WIKI: The Accounting Equation

What is the Accounting Equation?

The goal of business owners is to earn money for themselves or for the growth of their companies.
That’s why there will always be transactions. In a transaction, there is always an exchange. You
always get something for something. This exchange is captured in the Accounting Equation.
The Accounting Equation is a fundamental accounting concept. This is the basis of double
entry accounting. It illustrates the relationship between assets, liabilities, and equity.

Why do I need to learn the Accounting Equation?

Since the accounting equation is the basis of double entry accounting, knowing and then mastering
how the accounting equation works will help you understand the different transactions that happen in
business. A strong understanding of the accounting equation will allow you to be able to look at a
business and know that not all debts are bad and that having cash means that your business is
earning
money.

What does the Accounting Equation look like?

How do I use the Accounting Equation?

The first step in understanding the accounting equation is knowing that any transaction is always an
exchange. To demonstrate this, let's take a look at the events below:
1. You have P100 cash as allowance.
2. You paid for the jeepney fare worth P10 to go to school.
3. You ate lunch worth P50 at a local eatery.
4. You got a snack from a classmate worth P25.
5. At the end of class, you buy a shake worth P15.
Based on the conditions listed above, how are you getting home? Adding up the amounts, it seems
that you've spent P100. Using the accounting equation, let's take a look at the transactions more
closely. And remember, each transaction is an exchange.

For the first transaction, it is pretty easy. You have P100 in cash in exchange for ownership of
the P100. This means that the P100 is your money. Gaining ownership over something is still
considered an exchange. Next, let's take a look at the jeepney fare. You paid P10 of cash to go to
school. This means that you lost P10 of your cash in exchange for transportation to school.
Now, you have P90 left. You ate lunch worth P50. In this transaction, as you remember it, you paid
P50. You got lunch and lost P50 in cash. You now have P40 left.You then got a snack from your
classmate worth P25. You remembered that your classmate told you to just pay her the P25
tomorrow. You got a snack and you also owe someone money now. You still have P40 left.
Finally, you bought a shake worth P15 from a local store. You got a shake and lost P15 in cash. At
the end of the day, you will have P25 left. As you can see, all transactions are an exchange and the
items exchanged will always have an equal value. The next step in using the Accounting Equation is
analyzing how each of the parts in the transaction affect the accounting equation. In order to do that,
you will need to understand the elements of the Accounting Equation.

The first element of the accounting equation is the ​Asset. An asset is a type of resource that a
business owns that has value. In order to qualify something as your asset it must satisfy all of the
following criteria:
1. You will be able to get a future benefit from the item.
2. You can control who has access to these benefits.
3. The transaction involving the item has already occurred.
Evaluating a scenario where you get a loan from a bank in order to buy a car. The car can be used as
a Grab Car in order to generate income, if not, at the very least it can be resold at a later time for
money. This satisfies the first criterion of gaining a future benefit from the item. If you took a loan to
buy the car, this transaction would be something that has already occured. This satisfies the third
criterion. Since the car had already been bought, this would mean that the legal ownership has been
transferred from the seller to the buyer. This indicates that you control any benefit or liability that can
be gained from the item. This satisfies the second criterion. Only when all the criteria have been met
can the item be considered as part of your assets.

The second element of the accounting equation is the ​Liability​. Liabilities basically mean
something that is owed. Any instance where you owe something either to a person or a company is
referred to as a liability. In order to determine whether something is a liability, there are three
characteristics as well. The first is something that you can find in the definition. You owe something to
someone. The second characteristic is that a liability is a responsibility or obligation. The third
characteristic is that a liability is a probable economic sacrifice. Using the same example as the
assets definition, if you have applied for a loan, you would have gained a liability. You owe money to
a bank, you are responsible for paying off that loan. If the loan does not get paid, you will have to
return the car. The next element in the Accounting Equation is ​Equity​. To put equity in simple terms,
it means what part of the business belongs to you. Basing it on the accounting equation, equity is
what is left when you take out the liabilities from the assets. So if the business closes, you’ll be able
to see how much of the assets are still yours. Let’s take for example if you and a friend invest in a
business, if you invest P10,000 and your friend invests P20,000; at that point, you own P10,000 worth
of the business and your friend owns P20,000 worth of the business.

