Unit 9

Accounting for Merchandising Operations

Merchandising Revenue and Expense Accounts

When the seller sells goods to the customers (whether paid or not), an income has to
be recognized (under accrual basis of accounting). Such income is called “sales
revenue” or simply “sales”. Since this account is an income, it belongs to the credit
side. The “service income” account won’t be used anymore because the business is no
longer into rendering of services.

When the seller’s place of business is far from that of the buyer, goods are being
shipped through a courier. With that, either the seller or the buyer pays for the
delivery charge which is called “freight”. If the seller shoulders the freight, it is called
“freight out” by the seller and is treated as part of its expenses. It will be a different
story if the buyer shoulders the freight (we will have a separate discussion for that).

Note that the goods for sale are treated as assets and are collectively known as
“merchandise inventory”. These items intended for sale will remain as assets until
they are sold. When they are sold, they will no longer give the company any future
benefit, and thus, will cease to be part of assets. The goods sold shall be represented
by the account title “cost of sales” or “cost of goods sold” and will be treated as an
expense. Being an expense, it will be deducted from the revenues to get the net
income. (There will be a detailed discussion about cost of goods sold as we go along).

All other expense accounts used under service-concern business are also used in
merchandising business.

Examples:

A. The seller sold goods costing ₱10,000 to a customer at a price of ₱15,000. The sale
was on account and the seller paid for the freight worth ₱2,000.

Accounts Receivable 15,000

Sales 15,000

Freight-out 2,000
Cash 2,000

B. Collected half of the amount due from the customer

Cash 7,500
Accounts receivable 7,500

Inventory Systems

There are two existing inventory systems being used in accounting—Periodic

Inventory System and Perpetual Inventory System.

FABM1-009 Page 1 of 29
 When the Periodic Inventory System is employed, the volume of inventories and
corresponding records are updated in a regular interval by doing physical counting.

This system is used by companies with relatively less volume of items for sale such as
car dealers and art galleries.

The Perpetual Inventory System on the other hand makes it possible for the
company to have an up-to-date record of the inflow and outflow of goods as stock
records and sales are checked against each other for accuracy.

Buyer’s perspective

It has to be noted that the two systems differ in the use of some account titles. When
merchandise inventories are purchased from the supplier, the periodic inventory
system records the inflow by debiting the “purchases” account. Meanwhile, the
perpetual inventory system DIRECTLY records the inflow to “merchandise
inventory” account as a debit entry.

When goods purchased are defective, they may be returned to the supplier. When the
periodic inventory system is used, the goods returned will be credited to “purchase
returns and allowances”. However, when perpetual inventory system is used, the
goods returned will DIRECTLY be credited to the “merchandise inventory” account.

Examples:

1/9 Inventories worth ₱15,000 were purchased on account from the supplier.

Periodic Inventory System

Purchases 15,000
Accounts Payable 15,000

The purchases account is debited because it reflects an increase in assets

(inventories).

Perpetual Inventory System

Merchandise Inventory 15,000

Accounts Payable 15,000

Notice that the purchase of inventories is directly debited to the

merchandise inventory account under the perpetual inventory system.

1/12 Goods worth ₱5,000 were returned to the supplier due to minor damage.

Periodic Inventory System

Accounts Payable 5,000
Purchase Returns and Allowances 5,000

The purchase returns and allowances account is placed opposite to the

purchases account since it represents a decrease in inventories.

FABM1-009 Page 2 of 29
 The accounts payable is debited (therefore reduced) since the items
bought on account were sent back to the seller.

Perpetual Inventory System

Accounts Payable 5,000
Merchandise Inventory 5,000

Merchandise inventory account is placed on the credit side to reflect a

decrease in the volume of goods. Remember that inventories are assets.

The account purchase returns and allowances shall only be used if the
recording of the inflow of the goods involves the use of the purchases
account. Since the perpetual inventory system does not use the purchases
account, it cannot use the purchase returns and allowances account.

Seller’s perspective

When merchandise inventories are sold to the buyer, the periodic inventory system
records the outflow by crediting the “sales” account and debiting “cash” or “accounts
receivable”.

Meanwhile, the perpetual inventory system will have two sets of entries to record
the sale of merchandise. The first is to record the income account which is the “sales”
together with “cash” or “accounts receivable”, as the case may be (the same as that of
the periodic inventory system). The second set is to reflect the movement (outflow) of
goods wherein it is DIRECTLY credited to “merchandise inventory” account with a
corresponding debit to “cost of sales” or “cost of goods sold”.

This is so because merchandise inventories are assets. When assets decrease, they are
put on the credit side. The “cost of goods sold” or “cost of sales” is an expense
account so it will be placed on the debit side.

When goods sold are defective, they may be returned by the buyer. When the periodic
inventory system is used, the goods returned will be debited to “sales returns and
allowances”. However, when perpetual inventory system is used, the goods returned
will DIRECTLY be debited to the “merchandise inventory” account

Examples:
1/9 Inventories costing ₱10,000 were sold at a price of ₱15,000 on account
to the customer

Periodic Inventory System

Accounts receivable 15,000

Sales 15,000

Perpetual Inventory System

Accounts Receivable 15,000

Sales 15,000

FABM1-009 Page 3 of 29
 Cost of sales 10,000
Merchandise Inventory 10,000

Note that the periodic and the perpetual inventory system have the same
set of entries in recording the sales and accounts receivable account.

Notice that the amount reflected under sales is NOT the same with that of
cost of sales. This is because the sales account includes a mark-up that
represents the profit. In this case it is ₱5,000—difference of ₱15,000 and
₱10,000.

Under perpetual inventory system, the merchandise inventory account is

credited (therefore reduced) since the items have already been sold to the
customers. They will be reductions from the total assets.

1/12 Goods costing ₱4,000 with a selling price of ₱5,000 were returned by the buyer
due to minor damage.

