Acctg1_ PDF Instruction Manual

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U�IT 1

I�TRODUCTIO� – Accounting and its Environment

Development of Accounting

The origin of keeping accounts has been traced as far back as 8500 B.C., the date archaeologists

have established for certain clay tokens found in modern Iraq. These tokens represented commodities and

were used in the Middle East to keep records. The tokens were often sealed in clay tablets called bullae,

which were broken on delivery so the shipment could be checked against the invoice; bullae, in effect, were

the first bills of lading. Later, symbols impressed on wet clay tablets replaced the tokens. Some experts

consider this stage of record keeping the beginning of the art of writing, which spread rapidly along the

trade routes and took throughout the known civilized world. Clay tablets, stones and wood devices were

used to record payment of services in temples in Babylonia as early as 2300 B.C. In 200 B.C., government

records of Roman Empire classified items under cash receipts as rent and interest while expenses included

wages, entertainment and sacrifices.

Accounting for private business in terms of ventures was an outgrowth of Italian commerce during

the 13th century. Loans to trading firms and investments of money by partners led to the development of

special records and reports which would show their respective interests. In 1494, an Italian monk named

Luca Pacioli included a section on bookkeeping in a mathematics textbook. This was the first printed

description of double entry bookkeeping.

As the culture, politics and economy of a country changes with time, accounting methods and

techniques had to be developed to meet these changes. Accounting standards setting bodies have been

formed to establish and improve accounting standards in many countries. In the Philippines, the

Accounting Standards Council (ASC) is given this task.

The ASC was created in November 18, 1981 by the Philippine Institute of Certified Public

Accountants. Its main function is to establish and improve accounting standards that will be generally

accepted in the Philippines. The approved statements of the ASC are known as Statements of Financial

Accounting Standards (SFAS). The approved SFAS and the related interpretations are submitted to the

Professional Regulation Commission for final approval so that it will become effective.

Forms of Business Organizations

Sole Proprietorship. This business organization has a single owner called the proprietor who

generally is also the manager. Sole proprietorships tend to be small service-type businesses and retail

establishments.

Partnership. A partnership is formed by two or more persons who agreed to contribute money,

property or industry to a common fund, with the intention of dividing the profits among themselves. Each

partner acts as an agent of the partnership in the absence of any agreement to the contrary.

Corporation. A corporation is a business owned by its stockholders. It is an artificial being

created by operation of law, having the rights of succession and the powers, attributes and properties

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expressly authorized by law or incident to its existence. The stockholders are not personally liable for the

corporation’s debts. The corporation is a separate legal entity.

Activities Performed by Business Organizations

Service companies perform services for a fee (e.g. law firms, accounting firms, stock brokerage,

barber shops, medical clinics).

Merchandising companies purchase goods that are ready for sale and then sell these to customers

(e.g. grocery stores, department stores, car dealers).

Manufacturing companies buy raw materials, convert them into products and then sell the

products to other companies or to final consumers (e.g. drug manufacturers, steel mills, car

manufacturers).

Definitions of Accounting

1. Accounting is a service activity. Its function is to provide quantitative information, primarily

financial in nature, about economic entities that is intended to be useful in making economic

decisions.

2. Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of the information.

3. Accounting is the art of recording, classifying and summarizing in a significant manner and in

terms of money, transactions and events which are, in part at least, of a financial character,

and interpreting the results thereof.

Phases of Accounting

1. Recording – is popularly known as journalizing. This involves the routine and mechanical

process of committing to writing business transactions and events on the books of accounts in

a chronological sequence in accordance with established accounting rules and procedures.

2. Classifying – involves the sorting or grouping of similar items into their respective kinds.

This is done through the process of posting the information from the journal to the ledger.

3. Summarizing – involves the determination of the balances of each account and the preparation

of financial statements.

4. Interpreting – is considered as the analytical phase of accounting.

Fundamental Concepts

1. Entity. The most basic concept in accounting. The transactions of different entities should

not be accounted for together. Each entity should be evaluated separately.

2. Periodicity. An entity’s life can be meaningfully subdivided into equal time periods for

reporting purposes. This concept allows the users to obtain timely information to serve as a

basis on making decisions about future activities.

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3. Stable Monetary Unit. The Philippine peso is a reasonable unit of measure and that its

purchasing power is relatively stable. It allows accountants to add and subtract peso amounts

as though each peso has the same purchasing power as any other peso at any time. This is the

basis for ignoring the effects of inflation in the accounting records.

Basic Principles

Accounting practices follow certain guidelines. The set of guidelines and procedures that constitute

acceptable accounting practice at a given time is GAAP, which stands for generally accepted accounting

principles.

1. Objectivity Principle. Accounting records are based on information that flows from activities

documented by objective evidence.

2. Historical Cost. This principle states that acquired assets should be recorded at their actual

cost and not at what management thinks they are worth as at reporting date.

3. Revenue Recognition Principle. Revenue is to be recognized in the accounting period when

goods are delivered or services rendered or performed.

4. Expense Recognition Principle. Expenses should be recognized in the accounting period in

which goods and services are used up to produce revenue and not when the entity pays for

those goods or services.

5. Adequate Disclosure. Requires that all relevant information that would affect the user’s

understanding and assessment of the accounting entity be disclosed in the financial

statements.

6. Materiality. Financial reporting is only concerned with information that is significant enough

to affect evaluations and decisions. Materiality depends on the size and nature of the item

judged in the particular circumstances of its omission.

7. Consistency Principle. The firms should use the same accounting method from period to

period to achieve comparability over time within a single enterprise. However, changes are

permitted if justifiable and disclosed in the financial statements.

The Accounting Profession

Accountancy qualifies as a profession because it possesses the following attributes:

1. All members of the accountancy profession are Certified Public Accountants (CPAs).

2. CPAs have their own body of language.

3. CPAs adhere to a Code of Professional Ethics promulgated by the Board of Accountancy.

4. Like other professions, CPAs are members of a national organization, the PICPA, whose role

is to ensure the continued improvement of the accountancy profession to meet the demands of

the times.

Accountants employed by a particular business firm or not-for-profit organization as chief accountant or

comptroller are engaged in private accounting. Accountants who render accounting services on a fee basis

are engaged in public accounting. A large number of accountants are employed by the government

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especially by the Commission on Audit and the Bureau of Internal Revenue. They are engaged in

government accounting.

Specialized Accounting Services:

1. Auditing

2. Cost Accounting

3. Financial Accounting

4. Internal Auditing

5. Government Accounting

6. Tax Accounting

7. Management Consulting

8. International Accounting

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Exercise 1-1: True or False

1. Accounting is a service activity. Its function is to provide qualitative information, about economic

entities that is intended to be useful in making economic decisions.

2. A partnership is always owned by two individuals.

3. From the accounting viewpoint, the sole proprietorship is generally distinct from its proprietor.

There are instances that the proprietor’s personal financial statements are considered in the sole

proprietorship.

4. Manufacturing companies buy raw materials, convert them into products and then sell the

products to other companies or to final consumers.

5. All members of the accountancy profession are Certified Public Accountants.

6. A business transaction is the occurrence of an event or of a condition that must be recorded.

7. In a proprietorship, the owner receives all profits, absorbs all losses and is solely responsible for

all debts of the business. From the accounting viewpoint, the sole proprietorship is distinct from

its proprietor. In effect, the accounting records of the sole proprietor may include the proprietor’s

personal financial records.

8. Classification reduces the effects of numerous transactions into useful groups or categories.

9. A corporation is a business owned by its stockholders.

10. Recording involves the sorting or grouping of similar items into their respective kinds. This is

done through the process of posting the information from the journal to the ledger.

11. Accountants who render accounting services on a fee basis are engaged in private accounting.

12. An entity’s life can be meaningfully subdivided into equal time periods for reporting purposes.

This concept allows the users to obtain timely information to serve as a basis on making decisions

about future activities. This is otherwise known as the Entity Concept of Accounting.

13. Revenue Recognition Principle states that acquired assets should be recorded at their actual cost

and not at what management thinks they are worth as at reporting date.

14. Summarizing involves the routine and mechanical process of committing to writing business

transactions and events on the books of accounts in a chronological sequence in accordance with

established accounting rules and procedures.

15. Accounting is often characterized as the “language of business”.

Exercise 1-2: Multiple Choice

1. The basic purpose of accounting is

a. To provide the information that the managers of an economic entity need to control

its operations.

b. To provide information that the creditors of an economic entity can use in deciding

whether to make additional loans to the entity.

c. To measure the periodic income of the economic entity.

d. To provide quantitative financial information about a business enterprise that is

useful in making rational economic decision.

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2. The entity concept means that

a. because a firm is separate and distinct from its owners, those owners cannot have

access to its assets unless the firm ceases to trade.

b. the financial affairs of a firm and its owner are always kept separate for the purpose

of preparing accounts.

c. accounts must be prepared for every firm.

d. none of the above.

3. The concept of accounting entity is applicable

a. whenever accounting is involved.

b. only to the legal aspects of business organizations.

c. only to the economic aspects of business organizations.

d. only to business organizations.

4. The consistency concept means that

a. when preparing the accounts of a firm, one should normally account for similar items

in the same way from one accounting period to the next

b. firms in the same industry must account for similar items in the same way

c. firms may never change the way in which they prepare their accounts

d. none of the above

5. Which accounting process is the recognition or non-recognition of business activities as

accountable events?

a. communicating

b. recording

c. identifying

d. measuring

6. The financial statements should be stated in terms of a common financial denominator.

a. accrual

b. going concern

c. stable monetary unit

d. time period

7. They encompass the conventions, rules and procedures necessary to define what is accepted

accounting practice.

a. accounting assumptions

b. accounting concepts

c. conceptual frameworks

d. generally accepted accounting principles

8. Accounting is a service activity. Its function is to provide

a. qualitative information

b. quantitative information

c. quantitative and qualitative information


9. Which of the following best describes the attributes of a partnership?

a. limited ability to raise capital, limited personal liability of owners

b. ability to raise large capital; unlimited personal liability of owners

c. limited ability to raise capital; unlimited personal liability of owners

d. ability to raise large amounts of capital; limited personal liability of owners

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10. Which of the following accounting concepts states that an accounting transaction should be

supported by sufficient evidence to allow two or more qualified individuals to arrive at

essentially similar conclusion?

a. matching

b. objectivity

c. periodicity

d. stable monetary unit

11. Proponents of historical costs maintain that in comparison with all other valuation alternatives

for general purpose financial reporting, statements prepared using historical costs are more

a. objective

b. relevant

c. indicative of the entity’s purchasing power

d. conservative

12. The principle of objectivity includes the concept of

a. summarization

b. classification

c. conservatism

d. verifiability

13. This principle requires relevant information to form part of financial statements for decision-

making purposes.

a. objectivity

b. materiality

c. adequate disclosure

d. accounting entity

14. Accountants employed by a particular business firm or not-for-profit organization, perhaps as

chief accountant, controller, or financial vice president, are said to be engaged in

a. general accounting

b. public accounting

c. private accounting

d. independent accounting

15. Accountants do not recognize that the value of the peso changes over time. This concept is

called the

a. stable monetary unit concept

b. going-concern concept

c. cost principle

d. entity concept

16. The periodicity concept

a. requires that all companies prepare monthly, quarterly and annual financial

statements

b. results from the BIR requirement that taxable income be reported on an annual basis

c. requires all companies to use a fiscal year ending December 31

d. involves dividing the life of a business entity into accounting periods of equal length

thus enabling the financial users to periodically evaluate the results of business

operations

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U�IT 2

The Framework

Scope and Purpose of the Framework

The framework deals with the objective of financial statements; the qualitative characteristics that

determine the usefulness of information in financial statements; the definition, recognition and

measurement of the elements from which financial statements are constructed; and concepts of capital and

capital maintenance.

The framework is concerned with general-purpose financial statements. Such financial statements

are prepared and presented at least annually and are directed toward the common information needs of a

wide range of users. Financial statements form part of the process of financial reporting.

The framework applies to the financial statements of all commercial, industrial and business

reporting enterprises, whether in the public or the private sectors.

Users and Their Information �eeds

1. Investors need information to help them determine whether they should buy, hold or sell.

2. Employees are interested in information about the stability and profitability of the their

employers.

3. Lenders are interested in information that enables them to determine whether their loans and

the related interest will be paid when due.

4. Suppliers and other trade creditors are interested in information that enables them to

determine whether amounts owing to them will be paid when due.

5. Customers have an interest in information about the continuance of an enterprise, especially

when they have a long-term involvement with, or dependent on, the enterprise.

6. Government and their agencies are interested in the allocation of resources and, therefore,

the activities of the enterprise.

7. Public. Enterprises affect members of the public in a variety of ways. Financial statements

may assist the public by providing information about the trends and recent developments in

the prosperity of the enterprise and the range of its activities.

Objective of Financial Statements

The objective of financial statements is to provide information about the financial

- position

- performance and

- changes in financial position

of an enterprise that is useful to a wide range of users in making economic decisions.

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Underlying Assumptions

1. Accrual Basis

The financial statements, except for the cash flow statement, are prepared on the accrual basis

of accounting in order to meet their objectives. Meaning, the effects of transactions and other

events are recognized when they occur and not as cash or its equivalent is received or paid.

They are recorded in the accounting records and reported in the financial statements of the

periods to which they relate.

The timing of cash flows is relatively immaterial for determining when to recognize revenues

and expenses. As when the business performs a service, makes a sale of goods or incurs an

expense, the accountant records the transaction in the books, whether or not cash has been

received or paid.

Generally accepted accounting principles require that a business use the accrual basis. This

means that the accountant records revenues as they are earned and expenses as they are

incurred.

2. Going Concern

The financial statements are normally prepared on the assumption that an enterprise is a going

concern and will continue in operation for the foreseeable future. Hence, it is assumed that

the enterprise has neither the intention nor the need to liquidate or curtail materially the scale

of its operations.

This assumption underlies the depreciation of assets over their useful lives. If an entity

expects to liquidate in the near future, its assets are valued at their worth at liquidation rather

than original cost.

Qualitative Characteristics of Financial Statements

1. Relevance. Information must be relevant to the decision-making needs of users.

Information has the quality of relevance when it influences the economic decisions of

users by helping them evaluate past, present or future events, or confirming, or

correcting, their past evaluations. The relevance of information is affected by its nature

and materiality. Information is material if its omission or misstatement could influence

the economic decisions of users taken on the basis of financial statements.

Principal ingredients of Relevance:

a) Confirmatory role – financial information has a confirmatory role when it is

used to confirm or correct the decision-maker’s earlier expectations. It is an

analysis of the relationship between predictions and outcomes. The

information is used to assess how well management has performed its

function by comparing its achievements with expectations.

b) Predictive role – financial information has a predictive role when it is used to

make predictions of, for instance, future cash flows or income. As when

historical information can be extrapolated to make predictions about the

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future. Information to be relevant, it should assist in either the confirmation

of past predictions or in the making of new predictions.

2. Reliability. Information has the quality of reliability when its free from material error

and bias and can be depended upon by users to represent faithfully that which it either

purports to represent or could reasonably be expected to represent.

Financial information will be enhanced by the following:

a) Faithful representation. To be reliable, the information must represent

faithfully the transactions and other events it either purports to represent or

could reasonably be expected to represent.

b) Substance Over Form. It is necessary that transactions and other events are

accounted for and presented in accordance with their substance and economic

reality, and not merely their legal form.

c) (eutrality. Free from bias. Financial statements are not neutral if, by the

selection or presentation of information, they influence the making of a

decision or judgment in order to achieve a predetermined result or outcome.

d) Prudence/Conservatism. It is the inclusion of caution in the exercise of

judgment needed in making the estimates required under conditions of

uncertainty, such that assets or income are not overstated and liabilities or

expenses are not understated. This attitude is often expressed in the statement

“to anticipate no profits and provide for all probable and estimable losses.”

e) Completeness. Information must be complete within the bounds of materiality

and cost. An omission can cause false or misleading information and thus be

unreliable and deficient.

3. Comparability. Users must be able to compare the financial statements of an enterprise

through time in order to identify trends in its financial position and performance. Users

must also be able to compare the financial statements of different enterprises in order to

evaluate their relative financial position, performance and changes in financial position.

4. Understandability. An essential quality of the information provided in financial

statements is that it is readily understandable by users. Users are assumed to have a

reasonable knowledge of accounting, business and its economic activities. They should

also have the willingness to study the information with reasonable diligence.

Constraints on Relevant and Reliable Information

1. Timeliness. Accounting information is communicated early enough to be used for the

economic decisions that it might influence. If there is undue delay in the reporting of

information, it may lose its relevance. Management may need to balance the relative

merits of timely reporting and the provisions of reliable information.

2. Balance between Benefit and Cost. The benefits derived from information should

exceed the cost of providing it. The evaluation of benefits and costs is, however,

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substantially a judgmental process. Initially, the costs are incurred by the preparers of the

information while the benefits are enjoyed largely by the users.

3. Balance between Qualitative Characteristics. In practice, a balancing or trade-off

between qualitative characteristics is often necessary in order to meet the objective of

financial statements. The relative importance of the characteristics in different cases is a

matter of professional judgment.

Elements of Financial Statements

1. The elements directly related to the measurement of financial position in the balance

sheet are:

a) assets

b) liabilities and

c) equity.

2. The elements directly related to the measurement of performance in the income

statement are:

a) income and

b) expenses.

3. The statement of changes in financial position usually reflects income statement

elements and changes in balance sheet elements.

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the balance sheet or income statement an item that meets the

definition of an element and satisfies the criteria for recognition. An item that meets the definition of an

element should be recognized if:

- it is probable that any future economic benefit associated with the item will flow to or

from the enterprise; and

- the item has a cost or value that can be measured with reliability.

Measurement of the Elements of Financial Statements

Measurement is the process of determining the monetary amounts at which the elements of financial

statements are to be recognized and carried in the balance sheet and income statement. This involves the

selection of the particular basis of measurement. This includes historical cost, current cost, realizable value

and present value. The measurement basis most commonly adopted by enterprises in preparing financial

statements is historical cost.

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Exercise 2-1: Matching Type

Match each numbered term with the letter of the category.

A. Elements of financial statements

B. Constraints

C. Factors of reliability

D. Principal qualitative characteristics

E. Underlying assumptions

F. Users of accounting information

1. Accrual

2. Understandability

3. Substance over form

4. Reliability

5. Liabilities

6. Comparability

7. Public

8. Neutrality

9. Investors

10. Relevance

11. Employees

12. Balance between qualitative characteristics

13. Customers

14. Suppliers

15. Assets

16. Timeliness

17. Government

18. Balance between benefit and cost

19. Equity

20. Going concern

21. Income

22. Prudence

23. Expenses

24. Completeness

25. Faithful representation


1. This accounting concept justifies the usage of accruals and deferrals?

a. stable monetary unit

b. going concern

c. consistency

d. materiality

2. The effect of the prudence concept is that

a. Similar items should be treated in a consistent way from one accounting period to the

next.

b. Losses should be provided for as soon as they are foreseen and profit should not be

recorded prematurely.

c. Net profit is the difference between revenues and expenses rather than the difference

between receipts and payments.

d. None of the above

3. If a business is not being sold or closed, the amounts reported in the accounts for assets used in the

business operations are based on the cost of the assets. This practice is justified by

a. going concern

b. accounting entity

c. time period

d. accrual

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4. The effects of transactions and other events are recognized when they occur and not as cash or its

equivalent is received or paid, and they are recorded and reported in the financial statements of the

periods to which they relate.

a. monetary unit

b. accrual

c. time period

d. going concern

5. It is the exercise of care and caution in dealing with uncertainties in measurement so as not to

overstate assets and income and not understate liabilities and expenses.

a. faithful representation

b. prudence

c. neutrality

d. completeness

6. The financial accounting information is directed toward the common needs of users and is

independent of presumptions about particular needs and desires of specific users.

a. neutrality

b. verifiability

c. completeness

d. relevance

7. In the event of conflict between the economic substance of a transaction and its legal form, the

economic substance shall prevail. This concept is known as

a. completeness

b. substance over form

c. faithful representation

d. form over substance

8. It is the quality of information that assures readers that the information is free from bias or error

and faithfully represents what it purports to show.

a. comparability

b. relevance

c. understandability

d. reliability

9. The attributes of relevance include all except

a. materiality

b. feedback value

c. neutrality

d. predictive value

10. It is the capacity of information to make a difference in decision by helping users evaluate past,

present or future events, or confirming, or correcting, their past evaluations.

a. reliability

b. relevance

c. comparability

d. understandability

11. Financial reporting is concerned only with information that is significant enough to affect

evaluation or decision.

a. materiality

b. cost and benefit

c. comparability

d. timeliness

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12. It is the ability to bring together for the purpose of noting similarities and dissimilarities.

a. comparability

b. understandability

c. reliability

d. relevance

13. The financial information must be comprehensible or intelligible if it is to be useful

a. understandability

b. comparability

c. reliability

d. relevance

14. The conceptual framework of accounting sets out certain essential characteristics of accounting

information. Which of the following is not an essential characteristic?

a. comparability

b. reliability

c. profit-oriented


15. It is the result of the standard of adequate disclosure.

a. substance over form

b. faithful representation

c. completeness

d. neutrality

16. Which of the following will not enhance the reliability of financial information?

a. prudence

b. completeness

c. faithful representation


17. What is the quality of reliability that supports the immediate recognition of a loss?

a. conservatism

b. neutrality

c. completeness

d. consistency

18. It is an independent private sector body with the objective of achieving convergence in the

accounting principles that are used by businesses and other organizations for financial reporting

around the world.

a. International Organization of Securities Commissions

b. International Accounting Standards Board

c. International Federation of Accountants.

d. Financial Accounting Standards Board

19. Financial reports communicated after an accounting decision has been made defeat the primary

purpose of which characteristic?

a. timeliness

b. conservatism

c. materiality

d. adequate disclosure

20. Historically, managers, investors and accountants have generally preferred that possible errors in

measurement be in the direction of understatement of net income and net assets.

a. application of judgment

b. approximation

c. conservatism

d. materiality

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21. Which users need financial information to enable them to determine whether their loans and the

related interest will be paid when due?

a. investors

b. suppliers

c. lenders

d. customers

22. The underlying assumptions which suggests the continuation of an accounting entity in the

absence of evidence to the contrary is

a. consistency

b. substance over form

c. going concern

d. accounting entity

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U�IT 3

The Accounting Equation and the Double-Entry System

Accounting Information System

Every business organization must have an accounting information system which will generate reliable

financial information needed by the decision-makers in a timely manner.