The Revenue and Expense are the last elements of the Accounting Equation. As a business
goes through its activities, the money that the business makes is called Revenue. The money that the
business spends is called Expense. A business earns money through selling products or providing
services. When a business earns money, they also have to spend money. Rent on office space and
salaries of employees are some of the things that businesses will have to spend on. When
businesses spend on these, businesses don’t really own them as assets, they are considered
expenses.
The last part is how you put these all together. Whenever a transaction happens, you need to
determine which elements it will affect. Let's take a look at the transactions listed above.
1. You have P100 cash as allowance.
(You get cash, which is an asset, and you gain equity or ownership over that cash.)
2. You paid for the jeepney fare worth P10 to go to school.
(You lose P10 in cash and gain P10 in expenses for your transportation.)
3. You ate lunch worth P50 at a local eatery.
(You lose P50 in cash and gain P50 in food expenses.)
4. You got a snack from a classmate worth P25.
(You gain a food expense worth P25, and also gain P25 of a liability because you owe your
classmate money.)
5. At the end of class, you buy a shake worth P15.
(You lose P15 in cash, but gain P15 in expenses for the shake.)

WIKI: Creating Journal Entries

What is a Journal Entry?

Social media websites and applications such as Facebook, Instagram, and Twitter allow you to
capture moments in your life. They serve as a reminder of the things that you have done, places that
you have gone to, and people you have met. The way that lives become so documented is similar to
when people had diaries, when they would write in them regularly. This is similar to how journal
transactions work. Journal Entries are records of different business transactions.

Why do I need to learn how to create Journal Entries?

All transactions that happen in a business are recorded in the company's journal. By learning how the
Journal works, you can look at any particular day in the business and get an idea of all the
transactions that transpired during the day.

What does a Journal look like?

https://tinyurl.com/sampleGJ​ - SAMPLE GENERAL JOURNAL

How do I make a Journal Entry?

Double Entry Accounting: ​Remember that any transaction always involves two things and it is
always an exchange. You get something and you also give something away.

Debit and Credit:

This double entry is represented in Accounting as debits and credits. You may already know what
“debit” and “credit” mean, but in accounting, they mean something else. In accounting, debit just
means it’s on the left and credit means it’s on the right. Remember that debit should always be equal
to credit.
Journal Entries and the Accounting Cycle:
All businesses go through the Accounting Cycle and it is divided as follows:
1. Analyzing and journalizing transactions
2. Posting to the General Ledger
3. Preparing a Trial Balance
4. Adjusting Entries
5. Preparing an Adjusted Trial Balance
6. Preparing Financial Statements
7. Closing Entries

Remember that when creating Journal Entries, you have to perform the following steps:
1. Analyze the transaction - Evaluate the event that occurred. In professional accounting practice,
you will have to look at financial documentation in order to perform this analysis since not all
the transactions will be listed down like what you will see below.
2. Identify the accounts that are affected - Look at the transaction and then refer to the chart of
accounts to see which of those listed will be affected by the transaction. Each transaction will
always affect at least 2 account titles.
3. Determine whether the account goes up or down.
4. Enter these changes in the Journal.