Periodic Inventory System

Sales Returns and Allowances 5,000
Accounts Receivable 5,000

Perpetual Inventory System

Sales Returns and Allowances 5,000

Accounts Receivable 5,000

Merchandise Inventory 4,000

Cost of Sales 4,000

As reflected in the entries, both periodic and perpetual inventory system

have the same set of entries in recording the sales returns and allowances
and the accounts receivable. The accounts receivable is credited
(reduced) since the amount of the customer’s obligation to pay is reduced
when goods are returned to the seller.

The sales returns and allowances account is positioned on the debit side
since it reflects a reduction of sales.

Under the perpetual inventory system, the merchandise inventory account

is debited (therefore increased) because the customers returned the goods
to the seller. The cost of sales (expense) account is reduced by crediting
said account. Remember that expense accounts are placed on the debit side
when they increase. Since the volume of goods out from the company has
decreased, the cost of sales account must also decrease by crediting it.

FABM1-009 Page 4 of 29
Discounts

Cash Discounts

When a seller wants its customers to pay promptly but without compromising the
profits of the business, a cash discount may be offered to customers. The cash
discount can be availed by the customers if they make full payment within the
specified discount period set by the seller. The term can be expressed as: 2/10 – n/30.
This means that the customer can have 2% discount if he pays within 10 days after
the date of transaction instead of the normal 30-day period. Therefore, if the sales
transaction took place on March 12, the customer is entitled to avail the discount (and
pay less) if he pays not later than March 22. Beyond such 10-day discount period, the
customer is required to pay for the entire amount.

Examples:

BUYER’S POINT OF VIEW

1/9 Inventories worth ₱15,000 were purchased on account from the supplier,
2/12-n/30.

Periodic Inventory System

Purchases 15,000
Accounts Payable 15,000

Perpetual Inventory System

Merchandise Inventory 15,000

Accounts Payable 15,000

Since the discount term is expressed as 2/12-n/30, this means that the
customer can avail the 2% discount if he pays within 12 days from the date
of sale. The last day on which the customer can avail the discount is on
January 21.

1/17 Paid for the account to the supplier in full

Periodic Inventory System

Accounts Payable 15,000

Cash 14,700
Purchase Discount 300

Perpetual Inventory System

Accounts Payable 15,000

Cash 14,700
Merchandise Inventory 300

The company paid the amount due on the 17 th of the month which is within
the 12-day discount period counting from January 9. Because of that, the
buyer is entitled to a discount.

FABM1-009 Page 5 of 29
 The amount of discount is computed by multiplying ₱15,000 by 2%. This
gives us a discount of ₱300. The discount is then deducted from the total
amount due to get the ₱14,700 (15,000- 300).

The perpetual inventory system DOES NOT use the purchase discount
account because it DOES NOT use the purchases account in the first place.
When the goods are acquired, the goods are automatically debited to
merchandise inventory account. The discount will be charged against the
merchandise inventory account since it is considered as a reduction from
the total value of the goods.

If the company paid beyond the 12-day discount period, there shall be NO
discount. The full amount due has to be paid.

SELLER’S POINT OF VIEW

1/9 Inventories costing ₱10,000 were sold at ₱15,000 on account, 2/12-n/30.

Periodic Inventory System

Accounts Receivable 15,000

Sales 15,000

Perpetual Inventory System

A.

Accounts Receivable 15,000

Sales 15,000

B.

Cost of Sales 10,000

Merchandise Inventory 10,000

As demonstrated in prior examples, the entries to record the sales and

accounts receivable or cash will be the same under both periodic and
perpetual inventory system. However, the perpetual system will has an
extra journal entry to reflect the outflow of the goods as a debit to cost of
sales and a credit to merchandise inventory.

1/17 Received full payment from the customer

Periodic Inventory System

Cash 14,700
Sales Discount 300
Accounts Receivable 15,000

Perpetual Inventory System

Cash 14,700
Sales Discount 300
Accounts Receivable 15,000

FABM1-009 Page 6 of 29
 Observe that both the periodic and perpetual inventory system have the
same journal entry in recording the full collection and the discount.

The perpetual and periodic inventory system both use the sales discount
account because both of them use the sales account. The sales discount is
placed opposite to the position of sales. If the buyer paid beyond the 12-
day discount period, there shall be NO discount to be given.

Trade Discounts

While cash discounts are offered to encourage prompt payment by the customers,
another form of discount is given to encourage trading. This is called the trade
discount. Unlike the cash discounts, trade discounts are not recorded on the books of
the buyer or the seller. It is simply deducted from the list price of the item being
sold/ bought to get the invoice price. The resulting invoice price is the figure that is
recorded on the books of the buyer and seller.

Examples:

a. List price ₱8,000

Trade discount 5%

In this case, we simply multiply ₱8,000 by 5% to get the ₱400 trade

discount. Then the ₱400 shall be deducted from the list price of ₱8,000 to
get the invoice price of ₱7,600. Only the invoice price is to be recorded by
the buyer as purchases/ merchandise inventory and sales for the seller.

A more simple way of getting the ₱7,600 is to multiply ₱8,000 by 95%.

b. List price ₱8,000

Trade discount 5%, 8%, 10%

This case involves a series of calculations by using all the three (3) discount
rates. It is shown below:
➢ 8,000 x 5% = 400; 8,000 - 400 = 7,600
➢ 7,600 x 8% = 608; 7,600 – 608 = 6,992
➢ 6,992 x 10% = 699.2; 6,992 - 699.2 = 6,292.8

The invoice price can be computed in a simpler way:

8,000 x 95% = 7,600
7,600 x 92% = 6,992
6,992 x 90% = 6,292.8 Invoice price

**the 95%, 92% and 90% are derived by deducting 5%, 8%, and 10% from
100% respectively.

Computation of Cost of Goods Sold and Gross Margin

Cost of Goods Sold

Cost of Goods Sold or Cost of Sales represents the value of goods already sold to
customers. This account is an expense and therefore deducted from the revenues in
computing for the net income/ net loss.

