FINANCIAL ACCOUNTING AND REPORTING

The Accounting Cycle

The accounting cycle refers to the series of sequential steps or procedures performed to accomplish the accounting process.

The 10 steps in the accounting cycle are as follows:

Step 1 Identification of Events to be Recorded

Step 2 Transactions are recorded in the Journal
Step 3 Journal Entries are posted to the Ledger
Step 4 Preparation of the Trial Balance
Step 5 Preparation of the Worksheet including the Adjusting Entries
Step 6 Preparation of the Financial Statements
Step 7 Adjusting Entries are Journalized and Posted
Step 8 Closing Journal Entries are Journalized and Posted
Step 9 Preparation of a Post-Closing Trial Balance
Step 10 Reversing Entries are Journalized and Posted

This cycle is repeated each accounting period. The first three steps in the accounting cycle are accomplished during the period. The fourth to the ninth steps occur at
the end of the period. The last step is optional and occurs at the beginning of the next period.

Recording Business Transaction for Merchandising Entity

Now let's Journalize.

Problem A. The following accounts are used by Philip Masigasig Maintenance Services:

Step 1: ANALYZING the TRANSACTIONS ( IDENTIFYING THE ACCOUNTS AFFECTED)

ACCOUNT TITLES
 10. Service
1. Cash 4. Prepaid Insurance 7. Accounts Payable Revenues (same as
Service Income)

2. Accounts Receivable 5. Equipment 8. Masigasig, Capital 11. Rent Expense

12. Repairs Expense

3. Supplies 6. Notes Payable 9. Masigasig, Withdrawals

Let's analyze the transactions below by identifying the accounts affected , and weather it will increase, decrease or no change.

2020 Transactions Debit Credit

May 1 Paid supplies purchased on account last month P 5,000 Accounts Payable (Decrease) Cash (Decrease)

3 Billed customers for services performed P 30,000 Accounts Receivable (Increase) Service Revenues (Increase)

5 Paid the rent for this month., P 5,000 Rent Expense (Increase) Cash (Decrease)

6 Purchased supplies on credit P 15,000 Supplies (Increase) Accounts Payable (Increase)

8 Received cash from customers for services performed P 75,000 Cash (Increase) Service Revenues (Increase)

9 Acquired equipment on account P 50,000 Equipment (Increase) Accounts Payable (Increase)

10 Received a bill for repairs P 3,000 Repairs Expense (Increase) Accounts Payable (Increase)

12 Returned part of the supplies purchased in ( May 6) for credit P 5,000 Accounts Payable (Decrease) Supplies (Decrease)

13 Received cash from customers previously billed P 30,000 Cash (Increase) Accounts Receivable (Decrease)
 15 Paid the bill received in (May 10) P 3,000 Accounts Payable (Decrease) Cash (Decrease)

16 Booked an appointment for services estimated at P 100,000 None (No services has been done yet-NO NEED TO RECORD) None

18 Paid for repairs with cash P 2,500 Repairs Expense (Increase) Cash (Decrease)

20 Made cash withdrawals P 10,000 Masigasig, Withdrawals (Increase) Cash (Decrease)

Issued a promissory note (promise to pay) in exchange for the accounts

22 Accounts Payable (Decrease) Notes Payable (Increase)
payable pertaining to May 9 transaction P 50,000

Masigasig made an additional investment in the form of Equipment (his Masigasig, Capital (Increase)
25 equipment at home were brought to be used in the business) valued at P Equipment (Increase)
30,000 (Note that we follow the Separate Entity Concept)

31 Services are rendered for cash P 80,000 Cash (Increase) Service Revenues (Increase)

Table 2.2 Analysis of the Illustrative Problem

STEP 2: JOURNALIZE

We now record the accounts debited and credited from the analysis above in the general journal. Then provide a brief explanation after each journal entry transaction.
See answers below.