Remember that depending on the business, you may use different formats for your
Journals. The image above contains the basic information that can be found in the Journal.
1. Page number - The format of the page number depends on the business that you're generating
the journal for. In this example, we will use J, followed by the page number.
2. Date - This column will first be filled with the year. The year no longer needs to be entered in
the succeeding entries, unless you go into a new page. Below the year, you will enter the
month and day in the same line. The month only needs to be entered if it is the first entry of the
page or if there is a change in the month.
3. Account Description - If you notice, the Account Description is actually divided into two
columns. Not all journals will have two columns, though. Here the two columns will indicate
whether something is a debit OR a credit. You will always start with the debits first, followed by
the credit. The names that you will enter here will those that you can find listed on the Chart of
Accounts.
4. Debit - This is the amount that will be debited. This should be aligned with the Account Title
that is debited.
5. Credit - This is the amount that will be credited. This should be aligned with the Account Title
that is credited.
 WIKI: General Ledger and Ledger Entries

What is a General Ledger?

Similar to the General Journal, the General Ledger is also a record of the different transactions of the
company. The difference is that the transactions are not all listed together. The transactions within a
General Ledger are broken up into groups. Each group is based on the account title.

Why do I need to learn how to make a Ledger?

The General Ledger is an important Accounting document because it makes it easy to track how
much money has gone through each of the account titles. For example, if you want to know how
much money you have spent on transportation, you could look at the journal and go through each
one. With the ledger, the transportation expenses are all grouped together making it easier to track.

What does a Ledger look like?

A ledger looks quite similar to a General Journal. It has dates, descriptions, debit, and credit. What
makes it different is that it has a space provided to enter the account title, and a reference number for
the account title. These two are used to distinguish each of the different account titles, making it
easier to group them and sort the different transactions into them.
See the sample ledger below: ​https://tinyurl.com/sampleGL

How
do I make a Ledger?
Not all General Ledgers will look the same. There will be some differences depending on the
company that is creating the ledgers.

1. Go to the first General Journal entry that is not yet on the ledger. Check what account titles
were used for this transaction.
2. Copy the date listed in the <b>Date</b> column of the General Journal and copy it to the sheet
of the appropriate account title.
3. Check on the amount listed in the journal then copy it to the appropriate column in the ledger.
4. Once you have written the amount on the ledger, use the <b>ACCOUNT NO.</b> (number)
written on the ledger then enter it in the <b>Post Ref.</b> column of the journal entry. This is
 to indicate that the entry has been posted to the ledger. You will also enter the page number of
the journal in the Post Ref. column of the ledger. This is to indicate where the entry can be
found in the Journal. (This is especially helpful for multiple paged journals.)
5. Repeat the process until all the transactions have been transferred to the ledger

WIKI: The Trial Balance

What is a Trial Balance?
Preparing a Trial Balance is one of the steps in the Accounting Cycle. This is a worksheet that
contains all the balances from all the different ledgers. It is usually prepared at the end of a reporting
period. Reporting periods can vary depending on the organization, it can be at the end of month,
quarter, or year.

Why do I need to learn how to make a Trial Balance?

Learning to create a Trial Balance allows you to check whether your debits are equal to your credits.
Remember that in Accounting, all transactions are made up of debits and credits and that these two
should always be equal.

What does a Trial Balance look like?

A Trial Balance is essentially divided into three columns. The first column contains the account titles
used. The next 2 columns are for all the ledger balances that would be in the debit and credit
columns. See the example below:
How do I make a Trial Balance?
In preparing a Trial Balance, you will need to make sure that your ledger entries are complete. After
making sure of that, it is just adding all the balances that are debits and balances that are credits.

1. Launch the General Ledger. For each of the accounts in the General Ledger, add the amounts
in the debit column, followed by the amounts in the credit column.
2. Deduct the smaller value from the larger value. For example, if the totals for the debit and
credit columns are 8000 and 5000 respectively, deduct 5000 from the 8000 and enter that
amount in the debit column since it had the larger value.
3. Repeat this for all the account titles.
4. Copy all the account titles to the Trial Balance.
5. Enter the balances of each of the account titles in the same column as they appear in the
ledger after calculation. Add the debits column as well as the credits column and enter that
value at the bottom of the page. These values should be equal.

WIKI: The Income Statement

What is an Income Statement?
The Income Statement is known by other terms such as: Profit and Loss Statement, Statement of
Operations, or Statement of Income. The Income Statement is used to show the profitability of an
organization. It states how much money a company has made through its business activities, as well
how much it has spent in going through its business activities.

