Table of Contents

Topic 1: Inventory System of Merchandising Operation............................................................................1

Pro-porma Journal entry of the inventory system.....................................................................................2
Exercises: Inventory System.....................................................................................................................10
Topic 2: Statement of Comprehensive income of Merchandising...........................................................12
Trade discounts.........................................................................................................................................13
Cash discounts...........................................................................................................................................15
Exercises: Discounts..................................................................................................................................17
Cost of goods sold statement...................................................................................................................19
Exercises: Income Statement of Service Industry....................................................................................21
Topic 3: Completing the Accounting Cycle of Merchandising Entity........................................................24
Adjustments..............................................................................................................................................26
Exercises: Completing the Accounting Cycle............................................................................................33
References.................................................................................................................................................35
 FOREWORD
Module II focuses on the Accounting for Merchandising Businesses. Its main objective is to
introduce the concept of accounting for inventory in a business setup. This module will help the
reader to understand the difference between the Service entity and the Merchandising entity,
and will also help them to understand more the significant accounting policies of the latter.

This unit is composed of only one unit and its main focus is to discuss on how to account the
transactions in a Merchandising Operation. The Units starts by introducing the essential
questions and the intended learning outcome of the module, its goal is to give the reader a
picture of what will be discussed in this particular learning material. Then, the lesson begins by
explaining that the main difference of Merchandising entity and Service entity is the
Merchandise inventory, the discussion proceeds with the Inventory system used in recording
the inventory, in this part the two method of recording inventory will be discussed thoroughly.
After discussing the inventory system, the discussion proceeds in comparing the Income
statement of Merchandise and Service entity, the significant effect of inventory in it, and the
journal entry that is unique in the merchandising entity such as Sales, Purchases, and the
related contra accounts of the two. Lastly, after discussing the topics mentioned above, the
Module closes by discussing the complete accounting cycle of a merchandising inventory, the
discussion includes the additional closing and adjusting entry that is unique to Merchandising
entity, the usage of Special journal and Ledger in accounting for cash receipts, receivables and
cash disbursements, and additional concepts that is not present in the Accounting Cycle for
service industry.

To facilitate learnings, practice sets, both practical and theoretical, are included at the end of
each major topic. After reading this module, the readers are expected to have an understanding
and technical capabilities in accounting transactions and events of a merchandising entity,
Unit II: Merchandising Operation
Introduction: This unit discusses
 The basic concept of accounting for merchandising entity
 Inventory systems of merchandising entity
 The difference in financial statements service and merchandising entity

Essential Questions
 What are the basic journal entries used in merchandising entity?
 What are the different inventory systems use in recording the inventory?
 How to compute the inventory of a merchandising entity?
 What is the difference between the financial statements of service and merchandising
entity?

Intended learning outcomes

 Discuss the Perpetual and Periodic system in recording inventory
 Discuss the financial statements of Merchandising entity
 Discuss the different computation use in computing the inventory

Topic 1: Inventory System of Merchandising Operation

The main difference between the service industry and the merchandising industry lies primarily
in the presence of the merchandise inventory. Under the service industry, the entity is offering
service to the customer as a primary source of revenue, while in the merchandising industry,
the entity offers products or goods to customer as a primary source of income.

Since this module focuses in the Merchandising entity it is important for us to know how an
entity purchases their inventory.

The procedures to purchase inventory 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 to be sent to supplier.
3. After receiving the purchase order, the seller/ supplier then forwards an invoice to the
purchaser upon shipment of goods
The invoice—called a sales invoice by the seller and a purchase invoice by the buyer---
defines the terms of the transaction.
4. Upon receiving the goods, the purchaser's receiving department sees to it that the
terms in the purchase order are complied with, and prepares a receiving report.

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 5. Before paying the invoice, the accounts payable department compares the purchase
requisition, purchase order, purchase invoice and receiving report to ensure that
quantities, descriptions, and prices agree.

Merchandise Inventory consists of goods purchases for resale. It is a real account; therefore, it
is found in the balance sheet of the entity.

After purchasing the inventory, the entity needs to record the transaction, that is the time the
entity applies inventory systems. The entity can choose between Perpetual Inventory System,
and Periodic Inventory System.

Perpetual Inventory System

 Under this system, the inventory account is continuously updated.
 Stock cards, or accounting software is being used to update the inventory in every
purchases and sales.
 Even if there is running inventory record there is still a need for Inventory count at year
end to check the accuracy of the records.
 Advisable to be used by firms that sell low-volume, high-priced goods such as jewelry
and furniture.

Periodic Inventory System

 Under this system, the inventory account is not continuously updated.
 Inventory count at year end is required to know the end balance of the inventory.
 More advisable for firms that sell high-volume, low-priced goods such as hardware.

Note: If the problem is silent use the PERIODIC INVENTORY SYSTEM in recording the inventory

Pro-porma Journal entry of the inventory system

Perpetual Inventory System Periodic Inventory System
1. Recording of Purchase 1. Recording of purchase
Merchandise Inventory xx Purchases xx
Cash/Accounts Payable xx Cash/Accounts Payable xx
2. Recording of Purchase returns and allowances 2. Recording of Purchase returns and allowances
Cash/Accounts Payable xx Cash/Accounts Payable xx
Merchandise Inventory xx Purchase returns and allowances xx

3. Recording of Sales 3.Recording of Sales

Cash/Accounts Receivable xx Cash/Accounts Receivable xx
Sales xx Sales xx
Recording the outflow of inventory
Cost of good sold xx
Merchandise Inventory xx
4. Recording of sales return 4. Recording of Sales return

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 Sales Return xx Sales Return xx
Cash/Accounts Receivable xx Cash/Accounts Receivable xx
Recording the inflow of inventory
Merchandise Inventory xx
Cost of goods sold xx
5. Recording of sales allowance 5. Recording of sales allowances
Sales allowances xx Sales allowances xx
Cash/Accounts Receivable xx Cash/Accounts Receivable xx
6. Recording of freight when buying inventory 6. Recording of freight when buying inventory
Merchandise Inventory xx Freight in xx
Cash /Accounts Payable xx Cash/Accounts Payable xx
7. Recording freight when selling inventory 7. Recording freight when selling inventory
Freight out xx Freight out xx
Cash/Accounts Payable xx Cash/Accounts Payable xx

Explanations to the Journal Entry

1.Recording of purchase
Assuming that on January 3, the entity purchase P5,000,000 worth of goods.

 Perpetual – Since under the perpetual system inventory is being updated from time to
time, every purchase requires debit to inventory to update the inventory.
Journal Entry
Merchandise Inventory 5,000,000
Accounts Payable 5,000,000

 Periodic- Inventory account is not updated from time to time when using period system,
therefore an account Purchases is being used to record every purchase.
Journal Entry
Purchases 5,000,000
Accounts Payable 5,000,000

2.Recording of Purchase returns and allowances

Purchase returns
 The amount of inventory that was returned to the supplier.
 There is physical flow of inventory
 Recorded as deduction to inventory.