Date Account Titles and Explanation P.R. Debit Credit

2020
May
Accounts Payable ₱5,000
1
Cash ₱5,000

Payment of Supplies purchased last month

3 Accounts Receivable 30,000
Service Revenues 30,000
Performed services on account

5 Rent Expense 5,000

Cash 5,000
Payment of Rent for July 2020

6 Supplies 15,000
Accounts Payable 15,000
Purchased supplies on account

8 Cash 75,000
Service Revenues 75,000
Performed services for cash

9 Equipment 50,000
Accounts Payable 50,000
Acquired equipment on account

10 Repairs Expense 3,000

Accounts Payable 3,000
Received bill for Repairs

12 Accounts Payable 5,000

Supplies 5,000
Returned supplies

13 Cash 30,000
Accounts Receivable 30,000
 Received payment from customer
previously billed

15 Accounts Payable 3,000

Cash 3,000
Payment of Repairs

18 Repairs Expense 2,500

Cash 2,500
Payment of Repair Services

20 Masigasig, Withdrawals 10,000

Cash 10,000
Withdrawals by the owner

22 Accounts Payable 50,000

Notes Payable 50,000
Issuance of Notes Payable in exchange
for
Accounts Payable (Purchase of
Equipment)

25 Equipment 30,000
Masigasig, Capital 30,000
Additional Investment by the owner

31 Cash 80,000
Service Revenues 80,000
Performed services for cash

Table 2.3 Journal Entries for the Illustrative Problem

Now we are ready to account for merchandising business.
 Figure 2.3 Comparison of Service and Merchandising Operations

Figure 2.3 shows the operations of a service company as compared to a

merchandising company. A service company purchases supplies that shall be used
for the provision of services, provides services either for cash or on account and
then collects cash for customers billed on account. A merchandising company
purchases merchandise, sells the merchandise either for cash or on account and then
collects the receivables back to cash.

Terms Description Sample Problem Solution

Cash Discounts Prompt discounts. These are
discounts given by seller to induce
buyers to pay early. Cash discount
is designated by notation such as
"2/10" or "3/15". 2/10 denotes that
customers can have 2% discount if
paid within 10 days and 3/15
denotes 3% discount if paid within
15 days. n/30 means no discount
and can be made within 30 days.
Cash discounts are purchase
discounts for the buyer and sales
discounts for the seller.
On January 1, 2020, Ana Purchased
P 150,000 worth of merchandise on
account, terms 3/15, n/30 from
seller Maria.
150,000 x 3% =4,500 if paid from Jan
2-16, 2020.
Otherwise, if paid on Jan 17, the
buyer will have no discount but will
incur no additional cost if paid
within 30 days until January 31,
2020.
Assume that Ana paid on January
16, 2020
Assume that Ana paid on January
31, 2020
 Date Account Titles and Explanation Debit Credit

Ana’s Books
Jan 1. Purchases 150,000
Accounts Payable 150,000

Jan 16 Accounts Payable 150,000

Purchase Discount
4,500
Cash (P150,000 – P4,500)

IF PAID on Jan
Accounts Payable 150,000
31
Cash 150,000

Terms Description Sample Problem Solution

Trade Discounts 1. P 5,000 x 10 units = P 50,000 x

It encourages buyers to purchase in
bulk. The invoice price is the list price
less any trade discounts, hence this is
not reflected in the entry as trade
discounts are already deducted to
arrive at the invoice price.
Example:
1. Vergie quoted a list price of P
P5,000 for each hard drive, less a
trade discount of 20%. Mercy bought
10 units.
2. If Mercy buys 20 units she will
receive an additional 10% hence the
trade discounts would be less 20%
and 10%
20%=10,000. Total invoice price is P
40,000
2. P 5,000 x 10 units = P 50,000 x
20%=10,000.
(P 50,000-10,000)x 10%=P 4,000
Total Invoice Price is
P 50,000-10,000-4,000= P 36,000
The amount of Purchases and
Accounts Payable if the purchase is
on account would equal to P 36,000.
Transportation In

This is the cost of shipping the merchandise by a common carrier-either by a trucking company or by an airline. The carrier prepares the freight bill
which designates the party who shall cover the costs of shipment (either freight prepaid and freight collect)

FOB Shipping Point- Buyer shoulders the cost

- ownership passes to buyer when the shipment leaves the seller's place

FOB Destination - Seller shoulders the cost

- ownership passes to buyer when the shipment /goods arrives at the point of destination

Freight Prepaid-The seller pays the Transportation Cost

Freight Collect-The buyer pays the Transportation Cost

Freight Terms Who shoulders the Transportation Cost? Who pays the shipper?