Why do I need to learn how to create an Income Statement?

The Income Statement first shows how much a company has made, but it also takes into
account how much money it has spent. The end result of this statement is either a Net Income or a
Net Loss. Knowing this information will show whether a company is actually making money or not,
after the deduction of all of its the expenses.
Let's say that a business made P10,000 in profit. In order to get that amount, they spent
P5,000 on marketing, P4,000 for rent, and P10,000 for employee salary. The company spent P19,000
versus the P10,000 it has earned; it is therefore at a net loss of P9,000. By learning this, a company
can change their operations in order to increase profits or minimize expenses so they make sure that
they make money.
It is also a valuable tool if you are planning to invest in a business,. Through Income
Statements, you can see if a business is not making money,. If it isn’t, then you’ll know that it's less
practical to invest in it.

What does an Income Statement look like?

Most companies will have a variation on the format of the Income Statement. What is important is that
it starts with the Revenue account for the company and expenses are slowly subtracted until you
arrive at either a Net Income or Net Loss. See the sample Income Statement below:
How do I make an Income Statement?
The Income Statement is divided into 3 columns. The first column will be for the account titles, the
second column will be for the Final balances coming from the Trial Balance, and the third will be for
the totals. Remember that this is no longer like the other documents where the 2 columns are for
debit and credit.

1. You will start the Income Statement with the Revenue Accounts. Enter the account title used
for revenues in the first column and the final value of that account title in the second column.
2. After entering the revenue account in the Income Statement, list down all the contra revenue
accounts under the revenue accounts. The contra revenue accounts are accounts like
Discounts, Returns​,​ & Allowances since they reduce revenue.
3. Below the last Contra Revenue account, type in Net Sales and deduct the total of the contra
revenue accounts from the total of the revenue accounts and enter that amount in the third
column on the same line.
4. If you have a Cost of Sales/Cost of Goods Sold/Cost of Goods Manufactured account, enter
that account below Net Sales and deduct the final balance from Net Sales. Enter that value on
the third column below the Net Sales row, label this as Gross Income.
5. List your Operating Expenses per account along with their final balances and deduct that from
the Gross Income (Operating Expenses are costs that a company incurs in order for it to
function). This is your Operating Income.
6. Enter other Revenues or Expenses that do not directly come from the running of your business
and add/subtract that from the Operating Income.
7. List the value in the third column, that is your Net Income.
 WIKI: The Balance Sheet
What is The Balance Sheet?
The Balance Sheet is also known as the Statement of Financial Position. It contains the different
account titles that belong to the elements of the Accounting Equation. It is one of the major financial
statements that analysts and investors look at in evaluating a business. The purpose of the balance
sheet is to show a company's financial position. It shows the assets that a company owns, the
liabilities that it owes, as well as the amount of its equity.

Why do I need to learn how to make a Balance Sheet?

Since the Balance Sheet shows the Assets, Liabilities, and Equity of a company, it allows you to see
whether the company owes more than what they actually own. With this information, whether you are
a customer or an investor, you can see whether or not it will be a good idea to transact with a
business. If you are the business owner, it allows you to check on whether or not your company is
borrowing too much money.

What does a Balance Sheet look like?

In the Balance Sheet, the account titles are divided into the different elements of the Accounting
Equation. See the example below:

How do I make a Balance Sheet?

