Chapter 8

Competing the Accounting Cycle of a Merchandising Business

Learning Outcomes:
 Describe the flow of accounting information from the trial
balance into the financial statements
 Prepare a ten-column worksheet.

Review of the Accounting Cycle

As discussed in earlier chapter, the accounting cycle is a series of steps

performed during the accounting period to analyze, record, classify, summarize and

prepare financial reports that is intended for users of financial information in making

economic decisions.

This cycle can be categorized into two phases:

1. Recording Phase

The recording phase includes the analysis of business transactions and

events, journalizing and posting to the ledger.

2. Reporting Phase

The reporting phase comprises the preparation of trial balance up to the

preparation of reversing entries.

Analysis of Business Transaction and Events

In the analysis of business transactions and events, bookkeepers and

accountants use the fundamental accounting equation in determining which among

the activities of the business should be recorded in the books of accounts. Such

transaction or event should cause a measurable change in the amounts of the

entity’s assets, liabilities and equity. Additionally, such transaction or event occurred
must be supported by evidence. Every business transactions should come from the

so-called source documents such as sales invoice, official receipt, purchase order,

checks, promissory loan, etc.

Journalizing and Posting

After determining that a transaction or event affects the accounting equation,

such should be documented into the entity’s books via a journal entry. Aside from the

general journal, some merchandising business would prefer to use the special

journals to record recurring transactions. After all the transactions and events have

been entered into the appropriate journals, the journal entries will now be posted to

the general ledger and subsidiary ledger.

Preparation of Unadjusted Trial Balance

The trial balance prepared at the end of the accounting period would serve as

basis for the preparation of financial reports. It lists all the account balances found in

the general ledger. The accounts appear should be in order: assets, liabilities, equity,

revenue and expenses. Within the assets category, the most liquid assets appear

next to cash. The trial balance totals for the debit and credit should be equal in order

to prove that the books are in balance. If the total amount of the debit column does

not equal the total of the credit column, this would show that there was an error.

When errors are found, correcting entries must be made.

Preparation of Adjusting Entries

Aside from correcting entries, adjusting entries are also prepared in order to

allocate the revenue and expenses to the proper accounting period which they

actually occurred. There are several accounting entries and each one accounts for a

different situation.
1. Accruals

There are two accruals to be considered: accrued expense and accrued

revenue. Accrued revenues are revenues that have been recognized

which means that services have been performed or merchandise have

been delivered but their cash collections have not been received. Accrued

expenses, on the other hand, are expenses incurred but have not yet been

paid.

2. Prepayments

Adjusting entries are necessary to account for expenses which have been

paid in advance. When paid in advance, it is first recorded in a prepaid

expense account or in an expense account. Hence, at the end of the

period, it is necessary to determine how much have been used or

consumed during the period to make the proper adjustments.

3. Estimates

These are adjusting entries for bad debts and depreciaiton. Depreciaiton is

the process of estimating or allocating the cost of the asset over the

number of years over which it will be used by the entity.

There are several ways to depreciate fixed assets. The straight-line

method is the most common and the simplest way to depreciate. This

method split the value after taking into consideration the scrap value over

the useful life of the asset. The formula would be:

Depreciaiton for the period = Asset – Salvage/Scrap value

Estimated Useful Life

Straight Line Rate = 100%

Estimated useful life

The double-declining method is a slightly more complicated way. This

method doesn’t take salvage or scrap value into account and the straight-

line depreciation rate will be used in computing for the depreciaiton.

Hence, the formula is:

Depreciaiton for the period = (2 x straight line depreciation rate) x book

value at the beginning of the period

The sum-of-the-year’s-digit (SYD) is another method which depreciates

more of an asset in the early years of its useful life and less in the later

years. To calculate the SYD depreciation, add up the digits in the asset’s

useful life to come up with a fraction that will apply to each year of

depreciation. Then divide the asset’s remaining lifespan by the SYD, then

multiply by the number by the cost which is reduced by the scrap or

salvage value, if any.