FOB Destination, Freight Prepaid Seller Seller

FOB Shipping Point Freight Collect Buyer Buyer

FOB Destination, Freight Collect Seller Buyer

FOB Shipping Point, Freight Prepaid Buyer Seller

Inventory Systems
There are two inventory systems that are commonly used to record the business transaction involving merchandising type of business. One is the periodic
inventory system and the other one is the perpetual inventory system.

Periodic Inventory System

Under this inventory system, the inventory account is not continuously updated, instead account titles such as Purchases, Purchase Returns and Allowances,
Purchase Discounts, Transportation In or Freight In are being used to accumulate the transactions pertaining to Inventory. At the end of the accounting period,
a physical count will be conducted to determine the ending inventory. The value of the ending inventory shall then be deducted from the Cost of Goods
Available for Sale (CGAS) to arrive at Cost of Sales. This inventory method is usually applied by entities selling high volume but of low value products.

Perpetual Inventory System

Under the perpetual inventory system, the inventory account is continuously updated. Most companies are using the perpetual inventory systems with the use
of the point of sale (POS) equipment . This system is more advisable for firms that sell low volume-high priced goods such as motor vehicles, jewelry and
furniture. Unlike the periodic inventory systems, Inventory account is updated every time there is a purchase or sale transaction. Companies still conduct a
physical count to reconcile the items with what has been recorded in the books.

A comparison of the entries using the periodic and perpetual inventory systems is given below. The journal entries on the left pertain to the periodic inventory
system while entries on the right pertain to perpetual inventory system.

Periodic Inventory System Perpetual Inventory System

1. When merchandise inventory is purchased on account, P10,000; terms 2/10, n/30 (invoice price)

Purchase 10,000 Inventory 10,000

Accounts Payable 10,000 Accounts Payable 10,000

2. Returned merchandise Costing P 300 part of the P 10,000 purchase

Accounts Payable 10,000 Accounts Payable 10,000

Purchase Returns and Allowances 10,000 Inventory 10,000

3. Paid freight on the merchandise purchased, terms; FOB Shipping point, Freight collect P200

Transportation In 200 Inventory 200

Cash 200 Cash 200

4. Paid the merchandise purchased less cash discounts (10,000 - 300) – 2% discount

Accounts Payable 9,700 Accounts Payable 9,700

Purchase Discount 194 Inventory 194
Cash 9, 506 Cash 9, 506

5. Sold merchandise costing P5,000 for P8,000; terms 2/10, n/30

Accounts Receivable 8,000 Accounts Receivable 8,000

Sales 8,000 Sales 8,000
Cost of Sales 5,000
Inventory 5,000

6. Customer returned merchandise costing P312.50 that has been sold for P500 part of the P8,000 sale

Sales Return and Allowances 500 Sales Returns and Allowances 500
Accounts Receivable 500 Accounts Receivable 500
Inventory 312.5
Cost of Sales 312.5

7. Received payment from customer for merchandise sold less discounts (8,000 - 500) – 2%
 Cash 7,350 Cash 7,350
Sales Discount 150 Sales Discount 150
Accounts Receivable 7,500 Accounts Receivable 7,500

8. To transfer the beginning inventory balance to the Income Summary Account (part of the closing entries under the Periodic Inventory Systems) Assume beginning inventory of 50,000

