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MERCHANDISING OPERATIONS − Then, other operating income is added

Comparison of Income Statement:
Service Entities
− Perform services for a fee
− In ascertaining profit, a basic income
statement is all that is needed
− In Figure 6.1, profit is measured as the
difference between revenues from
services and expenses
Merchandising Entities
− Earn profit by buying and selling goods
− Use the same basic accounting methods
as service entities, but the process of
buying and selling merchandise requires
some additional accounts and concepts.
This process results in a more complex
income statement
To provide a better measure of
performance, the income statement of a
merchandising business is presented with
additional items:
and operating expenses (like distribution
costs, administrative expenses, and
other operating expenses) are deducted
from gross profit to arrive at operating
profit.
OPERATING PROFIT = GROSS PROFIT –
OPERATING EXP
− Investment revenues, other gains and
losses, and finance cost (e.g. interest
expense) are considered to arrive at
profit before tax then income tax
expense is deducted to have profit from
continuing operations.
− Finally, profit from discontinued
operations (net of tax) is taken to
account to get profit for the period.
Discontinued operations are the results of
operations of a component of an entity that
is either being held for sale or has already
been disposed of. The designated results of
operations must be reported as
discontinued operations within the financial
statements.

Parts of an Income Statement for a

Merchandising Entity:

In a Merchandising Business:
− Net sales – arise from the sale of goods
− Cost of sales or cost of goods sold –
represent the cost of inventory the entity
has sold to customers
− Gross Profit – the difference between OPERATING CYCLE OF A
net sales and cost of sales is called MERCHANDISING BUSINESS
gross profit
The merchandising entity purchases
GROSS PROFIT = NET SALES – COST inventory, sells the inventory, and uses the
OF SALES cash to purchase more inventory, and the
cycle continues. For cash sales, the cycle

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 Revamped and Reimagine Project Ulikid
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is from cash to inventory and back to cash. terms of delivery such as freight
For credit sales or sales on account, the terms, time, place, and the person
cycle is from cash to inventory to accounts named to receive the goods
receivable and back to cash. In any 3. Statement of Account
industry, the manager strives to shorten the - formal notice to the debtor detailing
cycle. The faster the sale of inventory and the accounts already due
the collection of cash, the higher the profits. 4. Official Receipt
The following illustrates the operating cycle - evidences the receipt of cash by the
of a merchandiser: seller or the authorized
representative
- notes the invoices paid and other
details by payment
- evidence that the seller received
cash
5. Deposit Slips
- printed forms with the depositor’s
name, account number and space
for details of the deposit
- validated deposit slip indicates that
cash and checks with the supplied
SOURCE DOCUMENTS
details were actually deposited or
Merchandising businesses use various
credited to the account holder
business forms and documents to help
6. Check
identify the transactions that should be
- a written order to a bank by a
recorded in the books. These source
depositor to pay the amount
documents contain vital information about
specified in the check from his
the nature and amount of the transactions.
checking account to the person
named in the check
The more common source documents along
- the entity issuing the check is the
with their descriptions are the following:
payor while the receiver is the
1. Sales Invoice (SI)
payee
- prepared by the seller of goods and
sent to the buyer
- this document contains the name 7. Purchase Requisition
and address of the buyer, the date - a written request to the purchaser of
of sale and information such as an entity from an employee or user
quantity, description and price department of the same entity that
about the goods sold goods be purchased
- also specifies the amount of sales, 8. Purchase Order
and the transportation and - an authorization made by the buyer
payment terms to the seller to deliver the
2. Bill of Lading (BoL) merchandise as detailed in the form
9. Receiving Report
- a document issued by the carrier,
- a document containing information
trucking, shipping, or airline that
about goods received from a vendor
specifies contractual conditions and

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 Revamped and Reimagine Project Ulikid
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- formally records the quantities and 4. Upon receiving the shipment of

description of the goods delivered
10. Credit memorandum
- a form used by the seller to notify
the buyer that his account is being
decreased due to errors or other
factors requiring adjustments
STEPS IN A PURCHASE
TRANSACTIONS
Whenever a purchase or sale of
merchandise occurs, the buyer and the
seller should agree on the price of the
merchandise, the payment terms, and the
party to shoulder the transportation costs.
Owners of small merchandising firms may
settle these terms informally by phone or by
discussion with the vendor’s representative.
Most large businesses, however, follow
certain procedures when purchasing
merchandise.
The procedures are as follows:
1. When certain items are needed, the
user department fills in a purchase
requisition form and sends it to the
purchasing department.
2. The purchasing department then
prepares a purchase order after
checking with the price lists, quotations,
or catalogs of approved vendors. The
purchase order, addressed to the
selected vendor, indicates the quantity,
description, and price of the
merchandise ordered. It also indicates
expected payment terms and
transportation arrangements.
3. After receiving the purchase order, the
seller forwards an invoice to the
purchaser upon shipment of the
merchandise. The invoice, called a
sales invoice by the seller and a
purchase invoice by the buyer defines
the terms of the transaction.
merchandise, the purchaser’s receiving
department sees to it that the terms in
the purchase order are complied with,
and prepares a receiving report.
5. Before approving the invoice for
payment, the accounts payable
department compares copies of the
purchase requisition, purchase order,
receiving report, and invoice to ensure
that quantities, descriptions, and prices
agree.
All of the above forms: purchase
requisition, purchase order, invoice, and
receiving report are source documents.
When the goods are received or when the
title has passed, the entity should record
purchases and a liability (or a cash
disbursement). Generally, the seller
recognizes the sales transaction in the
records when the goods have been
shipped.
TERMS OF TRANSACTIONS
Merchandise may be purchased and sold
either on credit terms or for cash on
delivery. When goods are sold on account,
a period of time called the credit period is
allowed for payment. The length of the
credit period varies across industries and
may even vary within an entity, depending
on the product.
When goods are sold on credit, both parties
should have an understanding of the
amount and time of payment. These terms
are usually printed on the sales invoice and
constitute part of the sales agreement. If the
credit period is 30 days, then payment is
expected within 30 days from the invoice
date. The credit period is usually described
as the net credit period or net terms. The
credit period of 30 days is noted as “n/30”.

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If the invoice is due ten days after the end of
the month, it may be marked “n/10 eom”
Cash Discounts
− Some businesses give discounts for
prompt payment called cash discounts.
If a trade discount is also offered, cash
discount is computed on the net amount
after the trade discount. This practice
improves the seller’s cash position by
reducing the amount of money in
accounts receivable. Cash discount is
designated by such notation as “2/10”
which means the buyer may avail of a
two percent discount if the invoice is
paid within ten days from the invoice
date. The period covered by the
discount, in this case, ten days, is
called the discount period.
− Called purchase discounts from the
buyer’s viewpoint (credit – deducted
from purchases)
− Sales discounts from the seller’s point
of view (debit)
− It is usually worthwhile for the buyer to
take a discount if offered although it may
be necessary to borrow the money to
make the payment.
− Deducted from invoice price
Example:
Assume that an invoice for P150,000 with
terms of 2/10, n/30, is to be paid within the
discount period. If an annual interest rate of
18% is assumed, the net savings to the
buyer is P1,530 which is determined as
follows:
Trade Discounts
− Suppliers furnish smaller wholesalers or
retailers with price lists and catalogs
showing suggested retail prices for their
products. These firms, however, also
include a schedule of trade discounts
from the listed prices to enable the
customer to determine the invoice price
to be paid. Trade discounts encourage
the buyer to purchase products because
of markdowns from the list price. Trade
discounts should not be confused with
cash discounts. This type of discount
enables the supplier to vary prices
periodically without the inconvenience of
revising price lists and catalogs.
− There is no trade discount account
and there is no special accounting
entry for this discount. Instead, all
accounting entries are based on the
invoice price which is obtained by
subtracting the trade discount from the
list price.
Example:
Illustration: Pinnacle Technologies quoted a
list price of P2,500 for each 64-gigabyte
flash drive, less a trade discount of 20%. If
Video Fantastic ordered seven units, the
invoice price would be as follows:
Trade discounts may be stated in a series.
Assume instead that the trade discount
given by Pinnacle to Video Fantastic is 20%
and 10%, the invoice price will be:

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 Revamped and Reimagine Project Ulikid
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In the first example, both the buyer and the
seller would record only the P14,000 invoice
price while in the second example, the
invoice price will be P12,600.
TRANSPORTATION COSTS
When merchandise is shipped by a
common carrier, a trucking entity or an
airline, the carrier prepares a freight bill in
accordance with the instructions of the party
making the shipping arrangements. The
freight bill designates which party shoulders
the costs, and whether the shipment is
freight prepaid or freight collect.
Freight Bills
− Usually show whether the shipping
terms are FOB shipping point or FOB
destination.
− F.O.B. – “free on board”
− the freight entity collects from the buyer
− Payment by either party will not dictate
who should ultimately shoulder the costs
− Normally, the party bearing the freight
cost pays the carrier
- FOB Shipping Point = Freight
Collect
- FOB Destination = Freight Prepaid
Sometimes as a matter of convenience, the
firm not bearing the freight cost pays the
carrier. When this situation occurs, the
seller and buyer simply adjust the amount of
the payment for the merchandise.
Treatment of Transportation Costs:

FOB Shipping Point (Buyer)

− When the freight terms are FOB
shipping point, the buyer shoulders the
shipping costs
− Ownership over the goods passes from
the seller to the buyer when the
inventory leaves the seller’s place of
business, the shipping point.
− The buyer already owns the goods while
still in transit and therefore, shoulders
the transportation costs.
FOB Destination (Seller)
− Seller bears the shipping costs
− Title passes only when the goods are
received by the buyer at the point of
destination; while in transit, the seller is
still the owner of the goods so the seller
shoulders the transportation costs.
Freight Prepaid
− seller pays the transportation costs
before shipping the goods sold
Freight Collect
The shipping costs borne by the buyer using
the periodic inventory system are debited
to transportation in account. In accounting,
the cost of an asset, the merchandise
inventory includes all costs (e.g. shipping
costs) incurred to bring the asset to its
intended use. In the cost of sales section of
the income statement, the balance in this
account is added to purchases in computing
for the net cost of purchases for the period.
 
