Timing and Reporting
The Accounting Period
- The value of information is linked to its timeliness.
- To provide timely information, accounting systems
prepare reports at regular interval.
- The time period assumption presumes that an
organization’s activities can be divided into specific
time periods such as a month, at three-month
quarter, at six-month interval, or a year.
Remember:
Most organizations use a year as their primary accounting
period…
- Records covering one-year period are known as
annual financial statements
- Many organizations also prepare interim financial
statements covering one, there, six months of
activity.
- The annual reporting period is not always a
calendar year ending on December 31.
- An organization can use fiscal year – any 12
consecutives months or 52 weeks.
- all activities are complete when financial statements are
Accrual basis versus cash basis
Several accounts require adjustments before their balances
appear in financial statements……
Accrual Basis Accounting
- Records revenue when services and products are
delivered and records expenses when incurred
(matched with revenues).
Cash Basis Accounting
- Records revenue when cash is received and records
expenses when cash is paid.
- Cash basis income is cash receipts minus cash
payments.
Most agree that accrual accounting better reflects business
performance than cash basis accounting. It also increases the
comparability of financial statements from period to period
To illustrate further, let’s have an example:
Let’s consider FastForward’s Prepaid Insurance account…
Accrual Basis
- FastForward paid Php 2400 for 24 months of
insurance coverage that began on December 1,
2021. Accrual accounting requires that Php 100 of
insurance expense be reported each month, from
December 2021 through November 2023
- Any unexpired premium is reported as a Prepaid
Insurance asset on the accrual basis balance sheet.
Cash Basis
- A cash basis income statement for December 2021
reports insurance expense of Php 2400. The cash
basis income statements for years 2022 and 2023
report no insurance expense.
- The cash basis balance sheet never reports a
prepaid insurance asset because it is immediately
expensed.
Recognizing revenues and expenses
We divide a company’s activities into time periods, nut not
prepared. Thus, adjustments are required to get the proper
account balances...
Two principles are used:
Revenue Recognition Principle
- Requires that revenue be recorded when goods or
services are provided to customers and at an
amount expected to be received from the
customers.
Remember...
Adjustments ensure revenue is recognized in the time period
when those services are provided.
Expenses Recognition/Matching Principle
- Requires that expenses be recorded in the same
accounting period as the revenues that are
recognized as a result of those expenses
Framework for adjustments
For types of adjustments:
Adjustments are made using 3-step process:
Step 1. Determine what the current account balance equals.
Step 2. Determine what the current account balance should
equal.
Step 3. Record an adjusting entry to get from step 1 to step 2 1
Cash 2,400
Remember...
- Adjusting entry reflects a transaction or event that Adjusting Entry
is not yet recorded. Dec. Insurance Expense 100
- An adjusting entry affects one or more income 31
Prepaid Insurance 100
statement accounts and one or more balance sheet
Deferral of Expense
accounts (but never the Cash Account).
Supplies
Prepaid Expenses/Deferred Expenses are assets paid for - We count supplies at period end and make
in advance of receiving their benefits. When these assets are adjusting entry.
used, those advance payments become expenses. Step 1. FastForward purchased Php 9,720 of supplies in
Framework: December, some of which were used during that same
- Adjusting entries for prepaid expenses increase month. When financial statements are prepared at December
expenses and decrease assets. 31, the cost of supplies used during December is expensed.
- Examples of prepaid expenses are prepaid Step 2. When FastForward computes (physically counts) its
insurance, prepaid rent, office supplies, a nd remaining unused supplies on December 31, it finds Php
depreciation. 8,670 of supplies remaining of the Php 9,720 total supplies.
- In each case we decrease an asset (balance sheet) The Php 1,050 difference between these two amounts is
account and increase an expense (income December’s supplies expense.
statement) account. Step 3. The adjusting entry to record this expense and
reduce the Supplies asset account, along with T-account
postings, follows.

Initial Entry
Dec. Office Supplies 9,720
1
Cash 9,720

Adjusting Entry
Dec. Office Supplies Expense 1,050
Prepaid insurance 31
- Prepaid insurance expires with time Office Supplies 1,050
Using the three-step process...
Step 1. We determine that the current balance of Depreciation
FastForward’s prepaid insurance is equal to its Php 2,400 Plant Assets
payment for 24 months of insurance benefits that began on - Plant assets, also called Property, Plant, and
December 1, 2021. Equipment, is a special category of prepaid
Step 2. The benefits of the insurance expire over time and a expenses.
portion of the Prepaid Insurance asset becomes expense. For - These are long-term tangible assets used to produce
FastForward, one month’s insurance coverage expires by and sell products or services.
December 31, 2021. - Examples include buildings, machineries, vehicles,
Step 3. The adjusting entry to record this expense and and equipment.
reduce the asset, along with T-account posting, follows. - All plant assets except land eventually wear out or
become less useful.
Initial Entry
Dec. Prepaid Insurance 2,400
 - The cost of plant assets is gradually reported as
expenses in the income statement over the assets’ The difference between asset costs less accumulated
useful lives. depreciation is called book value or net amount.
Depreciation
Deferral of Revenue
- The allocation of the costs of these assets over
their expected useful lives, but it does not Unearned Revenue is a cash received in advance of
necessarily measure decline in market value. providing products and services. Unearned or Deferred
Note: An asset’s expected value at the end of its useful life is Revenues are liabilities. We defer, or postpone, reporting
called salvage value. amounts received as revenues until the product or services is
provided.
Step 1. FastForward purchased equipment for Php 26,000 in Framework:
early December to use in earning revenue. This equipment’s - As products or services are provided, the liability
cost must be depreciated. decreases, and the unearned revenues becomes
Step 2. The equipment is expected to have a useful life of revenues.
five years and to be worth about Php 8,000 at the end of five - Adjusting entries for unearned revenue decrease
years. This means that the net cost of this equipment over its the unearned revenue (balance sheet) account and
useful life is Php 18,000. FastForward depreciates it using increase the revenue (income statement) account.
straight line method, which allocates equal amounts of the
asset’s net cost to depreciate using its useful life. Diving the
net cost by 60 months (5 years) in the asset’s useful life
gives a monthly cost of Php 300.
Step 3. The adjusting entry to record monthly depreciation
expense, along with T-account postings, follows.
Initial Entry
Dec. Equipment 26,000
1 Unearned consulting revenue
Cash 26,000 FastForward has unearned revenues. The company agreed
on December 26 to provide consulting services to a client for
Depreciation = (26,000 – 18,000) / 60 60 days for a fixed fee of
= 300
Adjusting Entry
Dec. Depreciation Expense 300
31
Accumulated 300
Depreciation