1. Begin by grouping your account titles into (1)ASSETS, (2)LIABILITIES, and (3)EQUITY.
 2. Check the chart of accounts of your ledger and classify all the account titles into one of the
main account types. All of the items in the chart of accounts should be classified into one of the
major account types.
3. Qualify your assets and determine which would be part of CURRENT ASSETS and which
would be part of PROPERTY, PLANT, and EQUIPMENT. Remember that CURRENT ASSETS
are those you are expecting to be converted to cash within a year's time.
4. Place those titles in the Balance Sheet.
5. Find the sum for all the Assets and place it at the bottom of the column.
6. Do the same for Liabilities. Liabilities are divided into CURRENT LIABILITIES and LONG
TERM LIABILITIES. Similar to Assets, CURRENT LIABILITIES are those that are generally
paid within a year such as Accounts Payable​; whereas LONG TERM LIABILITIES are those
that ​are​ paid for longer periods of time such as LOANS PAYABLE.
7. Do the same of Equity.
8. Add your NET INCOME​,​ or subtract if you have a NET LOSS​,​ to the Equity account.
9. Place the sum for the Liabilities and Equity at the bottom of the column.

WIKI: Closing Entries

What are Closing Entries?
Closing Entries occur at the end of an accounting period. It helps transfer temporary accounts into
permanent accounts. Temporary entries are created to close out the temporary accounts. These
entries are then closed into the permanent accounts.

Why do I need to learn how to make Closing Entries?

Closing Entries are important to organizations and users of financial information because the
temporary accounts that are closed through this process need to be refreshed for the next accounting
period. Temporary accounts should only be used until the end of an accounting period, then
transferred onto permanent accounts.

What does a Closing Entry look like?

The entries here look just like regular journal entries, but they introduce the Income Summary
account title. The Income Summary does not have a normal balance because it is used to close both
Revenue and Expense accounts. It won’t have the color-coding that was explained in the Accounting
Equation video.
How do I make a Closing Entry?
Temporary accounts fall into one of the following account types: Revenue, Expense, and Dividends.
Four Steps in Preparing Closing Entries
1. Close all income accounts to Income Summary.
2. Close all expense accounts to Income Summary.
3. Close Income Summary to the appropriate capital account.
4. Close withdrawals to the capital account/s (this step is for sole proprietorship and partnership
only).

Periodic Inventory System

In the Periodic Inventory System, there are additional closing entries that you will be required to
produce. Below are the steps that you will need to perform in order to do that:
Close out the following accounts: Freight In, Purchase Discounts and Purchase Returns and
Allowances to the Purchase account. This can be done by looking at the final balances of these
accounts in the General Ledger.

After looking at the balances of these accounts, create journal entries that will zero out the balance on
the ledger. For Freight In, since this is normally a debit balance, you will have to create a credit
journal entry for the same amount to zero it out. You will notice that the amount on the debit and
credit side are not equal. At this point, you will compute for the missing amount and enter that as part
of the entry using the ​Purchases ​account title.
After creating this entry, you will have a new amount for Purchases that will need to be entered to the
General Ledger. Determine the new balance of purchases after you enter this in the ledger.

You will now create the closing entry for purchases:

You will begin by debiting the amount of the inventory you have left. You will use the account title
Inventory for this entry. This will either be by counting the inventory yourself, or by expensing the
inventory and getting the amount from that. Next, will be the account title Cost of Goods Sold. At this
time, you will not have the amount for this accounting title yet, you will have to calculate it after
entering the rest of the items. The credit items will include the ​Inventory at the start of the period and
Purchases. ​For the Inventory, this will be the amount of the Inventory account from the previous year
as can be found in the previous year's Balance Sheet. If the business just started, it will just be zero.
The other entry that will need to be credited will be ​Purchases. This account should already be the
new balance after closing the Purchase Returns and Allowances, Freight In, and Purchase Discounts
to Purchases.

Remember to update the ledger with the closing entries. ​The Ending Inventory becomes part of
the Asset account type and Cost of Goods Sold will be treated as an Expense.