Assuming that on January 5, P500,000 worth of inventory was returned to the supplier because
of defect.

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  Perpetual- Purchase returns are deduction to inventory that is why merchandise
inventory is being credited.
Journal Entry
Accounts Payable 500,000
Merchandise Inventory 500,000

 Periodic- Under periodic, a contra purchases account is being recorded.

Journal Entry
Accounts Payable 500,000
Purchase Returns 500,000

Purchase allowance
 Reduction to price given to the entity because of inferior quality of goods received.
 There is no physical flow of inventory, only deduction to the price.
 Recorded as reduction to inventory

On January 6, the entity was given a price reduction of P200,000 resulting from some defect on
inventory purchased.

 Perpetual- Purchase allowances are deduction to the cost of inventory that is why
merchandise inventory is credited
Journal Entry
Accounts Payable 200,000
Merchandise Inventory 200,000

 Periodic- Under periodic, a contra purchase account is being recorded.

Journal Entry
Accounts Payable 200,000
Purchase allowances 200,000

3. Recording of Sales
On January 25, the entity sold merchandise costing P400,000 for P2,000,000. The sales were on
account.

 Perpetual- The first entry is the recording of Sales. While the second entry is the
recording of the outflow of the inventory following the concept that in Perpetual
system, inventory account is being updated every time there is a movement of
inventory.
Journal Entry
Accounts Receivable 2,000,000
Sales 2,000,000
#
Cost of goods sold 400,000
Merchandise Inventory 400,000

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 #

 Periodic – the only entry is to record the Sales. Under periodic system, inventory is not
updated when there is movement of inventory.
Journal Entry
Accounts Receivable 2,000,000
Sales 2,000,000

4. Recording of Sales return

Sales return
 The amount of inventory return to the entity by the purchaser
 There is an actual physical flow of inventory

On January 27, the customer returned inventory with a selling price of P500,000. The cost of
the inventory is P100,000.

 Perpetual- the first entry is to record the sales return as a contra sales account. The
second entry is to record the inflow of inventory resulting from the return of
merchandise.

Journal Entry
Sales Returns 500,000
Accounts Receivable 500,000
#
Merchandise Inventory 100,000
Cost of goods sold 100,000
#

Note: The sales return should be recorded at selling price while the inventory should be
recorded at cost.

 Periodic- the only journal entry made was to record the sales return as a contra sales
account.

Journal Entry
Sales Returns 500,000
Account Receivable 500,000

5. Recording of Sales allowances

Sales allowances

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  Deduction in price given to the customer resulting from inferior quality of sold
inventory.
 There is no actual physical flow of inventory, just deduction in the sales price.

 Perpetual – the only entry required is to reduce the sale price by establishing a contra
sales account. Since there is no actual physical flow of inventory, the cost of goods sold
and merchandise account is not use to record the sales allowance.
The main difference between sales return and sales allowance, is that in sales return
there is actual receipt of inventory that is why merchandise inventory needs to be
updated, while in sales allowance there is no receipt of inventory only a deduction to
the price that’s why there is no need to adjust the value of inventory.

 Periodic- the only entry required is to record the reduce in sales price by establishing a
contra sales account.

6. Recording of freight in buying inventory

7. Recording of freight in selling inventory
Freight – transportation cost
In recording transportation cost it is important to understand these freight terms

Who is required to
Freight terms Who actually paid the freight?
pay the freight?
FOB Destination, Freight Prepaid Seller Seller
FOB Destination, Freight Collect Seller Buyer
FOB Shipping Point, Freight Collect Buyer Buyer
FOB Shipping Point, Freight Prepaid Buyer Seller
Explanation
FOB Destination means that the freight is required to be paid by the seller. FOB Destination
means that the ownership of goods will pass to the buyer upon reaching the destination of
the buyer, meaning the goods is still in the ownership of seller while in transit, thus the seller is
the one required to pay the transit because the goods is still in his name during travel time.

FOB Shipping Point means that the freight is required to be paid by the buyer. FOB Shipping
point means that the ownership of goods will pass to the buyer upon reaching the dock or the
shipping area, therefore while in transit the owner is already the buyer and making him the
one required to pay the freight because the goods is already in his name.

Freight Prepaid means that the freight was actually paid by the seller. The keyword here is
prepaid, since the seller is the one who sent the inventory then he is the one who paid the
freight in advance.

Freight collect means that the freight was actually paid by the buyer. The keyword here is
collect, the carrier is yet to collect the freight charges when the inventory arrives to the buyer.

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Note: If the problem is silent, the Freight term is Shipping point, Freight Collect.

In recording freight, it is important to take note of the following

1. Know the point of view of the problem. Are you a seller or buyer?
2. What is the freight terms?

To illustrate further let us use these problems.

Use the periodic inventory system in recording the transactions.

 On January 10, 2021 the entity purchases a goods under FOB Shipping point, Freight
collect. The goods cost P1,000,000. The entity paid the freight charges worth P10,000.

 On January 12, 2021 the entity purchase goods under FOB Shipping point, Freight
prepaid. The goods worth P3,000,000. The freight costs P30,000.

 On January 15,2021 the entity pays P1,500,000 for goods. The freight term is FOB
destination, Freight prepaid. The freight costs P60,000.

 On January 31,2021 the entity purchase P3,000,000 worth of inventory under FOB
Destination freight collect. The entity paid the P50,000 freight.

 February 3,2021 the purchase on January 10 was paid.

 February 10, 2021 the purchase on January 12 was paid

 February 15,2021 the purchase on January 31 was paid.

Journal Entry
Date Buyer's Point of View Seller's Point of View
January 10 To record the purchase To record the sale
Purchases 1,000,000 Accounts Receivable 1,000,000
Accounts Payable 1,000,000 Sales 1,000,000
To record the freight
Freight in 10,000 Analysis: The entry made was just to
Cash 10,000 record sales. There is no entry
regarding the freight because the
Analysis: Since we are using periodic one required to pay it is the buyer,
inventory system, Purchases is the and the one who actually paid it is
account title used to record purchase the buyer as well.
of inventory.
The freight term is FOB Shipping
point, it means that the buyer is the
one required to pay the freight that is

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 why Freight in was debited, while the
Freight collect means that the buyer
actually paid it that is why cash was
credited.