Accumulated Depreciation
- Accumulated depreciation is a separate contra
account and has normal credit balance.
Note:
A contra account is an account linked with another account,
it has an opposite normal balance, and it is reported as a
subtraction from that other account’s balance.

The Accumulated Depreciation contra account includes total

depreciation expense for all prior periods for which the asset
was used.
Php 3,000.
Step 1. On December 26, the client paid the 60-day fee in
Accrued salaries expense
FastForward’s employee earns Php 70 per day, or Php 350
advance, covering the period December 27 to February 24.
for a five-day workweek beginning on Monday and ending
Step 2. As time passes, FastForwars earns this payment
on Friday.
through consulting. By December 31, it has provided five
Step 1. Its employee is paid every two weeks on Friday. On
days’ service and earned 5/60 of the Php 3,000 unearned
December 12 and 26, the wages are paid, recorded in a
revenue. The revenue recognition principle requires that Php
journal, and posted to the ledger.
250 of unearned revenue be reported as revenue on the
Step 2. The calendar shows three working days after the
December income statement.
December 26 payday (29,30,31). This means the employee
Step 3. The adjusting entry to reduce the liability account
has earned three days’ salary by the close of business on
and recognize revenue, along with T-account postings,
Wednesday, December 31, but this salary cost has not been
follows.
paid or recorded. FstForward must report the added expense
and liability for unpaid salary from December 29-31.
Initial Entry
Dec. Cash 3,000 Step 3. The adjusting entry for accrued salaries, along with
26 T-account postings, follows.
Unearned Consulting 3,000
Revenue Adjusting Entry
Dec. Salaries Expense 210
Adjusting Entry 31
Dec. Unearned Consulting 300 Salaries Payable 210
31 Revenue
Consulting Revenue 300 Accrued interest expense
- Interest expense is incurred as time passes.
Accrued Expenses - We need to adjust interest expense incurred but not
yet paid
Accrued Expenses or Accrued Liabilities are cost that are - The formula for computing accrued interest
incurred in a period that are both unpaid and unrecorded.
expense is:
Accrued are reported on the income statement for the period
Principal*Annual Interest Rate*Time
when incurred
- The adjusting entry debits Interest Expense and
Framework:
credit Interest Payable.
- Adjusting entries for recording accrued expenses
Accrued Revenue
increase the expense (income statement) account
and increase a liability (balance sheet) account.
- This adjustment recognizes expenses incurred in a Accrued Revenue are revenues earned in a period that are
period but not yet paid. both unrecorded and not yet received in cash (or another
- Examples are salaries, rent, interest, and taxes. asset). An example is a technician who bills customers after
the job is done. Accrued revenues are also called accrued
assets.
Framework:
 - The adjusting entry for accrued revenues increases Trial Balance is a list of accounts and balances after
a revenue (income statement) account and adjusting entries have been recorded and posted to the
increases an asset (balance sheet) account. ledger.

Accrued service revenue

Step 1. In the second week of December, FastForward
agreed to provide 30 days of consulting services to a fitness
club for a fixed fee of Php 2,700. FastForward will provide
services from December 12 through January 10. The club
agrees to pay FastForward Php 2,700 on January 10 when
the service is complete.
Step 2. On December 31, 20 days of services has already
been provided. Because the contracted service has not yet Preparing financial statements
been entirely provided, FastForward has neither billed the
We prepare financial statements in the following order: (1)
club nor recorded the services already provided. Still,
income statement (2) statement of owner’s equity (3)
FastForward has earned two-thirds of the 30-day fee. The
balance sheet.
revenue recognition principle requires FastForward to report
the Php 1,800 on the December income statement.
Step 2. The adjusting entry for accrued services, along with
T-account postings, follows.

