MODULE 1 - Review of Accounting Process

1. Introduction/Overview
The accounting process of a merchandising business is the same with the service entity. The difference
lies in the nature of the transactions, the account titles used and the forms of financial statements
prepared.
This module covers the review of the accounting process including the accounting equation and the steps
of the accounting cycle
3. Accounting Equation and Elements

Accounting is governed by a fundamental accounting equation that shows the relationship among the
three accounting elements found in a balance sheet - an expanded and detailed expression of the
fundamental accounting equation.
BALANCE SHEET ELEMENTS
 Assets – represent those economic resources and/or controlled by the enterprise, and which are
expected to have future usefulness to the business.
 Liabilities – include those economic obligations of the enterprise, and which require future
settlements that are expected to result in outflows of economic resources.
 Equity – the residual interest of the owner or owners over the assets of the enterprise, after
deducting its total liabilities.

RESULTS OF OPERATIONS

The income statement is an expanded and detailed expression of the income and expenses in order to
arrive at the profit earned or loss incurred during a given reporting period.
INCOME STATEMENT ELEMENTS
 Income – used in connection with the inflow of assets and/or outflow of liabilities that is related
to the activities of the business.
 Expenses – used in connection with the outflow of assets and/or inflow of liabilities that is
directly or indirectly related to the activities of the business enterprise.
ENDING BALANCE OF THE PROPRIETOR’S EQUITY
The equity of the proprietor may be computed independently from the asset and liability elements, if
information about profit and withdrawals for personal use is available.

4. The Accounting Cycle

Phase 1: Recording and Classifying

Step 1- Compile and arrange the source
documents that support the business
transactions.
Step 2- Analyze the business transactions and
determine their two-fold effects on the
accounting elements.
Step 3- Journalize the business transactions in
the books of original entry called journals.
Step 4- Post the journal entries to the books of
final entry called ledgers.
Step 5- Prepare the unadjusted trial balance.

Phase 2: Summarizing and Reporting

Step 6- gather the data needed to adjust the
accounts.
Step 7- Prepare the worksheet.
Step 8- Journalize and post the adjusting entries.
Step 9- Prepare the financial statements and supplementary schedules.
Phase 3: Closing Process
Step 10- Journalize and post the journal entries.
Step 11- Rule and balance the ledger accounts.
Step 12- Prepare the post-closing trial balance.
Step 13- Journalize and post the reversing entries.

5. Journalizing
DOUBLE-ENTRY BOOKKEEPING
based on the fundamental accounting assumption that all business transactions have two-fold effects –
that for every value received, there is a corresponding equal value given up.
ACCOUNT
a sorting device used to record, classify, and summarize the increases and decreases in the balance of each
accounting element as a result of the completed transactions of the business enterprise.
EXAMPLE:

RULES OF DEBIT AND CREDIT

RECORDING AND CLASSIFYING PROCESS

Step 1. Compile and arrange the source documents that support the transactions.
Step 2. Analyze the business transactions and determine their two-fold effects on the accounting elements.
Step 3. Journalize the business transactions in the books of original entry called journals.
Step 4. Post the journal entries to the books of final entry called ledgers.
Step 5. Prepare the unadjusted trial balance.

Journalizing the Business Transactions

- the process of analyzing and recording or entering a business transaction in a journal.
A journal entry has the following parts:
 the date when the transaction occurred
 the effects of the transaction as reflected by the account titles debited and account titles credited
  the monetary values (debit values and credit values) assigned to each accounting element that is
affected by the transaction
 a brief and clear explanation
 the posting references showing the code of the designation ledger account

Manner of recording in the general journal:

1. Write the page number on the upper right hand corner of the general journal.
2. Write the date (month and day) on the DATE column.
3. In the ACCOUNT TITLE/EXPLANATION column, enter the account/s to be debited. The amounts
will be entered on the DEBIT column.
4. Below the debit entry, enter the account/s to be credited.. The amounts will be entered on the CREDIT
column.
5. Below the credit entry, write a brief explanation of the transaction being recorded.
SAMPLE JOURNAL ENTRY