Compound Journal Entry

Purchases 1,000,000
Freight in 10,000
Account Payable 1,000,000
Cash 10,000

12 To record the purchase To record the sale

Purchases 3,000,000 Accounts Receivable 3,000,000
Accounts Payable 3,000,000 Sales 3,000,000

To record the freight To record the freight

Freight in 30,000 Accounts Receivable 30,000
Accounts Payable 30,000 Cash 30,000

Analysis: The freight term is FOB Analysis : The freight term is FOB
shipping point, therefore the buyer is Shipping points, thus the buyer is
the one required to pay the freight required to pay the freight that is
that is why we see a debit to freight why the freight out account was not
in, while the Freight prepaid means seen in the journal entry of the
that it is the seller who actually paid seller, but since the seller paid the
the freight charges that’s why we freight there is a credit to cash to
need to credit accounts payable to record the outflow of cash and a
record liability to seller since the debit to account receivable to record
seller paid the freight that was the receivable because the seller
suppose to be paid by the buyer. paid the freight that was supposed to
be paid by the buyer.
Compound Journal Entry
Purchases 3,000,000 Compound Journal Entry
Freight in 30,000 Accounts Receivable 3,030,000
Accounts Payable 3,030,000 Sales 3,000,000
Cash 30,000
15 To record the purchase To record the sale
Purchases 1,500,000 Cash 1,500,000
Cash 1,500,000 Sales 1,500,000
Analysis: The only entry made is to To record the freight
record the purchase. The Freight term Freight out 60,000
is FOB Destination, Freight prepaid, Cash 60,000
therefore the seller is required to pay Analysis: The freight term is FOB
the freight and actually paid the Destination; therefore, the seller is

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 freight as well. the one required to pay the freight
charges that is why freight out was
debited. Freight prepaid means that
the seller actually paid it, that is why
cash was credited.

Compound Journal Entry

Cash 1,440,000
Freight out 60,000
Sales 1,500,000
31 To record the purchase To record the sale
Purchases 3,000,000 Accounts Receivable 3,000,000
Accounts Payable 3,000,000 Sales 3,000,000
To record the freight To record the freight
Accounts Payable 50,000 Freight out 50,000
Cash 50,000 Accounts Receivable 50,000

Analysis: The freight term is FOB Analysis: FOB Destination means that
Destination, meaning the Seller is the the seller is the one required to pay
one who is required to pay the the shipping fee, that is why Freight
shipping fee, that is why there is no out was recorded, but since Freight
recording of freight-in in the book of collect means that the buyer actually
the buyer. Freight collect means that paid the freight that was supposed to
the buyer actually paid the freight, be paid by the seller, the proper
that is why we see a credit to cash to entry to account this is to reduce the
decrease the cash and a debit to account receivable from the buyer.
accounts payable to reduce the
payable to the seller because the Compound Journal Entry
buyer paid the freight that was Accounts Receivable 2,950,000
supposed to be paid by the seller. Freight out 50,000
Sales 3,000,000
Compound Journal Entry
Purchases 3,000,000
Accounts Payable 2,950,000
Cash 50,000
February 3 Accounts Payable 1,000,000 Cash 1,000,000
Cash 1,000,000 Accounts Receivable 1,000,000
10 Accounts Payable 3,030,000 Cash 3,030,000
Cash 3,030,000 Accounts Receivable 3,030,000

Analysis: The total accounts payable is

computed by adding the 3,000,000
from purchase and 30,000 from
freight paid by the seller.

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 15 Accounts Payable 2,950,000 Cash 2,950,000
Cash 2,950,000 Accounts Receivable 2,950,000

Analysis: The total accounts payable is

computed by deducting the 50,000-
freight paid by the buyer to its
3,000,000-payable arising from the
purchase of inventory.
Note:
You can use either the simple journal entry or the compound journal entry because it will yield
the same answer.
If the problem is silent as to what freight term is, the freight term is FOB Shipping point, freight
collect.

Exercises: Inventory System

Problem 1
Assuming that there is an inventory sold/purchased on account worth P800,000 and a freight
charge of P70,000. What will be the entry on the following scenario?

Freight Terms Seller Buyer

FOB
Destination,
Freight
Prepaid
FOB
Destination,
Freight Collect

FOB Shipping
Point, Freight
Prepaid

FOB Shipping
Point, Freight
Collect

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Problem 2
The following transactions took place during the period:
May 1 Purchase of merchandise on account, P300,000. Freight cost is 10,000,
Freight terms: FOB Shipping point, freight prepaid
4 Return of merchandise amounting to, P30,000.
6 Sale of Merchandise on Account, P400,000, at a gross profit of 40% based on sales.
Freight terms: FOB Destination, freight collect
8 Return of merchandise amounting to, P25,000
9 Ending Balance of Merchandise inventory, P65,000
Required: Provide journal entry for all the transaction using both the point of view of seller and
buyer.

Problem 3
Valenzuela Trader has the following transaction during the year
February 1 Purchase merchandise on account 400,000, Freight cost is 20,000
Freight terms: FOB Shipping point, freight collect
5 Sale of merchandise on account with a selling price of 600,000 and cost of 300,000.
Freight cost is 40,000. Freight terms: FOB Destination, Freight collect
6 Purchase returns amounting to 10,000
8 Sales Return amounting to 40,000, the cost is 20,000
10 Purchase of Merchandise on account 500,000. Freight cost is 40,000
Freight terms: FOB Destination, Freight Collect
12 Payment of accounts payable on February 1 less returns on Feb.6
14 Collection of Receivable from Feb 5 less returns on Feb 8
18 Payment of accounts payable on Feb. 10

Required: Provide Journal entry for the Valenzuela trader using both the Perpetual and Periodic
Inventory System

Multiple choice
1. Which of the following is true?
a. The inventory account is updated every purchases and sales if the entity uses the
Periodic Inventory System
b. Purchases account is being used in the Perpetual Inventory System
c. Entities who have low quantity and expensive products are encouraged to use
the Periodic Inventory System
d. Entities who have large quantity and inexpensive products are encouraged to
use the Periodic Inventory System

2. Which of the following is false?

a. Freight prepaid means that the freight was paid by the seller
b. FOB shipping point means that the freight must be paid by the buyer
c. Freight collect means that the freight must be paid by the buyer

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 d. Freight collect means that the freight was paid by the buyer

3. Periodic inventory system

a. Uses the account title “Merchandise Inventory” in recording the purchase of
inventory
b. Uses the account title “Freight in” when recording freight paid upon sales of
merchandise
c. Uses the account title “Freight out” when recording freight paid upon purchase
of merchandise
d. Uses the account title “Purchases” in recording purchase of inventory

4. Perpetual inventory system

a. Uses the account title “Merchandise Inventory” in recording the purchase of
inventory
b. Uses the account title “Freight in” when recording freight paid upon purchase of
merchandise
c. Uses the account title “Freight out” when recording freight paid upon purchase
of merchandise
d. Uses the account title “Purchases” in recording purchase of inventory

5. Under the perpetual inventory system, in addition to the entry to record sale, an entity
would record the outflow of entry by:
a. Debit Ending Inventory Credit Beginning Inventory
b. Debit Cash Credit Sales
c. Debit Cost of Goods Sold and Credit Merchandise Inventory
d. No additional entry is required

Topic 2: Statement of Comprehensive income of Merchandising Entity

Comparison of Income Statements of Service and Merchandising Entity

SERVICE MERCHANDISING
Income Statement Income Stateme
Revenue from Service
Net sales
LESS LESS

Expenses Cost of goods sold

IS EQUAL TO IS EQUAL TO

Profit ADD/MINUS Gross Profit

Income/ Expense

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 IS EQUAL TO

Profit
Let us breakdown the income statement of the Merchandising entity into details
Gross Sales XX
Less: Contra Sales (XX)
Net Sales XX
Less: Cost of goods sold (XX)
Gross Profit XX
Less: Operating Expenses (XX)
Add: Other income XX
Net Income (Net loss) XX

1. Gross Sales – the total amount of sales of inventory

- consist of total sales for cash and on credit.
- only sales of merchandise held for resale are recorded as gross sales.