Shipping costs borne by the seller are
debited to “transportation out” account,
which is also called delivery expense,
which is an operating expense in the
income statement.
BUYER SELLER
Transportation In Transportation Out
Freight In Freight Out
Delivery Expense
Added to purchases
Debit Debit

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 Revamped and Reimagine Project Ulikid
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− As the time of sale, cost of sales is

Who determined and recorded as a debit to
shoulders Who pays the cost of sales account and a credit to
Freight Terms the the the inventory account. With a perpetual
transportati shipper? inventory system, both the inventory and
on cost? cost of sales accounts receive entries
FOB throughout the accounting period.
Destination, Seller Seller − Many merchandising entities are now
Freight Prepaid
using the perpetual inventory system
FOB Shipping
without point-of-sale equipment.
Point, Freight Buyer Buyer
Computers have decreased in prices.
Collect
These powerful machines have
FOB
Destination, Seller Buyer dramatically reduced the time required
Freight Collect to manage inventory. Supermarkets and
FOB Shipping department stores use point-of-sale
Point, Freight Buyer Seller scanners built into checkout counters to
Prepaid collect transactional data for the cash
register and to update their perpetual
INVENTORY SYSTEMS inventory system. In the absence of
point-of-sale scanners, the perpetual
Merchandise Inventory inventory system is more advisable for
− Key factor in determining the cost of firms that sell low-volume, high-priced
sales goods such as motor vehicles, jewelry,
− Because merchandise inventory and furniture.
represents goods available for sale, − When an entity uses the perpetual
there must be a method of determining inventory system, the ending inventory
both the quantity and the cost of these should reconcile with the actual physical
goods. count at the end of the period assuming
− There are two systems available to that no theft, spoilage, or error has
merchandising entities to record events occurred. Even if there is little chance of
related to merchandise inventory: the suspension of inventory discrepancy,
perpetual inventory system and the most entities make a physical count. At
periodic inventory system. that time, the account is adjusted for any
- If silent = Periodic Inventory System inaccuracies discovered. The count
provides an independent check on the
PERPETUAL INVENTORY SYSTEM amount of inventory that should be
− Alternative to the periodic inventory reported at the end of the period.
system
− The inventory account is continuously PERIODIC INVENTORY SYSTEM
updated − Primarily used by businesses that sell
− Perpetually updating the inventory relatively inexpensive goods and that
account requires that at the time of are not yet using computerized scanning
purchase, merchandise acquisitions be systems to analyze goods sold
recorded as debits to the inventory − No entries are made to the inventory
account account as the merchandise is bought
and sold. When goods are purchased, a

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 Revamped and Reimagine Project Ulikid
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separate set of accounts, purchases, made to the delivery equipment, not to

purchases discounts, purchases returns, sales account.
and allowances, and transportation in
are used to accumulate information on The journal entry to record the sale of
the net cost of the purchases. merchandise for cash is as follows:
− Only at the end of the period, when the
inventory is counted, will entries be
made to the inventory account to
establish its proper balance. If the sale of merchandise is made on credit,
the entry will be:
INCOME STATEMENT

Sales Discounts
Assume that G. Detoya Traders sold
merchandise on Sept. 20 for P3,000; terms
2/10, n/60. At the time of sale, the entry is:

NET SALES
− First part of the merchandising income
statement as presented above
Gross Sales
− Under the accrual accounting, revenues
from the sale of merchandise are
considered to be earned in the
accounting period in which the title of
goods passes, usually at the point of
delivery, from the seller to the buyer.
− Consist of total sales for cash and on
credit during the accounting period
− Although cash for the sale is
uncollected, the revenue is recognized
as earned at the time of the sale. For
this reason, there is likely to be a
difference between net sales and cash
collected from those sales in a given
period.
− As an income account, the sales
account is credited whenever sales on
account or cash sales are made. Only
sales of merchandise held for resale are
recorded in the sales account. If a
merchandising firm sold one of its
delivery trucks, the credit would be
The customer may take advantage of the
sales discount any time on or before Sept.
30, which is 10 days after the date of the
invoice. If the client paid on Sept. 30, the
entry is:
At the end of the accounting period, the
sales discount account has accumulated all
the sales discounts for the period. The
account is considered a contra-income
account and deducted from gross sales in
the income statement.
Sales Returns and Allowances
− Each return or allowance is recorded as
a debit to an account called sales
returns and allowances. An example of
such transaction follows:

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 Revamped and Reimagine Project Ulikid
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There is no debit to transportation out

The seller usually issues the customer a
credit memorandum (i.e. Accounts
Receivable or Cash is credited), which is a
formal acknowledgment that the seller has
reduced the amount owed by the customer.
Sales returns and allowances is a
contra-income account and is accordingly
deducted from gross sales in the income
statement.
Transportation Out
− When the freight term is FOB
destination, the seller shoulders the
transportation costs; when the term is
FOB shipping point, the buyer bears the
shipping costs.
account since the shipping term provided
that the buyer should shoulder the
transportation costs. If his invoice is
collected on Dec. 5, the sales discount will
be P340 (P17,000 x 2%). The entry would
be:
Case No. 3. Now assume that G. Detoya
Traders sold merchandise totaling P17,000
FOB destination, freight collect; terms 2/10;
n/30. The transportation costs amounted to
P1,900. The entry to record this transaction
would be:

Case No. 1. Assume that G. Detoya

Traders sold merchandise totaling P17,000
FOB destination, freight prepaid; terms
Accounts receivable is decreased by the
2/10, n/30. The transportation costs
transportation charges paid by the buyer for
amounted to P1,900. The entry to record
the benefit of the seller. If this invoice is
this transaction would be:
collected on Dec. 5, the sales discount will
be P340 (P17,000 x 2%) since the discount
applies to total sales.

If this invoice is collected on Dec. 5, the

sales discount will be P340 (P17,000 x 2%).
Transportation out is an operating expense.
Case No. 2. Assume that G. Detoya
Traders sold merchandise totaling P17,000
FOB shipping point, freight collect; terms
2/10, n/30. The transportation costs
amounted to P1,900. The entry to record
this transaction would be:
Case No. 4. Assume further that G. Detoya
Traders sold merchandise totaling P17,000
FOB shipping point, freight prepaid; terms
2/10, n/30. The transportation costs
amounted to P1,900. The entry to record
the transaction would be:
If this invoice is collected on Dec. 5, the
sales discount will be P340 (P17,000 x 2%).
The discount only applies to total sales.

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 Revamped and Reimagine Project Ulikid
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COST OF SALES / COST OF GOODS

SOLD
− Largest single expense of the
merchandising business
− It is the cost of inventory that the entity
has sold to customers
− Every merchandising business has
goods available for sale to customers.
The goods available for sale during the
year is the sum of two factors,
merchandise inventory at the beginning
of the year and net cost of purchases
during the period.
GAFS = Beg. Inv. + Net Cost of
Purchases
− If an entity is able to sell all the goods
available for sale during the given
accounting period, the cost of sales
would then equal goods that had been
available for sale. In most cases,
however, the business will have goods
still unsold at the end of the year. To find
the actual cost of sales, the
merchandise inventory at the end of the
period is subtracted from the goods
available for sale.
Cost of Sales = GAFS – Ending Inv.
Exhibit 6-3 showed goods costing
P1,796,600 as available for sale. G. Detoya
started with P528,000 in beginning
merchandising inventory and a net cost of
purchases (or cost of goods purchased) of
P1,268,600 during the year. At the end of
the year, P483,000 of goods were left
unsold; this amount should appear as the
merchandise inventory in the balance sheet.
When this ending merchandise inventory is
subtracted from goods available for sale,
the resulting cost of sales is P1,313,600.
Exhibit 6-3
Figure 6-4
Figure 6-4 showed a pictorial diagram of the
cost of sales section. In summary, goods
available for sale during the period come
from the beginning inventory and net cost of
purchases. The goods are either sold
during the period or remain unsold at the
end of the period. Goods available for sale
will eventually turn to expense for the period
as cost of sales or to asset as merchandise
inventory. To understand fully the concept of
cost of sales, it is necessary to examine the
details affecting merchandise inventory and
the net cost of purchases.
Merchandise Inventory
− The inventory of a merchandising entity
consists of goods purchased for resale.
For a grocery store, inventory would be
made up of meats, vegetables, canned
goods, and other items. For lumber and
hardware, it would be plywood, nails,
paints, iron sheets, cement, tools, and
other items. Merchandising entities
purchase their inventories from

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manufacturers, wholesalers, and other debited to the purchases account as shown

suppliers.
− The merchandise inventory at the
beginning of the accounting period is
called the beginning inventory.
Conversely, the merchandise inventory
at the end of the accounting period is
called ending inventory. As presented
in Exhibit 6-3, beginning and ending
inventories are used in calculating the
cost of sales in the income statement.
The ending inventory shown in the
income statement will be the
merchandise inventory to be reported in
the balance sheet.
− Effectively, the ending inventory of the
current period will be the beginning
inventory of the next period.
Net Cost of Purchases
− Under the periodic inventory method,
net cost of purchases consists of gross
purchases minus purchases discounts,
and purchases returns and allowances
equal net purchases plus transportation
costs.
Net Cost of Purchases = P – PD – PRA =
NP + TI
below:
Purchases Returns and Allowances
(PRA)
− A contra account and is accordingly
deducted from purchases in the income
statement (see Exhibit 6-3).
− It is important that a separate account
be used to record purchase returns and
allowances because management
needs the information for
decision-making.
− It may be very costly to return
merchandise. There are costs that
cannot be recovered such as ordering
costs, accounting costs, transportation
costs, and interest on money invested in
the goods. There may be call for new
purchasing procedures or suppliers.
− Sales returns and allowances in the
seller’s books are recorded as
purchases returns and allowances in the
books of the buyer. This should be
recorded as follows:

Purchases (P)
− The purchases account, a temporary
account, is used for merchandise
purchased for resale.
− Its sole purpose is to accumulate the
total cost of merchandise purchased
during an accounting period.
− Purchases of other assets such as
equipment should be recorded in the
appropriate asset accounts.
− Recording merchandise purchases at
invoice price is known as the gross
price method of recording purchases.
When the periodic inventory method is
used, all purchases of merchandise are
Purchases Discounts (PD)
− Like purchases returns and allowances,
purchases discounts is a contra account
that is deducted from purchases on the
income statement.
− If the entity makes a partial payment on
an invoice, most creditors will allow the
entity to take the discount applicable to
the partial payment.
− This discount does not apply to the
transportation or other charges that
might appear on the invoice.

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Merchandise purchases are usually made

on credit and commonly involve purchases
discounts for early payment. In relation to
the Nov, 12 and 14 transactions, the
payment is recorded as follows: Case No. 3. Now assume that G. Detoya
Traders made purchases totaling P17,000
FOB destination, freight collect; terms 2/10,
n/30. The transportation costs amounted to
P1,900. The entry to record the transaction
Transportation In (TI) would be:
Case No. 1. Assume that G. Detoya
Traders made purchases totaling P17,000
FOB destination, freight prepaid; terms
2/10, n/30. Transportation costs amount to
P1,900. The entry would be:
Accounts payable is decreased by the
transportation charges paid by the buyer for
the benefit of the seller. If this invoice is paid
on Dec, 5, the purchases discount will be
There is no debit to transportation in P340 (P17,000 x 2%) because the discount
account since the shipping term provided applies to total purchases.
that the seller should shoulder the
transportation costs. In addition, the seller
prepaid the freight. If this invoice is paid on
Dec. 5, the purchases discount will be P340
(P17,000 x 2%). The entry would be:
Case No. 4. Assume further that G. Detoya
Traders made purchases totaling P17,000
FOB shipping point, freight prepaid; terms
2/10, n/30. The transportation costs
Case No. 2. Assume that G. Detoya amounted to P1,900. The entry to record
Traders made purchases totaling P17,000 the transaction would be:
FOB shipping point, freight collect; terms
2/10, n/30. The transportation costs
amounted to P1,900. The entry to record
this transaction would be:
If this invoice is collected on Dec. 5, the
sales discount will be P340 (P17,000 x 2%).
The discount only applies to total sales.