Depreciation = Remaining Lifespan x Cost of the Asset – Salvage Value

SYD

The units of production method is another simple way to depreciate asset

because the basis would not be the estimated useful life but how much

work it does. The formula is:

Depreciation = Cost of Asset – Scrap Value

Estimated Units Produced in Useful Life

Bad debt expense, on the other hand, is the portion of the accounts

receivable which was estimated to be uncollectible. There are methods of

recognizing bad debts: direct write-off method and allowance method.

The direct write-off method involves a direct recognition of loss from the

uncollected receivables. This method requires that a customer’s

uncollectible account be removed from the accounts receivable. Hence the

adjusting journal entry would be:

Date Accounts/Explanation PR Debit Credit

Bad Debt expense xx

Accounts receivable xx

The allowance method involves the recognition of a contra-asset account

that goes against accounts receivable. This method anticipates and

estimates the uncollected portion of accounts receivable that will not be

paid by clients or customers. Only if the entity determined that the account

cannot be collected, the receivable balance will be now be written off. The

bad debt expense in this method does not necessarily serve as a direct

loss against the revenue. Below are the pro-forma entries:

Date Accounts/Explanation PR Debit Credit

Bad Debt expense x
Allowance for bad debts xx
To adjust for the bad debts
Allowance for bad debts x
Accounts receivable xx
To write off bad debts

There are three approaches used in estimating bad debts expense under

allowance method: the percentage of sales, percentage of receivables and

aging of receivables. The percentage of sales involves determining what

percentage of net credit sales or total sales is uncollectible while the

percentage of total accounts receivable derives bad debts expense as a

percentage of the accounts receivable balance. The aging method

categorizes the accounts receivable balances by the length of time they

 have been outstanding and each category is multiplied by an estimated

percentage of uncollectibility.

4. Inventory

Adjusting entries prepared by a merchandising business that employs

periodic inventory system includes the adjustment for the merchandise

inventory since the balance found in the unadjusted trial balance is the

beginning balance. The objectives of these entries are to remove the

beginning balance and to enter the ending balance in the merchandising

inventory account. The pro-forma entries are:

Date Accounts/Explanation PR Debit Credit

Income and Expense Account x
Allowance for bad debts xx
To remove the beginning
balance
Merchandise Inventory x
Income and Expense Account xx
To establish the ending
balance

However, instead of preparing adjusting entries at the end of the period,

other entities opted to prepare closing entries to zero-out the beginning

merchandise inventory and establish the ending merchandise inventory.

Preparation of Financial Statements

After considering the necessary adjustments, through journalizing and posting

to the ledger; the next step is to prepare an adjusted trial balance, basis for the

preparation of financial statements. At times, bookkeepers or accountants made use

of worksheet as this contain all necessary information used in the preparation of

financial statements. It is a multi-column and informal document showing the

undusted trial balance, the adjustments, the income statement and the statement of

financial position of the entity.

Preparation of Closing Entries and Post-closing trial balance

Closing journal entries are prepared in order to zero-out all the nominal

accounts. First the balances of revenue and expense accounts are transferred to

Income and Expense Summary Account, which is a temporary account. Then the

credit or debit balance of the income summary account is then closed to the capital

account. And finally, the drawing account is closed to the capital account.

After incorporating the closing entries, the post-closing trail balance would

only present all permanent accounts. Like any the other two trial balances, the total

debits and total credits should be equal.

Preparation of Reversing Entries

Reversing entries are journal entries made at the beginning of each

accounting period. The purpose of a reversing entry is to cancel out all specific

adjusting entry made at the end of the prior period. In this way, bookkeepers and

accountants would be prevented from recording twice revenue and expenses since

the reversing entry would only include adjustment made for accruals.

Illustration 8.1:

On January 2, 2020 Ajay Puguon invested merchandise inventory with

P200,000, furniture and fixtures, P50,000 and cash of P50,000. On the same day, he
registered his business (AJP Store) and paid business permit and licenses for
P6,500. On January 3, 2020 he paid P15,000 to the lessor of stall as rent for the
months of January to March, 2020.
January 4 Bought equipment on account, P100,000 from JP General Mdse.
January 5 Sold merchandise worth P54,000 (cost, P37,800). Terms: 20% down
payment; 2/10,n/30; freight charges – P1,500 FOB destination prepaid.
January 8 Cash sales of walk-in customers for the week – P55,000 (cost, P41,250)
January 9 Purchased merchandise on account – P70,000 net of 5% trade
discount; 50% down; 5/2, 2/10
 January 10 Returned merchandise from January 9 purchases, P2,000 due to
defects
January 11 Collected January 5 transaction and purchased supplies, P10,000
January 11 Paid account from January 9 transaction
January 16 Cash sales of walk-in customers for the week – P60,000 (cost, 42,000)
January 19 Sold merchandise for cash, P65,000 (cost, P45,500). FOB shipping
point collect. Freight charges, P2,000
January 22 Purchased good for cash, P100,000
January 25 Sold goods costing P72,000 for P100,000 with 10% trade discount.
The credit terms is 2/10, n/30.
January 27 Paid salary of employees, P15,000
January 27 Settled account at JP General Mdse.
January 28 Purchased goods worth P75,000 with terms of 2/10, n/30. FOB
Shipping point collect. Freight charges – P1,500
January 29 Cash sales of walk-in customers for the week, P75,000 (cost, P52,500)
January 30 The entity conduct physical count to determine the cost of the unsold
goods. The unused supplies is worth P5,000.

Additional information:
1. The furniture and fixture and equipment have an estimated useful life of 10
years and 25 years, respectively. Further, the entity used straight line method
of depreciating fixed assets.
2. Telephone bill and electricity bill for the month are P500 and P800,
respectively

1. PERIODIC INVENTORY SYSTEM

General Journal
AJP Store
For the month of January, 2020
Date Particulars PR DR CR
Jan 2 Furniture and Fixtures 50,000
Merchandise inventory 200,000
Cash 50,000
Owner’s capital 300,000
Initial investment
Jan 2 Business Permit and Licenses 6,500
Cash 6,500
Secure business permit
Jan 3 Rent expense 15,000
Cash 15,000
Paid 3-month rent
Jan 4 Equipment 100,000
Accounts payable 100,000
Bought equipment on account
 Date Particulars PR DR CR
Jan 5 Cash 10,800
Accounts receivable 43,200
Sales 54,000
Sold goods
Jan 5 Freight out 1,500
Cash 1,500
Paid freight charges
Jan 8 Cash 55,000
Sales 55,000
Sale for the week
Jan 9 Purchases 70,000
Accounts payable 35,000
Cash 35,000
Purchase on account
Jan 10 Accounts payable 2,000
Purchase returns 2,000
Returned defective goods
Jan 11 Cash 42,336
Sales discount 864
Accounts receivable 43,200
Collected account
Jan 11 Supplies 2,000
Cash 2,000
Purchased supplies
Jan 11 Accounts payable 33,000
Cash 31,350
Purchase discount 1,650
Settled account
Jan 16 Cash 60,000
Sales 60,000
Cash Sales for the week
Jan 1 9 Cash 65,000
Sales 65,000
Sold goods on account
Jan 22 Purchases 100,000
Cash 100,000
Bought goods for cash
Jan 25 Accounts receivable 90,000
Sales 90,000
Sold goods on account
Jan 27 Salary expense 15,000
Cash 15,000
Paid wages of personnel
Jan 27 Accounts payable 50,000
Cash 50,000
Settled account
 Date Particulars PR DR CR
Jan 28 Purchases 75,000
Freight in 1,500
Accounts payable 75,000
Cash 1,500
Bought goods on account
Jan 29 Cash 75,000
Sales 75,000
Sold goods for cash

