Merchandising-Entity-Module PDF

Table of Contents {#table-of-contents.17} ================= **[Topic 1: Inventory System of Merchandising Operation]** 1 [**[Pro-porma Journal entry of the inventory system]** 2](%5Cl) [**[Exercises: Inventory System]** 10](%5Cl) [**[Topic 2: Statement of Comprehensive income of Merchandising]**...

Table of Contents {#table-of-contents.17} ================= **[Topic 1: Inventory System of Merchandising Operation]** 1 [**[Pro-porma Journal entry of the inventory system]** 2](%5Cl) [**[Exercises: Inventory System]** 10](%5Cl) [**[Topic 2: Statement of Comprehensive income of Merchandising]** 12](%5Cl) [***[Trade discounts]*** 13](%5Cl) [***[Cash discounts]*** 15](%5Cl) [**[Exercises: Discounts]** 17](%5Cl) [**[Cost of goods sold statement]** 19](%5Cl) [**[Exercises: Income Statement of Service Industry]** 21](%5Cl) [**[Topic 3: Completing the Accounting Cycle of Merchandising Entity]** 24](%5Cl) [**[Adjustments]** 26](%5Cl) [**[Exercises: Completing the Accounting Cycle]** 33](%5Cl) [[References] 35](%5Cl) **FOREWORD** Module II focuses on the Accounting for Merchandising Businesses. Its main objective is to introduce the concept of accounting for inventory in a business setup. This module will help the reader to understand the difference between the Service entity and the Merchandising entity, and will also help them to understand more the significant accounting policies of the latter. This unit is composed of only one unit and its main focus is to discuss on how to account the transactions in a Merchandising Operation. The Units starts by introducing the essential questions and the intended learning outcome of the module, its goal is to give the reader a picture of what will be discussed in this particular learning material. Then, the lesson begins by explaining that the main difference of Merchandising entity and Service entity is the Merchandise inventory, the discussion proceeds with the Inventory system used in recording the inventory, in this part the two method of recording inventory will be discussed thoroughly. After discussing the inventory system, the discussion proceeds in comparing the Income statement of Merchandise and Service entity, the significant effect of inventory in it, and the journal entry that is unique in the merchandising entity such as Sales, Purchases, and the related contra accounts of the two. Lastly, after discussing the topics mentioned above, the Module closes by discussing the complete accounting cycle of a merchandising inventory, the discussion includes the additional closing and adjusting entry that is unique to Merchandising entity, the usage of Special journal and Ledger in accounting for cash receipts, receivables and cash disbursements, and additional concepts that is not present in the Accounting Cycle for service industry. To facilitate learnings, practice sets, both practical and theoretical, are included at the end of each major topic. After reading this module, the readers are expected to have an understanding and technical capabilities in accounting transactions and events of a merchandising entity, Unit II: Merchandising Operation Introduction: This unit discusses - The basic concept of accounting for merchandising entity - Inventory systems of merchandising entity - The difference in financial statements service and merchandising entity Essential Questions - What are the basic journal entries used in merchandising entity? - What are the different inventory systems use in recording the inventory? - How to compute the inventory of a merchandising entity? - What is the difference between the financial statements of service and merchandising entity? Intended learning outcomes - Discuss the Perpetual and Periodic system in recording inventory - Discuss the financial statements of Merchandising entity - Discuss the different computation use in computing the inventory **Topic 1: Inventory System of Merchandising Operation** ======================================================== The main difference between the service industry and the merchandising industry lies primarily in the presence of the merchandise inventory. Under the service industry, the entity is offering service to the customer as a primary source of revenue, while in the merchandising industry, the entity offers products or goods to customer as a primary source of income. Since this module focuses in the Merchandising entity it is important for us to know how an entity purchases their inventory. The procedures to purchase inventory are as follows 1. When certain items are needed, the **user department** fills in a **purchase requisition form** and sends it to the purchasing department. 2. The **purchasing department** then prepares a **purchase order** to be sent to supplier. 3. After receiving the purchase order, the **seller/ supplier** then forwards an **invoice** to the purchaser upon shipment of goods 4. Upon receiving the goods, the **purchaser\'s receiving department** sees to it that the terms in the purchase order are complied with, and prepares a **receiving report.** 5. Before paying the invoice, the **accounts payable department** **compares** the **purchase requisition, purchase order, purchase invoice and receiving report** to ensure that quantities, descriptions, and prices agree. **Merchandise Inventory** consists of goods purchases for **resale.** It is a real account; therefore, it is found in the balance sheet of the entity. After purchasing the inventory, the entity needs to record the transaction, that is the time the entity applies inventory systems. The entity can choose between **Perpetual Inventory System, and Periodic Inventory System.** **Perpetual Inventory System** - Under this system, the **inventory account is continuously** **updated.** - Stock cards, or accounting software is being used to update the inventory in every purchases and sales. - Even if there is running inventory record **there is still a need for Inventory count at year end to check the accuracy of the records.** - Advisable to be used by firms that sell low-volume, high-priced goods such as jewelry and furniture. **Periodic Inventory System** - Under this system, the inventory account is **not continuously updated.** - **Inventory count** **at year end** **is required to know the end balance of the inventory.** - More advisable for firms that sell high-volume, low-priced goods such as hardware. Note: **If the problem is silent use the PERIODIC INVENTORY SYSTEM** in recording the inventory **Pro-porma Journal entry of the inventory system** =================================================== +-----------------------------------+-----------------------------------+ | **Perpetual Inventory System** | **Periodic Inventory System** | +-----------------------------------+-----------------------------------+ | **1. Recording of Purchase** | **1. Recording of purchase** | | | | | Merchandise Inventory xx | Purchases xx | | | | | Cash/Accounts Payable xx | Cash/Accounts Payable xx | +-----------------------------------+-----------------------------------+ | **2. Recording of Purchase | **2. Recording of Purchase | | returns and allowances** | returns and allowances** | | | | | Cash/Accounts Payable xx | Cash/Accounts Payable xx | | | | | Merchandise Inventory xx | Purchase returns and allowances | | | xx | +-----------------------------------+-----------------------------------+ | **3. Recording of Sales** | **3.Recording of Sales** | | | | | Cash/Accounts Receivable xx | Cash/Accounts Receivable xx | | | | | Sales xx | Sales xx | | | | | **Recording the outflow of | | | inventory** | | | | | | Cost of good sold xx | | | | | | Merchandise Inventory xx | | +-----------------------------------+-----------------------------------+ | **4. Recording of sales return** | **4. Recording of Sales return** | | | | | Sales Return xx | Sales Return xx | | | | | Cash/Accounts Receivable xx | Cash/Accounts Receivable xx | | | | | **Recording the inflow of | | | inventory** | | | | | | Merchandise Inventory xx | | | | | | Cost of goods sold xx | | +-----------------------------------+-----------------------------------+ | **5. Recording of sales | **5. Recording of sales | | allowance** | allowances** | | | | | Sales allowances xx | Sales allowances xx | | | | | Cash/Accounts Receivable xx | Cash/Accounts Receivable xx | +-----------------------------------+-----------------------------------+ | **6. Recording of freight when | **6. Recording of freight when | | buying inventory** | buying inventory** | | | | | Merchandise Inventory xx | Freight in xx | | | | | Cash /Accounts Payable xx | Cash/Accounts Payable xx | +-----------------------------------+-----------------------------------+ | **7. Recording freight when | **7. Recording freight when | | selling inventory** | selling inventory** | | | | | Freight out xx | Freight out xx | | | | | Cash/Accounts Payable xx | Cash/Accounts Payable xx | +-----------------------------------+-----------------------------------+ **Explanations to the Journal Entry** **1.Recording of purchase** Assuming that on January 3, the entity purchase P5,000,000 worth of goods. - **Perpetual --** Since under the perpetual system inventory is being updated from time to time, every purchase requires debit to inventory to update the inventory. - **Periodic-** Inventory account is not updated from time to time when using period system, therefore an account Purchases is being used to record every purchase. **2.Recording of Purchase returns and allowances** [Purchase returns] - The amount of inventory that was returned to the supplier. - **There is physical flow of inventory** - Recorded as deduction to inventory. Assuming that on January 5, P500,000 worth of inventory was returned to the supplier because of defect. - **Perpetual-** Purchase returns are deduction to inventory that is why merchandise inventory is being credited. - **Periodic-** Under periodic, a contra purchases account is being recorded. [Purchase allowance] - Reduction to price given to the entity because of inferior quality of goods received. - There is **no physical flow of inventory**, only deduction to the price. - Recorded as reduction to inventory On January 6, the entity was given a price reduction of P200,000 resulting from some defect on inventory purchased. - **Perpetual-** Purchase allowances are deduction to the cost of inventory that is why merchandise inventory is credited - **Periodic-** Under periodic, a contra purchase account is being recorded. **3. Recording of Sales** On January 25, the entity sold merchandise costing P400,000 for P2,000,000. The sales were on account. - **Perpetual-** The first entry is the recording of Sales. While the second entry is the recording of the outflow of the inventory following the concept that in Perpetual system, inventory account is being updated every time there is a movement of inventory. - **Periodic --** the only entry is to record the Sales. Under periodic system, inventory is not updated when there is movement of inventory. **4. Recording of Sales return** [Sales return ] - The amount of inventory return to the entity by the purchaser - **There is an actual physical flow of inventory** On January 27, the customer returned inventory with a selling price of P500,000. The cost of the inventory is P100,000. - **Perpetual-** the first entry is to record the sales return as a contra sales account. The second entry is to record the inflow of inventory resulting from the return of merchandise. **Note: The sales return should be recorded at selling price while the inventory should be recorded at cost.** - **Periodic-** the only journal entry made was to record the sales return as a contra sales account. **5. Recording of Sales allowances** [Sales allowances] - Deduction in price given to the customer resulting from inferior quality of sold inventory. - There is **no actual physical flow of inventory**, just deduction in the sales price. - **Perpetual --** the only entry required is to reduce the sale price by establishing a contra sales account. Since there is no actual physical flow of inventory, the cost of goods sold and merchandise account is not use to record the sales allowance. - **[Periodic-]** the only entry required is to record the reduce in sales price by establishing a contra sales account. **6. Recording of freight in buying inventory** **7. Recording of freight in selling inventory** Freight -- transportation cost In recording transportation cost it is important to understand these **freight terms** ------------------------------------- ------------------------------------- -------------------------------- **Freight terms** Who is required to pay the freight? Who actually paid the freight? FOB Destination, Freight Prepaid Seller Seller FOB Destination, Freight Collect Seller Buyer FOB Shipping Point, Freight Collect Buyer Buyer FOB Shipping Point, Freight Prepaid Buyer Seller ------------------------------------- ------------------------------------- -------------------------------- [Explanation] **FOB Destination** means that the freight is **required to be paid by the seller**. FOB Destination means that the **ownership of goods will pass to the buyer upon reaching the destination of the buyer**, meaning the goods is still in the ownership of seller while in transit, thus the seller is the one required to pay the transit because the goods is still in his name during travel time. **FOB Shipping Point** means that the freight is **required to be paid by the buyer.** FOB Shipping point means that the ownership of goods will pass to the buyer upon reaching the dock or the shipping area, therefore **while in transit the owner is already the buyer** and making him the one required to pay the freight because the goods is already in his name. **Freight Prepaid** means that the freight was **actually paid by the seller.** The keyword here is **prepaid,** since the seller is the one who sent the inventory then he is the one who paid the freight in advance. **Freight collect** means that the freight was **actually paid by the buyer.** The keyword here is **collect**, the carrier is **yet to collect the freight charges** when the inventory arrives to the buyer. **Note**: If the problem is silent, the Freight term is Shipping point, Freight Collect. In recording freight, it is important to take note of the following 1\. Know the point of view of the problem. Are you a seller or buyer? 2\. What is the freight terms? To illustrate further let us use these problems. Use the periodic inventory system in recording the transactions. - On January 10, 2021 the entity purchases a goods under FOB Shipping point, Freight collect. The goods cost P1,000,000. The entity paid the freight charges worth P10,000. - On January 12, 2021 the entity purchase goods under FOB Shipping point, Freight prepaid. The goods worth P3,000,000. The freight costs P30,000. - On January 15,2021 the entity pays P1,500,000 for goods. The freight term is FOB destination, Freight prepaid. The freight costs P60,000. - On January 31,2021 the entity purchase P3,000,000 worth of inventory under FOB Destination freight collect. The entity paid the P50,000 freight. - February 3,2021 the purchase on January 10 was paid. - February 10, 2021 the purchase on January 12 was paid - February 15,2021 the purchase on January 31 was paid. [Journal Entry] +-----------------------+-----------------------+-----------------------+ | Date | Buyer\'s Point of | Seller\'s Point of | | | View | View | +-----------------------+-----------------------+-----------------------+ | January 10 | [To record the | [To record the | | | purchase] | sale] | | | | | | | Purchases 1,000,000 | Accounts Receivable | | | | 1,000,000 | | | Accounts Payable | | | | 1,000,000 | Sales 1,000,000 | | | | | | | [To record the | Analysis: The entry | | | freight] | made was just to | | | | record sales. There | | | Freight in 10,000 | is no entry regarding | | | | the freight because | | | Cash 10,000 | the one required to | | | | pay it is the buyer, | | | Analysis: Since we | and the one who | | | are using periodic | actually paid it is | | | inventory system, | the buyer as well. | | | Purchases is the | | | | account title used to | | | | record purchase of | | | | inventory. | | | | | | | | The freight term is | | | | FOB Shipping point, | | | | it means that the | | | | buyer is the one | | | | required to pay the | | | | freight that is why | | | | Freight in was | | | | debited, while the | | | | Freight collect means | | | | that the buyer | | | | actually paid it that | | | | is why cash was | | | | credited. | | | | | | | | [Compound Journal | | | | Entry] | | | | | | | | Purchases 1,000,000 | | | | | | | | Freight in 10,000 | | | | | | | | Account Payable | | | | 1,000,000 | | | | | | | | Cash 10,000 | | +-----------------------+-----------------------+-----------------------+ | 12 | [To record the | [To record the | | | purchase] | sale] | | | | | | | Purchases 3,000,000 | Accounts Receivable | | | | 3,000,000 | | | Accounts Payable | | | | 3,000,000 | Sales 3,000,000 | | | | | | | [To record the | [To record the | | | freight] | freight] | | | | | | | Freight in 30,000 | Accounts Receivable | | | | 30,000 | | | Accounts Payable | | | | 30,000 | Cash 30,000 | | | | | | | Analysis: The freight | Analysis : The | | | term is FOB shipping | freight term is FOB | | | point, therefore the | Shipping points, thus | | | buyer is the one | the buyer is required | | | required to pay the | to pay the freight | | | freight that is why | that is why the | | | we see a debit to | freight out account | | | freight in, while the | was not seen in the | | | Freight prepaid means | journal entry of the | | | that it is the seller | seller, but since the | | | who actually paid the | seller paid the | | | freight charges | freight there is a | | | that's why we need to | credit to cash to | | | credit accounts | record the outflow of | | | payable to record | cash and a debit to | | | liability to seller | account receivable to | | | since the seller paid | record the receivable | | | the freight that was | because the seller | | | suppose to be paid by | paid the freight that | | | the buyer. | was supposed to be | | | | paid by the buyer. | | | [Compound Journal | | | | Entry] | [Compound Journal | | | | Entry] | | | Purchases 3,000,000 | | | | | Accounts Receivable | | | Freight in 30,000 | 3,030,000 | | | | | | | Accounts Payable | Sales 3,000,000 | | | 3,030,000 | | | | | Cash 30,000 | +-----------------------+-----------------------+-----------------------+ | 15 | [To record the | [To record the | | | purchase] | sale] | | | | | | | Purchases 1,500,000 | Cash 1,500,000 | | | | | | | Cash 1,500,000 | Sales 1,500,000 | | | | | | | Analysis: The only | [To record the | | | entry made is to | freight] | | | record the purchase. | | | | The Freight term is | Freight out 60,000 | | | FOB Destination, | | | | Freight prepaid, | Cash 60,000 | | | therefore the seller | | | | is required to pay | Analysis: The freight | | | the freight and | term is FOB | | | actually paid the | Destination; | | | freight as well. | therefore, the seller | | | | is the one required | | | | to pay the freight | | | | charges that is why | | | | freight out was | | | | debited. Freight | | | | prepaid means that | | | | the seller actually | | | | paid it, that is why | | | | cash was credited. | | | | | | | | [Compound Journal | | | | Entry] | | | | | | | | Cash 1,440,000 | | | | | | | | Freight out 60,000 | | | | | | | | Sales 1,500,000 | +-----------------------+-----------------------+-----------------------+ | 31 | [To record the | [To record the | | | purchase] | sale] | | | | | | | Purchases 3,000,000 | Accounts Receivable | | | | 3,000,000 | | | Accounts Payable | | | | 3,000,000 | Sales 3,000,000 | | | | | | | [To record the | [To record the | | | freight] | freight] | | | | | | | Accounts Payable | Freight out 50,000 | | | 50,000 | | | | | Accounts Receivable | | | Cash 50,000 | 50,000 | | | | | | | Analysis: The freight | Analysis: FOB | | | term is FOB | Destination means | | | Destination, meaning | that the seller is | | | the Seller is the one | the one required to | | | who is required to | pay the shipping fee, | | | pay the shipping fee, | that is why Freight | | | that is why there is | out was recorded, but | | | no recording of | since Freight collect | | | freight-in in the | means that the buyer | | | book of the buyer. | actually paid the | | | Freight collect means | freight that was | | | that the buyer | supposed to be paid | | | actually paid the | by the seller, the | | | freight, that is why | proper entry to | | | we see a credit to | account this is to | | | cash to decrease the | reduce the account | | | cash and a debit to | receivable from the | | | accounts payable to | buyer. | | | reduce the payable to | | | | the seller because | [Compound Journal | | | the buyer paid the | Entry] | | | freight that was | | | | supposed to be paid | Accounts Receivable | | | by the seller. | 2,950,000 | | | | | | | [Compound Journal | Freight out 50,000 | | | Entry] | | | | | Sales 3,000,000 | | | Purchases 3,000,000 | | | | | | | | Accounts Payable | | | | 2,950,000 | | | | | | | | Cash 50,000 | | +-----------------------+-----------------------+-----------------------+ | February 3 | Accounts Payable | Cash 1,000,000 | | | 1,000,000 | | | | | Accounts Receivable | | | Cash 1,000,000 | 1,000,000 | +-----------------------+-----------------------+-----------------------+ | 10 | Accounts Payable | Cash 3,030,000 | | | 3,030,000 | | | | | Accounts Receivable | | | Cash 3,030,000 | 3,030,000 | | | | | | | Analysis: The total | | | | accounts payable is | | | | computed by adding | | | | the 3,000,000 from | | | | purchase and 30,000 | | | | from freight paid by | | | | the seller. | | +-----------------------+-----------------------+-----------------------+ | 15 | Accounts Payable | Cash 2,950,000 | | | 2,950,000 | | | | | Accounts Receivable | | | Cash 2,950,000 | 2,950,000 | | | | | | | Analysis: The total | | | | accounts payable is | | | | computed by deducting | | | | the 50,000-freight | | | | paid by the buyer to | | | | its 3,000,000-payable | | | | arising from the | | | | purchase of | | | | inventory. | | +-----------------------+-----------------------+-----------------------+ **[Note:]** You can use either the simple journal entry or the compound journal entry because it will yield the same answer. If the problem is silent as to what freight term is, the freight term is FOB Shipping point, freight collect. **Exercises: Inventory System** =============================== **Problem 1** Assuming that there is an inventory sold/purchased on account worth P800,000 and a freight charge of P70,000. What will be the entry on the following scenario? +-----------------------+-----------------------+-----------------------+ | Freight Terms | Seller | Buyer | +-----------------------+-----------------------+-----------------------+ | FOB Destination, | Accounts receivable | Purchases 800k | | Freight Prepaid | 800k | | | | | Accounts payable 800k | | | Freight out 70k | | | | | | | | Sales 800k | | | | | | | | Cash 70k | | +-----------------------+-----------------------+-----------------------+ | FOB Destination, | Accounts receivable | Purchase 800k | | Freight Collect | 730k | | | | | AP 730k | | | Freight out 70k | | | | | Cash 70k | | | Sales 800k | | +-----------------------+-----------------------+-----------------------+ | FOB Shipping Point, | Accounts receivable | Purchases 800k | | Freight Prepaid | 870k | | | | | Freight in 70k | | | Sales 800k | | | | | AP 870k | | | Cash 70k | | +-----------------------+-----------------------+-----------------------+ | FOB Shipping Point, | Accounts receivable | Purchases 800k | | Freight Collect | 800k | | | | | Freight in 70k | | | Sales 800k | | | | | AP 800k | | | | | | | | Cash 70k | +-----------------------+-----------------------+-----------------------+ **Problem 2** The following transactions took place during the period: May 1 Purchase of merchandise on account, P300,000. Freight cost is 10,000, Freight terms: FOB Shipping point, freight prepaid 4 Return of merchandise amounting to, P30,000. 