Revamped and Reimagine Project Ulikid

Basic Accounting
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December 16, 2022

MERCHANDISING OPERATIONS − Then, other operating income is added

and operating expenses (like distribution
Comparison of Income Statement: costs, administrative expenses, and
Service Entities other operating expenses) are deducted
− Perform services for a fee from gross profit to arrive at operating
− In ascertaining profit, a basic income profit.
statement is all that is needed
− In Figure 6.1, profit is measured as the OPERATING PROFIT = GROSS PROFIT –
difference between revenues from OPERATING EXP
services and expenses
Merchandising Entities − Investment revenues, other gains and
− Earn profit by buying and selling goods losses, and finance cost (e.g. interest
− Use the same basic accounting methods expense) are considered to arrive at
as service entities, but the process of profit before tax then income tax
buying and selling merchandise requires expense is deducted to have profit from
some additional accounts and concepts. continuing operations.
This process results in a more complex − Finally, profit from discontinued
income statement operations (net of tax) is taken to
account to get profit for the period.
To provide a better measure of
performance, the income statement of a Discontinued operations are the results of
merchandising business is presented with operations of a component of an entity that
additional items: is either being held for sale or has already
been disposed of. The designated results of
operations must be reported as
discontinued operations within the financial
statements.

Parts of an Income Statement for a

Merchandising Entity:

In a Merchandising Business:
− Net sales – arise from the sale of goods
− Cost of sales or cost of goods sold –
represent the cost of inventory the entity
has sold to customers
− Gross Profit – the difference between OPERATING CYCLE OF A
net sales and cost of sales is called MERCHANDISING BUSINESS
gross profit
The merchandising entity purchases
GROSS PROFIT = NET SALES – COST inventory, sells the inventory, and uses the
OF SALES cash to purchase more inventory, and the
cycle continues. For cash sales, the cycle

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 Revamped and Reimagine Project Ulikid
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is from cash to inventory and back to cash. terms of delivery such as freight
For credit sales or sales on account, the terms, time, place, and the person
cycle is from cash to inventory to accounts named to receive the goods
receivable and back to cash. In any 3. Statement of Account
industry, the manager strives to shorten the - formal notice to the debtor detailing
cycle. The faster the sale of inventory and the accounts already due
the collection of cash, the higher the profits. 4. Official Receipt
The following illustrates the operating cycle - evidences the receipt of cash by the
of a merchandiser: seller or the authorized
representative
- notes the invoices paid and other
details by payment
- evidence that the seller received
cash
5. Deposit Slips
- printed forms with the depositor’s
name, account number and space
for details of the deposit
- validated deposit slip indicates that
cash and checks with the supplied
SOURCE DOCUMENTS
details were actually deposited or
Merchandising businesses use various
credited to the account holder
business forms and documents to help
6. Check
identify the transactions that should be
- a written order to a bank by a
recorded in the books. These source
depositor to pay the amount
documents contain vital information about
specified in the check from his
the nature and amount of the transactions.
checking account to the person
named in the check
The more common source documents along
- the entity issuing the check is the
with their descriptions are the following:
payor while the receiver is the
1. Sales Invoice (SI)
payee
- prepared by the seller of goods and
sent to the buyer
- this document contains the name 7. Purchase Requisition
and address of the buyer, the date - a written request to the purchaser of
of sale and information such as an entity from an employee or user
quantity, description and price department of the same entity that
about the goods sold goods be purchased
- also specifies the amount of sales, 8. Purchase Order
and the transportation and - an authorization made by the buyer
payment terms to the seller to deliver the
2. Bill of Lading (BoL) merchandise as detailed in the form
9. Receiving Report
- a document issued by the carrier,
- a document containing information
trucking, shipping, or airline that
about goods received from a vendor
specifies contractual conditions and

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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- formally records the quantities and 4. Upon receiving the shipment of

description of the goods delivered merchandise, the purchaser’s receiving
10. Credit memorandum department sees to it that the terms in
- a form used by the seller to notify the purchase order are complied with,
the buyer that his account is being and prepares a receiving report.
decreased due to errors or other 5. Before approving the invoice for
factors requiring adjustments payment, the accounts payable
department compares copies of the
STEPS IN A PURCHASE purchase requisition, purchase order,
TRANSACTIONS receiving report, and invoice to ensure
that quantities, descriptions, and prices
Whenever a purchase or sale of agree.
merchandise occurs, the buyer and the
seller should agree on the price of the All of the above forms: purchase
merchandise, the payment terms, and the requisition, purchase order, invoice, and
party to shoulder the transportation costs. receiving report are source documents.
Owners of small merchandising firms may When the goods are received or when the
settle these terms informally by phone or by title has passed, the entity should record
discussion with the vendor’s representative. purchases and a liability (or a cash
Most large businesses, however, follow disbursement). Generally, the seller
certain procedures when purchasing recognizes the sales transaction in the
merchandise. records when the goods have been
shipped.
The procedures are as follows:
1. When certain items are needed, the
TERMS OF TRANSACTIONS
user department fills in a purchase
requisition form and sends it to the
Merchandise may be purchased and sold
purchasing department.
either on credit terms or for cash on
2. The purchasing department then
delivery. When goods are sold on account,
prepares a purchase order after a period of time called the credit period is
checking with the price lists, quotations, allowed for payment. The length of the
or catalogs of approved vendors. The credit period varies across industries and
purchase order, addressed to the may even vary within an entity, depending
selected vendor, indicates the quantity, on the product.
description, and price of the
merchandise ordered. It also indicates When goods are sold on credit, both parties
expected payment terms and should have an understanding of the
transportation arrangements. amount and time of payment. These terms
3. After receiving the purchase order, the are usually printed on the sales invoice and
seller forwards an invoice to the constitute part of the sales agreement. If the
purchaser upon shipment of the credit period is 30 days, then payment is
merchandise. The invoice, called a expected within 30 days from the invoice
sales invoice by the seller and a date. The credit period is usually described
purchase invoice by the buyer defines as the net credit period or net terms. The
the terms of the transaction. credit period of 30 days is noted as “n/30”.

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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If the invoice is due ten days after the end of Trade Discounts
the month, it may be marked “n/10 eom” − Suppliers furnish smaller wholesalers or
retailers with price lists and catalogs
Cash Discounts showing suggested retail prices for their
− Some businesses give discounts for products. These firms, however, also
prompt payment called cash discounts. include a schedule of trade discounts
If a trade discount is also offered, cash from the listed prices to enable the
discount is computed on the net amount customer to determine the invoice price
after the trade discount. This practice to be paid. Trade discounts encourage
improves the seller’s cash position by the buyer to purchase products because
reducing the amount of money in of markdowns from the list price. Trade
accounts receivable. Cash discount is discounts should not be confused with
designated by such notation as “2/10” cash discounts. This type of discount
which means the buyer may avail of a enables the supplier to vary prices
two percent discount if the invoice is periodically without the inconvenience of
paid within ten days from the invoice revising price lists and catalogs.
date. The period covered by the − There is no trade discount account
discount, in this case, ten days, is and there is no special accounting
called the discount period. entry for this discount. Instead, all
− Called purchase discounts from the accounting entries are based on the
buyer’s viewpoint (credit – deducted invoice price which is obtained by
from purchases) subtracting the trade discount from the
− Sales discounts from the seller’s point list price.
of view (debit)
Example:
− It is usually worthwhile for the buyer to
Illustration: Pinnacle Technologies quoted a
take a discount if offered although it may
list price of P2,500 for each 64-gigabyte
be necessary to borrow the money to
flash drive, less a trade discount of 20%. If
make the payment.
Video Fantastic ordered seven units, the
− Deducted from invoice price
invoice price would be as follows:
Example:
Assume that an invoice for P150,000 with
terms of 2/10, n/30, is to be paid within the
discount period. If an annual interest rate of
18% is assumed, the net savings to the Trade discounts may be stated in a series.
buyer is P1,530 which is determined as Assume instead that the trade discount
follows: given by Pinnacle to Video Fantastic is 20%
and 10%, the invoice price will be:

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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In the first example, both the buyer and the − the freight entity collects from the buyer
seller would record only the P14,000 invoice
price while in the second example, the − Payment by either party will not dictate
invoice price will be P12,600. who should ultimately shoulder the costs
− Normally, the party bearing the freight
TRANSPORTATION COSTS cost pays the carrier
When merchandise is shipped by a - FOB Shipping Point = Freight
common carrier, a trucking entity or an Collect
airline, the carrier prepares a freight bill in - FOB Destination = Freight Prepaid
accordance with the instructions of the party
making the shipping arrangements. The Sometimes as a matter of convenience, the
freight bill designates which party shoulders firm not bearing the freight cost pays the
the costs, and whether the shipment is carrier. When this situation occurs, the
freight prepaid or freight collect. seller and buyer simply adjust the amount of
the payment for the merchandise.
Freight Bills
− Usually show whether the shipping Treatment of Transportation Costs:
terms are FOB shipping point or FOB
destination.
− F.O.B. – “free on board”

FOB Shipping Point (Buyer)

− When the freight terms are FOB The shipping costs borne by the buyer using
shipping point, the buyer shoulders the the periodic inventory system are debited
shipping costs to transportation in account. In accounting,
− Ownership over the goods passes from the cost of an asset, the merchandise
the seller to the buyer when the inventory includes all costs (e.g. shipping
inventory leaves the seller’s place of costs) incurred to bring the asset to its
business, the shipping point. intended use. In the cost of sales section of
− The buyer already owns the goods while the income statement, the balance in this
still in transit and therefore, shoulders account is added to purchases in computing
the transportation costs. for the net cost of purchases for the period.
FOB Destination (Seller)  
− Seller bears the shipping costs Shipping costs borne by the seller are
− Title passes only when the goods are debited to “transportation out” account,
received by the buyer at the point of which is also called delivery expense,
destination; while in transit, the seller is which is an operating expense in the
still the owner of the goods so the seller income statement.
shoulders the transportation costs.
BUYER SELLER
Transportation In Transportation Out
Freight Prepaid Freight In Freight Out
− seller pays the transportation costs Delivery Expense
before shipping the goods sold Added to purchases
Freight Collect Debit Debit

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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− As the time of sale, cost of sales is