If this invoice is paid on Dec. 5, the

purchases discount will be P340 (P17,000 x
2%). Transportation in will form part of the Accounts Description Normal
net cost of purchases. Balance

Merchandise ● Beginning Debit

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Inventory Inventory
● Ending The entries related to value-added tax are
Inventory: as follows:
Shown as
Merchandise
Inventory in
the
Balance Sheet

Purchases Temporary account Debit

closed at the end
of the period
Input tax increase the amount to be paid
Purchases Contra-account, Credit but has no effect on the cost of the
Discounts deducted from purchases. Output tax also increased the
purchases
Purchases amount collected but not necessarily, the
Returns & sales figure. The value of goods or
Allowances properties sold and subsequently returned
or for which allowances were granted by a
Transportation Freight cost Debit
In
VAT-registered person may be deducted
incurred by the
buyer from the gross sales or receipts for the
quarter in which the refund is made or a
credit memorandum is issued. Sales
VALUE-ADDED TAX ENTRIES discounts or indicated in the invoice at the
time of sale may be excluded from the gross
The foregoing entries for sales and sales within the same quarter it was given.
purchases did not incorporate the effects of
value-added taxes on the transactions to
simplify the illustrations. But the learning will
not be complete without the following Remedios Palaganas, because of the sales
illustration. discounts granted, will pay value-added tax
  due of P33,000 only.
Illustration. Remedios Palaganas Feeds
based in Pangasinan trades specialty feeds Value-Added Tax (VAT) = 12%
for race horses, fighting cocks, aquarium
fishes, zoo animals and other animals
generally considered as pets. On May 13, Input Tax
2019, Remedios Palaganas Feeds − Current asset
purchased on account specialty feed with a − Tax paid in advance to supplier
total amount payable of P784,000. A
wholesaler operating in the region bought Output Tax
for cash all of the available feeds on May − Liability; payable to BIR
25, 2019; amount of cash received was − Collecting tax from customer
P1,120,000. Remedios Palaganas Feeds − Minus input tax = VAT Payable
paid the value-added tax due by month end
not minding the actual deadline. OPERATING EXPENSES

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− Make up the third major part of the

income statement for a merchandising This appendix will demonstrate the entries
entity typically used with the periodic inventory
− These are expenses, other than the cost system, contrasted to the entries used with
of sales, which are incurred to generate the perpetual inventory system. Assume
profit for the entity’s major line of that the beginning inventory for the year is
business, merchandising. P250,000. Assuming that the transactions
− It is customary to group operating (nos. 1 to 7) were the only transactions for
expenses into useful categories. the entire year, the balance in the inventory
Distribution costs, administrative account at year-end under the periodic
expenses, and other operating inventory system is P250,000 (beginning
expenses are the categories. inventory). The year-end balance in the
inventory account under the perpetual
Distribution Costs / Selling Expenses inventory system is P231,860.
− Expenses related directly to the entity’s
efforts to generate sales Under the perpetual inventory system, the
− These include sales salaries and inventory account is increased by
commissions, and the related employer purchases, transportation in, and sales
payroll expenses; advertising and store returns and is decreased by the cost of
displays; traveling expenses; store sales, purchases returns and allowances,
supplies used; depreciation of store and purchases discounts.
property and equipment; and
transportation out. At year-end, the physical inventory is taken,
and it is revealed that the actual inventory
Administrative Expenses on hand is P231,500. The year-end journal
− Expenses related to the general entries (nos. 8 to 10) are then made to bring
administration of the business the inventory account balance into an
− These include officers and office agreement with the amount of the physical
salaries, and the related employer inventory. When posted to the general
payroll expenses; office supplies used; ledger, both the periodic and perpetual
depreciation of office property and inventory systems result in the same ending
equipment; business taxes; inventory amount, P231,500.
professional services; uncollectible
accounts expense and other general Corollary Entry – perpetual inventory
office expenses. system; the entry that follows after the first
Other Operating Expenses entry
− Expenses that are not related to the
central operations of the business
− These are expenses and losses from
peripheral or incidental transactions of
the enterprise; for example, loss on sale
of investments or loss on sale of
property and equipment.

PERIODIC AND PERPETUAL

INVENTORY SYSTEM COMPARED

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Income Summary
− Credit = income
− Debit = expense

COMPLETING THE CYCLE FOR A

MERCHANDISING BUSINESS

NEED FOR A PHYSICAL COUNT

Periodic Inventory System
− In the periodic inventory system,
purchases of merchandise are
accumulated in the purchases account.
During the accounting, no entry is made
to the merchandise inventory account
such that its balance at the end of the
period, before adjusting and closing
entries, is the same as the beginning
inventory.
− With no perpetual record of the cost of
sales during the period, the only way to
obtain the cost of ending inventory is to
make a physical count.
− It should be noted that the ending
inventory amount is needed in the
computation of the cost of sales. To
recapitulate, ending inventory is
deducted from goods available for sale
to obtain cost of sales.

Cost of Sales = Goods Available for Sale –

Ending Inventory

Steps Involved in the Physical Count:

1. All merchandise owned by the entity is
counted.
For Perpetual: 2. The quantity counted is multiplied by the
− If Sales Allowances – do not record cost per unit for each inventory item.
inventory 3. The costs of various items are added to
− Still need a physical count determine the total cost of inventory.
Summary:
− Transaction that involves
payment/purchases of Transportation In
& Sales Return = DEBIT Inventory
− Purchases Discounts, Purchases
Returns & Allowances, Cost of Sales =
CREDIT Inventory Ending Inventory

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− Resulting total cost of inventory

− This amount will appear as a deduction
in the cost of sales section of the income
statement, and as a current asset in the
balance sheet
− The physical count is made at or near
the balance sheet date
− A reliable physical count is very
significant because the ending inventory
amount will affect both the income
statement and the balance sheet
Example:
An understatement of ending inventory in
the 2018 income statement will cause an
overstatement of cost of sales. In effect,
gross profit and profit will be
understated. The understatement of ending
inventory in the current period means that
the beginning inventory of the next
period will also be understated. As a
result of this error or omission, the current
assets and the owner’s equity in the
2018 balance sheet would be
understated. In summary, an error in
valuing ending inventory will translate into
one inaccurate balance sheet and two
incorrect income statement.
MERCHANDISE INVENTORY AT THE
END OF THE PERIOD
At the end of the period, entries are made to
reflect in the inventory account the ending
balance. The objectives of these entries are
as follows:
a. To remove the beginning balance
from the merchandise inventory
account and to transfer it to income
summary.
b. To enter the ending balance in the
merchandise inventory account and
to establish it in the income
summary.
In this example, merchandise inventory was
P528,000 at the beginning of the year and
P483,000 at the end of the year. Effect A
removed the P528,000 from the
merchandise inventory account and
transferred it to income summary. In
income summary, the P528,000 is in effect
added to the cost of purchases because,
like expenses, the balance of the purchases
account is debited to income summary by a
closing entry.
 
Effect B establishes the ending balance of
merchandise inventory of P483,000 and
entered it as a credit in the income
summary account. The credit entry in
income summary has the effect of deducting
the ending inventory from goods available
for sale because both purchases and
beginning inventory are entered on the debit
side. To summarize, beginning
merchandise inventory and purchases
are debits to income summary; while
ending merchandise inventory is credit to
income summary.
Thus, the objectives stated above are
accomplished if Effect A and B concurred.
The question then arises as to how to
achieve these effects. Two acceptable
methods are available: the adjusting entry
method and the closing entry method. Each
method produces exactly the same result.
Adjusting Entry Method
Using the adjusting entry method, the two
entries indicated by effects A and B which
are prepared at the time the other adjusting
entries are made follow:

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− The first step in the preparation of

worksheet is to enter the balances from
the ledger accounts into the trial balance
columns. The merchandise inventory
account balance of P528,000 is the cost
of the beginning inventory.

Closing Entry Method
The closing entry method makes the debit
and the credit to merchandise inventory by
including them among the closing entries as
follows:
Notice that in both methods, merchandise
inventory is credited for the beginning
balance and debited for the ending balance
and that the opposite entries are made to
income summary.
PREPARING THE WORKSHEET
Adjustment Columns
− Under the closing entry method of
handling merchandise inventory, the
adjusting entries for G. Detoya Traders
are entered in the adjustments columns
in the same way that they were for
service entities. These involve
insurance expired during the period
(adjustment a); store and office supplies
(adjustments b and c); depreciation of
building and office equipment
(adjustments d and e); accrual of
interest expense (adjustment f). No
adjusting entries are made for
merchandise inventory because the
closing entry method was used. After
the adjusting entries are entered in the
worksheet, the trial balance columns
and adjustment columns are totaled to
prove the equality of the debits and
credits.

The worksheet of a merchandising business Omission of the Adjusted Trial Balance

is the same as that of a service business
except that it has to deal with the new
accounts related to merchandising
transactions. These accounts include sales,
sales returns and allowances, sales
discounts, purchases, purchases returns
and allowances, purchases discounts,
transportation in, merchandise inventory
and transportation out. The worksheet for
G. Detoya Traders using the closing entry
method is shown below. Each pair of
columns in the worksheet, and the adjusting
and closing entries are discussed as
follows:
Trial Balance Columns
− These two columns are used when there
are many adjusting entries to be
considered. When only a few adjusting
entries are required as in this case,
these columns are not necessary and
may be omitted.
Income Statement and Balance Sheet
Columns
− After the trial balance columns have
been totaled, the adjustments entered,
and the equality of the columns proved,
the balances are extended to statement
columns. Each accounts balance is

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entered in the proper column of the

income statement or balance sheet.
− The extension of the beginning and
ending inventory balances requires
some new procedures. First, the
beginning inventory balance of
P528,000 is extended to the debit
column of the income statement as
illustrated in 7-1. This procedure has
the effect of adding beginning inventory
to ent cost of purchases; observe that
the purchases account is also in the
debit column of the income statement.
− Second, the ending inventory balance
of P483,000 which is not in the trial
balance is entered in the credit column
of the income statement. This
procedure has the effect of subtracting
the ending inventory from goods
available for sale. Note that two
inventory amounts appeared in the
income statement columns. This is
because both the amounts appeared in
the income statement columns. This is
because both the beginning inventory
and ending inventory are needed in the
computation of cost of sales.
− Finally, the ending inventory is also
entered in the debit column of the
balance sheet. After all the items have
been extended to the proper statement
columns, the four columns are totaled.
The profit or loss is determined as the
difference between the debit and credit
columns of the income statement. In this
case, G. Detoya Traders earned a profit
of P455,210, which is extended to the
credit column of the balance sheet. The
four columns are then added to prove
the equality of the debits and credits.

