CHAPTER 6

ADJUSTMENTS ARE JOURNALIZED AND POSTED (STEP 7) 4. CLOSE THE WITHDRAWAL ACCOUNT

The adjustment process is a key element of accrual basis The withdrawal account shows the amount by which capital is
accounting. This worksheet helps in the identification of the reduced during the period by withdrawals of cash or other
accounts that need adjustments. The adjusting entries are assets of the business by the owner for personal use.
directly entered in the worksheet. Most accountants prepare
the financial statements immediately after completing the
worksheet. The adjustments are journalized and posted a the PREPERATION OF POST-CLOSING TRIAL BALANCE
closing entries are made. This step in the accounting cycle
brings the ledger into agreement with the data reported in It is possible to commit an error in posting the adjustments
the financial statements. and closing entries to the ledger accounts; thus, it is
necessary to test the equality of the accounts by preparing a
new trial balance.
CLOSING ENTRIES ARE JOURNALIZED AND POSTED (STEP 8) POST-CLOSING TRIAL BALANCE. Final trial balance.
INCOME, EXPENSE AND WITHDRAWAL ACCOUNTS are - POST-CLOSING TRIAL BALANCE verifies that all the
temporary accounts that accumulate information related to a debits equal the credits in the trial balance.
specific accounting period. - TRIAL BALANCE contains only the balance sheet
items, such as assets, liabilities, and ending capital
These temporary accounts facilitate income
because all income and expense accounts, as well as
statement preparation. At the end of each year, the balances
the withdrawal account, have a zero balances.
of these temporary accounts are transferred to the capital
account. Thus, the balance of the owner’s capital account REVERSING ENTRIES (STEP 10)
represents the cumulative net result of income, expense, and
withdrawal transactions. Preparing the post-closing trial balance may not be the last
step in the accounting cycle. Some entities elect to reverse
certain end-of-period adjustments on the first day of the new
period.
TEMPORARY ACCOUNTS is said to be closed when an entry is
made such that its balance becomes zero. CLOSING simply REVERSING ENTRY- is a journal entry which is the exact
transfers the balance od one account to another account. In opposite of the related adjusting entry a=made at the end of
this case, the balances of temporary accounts are transferred the period. It is basically a bookkeeping technique made to
to the capital account. A SUMMARY ACCOUN-INCOME simplify the recording of regular transactions in the next
SUMMARY is used to close the income and expense accounting period.
accounts.

1. CLOSING THE INCOME ACCOUNTS

CHAPTER 7
Income accounts have credit balances before the closing
entries are posted. For this reason, an entry debiting each OPERATING CYCLE OF A MERCHANDISING BUSINESS
revenue account in the amount of its balance is needed to The merchandising entity purchases inventory, sells the
close the account. The credit is made to income summary inventory and uses the cash to purchase more inventory and
account. the cycle continues, for cash sales, the cycle is from cash to
2. CLOSE THE EXPENSE ACCOUNTS inventory and back to cash. For sales on account, the cycle is
from cash to inventory to accounts receivable back to cash, in
Expense accounts have debit balances before the closing any industry, the manager strives to shorten the cycle. The
entries are posted. For this reason, a compound entry is faster the sale of inventory and the collection of cash, the
needed crediting each expense account for its balance and higher the profits.
debiting the income summary for the total.
FIG. 1 (CASH SALES)
3. CLOSE THE INCOME SUMMARY ACCOUNT CASH-PURCHASES-INVENTORY-CASH SALES (REPEAT)
After posting the closing entries involving the income and
FIG. 2 (SALES ON ACCOUNT)
expense accounts, the balance of the income summary
CASH-PURCHASES-INVENTORY-ACCOUNTS RECEIVABLE
account will be equal to the profit or loss for the period.
(REPEAT)
SOURCE DOCUMENTS 8. PURCHASE ORDER

