FUNDAMENTALS OF

USERS OF ACCOUNTING INFORMATION

ACCOUNTING
1. Internal Users – those who make decisions
ACCOUNTING is the process of recording financial that affect the internal operations of the
transactions pertaining to a business. The accounting company.
process includes summarizing, analyzing, and 2. External Users – those who make their
reporting these transactions to oversight agencies, decisions based on the company’s financial
regulators, and tax collection entities. Moreover, information.
accounting is a significant manner and terms of money,
transactions and events in which are in part atleast of THREE PRIMARY INFORMATION NEEDED BY THE
financial character and interpreting the result thereof. It USERS
is also a language of business. When we say 1. Financial Performance ( Income Statement)
BUSINESS, it is regulatory, profit-oriented, and coming also called Profit or Loss.
together with common sense. Business also define as
economic activity of buying and selling in order to Statement or Statement of Earnings -
obtain profit. report which describes how business operated or
produced wealth over a given period of time.
(Profit is obtained when the amount you receive if
more than the amount you paid for goods and services 2. Financial Position ( formerly called the
you sold) balance sheet ) - show how healthy or robust
the enterprise when it shows a listing of
(All business need a financial information before accumulated resources (cash and properties)
making decision) Statement of Changes in Owner’s
HISTORY OF ACCOUNTING Equity is another report prepared by the
accountant which explain the activities for a
 14th – 17th century (renaissance period) period of time that caused the owner’s equity
 Fra Luca Pacioli – Father of Accounting to change.
 Italy, Europe (debere-debit, credere-credit) 3. Cash Flow Statement of the business is a
financial statement which explains why the
OBJECTIVES OF ACCOUNTING amount of cash changed over a period of time.
The report makes a listing of the cash inflow
 Providing information to the usersfor rational
activities (cash receipts) and the cash outflow
decision-making.
(cash payments) of the business.
 Systematic recording of transaction.
 Ascertainment of results of above transaction.
 Ascertain the financial position of the business.
ACCOUNTING AREAS (BRANCHES OF
 To know the balance sheet.
ACCOUNTING)
WAYS OF OBTAINING PROFIT
 Basic Accounting or Bookkeeping – routine
 In service business – money is received for activity of recording, classifying, and
the cost of service rendered. summarizing business transactions in a
 In merchandising business – money is systematic manner. It is the procedural aspect
received for the cost of merchandise given of accounting.
 In manufacturing business – money is  Financial Accounting – involves in the
received for the cost of the product given. preparation and interpretation of financial
statements primarily intend for external users.
TYPES OF BUSINESS ACTIVITIES Financial Statements are primarily concerned
with historical financial information regarding
 FINANCING ACTIVITIES -- owner “finances”
performance(profit and loss), position (liquid,
the business with a capital in cash and other
solvent), structure (loan, equity) and a
resources.
compliance with legal and regulatory
 INVESTING ACTIVITIES -- involve the
requirements.
acquisition of properties such as land,
 Cost Accounting – deals with recording,
furniture, machineries and equipment.
classifying and summarizing the details of
 OPERATING ACTIVITIES -- day to day
material, labor and overhead necessary to
activities related to earning of income when
produce and sell a product of service.
goods or services are sold and the incurring of
 Management Accounting – deals with
expenses when wages, rent, utilities,
financial and non-financial information
transportation are paid.
primarily for managers and other internal users
to assist them in planning, directing and
controlling the affairs of business.
  Auditing – deals with the independent revenue, must be matched (subtracted)
verification and examination of the accounting against the revenue for the same period.
records for the purpose of giving credibility to 7. Consistency - This simply means that for the
the financial statements. financial statements to be comparative, the
 Government or Non-Profit Accounting uses application of the accounting methods,
“Fund Accounting” which deals with the procedures, or principles must be consisted
administration or use of public community with the previous period.
funds to bring about service to the people. 8. Accounting Period - Considering that the
 Tax Accounting – deals with tax matters business is assumed to be a going concern, its
affecting firms. It involves preparation of tax life is divided into periods ( usually one year) at
returns, interpretations and application of tax the end of which financial statements are
rules in the determination of tax liability, prepared.
analyzing tax effect on firm’s or individual’s 9. Full Disclosure -This simply means that the
projects or plans. financial statements should reflect all
 Forensic Accounting – is getting to be significant events or facts, which might
recognized as a new discipline which influence the decisions to be made by any
integrates accounting, auditing and interested party.
investigative skills. The fraud examiner or GOVERNMENT REGULATORY AGENCIES
forensic accountant works closely with lawyers
and helps in solving fraud which could be PROFESSIONAL REGULATION COMMISSION
tracked down by reviewing financial records, (PRC) -Is in charge of administering professional
papers and electronic trails. examination including CPA, regulate licensed
professionals, promulgation and enforcement of
professional ethics and standards.
GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP), CONCEPTS & BOARD OF ACCOUNTANCY (BOA) -Is in charge of
ASSUMPTIONS conducting semi-annually CPALE. It regulates the
practice of Accountancy.
Generally Accepted Accounting Principles (GAAP)
– are principles (including concepts and assumptions), FINANCIAL REPORTING STANDARDS COUNCIL
which have gained international acceptance in the (FRSC) -Formerly known as Accounting Standards
business world and accountancy profession. The Council. It formulates or develops the accounting
accounting procedures, the profit determination, standards which will guide the CPA practitioners.
preparation and financial statements must be in
conformity with generally accepted accounting DEPARTMENT OF TRADE AND INDUSTRY (DTI) -It
principles (GAAP). regulates the business who operates under single
proprietorship.