An accounting information system is the combination of personnel, records and procedures that a business

uses to meet its need form financial information.

Elements of Financial Statements

1. Financial Position (Balance Sheet)

a) Assets – are valuable resources owned by the entity. These are resources controlled

by the enterprise as a result of past events and from which future economic benefits

are expected to flow to the enterprise.

1. Current Assets

Cash

Cash Equivalents

Short-term Investments

Notes Receivable

Accounts Receivable

Inventories

Prepaid Expenses

2. �on-current Assets

Long-term Investments

Property, Plant and Equipment

Accumulated Depreciation

Intangible Assets

b) Liabilities - are obligations of the entity to outside parties who have furnished

resources. A liability is a present obligation of the enterprise arising from past

events, the settlement of which is expected to result in an outflow from the enterprise

of resources embodying economic benefits.

1. Current Liabilities

Accounts Payable

Notes Payable

Accrued Liabilities

Unearned Revenues

Current Portion of Long-Term Debt

2. �on-current Liabilities

Mortgage Payable

Bonds Payable

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c) Equity – is the residual interest in the assets of the enterprise after deducting all its

liabilities.

1. Capital

2. Withdrawals

3. Income Summary

#ote:

• In a sole proprietorship, there is only one owner’s equity account

because there is only one owner.

• In a partnership, an owner’s equity account exists for each partner.

• In a corporation, owner’s equity or stockholders’ equity consists of share

capital, retained earnings and reserves representing appropriations of

retained earnings among others.

2. Performance (Income Statement)

a) Income - is increases in economic benefits during the accounting period in the form

of inflows or enhancements of assets or decreases of liabilities that result in increases

in equity, other than those relating to contributions from equity participants. The

definition of income encompasses both revenue and gains.

1. Service Income

2. Sales

b) Expenses – are decreases in economic benefits during the accounting period in the

form of outflows or depletions of assets or incurrences of liabilities that result in

decreases in equity, other than those relating to distributions of equity participants.

The definition of expenses encompasses losses as well as those expenses that arise in

the course of the ordinary activities of the enterprise.

1. Cost of Sales

2. Salaries and Wages

3. Telecommunications, Electricity, Fuel and Water Expenses

4. Rent Expense

5. Supplies Expense

6. Insurance Expense

7. Depreciation Expense

8. Uncollectible Accounts Expense

9. Interest Expense

The Account

The basic summary device of accounting is the account. A separate account is maintained for

each element that appears in the balance sheet (assets, liabilities and equity) and in the income statement

(income and expenses). An account may be defined as a detailed record of the increases, decreases and

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balance of each element that appears in an entity’s financial statements. The simplest form of the account

is known as the “T” account because of its similarity to the letter “T”. The account has three parts:

Account Title (1)

Debit side (2) Credit side (3)

1. the title of the account

2. the space on the left side is called the debit side

3. the space on the right side is called the credit side

(ote: The amounts entered on the left side of the account are called debits or charges while the

amounts placed on the right side of the account are called credits.

The Accounting Equation

Assets are properties owned or controlled by the business. Rights or claims against the assets are

called equities. The relationship between assets and equities may be stated in the form of an equation as

follows:

ASSETS = EQUITIES

Equities is divided into two types: the equity of creditors called liabilities, and the equity of the

owner called capital. To give recognition to the two basic types of equities, the accounting equation is

expressed as:

ASSETS = LIABILITIES + CAPITAL

Owner’s equity or capital is the excess of total assets over total liabilities. Creditor’s claim (debts)

have priority over claims of the owner, thus, owner’s equity is considered residual. To give emphasis to the

residual claim of the owner or owners, the accounting equation may be expressed as follows:

ASSETS – LIABILITIES = CAPITAL

The Theory of Debit and Credit

The accounting equation states the fundamental relationship of the basic elements of accounting

stated as:

ASSETS = LIABILITIES + CAPITAL

The left side of the equation contains the assets while the right side contains the liabilities and

capital. This shows that assets are normally on the debit side while the liabilities and capital are normally

in the credit side. This would lead to another basic equation as follows:

DEBITS = CREDITS

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When a transaction occurs, it is recorded by debiting the value received and crediting the value

parted with. The value received is a debit while the value parted with is a credit. A minimum of two

accounts are affected in every business transaction and the sum of the debits is always equal to the sum of

the credits. This method of recording is known as double-entry bookkeeping.

DEBIT A�D CREDIT ACCOU�TS

Assets represent values owned. As assets are acquired, values are received, thus further debits.

Decrease in assets means values are given out, thus credit.

Liabilities are obligations to pay. These are values of promises given out, thus, credits. When a

liability is paid, the value of the promises given out is reduced or reacquired, thus a debit.

Capital represents the right given out by the business, thus a credit. Whenever the owner invests

some more, there are further credits to the account. If the owner withdraws assets for personal use, the

capital is reduced. But instead of debiting directly to the capital account, the drawing account is debited.

Revenue or income accounts are increases in the capital as a result of business operations.

Revenue represents services or goods given out, thus a credit.

Expenses are decreases in capital as a result of profit directed activities of the enterprise. They

imply services received, thus debits. Costs are decreases in capital resulting from the acquisition of goods

that were sold. Costs like purchases presupposes goods received, thus debits.

The rules of debits and credits and the normal balance of the various accounts are summarized

below:

ACCOU�T �ORMAL BALA�CE DEBIT CREDIT

Asset Debit Increase Decrease

Liability Credit Decrease Increase

Capital Credit Decrease Increase

Drawing Debit Increase Decrease

Revenue Credit Decrease Increase

Expenses Debit Increase Decrease

The rules of debits and credits are shown using T-accounts.

ASSETS LIABILITIES

DEBIT CREDIT DEBIT CREDIT

Increase Decrease Decrease Increase

20

DRAWING CAPITAL



EXPENSES REVENUE



Effects of Transactions in the Accounting Equation

Business transactions and events may result to changes in the values of the basic elements of the

accounting equation. The effects are summarized as follows:

1. Increase in assets accompanied by an increase in capital such as:

a. Original investment and additional investment by the owner. Source of Assets (SA)

b. Receipt of income. Source of Assets (SA)

2. Increase in assets accompanied by increase in liabilities. Source of Assets (SA)

3. Decrease in asset because of a decrease (payment) in liabilities. Use of Assets (UA)

4. Decrease in asset because of a decrease in capital due to

a. Withdrawal of the owner. Use of Assets (UA)

b. Expenses paid or incurred. Use of Assets (UA)

5. Increase in one asset account with a corresponding decrease in another asset account. Exchange

of Assets (EA)

6. Increase in one liability account with a corresponding decrease in another liability account.

Exchange of Claims (EC)

7. Increase in liability accompanied by a decrease in capital. Exchange of Claims (EC)

8. Decrease in liability accompanied by an increase in capital. Exchange of Claims (EC)

9. Increase in some forms of capital accounts accompanied by a decrease in other forms of capital

accounts. Exchange of Claims (EC)

Every accountable event has a dual but self-balancing effect on the accounting equation. Recognizing

these events will not in any manner affect the equality of the basic accounting mode.

21

The following illustration below, shows the effect of transactions in the accounting equation:

1. Tom Cruz invested P 50,000 cash to open a video rental business.

ASSETSASSETSASSETSASSETS ==== LIABILITIESLIABILITIESLIABILITIESLIABILITIES ++++ CAPITALCAPITALCAPITALCAPITAL

Cash = T. Cruz, Capital

50,000 = 0 + 50,000

Analysis: Increase in asset = Increase in capital (SA)

2. Tom Cruz invested an additional amount of P 25,000 cash.


Cash = T. Cruz, Capital

Bal. 50,000 = 0 + 50,000

+ 25,000 + 25,000

Bal. 75,000 0 + 75,000

Analysis: Increase in assets = Increase in capital (SA)

3. He purchased video tapes worth P 30,000.


Cash + Video Tapes = T. Cruz, Capital

Bal. 75,000 = 0 + 75,000

- 30,000 + 30,000

Bal. 45,000 + 30,000 0 + 75,000

Analysis: Decrease in one form of asset = Increase in another form of asset (EA)

4. He borrowed money from Tirso Cruise P 25,000.


Cash + Video Tapes = Accounts Payable + T. Cruz, Capital

Bal. 45,000 + 30,000 0 + 75,000

+25,000 + 25,000

Bal. 70,000 + 30,000 = 25,000 + 75,000

Analysis: Increase in asset = Increase in liabilities (SA)

5. Received P 15,000 as Income.



Bal. 70,000 + 30,000 = + 25,00 0 + 75,000

+15,000 +15,000

Bal. 85,000 + 30,000 = 25,000 + 90,000

Analysis: Increase in asset = Increase in capital (SA)

22

6. The business paid Tirso Cruise, P 10,000.



Bal. 85,000 + 30,000 = 25,00 0 + 90,000

- 10,000 - 10,000

Bal. 75,000 + 30,000 = 15,000 + 90,000

Analysis: Decrease in asset = Decrease in liabilities (UA)

7. Tom Cruz withdraw cash for personal use, P 6,000.



Bal. 75,000 + 30,000 = 15,00 0 + 90,000

- 6,000 - 6,000

Bal. 69,000 + 30,000 = 15,000 + 84,000

Analysis: Decrease in asset = decrease in capital (UA)

8. He issued a promissory note for the balance of his liability.


Cash + Video Tapes = Accts Payable + Notes Payable + T. Cruz, Capital

Bal. 69,000 + 30,000 = 15,000 + 84,000

- 15,000 + 15,000

Bal. 69,000 + 30,000 = 0 + 15,000 + 84,000

Analysis: Decrease in one form of liability = Increase in another form of liability (EC)

9. Paid P 4,000 for wages.


Cash + Video Tapes = Accts Payable + Notes Payable + T. Cruz, Capital

Bal. 69,000 + 30,000 = 0 + 15,000 + 84,000

- 4,000 - 4,000

Bal. 65,000 + 30,000 = 0 + 15,000 + 80,000

Analysis: Decrease in asset = Decrease in capital (UA)

23

Expanded Accounting Equation

A business entity is interested in transactions that result to either an increase or decrease in capital.

The increase may be due to the income derived from the profit-directed activities of the company or due to

an additional investment by the owner. If the increase is due to the income of the business, there is still a

need to analyze the transaction. Earning an income involves many activities such as purchasing, spending

and marketing. The businessman should verify the costs incurred in these activities in order to determine

the effectiveness of his operations. Furthermore, in order to determine the factors that resulted to the

increase or decrease in capital, the detailed composition of the capital section of the accounting equation

should be shown.

The capital account is affected by the following:

Capital originally invested. This increases the capital.

Additional investment. This also increases the capital.

Withdrawal. This decreases capital.

Revenue or income of the business. This increases the capital.

Expenses which include cost of merchandise and other expenses incident to its operations. These

decrease the capital since they are deductions from income.

The original equation of Assets = Liabilities + Capital may be expanded to include the detailed

composition of capital. It will be shown as follows:

ASSETS = LIABILITIES + [Original Investment + Additional Investment +

(Revenue – Expenses) – Withdrawal]

ACCOU�TI�G FOR BUSI�ESS TRA�SACTIO�S

Accountants observe many events that they identify and measure in financial terms. A business

transaction is the occurrence of an event or a condition that affects financial position and can be reliably

recorded.

Financial Transaction Worksheet

Every financial transaction can be analyzed or expressed in terms of its effects on the accounting equation.

The financial transactions will be analyzed by means of a financial transaction worksheet which is a form

used to analyze increases and decreases in the assets, liabilities or owner’s equity of a business entity.

Illustration. The following will show that when a specific asset, liability or owner’s equity item is created

by a financial transaction, it is listed in the financial transaction worksheet using appropriate accounts. A

notation on the right side of the owner’s equity or capital section of the accounting equation will show the

type of transaction.

24

1. Timothy Soi put up the Soi Laundromat with an investment of P200,000.

A S S E T S = LIABILITIES + CAPITAL

Cash = + T. Soi, Capital

1)

200,000

200,000 SA

2. He purchased laundry equipment costing P70,000.


Cash + Laundry = T. Soi, Capital

Equipment

Bal.

200,000

200,000

2)

(70,000)

70,000 EA

Bal.

130,000 +

70,000

200,000

3. He purchased for cash laundry supplies worth P5,000.


Cash + Laundry + Laundry T. Soi, Capital

Equipment Supplies

Bal.

130,000 +

70,000

200,000

3)

(5,000) +

5,000 EA

Bal.

125,000 +

70,000

+

5,000

=

200,000

4. Purchased additional laundry equipment on account from Samsung P20,000.


Cash + Laundry + Laundry = Accounts + T. Soi, Capital

Equipment Supplies Payable

Bal.

125,000 +

70,000

+

5,000

=

200,000

4)

20,000 =

20,000 SA

Bal.

125,000 +

90,000

+

5,000

=

20,000

+

200,000

5. Received cash P12,000 from customers for service rendered.




Bal.

125,000 +

90,000

+

5,000 =

20,000

+

200,000

5)

12,000

12,000 SA

Bal.

137,000 +

90,000

+

5,000 =

20,000

+

212,000

25

6. Paid P10,000 to Samsung.




Bal.

137,000 +

90,000 +

5,000

=

20,000 +

212,000

6)

(10,000)

(10,000) UA

Bal.

127,000 +

90,000 +

5,000

=

10,000 +

212,000

7. Timothy Soi invested additional cash to the business, P10,000.




Bal.

127,000 +

90,000 +

5,000 =

10,000 +

212,000

7)

10,000

10,000 SA

Bal.

137,000 +

90,000 +

5,000 =

10,000 +

222,000

8. Performed services to Vera Company. The value of service amounting to P13,000 will be paid on

a later date.


Cash + Laundry + Laundry + Accounts = Accounts + T. Soi, Capital

Equipment Supplies Rec'ble Payable

Bal.

137,000 +

90,000

+

5,000

=

10,000

+

222,000

8)

13,000

13,000 SA

Bal.

137,000

+

90,000

+

5,000

+

13,000

=

10,000

+

235,000

9. Paid the following expenses: Wages of employees, P4,000; Rent, P2,000; and Water & Electricity

P1,500.




Bal.

137,000

+

90,000

+

5,000

+

13,000

=

10,000

+

235,000

9)

(7,500)

(4,000) UA

(2,000) UA

(1,500) UA

Bal.

129,500

+

90,000

+

5,000

+

13,000

=

10,000

+

227,500

10. It was found out that P4,000 worth of supplies were used up.




Bal.

129,500

+

90,000

+

5,000

+

13,000

=

10,000

+

227,500

10)

(4,000)

(4,000) UA

Bal.

129,500

+

90,000

+

1,000

+

13,000

=

10,000

+

223,500

26

11. Timothy Soi withdrew P5,000 cash for personal use.




Bal.

129,500

+

90,000

+

1,000

+

13,000

=

10,000

+

223,500

11)

(5,000)

(5,000) UA

Bal.

124,500

+

90,000

+

1,000

+

13,000

=

10,000

+

218,500

Use of T-Accounts

Analyzing and recording transactions using the accounting equation is useful in conveying a basic

understanding of how transactions affect the business. However, it is not an efficient approach once the

number of accounts involved increases. Thus, a system of recording was developed to facilitate the

recording of transactions. The use of the account has been found beneficial. Before being recorded, a

transaction must be analyzed to determine which accounts must be increased or decreased. After this has

been determined, the rules of debit and credit are applied to effect the appropriate increases and decreases

to the accounts.

For exercise on the use of T-accounts in recording business transactions, use the transactions in the

illustration for the use of Financial Transaction Worksheet above. (otice that the same balances will be

arrived at for each of the accounts involved.

27


1. The accounting equation

a. is used to determine the amount of liabilities owed.

b. is used to determine the amount of income earned during the period.

c. shows the claims on the owner’s equity by the creditors.

d. shows the claims on the entity’s assets by both the creditors and owner.

2. Another way of stating the accounting equation is

a. Assets + Liabilities = Owner’s Equity

b. Assets – Liabilities = Owner’s Equity

c. Assets = Owner’s Equity – Liabilities

d. Owner’s Equity + Assets = Liabilities

e. Assets = Liabilities – Owner’s Equity

3. In the accounting equation, an increase in asset can be associated with

a. an increase in a liability

b. a decrease in owner’s equity

c. a decrease in a liability

d. an increase in another asset

4. The components of the balance sheet equation are

a. assets, income and owner’s equity

b. income, expenses and net income

c. investments, withdrawals and net income

d. assets, liabilities and owner’s equity

5. The following can be found in an income statement except

a. income

b. expenses

c. assets

d. net income or net loss

6. A current asset which includes coins, currencies and bank deposits is called

a. cash equivalents

b. cash

c. notes receivable

d. accounts receivable

7. Decrease in asset may

a. decrease another asset

b. increase capital

c. decrease liabilities

d. increase liabilities

8. When the proprietor withdraws cash or other assets, the withdrawal account is

a. debited

b. credited

c. debited and credited

d. not affected

9. All of the following affect the owner’s equity account except

a. original investment

b. additional investment

c. withdrawal by the owner

d. payment of liability

10. Withdrawals by the proprietor has all of the following effects except

a. reduction of total asset

b. reduction of owner’s equity

28

c. reduction of cash balance

d. reduction of net income for the period

11. The two sides of an account are called

a. debit and credit

b. revenue and expense

c. asset and liability

d. journal and ledger

12. Entries recorded on the right side of an account are called

a. debits

b. credits

c. increases

d. decreases

13. Credits are used to record

a. decreases in liabilities

b. decreases in owner’s equity

c. increases in revenue

d. increases in expenses

14. When cash is debited, a typical credit is to

a. withdrawal

b. expenses

c. accounts payable

d. accounts receivable

15. When office supplies is purchased on account, the credit is to

a. revenue account

b. an asset account

c. a liability account

d. an expense account

16. Which of the following is correct?

Assets Liabilities Capital

a. P7,850 P1,250 P6,600

b. P8,200 P2,800 P11,000

c. P9,550 P1,150 P8,200

d. P5,420 P6,540 P1,120

17. The purchase of a service vehicle on account

a. will increase asset and increase a liability

b. will increase asset and decrease a liability

c. will decrease equity

d. will decrease asset and decrease liability

18. The company collected in full an account receivable. Considering this transaction alone,

a. total assets will remain the same

b. total assets will increase

c. total assets will decrease

d. equity will increase

19. In recording transactions,

a. Assets, expenses, and drawing accounts are debited for increases.

b. The word “debit” means increase and the word “credit” means decrease.

c. Liabilities, revenue, and drawing accounts are debited for increases.

d. Assets, expenses, and capital accounts are debited for increases.