Who determined and recorded as a debit to
shoulders Who pays the cost of sales account and a credit to
Freight Terms the the the inventory account. With a perpetual
transportati shipper? inventory system, both the inventory and
on cost? cost of sales accounts receive entries
FOB throughout the accounting period.
Destination, Seller Seller − Many merchandising entities are now
Freight Prepaid
using the perpetual inventory system
FOB Shipping
without point-of-sale equipment.
Point, Freight Buyer Buyer
Computers have decreased in prices.
Collect
These powerful machines have
FOB
Destination, Seller Buyer dramatically reduced the time required
Freight Collect to manage inventory. Supermarkets and
FOB Shipping department stores use point-of-sale
Point, Freight Buyer Seller scanners built into checkout counters to
Prepaid collect transactional data for the cash
register and to update their perpetual
INVENTORY SYSTEMS inventory system. In the absence of
point-of-sale scanners, the perpetual
Merchandise Inventory inventory system is more advisable for
− Key factor in determining the cost of firms that sell low-volume, high-priced
sales goods such as motor vehicles, jewelry,
− Because merchandise inventory and furniture.
represents goods available for sale, − When an entity uses the perpetual
there must be a method of determining inventory system, the ending inventory
both the quantity and the cost of these should reconcile with the actual physical
goods. count at the end of the period assuming
− There are two systems available to that no theft, spoilage, or error has
merchandising entities to record events occurred. Even if there is little chance of
related to merchandise inventory: the suspension of inventory discrepancy,
perpetual inventory system and the most entities make a physical count. At
periodic inventory system. that time, the account is adjusted for any
- If silent = Periodic Inventory System inaccuracies discovered. The count
provides an independent check on the
PERPETUAL INVENTORY SYSTEM amount of inventory that should be
− Alternative to the periodic inventory reported at the end of the period.
system
− The inventory account is continuously PERIODIC INVENTORY SYSTEM
updated − Primarily used by businesses that sell
− Perpetually updating the inventory relatively inexpensive goods and that
account requires that at the time of are not yet using computerized scanning
purchase, merchandise acquisitions be systems to analyze goods sold
recorded as debits to the inventory − No entries are made to the inventory
account account as the merchandise is bought
and sold. When goods are purchased, a

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 Revamped and Reimagine Project Ulikid
Basic Accounting
Mock Examinations
December 16, 2022

separate set of accounts, purchases, made to the delivery equipment, not to

purchases discounts, purchases returns, sales account.
and allowances, and transportation in
are used to accumulate information on The journal entry to record the sale of
the net cost of the purchases. merchandise for cash is as follows:
− Only at the end of the period, when the
inventory is counted, will entries be
made to the inventory account to
establish its proper balance. If the sale of merchandise is made on credit,
the entry will be:
INCOME STATEMENT

Sales Discounts
Assume that G. Detoya Traders sold
merchandise on Sept. 20 for P3,000; terms
2/10, n/60. At the time of sale, the entry is:

NET SALES
− First part of the merchandising income
statement as presented above The customer may take advantage of the
Gross Sales sales discount any time on or before Sept.
− Under the accrual accounting, revenues 30, which is 10 days after the date of the
from the sale of merchandise are invoice. If the client paid on Sept. 30, the
considered to be earned in the entry is:
accounting period in which the title of
goods passes, usually at the point of
delivery, from the seller to the buyer.
− Consist of total sales for cash and on
credit during the accounting period At the end of the accounting period, the
− Although cash for the sale is sales discount account has accumulated all
uncollected, the revenue is recognized the sales discounts for the period. The
as earned at the time of the sale. For account is considered a contra-income
this reason, there is likely to be a account and deducted from gross sales in
difference between net sales and cash the income statement.
collected from those sales in a given
period.
− As an income account, the sales
account is credited whenever sales on Sales Returns and Allowances
account or cash sales are made. Only − Each return or allowance is recorded as
sales of merchandise held for resale are a debit to an account called sales
recorded in the sales account. If a returns and allowances. An example of
merchandising firm sold one of its such transaction follows:
delivery trucks, the credit would be

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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There is no debit to transportation out

account since the shipping term provided
that the buyer should shoulder the
The seller usually issues the customer a transportation costs. If his invoice is
credit memorandum (i.e. Accounts collected on Dec. 5, the sales discount will
Receivable or Cash is credited), which is a be P340 (P17,000 x 2%). The entry would
formal acknowledgment that the seller has be:
reduced the amount owed by the customer.
Sales returns and allowances is a
contra-income account and is accordingly
deducted from gross sales in the income
statement. Case No. 3. Now assume that G. Detoya
Traders sold merchandise totaling P17,000
Transportation Out FOB destination, freight collect; terms 2/10;
− When the freight term is FOB n/30. The transportation costs amounted to
destination, the seller shoulders the P1,900. The entry to record this transaction
transportation costs; when the term is would be:
FOB shipping point, the buyer bears the
shipping costs.

Case No. 1. Assume that G. Detoya

Traders sold merchandise totaling P17,000
FOB destination, freight prepaid; terms
Accounts receivable is decreased by the
2/10, n/30. The transportation costs
transportation charges paid by the buyer for
amounted to P1,900. The entry to record
the benefit of the seller. If this invoice is
this transaction would be:
collected on Dec. 5, the sales discount will
be P340 (P17,000 x 2%) since the discount
applies to total sales.

If this invoice is collected on Dec. 5, the

sales discount will be P340 (P17,000 x 2%).
Transportation out is an operating expense.
Case No. 4. Assume further that G. Detoya
Traders sold merchandise totaling P17,000
FOB shipping point, freight prepaid; terms
2/10, n/30. The transportation costs
Case No. 2. Assume that G. Detoya amounted to P1,900. The entry to record
Traders sold merchandise totaling P17,000 the transaction would be:
FOB shipping point, freight collect; terms
2/10, n/30. The transportation costs
amounted to P1,900. The entry to record
this transaction would be:
If this invoice is collected on Dec. 5, the
sales discount will be P340 (P17,000 x 2%).
The discount only applies to total sales.

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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COST OF SALES / COST OF GOODS

SOLD
− Largest single expense of the
merchandising business
− It is the cost of inventory that the entity
has sold to customers Exhibit 6-3
− Every merchandising business has
goods available for sale to customers.
The goods available for sale during the
year is the sum of two factors,
merchandise inventory at the beginning
of the year and net cost of purchases
during the period.
GAFS = Beg. Inv. + Net Cost of
Purchases
− If an entity is able to sell all the goods
available for sale during the given
accounting period, the cost of sales Figure 6-4
would then equal goods that had been Figure 6-4 showed a pictorial diagram of the
available for sale. In most cases, cost of sales section. In summary, goods
however, the business will have goods available for sale during the period come
still unsold at the end of the year. To find from the beginning inventory and net cost of
the actual cost of sales, the purchases. The goods are either sold
merchandise inventory at the end of the during the period or remain unsold at the
period is subtracted from the goods end of the period. Goods available for sale
available for sale. will eventually turn to expense for the period
Cost of Sales = GAFS – Ending Inv. as cost of sales or to asset as merchandise
inventory. To understand fully the concept of
Exhibit 6-3 showed goods costing cost of sales, it is necessary to examine the
P1,796,600 as available for sale. G. Detoya details affecting merchandise inventory and
started with P528,000 in beginning the net cost of purchases.
merchandising inventory and a net cost of
purchases (or cost of goods purchased) of Merchandise Inventory
P1,268,600 during the year. At the end of − The inventory of a merchandising entity
the year, P483,000 of goods were left consists of goods purchased for resale.
unsold; this amount should appear as the For a grocery store, inventory would be
merchandise inventory in the balance sheet. made up of meats, vegetables, canned
When this ending merchandise inventory is goods, and other items. For lumber and
subtracted from goods available for sale, hardware, it would be plywood, nails,
the resulting cost of sales is P1,313,600. paints, iron sheets, cement, tools, and
other items. Merchandising entities
purchase their inventories from

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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manufacturers, wholesalers, and other debited to the purchases account as shown

suppliers. below:
− The merchandise inventory at the
beginning of the accounting period is
called the beginning inventory.
Conversely, the merchandise inventory
at the end of the accounting period is Purchases Returns and Allowances
called ending inventory. As presented (PRA)
in Exhibit 6-3, beginning and ending − A contra account and is accordingly
inventories are used in calculating the deducted from purchases in the income
cost of sales in the income statement. statement (see Exhibit 6-3).
The ending inventory shown in the − It is important that a separate account
income statement will be the be used to record purchase returns and
merchandise inventory to be reported in allowances because management
the balance sheet. needs the information for
− Effectively, the ending inventory of the decision-making.
current period will be the beginning − It may be very costly to return
inventory of the next period. merchandise. There are costs that
cannot be recovered such as ordering
Net Cost of Purchases costs, accounting costs, transportation
− Under the periodic inventory method, costs, and interest on money invested in
net cost of purchases consists of gross the goods. There may be call for new
purchases minus purchases discounts, purchasing procedures or suppliers.
and purchases returns and allowances − Sales returns and allowances in the
equal net purchases plus transportation seller’s books are recorded as
costs. purchases returns and allowances in the
books of the buyer. This should be
Net Cost of Purchases = P – PD – PRA = recorded as follows:
NP + TI

Purchases (P)
− The purchases account, a temporary
account, is used for merchandise Purchases Discounts (PD)
purchased for resale. − Like purchases returns and allowances,
− Its sole purpose is to accumulate the purchases discounts is a contra account
total cost of merchandise purchased that is deducted from purchases on the
during an accounting period. income statement.
− Purchases of other assets such as − If the entity makes a partial payment on
equipment should be recorded in the an invoice, most creditors will allow the
appropriate asset accounts. entity to take the discount applicable to
− Recording merchandise purchases at the partial payment.
− This discount does not apply to the
invoice price is known as the gross
transportation or other charges that
price method of recording purchases.
might appear on the invoice.
When the periodic inventory method is
used, all purchases of merchandise are

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 Revamped and Reimagine Project Ulikid
Basic Accounting
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Merchandise purchases are usually made

on credit and commonly involve purchases
discounts for early payment. In relation to
the Nov, 12 and 14 transactions, the
payment is recorded as follows: Case No. 3. Now assume that G. Detoya
Traders made purchases totaling P17,000
FOB destination, freight collect; terms 2/10,
n/30. The transportation costs amounted to
P1,900. The entry to record the transaction
Transportation In (TI) would be:
Case No. 1. Assume that G. Detoya
Traders made purchases totaling P17,000
FOB destination, freight prepaid; terms
2/10, n/30. Transportation costs amount to
P1,900. The entry would be:
Accounts payable is decreased by the
transportation charges paid by the buyer for
the benefit of the seller. If this invoice is paid
on Dec, 5, the purchases discount will be
There is no debit to transportation in P340 (P17,000 x 2%) because the discount
account since the shipping term provided applies to total purchases.
that the seller should shoulder the
transportation costs. In addition, the seller
prepaid the freight. If this invoice is paid on
Dec. 5, the purchases discount will be P340
(P17,000 x 2%). The entry would be:
Case No. 4. Assume further that G. Detoya
Traders made purchases totaling P17,000
FOB shipping point, freight prepaid; terms
2/10, n/30. The transportation costs
Case No. 2. Assume that G. Detoya amounted to P1,900. The entry to record
Traders made purchases totaling P17,000 the transaction would be:
FOB shipping point, freight collect; terms
2/10, n/30. The transportation costs
amounted to P1,900. The entry to record
this transaction would be:
If this invoice is collected on Dec. 5, the
sales discount will be P340 (P17,000 x 2%).
The discount only applies to total sales.