6 Sale of Merchandise on Account, P400,000, at a gross profit of 40% based on sales. Freight terms: FOB Destination, freight collect 8 Return of merchandise amounting to, P25,000 9 Ending Balance of Merchandise inventory, P65,000 **Required**: Provide journal entry for all the transaction using both the point of view of seller and buyer. Buyer seller Purchase 300k AR 300K Freight in 10k sales 300k AP 300k Cash 10k AP 30k purchases 30k Purchases 30k AR 30k **Problem 3** Valenzuela Trader has the following transaction during the year February 1 Purchase merchandise on account 400,000, Freight cost is 20,000 Freight terms: FOB Shipping point, freight collect 5 Sale of merchandise on account with a selling price of 600,000 and cost of 300,000. Freight cost is 40,000. Freight terms: FOB Destination, Freight collect 6 Purchase returns amounting to 10,000 8 Sales Return amounting to 40,000, the cost is 20,000 10 Purchase of Merchandise on account 500,000. Freight cost is 40,000 Freight terms: FOB Destination, Freight Collect 12 Payment of accounts payable on February 1 less returns on Feb.6 14 Collection of Receivable from Feb 5 less returns on Feb 8 18 Payment of accounts payable on Feb. 10 **Required:** Provide Journal entry for the Valenzuela trader using both the Perpetual and Periodic Inventory System **Multiple choice** 1. Which of the following is true? a. The inventory account is updated every purchases and sales if the entity uses the Periodic Inventory System b. Purchases account is being used in the Perpetual Inventory System c. Entities who have low quantity and expensive products are encouraged to use the Periodic Inventory System d. Entities who have large quantity and inexpensive products are encouraged to use the Periodic Inventory System 2. Which of the following is false? e. Freight prepaid means that the freight was paid by the seller f. FOB shipping point means that the freight must be paid by the buyer g. Freight collect means that the freight must be paid by the buyer h. Freight collect means that the freight was paid by the buyer 3. Periodic inventory system i. Uses the account title "Merchandise Inventory" in recording the purchase of inventory j. Uses the account title "Freight in" when recording freight paid upon sales of merchandise k. Uses the account title "Freight out" when recording freight paid upon purchase of merchandise l. Uses the account title "Purchases" in recording purchase of inventory 4. Perpetual inventory system m. Uses the account title "Merchandise Inventory" in recording the purchase of inventory n. Uses the account title "Freight in" when recording freight paid upon purchase of merchandise o. Uses the account title "Freight out" when recording freight paid upon purchase of merchandise p. Uses the account title "Purchases" in recording purchase of inventory 5. Under the perpetual inventory system, in addition to the entry to record sale, an entity would record the outflow of entry by: q. Debit Ending Inventory Credit Beginning Inventory r. Debit Cash Credit Sales s. Debit Cost of Goods Sold and Credit Merchandise Inventory t. No additional entry is required **Topic 2: Statement of Comprehensive income of Merchandising Entity** Comparison of Income Statements of Service and Merchandising Entity **SERVICE MERCHANDISING** --------------- **Net sales** --------------- **Income Statement Income Stateme** -------------------------- **Revenue from Service** -------------------------- **LESS LESS** -------------- **Expenses** -------------- ------------------------ **Cost of goods sold** ------------------------ **IS EQUAL TO IS EQUAL TO** ------------------ **Gross Profit** ------------------ ------------ **Profit** ------------ **ADD/MINUS** --------------------- **Income/ Expense** --------------------- **IS EQUAL TO** ------------ **Profit** ------------ Let us breakdown the income statement of the Merchandising entity into details **Gross Sales XX** **Less: [Contra Sales] [(XX)]** **Net Sales XX** **Less: [Cost of goods sold] [(XX)]** **Gross Profit XX** **Less: Operating Expenses (XX)** **Add: [Other income] [XX]** **Net Income (Net loss) XX** 1. **Gross Sales** -- the total amount of sales of inventory 2. **Contra sales** \- composed of sales return, sales allowance, and sales discount. **Discounts --** a price reduction given to customer for a certain reason. There are two types of discount. The first one is the **Trade discount** and the second one is the **Sales Discount.** ***Trade discounts*** ===================== **--** A reduction to price given to customer to **encourage the customer to avail or buy the product.** Example: 10% off, 50% discount, buy one take one promo. **Trade discounts** are **not recorded** in the book of the entity, meaning if you happen to give or get a trade discount, such discounts will not be seen in the journal entry. In computing trade discounts, one must understand the meaning of these terms. **List price --** the original selling price **Invoice price --** the price agreed by the buyer and seller. **List price xx** **Less: [Trade Discounts] ([xx)]\-\-\-\-\-\-\-\-\-\-\-\--** List price x trade discount rate **Invoice Price xx \-\-\-\-\-\-\-\-\-\-\-\--** List price x (100%-Trade discount rate) **Sample problem**: The entity received cash for an inventory worth P5,000,000 with a 10% trade discount. Compute the invoice price and make the appropriate journal entry. Computation: List price x Trade discount rate = Trade discount 5,000,000 x.10 = 500,000 trade discount List price 5,000,000 Less: Trade discount [(500,000)] Invoice Price 4,500,000 **Shortcut** List price 5,000,000 [X 90%] \-\-\-- 100% less 10% trade discount rate Invoice Price 4,500,000 It is important to compute the invoice price because it is the monetary value that you will use in making journal entry. I prefer using the shortcut in computing the invoice price for the reason that it is easier and also because the trade discount is irrelevant for most of the time since it is unrecorded in the accounting records. +-----------------------------------+-----------------------------------+ | Seller\'s Journal Entry | Buyer\'s Journal Entry | +-----------------------------------+-----------------------------------+ | Cash 4,500,000 | Purchases 4,500,000 | | | | | Sales 4,500,000 | Cash 4,500,000 | +-----------------------------------+-----------------------------------+ Notice that in the journal entry there is no account title "Trade discounts", always remember that trade discounts are not recorded in the book of the seller nor in the book of the buyer. Another sample problem: An entity sold an inventory worth P6,000,000 less 10% ,20%, 30% Compute the invoice price and make the appropriate journal entry. Computation: 6,000,000 X [60%] \-\-\-\-- 10%+20%+30%= 60% 3,600,000 trade discounts. Well, I think that most of you would probably do that computation, but I have to tell you that that equation was **wrong.** When you see a lot of trade discounts, adding them would lead you to a wrong answer, because the right thing to do is to apply the discounts individually one after another. **The right equation is** 6,000,000 X [90%]\-\-\-\-\-\-\-- 100% less 10%- the first trade discount 5,400,000 X [80%]\-\-\-\-\-\-\-\-\--100% less 20% - the second trade discount 4,320,000 X [70%]\-\-\-\-\-\-\-\-\-\--100% less 30%- the third and the last trade discount 3,024,000 -- Invoice Price +-----------------------------------+-----------------------------------+ | Seller\'s Journal Entry | Buyer\'s Journal Entry | +-----------------------------------+-----------------------------------+ | Cash 3,024,000 | Purchases 3,024,000 | | | | | Sales 3,024,000 | Cash 3,024,000 | +-----------------------------------+-----------------------------------+ If there is more than one trade discount percentage, just apply the percentage one after another, never ever add them to compute the total discount. ***Cash discounts*** ==================== **--** a discount given to **encourage immediate or prompt payment** from the customer. The main difference between trade discount and cash discount is that the former\'s purpose is to get more sales, while the latter\'s purpose is to collect the cash from previous credit sales. Example 2/10, n/30. 