2. Contra sales
– Buyers may be dissatisfied with the merchandise received either because the goods
are damaged or defective, of inferior quality or not in accordance with their
specifications, those scenarios will result in returns and allowances. There are also times
where in the seller gives discount to the buyers.
- composed of sales return, sales allowance, and sales discount.
We already discussed the difference between sales return and allowance, and the
appropriate journal entry to record the two. Now let's focus in the concept of Sales
discount

Discounts – a price reduction given to customer for a certain reason. There are two types of
discount. The first one is the Trade discount and the second one is the Sales Discount.

Trade discounts
– A reduction to price given to customer to encourage the customer to avail or buy the
product.
Example: 10% off, 50% discount, buy one take one promo.

Trade discounts are not recorded in the book of the entity, meaning if you happen to give or
get a trade discount, such discounts will not be seen in the journal entry.

In computing trade discounts, one must understand the meaning of these terms.
List price – the original selling price
Invoice price – the price agreed by the buyer and seller.

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 List price xx
Less: Trade Discounts (xx)------------- List price x trade discount rate
Invoice Price xx ------------- List price x (100%-Trade discount rate)

Sample problem: The entity received cash for an inventory worth P5,000,000 with a 10% trade
discount. Compute the invoice price and make the appropriate journal entry.

Computation:
List price x Trade discount rate = Trade discount
5,000,000 x .10 = 500,000 trade discount

List price 5,000,000

Less: Trade discount (500,000)
Invoice Price 4,500,000

Shortcut
List price 5,000,000
X 90% ---- 100% less 10% trade discount rate
Invoice Price 4,500,000
It is important to compute the invoice price because it is the monetary value that you will
use in making journal entry. I prefer using the shortcut in computing the invoice price for the
reason that it is easier and also because the trade discount is irrelevant for most of the time
since it is unrecorded in the accounting records.
Seller's Journal Entry Buyer's Journal Entry
Cash 4,500,000 Purchases 4,500,000
Sales 4,500,000 Cash 4,500,000

Notice that in the journal entry there is no account title “Trade discounts”, always remember
that trade discounts are not recorded in the book of the seller nor in the book of the buyer.

Another sample problem: An entity sold an inventory worth P6,000,000 less 10% ,20%, 30%
Compute the invoice price and make the appropriate journal entry.
Computation:
6,000,000
X 60% ----- 10%+20%+30%= 60%
3,600,000 trade discounts.
Well, I think that most of you would probably do that computation, but I have to tell you that
that equation was wrong.
When you see a lot of trade discounts, adding them would lead you to a wrong answer,
because the right thing to do is to apply the discounts individually one after another.

The right equation is

6,000,000
X 90%-------- 100% less 10%- the first trade discount

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 5,400,000
X 80%----------100% less 20% - the second trade discount
4,320,000
X 70%-----------100% less 30%- the third and the last trade discount
3,024,000 – Invoice Price

Seller's Journal Entry Buyer's Journal Entry

Cash 3,024,000 Purchases 3,024,000
Sales 3,024,000 Cash 3,024,000
If there is more than one trade discount percentage, just apply the percentage one after
another, never ever add them to compute the total discount.

Cash discounts
– a discount given to encourage immediate or prompt payment from the customer.
The main difference between trade discount and cash discount is that the former's purpose is
to get more sales, while the latter's purpose is to collect the cash from previous credit sales.
Example
2/10, n/30 . 3/15, N/45

To better understand cash discount let us first discuss how to read the cash discount in the
problem.
You will often see 2/10, n/30 in a problem, but the question is how will you interpret such
figures?
Let us break down the illustration in to two parts. The first one talks about the discount and the
second one talks about the credit terms.

2/10 – The first digit is the discount rate, while the second digit is the discount period.
Meaning you will get 2% discount rate when you pay within the 10 days discount period.
N/30 – Means that the net credit term is 30 days. Meaning, the buyer is only allowed to pay
within 30 days.
So, 2/10, n/30 means that the buyer will receive 2% discount if he pays within 10 days, but if he
didn’t pay within 10 days it is still fine as long as he pays within 30 days, but in that case no
discount will be given.
If the customer pays 1-10 days = The customer is entitled to discount
If the customer pays 11-30 days= NO DISCOUNT
If the customer pays don’t pay within 30 days = the entity has enough doubt as to collectivity of
the account to set up an allowance for doubtful account as part of its adjusting entries.

Sample problems
On January 12, an entity sold merchandise for P5,000,000, terms 3/15 n/45.
On January 25, the entity received the payment for the January 12 transaction
On January 30, an entity sold merchandise for P6,000,000 terms 2/10 n/30
On February 11, the entity received the payment for January 30 transaction

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Journal Entry
Date Seller's Journal Entry Buyer's Journal Entry
January 12 Accounts Receivable 5,000,000 Purchases 5,000,000
Sales 5,000,000 Accounts Payable 5,000,000
25 Cash 4,850,000 Accounts Payable 5,000,000
Sales Discount 150,000 Cash 4,850,000
Accounts Receivable 5,000,000 Purchase Discount 150,000
Computation
5,000,000---- Invoice Price
X 3%----Cash discount rate
150,000---- Cash Discount

5,000,000--- Invoice Price

- 150,000----cash discount
4,850,000--- cash receipt
Explanation: The cash discount is base on invoice price. The sales were made on January 12,
the discount period of 15 days will expire on January 27, but the customer paid on January 25
which is still inside the discount period that is why he is entitled to 3% discount rate. One of
the main differences of the Trade discount and cash discount is that, the former is unrecorded
in the books while the latter is recorded in journal entry under the account title “Sales
Discount” for seller and “Purchase Discount” for the buyer.

Journal Entry
Date Seller's Journal Entry Buyer's Journal Entry
January 30 Accounts Receivable 6,000,000 Purchases 6,000,000
Sales 6,000,000 Accounts Payable 6,000,000
February 11 Cash 6,000,000 Accounts Payable 6,000,000
Accounts Receivable 6,000,000 Cash 6,000,000
Explanation: The January 30 transaction is under the term 2/10 meaning that if the buyer pays
within 10 days, he is entitled to a 2% discount, thus the payment date February 11 is already
outside the discount period of 10 days that's the reason why he did not get any discount.