There would be no problem in computing for the Cost of Goods Sold when using the
Perpetual Inventory System since the account itself is reflected in the journal entries.

FABM1-009 Page 7 of 29
 You simply have to follow the flow of the account in the journal entries and in the
ledger/t-account. The total debits to this account minus its total credits will give you
the final balance.

When using the Periodic Inventory System, this would be the format for the
computation of Cost of Goods Sold (cost of sales):

Beginning Inventory xx
Add: Net Purchases
Purchases (gross) xx
Add:
Freight-in xx
Less:
Purchase Returns and allowances xx
Purchase Discounts xx xx
Net Purchases xx

Cost of Goods Available for Sale xx

Less: Ending Inventory xx

Cost of Goods Sold/ Cost of Sales xx

Gross Margin

Gross Margin or Gross Profit is the result AFTER deducting the cost of goods sold
from the net sales. This is the part of income BEFORE deducting the operating
expenses, finance charge and income tax. See the format below.

Sales (gross) xx
Less:
Sales Discount xx
Sales Returns and Allowances xx xx

Net Sales xx
Less:
Cost of Goods Sold/ Cost of Sales xx

Gross Profit xx

Example:

The records of ViRG Enterprises show the following:

Beginning Inventory ₱ 17,000

Purchases 40,000
Purchases Returns 8,000
Freight-in 5,000
Sales (gross) 69,000
Sales Discount 1,800

FABM1-009 Page 8 of 29
 The inventory count at the end of the accounting period determined the ending
inventory to be at ₱15,000. Determine the Cost of Goods Sold and compute for the
Gross Margin.

Solution:
ViRG Enterprises
Cost of Goods Sold Statement

Beginning Inventory 17,000

Add: Net Purchases
Purchases (gross) 40,000
Add:
Freight-in 5,000
Less:
Purchase Returns and allowances 8,000
Purchase Discounts 0 8,000
Net Purchases 37,000

Cost of Goods Available for Sale 54,000

Less: Ending Inventory 15,000

Cost of Goods Sold/ Cost of Sales 39,000

If there is NO beginning inventory, you may just proceed with the purchases.

Note the difference between “gross purchases” and “net purchases”. Gross
Purchases or simply “purchases” represent the amount of goods bought from
supplier BEFORE adding the freight charges paid (if any) and BEFORE deducting
any discounts and returns.

The Net Purchases account is the value of goods acquired AFTER adding the
freight charges paid (if any) and AFTER deducting any discounts and returns.

The Cost of Goods Available for Sale is the result AFTER adding the beginning
inventory and the net purchases. This represents the value of goods that the
seller CAN sell to the customers.

The ending inventory represents the REMAINING goods or the UNSOLD goods at
the end of the accounting period.

Logically speaking, if you deduct the value of the remaining/unsold goods from the
value of the goods that CAN BE sold (available for sale), it will result to the value of
the goods that are already SOLD. This is actually your Cost of Goods Sold or Cost
of Sales.

Take note that whether you use Periodic or Perpetual Inventory System, the
amount of Cost of Goods Sold will still be THE SAME.

FABM1-009 Page 9 of 29
 Gross Margin/ Gross Profit

Sales (gross) 69,000

Less:
Sales Discount 1,800
Sales Returns and Allowances 0 1,800

Net Sales 67,200

Less:
Cost of Goods Sold/ Cost of Sales 39,000

Gross Profit 28,200

Note the difference between “gross sales” and “net sales”. Gross Sales represent
the total value of income from selling of goods BEFORE deducting any sales returns
and sales discounts. The Net Sales is the opposite.

Freight

As discussed in the early part of this unit, freight is the cost associated with the delivery of
items purchased. This cost can be called freight-in or freight-out depending on which
party records it.

Freight-in is recorded by the buyer. This is an adjunct account and is considered as

capitalizable cost—meaning, it is added as part of the cost/value of the item for which it
was incurred. Since it is added to the cost of the asset purchased, it therefore belongs to the
debit side.

The freight-out account on the other hand is recorded by the seller and is treated as an
expense. Being an expense, it is placed on the debit side every time the seller incurs it. This
shall also be deducted from the revenues in computing for the net income or net loss.

11.5.1 Who Shoulders and Records the Freight?

This question can be answered by identifying first the shipping terms used. For
discussion purposes, we will only tackle the two (2) most basic shipping terms: FOB
Shipping Point and FOB Destination Point.

Under FOB Shipping Point, ownership of the goods is transferred to the buyer even if
they are still in transit (on the way). The buyer, being the owner of the goods while in
transit, should be the one to pay for the freight and should also record the same as
“freight in”.

On the other hand, ownership of the goods is transferred to the buyer when they
reach the destination under FOB Destination Point. This means that while the goods
are still in transit, ownership still belongs to the seller. The seller, being the owner
of the goods while in transit, should be the one to pay for the freight and should
record the same as “freight out”.

In reality, however, there are times that the other party ACTUALLY pays for the
freight instead of the supposed payor. With this, we have to go further by knowing
whether the freight is under “freight prepaid” or “freight collect”.

FABM1-009 Page 10 of 29
 Freight prepaid means that the freight cost is paid in advance to the courier even
before the goods are delivered. This means that it is the seller that ACTUALLY pays
for the shipping fee since it is the seller whom the courier meets first. The seller,
therefore, records a credit entry to cash account.

Freight collect means that the delivery/shipping cost is paid once the goods arrive to
the buyer. It is therefore the buyer that ACTUALLY pays for the freight. The buyer,
therefore, records a credit entry to cash account.

