TYPES OF BUSINESS

ACCORDING TO ACTIVITIES

PREPARED BY : PROF. JONAH C. PARDILLO

 LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 Compare and Contrast the types of business according to

activities;

 Identify the advantages, and disadvantages, and business

requirements of each type.
 Service Business
 This type of business provides various forms of services, not tangible products, to its
customers or clients. Some examples of entities that render services are:
professional, repair shops, banks, brokers, consultants, schools, hotels, insurance
companies, utility enterprises, and service contractors. A service enterprise
recognizes income in the form of fees, rents, interests, realties, retainers, or
commissions.
 Service Business
 The typical financial transactions recorded for a service company include
collecting a deposit from the customer, providing the service and receiving
payment. These activities may occur in the same accounting cycle or in several
cycles.
Receive Cash
Cash

Accounts
Receivable
 Merchandising Business

 This type of business entity is in the “buy and sell” business. A “trading” or
merchandising enterprise buys ready-to-use products, such as appliances,
vehicles, households items, toys, clothing apparels, supplies, ready-to-eat food. A
business enterprise that purchases ready-to-use materials from wholesalers or
manufacturers, and then sells the same to other processors or manufacturers,
without changing the form of the materials bought and sold, is also classified as a
merchandising enterprise.
 Merchandising Business

 Wholesaler buys large quantities of finished goods directly from the manufacturers
or importers, and then resells the same to the different merchandisers.

 Retailers or traders sell the goods directly to the end-customers. Examples: (SM,
Mercury Drugs, Uniwide, Rustan’s and supermarkets.
 Merchandising Operating Cycle

 The primary sources of revenues is referred to as sales revenue or

sales.
 The operating cycle of a merchandising company ordinarily is longer
than that of a service company
 Income Measurement of Merchandising Business
Not used in a service
business
Sales less
Revenue
Equals
Cost of Gross
Good sold Profit
less

Cost of goods sold is the total cost Operating Equals Net Income
Of Merchandise sold during the period. Expenses (Loss)
 Inventory systems
 Perpetual System

Features:

1. Purchases increase Merchandise Inventory.

2. Freight costs, Purchase Returns and Allowances and Purchase discounts are included in
Merchandise Inventory.

3. Costs of Goods Sold is increased and Merchandise Inventory is decreases for each sale.

4. Physical count done to verify Merchandise Inventory balance.

The perpetual inventory system provides a continuous record of Merchandise Inventory and
Cost of Goods Sold.
 Inventory systems
 Periodic system

Features:

1. Purchases of merchandise increase purchases.

2. Ending inventory determined by physical count.

3. Calculation of Cost of Goods Sold:

Beginning inventory

Add: Purchases, net

Goods available for sale

 Recording Purchases of Merchandise

 Made using cash or credit (on account)

 Normally recorded when goods are received.

 Purchase invoice should support each credit purchase.

 Recording Purchases of Merchandise
 Freight Costs

Terms

 FOB shipping point – seller places goods Free on Board the carrier, and buyer pays
freight costs.

 FOB destination – seller places the goods Free on Board to the buyer’s place of
business, and seller pays freight costs.

Freight costs incurred by the seller on outgoing merchandise are an operating

expense to the seller (Freight-out or Delivery Expense).
 Recording Purchases of Merchandise
 Purchase Returns and Allowances

 Purchaser may be dissatisfied because goods are damaged or defective, of inferior

quality, or do not meet specifications.

 Purchase Return

 Return goods for credit if the sale was made on credit, or for a cash refund if the
purchase was for cash.

 Purchase Allowance

 May choose to keep the merchandise if the seller will grant an allowance (deduction)
from the purchase price.
 Recording Purchases of Merchandise
 Purchase Discounts

 Purchase terms may permit buyer to claim a cash discount for prompt payment.

 Advantages:

 Purchaser saves money.

 Seller shortens the operating cycle.

 Example:

 Credit terms of 2/10, n/30, is read “two-ten, net thirty”. 2% cash discount if payment is
made within 10 days.
 Recording Purchases of Merchandise
 Purchase Discounts Terms

Credit term: 2/10, n/30

 2% discount of paid within 10 days, otherwise net amount due within 30 days.

Credit term: 1/10 EOM

 1% discount if paid within first 10 days of next month.

Credit term: n/10 EOM

 Net amount due within the first 10 days of the next month.
Computation of the Profit of service vs. merchandising
business
Service Business
Revenue from services rendered P xx
Less: Operating expenses xx
Profit of the period P xx

Merchandise Business
Revenue from goods sold P xx
Less: Cost of goods sold xx
Gross profit on sales P xx
Less: other operating expenses xx
Profit of the period P xx
 Gross Profit on sale equation
Derived Equation:

Sales – Cost of goods sold = Gross profit on sales

Sales – Gross profit on sales = Cost of goods sold

Sales – Cost of goods sold + Gross profit on sales

Gross profit on sales – other operating expenses = Profit

Gross profit on sales – Profit = Other operating expenses

Gross profit on sales = Other operating expenses + Profit

 Sample Computation of gross profit on sale
Compute for the missing amounts.

