The sales transactions resulting from the sale of these low-priced items are
voluminous. As such, it is not feasible to be tracing from the records the cost of each small item every
time a sale is consummated. A supermarket for instance, cannot trace the cost of every bar of soap or
bottle of shampoo sold. Businesses selling low priced items usually determine the cost of goods sold at
the end of the accounting period.

Under the periodic system, transactions related to the acquisition of inventory are recorded
accordingly as purchases, purchase discounts, and purchase returns and allowances. Cost of transporting
the goods shouldered by the buyer is recorded as freight in Furthermore, transactions related to the sale of
inventory are recorded accordingly as sales, sales discount, and sales returns and allowances. Cost of
transporting the goods shouldered by the seller is recorded as freight-out or delivery expense.

Recording Transactions Under the Periodic System

Discount

A discount is a reduction from a certain price or amount. There are two kinds of discount in
accounting for merchandising transactions, the trade discount and the cash discount.

1. Trade Discount-a deduction from the list price or catalogue price granted to customers to
encourage purchase of goods or merchandise in big quantities or volume. This is not recorded or
shown in the buyer's or seller's books

Illustrative Problem

a) Spitz Co. bought merchandise for cash with a list price of P10,000 less 10% trade
discount.

List Price P10,000

Less: 10% Trade Discount
P10,000 x 0.1 1,000
Purchase Price P9.000

Journal Entry on the books of Spitz Co.

Purchases 9,000
 Cash 9,000
Purchased merchandise for cash.

Note: The trade discount was not shown in the books and the purchase price recorded in
the books is P9,000. The list price of P10,000 did not reflect in the books.

b) Terrier Co. sold merchandise to Poodle Co. with a list price of P50,000. Terms:
10%, 10%, 2/10, n/30.

List Price P50,000

Less: 10% Trade Discount
P50,000 x 0.1 5,000
Balance P45,000
Less: 10% Trade Discount
P45,000 x 0.1 4,500
Sale Price P40.500
24
Journal Entry on the books of Spitz Co.

Accounts Receivable 40,500

Sales 40,500
Sold merchandise on account.
Terms: 2/10, n/30

c) Dalmatian Co. bought goods from Rotweiller Inc. with list price of P125, 000. Terms
20-10, 1/10, n/30.

List Price P125,000

Less: 20% Trade Discount
P125,000 x 0.20 25,000
Balance P100,000
Less: 10% Trade Discount
P100,000 x 0.10 10,000
Sale Price P90.000

Journal Entry on the books of Spitz Co.

Purchases 90,000
Accounts Payable 90,000
Purchased merchandise on account.
Terms: 1/10, n/30

Note: 1. The 20-10 in the terms represents the trade discount given to the buyer while
the 1/10, and n/30 are the terms of payment.
2. The trade discount was not shown in the books and the purchase price
recorded on the books is P90,000. The list price of P 125,000 did not reflect in
the books.

2. Cash Discount -a deduction from the selling or purchase price granted to customers to encourage
prompt payments of accounts. This is recorded or shown in the buyer's and seller's books. This is recorded
as purchase discount in the books of the buyer or sales discount in the books of the seller. This method of
recording cash discount in the books of the buyer or seller is known as the Gross Method.
Examples of different credit terms:
1. 3/15, 2/20, n/30-means that a 3% cash discount is granted to the buyer if account
is paid within 15 days from date of purchase, 2% cash discount is given if
account is paid within 20 days, purchase price less returns and allowances if any
is payable within 30 days.
 2. 1/10, n/60- means that a 1% cash discount is granted to the buyer if account is
paid within 10 days from date of purchase, purchase price less returns and
allowances if any, is payable within 60 days.
3. n/30 - means that no cash discount is available to the buyer. Purchase price less
returns and allowances if any, is payable within 30 days.
4. 2/10 EOM, n/60-means that a 2% cash discount is granted to the buyer if paid 10
days after the end of the month. Purchase price less returns and allowances if
any. is payable within 60 days.

