FAR Notes (Finals) Sales

© Gwyneth P. Malaga - Sales Returns and Allowances

- Sales Discounts
Merchandising Business Net Sales

Definition - Cost of Goods Sold

Gross Profit
• Engaged in “buy and sell” activities
- Operating Expenses
• Buys products from manufacturers and
sells it at higher prices Operating Income
+ Other Income
Owner of the business
- Other Expenses
• May be a wholesaler or retailer - Interest Expense
Wholesaler Retailer Net Income Before Tax
- Income Tax Expense
Buys directly from Buys from
manufacturers wholesalers Net Income After Tax

Sells to retailers Sells to end-

customers Sales

• Account used to record sales made by

the firm
Sales • recorded when earned
Less: Sales returns and Allowances • earned when the goods are delivered
Sales Discount from the seller to the buyer
Net Sales • May be sales on cash or sales on
Less: Cost of Sales account
Beginning Merchandise Inventory
Add: Net Purchases Example 1:
Gross Purchases xx
On December 1, 2019, EGR Co sold P100,000
Add: Freight-in xx
worth of merchandise for cash. The entry will
Balance xx
be:
Less: Purch rets and Allows xx
Purchase Disct xx xx Cash 100,000
Net Purchases
Total Goods Available for Sale Sales 100,000
Less: Ending Merchandise Inventory
Cost of Sale
Gross Profit Example 2:
Less: Operating Expenses
General and Administrative On December 15, 2019, EGR Co sold goods to
Selling Mr. GJ for P100,000 on account, terms: 2/10,
n/30. The entry will be:
Net Income
Account receivable 100,000
Merchandising Business Income Statement Sales 100,000
From Book of JCD (Bentahan) Assuming the goods were sold to Mr GJ. In
installment, Down payment ofP20,000, then the
Purchases
entry will be:
+ Freight- in
Gross Purchases Account receivable 100,000

- Purchase Returns and Allowances Sales 100,000

- Purchase Discounts
Cash 20,000
Net Purchases
+ Beginning Inventory Account receivable 20,000

Cost of Goods Available for Sale

- Ending Inventory
Cost of Goods Sold
 2/10 kapag nagbayad within 10 days, Discount period
may 10% discount
• period during which the
n/30 wala nang discount pero kailangan customer can avail the discount
magbayad within 10 days o 10 days in the example

If the customer does not pay within

Sales Returns and Allowances
• Account used when customers return
merchandise that have been previously
recorded in the Sales account 2/10.
• Normal balance is debit EOM,
• evidenced by the issuance of a credit N/60
memorandum by the seller
10 days, he/she must pay the full
price within 30 days from the date
of sale
if the customer pays by the tenth of
the month following the month of
sale a two percent discount is
provided.

Example: EOM

On December 18, 2019, Mr. GJ, a • means end of month

customer, returned defective o example: date of sale is
merchandise with a selling price of P20,000. 6/10. July 1-10 will be the
The entry to record the return will be: discount period

Sales returns and allowances 20,000 Beyond this period, the full amount
must be paid (within 60 days from
Accounts Receivable 20,000 the date of sale)

Bakit hindi pwede idebit na lang ang Sales?

When the seller elects not to offer a cash
Dahil dalawa ang contra-sales account discount for prompt payment,

• Sales Returns and Allowances Credit terms

• Sales Discounts
• will specify only the maximum time
Sales period for paying the balance due
• for example, n/30 or n/60
• Magiging net value na lang kung pati
account na ito ang idedebit n/30 purchase price must be paid by the
customer within 30 days from date
Cash Refund of sale
• Made for a sales return or allowance on n/60 purchase price must be paid by the
a cash sale customer within 60 days from date
of sale
Transaction

• recorded by debiting sales returns and

allowances and crediting cash

Accounting for Sales Discounts

Sales Discount Sales Discount
• Cash discount included in the terms of a • Account debited when cash discounts
credit sale are taken by the customers
• Given to encourage customers to pay
their accounts promptly Normal Balance
• Term used to call the amount of the
reduction • Debit

Common Examples Sales Discount and Sales Returns and

Allowances
2/10, two percent may be deducted
n/30 from the amount due • Deducted from Sales account to arrive
at net sales to be presented in the
if the customer pays within 10 days Income Statement
from the date of sale
Example: Example:

On December 22, 2019, ERG Co received full Visual Co. sold to Ciudad Company
payment from Mr. GJ related to the sale made merchandise with a list price of P52,000 (before
in December 15, 2019. The amount received is
VAT) and with trade discounts of 20% and 10%.
computed as follows:
The sales price will be computed as follows:
Sales-December 15, 80,000
List price P52,000.00
Less: Returns on Dec. 18 20,000
Less: First discount (20% x
10,400.00
Amount due before the discount 60,000 P52,000)
Balance after discount P41,600.00
Less: 2% discount (P60,000x 2%) 1,200
Less: Second discount (10% x
4,160.00
Net of discount 58,800 P41,600)
Net sales price P37,440.00

Journal Entry to record the return

Shortcut:
Cash 58,800
• 52,000(0.80)(0.90) = 37,440
Sales Discount 1,200
Journal Entry:
A/R 60,000
A/R or Cash 37,440

Trade Discounts Sales 37,440

List Price Remember!