Revenue and Contra Revenue accounts

Check the final balance of all the Revenue Accounts from the ledger. Usually, revenue will have a
credit balance. If the final balance of the revenue accounts is a credit, you will have to create an entry
that is a debit for that account to close it out. (Ex. The final balance of the Service Revenue account
title is P50,000, you will have to create a journal entry that debits Service Revenue for that same
amount). If the final balance is a debit, then you will close it out with a credit entry. The accompanying
entry to the revenue will be the ​Income Summary for the same amount. The contra revenue
accounts (Discounts, etc.) should also be closed out.
Note: Contra accounts are account types that are directly connect to a particular account title. It
however will have the opposite normal balance compared to that account title. For example, when a
customer buys a product, that is considered a ​Sale (a revenue account). There are instances that in
that sale, a customer can receive a discount. Because the customer received a discount for that sale,
the discount directly negatively impacts ​Sales.

Post the closing entry to the General Ledger, input Closing Entry as its​ Description​.

Expense accounts:
Look at the final balances of your expense accounts. Create a journal entry that will have ​Income
Summary as the debit amount. You will not yet have the amount for Income Summary Credit each of
the final balances of the expenses as part of this journal entry. Each expense should have its own
row in the sheet. When you list all the expense entries in one transaction, the sum of all the expenses
will be the amount that you will enter for Income Summary.
Income Summary:
Create a ledger account for the Income Summary. Post the amounts from the closing entries that you
created. Get the total for the debit and credit column. Place this total below the last line used for this
ledger and write ​Total as the description. Below the total, write ​Final Balance as the description and
subtract the column with the smaller value from the column with the larger value. Place the difference
in the column with the larger value (Ex. The debit column has a total of P25,000 and the credit
column has a total of P60,000, the difference is P35,000. Since the credit column has the larger
value, P35,000 will be entered in the credit column. Close out the Income Summary using another
journal entry. Create an entry using the value of the Final Balance of the Income Summary but in the
opposite column as the final balance. The accompanying entry for the Income Summary will be the
permanent account, Capital or Retained Earnings.

Drawing or Withdrawals:
After closing out the Income Summary, close out the Final Balance of the Drawing account to the
Capital account.

WIKI: Adjusting Entries

What is an Adjusting Entry?

Accounting is a process that is divided into periods. Within an accounting period, there are
transactions that occur in one period and end in the next. Normally, these transactions would be
recorded when the exchange happens. For example:
● An accounting period is one month.
● A worker is paid every two weeks. Essentially, the worker is paid every 14 days.
If the months has 30 days, the worker would have gotten paid twice during that accounting period.
Both of these would be accounted for. There are 2 more days in the month that have not yet been
accounted for. The worker won’t be paid until the next accounting period. Because of all these
circumstances, you won't be able to account for those two days until the worker gets paid. You won’t
be able to accurately record how much your worker has earned for the month. In order to solve this,
adjusting entries are created. Adjusting entries simulate "transactions" so that accounts are accurate
at the end of the period.

Why do I need to learn how to make Adjusting Entries?

For example: Let’s say a company has paid for 6 months of rent. The rent, cannot be considered an
expense right away. Why? Because the company hasn’t used up all 6 of those months yet. At the end
of the first month, the company will have used up 1 of the 6 months. This change will need to be
accounted for and that is what Adjusting Entries are for. It is important for businesses to create
adjusting entries because it ​keeps their records accurate by showing the changes that the
passage of time has made on the account.

What does an Adjusting Entry look like?

Adjusting Entries look just like normal journal entries, the difference is that they represent something
else. They represent the passage of time and do not use cash transactions.
In the images above, you will notice that insurance has been paid 6 months in advance on the 1st of
December. On the 31st, since a month has passed, an adjusting entry is performed to show that a
month of the 6 months has already been used up.

How do I make an Adjusting Entry?

There are several transactions that require adjusting entries:
1. Accrued Expenses
2. Accrued Revenue
3. Prepaid Expenses
4. Unearned Revenue

Accrued Expenses
An Accrued Expense occurs when a company incurs an expense within a period, but will not be paid
until a later period. This would be like having internet service where your service starts on the 17th of
the month. At the end of the month, you would have already incurred the expense starting from the
17th but you won’t be paying it until the next month. Your facilitator will show you a video on creating
adjusting entries for accrued expenses.