25

5. 1/EOM, n/30 - means that a 1% cash discount is given if the buyer pays until the
end of the month. Purchase price less returns and allowances if any, is payable
within 30 days.
6. EOM-means that no cash discount is available. Purchase price less returns and
allowances if any, is payable at the end of the month.

Note: In numbers 4, 5, and 6 above, EOM can also be written as eom.

Illustrative Problem
a) On July 1, Siamese Kat Merchandising purchased goods from Persian Kat Trading
for P 70,000. Terms 1/10, n/30.

The terms 1/10, n/30 mean that a 1% discount will be given if payment is made within 10
days from July 1 and no discount will be given if payment is made beyond 10 days.
(Purchase price less returns and allowances if any) is payable within 30 days.

July 1------------------------July 11 July 12----------------------July 31 1%

discount no discount

Purchase Price P70,000

Less: 1% x P70,000 700
Payment within 10 days P69,300

b) Assuming the terms of Siamese Kat Merchandising's purchase is 3/10, 2/15, n/30
and Siamese Kat Merchandising paid on July 16.

The terms 3/10, 2/15, n/30 mean that a 3% discount will be given if payment is made
within 10 days from July 1, 2% discount will be given if payment is made within 15 days
from July 1, and no discount will be given if payment is made beyond 15 days. (Purchase
price less returns and allowances if any) is payable within 30 days.

July 1------------------July 11 July 12------------July 16 July 17-----------July 31 1%

discount 2% discount no discount

Purchase Price P70,000

Less: 2% x P70,000 1,400
Payment within 10 days P68,600

c) Assuming the terms of Siamese Kat Merchandising's purchase is 3/10 EOM. 60 and
Siamese Kat Merchandising paid on August 10.

The terms 3/10 EOM, n/60 mean that a 3% discount will be given if payment is made 10
days after the end of the month and no discount will be given if payment is made beyond
 the discount period. (Purchase price less returns and allowances if any) is payable within
60 days.

July 1------------------------August 10 August 11---------------------- August 30

3% discount no discount

Purchase Price P70,000

Less: 1% x P70,000 2.100
Payment within 10 days P67,900
26
Buyer’s Point of View
A buyer is the one who purchases goods. Merchandise inventory are goods or commodities
purchased by the company for sale normally at a profit. Certain documents are prepared by the buyer to
complete a purchase transaction.
1. Purchase Order - a document sent by the buyer to the seller ordering certain goods where the date,
quantity, description of goods, and the total amount of the order is indicated. This authorizes the seller to
deliver the goods to the buyer under the agreed specifications, terms, and conditions.
2. Receiving Report-a form prepared by the buyer's receiving personnel stating the quantity and condition
of the goods delivered by the seller.
3. Debit Memorandum - a written notice from the buyer informing the seller that the buyer will debit the
account or decrease the amount owed to the seller for returned goods or allowances requested due to
defect or wrong specifications.

Pro forma Journal Entries: Buyer's Point of View

1. Purchased merchandise for cash

Purchases XXX
Cash XXX

2. Purchased merchandise on account

Purchases XXX
Accounts Payable XXX

3. a. Returned defective merchandise bought on account.

b. Allowances granted by seller for the account purchases
c. Issued a debit memo to the seller for merchandise returned
Accounts Payable XXX
Purchase Returns and Allowances XXX

Account Titles Used

1. Purchases- the account used to record the cost of the goods or merchandise bought for purpose of resale.

2. Purchase Returns and Allowances - the account used to record returns acknowledged or allowances
granted by the supplier to the buyer from the purchase of goods
3. Purchase Discount - a reduction from the purchase price of the merchandise te goods bought granted
by the supplier to the buyer or customer for paying within the discount period.
4. Freight-in-the cost of transporting the merchandise or goods from the seller's place to the buyer's place
of business. This is also called Transportation-in.
Illustrative Problem

1. On April 5, Cinder Company purchased from Rella Company merchandise for cash worth
P150,000.
Purchases 150,000
Cash 150,000
 Purchased merchandise for cash.