Merchandising businesses use various business forms and An authorization made by the buyer to the seller to deliver
documents to help identify the transactions that should be the merchandise as detailed in the form.
recorded in books. These source documents contain vital
9. RECEIVING REPORT
information that should be recorded in the books. These
source documents contain vital information about the nature Document containing information about goods received from
and amount of the transactions. a vendor. It formally records the quantities and description of
the goods delivered.
1. SALE INVOICE
10. CREDIT MEMORANDUM
Prepared by the seller of goods and sent to the buyer. This
document contains the name and address of the buyer, the Form used by the seller to notify the buyer that his account is
date of sale and information-quantity, description and price being due to errors or other factors requiring adjustments.
about the goods sold. It also specifies the amount of sales,
and the transportation and payment terms.

2. BILL OF LANDING STEPS IN A PURCHASE TRANSACTION

Document issued by the carrier a trucking, shipping, or airline 1. When certain items are needed, the user
that specifies contractual conditions and terms of delivery department fills in a purchase requisition and sends
such as fright terms, time, place, and the person named to it to the purchasing department.
received the goods. 2. The purchasing department then prepares a
purchase order after checking with the price lists,
3. STATEMENT OF ACCOUNT quotation, or catalogs of approved vendors. The
purchase order, addressed to select vendor,
A formal notice to the debtor detailing the accounts already
indicates the quantity, description, and price of the
due.
merchandise ordered. It also indicates expected
4. OFFICE RECEIPT payment terms and transportation arrangements.
3. After receiving the purchase order, the seller
Evidences the receipt of cash by the seller or the authorized
forwards an invoice to the purchaser upon shipment
representative. It noes the invoice paid and other details of
of the merchandise. The invoice called a sales
payment.
invoice by the seller and a purchase invoice by the
5. DEPOSIT SLIPS buyer defines the terms of the transaction.
4. Upon receiving the shipment of merchandise, the
Printed forms with depositor’s name, account number and purchaser’s receiving department sees to it that the
space for details of the deposit. terms in the purchase order are complied with, and
prepares a receiving point.
VALIDATED DEPOSIT SLIP
5. Before approving the invoice for payment, the
Indicates that cash and checks with the supplied details were accounts payable department compares copies of
actually deposited or creditor to the account holder. the purchase requisition, purchase order, receiving
report and invoice to ensure that quantities,
6. CHECK descriptions, and prices agree.
A written order to a bank by a depositor to pay the amount TERMS OF TRANSACTIONS
specified in the check from his check account to the person
named in the check. CREDIT PERIOD- Merchandise may be purchased
and sold either on credit terms for cash on delivery.
PAYOR (ISSUING THE CHECK) When goods are sold on account, with a period. This
PAYEE (RECIEVER) is allowed for payment.

7. PURCHASE REQUISITION When goods are sold on credit, both parties should have an
understanding as to the amount and time of payment. These
A written request to the purchaser of an entity from an terms are usually printed on the sales invoice and constitute
employee or user department of the same entity that goods part of the sales agreement. If the credit period is 30 days,
be purchased. then payment is expected within 30 days from the invoice
date. The credit period is usually described as the net credit leaves the seller’s place of business the shipping pint. The
period or net terms. The credit period of 30 days is noted as buyer already owns the goods while still in transit and
“n/30”. If the invoice is due ten days after the end of the therefore, shoulders the transportation costs.
month, it may be marked “n/10 eom.”