1. Business Entity Concept - The business is

treated, as having a separate personality from SECURITIES AND EXCHANGE COMMISSION (SEC)
the owner/s a such the transactions of the -It regulates the business operations of partnerships
business must be divorced from the and corporation.
transactions of the owner/s. COOPERATIVE DEVELOPMENT AUTHORITY (CDA)
2. Going Concern Concept – It is assumed that -It regulates the business operations of a cooperative.
the business will continue operations
indefinitely unless there is evidence to the BUREAU OF INTERNAL REVENUE (BIR) -It is
contrary. responsible for collection of taxes and tax compliance.
3. Accrual Basis of Accounting - This simply
means that expenses of the business are
recognized or recorded when incurred whether
paid or not the revenue is recognized when
earned whether collected or not.
4. Objectivity - This simply means that
transactions recorded, or amounts reported
can be verified thru supporting documents.
5. Cost Principle - This simply means that
properties or assets acquired must be
recorded at the actual acquisition cost and not
an estimated cost.
6. Matching Costs Against Revenue - This
simply means that all cost and expenses
incurred during the period in generating the
BANGKO SENTRAL NG PILIPINAS (BSP) -It allocated (spread out) as expense over the
regulates the operations of banks and other financial years that will benefit from its use.
institutions. 3. Periodic expense are necessary to operate
the business such as salaries for services
received from employees, rent for use of office
THREE ELEMENTS OF BUSINESS space, utilities for telephone, light and water
used.
1.Assets – are economic resources owned by the
business. They are used in operating the business and An INCOME represents inflow of cash or other assets
are expected to benefit the business over a number of coming from a client for service rendered or for
years. The most common properties or assets of a merchandise sold. Income encompasses revenues
business are: and gains.

Tangible Assets Cash, receivables, furniture

Examples of revenues :

 amount received by an airline or bus company

from passengers for
 transportation services rendered,
 amount received by a hospital from patients for
medical services rendered,
 amount received by a drugstore from
and fixtures, office equipment, machineries, delivery customers for medicine sold.
truck, land, building etc.  The account title used to describe revenue
common to all service providers is Service
Intangible Assets Franchise, patent, Income or Professional Income.
trademark, copyright, goodwill etc. These intangible
assets will be discussed in higher accounting subjects. An ACCOUNT RECEIVABLE represents a right to
collect from patients, clients or customers and is
2. Liabilities – these are amounts owed by the considered an asset because it is convertible into
business. They are debt or legal obligations of the cash.
business to individuals or other business.
(A business cannot operate to earn revenue without
3.Capital ( Also called Owner’s Equity)- This is the consuming some assets or using up the services of
owner’s interest or claim in the assets of the business other businesses or persons. The consumption of
after subtracting the interest of the creditors. It is the asset or using up of service to generate revenue is
difference between the amount of assets and amount called an expense. An expense will decrease an asset
liabilities. or increase a liability with a corresponding decrease in
owner’s equity.)
THE DEBIT AND CREDIT
(The general purpose financial statements on which
Debit- The value received by the business or what the
sound judgment and decisions are formulated are the
business paid for.
statement of cash flows, statement of comprehensive
Credit- The value parted with or given up by the income, statement of changes in equity and statement
business or the source of the value received by the of financial position.)
business.
Company Name
Income Statement
(Realization, it recognizes revenue when it is earned For the month ended March 31, 2020
regardless of collection.)
Service Income 2000
(Expenses are recognized in association with the Less: Operating Expenses
earnings of specific income items within a specific Rent Expense 500
Utilities Expense 200 700
period of time.) Net Income P1300
THREE WAYS OF RECOGNIZING EXPENSES