Another sample problem

On January 15, the entity sold P5,000,000 worth of inventory less 10, 30, 40. Terms 3/15 N/45.
On January 25, the payment was received.

Journal Entry
Date Seller's Point of view Buyer's point of view
January 15 Accounts Receivable 1,890,000 Purchases 1,890,000
Sales 1,890,000 Accounts Payable 1,890,000
Computation
List price 5,000,000

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 X 90%------- 100% less 10%-- first trade discount
4,500,000
X 70%------- 100% less 30% --- second trade discount
3,150,000
X 60%--------100% less 40%---- third trade discount
1,890,000----Invoice Price

Journal Entry
Date Seller's Point of view Buyer's point of view
January 15 Cash 1,833,300 Accounts Payable 1,890,000
Sales Discount 56,700 Cash 1,833,300
Accounts Receivable 1,890,000 Purchase Discounts 56,700
Computation
Invoice price 1,890,000
X 3% ------Cash discount rate
56,700------Cash discount

Invoice Price 1,890,000

Cash discount (56,700)
Cash Payment 1,833,700

Exercises: Discounts

Problem Solving
Problem 1
ABC Merchandiser has the following transaction during the period:
The list price of merchandise purchased merchandise on account, P800,000 less 20% and 10%,
with credit terms of 2/10, n/30. Compute and Journalize the transaction using the following
assumptions
a. Assume that payment is made within the discount period:
b. Assume that payment is made beyond the discount period:

Problem 2
Transactions for the Faith bookstore for May 2020 follows:

May. 2 Purchased merchandise on credit from ABC Publishers, terms 2/10, n/30, FOB
destination, P84,000.
3 Sold Merchandise on credit to Love Books Shop, terms 1/10, n/30, FOB shipping
point, P100,000.
5 Sold merchandise for cash, P7,000.
6 Purchased and received merchandise on credit from Hope Bookstore, terms 2/10,
n/30, FOB shipping point, P52,000.
7 Received freight bill from Super Express from shipment received on Mar. 6, P570.

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 9 Sold merchandise on credit to Recoletos Books, terms 1/10, n/30, FOB destination,
P58,000.
10 Purchased merchandise from ABC Publishers, terms 2/10, n/30, FOB shipping
point, P36,500, including freight costs of P500.
11 Received freight bill from Super Express for sale on Mar. 9, P291.
12 Paid ABC publishers for purchase of Mar. 2.
13 Received payment in full for Love Book Shop’s purchase of Mar. 3.
14 Paid Hope Bookstore half the amount owed on the Mar. 6 purchase. A discount is
allowed on partial payment.
15 Returned faulty merchandise worth P5,000 to ABC Publishers for credit against
purchase of Mar. 10
16 Purchased Office supplies from Okay Supplies for P6,780, terms n/10.
17 Received payment from Recoletos Books for half of the purchase of Mar. 9. A
discount is allowed on partial payment.
18 Paid ABC publishers in full for amount owed on purchase of Mar. 10, less return on
Mar. 15.
19 Sold merchandise to Manila Traders on credit, terms 2/10, n/30, FOB shipping
point, P7, 800.
20 Returned for credit several items of office supplies purchased on Mar. 16, P1,880.
22 Issued a credit memo to Manila Traders for returned merchandise, P1,800
25 Paid of purchase on Mar, 16, less returns on Mar. 20.
26 Paid freight entity for freight charges for Mar. 7 and 11.
27 Received payment of amount owed by Manila Traders for purchase of Mar. 19,
less credits of Mar. 22
28 Paid Hope Bookstore for the balance on Mar. 6 purchase.
31 Sold merchandise for cash, P9,730.
Required: Prepare the journal entries.

Problem 3
ABC Merchandiser has the following transaction during the period:
The invoice price of merchandise purchased merchandise on account, P600,000 20% and 10%,
with credit terms of 2/10, n/30.
1. Compute for the list price
2. Provide journal entry assuming the following (Use both seller and buyer’s point of view)
a. The buyer paid within the discount period
b. The buyer paid after the expiration of discount period

3. Net sales – the amount computed after deducting contra sales account to the gross
sales.
Gross Sales xx
Less: Sales Returns (xx)
Sales Allowances (xx)
Sales Discounts (xx)
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 Net Sales xx

4. Cost of goods sold

 -The largest single expense of the merchandising business
 -It is the cost of inventory that the entity has sold to customers
 -recorded at cost

Cost of goods sold statement

Beginning Inventory xx
Add: Gross Purchases xx
Less: Purchase Returns (xx)
Purchase allowances (xx)
Purchase discounts (xx)
Net purchases xx
Add: Freight in xx
Net cost of purchases xx
Total goods available for sale (TGAS) xx
Less: Ending inventory (xx)
Cost of goods sold (COGS) xx
Sample problem
The entity reported the following during the period
Beginning Inventory 6,000,000
Purchases 4,000,000
Purchase returns 1,000,000
Purchase allowances 500,000
Ending inventory 400,000
Freight in 600,000
Freight out 500,000
Requirement: Compute for the COGS
Solution
Beginning Inventory 6,000,000
Add: Gross Purchases 4,000,000
Less: Purchase Returns (1,000,000)
Purchase discounts 0
Purchase allowances (500,000)
Net purchases 2,500,000
Add: Freight in 600,000
Net cost of purchases 3,100,000
Total goods available for sale(TGAS) 9,100,000
Less: Ending inventory (400,000)
Cost of goods sold (COGS) 8,700,000
Note: Freight out is excluded in the COGS because it is
part
19 | Pofaexpenses.
ge
 5. Gross profit – computed by deducting Cost of goods from Net sales. It is the initial
profit of the entity before deducting expenses not directly related to the product being
sold.
Net Sales xx
Cost of Goods Sold xx
Gross profit xx

6. Operating Expenses – these are expenses, other than the cost of sales, which are
incurred to generate profit from the entity's major line of business. Consist of
Administrative or general expenses, Selling or Distribution expenses, and other
expenses.

 Selling or Distribution expense- cost incurred directly related to the entity's

effort to generate sales. These includes any expenses incurred inside the store,
including depreciation of the store itself and furniture inside of it, sales agent
commission and salaries, depreciation of delivery truck, Doubtful account
expense if the collection authority is vested in the sales manager, advertising
expense, and freight out.

 Administrative or general expense- are those expenses related to the general

administration of the business. These includes any expenses incurred inside the
office, including the officer and office salaries, depreciation of the office building
or rent of office building, accountant's salary, Doubtful account expense if silent.
If expenses have no info whether where it was incurred it is assumed that it was
incurred for administrative purposes, meaning if the expense has no designation
it is considered to be part of admin expense.

 Other expense – are those expenses not related to the central operations of the
business. These are losses from incidental transactions such as loss on sale of
investments or loss on sale of equipment.