If this invoice is paid on Dec. 5, the

purchases discount will be P340 (P17,000 x
2%). Transportation in will form part of the Accounts Description Normal
net cost of purchases. Balance

Merchandise ● Beginning Debit

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 Revamped and Reimagine Project Ulikid
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Inventory Inventory
● Ending The entries related to value-added tax are
Inventory: as follows:
Shown as
Merchandise
Inventory in
the
Balance Sheet

Purchases Temporary account Debit

closed at the end
of the period
Input tax increase the amount to be paid
Purchases Contra-account, Credit but has no effect on the cost of the
Discounts deducted from purchases. Output tax also increased the
purchases
Purchases amount collected but not necessarily, the
Returns & sales figure. The value of goods or
Allowances properties sold and subsequently returned
or for which allowances were granted by a
Transportation Freight cost Debit
In
VAT-registered person may be deducted
incurred by the
buyer from the gross sales or receipts for the
quarter in which the refund is made or a
credit memorandum is issued. Sales
VALUE-ADDED TAX ENTRIES discounts or indicated in the invoice at the
time of sale may be excluded from the gross
The foregoing entries for sales and sales within the same quarter it was given.
purchases did not incorporate the effects of
value-added taxes on the transactions to
simplify the illustrations. But the learning will
not be complete without the following Remedios Palaganas, because of the sales
illustration. discounts granted, will pay value-added tax
  due of P33,000 only.
Illustration. Remedios Palaganas Feeds
based in Pangasinan trades specialty feeds Value-Added Tax (VAT) = 12%
for race horses, fighting cocks, aquarium
fishes, zoo animals and other animals
generally considered as pets. On May 13, Input Tax
2019, Remedios Palaganas Feeds − Current asset
purchased on account specialty feed with a − Tax paid in advance to supplier
total amount payable of P784,000. A
wholesaler operating in the region bought Output Tax
for cash all of the available feeds on May − Liability; payable to BIR
25, 2019; amount of cash received was − Collecting tax from customer
P1,120,000. Remedios Palaganas Feeds − Minus input tax = VAT Payable
paid the value-added tax due by month end
not minding the actual deadline. OPERATING EXPENSES

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 Revamped and Reimagine Project Ulikid
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− Make up the third major part of the

income statement for a merchandising This appendix will demonstrate the entries
entity typically used with the periodic inventory
− These are expenses, other than the cost system, contrasted to the entries used with
of sales, which are incurred to generate the perpetual inventory system. Assume
profit for the entity’s major line of that the beginning inventory for the year is
business, merchandising. P250,000. Assuming that the transactions
− It is customary to group operating (nos. 1 to 7) were the only transactions for
expenses into useful categories. the entire year, the balance in the inventory
Distribution costs, administrative account at year-end under the periodic
expenses, and other operating inventory system is P250,000 (beginning
expenses are the categories. inventory). The year-end balance in the
inventory account under the perpetual
Distribution Costs / Selling Expenses inventory system is P231,860.
− Expenses related directly to the entity’s
efforts to generate sales Under the perpetual inventory system, the
− These include sales salaries and inventory account is increased by
commissions, and the related employer purchases, transportation in, and sales
payroll expenses; advertising and store returns and is decreased by the cost of
displays; traveling expenses; store sales, purchases returns and allowances,
supplies used; depreciation of store and purchases discounts.
property and equipment; and
transportation out. At year-end, the physical inventory is taken,
and it is revealed that the actual inventory
Administrative Expenses on hand is P231,500. The year-end journal
− Expenses related to the general entries (nos. 8 to 10) are then made to bring
administration of the business the inventory account balance into an
− These include officers and office agreement with the amount of the physical
salaries, and the related employer inventory. When posted to the general
payroll expenses; office supplies used; ledger, both the periodic and perpetual
depreciation of office property and inventory systems result in the same ending
equipment; business taxes; inventory amount, P231,500.
professional services; uncollectible
accounts expense and other general Corollary Entry – perpetual inventory
office expenses. system; the entry that follows after the first
Other Operating Expenses entry
− Expenses that are not related to the
central operations of the business
− These are expenses and losses from
peripheral or incidental transactions of
the enterprise; for example, loss on sale
of investments or loss on sale of
property and equipment.

PERIODIC AND PERPETUAL

INVENTORY SYSTEM COMPARED

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Income Summary
− Credit = income
− Debit = expense

COMPLETING THE CYCLE FOR A

MERCHANDISING BUSINESS

NEED FOR A PHYSICAL COUNT

Periodic Inventory System
− In the periodic inventory system,
purchases of merchandise are
accumulated in the purchases account.
During the accounting, no entry is made
to the merchandise inventory account
such that its balance at the end of the
period, before adjusting and closing
entries, is the same as the beginning
inventory.
− With no perpetual record of the cost of
sales during the period, the only way to
obtain the cost of ending inventory is to
make a physical count.
− It should be noted that the ending
inventory amount is needed in the
computation of the cost of sales. To
recapitulate, ending inventory is
deducted from goods available for sale
to obtain cost of sales.

Cost of Sales = Goods Available for Sale –

Ending Inventory

Steps Involved in the Physical Count:

1. All merchandise owned by the entity is
counted.
For Perpetual: 2. The quantity counted is multiplied by the
− If Sales Allowances – do not record cost per unit for each inventory item.
inventory 3. The costs of various items are added to
− Still need a physical count determine the total cost of inventory.
Summary:
− Transaction that involves
payment/purchases of Transportation In
& Sales Return = DEBIT Inventory
− Purchases Discounts, Purchases
Returns & Allowances, Cost of Sales =
CREDIT Inventory Ending Inventory

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− Resulting total cost of inventory

− This amount will appear as a deduction
in the cost of sales section of the income
statement, and as a current asset in the
balance sheet
− The physical count is made at or near
the balance sheet date In this example, merchandise inventory was
− A reliable physical count is very P528,000 at the beginning of the year and
significant because the ending inventory P483,000 at the end of the year. Effect A
amount will affect both the income removed the P528,000 from the
statement and the balance sheet merchandise inventory account and
transferred it to income summary. In
Example: income summary, the P528,000 is in effect
An understatement of ending inventory in added to the cost of purchases because,
the 2018 income statement will cause an like expenses, the balance of the purchases
overstatement of cost of sales. In effect, account is debited to income summary by a
gross profit and profit will be closing entry.
understated. The understatement of ending  
inventory in the current period means that Effect B establishes the ending balance of
the beginning inventory of the next merchandise inventory of P483,000 and
period will also be understated. As a entered it as a credit in the income
result of this error or omission, the current summary account. The credit entry in
assets and the owner’s equity in the income summary has the effect of deducting
2018 balance sheet would be the ending inventory from goods available
understated. In summary, an error in for sale because both purchases and
valuing ending inventory will translate into beginning inventory are entered on the debit
one inaccurate balance sheet and two side. To summarize, beginning
incorrect income statement. merchandise inventory and purchases
are debits to income summary; while
ending merchandise inventory is credit to
MERCHANDISE INVENTORY AT THE income summary.
END OF THE PERIOD
Thus, the objectives stated above are
At the end of the period, entries are made to accomplished if Effect A and B concurred.
reflect in the inventory account the ending The question then arises as to how to
balance. The objectives of these entries are achieve these effects. Two acceptable
as follows: methods are available: the adjusting entry
a. To remove the beginning balance method and the closing entry method. Each
from the merchandise inventory method produces exactly the same result.
account and to transfer it to income
summary. Adjusting Entry Method
b. To enter the ending balance in the
merchandise inventory account and Using the adjusting entry method, the two
to establish it in the income entries indicated by effects A and B which
summary. are prepared at the time the other adjusting
entries are made follow:

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− The first step in the preparation of

worksheet is to enter the balances from
the ledger accounts into the trial balance
columns. The merchandise inventory
account balance of P528,000 is the cost
of the beginning inventory.

Adjustment Columns
Closing Entry Method − Under the closing entry method of
handling merchandise inventory, the
The closing entry method makes the debit adjusting entries for G. Detoya Traders
and the credit to merchandise inventory by are entered in the adjustments columns
including them among the closing entries as in the same way that they were for
follows: service entities. These involve
insurance expired during the period
(adjustment a); store and office supplies
(adjustments b and c); depreciation of
building and office equipment
(adjustments d and e); accrual of
interest expense (adjustment f). No
adjusting entries are made for
Notice that in both methods, merchandise merchandise inventory because the
inventory is credited for the beginning closing entry method was used. After
balance and debited for the ending balance the adjusting entries are entered in the
and that the opposite entries are made to worksheet, the trial balance columns
income summary. and adjustment columns are totaled to
prove the equality of the debits and
PREPARING THE WORKSHEET credits.

The worksheet of a merchandising business Omission of the Adjusted Trial Balance

is the same as that of a service business − These two columns are used when there
except that it has to deal with the new are many adjusting entries to be
accounts related to merchandising considered. When only a few adjusting
transactions. These accounts include sales, entries are required as in this case,
sales returns and allowances, sales these columns are not necessary and
discounts, purchases, purchases returns may be omitted.
and allowances, purchases discounts,
transportation in, merchandise inventory
and transportation out. The worksheet for
G. Detoya Traders using the closing entry Income Statement and Balance Sheet
method is shown below. Each pair of Columns
columns in the worksheet, and the adjusting − After the trial balance columns have
and closing entries are discussed as been totaled, the adjustments entered,
follows: and the equality of the columns proved,
the balances are extended to statement
Trial Balance Columns columns. Each accounts balance is

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entered in the proper column of the

income statement or balance sheet.
− The extension of the beginning and
ending inventory balances requires
some new procedures. First, the
beginning inventory balance of
P528,000 is extended to the debit
column of the income statement as
illustrated in 7-1. This procedure has
the effect of adding beginning inventory
to ent cost of purchases; observe that
the purchases account is also in the
debit column of the income statement.
− Second, the ending inventory balance
of P483,000 which is not in the trial
balance is entered in the credit column
of the income statement. This
procedure has the effect of subtracting
the ending inventory from goods
available for sale. Note that two
inventory amounts appeared in the
income statement columns. This is
because both the amounts appeared in
the income statement columns. This is
because both the beginning inventory
and ending inventory are needed in the
computation of cost of sales.
− Finally, the ending inventory is also
entered in the debit column of the
balance sheet. After all the items have
been extended to the proper statement
columns, the four columns are totaled.
The profit or loss is determined as the
difference between the debit and credit
columns of the income statement. In this
case, G. Detoya Traders earned a profit
of P455,210, which is extended to the
credit column of the balance sheet. The
four columns are then added to prove
the equality of the debits and credits.