2. On April 10, Snow Company purchased merchandise from White Company for P300,000 paying
P50,000 and the balance on account. Terms: 2/10, 1/30

27

Purchases 300,000
Accounts Payable - White Co. 250,000
Cash 50,000 Purchased merchandise on account.
Terms: 2/10, n/30

Note: The terms 2/10, n/30 mean that a 2% discount will be given if payment of the balance is made
within 10 days from the sales invoice date but no discount will be given if payment is made beyond 10
days. Net amount (purchase price less returns and allowances if any) is payable within 30 days.

April 10-------------------------------April 20 April 21---------------------------------May 10 2%

discount no discount

3. Snow Company returned defective merchandise to White Company worth P30,000.

Accounts Payable-White Co. 30,000
Purchase Returns and Allowances 30,000
Returned defective merchandise purchased on account.

4. Snow Company made a partial payment of P20,000 to White Company.

Accounts Payable-White Co. 20,000
Cash 20,000
Partial Payment

7. Paid account to White on April 20

Accounts Payable-White Co. 200,000
Purchase Discount 4,400
Cash 195,600
Paid account within the discount period.

Computation
Purchases (April 10) P300,000
Less: Down Payment 50,000
Account Purchases P250,000
Less: Purchase Returns 30,000
Net Purchases P220,000
Less: Purchases Discount
P220,000 x 0.02 4,400
Balance P215,600
Less: Partial Payment 20,000
Payment within discount period P195,600

Seller's Point of View

A seller is one who offers his/her merchandise for sale in exchange for monetary payment. In a
sales transaction, documents are ordinarily issued by the seller to evidence the sale of goods.
1. Sales Invoice - contains the name and address of the buyer, the description of the goods sold, the credit
terms, unit price, quantities, total amount, and date of sale. This evidences the transfer of ownership of the
goods from the seller to the buyer.
2. Official Receipt - a written acknowledgement of money received by the seller evidencing payment of
the buyer for goods purchased and received
 3. Credit Memorandum - a written notice from the seller signifying acknowledgement or acceptance of
the goods returned by the buyer. This notifies the buyer of a corresponding reduction in the amount owed
by the buyer because of goods returned or allowances granted due to defect or wrong specifications.

28
Pro Forma Journal Entries: Seller's Point of View
1. Sold merchandise for cash

Cash XXX
Sales XXX

2. Sold merchandise on account

Accounts Receivable XXX
Sales XXX

3. a. Received defective merchandise sold on account

b. Allowances granted to buyer for the account sales
c. Issued a credit memo to the buyer for merchandise returned

Sales Returns and Allowances XXX

Accounts Receivable XXX
4. Paid cash refund for returned merchandise

Sales Returns and Allowances. XXX

Cash XXX
5. Transportation charges incurred in selling merchandise
Freight-out or Delivery Expense XXX
Cash or Accounts Payable XXX

Note: Freight-out is debited if delivery of goods is outside the area of the seller's place of business.
Delivery Expense is debited if delivery of goods is within the area of the seller's place of business.
6. Collected account within the discount period arising from the sale of merchandise
Cash XXX
Sales Discount XXX
Accounts Receivable XXX

7. Collected account after the discount period

Cash XXX
Accounts Receivable XXX

Account Titles Used

1. Sales-the proceeds from the sales price of goods sold credited to the revenue account in the accounting
period when the sales were made
2. Sales Returns and Allowances - the account used to record returns acknowledged or allowances
granted by the supplier to the buyer from the sale of goods
3. Sales Discount - a reduction from the sales price of the merchandise or goods sold granted by the seller
to the buyer or customer for paying within the discount period
4. Freight-Out or Delivery Expense the cost of transporting the merchandise or goods from the seller's
place to the buyer's place of business
Illustrative Problem
1. On July 15, ABC Trading sold merchandise to XYZ for P150,000 receiving P20,000 down
payment and the balance on account. Terms: 2/10, 1/15, n/60.