Adjusting Entry
Dec. Accounts Receivable 1,800
31
Consulting Revenue 1,800

Trial Balance and Financial Statements

An Unadjusted Trial Balance is a list of accounts and
balances before adjustments are recorded. An Adjusted
Benefits of a Work Sheet (Spreadsheet)
A worksheet is a document that is used internally by
companies to help with adjusting and closing accounts and
with preparing financial statements. It is an internal
accounting aid and is not a substitute for journals, ledgers,
or financial statements. A worksheet:
- Helps in preparing financial statements.
- Reduces the risk of errors when working with
many accounts and adjustments.
- Links accounts and adjustments to financial
statements.
- Shows the effects of proposed or “what-if”
transactions.
Use of a worksheet
Remember...
- When a work sheet is used to prepare financial
statements, it is constructed at the end of a period
before the adjusting process.
- The complete work sheet includes a list of the
accounts, their balances and adjustments, and their
sorting into financial statement columns.
Preparing the work sheet has five steps:
Step 1. Enter Unadjusted Trial Balance
- The first step in preparing a work sheet is to list the
title of each account and its account number.
- This includes all accounts in the ledger plus any
expected ones from adjusting entries.
- The unadjusted balance for each account is then
entered in the correct Debit or Credit column of the
unadjusted trial balance columns.
- The totals of these two columns must be equal.
Step 2. Enter Adjustments
- The second step is to enter adjustments in the
Adjustments columns.
- An identifying letter links the debit and credit of
each adjustment. This is called keying the
adjustments.
- The Adjustments columns provide the information
for adjusting entries in the journal.
Step 3. Prepare Adjusted Trial Balance
- The adjusted trial balance is prepared by combining
the adjustments with the unadjusted balances for
each account.
- The totals of the Adjusted Trial Balance columns
confirm debits and credits are equal.
Step 4. Sort Adjusted Trial Balance Amounts to Financial
Statements
 - This step involves sorting account balances from
the adjusted trial balance to their proper financial
statement columns.
- Expenses go to the Income Statement Debit
column, and revenues to the Income Statement
Credit column.
- Assets and withdrawals go to the Balance Sheet &
Statement of Owner’s Equity Debit column.
- Liabilities and owner’s capital go to the Balance
Sheet & Statement of Owner’s Equity Credit
column. Closing Process
Step 5. Total Statement Columns, Compute Income or Loss,
and Balance Columns
- Each financial statement column (from step 4) is
totaled.
- The difference between the Debit and Credit
column totals of the Income Statement columns is
net income or net loss.
- This occurs because revenues are entered in the
Credit column and expenses in the Debit column.
- If the Credit total exceeds the Debit total, there is
net income. If the Debit total exceeds the Credit
total, there is a net loss.
Note!
The net income from the Income Statement columns is
then entered in the Balance Sheet & Statement of
Owner’s Equity Credit column. Adding net income to the
last Credit column means that it is to be added to owner’s
capital. If a loss occurs, it is added to the Debit column.
The ending balance of owner’s capital does not appear in
the last two columns as a single amount, but it is
computed in the statement of owner’s equity using these
account balances. When net income or net loss is added to
the Balance Sheet & Statement of Owner’s Equity
column, the totals of the last two columns must balance.
If they do not, one or more errors have occurred.
The closing process occurs at the end of an accounting
period after financial statements are completed. In the
closing process we:
- identify accounts for closing
- record and post the closing entries
- prepare a post-closing trial balance
The closing process has two purposes...
a) It resets revenue, expense, and withdrawals account
balances to zero at the end of each period. This is
done so that these accounts can properly measure
income and withdrawals for the next period.
b) It updates the balance in the owner’s capital
account to match the amount reported on the
statement of owner’s equity and the balance sheet.
Temporary and Permanent Accounts
Temporary accounts
- Relate to one accounting period.
- They include all income statement accounts, the
owner withdrawals account, and the Income
Summary account.
- They are temporary because such accounts are used
for a period and then closed at period-end.
- The closing process applies only to temporary
accounts.
Permanent accounts
- Report on activities related to one or more future
accounting periods.
- They include asset, liability, and owner capital
accounts (all balance sheet accounts).
- Permanent accounts are not closed each period and
carry their ending balance into future periods.
Recording Closing Entries
Closing entries transfer the end-of-period balances in
revenue, expense, and withdrawals accounts to the
permanent capital account. Closing entries are necessary
at the end of each period after financial statements are
prepared because:
- Revenue, expense, and withdrawals accounts must
begin each period with zero balances.
- Owner’s capital must reflect prior periods’
revenues, expenses, and withdrawals.
Post-Closing Trial Balance
A post-closing trial balance is a list of permanent accounts
and their balances after all closing entries. Only balance
sheet (permanent) accounts are on a post-closing trial
balance. A post-closing trial balance verifies that...
- total debits equal total credits for permanent
accounts and
- all temporary accounts have zero balances.

An income statement reports revenues and expenses for an

accounting period. Owner withdrawals are also reported for
an accounting period. Because revenue, expense, and
withdrawals accounts record information separately for each
period, they must start each period with zero balances.

Step 1- To close revenue and expense accounts, we

2. transfer their balances to Income Summary.
Income Summary is a temporary account only
used for the closing process that contains a
credit for total revenues (and gains) and a debit
for total expenses (and losses).
Step 3. Accounting Cycle
The Income Summary balance, which equals
net income or net loss, is transferred to the
capital account.
Step 4. The withdrawals account balance is transferred
to the capital account. After closing entries are
posted, the revenue, expense, withdrawals, and
Income Summary accounts have zero balances
and are said to be closed or cleared.
 Classified Balance Sheet
Analyze transactions
Analyze transactions to prepare
for journalizing.
Record accounts, including
Journalize
debits and credits, in a journal.
Transfer debits and credits
Post
from the journal to the ledger.
Prepare unadjusted trial Summarize unadjusted ledger
balance accounts and amounts.
Record adjustments to bring
Adjust and post account balances up to date;
then journalize and post.
Prepare adjusted trial Summarize adjusted ledger
balance accounts and amounts.
Prepare financial Use adjusted trial balance to
statements prepare financial statements.
Journalize and post entries to
Close Accounts
close temporary accounts.
Prepare post-closing Test clerical accuracy of the
trial balance closing procedures.
An unclassified balance sheet broadly groups accounts into
assets, liabilities, and equity. A classified balance sheet
organizes assets and liabilities into subgroups.
Classification Structure
- An important classification is the separation
between current (short-term) and noncurrent (long-
term) for both assets and liabilities.
- Current items are expected to come due (either
collected or owed) within one year or the
company’s operating cycle, whichever is longer.
- The operating cycle is the time span from when
cash is used to acquire goods and services until
cash is received from the sale of goods and
services.
- To make it easy, assume an operating cycle of one
year, unless we say otherwise.
- A balance sheet lists current assets before
noncurrent assets and current liabilities before
noncurrent liabilities.
- Current assets and current liabilities are listed in
order of how quickly they will be converted to, or
paid in, cash.
Classification Categories - Notes payable, mortgages payable, bonds payable,
Current Assets and lease obligations are common long-term
liabilities.
- Current assets are cash and other resources that are
Equity
expected to be sold, collected, or used within one
year or the company’s operating cycle, - Equity is the owner’s claim on assets.
whichever is longer. - For a proprietorship, this claim is reported in the
- Examples are cash, short-term investments, equity section with an owner’s capital account.
accounts receivable, short-term notes receivable, - Equity is not separated into current and noncurrent
merchandise inventory (goods for sale), and prepaid categories.
expenses.
Long-Term Investments
- Long-term (or noncurrent) investments include
notes receivable and investments in stocks and
bonds when they are expected to be held for more
than the longer of one year or the operating cycle.
Plant Assets
- Plant assets are tangible assets that are both long-
lived and used to produce or sell products and
services.
- Examples are equipment, machinery, buildings, and
land.
- Plant assets are also called property, plant, and
equipment (PP&E) or fixed assets.