• Also called catalog price Cash Discount Trade Discount
• not the item’s intended selling price
Recorded Not recorded
Intended selling price

• List price minus a given percent called a

trade discount

Trade Discounts Financial Statement Presentation

• used to reduce the list price to actual As contra-revenue accounts,

sales price
Sales returns and allowances and sales
• smay be due to the volume of
discounts
transaction
• are deducted from sales in the income
statement to arrive at net sales

An example of the sales revenue section of

the income statement (based on assumed
data) is as follows:
Accounting for Trade Discounts
Sales P180,000
Trade Discounts Less: Sales Return and
Allowances P 20,000
• not recorded, either in the books of the Sales Discounts 1,200 11,200
NET SALES P158,800
seller or the books of the buyer

When a sale or purchase is made,

Amount recorded
• is always the net of the trade discount
Cost of Goods Sold

• the total cost of merchandise sold 1) record purchases

during the period of merchandise
• This expense is directly related to the
revenue recognized from sale of the 2) determine the cost
goods of goods purchased

3) determine the cost

Simpler Formula of COGS of goods on hand at
the beginning and
Beginning Inventory
end of the period
Additional Purchases
- Ending inventory Has separate journal
entry to record
COGS
decrease in inventory
balance
Gross Profit

• Sales Revenue minus cost of goods sold

• also called gross profit (or gross margin) Mechanics of A traditional periodic inventory
on sales system operates as follows:

Merchandise Inventory a. When goods for resale are purchased,

Purchases account
• includes the goods purchased for the
• is debited at the amount of acquisition
principal purpose of selling them in the
cost
ordinary course of business operations
b. Upon making a sale,
Merchandiser
Income
• keeps its inventory in stock before
making a sale to a customer • recognized by crediting sales, based
on the selling price of the goods

Cost of goods Sold Vs. Merchandise Inventory c. No separate entry is prepared to record the
decrease in the inventory balance as a result
Cost of goods sold Merchandise Inventory
of sale
expense (sold) asset (unsold) portion of
Inventory ledger balance
portion of goods held goods held for sale
for sale • need not be updated as the buying
and selling transactions occur

Inventory Systems Used For Merchandising

Transactions Periodic Inventory System

1. Periodic Inventory System • requires updating the inventory

2. Perpetual Inventory System account only at the end of the period
to reflect the quantity and cost of
Periodic Perpetual
goods both available and sold
When cost of goods is maintains detailed
Cost of merchandise
determined only at records of the cost of
the end of an each inventory item • recorded in a temporary Purchases
accounting period account

To determine the cost continuously show the When a company sells merchandise,
of goods sold, it is inventory that should
• it records revenue but not the cost of
necessary to be on hand
the merchandise sold
The cost of merchandise available Accounting for Purchases

• computed by relating the quantities Cash purchases

counted to the purchase records that
show each item’s original cost
• will then be used to compute cost of
goods sold
For credit purchases,
Inventory account
• then adjusted to reflect the amount
computed from the physical count of
inventory
• recorded by a debit to Purchases and a
credit to Cash
• each transaction should be supported
by a purchase invoice indicating the
total purchase price and other relevant
information (such as discounts offered)

The purchaser

Accounting for Purchases and Related
Accounts
Purchases
• account debited for the cost of the
goods bought for resale
• may be made for cash or on account
(credit
• has a normal balance of debit
• does not prepare a separate purchase
invoice
• the copy of the sales invoice sent by the
seller becomes a purchase invoice to
the buyer
12% Value Added Tax (input tax)
• normally incorporated in the price and
entries

Classified as: Example:

Cost of Goods Sold Merchandising inventory On December 6, 2019, ERG CO. purchased
goods from RR Co. for P160,000 terms: 2/10,
upon sale If unsold n/30. Input Tax is 12% of the purchase price.

Journal entry:

o Purchases account at the end of the Purchase 160,000

fiscal period appears in the Income
Accounts Payable 160,000
statement Purchase
• normally recorded by the purchaser
when the goods are received from the If cash purchase, journal entry is:
seller
Purchases 160,000
Every purchase
Cash 160,000
• should be supported by business
document that provide written
And if only P20,000 was paid as down payment
evidence of the transaction
the entry will be:
Each cash purchase
Purchases 160,000
• should be supported by a cancelled Cash 20,000
check or cash register receipt indicating
the items purchased A/P 140,000

Purchase Returns and Allowances

• Returns made and recorded by the
buyer

Sales return or sales Purchase return or

allowance on the = allowance on the
seller’s books purchaser’s books
Possible reasons for returns Accounting for Purchase Discounts

1. Defective products Purchase Discount

2. Damaged due to shipment
• Account used to record the amount
3. Wrong set of products delivered
saved by paying promptly
Purchase Allowance • contra account having a normal credit
balance
• happens when the company is still
willing to accept the said goods, but Similar to purchase returns and allowances,
with a reduction in price
• it is a deduction from the purchases
account
• closed to Income Summary account at
Accounting for Purchase Returns and the end of the period
Allowances
Alternative Methods of accounting for
The purchaser purchase discounts:
1. Gross Price Method
• initiates the request for a reduction of 2. Net Price Method
the balance due through the issuance 3. Allowance Method
of a debit memorandum

Debit memorandum Gross Price Method

• a document the purchaser issues to Under this method,

inform the supplier of a debit made to
the supplier’s account, including the Purchases and Accounts Payable
reason for the return or allowance
• recorded at gross
Purchase Returns and Allowances
Purchase discounts
• Recorded by debiting accounts
• recorded only when taken
payable and crediting purchase returns
and allowances Example: (Gross Method)

Example: On December 6, 2019, ERG purchased

goods from RR Co. for P160,000 terms: 2/10,
On December 8, 2019, ERG Co. returned to RR
n/30. The journal entry is:
Co. P10,000 worth of defective goods.
Purchases 160,000
Journal Entry
A/P 160,000
A/P 10,000