29
 Cash 20,000
Accounts Receivable – XYZ 130,000
Sales 150,000
Sold merchandise on account.
Terms: 2/10, 1/15, n/60

Note: The terms 2/10, 1/15, n/60 mean that a 2% discount will be given if payment of the balance is made
within 10 days from July 15; 1% discount will be given if payment of the balance is made within 15 days;
and no discount will be given if full payment is made beyond 15 days. Net amount (sales price less returns
and allowances if any) is payable within 60 days.
July 15-------------------July 25 July 26---------------------July 30 July 31------------------------Sept. 13
2% discount 1% discount no discount

2. ABC Trading received defective merchandise worth P10,000 from XYZ Company.
Sales Returns and Allowances 10,000
Accounts Receivable-XYZ Co 10,000
Received returns on merchandise sold on account.

3. ABC Trading received a partial payment of P20,000 from XYZ Company.

Cash 20,000
Accounts Receivable-Porket Co 20,000
Partial Payment

4. Received payment from XYZ Company on July 30

Cash 98,800
Sales Discount 1,200
Accounts Receivable 100,000
Received payment

ASSESSMENT: True or False

Instruction: Write the letter T if the statement is correct or F if it is incorrect.

1. In a merchandising business, the main source of revenue is the sale of merchandise.

2. Generally, sales are recorded only when the sale is on cash.
3. The sales returns and allowances account is a contra-revenue account.
4. Periodic inventory system is the same as physical inventory system.
5. As a rule, cash discount is given only when the accounts are fully paid within the discount period.
6. If the seller grants an allowance for the reported defective merchandise, the seller has to issue a
credit note to the buyer for the corresponding amount.
7. Sales return will decrease the total net sales for the period. A debit note issued by the supplier to
the buyer will decrease the payables of the buyer.
8. Purchases of items other than those which form part of inventory and intended for sale in the
normal course of business are recorded as purchases.
9. The gross profit from sale is equal to sales minus cost of sales.
10. The main difference of a merchandising business from servicing business is the existence of
merchandise inventory.

30
 Perpetual Inventory Systems in a Merchandising Business
Lesson 16
Lesson Overview

Topics covered:
I. The Perpetual System

Learning Objectives:
At the end of this lesson, you are expected to journalize the transactions on the seller’s and buyer’s books
under the periodic inventory system.

Assessment:
Quiz- Multiple Choice
Activity- Journalizing
Performance Task- Completing the accounting cycle of a merchandising business.

The Perpetual System

Under this method, an acquisition of merchandise is debited to merchandise inventory Also,
the sale of the merchandise is recorded as a credit to merchandise inventory with a corresponding debit to
cost of goods sold account. In other words, any movement in merchandise inventory is directly debited or
credited to this account, thus maintaining a record of the inventory items.

Recording Transactions Under the Perpetual System

Pro Forma Journal Entries: Buyer's Point of View
1. Purchased merchandise for cash/ on account
Merchandise Inventory XXX
Cash/Accounts Payable XXX

2. Incurred transportation charges in the purchase of merchandise

Merchandise Inventory XXX
Cash/Accounts Payable XXX

3. a. Returned defective merchandise bought on account

b. Granted allowances to the buyer for the account purchases
c. Issued a debit memo to the seller for merchandise returns
Accounts Payable XXX
Merchandise Inventory XXX

4. Paid account within the discount period arising from the purchase of merchandise
Accounts Payable XXX
Merchandise Inventory XXX

5. Paid account after the discount period arising from the purchase of merchandise
Accounts Payable XXX
Merchandise Inventory XXX
Cash XXX

31
 Pro Forma Journal Entries: Seller's Point of View
1. Sold merchandise for cash/ on account
Cash/ Accounts Receivable XXX
Sales XXX
Cost of Sales XXX
Merchandise Inventory XXX

Note: 1. The amount of cash accounts receivable and sales on the first entry is the total sales price of the
goods sold.
2. The amount of cost of sales and merchandise inventory on the second entry the cost of
merchandise sold.
*The second entry removes the sold goods from the merchandise inventory account and
transfers it to the cost of goods sold.
2. a. Received defective merchandise sold on account
b. Granted allowances to the buyer for the account sales
c. Issued a credit memo to the buyer for merchandise returns
Sales Returns and Allowances XXX
Accounts Receivable XXX
Merchandise Inventory XXX
Cost of Sales XXX

Note: 1. The amount of sales returns and allowances and accounts receivable on the first entry in the
total sales price of the goods returned.