GENERAL LEDGER PAGE 1

CASH Account # 101
Date Particular PR Dr Cr Balance
Jan 2 Investment 50,000 50,000
2 Paid business permit 6,500 43,500
3 Paid rent 15,000 28,500
5 Sold goods 10,800 39,300
5 Paid freight 1,500 37,800
8 Sold goods 55,000 92,800
9 Bought goods 35,000 57,800
11 Bought supplies 10,000 47,800
11 Sold goods 42,336 90,136
11 Settled account 31,350 58,786
16 Sold goods 60,000 118,786
19 Sold goods 65,000 183,786
22 Bought goods 100,000 83,786
27 Paid salary 15,000 68,786
27 Paid account 50,000 18,786
28 Paid transportation in 1,500 17,286
29 Sold goods 75,000 92,286
ACCOUNTS RECEIVABLE Account # 201
Date Particular PR Dr Cr Balance
Jan 5 Sold goods 43,200 43,200
Collected account 43,200 -
Sold goods 90,000 90,000
SUPPLIES Account # 210
Date Particular PR Dr Cr Balance
Jan 11 Bought supplies 10,000 10,000
MERCHANDISE INVENTORY Account # 205
Date Particular PR Dr Cr Balance
Jan 2 Investment 200,000 200,000
FURNITURE AND FIXTURES Account # 220
Date Particular PR Dr Cr Balance
Jan 2 Investment 50,000 50,000
EQUIPMENT Account # 223
Date Particular PR Dr Cr Balance
Jan 4 Purchased on account 100,000 100,000
 GENERAL LEDGER PAGE 2
ACCOUNTS PAYABLE Account # 301
Date Particular PR Dr Cr Balance
Jan 4 Bought equipment 100,000 100,000
9 Bought goods 35,000 135,000
10 Received returned goods 2,000 133,000
11 Settled account 33,000 100,000
27 Settled account 50,000 70,000
27 Bought goods 75,000 125,000
OWNER’S CAPITAL Account # 401
Date Particular PR Dr Cr Balance
Jan 2 Initial investment 300,000 300,000
SALES Account # 403
Date Particular PR Dr Cr Balance
Jan 5 Sold goods 54,000 54,000
8 Sold goods 55,000 109,000
16 Sold goods 60,000 169,000
19 Sold goods 65,000 234,000
25 Sold goods 90,000 324,000
29 Sold goods 75,000 399,000
SALES DISCOUNT Account # 404
Date Particular PR Dr Cr Balance
Jan 11 Collection 864 864
PURCHASES Account # 410
Date Particular PR Dr Cr Balance
Jan 9 Bought goods 70,000 70,000
22 Bought goods 100,000 170,000
28 Bought goods 75,000 245,000
PURCHASE DISCOUNTS Account # 411
Date Particular PR Dr Cr Balance
Jan 11 Settled account 1,650 1,650
PURCHASE RETURNS Account # 412
Date Particular PR Dr Cr Balance
Jan 10 Received returned goods 2,000 2,000
FREIGHT IN Account # 413
Date Particular PR Dr Cr Balance
Jan 28 Freight charges 1,500 1,500
FREIGHT OUT Account # 420
Date Particular PR Dr Cr Balance
Jan 5 Freight charges 1,500 1,500
RENT EXPENSE Account # 421
Date Particular PR Dr Cr Balance
Jan 3 Paid 3-month rent 15,000 15,000
BUSINESS PERMIT & LICENSES Account # 422
Particular PR Dr Cr Balance
Jan 2 Secured business permit 6,500 6,500
SALARY EXPENSE Account # 423
Particular PR Dr Cr Balance
Jan 27 Paid wages for the month 15,000 15,000
 AJP STORE
UNADJUSTED TRIAL BALANCE
As of January, 2020
Cash 92,286
Accounts receivable 90,000
Merchandise inventory 200,000
Supplies 10,000
Furniture and Fixtures 50,000
Equipment 100,000
Accounts payable 125,000
Owner’s capital 300,000
Sales 399,000
Sales discount 864
Purchases 245,000
Purchase discount 1,650
Purchase returns 2,000
Freight in 1,500
Freight out 1,500
Rent expense 15,000
Business permit and licenses 6,500
Salary expense 15,000
TOTAL 827,650 827,650

General Journal
AJP Store
For the month of January, 2020
Date Particulars PR DR CR
Jan 31 Depreciation expense 750
Accumulated depreciation-equipment 333
Accumulated depreciation-furniture 417
Adjustment for depreciation
31 Supplies expense 5,000
Supplies 5,000
Adjustment for used supplies
31 Telephone expense 500
Electricity expense 800
Accrued expense 1,300
Adjustment for unpaid utilities
31 Prepaid rent 10,000
Rent expense 10,000
Adjustment for unexpired rent
Posting the adjusting entries to the general ledger