MODULE 2 - Accounting for Merchandising Activities

1. Introduction/Overview
The transactions of a merchandising business is more complicated than a service entity. It has transaction
and uses terms and account titles peculiar to trading business.
This module introduces the merchandising type of business. It covers the nature and operations of this
type of business, sales and purchase transactions, terms of shipment and the accounting thereof.
3. The Merchandising Enterprise
Merchandising Enterprises – engaged in the buying of goods or merchandise which will be sold (in its
original form) at a higher price than the purchase cost
Wholesaler– buys large quantities of finished goods directly from the
manufacturers or importers, and then resells the same to different
merchandisers
Retailers– sell the goods directly to end-consumers
NORMAL OPERATING CYCLE
- average length of time from the spending of cash to acquired
goods, utilities, services and other benefits, until cash is realized or
received in the ordinary sale of goods
MERCHANDISE INVENTORY
- includes the goods purchased for the principal purpose of reselling them
Inventory Systems Used for Merchandising Transactions
 Perpetual Inventory System – requires the maintenance of records called stock card for each kind
of good. The stock card normally shows the inflow, the outflow and the running balance of
inventory.
 Periodic Inventory System – the inventory is determined by physical counting of goods on hand
at the end of accounting period to determine quantities. The quantities for each kind of good are
then multiplied by the corresponding unit cost to get the inventory value.
Periodic Inventory System
 When goods for resale are purchased, Purchases is debited at the amount of the acquisition cost
(List price, net of trade discount, if there is any).
 Upon making a sale, income is recognized by crediting Sales based on the selling price of the
goods, net of trade discount.
 No separate entry is prepared to record the decrease in the inventory balance as a result of sale.
 There are no inventory ledger accounts that need to be updated as the buying and selling
transactions occur.
4. Accounting for Merchandising Activities

Sample Computation of the Net Profit of a merchandising concern:

Sample computation of Cost of Sales

ACCOUNTING FOR MERCHANDISING TRANSACTIONS

 Cash or COD (Cash on Delivery) – means that the purchase of merchandise is payable in cash
 On Credit or On Account – purchase of merchandise is payable at some future time
 End of Month (EOM) – means the purchase of merchandise is payable at the end of the month.
 Credit Term or Credit Period – time within which the payment should be made
  Cash Discount – a discount given to the buyer for paying within a specified period of time which
is usually earlier than the credit period. Given in consideration of prompt payment.
 Trade discount – discount given in consideration of the volume or the amount purchased. It is an
outright deduction from the list price and not recorded in the books of either the seller or the
buyer, meaning the transaction is recorded net of the discount.
 Discount Period – period of time within which to pay to be entitled to a discount
 Returns – involves physical return of all or a part of the goods delivered by the seller
 Allowances – reduction in the account due to varied reasons such as inferior quality, slight
damage, etc. without physical return of the goods purchased.

ACCOUNT TITLES USED IN MERCHANDISING TRANSACTIONS

Purchases
Purchase discount
Purchase returns and allowances
Freight in
Sales
Sales discount
Sales returns and allowances
Freight out
Merchandise inventory

Examples of Credit Terms:

 n/30 – payable within 30 days from the date of the invoice
 n/EOM – payable at the end of the month when the purchase was made
 10 EOM – payable up to 10 days after the end of the month of the purchase

Transaction involving Trade Discount:

Ex. A supplier offers a 20% trade discount on goods costing P10,000.
The trade discount is P 2,000 (P 10,000 x 20%).
The invoice price becomes P 8,000 (P10,000 – P2,000) OR (P10,000 x 80%)

Transaction involving Multiple Trade Discounts:

Ex. A supplier offers a 20%, 10% trade discount on goods costing P10,000.
The trade discount is P 2,800 (P 10,000 x 20%) + (P10,000 – P2,000) x 10%).
The invoice price becomes P 7,200 (P10,000 – P2,800) OR (P10,000 x 80% x 90%)

Credit Terms with Discounts Offered:

2/10, n/30 – there is a 2% discount if paid within 10 days from the date of the invoice or, if payment is
made after the discount period, it must be paid not later than 30 days.
Partial payment(s) on account within the discount period may be granted cash discount in accordance
with the terms of purchase, that is depending on the agreement between the buyer and the seller. In the
absence of an agreement, cash discount is applied only upon full payment within the discount period.
Hence, no cash discount on partial payment(s).
Purchase of Merchandise on Cash
Ex. Ictus Electrical Supplies purchased merchandise on cash, P5,000
Purchases 5,000
Cash 5,000

Purchase of Merchandise on Account

Ex. Ictus Electrical Supplies purchased merchandise on account, P5,000. Terms: n/60
Purchases 5,000
Accounts payable 5,000

Upon payment:
Accounts payable 5,000
Cash 5,000

Purchase of Merchandise on Account with Cash Discount

Ex. On March 2, 20-1 Ictus Electrical Supplies purchased merchandise on account, P5,000. Terms: 1/10,
n/60
Mar 2 - Purchases 5,000
Accounts payable 5,000
Purchased merchandise. Terms 1/10, n/60.

Payment within the discount period:

Mar 12 - Accounts payable 5,000
Cash 4,950
Purchase discount 50
Full payment of account.

Payment beyond the discount period:

Mar 16 - Accounts payable 5,000
Cash 5,000
Full payment of account.

Purchase of Merchandise on Account with Cash Discount and Partial Payment

Ex. On March 2, 20-1 Ictus Electrical Supplies purchased merchandise on account, P5,000. Terms: 1/10,
n/60. On March 7, Ictus partially paid its account, P2,000.
Mar 2 - Purchases 5,000
Accounts payable 5,000
Purchased merchandise.
Terms 1/10, n/60.