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− Examples include raw materials and

PREPARING THE FINANCIAL
STATEMENTS
 
Income Statement
− The statement may be prepared by
referring to the income statement
columns of the worksheet. Per revised
PAS No. 1, an enterprise should present
an analysis of expenses using a
classification based on either the nature
of expenses or their function within the
entity, whichever provides information
that is reliable and more relevant.
Entities are encouraged to present the
analysis of expenses on the face of the
income statement.
Nature of Expense Method
− Expenses are aggregated or combined
in the income statement according to
their nature and are not reallocated
among various functions within the
entity. This method is simple to apply in
many smaller enterprises because no
allocation of operating expenses
between functional classifications is
necessary.
consumables used, employee benefits
expense, depreciation and amortization
expense, transportation costs,
advertising costs and other operating
expenses.
Function of Expense Method
− This method, also referred to as the
“cost of sales” method, classifies
expenses according to their function as
part of the cost of sales,
distribution/selling, administrative and
other operating activities. This
presentation often provides information
that is more relevant to users than the
nature of expense method but the
allocation of costs to functions can be
arbitrary and involves considerable
judgment. This method provides multiple
classifications and intermediate
differences to highlight significant
relationships.
− In a merchandising business, net sales
arise from the sale of goods while cost
of sales or cost of goods sold
represents the cost of inventory the
entity has sold to customers. The

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difference between the net sales and Statement of Changes in Equity

cost of sales is gross profit.
− Then, other operating income is added
and operating expenses (like distribution
costs, administrative expenses, and
other operating expenses) are deducted
from gross profit to arrive at operating
profit.
− Investment revenues, other gains and
loss, and finance costs (e.g. interest
expense) are considered to arrive at
Balance Sheet
profit before tax then income tax
The balance sheet dated “Dec. 31, 2019” is
expense is deducted to arrive at profit
implicitly understood to mean “at the close
for continuing operations. Finally, profit
of business on Dec. 31, 2019”
from discontinued operations (net of tax)
is taken to account to get profit for the
period.

ADJUSTING AND CLOSING ENTRIES

 
The adjusting entries are journalized and
posted to the ledger as they would be in a

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service entity. The closing entries for G.

Detoya Traders under the closing entry
method appear below.
 
Note that merchandise inventory is credited
in the 1st entry for the amount of the
beginning inventory, P528,000; and debited
in the 2nd entry for the ending inventory,
P483,000. Except for the closing of the
temporary accounts typical of a
merchandising business, the closing
procedures are the same with that of a
service business.

WORKSHEET IN A PERPETUAL
INVENTORY SYSTEM

The worksheet is prepared after all

POST-CLOSING TRIAL BALANCE
A final trial balance is prepared to test the
equality of the accounts after posting the
adjusting and closing entries. This trial
balance is similar to the one discussed in
service business except for the addition of
the merchandise inventory account.
transactions for the year have been
journalized and posted. However, the
following items should be noted:
1. The inventory amount in the trial
balance is the year-end balance since
the inventory account is perpetually
updated. There will be no merchandise
inventory adjusting or closing entry
unlike when the periodic inventory
system is used. The year-end inventory
balance will simply be extended to the
debit column of the balance sheet.
2. The cost of sales account is a ledger
account in the perpetual inventory
system. There will be no account for
purchases, purchases returns and
allowances, purchases discounts and
transportation in because information
related to these items is recorded
directly in the inventory account. When
the closing entries are made, cost of
sales will be closed with the other
temporary accounts with debit balances.
3. The adjustments are handled in exactly
the same way as they are handled in the
periodic worksheet.
4. An adjusting entry is necessary when
the year-end inventory account balance

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does not tally with the physical inventory accounts of individual customers and
amount. creditors.

SPECIAL AND COMBINATION CONTROL ACCOUNTS AND

JOURNALS, AND VOUCHER SYSTEM SUBSIDIARY LEDGERS

LIMITATIONS OF USING THE GENERAL When an entity keeps charges to and

JOURNAL AND GENERAL LEDGER
The discussions in the previous chapters
were limited to processing transactions
recorded in the general journal and posted
to the general ledger. This type of
accounting system is satisfactory for
introducing basic accounting procedures.
However, this system would be inadequate
for a business having even a moderate
volume of transactions for some reasons:
− Only a limited number of transactions
can be processed daily because only
one person at any one time can
introduce entries into the general
journal.
− Transactions recorded in the general
journal must be posted individually in the
general ledger, resulting to a great deal
of posting later.
To overcome these limitations, entities
adopt an accounting system that
incorporates either the use of the usual
special journals (non-voucher) or the
voucher system.
payments from all customers in a single
accounts receivable account in the general
ledger, the account in T-account form would
appear as follows:
Using this procedure, the entity cannot
easily bill or mail statements to customers,
answer inquiries about individual customer
balances, or make any collection efforts if it
has only a single record showing total
claims against all customers. The entity
needs to know each customer’s name and
address, transaction dates, amounts billed
and amounts received on account for each
account receivable.
The problem can be partly solved by
maintaining in the general ledger an
account for each customer. The trial
balance of such general ledger may appear
as follows:

Also, the illustrations have utilized only one

account of accounts receivable and another
one for accounts payable. Entities that
maintain accounts with numerous
customers and creditors will find it
burdensome to work with a general ledger
containing a large number of customer and
creditor accounts. Therefore, entities adopt
an accounting system that uses control
accounts in the general ledger and separate This approach has limitations too. The
subsidiary ledgers to record and control the general ledger becomes unreasonably large
when hundreds of customers’ accounts are

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involved. With thousands of customers, it accounts payable, inventory, and property

becomes unworkable. and equipment.

This problem can be best addressed using SPECIAL JOURNAL

an accounts receivable control account in − These are journals of original entry other
the general ledger; and individual customer than the general journal that are
accounts in a subsidiary ledger. Under this designed for recording specific types of
approach, the general ledger is kept to a transactions of a similar nature.
manageable size, and a detailed record of − Most entities use the following special
transactions with individual customers exist journals:
in the subsidiary ledger. It is a controlling
account in the sense that its balance should Specific
Posting
equal the total of the individual account Journal Transactions
Abbreviation
balances in the subsidiary ledger. The Recorded
individual customer accounts are the Sales Journal Sales of S
subsidiary accounts. They are controlled by merchandise
the accounts receivable account in the on account
general ledger. The accounts receivable Cash Receipts Receipts of CR
subsidiary ledger, like the general ledger, Journal cash
may simply be a group of accounts in a Purchase Credit P
Journal purchases of
binder, or it may be a file card arrangement.
merchandise
In either case, the order is either numerical
and other
by customer number or alphabetical by items
customer name. Cash Payments of CD
Disbursement cash
The following shows the relationships Journal
between the accounts receivable control General Entries that do GJ
account in the general ledger and the Journal not fit in the
accounts receivable subsidiary ledger. other journals

The control account-subsidiary ledger
technique can be used to yield a detailed
breakdown of many general ledger
accounts, not just accounts receivable.
Subsidiary ledgers are often used for
Cash Sales
− Usually recorded in the cash receipts
journal rather than in the sales journal
because cash is best controlled when all
routine cash receipts are recorded in
one journal
− Similarly, an entity can increase control
over cash disbursements by recording
cash purchases of merchandise or other
items in the cash disbursements journal
rather than in the purchases journal.
When special journals are used, the
general journal is maintained for adjusting,
closing, and reversing entries; and for
recording transactions that do not fit in other

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special journals. Examples of the latter more transactions are involved,

include the recording of purchases returns more posting time is saved.
and allowances, and sales returns and
allowances. SALES JOURNAL

Advantages of Using Special Journals:

1. Permits division of labor
- When special journals are used, the
recording step in the accounting
cycle can be divided among several
persons, each of whom is
responsible for particular types of
transactions. Personnel making
entries in special journals need not
have a thorough knowledge of the
entire accounting system.
- Major advantage

2. Reduces recording time

- Special journal transactions need no
routine explanation for each entry.
Also, because special column
headings are used, account titles
need not to be repeated unlike in the
general journal.
- Time saved in posting from the
journals to the ledgers
- When a general journal is used,
each entry must be posted
separately to the general ledger.
The tabular arrangement of special
journals, however, often permits all
entries to a given account in a
specific journal to be added and
posted as a single aggregate posting
- For instance, if you entered 800
sales transactions in a general
journal, you would make 800 debit
postings to the accounts receivable
account and another 800 separate
credit postings to the sales account.
Using the sales journal, however,
there will only be two postings from
the sales journal to the general
ledger; one to accounts receivable
and another to sales. Clearly, as
Exhibit 8-1
The sales journal of the Nazario Sea
Products, shown in Exhibit 8-1, is designed
for an entity using the periodic inventory
system. This journal lists all credit sales for
the month of June. The information for each
sale is obtained from a copy of the related
sales invoice, which should be
prenumbered for control purposes. This
journal is specifically designed to record
sales of merchandise on account. In
contrast, cash sales are recorded in the
cash receipts journal. Credit sales of assets
other than merchandise inventory (e.g.
property and equipment) are entered in the
general journal.
For each transaction, the accountant enters
the date, sales invoice number, and
customer account to be debited along with
the amount. If the same credit term is
extended to all customers, as assumed in
the illustration, there is no need to insert a

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column to describe the sales terms in the

sales journal.
The posting of any journal to the general
ledger may result in equal debits and
credits. In addition, for any posting to a
control account in the general ledger, the
same total amount must be posted to one or
more related subsidiary ledger accounts.
Exhibit 8-1 illustrates how to post the
amounts in Nazario Sea Products sales
journal.
Amounts recorded in the sales journal are
posted daily to the subsidiary ledger to keep
a current record of the accounts receivable
from each customer. Daily posting permits
the business to answer customer inquiries
promptly. A check mark ( √ ) is placed in the
posting reference column of the sales
journal to signify that the amount has been
posted to the customer’s account in the
subsidiary ledger.
Updating the subsidiary ledger daily also
allows the credit department to review and
monitor a customer’s account balance at
times other than the billing date. Cycle
billings may likewise be implemented; for
example, billing customers whose names
begin with different letters at different times
of the month. The advantage of cycle
billings is that statements of account can be
mailed throughout the month rather than in
one large group at the end of the month.
At the end of the month, when all sales
have been recorded and sales journal has
been totaled and ruled, the total sales figure
is posted to the general ledger as a debit to
the accounts receivable control account and
as a credit to the sales account. Note that
the double posting reference at the bottom
of the sales journal; indicates that accounts
receivable is account no. 120 in the general
ledger and sales is account no. 410.
When amounts are posted to the ledgers,
the journal page number is entered in the
account to identify the source of the data. In
Exhibit 8-1, all journal references in the
ledger are “S1” since the postings originated
from page 1 of the sales journal.
Sales journals may accommodate additional
information. For example, columns could be
included for sales by department or by
product, so that a breakdown of sales is
available to management. Columns may
also be provided for output tax information,
when necessary.
Additional Notes:
− 140,000 > 150,000
− Subsidiary Ledger > General Ledger
− Cr. Accounts Receivable
CASH RECEIPTS JOURNAL
All transactions involving cash receipts are
recorded in a cash receipts journal. Exhibit
8-2 showed the cash receipts journal for an
entity using the periodic inventory system.
In a merchandising business, the main
sources of cash are collections of accounts
and cash sales. Thus, this journal has debit
columns for cash and sales discounts; the
credit columns for accounts receivable and
sales. In addition, there are columns on the
right-hand side of the journal which can be
used to record the account titles and credits
to other accounts resulting from cash
receipts not related to cash sales and
collections on account. Examples of these
include investments by the owner and loan
releases.
Cash receipts are evidenced by source
documents like prenumbered official
receipts (OR), cash register tapes (CRT) or
cash slips, and bank credit memorandum
(CM). Note that the entries on June 15 and

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June 30, debiting cash and crediting sales,

recorded cash sales for a certain period. In
practice, cash sales, which are usually
supported by cash register tapes, should be
recorded daily rather than semi-monthly.