The general format for it is:

Debit - Expense and Credit - Payable.

Accrued Revenue
Accrued Revenue is when your company completes performing a service, but the service that has not
been paid for yet. At the end of the period, the service that was completed has to be recorded even if
no actual cash payment has been made yet. This is where you will use an Adjusting Entry. Your
facilitator will show you a video on creating adjusting entries for accrued revenues.

The general format for the adjusting entry is:

Debit - Accounts Receivable and Credit - Revenue.

Prepaid Expenses
A Prepaid Expense occurs when you pay for a service in advance. When you pay for it you get the
title Prepaid ___. It can be Prepaid Rent, Prepaid Insurance, etc. Your facilitator will show you a
video on creating adjusting entries for prepaid expenses.

The general format for the adjusting entry for this is:
Debit - Expense and Credit - Prepaid Expense.

Unearned Revenue
An Unearned Revenue occurs when a customer already pays you for a service that your company
has yet to perform. This transaction first shows up as:
Debit - Cash and Credit - Unearned Revenue.
The general format for this is:
Debit - Unearned Revenue and Credit - Revenue.

Adjusted Trial Balance

The Adjusted Trial Balance is similar to the Trial Balance. The difference is that the new accounts
after the Adjusting Entries need to be added to the Ledger and Trial Balance. Your facilitator will show
you a video on preparing an adjusted trial balance.

WIKI: The Statement of Cost of Goods Sold

What is the Statement of Cost of Goods Sold?
The Statement of Cost of Goods Sold is based on the accounting formula for the Cost of Goods Sold.
It shows how much an organization has spent in order to earn the money that it made. This type of
statement is not found in a Service type business but with Merchandising and Manufacturing
businesses.

Why do I need to learn how to make a Statement of Cost of Goods Sold?

Learning how to make a Statement of Cost of Goods Sold is important because this will allow an
organization to monitor how much they spend versus how much they make. The cost reflected here,
unlike that in the Income Statement, is specific to getting the product sold. This statement also helps
keep track of the status of Inventory.

What does a Statement of Cost of Goods Sold look like?

How do I make a Statement of Cost of Goods Sold?
1. Perpetual will give you the amount of inventory you have throughout the accounting period.
2. Periodic will give you the amount of inventory at the end of a certain period.
3. Periodic is where you will still have to calculate for the Cost of Goods Sold.
-----------------------------------------------------------------------------------------------------------------------------
Creating purchase entries fo r the Perpetual Inventory System.
1. There are several transactions where this can be used: Purchases, Shipping Costs, Purchase
Returns, and Discounts
2. The account title, Merchandise Inventory, will be used only in the Perpetual Inventory System.
3. FOB (Free on Board) Shipping means that the buyer pays for the shipping cost. For
purchasing additional inventory, this is what you will need to account for.
4. FOB Destination means that the seller pays for the shipping cost. There is no need for a
journal entry if you are purchasing additional inventory.
5. There are two types of discounts: Quantity (when you purchase in bulk) and Purchase (when
you pay with cash early).
6. Purchase discounts have a format (Ex. 2/10 n/30 which translates to a 2% discount if paid
within 10 days with a total of 30 days to pay). The first number represent that percentage of the
discount that will be received if it is paid within the indicated number of days. The number of
days is indicated by the second number. The third number represents that total number of
days to pay for the purchase.