If the agreement provides that discount is also applicable to partial payment

March 7 - Accounts payable (2,000/.99) 2,020.20
Purchase discount 20.20
Cash 2,000.00
Partial payment of account.
Full payment within the discount period:
Mar 12 - Accounts payable 2,979.80
Purchase discount 29.80
Cash 2,950.00
Full payment of account.

Payment beyond the discount period:

Mar 16 - Accounts payable 2,979.80
Cash 2,979.80
Full payment of account.

If there is no agreement that discount is also applicable to partial payment

March 7 - Accounts payable 2,000
Cash 2,000
Partial payment of account.
Full payment within the discount period:
Mar 12 - Accounts payable 3,000
Purchase discount 50
Cash 2,950
Full payment of account.

Payment beyond the discount period:

Mar 16 - Accounts payable 3,000
Cash 3,000
Full payment of account.

Purchase Returns and Allowances

Ex. Returned P 2,000 worth of goods.
Accounts payable 2,000
Purchase returns and allowances 2,000
Returned goods.

ACCOUNTING FOR SALE OF MERCHANDISE

 Sales Invoice – document that the seller gives to the buyer listing the items ordered or sold
together with the quantity, price, description, terms of the sale, and total price

Sale of Merchandise on Cash

Ex. Ictus Electrical Supplies sold merchandise to customers on cash basis totaling P12,750.
Cash 12,750
Sales 12,750

Sale of Merchandise on Account

Ex. Ictus Electrical Supplies sold merchandise to customers on account totaling P12,750.
Accounts Receivable 12,750
Sales 12,750
Sold goods on account.
Sale of Merchandise on Account with Cash Discount
Ex. On March 2, 20-1 Ictus Electrical Supplies sold merchandise on account, P5,000. Terms: 1/10, n/60
Mar 2 - Accounts Receivable 5,000
Sales 5,000
Sold goods. Terms: 1/10, 60
Payment within the discount period:
Mar 5 Cash 4,950
Sales Discount 50
Accounts Receivable 5,000
Full, net of 1% discount

Payment beyond the discount period:

Mar 16 Cash 5,000
Accounts Receivable 5,000
In full of the account.
Sale of Merchandise on Account with Cash Discount and Partial Payment
Ex. On March 2, 20-1, Ictus Electrical Supplies sold merchandise on account, P5,000. Terms: 1/10,
n/60.
On March 7, Ictus received P2,000 to apply on the account.
Mar 2 - Accounts Receivable 5,000
Sales 5,000
Sold goods. Terms: 1/10, 60

If there is an agreement to apply cash discount on partial payment(s).

Mar 7 - Cash 2,000.00
Sales discount 20.20
Accounts receivable 2,020.20
Received partial payment.

Full Payment within the discount period:

Mar 12 Cash 2,950.00
Sales Discount 29.80
Accounts Receivable 2,979.80
Full, net of 1% discount

Payment beyond the discount period:

Mar 16 Cash 2,979.80
Accounts Receivable 2,979.80
In full of the account.

If there is no agreement to apply cash discount on partial payment(s).

Mar 7 - Cash 2,000
Accounts receivable 2,000
Received partial payment.
Full Payment within the discount period:
Mar 12 Cash 2,950
Sales Discount 50
Accounts Receivable 3,000
Full, net of 1% discount

Payment beyond the discount period:

Mar 16 Cash 3,000
Accounts Receivable 3,000
In full of the account.

Sales Returns and Allowances

Customer returned P 5,000 worth of goods

Sales Returns and Allowances 2,000
Accounts Receivable 2,000
Received goods returned.

ACCOUNTING FOR FREIGHT OF MERCHANDISE

 Free on Board (F.O.B) Shipping Point – the ownership over the goods is transferred to the
buyer at the point of shipment. Freight charge is presumed to be shouldered by the buyer.
 Free on Board (F.O.B) Destination – the ownership over the goods is transferred to the buyer at
the point of destination or delivery, normally, the place of the buyer. Freight charge is presumed
to be shouldered by the seller.
 Freight Collect – the freight is paid by (or collected from) the buyer upon delivery.
 Freight Prepaid – the freight is paid by the seller before delivery.
 Freight In (or Transportation in) - costs incurred by the buyer for transporting the goods from
the seller’s place to the buyer’s place. Presented as part of cost of merchandise purchased.
 Freight Out (or Transportation out or Delivery expense) - costs incurred by the seller for
transporting the goods from the seller’s place to the buyer’s place. Presented as part of operating
expenses.
ILLUSTRATIVE RECORDING OF TRANSACTIONS:

ILLUSTRATIVE EXAMPLE
Jan 1 Abby Trading bought goods from Maggi Inc., P10, 000. Terms: 2/10, n/30.