We can combine all these by having four (4) different scenarios:

➢ FOB Shipping Point (freight prepaid)
➢ FOB Shipping Point (freight collect)
➢ FOB Destination Point (freight prepaid)
➢ FOB Destination Point (freight collect)

Examples:

FOB Shipping Point (freight prepaid)

Books of the BUYER Books of the SELLER

Purchases 10,000 Accounts Receivable 12,000

Freight- in 2,000 Cash 2,000
Accounts Payable 12,000 Sales 10,000

The illustration uses FOB Shipping Point which means that the owner of the goods
while in transit is the BUYER. Since the buyer is the owner, it follows that the buyer
SHOULD be the one to pay and record the freight (freight-in). Furthermore, the case
also uses “freight prepaid” which tells us that the shipping fee was already paid in
advance—meaning, the seller made the payment to the courier.

In the entries above, notice that there is a debit entry to “freight-in” in the books of
the buyer. Since the buyer who is supposed to pay for the shipment did not do the
actual payment (freight prepaid), the ₱2,000 shipping fee increases his liability
(accounts payable) to ₱12,000 instead of having only ₱10,000.

Notice that there is a credit entry to “cash” in the books of the seller. This is so
because it is the seller that has made the payment to the courier. This situation
creates an additional receivable on the part of the seller—an increment of ₱2,000
making the total receivable ₱12,000 instead of only ₱10,000.

FOB Shipping Point (freight collect)

Books of the BUYER Books of the SELLER

Purcahses 10,000 Accounts Receivable 10,000

Freight- in 2,000 Sales 10,000
Cash 2,000
Accounts Payable 10,000

FABM1-009 Page 11 of 29
 The figure above uses FOB Shipping Point. This means that the buyer should pay
and record the freight (freight-in). This case is a bit different with the first one since
the second scenario uses freight collect which means that payment to the courier was
actually made by the BUYER.

In the journal entries, the buyer’s books show a credit entry of “cash” account with no
additional liability. This is so because the buyer who is supposed to pay for the
shipping fee also did the actual payment. Notice that the seller’s record shows no
credit entry for the “cash” account.

FOB Destination Point (freight prepaid)

Books of the BUYER Books of the SELLER

Purchases 10,000 Accounts Receivable 10,000

Accounts Payable 10000 Freight-out 2,000
Sales 10,000
Cash 2,000

Since the case uses FOB Destination (freight prepaid), the buyer’s books will only
reflect the purchase of the goods. The seller is the owner of the goods while in transit
and this is the reason that the seller should be the one to record and pay for the
freight (freight-out).

Notice that the records of the seller show a debit to freight-out account and a credit
to cash account. There’s not much of a problem in this case since the seller is the
party required to pay the courier and it is also the same that made the actual payment.

FOB Destination Point (freight collect)

Books of the BUYER Books of the SELLER

Purchases 10,000 Accounts Receivable 8,000

Accounts Payable 8,000 Freight-out 2,000
Cash 2,000 Sales 10,000

Under FOB Destination, the seller records the freight (freight-out) because
ownership of the goods while in transit still belongs to them. Notice the debit entry
for freight-out account on the seller’s books.

Since the case uses “freight collect”, the buyer ACTUALLY paid for the shipping cost.
That is why you can see a credit entry using cash account under the books of the
buyer. Considering that it is the seller who is supposed to pay for the freight but did
not actually paid for it, the payable of the buyer (receivable of the seller) will be
lessened by ₱2,000. So, instead of recording ₱10,000, only ₱8,000 is recorded.

FABM1-009 Page 12 of 29
Summary of topic/section

Topic General Description Revenue Account Used Expense Accounts Used

Merchandising business Buying and Selling Sales/ Sales Revenue * Cost of Sales or
of goods Cost of Goods Sold

* Freight-out
* All other expenses used under
service concern business

Topic General Description Recording

Periodic Inventory System * Uses physcial counting at the * Buyer uses purchases account
end of the period in the debit side when goods are
* Used by businesses with less bought.
volume of goods maintained * Buyer uses purchase returns
account on the credit side when
goods bought are returned to the
seller.

Perpetual Inventory System * Uses stock cards for monitoring * Buyer directly debits merchandise
inventory account when goods are
acquired.
* Buyer directly credits merchandise
inventory account when goods
bought are returned to the seller.
* Seller directly credits merchandise
inventory account when goods
are sold.
* Seller records cost of sales on the
debit side when goods are sold.

FABM1-009 Page 13 of 29
 Topic General Description Recording

Cash Discount * Used by sellers to encourage * Purchase discount on the books of

buyers to pay promptly the buyer (credit side)
* Given to customers upon full * Sales discount on the books of the
payment within the discount seller (debit side)
period

Trade Discount * Used by sellers to encourage * NOT recorded on either books

trading
* Computed by deducting a
certain percentage from the
list price to get the invoice price.

Topic General Description Recording Computation

Cost of Goods Sold or * Treated as an expense * Recorded by the seller * Follow the journal entries
Cost of Sales * Represents the value of the * Debited when goods are sold under when using Perpetual
goods already sold to the Perpetual Inventory System Inventory System.
buyers. * Shown as an adjustment under * Deduct the ending inventory
Periodic Inventory System from the cost of goods available
for sale under Periodic Inventory
System

Gross Profit or * That part of income after NA * Subtract the cost of sales from
Gross Margin deducting cost of sales from the net sales
the net sales revenue but before
subtracting any other expense.

Topic General Description Recording

Freight-in * Adjunct account . Added to * Recorded by the buyer on the

the cost of goods purchased. debit side.
Therefore, this will become
part of the cost of the
merchandise inventory.
* Represents delivery cost
of goods bought

Freight-out * Treated as expense by the * Recorded by the seller on the

seller. debit side
* Represents delivery cost of
goods sold .

FABM1-009 Page 14 of 29
Completing the Accounting Cycle for Merchandising Operations

Illustrative Problem

Below is the post-closing trial balance of VKA General Merchandise dated December
2019.