GENERAL LEDGER PAGE 3

Supplies Account # 215
Date Particular PR Dr Cr Balance
Jan 11 Bought supplies 10,000 10,000
31 Adjustment for used supplies 5,000 5,000
Rent expense Account # 421
Date Particular PR Dr Cr Balance
Jan 3 Paid 3-month rent 15,000 15,000
31 Adjustment 10,000 5,000
Prepaid rent Account # 216
Jan 31 Adjustment 10,000 10,000
Accumulated depreciation-equipment Account # 224
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 333
Accumulated depreciation-equipment Account # 221
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 417 417
Accrued expense Account # 302
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 1,300 1,300
Depreciation expense Account # 424
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 750 750
Supplies expense Account # 425
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 5,000 5,000
Telephone expense Account # 426
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 500 500
Electricity expense Account # 427
Date Particular PR Dr Cr Balance
Jan 31 Adjustment 800 800
 AJP STORE
ADJUSTED TRIAL BALANCE
As of January 31, 2020
Cash 92,286
Accounts receivable 90,000
Merchandise inventory 200,000
Supplies 5,000
Prepaid rent 10,000
Furniture and Fixtures 50,000
Equipment 100,000
Accumulated depreciation-equipment 333
Accumulated depreciation-furniture 417
Accounts payable 125,000
Accrued expense 1,300
Owner’s capital 300,000
Sales 399,000
Sales discount 864
Purchases 245,000
Purchase discount 1,650
Purchase returns 2,000
Freight in 1,500
Freight out 1,500
Rent expense 5,000
Business permit and licenses 6,500
Salary expense 15,000
Telephone expense 500
Electricity expense 800
Depreciaiton expense 750
Supplies expense 5,000
TOTAL 829,700 829,700

2. Perpetual Inventory System

General Journal
AJP Store
For the month of January, 2020
Date Particulars PR DR CR
Jan 2 Furniture and Fixtures 50,000
Merchandise inventory 200,000
Cash 50,000
Owner’s capital 300,000
Initial investment
Jan 2 Business Permit and Licenses 6,500
Cash 6,500
Secure business permit
Jan 3 Rent expense 15,000
Cash 15,000
Paid 3-month rent
Date Particulars PR DR CR
Jan 4 Equipment 100,000
Accounts payable 100,000
Bought equipment on account
Jan 5 Cash 10,800
Accounts receivable 43,200
Sales 54,000
Sold goods
Jan 5 Cost of goods sold 37,800
Merchandise inventory 37,800
To record the cost of goods sold
Jan 5 Freight out 1,500
Cash 1,500
Paid freight charges
Jan 8 Cash 55,000
Sales 55,000
Sale for the week
Jan 8 Cost of goods sold 41,250
Merchandise inventory 41,250
To record the cost of goods sold
Jan 9 Merchandise inventory 70,000
Accounts payable 35,000
Cash 35,000
Purchase on account
Jan 10 Accounts payable 2,000
Merchandise inventory 2,000
Returned defective goods
Jan 11 Cash 42,336
Sales discount 864
Accounts receivable 43,200
Collected account
Jan 11 Supplies 2,000
Cash 2,000
Purchased supplies
Jan 11 Accounts payable 33,000
Cash 31,350
Merchandise inventory 1,650
Settled account
Jan 16 Cash 60,000
Sales 60,000
Cash Sales for the week
Jan 16 Cost of goods sold 42,000
Merchandise inventory 42,000
To record the cost of goods sold
Jan 19 Cash 65,000
Sales 65,000
Sold goods on account
Jan 19 Cost of goods sold 45,500
Merchandise inventory 45,500
 Date Particulars PR DR CR
Jan 22 Merchandise inventory 100,000
Cash 100,000
Bought goods for cash
Jan 25 Accounts receivable 90,000
Sales 90,000
Sold goods on account
Jan 25 Cost of goods sold 72,000
Merchandise inventory 72,000
To record the cost of goods sold
Jan 27 Salary expense 15,000
Cash 15,000
Paid wages of personnel
Jan 27 Accounts payable 50,000
Cash 50,000
Settled account
Jan 28 Merchandise inventory 76,500
Accounts payable 75,000
Cash 1,500
Bought goods on account
Jan 29 Cash 75,000
Sales 75,000
Sold goods for cash
Jan 29 Cost of goods sold 52,500
Merchandise inventory 52,500
To record cost of goods sold