3/15, N/45 To better understand cash discount let us first discuss how to read the cash discount in the problem. You will often see 2/10, n/30 in a problem, but the question is how will you interpret such figures? Let us break down the illustration in to two parts. The first one talks about the discount and the second one talks about the credit terms. 2/10 -- The **first digit** is the **discount rate**, while the **second digit** is the **discount period.** Meaning you will get 2% discount rate when you pay within the 10 days discount period. N/30 -- Means that the net credit term is 30 days. Meaning, the buyer is only allowed to pay within 30 days. So, 2/10, n/30 means that the buyer will receive 2% discount if he pays within 10 days, but if he didn't pay within 10 days it is still fine as long as he pays within 30 days, but in that case no discount will be given. If the customer pays 1-10 days = The customer is entitled to discount If the customer pays 11-30 days= NO DISCOUNT If the customer pays don't pay within 30 days = the entity has enough doubt as to collectivity of the account to set up an allowance for doubtful account as part of its adjusting entries. Sample problems On January 12, an entity sold merchandise for P5,000,000, terms 3/15 n/45. On January 25, the entity received the payment for the January 12 transaction On January 30, an entity sold merchandise for P6,000,000 terms 2/10 n/30 On February 11, the entity received the payment for January 30 transaction [Journal Entry] +-----------------------+-----------------------+-----------------------+ | Date | Seller\'s Journal | Buyer\'s Journal | | | Entry | Entry | +-----------------------+-----------------------+-----------------------+ | January 12 | Accounts Receivable | Purchases 5,000,000 | | | 5,000,000 | | | | | Accounts Payable | | | Sales 5,000,000 | 5,000,000 | +-----------------------+-----------------------+-----------------------+ | 25 | Cash 4,850,000 | Accounts Payable | | | | 5,000,000 | | | Sales Discount | | | | 150,000 | Cash 4,850,000 | | | | | | | Accounts Receivable | Purchase Discount | | | 5,000,000 | 150,000 | +-----------------------+-----------------------+-----------------------+ Computation 5,000,000\-\-\-- Invoice Price [X 3%]\-\-\--Cash discount rate 150,000\-\-\-- Cash Discount 5,000,000\-\-- Invoice Price [- 150,000\-\-\--cash discount] 4,850,000\-\-- cash receipt Explanation: The **cash discount** is base on **invoice price.** The sales were made on January 12, the discount period of 15 days will expire on January 27, but the customer paid on January 25 which is still inside the discount period that is why he is entitled to 3% discount rate. One of the main differences of the Trade discount and cash discount is that, the former is unrecorded in the books while the latter is recorded in journal entry under the account title "Sales Discount" for seller and "Purchase Discount" for the buyer. [Journal Entry] +-----------------------+-----------------------+-----------------------+ | Date | Seller\'s Journal | Buyer\'s Journal | | | Entry | Entry | +-----------------------+-----------------------+-----------------------+ | January 30 | Accounts Receivable | Purchases 6,000,000 | | | 6,000,000 | | | | | Accounts Payable | | | Sales 6,000,000 | 6,000,000 | +-----------------------+-----------------------+-----------------------+ | February 11 | Cash 6,000,000 | Accounts Payable | | | | 6,000,000 | | | Accounts Receivable | | | | 6,000,000 | Cash 6,000,000 | +-----------------------+-----------------------+-----------------------+ Explanation: The January 30 transaction is under the term 2/10 meaning that if the buyer pays within 10 days, he is entitled to a 2% discount, thus the payment date February 11 is already outside the discount period of 10 days that\'s the reason why he did not get any discount. Another sample problem On January 15, the entity sold P5,000,000 worth of inventory less 10, 30, 40. Terms 3/15 N/45. On January 25, the payment was received. [Journal Entry] +-----------------------+-----------------------+-----------------------+ | Date | Seller\'s Point of | Buyer\'s point of | | | view | view | +-----------------------+-----------------------+-----------------------+ | January 15 | Accounts Receivable | Purchases 1,890,000 | | | 1,890,000 | | | | | Accounts Payable | | | Sales 1,890,000 | 1,890,000 | +-----------------------+-----------------------+-----------------------+ Computation List price 5,000,000 X [90%]\-\-\-\-\-\-- 100% less 10%\-- first trade discount 4,500,000 X [70%]\-\-\-\-\-\-- 100% less 30% \-\-- second trade discount 3,150,000 X [60%]\-\-\-\-\-\-\--100% less 40%\-\-\-- third trade discount 1,890,000\-\-\--Invoice Price [Journal Entry] +-----------------------+-----------------------+-----------------------+ | Date | Seller\'s Point of | Buyer\'s point of | | | view | view | +-----------------------+-----------------------+-----------------------+ | January 15 | Cash 1,833,300 | Accounts Payable | | | | 1,890,000 | | | Sales Discount 56,700 | | | | | Cash 1,833,300 | | | Accounts Receivable | | | | 1,890,000 | Purchase Discounts | | | | 56,700 | +-----------------------+-----------------------+-----------------------+ Computation Invoice price 1,890,000 X [3%] \-\-\-\-\--Cash discount rate 56,700\-\-\-\-\--Cash discount Invoice Price 1,890,000 Cash discount [(56,700)] Cash Payment 1,833,700 **Exercises: Discounts** ======================== **Problem Solving** **Problem 1** ABC Merchandiser has the following transaction during the period: The list price of merchandise purchased merchandise on account, P800,000 less 20% and 10%, with credit terms of 2/10, n/30. Compute and Journalize the transaction using the following assumptions a. Assume that payment is made within the discount period: b. Assume that payment is made beyond the discount period: **Problem 2** Transactions for the Faith bookstore for May 2020 follows: May. 2 Purchased merchandise on credit from ABC Publishers, terms 2/10, n/30, FOB 3 Sold Merchandise on credit to Love Books Shop, terms 1/10, n/30, FOB shipping 5 Sold merchandise for cash, P7,000. 6 Purchased and received merchandise on credit from Hope Bookstore, terms 2/10, 7 Received freight bill from Super Express from shipment received on Mar. 6, P570. 9 Sold merchandise on credit to Recoletos Books, terms 1/10, n/30, FOB destination, 10 Purchased merchandise from ABC Publishers, terms 2/10, n/30, FOB shipping 11 Received freight bill from Super Express for sale on Mar. 9, P291. 12 Paid ABC publishers for purchase of Mar. 2. 13 Received payment in full for Love Book Shop's purchase of Mar. 3. 14 Paid Hope Bookstore half the amount owed on the Mar. 6 purchase. A discount is 15 Returned faulty merchandise worth P5,000 to ABC Publishers for credit against 16 Purchased Office supplies from Okay Supplies for P6,780, terms n/10. 17 Received payment from Recoletos Books for half of the purchase of Mar. 9. A 18 Paid ABC publishers in full for amount owed on purchase of Mar. 10, less return on 19 Sold merchandise to Manila Traders on credit, terms 2/10, n/30, FOB shipping 20 Returned for credit several items of office supplies purchased on Mar. 16, P1,880. 22 Issued a credit memo to Manila Traders for returned merchandise, P1,800 25 Paid of purchase on Mar, 16, less returns on Mar. 20. 26 Paid freight entity for freight charges for Mar. 7 and 11. 27 Received payment of amount owed by Manila Traders for purchase of Mar. 19, 28 Paid Hope Bookstore for the balance on Mar. 6 purchase. 31 Sold merchandise for cash, P9,730. Required: Prepare the journal entries. **Problem 3** ABC Merchandiser has the following transaction during the period: The invoice price of merchandise purchased merchandise on account, P600,000 20% and 10%, with credit terms of 2/10, n/30. 