Sample problem
The entity showed the following data as of the year end
Depreciation Expense 5,000,000
Rent expense 4,000,000
Salesman Salary 3,000,000
Doubtful account expense 4,000,000
Freight out 1,000,000
Prepaid rent expense 3,000,000

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 Compute the admin and selling expense.
Computation
Admin expense:
Depreciation Expense 5,000,000
Rent Expense 4,000,000
Doubtful account expense 4,000,000
Administrative Expense 13,000,000

Since depreciation and rent expense was silent, there Is no indication where it was
incurred then it is assumed to be incurred for admin purposes. Doubtful accounts expense is
also silent, it is not indicated that the collection authority is vested in the sales manager, thus
that doubtful account expense is treated as admin expense. Prepaid rent expense is an asset,
that is why it is not Included in the admin expense.

Selling expense:
Salesman salary 3,000,000
Freight out 1,000,000
Selling Expense 4,000,000

Salary is part of the selling expense because it was specifically assign to the salary of
salesman, someone who works inside the store. Freight out is also included because it is the
delivery expense.

7. Other Income- are income resulting from incidental transactions such as selling of
equipment, building or anything aside from the inventory.

Exercises: Income Statement of Service Industry

Multiple Choice
Use the following information to answer questions 1-5

Account Name Debit Credit

Sales 750,000
Sales Returns and Allowances 20,000
Sales Discounts 15,000
Purchases 200,000
Purchases Returns and Allowances 30,000
Transportation In 30,000
Selling Expense 75,000
General and Admin Expense 275,000

Additional information: Beginning merchandise inventory was P40,000 and ending merchandise
inventory was P85,000

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 1. Net sales for the period
a. 725,000
b. 715,000
c. 700,000
d. 750,000
2. Net cost of purchases for the period
a. 230,000
b. 200,000
c. 170,000
d. 140,000
3. Cost of goods sold for the period
a. 200,000
b. 240,000
c. 155,000
d. 185,000
4. Gross profit for the period
a. 715,000
b. 560,000
c. 600,000
d. 210,000
5. Profit for the period
a. 715,000
b. 560,000
c. 600,000
d. 210,000
6. Assuming that during the year the Net purchases was 800,000, and the inventory
decreases by 100,000 during the year. What is the cost of goods sold?
a. 800,000
b. 700,000
c. 900,000
d. 1,000,000
Use the following data in answering the 7-10
Depreciation Expense- Office Building 200,000 Salary of Salesmen 200,000
Depreciation Expense- Store Building 100,000 Salary of accountant 50,000
Depreciation Expense- Equipment 80,000 Salary of personnel 400,000
Store supplies Expense 60,000 Rent of Delivery Car 300,000
Office Supplies Expense 40,000 Freight out 200,000
Net cost of purchases 300,000 Beginning Inventory 400,000
Bad debts Expense 80,000 Ending Inventory 600,000
Net sales 2,000,000 Freight in 200,000

7. Compute for the Selling expense

a. 850,000

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 b. 660,000
c. 940,000
d. 860,000
8. Compute for the Administrative Expense
a. 660,000
b. 860,000
c. 850,000
d. 1,050,000
9. Compute for the Gross profit
a. 1,700,000
b. 1,900,000
c. 1,600,000
d. 1,800,000
10. Compute for the Net income/ Net loss
a. 1,900,000
b. 1,710,000
c. 190,000
d. (10,000)

Problem Solving

Problem 1
ABC company have the following data for the past four years

2017 2018 2019 2020

Beginning Inventory 60,000 80,000 70,000 40,000
Net cost of purchases 120,000 140,000 100,000 150,000
Goods Available for Sale 180,000 220,000 170,000 190,000
Ending Inventory (80,000) (70,000) (40,000) (60,000)
Cost of Goods Sold 100,000 150,000 130,000 130,000

Assuming that the following error was committed during those four years
2017: Beginning Inventory was overstated by 2,000
2018: Ending Inventory was understated by 3,000
2019: Ending inventory was overstated by 5,000
2020: Ending inventory was understated by 10,000
Compute for the correct cost of goods sold for the year, 2017, 2018, 2019 and 2020

Problem 2
The table below contains portions of the income statement of the ABC Company for the past 3
years
2017 2018 2019
Net Sales 500,000 400,000 800,000

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Beginning Inventory 60,000 100,000 300,000
Net Cost of Purchases 400,000 b. 200,000
Goods Available for Sales a. 800,000 f.
Ending Inventory 100,000 300,000 g.
Cost of Goods sold c. e. 800,000
Gross profit d. i.

Compute for the missing amount

Topic 3: Completing the Accounting Cycle of Merchandising Entity

The accounting cycle of Merchandising Entity is also the same with the Service entity. It is
composed of:
 Analyzing Transactions
 Journalizing Transactions
 Posting/Accumulating Transactions
 Preparation of Unadjusted Trial Balance
 Adjustments
 Preparation of Financial Statements
 Closing Entries
 Post-Closing Trial Balance
 Reversing Entries

Analyzing Transactions- analyzing transactions in Merchandise entity would also involve in

knowing the Account title affected (Classifying)
I. Monetary Value (Measuring)
II. The Inventory system used, is it Perpetual or Periodic?
III. The inventory valuation system, is it FIFO, Weighted Average, or Specific
Identification?
III and IV analysis are only done in the Merchandising entity and not in the service
entity, because Merchandise Inventory is only found in the Merchandising Entity.
Inventory valuation system will be discussed in FAR 2

Journalizing Transactions
- The main difference between service and merchandising entity's journal entry is the journal
entry for inventory and sales. Inventory are recorded in the General Journal while the Sales are
divided into two- Credit Sales which is recorded in the Sales journal while the Cash sales are
recorded in the Cash receipts journal

Sales Journal
 Sales journal is a special journal is designed to record sales of merchandise on account.
 The important data that needs to be in the Sales Journal is the Date of the transaction,
Sales invoice number, and the customer account.

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  The data from the Sales Journal will be posted to the Subsidiary Ledger daily to have a
current record and balance of each customer in order to answer customer’s questions
regarding their current balances.
 At the end of the month, the total balance is posted to the Account Receivable and Sales
in the General Ledger
 The usual posting abbreviation used in posting is “S”

Sales Journal
Date Invoice No. Posting Accounts Receivable
Account Debited Reference Dr. /Sales Cr
May 1 001 ABC Corporation / 40,000
2 002 Manila Traders / 30,000
10 003 Valenzuela Traders / 20,000
20 004 Caloocan Traders / 10,000
25 005 Quezon Traders / 60,000
160,000
-since the transaction that will be recorded in the Sales journal is only the Credit sales, there is
no need to put the journal entry of each transaction. The account debited is important because
it is where you will put the receivable in their respective subsidiary ledger

Accounts Receivable
Subsidiary Ledger

ABC Corporation Manila Traders Valenzuela Traders

5/1 S1 40,000 5/2 S1 30,000 5/10 S1 20,000

Caloocan Traders Quezon Traders

5/20 S1 10,000 5/25 S1 60,000

 In subsidiary ledger, the name of the debtor is listed along with the increase and
decrease of their accounts.