The June 8 entry recorded P19,600 cash

collection from Zamboanga Exports related
to sales on account on June 1 of P20,000.
The cash discounts were taken. The entry
debited cash for P`19,600 and sales
discounts for P400, and credited accounts
receivable for P20,000. Official Receipt
(OR) no. 001 was issued to acknowledge
the cash receipt of P19,600. The entry for
Dipolog Traders on June 29 is similar.

The June 21 transaction illustrated the use

of two journals, cash receipts and general
journal, to record a business event. Here,
Cagayan de Oro Stores settled its P100,000
June 12 account by issuing a promissory
note for P50,000 and remitting P49,000
(P50,000 less 2% sales discounts) for the
balance.

In the cash receipts journal, the debits are

to cash, P49,000 and sales discounts,
P1,000; and accounts receivable is credited
for P50,000. The receipt of notes
receivable in lieu of an existing accounts
receivable is a non-cash transaction that
should be recorded in the general journal.
The entry debits notes receivable and
credits accounts receivable for P50,000
each.

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other accounts’ column are posted to the

The June 1 entry represented cash received
as investments by the owner, Milavel
Nazario. The June 10 cash receipts
pertained to a DBA Bank loan released
through a credit to the current account of
Nazario Sea Products maintained in the
same bank. In both cases, the other
accounts’ columns are used.
Before posting the cash receipts journal,
each column is added and the journal
balanced to make sure that total debits
equal total credits. In the illustration,
P1,348,000 + P2,000 = P100,000 +
P450,000 + P800,000.
The totals of the cash, sales discounts,
accounts receivable, and sales columns are
posted to the general ledger, as noted by
the posting references below these
columns. In addition, the individual items in
general ledger. The total of this column is
used only to balance the journal and are not
posted.
Individual items in the accounts receivable
column are posted on a daily basis to the
customer’s subsidiary ledger to keep this
ledger in balance with the accounts
receivable control account. Postings to the
customer’s accounts are indicated by a
check mark (√).
A schedule of account balances in the
subsidiary ledger is usually prepared at the
end of each accounting period to verify that
the subsidiary ledger agrees with the related
control account. The schedule of accounts
receivable for Nazario Sea Products
indicated that the subsidiary ledger agreed
with its control account in the general
ledger.

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PURCHASES JOURNAL

Merchandising business frequently

purchase merchandise and supplies. Such
purchases are usually made on account.
The purchase journal is designed to account
for purchases, supplies and other assets on
account. In contrast, cash purchases are
recorded in the cash disbursements journal.

Exhibit 8-3 illustrated the purchases journal

for an entity using the periodic inventory
system. In the illustration, the primary
source documents used as the basis for the
entries in the journal is the receiving report
(RR). The journal showed special columns
for debits to purchases, office supplies, and
store supplies, as well as for credits to
accounts payable. A column is provided for
debits to accounts for which no special
column is available. In practice, a column
for input taxes may be included. A separate
column for purchase terms may also be
provided to help identity the due date and
the discounts available.

The amounts in the accounts payable

column are posted to the accounts payable
subsidiary ledger on a daily basis. A
checkmark in the posting reference column
indicates that this has been done. At the
end of the month, the columns are totaled,
and the journal is balanced to ensure that
total debits equal total credits. The posting
pattern for the purchases journal is
diagrammed in Exhibit 8-3.

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After both the purchases and the cash

CASH DISBURSEMENTS JOURNAL disbursements journal have been posted,
the accounts payable control account has a
All cash payments are recorded in a cash balance of P330,000 (P590,000 from Exhibit
disbursements journal. Exhibit 8-4 showed 9-3 less P260,000 payment). This total
the June cash disbursements journal for agreed with the schedule of accounts
Nazario Sea Products after the related payable below:
transactions have been recorded, and the
journal balanced and posted. Note the
special columns for credits to cash and
purchases discounts, and for debits to
accounts payable and purchases.
Ordinarily, these accounts will have the
most entries. This special journal has
columns for the date and the number of
checks issued for each cash payment. Also,
the other accounts column is available for
recording debits to other accounts.

The June 2 entry in Exhibit 7-4 recorded the

issue of check no. 101 for P280,000 as
payment for accrued salaries at the end of
May. The entries on June 12 and June 19
recorded payment on accounts to Gingoog
Distributors and Oroquieta Suppliers, less
2% and 1% purchases discounts,
respectively.

Note that an equipment worth P100,000

was acquired on June 15 by giving P50,000
cash and a note payable for P50,000. The
cash payment of P50,000 was recorded in
the cash disbursement journal. The
issuance of notes for the acquired
equipment was recorded in the general
journal rather than in the purchases journal;
this is because the purchases journal in the
illustration did not provide for a special
credit column for notes payable. Of the
entity frequently issues notes to support
acquisitions on account, then a notes
payable credit column should be created in
the purchases journal. The other entries in
the journal are self-explanatory.

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GENERAL JOURNAL accounts in the accounts payable

When special journals are used,
transactions that cannot be recorded
appropriately in a special journal are
recorded in the general journal. Examples
include merchandise returns, write-offs of
uncollectible accounts; and certain
non-cash transactions involving notes
receivable and notes payable.
The entries below demonstrates that
whenever a posting is made to the accounts
receivable or accounts payable control
account from the general journal, a posting
is also made to the related subsidiary ledger
account.
subsidiary ledger.
This control procedure is important because
this helps ensure the accuracy of the
accounting records.
FLEXIBILITY OF SPECIAL-PURPOSE
JOURNALS
The functions of special-purpose journals
are to reduce and simplify the work in
accounting and to allow for division of labor.
These journals should be designed to fit the
business for which they are used. As noted
earlier, if certain accounts manifest often in
the other accounts column of a journal, it
may be advisable to add a column for those
accounts when a new page of a
special-purpose journal is prepared.

By addition, if certain transactions appear

PROVING THE LEDGERS
At the end of the period, after all postings
have been made, equality should exist
between the following:
● Total debit balances and total credit
balances of the accounts in the
general ledger. These amounts are
used to prepare the trial balance.
● The balance of the accounts
receivable control account in the
general ledger and the sum of the
individual customer accounts in the
accounts receivable subsidiary
ledger.
● The balance of the accounts payable
control account in the general ledger
and the sum of the individual creditor
repeatedly in the general journal, it may be
advisable to set up a new special journal for
that purpose. For example, if Nazario Sea
Products finds that it must often give
allowances to customers, it may set up a
sales returns and allowances journal. In
short, special journals should be designed
to suit transactions commonly encountered
by an entity.
VOUCHER SYSTEM
Most entities control purchases and cash
disbursements by formalizing the process of
verification and approval of payments using
a method known as the voucher system.
Under this system, checks may be drawn
only upon a written authorization in the form
of a voucher approved by responsible
officials. The system consists of vouchers,
voucher register, unpaid voucher file, check
register, and paid voucher file. The voucher
register takes the place of the purchases
journal while the check register substitutes
the cash disbursements journal.

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expenditures are recorded first in the

− Cash disbursements have to pass the
voucher register first
− Dr. Expense Cr. Accounts Payable
− Non-voucher system:
Dr. Salaries Expense
Cr. Cash
Voucher
- The voucher is a serially numbered form
that identifies the name and address of
the payee, the due date, terms,
description and invoice amount. The
form includes a section for designated
officers to sign their approval for
payment. It also has spaces for details
such as the date of payment, check
number and ledger entries.
- Before the designated official approves
the voucher for payment, various
personnel perform verification
procedures that include the following:
1. Comparison of purchase requisition,
purchase order, invoice and
receiving report for agreement of
quantities, prices, types of goods,
and terms.
2. Review of extensions and footings in
the invoice.
3. Approval of account distribution (i.e.
the general ledger accounts to be
debited).
Copies of the purchase requisition,
purchase order, invoice and receiving report
should be attached to the voucher. These
documents will comprise the voucher
package. The voucher is recorded in the
book of original entry called the voucher
register.
Voucher Register
- As noted, the voucher register takes the
place of the purchases journal, and
provides a record of all authorized check
payments. In a voucher system, all
voucher register.
- Approved vouchers are entered in the
voucher register in numerical sequence.
The voucher should be prenumbered so
they can be accounted for and referred
to easily. Observe Exhibit 8-5 that all
entries in the voucher register resulted
to a credit to accounts payable control
account. The voucher payable account
may also be used in place of the
accounts payable account. If an entity
opted for the use of the vouchers
payable account, the balance in this
account may be properly reported in the
balance sheet as accounts payable.
- The register has columns for expense
and asset accounts frequently debited
such as purchases, transportation in,
office supplies, and transportation out.
Debits and credits to accounts for which
columns are not provided for are made
in the other accounts section.
Unpaid Voucher File
- The voucher register has columns to
record payment date and check number,
which are entered when the voucher is
paid. After vouchers have been entered
in the voucher register, they are filed in
the order of required date of payment.
In this way, the entity will not miss
discounts, and its credit standing will not
be impaired. When a voucher is
processed, the due date is written on the
face of the voucher for filing
convenience.
- The absence of entries in the payment
date and check number columns of the
voucher register indicate that the
voucher is unpaid. The total unpaid
vouchers at any time may be
determined by adding the items in the
voucher register for which the date paid
and check number columns contain no
entries. This total should agree with the

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total of the vouchers in the unpaid file

and, at the end of the month, with the
amount in the accounts payable
account.

Check Register
- The check register in Exhibit 8-6 is a
simplified form of the cash
disbursements journal. The register is a
record of all check payments. Since
checks are entered in the check register
in numerical sequence, this record
provides a convenient reference for the
check number and the date of payment.
- Checks are issued only in payment of
approved and recorded vouchers. Every
check issued is recorded by a debit to
accounts payable and credit to cash,
and to purchases discounts, if
appropriate.
- On or before the due date, the voucher
package is removed from the unpaid file
and forwarded to the disbursing officer
for final approval of payment. After
signing the voucher, the disbursing
officer has a check drawn. The check
number and payment date are recorded
in the voucher, which is then returned to
the accounting department.
- To safeguard against irregularities, the
voucher and its underlying documents
should be canceled by the disbursing
officer before the voucher is returned to
the accounting department. The
department is now responsible for the
recording of the check payment in the
check register and the voucher register.

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voucher. For example, the entries for

recording and paying the liability to
Paid Voucher File Rodriguez Company for merchandise
- The paid voucher along with its (voucher no. 121, dated Dec. 1; see
supporting documents are filed in Exhibit 8-6) are summarized in general
numerical sequence in a paid vouchers journal form as follows:
file. This file is then available for
examination by internal and external
auditors requiring the information about
a specific expenditure.