Intangible Assets
- Intangible assets are long-term assets that benefit
Reversing Entries
business operations but lack physical form.
- Examples are patents, trademarks, copyrights,
franchises, and goodwill.
Reversing Entries is an optional step in the accounting
- Their value comes from the privileges or rights
cycle. However, it is useful in facilitating the recording of
granted to or held by the owner. asset, liabilities, revenues, and expenses in the usual manner.
Current Liabilities They are journalized and posted at the beginning of the new
- Current liabilities are liabilities due to be paid or accounting period.
settled within one year or the operating cycle,
whichever is longer. Adjusting entries that are recommended to undergo
- They usually are settled by paying out cash. reversing entries:
- Current liabilities include accounts payable, wages - Prepayments under expense method
payable, taxes payable, interest payable, and - Deferrals under revenue method
unearned revenues. - Accrued Revenues
- Also, any portion of a long-term liability due to be
- Accrued Expenses
Preparation of Cash Flows
paid within one year or the operating cycle,
whichever is longer, is a current liability.
Long-Term Liabilities
- Long-term liabilities are liabilities not due within Purpose of Statement of Cash Flows
one year or the operating cycle, whichever is - How does a company receive its cash?
longer. - Why do income and cash flows differ?
 - What explains the change in cash balance?
- Where does a company spend its cash? Investing Activities
- Related to selling of long-term assets
Importance of Cash Flows Cash Inflows Cash Outflows
From selling intangible To buy intangible assets.
Cash flows help...
assets. To loan money in return
- Users decide if a company has cash to pay its debts,
From selling plant assets. for notes receivables.
- Users evaluate company’s ability to pursue
From selling long-term To buy plant assets.
opportunities,
investments. To buy short-term
- Managers plan day-to-day operations, From selling short-term investments.
- Managers make long term investment decisions. investments. To buy long-term
From collecting principal on investments.
Classification of Cash Flows notes receivable.
- Direct Method From selling notes
- Indirect Method receivable.

The Statement of Cash Flows includes the following three
sections:
- Operating Activities
- Investing Activities
- Financing Activities
Operating Activities
- Relate to all business operations
Cash Inflows
From cash sales to
customers.
From collections on credit
sales.
From receipt of dividend
revenue.
From receipt of interest
revenue.
Cash Outflows
To pay operating expenses.
To pay taxes and fines.
To pay salaries and wages.
To pay interest owed.
To pay suppliers for goods
and services.
Financing Activities
- Pertains to how you finance the business
Cash Inflows Cash Outflows
From issuing its common To pay dividends to
and preferred stocks. shareholders.
From issuing its short- and Withdrawals by owner.
long-term debt. To purchase treasury stock.
From reissuing its treasury To pay off its short- and
stock. long-term debt.
From contributions by
owners.
Link between Classification of Cash Flows and
the Balance Sheet
- Operating, investing, and financing activities are
loosely linked to the balance sheet.
- Operating activities are affected by changes in
current assets and current liabilities.
- Investing activities are affected by changes in long-
term assets.
- Financing Activities are affected by changes in
long-term liabilities and equity.

Example of Statement of Cash Flow...

 Note: Some service companies use the term sales instead of
revenues; cost of goods sold is also called cost of sales.

Preparing the statement of cash flows

- Compute net increase or decrease in cash.
- Compute net cash from or operating activities.
- Compute net cash from or investing activities.
- Compute net cash from or financing activities.
- Compute net cash from all sources; then prove it by
adding it to beginning cash to get ending cash.

Merchandising Operations
Merchandising activities
Points to remember...
- Merchandise refers to products, also called goods,
that a company buys to resell.
- A merchandiser earns net income by buying and
selling merchandise. Merchandisers are
wholesalers or retailers.
- A wholesaler buys products from manufacturers
and sells them to retailers.
- A retailer buys products from manufacturers or
wholesalers and sells them to consumers.
Reporting Income for a Merchandiser
Net income for a merchandiser equals revenues from selling
merchandise minus both the cost of merchandise sold and
other expenses.
Revenue from selling merchandise is called sales, and the
expense of buying and preparing merchandise is called cost
of goods sold.
Reporting Inventory for a Merchandiser
A merchandiser’s balance sheet has a current asset called
merchandise inventory, an item not on a service company’s
balance sheet.
- Merchandise inventory, or simply inventory,
refers to products that a company owns and
intends to sell.
- Inventory cost includes the cost to buy the goods,
ship them to the store, and make them ready for
sale.
Operating Cycle for a Merchandiser
The cycle moves from:
(a) cash purchases of merchandise to
(b) inventory for sale to
(c) credit sales to
(d) accounts receivable to
(e) receipt of cash.
Inventory Systems
A company’s merchandise available for sale consists of what
it begins with (beginning inventory) and what it purchases
(net purchases).
The merchandise available for sale is either sold (expensed
on the income statement as cost of goods sold) or kept for
future sales (as inventory, a current asset on the balance
sheet).
Companies account for inventory in one of two ways:
- Perpetual inventory system records cost of goods
sold at the time of each sale.
- Periodic inventory system records cost of goods
sold at the end of the period.
- Sellers can grant a cash discount to encourage
buyers to pay earlier.
(A buyer views a cash discount as a purchases
discount. A seller views a cash discount as a sales
discount)
- Any cash discounts are described on the invoice.
The invoice date sets the discount and credit
periods.
- For example, credit terms of “2∕10, n∕60” mean that
full payment is due within a 60-day credit period,
but the buyer can deduct 2% of the invoice amount
if payment is made within 10 days of the invoice
date. This reduced payment is only for the discount
period.