1. Expense is recognized when revenue is

recognized because it is not possible to earn
revenue without incurring expenses.
2. Resources or assets that will benefit the
business over a number of years should be
 Company Name
Statement of Changes in Owners Equity
For the month ended March 31, 2020
Company Name
Balance Sheet Gomez, Capital March 1 2000
As of (date) Add: Net Income 1000
Total 3000
Less: Drawing 700
Assets Gomez, Capita; March 31 2300
Total
Liabilities
Total Accounts Receivable (AR) is the proceeds or
Owner’s Equity payment which the company will receive from its
Total Liabilities and OE customers who have purchased its goods & services
on credit. Usually the credit period is short ranging
from few days to months or in some cases maybe a
year.
Company Name Accounts payable (AP) are amounts due to vendors
Statement of Cash Flow
For the month ended March 31, 2020
or suppliers for goods or services received that have
not yet been paid for. The sum of all outstanding
Operating Activities amounts owed to vendors is shown as the accounts
================= payable balance on the company's balance sheet.
Investing Activities
=================
Financing Activities
A post-dated cheque is a regular cheque where the
================ writer specifies a future date on the cheque. They do
Ending Cash Balance that to ensure the payment is made to the payee on or
after the stipulated date. This date can be any future
date, depending on the needs of the individual or the
ACCOUNTING CYCLE company.

The first step is collecting data based on various A trial balance is a list of accounts with ledgers
documents or business papers. The second step balances. Assets, owner’s drawing and expenses have
involves analyzing and recording the documents in a normal balances on the debit side while liabilities,
book called the journal. The involves classifying and owner’s capital and revenue have normal balances on
posting from the journal to another book called the the credit side.
ledger. The fourth step is extracting the balances of
PURPOSE OF TRIAL BALANCE
each of the accounts found in the general ledger and
preparing a trial balance. The remaining steps in the 1. To check the accuracy of posting (recording in
accounting cycle which are usually done at the end of the general ledger) by testing the equality of
the year at the end of accounting period, are discussed the debit and credit amounts.
in the succeeding chapter. 2. It aids in locating errors in posting.
3. It serves as a basis in the preparation of the
BUSINESS PAPERS
financial statements.
 INVOICE issues when service or merchandise
KINDS OF TRIAL BALANCE
is given to customer.
 OFFICIAL RECEIPT issued when cash is 1. Preliminary Trial Balance-the trial balance
received. before adjustments.
 CASH OR CHECKED VOUCHER is a A. Trial Balance of balances- it is the
document used when cash is paid, or a check traditional or conventional way of
is issued. preparing the trial balance. Only the
 CHECK is negotiable instrument used as account with balances are listed. Accounts
substitute for cash. with zero balances are not included or
 PROMISSORY NOTE is a written promise to shown in the trial balance.
pay a certain sum of money at a future date. B. Trial Balance of Totals- all accounts with
 A STATEMENT OF ACCOUNT is a bill postings or entries with or without
presented to a customer for service rendered balances are listed. This kind of Trial
which payment is demandable. Balance is used for auditing purposes.
2. Adjusted Trial Balance- the trial balance after
T Account is a visual presentation of accounting adjustments.
journal entries that are recorded by the company in its 3. Post-closing Trial Balance- the trial balance
general ledger account in such a way that it resembles after the closing entries.
the shape of the alphabet 'T' and depicts credit
balances graphically on the right side of the account Errors in trial balance which cannot be detected.
and debit balances on the left side of the account.
1. No entry was made for a given transaction.
 2. A journal entry was not posted to the general  Natural Business Year- A 12-month period
ledger. which ends in the month business activities at
3. A journal entry was posted twice. their lowest.
4. Incorrect accounts were used to record a given
transaction. INCOME STATEMENT
5. Incorrect amounts were recorded for a given  This statement summarizes the different
transaction.
revenues and expenses of the business to
The following procedures for each type of error arrive at the net income.
above must be followed to correct the errors.  The statement will show whether the business
makes a profit or incurs a loss.
 Error 1- Just prepare the correct journal entry  It shows the results of the operations of the
which was advertently or inadvertently omitted. business.
 Error 2- Just post to the general ledger the  All the accounts appearing in this statement
journal entry omitted. are called nominal accounts in the sense that
 Error 3- Reverse the second entry made and they are merely temporary accounts and are
post to the general ledger. not carried forward from period to period.
 Error 4- Reverse the erroneous entry made
and prepare the correct entry in the general STATEMENT OF OWNER’S EQUITY
journal and then post to the general ledger.  This statement will show the changes
 Error 5- Same procedure in error 4. (increase or decrease) in the owner’s equity.
 Owner’s equity will increase as a result of
additional investment of the owner and the net
Example of Errors income earned by the business.
Example of error in the account used- Insurance Expense for P  Owner’s equity will decrease as result of the
2,000.00 was erroneously debited to Advertising Expense in both the regular withdrawal (drawing) of the owner or
general journal and general ledger. the net loss incurred.
Insurance Expense P 2,000.00  This statement merely supplements the
Balance Sheet.
Advertising Expense P 2,000.00