2. The amount of merchandise inventory and cost of sales on the second entry is the cost of
merchandise returned.
*The second entry transfers back to the merchandise inventory account the cost of returned goods
while removing it from the cost of goods sold.
3. Collected account within the discount period

Cash XXX
Sales Discount XXX
Accounts Receivable XXX

4. Collected account after the discount period

Cash XXX
Accounts Receivable XXX

Illustrative Problem

1. DDD Trading sold P50,000 merchandise to FFF Enterprise. Term: 2/10, 1/30
Accounts Receivable 50,000
Sales 50,000
Sales on account, Terms:2/10, 1/30

Cost of Sales 35,000

Merchandise Inventory 35,000
Cost of Merchandise Sold

32
2. Received merchandise returns, P8,000 (Cost of returns, P5,000)

Sales Returns and Allowances 8,000

Accounts Receivable 8,000
 Received merchandise returns

Merchandise Inventory 5,600

Cost of Sales 5,600
Put back to merchandise inventory the cost of returns

3. DDD Trading paid P2.000 freight charges for sales made to FFF Enterprises

Freight out or Delivery Expense 2,000

Cash 2,000
Paid freight charges

4. Received full settlement of account from Duckling Enterprise.

Cash 41,160
Sales Discount 840
Accounts Receivable 42,000
Full settlement of account

Computation
Sales P50,000
Less: Returns 8,000
Balance 42,000
Less: Sales Discount 840
Amount Received P41,160

Accounting for Freight Costs

The sales agreement should indicate whether the seller or the buyer is to pay the cost of
transporting the goods to the buyer’s place of business. The two most common arrangements for freight
costs are FOB Shipping Point and FOB Destination.

FOB Shipping Point

FOB shipping point means the buyer should be the one to pay for the cost of transporting the
goods from the seller's place to the buyer's place. Once the merchandise leaves the seller's place for
shipping, ownership of the goods is transferred to the buyer. Therefore, the buyer shoulders the cost of
transportation.

FOB Shipping Point, Freight Collect

FOB shipping point, freight collect means that the goods are free on board up to the
shipping point and the freight company collects payment for the freight charges from the buyer.
Since ownership of the goods passes to the buyer once the goods reach the shipping point, the
buyer should be the one to shoulder or pay for the cost of freight.
Journal entries on the books of buyer to record the freight:

Freight-in xxx
Cash xxx
Paid freight charges

Journal entries on the books of seller to record the freight:

There is no entry on the books of seller, because the buyer should shoulder or pay
the cost of the freight, and the freight company collected the freight charges from buyer.

33

FOB Shipping Point, Freight Prepaid

Fob shipping point, freight prepaid means that the goods are free on board up to the
shipping point, and the seller paid for the freight charges at the time of shipment Because
 ownership of the goods passes to the buyer once the gods reach the shipping point, the buyer
should be the one to shoulder or pay for the cost of freight. However, the seller paid for the
freight at the time of shipment, the buyer should reimburse the out of shipment to the seller.
The seller can debit this as a receivable from the
Journal entries on the books of buyer to record the freight:

Freight-in xxx
Accounts payable xxx
Cost of freight charges

Journal entries on the books of seller to record the freight:

Accounts receivable xxx

Cash xxx
Freight charges collectible from buyer

FOB Destination
FOB destination means the seller should be the one to pay for the cost of transporting the goods. This
is because ownership of the merchandise is transferred to the buyer only when the merchandise reaches
the buyer's place of business.