Purchase R/A 10,000

On December 8, 2019, ERG Co. returned to RR
Co. P10,000 worth of defective goods.
Purchase Discounts
Journal Entry
• Based on the invoice cost less returns
A/P 10,000
and allowances, (if any)
Purchase R/A 10,000
Payment made within the discount period Allowance Method

If payment was made to RR Co. within the Purchases

discount period (for example, if payment was
made on December 15, 2019), the 2% discount • recorded at net
shall be deducted from the amount due to Accounts payable
National Co., as follows:
• Recorded at gross (Purchase discounts
Purchases-December 6 160,000 are recorded when taken)
Less: December 8 returns (10,000)
Allowance method
Amount Due 150,000
Less: 2% discount (3000) • like a combination of the two previous
methods
Net Purchases 147,000
Sales Discount Sales Discount Forfeited

Journal Entry Hindi na makikita Irerecord ng seller kung

kung nakaavail ng hindi maaavail ng
A/P 150,000 discount ang buyer buyer ang discount
Purchase Discount 3,000

Cash 147,000 On December 6, 2019, ERG purchased

goods from RR Co. for P160,000 terms: 2/10,
n/30. If the 2% discount is given, the journal
Payment made outside the Discount Period entry is:

If payment was made outside the discount Journal Entry

period, the full price of purchased goods
(excluding returns) and input tax thereon shall Purchases 147,000
be paid. A/P 147,000
Purchases-December 6, 160,000
Less: December 8 returns (10,000)
For basic accounting purposes, only the Net
(before input tax)
Price Method shall be illustrated in the next
Amount Due (before 150,000 page. The Allowance method is covered in
input tax) intermediate accounting courses.

Journal Entry
Shipping Charges on Merchandise Purchased
Accounts Payable 150,000 or Sold
Cash 150,000
Buyer and Seller must agree on

1. who is responsible for paying any freight

Net Price and Allowance Methods
Net Price Method
Purchases and Accounts Payable
costs
2. who bears the risk of loss during transit for
merchandising transactions

• recorded at net of the discounts offered o To know what point ownership transfers
from the seller to the buyer
Purchase discounts lost account
Point of Transfer of Ownership
• used to record purchase discounts
which have been forfeited • sometimes called the point of passage
• presented either as part of operating of title
expenses or as part of finance cost
(interest expense)
Point when ownership transfers from the seller FOB destination
to the buyer
Seller Buyer/ Purchaser
• determines who pays transportation has agreed to pay all receives title to the
costs (and other incidental costs of the shipping costs goods at point of
transit such as insurance) destination
• can be derived from the freight terms
Record of Shipping
agreed between the seller and the
Charges
buyer
Debited to Freight-
Out or Transpo Out

Considered as selling
Freight terms: FOB Shipping Point and FOB
expense listed
Destination
among the OPEX in
Cost of Shipping the Merchandise the Income stateme.

• May be shouldered by the buyer or

seller Since the seller still has title to the goods while
• depending upon the arrangements the same are in transit,
made prior to the purchase or sale of
Shipping cost
the merchandise
• properly an expense of the seller
Remember!
Example:
Freight-out Freight-In
Selling expense ng Adjunct account On January 3, 2019, goods with a selling price
seller of P30,000 are purchased by Manila Co. from
Cebu Trading, a company in Cebu City. Terms
Idinadagdag sa
are 2/10, n/30, FOB Manila. Amount of freight
purchases
cost is P1,600.

Shipping Arrangements Journal Entries

• FOB destination FOB Destination, Freight Prepaid
• FOB shipping point

FOB destination FOB shipping point Manila Company Books

Seller shoulders costs Buyer shoulders costs (buyer)
Ownership is until Ownership is from the Purchases 30,000
transit only time goods are Accounts payable 30,000
shipped
Pag nasa byahe, si Pag nasa byahe na, No journal entry for the freight cost.
seller pa ang may- si buyer na ang may-
ari. ari hanggang sa Bicol Company Books
makarating sa (seller)
destination A/R 30,000
Pag dumating na sa
Sales 30,000
destination, si buyer
na ang may-ari
Freight out 1,600
Cash 1,600

The entries assumed that the seller paid the

shipping company (FOB destination, freight
prepaid)
 FOB destination, FOB destination, freight FOB Shipping Point
freight prepaid collect
Buyer/ Purchaser
Freight cost Freight cost
• has agreed to shoulder all the shipping
chargeable to the chargeable to the
costs
seller who pays the seller
• receives title to goods at shipping point
shipping company but the buyer has to
pay the shipping
company upon receipt Shipping charges with terms FOB shipping point
of the goods
• additional costs of the purchased goods
• debited to an account called
Transportation In or “Freight In” in the
Journal Entry for FOB destination, freight collect
books of the buyer,
• shown in the Income Statement as an
Manila Company Books
addition to the cost of merchandise
(buyer)
purchased
Purchases 30,000
Accounts payable 30,000 Example:
Accounts payable 1,600 Assume that on January 4, 2019, Atlas Co.
Cash 1,600
located in Manila purchased goods with a
selling price of P40,000 from Davao Co. Freight
Bicol Company Books cost was P3,000.
(seller)
A/R 30,000 Assume that the terms are 2/10, n/30, FOB
Sales 30,000 shipping point, freight collect. The entries to
record the transactions are as follows:
Freight out 1,600
A/R 1,600
Atlas Company Books
(buyer)
Assuming payment is made on January 9, Purchases 40,000
entries will be: Accounts payable 40,000
Freight-In 3,000
Manila Company Books Cash 3,000
(buyer)
Accounts payable 28,400 Davao Company Books
Purchase Discount 600 (buyer)
Accounts Receivable 40,000
Cash 27,800
Sales 40,000
No entry for the freight cost