To record correcting entry.

DEFERRALS Is the postponement of the recognition
of “an expense already paid but not yet incurred” or of
Prepare a correcting entry in the general journal as shown below “a revenue already collected but not yet earned”.
and post the general ledger.

Rent Expense P 2,700.00

Deferrals would be needed in two cases:

Cash P 2,700.00 1. Allocating assets to expense to reflect

expenses incurred during the accounting
To record correcting entry.
period. Ex. prepaid insurance, supplies and
Correction on more complicated errors or prior years’ errors will be depreciation.
taken up in the higher accounting subject particularly in Auditing 2. Allocating revenue received in advance to
subject.
revenue to reflect revenue earned during the
FINANCIAL STATEMENT accounting period ex. Subscriptions.

At the end of every accounting period, accounting ACCRUAL Is the recognition of an “expense already
period, accounting reports are prepared by the incurred but not yet paid” or revenue earned but not
accountant to inform the owner/s, management and yet collected.
other interested parties regarding the status of the Accruals would be required in two cases:
business, particularly the results of its operations and
its financial condition. These reports are called 1. Accruing expenses to reflect expenses
Financial Statements. These statements serve as the incurred during the accounting period that are
means of communication between the business and all unpaid and unrecorded.
interested parties. 2. Accruing expenses revenues to reflect
revenues earned during the accounting period
The Accounting period is the period at the end of that are uncollected and unrecorded.
which financial statements are prepared. The period
generally covers one year because it jibes with the PREPAID EXPENSES Some expenses are
payment of income tax which is annually. customarily paid in advance. These expenditures (ex.
Supplies, rent, and insurance) are called prepaid
 Calendar Year- A 12-month period which ends expenses. Prepaid expenses are assets, not
December 31 expenses.
 Fiscal Period- Any 12-month period which
does not end December 31.
DEPRECIATION Refers to the decrease in the value of = P1,400.00
a non-current asset (fixed asset) due to the ordinary
EX. Interest Expense P 1,400.00
wear and tear or passage of time. Accumulated
Depreciation is contra asset account will be shown in Interest Payable P1,400.00
Balance Sheet as deduction from the asset being
To record accrued interest.
depreciated to arrive at the Carrying Amount
ACCRUED REVENUES An entity may provide
Three factors in computing depreciation expense:
services during the period that are neither paid for by
1. Asset cost is the amount an entity paid to clients nor billed at the end of the period. The value of
acquire the depreciable asset. these services represents revenue earned by the
2. Estimated salvage value is the amount that the entity. Any revenue that has been earned but not
asset can probably be sold for at the end of its recorded during the accounting period calls for an
estimated useful life. adjusting entry that debits an asset account and credits
3. Estimate useful life is the estimated number of an income account.
periods that an entity can make use of the
EX. Accounts Receivable P2,500.00
asset. Useful life is an estimate, not an exact
measurement. Lawn Cutting Revenue P2,500.00

To record accrued revenues.