1. Compute for the list price 2. Provide journal entry assuming the following (Use both seller and buyer's point of view) a. The buyer paid within the discount period b. The buyer paid after the expiration of discount period 3. **Net sales --** the amount computed after deducting contra sales account to the gross sales. Gross Sales xx Less: Sales Returns (xx) Sales Allowances (xx) [Sales Discounts (xx)] Net Sales **xx** 4. **Cost of goods sold** - -The largest single expense of the merchandising business - It is the cost of inventory that the entity has sold to customers - recorded **at cost** +-----------------------------------------------------------------------+ | **Cost of goods sold statement** | | ================================ | | | | Add: Gross Purchases xx | | | | Less: Purchase Returns (xx) | | | | Purchase allowances (xx) | | | | [Purchase discounts (xx) ] | | | | Net purchases xx | | | | Add: [Freight in xx] | | | | [Net cost of purchases xx] | | | | Total goods available for sale (TGAS) xx | | | | Less: [Ending inventory (xx)] | | | | **Cost of goods sold (COGS) xx** | +-----------------------------------------------------------------------+ Sample problem The entity reported the following during the period Beginning Inventory 6,000,000 Purchases 4,000,000 Purchase returns 1,000,000 Purchase allowances 500,000 Ending inventory 400,000 Freight in 600,000 Freight out 500,000 Requirement: Compute for the COGS [Solution] +-----------------------------------------------------------------------+ | Beginning Inventory 6,000,000 | | | | Add: Gross Purchases 4,000,000 | | | | Less: Purchase Returns (1,000,000) | | | | Purchase discounts 0 | | | | Purchase allowances [(500,000)] | | | | Net purchases 2,500,000 | | | | Add: [Freight in 600,000] | | | | [Net cost of purchases 3,100,000] | | | | Total goods available for sale(TGAS) 9,100,000 | | | | Less: [Ending inventory (400,000)] | | | | Cost of goods sold (COGS) 8,700,000 | | | | Note: Freight out is excluded in the COGS because it is part of | | expenses. | +-----------------------------------------------------------------------+ 5. **Gross profit --** computed by deducting Cost of goods from Net sales. It is the initial profit of the entity before deducting expenses not directly related to the product being sold. 6. **Operating Expenses --** these are expenses, other than the cost of sales, which are incurred to generate profit from the entity\'s major line of business. Consist of **Administrative or general expenses, Selling or Distribution expenses, and other expenses.** - **Selling or Distribution expense-** cost incurred directly related to the entity\'s effort to generate sales. These includes **any expenses incurred inside the store,** including depreciation of the store itself and furniture inside of it, sales agent commission and salaries, depreciation of delivery truck, **Doubtful account expense if the collection authority is vested in the sales manager,** advertising expense, and **freight out.** - **Administrative or general expense-** are those expenses related to the general administration of the business. These includes **any expenses incurred inside the office**, including the officer and office salaries, depreciation of the office building or rent of office building, accountant\'s salary, **Doubtful account expense if silent.** If expenses have no info whether where it was incurred it is assumed that it was incurred for administrative purposes, meaning if the expense has no designation it is considered to be part of admin expense. - **Other expense --** are those expenses not related to the central operations of the business. These are **losses from incidental transactions** such as loss on sale of investments or loss on sale of equipment. The entity showed the following data as of the year end Since depreciation and rent expense was silent, there Is no indication where it was incurred then it is assumed to be incurred for admin purposes. Doubtful accounts expense is also silent, it is not indicated that the collection authority is vested in the sales manager, thus that doubtful account expense is treated as admin expense. Prepaid rent expense is an asset, that is why it is not Included in the admin expense. Salary is part of the selling expense because it was specifically assign to the salary of salesman, someone who works inside the store. Freight out is also included because it is the delivery expense. 7. **Other Income-** are income resulting from incidental transactions such as selling of equipment, building or anything aside from the inventory. **Exercises: Income Statement of Service Industry** =================================================== **Multiple Choice** Use the following information to answer questions 1-5 Account Name Debit Credit Sales 750,000 Sales Returns and Allowances 20,000 Sales Discounts 15,000 Purchases 200,000 Purchases Returns and Allowances 30,000 Transportation In 30,000 Selling Expense 75,000 General and Admin Expense 275,000 Additional information: Beginning merchandise inventory was P40,000 and ending merchandise inventory was P85,000 1. Net sales for the period a. 725,000 b. 715,000 c. 700,000 d. 750,000 2. Net cost of purchases for the period e. 230,000 f. 200,000 g. 170,000 h. 140,000 3. Cost of goods sold for the period i. 200,000 j. 240,000 k. 155,000 l. 185,000 4. Gross profit for the period m. 715,000 n. 560,000 o. 600,000 p. 210,000 5. Profit for the period q. 715,000 r. 560,000 s. 600,000 t. 210,000 6. Assuming that during the year the Net purchases was 800,000, and the inventory decreases by 100,000 during the year. What is the cost of goods sold? u. 800,000 v. 700,000 w. 900,000 x. 1,000,000 Use the following data in answering the 7-10 Depreciation Expense- Office Building 200,000 Salary of Salesmen 200,000 Depreciation Expense- Store Building 100,000 Salary of accountant 50,000 Depreciation Expense- Equipment 80,000 Salary of personnel 400,000 Store supplies Expense 60,000 Rent of Delivery Car 300,000 Office Supplies Expense 40,000 Freight out 200,000 Net cost of purchases 300,000 Beginning Inventory 400,000 Bad debts Expense 80,000 Ending Inventory 600,000 Net sales 2,000,000 Freight in 200,000 7. Compute for the Selling expense y. 850,000 z. 660,000 a. 940,000 b. 860,000 8. Compute for the Administrative Expense c. 660,000 d. 860,000 e. 850,000 f. 1,050,000 9. Compute for the Gross profit g. 1,700,000 h. 1,900,000 i. 1,600,000 j. 1,800,000 10. Compute for the Net income/ Net loss k. 1,900,000 l. 1,710,000 m. 190,000 n. (10,000) **Problem Solving** **Problem 1** ABC company have the following data for the past four years 2017 2018 2019 2020 Beginning Inventory 60,000 80,000 70,000 40,000 Net cost of purchases [120,000 140,000 100,000 150,000] Goods Available for Sale 180,000 220,000 170,000 190,000 Ending Inventory [(80,000) (70,000) (40,000) (60,000)] Cost of Goods Sold **100,000 150,000 130,000 130,000** Assuming that the following error was committed during those four years 2017: Beginning Inventory was overstated by 2,000 2018: Ending Inventory was understated by 3,000 2019: Ending inventory was overstated by 5,000 2020: Ending inventory was understated by 10,000 Compute for the correct cost of goods sold for the year, 2017, 2018, 2019 and 2020 **Problem 2** The table below contains portions of the income statement of the ABC Company for the past 3 years 2017 2018 2019 Net Sales 500,000 400,000 800,000 Beginning Inventory 60,000 100,000 300,000 Net Cost of Purchases 400,000 b. 200,000 Goods Available for Sales a. 800,000 f. Ending Inventory 100,000 300,000 g. Cost of Goods sold c. e. 800,000 Gross profit d. i. Compute for the missing amount **Topic 3: Completing the Accounting Cycle of Merchandising Entity** The accounting cycle of Merchandising Entity is also the same with the Service entity. It is composed of: - Analyzing Transactions - Journalizing Transactions - Posting/Accumulating Transactions - Preparation of Unadjusted Trial Balance - Adjustments - Preparation of Financial Statements - Closing Entries - Post-Closing Trial Balance - Reversing Entries **Analyzing Transactions-** analyzing transactions in Merchandise entity would also involve in knowing the Account title affected (Classifying) I. Monetary Value (Measuring) II. The Inventory system used, is it Perpetual or Periodic? III. The inventory valuation system, is it FIFO, Weighted Average, or Specific Identification? III and IV analysis are only done in the Merchandising entity and not in the service Inventory valuation system will be discussed in FAR 2 **Journalizing Transactions** **-** The main difference between service and merchandising entity\'s journal entry is the journal entry for inventory and sales. Inventory are recorded in the General Journal while the Sales are divided into two- Credit Sales which is recorded in the Sales journal while the Cash sales are recorded in the Cash receipts journal ***Sales Journal*** - **Sales journal** is a special journal is designed to record **sales of merchandise on account.