VKA General Merchandise

Trial Balance
December 31, 2019

PARTICULARS Debit Credit

Cash 195,600
Accounts Receivable 15,000
Allowance for Doubtful Accounts 1,500
Merchandise Inventory 13,500
Office Supplies 1,000
Land 1,000,000
Building 480,000
Accumulated Depreciation- Building 32,000
Furniture and Fixture 20,000
Accumulated Depreciation- Furniture and Fixture 2,000
Machinery 20,000
Accumulated Depreciation- Machinery 2,000
Accounts Payable 8,900
VKA, Capital 1,698,700
1,745,100 1,745,100

The following are transactions of VKA General Merchandise for the month of January,
2020.

1/2 Made credit purchases from RMG Trading for merchandise worth ₱50,000.
Term is 2/10-n/30.

1/3 Customers purchased goods costing VKA ₱9,400 with an aggregate selling
price of ₱12,220 on a cash basis.

1/5 Goods costing ₱5,800 were sold on cash basis at ₱7,540.

1/6 Inventories with a cost of ₱4,000 were sold on account to Gino Paul for
₱5,200. Term is 3/10-n/30.

1/8 Office supplies were bought from a supplier, ₱3,500 (on cash basis).

1/10 Collected the receivable from Gino Paul in full.

1/11 Made sales on cash basis for goods costing ₱8,500 for ₱11,050.

FABM1-009 Page 15 of 29
 1/13 Merchandise worth ₱5,500 were sold on account to Osang for ₱7,150. Term
is 2/10-n/30.

1/15 Paid the salaries of the store’s crews, ₱10,000.

1/16 Goods costing ₱1,000 and a selling price of ₱1,300 sold to Osang were
returned due to some damage.

1/18 A purchase (on account) was made for merchandise from Dapeh Marketing
in Cebu City worth ₱60,000. The goods were shipped FOB shipping point,
freight collect. Freight cost amounted to ₱4,000. Term is 3/10-n/30.

1/20 Made sales on a cash basis. The goods cost ₱4,100 and priced at ₱5,330.

1/21 Made full payment to RMG Trading.

1/22 Received the full payment from Osang.

1/25 Acquired additional merchandise from Gratcheyva on account, ₱12,000 with

a term of 2/10-n/30.

1/27 A third (1/3) of the goods bought from Gratcheyva was returned because of a
mismatch with the product description.

1/29 Paid utilities expenses worth ₱4,500.

1/30 Paid the salaries of the crews, ₱10,000.

Use the following additional information for adjustments:

a. Office supplies worth ₱500 were used.

b. Doubtful Accounts Expense for the month of January is ₱125
c. The furniture and fixture and machinery both have 10-year useful life with no
salvage value. They are depreciated using the straight line method. (round off)
d. The building has a salvage value of ₱96,000. It is depreciated over 12 years using
the straight line method. (round off)

REQUIREMENTS:

a. Prepare the journal entries for the above transactions (under both inventory
systems)
b. Post the entries to the ledger/ t-account
c. Prepare the unadjusted trial balance for the month of January
d. Prepare adjusting entries
e. Adjusted Trial Balance
f. Income Statement
g. Statement of Changes in Equity
h. Balance Sheet
i. Closing Entries
j. Post-closing Trial Balance

FABM1-009 Page 16 of 29
 ANSWERS:

a. Journal Entries

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

2-Jan Purchases 50,000 2-Jan Merchandise Inventory 50,000

Accounts Payable 50,000 Accounts Payable 50,000
3-Jan Cash 12,220 3-Jan Cash 12,220
Sales 12,220 Sales 12,220

Cost of Sales 9,400

Merchandise Inventory 9,400
5-Jan Cash 7,540 5-Jan Cash 7,540
Sales 7,540 Sales 7,540

Cost of Sales 5,800

Merchandise Inventory 5,800
6-Jan Accounts Receivable 5,200 6-Jan Accounts Receivable 5,200
Sales 5,200 Sales 5,200

Cost of Sales 4,000

Merchandise Inventory 4,000
8-Jan Office Supplies 3,500 8-Jan Office Supplies 3,500
Cash 3,500 Cash 3,500
10-Jan Cash 5,044 10-Jan Cash 5,044
Sales Discount 156 Sales Discount 156
Accounts Receivable 5,200 Accounts Receivable 5,200
11-Jan Cash 11,050 11-Jan Cash 11,050
Sales 11,050 Sales 11,050

Cost of Sales 8,500

Merchandise Inventory 8,500
13-Jan Accounts Receivable 7,150 13-Jan Accounts Receivable 7,150
Sales 7,150 Sales 7,150

Cost of Sales 5,500

Merchandise Inventory 5,500

FABM1-009 Page 17 of 29
15-Jan Salaries Expense 10,000 15-Jan Salaries Expense 10,000
Cash 10,000 Cash 10,000
16-Jan Sales Returns and Allowances 1,300 16-Jan Sales Returns and Allowances 1,300
Accounts receivable 1,300 Accounts receivable 1,300

Merchandise Inventory 1,000

Cost of Sales 1,000
18-Jan Purchases 60,000 18-Jan Merchandise Inventory 64,000
Freight-in 4,000 Accounts Payable 60,000
Accounts Payable 60,000 Cash 4,000
Cash 4,000
20-Jan Cash 5,330 20-Jan Cash 5,330
Sales 5,330 Sales 5,330