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− Examples include raw materials and

PREPARING THE FINANCIAL consumables used, employee benefits
STATEMENTS expense, depreciation and amortization
  expense, transportation costs,
Income Statement advertising costs and other operating
− The statement may be prepared by expenses.
referring to the income statement Function of Expense Method
columns of the worksheet. Per revised − This method, also referred to as the
PAS No. 1, an enterprise should present “cost of sales” method, classifies
an analysis of expenses using a expenses according to their function as
classification based on either the nature part of the cost of sales,
of expenses or their function within the distribution/selling, administrative and
entity, whichever provides information other operating activities. This
that is reliable and more relevant. presentation often provides information
Entities are encouraged to present the that is more relevant to users than the
analysis of expenses on the face of the nature of expense method but the
income statement. allocation of costs to functions can be
Nature of Expense Method arbitrary and involves considerable
− Expenses are aggregated or combined judgment. This method provides multiple
in the income statement according to classifications and intermediate
their nature and are not reallocated differences to highlight significant
among various functions within the relationships.
entity. This method is simple to apply in − In a merchandising business, net sales
many smaller enterprises because no
arise from the sale of goods while cost
allocation of operating expenses
of sales or cost of goods sold
between functional classifications is
represents the cost of inventory the
necessary.
entity has sold to customers. The

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difference between the net sales and Statement of Changes in Equity

cost of sales is gross profit.
− Then, other operating income is added
and operating expenses (like distribution
costs, administrative expenses, and
other operating expenses) are deducted
from gross profit to arrive at operating
profit.
− Investment revenues, other gains and
loss, and finance costs (e.g. interest
expense) are considered to arrive at
Balance Sheet
profit before tax then income tax
The balance sheet dated “Dec. 31, 2019” is
expense is deducted to arrive at profit
implicitly understood to mean “at the close
for continuing operations. Finally, profit
of business on Dec. 31, 2019”
from discontinued operations (net of tax)
is taken to account to get profit for the
period.

ADJUSTING AND CLOSING ENTRIES

 
The adjusting entries are journalized and
posted to the ledger as they would be in a

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service entity. The closing entries for G.

Detoya Traders under the closing entry
method appear below.
 
Note that merchandise inventory is credited
in the 1st entry for the amount of the
beginning inventory, P528,000; and debited
in the 2nd entry for the ending inventory,
P483,000. Except for the closing of the
temporary accounts typical of a
merchandising business, the closing
procedures are the same with that of a
service business.

WORKSHEET IN A PERPETUAL
INVENTORY SYSTEM

The worksheet is prepared after all

transactions for the year have been
journalized and posted. However, the
following items should be noted:
1. The inventory amount in the trial
balance is the year-end balance since
the inventory account is perpetually
updated. There will be no merchandise
inventory adjusting or closing entry
unlike when the periodic inventory
system is used. The year-end inventory
balance will simply be extended to the
debit column of the balance sheet.
2. The cost of sales account is a ledger
account in the perpetual inventory
system. There will be no account for
purchases, purchases returns and
allowances, purchases discounts and
POST-CLOSING TRIAL BALANCE transportation in because information
related to these items is recorded
A final trial balance is prepared to test the directly in the inventory account. When
equality of the accounts after posting the the closing entries are made, cost of
adjusting and closing entries. This trial sales will be closed with the other
balance is similar to the one discussed in temporary accounts with debit balances.
service business except for the addition of 3. The adjustments are handled in exactly
the merchandise inventory account. the same way as they are handled in the
periodic worksheet.
4. An adjusting entry is necessary when
the year-end inventory account balance

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does not tally with the physical inventory accounts of individual customers and
amount. creditors.

SPECIAL AND COMBINATION CONTROL ACCOUNTS AND

JOURNALS, AND VOUCHER SYSTEM SUBSIDIARY LEDGERS

LIMITATIONS OF USING THE GENERAL When an entity keeps charges to and

JOURNAL AND GENERAL LEDGER payments from all customers in a single
accounts receivable account in the general
The discussions in the previous chapters ledger, the account in T-account form would
were limited to processing transactions appear as follows:
recorded in the general journal and posted
to the general ledger. This type of
accounting system is satisfactory for
introducing basic accounting procedures.
However, this system would be inadequate Using this procedure, the entity cannot
for a business having even a moderate easily bill or mail statements to customers,
volume of transactions for some reasons: answer inquiries about individual customer
− Only a limited number of transactions balances, or make any collection efforts if it
can be processed daily because only has only a single record showing total
one person at any one time can claims against all customers. The entity
introduce entries into the general needs to know each customer’s name and
journal. address, transaction dates, amounts billed
− Transactions recorded in the general and amounts received on account for each
journal must be posted individually in the account receivable.
general ledger, resulting to a great deal
of posting later. The problem can be partly solved by
maintaining in the general ledger an
To overcome these limitations, entities account for each customer. The trial
adopt an accounting system that balance of such general ledger may appear
incorporates either the use of the usual as follows:
special journals (non-voucher) or the
voucher system.

Also, the illustrations have utilized only one

account of accounts receivable and another
one for accounts payable. Entities that
maintain accounts with numerous
customers and creditors will find it
burdensome to work with a general ledger
containing a large number of customer and
creditor accounts. Therefore, entities adopt
an accounting system that uses control
accounts in the general ledger and separate This approach has limitations too. The
subsidiary ledgers to record and control the general ledger becomes unreasonably large
when hundreds of customers’ accounts are

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involved. With thousands of customers, it accounts payable, inventory, and property

becomes unworkable. and equipment.

This problem can be best addressed using SPECIAL JOURNAL

an accounts receivable control account in − These are journals of original entry other
the general ledger; and individual customer than the general journal that are
accounts in a subsidiary ledger. Under this designed for recording specific types of
approach, the general ledger is kept to a transactions of a similar nature.
manageable size, and a detailed record of − Most entities use the following special
transactions with individual customers exist journals:
in the subsidiary ledger. It is a controlling
account in the sense that its balance should Specific
Posting
equal the total of the individual account Journal Transactions
Abbreviation
balances in the subsidiary ledger. The Recorded
individual customer accounts are the Sales Journal Sales of S
subsidiary accounts. They are controlled by merchandise
the accounts receivable account in the on account
general ledger. The accounts receivable Cash Receipts Receipts of CR
subsidiary ledger, like the general ledger, Journal cash
may simply be a group of accounts in a Purchase Credit P
Journal purchases of
binder, or it may be a file card arrangement.
merchandise
In either case, the order is either numerical
and other
by customer number or alphabetical by items
customer name. Cash Payments of CD
Disbursement cash
The following shows the relationships Journal
between the accounts receivable control General Entries that do GJ
account in the general ledger and the Journal not fit in the
accounts receivable subsidiary ledger. other journals

Cash Sales
− Usually recorded in the cash receipts
journal rather than in the sales journal
because cash is best controlled when all
routine cash receipts are recorded in
one journal
− Similarly, an entity can increase control
over cash disbursements by recording
cash purchases of merchandise or other
items in the cash disbursements journal
rather than in the purchases journal.
The control account-subsidiary ledger
technique can be used to yield a detailed When special journals are used, the
breakdown of many general ledger general journal is maintained for adjusting,
accounts, not just accounts receivable. closing, and reversing entries; and for
Subsidiary ledgers are often used for recording transactions that do not fit in other

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special journals. Examples of the latter more transactions are involved,

include the recording of purchases returns more posting time is saved.
and allowances, and sales returns and
allowances. SALES JOURNAL

Advantages of Using Special Journals:

1. Permits division of labor
- When special journals are used, the
recording step in the accounting
cycle can be divided among several
persons, each of whom is
responsible for particular types of
transactions. Personnel making
entries in special journals need not
have a thorough knowledge of the
entire accounting system.
- Major advantage

2. Reduces recording time

- Special journal transactions need no
routine explanation for each entry.
Also, because special column Exhibit 8-1
headings are used, account titles
need not to be repeated unlike in the The sales journal of the Nazario Sea
general journal. Products, shown in Exhibit 8-1, is designed
- Time saved in posting from the for an entity using the periodic inventory
journals to the ledgers system. This journal lists all credit sales for
the month of June. The information for each
- When a general journal is used,
sale is obtained from a copy of the related
each entry must be posted sales invoice, which should be
separately to the general ledger. prenumbered for control purposes. This
The tabular arrangement of special journal is specifically designed to record
journals, however, often permits all sales of merchandise on account. In
entries to a given account in a contrast, cash sales are recorded in the
specific journal to be added and cash receipts journal. Credit sales of assets
posted as a single aggregate posting other than merchandise inventory (e.g.
- For instance, if you entered 800 property and equipment) are entered in the
sales transactions in a general general journal.
journal, you would make 800 debit
postings to the accounts receivable For each transaction, the accountant enters
account and another 800 separate the date, sales invoice number, and
credit postings to the sales account. customer account to be debited along with
Using the sales journal, however, the amount. If the same credit term is
there will only be two postings from extended to all customers, as assumed in
the sales journal to the general the illustration, there is no need to insert a
ledger; one to accounts receivable
and another to sales. Clearly, as

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column to describe the sales terms in the

sales journal. When amounts are posted to the ledgers,
the journal page number is entered in the
The posting of any journal to the general account to identify the source of the data. In
ledger may result in equal debits and Exhibit 8-1, all journal references in the
credits. In addition, for any posting to a ledger are “S1” since the postings originated
control account in the general ledger, the from page 1 of the sales journal.
same total amount must be posted to one or
more related subsidiary ledger accounts. Sales journals may accommodate additional
Exhibit 8-1 illustrates how to post the information. For example, columns could be
amounts in Nazario Sea Products sales included for sales by department or by
journal. product, so that a breakdown of sales is
available to management. Columns may
Amounts recorded in the sales journal are also be provided for output tax information,
posted daily to the subsidiary ledger to keep when necessary.
a current record of the accounts receivable
from each customer. Daily posting permits Additional Notes:
the business to answer customer inquiries − 140,000 > 150,000
promptly. A check mark ( √ ) is placed in the − Subsidiary Ledger > General Ledger
posting reference column of the sales − Cr. Accounts Receivable
journal to signify that the amount has been
posted to the customer’s account in the CASH RECEIPTS JOURNAL
subsidiary ledger.
All transactions involving cash receipts are
Updating the subsidiary ledger daily also recorded in a cash receipts journal. Exhibit
allows the credit department to review and 8-2 showed the cash receipts journal for an
monitor a customer’s account balance at entity using the periodic inventory system.
times other than the billing date. Cycle In a merchandising business, the main
billings may likewise be implemented; for sources of cash are collections of accounts
example, billing customers whose names and cash sales. Thus, this journal has debit
begin with different letters at different times columns for cash and sales discounts; the
of the month. The advantage of cycle credit columns for accounts receivable and
billings is that statements of account can be sales. In addition, there are columns on the
mailed throughout the month rather than in right-hand side of the journal which can be
one large group at the end of the month. used to record the account titles and credits
to other accounts resulting from cash
At the end of the month, when all sales receipts not related to cash sales and
have been recorded and sales journal has collections on account. Examples of these
been totaled and ruled, the total sales figure include investments by the owner and loan
is posted to the general ledger as a debit to releases.
the accounts receivable control account and
as a credit to the sales account. Note that Cash receipts are evidenced by source
the double posting reference at the bottom documents like prenumbered official
of the sales journal; indicates that accounts receipts (OR), cash register tapes (CRT) or
receivable is account no. 120 in the general cash slips, and bank credit memorandum
ledger and sales is account no. 410. (CM). Note that the entries on June 15 and

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June 30, debiting cash and crediting sales,

recorded cash sales for a certain period. In
practice, cash sales, which are usually
supported by cash register tapes, should be
recorded daily rather than semi-monthly.