29

20. Which is false concerning the rules of debit and credit?

a. The left side of an account is always the debit side and the right side is always the credit

side.

b. The word “debit” means to increase and the word “credit” means to decrease.

c. Increases in assets and expenses are debit entries, and increase the liabilities, equity and

revenue are credit entries

d. The normal balance of any account appears on the side for recording increases.

Exercise 3-2 : Elements of Financial Statements

Assets Liabilities Capital

a. 626,600 376,240 ?

b. 760,000 360,000 ?

c. ? 108,000 760,000

d. 860,000 ? 592,000

e. ? 850,000 (200,000)

Required: Fill in the amount of the missing element of financial position.

Exercise 3-3: Elements of Financial Position

a. A water refilling company has assets of P700,000 and owner’s equity of P335,000.

b. A grocery store has liabilities of P450,000 and owner’s equity of P650,000.

c. A brokerage firm has assets of P340,000 and liabilities of P145,000.

d. A travel agency has liabilities of P170,000 and owner’s equity of P370,500.

e. A restaurant business has assets of P780,000 and liabilities of P250,000.

Required: Compute the amount of the missing element of financial position.

Exercise 3-4: Income and Expenses

Income Expenses �et Income/(Loss)

a. 840,000 ? 360,000

b. ? 1,800,000 (400,000)

c. 2,400,000 ? 540,000

d. ? 2,000,000 720,000

e. 1,300,000 860,000 ?

Required: Supply the missing element of performance.

Exercise 3-5: Income and Expenses

a. A medical practitioner has income of P560,000 and net income of P145,000.

b. An internet café business has expenses of P46,000 and net income of P98,000.

c. A small hotel business has expenses of P239,000 and a net loss of P15,000.

d. A forwarding company has income of P650,000 and net income of P230,000.

e. A cafeteria has income of P260,000 and a net loss of P54,000.

Required: In each of the preceding five situations, determine the amount of the missing element

of performance.

Exercise 3-6: Classification of Events

a. Received cash investment from the owner.

b. Paid cash on accounts payable.

c. Collected cash from accounts receivable.

30

d. Made cash distribution to the owner.

e. Paid cash for rent expense.

f. Invest cash in time deposit.

g. Purchased land with cash.

h. Performed services for clients on account.

i. Incurred operating expenses on account.

j. Performed services for cash.

Required: Indicate whether each of the above transactions is a Source of Assets (SA), Use of

Assets (UA), Exchange of Assets (EA), or Exchange of Claims (EC) transaction.

Exercise 3-7: Recording Transactions in a Financial Transaction Worksheet

On June 3, 2005, Jose Boni opened a VCD/DVD rental store, Boni Video, by investing P500,000 cash from

his savings account. During the month of June, the following transactions took place:

June 3 Acquired supplies on account, P50,000.

4 Acquired VCDs/DVDs costing P245,000, on account.

5 Paid P100,000 to creditors.

8 Received P75,000 cash from Biggy’s Video, a client, for rental fees.

11 Billed Movies & More Video for video rentals, P130,000.

16 Paid salaries, P69,000.

17 Collected P65,000 from Movies & More.

23 Boni withdrew P25,000 from the business.

24 Paid rent for the month, P37,000.

30 Paid utilities bill for the month, P15,000.

Required: Record the transactions for the month of June 2005 using a financial transaction

worksheet. Use the following accounts: Cash; Accounts Receivable; Supplies; VCDs/DVDs; Accounts

Payable; and Boni Capital.

Exercise 3-8: Effect of Transactions on the Accounting Equation

Jeyson Geron, after receiving his degree in Information Technology, started his own business, Geronskie

Technologies. He completed the following transactions during the month:

July 1 Deposited P90,000 in the bank and contributed a systems library valued at

P39,000 to start his business.

2 Paid office rent for the month, P3,600.

9 Acquired computer equipment for cash, P75,000.

10 Purchased computer supplies on credit, P6,000.

11 Received payment from a client for programming done, P30,000.

12 Billed a client on completion of a programming project, P8,200.


23 Received a partial payment from the client billed on July 12, P5,000.

27 Withdrew P3,000 for personal expenses.

30 Made partial payment on the supplies purchased, P2,500.

Required: Record the transactions for the month of July 2005 using the financial transaction

worksheet. Use the following accounts: Cash; Accounts Receivable; Computer Supplies; Computer

Equipment; Systems Library; Accounts Payable; and Geron, Capital. If the owner’s equity account is

affected by a transaction, identify it as revenue, expense, investment or withdrawal.

31

Exercise 3-9: Recording Transactions in T-Accounts

The accounts and transactions of Ruth Bagat, Systems Consultant, are shown below:

a. Invested P150,000 in cash to start the business.

b. Paid P7,500 for one month’s rent.

c. Bought office furniture for P26,000 in cash.

d. Performed services for P10,500 in cash.

e. Performed services for P12,750 on credit.

f. Bought a desktop computer for P55,000; paid 50% down, balance in 30 days.

g. Acquired a personal copier for P39,500 on credit; paid P9,500 cash, balance due in 30 days.

h. Received P7,000 from credit clients.

i. Bought additional office chairs for P8,000 on credit.

j. Issued a check for P32,500 to pay for salaries.

k. Performed services for P10,250 in cash.

l. Performed services for P11,500 on credit.

m. Collected P6,000 on accounts receivable.

n. Issued a check for P4,000 in partial payment of the amount owed for office chairs.

o. Paid P2,250 for the monthly telephone bill.

p. Paid P2,500 for the monthly electric bill.

q. Bagat withdrew P10,000 in cash for personal expenses.

Required:

1. With the aid of T-accounts, record the transactions listed above. Use the following accounts:

Cash; Accounts Receivable; Office Furniture; Office Equipment; Accounts Payable; Bagat,

Capital; Bagat, Withdrawals; Consulting Revenues; Salaries Expense; Rent Expense; Utilities

Expense and Miscellaneous Expense.

2. Determine the balances of the T-accounts.

Exercise 3-10: Recording Transactions in T-Accounts

Ethan Hunt withdrew P250,000 from his personal savings account on October 1, 2005, and deposited the

cash in an account for his newly established company, Hunt Carpet Cleaning Service. During the month of

October, the following transactions occurred:

Oct. 1 Paid monthly rent for office space, P25,000.

2 Acquired cleaning supplies on account, P45,000.

5 Acquired a service vehicle for P500,000 by issuing a note payable in that

amount, which will be due on Oct. 31, 2006.

6 Received cash in the amount of P120,000 for carpet cleaning services

rendered to the Days Hotel.

9 Paid P15,000 for cleaning supplies acquired on Oct. 2.

13 Billed clients P325,000 for carpet cleaning services rendered.

15 Paid utilities bill of P12,000.

16 Paid salaries of P64,000.

20 Received P215,000 cash from clients billed on Oct. 13.

23 Hunt withdrew P75,000 from the business.

Required: With the aid of T-accounts, record the transactions listed above. Use the following

accounts: Cash; Accounts Receivable; Cleaning Supplies; Service Vehicle; Notes Payable; Accounts

Payable; Hunt, Capital; Hunt, Withdrawals; Cleaning Revenues; Salaries Expenses; and Utilities Expenses.

32

U�IT 4

Recording Business Transactions

ACCOU�TI�G CYCLE The accounting cycle refers to a series of sequential steps or procedures performed to accomplish

the accounting process. The steps in the cycle are the following:

Step 1 Identification of Events to be Recorded

Step 2 Transactions are Recorded in the Journal

Step 3 Journal Entries are Posted to the Ledger

Step 4 Preparation of a Trial Balance

Step 5 Preparation of the Worksheet including Adjusting Entries

Step 6 Preparation of the Financial Statements

Step 7 Adjusting Journal Entries are Journalized and Posted

Step 8 Closing Journal Entries are Journalized and Posted

Step 9 Preparation of a Post-Closing Trial Balance

Step 10 Reversing Journal Entries are Journalized and Posted

This cycle is repeated each accounting period. The first three steps in the accounting cycle are

accomplished during the period. The fourth to the ninth steps generally occur at the end of the period. The

last step is optional and occurs at the beginning of the next period.

In the previous chapter, transactions were analyzed using its effect in the accounting equation and

also its effect I the different accounts by using T-accounts.

In actual practice, transactions are evidenced by business documents such as sales invoice, official

receipts, cash voucher, bank deposit slips, bank statements, checks, cash register tapes, purchase orders,

time cards,etc. Based on these documents, transactions are analyzed using the rules of the debit and credit.

They are then recorded in a journal and subsequently recorded in the ledger. These are known as the

recording phase of the accounting process.

The Journal

The journal is a chronological record of the entity’s transactions. A journal entry shows all the

effects of a business transaction in terms of debits and credits. Each transaction is initially recorded in a

journal rather than directly in the ledger. A journal is called the book of original entry. The nature and

volume of transactions of the business determine the number and type of journals needed. The general

journal is the simplest journal (see sample on the next page).

33

GE�ERAL JOUR�AL

Page 5

Date Description P.R. Debit Credit

2005

July 04 Cash 1 0 0 0 00

Sales 1 0 0 0 00

Cash sales for the day.

04

Advertising Expense 5 0 0 00

Cash 5 0 0 00

Advertisements in news.

Format

1. Date. The year and month are not rewritten for every entry unless the year or month changes

or a new page is needed.

2. Description. The account to be debited is entered at the extreme left of the first line while the

account to be credited is entered slightly indented on the next line. A brief description of the

transaction is usually made on the line below the credit. Generally, skip a line after each

entry.

3. P. R. (posting reference). This will be used when the entries are posted, that is, until the

amounts are transferred to the related ledger accounts. The posting process will be described

later.

4. Debit. The debit amount for each account is entered in this column.

5. Credit. The credit amount for each account is entered in this column.

Simple and Compound Entry

In a simple entry, only two accounts are affected—one account is debited and the other account credited.

However, some transactions require the use of more than two accounts. When three or more accounts are

required in a journal entry, the entry is referred to as a compound entry.

Transactions are Journalized

After the transaction or event has been identified and measured, it is recorded in the journal. The process

of recording a transaction is called journalizing. The rules of double-entry system are observed in each

transaction, that is, (1) two or more accounts are affected by each transaction; (2) the sum of the debits for

every transaction equals the sum of the credits; and (3) the equality of the accounting equation is always

maintained.

34

ILLUSTRATIO�: On July 1, 2005, after gaining enough experience in dressmaking, Sally Tabal, with

three sewers to assist her, opened the Sally Fashions. Transactions during the month will be used to

illustrate journalizing.

July 01

Analysis

Rules

Entry

Sally Tabal invested cash of P30,000 and four (4) brand new sewing machines

with a total cost of P120,000.

Cash, an asset account is increased. Sewing Machine, also an asset account, is

increased. Tabal, Capital, an owner’s equity or capital account, is also increased.

Increases in assets are recorded by debits. Increases in owner’s equity are

recorded by credits.

Debit Cash, debit Sewing Machine, credit Tabal, Capital.

Dr. Cr.

Cash 30,000

Sewing Machine 120,000

Tabal, Capital 150,000

July 01

Analysis

Rules

Entry

Purchased sewing supplies and materials for cash, P5,000.

Sewing Supplies, an asset account, is increased, Cash, also an asset account, is

decreased.

Increases in assets are recorded by debits. Decreases in assets are recorded by

credits.

Debit Sewing Supplies, credit Cash.

Dr. Cr.

Sewing Supplies 5,000

Cash 5,000

July 01

Analysis

Rules

Entry

Paid two months rent in advance, P6,000.

Prepaid rent, an asset account is increased. Cash, another asset account, is

decreased.


credits.

Debit Prepaid Rent, credit Cash.

Dr. Cr.

Prepaid Rent 6,000

Cash 6,000

July 5

Analysis

Rules

Entry

Completed sewing job from customers and received cash of P8,000.

Cash, an asset account, is increased. Service Fee, a revenue account, is increased.

Increases in assets are recorded by debits. Increases in revenues are recorded by

credits.

Debit Cash, credit Service Fee.

Dr. Cr.

Cash 8,000

Service Fee 8,000

35

July 08

Analysis

Rules

Entry

Bought additional sewing supplies on account, P3,000.

Sewing supplies, an asset account, is increased. Accounts Payable, a liability

account, is also increased.

Increases in assets are recorded by debits. Increases in liabilities are recorded by

credits.

Debit Sewing Supplies, credit Accounts Payable.

Dr. Cr.

Sewing Supplies 3,000

Accounts Payable 3,000

July 10

Analysis

Rules

Entry

Completed a sewing job from customers on account, P10,000.

Accounts Receivable, an asset account, is increased. Service Fee, a revenue

account, is also increased.


credits.

Debit Accounts Receivable, credit Service Fee.

Dr. Cr.

Accounts Receivable 10,000

Service Fee 10,000

July 12

Analysis

Rules

Entry

Received P6,000 for sewing job completed.

Cash, an asset account, is increased. Service Fee, a revenue account , is also

increased.


credits.

Debit Cash, credit Service Fee.

Dr. Cr.

Cash 6,000

Service Fee 6,000

July 13

Analysis

Rules

Entry

Paid bi-weekly wages of sewers, P5,400.

Wages Expense, an expense account, is increased. Cash, an asset account, is

decreased.

Increases in expenses are recorded by debits. Decreases in assets are recorded by

credits.

Debit Wages Expense, credit Cash.

Dr. Cr.

Wages Expense 5,400

Cash 5,400

36

July 15

Analysis

Rules

Entry

Received P3,000 from customers on account (refer to July 10 transaction).

Cash, an asset account, is increased. Accounts Receivable, an asset account, is

decreased.


credits.

Debit Cash, credit Accounts Receivable.

Dr. Cr.

Cash 3,000


July 18

Analysis

Rules

Entry

Sally Tabal withdrew P5,000 from the business for personal living expenses.

Tabal, Drawings, a drawing account is increased. Cash, an asset account, is

decreased.

Increases in drawings are recorded by debits. Decreases in assets are recorded by

credits.

Debit Tabal, Drawings, credit Cash.

Dr. Cr.

Tabal, Drawings 5,000

Cash 5,000

July 20

Analysis

Rules

Entry

Paid P2,000 for sewing supplies purchased on account (refer to July 8

transaction).

Accounts Payable, a liability account, is decreased. Cash, an asset account, is

decreased.

Decreases in liabilities are recorded by debits. Decreases in assets are recorded by

credits.

Debit Accounts Payable, credit Cash.

Dr. Cr.


Cash 2,000

July 27

Analysis

Rules

Entry

Paid bi-weekly wages to sewers, P5,400.

Wages Expense, an expense account, is increased. Cash, an asset account, is

decreased.


credits.

Debit Wages Expense, credit Cash.

Dr. Cr.

Wages Expense 5,400

Cash 5,400

37

July 30

Analysis

Rules

Entry

Received P5,000 cash from customer as down payment for 50 sets of high

school uniform to be delivered on August 15, 2005.

Cash, an asset account, is increased. Unearned Revenue, a liability account, is

increased.

Increases in assets are recorded by debits. Increases in liabilities are recorded by

credits.

Debit Cash, credit Unearned Revenue.

Dr. Cr.

Cash 5,000

Unearned Revenue 5,000

July 31

Analysis

Rules

Entry

Paid utility bills of P2,000.

Utilities Expense, and expense account, is increased. Cash, an asset account, is

decreased.


credits.

Debit Utilities Expense, credit Cash.

Dr. Cr.

Utilities Expense 2,000

Cash 2,000

The Ledger

A grouping of the entity’s accounts is referred to as a ledger. Although some firms may use

various ledgers to accumulate certain detailed information, all firms have a general ledger. A general

ledger is the “reference book” of the accounting system and is used to classify and summarize transactions,

and to prepare data for basic financial statements. The accounts in the general ledger are classified into two

groups:

1. balance sheet or permanent accounts (assets, liabilities and owner’s equity).

2. income statement or temporary accounts (income and expenses). Temporary or nominal

accounts are used to gather information for a particular accounting period. At the end of the period, the

balances of these accounts are transferred to a permanent owner’s equity account.

Each account has its own record in the ledger. Every account in the ledger maintains the basic

format of the T-account but offers more information (e.g. the account number at the upper right corner and

the journal reference column). Compared to a journal, a ledger organizes information by account.

38

CHART OF ACCOU�TS

In recording business transactions and events, the bookkeeper is usually guided by a chart of

accounts. A chart of accounts is a list of account titles classified or arranged according to the statements

wherein they appear. They agree with the order of the items in the balance sheet and income statements.

The number of accounts maintained for a particular business depends upon the nature of its

operations, the volume of transactions, and the extent to which details are desired.

Accounts in the chart of accounts are numbered to permit indexing and also for use as posting

references.

Below is an example of a chart of accounts. All numbers have two digits, the first digit indicates

the major division of the ledger in which the account is placed. Accounts beginning with 1 represent

assets; 2 liabilities; 3 capital; 4 revenue; and 5 expenses. The second digit indicates the position of the

account within its division.

CHART OF ACCOU�TS

BALANCE SHEET ACCOUNTS

Account (umber Account

1. ASSETS

11 Cash

12 Accounts Receivable

13 Sewing Supplies

14 Prepaid Rent

16 Sewing Machine

16A Accu. Depreciation-Sewing Machine

2. LIABILITIES

21 Accounts Payable

22 Wages Payable

23 Unearned Revenue

3. CAPITAL

31 Tabal, Capital

32 Tabal, Drawings

33 Income Summary

INCOME STATEMENT ACCOUNTS

4. REVENUE

41 Service Fee

5. EXPENSES

51 Wages Expense

52 Sewing Supplies Expense

53 Rent Expense

54 Depreciation Exp-Sew. Machine

55 Utilities Expense

�ORMAL BALA�CE OF A� ACCOU�T

The normal balance of any account refers to the side of the account—debit or credit—where increases are

recorded. Assets, owner’s withdrawal and expense accounts normally have debit balances; liability,

owner’s equity and income accounts normally have credit balances. This result occurs because increases in

an account are usually greater than or equal to decreases.

39

Posting

Posting means transferring the amounts from the journal to the appropriate accounts I the ledger. Debits in

the journal are posted as debits in the ledger, and credits in the journal as credits in the ledger. The steps

illustrated as follows:

1. Transfer the date of the transaction from the journal to the ledger.

2. Transfer the page number from the journal to the journal reference (J.R.) column of the

ledger.

3. Post the debit figure from the journal as debit figure in the ledger and the credit figure from

the journal as a credit figure in the ledger.

4. Enter the account number in the posting reference column of the journal once the figure has

been posted to the ledger.

The Journal

The Ledger

page 1

Date Description P.R. Debit Credit

2005

July 01 Cash 11

30,000

Sewing Machine 16

120,000

Tabal, Capital 31

150,000

Initial investment.

Account: Cash Account No. 11

Date Explanation J.R. Debit Credit Balance

2005

July 01 J-1

30,000

30,000

Account: Sewing Machine Account No. 16


2005

July 01 J-1

120,000

120,000

Account: Tabal, Capital Account No. 31


2005

July 01 J-1

150,000

150,000

40

LEDGER ACCOU�TS AFTER POSTI�G

After the end of an accounting period, the debit or credit balance of each account must be

determined to enable us to come up with a trial balance.

* Each account balance is determined by footing (adding) all the debits and credits.

* If the sum of an account’s debits is greater than the sum of its credits, the account has a debit

balance.

* If the sum of its credits is greater, that account has a credit balance.

Illustration: The ledger accounts of Sally Fashions after posting are shown below. The account numbers

and journal reference columns are purposely omitted. The balance of each account has been determined.