Merchandise purchases
This section explains how we record purchases under
different purchase terms.
Invoice
Purchases without Cash Discounts On November 2, Z-Mart purchases $500 of merchandise on
Z-Mart records a $500 cash purchase of merchandise on credit with terms of 2∕10, n∕30. The amount recorded for
November 2 as follows. merchandise inventory includes its purchase cost, shipping
Journal Entry fees, taxes, and any other costs necessary to make it ready
Nov. Merchandise Inventory 500 for sale.
2
Cash 500
Purchased goods for cash
If these goods are instead purchased on credit, Z-Mart makes
the same entry except that Accounts Payable is credited
instead of Cash.

Purchases with Cash Discounts

The purchase of goods on credit requires credit terms.

Credit terms
- include the amounts and timing of payments from a
buyer to a seller. To demonstrate, when sellers
require payment within 60 days after the invoice
date, credit terms are “n∕60,” meaning net 60 days.
Points to remember...
- The amount of time allowed before full payment is
due is the credit period.
Note: This is a purchase invoice for Z-Mart (buyer) and a
sales invoice for Trex (seller).
gross method
Z-Mart purchases $500 of merchandise on credit terms of
2∕10, n∕30. The November 2 invoice offers a 2% discount if
paid within 10 days; if not, Z-Mart must pay the full amount
within 30 days. The buyer has two options:
Pay within discount period Pay after discount period - Purchases allowances refer to a seller granting a
(Nov. 2 through Nov. 12): (Nov. 13 through Dec. 2): price reduction (allowance) to a buyer of defective
Due = $490 Due = $500 or unacceptable merchandise.
On the purchase date, we do not know if payment will occur
within the discount period. The gross method records the Purchases Allowances
purchase at its gross (full) invoice amount. On November 5, Z-Mart (buyer) agrees to a $30 allowance
The gross method is used here because it (1) complies with from Trex for defective merchandise (assume allowance is
new revenue recognition rules, (2) is used more in practice, $30 whether paid within the discount period or not). Z-
and (3) is easier and less costly to apply. Mart’s entry to update Merchandise Inventory and record the
allowance follows. Z-Mart’s allowance for defective
Purchases on Credit merchandise reduces its account payable to the seller. If cash
Z-Mart’s entry to record the November 2 purchase of $500 is refunded, Cash is debited instead of Accounts Payable.
of merchandise on credit follows. Journal Entry
Journal Entry Nov. Accounts Payable 30
Nov. Merchandise Inventory 500 2
2 Merchandise Inventory 30
Accounts Payable 500 Allowance for defective goods
Purchased goods 2/10, n/30
Payment within Discount Period Purchases Returns
Good cash management means that invoices are not paid Returns of inventory are recorded at the amount charged for
until the last day of the discount or credit period. This is that inventory. On June 1, Z-Mart purchases $250 of
because the buyer can use that money until payment is merchandise with terms 2∕10, n∕60—see entries below. On
required. If Z-Mart pays the amount due on or before June 3, Z-Mart returns $50 of those goods. When Z-Mart
November 12, the entry is... pays on June 11, it takes the 2% discount only on the $200
Journal Entry remaining balance ($250 − $50). When goods are returned, a
Nov. Accounts Payable 500 buyer takes a discount on only the remaining balance.
2
Merchandise Inventory 500 Journal Entry
Cash June Merchandise Inventory 250
Paid for goods within 1.
discount period Accounts Payable 250
Purchased goods, terms 2/10,
Payment after Discount Period n/60.
If the invoice is paid after November 12, the discount is lost. June Accounts Payable 50
If Z-Mart pays the gross (full) amount due on December 2 3.
(the n∕30 due date), the entry Merchandise Inventory 50
Journal Entry Returned goods to seller.
Nov. Accounts Payable 500 June Accounts Payable 200
2 11.
Cash 500 Merchandise Inventory 4
Paid for goods outside discount Cash 196
period Paid for $200 of goods less $4
discount.
Purchases with Returns and Allowances
- Purchases returns are merchandise a buyer Purchases and Transportation Costs
purchase but then returns. The buyer and seller must agree on who is responsible for
paying freight (shipping) costs and who has the risk of loss
during transit. This is the same as asking at what point
ownership transfers from the seller to the buyer. The point
of transfer is called the FOB (free on board) point.
sold. The perpetual accounting system requires that each
sales transaction for a merchandiser, whether for cash or
on credit, has two entries: one for revenue and one for
cost.
1. Revenue recorded (and asset increased) from the
customer.
2. Cost of goods sold incurred (and asset decreased) to
the customer.