2 - Abby Trading returned P 2,000 worth of goods to Maggi Trading.

5 - Abby Trading made partial payment to Maggi Trading, P3,000

11 - Abby Trading paid in full. (within the discount period).

MODULE 3 - Adjusting Entries

1. Introduction/Overview

As mentioned in the previous module, the accounting process of a merchandising business is the same
with the service entity except in the nature of transactions and the forms of financial statements. In the
same manner, the adjusting entries that may be required for a service concern is the same with the trading
business, except for the Merchandise inventory which is peculiar to the latter.
This module explains the reporting process of the accounting cycle. It describes the differences between
accrual and cash basis of accounting as well as the concepts and principles used in income and expense
recognition. Moreover, this module discusses and illustrates on how to correctly account for the
adjustments of accrued and deferred income and expenses and other adjustments such as depreciation,
doubtful accounts and merchandise inventory.

3. Accrual and Cash Basis of Accounting

Accrual Basis Accounting

Under this, the effects of the activities and events are measured, recognized and reported in the period
when they occur - not necessarily when cash or its equivalent is received or paid out.
Cash Basis Accounting
Under this basis, activities and events are recognized and reported in the period when cash is actually
received or paid out.

RECOGNITION OF: ACCRUAL BASIS CASH BASIS

Income When earned When received
Expenses When incurred When paid

MATCHING CONCEPT
The profit of an enterprise could be properly measured if there is a proper matching of earned income and
incurred expenses within the reporting period.
Proper matching is attained only if there is proper measurement, recognition, and reporting of both the
earned income (revenues and gains) and the related incurred expenses and losses.
INCOME RECOGNITION
The general rule is the income is recognized when the earning process is complete or almost complete.
Income is recognized in the period when there is a measurable increase in future economic benefits,
related to either an increase in an asset or decrease in a liability.
Generally, income is recognized when services have been rendered (service concern) or when goods have
been delivered (trading/merchandising/manufacturing).

EXPENSE RECOGNITION
 Direct association – this involves the simultaneous recognition of the income and expenses that
resulted directly from the same transaction.
 Systematic and rational allocation – the procedure recognizes expenses during periods when the
economic benefits are used, expired or are divided.
 Immediate Recognition – occurs from the moment an item to have no future economic usefulness
or when an item ceases to produce future economic benefits.

ADJUSTING ENTRIES
Entries that are used to update the books
Purpose:
 To conform with the principle of “Matching Costs against Revenue” (matching concept) which
will result in a more accurate measurement of the net income;
 To arrive at the correct valuation of assets and liabilities;
 To arrive at the correct determination of the owner’s equity.

PERIODICITY CONCEPT
Assumes that the operating life of the business may be divided into time-periods so that timely and
regular financial reports will be available for the use of decision-makers.
As a result of the end-of-the-period cut-offs, measurement and recognition problems arise. The major
problems revolve around the determination of the amounts that pertain to an element’s year life.

ITEMS TO BE ADJUSTED
4. Accrued Income
ACCRUED INCOME (REVENUE)
Arises if income is already earned but not yet collected as of the reporting date.

Case 1:
A 30-day, 9% promissory note for P 60,000 was received by the business from sale of merchandise on
December 16, 20-1.
Analysis:
For every day that passes, the business (seller) earns interest income. As of December 31, interest income
of P225 for 15 days (from December 16 to 31), at 9% per annum, is considered earned. Since the earned
interest income is not yet collected, an asset, in the form of a receivable, is taken up in the records.
Journal Entry:
Interest receivable 225
Interest income 225
(P60,000 x 9% x 15/360)

Case 2:
The December rent for a store space subleased has not been collected as of December 31, 20-1. Monthly
rental is P5,000.
Analysis:
Certain income items, such as interest income and rent income, are considered as earned in proportion to
the passage of time. Since the rent for December 20-1 is already earned but not collected, a receivable
account is recognized before the landlord or lessor prepares his financial statements.
Journal Entry:
Rent income receivable 5,000
Rent income 5,000

5. Accrued Expenses

ACCRUED EXPENSES
expenses already incurred but not yet paid.

Case 1:
Three sales clerks, with daily wage of P500, are paid weekly salary for services they rendered from
Monday to Saturday on the next Monday. December 31, 20-1 fell on a Thursday.
Analysis:
Businesses have different policies in paying the wages of their workers. Amounts already earned by the
workers but not paid as of the end of reporting period (Monday to Thursday) must be adjusted by a debit
to an expense account and with a corresponding credit to a liability account.
Journal Entry:
Wages expense 6,000
Wages payable 6,000
(P500 x 4 days x 3 clerks)
Case 2:
Sales taxes of 3% is being assessed by the government on the monthly sales of the business which is
payable on the 20th day of the succeeding month. For December 20-1, the business had sales of P300,000.
Analysis:
Some forms of taxes – such as property taxes and business permits – are paid to the government in
advance. However, there are taxes – such as sales taxes, income taxes, and transfer taxes – that are
computed and paid only after certain activities or events have occurred. Obligations for taxes based on
transactions that have occurred in the year 20-1 must be recognized before preparing the income
statement.
Journal Entry:
Taxes expense 9,000
Taxes payable 9,000
(P300,000 x 3%)