Bicol Company Books If the terms are FOB shipping point, freight
(seller) prepaid,
Cash 27,800
• all the shipping cost is for the account of
Sales Discount 600
the buyer
Accounts Receivable 28 400 • but the seller advanced the payment to
the shipping company

Journal Entries:

Atlas Company Books

(buyer)
Purchases 40,000
Accounts payable 40,000
Freight-In 3,000
Accounts payable 3,000
 Davao Company Books FOB Shipping Point, Freight collect
(seller)
Who has Who pays the
Accounts Receivable 40,000 responsibility shipping comp
Sales 40,000
Buyer
Accounts Receivable 3,000
Cash 3,000 Seller
Note: Si seller ang nagbabayad muna then
The payment made by the seller to the pagkatanggap ng goods si buyer na ang
shipping Co. will be charged to the account of magbabayad
Atlas Co. hence the debit to Account
Receivable in the books of the Davao Co.
FOB Shipping Point, Freight prepaid
Assume that the payment is made on January Who has Who pays the
9, within the discount period: responsibility shipping comp
Atlas Company Books Buyer
(buyer) Seller
Accounts Payable 43,000
Note: Si seller ang nagbabayad muna then
Cash 42,200 pagkatanggap ng goods si buyer na ang
magbabayad
Purchase Discount 800

Davao Company Books

Determining the Cost of Goods Purchased
(seller)
Cash 42,200 Remember:

Sales Discount 800 Account Normal Balance

Purchases Debit
Accounts Receivable 43,000 Purchase returns &
allowances Credit
Purchase discounts Credit
Freight in Debit
Notes:

FOB Destination, Freight prepaid The procedure for determining the cost of
Who has Who pays goods purchased is as follows:
responsibility
1. Get Net Purchases
Buyer
Seller Purchases

(Purchase Discounts)

FOB Destination, Freight collect (Purchase Returns and Allowances)

Who has Who pays the
Net Purchases
responsibility shipping comp
Buyer
Seller 2. Get Cost of Goods Purchased
Note: Si seller ang nagbabayad muna then
Net Purchases
pagkatanggap ng goods si buyer na ang
magbabayad Freight-In

Cost of goods purchased

Example: All increases and decreases related to
merchandise
XYZ Co. shows the following balance for the
above accounts: Purchases P350,000; • are recorded directly in the
Purchase Return and Allow. P10,000; Purchase Merchandise Inventory account under
Discounts P6,000; and Freight In P 5,000.
the Perpetual Inventory System
Purchases 350,000 Therefore,
Less; Purchase R/A 10,000
Less. Purchase Discounts 1,600 These accounts are NOT used:
Net Purchases 338,400
Add. Freight-In 5,000 1. Purchases
Cost of Goods Purchased 343,400 2. Purchase return and allowances
3. Purchase discounts
4. Freight-In
Mechanics of the Perpetual Inventory System

Under the perpetual inventory system,

Records

• are kept of the quantity and cost of

each item as it is bought, held in
inventory and sold

Because of the detailed information available

under this system,

Management is able to:

• respond to inquiries of salespersons and

customers about merchandise
availability,
• maintain optimum inventory levels
• avoid running out of stock

Under the Perpetual system,

a. Cost of each item

• debited to the Merchandise Inventory

account upon purchase

b. At the time of sale, the cost of each item

• is transferred from the Merchandise

Inventory account to the Cost of Goods
Sold account
• By debiting cost of goods sold and
crediting merchandise inventory

Therefore, at all times

Cost of Goods = Cost of Merchandise

Sold Sold
Merchandise = Cost of Merchandise
Inventory on Hand
 Comparison of Entries Between Periodic And Perpetual Inventory System

1. Purchased merchandise worth P80,000, terms 2/10, n/30, FOB shipping point.
Periodic System Perpetual System

Purchases 80,000.00 Mdse. Invty 80,000.00

Accounts payable 80,000.00 Accounts payable 80,000.00

2. Paid the shipping company (FOB shipping point, collect) P2,000.

Periodic System Perpetual System
Freight-in 2,000.00 Mdse. Invty 2,000.00
Cash 2,000.00 Cash 2,000.00

3. Returned defective Merchandise with price of 12,000.

Periodic System Perpetual System

Accounts payable 12,000.00 Accounts payable 12,000.00

Purch Ret. & Allow 12,000.00 Mdse. Invty 12,000.000

4. Paid Merchandise purchased in No. 1 less discount.

Periodic System Perpetual System

Accounts payable 68,000.00 Accounts payable 68,000.00

Purch Discounts 1,360.00 Mdse. Invty 1,360.00
Cash 66,640.00 Cash 66,640.00

5. Sold merchandise costing P20,000 for P24,000, terms: 2/10, n/30.

Periodic System Perpetual System

Accounts receivable 24,000.00 Accounts receivable 24,000.00

Sales 24,000.00 Sales 24,000.00
No entry to record the cost of Cost of Goods Sold 20,000
goods sold at the time of sale Mdse. Invty 20,000

Note: Under the periodic system, an adjusting entry at the end of the accounting period is made to
record the costs of goods sold after a physical count of unsold merchandise.