Sales without Cash Discounts

Revenue Side: Inflow of Assets
FOB shipping point Z-Mart sold $1,000 of merchandise on credit terms n∕60 on
- means the buyer accepts ownership when the November 12. The revenue part of this transaction is
goods depart the seller’s place of business. The recorded as follows. This entry shows an increase in Z-
buyer pays shipping costs and has the risk of loss Mart’s assets in the form of accounts receivable. It also
in transit. shows the increase in revenue (Sales). If the sale is for cash,
- The goods are part of the buyer’s inventory when debit Cash instead of Accounts Receivable.
they are in transit because ownership has Journal Entry
transferred to the buyer. Nov. Accounts Receivable 100
FOB destination 12 0
- means ownership of goods transfers to the buyer Sales 100
when the goods arrive at the buyer’s place of 0
business. The seller pays shipping charges and Sold goods on credit. [Revenue
has the risk of loss in transit. recognition.]
- The seller does not record revenue until the goods Cost Side: Outflow of Assets
arrive at the destination. The cost side of each sale requires that Merchandise
Points to remember... Inventory decrease by that item’s cost. The cost of the
The cost principle requires that transportation costs of a merchandise Z-Mart sold on November 12 is $300, and the
buyer (often called transportation-in or freight-in) be part entry to record the cost part of this transaction follows.
of the cost of merchandise inventory. Journal Entry
When a seller is responsible for paying shipping costs, it Nov. Cost of Goods Sold 30
records these costs in a Delivery Expense account. Delivery 12 0
expense, also called transportation-out or freight-out, is Merchandise Inventory 30
reported as a selling expense in the seller’s income 0
Record cost [Expense recognition.]
statement.
Sales with Cash Discounts
Itemized Costs of Purchases
Offering discounts on credit sales benefits a seller through
In summary, purchases are recorded as debits to
earlier cash receipts and reduced collection efforts. The
Merchandise Inventory. Purchases discounts, returns, and
gross method records sales at the full amount and records
allowances are credited to (subtracted from) Merchandise
sales discounts if, and when, they are taken.
Inventory. Transportation-in is debited (added) to
Merchandise Inventory.
Sales on Credit
Merchandise sales Z-Mart makes a credit sale for $1,000 on November 12 with
Merchandising companies must account for sales, sales terms of 2∕10, n∕45 (cost of the merchandise sold is $300).
discounts, sales returns and allowances, and cost of goods The entries to record this sale follow.
Journal Entry refund (sales return) or keep the merchandise along with a
Nov. Accounts Receivable 100 partial refund (sales allowance).
12 0
Sales 100
0
Sold goods, terms 2/10, n/45. Buyer Returns Goods—Revenue Side
Nov Cost of Goods Sold 300 When a buyer returns goods, it impacts the seller’s revenue
12. and cost sides. When a return occurs, the seller debits Sales
Merchandise Inventory 300
Returns and Allowances, a contra revenue account to Sales.
Record cost of Nov. 12 sale.
Assume that a customer returns merchandise on December
29 that sold for $15 and cost $9; the revenue-side returns
Buyer Pays within Discount Period.
entry is
One option is for the buyer to pay $980 within the 10-day
discount period ending November 22. The $20 sales Journal Entry
Dec Sales return and Allowances 15
discount is computed as $1,000 × 2%. If the customer pays
29.
on (or before) November 22, Z-Mart records the cash receipt
Cash 15
as follows. Goods returned from Nov. 12 sale.
Note!
Sales Discounts is a contra revenue account, meaning the Buyer Returns Goods—Cost Side
Sales Discounts account is subtracted from the Sales account When a return occurs, the seller must reduce the cost of
when computing net sales. The Sales Discounts account has sales. If the merchandise returned is not defective and can be
a normal debit balance because it is subtracted from Sales, resold, the seller adds the cost of the returned goods back to
which has a normal credit balance. inventory and reduces cost of goods sold as follows.
Journal Entry
Journal Entry Dec Merchandise Inventory 9
Nov. Cash 980
29.
22 Sales Discounts 20 Cost of Goods Sold 9
Accounts Receivable 100 Returned goods are added back to
0 inventory.
Received payment on sale less
discount. Buyer Granted Allowances
If a buyer is not satisfied with the goods, the seller might
Buyer Pays after Discount Period
offer a price reduction for the buyer to keep the goods. There
The customer’s second option is to wait 45 days until
is no cost-side entry in this case as the inventory is not
December 27 (or at least until after the discount period) and
returned.
then pay $1,000. Z-Mart records that cash receipt as
On the revenue side, the seller debits Sales Returns and
Journal Entry Allowances and credits Cash or Accounts Receivable
Dec Cash 100
depending on what’s agreed.
27. 0
Journal Entry
Accounts Receivable 100
Nov Sales Discount and Allowances 10
0
24.
Received payment on Nov. 12 sale
Accounts Receivable 10
after discount period.
Sales allowance granted.
Sales with Returns and Allowances
If a customer is unhappy with a purchase, many sellers allow ADJUSTING AND CLOSING FOR
the customer to either return the merchandise for a full MERCHANDISERS
Points to remember...
 - Beginning inventory plus the net cost of purchases Close credit balances in temporary
is the merchandise available for sale. accounts.
- As inventory is sold, its cost is recorded in cost of
goods sold on the income statement; what remains Step 2. Close Debit Balances in Temporary Accounts to
is ending inventory on the balance sheet. Income Summary. Sales Discounts, Sales Returns and
- A period’s ending inventory is the next period’s Allowances, and Cost of Goods Sold, having normal debit
balances, are credited
beginning inventory.
Journal Entry
Dec Income Summary 308,1
31. 00
Sales Discount 4,300
Sales Returns and Allowances 2,000
Cost of Goods Sold 230,4
Adjusting Entries for Merchandisers
Depreciation Expense 00
Each of the steps in the accounting cycle described in the
Salaries Expense 3,700
prior chapter applies to a merchandiser. We expand upon
Insurance Expense 43,80
three steps of the accounting cycle for a merchandiser—
Rent Expense 0
adjustments, financial statement preparation, and closing.
Supplies Expense 600
Advertising Expense 9,000
Inventory Shrinkage—Adjusting Entry
3,000
- A merchandiser using a perpetual inventory system
11,30
makes an adjustment to Merchandise Inventory for
0
any loss of merchandise, including theft and Close debit balances in temporary
deterioration. accounts.
- Shrinkage is the loss of inventory; it is computed
by comparing a physical count of inventory with Step 3. Close Income Summary. The third and fourth
recorded amounts. closing entries are identical for a merchandiser and a service
Journal Entry company.
Dec Cost of Goods Sold 250 Journal Entry
31. Dec Income Summary 12,9
Merchandise Inventory 250 31. 00
Adjust for $250 shrinkage. K. Marty Capital 12,9
00
Closing Entries for Merchandisers
Closing entries are similar for service companies and Step 4. Close Withdrawals. The third and fourth closing
merchandising companies. The difference is that we close entries are identical for a merchandiser and a service
some new temporary accounts that come from company.
merchandising activities. Z-Mart has temporary accounts Journal Entry
unique to merchandisers: Sales (of goods), Sales Discounts, Dec K. Marty Capital 4,00
Sales Returns and Allowances, and Cost of Goods Sold. 31. 0
Step 1. Close Credit Balances in Temporary Accounts to K. Marty Withdrawals 4,00
Income Summary. Sales, having a normal credit balance, is 0
debited.
Journal Entry Summary for merchandising Entries
Dec Sales 321,0
31. 00
Income Summary 321,0
00
 (2) income from operations, which is gross profit minus
operating expenses.
(3) net income, which is income from operations plus or
minus nonoperating items.