UNCOLLECTIBLE ACCOUNTS Entities often allow

clients to purchase goods or avail of services on credit.
Some of these accounts will never be collected; hence,
FORMULA there is a need to reflect these as charges against
income. In practice, an expense is recognized for the
Asset Cost estimated uncollectible accounts in the current period,
rather than when specific accounts become
Less: Estimated Salvage Value
uncollectible. The Allowance for Uncollectible Accounts
Depreciation Cost is treated as contra asset account and deductible from
Accounts Receivable to arrive at the Net Realizable
Divided by: Estimated useful life
Value.
Depreciation Expense for each time period
COMPLETING THE ACCOUNTING CYCLE
ACCRUALS An entity often incurs expenses before
1. JOURNALIZING is the process of recording
paying for them. Cash payments are usually made at
the business transactions in the journal (book
regular intervals of time such as weekly, monthly,
of original entry). The bases for recording in
quarterly or annually. If the accounting period ends on
the journal are the different business forms
a date that does not coincide with the scheduled cash
such as the purchase/sales invoice, official
payment date, an adjusting entry is needed to reflect
receipts, delivery receipts, bank statements,
the expense incurred since the last payment. Ex.
bank deposit slips, check vouchers, petty cash
Salaries, interest, utilities, electricity, and taxes are
vouchers, credit/debit memo, etc. This is done
examples of expenses that incurred before payment is
on a day to day basis.
made.
2. POSTING is the process of transferring the
ACCRUED SALARIES Accrued salaries refers to the entries in the journal to the general ledger.
amount of liability remaining at the end of a reporting Entries in the general journal are posted to the
period for salaries that have been earned by general ledger on a day to day basis.
employees but not yet paid to them. However, entries in the special journals with
separate columns for specific accounts, are
EX. Salaries ExpenseP 1,600.00 posted at the end of each month.
Salaries Payable P1,600.00 3. PRELIMINARY TRIAL BALANCE
(UNADJUSTED) this is prepared to check the
To record accrued salaries. accuracy of posting and to prove the equality
ACCRUED INTEREST refers to the amount of interest of the debits and credits. A trial balance is
that has been incurred, as of a specific date, on a loan prepare every end of the month.
or other financial obligation but has not yet been paid 4. ADJUSTING ENTRIES these are prepared at
out. the end of the accounting period to update the
books. The items to be adjusted are the
FORMULA transactions which are still unrecorded
(accrued income or expense) or accounts
Interest= Principal x interest rate x Length of Time
which are under or overstated (prepayments of
= P100,000.00 x 18% per year x 28/360 of year expenses or pre-collection of income).
 5. WORKSHEET the purpose of preparing the
worksheet is merely to facilitate the
preparation of the financial statements. This is
accomplished by showing the adjustments in
the worksheet and then classifying all the
accounts into real accounts (Balance Sheet
accounts) and nominal accounts (Income
Statement accounts). Preparation of the
worksheet is optional. If interim financial
statements are prepared, a worksheet will be
very useful.
6. FINANCIAL STATEMENT these are the
accounting reports prepared at the end of the summary account will be equal to the profit or loss for
accounting period. The principal statements the period. A profit is indicated by a credit balance and
are the Income Statements, Statement of a loss by a debit balance. The income summary
Changes in Owner’s Equity, Balance Sheet, account, regardless of the nature of its balance, must
and Statement of Cash Flows. These are the be closed to the capital account.
means of communication between the
business and the interested parties. The EX. No. 30 Income Summary P17,000.00
preparation of the financial statements is the Del Mundo, Capital 17,000.00
summarizing function of accounting.
To record the closing of income summary.

CLOSE THE WITHDRAWAL ACCOUNT The

withdrawal account shows the amount by which capital
is reduced during the period by withdrawals of cash or
WORKSHEET EXAMPLE
other assets of the business by the owner for personal
Acc title Trial
balance
Adjustments Adjusted
trial balan
Income
statement
Bal sheet use.
------ EX. No. 30 Del Mundo, Capital P5,000.00
------
Total
Del Mundo, Withdrawals 5,000.00
Net profit
To record the closing of drawing account.