6. Merchandise costing P2,000 and sold at P2,400 is returned by the customer.

Periodic System Perpetual System

Sales R/A 2,400.00 Sales R/A 2,400.00

Accounts Receivable 2,400.00 Accounts Receivable 2,400.00
No entry to record the cost of goods returned Mdse. Invty 2,000.00
(by customers) at the time of sale Cost of Goods Sold 2,000.00

Reference/ Source: Beticon, J., Hinayon, M., and Ireneo, S. (2017). Fundamentals of Accounting.
Manila: FCA Publishing.
Setting Up Ending Inventory Computing Cost of Goods Sold

Under the periodic inventory system, Assume the following account balances taken
from the unadjusted Trial Balance of Be-Cool
Purchases Computations Company on December 31,
• is debited whenever goods are 2020:
purchased Selected Trial Debit Credit
Accounts pertaining to cost of goods Balance Accts
purchased are as follows: Merch. Inventory 80,000
(Jan 1, beg. balance)
1. Purchases (Debit)
Purchases 1,280,000
2. Purchase returns and allowances
(Credit) Freight-In 10,000
3. Purchase discounts (Credit) Purchase R/A 64,000
4. Freight-in (Debit) Purchase Discounts 46,000

The cost of inventory on hand

A physical inventory count was conducted at
• determined by having a physical count December 31, 2020 and showed a balance of
of inventory P160,000. The cost of goods sold can now be
computed as follows:
Physical counts
Merch. Inventory, 80,000
• Done at the end of the period
Jan 1,2020
Taking a physical inventory count involves: Add: Net Purchases 1,280,000
1. Counting the units on hand for each 10,0000
item on inventory (64,000)
2. Applying unit costs to the total units on
(46,000) 1,180,000
hand for each item of inventory
Cost of Goods Available 1,260,000
3. Segregating the costs of each item of
for Sale
inventory to determine the total cost of
goods on hand Less: Merch. Inventory, 160,000
Dec 31
The account Merchandise Inventory Cost of Goods Sold 1,100,000
• used to record the cost of inventory
on hand (ending inventory) at the
reporting date
• This amount becomes the beginning Adjusting Journal Entries
inventory for the next accounting
period Based on the above computation, the
following adjustments shall be made:

1. Removing the beginning inventory figure of

P80,000 After this entry, the Merchandise
Inventory account has a zero balance.

Cost of Goods Sold 80,000

Merch. Inventory 80,000

2. Closing the Purchases account and

purchases-related accounts (freight-in,
purchase discounts, purchase returns and
allowances).
 Cost of Goods Sold 1,180,000 Computing Gross Profit
Purch R/A 64,000
Using the cost data from the previous
Purch Discounts 46,000 illustration, additional information are as
Purchases 1,280,000 follows:
Freight-In 10,000 Sales, P2,000,000; Sales returns and allowances,
P30,000; and Sales Discount, P20,000.
3. Setting up the (inventory, end) Ending
Inventory figure. Gross profit is computed as follows:

Merch. Inventory 160,000 Sales 2,000,000

Cost of Goods Sold 160,000 Less: Sales R/A 30,000

Sales Discounts 20,000 50,000

Cost of Goods Sold Net Sales 1,950,000

80,000 160,000
Less: Cost of Goods Sold 1,100,000
1,180,000
1,100,000 GROSS PROFIT 850,000

Merchandise Inventory Preparation of the Worksheet

80,000 80,000
The process of preparing a worksheet of a
1,160,000 merchandising business

• same as that of a service business

Merchandise Inventory,end of 160,000
• Shown on the statement of financial
position
• as a current asset
• except that it has to deal with the
additional accounts peculiar to a
trading business
New accounts include

Cost of Goods Sold of P1,100,000 1. Sales

2. sales returns & allowances
• shown on the statement of 3. sales discount
comprehensive income 4. purchases
• as a deduction from Sale 5. purchase returns & allowances
6. purchase discount
Cost of goods sold method
7. freight-in
• method of adjusting merchandise 8. freight-out
inventory used in the given 9. Merchandise inventory

Methods of preparing a worksheet for a

merchandising or trading business

• cost of goods sold method

• direct extension method
Filling up the Worksheet of a Merchandising CGS Method DE Method
Business
also known as the No adjusting entry to
1. Unadjusted trial balance colmns adjusting entry method set up Cost of
or the expense Goods Sold
Data for the unadjusted trial balance method

• obtained from the unadjusted ledger because the adjusting Only the other year-
balances of the company entry summarizes all end adjustments are
the costs involved in entered in the
Note! the buying aspect of Adjustments
Amount shown for Merchandise Inventory the business columns
into one account
• is the beginning inventory
called “Cost of goods
• because the adjusting journal entries for
sold”
inventory accounts have not yet been
made

CGS Method DE Method 3. Adjusted Trial Balance Columns

Transfer the unadjusted
ledger balances to the
trial balance columns of
the worksheet
The same as the The adjusted trial balance
CGS Method
• shows the balance of all accounts after
adjustments at the end of the
accounting period

CGS Method DE Method

2. Adjustments columns Merchandise Inventory Because no adjusting
entry is made to set
Merchandising business no longer contains the
up Cost of Goods
beginning balance (as
• generally has the same types of a result of the adjustment
Sold,
adjustments as a service business to set up COGS) 1. There is no Cost of
• except for the adjustments relating to Goods Sold Account
merchandise inventory
Beg. Balance = 0 2. The Merchandise
Adjusting Entries needed Inventory account
already has the
still contains the
1. Usual year-end adjustments ending balance per
beginning balance
2. An entry to set up the total cost of physical count
goods sold (COGS) 3. The Purchases and
The purchases and
purchases-related
purchases-related
The pro-forma compound entry is as follows: accounts are still
accounts (purchase
open
Cost of Goods Sold xxxx discounts, R/A , freight-
Merch. Inventory xxxx in) have been closed