Cash Accounts Payable

July 01 30,000 July 01

5,000 July 20

2,000 July 08 3,000

05 8,000 01

6,000 Balance

1,000

12 6,000 13

5,400

15 3,000 18

5,000

30 5,000 20

2,000 Unearned Revenue

27

5,400 July 30 5,000

31

2,000 Balance 5,000

52,000

30,800

Balance 21,200

Tabal, Capital

July 01 150,000

Accounts Receivable Balance 150,000

July 10 10,000 July 15

3,000

Balance 7,000 Tabal, Drawings

July 18

5,000

Sewing Supplies Balance

5,000

July 01 5,000

08 3,000

Balance 8,000 Service Fee

July 05 8,000

10 10,000

Prepaid Rent 12 6,000

July 01 6,000 24,000

Balance 6,000 Balance 24,000

Sewing Machine Wages Expense

July 01 120,000 July 13

5,400

Balance 120,000 27

5,400

10,800

Balance

10,800

Utilities Expense

July 31

2,000

Balance

2,000

41

Trial Balance

The trial balance is a list of all accounts with their respective debit or credit balances. It is prepared to

verify the equality of debits and credits in the ledger at the end of each accounting period or at any time the

postings are updated.

The procedures in the preparation of a trial balance follow:

1. List the account titles in numerical order.

2. Obtain the account balance of each account from the ledger and enter the debit balances in the

debit column and the credit balances in the credit column.

3. Add the debit and credit columns.

4. Compare the totals.

The trial balance is a control device that helps minimize accounting errors. When the totals are equal, the

trial balance is in balance. This equality provides an interim proof of the accuracy of the records but it

does not signify the absence of errors. For example, if the bookkeeper failed to record payment of rent, the

trial balance columns are equal but in reality, the accounts are incorrect since rent expense is understated

and cash overstated. The trial balance for the illustration follows:

Sally Fashions

Trial Balance

July 31, 2005

Cash

21,200

Accounts Receivable

7,000

Sewing Supplies

8,000

Prepaid Rent

6,000

Sewing Machines

120,000

Accounts Payable

1,000

Unearned Revenue

5,000

Tabal, Capital

150,000

Tabal, Drawings

5,000

Service Fee

24,000

Wages Expense

10,800

Utilities Expense

2,000

180,000

180,000

42


1. The accrual basis of accounting recognizes

a. revenues when products are produced as part of operating activities

b. expenses when resources are consumed as part of operating activities

c. revenues when cash is received

d. expenses when cash is paid

2. The accounting cycle is

a. the length of time it takes to complete a set of financial statement after the books are

closed

b. a process that begins with adjusting entries and ends with the preparation of the financial

statements

c. applicable only to manual systems, not to computerized systems

d. the sequence of procedures used by a business to process economic information and to

produce financial statements

3. The primary function of an account in the accounting system is to

a. identify the type of organization

b. accumulate accounting information

c. determine at what point a transaction should be recorded

d. store accounting transactions until they re classified

4. The first step in the accounting cycle is to

a. record transactions in a journal

b. analyze transactions from source documents

c. post journal entries to general ledger accounts

d. adjust the general ledger accounts

5. The manner in which the accounting records are organized and employed within a business is

referred to as

a. accounting information system

b. business document

c. voucher system

d. special voucher

6. An account has two sides called the

a. debit and credit

b. asset and liability

c. income and expense

d. journal and ledger

7. Transactions are recorded chronologically in the

a. journal

b. T-account

c. Daybook

d. Ledger

8. The first step in recording a transaction in a journal is to

a. write an explanation

b. record the debit

c. record the date

d. record the credit

43

9. A journal entry composed of two or more debits or more credits is called a

a. multiple journal entry

b. compound journal entry

c. complex journal entry

d. double journal entry

10. A simple journal entry

a. consists of two debits and one credit

b. consists of one debit and two credits

c. is a memorandum entry

d. consists of one debit and one credit

11. What function do accounting journals serve in the accounting process?

a. Classifying

b. Summarizing

c. Recording

d. Reporting

12. The normal balance of an account is on the

a. debit side of the account

b. side represented by increases in the account balance

c. credit side of the account

d. side represented by decrease in the account balance

13. All of the following are assets except

a. unearned revenue

b. cash

c. equipment

d. inventory

14. When a customer buys services on credit, the contract is regarded as complete when

a. the services are rendered

b. the bill is presented

c. the cash payment is received

d. the date specified in the contract is at hand

15. A sale of merchandise on credit represents an exchange of goods for a promise of future payment.

This promise is

a. an asset

b. a liability

c. an increase in accounts payable

d. a revenue

16. Debits to expense accounts signify

a. increases in capital

b. increases in assets

c. decreases in capital

d. increases in liabilities

17. Credit to cash results to

a. an increase in owner’s equity

b. a decrease in assets

c. an increase in liabilities

d. an increase in income

44

18. Payment of insurance premiums in advance gives rise to

a. unearned income

b. prepaid expense

c. accrued income

d. accrued expense

19. The withdrawal account of a sole proprietorship is debited when

a. the owner invests cash

b. the owner withdraws cash

c. an expense is paid

d. a liability is paid

20. When cash is debited, a typical credit is to

a. accounts payable

b. accounts receivable

c. expenses

d. withdrawals

21. When owner’s equity decreases, one of the following must occur:

a. an asset increases

b. an income increases

c. a liability increases

d. withdrawals decreases

22. When an asset increases, one of the following must occur:

a. a liability decreases

b. owner’s equity decreases

c. an expense increases


23. The equality of debits and credits in the ledger should be verified at the end of each accounting

period by preparing

a. an accounting statement

b. an account verification report

c. a trial balance

d. a balance report

24. An entity’s trial balance

a. shows its financial position

b. establishes whether its accounting records are correct

c. lists all of the entries in its double-entry accounting records

d. is a list of all of the accounts with their respective debit or credit balances

25. Posting is the process of transferring information from the

a. journal to the trial balance

b. ledger to the financial statements

c. ledger to the trial balance

d. journal to the ledger

45

Exercise 4-2: Recording Transactions in T-accounts and Preparing a Trial Balance

Morty Garfa established the Garfa Data Encoders on March 15, 2005. The following transactions occurred

during the month:

a. Garfa invested P157,000 cash to establish the business.

b. Bought office desks and filing cabinet for cash, P15,150.

c. Garfa invested in the business her personal computer with a fair market value of P57,500.

d. Bought computer software for use in the business from Concept Computer for P39,000, paying

P15,000 down; the balance is due in thirty days.

e. Paid rent for the month, P5,300.

f. Received cash for services rendered, P5,160.

g. Ordered a panaflex sign for P9,000 from Royal Bright Enterprises, with a P5,000 as down

payment and he balance due when installed.

h. Received bill for advertising from Panay News, P3,230.

i. Bought print paper and stationery on account, P2,290.

j. Received and paid electric bill, P1,240.

k. Paid bill for advertising recorded previously in transaction (h).

l. Received cash for services rendered, P10,900.

m. Paid salaries to employees, P8,400.

n. Garfa withdrew cash for personal use, P4,500.

Required:

1. Establish the following T-accounts: Cash; Accounts Receivable; Supplies; Office

Equipment; Computer Software; Signage; Accounts Payable; Garfa, Capital; Garfa,

Withdrawals; Service Revenues; Salaries Expense; Advertising Expense; Rent Expense;

Utilities Expense and Miscellaneous Expense.

2. Record the transactions directly into the T-accounts using the alphabets to identify each

transaction.

3. Prepare trial balance.

Exercise 4-3: Recording Transactions in T-accounts and Preparing a Trial Balance

Lorna Gella recently established her own business, which she called Gella Delivery Service. During the

first month of business in August 2005, the following transactions were completed.

Aug. 01 Deposited P19,500 of personal savings in an account at the IC Development Bank in the

name of Gella Delivery Service.

02 Acquired a second-hand service vehicle costing P63,000, paying P7,000 in cash, and

Financing the remaining P56,000 by issuing a note payable.


05 Acquired supplies on account P6,200.

06 Paid for three months’ insurance and recorded prepaid insurance in the amount of P3,000.

08 Received P15,000 cash for delivery work done for the Avesco Corporation.

10 Acquired additional supplies for cash, P 4,000.


16 Completed as assignment for Pula Company and billed the company P13,000.

17 Paid P2,500 of the amount owed from the Aug. 05 transaction.

19 Paid miscellaneous expenses, P800.

21 Withdrew cash from the business for personal use P5,000.

22 Collected P8,000 on account from Pula Company.


25 Paid utilities expense, P1,200.

27 Billed the Lopez Corporation for delivery services rendered, P16,000.

Required:

1. Establish the following T-accounts: Cash; Accounts Receivable; Supplies; Prepaid Insurance;

Service Vehicle; Notes Payable; Accounts Payable; Gella, Capital; Gella, Withdrawals;

Delivery Revenues; Salaries Expense; Rent Expense; Utilities Expense; and Miscellaneous

Expense.

2. Record the transactions directly into the T-accounts, using the dates of the transactions to

identify each transaction.

3. Prepare trial balance.

46

Exercise 4-4: Journalizing, Posting and Preparing a Trial Balance

Gedion Sarasa opened a computer school. The following are his transactions for the first month (July

2005) of his operation:

July 01 G. Sarasa made an initial investment composed of the following:

Cash P 500,000

Books 50,000

Computers 1,200,000

Desks, Chairs and Tables 100,000

P1,850,000

01 Rented a building and paid rent for the month, P20,000.

02 Bought supplies for cash.

03 Purchase a mimeographing machine from BisMac for P40,000, paying P15,000 cash

and giving a notes payable for the balance.

10 Paid advertising, P10,000, and office expenses, P2,000.

11 Received P105,000 cash from tuition fees.


22 Borrowed P100,000 from Keppel Monte Bank, giving a promissory note.

23 Bought a van for business use, P350,000, paying P50,000 cash, and giving a promissory

note for the balance.

27 Received a bill from Goodwill Bookstore for library books acquired, P15,000.

28 Collected P35,000 cash from tuition fees.

29 Income collected and billed:

Cash collected from students P40,000

Tuition billed to student 60,000

30 Expenses paid for salaries and office, P15,000 and P3,000, respectively.

31 Bills received:

From Shell Gasoline Station for oil and fuel, P3,000

From Panay News, for advertisement for the month, P3,000

31 Paid Goodwill Bookstore, P11,000 cash, to apply on account.

Required:

A. Journalize and post to T-accounts the above transactions by using the chart of accounts given.

CHART OF ACCOUNTS

Assets Revenue

11 Cash 41 Tuition Fees

12 Notes Receivable

13 Accounts Receivable

14 Supplies

15 Library

16 Equipment

17 Furniture

18 Service Vehicle

Liabilities Expenses

21 Notes Payable 51 Rent Expense

22 Accounts Payable 54 Advertising Expense

56 Office Expense

57 Salaries Expense

58 Oil and Gas Expense

Capital

31 G. Sarasa, Capital

B. Prepare a trial balance.

47


Daisy Edrosolano Shooters completed the following transactions during October 2004:

Oct. 1 Edrosolano transferred cash from a personal account to an account to used for the

Business, P243,000.

3 Edrosolano invested in the business personal weapons having a fair market value

of P34,000.

4 Bought communication equipment on account from Centro Electronics, P13,740.


6 Bought a used service vehicle car for P93,000, paying P45,000 down, with the balance

due in thirty days.

9 Received invoice and paid insurance premium to Pioneer Insurance Co. for bonding

employees, P7,710.

12 Performed security services for MaryMart Mall. Billed MaryMart for services rendered,

P10,000.

16 Received bill from Makiuga Printers for office stationery, P1,500.

17 Billed Leyson Construction for services rendered, P14,500.

22 Paid Sheila Shell Service for gasoline for service vehicle, P900.

24 Performed security services at a rock concert. Billed organizers for services rendered,

P23,000.

27 Paid Centro Electronics P5,500 to apply on an account.

29 Received P10,000 from MaryMart Mall in full payment of account.

30 Billed GE Bank for services rendered, P26,000.

31 Received and paid telephone bill, P2,400.

31 Paid salaries to employees, P40,000.

31 Edrosolano withdrew cash for personal use, P15,000.

Required:

1. Prepare the journal entries for the October transactions.

2. Set up the following ledger accounts and post all the journal entries: Cash; Accounts Receivable;

Prepaid Insurance; Arms & Communication Equipments; Service Vehicle; Accounts Payable;

Edrosolano, Capital; Edrosolano, Withdrawals; Service Revenues; Salaries Expense; Rent

Expense; Supplies Expense; Gasoline Expense and Utilities Expense.

3. Prepare a trial balance.


Charlie Gaba recently established a business that will operate as Gaba Cleaning Service. The transactions

for February 2004 are presented below.

Feb. 1 Deposited P85,000 cash in a bank account in the name of the new company.

3 Acquired cleaning supplies on account, P24,000.

5 Acquired cleaning equipment on account, P16,000.

6 Acquired an old service vehicle costing P50,000 for the business, paying P10,000

cash, and financing the remaining P40,000 by issuing a note payable.

7 Paid rent on office space for the month, P7,300.

9 Received P31,800 cash for cleaning services rendered.

10 Paid for a newspaper advertisement, P1,500.

12 Paid for insurance for the next six months by recording prepaid insurance, P6,000.

13 Paid P8,000 on account.

14 Paid miscellaneous expenses, P2,500.

15 Billed customers P17,500 for cleaning services rendered.


48

Feb. 20 Received P8,500 from customers billed on Feb. 15.

22 Paid amount due on the note payable, P2,300.

25 Paid telephone expense, P1,100.


28 Billed customers for cleaning services rendered, P25,000.

28 Withdrew P9,800 from the business.

Required:

1. Prepare the journal entries for the February transactions.

2. Set up the following ledger accounts and post all the journal entries: Cash; Accounts Receivable;

Cleaning Supplies; Prepaid Insurance; Cleaning Equipment; Service Vehicle; Notes Payable;

Accounts Payable; Gaba, Capital; Gaba, Withdrawals; Cleaning Revenues; Salaries Expense; Rent

Expense; Advertising Expense; Telephone Expense; and Miscellaneous Expense.



Vic Gador is a painting contractor. During the month September, he completed the following transactions.

Sept. 2 Invested in the business painting equipment valued at P12,300 and placed P91,000 in

a business checking account.

3 Acquired a service vehicle costing P80,000. Paid P50,000 cash and signed a note for

the balance.

4 Purchased painting supplies on account for P3,200.

5 Completed a painting job and billed the customer P4,800.

7 Received P1,500 cash for painting an apartment room.

10 Purchased painting supplies for P1,600 cash.

11 Received a P4,800 check from the customer billed on September 5.

12 Paid P4,000 for an insurance policy for a one-year coverage.

13 Billed a customer P6,200 for a painting job.

14 Paid the assistant P1,500 for twenty-five hours’ work.

15 Paid P400 for a tune-up of the service vehicle.

18 Paid for the painting supplies purchased on September 4.

20 Purchased new ladder for P6,000 and painting supplies for P2,900, on account.

22 Received a telephone bill for P600, due next month.

23 Received P3,300 in cash from the customer billed on September 13.

24 Transferred P3,000 to a personal checking account.

25 Received P3,600 in cash for painting a two-room apartment.

27 Paid P2,000 on the note signed for the service vehicle.

29 Paid the assistant P1,800 for thiry hours’ work.

Required:

1. Prepare the journal entries to record the September transactions.

2. Set-up the following ledger accounts and post all the journal entries: Cash; Accounts Receivable;

Painting Supplies; Prepaid Insurance; Painting Equipment; Service Vehicle; Notes Payable;

Accounts Payable; Gador, Capital; Gador, Withdrawals; Painting Revenues; Wages Expense;

Utilities Expense; and Miscellaneous Expense.


49

U�IT 5

Adjusting the Accounts

Periodicity Concept

The only way to know how successfully a business has operated is to close its doors, sell

all the assets, pay the liabilities and return any excess cash to the owners. This process of

going out of business is called liquidation. This, however, is not a practical way of

measuring business performance.

Accounting information is valued when it is communicated early enough to be used for

economic decision-making. To provide timely information, accountants have divided the

economic life of a business into artificial time periods. This assumption is referred to as

the periodicity concept.

Accounting periods are generally a month, a quarter or a year. The most basic

accounting period is one year. Business firms however, differ in their choice of the

accounting year, it can be fiscal, calendar or natural. Some even uses the interim period.

Entities need periodic reports to assess their financial position and performance, and

periodicity concept sees to it that accounting information is reported at regular intervals.

This concept interacts with the revenue recognition and expense recognition principles to

underlie the use of accruals. To measure income in a fair manner, businesses update the

income and expense accounts immediately before the end of the period.

Revenue and Expense Recognition Principles

The process of measuring the performance of an entity requires that certain income and

expense transactions be allocated over several accounting periods. The adjustment

process relies on the revenue recognition and expense recognition principles. Revenue

should be recognized when earned. In most instances, revenue is earned in the

accounting period when the services are rendered or the goods sold are delivered. On the

other hand, expenses are recognized in the income statement when it is probable that a

decrease in future economic benefits related to a decrease in an asset or an increase of a

liability has arisen, and that the decrease in economic benefits can be measured reliably.

The expense recognition principle has actually three broad applications, that expenses are

recognized in the income statement (1) on the basis of direct association; (2) on the basis

of systematic and rational allocation; and (3) immediately.

50

Adjusting the Accounts

An accounting period by definition must end on a particular day. On that day, the

balance sheet must contain all assets and liabilities as of the end of that day. Although a

business is recognized as a continuous process, there must be a cut off period. Some

transactions invariably span the cut off period, and as a result some of the accounts need

adjustment.

The Adjustment Process

Adjusting entries are entries made at the end of the accounting period to correct or

upgrade the account to be able to portray realistic financial statements. They have at least

one balance sheet account entry and at least one income statement account entry. They

are needed when deferrals or accruals exist.

A deferral is the postponement of the recognition of an expense already paid or of a

revenue already received. Deferrals would be needed in the following two cases:

1. There are costs recorded that must be apportioned between two or more

accounting periods. Examples are the cost of the building, prepaid insurance and

supplies.

2. There are revenues recorded that must be apportioned between tow or more

accounting periods. An example is commissions collected in advance for services to be

rendered in later periods.

An accrual is the recognition of an expense or revenue that has arisen but has not been

recorded. Accruals would be required in the following two cases:

1. There are unrecorded revenues. An example is commissions earned but not

yet collected or billed to customers.

2. There are unrecorded expenses. An example is the wages earned by

employees in the current accounting period but after the last pay period.

To illustrate this process, let us again use the transactions for Sally Fashions.

Apportioning Recorded Costs Between Two or More Accounting Periods

(Deferrrals)

Companies often make expenditures that benefit more than one period. These

expenditures are generally debited to an asset account. At the end of the accounting

period, the amount that has been used up in the period is transferred from the asset

account to an expense account. Two of the most important kinds of adjustments are

prepaid expenses and depreciation of property, plant & equipment.

51

PREPAID EXPE�SES

Some expenses are customarily paid in advance. These expenditures are called prepaid

expenses. Among these items are rent, insurance, and supplies. At the end of the

accounting period, a portion (or all) of these goods or services most likely will have been

used up or will have expired. The part of the expenditure that has benefited current

operations is treated as an expense of the period. On the other hand, the part not

consumed or expired is treated as an asset that applies to the future operations of the

company. If the adjusting entries for the prepaid expenses are not made at the end of the

month, both the balance sheet and the income statement will be stated wrong. First, the

assets of the company will be overstated, and second, the expenses of the company will

be understated. For this reason, owner’s equity on the balance sheet and the net income

will be overstated.

At the beginning of the month, Sally Fashions paid two months rent in advance. This

expenditure resulted in an asset consisting of the right to occupy the office for two

months. As each day in the month passes, part of the asset expires and becomes a cost or

expense. By July 30, one-half had expired, and should be treated as an expense. The

analysis of this economic event is shown below:

Prepaid Rent (adjustment a)

Transaction: Expiration of one month rent.

Analysis : Prepaid Rent, an asset is decreased. Rent Expense, an expense is

increased.

Rule : Debit to increase an expense, credit to decrease an asset.

Entry : Debit Rent Expense, credit Prepaid Rent.

The Prepaid Rent account now has a balance of P3,000 which represents one

month rent paid in advance. The rent expense account reflects the P3,000 expense of the

month.

Early in the month, Sally Fashions purchased sewing supplies. As Sally Fashions

did sewing jobs for various customers during the month, sewing supplies were consumed.

There is no need to account for these supplies every day, because the financial statements

are not prepared until the end of the month, and the record keeping would involve too

much work.