Case 1 Case 2 Case 3 Case 4

Sales Revenue 1,244,325 2,468,540 1,425,360 ?
Cost of goods sold 825,450 1,727,970 ? 875,890
Gross margin ? ? ? ?
Other operating expenses 245,330 ? 301,320 275,280
Profit during the period ? 210,335 132,550 125,200
 Check your Answers
Compute for the missing amounts.

Case 1 Case 2 Case 3 Case 4

Sales Revenue 1,244,325 2,468,540 1,425,360 1,276,370
Cost of goods sold 825,450 1,727,970 991,490 875,890
Gross margin 418,875 740,570 433,870 400,480
Other operating expenses 245,330 530,235 301,320 275,280
Profit during the period 173,545 210,335 132,550 125,200
 Cost of goods sold Equation
Cost of goods sold formula on periodic Inventory system:

Inventory that is
Inventory at the + Net purchases = available for sale
beginning of the during the during the reporting
reporting period reporting period period

Inventory that is Unsold portion, which is Sold portion, which

available for sale becomes,
Ending merchandise
- = cost of goods sold,
during the inventory, reported reported in the income
reporting period statement
in the balance sheet
 Sample Computation on cost of goods sold
Compute for the missing amounts.

Case 1 Case 2 Case 3 Case 4

Inventory, beginning 125,750 87,985 55,780 ?
Purchases 775,350 822,500 ? 695,220
Inventory available for sale ? ? ? ?
Inventory, ending 85,755 ? 45,230 91,245
Cost of goods sold ? 750,335 615,750 855,455
 Check your Answers
Compute for the missing amounts.

Case 1 Case 2 Case 3 Case 4

Inventory, beginning 125,750 87,985 55,780 251,480
Purchases 775,350 822,500 605,200 695,220
Inventory available for sale 901,100 910,485 660,980 946,700
Inventory, ending 85,755 160,150 45,230 91,245
Cost of goods sold 815,345 750,335 615,750 855,455
 Manufacturing Business
 Manufacturer also called fabricator, producer or processor

 Is in the normal business of producing the goods that he sells. He has factory
facilities where the finished goods are produced out of materials and supplies
by applying labor and other manufacturing costs.

 Manufacturing firms will purchase raw materials from suppliers and convert
them into finished products, such as Apple iPods, Levi Stauss jeans, and Ford
trucks and cars.
 Manufacturing Business
Manufacturer

Wholesaler
Selling Goods and
Services to Customers
Retailer

Consumer

Service
Company
 Manufacturing Business
 Manufacturing Costs
 Represents all the costs associated with producing or manufacturing a physical product.

 Direct materials: includes the major material inputs that can be directly and conveniently
traced to each unit of product(the cost object).

 Direct labor costs: refers to the “hands on” labor that can be directly conveniently traced
to the product, such as the wages of employees on the production of the product (pizza)
production line and in the packaging department.

 Manufacturing overhead: includes all manufacturing costs other than direct materials and
direct labor incurred to produce a physical product. It includes all of the indirect costs that
are incurred inside the manufacturing facility or factory that cannot be traced to each unit
of product, such as indirect materials, indirect labor, factory rent, factory insurance, and
factory utilities.
 Manufacturing Business
 Manufacturing Costs
 Represents all the costs associated with producing or manufacturing a physical product.

 Direct materials: includes the major material inputs that can be directly and conveniently
traced to each unit of product(the cost object).

 Direct labor costs: refers to the “hands on” labor that can be directly conveniently traced
to the product, such as the wages of employees on the production of the product (pizza)
production line and in the packaging department.

 Manufacturing overhead: includes all manufacturing costs other than direct materials and
direct labor incurred to produce a physical product. It includes all of the indirect costs that
are incurred inside the manufacturing facility or factory that cannot be traced to each unit
of product, such as indirect materials, indirect labor, factory rent, factory insurance, and
factory utilities.
 Manufacturing Business
 Prime costs: taken together, direct materials and direct labor. Direct labor and
direct materials are considered as “primary” costs of manufacturing product.

Formula:

Prime Cost = Direct materials + Direct labor

 Conversion costs: the costs incurred to convert direct materials into a finished
product. Direct labor and manufacturing overhead are referred to collectively as
conversion costs.

Formula:

Direct labor + Manufacturing overhead

 Non-Manufacturing Costs
 Non-manufacturing costs: are the costs associated with running the business and
selling the product as opposed to manufacturing the product. They are generally
classified into one of two groups:

 Marketing or selling expenses: are incurred to get the final product to the customer.