GENERAL LEDGER PAGE 1

CASH Account # 101
Date Particular PR Dr Cr Balance
Jan 2 Investment 50,000 50,000
2 Paid business permit 6,500 43,500
3 Paid rent 15,000 28,500
5 Sold goods 10,800 39,300
5 Paid freight 1,500 37,800
8 Sold goods 55,000 92,800
9 Bought goods 35,000 57,800
11 Bought supplies 10,000 47,800
11 Sold goods 42,336 90,136
11 Settled account 31,350 58,786
16 Sold goods 60,000 118,786
19 Sold goods 65,000 183,786
22 Bought goods 100,000 83,786
27 Paid salary 15,000 68,786
27 Paid account 50,000 18,786
28 Paid transportation in 1,500 17,286
29 Sold goods 75,000 92,286
ACCOUNTS RECEIVABLE Account # 201
Date Particular PR Dr Cr Balance
Jan 5 Sold goods 43,200 43,200
Collected account 43,200 -
Sold goods 90,000 90,000
SUPPLIES Account # 210
Date Particular PR Dr Cr Balance
Jan 11 Bought supplies 10,000 10,000
MERCHANDISE INVENTORY Account # 205
Date Particular PR Dr Cr Balance
Jan 2 Investment 200,000 200,000
5 Sold goods 37,800 162,200
8 Sold goods 41,250 120,950
9 Purchased goods 70,000 190,950
10 Returned goods 2,000 188,950
11 Settled account 1,650 187,300
16 Sold goods 42,000 145,300
19 Sold goods 45,500 99,800
22 Purchased goods 100,000 199,800
25 Sold goods 72,000 127,800
28 Purchased goods 76,500 204,300
29 Sold goods 52,500 151,800
FURNITURE AND FIXTURES Account # 220
Date Particular PR Dr Cr Balance
Jan 2 Investment 50,000 50,000
EQUIPMENT Account # 223
Date Particular PR Dr Cr Balance
Jan 4 Purchased on account 100,000 100,000
ACCOUNTS PAYABLE Account # 301
Date Particular PR Dr Cr Balance
Jan 4 Bought equipment 100,000 100,000
9 Bought goods 35,000 135,000
10 Received returned goods 2,000 133,000
11 Settled account 33,000 100,000
27 Settled account 50,000 70,000
27 Bought goods 75,000 125,000
OWNER’S CAPITAL Account # 401
Date Particular PR Dr Cr Balance
Jan 2 Initial investment 300,000 300,000
SALES Account # 403
Date Particular PR Dr Cr Balance
Jan 5 Sold goods 54,000 54,000
8 Sold goods 55,000 109,000
16 Sold goods 60,000 169,000
19 Sold goods 65,000 234,000
25 Sold goods 90,000 324,000
29 Sold goods 75,000 399,000
SALES DISCOUNT Account # 404
Date Particular PR Dr Cr Balance
Jan 11 Collection 864 864
COST OF GOODS SOLD
Date Particular PR Dr Cr Balance
Jan 5 Sold goods 37,800 37,800
8 Sold goods 41,250 79,050
16 Sold goods 42,000 121,050
19 Sold goods 45,500 166,550
25 Sold goods 72,000 238,550
29 Sold goods 52,500 291,050
FREIGHT OUT Account # 420
Date Particular PR Dr Cr Balance
Jan 5 Freight charges 1,500 1,500
RENT EXPENSE Account # 421
Date Particular PR Dr Cr Balance
Jan 3 Paid 3-month rent 15,000 15,000
BUSINESS PERMIT & LICENSES Account # 422
Date Particular PR Dr Cr Balance
Jan 2 Secured business permit 6,500 6,500
SALARY EXPENSE Account # 423
Date Particular PR Dr Cr Balance
Jan 27 Paid wages for the month 15,000 15,000