General Ledger

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 Accounts Receivable Sales
6/30 S1 160,000 6/30 S1 160,000

At the end of the month, the total value of the Sales Journal will be posted in the general ledger
as debit to Account Receivable control account and credit to the Sales Account.

Cash Receipts Journal

 All transactions involving cash receipts are recorded in this special journal.
 Cash sales are recorded in this journal rather than in the sales journal because cash is
best controlled when all cash receipts are recorded in one journal.

Purchases Journal
 It is used to record every purchases of inventory, supplies and other assets on account.

Cash disbursements Journal

 It is used to record all cash payments.

Posting Transactions – Posting in merchandising is the same as service industry, it is just

transferring items in the journal to the ledger to compute the balances that will be used in the
making of Unadjusted Trial Balance

Unadjusted Trial Balance – made to check the equality of debit and credit.

Adjustments – Aside from the concepts that was discussed in the Adjustments of Service
industry, for it is just the same with the Merchandising Entity, there is one distinct adjusting
entry done for merchandising entity, it is the Adjusting Entries for the Ending Inventory.

Adjusting entries related to inventory:

1. Recording of ending inventory and closing of beginning inventory for Periodic Inventory
System
-under the Periodic inventory system ending inventory is not known therefore this adjusting
entry is just for Periodic Inventory System only. Perpetual inventory system already has a
record of ending inventory so this adjusting entry is irrelevant and not needed.

The objectives of these entries are as follows

1. To remove the beginning inventory and to transfer it to income summary
Pro-forma Journal Entry
Income summary xx
Merchandise Inventory, Beginning xx

26 | P a g e
 2. To record the ending balance of inventory and to establish it in the income summary.
Merchandise Inventory, End xx
Income summary xx

Sample Problem
The entity uses the Periodic Inventory System in recording inventory. The beginning inventory is
P4,000,000. Before year ends, the entity conducts a physical count of P5,000,000. Make the
proper adjusting entry.

Step 1: Remove the beginning inventory and transfer it to income summary

Income summary 4,000,000
Merchandise Inventory, Beginning 4,000,000
Explanation: The main goal of this journal entry is to make the beginning inventory zero and to
transfer it to income summary account. Under periodic inventory system, the Merchandise
Inventory account is not updated from time to time, so it means that the recorded inventory
before any adjusting entries is the ending inventory of last period, that is why you need to close
it first before inputting the right of inventory as per physical count

Step 2: Enter the balance of ending inventory as per physical count

Merchandise Inventory 5,000,000
Income Summary 5,000,000
Explanation: The main goal of this journal entry is to record the right amount of Ending
inventory.
Note: This adjusting entry is only for the Periodic inventory system because under Periodic
system the inventory is not updated from time to time, therefore there is a need to close the
beginning inventory and to input the ending inventory at year end.

2. Adjusting entries for shortage or overage

 Adjusting entries for shortage and overage are only made if an entity is using a
Perpetual Inventory System,
 Periodic inventory system will just record the result of physical count as ending
inventory just like in the previous illustration

The need for physical count

One of the most important account in the Merchandising Entity is the Merchandise Inventory
account. Before the year ends, there is a need for physical count whether you are using
Perpetual Inventory or Periodic Inventory System.

Purpose of Physical Count

1. Perpetual Inventory system
 To know whether the running file or record of the inventory is accurate. Even if
the inventory is updated from time to time under this system, there is still no

27 | P a g e
 absolute assurance that the record is correct, hence a need for Physical count at
year end to check the accuracy of the record.
2. Periodic Inventory System
 To know the ending inventory and cost of goods sold. Under the periodic
inventory system, inventory account is not updated when there is a purchase or
sale, that is why the only way to know the ending inventory and cost of goods
sold is by counting the ending inventory.

After conducting a physical count, three scenarios may arise in Perpetual Inventory System

1. The recorded amount of inventory is more than the physical count

 In this case adjustments is done to decrease the recorded amount to follow
the actual physical amount.

Pro-forma Adjusting Entry

Inventory shortage xx
Merchandise Inventory xx

Sample problem: The entity conducted a physical at year end and its result is P400,000
but the perpetual record shows P500,000.
Adjusting Entry
Perpetual Inventory System Periodic Inventory System
Inventory Shortage 100,000 Merchandise Inventory, end 400,000
Merchandise Inventory 100,000 Income summary 400,000
Computation Explanation: In periodic inventory
Physical count 400,000 system there is no such thing as
Per record 500,000 inventory shortage or overage because
Shortage (100,000) there is no record about how many
Explanation: Since the physical count is just inventories an entity has at year end.
400,000 which is 100,000 lower than the The purpose of physical count in Periodic
recorded amount, the proper way to correct it is is to know the ending inventory. The
by reducing the recorded amount by 100,000. only entry made is to input the value of
Recorded amount > Physical Count = inventory Ending inventory (See previous
shortage discussion for adjusting entry of periodic
Note: Inventory Shortage is part of Other inventory system)
expense

2. The recorded amount is less than the physical count

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  In this case, an adjustment is made to increase the recorded amount to
equal the actual inventory which is the physical count.

Pro-forma Adjusting Entry

Merchandise Inventory xx
Inventory overage xx

Sample problem
The entity conducted a physical count resulting to P700,000. The perpetual record
shows a balance of P500,000.

Adjusting Entry
Perpetual Inventory System Periodic Inventory System
Merchandise Inventory 200,000 Merchandise Inventory, end 700,000
Inventory Overage 200,000 Income Summary
Computation: 700,000
Physical count 700,000 Explanation: The journal entry
Per record 500,000 required is to record the physical
Overage 200,000 count to Merchandise Inventory
Explanation: Since the actual inventory is higher
than the recorded amount, the right adjustment
is by increasing the recorded inventory to equal
the physical count which is the actual inventory.
Recorded amount < Physical count = Inventory
overage
Note: Inventory overage is part of other income.

3. The recorded amount is equal to the physical count

 In this case, no adjustments are required because the actual amount is equal
to the recorded amount.

Sample problem: The entity has a perpetual inventory record amounting to

P4,000,000. The physical count agrees with the record of the entity of
P4,000,000
Adjusting entry
Perpetual Inventory System Periodic Inventory System
Computation: Merchandise Inventory, end 4,000,000
Physical count 4,000,000 Income Summary 4,000,000
Per record 4,000,000 Explanation: The journal entry required is
Adjustments 0 to record the physical count to the
Explanation: There is no adjustments needed Merchandise Inventory

29 | P a g e
 because the recorded amount is equal to the
physical count.
Recorded amount = Physical count, then
there is no adjustment to the inventory

Cases where physical count is impossible

1. The inventory was destroyed or stolen
 in this case the entity needs to use inventory estimation method such as
Gross profit method and Retail Inventory method (will be discussed in your
FAR2)
2. The inventory is in transit
 just add the value of the goods in transit to your inventory in the warehouse

Adjusted Balance / Preparation of Financial Statements

The components of Financial Statements for the Merchandising Entity are the same with the
Service entity. It is composed of, in the right order,
 Statement of Comprehensive income
 Statement of Other Comprehensive Income
 Statement of Changes in Equity
 Statement of Cash flow
 Statement of Financial Statements
 Notes to Financial Statements

Closing Entries – transferring all nominal account into the capital account.
Closing entries for Service and Merchandising are the same, with the exception of

Additional Closing entries for Periodic Inventory System

 Closing of beginning Inventory
Income Summary xx
Merchandise Inventory xx

 Recognition of ending inventory

Merchandise Inventory xx
Income summary xx
Note: The entity has the option whether classify this entry as adjusting entries or closing
entries, that is the reason why it is also discussed under the adjusting entry.