F. O. B. DESTINATION
CASH DISCOUNTS
- The seller bears the shipping cost. Title passes only when
cash discount is computed on the net amount after the trade the goods are received by the buyer at the point of
discount. This practice improves the seller’s cash position by destination; while in transit, the seller is still the owner of the
reducing the amount of money in accounts receivable. Cash goods, so the seller shoulders the transportation costs.
discount is designated by such notation as “2/10” which by
FREIGHT PREPAID
means the buyer may avail of a two percent discount if the
invoice paid within ten days from the invoice date. - The seller pays the transportation costs before shipping the
goods sold.
CASH DICOUNTS (Purchase discounts)
- Some business gives discounts for prompt FREIGHT COLLECT
payment.
- Cash discounts are called purchase discounts from - The freight entity collects from the buyer. Payment either
the buyer’s viewpoint. party will not indicate who should ultimately shoulder the
costs.
SALES DISCOUNT (from the seller’s viewpoint). Freight terms Who shoulders the Who pays the
transportation shippers?
DISCOUNT PERIOD- The period covered by the cost?
discount, in this case ten F. O. B. DESTINATION SELLER SELLER
days. , FREIGHT PREPAID
F. O. B. SHIPPING POINT, BUYER BUYER
FREIGHT COLLECT
TRADE DISCOUNTS
F. O. B. DESTINATION SELLER BUYER
, FREIGHT COLLECT
- Encourages the buyers to purchase products F. O. B. SHIPPING POINT, BUYER SELLER
because of markdowns from the list price. FREIGHT PREPAID
- Trade discounts should not be confused with cash
discounts. This type of discount enables the
SHIPPING COSTS BORNE BY THE SELLER ARE DEBITED TO
suppliers to vary prices periodically without the
TRANSPORTATION OUT ACCOUNT. THIS ACCOUNT WHICH
inconvenience of revising price lists and catalogs.
ALSO CALLED DELIVERY EXPENSE, IS AN OPERATING
There is no trade discount account and there is no special EXPENSE IN THE INCOME STATEMENT.
accounting entry for this discount.
DELIVERY EXPENSE-OPERATING EXPENSE (IS)
Instead, all accounting entries are based on the
invoice price which is obtained by subtracting the trade
discount from the list price. INVENTORY SYSTEM

- Merchandise inventory is the key factor in determining cost

TRANSPORTATION COSTS of sales. Because merchandise inventory represents goods
available for sale, there must be a method of determining the
The freight bill designates which party shoulders the costs,
quantity and the cost of these goods. There are two systems
and whether the shipment is freight prepaid or freight collect. available to merchandising entities to record events related
Freight bills usually show whether the shipping terms are FOB
to merchandise inventory: the perpetual inventory system
shipping point or FOB destination. and the periodic inventory system.

PERPETUAL INVENTORY SYSTEM

F. O. B. (Free On Board)
- An alternative to the periodic inventory system. Under the
F. O. B. SHIPPING POINT
perpetual inventory system, the inventory account is
- The buyer shoulders the shipping costs; ownership over the continuously updated. Perpetually updating the inventory
goods passes from seller to the buyer when the inventory
account requires that at the time of purchase.
- When an entity uses the perpetual inventory system, the MERCHANDISING INVENTORY
ending inventory should reconcile with the actual PHYSICAL
COUNT at the end of the period if no theft, spoilage, or error - The inventory of merchandising entity consists of
has occurred. goods purchased for resale. For a grocery store,
inventory would be made up of meats, vegetables,
PERIODIC INVENTORY SYSTEM canned goods, and other items.
- Merchandising entities purchase their inventories
- Primarily used by the business that sell relatively from manufacturers, wholesalers, and other
inexpensive goods that are not yet using computerized supplier.
scanning systems to analyze goods sold.
BEGINNING INVENTORY- The merchandise inventory at the
- Not computerized at all to recognized goods. beginning of the accounting period.
- No entries made to the inventories account.
- Inexpensive goods. ENDING INVENTORY- the merchandise inventory at the end
of the accounting period.
GROSS SALES

- Under accrual accounting, revenues from the sale of

merchandise are considered to be earned in the accounting NET COST OF PURCHASES
period in which the title of goods passes usually at the point
of delivery from the seller to the buyer. Gross sales consist of Under the periodic inventory method, net cost of purchases
total sales for cash and on credit during an accounting period. consists of gross purchases minus discounts and purchases
returns and allowances equals net purchases plus transaction
costs.