AJP STORE
UNADJUSTED TRIAL BALANCE
As of January, 2020
Cash 92,286
Accounts receivable 90,000
Merchandise inventory 151,800
Supplies 10,000
Furniture and Fixtures 50,000
Equipment 100,000
Accounts payable 125,000
Owner’s capital 300,000
Sales 399,000
Sales discount 864
Cost of goods sold 291,050
Freight out 1,500
Rent expense 15,000
Business permit and licenses 6,500
Salary expense 15,000
TOTAL 824,000 824,000
 General Journal
AJP Store
For the month of January, 2020
Date Particulars PR DR CR
Jan 31 Sales 399,000
Income and expense summary 399,000
To close all revenue accounts
Jan 31 Income and expense summary 326,964
Sales discount 864
Cost of goods sold 291,050
Freight out 1,500
Rent expense 5,000
Business permit and licenses 6,500
Depreciaiton expense 750
Salary expense 15,000
Supplies expense 5,000
Telephone expense 500
Electricity expense 800
To close all expense accounts
Jan 31 Income and expense summary 72,036
Owner’s capital 72,036
To close the income & expense

AJP STORE
POST CLOSING TRIAL BALANCE
As of January 31, 2020
Cash 92,286
Accounts receivable 90,000
Merchandise inventory 151,800
Supplies 5,000
Prepaid rent 10,000
Furniture and Fixtures 50,000
Equipment 100,000
Accumulated depreciaiton-equipment 417
Accumulated depreciation-furniture 333
Accounts payable 125,000
Accrued expense 1,300
Owner’s capital 372,036

TOTAL 499,086 499,086

Date Particulars PR DR CR
Feb 1 Accrued expense 1,300
Telephone expense 500
Electricity expense 800
To reverse the accrued expense
 Chapter 9

Merchandising Financial Statements

Learning Outcomes:
 Critique the financial statement of a merchandising business

A merchandising business uses the same set of financial statements that has

been discussed in earlier topics: the income statement, the statement of changes in

equity, the statement of financial position, statement of cash flows and notes to the

financial statements

The Income Statement

An income statement shows the financial performance or the result of

operations of an entity for a specific period of time. It gives a picture on how well the

management worked and used the entity’s resources in order to earn profit.

In the preceding chapters, the illustrated income statement for a service

business consists only of two categories – revenues and expenses. The format used

is referred to as natural. Though this format may be used by merchandising and

manufacturing businesses, some users of financial data prefer the other form of

presentation. The other format is expanded to include groupings and subheadings

necessary to make it easier to read and understand the presentation. It is referred to

as multi-step income statement or functional format. The major headings of the

classified multi-step income statement are as follows:

1. Net sales are the revenues generated by the major activities of the business.

It is derived from deducting sales returns, sales allowances and sales

discounts from the gross sales.

2. Cost of goods sold is the major expense in a merchandising business. It

represents the cost of merchandise inventory sold during the period.

3. Gross margin or gross profit is the difference between net sales and cost of

goods sold. In other words, it refers to the entity’s markup.

4. Operating expenses for a merchandising business are expenses, other than

the cost of goods sold, incurred in the normal operating functions of the entity.

Operating expenses are sub-categorized into two: selling and administrative

expenses. Selling expenses are expenses an entity incurs in selling and

marketing efforts such as salaries and commissions of salespersons,

advertising, delivery, sales supplies and depreciaiton of delivery trucks used

in sales. Administrative expenses are expenses incurred in the overall

management of a business. Examples include rent or depreciaiton, utilities,

salaries of administrative personnel, administrative supplies and insurance

expense.

5. Income from operations is the result after deducting the total operating

expenses from the gross margin.

6. Other revenue and expenses are revenues and expenses not related to the

sale of merchandise. This typically includes interest revenue and interest

expense.

7. Net income is the income earned after adding other revenues and deducting

other expenses as well as income tax expense.

 Figure 9.1 Sample Income Statement

HPG Enterprise
Income Statement
For the year ended December 31, 2020
Sales P275,000
Less Sales returns and allowances 2,000
Sales discounts 1,000 3,000
Net sales P272,000
Less: Cost of Goods Sold
Merchandise inventory, January 1 P24,000
Add: Net Purchases
Purchases P167,000
Less: Purchase returns 3,000
Purchase discounts 8,000 156,000
Add: Transportation in 10,000
Cost of goods available for sale 190,000
Less: Merchandise inventory, December 31 31,000 159,000
Gross Profit P113,000
Less: Operating Expenses
Selling expenses
Advertising 7,000
Commission 10,000
Sales salaries 20,000
Rent 12,000 49,000
Administrative expenses
Rent 12,000
Office salaries 40,000
Utilities 5,000 57,000 106,000
Income from operations 7,000
Other revenue (expense)
Interest revenue 100
Net Income P7,100

The Statement of Financial Position

The statement of financial position provides information on the status or

condition of the entity. It presents the total assets as well as the total liabilities and

the owner’s interest.