The June 8 entry recorded P19,600 cash

collection from Zamboanga Exports related
to sales on account on June 1 of P20,000.
The cash discounts were taken. The entry
debited cash for P`19,600 and sales
discounts for P400, and credited accounts
receivable for P20,000. Official Receipt
(OR) no. 001 was issued to acknowledge
the cash receipt of P19,600. The entry for
Dipolog Traders on June 29 is similar.

The June 21 transaction illustrated the use

of two journals, cash receipts and general
journal, to record a business event. Here,
Cagayan de Oro Stores settled its P100,000
June 12 account by issuing a promissory
note for P50,000 and remitting P49,000
(P50,000 less 2% sales discounts) for the
balance.

In the cash receipts journal, the debits are

to cash, P49,000 and sales discounts,
P1,000; and accounts receivable is credited
for P50,000. The receipt of notes
receivable in lieu of an existing accounts
receivable is a non-cash transaction that
should be recorded in the general journal.
The entry debits notes receivable and
credits accounts receivable for P50,000
each.

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other accounts’ column are posted to the

general ledger. The total of this column is
The June 1 entry represented cash received used only to balance the journal and are not
as investments by the owner, Milavel posted.
Nazario. The June 10 cash receipts
pertained to a DBA Bank loan released Individual items in the accounts receivable
through a credit to the current account of column are posted on a daily basis to the
Nazario Sea Products maintained in the customer’s subsidiary ledger to keep this
same bank. In both cases, the other ledger in balance with the accounts
accounts’ columns are used. receivable control account. Postings to the
customer’s accounts are indicated by a
Before posting the cash receipts journal, check mark (√).
each column is added and the journal
balanced to make sure that total debits A schedule of account balances in the
equal total credits. In the illustration, subsidiary ledger is usually prepared at the
P1,348,000 + P2,000 = P100,000 + end of each accounting period to verify that
P450,000 + P800,000. the subsidiary ledger agrees with the related
control account. The schedule of accounts
The totals of the cash, sales discounts, receivable for Nazario Sea Products
accounts receivable, and sales columns are indicated that the subsidiary ledger agreed
posted to the general ledger, as noted by with its control account in the general
the posting references below these ledger.
columns. In addition, the individual items in

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PURCHASES JOURNAL

Merchandising business frequently

purchase merchandise and supplies. Such
purchases are usually made on account.
The purchase journal is designed to account
for purchases, supplies and other assets on
account. In contrast, cash purchases are
recorded in the cash disbursements journal.

Exhibit 8-3 illustrated the purchases journal

for an entity using the periodic inventory
system. In the illustration, the primary
source documents used as the basis for the
entries in the journal is the receiving report
(RR). The journal showed special columns
for debits to purchases, office supplies, and
store supplies, as well as for credits to
accounts payable. A column is provided for
debits to accounts for which no special
column is available. In practice, a column
for input taxes may be included. A separate
column for purchase terms may also be
provided to help identity the due date and
the discounts available.

The amounts in the accounts payable

column are posted to the accounts payable
subsidiary ledger on a daily basis. A
checkmark in the posting reference column
indicates that this has been done. At the
end of the month, the columns are totaled,
and the journal is balanced to ensure that
total debits equal total credits. The posting
pattern for the purchases journal is
diagrammed in Exhibit 8-3.

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After both the purchases and the cash

CASH DISBURSEMENTS JOURNAL disbursements journal have been posted,
the accounts payable control account has a
All cash payments are recorded in a cash balance of P330,000 (P590,000 from Exhibit
disbursements journal. Exhibit 8-4 showed 9-3 less P260,000 payment). This total
the June cash disbursements journal for agreed with the schedule of accounts
Nazario Sea Products after the related payable below:
transactions have been recorded, and the
journal balanced and posted. Note the
special columns for credits to cash and
purchases discounts, and for debits to
accounts payable and purchases.
Ordinarily, these accounts will have the
most entries. This special journal has
columns for the date and the number of
checks issued for each cash payment. Also,
the other accounts column is available for
recording debits to other accounts.

The June 2 entry in Exhibit 7-4 recorded the

issue of check no. 101 for P280,000 as
payment for accrued salaries at the end of
May. The entries on June 12 and June 19
recorded payment on accounts to Gingoog
Distributors and Oroquieta Suppliers, less
2% and 1% purchases discounts,
respectively.

Note that an equipment worth P100,000

was acquired on June 15 by giving P50,000
cash and a note payable for P50,000. The
cash payment of P50,000 was recorded in
the cash disbursement journal. The
issuance of notes for the acquired
equipment was recorded in the general
journal rather than in the purchases journal;
this is because the purchases journal in the
illustration did not provide for a special
credit column for notes payable. Of the
entity frequently issues notes to support
acquisitions on account, then a notes
payable credit column should be created in
the purchases journal. The other entries in
the journal are self-explanatory.

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GENERAL JOURNAL accounts in the accounts payable

subsidiary ledger.
When special journals are used,
transactions that cannot be recorded This control procedure is important because
appropriately in a special journal are this helps ensure the accuracy of the
recorded in the general journal. Examples accounting records.
include merchandise returns, write-offs of
uncollectible accounts; and certain FLEXIBILITY OF SPECIAL-PURPOSE
non-cash transactions involving notes JOURNALS
receivable and notes payable. The functions of special-purpose journals
are to reduce and simplify the work in
The entries below demonstrates that accounting and to allow for division of labor.
whenever a posting is made to the accounts These journals should be designed to fit the
receivable or accounts payable control business for which they are used. As noted
account from the general journal, a posting earlier, if certain accounts manifest often in
is also made to the related subsidiary ledger the other accounts column of a journal, it
account. may be advisable to add a column for those
accounts when a new page of a
special-purpose journal is prepared.

By addition, if certain transactions appear

repeatedly in the general journal, it may be
advisable to set up a new special journal for
that purpose. For example, if Nazario Sea
Products finds that it must often give
allowances to customers, it may set up a
sales returns and allowances journal. In
short, special journals should be designed
PROVING THE LEDGERS to suit transactions commonly encountered
At the end of the period, after all postings by an entity.
have been made, equality should exist
between the following: VOUCHER SYSTEM
● Total debit balances and total credit
balances of the accounts in the Most entities control purchases and cash
general ledger. These amounts are disbursements by formalizing the process of
used to prepare the trial balance. verification and approval of payments using
● The balance of the accounts a method known as the voucher system.
receivable control account in the Under this system, checks may be drawn
general ledger and the sum of the only upon a written authorization in the form
individual customer accounts in the of a voucher approved by responsible
accounts receivable subsidiary officials. The system consists of vouchers,
ledger. voucher register, unpaid voucher file, check
● The balance of the accounts payable register, and paid voucher file. The voucher
control account in the general ledger register takes the place of the purchases
and the sum of the individual creditor journal while the check register substitutes
the cash disbursements journal.

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expenditures are recorded first in the

− Cash disbursements have to pass the voucher register.
voucher register first - Approved vouchers are entered in the
− Dr. Expense Cr. Accounts Payable voucher register in numerical sequence.
− Non-voucher system: The voucher should be prenumbered so
Dr. Salaries Expense they can be accounted for and referred
Cr. Cash to easily. Observe Exhibit 8-5 that all
entries in the voucher register resulted
Voucher to a credit to accounts payable control
- The voucher is a serially numbered form account. The voucher payable account
that identifies the name and address of may also be used in place of the
the payee, the due date, terms, accounts payable account. If an entity
description and invoice amount. The opted for the use of the vouchers
form includes a section for designated payable account, the balance in this
officers to sign their approval for account may be properly reported in the
payment. It also has spaces for details balance sheet as accounts payable.
such as the date of payment, check - The register has columns for expense
number and ledger entries. and asset accounts frequently debited
- Before the designated official approves such as purchases, transportation in,
the voucher for payment, various office supplies, and transportation out.
personnel perform verification Debits and credits to accounts for which
procedures that include the following: columns are not provided for are made
1. Comparison of purchase requisition, in the other accounts section.
purchase order, invoice and
receiving report for agreement of Unpaid Voucher File
quantities, prices, types of goods, - The voucher register has columns to
and terms. record payment date and check number,
2. Review of extensions and footings in which are entered when the voucher is
the invoice. paid. After vouchers have been entered
3. Approval of account distribution (i.e. in the voucher register, they are filed in
the general ledger accounts to be the order of required date of payment.
debited). In this way, the entity will not miss
discounts, and its credit standing will not
Copies of the purchase requisition, be impaired. When a voucher is
purchase order, invoice and receiving report processed, the due date is written on the
should be attached to the voucher. These face of the voucher for filing
documents will comprise the voucher convenience.
package. The voucher is recorded in the - The absence of entries in the payment
book of original entry called the voucher date and check number columns of the
register. voucher register indicate that the
voucher is unpaid. The total unpaid
Voucher Register vouchers at any time may be
- As noted, the voucher register takes the determined by adding the items in the
place of the purchases journal, and voucher register for which the date paid
provides a record of all authorized check and check number columns contain no
payments. In a voucher system, all entries. This total should agree with the

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total of the vouchers in the unpaid file

and, at the end of the month, with the
amount in the accounts payable
account.

Check Register
- The check register in Exhibit 8-6 is a
simplified form of the cash
disbursements journal. The register is a
record of all check payments. Since
checks are entered in the check register
in numerical sequence, this record
provides a convenient reference for the
check number and the date of payment.
- Checks are issued only in payment of
approved and recorded vouchers. Every
check issued is recorded by a debit to
accounts payable and credit to cash,
and to purchases discounts, if
appropriate.
- On or before the due date, the voucher
package is removed from the unpaid file
and forwarded to the disbursing officer
for final approval of payment. After
signing the voucher, the disbursing
officer has a check drawn. The check
number and payment date are recorded
in the voucher, which is then returned to
the accounting department.
- To safeguard against irregularities, the
voucher and its underlying documents
should be canceled by the disbursing
officer before the voucher is returned to
the accounting department. The
department is now responsible for the
recording of the check payment in the
check register and the voucher register.

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voucher. For example, the entries for

recording and paying the liability to
Paid Voucher File Rodriguez Company for merchandise
- The paid voucher along with its (voucher no. 121, dated Dec. 1; see
supporting documents are filed in Exhibit 8-6) are summarized in general
numerical sequence in a paid vouchers journal form as follows:
file. This file is then available for
examination by internal and external
auditors requiring the information about
a specific expenditure.