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Creating sales entries for the Perpetual Inventory System.
1. Cost of Goods sold is an account title that will be used here.
2. This involves several transactions: Sales, Shipping Costs, Sales Returns, and Discounts.
3. This involves the Matching Principle (Sales/Revenue should be recorded at the same time as
the expenses incurred in generating the sale).
4. Sales in the Perpetual Inventory System will have two sets of entries for a transaction to
account for the revenue and the expense.
5. FOB Destination will have an account since the seller pays for shipping the product. Freight
Out is the account title used.
6. FOB Shipping has no entry for Sales entries.
7. Sales Returns will use the account title, Sales Returns and Allowances (Contra Sales account)
to account for the reduction in Sales/Revenue.
8. Discounts are accounted using the account title, Sales Discount, which is a Contra Sales
account).
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Creating purchase and sales entries using the Periodic Inventory System.
1. Inventory is not tracked alongside Sales.
2. The transactions that will be involved here are: Purchases, Shipping Costs, Purchase Returns,
and Discounts.
 3. Purchases uses the account title, Purchases.
4. It also uses discount terms with the format 2/10 n/30 which means a 2% discount if paid within
10 days, with a total of 30 days to pay.
5. FOB Shipping uses the account title, Freight In. No entry for FOB Destination.
6. Purchase Returns use the account title, Purchase Returns and Allowances.
7. Discounts use the account title, Purchase Discounts.
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For Sales in the Periodic System:
1. Sales is the account title used for accounting of Sales/Revenue.
2. Freight Out is the account title used for FOB Destination, still no entry for FOB Shipping.
3. Returns are accounted for using the account title, Sales Returns and Allowances.
4. Sales Discount is the account title used for discounts.
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Once the Sales and Purchases have been entered, you will need to Expense them to reach the
Ending Inventory. Expensing means that you find out how much your company spent in order to get
the merchandise it sells. There are 3 ways that this can be done. First is through Specific
Identification:
1. Inventory is counted at the end of the accounting period, which is shown in the Balance Sheet.
2. Specific Identification would be very tedious as the cost of EACH of the items sold is
accounted for.
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Next is the FIFO method:
1. In the FIFO Method, we expense the earliest inventory that we have.
2. The Cost of Goods Sold will be the same whether it's in the Perpetual or Periodic Inventory
System.
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Last is the Weighted Average:
1. COGS and Ending Inventory will be different for the the Periodic and Perpetual Inventory
System.This is how it will be expensed in the periodic system.
2. You will have to get the average unit price in order to expense the inventory so there will only
be one price used in expensing despite having different unit costs.
3. You will have to use the weighted average, this means that you do not just add the prices and
average the price. You will have to multiply the quantity and its price, add that, and then divide
by the total number of units

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Creating the Statement of Cost of Goods Sold:
1. Enter your BEGINNING INVENTORY. This would be the inventory you had at prior to the start
of this accounting period. If you’ve already finished an accounting period, this would be the
Ending Inventory from the previous period. If the business is just starting out, this would be 0
(zero).
2. Add any additional PURCHASES below this item.
3. Apply any FREIGHT charges by listing them down below the purchases.
4. Deduct any PURCHASE RETURNS. The answer you will get here will be the COST OF
GOODS AVAILABLE FOR SALE. You will need to add a line to indicate this in your Statement
of COGS.
5. Add any DIRECT LABOR. Remember that Direct Labor would be salary expenses that the
company incurs in order to create the product or in order to perform the service. Direct Labor
would generally apply to Service and Manufacturing type businesses.
6. Expense the inventory using the method used by the company to obtain the ENDING
INVENTORY. This is extremely important if the purchase price of the inventory varies since
you will have to account for the variation in cost.
7. Deduct your ENDING INVENTORY which is the final balance of your Inventory as you are
preparing the financial statement.
8. The answer will be your COST OF GOODS SOLD. Add a line to indicate for your Cost of
Goods Sold.
9. Create the Journal Entry for the ENDING INVENTORY.
10. Apart from closing out Revenues and Expenses, in the Periodic Inventory System, Purchases
are also considered temporary accounts that need to be closed out. This would include
Purchase Returns and Allowances, and Purchase Discounts.
11. Close Purchase Discounts and Purchase Returns and Allowances to the Purchase account.
12. Add the new entry for the Purchase account to the ledger.
13. Add the total of the Purchase accounts and create the closing entry for it by using the ENDING
INVENTORY balance and the missing balance as the Cost of Goods Sold.