** - The important data that needs to be in the Sales Journal is the **Date of the transaction, Sales invoice number, and the customer account.** - The data from the Sales Journal will be posted to the Subsidiary Ledger **daily** to have a current record and balance of each customer in order to answer customer's questions regarding their current balances. - At the end of the month, the total balance is posted to the Account Receivable and Sales in the General Ledger - The usual posting abbreviation used in posting is "S" ---------- ----------------- --------------------- ----------------------- --------------------------------------- **Date** **Invoice No.** **Account Debited** **Posting Reference** **Accounts Receivable Dr. /Sales Cr** May 1 001 ABC Corporation / 40,000 2 002 Manila Traders / 30,000 10 003 Valenzuela Traders / 20,000 20 004 Caloocan Traders / 10,000 25 005 Quezon Traders / 60,000 **160,000** ---------- ----------------- --------------------- ----------------------- --------------------------------------- **-**since the transaction that will be recorded in the Sales journal is only the Credit sales, there is no need to put the journal entry of each transaction. The account debited is important because it is where you will put the receivable in their respective subsidiary ledger ABC Corporation Manila Traders Valenzuela Traders 5/1 S1 40,000 5/2 S1 30,000 5/10 S1 20,000 Caloocan Traders Quezon Traders 5/20 S1 10,000 5/25 S1 60,000 - In subsidiary ledger, the name of the debtor is listed along with the increase and decrease of their accounts. Accounts Receivable Sales 6/30 S1 160,000 6/30 S1 160,000 At the end of the month, the total value of the Sales Journal will be posted in the general ledger as debit to Account Receivable *control account* and credit to the Sales Account. ***Cash Receipts Journal*** - All transactions involving cash receipts are recorded in this special journal. - Cash sales are recorded in this journal rather than in the sales journal because cash is best controlled when all cash receipts are recorded in one journal. ***Purchases Journal*** - It is used to record every **purchases of inventory, supplies and other assets on account.** ***Cash disbursements Journal*** - It is used to record **all cash payments.** **Posting Transactions** -- Posting in merchandising is the same as service industry, it is just transferring items in the journal to the ledger to compute the balances that will be used in the making of Unadjusted Trial Balance **Unadjusted Trial Balance --** made to check the equality of debit and credit. **Adjustments** -- Aside from the concepts that was discussed in the Adjustments of Service industry, for it is just the same with the Merchandising Entity, there is one distinct adjusting entry done for merchandising entity, it is the Adjusting Entries for the Ending Inventory. Adjusting entries related to inventory: ***1. Recording of ending inventory and closing of beginning inventory for Periodic Inventory System*** -under the Periodic inventory system ending inventory is not known therefore this adjusting entry is just for **Periodic Inventory System only**. Perpetual inventory system already has a record of ending inventory so this adjusting entry is irrelevant and not needed. The objectives of these entries are as follows 1. To **remove** the **beginning inventory** and to transfer it to **income summary** 2. To **record** the **ending balance of inventory** and to establish it in the **income summary.** Sample Problem The entity uses the Periodic Inventory System in recording inventory. The beginning inventory is P4,000,000. Before year ends, the entity conducts a physical count of P5,000,000. Make the proper adjusting entry. ***Step 1*:** Remove the beginning inventory and transfer it to income summary Income summary 4,000,000 Merchandise Inventory, Beginning 4,000,000 Explanation: The main goal of this journal entry is to make the beginning inventory zero and to transfer it to income summary account. Under periodic inventory system, the Merchandise Inventory account is not updated from time to time, so it means that the recorded inventory before any adjusting entries is the ending inventory of last period, that is why you need to close it first before inputting the right of inventory as per physical count ***Step 2:*** Enter the balance of ending inventory as per physical count Merchandise Inventory 5,000,000 Income Summary 5,000,000 Explanation: The main goal of this journal entry is to record the right amount of Ending inventory. **Note:** This adjusting entry is only for the Periodic inventory system because under Periodic system the inventory is not updated from time to time, therefore there is a need to close the beginning inventory and to input the ending inventory at year end. ***2. Adjusting entries for shortage or overage*** - Adjusting entries for shortage and overage are only made if an entity is using a **Perpetual Inventory System**, - **Periodic inventory system** will just record the result of physical count as ending inventory just like in the previous illustration **The need for physical count** One of the most important account in the Merchandising Entity is the Merchandise Inventory account. Before the year ends, there is a need for physical count whether you are using Perpetual Inventory or Periodic Inventory System. Purpose of Physical Count 1. Perpetual Inventory system - To know whether the running file or record of the inventory is accurate. Even if the inventory is updated from time to time under this system, there is still no absolute assurance that the record is correct, hence a need for Physical count at year end to **check the accuracy** of the record. 2. Periodic Inventory System - After conducting a physical count, three scenarios may arise in Perpetual Inventory System 1. The **recorded amount** of inventory is **more than** the **physical count** - In this case adjustments is done to **decrease the recorded amount** to follow the actual physical amount. [Adjusting Entry] +-----------------------------------+-----------------------------------+ | Perpetual Inventory System | Periodic Inventory System | +-----------------------------------+-----------------------------------+ | Inventory Shortage 100,000 | Merchandise Inventory, end | | | 400,000 | | Merchandise Inventory 100,000 | | | | Income summary 400,000 | | Computation | | | | Explanation: In periodic | | Physical count 400,000 | inventory system there is no such | | | thing as inventory shortage or | | Per record [500,000] | overage because there is no | | | record about how many inventories | | Shortage (100,000) | an entity has at year end. The | | | purpose of physical count in | | Explanation: Since the physical | Periodic is to know the ending | | count is just 400,000 which is | inventory. The only entry made is | | 100,000 lower than the recorded | to input the value of Ending | | amount, the proper way to correct | inventory (See previous | | it is by reducing the recorded | discussion for adjusting entry of | | amount by 100,000. | periodic inventory system) | | | | | **Recorded amount \> Physical | | | Count = inventory shortage** | | | | | | Note: **Inventory Shortage is | | | part of Other expense** | | +-----------------------------------+-----------------------------------+ | | | +-----------------------------------+-----------------------------------+ 2. The **recorded amount** is **less than** the **physical count** - In this case, an adjustment is made to **increase the recorded amount** to equal the actual inventory which is the physical count. [Adjusting Entry] +-----------------------------------+-----------------------------------+ | Perpetual Inventory System | Periodic Inventory System | +-----------------------------------+-----------------------------------+ | Merchandise Inventory 200,000 | Merchandise Inventory, end | | | 700,000 | | Inventory Overage 200,000 | | | | Income Summary 700,000 | | Computation: | | | | Explanation: The journal entry | | Physical count 700,000 | required is to record the | | | physical count to Merchandise | | Per record [500,000] | Inventory | | | | | Overage 200,000 | | | | | | Explanation: Since the actual | | | inventory is higher than the | | | recorded amount, the right | | | adjustment is by increasing the | | | recorded inventory to equal the | | | physical count which is the | | | actual inventory. | | | | | | **Recorded amount \< Physical | | | count = Inventory overage** | | | | | | Note: **Inventory overage is part | | | of other income.