Case 3:
The business received the bill for its telephone on January 5, 20-2. The statement of account shows
P3,000 as the amount being billed for the month of December 20-1.
Analysis:
These are usually paid and taken up in the records after a statement of account has been received from the
service provider. If at the end of the reporting period there are benefits already received but not yet paid to
the service provider, adjustments must be prepared to take up the expense and the corresponding liability.
Journal Entry:
Communication expense 3,000
Communication payable 3,000

6. Unearned Income

PRE-COLLECTED OR UNEARNED INCOME

Income Method Liability Method
If the advance income collection was recorded by If a liability account was credited upon recording
making a credit to an income account, the income the advance income collection, the liability
method is in use. The income account is a mixed method is in use. The liability account is a mixed
account before the adjusting entries are prepared. account before the adjusting entries are prepared.
Upon adjustment, a liability account is credited for Upon adjustment, an income
the unearned portion. account is credited for the earned portion.

After the adjustment, the remaining balance in the After the adjustment, the remaining balance in the
income account is the earned portion. liability account is the unearned portion.

Case 1:
On November 1, 20-1, Rose Merchandising collected P 25,000 representing the rent for 5 months on
space subleased. The rent took effect on the same date.
Analysis:
Since the rent collected by the lessor Rose Merchandising, pertains to period that extends beyond the end
of the current reporting period, then the collection becomes part income and part liability. Out of five
months, 2 months’ rent (pertaining to November and December 20-1) is already earned in 20-1. 3 months’
rent (pertaining to January to March 20-2) is unearned as of December 31, 20-1. At the end of the current
reporting period, an adjusting entry is prepared to separate the income portion from the liability portion.

Case 2:
The business received a promissory note for the loan extended to one of its customers. The principal
amount of the note is P100,000 discounted at 6% for 90 days. The note was dated December 1, 20-1
Analysis:
When a note is discounted, it means that the total interest has been deducted from the loan proceeds.
Hence, the interest is collected in advance. Since only 30 days have been earned from December 1 to 31,
20-1, the remaining 60 days are still unearned.

7. Prepaid Expenses

PREPAID OR UNEXPIRED EXPENSES

Expense Method Asset Method

If the advance payment was recorded by making If an asset account was debited upon recording
a debit to an expense account, the expense the advance payment, the asset method is in
method is in use. The expense account is a use. The asset account is a mixed account before
mixed account before the adjusting entries are the adjusting entries are prepared. Upon
prepared. Upon adjustment, an asset adjustment, an expense account is debited for
account is debited for unused or unexpired the used or expired portion.
portion.
After the adjustment, the remaining balance in
After the adjustment, the remaining balance in the asset account is the unused portion.
the expense account is the used portion.
Case 1:
Paid insurance premium of P 3,600 on May 1, 20-1. The premium paid is good for a period of one year,
until April 30, 20-2.
Analysis:
Of the total premium paid of P 3,600, only P 300 is incurred per month. The premium pertaining to 8
months (May to Dec 20-1), P 2,400, is already incurred in 20-1. The premium applicable to four months
(Jan – Apr 20-2), P 1,200, is still unexpired and is treated as an asset as of Dec 31, 20-1.

Case 2:
Bought office supplies on August 18, 20-1, P4,280. As of December 31, 20-1, approximately ¾ of the
supplies have been used up.
Analysis:
As of December 31, 20-1, P 3,210 of the supplies bought is used up and is considered as expense in 20-1.
The rest of the supplies P 1,070, will be used next year and is treated as an asset as of Dec 31, 20-1.

Case 3:
Borrowed P 80,000 from the bank on September 15, 20-1. The 6-month loan carries an interest rate of
12%. The bank deducted the P 4,800 interest from the face value of the loan. Cash proceeds were P
75,200.
Analysis:
Upon borrowing, the bank immediately deducted from the face value of the loan the 6-month interest of P
4,800 (or P 80,000 – P 75,200, or P 80, 000x 12% x 6/12). As of Dec 31, 20-1, 3 ½ months (Sept 15 –
Dec 31, 20-1) out of 6 months passed; therefore, P 2,800 of the interest paid is already expired or
incurred. P 2,000 of the interest pertaining to year 20-2 (2 ½ months) is not yet expired and is considered
as a prepaid interest expense, an asset.
ENDING INVENTORY
At the end of the accounting period, the adjustment for ending inventory is taken up representing the
unsold merchandise and on hand.