Special Problems in a Voucher System

Gross or Net Amounts
- Under the voucher system, discounts
may cause the amount of the check to
differ from the gross amount of this

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- In addition, a notation about the new

Because both the gross and the net
amounts of the liability are indicated in the
voucher, this system should create no
difficulty. Some entities, however, anticipate
taking all discounts and prepare vouchers at
the net amount. When this procedure is
followed, only two money columns are
needed in the check register, one for a debit
to accounts payable and the other for a
credit to cash in bank.
If the entity should miss a discount, an
adjustment must be made in the voucher (or
the original voucher must be canceled and a
new one prepared). The accountant must
also record discounts lost in the general
journal. An alternative solution for handling
lost discounts when the net price method is
used to provide a discounts lost column in
the check register.
Recording Purchases Returns and
Allowances
- Companies usually handle purchases
returns and allowances by canceling the
original voucher and issuing a new one
for the lower amount. For example, in
Exhibit 8-7, voucher no. 147 for
P25,000, prepared for a merchandise
purchase from Nancy Mulles Company,
was recorded in the voucher register on
Dec. 27. Merchandise costing P5,000 is
returned for credit and that a credit
memo is received on Dec. 30. The
original voucher for P25,000 is canceled
and a reference made on it to a new
voucher for P20,000.
voucher (no. 149) is made in the date
paid column of the voucher register
beside the entry for the original voucher.
In recording the new voucher, the
bookkeeper credits P20,000 in the
accounts payable column.
- In the other accounts column, accounts
payable is debited for P25,000 and
purchases returns and allowances is
credited for P5,000. The net effect of
these recording procedures is a debit of
P25,000 to purchases and a credit of
P20,000 to accounts payable, and a
credit of P5,000 to purchases returns
and allowances.
Recording Partial Payments
- When installment or partial payments
are made on invoices, a separate
voucher is prepared for each check
issued. If a single voucher has been
prepared for an invoice and the entity
later decided to pay in installment, the
original voucher is canceled and new
voucher are prepared. The cancellation
of the original voucher and the issuance
of new vouchers can be recorded in the
same way that purchases returns are
recorded.
COMBINATION JOURNAL
− Multi-column
− Sales, Cash Receipts, Cash
Disbursements, Purchases, General
Journal combined
− Special & General Journals combined
− Combination journal provides the
cornerstone for a simple yet effective
accounting system in many small
entities. This journal combines features
of the general journal and the special
journals in a single record. If a small
entity has enough transactions to make
the general journal difficult to use but too
few transactions to make it worthwhile to

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set up special journals, the combination - Debit to Purchases/Appropriate

journal offers a solution. This journal is Asset Account, Credit to
used most often in small professional Accounts Payable
offices and small service businesses. - Ex. Nov. 25, TXT Co. purchased
− Like the special journals, the office supplies on account from
combination journal contains separate EN Bookstore, P17,000.
amount columns for the accounts used 3. Cash Receipts Journal
most often (e.g. Cash-debit and credit, - Receipts of cash
Accounts Receivable-debit and credit, - This involves cash sales,
Accounts Payable-debit and credit, collection of accounts receivable,
Sales-credit, Salaries Expense-debit) to and recognition of sales
record and permit summary postings at discounts.
the end of the month. - Includes Sundry Accounts
− Other accounts columns allow the - Debit to Cash, Credit to
recording of the transactions that do not Appropriate Account
fit into any of the special columns. - Ex. Nov. 29, AAA Co. borrowed
These columns are also used for entities money from a bank, P23,000.
that would normally appear in the 4. Cash Disbursement Journal
general journal such as adjusting and - Payments of cash
closing entries. - This involves cash purchases,
clearing of accounts payable,
SUMMARY and recognition of purchase
SPECIAL JOURNALS discounts.
- journals of original entry, other than the - Includes Sundry Accounts
general journal, that record types of - Debit to Appropriate Account,
transactions that occur frequently, that Credit to Cash
may be seen as a repetitive list of - Ex. Nov. 30, HYBE Co. paid
entries when a general journal is used. half-month salaries of
1. Sales Journal employees, P77,000.
- Sales of merchandise on
account General Journal
- Debit to Accounts Receivable, - Entries that do not fit in the other
Credit to Sales journals are recorded in this journal
- Ex. Nov. 27, SVT sold - Includes adjusting entries, closing
merchandise on account to BTS entries, reversing entries, sales returns
costing P24,000. and allowances (with a credit to
2. Purchase Journal Accounts Receivable), purchase returns
- Credit purchases of merchandise and allowances (with a debit to
and other items Accounts Payable), write-offs of
- Includes Sundry Accounts: uncollectible accounts, and certain
miscellaneous or mixed non-cash transactions involving notes
accounts. All accounts in the receivable and notes payable.
sundry accounts are posted
individually to their respective Advantages of Using Special Journals
ledgers. 1. Saves time in journalizing and posting
2. Promotes division of labor

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3. Helps in management analysis receiving report.

Subsidiary Ledgers – supporting ledgers 2. Voucher Register – book of original

for the general ledgers. It is a list of
individual accounts that record transactions
with common characteristics linked to a
control account. They are ledgers for each
credit customer (Accounts Receivable
Subsidiary Ledger) and for each company
which the firm made a credit purchase
(Accounts Payable Subsidiary Ledger).
A schedule of account balances in the
subsidiary ledger is usually prepared at the
end of each accounting period to verify that
the subsidiary ledger agrees with the related
control account.
entry where the voucher is recorded. This
takes the place of the purchases journal and
provides a record of all authorized check
payments. In a voucher system, all
expenditures are recorded first in the
voucher register.
3. Unpaid Voucher File - where all
vouchers that have been authorized, but not
yet been
paid are kept. The absence of entries in the
payment date and check number columns
of the voucher register indicates that the
voucher is unpaid.

VOUCHER SYSTEM 4. Check Register - a simplified form of the

Under this system, checks may be drawn
only upon a written authorization in the form
of a voucher approved by responsible
officials. The system consists of vouchers,
voucher register, unpaid voucher file, check
register, and paid voucher file. The voucher
register takes the place of the purchases
journal while the check register substitutes
the cash disbursements journal.
1. Voucher – a serially numbered form that
identifies the name and address of the
payee, the due date, terms, description,
and invoice amount. Before approving
the voucher for payment, the following
verification procedures are performed:
a. Comparison of purchase requisition,
purchase order, invoice, and
receiving report for agreement of
quantities, prices, types of goods,
and terms.
b. Review of extensions and footings in
the invoice.
c. Approval of account distribution.
Voucher Package – composed of the
purchase requisition, purchase order,
invoice and
cash disbursements journal. The check
register is a record of all check payments.
5. Paid Voucher File - Where all paid
vouchers are kept. The paid vouchers
should be filed in numerical order.
COMBINATION JOURNAL
- combines features of the general journal
and the special journals in a single
record
- contains separate amount columns for
the accounts used most often (e.g.
Cash-debit and credit, Accounts
Receivable-debit and credit, Accounts
Payable-debit and credit, Sales-credit,
Salaries Expense-debit) to record and
permit summary postings at the end of
the month.
CORPORATIONS: BASIC
CONSIDERATIONS
Corporation - A corporation is an artificial
being created by operations of law, having
the right of succession and the powers,
attributes and properties expressly

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authorized by law or incident to its 1. Relatively complicated in formation and

existence. management.
2. There is a greater degree of government
ATTRIBUTES OF A CORPORATION control and supervision.
1. Separate Legal Entity – Artificial 3. Requires a relatively high cost of
Being. A corporation is an artificial being formation and operations.
with a personality that is separate from that 4. Subject to heavier taxation than other
of its individual owners. forms of business organizations.
5. Minority shareholders are subservient to
2. Created by Operation of Law. A the wishes of the majority.
corporation is generally created by the 6. In large corporations, management and
operation of law. The mere agreement of control have been separated from
the parties cannot give rise to a corporation. ownership.
7. Transferability of shares permits the
3. Right of Succession. A corporation has uniting of incompatible and conflicting
the capacity of continued existence subject elements in one venture.
to the period stated in the Articles of
Incorporation. The death, withdrawal, CLASSES OF CORPORATIONS
insolvency, or incapacity of the individual 1. Stocks Corporation. Corporations that
shareholders or members will not dissolve have share capital divided into shares and
the corporation. The transfer of ownership are authorized to distribute to the
of shares or stock does not dissolve the shareholders’ dividends based on their
corporation. shares held.
2. Non-stock Corporation. No part of its
4. Powers, Attributes, Properties income is distributable as dividends to its
Authorized by Law. A corporation has only members, trustees, or officers. Ex. USLS
the powers, attributes, and properties
expressly authorized by law or incident to its OTHER CLASSIFICATIONS OF
existence. CORPORATIONS
1. As to the number of persons:
ADVANTAGES OF A CORPORATION a. Corporation aggregate. A
1. Has the legal capacity to act as a legal corporation consisting of more than
entity. one corporator.
2. Shareholders have limited liability. b. Corporation sole. A corporation
3. Has continuity of existence. which consists of only one member
4. Shares of stock can be transferred or corporator and his successors
without the consent of the other such as a bishop.
shareholders. c. One-Person Corporation. OPC is a
5. Management is centralized in the board corporation with a single
of directors. stockholder, who
6. Shareholders are not general agents of can only be a natural person (who must be
the business. of legal age).
7. Has greater ability to acquire funds.
2. As to nationality:
DISADVANTAGES OF A CORPORATION a. Domestic corporation. Organized
under Philippine laws.

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b. Foreign corporation. Organized

under foreign laws. 7. According to their relation to another
corporation:
3. As to whether for public or private a. Parent or holding corporation.
purpose: Related to another corporation that it
a. Public corporation. Formed for the has the power to either directly or
government of a portion of the state. indirectly elect the majority of the
b. Private corporation. A corporation directors of a subsidiary corporation.
created for private aim, benefit, or b. Subsidiary corporation. Controlled
purpose. by another corporation known as a
parent
4. As to whether for a charitable purpose corporation.
or not:
a. Ecclesiastical corporation. STEPS IN THE CREATION OF A
Organized for religious purposes. CORPORATION
b. Eleemosynary corporation. 1. Promotion
Established for public charity. 2. Incorporation
c. Civil corporation. Established for Note: Operations of a corporation will not
business or profit. start without the issuance by the SEC of the
certificate of incorporation.
5. As to their legal right to corporate 3. Formal organization and commencement
existence: of business operations.
a. De jure corporation. Existing in fact
or law, organized in strict conformity ARTICLES OF INCORPORATION
with the law. - Documents the incorporators must file to
b. De facto corporation. Existing in the SEC.
fact but not in law.
BY-LAWS
6. As to the degree of public - Rules of action adopted by the corporation
participation regarding share ownership: for its internal government and for the
a. Close corporation. Share government of its officers, shareholders, or
ownership is limited to selected members.
persons or members of a family not
exceeding 20 persons. RIGHTS OF A SHAREHOLDER
b. Open corporation. Share is - Pre-emptive Right – right to purchase a
available for subscription or portion of any new shares issued to
purchase by any person. maintain the same percentage of stock
c. Publicly-held corporation. A ownership
corporation with a class of equity
securities listed on an exchange or COMPONENTS OF A CORPORATION
with assets in excess of 1. Corporators are those who compose a
P50,000,000 and having 200 or corporation whether as shareholders or
more holders, or at least 200 of members, at any time. Note: A corporation
which are holding at least 100 or a partnership can be a corporator but
shares of a class of its equity cannot be an incorporator. A partnership
securities. can be a corporator in a corporation, but a