Income Summary 50,000 No entry

Inventory 50,000

9. To record the ending inventory balance, assume that the amount is P45,000 (part of the closing entries under the Periodic Inventory Systems)

Inventory 45,000 No entry

Income Summary 45,000

10. To adjust the ending perpetual inventory balance for the shrinkage during the year. Assume that the shrinkage amounts to P1,000

Shrinkage already effected in No.10 entry Cost of Sales 1,000

Inventory 1,000

Table 2.4 Comparison of Service and Merchandising Company's Statement of Financial Performance

Table 2.4 above shows that the Statement of Financial Performance for a Merchandising Company includes another account which is the Cost of Goods Sold. To
compute for the Cost of Goods Sold we add the Merchandise Inventory beginning (Inventory that was unsold last month -note that the ending inventory last month
becomes the beginning inventory this month) and the net purchases this month including the transportation in or freight in. The resulting amount is known as the Cost
of Goods Available For Sale (CGAS). From CGAS, we deduct the merchandise inventory end (the value of the unsold units this month) to arrive at Cost of Goods Sold.
The classification of Expenses in the Service type of business are also the same classification that shall be used in the merchandising type of business.

NET COST of PURCHASES

A. Net Cost of Purchases.

We normally record purchases using the periodic inventory method. Under the periodic inventory method, we debit purchases when we purchase merchandise
and we either credit cash if we pay cash and we credit accounts payable if we purchase on account. When we record purchases at the invoice price, we are
using the gross method of recording purchases meaning purchases discounts are accounted for during payments and not on the date of purchase. Trade or
 volume discounts are discounts granted to buyers in order to induce them to buy he products or merchandise in large quantities or in bulk. Purchase discounts
is given when a customer/ buyer who purchases on account pays within the discount period. Purchase discounts are given to encourage early payments of
accounts. In the case of purchases, we are the buyer of the merchandise and it is best to take advantage of purchase discounts to lower the cost of sales and
have better profits. As a rule trade discounts are already deducted from the cost of our purchases hence purchases is net of trade or volume discounts but
gross of purchase discounts. Purchase discounts and purchase returns and allowances are deducted from Purchases to arrive at Net Purchases while
Transportation In is added to get the Net Cost of Purchases.

B. Transportation In-It forms part of the Net Cost of Purchases. Let's look at different examples and how they are journalized.
Case 1.

Assume that G. Divina Trading Company made purchases on January 25,2020 totaling P 17,000 FOB destination, freight prepaid; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.

January 25 Purchases ₱17,000

Accounts Payable ₱17,000

Note: No additional entry, FOB Destination says that the seller SHOULD pay the transportation cost and FREIGHT prepaid says that indeed the seller pays the
cost.

Case 2.

Assume that G. Divina Trading Company made purchases on January 25,2020 totaling P 17,000 FOB shipping point, freight collect; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.

January 25 Purchases ₱17,000

Transportation In 2,000
Accounts Payable ₱17,000
Cash 2,000

Note: An entry was made to record the payment of Transportation In. Since the terms of the purchase is FOB Shipping point, the Buyer SHOULD pay the
transportation costs and FREGHT collect states that it is the buyer who paid the cost hence an credit to CASH for P 2000 was recorded.
Case 3

Assume that G. Divina Trading Company made purchases on January 25,2020 totaling P 17,000 FOB destination, freight collect; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.

January 25 Purchases ₱17,000

Accounts Payable ₱15,000
Cash 2,000

Note: The payment by the buyer of the transportation costs amounting to P 2,000 (freight collect) reduces the amount owed to the supplier since the latter is the
one responsible for the payment of the transportation cost (FOB Destination)

Case 4

Assume that G. Divina Trading Company made purchases on January 25,2020 totaling P 17,000 FOB shipping point, freight prepaid; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.

January 25 Purchases ₱17,000

Transportation In 2,000
Accounts Payable ₱19,000

Note: The payment by the seller of the transportation costs amounting to P 2,000 (freight prepaid) increases the amount owed by the buyer since the latter is the
one responsible for the payment of the transportation cost (FOB Shipping point).