FOB Destination, Freight Collect

FOB destination, freight collect indicates that the goods are free on board up to the
destination and the freight company collects payment for the freight charges from the buyer.
Because ownership of the goods passes to the buyer only when the goods reach the buyer's place
of business, the seller should be the one to shoulder or pay for the cost of freight. However, since
the freight company collected the freight charges from the buyer. the seller should reimburse
the buyer for the amount of freight paid. The buyer, on the other hand, can reduce its accounts
payable to the seller for the cost of transportation paid to the freight company.
Journal entries on the books of buyer to record the freight:
Accounts payable xxx
Cash xxx
Paid freight charges

Journal entries on the books of seller to record the freight:

Freight out xxx

Accounts receivable xxx
Freight charges

FOB Destination, Freight Prepaid

FOB destination, freight prepaid means that the goods are free on board up to the
destination and the seller paid for the freight charges at the time of shipment. Because ownership
of the goods passes to the buyer only when the goods reach the buyer's placed business, the seller
should be the one to shoulder or pay for the cost of freight.
Journal entries on the books of buyer to record the freight:

There is no entry on the books of the buyer, since the seller actually paid for the
freight as it should.
34
Journal entries on the books of seller to record the freight:

Freight –out xxx

Cash xxx
Freight charges
Terms of Freight Who should pay for Who paid?
the freight charges?

FOB Shipping point, Freight Collect Buyer Buyer

 FOB Shipping point, Freight Prepaid Buyer Seller

FOB Destination, Freight Collect Seller Buyer

FOB Destination, Freight Prepaid Seller Seller

The Cost of Sales or Cost of Goods Sold

The cost of sales or cost of goods sold represents the cost of merchandise inventory sold by the
business to its customers. This cost comprises the company's biggest expense and is deducted from the net
sales to arrive at the gross profit or gross margin. Computation of cost of sales is as follows:
Merchandise Inventory, Beginning P xxx
Add: Net Cost of Purchases
Purchases P xxx
Less: Purchase Returns and Allowances P xxx
Purchase Discount xxx xxx
Net Purchases xxx
Add: Freight-in xxx xxx
Goods Available for Sale xxx
Less: Merchandise Inventory, End xxx
Cost of Sales P xxx

The Closing Entries

The closing entries of a merchandising business are the same as those of a service business except
for the additional temporary accounts presented in lessons 15 and 16.
Closing the entries of a merchandising business includes setting up the ending inventory and
closing the beginning inventory. Closing entries for a merchandising business are as follows:

1. Income Summary xxx

Merchandise Inventory, Beginning xxx
Nominal Accounts with Debit Balances xxx
To close beginning inventory and nominal accounts with debit balances

2. Merchandise Inventory, End xxx

Nominal Accounts with Credit Balances xxx
Income Summary xxx

3. Income Summary xxx

Owner's Capital xxx
To close income summary to capital (FOR NET INCOME) OR

Owner's Capital xxx

Income Summary xxx
To close income summary to capital (FOR NET LOSS)

4. Owner's Capital xxx

Owner's Drawing xxx
To close drawing account to capital

35

ASSESSMENT- Multiple Choice

Instruction: Encircle the letter that corresponds to the best answer. 2 points each.

1. The following discounts are usually recorded in the journal and posted to the ledger, except:
a. trade discount b. cash discount.
 c. purchase discount. d. discount due to defect of products

2. This system of recording goods intended for sale maintains the merchandise inventory account in
every transaction.
a. Periodic inventory b. Just-in-time inventory
c. Perpetual inventory d. Maintenance inventory

3. Which of the following is the income representing the difference between the sales and cost of
sales?
a. Gross profit b. Net operating income
c. Operating income d. Net income before tax

4. Which of the following is to be included in the inventory of the seller?

a. Goods in transit sold under FOB destination c. Botha a & b
b. Goods in transit sold under FOB shipping point d. None of the choices

5. This discount is granted because of bulk buying.

a. trade discount b. cash discount.
c. purchase discount. d. discount card

Activity
1. On September 15, Bell Accessories purchases P100,000 worth of merchandise from Clang
Supplies on account, terms 2/10, n/30. On September 15, P10,000 worth of damage goods were
returned to Clang Supplies. Full payment was made on September 25. Give the necessary journal
entries under the periodic inventory system.
2. Bad Brett Company sold 20,000 merchandise to Good Vibes Trading March 1 with terms 1/10,
n/30. Cost of merchandise sold is 16,000. Due wrong specifications, a P1,500 worth of
merchandise was returned. Cost merchandise returned is 1,200. The account was settled on
March 11. Give the necessary journal entries under the perpetual inventory system.