Cost of Sales 4,100

Merchandise Inventory 4,100
21-Jan Accounts Payable 50,000 21-Jan Accounts Payable 50,000
Cash 50,000 Cash 50,000
22-Jan Cash 5,733 22-Jan Cash 5,733
Sales Discount 117 Sales Discount 117
Accounts Receivable 5,850 Accounts Receivable 5,850
25-Jan Purchases 12,000 25-Jan Merchandise Inventory 12,000
Accounts Payable 12,000 Accounts Payable 12,000
27-Jan Accounts Payable 4,000 27-Jan Accounts Payable 4,000
Purchase Returns 4,000 Merchandise Inventory 4,000
29-Jan Utilities expense 4,500 29-Jan Utilities expense 4,500
Cash 4,500 Cash 4,500
30-Jan Salaries Expense 10,000 30-Jan Salaries Expense 10,000
Cash 10,000 Cash 10,000

***below are the computations of discount:

Jan 10: The selling price to Gino Paul was ₱5,200 and the discount was 3% within 10
days. Since the sales transaction originally happened last January 6 and payment was
made on January 10, Gino is entitled to a discount of ₱156. (5,200 x 3% = 156)

Jan 22: The original price of items sold to Osang was ₱7,150. However she returned
some goods with a price of ₱1,300 on January 16. This reduces her liability to ₱5,850.
Osang was able to pay within the discount period since she made the purchase on
January 13 and paid on January 22. Thus, we multiply ₱5,850 by 2%. (5,850 x 2% =
117)

FABM1-009 Page 18 of 29
 b. T-Accounts (for purposes of illustration, we will use the Perpetual Inventory
System)

Cash
Dr Cr
1-Jan Beginning Balance 195,600 8-Jan Purchase of suuplies 3,500
3-Jan Cash Sales 12,220 15-Jan Payment of salaries 10,000
5-Jan Cash Sales 7,540 18-Jan Payment for freight 4,000
10-Jan Collection with discount 5,044 21-Jan Payment of account 50,000
11-Jan Cash Sales 11,050 29-Jan Payment of utilities 4,500
20-Jan Cash Sales 5,330 30-Jan Payment of salaries 10,000
22-Jan Collection with discount 5,733
242,517 82,000
160,517

Accounts Receivable
Dr Cr
1-Jan Beginning Balance 15,000 10-Jan Collection of account 5,200
6-Jan Sales on account 5,200 16-Jan Sales returns 1,300
13-Jan Sales on account 7,150 22-Jan Collection of account 5,850
27,350 12,350
15,000

Allowance for Doubtful Accounts

Dr Cr
1-Jan Beginning Balance 1,500
1,500

Allowance for Doubtful Accounts

Dr Cr
1-Jan Beginning Balance 1,500
1,500

Merchandise Inventory
Dr Cr
1-Jan Beginning Balance 13,500 3-Jan Goods sold (at cost) 9,400
2-Jan Purchase on account 50,000 5-Jan Goods sold (at cost) 5,800
16-Jan Goods returned (at cost) 1,000 6-Jan Goods sold (at cost) 4,000
18-Jan Purchase on account 64,000 11-Jan Goods sold (at cost) 8,500
25-Jan Purchase on account 12,000 13-Jan Goods sold (at cost) 5,500
20-Jan Goods sold (at cost) 4,100
27-Jan Purcahses returns 4,000
140,500 41,300
99,200

Office Supplies
Dr Cr
1-Jan Beginning Balance 1,000
8-Jan Purchase on cash basis 3,500
4,500

FABM1-009 Page 19 of 29
 Land
Dr Cr
1-Jan Beginning Balance 1,000,000
1,000,000

Building
Dr Cr
1-Jan Beginning Balance 480,000
480,000

Accumulated Depreciation- Building

Dr Cr
1-Jan Beginning Balance 32,000
32,000

Furniture and Fixture

Dr Cr
1-Jan Beginning Balance 20,000
20,000

Accumulated Depreciation- Furniture and Fixture

Dr Cr
1-Jan Beginning Balance 2,000
2,000

Machinery
Dr Cr
1-Jan Beginning Balance 20,000
20,000

Accumulated Depreciation- Machinery

Dr Cr
1-Jan Beginning Balance 2,000
2,000

Accounts Payable
Dr Cr
21-Jan Payment of account 50,000 1-Jan Beginning Balance 8,900
27-Jan Purchase returns 4,000 2-Jan Purchase on account 50,000
18-Jan Purchase on account 60,000
25-Jan Purchase on account 12,000
54,000 130,900
76,900

VKA, Capital
Dr Cr
1-Jan Beginning Balance 1,698,700
1,698,700

FABM1-009 Page 20 of 29
 Sales
Dr Cr
3-Jan Cash sales 12,220
5-Jan Cash sales 7,540
6-Jan Sales on account 5,200
11-Jan Cash sales 11,050
13-Jan Sales on account 7,150
20-Jan Cash sales 5,330
48,490

Sales Returns and Allowances

Dr Cr
16-Jan Goods sold and returned 1,300
1,300

Sales Discount
Dr Cr
10-Jan Discount given 156
22-Jan Discount given 117
273

Salaries Expense
Dr Cr
15-Jan Salaries paid 10,000
30-Jan Salaries paid 10,000
20,000

Utilities Expense
Dr Cr
29-Jan Utilities paid 4,500
4,500

Cost of Sales
Dr Cr
3-Jan Goods sold (at cost) 9,400 16-Jan Goods sold & returned 1,000
5-Jan Goods sold (at cost) 5,800
6-Jan Goods sold (at cost) 4,000
11-Jan Goods sold (at cost) 8,500
13-Jan Goods sold (at cost) 5,500
20-Jan Goods sold (at cost) 4,100
37,300 1,000
36,300

**If the Periodic Inventory System is used, you have to follow the account titles used
under it for your t-accounts. Therefore, you will not use the Merchandise Inventory account
in your t-accounts. Instead, you will use Purchases, Purchases Returns and Allowances,
Purchase Discount and Freight-in. Furthermore, you will also not use the Cost of Sales/
Cost of Goods Sold. All other accounts under Periodic and Perpetual Inventory System will
be the same.