Instead, Sally Tabal makes careful inventory of the sewing supplies at the end of

the month. This inventory records the quantity and the cost of those supplies that are still

assets of the company—yet to be consumed. The inventory shows that the sewing

supplies costing P3,500 are still on hand. This means that of the sewing supplies of

P8,000 purchased during the month, P4,500 worth were used up or became an expense.

These transaction is analyzed and recorded as follows:

Prepaid Rent Rent Expense

7/1 6,000 7/30 3,000 67/30

3,000

52

Sewing supplies (Adjustment b)

Transaction: Consumption of sewing supplies.

Analysis : Sewing Supplies, an asset account, is decreased.

Sewing Supplies Expense, an expense account, is increased.

Rule : Credit to decrease an asset, debit to increase an expense.

Entries : Debit Sewing Supplies Expense,

Credit Sewing Supplies.

Sewing Supplies Sewing Supplies Expense

7/01 6,000 7/30 4,500 7/30

4,500

7/08 3,000

The asset account, Sewing Supplies, now reflects the proper amount of P3,500,

yet to be consumed. In addition, the amount of sewing supplies used during the

accounting period is reflected as P4,500.

DEPRECIATIO� OF PLA�T A�D EQUIPME�T

When the company buys a long lived asset such as building, equipment, trucks,

automobiles, computers, store or office fixtures, it is basically buying or prepaying for the

usefulness of that asset for as long as the asset provides a benefit to the company. Proper

accounting therefore requires the allocation of the cost of the asset over its estimated

useful life. The amount allocated to any one accounting period is called depreciation or

depreciation expense. Depreciation is an expense just like any other cost incurred during

an accounting period to obtain revenue.

It is often impossible to tell how long an asset or how much of the asset is used in

any one period. For this reason, depreciation must be estimated. Accountants have

developed a number of methods for estimating the depreciation and for dealing with other

complex problems concerning it.

To illustrate a simple example on this, supposing that Sally Fashions estimates

that the sewing machine will last for ten years (120 months) and will be worthless at the

end of that time. The depreciation of the sewing machine is computed at P1,000 or

(P120,000/120 months). This amount represents the cost allocated for the month, thus

reducing the asset account and increasing the expense account.

Sewing Machine (Adjustment c)

Transaction: Recording depreciation expense.

Analysis : Asset is decreased. Owner’s equity is decreased by increasing

the expense account.

Rule : Credit to decrease an asset, debit to decrease owner’s equity or

increase expense.

53

Entries : Owner’s equity is decreased by debit to Depreciation Expense—

Sewing Machine. Asset is decreased by credit to a contra-asset

account, Accumulated Depreciation—Sewing Machine.

Sewing Machine Accum. Depr.-Sewing Machine Depr. Exp.-Sewing Machine

7/01

120,000 7/30

1,000 7/30

1,000

Accumulated Depreciation – A Contra Account

In the analysis on adjustment c, the asset account was not credited directly. Instead, a

new account Accumulated Depreciation, is used. Accumulated Depreciation account is a

contra-asset account used to accumulate the total past depreciation on a specific long-

lived asset. It is called contra-account because it represents a balance that is subtracted

from the balance of an associated account. In this case, the balance of Accumulated

Depreciation—Sewing Machine, is a deduction from the associated account Sewing

Machine. After the adjusting entry has been made, the plant and equipment section of the

balance sheet for Sally Fashions would appear as:

Plant and Equipment:

Sewing Machine P 120,000

Less: Accumulated Depreciation 1,000 P 119,000

The contra account is used to recognize that depreciation is an estimate and it preserves

the fact of the original cost of the asset and shows how much of the asset has been

allocated to expense as well as the balance left to be depreciated. As time passes by

(usually on a monthly basis), the amount of the accumulated depreciation will grow, and

so the net amount shown as an asset will be reduced. In five months, for instance,

Accumulated Depreciation—Sewing Machine, will have a total of P5,000; when this

amount is subtracted from Sewing Machine, the net amount of P 115,000 will remain,

referred to as the net book value of the asset.

Apportioning Recorded Revenues Between Two or More Accounting Periods

(Deferrals)

Just as costs may be paid and recorded before they are used up, revenues may be

received before they are earned. When such revenues are received in advance, the

company has an obligation to deliver goods or perform services. Therefore, unearned

revenues would be a liability account. For example, publishing companies usually

receive payment for magazine subscriptions in advance. These payments must be

recorded in a liability account. If the company fails to deliver the magazine it has the

obligation to return the advance payment received from its customers. Upon delivery of

the magazines, weekly or monthly, it earns part of the Subscription Revenue account.

54

On July 30, Sally Fashions received P 5,000 cash from a customer as down

payment for a sewing job to be delivered on August 15. Since no service has been

rendered yet, the down payment is treated as unearned revenue. On August 15, when the

sewing job is completed, the Unearned Revenue will be transferred to Service Fee (an

earned revenue account).

U�RECORDED OR ACCRUED REVE�UES (Accruals)

Unrecorded or accrued revenues are revenues for which the service has been

performed of the goods delivered but for which no entry has been recorded in the

account. Any revenues that have been earned but not recorded during the accounting

period call for an adjusting entry that debit an asset account and credits a re revenue

account. For example, the interest on a note receivable is earned day by day but may not

in fact be received until another accounting period. Interest Revenue should be credited

and Interest Receivable be debited for the interest accrued at the end of the current

period.

U�RECORDED OR ACCRUED EXPE�SES (Accruals)

At the end of the accounting period, there are usually expenses that have been

incurred but not recorded in the account. These expenses require adjusting entries. One

such case is borrowed money. Each day interest accumulates on the debt, and it is

necessary to use an adjusting entry at the end of each accounting period to record the

accumulated interest, which is an expense to the period, and the corresponding liability to

pay the interest. Other comparable expenses are taxes, wages, and salaries. As the

expense and the other corresponding liability accumulate, they are said to accrue—hence,

the term accrued expenses.

Suppose that the calendar appears as shown in the following illustration:

SU# MO# TUE WED THU FRI SAT

1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30 31

By the end of business on July 31, the Sally Fashions sewers will have worked

three days (Monday, Tuesday and Wednesday) beyond the last biweekly pay period

which ended on July 27. The sewers have earned their wages for these days, but it is not

due to be paid until the regular payday in August. The wages for these three days is

rightfully an expense for July, and the liabilities should reflect the fact that the company

does owe the sewers for those days. Because the daily wage rate of the three sewers is

P150 a day, the expense for three days is P 1,350 or (P150 x 3x 3).

55

Unrecorded or Accrued Wages (Adjustment d)

Transaction: Accrual of unrecorded expense.

Analysis : Wages expense is increased. Wages payable, a liability account

Account, is increased.

Rule : Debit to increase an expense, credit to increase a liability.

Entry : Debit Wages Expense, credit Wages Payable.

The liability account of P1,350 is now correctly reflected in the Wages Payable

account. The actual expense incurred for the wages during the month is also correct at

P12, 150.

Wages Expense Wages Payable

7/13

5,400 7/31

1,350

7/27

5,400

7/31

1,350

56

Exercise 5- 1: True of False

1. If all transactions were originally recorded in conformity with GAAP, there would

be no need for adjusting entries at the end of the period.

2. When the reduction in prepaid expenses is not properly recorded, this causes the

asset accounts and expense accounts to be understated.

3. Accumulated depreciation accounts may be referred to as contra-asset accounts.

4. The adjustment to record depreciation of property and equipment consists of a

debit to depreciation expense and a credit to accumulated depreciation.

5. The amount of accrued revenues is recorded by debiting an asset account and

crediting and income account.

6. Acquiring a computer for cash is just exchanging one asset for another and will

not result in an expense even in future periods.

7. A decrease in an expense account is the equivalent of a decrease in owner’s

equity.

8. Accrued revenue is a term used to describe revenue that has been received but not

yet earned.

9. Book value is the original cost of a building less depreciation for the year.

10. The adjusting entry to allocate part of the cost of a one-year fire insurance policy

to expense will cause total assets to increase.

11. The adjusting entry to recognize an expense which is unrecorded and unpaid will

cause total assets to increase.

12. The adjusting entry to recognize earned revenues which was received in advance

will cause total liabilities to decrease.


1. Under the revenue recognition principle, revenue is recorded

a. at the earliest acceptable time.

b. at the latest acceptable time.

c. after it has been earned, but not before.

d. at the end of the accounting period.

2. Adjusting entries

a. assign revenues to the period in which they are earned.

b. help to properly measure the period’s net income or net loss.

c. bring asset and liability accounts to correct balances.

d. all of the above.

57

3. Entries required at the end of an accounting period to bring the accounts up to

date and to ensure the proper matching of income and expenses are called

a. matching entries

b. adjusting entries

c. correcting entries

d. contra entries

4. The broad classification of adjusting entries are

a. accruals and closing

b. accrual and deferrals

c. trials and deferrals

d. closing and trials

5. A prepaid expense is not an

a. asset

b. expired cost

c. unexpired cost

d. economic resource

6. The decrease in usefulness of property and equipment as time passes is called

a. consumption

b. deterioration

c. depreciation

d. contra-asset

7. If a P2,500 adjustment for depreciation is omitted, which of the following

financial statement errors will occur?

a. expenses will be overstated

b. net income will be understated

c. owner’s equity will be overstated

d. assets will be understated

8. The amount of accrued but unpaid expenses at the end of the period is both an

expense and

a. a liability

b. an asset

c. a deferral

d. an income

9. From the viewpoint of the firm receiving the cash, an item that represents services

that have been paid for by the customer, but have not yet been provided to that

customer by the firm which received the cash, is called

a. a prepaid expense

b. an accrued expense

c. an accrued revenue

d. an unearned revenue

58

10. An item that represents services that have been paid for by the firm, but which

have not yet been received by that firm is called


b. an unearned revenue

c. an accrued expense

d. an accrued revenue

11. An item that represents services by the firm for which it will pay for in the future

is called




d. an accrued expense

12. An item that represents services provided by a firm for which it will receive

payment in the future is called




d. an accrued expense

13. Accrued revenues

a. decrease assets

b. increase assets

c. increase liabilities

d. decrease liabilities

14. Accrued expenses

a. decrease assets

b. decrease liabilities

c. increase assets

d. increase liabilities

15. A law firm began November with office supplies of P16,000. During the month,

the firm purchased supplies of P29,000. On November 30. supplies on hand

totaled P21,000. Supplies expense for the period is

a. P21,000

b. P24,000

c. P29,000

d. P45,000

16. The adjusting entry to accrue salaries expense

a. debits salaries expense and credits cash

b. debits salaries payable and credits salaries expense

c. debits salaries payable and credits cash

d. debits salaries expense and credits salaries payable

59

17. Accumulated Depreciation is reported in the

a. balance sheet

b. income statement

c. statement of owner’s equity

d. both a and b

18. Adjusting entries involve

a. only real accounts

b. only nominal accounts

c. only capital accounts

d. at least one real and one nominal accounts

19. A company has P1,500 of supplies on hand at the end of 2003. During 2004,

P2,750 of supplies were purchased. A count of supplies on hand at end of 2004

found an inventory of P875. What was the amount of supplies expense for 2004?

a. P1,875

b. P3,375

c. P4,250

d. P5,125

20. At the beginning of 2003, a company purchased a fire insurance policy covering a

property for a period of two years. The P5,600 cost of the policy was paid in

cash. At the end of 2003, the company will reduce Prepaid Insurance for this

policy by

a. P 0

b. P 467

c. P 2,800

d. P 5,600

21. An accrued revenue should be recorded by a

a. seller when a customer pays for a service before the service is rendered

b. seller when a service is rendered on receipt of cash

c. buyer when a service is received on payment of cash

d. seller when a service is rendered before receipt of cash

22. The purchase of a prepaid insurance policy would initially be recorded as

a. a deferred revenue

b. a deferred expense



23. Salaries and wages that are recorded as expenses at year end but remain unpaid

are an example of

a. a deferred revenue

b. a deferred expense



60

Exercise 5-3: Problem on Accrual of Interest Expense

PamStones Forwarders borrowed P500,000 from the bank on Sept. 1, 2004. The note

carried a 7% annual rate of interest and was set to mature on Feb. 28, 2005. Interest and

principal were paid in cash on the maturity date.

Required:

1. What was the amount of interest expense paid in cash in 2004?

2. What was the amount of interest expense recognized on the 2004

income statement?

3. What was the amount of total liabilities shown on the 2004 balance

sheet?

4. What was the total amount of cash that was paid to the bank on Feb.

28, 2005 for principal and interest?

5. What was the amount of interest expense shown on the 2005 income

statement?

Exercise 5-4: Problem on Depreciation

Milde Ragaf operates a business center in Bacolod City. On Jan. 1, 2005, she bought an

office equipment at a cost of P 35,000. It has an expected useful life of 6 years and a

salvage value of P5,000.

Required:

1. How much of the asset is subject to depreciation?

2. What will be the annual depreciation expense?

3. What is the adjusting entry to recognize depreciation for the year?

4. Determine the book value of the asset at the end of the year.

5. What is the book value of the asset after it has been depreciated for 6 years?

6. What happens to the book value of the asset during each year of its useful

life?


1. Minda Naw Services acquired an equipment on July 1, 2003, for P80,000. The

equipment has as estimated useful life of 10 years and an estimated salvage value

of P5,000. Naw computes depreciation on a straight-line basis. How much

depreciation should be recorded for 2003?

a. P 3,750

b. P 4,000

c. P 8,000

d. P 7,500

61

2. Which of the following transactions did not result in revenue being reported?

a. Sold merchandise for cash

b. Sold merchandise on account

c. Collected an accounts receivable

d. All of the above transactions would result in revenue being reported.

3. Happy Maligaya Services purchased a 1-year insurance policy on April 1, 2003,

for P6,000. The amount of prepaid insurance reported on the balance sheet and

the amount of insurance expenses reported on the income statement at Dec. 31,

2003, are, respectively:

a. P 1,500; P 4,500

b. P 4,500; P 1,500

c. P 2,000; P 4,000

d. P 4,000; P 2,000

4. Which of the following accounts is not an expense?

a. Delivery Expense

b. Sales Salaries

c. Withdrawals

d. Depreciation

5. The normal balances in the accounts, Depreciation Expense and the related

Accumulated Depreciation, are:

a. both have debit balances

b. credit and debit, respectively

c. both have credit balances

d. debit and credit, respectively

6. At the beginning of the month, Jetz Balsomo Business Services reported a P 3,600

balance in its Prepaid Insurance account. At month-end, the company reported

Insurance Expense of P 4,500 in its income statement and a balance of P 1,900 in

the Prepaid Insurance account. What was the cost of the additional insurance

during the month?

a. P 4,500

b. P 6,400

c. P 6,200

d. P 2,800

7. An accountant debited Supplies Expense P16,000 and credited Cash P16,000 in

error. The correct entry should have been to debit Supplies for P16,000 and credit

Cash for P16,000. As a result of this error,

a. assets are overstated by P16,000

b. expenses are understated by p16,000

c. the trial balance will not balance

d. expenses are overstated by P16,000

62

8. Accounts receivable had total debits for the month of P15,000 and total credits for

the month of P7,000. if the beginning balance in Accounts Receivable was

P12,000, what was the net change in Accounts Receivable?

a. a decrease of P8,000

b. an increase of P32,000

c. an increase of P8,000

d. a decrease of P32,000

Exercise 5-6: Preparing Adjusting Entries

For each of the following transactions, make the necessary adjusting entries for Anas

Services at December 31, 2004:

a. Received cash of P90,000 on Sept. 1, 2004 for a half-year’s rent in advance. Use

the liability method.

b. On Oct. 1, 2004, Anas loaned another party P40,000 on an 10%, six month note.

c. The supplies account showed a balance of P20,000 but supplies on hand is just

P5,000.

d. On July 1, 2004, the company paid P8,500 for a one year insurance coverage.

Use the asset method.

e. On December 1, 2004, the company signed a lease to rent a photocopying

machine for six months at P0.50 a copy. During December, 5,000 copies were

made. No recognition has been made on this rental agreement.

f. On Dec. 18, 2004, the company signed an agreement to acquire a new company

vehicle on March 2, 2005 from Honda Cars-Iloilo. No down payment was given.


Using T accounts, record the adjusting entries for each of the situations listed below. The

last day of the accounting period is Dec. 31.

a. Three-days’ salaries are unpaid as at Dec. 31. Salaries are P75,000 for a five-day

work week.

b. On Aug. 1, a P18,000 premium was paid on a one-year insurance policy. The

amount of the premium was debited to Prepaid Insurance.

c. Before adjustments, the Supplies account has a balance of P35,400. the count of

supplies on hand amounted to P22,300.

d. Office equipment was purchased on March 3, for P270,000. The expected life of

the equipment is eight years.


Prepare the adjusting entry for each of the following for the year ending Dec. 31, 2004:

a. Paid P24,000 for a 1-year fire insurance policy to commence on Sept. 1. The

amount of premium was debited to Prepaid Insurance.

b. Borrowed P100,000 by issuing a 1-year note with 7% annual interest to GE

Savings Bank on Oct. 1, 2004.

63

c. Paid P160,000 cash to purchase a delivery van (surplus) on Jan. 1. The van was

expected to have a 3-year life and a P10,000 salvage value. Depreciation is

computed on a straight-line basis.

d. Received an P18,000 cash advance for a contract to provide services in the future.

The contract required a 1-year commitment, starting April 1.

e. Purchased P6,400 of supplies on account. At year’s end, P750 of supplies

remained on hand.

f. Invested P90,000 cash in a certificate of deposit that paid 4% annual interest. The

certificate was acquired on May 1 and carried a 1-year term to maturity.

g. Paid P78,000 cash in advance on Sept. 1 for a 1-year lease on office space.

64

U�IT 6

Completion of the Accounting Cycle

Preparation of a Worksheet

After the preparation of the trial balance, accountants gather or compile data that

need to be adjusted at the end of the accounting period. At this point, he can already

prepare the financial statements. As preliminary step, he usually prepares a working

paper that facilitates the preparation of these statements. This working paper is usually

called a worksheet.

The worksheet may contain as many money columns as its use may require. The

simplest is the six-column worksheet. Illustrated on the next page is a ten column

worksheet for Sally Fashions. It is identified by a heading consisting of the following:

1. The name of the company.

2. The title “Worksheet”.

3. The period covered (as on the income statement).

Steps in the preparation of a Worksheet:

1. Copy the trial balance as is with amounts contained therein placed under the

first pair of columns.

2. Enter the adjustments (adjustments discussed under the Adjustment Process)

in the Adjustments columns.

3. Enter the account balances as adjusted in the Adjusted Trial Balance columns.

4. Extend the account balances from the Adjusted Trial Balance columns to the

Income Statement columns or to the Balance Sheet columns. Income

Statement accounts should be extended to the Income Statement columns and

Balance Sheet accounts should be extended to Balance Sheet columns.

5. Total the Income Statement columns and Balance Sheet columns.

6. Get the difference between the debit total and the credit total of the income

statement columns. If the debit total is more than the credit total, the

difference represents net loss. If the credit total is more than the debit total,

the difference represents net income.

7. The difference between the two totals of the Income Statement columns is

placed under the column with a lesser total in order to balance or equalize the

two columns. Total of the two columns will be equal.

8. The difference is also extended to the Balance Sheet columns. It is placed

under the column with a lesser total. The total of the two columns will be

equal.

Three principal uses of a worksheet:

1. Preparation of the financial statements.

2. Recording of adjusting entries.

3. Recording of closing entries.

66

PREPARI�G FI�A�CIAL STATEME�TS

After preparing the worksheet, financial statements can easily be prepared. The

figures shown in the income statement, and capital statement below and the balance sheet

are taken for the worksheet of the previous page.