SALES RETURN AND ALLOWANCES (contra INCOME account)

Buyers may be satisfied with the merchandise PURCHASES

received either because the goods are damaged or defective,
of inferior quality or in accordance with their specifications. In - Temporary account
such cases, the buyer may return the goods to the seller for - Used only for merchandise purchased for resale.
credit if the sale was made on account or for cash refund if
sale was cash. Its sole purpose is o accumulate the total cost of merchandise
purchased during an accounting period. Purchases of other
Alternatively, the seller may just grant an allowance
assets such as equipment should be recorded in the
or deduction from the selling price. A high sales return s
appropriate asset accounts.
allowances figure is not commendable because it may signal
poor quality of goods and thus may result to dissatisfied
GROSS PRICE METHOD- Recording merchandise purchases at
customers.
invoice price.
CREDIT MEMORANDUM (ACCOUNTS RECEIVABLE OR CASH
IS CREDITED) which is a formal acknowledgement that the
seller has reduced the amount owed by the customer. OPERATING EXPENSES

Make up the third major part of the income statement for a

COST OF SALES (COST OF GOODS SOLD) merchandising entity. These are expenses, other than the
- The largest single expense of the merchandising cost of sales, which are incurred to generate profit from the
business. It is the cost of inventory that the entity has sold to entity’s major line of business-merchandising. It is customary
costumers. Every merchandising business has goods available to group operating expenses into useful categories.
for sale to costumers. The goods available for sale during the Distribution costs, administrative expenses and other
year is the sum of two factors merchandise inventory at the operating expenses are the categories.
beginning of the year and net cost of purchases during the
period. DISTRIBUTION COSTS (SELLING EXPENSES)

Those expenses related directly to the entity’s efforts to

generate sales. These include sales salaries and commissions,
and the related employer payroll expenses; advertising and
store dismays; traveling expenses; store supplies used;
depreciation of store property and equipment; and PREPARING THE WORKSHEET
transportation out.
The worksheet of a merchandising business is the same as
that of a service business except that is has to deal with the
new accounts related to merchandising transactions. These
ADMINISTRATIVE EXPENSES accounts include sales, sales returns and allowances, sales
discounts, purchases, purchases returns and allowances,
These expenses related to the general administration of the purchases discounts, transportation in, merchandise
business. These include officers and office salaries, and the inventory and transportation out.
related employer payroll expenses; office supplies used;
depreciation of office property and equipment; business TRAIL BALANCE COLUMNS. The first step in the preparation
taxes; professional services; uncollectible accounts expenses of the worksheet is to enter the balances from the ledger into
and other general office expenses. the trial balance columns.

OTHER OPERATING EXPENSES ADJUSTMENT COLUMNS. Under the closing entry method of
handling merchandise inventory, the adjusting entries for
These expenses that are not related to the central operations Christopher Biore Traders (Book Example) are entered in the
of the business. These are expenses and losses from adjustment’s columns in the same way that they were for
peripheral or incidental transactions of the enterprise, for service entities.
example, loss on sale of investments or loss on sales of
property and equipment. OMISSION OF ADJUSTED 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
CHAPTER 8 may be omitted.

A RELIABLE PHYSICAL ACCOUNT is very significant because INCOME STATEMENT AND BALANCE SHEET COLUMNS. After
the ending inventory amount affects both the income the trial balance columns have been totaled, the adjustments
statement and the balance sheet. For example, an entered, and the equality of the columns proved, the
understatement of ending inventory in the 2020 income balances are extended to the statement columns. Each
statement will cause an overstatement of ending inventory in account balance is entered in the proper column of the
the current period means that the beginning inventory of the income statement or balance sheet.
next period will also be understated. As a result of this error
or omission, the current assets and the owner’s equity in the
2020 balance sheet would be understated. In summary, an
error in valuing ending inventory will translate into one PREPARING THE FINANCIAL STATEMENTS
inaccurate balance sheet and two incorrect income
statements. INCOME STATEMENT