How to compute for Cost of Goods Sold:

Beginning inventory Php 19,000
Net cost of purchases 232,400
Goods available for sale 251,400
Less ending inventory 21,000
Cost of goods sold Php 230,400

MORE ON FINANCIAL STATEMENT

FORMATS
This section covers two income statement formats: multiple-
step and single-step. The classified balance sheet of a
merchandiser also is covered.
Multiple-Step Income Statement
A multiple-step income statement details net sales and
expenses and reports subtotals for various types of items.
The statement has three main parts:
(1) gross profit, which is net sales minus cost of goods sold.
Operating expenses are separated into two sections...
- Selling expenses are costs to market and distribute
products and services such as advertising of
merchandise, store supplies and rent, and delivery
of goods to customers.
- General and administrative expenses are costs to
administer a company’s overall operations such as
office salaries, office equipment, and office
supplies.
Other parts of the multi-step income statement...
 - Nonoperating activities consist of other expenses,
revenues, losses, and gains that are unrelated to a
company’s operations.
- Other revenues and gains commonly include
interest revenue, dividend revenue, rent revenue,
and gains from asset disposals.
- Other expenses and losses commonly include
interest expense, losses from asset disposals, and
casualty losses.
- When there are no reportable nonoperating
activities, its income from operations is simply
labeled net income.
Single-Step Income Statement
It lists cost of goods sold as another expense and shows only
one subtotal for total expenses. Expenses are grouped into
categories. Net income is the same under either format, so
management chooses the format that best informs users.
of merchandise is recorded in a temporary Purchases
account. When a company sells merchandise, it records
revenue but not the cost of the goods sold. At the end of
the period, it takes a physical count of inventory to get
ending inventory. The cost of goods sold is then computed
as cost of merchandise available for sale minus ending
inventory.
Recording Merchandise Purchases...
Under a periodic system, the purchases, purchases returns
and allowances, purchases discounts, and transportation-in
transactions are recorded in separate temporary accounts.
Credit Purchases with Cash Discounts
- The periodic system uses a temporary Purchases
account that accumulates the cost of all purchase
transactions during each period.
- The Purchases account has a normal debit
balance, as it increases the cost of merchandise.
For example, Z-Mart’s November 2 entry to record the
purchase of merchandise for $500 on credit with terms of
2/10, n/30 is
Periodic Inventory System
Dec Purchases 500
31.
Accounts Payable 500

Perpetual Inventory System

Dec Merchandise Inventory 500
31.
Accounts Payable 500
Classified Balance Sheet
The classified balance sheet reports merchandise inventory Payment of Purchases
as a current asset, usually after accounts receivable, The periodic system uses a temporary Purchases Discounts
according to how quickly they can be converted to cash. account that accumulates discounts taken during the
Inventory is converted less quickly to cash than accounts period. If payment for transaction a is made within the
receivable because inventory first must be sold before cash discount period, the entry is
can be received. Periodic Inventory System
Dec Accounts Payable 500
31.
Cash 490
Purchase Discounts 10

Perpetual Inventory System

Dec Accounts Payable 500
Periodic inventory system
31.
A periodic inventory system requires updating the inventory
Cash 490
account only at the end of a period. During the period, the
Merchandise Inventory 10
Merchandise Inventory balance remains unchanged and cost
If payment for transaction a is made after the discount period balance as it increases the cost of
expires, the entry is the same. merchandise available for sale.
Purchases Allowances
Periodic Inventory System
The buyer and seller agree to a $30 purchases allowance for Dec Transportation-In 75
defective goods (whether paid within the discount period or 31.
not). Cash 75
- In the periodic system, the temporary Purchases
Returns and Allowances account accumulates Perpetual Inventory System
the cost of all returns and allowances during a Dec Merchandise Inventory 75
period. The buyer records the $30 allowance as 31.
Periodic Inventory System Cash 75
Dec Accounts Payable 30 Recording Merchandise Sales...
31. Journal entries under the periodic system are
Purchase Returns and 30
Allowances
shown for the most common transactions.
Perpetual system entries are shown to the right of
Perpetual Inventory System each periodic entry. Differences are highlighted.
Dec Accounts Payable 30
31.
Merchandise Inventory 30
Credit Sales and Receipt of Payments
- Both the periodic and perpetual systems
Note: Purchases Discounts and Purchases Returns and record sales entries similarly, using the
Allowances are contra purchases accounts and have normal gross method.
credit balances, as they both decrease the cost of
- The same holds for entries related to
merchandise available for sale.
payment of receivables from sales both
Purchases Returns during and after the discount period.
The buyer returns $50 of merchandise within the discount - However, under the periodic system, the
period. The entry is cost of goods sold is not recorded at the
Periodic Inventory System
time of each sale (whereas it is under the
Dec Accounts Payable 50
31. perpetual system).
Purchase Returns and 50 For example, the entry to record $1,000 in credit
Allowances sales (costing $300) is
Periodic Inventory System
Perpetual Inventory System Dec Accounts Receivable 1,00
Dec Accounts Payable 50 31. 0
31. Sales 1,0
Merchandise Inventory 50 00