CLOSING ENTRIES these are entries prepared in the

general journal at the end of the accounting period
(after the financial statements are completed) to close
all the nominal accounts preparatory to formally closing
the books. This is accomplished by reversing the
position of the accounts, i.e accounts with credit
balances are debited and accounts with debit balances
are credited. TYPES OF INVENTORY SYSTEM
EX. Nov. 30 Lawn Cutting Revenues P42,250.00
1. PERIODIC SYSTEM a company physically
Income Summary 42,250 counts inventory at the end of each period to
determine what's on hand and the cost of
To record closing of revenue account. goods sold. Many companies choose monthly,
quarterly, or annual periods depending on their
CLOSE THE EXPENSE ACCOUNT Expense
product and accounting needs.
accounts have debit balances before the closing
2. PERPETUAL SYSTEM is a program that
entries are posted. For this reason, a compound entry
continuously estimates your inventory based
is needed crediting each expense account for its
on your electronic records, not a physical
balance and debiting the income summary for the total.
inventory. This system starts with the baseline
EX. Income Summary from a physical count and updates based on
purchases made in and shipments made out.
Expense
Merchandise may be purchased and sold either on
Expense
credit or for cash on delivery. When goods are sold on
To record closing expense. account, a period of time called credit period is allowed
for payment. The length of the credit period varies
CLOSE THE INCOME SUMMARY ACCOUNT After across industries and may even vary within an entity,
posting the closing entries involving the income and depending on the product. When goods are sold on
expense accounts, the balance of the income credit, both parties should have an understanding as to
the amount and time of payment. These terms are List Price (2,500 x 7) P17,500
usually printed on the sales invoice and constitute part
Less: 20% trade discount 3,500
of the sales agreement. If the credit period is 30 days,
then payment is expected within 30 days from the Invoice Price P14,000
invoice date. The credit period is usually described as
Trade discounts may be stated in a series. Assume instead
the net credit period or net terms. The credit period of
that trade discount given by the computer shop to the buyer
30 days is notes n/30. if the invoice is due ten days is 20% and 10% the invoice price will be:
after the end of the month. It may be marked “n/10
eom.” List price (2,500 x 7) P17,500

CASH DISCOUNTS Some business give discounts for Less: 20% trade discount 3,500
prompt payment called cash discounts. If a trade Balance 14,000
discount is also offered, cash discount is computed on
the net amount after the trade discount. This practice Less: 10% trade discount 1,400
improves the seller’s cash position by reducing the
Invoice Price P12,600
amount of money in accounts receivable. Cash
discount is designated by such notation as “2/10” TRANSPORTATION COSTS When merchandise is
which means the buyer may avail of a two percent shipped by a common carrier-a trucking entity or an
discount if the invoice is paid within ten days from the airline, the carrier prepares a freight bill in accordance
invoice date. The period covered by the discount, in with the instructions of the party making the shipping
this case- ten days is called the discount period. Cash arrangements. The freight bill designates which party
discounts are called Purchase Discounts from the shoulders the costs, and whether the shipment is
buyer’s viewpoint and Sales Discounts from the freight prepaid or freight collect. Freight bills usually
seller’s point of view. It is usually worthwhile for the show whether the shipping terms are FOB Shipping
buyer to take a discount if offered even if it would point or FOB destination. F.O.B means “free on board”.
mean borrowing the money to make the payment. When the freight terms are FOB Shipping Point, the
buyer shoulders the shipping costs; ownership over the
goods passes from seller to the buyer when the
EX. An invoice of P150,000n with terms 2/10, n/30 is to be inventory leaves the seller’s place of business, the
paid within the discount period with money borrowed for the shipping point. The buyer already owns the goods
remaining 20 days of the credit period. If an annual interest while still in transit and therefore, shoulders the
rate of 18% is assumed, the net savings to the buyer is transportation costs. If the terms are FOB Destination,
P1,530 which is determined as follows: the seller bears the shipping costs. Title passes only
1st Cash discount of 2% on 150,000 3,000 when the goods are received by the buyer at the point
of destination; while in transit, the seller is still the
2nd Minus the discount to 150,000 147,000 owner of the goods so the seller shoulders the
3rd 147,000 x interest (18%) x days/360 1,470
transportation costs. In freight prepaid, the seller pays
the transportation costs before shipping the goods
4th Cash discount (1st) minus it (1470) saving effected by sold; while in freight collect, the freight entity collects
borrowing 1,530 from the buyer. Payment by either party will not dictate
who should ultimately shoulder the costs. Normally, the
TRADE DISCOUNTS Suppliers furnish smaller
party bearing the freight cost pays the carrier. Thus,
wholesalers or retailers with price lists and catalogs
goods are typically shipped freight collect when the
showing suggested retail prices for their products.
terms are shipping FOB Shipping Point; and freight
These suppliers, however, also include a schedule of
prepaid when the terms are FOB destination.
trade discounts from the listed prices to enable the
Sometimes, as a matter of convenience, the firm not
wholesalers and schedule of trade discounts from the
bearing the freight cost pays the carrier. When this
listed prices to enable the wholesalers and retailers to
situation occurs, the seller and buyer simply adjust the
determine the invoice price to be paid. Trade Discounts
amount of the payment for the merchandise.
encourage the buyers to purchase products because
of markdowns from the list price. Trade discounts
should not be confused with cash discounts. Trade
discounts enable the suppliers to vary prices
periodically without the inconvenience of revising price
lists and catalogs. There is no trade discount account
and there is no special entry for this discount instead,
all accounting entries are based on the invoice price
which is obtained by subtracting the trade discount
from the list price.
EX. A computer shop quoted a list price of P2,500 for each
tablet computer, less a trade discount of 20%. If a buyer
ordered seven units, the invoice price would be as follows:
The shipping costs borne by the buyer using the Accounts Receivable 3,000
periodic inventory system are debited to Transportation
To record collection and discount taken.
In account. In accounting, the cost of an asset, the
merchandise inventory includes all costs (e.g., SALES RETURN AND ALLOWANCES Buyers may
shipping costs) to bring the asset to its intended use. In be dissatisfied with the merchandise received either
the cost of sales section of the income statement, the because the goods are damaged or defective, of
balance in this account is added to purchases in inferior quality or not in accordance with their
computing for the net purchases for the period. specifications. In such cases the buyer may return the
Shipping costs borne by the seller are debited to goods to the seller for credit if the sale was made on
Transportation Out account. This account which also account or for cash refund if the sale was for cash.
called delivery expense, is an operating expense in the
income. EX. Each return or allowance is recorded as a debit to an
account called sales returns and allowances. the entry for
TRANSPORTATION IN – borne by the buyer 760 returns:

TRANSPORTATION OUT – borne by the seller If transactions happened on credit;

CASH/CREDIT SALES Sept 17 Sales Returns And Allowances 760

Accounts Receivable 760

The journal entry to record the sale of merchandise for
cash is as follows: To record sales returns and allowances.

If on cash;

Sept 17 Sales Returns And Allowances 760

Cash 760

To record sales returns and allowances.

TRANSPORTATION OUT When the freight term is

FOB destination, the seller shoulders the
transportation costs; when the term is FOB shipping
Sept 16 Cash 25,000 point, the buyer bears the shipping costs.
Sales 25,000 EX. Case no. 1 Assume that Figueroa Traders sold
merchandise totaling 17,000 FOB Destination, freight
To record sale of merchandise for cash.
prepaid; terms 2/10, n/30. the transportation costs amounted
If the sale of merchandise is made on credit, the entry to P1,900.
will be; Nov. 25 Accounts Receivable 17,000
Sept 16 Accounts Receivable 25,000 Transportation Out 1,900
Sales 25,000 Sales 1,000
To record sale of merchandise on credit. Cash 1,900

If this invoice is collected on Dec. 5

SALES DISCOUNT At the end of the accounting Dec. 5 Cash 16,660

period, the sales discounts accounts has accumulated
Sales Discount 340
all the sales discount for the period. The account is
considered a contra-income account and deducted Accounts Receivable 17,000
from gross sales in the income statement.
To record collection on account.
Assume that Figueroa Traders sold merchandise on
Case no. 2 same scenario but FOB Shipping point freight
Sept 20 for P3,000; terms 2/10, n/60. at the of sale, the
collect.
entry is:
Nov. 25 Accounts Receivable 17,000
Sept 20 Accounts Receivable 3,000
Sales 17,000
Sales 3,000
To record sales on account
To record sales on credit; terms 2/10, n/60
If this invoice is collected on Dec. 5
The customer takes advantage the sales discount and
made payment anytime on or before Sept. 30. Dec. 5 Cash 16,660

Sept 30 Cash 2,940 Sales Discount 340

Sales Discount 60 Accounts Receivable 17,000

 To record collection on account. inventory at the end of the period is subtracted from
the goods available for sale.
Case no. 3 Assume that Figuero Traders sold merchandise
P17,000 FOB Destination, freight collect; terms 2/10, n/30. MERCHANDISE INVENTORY The inventory of a
The transportation costs amounted to P1,900.
merchandising entity consists of goods purchased for
Nov. 25 Accounts Receivable 15,100 resale. For a grocery store, inventory would be made
up meats, vegetables, canned goods, and other items.
Transportation Out 1,900 For a lumber and hardware, it would by plywood, nails,
Sales 17,000 paint, iron sheets, cement, tools, and other items.
Merchandising entities purchase their inventories from
To record sales on account. manufacturers, wholesalers and other suppliers. The
If this invoice is collected on Dec. 5 merchandise inventory at the beginning of the
accounting period is called the beginning inventory.
Dec. 5 Cash 14,760 The merchandise inventory at the end of the
accounting period is the called the ending inventory
Sales Discount 340
(reported to balance sheet). Beginning inventory and
Accounts Receivable 15,100 ending inventories are used in calculating cost of sales
in the income statement.
To record collection on account.
NET COST OF PURCHASES Under the periodic
Case no. 4 Assume that Figuero Traders sold merchandise
P17,000 FOB Shipping point, freight prepaid; terms 2/10, inventory method, net cost of purchases consist of
n/30. the transportation costs amounted to P1,900. gross purchases minus purchases discounts and
purchase returns and allowances equals net
Nov. 25 Accounts Receivable 18,900 purchases; plus transportation costs.
Sales 17,000 PURCHASES When the periodic inventory method is
Cash 1,900 used, all purchases of merchandise are debited to the
purchases account as shown below:
To record sales on account.
Nov. 12 Purchases 15,000
If this invoice is collected on Dec. 5
Cash 15,000
Dec. 5 Cash 18,560
To record purchase of merchandise for
Sales Discount 340 cash.
Accounts Receivable 18,900