 Closing of Purchases related account

Purchase Return xx
Purchase allowance xx
Purchase Discount xx
Income Summary xx

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 Freight in xx
Purchases xx
Note: After closing these three journal entries, the balance of the Income Summary
account is equal to the Cost of goods sold.

Sample problem:
The entity reported the following during the year
Beginning Inventory 2,000,000
Purchases 3,000,000
Purchase return 200,000
Purchase allowance 300,000
Purchase discount 100,000
Freight In 200,000
Before the year ends, the entity conducted a physical inventory count resulting to
P1,000,000. Prepare the necessary closing entries.

Closing Entries
a. Income summary 2,000,000
Merchandise Inventory, Beginning 2,000,000
To close the beginning inventory
#
b. Merchandise Inventory, end 1,000,000
Income summary 1,000,000
To enter the ending inventory to the books
#

c. Purchase Return 200,000

Purchase allowance 300,000
Purchase Discount 100,000
Income summary 2,600,000--------------Balancing figure
Purchases 3,000,000
Freight in 200,000
To close the inventory related account
#

Income Summary account Cost of goods sold

a. 2,000,000 debit Beginning Inventory 2,000,000
b. 1,000,000 credit Purchases 3,000,000
c. 2,600,000 debit Purchase Returns (200,000)
Total:3,600,000 debit Purchase Allowances (300,000)
Purchase Discounts (100,000)
Freight In 200,000
TGAS 4,600,000
Ending Inventory (1,000,000)

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 COGS 3,600,000
Explanation: After making the closing entries of the Inventory related account, the total value in
the income summary must always be equal to the Cost lf goods sold because those closing
entries are done to compute for the Cost of goods sold. It is only done in the Periodic Inventory
System because under the Perpetual System the cost of goods sold is already known for it is
always included in the journal entry every time there is as a sale.

 Closing of Sales related account

Sales xx
Sales Returns xx
Sales allowances xx
Sales Discounts xx
Income Summary xx

Additional Entries for Perpetual Inventory System

 Closing of Shortage or Overage
Income Summary xx
Inventory Shortage xx
#
When there is inventory shortage, the inventory shortage is debited, that is why in order
to close it you need to put it into credit.

Inventory Overage xx
Income Summary xx
#
When there is an inventory overage, the inventory overage is credited, that is why you
will put it in debit when you made the closing entry

 Closing of Sales related account

Sales xx
Sales Returns xx
Sales allowances xx
Sales Discounts xx
Income Summary xx
Note: In Perpetual inventory system there is no Purchases related account, that is why
there is no closing entries relating to the Purchases related account.
At

Post closing trial balance -Done to ensure that after the closing and adjusting entries, the
debit and credit are still equal.

Reversing Entries
 Done at the beginning of the next period.

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  Only adjusting entries under Accrual and Adjusting entries under Deferral using
the Income and expense method can be reversed. Reversing Entries are done to
simplify the next accounting records.

Exercises: Completing the Accounting Cycle

Multiple Choice
1. Which of the following accounts would appear on a worksheet for a merchandising
entity that uses Perpetual Inventory System?
a. Purchases
b. Freight In
c. Freight out
d. Purchase return
2. Which of the following accounts would not appear on a worksheet for a merchandising
entity that uses Periodic Inventory system?
a. Purchases
b. Freight out
c. Freight in
d. Cost of goods sold
3. Which of the following would not be closed by a merchandising entity that uses
Perpetual inventory system?
a. Cost of goods sold
b. Sales return
c. Sales
d. Merchandise Inventory
4. Which of the following would not be closed by a merchandising entity that uses Periodic
Inventory System?
a. Cost of goods sold
b. Sales return
c. Sales
d. Merchandise Inventory
5. Which of the following would appear on a worksheet for a merchandising entity that
uses Perpetual Inventory System?
a. Freight in
b. Purchases
c. Cost of goods sold
d. Purchase returns and allowances

Problem Solving

Problem 1
The unadjusted trial balance of Faith Food Shop on December 31, 2019 appears below:

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 Faith Food SHOP

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 WORKSHEET
December 31, 2020

Unadjusted Trial Adjusted Income Balance

Balance Adjustments Trial Balance Statement Sheet
ACCOUNT TITLE
Credi Debi Credi Debi Credi Debi Credi
Debit Credit Debit t t t t t t t

Cash 100,000

Accounts Receivable 500,000

Merchandise
Inventory 700,000

Prepaid Rent 300,000

Shop Equipment 1,600,000

Accumulated
Depreciation 200,000

Accounts Payable 400,000

Salaries Payable

Faith, Capital 1,300,000

Faith, withdrawal 100,000

Sales 2,900,000

Sales Discounts 100,000

Purchases 800,000
Purchase Return and
Allowance 200,000

Transportation In 100,000

Salaries Expense 400,000

Advertising Expense 150,000

Utilities Expense 100,000

Supplies Expense 50,000

Rent Expense

Depreciation Expense

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 Income Summary
Account
Totals 5,000,000 5,000,000
Profit
Grand Totals
Additional Information:
a. Accrued salaries at year-end amounted to P130,000.
b. Rent in the amount of P150,000 has expired during the year.
c. Depreciation on shop equipment is P400,000.
d. December 31, merchandise inventory amounted to P400,000.
Requirement: Prepare the worksheet of Faith Food shop

Problem 2
The following are the information regarding the inventory of ABC Company
Purchase of Inventory during the year 400,000
Returned merchandised to the supplier 100,000
Sales during the year 1,000,000
Sales return 400,000
Beginning, Inventory 200,000
Ending Inventory 400,000
Prepare the necessary closing entries under Perpetual and Periodic inventory system

References

Ballada, Win, Ballada, Susan, Basic Financial Accounting and Reporting (2019 Issue- 22nd
Edition) . DomDane Publishers & Made Easy Books

Peralta, J.F. , Valix, C.A., & Valix , C.M. (2019). Intermediate Accounting Volume 1
(2019 edition) GIC Enterprises & Co., Inc.

Uberita, C.O (2015). Practical Accounting 1 (2015 edition). DomDane Publishers & Made
Easy Books

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