MERCHANDISE INVENTORY AT THE END OF THE PERIOD The discussion on the major parts of the income statement
for a merchandising entity has been made in the previous
At the end of the period, entries are made to reflect in the chapter. The statement may be prepared by referring to the
inventory account the ending balance. The objectives of these income statement columns of the worksheet. Per revised PAS
entries are as follow: No. 1, an enterprise should present an analysis of expenses
using a classification based on either the nature of expenses
a. To remove the beginning balance from the on their function within the entity, whichever provides
merchandise inventory account and to transfer it information that is reliable and more relevant. Entities are
into summary. encouraged to present the analysis of expenses on the face of
b. To enter the ending balance in the merchandise the income statement.
inventory account and to establish it in the income
summary.
NATURE OF EXPENSE METHOD The sum all the individual balances in the accounts
receivable subsidiary ledger must equal the balance in the
Expenses are aggregated or combined in the income accounts receivable control account in the general ledger. For
statement according to their nature and are not reallocated every amount posted to the accounts receivable control
among various functions within the entity. This method is account, an equal amount must be posted to one or more of
simple to apply in many smaller enterprises because no the customers’ accounts in the accounts receivable subsidiary
allocation of operating expenses between functional ledger.
classifications is necessary.

SPECIAL JOURNALS
FUCTION OF EXPENSE METHOD
These are journals of original entry other than the general
This method, also referred to as the “cost of sales” method, journal that are designed for recording specific types of
classifies expenses according to their functions as part of cost transactions of a similar nature.
of sales, distribution/selling, administrative and other JOURNAL SPECIFIC TRANSACTIONS POSTING
operating activities. This presentation often provides RECORDED ABBREVIATION
Sale journal Sales of merchandise on S
information that is more relevant to users than the nature of account
expense method but the allocation of costs to functions can Cash receipts journal Receipts of cash CR
be arbitrary and involves considerable judgement. This Purchases journal Credit purchases of P
merchandise and other
method provides multiple classifications and intermediate items
differences to highlight significant relationships. Cash disbursements Payments of cash CD
journal
General journal Entries that do not fit in GJ
GROSS PROFIT- the difference between net sales and cost of
the other journals
sales.
CASH SALES
POST-CLOSING TRIAL BALANCE
Recorded in the cash receipts journal rather than in the sales
A final trial balance is prepared to test the equality of the journal because cash is best controlled when all routine cash
accounts after posting the adjusting and closing entries. This receipts are recorded in one journal.
trial balance is similar to the one discussed in the service
business except for the addition of the merchandise
inventory account.
ADVANTAGES OF USING SPEACIAL JOURNALS

A major advantage of special journals is that their

CHAPTER 9 use permits division of labor. When special journals are used,
the recording step in the accounting cycle can be divided
CONTROL ACCOUNTS AND SUBSIDIARY LEDGERS among several persons, each of whom is responsible for
particular types of transactions. Personnel making entries in
The general ledger is kept to a manageable size, and
special journals need not have a through knowledge of the
a detailed record of transactions with individual costumers
entire accounting system.
exists in the subsidiary ledger. It is a controlling account in the
sense that its balance should equal to total of the individual The use of special journals often reduces recording
account balances in the subsidiary ledger. The individual time. Special journal transactions need no routine
customer accounts are the subsidiary accounts. They are explanations for each entry. Also, because special column
controlled by the accounts receivable account in the general headings are used, account titles need not be prepared unlike
ledger. in the general journal. Probably the most significant
advantage of using special journals is the time saved in
The accounts receivable subsidiary ledger, like the
posting from the journals to the ledger. When a general
general ledger, may simply be a group of accounts in a binder,
journal is used, each entry must be posted separately to the
or it may e a file card arrangement. In either case, the order is
general ledger. The tabular arrangement of special journals,
either numerical by customer number or alphabetical by
however, often permits all entries to a given account in a
customer name.
specific journal to be added and posted as a single aggregate
posting.
SLES JOURNAL PROVIDING THE LEDGERS