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corporation cannot be a general partner in a pro-rata division of profits without

partnership. any preference.
2. Incorporators are shareholders or 7. Preference shares. These shares
members mentioned in the articles of entitle the holder to certain
incorporation as originally forming the advantages or benefits over the
corporation and are signatories to said holders of ordinary shares.
articles of incorporation. 8. Promotion shares. Those issued to
Note: All incorporators (if they continue to promoters as compensation in
be shareholders) are corporators of a promoting the incorporation of a
corporation, but not all corporators are corporation.
incorporators. 9. Treasury shares. A stock that has
3. Shareholders or stockholders are been issued by the corporation as
corporators in a stock corporation. fully paid and later reacquired but
4. Members are corporators of a non-stock not retired.
corporation. 10. Convertible shares. A stock that is
5. Subscribers are persons who have convertible or changeable from one
agreed to take and pay for original, class to another class.
unissued shares of a corporation formed or
to be formed. Note: All incorporators are BASIC CORPORATE ORGANIZATIONAL
subscribers, but a subscriber need not be STRUCTURE
an incorporator. - The ultimate control of the
6. Promoters are persons who bring about corporation rests with the
or cause to bring about the formation and shareholders.
organization of a corporation. - Hierarchy of Corporate Structure
7. Underwriters are those who undertake
to dispose of the shares to the general
public.
8. An Independent Director is a person
independent of management and free from
any business or other relationship which
could materially interfere with his exercise of
independent judgment in carrying out the
responsibilities of a director.
- The president of a corporation must
CLASSES OF SHARES IN GENERAL be a director of the corporation, but
1. Par value shares cannot act as president and
2. No-par but with stated value secretary or as president and
shares treasurer at the same time.
3. No-par, no stated value shares
4. Voting shares. Those issued with CORPORATE BOOKS AND RECORDS
the right to vote. 1. Minutes Book - contains the
5. Non-voting shares. Those issued minutes of the meetings of the
without the right to vote. directors and stockholders.
6. Ordinary shares. These shares 2. Stock and Transfer Book - a record
entitle the holder to an equal of the names of the shareholders,
installments paid and unpaid by the

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shareholders and dates of payment, without any preference or advantage

any transfer of stock and dates
thereof, by whom and to whom
made.
3. Books of Accounts - represent the
record of all business transactions.
4. Subscription Book - a book of
printed blank subscriptions.
5. Shareholders’ Ledger - a ledger
that details the number of shares
issued to each shareholder.
6. Subscribers’ Ledger – a subsidiary
ledger for the subscriptions
receivable account; it reports the
individual subscriptions of the
subscribers.
7. Stock Certificate - a book of printed
blank certificates of stock.
CORPORATIONS: SHARE CAPITAL,
RETAINED EARNINGS, AND FINANCIAL
REPORTING
Share Capital (Capital Stock)
- Share capital is also known as
capital stock.
- It is the amount fixed by the
corporate charter to be subscribed
and paid in or secure to be paid in
by the shareholders of a corporation
either in money or in property, labor,
or services upon the organization of
the corporation or afterwards; and
upon which it is to conduct its
operations.
Classes of Share Capital
1. Ordinary Share Capital (Common
Stock). It is when a corporation
issued a single class of share
capital. It entitles the holder to an
equal or pro-rata division of profits
over any class of shares.
2. Preference Share Capital (Preferred
Stock). It entitles the holder to enjoy
priority as to the distribution of
dividends and distribution of assets
upon corporate liquidation.
Share Capital may be issued with:
1. Par Value Shares. Have nominal or
face value stated on the face of the
stock certificate and in the articles of
incorporation.
2. No-par but with Stated Value
Shares. Have nominal value stated
in the articles of incorporation but
not on the face of the stock
certificate.
3. No-par, No Stated Value Shares.
Have no nominal value stated either
in the articles of incorporation nor on
the face of the stock certificate.
(Note: According to the Corporation Code, a
no-par share capital is to be issued for a
consideration of not less than five pesos
(P5.00).)
Authorized Share Capital
- The maximum number of shares
(both preference and ordinary
shares) that a corporation may
issue.
- It is determined by multiplying the
authorized shares by the par or
stated value of the share capital.
- A corporation cannot issue shares
more than the authorized shares
stated in the articles of incorporation.
However, it may increase its
authorized shares and authorized

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share capital by amending its article

of incorporation. Issuance of Share Capital

Share capital may be issued in exchange

Recording the Authorized Share Capital
for:
(2 ways)
1. Cash
1. Memorandum Entry Method
2. Non-cash Assets
- A memo entry is made to
3. Services
record the authorization of
share capital.
Issuance of Par Value Shares for Cash
- More popular method
Illustration: The Happy Corporation was
- This is used when the
organized on January 1, 2021 and is
problem is silent as to the
authorized to issue 100,000 shares of P10
method to use.
par value ordinary shares. Subsequently,
Example:
25,000 shares were sold.
Authorized to issue 100,000 shares
with a
Memorandum Entry Method
par value of P100.
Case 1: The issuance price is P10 (at par)
Cash (25,000 x P10)
2. Journal Entry Method
250,000
- The usual debit and credit entry is
Ordinary Shares
made to record the authorization of
250,000
share capital.
- This method cannot be used if the
Case 2: The issuance price is P15 (above
share capital is a no-par and
par)
no-stated value stock.
Cash (25,000 x P15)
Examples (using the data in the
375,000
previous example):
Ordinary Shares (25,000 x P10)
250,000
Unissued Ordinary Shares (100,000 x 100)
Share Premium (25,000 x P5)
10,000,000
125,000
Authorized Ordinary Shares
10,000,000
Journal Entry Method
If preference shares were issued in the Case 1: The issuance price is P10 (at par)
foregoing, the entry would be: Cash (25,000 x P10)
250,000
Unissued Preference Shares (100,000 x 100) Unissued Ordinary Shares
10,000,000 250,000
Authorized Preference Shares
10,000,000 Case 2: The issuance price is P15 (above
par)
Authorized Ordinary (Preference) Shares – Cash (25,000 x P15)
capital account, normal balance is credit 375,000
Unissued Ordinary (Preference) Shares – Unissued Ordinary Shares (25,000 x P10)
contra-capital account, normal balance is 250,000
debit

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Share Premium (25,000 x P5) Ordinary Shares

125,000 100,000

(Note: Issuance of shares below par (i.e., at

a discount) is not allowed by the Issuance of Par Value Shares in
Corporation Code.) Exchange for Services

Issuance of Par Value Shares
Non-cash Assets or Property
Guidelines in valuation when recording the
issuance:
1. The asset received is recorded at its
fair market value, or the fair market
value of the shares issued,
whichever is more clearly
determinable.
2. If no market value is known for both
the asset received or the shares
issued, the asset received is
recorded at its appraised value.
3. If #1 and #2 are not available, the
exchange is recorded using the par
value of the shares.
Illustration: The Happy Corporation issued
10,000 shares of its P10 par ordinary
shares in exchange for land.
Case 1: The land has a fair value of
P175,000.
Land
Ordinary Shares (10,000 x P10)
Share Premium (P175,000 – P100,000)
Case 2: The land has no known market
value. The fair value of ordinary share
capital on the date of exchange is P15.
Land
Ordinary Shares (10,000 x P10)
Share Premium (10,000 x P5)
Case 3: There is no known market value for
both land and the ordinary shares.
Land (10,000 x P10)
100,000
for Guidelines in valuation when recording the
issuance:
1. The transaction is valued using the
fair market value of the services
rendered or the fair market value of
the shares issued.
2. If no market value is known for both
the services rendered and the
shares issued, the transaction is
measured using the par value of the
shares.
Illustration: The Happy Corp. issued 1,000
shares of P10 par ordinary shares in
payment for the services of the lawyer
rendered during incorporation.
Case 1: The lawyer’s services is valued at
P25,000.
Organization Cost 25,000
Ordinary Shares (1,000 x P10)
10,000
Share Premium (25,000 - 10,000)
15,000
175,000
100,000 Case 2: There is no known fair market value
75,000
for the
lawyer’s services. The fair market
value of
the ordinary shares issued is P15
150,000 per share.
100,000 Organization Cost (1,000 x P15)
50,000 15,000
Ordinary Shares (1,000 x P10)
10,000
Share Premium (1,000 x P5)
5,000

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Case 3: There is no known market value for Illustration: The Happy Corporation issued
both 10,000 shares of its P10 par ordinary
the services rendered and the shares in exchange for land.
ordinary
shares issued. Case 1: The land has a fair value of
Organization Cost (1,000 x P10) P175,000.
10,000 Land 175,000
Ordinary Shares Ordinary Shares
10,000 175,000

Issuance of No-par but with Stated Value Case 2: The land has no known market
Shares value. The fair value of ordinary share
The same rules discussed in the issuance capital on the date of exchange is P15.
of shares with par value are applicable to Land 150,000
the issuance of no-par but with stated value Ordinary Shares
shares. 150,000

Issuance of No-par, No Stated Value Issuance of No-par, No Stated Value

Shares for Cash
Illustration: The Happy Corporation was
organized on January 1, 2021 and is
authorized to issue 100,000 shares of
no-par, no stated value ordinary shares.
Subsequently, 25,000 shares were sold at
P15 per share.
Cash (25,000 x P15) 375,000
Ordinary Shares
375,000
Issuance of No-par, No Stated Value
Shares for Non-cash Assets or Property
Guidelines in valuation when recording the
issuance:
1. The asset received is recorded at its
fair market value, or the fair market
value of the shares issued,
whichever is more clearly
determinable.
2. If no market value is known for both
the asset received or the shares
issued, the asset received is
recorded at its appraised value.
Shares in Exchange for Services
Guidelines in valuation when recording the
issuance:
1. The transaction is valued using the
fair market value of the services
rendered or the fair market value of
the shares issued.
Illustration: The Happy Corp. issued 1,000
shares of P10 par ordinary shares in
payment for the services of the lawyer
rendered during incorporation.
Case 1: The lawyer’s services is valued at
P25,000.
Organization Cost 25,000
Ordinary Shares
25,000
Case 2: There is no known fair market value
for the lawyer’s services. The fair market
value of the ordinary shares issued is P15
per share.
Organization Cost 15,000
Ordinary Shares
5,000

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Subscription of Shares Subscriptions Receivable – contra-capital

The sale of share capital on a subscription
basis generally involves three major
transactions:
1. Receipt of subscription
2. Collection from subscribers
3. Issuance of stock certificate upon full
payment of subscription
Illustration: On June 3, 2021, the Happy
Corporation received a subscription for
5,000 shares of its P10 par value ordinary
shares at P15. A down payment of 25% was
received and the balance was paid in full on
July 4, 2021.
a. To record the receipt of
subscription
Subscriptions Receivable 75,000
Subscribed Ordinary Shares
50,000
Share Premium
25,000
b. To record collection of subscription
from subscribers
account, normal balance is debit
Subscribed Ordinary Shares – capital
account, normal balance is credit
Share Premium – capital account, normal
balance is credit
Ordinary Shares – capital account, normal
balance is credit
Subscription Defaults
Illustration: On June 15, 2021, the Happy
Corporation received subscription for 2,000
shares of its P10 par value ordinary shares
at P15. A down payment of 60% was
received. The final payment was due on
August 15, 2021, although several notices
were sent to the subscriber, no payment has
the been received. On August 31, the
subscription was declared delinquent and
was offered for sale in a public auction. On
September 6, expenses of P500 were
incurred in connection with the delinquency
sale. On September 21, payment was
received from the highest bidder and shares
were issued – 1,500 to the highest bidder
and 500 to the defaulting subscriber.