SALLY FASHIONS

Income Statement

For the month ended July 31, 2005

Service Fee P 24,000

Less: Operating expenses:

Wages expense P 11,700

Sewing supplies expense 6,000

Rent expense 3,000

Depreciation expense – Sewing machine 1,000

Utilities expense 2,000

Total expenses 23,700

Net Income P 300

SALLY FASHIONS

Capital Statement

For the month ended July 31, 2005

Tabal, Capital, July 1, 2005 P 150,000

Add: Net Income for the period P 300

Less: Tabal, Drawings 5,000

Decrease in Capital (4,700)

Tabal, Capital, July 31, 2005 P 145,300

67

SALLY FASHIONS

Balance Sheet

July 31, 2005

ASSETS

Current assets:

Cash P 21,200

Accounts receivable 7,000

Sewing supplies 2,000

Prepaid rent 3,000

Total current assets P 33,200

Noncurrent assets:

Sewing machine P 120,000

Less: Accumulated depreciation 1,000

Net noncurrent asset 119,000

TOTAL ASSETS P 152,200

LIABILITIES

Current liabilities:

Accounts payable P 1,000

Wages payable 900

Unearned revenue 5,000

Total liabilities P 6,900

CAPITAL


TOTAL LIABILITIES AND CAPITAL P 152,200

68

RECORDI�G THE ADJUSTI�G E�TRIES

Adjusting entries could have been recorded at the time data for adjustment were

compiled. However, it is usually convenient to delay their recording until after the

preparation of the worksheet and the financial statements. Adjusting entries can simply

be copied from the worksheet to the general journal and then posted to the ledger.

Recording of adjusting entries is illustrated below.

ADJUSTI#G E#TRIES

GENERAL JOURNAL

Date Description PR Debit Credit

2005

July 31 Rent expense 3,000

Prepaid rent 3,000

To record expiration of one month rent.

31 Sewing supplies expense 6,000


To take up sewing supplies used during the month.

31 Depreciation expense-Sewing machine 1,000

Accumulated depreciation-Sewing machine 1,000

To rec. depreciation of sewing machine for 1 month.

31 Wages expense 900

Wages payable 900

To take up accrued wages.

69

RECORDI�G OF CLOSI�G E�TRIES

Closing entries are journal entries made at the end of an accounting period to

clear or eliminate the balances of the temporary accounts in preparation for the next

accounting period. The worksheet can be used as reference in preparing closing entries.

An account titled Income Summary is used for summarizing the data for the

revenue and expense accounts. It is only opened and then closed at the end of the

accounting period. Other terms used are: Revenue and Expense Summary and Profit and

Loss Summary.

Steps in journalizing and posting of closing entries:

1. Revenue accounts, represented by accounts with credit balances under the Income

Statement columns, are debited and Income Summary account is credited for the

total.

2. Expense accounts, represented by accounts with debit balances under the Income

Statement columns, are credited and Income Summary account is debited for the

total.

3. If the credit entry of the Income Summary account is more than the debit entry,

the difference represents net income. Income Summary is then debited for the

difference and owner’s equity or capital is credited. Net income increases capital,

hence, the credit entry to the capital account. If the debit entry is more than the

credit, the difference represents net loss. Owner’s equity or capital is then debited

and Income Summary account is credited. Net loss decreases capital, hence, the

debit entry to the capital account.

4. Drawing account is used to show reduction of capital by withdrawals of cash and

other assets made by the owner during the period. At the end of the accounting

period, it is credited for the amount of its balance and the capital account is

debited for the same amount.

5. The closing entries are then posted to the ledger in the usual manner. After the

closing entries are posted to the ledger, revenue, expense, and drawing accounts

(nominal or temporary accounts) have zero balances. The capital account is

increased or decreased depending on the net income or net loss and withdrawals.

Balance sheet accounts (real accounts) have balances which are carried forward to

the next accounting period.

70

Recording of closing entries is illustrated as follows:

CLOSI#G E#TRIES

GENERAL JOURNAL

Date Description PR Debit Credit

2005

July 31 Service Fee 24,000

Income Summary 24,000

To close revenue accounts.

31 Income Summary 23,700

Wages expense 11,700

Sewing supplies expense 6,000

Rent expense 3,000

Depreciation expense-Sewing machine 1,000

Utilities expense 2,000

To close the expense accounts.

31 Income Summary 300

Tabal, Capital 300

To close the Income Summary account.

31 Tabal, Capital 5,000

Tabal, Drawing 5,000

To close the drawing account.

71

THE POST-CLOSI�G TRIAL BALA�CE

The last step in the accounting cycle for a service concern is the preparation of the

post-closing trial balance. The balances are taken from the ledger accounts after posting

the adjusting and closing entries. The purpose of this is to make sure that the ledger

accounts are in balance at the beginning of the next period. Illustration of the post-

closing trial balance:

SALLY FASHIONS

Post-closing Trial Balance

July 31, 2005

Debit Credit

Cash P 21,200

Accounts receivable 7,000


Prepaid rent 3,000

Sewing machine 120,000

Accum. Depr’n-Sewing machine P 1,000

Accounts payable 1,000

Wages payable 900

Unearned revenue 5,000


P 153,200 P 153,200

REVERSI�G E�TRIES

Reversing entries are journal entries made at the beginning of the new accounting

period to reverse the adjusting entries made at the end of the preceding period. This

process is for transactions involving certain types of adjustments. Not all adjusting

entries are reversed. For illustration used in this unit, only the accrued revenues and

accrued expenses are reversed. Deferrals are not reversed.

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1. The worksheet is not presented with the financial statements.

2. The third step in worksheet preparation is to enter the adjusted account balances

in the adjusted trial balance columns.

3. The worksheet is a convenient device for completing the accounting cycle.

4. After all necessary adjustments are entered in the worksheet, the two adjustments

columns are totaled to prove the equality of debits and credits.

5. Income and expense accounts are moved to the balance sheet columns.

6. Assets, liabilities, capital and withdrawal accounts are extended to the income

statement columns.

7. The balance of unearned revenues account will appear in the balance sheet credit

columns of the worksheet.

8. The balance sheet credit column of the worksheet usually contains only the

liability and equity accounts.

9. When income statement columns of the worksheet are totaled, the excess of debits

over credits is called net income.

10. The totals of the balance sheet columns of the worksheet will usually be the same

as the totals appearing in the formal balance sheet.

11. The last step in worksheet preparation is to enter the net income or net loss figure

as a balancing figure in the income statement and balance sheet columns.

12. Financial statements are confidential documents which are available only to the

owner of the business.

13. The focal point of the accounting cycle is the financial statements.

14. The income statement shows the types and amounts of revenues and expenses for

the accounting period.

15. The excess of expenses over revenues is called net loss.

16. Expenses are increases in equity caused by entity’s income-generating activities.

17. Cash loaned from a bank constitutes income.

18. Financial flexibility is the ability to take effective actions to alter the amounts and

timings of cash flows so that it can respond to unexpected needs and

opportunities.

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19. Solvency refers to availability of cash over the longer term to meet financial

commitments as they fall due.

20. Liquidity refers to the availability of cash in the near future after taking account of

the financial commitments over this period.

21. An income statement relates to a specified period while a balance sheet shows the

financial position of the entity at a particular date.

Exercise 6-2: Worksheet Extensions

Classify each of the accounts listed below as assets (A), liabilities (L), owner’s equity

(OE), revenue (R), or expenses (E). Indicate the normal debit or credit balance of each

account. Indicate whether each account will appear in the Income Statement columns (I)

or the Balance Sheet columns (B) of the work sheet.

Account Classification (orman Balance Income Statement or

Balance Sheet

Columns

a. Rent expense

b. Prepaid insurance

c. Accounts receivable

d. Depreciation exp-bldg.

e. Supplies

f. Consulting revenues

g. Mabanes, Withdrawal

h. Accounts payable

i. Accum. Depreciation-bldg.

j. Building

k. Mabanes, Capital

l. Unearned revenue


1. After the adjusting and closing entries have been recorded and posted, the general

ledger accounts that appear on the balance sheet have no balances.

2. General ledger account balances agree with those in the financial statements even

before adjusting and closing entries are recorded and posted.

3. The income summary account is used to close the income and expense accounts.

4. The balance of the owner’s capital account represents the cumulative net result of

income, expense and withdrawal transactions.

5. Closing entries clear income and expense accounts at the end of the period.

74

6. The post-closing trial balance contains asset, liability, withdrawal and capital

accounts.

7. The final trial balance is called a post-closing trial balance.

8. A reversing entry is a journal entry which is the exact opposite of a related

adjusting entry made at the end of the period.

9. To simplify the recording of regular transactions in the next accounting period, all

adjusting journal entries are reversed.

10. Post-closing trial balance tests the equality of the accounts after the adjustments

and the closing entries are posted.

Exercise 6-3: Worksheet Extensions

Trial Balance Income Statement Balance Sheet

Debit Credit Debit Credit Debit Credit

Three of the major column headings in a worksheet are the Trial Balance, Income

Statement, and Balance Sheet. For each of the following items, write the letters on the

column heading it would appear. For example, cash would appear under the debit side of

the Trial Balance and Balance Sheet columns.

a. Accounts receivable

b. Service revenues

c. Advertising expense

d. Accounts payable

e. Delos Santos, Capital

f. Delos Santos, Withdrawal

g. Net loss for the month

h. Net income for the month

75

Exercise 6-4: Permanent or Temporary Accounts

Classify the accounts listed below as permanent or temporary, and indicate whether or

not each account is closed. Also, indicate the financial statement in which the account

will appear.

Account Title Permanent Temporary Account

is closed

Account

is not

closed

Balance

Sheet

Income

Statement

Building

Prepaid Insurance

Rent Expense

Accounts Receivable

Supplies Expense

Accu. Depr-F/F

Service Revenue

Depr. Exp-F/F

Interest Expense

Notes Payable

Exercise 6-5: Extension of Account Balances to Proper Worksheet Columns

Listed below are the ledger accounts appearing in the adjusted trial balance columns of a

worksheet:

1. Cash _____ 11. Accounts Receivable _____

2. Buildings _____ 12. Interest Expense _____

3. Salaries Expense _____ 13. Interest Revenue _____

4. Mortgage Payable _____ 14. Unearned Revenues _____

5. Prepaid Insurance _____ 15. Office Supplies _____

6. Equipment _____ 16. Withdrawals _____

7. Utilities Expense _____ 17. Interest Payable _____

8. Land _____ 18. Accu. Depr-Bldg. _____

9. Service Revenues _____ 19. Rent Expense _____

10. Salaries Payable _____ 20. Accounts Payable _____

Required:

On the space provided, indicate in which column of the worksheet the amount in

each account would be extended by entering the following letters:

a. balance sheet, debit

b. balance sheet, credit

c. income statement, debit

d. income statement, credit

76

Exercise 6-6: Worksheet Preparation

Michael Alab is a CPA-lawyer specializing in mergers& acquisitions. Provided below is

a trial balance taken on December 31, 2005:

Alab Legal Services

Trial Balance

December 31, 2005

Cash 70,000

Office Supplies 8,000

Prepaid Insurance 12,000

Office Equipment 150,000

Computer Equipment 60,000

Note Payable 50,000


Alab, Capital 114,000

Alab, Withdrawals 35,000

Consulting Revenues 385,000

Rent Expense 50,000

Salaries Expense 120,000

Telephone Expense 10,000


554,000 554,000

Information for year-ended adjustments:

a. Office supplies on hand at year-end amounted to P3,000.

b. On Jan. 1 of the current year, Alab purchased office equipment which cost

P150,000 with an expected life of 5 years and no salvage.

c. Computer equipment costing P60,000 with an expected life of three years and no

salvage value was purchased on July 1 of the current year.

d. A premium of P12,000 for a one-year insurance policy was paid on December 1.

e. Salaries earned by legal aide, which have not yet been paid, amounted to P3000.

Required:

1. Prepare the adjustments on the worksheet and complete the worksheet.

2. Journalize the adjusting entries.

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The May 31, 2005 trial balance for O. Pagunaling Catering Services is presented as

follows:

The following information pertaining to the year-end adjustments is available:

1) The P360,000 prepaid advertising represents expenditure made on Nov. 1, 2004

for monthly advertising over the next 18 months.

2) A count of the catering supplies at May 31, 2004 amounted to P90,000.

3) Depreciation of the catering equipments amounted to P610,000.

4) One-third of the unearned catering revenues has been earned at year-end.

5) At year-end, salaries in the amount of P140,000 have accrued.

6) Interest of P60,000 on the notes payable has accrued at year-end.

Required: Prepare the adjustments on the worksheet and complete the worksheet.

O. Pagunaling Catering Services

Trial Balance

May 31, 2005

Cash 210,000


Prepaid Advertising 360,000

Catering Supplies 270,000

Catering Equipments 1,890,000

Accum. Depreciation-Catering Equipt. 640,000


Unearned Catering Revenues 120,000

Notes Payable 500,000

Pagunaling, Capital 1,120,000

Pagunaling, Withdrawals 700,000

Catering Revenues 6,510,000

Salaries Expense 3,270,000

Rent Expense 960,000

Insurance Expense 250,000


Miscellaneous Expense 80,000

Totals 9,080,000 9,080,000

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The unadjusted trial balance of the J. Anas Company for Dec. 31, 2005 follows:

Cash 423,000


Prepaid Rent 144,000

Cooking Supplies 388,000

Land 630,000

Building 1,250,000

Accumulated Depreciation-Bldg. 413,000

Cooking Equipment 870,000

Accumulated Depreciation-Cooking Equipt. 212,000

Notes Payable 1,400,000


Anas, Capital 1,400,000

Anas, Withdrawal 240,000

Gourmet Cooking Revenues 2,202,000


Travel Expense 127,000

Advertising Expense 215,000



Miscellaneous Expense 46,000

Totals 5,737,000 5,737,000

Additional information:

a) One-half of the prepaid rent has expired.

b) Cooking supplies on hand at year-end amounted to P35,000.

c) Depreciation on the building and the cooking equipment amounted to P30,000

and P48,000, respectively.

d) Accrued salaries at year-end amounted to P25,000.

e) Interest amounting to P252,000 has accrued on notes payable. Interest on the note

is paid every Jan. 1. The note matures on Jan. 1, 2006.

Required: Prepare the adjustments on the worksheet and complete the worksheet.

79

Exercise 6-9: Balance Sheet Concepts

Julio Sebastian established a trucking business serving the needs of businesses in the

island of Panay. His balance sheet follows:

Sebastian Forwarders

Balance Sheet

December 31, 2005

Cash 199,000 Accounts Payable 32,000

Accounts Receivable 28,000 Notes Payable 303,500

Supplies 12,000 Total Liabilities 335,500

Service Vehicle 380,000 J. Sebastian, Capital 283,500

Total Assets 619,000 Total Liabilities & Capital 619,000

Required:

1. When was the balance sheet prepared?

2. How does the date on this balance sheet differ from the date on the statement of

changes in equity or the income statement?

3. Can Sebastian acquire another service vehicle paying cash of P200,000? Why?

4. What is the total equity of Sebastian Forwarders?

5. What is the total amount of Sebastian’s claims against the business’ assets?

6. What is the amount of the creditors’ claims against the assets of the business?

7. What is the net income for the period?

8. What was the owner’s equity on Jan. 1, 2005?

9. In order to prepare this statement, which financial statements should be prepared

first and why?

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Exercise 6-10: Income Statement Concepts

Julius Teodoro has an upstart business, Teodoro Rent-A-Car. His income statement

follows:

Teodoro Rent-A-Car

Income Statement

For the Year Ended Dec. 31, 2005

Revenues:

Car Rentals 1,540,000

Expenses:

Repairs Expense 110,500


Gas and Oil Expense 230,300

Depreciation Expense 60,000


Total Expenses 700,800

Net Income 839,200

Required:

1. What is the period of time covered by the income statement?

2. What is the source of revenue?

3. What is the total revenue?

4. What are the total expenses?

5. What is the concept of net income?

6. Is this statement an interim statement? Why?

7. To whom does the net income belong?

81

U�IT 7

Merchandising Operations

Introduction

The previous units dealt with accounting for activities of companies that earned

their revenues by rendering services to customers for fees or commissions. In contrast to

services-type business, merchandising businesses acquire goods for resale to customers.

The fundamental accounting concepts applicable to service type businesses also apply to

merchandising businesses. But additional accounts and techniques are needed to account

for purchases and sale of a merchandising business.

In this unit, we illustrate and explain various types of merchandising transactions,

the computation of net sales, discounts and cost of goods sold. This chapter will focus on

the operations of merchandising businesses, their journal entries and preparation of

financial reports.

�ature of a Merchandising Business

A service business sells knowledge or expertise while a merchandising business

sells a particular or a group of product. The primary objective of a merchandising

business is to buy goods and resell them at a profit. These firms typically have a large

investment in their merchandise inventory., an asset which requires some special

accounting treatment.

Merchandising business such as the grocery stores, department stores, hardware

stores, drugstores and specially clothing stores, are familiar retail outlets that sell goods

to final consumers. Others include the wholesale distributors that supply goods to

retailers and other businesses.

Activities of Merchandising Business

The major activities of a merchandising concern are described as follows:

1) Purchasing - Business firms firm buys goods or merchandise for resale.

Information as to kind, quality, quantity and cost of goods purchased are

maintained for management use.

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2) Handling - The cost of transporting and storing the goods before its sale. These

costs are added to the cost of goods bought. Transportation costs include freight,

express, drayage and cartage.

3) Returning of goods purchased - Some goods purchased and received may be

unsatisfactory or not in accordance with the purchase order, hence, may be

returned to vendor or supplier. If goods are not returned, certain deduction is

allowed from the original purchase price.

4) Selling - This activity is the major source of revenue of a merchandising firm.

Sale of goods purchased at a price above the cost is to provide adequate margin of

profit.

5) Returning of goods sold - Some goods sold may be returned by customers due to

some defects, or is not in accordance with their purchase order. If those goods are

not returned, the customers are granted reduction on the sales price.

6) Maintaining adequate stock on hand - A stock of goods or merchandise on hand

is called inventory on hand. This inventory is to satisfy orders of customers at all

times.

Operating Cycle of a Merchandising Business

The merchandising firm purchases inventory, sells the inventory and uses the cash

or credit to purchase more inventory and the cycle continues. For cash sales, the cycle is

from cash to inventory and back to cash. For sales on account, the cycle is from cash to

inventory to account receivable and back to cash. The management strives to shorten the

cycle. The faster the sale of inventory and the collection of cash, the higher the profits.

83

Business Documents of a Merchandising Business

Merchandising businesses use various business forms and documents to help

identify the transactions that should be recorded in the books. These documents contain

vital information about the nature and amount of the transactions. The common source

documents are:

1. Sales Invoice - Prepared by the seller of goods and sent to the buyer. This

document contains the name and address of the buyer, the date of sale and

information about the goods sold. It specifies the amount of sales, the

transportation and payment terms.

2. Bill of Lading - A document issued by the carrier (trucking, shipping or airline)

that specifies contractual conditions and terms of delivery such as freight terms,

time, place and the person named to receive goods.

3. Statement of Account - Formal notice to the debtor detailing the amount already

due.

4. Official Receipt - Evidences the receipt of cash by the seller.

5. Deposit Slips - Printed forms with depositor’s name, account number and space

for details of the deposit. A validated deposit slip indicates that cash and checks

where actually deposited.

6. Check - A written order to a bank by a depositor to pay the amount specified in

the check from the checking account of the depositor to the person named in the

check. The entity issuing the check is the payor while the receiver is the payee.

7. Purchase Requisition - A written request to the purchaser of an entity from an

employee or user department of the same entity that goods be purchased.

8. Purchase Order - An authorization made by the buyer to seller to deliver the

merchandise.

9. Receiving Report - A document containing information about goods received

from a vendor.

10. Credit Memorandum - A form used by the seller to notify the buyer that his

account is being decreased due to errors or other factors requiring adjustments.

84

MERCHA�DISI�G ACCOU�TS

Sales Revenue

1. Sales

The major source of revenue of a merchandising company results

from sale of merchandise. A sale consists of the transfer of legal ownership

of goods (called passage of title) from one party to another. It is usually

accomplished by physical delivery of the goods. Each time a sale is made,

a revenue account called Sales is increased (credited) by the amount of the

selling price of the goods sold. The accompanying debit is Cash if the

term of sale is cash or to Accounts Receivable if the goods are sold on

account.

Typically, the entry will be based on a business document called a

sales invoice. The sales invoice is prepared after the accounting department

receives notice from the shipping department of the shipment of the goods

to the customer.

2. Sales Returns

Goods sold and delivered to a customer may be returned to the seller

for a variety of reasons. These include wrong color, wrong style, wrong

amount or inferior quality. A sales return is a cancellation of a sale. It

could be recorded as a debit in the Sales account, but the amount of sales

returns may be a useful information to owners or other interested parties.

Thus, they are recorded in a separate account entitled Sales Returns and

Allowances, which is a contra revenue account to Sales.