Ex. On December 31, 20-1, physical count revealed unsold merchandise amounting to P150,000.
Merchandise Inventory 150,000
Income Summary 150,000

MODULE 4 - Completing the Accounting Cycle

1. Introduction/Overview

The accounting cycle of a merchandising concern is the same as that of a service entity. They only vary in
the adjusting entry (the merchandising concern has Merchandise inventory account) and the forms of
financial statements.
This module covers the following steps in the accounting process of a merchandising business:
1. Worksheet;
2. Financial statements;
3. Closing entries;
4. Post-closing trial balance; and
5. Reversing entries.

3. Preparation of the Worksheet

The preparation of worksheet for a merchandising business is the same with the worksheet for a service
entity. The only difference is the account titles peculiar to a merchandising concern. Worksheet
preparation is only optional in the accounting process. However, it is prepared to facilitate the convenient
preparation of financial statements. A sample worksheet is presented below.
4. Financial Statements of a Merchandising Business

Financial statements include:

 Balance Sheet
 Income Statement
 Statement of Changes in the Owners’ Equity
 Statement of Cash Flows
 Notes, comprising of the summary of significant accounting policies and other explanatory notes

Sample Balance Sheet (account form) of a merchandising concern is presented below:

Sample income statement (multiple step) of a merchandising concern is presented below:

5. Closing Entries

The nominal accounts (temporary accounts or income statement accounts) of the business are closed to
capital at the end of the accounting period.
Sample closing entries are presented below.

Sales 825,000
Purchase discount 3,000
Purchase returns and allowances 12,000
Merchandise inventory, Dec. 31 175,000
Rent income 6,000
Interest income 925
Income summary 1,021,925
To close nominal accounts with credit balances.

Income summary 933,525

Purchases 465,000
Sales discount 10,000
Sales returns and allowances 15,000
Merchandise inventory, Jan. 1 165,000
Freight in 14,000
Store salaries 86,000
Depreciation expense – SFE 16,000
Light water – store 11,700
Store supplies 9,400
Freight out 8,000
Communication – store 7,200
Office salaries 61,000
Light and water – office 20,000
Depreciation expense – OFE 14,800
Communication expense – office 13,000
 Interest expense 7,875
Transportation expense 6,300
Doubtful accounts expense 3,250
To close nominal accounts with
debit balances.

Income summary 88,400

R. De Guzman, capital 88,400
To close the net income to
capital account.

R. De Guzman, capital 10,000

R. De Guzman, drawing 10,000
To close drawing account to
capital account.

6. Post-Closing Trial Balance

Sample post-closing trial balance is presented below.

7. Reversing Entries

The following adjusting entries made at the end of the accounting period may be reversed at the
beginning of the succeeding period:
1. Accrued income
2. Accrued expense
3. Deferred income – income method
4. Deferred expense – expense method

Sample reversing entries are presented below:

Interest income 925

Interest receivable 925
To reverse the adjusting entry on
accrued interest income.

Interest payable 1,125

Interest expense 1,125
To reverse the adjusting entry on
accrued interest expense.

Accrued light and water 3,200

Light and water – store 1,200
Light and water – office 2,000
To reverse the adjusting entry on
accrued light and water.

Unearned rent 2,000

Rent income 2,000
To reverse the adjusting entry on
unearned rent income.

MODULE 5 - Accounting for VAT

1. Introduction/Overview
Value added tax (VAT) is already part not only of a FIlipino's personal daily activities but also of a
business daily transactions. As our personal transactions involve the purchase of necessities such as
groceries, medicines, food, fuel and other products, part of our payments for these goods and for some
services is the VAT. Same goes with the businesses wherein part of their payments for goods and services
needed in their operations goes to VAT. More so if the business is a VAT-registered taxpayer wherein its
sales, purchases and expenses may be subject to VAT.
This chapter discusses and illustrates the transactions of a business with VAT component, how the VAT
is calculated and how the VAT transactions are analyzed and recorded.
3. Value Added Tax

VALUE ADDED TAX (VAT)

 business tax imposed on sale of goods or services.
 The tax is paid by the seller but is passed on to the buyer.
 VAT on sale is recorded as Output taxes while VAT on purchase is recorded as Input taxes.
 VAT on sales return, allowance or discount shall be recorded as debit to Output taxes.
 VAT on purchase return, allowance or discount is credited to Input taxes.
4. Purchase Transactions