 General and administrative expenses: are associated with running the overall business.
They include general management salaries, rent and utilities for corporate
headquarters, and corporate service functions such as the accounting, payroll, and
legal departments.
Product and Period Cost Flows
 Manufacturing Cost Concepts

Financial Accounting Managerial Accounting

Cost is a measure of resources Product costs are the costs a
used or given up to achieve a company assigns to units
stated purpose. produced.
 Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product
 Classifications of Costs
Manufacturing costs are often
combined as follows:

Direct Direct Manufacturing

Materials Labor Overhead

Prime Conversion
Cost Cost
 Nonmanufacturing Costs
Marketing and selling costs . . .
– Costs necessary to get the order and deliver the product.
Administrative costs . . .
– All executive, organizational, and clerical costs.
 Product Costs Versus Period Costs
Product costs include direct Period costs are not included in
materials, direct labor, and product costs. They are expensed
manufacturing overhead. on the income statement.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
– Cash  Cash
– Receivables  Receivables
– Prepaid Expenses  Prepaid Expenses
– Merchandise Inventory  Inventories
Raw Materials
Work in Process
Finished Goods
 Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
– Cash  Cash
– Receivables  Receivables
Materials waiting to be
– Prepaid Expenses processed.
 Prepaid Expenses
– Merchandise
Partially Inventory
complete products –  Inventories
some material, labor, or overhead Raw Materials
has been added. Work in Process
Finished Goods

Completed products awaiting

sale.
 The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods
sold for merchandisers.

Merchandising Company Manufacturing Company

Cost of goods sold:

Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $236,250
 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials
 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead
 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold
 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
 Inventory Flows
Beginning
Additions Available
balance + $$$ = $$$$$
$$
_
Withdrawals
$$$

=
Ending
balance
$$
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw
materials inventory

Beginning inventory is the

inventory carried over from the
prior period.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw materials inventory and
in production placed into the production process, they are
called direct materials.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process
Conversion costs are
Beginning raw Direct materials costs incurred to convert
materials inventory + Direct labor
+ Raw materials + Mfg. overhead the direct material into a
purchased = Total manufacturing finished product.
= Raw materials costs
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory All manufacturing costs incurred during the period
process are
inventory
= Raw materials used added to the beginning balance of work
= Cost in process.
of goods
in production manufactured.
 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
Costs associated
inventory with the goods that are completed during process inventory
= Raw materials used = Cost of goods
the period are transferred to finished goods inventory.
in production manufactured.
 Product Costs - A Closer Look
Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold
Cost Classifications for Predicting Cost Behavior

How a cost will react to changes in

the level of business activity.
– Total variable costs change when
activity changes.
– Total fixed costs remain unchanged
when activity changes.
 Total Variable Cost
Your total long distance telephone bill is based on how many
minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
 Variable Cost Per Unit
The cost per long distance minute talked is constant. For example,
10 cents per minute.

Telephone Charge
Per Minute
Minutes Talked
 Total Fixed Cost
Your monthly basic telephone bill probably does not change
when you make more local calls.
Monthly Basic
Telephone Bill

Number of Local Calls

 Fixed Cost Per Unit
The average cost per local call decreases as more local calls are
made.

Monthly Basic Telephone Bill

per Local Call
Number of Local Calls
Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
 Direct Costs and Indirect Costs
Direct costs Indirect costs
• Costs that can be • Costs cannot be easily and
easily and conveniently traced to a conveniently traced to a unit of
unit of product or other cost product or other cost object.
objective. • Example: manufacturing overhead
• Examples: direct material and direct
labor
 Differential Costs and Revenues
Costs and revenues that differ among alternatives.

Example: You have a job paying $1,500 per month in your hometown. You have a
job offer in a neighboring city that pays $2,000 per month. The commuting cost to
the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500
 Differential Costs and Revenues
Costs and revenues that differ among alternatives.

Example: You have a job paying $1,500 per month in your hometown. You have a
job offer in a neighboring city that pays $2,000 per month. The commuting cost to
the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500
Differential cost is:
$300
 Opportunity Costs
The potential benefit that is given up
when one alternative is selected over
another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for one year is
$15,000.
 Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential
costs and should be ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years ago.
The $10,000 cost is sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.
Types of Definition Input Output Advantages Disadvantages Examples
Business
According to
Activities
Service Firms that Labor Intangible • Absence of • Inability to Accounting
generally inventory standardize and law
use their • No services firms,
employees production hospitals,
to provide facilities schools,
services to salons
customers
Merchandisi Firms that Goods or Tangible; • Visible Managing Supermarket
ng buy finished merchan merchand products inventory s
or almost dise ise • Less convenienc
finished bought conversion, e stores,
goods from from time, and book stores,
their suppliers effort department
suppliers stores
and resell
the same to
customers
Types of Definition Input Output Advantages Disadvantages Examples
Business
According to
Activities
Manufacturing Firms that Raw Tangible; • Quality control • Generally Car
create their materials, manufacture • Visible need companies,
own products labor, d products products production consumer
overhead facilities products,
• High electronics
conversion companies,
costs energy
• Cost of manufacturers
Quality
control
• Managing
inventory
 THE END

References:

Kimwell, M.B., “Fundamentals of Accounting”

Manuel, Z.C “Accounting Process, Basic Concepts and Procedures, Int’l Ed.”
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