This journal is specially designed to record sales of At the end of the period, after all postings have been made,
merchandise on account. In contrast, cash sales are recorded equality should exist between the following:
in the cash receipts journals. Credit sales of assets other than
merchandise inventory. - Total debit balances and total credit balances of the
accounts in the general ledger. These amounts are
Amounts recorded in the sales journal are posted used to prepare the trial balance.
daily to the subsidiary ledger to keep a current record of the - The balance of the accounts receivable control
accounts receivable from each customer. Daily posting account in the general ledger and the sum of
permits the business customer inquires promptly. A check individual customer accounts in the accounts
mark (/) is placed in the posting reference column of the sales receivable subsidiary ledger.
journal to signify that the amount has been posted to the - The balance of the accounts payable control account
customer’s account in the subsidiary ledger. in the general ledger and the sum of individual
creditor accounts in the account’s payable subsidiary
At the end of the month, when all sales have been ledger.
recorded and the sales journal has been totaled and ruled,
the sales figure is posted to the general ledger as a debit to This control procedure is important because this helps ensure
the accounts receivable control account and as a credit to the the accuracy of the accounting records.
sales account. Note the double posting reference at the
bottom of the sales journal; this indicates that accounts
receivable account no. 120 in the general ledger and sales in
account no. 410. 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
CASH RECEIPTS JOURNAL labor. These journals should be designed to fit the business
for which they are used.
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 June 30, debiting cash and VOURCHER SYSTEM
crediting ales, recorded cash sales for a certain period. In
practice, cash sales, which are usually supported by cash Most entities control purchases and cash
register tapes, should be recorded daily rather than semi- disbursement by formalizing the process of verification and
monthly. 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,
PURCHASES JOURNAL voucher register, unpaid file, check register and paid voucher
file. The voucher register takes the place of the purchases
Merchandising business frequently purchase merchandise journal while the check register substitutes the cash
and supplies. Such purchases are usually made on account. disbursement journal.
The purchases journal is designed to account for purchases of
merchandise, supplies and other on account. In contrast, VOUCHER
cash purchases are recorded in the cash disbursements
journal. The voucher is a serially numbered form that identifies the
name and address of the payee, the due date, terms,
GENERAL JOURNAL description, and invoice amount. This form includes a section
for designated officers to sign their approval for payment. It
When special journals are used, transactions that cannot be also has spaces for details such as the date of payment, check
recorded appropriately in a special journal are recorded in number and ledger entries.
the general journal. Examples include merchandise returns;
write-offs of uncollectible accounts; and certain non-cash
transactions involving notes receivable and notes payable.
VOUCHER REGISTER voucher is canceled, and new vouchers are prepared. The
cancellation of the original voucher and the issuance of new
As noted, the voucher register takes the place of the vouchers can be recorded in the same way that purchases
purchases journal and provides a record of all authorized returns are recorded.
check payments. In a voucher system, all expenditures are
recorded first in the voucher register. COMBINATION JOURNAL

UNPAID VOUCHER FILE Combination journal provides the cornerstone for a simple
yet effective accounting system in many small entries. This
The voucher registers have columns to record journal combines features of the general journal and the
payment date and check number, which are entered when special journals in a single record. If a smell business entity
the voucher is paid. After vouchers have been entered in the has enough transactions to make the general journal difficult
voucher register, they are filed in the order of required date to use but too few transactions to make it worthwhile to set
of payment. In this way, the entity will not miss discounts, up special journals, the combination journal offers a solution.
and its credit standing will not be impaired. When a voucher This journal is used most often in small professional offices
is processed, the due date is written on the face of the and small services business.
voucher for filling 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
contains no entries. This total should agree with the total of
vouchers in the unpaid file and, at the end of the month, with
the amount in the accounts payable account.

CHECK REGISTER

Check is 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 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.

PAID VOUCHER

Along with its supporting documents are filled in numerical

sequence in a paid vouchers file. This file is then available for
examination by internal or external auditors requiring
information about a specific information about a specific
expenditure.

RECORDING PARTIAL PAYMENTS

When installment or partial payments are made on invoices,

a sperate 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 installments, the original