Special Problems in a Voucher System

Gross or Net Amounts
- Under the voucher system, discounts
may cause the amount of the check to
differ from the gross amount of this

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- In addition, a notation about the new

voucher (no. 149) is made in the date
paid column of the voucher register
beside the entry for the original voucher.
In recording the new voucher, the
bookkeeper credits P20,000 in the
accounts payable column.
- In the other accounts column, accounts
Because both the gross and the net payable is debited for P25,000 and
amounts of the liability are indicated in the purchases returns and allowances is
voucher, this system should create no credited for P5,000. The net effect of
difficulty. Some entities, however, anticipate these recording procedures is a debit of
taking all discounts and prepare vouchers at P25,000 to purchases and a credit of
the net amount. When this procedure is P20,000 to accounts payable, and a
followed, only two money columns are credit of P5,000 to purchases returns
needed in the check register, one for a debit and allowances.
to accounts payable and the other for a
credit to cash in bank. Recording Partial Payments
- When installment or partial payments
If the entity should miss a discount, an are made on invoices, a separate
adjustment must be made in the voucher (or voucher is prepared for each check
the original voucher must be canceled and a issued. If a single voucher has been
new one prepared). The accountant must prepared for an invoice and the entity
also record discounts lost in the general later decided to pay in installment, the
journal. An alternative solution for handling original voucher is canceled and new
lost discounts when the net price method is voucher are prepared. The cancellation
used to provide a discounts lost column in of the original voucher and the issuance
the check register. of new vouchers can be recorded in the
same way that purchases returns are
Recording Purchases Returns and recorded.
Allowances
- Companies usually handle purchases COMBINATION JOURNAL
returns and allowances by canceling the − Multi-column
original voucher and issuing a new one − Sales, Cash Receipts, Cash
for the lower amount. For example, in Disbursements, Purchases, General
Exhibit 8-7, voucher no. 147 for Journal combined
P25,000, prepared for a merchandise − Special & General Journals combined
purchase from Nancy Mulles Company, − Combination journal provides the
was recorded in the voucher register on cornerstone for a simple yet effective
Dec. 27. Merchandise costing P5,000 is accounting system in many small
returned for credit and that a credit entities. This journal combines features
memo is received on Dec. 30. The of the general journal and the special
original voucher for P25,000 is canceled journals in a single record. If a small
and a reference made on it to a new entity has enough transactions to make
voucher for P20,000. the general journal difficult to use but too
few transactions to make it worthwhile to

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set up special journals, the combination - Debit to Purchases/Appropriate

journal offers a solution. This journal is Asset Account, Credit to
used most often in small professional Accounts Payable
offices and small service businesses. - Ex. Nov. 25, TXT Co. purchased
− Like the special journals, the office supplies on account from
combination journal contains separate EN Bookstore, P17,000.
amount columns for the accounts used 3. Cash Receipts Journal
most often (e.g. Cash-debit and credit, - Receipts of cash
Accounts Receivable-debit and credit, - This involves cash sales,
Accounts Payable-debit and credit, collection of accounts receivable,
Sales-credit, Salaries Expense-debit) to and recognition of sales
record and permit summary postings at discounts.
the end of the month. - Includes Sundry Accounts
− Other accounts columns allow the - Debit to Cash, Credit to
recording of the transactions that do not Appropriate Account
fit into any of the special columns. - Ex. Nov. 29, AAA Co. borrowed
These columns are also used for entities money from a bank, P23,000.
that would normally appear in the 4. Cash Disbursement Journal
general journal such as adjusting and - Payments of cash
closing entries. - This involves cash purchases,
clearing of accounts payable,
SUMMARY and recognition of purchase
SPECIAL JOURNALS discounts.
- journals of original entry, other than the - Includes Sundry Accounts
general journal, that record types of - Debit to Appropriate Account,
transactions that occur frequently, that Credit to Cash
may be seen as a repetitive list of - Ex. Nov. 30, HYBE Co. paid
entries when a general journal is used. half-month salaries of
1. Sales Journal employees, P77,000.
- Sales of merchandise on
account General Journal
- Debit to Accounts Receivable, - Entries that do not fit in the other
Credit to Sales journals are recorded in this journal
- Ex. Nov. 27, SVT sold - Includes adjusting entries, closing
merchandise on account to BTS entries, reversing entries, sales returns
costing P24,000. and allowances (with a credit to
2. Purchase Journal Accounts Receivable), purchase returns
- Credit purchases of merchandise and allowances (with a debit to
and other items Accounts Payable), write-offs of
- Includes Sundry Accounts: uncollectible accounts, and certain
miscellaneous or mixed non-cash transactions involving notes
accounts. All accounts in the receivable and notes payable.
sundry accounts are posted
individually to their respective Advantages of Using Special Journals
ledgers. 1. Saves time in journalizing and posting
2. Promotes division of labor

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3. Helps in management analysis receiving report.

Subsidiary Ledgers – supporting ledgers 2. Voucher Register – book of original

for the general ledgers. It is a list of entry where the voucher is recorded. This
individual accounts that record transactions takes the place of the purchases journal and
with common characteristics linked to a provides a record of all authorized check
control account. They are ledgers for each payments. In a voucher system, all
credit customer (Accounts Receivable expenditures are recorded first in the
Subsidiary Ledger) and for each company voucher register.
which the firm made a credit purchase
(Accounts Payable Subsidiary Ledger). 3. Unpaid Voucher File - where all
vouchers that have been authorized, but not
A schedule of account balances in the yet been
subsidiary ledger is usually prepared at the paid are kept. The absence of entries in the
end of each accounting period to verify that payment date and check number columns
the subsidiary ledger agrees with the related of the voucher register indicates that the
control account. voucher is unpaid.

VOUCHER SYSTEM 4. Check Register - a simplified form of the

Under this system, checks may be drawn cash disbursements journal. The check
only upon a written authorization in the form register is a record of all check payments.
of a voucher approved by responsible
officials. The system consists of vouchers, 5. Paid Voucher File - Where all paid
voucher register, unpaid voucher file, check vouchers are kept. The paid vouchers
register, and paid voucher file. The voucher should be filed in numerical order.
register takes the place of the purchases
journal while the check register substitutes COMBINATION JOURNAL
the cash disbursements journal. - combines features of the general journal
and the special journals in a single
1. Voucher – a serially numbered form that record
identifies the name and address of the - contains separate amount columns for
payee, the due date, terms, description, the accounts used most often (e.g.
and invoice amount. Before approving Cash-debit and credit, Accounts
the voucher for payment, the following Receivable-debit and credit, Accounts
verification procedures are performed: Payable-debit and credit, Sales-credit,
a. Comparison of purchase requisition, Salaries Expense-debit) to record and
purchase order, invoice, and permit summary postings at the end of
receiving report for agreement of the month.
quantities, prices, types of goods,
and terms. CORPORATIONS: BASIC
b. Review of extensions and footings in CONSIDERATIONS
the invoice.
c. Approval of account distribution. Corporation - A corporation is an artificial
Voucher Package – composed of the being created by operations of law, having
purchase requisition, purchase order, the right of succession and the powers,
invoice and attributes and properties expressly

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authorized by law or incident to its 1. Relatively complicated in formation and

existence. management.
2. There is a greater degree of government
ATTRIBUTES OF A CORPORATION control and supervision.
1. Separate Legal Entity – Artificial 3. Requires a relatively high cost of
Being. A corporation is an artificial being formation and operations.
with a personality that is separate from that 4. Subject to heavier taxation than other
of its individual owners. forms of business organizations.
5. Minority shareholders are subservient to
2. Created by Operation of Law. A the wishes of the majority.
corporation is generally created by the 6. In large corporations, management and
operation of law. The mere agreement of control have been separated from
the parties cannot give rise to a corporation. ownership.
7. Transferability of shares permits the
3. Right of Succession. A corporation has uniting of incompatible and conflicting
the capacity of continued existence subject elements in one venture.
to the period stated in the Articles of
Incorporation. The death, withdrawal, CLASSES OF CORPORATIONS
insolvency, or incapacity of the individual 1. Stocks Corporation. Corporations that
shareholders or members will not dissolve have share capital divided into shares and
the corporation. The transfer of ownership are authorized to distribute to the
of shares or stock does not dissolve the shareholders’ dividends based on their
corporation. shares held.
2. Non-stock Corporation. No part of its
4. Powers, Attributes, Properties income is distributable as dividends to its
Authorized by Law. A corporation has only members, trustees, or officers. Ex. USLS
the powers, attributes, and properties
expressly authorized by law or incident to its OTHER CLASSIFICATIONS OF
existence. CORPORATIONS
1. As to the number of persons:
ADVANTAGES OF A CORPORATION a. Corporation aggregate. A
1. Has the legal capacity to act as a legal corporation consisting of more than
entity. one corporator.
2. Shareholders have limited liability. b. Corporation sole. A corporation
3. Has continuity of existence. which consists of only one member
4. Shares of stock can be transferred or corporator and his successors
without the consent of the other such as a bishop.
shareholders. c. One-Person Corporation. OPC is a
5. Management is centralized in the board corporation with a single
of directors. stockholder, who
6. Shareholders are not general agents of can only be a natural person (who must be
the business. of legal age).
7. Has greater ability to acquire funds.
2. As to nationality:
DISADVANTAGES OF A CORPORATION a. Domestic corporation. Organized
under Philippine laws.

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b. Foreign corporation. Organized

under foreign laws. 7. According to their relation to another
corporation:
3. As to whether for public or private a. Parent or holding corporation.
purpose: Related to another corporation that it
a. Public corporation. Formed for the has the power to either directly or
government of a portion of the state. indirectly elect the majority of the
b. Private corporation. A corporation directors of a subsidiary corporation.
created for private aim, benefit, or b. Subsidiary corporation. Controlled
purpose. by another corporation known as a
parent
4. As to whether for a charitable purpose corporation.
or not:
a. Ecclesiastical corporation. STEPS IN THE CREATION OF A
Organized for religious purposes. CORPORATION
b. Eleemosynary corporation. 1. Promotion
Established for public charity. 2. Incorporation
c. Civil corporation. Established for Note: Operations of a corporation will not
business or profit. start without the issuance by the SEC of the
certificate of incorporation.
5. As to their legal right to corporate 3. Formal organization and commencement
existence: of business operations.
a. De jure corporation. Existing in fact
or law, organized in strict conformity ARTICLES OF INCORPORATION
with the law. - Documents the incorporators must file to
b. De facto corporation. Existing in the SEC.
fact but not in law.
BY-LAWS
6. As to the degree of public - Rules of action adopted by the corporation
participation regarding share ownership: for its internal government and for the
a. Close corporation. Share government of its officers, shareholders, or
ownership is limited to selected members.
persons or members of a family not
exceeding 20 persons. RIGHTS OF A SHAREHOLDER
b. Open corporation. Share is - Pre-emptive Right – right to purchase a
available for subscription or portion of any new shares issued to
purchase by any person. maintain the same percentage of stock
c. Publicly-held corporation. A ownership
corporation with a class of equity
securities listed on an exchange or COMPONENTS OF A CORPORATION
with assets in excess of 1. Corporators are those who compose a
P50,000,000 and having 200 or corporation whether as shareholders or
more holders, or at least 200 of members, at any time. Note: A corporation
which are holding at least 100 or a partnership can be a corporator but
shares of a class of its equity cannot be an incorporator. A partnership
securities. can be a corporator in a corporation, but a