To record collection on account.

If purchase of merchandise with terms 2/10, n/30, the

entry will be;
Nov. 12 Purchases 15,000

COST OF SALES Cost of sales or cost of goods sold Accounts Payable 15,000
is the largest single expense of the merchandising To record purchase of merchandise on
business. it is the cost of inventory that the entity has credit.
sold to customers. Every merchandising business has
goods available for sale. The goods available for sale PURCHASE DISCOUNT Merchandise purchases are
during the year is the sum of two factors; merchandise usually made on credit and commonly involve
inventory at the beginning of the year and net purchases discounts for early payment. In relation to
purchases during the period. If an entity is able to sell the Nov. 12 and 14 transactions, the payment is
the goods available for sale a given accounting period, recorded as follows:
the cost of sales would then equal goods that had Nov. 22 Accounts Payable 13,000
been available for sale. In most cases, however, the
business will have goods still unsold at the end of the Purchase Discount 260
year. To find the actual cost of sales, the merchandise
Cash 12,740

To record payment and discount taken.

Like purchases returns and allowances, purchase discounts

is contra account that is deducted from purchases on
the income statement. If the entity make a partial
payment on an invoice, most creditors will allow the
entity to take the discount.
TRANSPORTATION IN Assume that Figueroa Traders VAT Payable 36,000
made purchases totaling P8,500 FOB destination,
freight prepaid; terms 2/10, n/30. transportation costs
amounted to P950. The entry would be: VAT Payable 36,000

Nov. 25 Purchases 8,500 Cash in Bank 36,000

Accounts Payable 8,500 Assume that the wholesaler purchased on May 25 and
granted with 2/10. On May 30, Barbo was able to collect the
If this invoice is paid on Dec. 5 account.
Dec. 5 Accounts Payable 8,500 May 30 Cash (1,120,000-20,000-2,400) 1,097,600
Purchase Discount 170 Output Tax (1,000,000 x 12% x 2%) 2,400
Cash 8,330 Sales Discount (1,000,000 x 2%) 20,000

OPERATING EXPENSES Operating expenses make Accounts Receivable 1,120,000

up third major part of the income statement for a
The VAT payable is 33,600 ((120,000-2,400)- 84,000).
merchandising entity. These are expenses, other than
the cost of sales, which are incurred to generate profit
from the entity’s major lines of business –
merchandising. It is customary to group operating
expenses into useful categories. Distribution costs,
.
administrative expenses are the categories.
Distribution costs or selling expenses are those
expenses related directly to the entity’s efforts to
generate sales. These includes sales salaries and
commissions, and the related employer payroll
expenses; advertising and store displays, traveling
expenses’ store supplies used; depreciation of store
property and equipment, and transportation out

VALUE ADDED TAX Previous entries for sales and

purchases did not incorporate the effect of value-
added taxes on the transactions to simplify the
illustration. The illustration below will give you an idea.
Extensive discussion of VAT is in another text, Transfer
and Business Taxation.

EX. On May 13, 2019, Samuel Barbo Feeds purchased on

account specialty feeds with a total amount payable of
784,000. A wholesaler bought the feeds on May 25, 2019,
amount of cash received was P1,120,000. Samuel Barbo
Feeds paid the VAT due by month end not minding the actual
deadline.

May 13 Purchases (784,000/112%) 700,000

Input Tax (700,000 x 12%) 84,000

Accounts Payable 784,000

Cash 1,120,00

Sales (1,120,000/112%) 1,000,000

Output Tax (1,000,000 x 12%) 120,000

31 Output Tax 120,000

Input Tax 84,000