(for the ending figure) Only two remain open

after the adjusting
Purchase R/A xxxx
entry:
Purchase Discounts xxxx
1. Merch. Inventory, end
Merch. Inventory xxxx
2. Cost of Goods Sold
(for the beg. figure)
Purchases xxxx
Freight-In xxxx
4. Income Statement and Balance Sheet Credit to the income statement
Columns columns

Accounts and balances that affect the • makes it possible to deduct

ending inventory from the cost
income statement and balance sheet
of goods available for sale
• are transferred from the adjusted trial • to compute cost of goods sold
balance columns to the income Debit to the balance sheet
statement columns and the balance columns
sheet columns
means that the ending inventory
CGS Method can be reported as a current
asset on the statement of
Cost of Goods Sold Merchandise financial position
account Inventory

contains a debit account also

balance contains a debit
Comprehensive Example: Triple M Trading
balance
Company
extended to the extended to the
debit side of the debit side of the The two methods are illustrated using the trial
Income Statement Balance Sheet balance of Triple “M” Trading Co. shown in the
columns columns next page, and the adjusting information
obtained from various documents, including
the results of a physical count of inventory on
DE Method December 31, 2020:

Purchases and All of the balances of

related accounts are still open
The trial balance of Triple “M” Trading
Purchases and extended on the debit
Company is presented in the next page:
Freight-in side of the Income
Statement columns

Contra purchase extended to the credit

accounts like side of the Income
Purchase return Statement columns
and Purchase
Discounts
Merchandise extended from the
Inventory, beg adjusted trial balance to
balance the debit side of the
income statement

From this location

it can be used to
compute the cost of
goods available for sale
in the income statement

Merchandise has not been set up no

Inventory, end adjusting entry was
balance made
written on the credit side
of the income statement
extended to the
balance sheet debit
column
 Trial Balance
December 31, 2020

Debit Credit
Cash 169,400
Petty cash fund 10,000
Accounts receivable 139,300
Notes receivable 69,360
Merchandise inventory 246,840
Supplies inventory 16,800
Prepaid insurance 24,000
Land 1,870,000
Building 1,640,000
Accum. depreciation – Building 340,800
Equipment 167,800
Accum. depreciation – Equipment 33,560
Accounts payable 133,400
Notes payable 100,000
J. Cancio, capital 3,457,280
J. Cancio, drawing 65,600
Sales 1,964,200
Sales discount 19,200
Sales returns and allowances 16,200
Purchases 1,371,400
Purchase discount 13,920
Purchase returns and allowances 9,520
Freight-in 11,280
Sales salaries 73,800
Advertising expense 20,980
Miscellaneous selling expense 11,100
Office salaries 39,000
Light and water expense 37,360
Taxes and licenses 13,780
Miscellaneous general expense 19,480
TOTAL 6,052,680 6,052,680
Adjusting Information:

a. A physical count of the unsold goods on December 31, 2020 revealed that inventory of P179,600 is
still on hand.

CGS Method Direct Extension Method

Cost of goods sold 1,426,480

Merch Invty, 12/31 179,600
Purch ret & allow 9,520 -no AJE to set-up CGS-
Purchase discount 13,920
Merch Invty, 1/1 246,840
Purchases 1,371,400
Freight-in 11,280

b. The prepaid insurance on the company’s building and its contents is for a period of one year
starting May 1, 2020.

CGS Method Direct Extension Method

Insurance Expense 16,000 Insurance Expense 16,000

Prepaid Insurance 16,000 Prepaid Insurance 16,000

c. Supplies used during the year amounted to P15,200.

CGS Method Direct Extension Method

Supplies Expense 15,200 Supplies Expense 15,200

Supplies inventory 15,200 Supplies inventory 15,200

d. As of December 31, 2020, the unused portion of the advertising paid during the year is P5,300.

CGS Method Direct Extension Method

Prepaid Advertising 5,300 Prepaid Advertising 5,300

Advertising Expense 5,300 Advertising Expense 5,300

e. Unpaid salaries of December 31, 2020 are:

Sales salaries 3,600

Office Salaries 1,960

CGS Method Direct Extension Method

Sales Salaries 3,600 Sales Salaries 3,600

Office Salaries 1,960 Office Salaries 1,960
Salaries Payable 5,560 Salaries Payable 5,560
f. The notes payable is a 6%, 60-day promissory note issued to LBP dated December 1, 2020.

CGS Method Direct Extension Method

Interest Expense 500 Interest Expense 500

Interest payable 500 Interest payable 500

g. Accrued interest on notes receivable as of December 31, 2020 is P1,720.

CGS Method Direct Extension Method

Interest Receivable 1,720 Interest Receivable 1,720

Interest Income 1,720 Interest Income 1,720

h. Depreciation rates are:

Building 5%

Equipment 10%

CGS Method Direct Extension Method

Dep. Exp- Building 82,000 Dep. Exp- Building 82,000

Dep. Exp- Equipment 16,780 Dep. Exp- Equipment 16,780
Accum. Dep - Bldg 82,000 Accum. Dep - Bldg 82,000
Accum. Dep - Eqpt 16,780 Accum. Dep - Eqpt 16,780

i. The estimated bad debts expense for the year is P9,644

CGS Method Direct Extension Method

Bad debts Expense 9,644 Interest Receivable 9,644

Allowance for Bad Debts 9,644 Interest Income 9,644

1. From the illustration above prepare the worksheet using

a. Cost of good sold method

b. Direct method

2. Prepare the necessary financial statements for year ending December 31, 2020.

Reference/ Source: Beticon, J., Hinayon, M., and Ireneo, S. (2017). Fundamentals of Accounting.
Manila: FCA Publishing.
Manufacturing Businesses Stages of Production