3. Sales Allowances

They are deductions from original invoice sales price. An allowance

may be granted to a customer for any of a number of reasons, including

inferior quality or damage or deterioration in transit. Sales allowance could

be recorded directly a debits in the Sales account because they do cancel

part of the recorded selling price. But, because their amount may be a

useful information, they are either recorded in a separate Sales Allowances

account or recorded in a combined Sales Returns and Allowances account.

In either case, the account is a contra account (a reduction account) to

Sales. It is not an expense account even though it has a debit balance.

4. Sales Discounts

Whenever goods are sold on account, the terms of payment are

specified clearly on the sales invoice. The terms may be “net 30” which

means that the amount of the invoice must be paid on or before 30 days

after sales.

85

If the term reads “n/10 E.O.M.” the invoice would be due on the

tenth day of the month following the month of sale. Credit terms vary from

industry to industry according to trade practices. In many instances, when

credit periods are long, sellers offer a cash discount to induce early payment

of an account. Theoretically, a cash discount is an adjustment to the gross

invoice price to arrive at the actual cost—cash price—of the merchandise.

The discount, usually ranging from 1 to 3 percent of the gross invoice price

of the merchandise, may or may not be taken by the purchaser. To the

purchaser, it is purchase discount, to the seller, it is a sales discount.

The granting off sales discount is another factor that reduces the

amount of cash actually collected from the sale of goods.

The sales discount is a contra account to Sales and should be shown

as deduction from gross sales in the income statement. It is not an expense

incurred in generating revenue. Rather, its purpose is to reduce recorded

revenue to the amount actually realized from sales—the net invoice price.

Purchases of Merchandise

1. Purchases

The Purchases account is a temporary or nominal account, and is used

only for merchandise purchased during an accounting period. The account

may be accompanied by a cash sales invoice or charge sales invoice of the

supplier. It is debited for the cost of the goods bought as shown on the

seller’s invoice.

2. Purchase Returns and Allowances

Purchase Returns and Allowances is a contra account and is

accordingly deducted from Purchases in the Income Statement. It is

important that a separate account be used to record purchase returns and

allowances because management needs the information for decision making.

3. Purchase Discounts

This is a reduction in the amount due that is granted by the supplier

when the buyer pays its account within the discount period. Discounts are

incentives of the company for buyers to pay early. Purchase Discounts is a

contra account that is deducted from Purchases on the income statement.

4. Freight In

If the buyer pays the expenses of transporting the goods from the

place of the seller to the place of the buyer, such expenses are debited to

Freight in. This account is an addition to the Purchases account. Other

86

accounts used for these expenses are Transportation In, Transportation on

Purchases and Inward Transportation.

5. Freight Out

An expense account, showing one of the expenses incurred in making

the sale to the customer.

TERMS OF TRA�SACTIO�S

Merchandise may be purchased and sold either on credit terms or for cash on

delivery. When goods are sold on account, a period of time called the credit period is

allowed for payment. The length of the credit period varies across industries and may

even vary within an entity, depending on the product.

DISCOU�TS O� MERCHA�DISE

There are two types of discounts on merchandise.

1. TRADE DISCOU#TS

Many firms publish a catalog describing their products and quoting a list price. A

substantial reduction of this price may be granted to certain customers such as those who

buy in large quantities. This discount is frequently increased with the size of the

purchases as an inducement to buy in large quantities. The use of a list price with

allowed trade discounts provides a convenient method of changing the net price without

having to reprint and redistribute catalogs, since only the trade discounts need to be

altered.

Deductions from the list price are called trade discounts. This type of discount is

considered a means of arriving at the selling price and is not recorded in the accounting

records. A trade discount may be stated as a series of discounts.

When a series of discounts is stated, the first rate applies to the list price and each

succeeding rate applies to the diminishing base.

87

Illustration:

a) Assume a credit invoice of P 6,000. Term: 20, n/30.

List Price P 6,000

Less: Trade discount 20% 1,200

Invoice Price P 4,800

b) Assume a credit invoice of P 6,000. Terms: 20 and 10, n/30.

List Price P 6,000

Less: 1st Trade discount 20% 1,200

P 4,800

Less: 2nd

Trade discount 10% 480

Invoice Price P 4,320

2. CASH DISCOU#TS

Some business give discounts for prompt payment called cash discounts. This

practice improves the seller’s cash position by reducing the amount of money in accounts

receivable. A cash discount is a strong inducement to pay the bill within the discount

period. Cash discounts are called purchase discounts from the buyer’s view point and

sales discounts from the seller’s point of view.

For example, an invoice for P 10,000, with the term of 2/10, n/30, would mean that

if the payment is made on or before the tenth day, a discount of 2% is given, hence

instead of paying P 10,000, only P 9,800 will be paid to settle the account.

Example of cash discount terms:

a) 2/10, n/30 - This means that if the invoice is paid in 10 days after the invoice

date, a 2% discount is granted. If the invoice is paid beyond 10 days but not more

than 30 days after the invoice date, the invoice amount will have to be paid in full.

If paid beyond 30 days, the amount will earn interest from the 31st day.

b) 2/10, 1/20, n/40 - A discount of 2% is granted if the invoice is paid in 10 days, a

discount of 1% is granted if the invoice is paid from 11th to 20

th day from invoice

date, no discount from the 21st to the 40

th day. After the 40

th day, there will be

interest.

c) 2/10 EOM - A discount of 2% if the amount is paid in 10 days after the end of

the month.

d) 2/10 MOM - A discount of 2% if the account is paid in 10 days after the middle

of the month.

88

(ote: A cash discount is computed on the amount of the invoice less any returns,

allowances and down payment.

Illustration: Assume an invoice of P20,000 dated Jan. 1, 2005; Terms 10, 2/10, n/30.

The journal entries on the buyer’s and seller’s books are as follows:

Buyer Seller

1-1 Purchases 18,000


Jan. 11 Payment within the discount period.

1-11 Accounts Payable 18,000

Purchase discounts 360

Cash 17,640

If payment is made after the discount period.


Cash 18,000

1-1 Accounts Receivable 18,000

Sales 18,000

1-11 Cash 17,640

Sales discounts 360


Cash 18,000


Cash discounts are called purchase discounts from the buyer’s viewpoint and sales

discounts from the seller’s point of view.

It is usually worthwhile for the buyer to take a discount if offered although it may

be necessary to borrow the money to make the payment.

Illustration: Assume that an invoice for P150,000 with terms 2/10, n/30, is to be paid

within the discount period with money borrowed for the remaining 20 days of the credit

period. If an annual interest rate of 18% is assumed, the net savings to the buyer is

P1,530 which is determined as follows:

Cash discount of 2% on P150,000 P 3,000

Interest for 20 days at an annual rate of 18% on the

amount due within the discount period:

P 147,000* x 18% x 20/360 = 1,470

Savings effected by borrowing P 1,530

*Amount Due = P150,000 Invoice Price – P3,000 Cash Discount

TRA�SPORTATIO� COSTS (Freight on Merchandise)

Whenever goods are purchased, costs will be incurred to deliver them to the buyer.

The term F.O.B. Shipping point means free on board at the shipping point; that is, buyer

incurs all transportation costs after the merchandise is loaded on a common carrier—a

trucking company or an airline or a shipping company—at the point of shipment. The

term F.O.B. destination means that the seller incurs all transportation charges to the

destination of the shipment. In general, title to the goods passes from the seller to the

buyer at the point at which the buyer becomes responsible for the transportation charges.

89

Freight may be carried in the books as freight in or freight out. Both are debit

accounts and may be paid in cash or may be incurred on account. Freight , according to

the manner of its payment, may either be prepaid or collect.

Freight is prepaid if it is paid before goods are transported or shipped. However,

freight is said to be collect if payment is made upon delivery.

Transportation or freight on merchandise bought is recorded as an expense in the

books of the party who, as per contract, should shoulder the expense. Merchandise may

be billed to the buyer on one of the following basis:

a) F.O.B. shipping point. Freight prepaid.

b) F.O.B. shipping point. Freight collect.

c) F.O.B. destination. Freight prepaid.

d) F.O.B. destination. Freight collect.

Illustration: Ana Tagay sold merchandise to Josh Vulcraft of Cebu, on

account. The invoice showed the following:

Price of merchandise P 10,000

Freight charges to Cebu 1,000

Total P 11,000

The journal entries of the buyer and the seller are presented with the following freight

terms.

1. F.O.B. Shipping point, freight prepaid.

Josh Vulcraft’s Book (Buyer) Ana Tagay’s Book (Seller)

Purchases 10,000

Freight in 1,000

Accounts Payable 11,000 Purchase on account.


Sales 10,000

Cash 1,000 Sales on account.

Analysis: FOB Shipping point—the freight will be shouldered by the buyer from

shipping point to destination. Freight prepaid means that the seller has paid the freight

already. Since the buyer will be the one to shoulder the freight but the seller already

paid, therefore, the buyer has an additional accounts payable to the seller.

2. F.O.B. Shipping point, freight collect.


Purchases 10,000

Freight in 1,000


Cash 1,000 Purchase on account.


Sales 10,000 Sales on account.

90

Analysis: FOB Shipping point means that the buyer will shoulder the freight. Freight

collect means that the buyer will be the one to pay the freight.

3. F.O.B. Destination, freight prepaid.


Purchases 10,000

Accounts Payable 10,000 Purchase on account.


Freight out 1,000

Sales 10,000

Cash 1,000 Sales on account.

Analysis: FOB Destination means that the seller will shoulder the freight. Freight

prepaid means that the seller had already paid the freight.

4. F.O.B. Destination, freight collect.


Purchases 10,000


Cash 1,000 Purchase on account.


Freight out 1,000

Sales 10,000 Sales on account.

Analysis: FOB Destination means that the seller will shoulder the freight. Freight collect

means that the buyer will pay the freight. Since it is the seller who will shoulder the

freight but the buyer paid for it, therefore, the buyer has a collectible from the seller for

the amount paid. This can be deducted from his accounts payable to the seller.

ACCOU�TI�G OF MERCHA�DISI�G TRA�SACTIO�S

The following are the pro-forma entries relating to the merchandising transactions:

1. To record sales for cash

Cash xx

Sales xx

2. To record sales on account

Accounts Receivable xx

Sales xx

3. To record returns or allowances of defective merchandise sold on account.

Sales Returns and Allowances xx


4. To record returns or allowances of defective merchandise sold for cash.

91

Sales Returns and Allowances xx

Cash xx

5. To record collection of account less discount

Cash xx

Sales Discounts xx


6. To record collection of accounts without discount

Cash xx


7. To record payment of freight on merchandise to customer.

Freight Out/Delivery Exp. xx

Cash xx

8. To record purchases for cash

Purchases xx

Cash xx

9. To record purchases on account on credit

Purchases xx

Accounts Payable xx

10. To record returns or allowances of defective merchandise purchased on account.

Accounts Payable xx

Purchase Returns & Allowances xx

11. To record returns or allowances of defective merchandise purchased for cash.

Cash xx

Purchase Return & Allowances xx

12. To record payment of account within the discount payment.

Accounts Payable xx

Purchase Discount xx

13. To record payment of accounts after the discount period.

Accounts Payable xx

92

Cash xx

14. To record payments of freight on merchandise delivered by suppliers.

Freight In xx

Cash xx

When merchandise is sold, the transaction is recorded as a debit to an asset account and a

credit to sales account. A sales transaction with an agreement that the merchandise will

be paid in a later date is called a sales on account or credit sale. A person or a business

to whom a sale on account is made is called a charge customer.

All freight expenses or postage paid by the seller to secure the delivery of the

merchandise that he has sold is considered an expense of making a sale. As it is paid, it

is debited to a selling expense account called a Delivery Expense or Freight Out. The

account also covers the cost of operating the delivery truck such as wages of the driver,

gasoline consumed, oils used and repairs on the truck.

Occasionally, merchandise sold is defective or fails to meet a customer’s specifications.

In which case, a dissatisfied customer is permitted to return the unsatisfactory

merchandise. The customer receives a refund of his money or credit on his account for

the amount of merchandise returned. Sometimes, the customer is permitted to keep the

unsatisfactory merchandise and is granted a reduction in the sales price or an allowance

on the sales price.

All returns and allowances are debited to an account called Sales Returns and

Allowances. This account is shown as a deduction from the sales account to arrive at net

sales.

Most often, a business grants cash discounts to credit customers as an inducement for the

customer to pay their accounts early. This reductions in the revenue is debited to a Sales

Discounts account. This account, like the Sales Returns and Allowances is shown as a

deduction from the Sales account in the Income Statement.

Terms commonly used in connection with sales of merchandise are interpreted as

follows:

• C.O.D. – Collect on delivery. The amount of the invoice must be paid at the time

the merchandise is delivered.

• 30 days – The invoice amount must be paid within 30 days from the date of

invoice.

93

• 2/10, n/30 – A discount of 2% is allowed if payment is made within 10 days from

the date of the invoice, if not paid within the discount period, the total amount of

the invoice must be paid within the 30 days from its date.

• 2/EOM, n/60 – A 2% discount is allowed if payment is made before the end of the

month, otherwise, the total amount of the invoice must be paid within 60 days

from its date.

• 4/10 EOM – A discount of 4% is allowed if payment is made within 10 days after

the end of the current month.

A merchandise purchased with the intention of selling it, is debited to a temporary

account called Purchases at its cost, and credited to cash if acquired on cash basis or to

Accounts Payable if purchased on account or on credit.

Only merchandise purchased for resale is debited to the Purchases account. Assets

purchased for use in the business such as office supplies, typewriter, office tables and the

like are not debited to the purchases account because they are not for sale and should not

enter in the calculation of the costs of goods sold. Part of the merchandise purchased for

resale will be sold and part will remain unsold at the end of the accounting period. This

unsold merchandise is called Merchandise Inventory.

Cash discounts granted by suppliers for payment within a stipulated period of time are

recorded in a Purchase Discounts account. This account has a credit balance and is

shown as a deduction from the cost of merchandise purchased during the period.

Purchase discounts are stated in terms similar to those discussed under Sales Discounts.

The account Purchase Returns and Allowances is used to accumulate the cost of

merchandise returned to supplier, or allowances received for defective merchandise. Any

allowance granted by the supplier for purchases during the period is shown as a deduction

from Purchases in determining the cost of merchandise available for sale.

When a buyer receives merchandise in damaged conditions, not in accordance to the

goods ordered, short of the amount ordered, or which were never ordered, the goods may

be returned or an allowance may be claimed for the damage or shortage from the seller.

If a sales return is received, or a sales allowance granted, the customer is usually

informed in writing. A pre-numbered form sent to a customer (debtor), showing the

details of the amount of credit covering the return or allowance granted is called a credit

memorandum.

A credit memorandum is a form issued by a seller to inform a debtor that a credit has

been posted to the debtor’s accounts receivable. It is called a credit memorandum

94

because the asset Accounts Receivable is decreased. The credit memorandum is also

called “credit memo” or CM. It is prepared in duplicate. One copy is given to the

customer, and the other copy is retained and used as a source document for the journal

entry debiting the Sales Returns and Allowances account.

If merchandise purchased is to be returned or an allowance is to be claimed from supplier

(creditor), the same should be confirmed in writing. A pre-numbered form sent to the

supplier containing the details of the amount of debit covering the return or allowance

claimed is called a debit memorandum.

A debit memorandum is a form issued by a purchaser to inform a creditor that the debit

has been posted to the creditor’s accounts payable. It is called a debit memorandum

because the account is a deduction from the liability account, Account Payable. The

debit memorandum is sometimes referred to as a “debit memo” or simply “DM”. It is

usually prepared in duplicate. One copy is sent to the supplier and the other copy is used

as the source document for the journal entry crediting Purchase Returns and Allowances

account.

ILLUSTRATIVE PROBLEM # 1

June 11 - Sold merchandise to Hope Marketing, P12,000. Terms: 2/10, 1/30, n/60.

11 - Paid the freight on merchandise sold to Hope Mktg, P600 cash.

15 - Issued a credit memo to Hope Mktg for defective merchandise returned

worth, P2,000.

July 5 - Received a check from Hope Mktg in full settlement of their account.

Answer: June 11 Accounts Receivable 12,000

Sales 12,000

Sales on account. Term 2/10, 1/30, n/60

#

11 Freight Out 600

Cash 600

Freight on merchandise delivered.

#

15 Sales Returns and Allowances 2,000


Credit memo for returned merchandise.

#

July 5 Cash 9,900

Sales Discounts 100

95


Collection of account less discount.

Computation of collection:

Amount of invoice P 12,000

Less: Sales Returns & Allowances 2,000

Balance P 10,000

Less: 1% discount (10,000 x 1%) 100

Amount collected P 9,900


Sept. 21 - Sold merchandise to Moon Store, P21,000. Terms: 20% down,

balance, n/30 days.

21 - Paid delivery expense of P800 for the above sales.

23 - Issued a credit memo for defective merchandise returned by Moon

Store, P2,400.

Oct. 21 - Received a 10-day, 10% note from Moon Store in settlement of their

account.

31 - Received from Moon Store a check in full payment of their note

plus interest due.

Answer: Sept. 21 Cash 4,200


Sales 21,000

Sales on acct. 20% dwn,bal. n/30

#

21 Freight Out 800

Cash 800

Freight on merchandise delivered

#

23 Sales Returns & Allowances 2,400


CM for returned merchandise

#

96

Oct. 21 Notes Receivable 14,400


Recd a 10-day, 10% note from

Moon Store as settlement of their

account

#

31 Cash 14,440

Notes Receivable 14,400

Interest Income 40

Collection of note plus interest

Computation of collection:

Notes Receivable P14,400

Add: Interest (P14,400 x 10% x 10/360) 40

Amount collected P14,440


April 10 - Sold merchandise to Tonton Trading, P30,000, subject to trade discount of

10%, terms 2/10, n/30.

15 - Received a check in full payment of account.

21 - Sold merchandise to Mycah Trading, P20,000, subject to trade discounts of

10% and 5%, balance, 2/10, n/30.

25 - Issued a credit memo to Mycah Trading for defective merchandise returned,

P2,100.

May 8 - Received a check in full settlement of account from Mycah.

Answer: April 10 Accounts Receivable 27,000

Sales 27,000

Sales on acct, trade disc of 10%

Terms 2/10, n/30

#

15 Cash 26,460

Sales discounts 540


Collection of acct. less discount

#

21 Accounts Receivable 17,100

Sales 17,100

Sales on acct, trade disc of 10%

and 5%, bal. 2/10, n/30

#

25 Sales Returns and Allowances 2,100


Credit memo to Mycah Trading

#

May 8 Cash 15,000

97


Received a check in full settlement

of account

Computation of net selling price on April 10:

List Price P30,000

Less: Trade discount, 10% 3,000

Net selling price P27,000

Less: Sales discount, 2% 540

Amount collected, April 15 P26,460

Computation of net selling price on April 21:

List price P20,000

Less: 1st Trade discount 10% 2,000

P18,000

Less: 2nd Trade discount 5% 900

Net selling price P17,100

Less: Sales Ret & Allow 2,100

Amount collected, May 8 P15,000


March 16 - Purchased from JM Enterprises merchandise amounting to P10,000,

terms : 3% 10EOM.

16 - Paid the freight on the above purchases P500. This amount, as agreed, is

chargeable to JM Enterprises.

20 - Returned defective merchandise to JM Enterprises for which a credit memo

was received, P1,000.

April 5 - Issued a check to JM Enterprises in full payment of account.

Answer: March 16 Purchases 10,000


Purchases on acct. term 3% 10EOM

#

16 Accounts Payable 500

Cash 500

Freight paid chargeable to supplier

#

20 Accounts Payable 1,000

Purchase Returns & Allowances 1,000

Defective merchandise returned

#

April 5 Accounts Payable 8,500


Cash 8,230

98

Full payment of account less disc.

Computation of cash payment:

Invoice Cost P10,000

Less: Returns & Allowances 1,000

Net amount P 9,000

Less: Cash discount (9,000 x 3%) 270

Balance P 8,730

Less: Freight paid charged to supplier 500

Cash payment P 8,230


Oct. 10 - Purchased from Paris Co. merchandise worth P25,000. Trade discounts

10 and 10. Terms: 2/10, n/30.

15 - Returned defective merchandise to Paris Co. for which a credit memo was

received for P2,500 (net of trade discount).

20 - Issued a check to Paris Co. in full payment of account.