FABM1-009 Page 21 of 29
 c. Trial Balance (Unadjusted) – based on Perpetual Inventory System

VKA General Merchandise

Trial Balance
January 31, 2020

Particulars Debit Credit

Cash 160,517
Accounts Receivable 15,000
Allowance for Doubtful Accounts 1,500
Merchandise Inventory 99,200
Office Supplies 4,500
Land 1,000,000
Building 480,000
Accumulated Depreciation- Building 32,000
Furniture and Fixture 20,000
Accumulated Depreciation- Furniture & Fixture 2,000
Machinery 20,000
Accumulated Depreciation- Machinery 2,000
Accounts Payable 76,900
VKA, Capital 1,698,700
Sales 48,490
Sales Returns and Allowances 1,300
Sales Discount 273
Cost of Sales 36,300
Salaries Expense 20,000
Utilties Expense 4,500
1,861,590 1,861,590

Note that the process of preparing the trial balance under the merchandising concern
business does not differ from that of the service concern.

d. Adjusting Entries

Office Supplies Expense 500

Office Supplies 500

Doubtful Accounts Expense 125

Allowance for Doubtful Accounts 125

Depreciation Expense 3,001

Accumulated depreciation- Furniture and Fixture 167
Accumulated depreciation- Machinery 167
Accumulated depreciation- Building 2,667

FABM1-009 Page 22 of 29
**If the Periodic Inventory System is used, there are additional adjusting entries to be
recorded. These entries are to close the beginning inventory and to setup the ending
merchandise inventory since there is NO Merchandise Inventory account yet in the
records. The entries are done this way:

(1) Done only if there is beginning inventory

Income and Expense Summary xx

Merchandise Inventory, beginning xx

(2) To setup the ending inventory

Merchandise Inventory, end xx

Income and Expense Summary xx

The two (2) Income and Expense Summary accounts above will be closed to the capital
account during the preparation of the closing entries. The Merchandise Inventory, end
account will be reflected in the Adjusted Trial Balance.

***Below are the computations for depreciation:

Furniture and Machinery

(Cost – Salvage value) / 10 years = Annual Depreciation
(20,000 – 0) / 10 years = 2,000

Then, the ₱2,000 annual depreciation is multiplied by 1/12 to get the monthly
depreciation. We only get one month because the requirement is only for the month
of January and NOT for the whole year. (2,000 x 1/12 = 167)

Building
(Cost – Salvage value) / 12 years = Annual Depreciation
(480,000 – 96,000) / 12 years = 32,000

Then, the ₱32,000 annual depreciation is multiplied by 1/12 to get the monthly
depreciation. We only get one month because the requirement is only for the month
of January and NOT for the whole year. (32,000 x 1/12 = 2,667)

FABM1-009 Page 23 of 29
 e. Adjusted Trial Balance

VKA General Merchandise

Adjusted Trial Balance
January 31, 2020

Particulars Debit Credit

Cash 160,517
Accounts Receivable 15,000
Allowance for Doubtful Accounts 1,625
Merchandise Inventory 99,200
Office Supplies 4,000
Land 1,000,000
Building 480,000
Accumulated Depreciation- Building 34,667
Furniture and Fixture 20,000
Accumulated Depreciation- Furniture & Fixture 2,167
Machinery 20,000
Accumulated Depreciation- Machinery 2,167
Accounts Payable 76,900
VKA, Capital 1,698,700
Sales 48,490
Sales Returns and Allowances 1,300
Sales Discount 273
Cost of Sales 36,300
Salaries Expense 20,000
Utilties Expense 4,500
Office Supplies Expense 500
Depreciation Expense 3,001
Doubtful Accounts Expense 125
1,864,716 1,864,716

In the unadjusted trial balance of VKA, the Allowance for Doubtful Accounts only
had ₱1,500 on the credit side. Since the adjusting entries showed a credit entry of
₱125 to the said account, the ADJUSTED Trial Balance will show an increased
amount—₱1,625.

Originally, the Office Supplies account had a balance of ₱4,500 in the unadjusted
trial balance. Since the adjusting entries showed a credit entry of ₱500 that means
that it will be reduced by ₱500. Remember that office supplies belong to assets and
that assets decrease when they are credited. This is the reason why the ADJUSTED
Trial Balance shows office supplies at ₱4,000.

The Accumulated Depreciation account for building, machinery and furniture and
fixture had balances of ₱32,000, ₱2,000 and ₱2,000 respectively in the unadjusted
trial balance. Since the adjusting entry records credit entries for ₱2,667, ₱167 and
₱167 for the aforementioned assets, their respective accumulated depreciation
accounts will INCREASE by the same amount.

FABM1-009 Page 24 of 29
 Thus, in the adjusted trial balance, their respective accumulated depreciation
accounts show ₱34,667, ₱2,167, and ₱2,167. There is an increase because the
normal balance of accumulated depreciation is credit being a contra-asset account.

It has to be noted that the set of adjusting entries also show debit entries for Doubtful
Accounts Expense (₱125), Office Supplies Expense (₱500) and Depreciation
Expense (₱3,001). These accounts are nowhere to be found on the face of the
unadjusted trial balance. However, since they appear on the adjusting entries, they
shall be inserted on the ADJUSTED Trial Balance. They will be positioned on the
debit side because that is their normal balance.

For all the other accounts found on the UNADJUSTED Trial Balance but are not
affected by the adjustments, they will stay the same on the ADJUSTED Trial
Balance.

f. Income Statement

VKA General Merchandise

Income Statement
for the month ended January 31, 2020
(in Philippine Peso)

Gross Sales 48,490

Less:
Sales Discount 273
Sales Returns and Allowances 1,300 1,573
Net Sales 46,917
Less:
Cost of Sales 36,300

Gross Profit 10,617

Less: Operating Expenses

Salaries Expense 20,000
Utilities Expense 4,500
Office Supplies Expense 500
Depreciation Expense 3,001
Doubtful Accounts Expense 125 28,126

Net Loss -17,509

*** the resulting figure is a NET LOSS since the total expenses
exceeded the income.

The Sales Discount and Sales Returns are added to get ₱1,573. The sum is deducted
from the Gross Sales (₱48,490) to get the Net Sales (₱46,917).