** | | +-----------------------------------+-----------------------------------+ 3. The **recorded amount** is **equal to** the **physical count** - In this case, **no adjustments are required** because the actual amount is equal to the recorded amount. [Adjusting entry] +-----------------------------------+-----------------------------------+ | Perpetual Inventory System | Periodic Inventory System | +-----------------------------------+-----------------------------------+ | Computation: | Merchandise Inventory, end | | | 4,000,000 | | Physical count 4,000,000 | | | | Income Summary 4,000,000 | | Per record | | | [4,000,000] | Explanation: The journal entry | | | required is to record the | | Adjustments 0 | physical count to the Merchandise | | | Inventory | | Explanation: There is no | | | adjustments needed because the | | | recorded amount is equal to the | | | physical count. | | | | | | **Recorded amount = Physical | | | count, then there is no | | | adjustment to the inventory** | | +-----------------------------------+-----------------------------------+ **Cases where physical count is impossible** 1. The inventory was destroyed or stolen - in this case the entity needs to use inventory estimation method such as **Gross profit method and Retail Inventory method (**will be discussed in your FAR2) 2. The inventory is in transit - just add the value of the goods in transit to your inventory in the warehouse **Adjusted Balance / Preparation of Financial Statements** The components of Financial Statements for the Merchandising Entity are the same with the Service entity. It is composed of, in the right order, - Statement of Comprehensive income - Statement of Other Comprehensive Income - Statement of Changes in Equity - Statement of Cash flow - Statement of Financial Statements - Notes to Financial Statements **Closing Entries --** transferring all nominal account into the capital account. - Closing of beginning Inventory Merchandise Inventory xx - Recognition of ending inventory Merchandise Inventory xx Income summary xx Note: The entity has the option whether classify this entry as adjusting entries or closing entries, that is the reason why it is also discussed under the adjusting entry. - Closing of Purchases related account a. 2,000,000 debit Beginning Inventory 2,000,000 b. 1,000,000 credit Purchases 3,000,000 c. [2,600,000 debit] Purchase Returns (200,000) Total:**3,600,000 debit** Purchase Allowances (300,000) Explanation: After making the closing entries of the Inventory related account, the total value in the income summary must always be equal to the Cost lf goods sold because those closing entries are done to compute for the Cost of goods sold. It is only done in the Periodic Inventory System because under the Perpetual System the cost of goods sold is already known for it is always included in the journal entry every time there is as a sale. - Closing of Sales related account **Additional Entries for Perpetual Inventory System** - Closing of Shortage or Overage - Closing of Sales related account **Post closing trial balance** -Done to ensure that after the closing and adjusting entries, the debit and credit are still equal. **Reversing Entries** - Done at the beginning of the next period. - Only **adjusting entries under Accrual** and **Adjusting entries under Deferral using the Income and expense method** can be reversed. Reversing Entries are done to simplify the next accounting records. **Exercises: Completing the Accounting Cycle** ============================================== **Multiple Choice** 1. Which of the following accounts would appear on a worksheet for a merchandising entity that uses Perpetual Inventory System? a. Purchases b. Freight In c. Freight out d. Purchase return 2. Which of the following accounts would not appear on a worksheet for a merchandising entity that uses Periodic Inventory system? e. Purchases f. Freight out g. Freight in h. Cost of goods sold 3. Which of the following would not be closed by a merchandising entity that uses Perpetual inventory system? i. Cost of goods sold j. Sales return k. Sales l. Merchandise Inventory 4. Which of the following would not be closed by a merchandising entity that uses Periodic Inventory System? m. Cost of goods sold n. Sales return o. Sales p. Merchandise Inventory 5. Which of the following would appear on a worksheet for a merchandising entity that uses Perpetual Inventory System? q. Freight in r. Purchases s. Cost of goods sold t. Purchase returns and allowances **Problem Solving** **Problem 1** The unadjusted trial balance of Faith Food Shop on December 31, 2019 appears below: ------------------------------- -------------------------- ------------- ------------------------ ------------------ --------------- -------- ------- -------- ------- -------- **Faith Food SHOP** **WORKSHEET** **December 31, 2020**                       ACCOUNT TITLE Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 100,000                 Accounts Receivable 500,000                 Merchandise Inventory 700,000                 Prepaid Rent 300,000                 Shop Equipment 1,600,000                 Accumulated Depreciation 200,000                 Accounts Payable 400,000                 Salaries Payable                 Faith, Capital 1,300,000                 Faith, withdrawal 100,000                 Sales 2,900,000                 Sales Discounts 100,000                 Purchases 800,000                 Purchase Return and Allowance 200,000                 Transportation In 100,000                 Salaries Expense 400,000                 Advertising Expense 150,000                 Utilities Expense 100,000                 Supplies Expense 50,000                 Rent Expense                 Depreciation Expense                 Income Summary Account                 Totals 5,000,000 5,000,000                 Profit Grand Totals         ------------------------------- -------------------------- ------------- ------------------------ ------------------ --------------- -------- ------- -------- ------- -------- Additional Information: a. Accrued salaries at year-end amounted to P130,000. b. Rent in the amount of P150,000 has expired during the year. c. Depreciation on shop equipment is P400,000. d. December 31, merchandise inventory amounted to P400,000. **Requirement: Prepare the worksheet of Faith Food shop** **Problem 2** The following are the information regarding the inventory of ABC Company Purchase of Inventory during the year 400,000 Returned merchandised to the supplier 100,000 Sales during the year 1,000,000 Sales return 400,000 Beginning, Inventory 200,000 Ending Inventory 400,000 **Prepare the necessary closing entries under Perpetual and Periodic inventory system** References ========== Ballada, Win, Ballada, Susan, *Basic Financial Accounting and Reporting (*2019 Issue- 22^nd^ Peralta, J.F. , Valix, C.A., & Valix , C.M. (2019). *Intermediate Accounting Volume 1* Uberita, C.O (2015). *Practical Accounting 1* (2015 edition). DomDane Publishers & Made Easy Books