Answer:

Oct. 10 Purchases 20,250


Purchase on account

#


Purchase returns & allowances 2,500

Returned defective mdse.

#



Cash 17,395

Full payt of account less disc.

Computation of net purchase price:

List price P25,000

Less 10% of P25,000 2,500

99

Balance 22,500

Less 10% of P22,500 2,250

Net purchase price P20,250

Computation of cash payment:

Net purchase price P20,250

Less returns & allowances 2,500

Balance 17,750

Less cash discount (17,750 x 2%) 355

Cash payment P17,395


Jan. 5 - Purchased from ConceptComp an office computer, P50,000. Terms: 10%

Down, balance n/30 days.

5 - Paid freight charges P2,000 on office equipment.

6 - Paid installation costs, P3,000.

7 - Received a credit from ConceptComp for some minor defects on the equipt,

P5,000.

Feb. 4 - Issued a 20-day, 18% note to ConceptComp in settlement of acct. with them.

24 - Issued a check payable to ConceptComp in payt of the note plus interest due.

Answer: Jan. 5 Office equipment 50,000

Accounts payable 45,000

Cash 5,000

Purchase office equipt. 10% down

Balance n/30

#

5 Office equipment 2,000

Cash 2,000

Freight charges paid

#

6 Office equipment 3,000

Cash 3,000

Installation cost paid

#

7 Accounts payable 5,000

Office equipment 5,000

Allowances for minor defects

#

100

Feb. 4 Accounts payable 40,000

Notes payable 40,000

Issued a 20-day, 18% rate

#

24 Notes payable 40,000

Interest expense 400

Cash 40,400

Payment of note plus interest

Computation of interest: P40,000 x 18% x 20/360 = P400.

#ote: Freight charges and installation costs for the office equipment are debited to Office

Equipment account; returns and allowances are credited to the same account.

MERCHA#DISE I#VE#TORY ACCOU#T

The inventory of a merchandising business consists of goods on hand and available for

sale to customers. The merchandise inventory on hand at the beginning of the accounting

period is called the beginning inventory while merchandise inventory at the end of the

accounting period is called the ending inventory.

The merchandise inventory at the end of one accounting period is the merchandise

inventory at the beginning of the next accounting period.

I�VE�TORY SYSTEM

Merchandise inventory is a key factor in determining the cost of goods sold. Because

merchandise inventory represents goods available for sale, there must be a method of

determining both the quantity and the cost of these goods. There are two systems

available to merchandising entities to record accounts related to merchandise inventory.

1. Periodic Inventory System

The periodic system calls for the physical counting of goods on hand at the end of the

accounting period to determine quantities. This approach give actual or physical

inventories. The procedure is generally used where the individual inventory items have

101

small peso investment and sells relatively inexpensive such that it may prove impractical

or inconvenient to record inventory inflow and outflow.

2. Perpetual Inventory System

The perpetual procedure is commonly used where inventory items treated individually

represent a relatively large peso investment. This procedure is designed for control

purposes. When the perpetual system is used, a physical count of the units on hand

should at least be made once a year or as frequent interval to confirm the balances

appearing on the stock card.

To illustrate:

Periodic Inventory System Perpetual Inventory System

1. Sold merchandise on account costing P8,000 at a selling price of P10,000; term 2/10,

n/30.


Sales 10,000


Sales 10,000

#

Cost of Goods Sold 8,000

Inventory 8,000

2. Customer returned merchandise costing P400 that had been sold on account for P500

(part of the P10,000 sales).

Sales returns & allowances 500

Accounts Receivable 500

Sales returns & allowances 500

Accounts Receivable 500

#

Inventory 400

Cost of Goods Sold 400

3. Received payment from customer for merchandise sold above [Cash discount taken:

(P10,000 sales – P500 returns) x 2% discount = P190].

Cash 9,310

Sales Discount 190


Cash 9,310

Sales Discount 190


102

4. Purchased on account merchandise for resale for P6,000; terms were 2/10, n/30

(purchases recorded at invoice price).

Purchases 6,000


Inventory 6,000


5. Paid P200 freight on the P6,000 purchases: Terms were FOB shipping point, freight

collect.

Freight in 200

Cash 200

Inventory 200

Cash 200

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

Accounts Payable 300

Purchase ret. & allow. 300

Accounts Payable 300

Inventory 300

7. Paid for merchandise purchased [Cash discount taken: (P6,000 purchases – P300

returns) x 2% discount = P114]



Cash 5,586


Inventory 114

Cash 5,586

8. To transfer the beginning inventory balance to the Income Summary account (part of

The closing entries under the periodic inventory system).


Inventory 250,000

No entry required.

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

system).

Inventory 231,500


No entry required.

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

Shrinkage already affected

in no. 9 entry.

Cost of Goods Sold 360

Inventory 360

103

COST OF GOODS SOLD

Cost of goods sold or cost of sales is the largest single expense of the merchandising

business. It is the cost of inventory that the entity has sold to customers. All

merchandising business has goods available for sale to customers. The goods available

for sale during the year consist of merchandise inventory at the beginning of the year and

net purchases during the period.

If the firm is able to sell all the goods available for sale during a given accounting

period, the cost of goods sold would then equal goods that had been available for sale.

However, in most cases, the business will have goods still unsold at the end of the year.

To find the actual cost of goods sold, the merchandise inventory at the end of the period

is subtracted from the goods available for sale.


The selected ledger account balances as of June 30 covering a six-month period showed

the following:

Merchandise inventory (Jan. 1) P328,400

Purchases 665,300

Purchase returns & allowances 23,670

Purchase discounts 19,250

Freight in 85,110

104

A physical count of the unsold merchandise as of June 30 amounted to P410,500.

Required: Determine the cost of goods sold.

Answer:

Merchandise inv., Jan. 1 328,400

Purchases 665,300

Less: Purchase ret. & allow. 23,670

Purchase discount 19,250 42,920

Total 622,380

Add: Freight in 85,110

Net Purchases 707,490

Total merchandise available for sale 1,035,890

Less: Merchandise inventory, June 30 410,500


Calculating the #et Income

In a merchandising firm, gross profit is calculated by deducting the cost of goods sold

from the net sales. After the gross profit is determined deduct the operating expenses

from the gross profit and the result will be (et Income or ((et Loss).

Sales P xxx

Less: Sales returns & allowances P xxx

Sales discounts xxx xxx

Net Sales xxx

Less: Cost of Goods Sold xxx

Gross Profit xxx

Less: Operating Expenses xxx

Net Income/(Net Loss) xxx


Assuming the same account balances in Problem #7, additional account balances are

provided below:

Sales P 1,925,000

Sales discounts 33,320

Sales returns & allowances 12,550

Operating expenses 864,160

Required: Compute the (a) gross profit and (b) the net profit.

A(SWER:

Sales P 1,925,000

105

Less: Sales discounts 33,320

Sales returns & allowances 12,550 45,870

Net Sales 1,879,130

Less: Cost of Goods Sold (Prob. #7) 625,390

Gross Profit 1,253,740 (a)

Less: Operating expenses 864,160

Net Profit 389,580 (b)

Note: Sales discounts can also be presented in the income statement as other

expense instead of a deduction from Sales. Purchase discounts can also

be presented in the income statement as other income instead of a

deduction from Purchases.

In a merchandising business, revenues from sales arise from the sales of goods while

cost of goods sold represents the cost of inventory the entity has sold to customers. The

difference between revenues from sales and cost of goods sold is called gross margin

from sale or gross profit. Operating expenses are deducted from gross margin to arrive at

operating income or income from operations. Operating expenses are those expenses,

other than cost of goods sold, which are incurred to generate a revenue from the entity’s

major line of business—merchandising.

Finally, other income and expenses are considered to arrive at net income or net loss

figure. Other income and expenses are shown at net amount in the income statement.

This include interest income and expenses, royalty and dividend income and other gains

and losses.

106

Exercise 7-1: Matching Type

A. Trade discounts

B. Purchase discounts

C. Perpetual inventory system

D. Periodic inventory system

E. Official receipt

F. Invoice

G. FOB shipping point

H. FOB destination

I. Debit memorandum

J. Credit memorandum

K. Purchase order

L. Purchase requisition

Required: From the list of terms above, select the one that relates to each of the

following statements:

1. This is an authorization made by the buyer to the seller to deliver the

merchandise as detailed in the form.

2. It is the discount taken by the buyer for the early payment of an invoice.

3. The document issued by the seller authorizing the return of merchandise or the

grant of an allowance.

4. This document evidences the receipt of cash by the seller.

107

5. This transportation arrangement passes ownership to the goods to the buyer only

when the buyer receives the merchandise.

6. Under this inventory system, revenues from sales are recorded when sales are

made, but no attempt is made on the sales date to record the cost of goods sold.

7. Under this inventory system, both the sales amount and cost of goods sold amount

are recorded when each item of merchandise is sold.

8. The document prepared by the seller of goods and sent to a buyer detailing the

specifics of a sale.

9. This discount encourages the buyers to purchase goods because of markdowns

from the list price.

10. This is the shipping term if the buyer shoulders the shipping costs.

Exercise 7-2: Trade and Cash Discount Calculations

On April 1, 2005, De Florence Food Products sold merchandise with a P150,000 list

price.

Trade Discount Credit Terms Date Paid

a. 20% 2/10, n/30 April 8

b. 40% 1/10, n/30 April 15

c. - 3/10, n/30 April 11

d. 10% 1/15, n/30 April 14

e. 45% n/30 April 28

Required:

For each of the sales terms, determine the following:

1. the amount recorded as a sale.

2. the amount of cash received.

Exercise 7-3: Trade and Cash Discount Calculations

On July 15, 2005, the D’ Tops Book Distributors acquired for resale books on account

with a list price of P120,000. National Publishing, the supplier, allowed a 20% trade

discount as well as credit terms of 2/10, n/30. D’ Tops paid the invoice in full on July 20,

2005.

Required: Prepare the journal entries for D’ Tops Book Distributors.

108

Exercise 7-4: Cash Discount and Remittance Calculations

For each of the following Rayala Company purchases, assume that credit terms are 2/10,

n/30 and that any credit memorandum was issued and known before Rayala Company

made the payments.

Purchases Shipping Terms Prepaid

Freight (by

seller)

Credit

Memo

a. 22,000 FOB shipping point 2,000 4,000

b. 24,000 FOB destination 2,400 6,000

c. 18,000 FOB shipping point 2,500

d. 60,000 FOB shipping point 4,000

Required:

1. Determine the cash discount available.

2. Determine the cash remitted if the payment is made within the discount period.

Exercise 7-5: Cash Discounts and Remittance Calculations

Baarde Company engaged in the following purchase transactions during the month. The

company observes the policy that all returns are made one day after the goods are

received, and that all purchases are paid within the discount period.

List Price FOB Terms Freight

Charges

Purchase

Returns &

Allowances

Credit

Terms

Trade

Discount

224,000 Shipping pt. 3,000 18,000 2/10, n/30 25%

162,000 Destination 8,000 6,000 1/10, n/30 20%

90,000 Shipping pt. 5,000 - 2/10, n/30 30%

46,000 Shipping pt. 2,000 4,000 n/30 -

430,000 Destination 16,000 22,000 4/10, n/30 10%

Required: Using the table above, calculate the amount needed to settle each purchase.

Exercise 7-6: Sales Transactions

Some of the sales transactions of M. Yulo Company whose credit terms are 2/10, n/30

follow:

February 1 Cash sales, P200,000.

4 Sales on account, P550,000.

7 Received returned merchandise sold on account, P 30,000.

10 Collected the amount due from credit sales.

109

Required: Prepare the journal entries.

Exercise 7-7: Sales Transactions

On September 8, 2005, Atinado Company sold merchandise for P18,000 to Flores

Company; terms 2/10, n/30. On September 12, P3,000 worth of the merchandise was

returned. On September 18, Atinado Company received a check for the amount due.

Atinado uses periodic inventory system.

Required: Prepare the journal entries for Atinado Company.

Exercise 7-8: Purchase Transactions

Several purchase transactions of the H. Acutillar Company are presented below. The

credit terms of the company are 3/10, n/30.

March 6 Purchased merchandise for cash, P200,000; FOB shipping point.

12 Purchased merchandise on account, P700,000.

15 Returned merchandise purchased on account, P50,000.

17 Paid supplier the amount due.

19 Paid freight charges of P7,000 on merchandise acquired last March 6.


Exercise 7-9: PurchaseTransactions

On July 10, 2005, Asis Company purchased P18,000 worth of merchandise from Begaso

Company; terms 1/10, n/30, FOB shipping point. On July 12, Asis paid P360 freight on

the shipment. On July 15, Asis returned P2,000 of merchandise for credit. Final

payment was made to Begaso on July 19. Asis Company uses the periodic inventory

system.

Required:

1. Prepare the journal entries for Asis Company.

2. Prepare the journal entries assuming that the terms are FOB destination.

110

Exercise 7-10: Effect of Freight Terms to Inventory

For each of the following transactions, indicate which company should include the

inventory on its Dec. 31, 2005 balance sheet:

a) Balbastro Supplies shipped merchandise to Dalipe Sales on Dec. 28, 2005, terms

FOB destination. The merchandise arrives at Dalipe’s on Jan. 4, 2006.

b) Pico shipped merchandise to Estrada on Dec. 25, 2005, FOB destination. Estrada

received the merchandise on Dec. 31, 2005.

c) Necor Bros. shipped merchandise to Naga Company on Dec. 27, 2005, FOB

shipping point. Naga Company received the merchandise on Jan. 3, 2006.

d) Jayme Company shipped merchandise to Lebraso on Dec. 24, 2005, FOB

shipping point. The merchandise arrived at Lebraso’s on Dec. 29, 2005.

e) Canonigo Company consigned merchandise to Gabrillo on Dec. 23, 2005. The

merchandise was sold on Dec. 30, 2005.

f) Gicos Dealers consigned merchandise to Ybanez Company on Dec. 18, 2005.

The merchandise was sold on Jan. 4, 2006.

Exercise 7-11: Journalizing Merchandising Transactions

Jarobilla Company entered into the following transactions during the month of April

2005:

April 2 Purchased 1,000 tires at a cost of P600 per tire. Terms of payment: 1/10,

n/45.

4 Paid trucking firm P8,000 to ship the tires purchased on April 2.

5 Purchased 600 tires at a cost of P600 per tire. Terms of payment: 2/10, net

30.

6 Paid trucking firm P5,000 to ship the tires purchase on April 5.

7 Returned 150 of the tires purchased on April 2 because they were defective.

Received a credit on open account form the seller.

11 Paid for tires purchased on April 2.

13 Sold 700 tires from those purchased on April 2. The selling price was P900

per tire. Terms: 1/10, net 30.

22 Received cash from sale of tires on April 13.

30 Paid for tires purchased on April 5.

Required:

Prepare the journal entries.


111

Maderable Furniture Store entered into the following transactions in the month of

February:

Feb. 3 Purchased 50 lounge chairs at P1,500 each with terms 2/10, n/45. The

chairs were shipped FOB destination.

7 Sold 6 chairs for P3,200 each, terms 2/10, n/30.

8 Purchased 20 patio umbrella tables for P1,200 each, FOB shipping point,

terms 1/10, n/30.

9 Due to defects, returned 5 lounge chairs purchased on Feb. 3.

10 Paid the trucking firm P860 for delivery of the tables purchased on Feb. 8.

13 Paid for the chairs purchased on Feb. 3.

17 Received payment for the chairs sold on Feb. 7.

20 Paid for the tables purchased on Feb. 8.

Required:

Prepare the journal entries.


Estuche Company engaged in the following transactions in October 2005:

Oct. 1 Sold merchandise to Villagracia Trading on credit, terms n/30, FOB

shipping point, P21,000.

3 Purchased merchandise on credit from Socias Stores, terms n/30, FOB

shipping point, P38,000.

5 Paid Pambato Forwarders for freight charges on merchandise received,

P290.

6 Purchased store supplies on credit from Izeem Trading, terms n/20, P6,000.

8 Purchased merchandise on credit from Bracamonte Company, terms n/30,

FOB shipping, P36,000. Bracamonte Company paid P600 for freight costs.

12 Returned some of the merchandise received on Oct. 3 for credit, P6,000.

15 Sold merchandise on credit to Socias Stores, terms n/30, FOB shipping

point, P12,000.

16 Returned some of the store supplies purchased on Oct. 6 for credit, P1,500.

17 Sold merchandise for cash, P8,000.

18 Accepted for full credit a return from Villagracia Trading, P2,500.

24 Paid accounts to Socias Stores.

25 Received full payment from Villagracia Trading.


112

Exercise 7-14: Journalizing Sales and Purchase-Related Transactions

During the month of June 2005, the Estrada Company and the Pico Supply Company

entered into the following transactions.

June 05 Estrada purchased merchandise on account from Pico Supply, P243,000.

Terms: FOB shipping point; 3/10, n/30. Paid freight charges amounting

the P4,000.

07 Estrada purchased merchandise on account from Pico Supply, P470,000.

Terms: FOB destination; 3/10, n/30. Freight charges amounted P6,000.

08 Estrada returned P18,000 of merchandise to Pico Supply from the June 05

purchase.

10 Estrada paid Pico Supply the amount due on the June 05 transaction less

returns and discounts.

11 Pico Supply paid the transportation charges on the June 07 shipment.

14 Estrada paid Pico Supply the amount due from the June 07 transaction.

21 Estrada purchased merchandise from Pico Supply on account, P270,000.

Terms: 20% trade discount; FOB shipping point; 3/10, n/30.

25 Freight charges on the June 21 transaction amounted to P3,000 and were

paid by Estrada.

26 Estrada paid Pico Supply the amount due on the June 21 transaction.

Required: 1. Prepare the journal entries for Estrada Company.

2. Prepare the journal entries for Pico Supply Company.

Exercise 7-15: Preparing the Cost of Goods Sold Section of the Income Statement

Merchandise inventory, May 31, 2006 310,000

Merchandise inventory, June 1, 2005 260,000

Purchases 830,000

Purchase Returns & Allowances 8,300

Freight in 12,000


Required: Prepare the cost of goods sold section of the income statement of Florence

Company for the year ended May 31, 2006.

Exercise 7-16: Preparing the Cost of Goods Sold Section of the Income Statement

Purchases 4,150,000


Freight in 155,000

Merchandise inventory, Jan. 1, 2005 1,006,000

Purchase returns and allowances 140,000

Merchandise inventory, Dec. 31, 2005 1,750,500

113

Required: Prepare the cost of goods sold section of the income statement for the year

ended December 31, 2005.

Exercise 7-17: Determining the Beginning Merchandise Inventory

Below are important information from the books of Tacan Company:


Merchandise inventory, October 31, 2005 190,000


Freight in 15,000

Purchases 850,000


Required: Compute the merchandise inventory as at October 1, 2005.

Exercise 7-18: Determining Ending Merchandise Inventory

On February 14, 2005, a fire destroyed the merchandise inventory of Capindo Company.

The following information was available from the company’s accounting office:

Purchases 1,230,000



Cost of goods sold 1,206,000

Merchandise inventory, January 1, 2005 320,500

Freight in 36,900

Required: Compute the value of the lost merchandise.

Exercise 7-19: Determining the Missing Elements of the Income Statement

Compute the amount of each item indicated by a letter in the following table. Treat each

horizontal row of numbers as a separate problem.

Sales Beg. Invty #et

Purchases

Ending

Inventory

Cost of

Goods

Sold

Gross

Margin

Operating

Expenses

#et

Income or

(Loss)

125,000 A 35,000 10,000 B 40,000 C 12,000

114

D 12,000 E 18,000 108,000 60,000 40,000 20,000

230,000 22,000 167,000 F G 50,000 H (1,000)

390,000 40,000 I 60,000 J K 120,000 40,000

Exercise 7-20: Determining the Missing Elements of the Income Statement

The partial income statements of the five different companies are as follows:

1 2 3 4 5

�et sales A D 250,000 290,000 400,000

Merchandise inventory, 1/1/2005 B 50,000 70,000 J 120,000

�et purchases 80,000 E G 160,000 390,000

Goods available for sale 110,000 160,000 H K M

Merchandise invty, 12/31/2005 40,000 F 30,000 70,000 �

Cost of goods sold C 140,000 230,000 L 380,000

Gross profit 50,000 40,000 I 160,000 O

Required: Replace the lettered blanks with the appropriate amounts.

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