Given the ff., provide the necessary Journal Entries.

Date Transaction Amount Terms Freight Returns(P) Date of
(P) Charges Payment
(P)

Jan. 4 Sales 20,000 5-5 2/10, n/30 1,000 4,000 Jan. 14

FOB Shipping
Point prepaid

Jan. 5 Sales 18,000 1/5 EOM 1,500 -0- Feb. 5

FOB Shipping
Destination prepaid

Jan. 8 Purchases 12,000 2/EOM, n/30 2,000 3,000 Jan. 31

FOB Shipping
Destination collect

36
Performance Task: Completing the Accounting Cycle
The account balances of E & N Marketing are as follows as of February 28, 2008
Debit Credit

Cash P100,000 Accounts payable P 50,000

Accounts receivable 400,000 Notes payable 200,000

Merchandise inventory 250,000 E, Capital 565,000

Prepaid Supplies 5,000 Allowance for Bad 20,000

debts
 E, Drawings 80,000

Transactions for the month of March 2008

3/1 Purchases on account, P580,000, terms: 2/20, n/30. F.O.B. shipping point, freight
prepaid, P1,800.
3/2 Sold merchandise on account, P650,000, terms: 10; 5/15, n/30. F.O.B., shipping point, freight
prepaid, P20,000.
3/15 Paid 15-month salary, P150,000.
3/16 Collected sales March 2
3/20 Paid purchases made on March 1.
3/22 Sold goods for cash to various customers, P400,000.
3/23 Received sales returns, P20,000 from various customers.
3/26 Sold goods on account, P500,000, F.O.B., destination, freight collect, P30,000. 3/31
Purchased goods on account P100,000, F.O.B., destination, freight prepaid, P10,000. Requirement:

1. Journalize the above transactions using (a) periodic method and (b) perpetual method. (Assume
that cost of sales is 60% of the invoice price.)
2. Give the adjusting entries of the following:
a. Required allowance for bad debts is P50,000.
b. Unpaid Salaries, P150,000
c. Ending inventory per count is P47, 200
d. Unused supplies, P2,000
3. Post to ledger
4. Prepare the Unadjusted Trial Balance
5. Journalize the adjusting entries
6. Prepare the Adjusted Trial Balance
7. Prepare the Financial Statements
a. Income Statement
b. Statement of Changes in Equity
c. Balance Sheet
8. Prepare the Closing Entries
9. Prepare Post-Closing Trial Balance

37

References
Financial Accounting. Merchandising Operations (n.d.) Retrieved from http://www.youtube.com/watch?
v=ySVzjrPh-J4
Haddock, M., Price, J., & Farina, M. (2012). College Accounting: A Contemporary Approach, 2nd ed.
New York: McGraw-Hill/Irvin

Nickolas, Steven. What is the distinction between Free on Board (FOB) shipping point and destination?
(n.d). Retrieved from http://www.investopedia.com/ask/ answers/052515/what-distinction-between-free
board fob-shopping-point-and-destination.asp
Ong, F. L (2016) Fundamentals of Accountancy Business and Management 1 for Senior High School
Valencia, E.G.& Roxas, G.F. (2010). Basic Accounting 3rd ed., Mandaluyong City, Philippines: Valencia
Educational Supply
Valencia, E.G.& Roxas, G.F. (2014-2015). Basic Accounting 4th ed., Mandaluyong City, Philippines:
Valencia Educational Supply
Weygandt, J. et. al. (2012). Accounting Principles 10th ed. John Wiley & Sons (Asia) Pte. Ltd.

38