I. Merchandising Business The production process passes through three

o Buy, process and sell basic stages:
o Creates own products
1. Work not started or raw materials
1. Purchases materials 2. Work started but not completed or work
2. Processes them in process
3. Sells finished products 3. Finished work or finished goods

In addition to heavy equipment and

machinery, the business needs Inventory Accounts of a Manufacturing
Labor → to process raw materials into finished Company
goods
1. Raw Materials Inventory
2. Work in Process Inventory
Difference between a Merchandising and 3. Finished Goods Inventory
Manufacturing Company
Raw materials Work-in- Finished goods
Merchandising Manufacturing process
Goods Undergone Completed
company purchases purchases raw
purchased processing processing
goods in finished materials or parts
condition and sells it and converts or To be molded Not yet Ready to be sold
to customers transforms it into into a new converted
finished products product Similar to
Merchandise Invtry
Department Food processing
stores companies
Grocery stores furniture shop Classifications of Manufacturing Costs
Auto parts beverages (Production Area)
car dealers companies
1. Direct Materials
2. Direct Labor
Production Area and Non-Production Area 3. Manufacturing Overhead
a. Indirect materials
Three departments of a manufacturing b. Indirect Labor
company c. Other expenses like depreciation,
repairs exp. Etc)
1. production department
2. administrative department Direct Materials Indirect Materials
3. sales department Attributed directly to Cannot be directly
the product identifiable
Production Administrative Sales
Department Department Department Gold → Ring Hindi obvious sa
Wood→Furnitur product
in charge of in charge with the e
manufacturing executive, organizational, Paper → Books Lubricants
the finished clerical, general Glue
Cleaning
products of a management of an
Supplies
company organization, warehousing,
transporting, or delivering a Could appear under
product Factory Supplies
Account

Rather than Raw

materials account
 2 Classifications of Labor
Related to Factory recognized as
Direct Labor Indirect Labor
expense in the
Sila ang talagang Salaries and wages of Total Manufacturing
period incurred
gumagawa employees who Costs
indirectly work on the Inventoriable cost
Salaries and wages of product
employees who Product Cost = Period Costs =
directly work on the Janitorial Direct Materials + Selling expenses +
product Services
Factory Direct Labor + G & A expenses
Welders Manager Factory Overhead
Painters Quality Control
Assembly Inspectors
workers Security Types of Product Costs
Personnel
Prime Costs Conversion Costs
Assembly workers
-- makes different Quality Control Main Incurred to transform
parts that are to be Inspectors raw materials into
Directly associated
assembled and to be -- nagsusupervise sa final form
expenditures
formed into finished quality ng products
goods Prime Costs = Conversion costs =
Direct Materials + Direct labor +
2 Kinds of Factory Overhead Direct Labor Factory Overhead
Actual Applied
Actual FO= Applied FO= Journal Entries for a Manufacturing Company
Indirect Materials + Rate given with 1. Purchase of raw materials
Independent
Indirect Labor +
Variable Raw materials xxx
Other Factory
Expenses Cash or A/P xxx

2. Direct raw materials used in the production

Classifications of nonmanufacturing costs Work in process xxx
(Non-Production Area)
Raw materials xxx
1. Selling costs

• includes all costs to sell the finished 3. Indirect raw materials used in the production
products
Factory overhead xxx
2. Administrative costs
Raw Materials xxx
• includes organizational and executive
costs related with the administration of
an organization 4. Direct labor incurred in the production

Product Costs Vs Period Costs Work in process xxx

Product Costs Period Costs Cash or S and W/P xxx
Costs incurred in Remaining operating
manufacturing expenses
process 5. Indirect labor incurred in the production
Once product costs
(Buy-Process) are taken out Factory overhead xxx

Cash or S and W/P xxx

Recognized as Related to Store and
expenses when Office
products are sold
Expenses incurred in the Manufacturing or Items used as indirect materials
production department other than direct
material, indirect material, direct labor, indirect o often appear on a balance sheet as
labor: factory supplies or are included in raw
materials
Factory overhead xxx
Some direct materials
Various Accounts xxx
o are classified as indirect materials when
Expenses incurred in the administrative their costs are low or insignificant
department
Using the materiality principle,
Expenses-G&A xxx
o individually tracing the costs of each of
Various Accounts xxx these materials and classifying them
separately as direct materials does not
Expenses incurred in the sales department
make economic sense
Expense-selling xxx

Various Accounts xxx 2. Goods in Process Inventory

• Also called work in process inventory

If goods are finished
1. Work In Progress
Factory Overhead
2. Finished Goods
Work In Progress
Pag may nabenta na (cost ay 500, price ay
800)(lagi perpetual)
• consists of products in the process of
being manufactured but not yet
complete
150
The amount of goods in process inventory
150
• depends on the type of production
700
process
700
Short time required Long time required
goods in process goods in process
inventory is likely inventory is usually
small bigger

1. Cash/ A.R 800

3. Finished Goods inventory
Sales 800
• consists of completed products ready
COGS 500 for sale.
• similar to merchandise inventory owned
Finished Goods 500
by a merchandising business

Manufacturer’s Statement of Financial Position

Manufacturers

• carry several unique assets

• usually have three types of inventories
instead of the single inventory that Manufacturer’s Statement of Comprehensive
merchandisers carry Income
1. Raw Materials Inventory Items making up cost of goods sold
• goods a company acquires to use in • The main difference between the
making products income statement of a manufacturer
1. Direct Materials and that of a merchandiser
2. Indirect Materials
 Merchandiser Manufacturer
Merchandise finished goods
inventory, beg inventory, beg
Accounting Procedure
cost of goods cost of goods
purchased manufactured • is basically the same as those for a
merchandising or trading business
- Merchandise - finished goods
• but there is the production process
inventory, end inventory, end
Cost of goods sold Cost of goods sold