Cash 18,750 a. To record the receipt of the

Subscriptions Receivable subscription
18,750
Subscriptions Receivable 30,000
Cash 56,250 Subscribed Ordinary Shares
Subscriptions Receivable 20,000 Share Premium
56,250 10,000

c. To record issuance of stock b. To record collection of subscription

certificate upon full payment of from subscribers
subscription
Cash 18,000
Subscribed Ordinary Shares 50,000 Subscriptions Receivable
Ordinary Shares 18,000
50,000
c. Costs incurred in connection with the
delinquency sale

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Additional information:
Receivable from Highest Bidder 500 - The purchase of treasury shares
Cash does not decrease the number of
500 shares issued; only the outstanding
shares decrease.
d. Upon receipt of payment from the
highest bidder Illustration: The Happy Corporation decided
to minimize outstanding shares by
Cash 12,500 purchasing 1,000 shares with a par value of
Receivable from Highest Bidder P20 for P24. (The cost method will be
500 used.)
Subscription Receivable
12,000 Purchase of Treasury Shares

e. Upon issuance of the certificate of Treasury Shares 24,000

stock Cash
24,000
Subscribed Ordinary Shares 20,000
Ordinary Shares Reissuance of Treasury Shares
20,000
Case 1: At cost. Assume that the treasury
If there are no bidders, all of the delinquent shares were subsequently reissued at cost.
shares will be issued in the name of the Cash 24,000
corporation. Such shares are considered Treasury Shares
treasury shares. 24,000

Treasury Stock 12,500 Case 2: Above cost. Assume that all

Receivable from Highest Bidder treasury shares were reissued at P30 per
500 share.
Subscriptions Receivable Cash 30,000
12,000 Treasury Shares
24,000
Treasury Shares Share Premium-Treasury
6,000
There are two methods of accounting for
treasury shares transactions: Case 3: Below cost. Assume that the 1,000
1. Par or Stated Value Method treasury shares were reissued at P20 per
2. Cost Method share.
Cash 20,000
Reacquisition by the issuing corporation of Retained Earnings
shares that have been issued and fully paid 4,000
for involves three general transactions: Treasury Stock
1. Purchase of Treasury Shares 24,000
2. Reissuance of Treasury Shares
3. Retirement of Treasury Shares (Note: The excess of the cost over reissue
price of P4,000 should be debited to share

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premium-treasury to the extent of its
balance. In the absence of any balance in
this account, the “loss” is debited to retained
earnings. It is assumed in the above
illustration that the share premium-treasury
has a zero balance.)
Retirement of Treasury Shares
Case 1: With gain on retirement. Assume
that Happy Corporation purchased the
treasury shares for P15 per share. (There is
a “gain” on retirement if the cost of treasury
shares is less than the par value.)
Ordinary Shares 20,000
Share Premium
5,000
Treasury Share
15,000
Case 2: With a loss on retirement. Assume
that Happy Corporation purchased 1,000
treasury shares for P24 per share.
Ordinary Shares 20,000
Share Premium*
6,000
Retained Earnings
6,000 Treasury Shares
32,000
(*The loss on retirement of P1,500,000
should be debited to the following accounts
in the order given: (1) share premium to the
extent of the credit when the share is
issued; (2) share premium from treasury
stock transactions of the same class of
share; (3) retained earnings)
- Distributions may take the form of:
1. Cash
2. Non-cash assets
3. Notes or other evidence of
corporate indebtedness
4. Shares of the company’s own
share capital
- Distributions are paid out of the
accumulated earnings of the
corporation.
The declaration and payment of dividends
involve three important dates and they are:
1. Date of declaration – this is the date
when the board of directors
approved the resolution to distribute
dividends. The liability of the
corporation to the shareholders is
recorded on this date.
2. Date of record – this is the date
when the company determines the
shareholders who are entitled to the
receipt of declared dividends. No
entry is required on this date;
however, a list of registered
shareholders is made as of the close
of business on this date. Share
capital is selling dividends-on prior to
this date and is selling ex-dividends
the day following this date.
3. Date of payment – this is the date
when dividends declared are paid or
distributed to the shareholders. The
liability recognized on the date of
declaration is canceled or
extinguished on this date.

Treasury Shares – contra-capital account, Cash Dividends

normal balance is debit
Share Premium-Treasury – capital account,
normal balance is credit
Dividends
- Distributions to shareholders of
corporate earnings in proportion to
the number of shares held by them.
Illustration: Happy Corporation has 10,000
shares of P100 par value ordinary share
capital outstanding as of December 1, 2021.
On this date, the Board of Directors
declared a cash dividend of P10.00 per
share to shareholders of record of
December 30, 2021 payable on January 15,
2022.

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this date, the Board of Directors declared a

Retained Earnings* 100,000 share dividend distributable to shareholders
Cash Dividends Payable of record of December 30, 2021 payable on
100,000 January 15, 2021. The fair market value of
Happy Corporation’s shares on December 1
Cash Dividends Payable 100,000 is P105; on December 30, P110; on January
Cash 15, P106.
100,000
Case 1 – A share dividend of 10% was
(*The account, Cash Dividends Declared, declared.
may be used in place of the debit to
Retained Earnings. At the end of the Retained Earnings*
accounting period, this temporary 105,000
shareholders’ equity account will be closed Shares Distributable
by debiting Retained Earnings and crediting 100,000
Cash Dividends Declared.) Share Premium
5,000
Share Dividends
- This type of dividend does not affect Shares Distributable
total assets and total shareholders’ 100,000
equity, rather it simply represents a Ordinary Shares
transfer of capital from retained 100,000
earnings to contributed capital.
Hence, total shareholders’ equity Case 2 – A share capital dividend of 30%
before and after the declaration and was declared.
distribution of share capital
dividends are the same. Retained Earnings
300,000
Small Share Dividends Shares Distributable
- Share dividends representing less 300,000
than 20% of the outstanding shares.
- Retained earnings is debited for the Shares Distributable
fair value of the share capital on the 300,000
date of declaration. Ordinary Shares
300,000
Large Share Dividends
- Share dividends representing more (*The account, Share Dividends Declared,
than 20% or more of the outstanding may be used in place of the debit to
shares. Retained Earnings. At the end of the
- Retained earnings is debited for the accounting period, this temporary
par or stated value of the share shareholders’ equity account will be closed
capital. by debiting Retained Earnings and crediting
Share Dividends Declared.)
Illustration: Happy Corporation has 10,000
shares of P100 par value ordinary shares Shares Distributable – capital account,
outstanding as of December 1, 2021. On normal balance is credit

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Equity & Statement of Financial Position

Illustration: The accounts below appeared in (Shareholders’ Equity section)
the Dec. 31, 2021 trial balance of the Wow - The equity section of the statement
Corporation: of financial position of a corporation
Ordinary Shares, P20 par, 50,000 shares is called shareholders’ equity or
authorized, 22,000 shares issued stockholders’ equity and is
P440,000 generally composed of Contributed
Subscriptions Receivable Capital and Retained Earnings.
23,000
Subscribed Ordinary Shares 1. Contributed Capital. It represents
33,000 corporate capital arising investment
Retained Earnings by shareholders. It is further divided
200,000 Share Premium into two sections:
75,000 a. Legal Capital. This section
Treasury Stock, 1,500 shares, at cost reports both preference
30,000 (preferred) and ordinary
(common) shares issued,
Determine the following: subscribed, and distributable
Total authorized ordinary shares as dividends, stated at par or
P1,000,000 stated value. In case of share
Total unissued ordinary shares capital without par value nor
560,000 Total issued ordinary shares stated value, the amount
440,000 Ordinary shares reported is the total value of
subscribed 33,000 Total consideration received in
shareholders’ equity 695,000 exchange for the shares.
b. Share Premium. This section
reports investment by
shareholders in excess of the
par or stated value of the
share capital. It includes
paid-in capital in excess of
par value or stated value
(share premium) of both
preference and ordinary
shares.
Number of shares issued
22,000 2. Retained Earnings (Earned Surplus).
Number of shares subscribed It represents the undistributed
1,650 earnings of the corporation. It
Number of shares in treasury represents the capital of the
1,500 corporation arising from its
Number of outstanding shares operations. The Retained Earnings
20,500 account has a normal credit balance.
A debit balance in the account is
Statement of Retained Earnings, called a deficit. The balance of the
Statement of Changes in Shareholders’

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account is generally divided into two I. Prepare journal entries to record the
parts, as follows: foregoing transactions.
a. Appropriated Retained II. Prepare the retained earnings
Earnings. It is the portion of statement for 2021.
Retained Earnings set aside
for a specific purpose.
b. Unappropriated Retained
Earnings. It is the portion of
Retained Earnings available
for distribution as dividends
to the shareholders. It is
normally described as
“unrestricted earnings.”

Illustration 1: The shareholders’ equity of

Angry Corporation at January 1, 2021
appeared below:

Ordinary shares, P25 par, 500,000 shares

authorized, 80,000 shares issued
and outstanding
P2,000,000
Share Premium
6,310,000 Retained Earnings
2,650,000

During 2021, the following transactions

occurred:
Jul 7 Declared a 15% share dividend; the
market value of the ordinary shares was
P120 per share.
28 Issued the share dividend declared
on June 7.
Dec 5 Declared a cash dividend of P15 per
share.
26 Paid the cash dividend declared on
Dec. 5.
31 Closed profit of P1,560,000 from the
income
summary account to retained
earnings.
31 Closed the dividend accounts to
retained
earnings.

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Dec 18 Declared a cash dividend of P2.00

Illustration 2: The shareholders’ equity per
section of Sad Corporation at December 31, outstanding ordinary share, payable
2021, follows: on Jan.
9 to shareholders of record on Dec.
Ordinary Shares, P15 par, 200,000 shares 31.
authorized, 75,000 shares issued, 7,000 31 Closed the income summary
shares are in the treasury account, with
P1,125,000 profit of P303,000 to retained
Share Premium Earnings.
425,000 31 Closed the dividend accounts to
Share Premium-Treasury retained
15,000 earnings.
Retained Earnings
250,000 I. Prepare journal entries to record the
Total foregoing transactions.
1,815,000 II. Prepare the statement of changes in
Less: Treasury Stock, 5000 shares at cost shareholders’ equity for 2021.
120,000 III. Prepare the shareholders’ equity
Total Shareholders’ Equity section of the statement of financial
P1,695,000 position as of December 31, 2021.

Note: A portion of retained earnings is

restricted due to the purchase of treasury
shares.

The following transactions affecting

shareholders’ equity occurred during 2021:

Jan 8 Issued 20,000 shares of previously

unissued ordinary shares for P30
cash per share.
Mar 12 Sold all of the treasury shares for
P28 cash
per share.
Jun 30 Declared a 5% share dividend on all
outstanding ordinary shares. The
market
value of the share was P25 per
share.
Jul 10 Issued the share dividend declared
on June
30.
Oct 7 Acquired 1,200 ordinary shares for
the
treasury at P30 per share.

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Pro-forma Financial Statements of a

Corporation

Trial Balance

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Worksheet

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Statement of Financial Performance Statement of Financial Position (Balance

(Income Statement) Sheet)

Statement of Changes in Shareholders’

Equity

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Adjusting Entries Reversing Entries

Closing Entries

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