C. Net Sales. Using the Accrual basis, we record sales when goods have been delivered not when cash are collected. A merchandising firm use the
account title sales when ownership and title to the goods passes to the buyer. However sale of old truck will not result to recording sales unless
the company's nature of business is to buy and sell used trucks. Net sales is computed as Gross Sales-Sales Returns and Allowances-Sales
Discounts. Transportation Out does not affect the computation of Net Sales.
D. Transportation Out. Illustrative problems are given below.

Case 1.

Assume that G. Divina Trading Company sold merchandise on January 25,2020 totaling P 17,000 FOB destination, freight prepaid; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.

January 25 Accounts Receivable ₱17,000

Transportation Out 2,000
Sales ₱17,000
Cash 2,000

Note: FOB Destination says that the seller SHOULD pay the transportation cost and FREIGHT prepaid says that indeed the seller pays the cost. Transportation
out is part of operating expenses.

Case 2.

Assume that G. Divina Trading Company sold merchandise on January 25,2020 totaling P 17,000 FOB shipping point, freight collect; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.
January 25 Accounts Receivable ₱17,000

Sales ₱17,000

Note: Since the terms of the sales is FOB Shipping point, the Buyer SHOULD pay the transportation costs and FREGHT collect states that it is the buyer who
paid the cost hence no entry for the seller.

Case 3

Assume that G. Divina Trading Company sold merchandise on account on January 25,2020 totaling P 17,000 FOB destination, freight collect; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.
January 25 Accounts Receivable ₱15,000
Transportation Out 2,000
Sales ₱17,000
Note: The payment by the buyer of the transportation costs amounting to P 2,000 (freight collect) reduces the amount owed by the buyer since the seller is the
one responsible for the payment of the transportation cost (FOB Destination).
Case 4

Assume that G. Divina Trading Company sold merchandise on January 25,2020 totaling P 17,000 FOB shipping point, freight prepaid; terms 2/10, n/30.
Transportation Costs amounted to P 2,000.
January 25 Accounts Receivable ₱19,000
Sales ₱17,000
Cash ₱2,000

Note: The payment by the seller of the transportation costs amounting to P 2,000 (freight prepaid) increases the amount owed by the buyer since the latter is the
one responsible for the payment of the transportation cost (FOB Shipping point).

Recording Transactions with Value Added Tax

Value-Added Tax (VAT) is a form of sales tax. It is a tax on consumption levied on the sale, barter, exchange or lease of goods or properties and services in the
Philippines and on importation of goods into the Philippines.
When we purchase goods there is a corresponding entry to Input Tax (normal balance is DEBIT) and when we sell goods, we credit Output Tax (normal balance
is CREDIT). The input tax or output tax is 12% of the amount of purchases or sales. The total invoice price already includes the input or output tax.

On May 25, 2020, Rhea purchased on account merchandise with a total amount payable of P 784,000. She sold all the purchased goods to Mario on May 31, 2020
and received a total amount of P 1,120,000. Rhea is a Vat registered entity.

2020
May 25 Purchases ₱700,000
Input Tax ₱84,000
Accounts Payable ₱784,000

(Input Tax = 784,000/1.12 x 12%)

31 Cash ₱1,120,000
Sales ₱1,000,000
Output Tax ₱120,000

Output Tax ₱120,000

Input Vat ₱84,000
VAT Payable ₱36,000

Vat Payable ₱36,000

Cash ₱36,000

The Value added Tax Payable is the difference between the Output Tax and the Input tax. A higher output tax will result to VAT payable and is paid quarterly .

Assume that the sales were on account and the buyer paid within the discount period and is entitled to 2% discount.

May 31 Cash
Output Tax
Sales discounts
Accounts Receivable
(Sales Discounts = 1,120,000/1.12= 1,000,000 Sales x 2%= P 20,000)
(Out put Tax= P 20,000 x 12%= P 2,400)