The expenses are added to get ₱28,126. The sum is deducted from the Gross Profit
(₱10,617) to get the Net Income or Net Loss.

FABM1-009 Page 25 of 29
 g. Statement of Changes in Equity

VKA General Merchandise

Statement of Changes in Equity
for the month ended January 31, 2020
(in Philippine Peso)

VKA, Capital- January 1 1,698,700

Less: Net Loss 17,509

VKA, Capital- January 31 1,681,191

The NET Loss is deducted from the beginning capital. If the result of operation is a
Net Income, the amount is to be added.

If there is additional investment from the owner, the amount is to be added to the
beginning capital. If there are withdrawals, the same is to be deducted.

FABM1-009 Page 26 of 29
 h. Balance Sheet/ Statement of Financial Position

VKA General Merchandise

Statement of Financial Position
as of January 31, 2020
(in Philippine Peso)

ASSETS

Current Assets
Cash 160,517
Accounts Receivable 15,000
Allowance for Doubtful Accounts 1,625 13,375
Merchandise Inventory 99,200
Office Supplies 4,000
Total Current Assets 277,092

Non-current Assets
Land 1,000,000
Building 480,000
Accumulated Depreciation- Building 34,667 445,333

Furniture and Fixture 20,000

Accumulated Depreciation- Furniture and Fixture 2,167 17,833

Machinery 20,000
Accumulated Depreciation- Machinery 2,167 17,833
Total Non-current Assets 1,480,999

TOTAL ASSETS 1,758,091

LIABILITIES

Current Liabilities
Accounts Payable 76,900

TOTAL LIABILITIES 76,900

OWNER'S EQUITY/ CAPITAL

VKA, Capital 1,681,191

TOTAL OWNER'S EQUITY/CAPITAL 1,681,191

TOTAL LIABILITY and OWNER'S EQUITY 1,758,091

Remember that the allowance for doubtful accounts and accumulated depreciation
are contra-asset accounts. They are deducted from their related assets.

Note that the sum of total liabilities and total capital must be equal to the total
assets.

FABM1-009 Page 27 of 29
 i. Closing Entries

Sales 48,490
Income and Expense Summary 48,490

Income and Expense Summary 1,573

Sales Discount 273
Sales Returns and Allowances 1,300

Income and Expense Summary 64,426

Office Supplies Expense 500
Doubtful Accounts Expense 125
Depreciation Expense 3,001
Cost of Sales 36,300
Utilities Expense 4,500
Salaries Expense 20,000

VKA, Capital 17,509

Income and Expense Summary 17,509

**If the Periodic Inventory System is used, the Purchases, Purchase Returns and
Allowances, Purchase Discount and Freight-in shall also be closed by putting them on the
side opposite to their normal balance and paired with Income and Expense Summary
account. It is done this way (amounts are assumed):

Purchase Returns and Allowances 1,000

Purchase Discount 900
Income and Expense Summary 600
Freight-in 2,500

Remember that in making closing entries, you only need to close the nominal
accounts (temporary accounts). Any account not belonging to assets and contra-
assets, liabilities, and capital shall be closed and therefore reduced to zero (0).

Sales represent an income account (temporary account) with a normal credit

balance. To reduce it to zero, it must be placed on the debit side and paired with
Income and Expense Summary account.

The Sales Discount and Sales Returns and Allowances are accessory accounts of
Sales. Since the Sales account has already been closed, the same shall also be done
with the two. They have normal debit balances (opposite of Sales) so they will be
placed on the credit side upon closing and paired with Income and Expense
Summary account.

The expense accounts are also temporary accounts and therefore have to be closed.
Since their normal balance is on the debit side, they will be placed on the credit side
when closed and shall be paired with Income and Expense Summary account.

FABM1-009 Page 28 of 29
 After finishing the above mentioned closing entries, the Income and Expense
Summary account will have total credits of ₱48,490 and total debits of ₱65,999. If
you get the difference between the two balances, it will give you a debit balance of
₱17,509. This is so because the total debit amount is higher than the total credit
amount.

The debit balance of Income and Expense Summary account amounting to ₱17,509
actually represents the NET LOSS. In order to close such debit balance, the Income
and Expense Summary is placed on the credit side and is paired with a debit entry to
VKA, Capital. The capital account is debited because a net loss decreases the
capital (remember that capital account has a normal credit balance and will
therefore decrease once debited). Had the result been a NET INCOME, the last closing
entry would have opposite positions.

j. Post-Closing Trial Balance

VKA General Merchandise

Post-Closing Trial Balance
January 31, 2020

Particulars Debit Credit

Cash 160,517
Accounts Receivable 15,000
Allowance for Doubtful Accounts 1,625
Merchandise Inventory 99,200
Office Supplies 4,000
Land 1,000,000
Building 480,000
Accumulated Depreciation- Building 34,667
Furniture and Fixture 20,000
Accumulated Depreciation- Furniture & Fixture 2,167
Machinery 20,000
Accumulated Depreciation- Machinery 2,167
Accounts Payable 76,900
VKA, Capital 1,681,191
1,798,717 1,798,717

You will notice that the Post-Closing Trial Balance is relatively shorter than the
Adjusted Trial Balance. This happens because the nominal accounts (income and
expenses) have already been closed and are already reduced to zero. Since their
amounts are already zero, they are no longer included in the report.

References:

HBL Module by Chavez & Malquisto

********** Nothing Follows**********

FABM1-009 Page 29 of 29