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corporation cannot be a general partner in a pro-rata division of profits without

partnership. any preference.
2. Incorporators are shareholders or 7. Preference shares. These shares
members mentioned in the articles of entitle the holder to certain
incorporation as originally forming the advantages or benefits over the
corporation and are signatories to said holders of ordinary shares.
articles of incorporation. 8. Promotion shares. Those issued to
Note: All incorporators (if they continue to promoters as compensation in
be shareholders) are corporators of a promoting the incorporation of a
corporation, but not all corporators are corporation.
incorporators. 9. Treasury shares. A stock that has
3. Shareholders or stockholders are been issued by the corporation as
corporators in a stock corporation. fully paid and later reacquired but
4. Members are corporators of a non-stock not retired.
corporation. 10. Convertible shares. A stock that is
5. Subscribers are persons who have convertible or changeable from one
agreed to take and pay for original, class to another class.
unissued shares of a corporation formed or
to be formed. Note: All incorporators are BASIC CORPORATE ORGANIZATIONAL
subscribers, but a subscriber need not be STRUCTURE
an incorporator. - The ultimate control of the
6. Promoters are persons who bring about corporation rests with the
or cause to bring about the formation and shareholders.
organization of a corporation. - Hierarchy of Corporate Structure
7. Underwriters are those who undertake
to dispose of the shares to the general
public.
8. An Independent Director is a person
independent of management and free from
any business or other relationship which
could materially interfere with his exercise of
independent judgment in carrying out the
responsibilities of a director.
- The president of a corporation must
CLASSES OF SHARES IN GENERAL be a director of the corporation, but
1. Par value shares cannot act as president and
2. No-par but with stated value secretary or as president and
shares treasurer at the same time.
3. No-par, no stated value shares
4. Voting shares. Those issued with CORPORATE BOOKS AND RECORDS
the right to vote. 1. Minutes Book - contains the
5. Non-voting shares. Those issued minutes of the meetings of the
without the right to vote. directors and stockholders.
6. Ordinary shares. These shares 2. Stock and Transfer Book - a record
entitle the holder to an equal of the names of the shareholders,
installments paid and unpaid by the

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shareholders and dates of payment, without any preference or advantage

any transfer of stock and dates over any class of shares.
thereof, by whom and to whom 2. Preference Share Capital (Preferred
made. Stock). It entitles the holder to enjoy
3. Books of Accounts - represent the priority as to the distribution of
record of all business transactions. dividends and distribution of assets
4. Subscription Book - a book of upon corporate liquidation.
printed blank subscriptions.
5. Shareholders’ Ledger - a ledger
that details the number of shares
issued to each shareholder.
6. Subscribers’ Ledger – a subsidiary Share Capital may be issued with:
ledger for the subscriptions 1. Par Value Shares. Have nominal or
receivable account; it reports the face value stated on the face of the
individual subscriptions of the stock certificate and in the articles of
subscribers. incorporation.
7. Stock Certificate - a book of printed 2. No-par but with Stated Value
blank certificates of stock. Shares. Have nominal value stated
in the articles of incorporation but
CORPORATIONS: SHARE CAPITAL, not on the face of the stock
RETAINED EARNINGS, AND FINANCIAL certificate.
REPORTING 3. No-par, No Stated Value Shares.
Have no nominal value stated either
Share Capital (Capital Stock) in the articles of incorporation nor on
the face of the stock certificate.
- Share capital is also known as
capital stock. (Note: According to the Corporation Code, a
- It is the amount fixed by the no-par share capital is to be issued for a
corporate charter to be subscribed consideration of not less than five pesos
and paid in or secure to be paid in (P5.00).)
by the shareholders of a corporation
either in money or in property, labor,
or services upon the organization of Authorized Share Capital
the corporation or afterwards; and
- The maximum number of shares
upon which it is to conduct its
(both preference and ordinary
operations.
shares) that a corporation may
issue.
- It is determined by multiplying the
Classes of Share Capital authorized shares by the par or
1. Ordinary Share Capital (Common stated value of the share capital.
Stock). It is when a corporation - A corporation cannot issue shares
issued a single class of share more than the authorized shares
capital. It entitles the holder to an stated in the articles of incorporation.
equal or pro-rata division of profits However, it may increase its
authorized shares and authorized

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share capital by amending its article

of incorporation. Issuance of Share Capital

Share capital may be issued in exchange

Recording the Authorized Share Capital
for:
(2 ways)
1. Cash
1. Memorandum Entry Method
2. Non-cash Assets
- A memo entry is made to
3. Services
record the authorization of
share capital.
Issuance of Par Value Shares for Cash
- More popular method
Illustration: The Happy Corporation was
- This is used when the
organized on January 1, 2021 and is
problem is silent as to the
authorized to issue 100,000 shares of P10
method to use.
par value ordinary shares. Subsequently,
Example:
25,000 shares were sold.
Authorized to issue 100,000 shares
with a
Memorandum Entry Method
par value of P100.
Case 1: The issuance price is P10 (at par)
Cash (25,000 x P10)
2. Journal Entry Method
250,000
- The usual debit and credit entry is
Ordinary Shares
made to record the authorization of
250,000
share capital.
- This method cannot be used if the
Case 2: The issuance price is P15 (above
share capital is a no-par and
par)
no-stated value stock.
Cash (25,000 x P15)
Examples (using the data in the
375,000
previous example):
Ordinary Shares (25,000 x P10)
250,000
Unissued Ordinary Shares (100,000 x 100)
Share Premium (25,000 x P5)
10,000,000
125,000
Authorized Ordinary Shares
10,000,000
Journal Entry Method
If preference shares were issued in the Case 1: The issuance price is P10 (at par)
foregoing, the entry would be: Cash (25,000 x P10)
250,000
Unissued Preference Shares (100,000 x 100) Unissued Ordinary Shares
10,000,000 250,000
Authorized Preference Shares
10,000,000 Case 2: The issuance price is P15 (above
par)
Authorized Ordinary (Preference) Shares – Cash (25,000 x P15)
capital account, normal balance is credit 375,000
Unissued Ordinary (Preference) Shares – Unissued Ordinary Shares (25,000 x P10)
contra-capital account, normal balance is 250,000
debit

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Share Premium (25,000 x P5) Ordinary Shares

125,000 100,000

(Note: Issuance of shares below par (i.e., at

a discount) is not allowed by the Issuance of Par Value Shares in
Corporation Code.) Exchange for Services

Issuance of Par Value Shares for Guidelines in valuation when recording the
Non-cash Assets or Property issuance:
1. The transaction is valued using the
Guidelines in valuation when recording the fair market value of the services
issuance: rendered or the fair market value of
1. The asset received is recorded at its the shares issued.
fair market value, or the fair market 2. If no market value is known for both
value of the shares issued, the services rendered and the
whichever is more clearly shares issued, the transaction is
determinable. measured using the par value of the
2. If no market value is known for both shares.
the asset received or the shares
issued, the asset received is Illustration: The Happy Corp. issued 1,000
recorded at its appraised value. shares of P10 par ordinary shares in
3. If #1 and #2 are not available, the payment for the services of the lawyer
exchange is recorded using the par rendered during incorporation.
value of the shares.
Case 1: The lawyer’s services is valued at
Illustration: The Happy Corporation issued P25,000.
10,000 shares of its P10 par ordinary Organization Cost 25,000
shares in exchange for land. Ordinary Shares (1,000 x P10)
10,000
Case 1: The land has a fair value of Share Premium (25,000 - 10,000)
P175,000. 15,000
Land 175,000
Ordinary Shares (10,000 x P10) 100,000 Case 2: There is no known fair market value
Share Premium (P175,000 – P100,000) 75,000
for the
lawyer’s services. The fair market
Case 2: The land has no known market
value of
value. The fair value of ordinary share
the ordinary shares issued is P15
capital on the date of exchange is P15.
Land 150,000 per share.
Ordinary Shares (10,000 x P10) 100,000 Organization Cost (1,000 x P15)
Share Premium (10,000 x P5) 50,000 15,000
Ordinary Shares (1,000 x P10)
Case 3: There is no known market value for 10,000
both land and the ordinary shares. Share Premium (1,000 x P5)
Land (10,000 x P10) 5,000
100,000

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Case 3: There is no known market value for Illustration: The Happy Corporation issued
both 10,000 shares of its P10 par ordinary
the services rendered and the shares in exchange for land.
ordinary
shares issued. Case 1: The land has a fair value of
Organization Cost (1,000 x P10) P175,000.
10,000 Land 175,000
Ordinary Shares Ordinary Shares
10,000 175,000

Issuance of No-par but with Stated Value Case 2: The land has no known market
Shares value. The fair value of ordinary share
The same rules discussed in the issuance capital on the date of exchange is P15.
of shares with par value are applicable to Land 150,000
the issuance of no-par but with stated value Ordinary Shares
shares. 150,000

Issuance of No-par, No Stated Value Issuance of No-par, No Stated Value

Shares for Cash Shares in Exchange for Services
Illustration: The Happy Corporation was
organized on January 1, 2021 and is Guidelines in valuation when recording the
authorized to issue 100,000 shares of issuance:
no-par, no stated value ordinary shares. 1. The transaction is valued using the
Subsequently, 25,000 shares were sold at fair market value of the services
P15 per share. rendered or the fair market value of
the shares issued.
Cash (25,000 x P15) 375,000
Ordinary Shares Illustration: The Happy Corp. issued 1,000
375,000 shares of P10 par ordinary shares in
payment for the services of the lawyer
Issuance of No-par, No Stated Value rendered during incorporation.
Shares for Non-cash Assets or Property
Case 1: The lawyer’s services is valued at
Guidelines in valuation when recording the P25,000.
issuance: Organization Cost 25,000
1. The asset received is recorded at its Ordinary Shares
fair market value, or the fair market 25,000
value of the shares issued,
whichever is more clearly Case 2: There is no known fair market value
determinable. for the lawyer’s services. The fair market
2. If no market value is known for both value of the ordinary shares issued is P15
the asset received or the shares per share.
issued, the asset received is Organization Cost 15,000
recorded at its appraised value. Ordinary Shares
5,000

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Subscription of Shares Subscriptions Receivable – contra-capital

account, normal balance is debit
The sale of share capital on a subscription Subscribed Ordinary Shares – capital
basis generally involves three major account, normal balance is credit
transactions: Share Premium – capital account, normal
1. Receipt of subscription balance is credit
2. Collection from subscribers Ordinary Shares – capital account, normal
3. Issuance of stock certificate upon full balance is credit
payment of subscription
Subscription Defaults
Illustration: On June 3, 2021, the Happy Illustration: On June 15, 2021, the Happy
Corporation received a subscription for Corporation received subscription for 2,000
5,000 shares of its P10 par value ordinary shares of its P10 par value ordinary shares
shares at P15. A down payment of 25% was at P15. A down payment of 60% was
received and the balance was paid in full on received. The final payment was due on
July 4, 2021. August 15, 2021, although several notices
were sent to the subscriber, no payment has
a. To record the receipt of the been received. On August 31, the
subscription subscription was declared delinquent and
was offered for sale in a public auction. On
Subscriptions Receivable 75,000 September 6, expenses of P500 were
Subscribed Ordinary Shares incurred in connection with the delinquency
50,000 sale. On September 21, payment was
Share Premium received from the highest bidder and shares
25,000 were issued – 1,500 to the highest bidder
and 500 to the defaulting subscriber.
b. To record collection of subscription
from subscribers