There are two acceptable formats in presenting statement of financial

position: the account and the report format. The account format lists the assets on

the left and the liabilities and equity section on the right. The report format, on the

other hand, presents first the assets and followed by the liabilities and equity section.
 Moreover, in order to make the information in the statement of financial

position useful to users, the assets and liabilities section should be categorized into

current and noncurrent.

The Statement of Cash Flows

The statement of cash flows provides information about the inflows and

outflows of cash on an entity during a period. It is a formal statement cash collections

and cash payments according to nature of activity. An entity’s activity can be

classified into: operating activities, investing activities or financing activities.

Operating activities generally involve all activities in order to provide services/goods

to customers. Cash inflows from operating activities include sale of goods or

providing services to clients or receipts of other revenues. Cash outflows from

operating activities comprise of purchase of goods for resale and payment of

operating expenses.

Investing activities include buying or selling fixed assets and making or

collecting loans.

Financing activities involve obtaining cash from investments/withdrawals made

by the owner/s or from borrowing/repayment from creditors.

In presenting statement of cash flows, there are two formats allowed by the

standard: the indirect method and the direct method. The format is only applied to

the cash inflows and outflows from operating activities. In the indirect method, the

net cash provided by (used by) operating activities derive from adjusting the net

income by adding non-cash expenses such as depreciaiton and doubtful account

expense and by adding and subtracting increases and decreases in current assets

and current liabilities.

 In the direct method, list first all the cash receipts and deduct the total cash

payments for operating expenses.

The Statement of Changes in Equity

Just like the statement of cash flows, the statement of changes in equity

supports the equity section of the statement of financial position. This statement

gives detailed information about the transactions and events that affects the capital

or equity of the entity.

Note to the Financial Statements

The notes to the financial statements are used to list the accounting standards

used in the preparation of financial statements. It also provides additional information

on the data presented in the financial statements.

 Exercise Number 9.1

Critiquing

Name: Date: Score:

Requirement: Below is a complete set of financial statements, critique the

presentation if it conforms to the accounting standards. If no, please prepare the
statement following the standards.

AJP Store
Income Statement
For the year ended December 31, 2020
Sales P399,000
Sales discounts 864
Net sales P398,136
Less: Expenses
Cost of goods sold P291,050
Freight out 1,500
Rent expense 5,000
Salary expense 15,000
Supplies expense 5,000
Business permit and licenses 6,500
Depreciation expense 750
Telephone expense 500
Electricity expense 800 326,100
NET INCOME P72,036
 AJP Store
Statement of Financial Position
For the year ended December 31, 2020
Assets
Noncurrent Assets
Furniture and fixtures P50,000
Accumulated depreciation 333 P49,667
Equipment 100,000
Accumulated depreciation 417 99,583 P149,250
Current Assets
Accounts receivable 90,000
Merchandise inventory 151,800
Supplies 5,000
Prepaid rent 10,000
92,286 349,086
Total Assets P498,336
LIABILITIES AND OWNER’S EQUITY
Current Liabilities
Accounts payable 125,000
Accrued expense 1,300 126,300
Owner’s Equity
Owner’s capital 372,036
Total Liabilities and Owner’s equity P498,336

AJP Store
Statement of Cash Flows
For the year ended December 31, 2020
Cash flows from operating activities
Cash receipts from investments by owners P50,000
Cash paid to suppliers of merchandise (167,850)
Net cash provided from operating activities (117,850)
Cash flows from investing activities
Cash received from customers 308,136
Cash paid operating expenses (48,000)
Net cash provided from investing activities 260,136
Cash flows from financing activities
Cash paid to acquire equipment (50,000)
Net cash used from investing activities (50,000)
Net increase in Cash P92,286
Cash balance at the beginning of the period -
Cash balance at the end of the period P92,286