Recording Purchases, Freight In, Returns, and Payments

Case 1: VAT is not yet included in the purchase price. (VAT exclusive)
 Bought merchandise from Ward Trading, P 10,000 terms 2/10, n/30.
Purchases 10,000
Input Taxes (12% x 10,000) 1,200
Accounts Payable 11,200
 Paid freight on purchases, P 500.
Freight In 500
Input Taxes(12% x 500) 60
Cash 560
 Returned defective merchandise to Ward Trading, P 2,000.
Accounts Payable 2,240
Purchase Returns & Allow. 2,000
Input Taxes 240
 Made partial payment of P3,000 to Ward Trading.
Accounts Payable 3,000
Cash 3,000
 Paid the account in full within the discount period.
Accounts Payable (11,200-2,240-3,000) 5,960
Purchase Discount (2% x 8,000) 160
Cash 5,800
 Paid the account in full after the discount period.
Accounts Payable 5,960
Cash 5,960
 Bought merchandise with a list price of P 10,000 with trade discount of 10%.
Purchases (90% x 10,000) 9,000
Input Taxes (12% x 9,000) 1,080
Cash 10,080

Case 2: VAT is already included in the purchase price. (VAT inclusive)

 Bought merchandise from Magnus Co. P 22,400 terms 2/10, n/30.
Purchases (22,400/112%) 20,000
Input Taxes (12% x 20,000) 2,400
Accounts Payable 22,400
 Paid freight of P 1,120 on the above purchase.
Freight In(1,120/112%) 1,000
 Input Taxes(12% x 1,000) 120
Cash 1,120
 Returned defective merchandise to Magnus Co., P 4,480.
Accounts Payable 4,480
Purchase Returns & Allow. 4,000
Input Taxes 480
 Made partial payment of P 5,000 to Magnus Co.
Accounts Payable 5,000
Cash 5,000
 Paid Magnus Co. in full within the discount period.
Accounts Payable (22,400-4,480-5,000) 12,920.00
Purchase Discount (2% x 16,000) 320.00
Input tax 38.40
Cash 12,561.60
 Paid Magnus Co. in full after the discount period.
Accounts Payable 12,920
Cash 12,920
 Bought merchandise from Magnus Co., P 20,160, net of 10% trade discount.
Purchases(20,160/112%) 18,000
Input Taxes(12% x 18,000) 2,160
Cash 20,160
Note: The list price is P 18,000/90% = P 20,000 (w/o VAT)

Case 3: Purchases with Freight Charges (VAT exclusive)

 Bought merchandise costing P 10,000 with freight charges of P 1,000, terms FOB Shipping Point,
freight collect, 2/10, n/30.
Purchases 10,000
Input Taxes (12% x 10,000) 1,200
Accounts Payable (112% x 10,000) 11,200

Freight In 1,000
Input Taxes (12% x 1,000) 120
Cash 1,120

Note: The freight is chargeable to the buyer hence freight is recognized. The freight is paid by the buyer
hence cash is credited.
 Paid the account in full. (with discount)
Accounts Payable 11,200
Purchase Discount (2% x 10,000) 200
Input taxes(200 x 12%) 24
Cash 10,976
 Bought merchandise costing P 10,000 with freight charges of P 1,000, terms FOB Shipping
Point, freight prepaid, 2/10, n/30.
Purchases 10,000
Freight In 1,000
Input Taxes (12% x 11,000) 1,320
 Accounts Payable (112% x 10,000) 12,320
Note: Because the freight is prepaid by the seller, the Accounts Payable is increased by the amount of the
freight.
 Paid the account in full. (with discount)
Accounts Payable 12,320
Purchase Discount (2% x 10,000) 200
Input taxes (200 x 12%) 24
Cash 12,096
 Bought merchandise costing P 10,000 with freight charges of P 1,000, terms FOB Destination,
freight collect, 2/10, n/30.
Purchases 10,000
Input Taxes (12% x 10,000) 1,200
Accounts Payable( 11,200 – 1,120) 10,080
Cash 1,120
 Paid the account in full. (with discount)
Accounts Payable 10,080
Purchase Discount (2% x 10,000) 200
Input taxes (200 x 12%) 24
Cash 9,856
 Bought merchandise costing P 10,000 with freight charges of P 1,000, terms FOB Destination,
freight prepaid, 2/10, n/30.
Purchases 10,000
Input Taxes (12% x 10,000) 1,200
Accounts Payable 11,200
 Paid the account in full. (with discount)
Accounts Payable 11,200
Purchase Discount (2% x 10,000) 200
Input taxes (200x 12%) 24
Cash 11,976

Case 4: Purchases with Freight Charges (VAT inclusive)