Cash 18,750 a. To record the receipt of the

Subscriptions Receivable subscription
18,750
Subscriptions Receivable 30,000
Cash 56,250 Subscribed Ordinary Shares
Subscriptions Receivable 20,000 Share Premium
56,250 10,000

c. To record issuance of stock b. To record collection of subscription

certificate upon full payment of from subscribers
subscription
Cash 18,000
Subscribed Ordinary Shares 50,000 Subscriptions Receivable
Ordinary Shares 18,000
50,000
c. Costs incurred in connection with the
delinquency sale

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Additional information:
Receivable from Highest Bidder 500 - The purchase of treasury shares
Cash does not decrease the number of
500 shares issued; only the outstanding
shares decrease.
d. Upon receipt of payment from the
highest bidder Illustration: The Happy Corporation decided
to minimize outstanding shares by
Cash 12,500 purchasing 1,000 shares with a par value of
Receivable from Highest Bidder P20 for P24. (The cost method will be
500 used.)
Subscription Receivable
12,000 Purchase of Treasury Shares

e. Upon issuance of the certificate of Treasury Shares 24,000

stock Cash
24,000
Subscribed Ordinary Shares 20,000
Ordinary Shares Reissuance of Treasury Shares
20,000
Case 1: At cost. Assume that the treasury
If there are no bidders, all of the delinquent shares were subsequently reissued at cost.
shares will be issued in the name of the Cash 24,000
corporation. Such shares are considered Treasury Shares
treasury shares. 24,000

Treasury Stock 12,500 Case 2: Above cost. Assume that all

Receivable from Highest Bidder treasury shares were reissued at P30 per
500 share.
Subscriptions Receivable Cash 30,000
12,000 Treasury Shares
24,000
Treasury Shares Share Premium-Treasury
6,000
There are two methods of accounting for
treasury shares transactions: Case 3: Below cost. Assume that the 1,000
1. Par or Stated Value Method treasury shares were reissued at P20 per
2. Cost Method share.
Cash 20,000
Reacquisition by the issuing corporation of Retained Earnings
shares that have been issued and fully paid 4,000
for involves three general transactions: Treasury Stock
1. Purchase of Treasury Shares 24,000
2. Reissuance of Treasury Shares
3. Retirement of Treasury Shares (Note: The excess of the cost over reissue
price of P4,000 should be debited to share

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premium-treasury to the extent of its - Distributions may take the form of:
balance. In the absence of any balance in 1. Cash
this account, the “loss” is debited to retained 2. Non-cash assets
earnings. It is assumed in the above 3. Notes or other evidence of
illustration that the share premium-treasury corporate indebtedness
has a zero balance.) 4. Shares of the company’s own
share capital
Retirement of Treasury Shares - Distributions are paid out of the
accumulated earnings of the
Case 1: With gain on retirement. Assume corporation.
that Happy Corporation purchased the
treasury shares for P15 per share. (There is The declaration and payment of dividends
a “gain” on retirement if the cost of treasury involve three important dates and they are:
shares is less than the par value.) 1. Date of declaration – this is the date
Ordinary Shares 20,000 when the board of directors
Share Premium approved the resolution to distribute
5,000 dividends. The liability of the
Treasury Share corporation to the shareholders is
15,000 recorded on this date.
Case 2: With a loss on retirement. Assume 2. Date of record – this is the date
that Happy Corporation purchased 1,000 when the company determines the
treasury shares for P24 per share. shareholders who are entitled to the
Ordinary Shares 20,000 receipt of declared dividends. No
Share Premium* entry is required on this date;
6,000 however, a list of registered
Retained Earnings shareholders is made as of the close
6,000 Treasury Shares of business on this date. Share
32,000 capital is selling dividends-on prior to
this date and is selling ex-dividends
(*The loss on retirement of P1,500,000 the day following this date.
should be debited to the following accounts 3. Date of payment – this is the date
in the order given: (1) share premium to the when dividends declared are paid or
extent of the credit when the share is distributed to the shareholders. The
issued; (2) share premium from treasury liability recognized on the date of
stock transactions of the same class of declaration is canceled or
share; (3) retained earnings) extinguished on this date.

Treasury Shares – contra-capital account, Cash Dividends

normal balance is debit Illustration: Happy Corporation has 10,000
Share Premium-Treasury – capital account, shares of P100 par value ordinary share
normal balance is credit capital outstanding as of December 1, 2021.
On this date, the Board of Directors
Dividends declared a cash dividend of P10.00 per
- Distributions to shareholders of share to shareholders of record of
corporate earnings in proportion to December 30, 2021 payable on January 15,
the number of shares held by them. 2022.

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this date, the Board of Directors declared a

Retained Earnings* 100,000 share dividend distributable to shareholders
Cash Dividends Payable of record of December 30, 2021 payable on
100,000 January 15, 2021. The fair market value of
Happy Corporation’s shares on December 1
Cash Dividends Payable 100,000 is P105; on December 30, P110; on January
Cash 15, P106.
100,000
Case 1 – A share dividend of 10% was
(*The account, Cash Dividends Declared, declared.
may be used in place of the debit to
Retained Earnings. At the end of the Retained Earnings*
accounting period, this temporary 105,000
shareholders’ equity account will be closed Shares Distributable
by debiting Retained Earnings and crediting 100,000
Cash Dividends Declared.) Share Premium
5,000
Share Dividends
- This type of dividend does not affect Shares Distributable
total assets and total shareholders’ 100,000
equity, rather it simply represents a Ordinary Shares
transfer of capital from retained 100,000
earnings to contributed capital.
Hence, total shareholders’ equity Case 2 – A share capital dividend of 30%
before and after the declaration and was declared.
distribution of share capital
dividends are the same. Retained Earnings
300,000
Small Share Dividends Shares Distributable
- Share dividends representing less 300,000
than 20% of the outstanding shares.
- Retained earnings is debited for the Shares Distributable
fair value of the share capital on the 300,000
date of declaration. Ordinary Shares
300,000
Large Share Dividends
- Share dividends representing more (*The account, Share Dividends Declared,
than 20% or more of the outstanding may be used in place of the debit to
shares. Retained Earnings. At the end of the
- Retained earnings is debited for the accounting period, this temporary
par or stated value of the share shareholders’ equity account will be closed
capital. by debiting Retained Earnings and crediting
Share Dividends Declared.)
Illustration: Happy Corporation has 10,000
shares of P100 par value ordinary shares Shares Distributable – capital account,
outstanding as of December 1, 2021. On normal balance is credit

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Equity & Statement of Financial Position

Illustration: The accounts below appeared in (Shareholders’ Equity section)
the Dec. 31, 2021 trial balance of the Wow - The equity section of the statement
Corporation: of financial position of a corporation
Ordinary Shares, P20 par, 50,000 shares is called shareholders’ equity or
authorized, 22,000 shares issued stockholders’ equity and is
P440,000 generally composed of Contributed
Subscriptions Receivable Capital and Retained Earnings.
23,000
Subscribed Ordinary Shares 1. Contributed Capital. It represents
33,000 corporate capital arising investment
Retained Earnings by shareholders. It is further divided
200,000 Share Premium into two sections:
75,000 a. Legal Capital. This section
Treasury Stock, 1,500 shares, at cost reports both preference
30,000 (preferred) and ordinary
(common) shares issued,
Determine the following: subscribed, and distributable
Total authorized ordinary shares as dividends, stated at par or
P1,000,000 stated value. In case of share
Total unissued ordinary shares capital without par value nor
560,000 Total issued ordinary shares stated value, the amount
440,000 Ordinary shares reported is the total value of
subscribed 33,000 Total consideration received in
shareholders’ equity 695,000 exchange for the shares.
b. Share Premium. This section
reports investment by
shareholders in excess of the
par or stated value of the
share capital. It includes
paid-in capital in excess of
par value or stated value
(share premium) of both
preference and ordinary
shares.
Number of shares issued
22,000 2. Retained Earnings (Earned Surplus).
Number of shares subscribed It represents the undistributed
1,650 earnings of the corporation. It
Number of shares in treasury represents the capital of the
1,500 corporation arising from its
Number of outstanding shares operations. The Retained Earnings
20,500 account has a normal credit balance.
A debit balance in the account is
Statement of Retained Earnings, called a deficit. The balance of the
Statement of Changes in Shareholders’

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account is generally divided into two I. Prepare journal entries to record the
parts, as follows: foregoing transactions.
a. Appropriated Retained II. Prepare the retained earnings
Earnings. It is the portion of statement for 2021.
Retained Earnings set aside
for a specific purpose.
b. Unappropriated Retained
Earnings. It is the portion of
Retained Earnings available
for distribution as dividends
to the shareholders. It is
normally described as
“unrestricted earnings.”

Illustration 1: The shareholders’ equity of

Angry Corporation at January 1, 2021
appeared below:

Ordinary shares, P25 par, 500,000 shares

authorized, 80,000 shares issued
and outstanding
P2,000,000
Share Premium
6,310,000 Retained Earnings
2,650,000

During 2021, the following transactions

occurred:
Jul 7 Declared a 15% share dividend; the
market value of the ordinary shares was
P120 per share.
28 Issued the share dividend declared
on June 7.
Dec 5 Declared a cash dividend of P15 per
share.
26 Paid the cash dividend declared on
Dec. 5.
31 Closed profit of P1,560,000 from the
income
summary account to retained
earnings.
31 Closed the dividend accounts to
retained
earnings.

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Dec 18 Declared a cash dividend of P2.00

Illustration 2: The shareholders’ equity per
section of Sad Corporation at December 31, outstanding ordinary share, payable
2021, follows: on Jan.
9 to shareholders of record on Dec.
Ordinary Shares, P15 par, 200,000 shares 31.
authorized, 75,000 shares issued, 7,000 31 Closed the income summary
shares are in the treasury account, with
P1,125,000 profit of P303,000 to retained
Share Premium Earnings.
425,000 31 Closed the dividend accounts to
Share Premium-Treasury retained
15,000 earnings.
Retained Earnings
250,000 I. Prepare journal entries to record the
Total foregoing transactions.
1,815,000 II. Prepare the statement of changes in
Less: Treasury Stock, 5000 shares at cost shareholders’ equity for 2021.
120,000 III. Prepare the shareholders’ equity
Total Shareholders’ Equity section of the statement of financial
P1,695,000 position as of December 31, 2021.

Note: A portion of retained earnings is

restricted due to the purchase of treasury
shares.

The following transactions affecting

shareholders’ equity occurred during 2021:

Jan 8 Issued 20,000 shares of previously

unissued ordinary shares for P30
cash per share.
Mar 12 Sold all of the treasury shares for
P28 cash
per share.
Jun 30 Declared a 5% share dividend on all
outstanding ordinary shares. The
market
value of the share was P25 per
share.
Jul 10 Issued the share dividend declared
on June
30.
Oct 7 Acquired 1,200 ordinary shares for
the
treasury at P30 per share.

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Pro-forma Financial Statements of a

Corporation

Trial Balance

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Worksheet

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Statement of Financial Performance Statement of Financial Position (Balance

(Income Statement) Sheet)

Statement of Changes in Shareholders’

Equity

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Adjusting Entries Reversing Entries

Closing Entries

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