Transportation-In Perpetual Inventory System

The buyer paid a $75 freight charge to transport Dec Accounts Receivable 1,00
31. 0
goods with terms FOB shipping point.
Sales 1,0
- In the periodic system, this cost is recorded 00
in a temporary Transportation-In Cost of Goods Sold 300
account, which has a normal debit Merchandise Inventory 300
Returns Received by Seller
A customer returned merchandise for a cash refund. Expected Returns and Allowances—Adjusting Entry -
The goods sell for $15 and cost $9. (Recall: The Both the periodic and perpetual inventory systems estimate
periodic system records only the revenue effect, not the returns and allowances arising from current-period sales that
will occur in future periods. The adjusting entry for both
cost effect, for sales transactions.) The entry for the
systems is identical for the sales side, but slightly different
seller to take back the return is
for the cost side.
Periodic Inventory System
- The last two period-end entries are used to record
Dec Sales Return and Allowances 15
the updates to expected sales refunds of $900 and
31.
Cash 15 the cost side of $300.
- Under both systems, the seller sets up a Sales
Refund Payable account, which is a current
Perpetual Inventory System
Dec Sales Return and Allowances 1,00 liability reflecting the amount expected to be
31. 0 refunded to customers, and an Inventory Returns
Cash 1,0 Estimated account, which is a current asset
00 reflecting the inventory estimated to be returned.
Cost of Goods Sold 300
Merchandise Inventory 300 Recording Closing Entries...
Periodic and perpetual inventory systems have slight
Allowances Granted by Seller differences in closing entries. 
The seller gives a price reduction and credits the - The period-end Merchandise Inventory balance
buyer’s accounts receivable for $10. The entry is (unadjusted) is $19,000 under the periodic system.
Because the periodic system does not update the
identical under the periodic and perpetual systems. The
Merchandise Inventory balance during the period,
seller records this allowance as
the $19,000 amount is the beginning inventory.
Periodic/Perpetual Inventory System
- Recording the periodic inventory balance is a
Dec Sales Returns and Allowances 10
two-step process.
31.
Accounts Receivable 10 - The ending inventory balance of $21,000 is entered
by debiting the inventory account in the first
Recording Adjusting Entries... closing entry.
- The beginning inventory balance of $19,000 is
deleted by crediting the inventory account in the
second closing entry.
Periodic Inventory System
Dec Sales 321,0
Shrinkage—Adjusting Entry - The $250 shrinkage is only 31. Merchandise Inventory (ending) 00
recorded under the perpetual system. Shrinkage in cost of Purchases Discounts 21,00
goods is unknown using a periodic system because inventory Purchases Returns and Allowances 0
is not continually updated and therefore cannot be compared 4,200
to the physical count. 1,500
Income Summary 347,7
00
Expected Sales Discounts—Adjusting Entry - Both the
Dec Income Summary
periodic and perpetual methods make a period-end adjusting
31.
entry under the gross method to estimate the $50 sales
Sales Discount 4,300
discounts arising from current-period sales that are likely to
Sales Returns and Allowances 2,000
be taken in future periods.
Merchandise Inventory 230,4
 (beginning) 00
Purchases 3,700
Transportation-In 43,80
Depreciation Expense 0
Salaries Expense 600
Insurance Expense 9,000
Rent Expense 3,000
Note!
Supplies Expense 11,30
This $230,400 effect on Income Summary is the cost of
Advertising Expense 0
goods sold amount (which is equal to cost of goods sold
Dec Income Summary 12,90
reported in a perpetual inventory system). The periodic
31. 0
K. Marty, Capital 12,90 system transfers cost of goods sold to the Income Summary
0 account but without using a Cost of Goods Sold account.
Dec K. Marty, Capital 4,000 Also, the periodic system does not separately measure
31. shrinkage. Instead, it computes cost of goods available for
K. Marty, Withdrawals 4,000 sale, subtracts the cost of ending inventory, and defines the
difference as cost of goods sold, which includes shrinkage.
Periodic Inventory System
Dec Sales 321,0
31. 00 Net Method for Merchandising
Income Summary 321,0
The net method records an invoice at its net amount (net
00
of any cash discount). The gross method, covered earlier in
Dec Income Summary
the chapter, initially records an invoice at its gross (full)
31.
amount.
Sales Discount 4,300
Points to remember...
Sales Returns and Allowances 2,000
- When invoices are recorded at net amounts, any
Cost of Goods Sold 230,4
Depreciation Expense 00 cash discounts are deducted from the balance of the
Salaries Expense 3,700 Merchandise Inventory account when initially
Insurance Expense 43,80 recorded. This assumes that all cash discounts will
Rent Expense 0 be taken.
Supplies Expense 600 - If any discounts are later lost, they are recorded in a
Advertising Expense 9,000 Discounts Lost expense account reported on the
3,000 income statement.
11,30
0 Perpetual Inventory System
Dec Income Summary 12,90 Purchases - A company purchases merchandise on
31. 0 November 2 at a $500 invoice price ($490 net) with terms of
K. Marty, Capital 12,90 2/10, n∕30. Its November 2 entries under the gross and net
0 methods are
Dec K. Marty, Capital 4,000
31.
K. Marty, Withdrawals 4,000
By updating Merchandise Inventory and closing Purchases, If the invoice is paid on (or before) November 12 within the
Purchases Discounts, Purchases Returns and Allowances, discount period, it records
and Transportation-In, the periodic system transfers the cost
of sales amount to Income Summary.
If the invoice is paid after the discount period, it records

Sales - A company sells merchandise on November 2 at a

$500 invoice price ($490 net) with terms of 2∕10, n∕30. The
goods cost $200. Its November 2 entries are

If cash is received on (or before) November 12 within the

discount period, it records

If cash is received after the discount period, it records