Some Expenses
Cost of goods Cost of goods • may have to be allocated among the
purchased manufactured three areas covered or affected by the
cost of buying sum of direct materials, expenditure
product to be direct labor, and factory
Examples:
sold overhead costs incurred
in producing products Insurance
depreciation of buildings
taxes and licenses
Manufacturing formula for COGS

Finished goods, beg Comprehensive Example

Add. Cost of Goods Manufactured
Check material given
Total Goods Available for Sale
Less. Finished goods, end (Gwyn print 8-17)

COGS

Closing Entries of a Manufacturing Company

• more complex compared to a merchandising company

Manufacturing Company

• maintains three categories of inventory accounts

• RM, WIP, FG
• Other than cost of goods sold, a cost of goods manufactured account

The closing entries for VOLFANGO Manufacturing Co. are based on the computation of cost of
goods manufactured (CGM). Accordingly:
Dec 31 Cost of goods manufactured 652,040
Goods-in-process invty 1/01 38,600
Raw materials invty 1/01 52,800
Purchases 266,800
Freight-in 12,000
Direct labor 122,100
Indirect labor 45,600
Heat, light and power 38,000
Factory insurance expense 18,400
Repairs and maintenance 22,000
Misc. factory expense 16,700
Depr. Exp. - Machinery 12,140
Factory supplies expense 6,900
 31 Goods-in-process invty 12/31 46,200
Raw materials invty 12/31 48,600
Purchase returns & allowances 8,700
Purchase discount 6,500
Cost of goods manufactured 110,000

First compound entry To do this,

• closes all debit balance nominal 1. the beginning balance of Finished Goods
accounts which are related to the inventory
computation of cost of goods
manufactured • must be removed from the books
• In addition, the inventory accounts • debit Income Summary and credit
(Raw materials, Goods in process) have Finished Goods Inventory for the
their beginning balances transferred to beginning balance
the cost of goods manufactured (CGM) 2. the ending balance is recorded
account
• debit Finished Goods Inventory and
Second compound entry credit Income Summary for the ending
• sets up the ending balance of Raw balance
Materials and Goods in process Other closing entries are
• closes CGM-related nominal accounts
with credit balances, such as the Dec Finished goods, invty, 76,500
purchase returns and allowances 31 end
account Sales 844,000
Income Summary 920,500
Immediately after the second compound
entry,
31 Income Summary 847,256
o all CGM-related nominal accounts have Finished goods, 46,000
been closed invty, beg
o the Raw Materials inventory and Goods
Sales R/A 12,000
in Process inventory accounts already
Sales discount 8,800
contain their respective ending
balances Sales Salaries 64,200
Advertising expense 29,900
Direct extension method
Miscellaneous selling 33,600
• Used in the example exp
• Accordingly, no entry to set up Cost of Office salaries 44,000
Goods Sold has been made in the Taxes and licenses 13,000
books of VOLFANGO Manufacturing Co Misc. gen. & adm. Exp. 28,100
• Instead, all nominal accounts, including
Depr. Exp. – Building 18,000
CGM, are closed directly to the Income
Depr. Exp. – Office 3,500
Summary account
equip.
Bad debts expense 4,116
The closing entries Cost of good 542,040
manufactured
• also include the set-up of ending
Finished Goods inventory
Income Summary 73,244
VOLFANGO, Drawing 73,244
 VOLFANGO, Drawing 55,364
VOLFANGO, Capital 55,364

Note: The adjusting and closing entries herein

presented assumes that the periodic inventory
system is in use
Formula Bank

Actual Factory Overhead Cost of Goods Manufactured

Indirect Materials Work-in-Process, beg

Indirect Labor Add. Total Manufacturing Cost
Other Factory Expenses Total Goods Placed in Process
Actual Factory Overhead Less. Work-in-Process, end
Cost of Goods Manufactured

Applied Factory Overhead

Rate given with Independent Variable Cost of Goods Sold

Product Cost/Total Manufacturing Costs Finished goods, beg

Add. Cost of Goods Manufactured
Direct Materials Total Goods Available for Sale
Direct Labor Less. Finished goods, end
Other Factory Expenses Cost of Goods Sold

Product Cost/Total Manufacturing Costs

Net Sales
Period Costs

Gross Sales
Selling expenses
(Sales Discounts)
G & A expenses
(Sales Returns and Allowances)
Period Costs
Net Sales

Prime Costs
Net Income
Net Sales
Direct Materials
Less. COGS
Direct Labor
Gross Profit
Prime Costs
Less. Operating Expenses
Operating Income
Conversion Costs
Add. Other Income
Less. Losses
Direct Labor
Earnings before Interest and Tax
Factory Overhead
Less. Interest Expense
Conversion Costs
Earnings before Tax
Less. Tax Expense
Direct Materials Net Income

Raw materials, beg

Add. Purchases
Raw materials used
Ass. Freight-in
Raw materials invty, beg
Less. Purchase Discounts
Add. Net Purchases
Less. Purchase R/A
Total raw materials available for use
Raw Materials Available for Use
Less. Raw materials invty, end
Less. Raw Materials, end
Raw materials used
Raw Materials Used
Factory Overhead
Indirect labor
Various Expenses
Factory Overhead

Raw Materials Used

RM used

- indirect material

= direct material used