 Bought merchandise costing P 28,000 with freight charges of P 1,792, terms FOB Shipping Point,
freight collect, 2/10, n/30.
Purchases (28,000/112%) 25,000
Freight In (1,792/112%) 1,600
Input Taxes (12% x 26,600) 3,192
Accounts Payable (112% x 25,000) 28,000
Cash 1,792
 Paid the account in full. (with discount)
Accounts Payable 28,000
Purchase Discount (2% x 25,000) 500
Input taxes (500 x 12%) 60
Cash 27,440
 Bought merchandise costing P 28,000 with freight charges of P 1,792, terms FOB Shipping Point,
freight prepaid, 2/10, n/30.
Purchases (28,000/112%) 25,000
Freight In (1,792/112%) 1,600
Input Taxes (12% x 26,600) 3,192
Accounts Payable (112% x 25,000) 29,792
Note: Because the freight is on the account of the buyer but prepaid by the seller, the Accounts Payable is
increased by the amount of the freight.
 Paid the account in full. (with discount)
Accounts Payable 29,792
Purchase Discount (2% x 25,000) 500
Input taxes (500 x12%) 60
Cash 29,232
 Bought merchandise costing P 28,000 with freight charges of P 1,792, terms FOB Destination,
freight collect, 2/10, n/30.
Purchase s(28,000/112%) 25,000
Input Taxes (12% x 25,000) 3,000
Accounts Payable (28,000 – 1,792) 26,208
Cash 1,792
 Paid the account in full. (with discount)
Accounts Payable 26,208
Purchase Discount(2% x 25,000) 500
Input taxes (500 x 12%) 60
Cash 25,648
 Bought merchandise costing P 28,000 with freight charges of P 1,792, terms FOB Destination,
freight prepaid, 2/10, n/30.
Purchases (28,000/112%) 25,000
Input Taxes (12% x 25,000) 3,000
Accounts Payable 28,000
 Paid the account in full. (with discount)
Accounts Payable 28,000
Purchase Discount(2% x 25,000) 500
Input taxes (500 x 12%) 60
Cash 27,440

5. Expenses with VAT

How to Record Payment of Expenses with VAT

Most expenses paid by the business are also subject to VAT. They include (not all
inclusive) Advertising, Rent, Telephone, Light & Water, Insurance, and Supplies.

Examples:
Paid advertising, P 12,000 exclusive of VAT.
Advertising Expense 12,000
Input Taxes 1,440
Cash 13,440

Paid insurance premium, P 12,320 inclusive of VAT.

Insurance Expense 11,000
Input Taxes 1,320
Cash 12,320
Expenses paid which are not subject to VAT include among others (not all
inclusive) interest, taxes, licenses, publications, and postage stamps.

6. Sales Transactions

Recording Sales, Freight Out, Returns, and Collections

Case 1: VAT is not yet included in the sales price. (VAT exclusive)
 Sold merchandise to Ward Trading, P 30,000 terms 2/10, n/30.
Accounts Receivable (112% x 30,000) 33,600
Sales 30,000
Output Taxes (12% x 30,000) 3,600
 Paid freight of P 2,000 on the above sale.
Freight Out 2,000
Input Taxes 240
Cash 2,240
 Ward Trading returned defective merchandise, P 2,000.
Sales Returns & Allow. 2,000
Output Taxes 240
Accounts Receivable 2,240
 Ward Trading made partial payment of P 10,000.
Cash 10,000
Accounts Receivable 10,000
 Ward Trading paid its account in full within the discount period.
Cash 20,732.80
Sales Discount(2% x 28,000) 560.00
Output taxes 67.20
Accounts Receivable 21,360
(33,600-2,240-10,000)
 Ward Trading paid its account in full after the discount period.
Cash 21,360
Accounts Receivable 21,360
 Sold merchandise P 50,000 with trade discount of 5%.
Cash 53,200
Sales (95% x 50,000) 47,500
Output Taxes (12% x 47,500) 5,700

Case 2: VAT is already included in the sales price. (VAT inclusive)

 Sold merchandise to Magnus Co., P 28,000 terms 2/10, n/30.

Accounts Receivable 28,000

Sales (28,000/112%) 25,000
Output Taxes (12% x 25,000) 3,000
 Paid freight on the above sale, P 3,360.
Freight Out (3,360/112%) 3,000
Input Taxes (12% x 3,000) 360
Cash 3,360
 Magnus Co., returned defective merchandise, P 6,720.
Sales Returns (6,720/112%) 6,000
Output Taxes (12% x 6,000) 720
Accounts Receivable 6,720
 Magnus Co. made a partial payment of P 5,000.
Cash 5,000
Accounts Receivable 5,000
 Magnus Co. paid its account in full within the discount period.
Cash 15,854.40
Sales Discount (2% x 19,000) 380.00
Output taxes 45.60
Accounts Receivable 16,280.00
(28,000-6,720-5,000)
 Magnus Co. paid its account in full after the discount period.
Cash 16,280
Accounts Receivable 16,280
 Sold merchandise P 12,096, net of 10% trade discount.
Cash 12,096
Sales (12,096/112%) 10,800
Output Taxes (12% x 10,800) 1,296

Case 3: Sales with Freight Charges (VAT exclusive)

 Sold merchandise worth P 40,000 with freight charges of P 3,000 terms FOB Shipping Point,
freight collect, 2/10, n/30.
Accounts Receivable 44,800
Sales 40,000
Output Taxes 4,800
Note: The freight is paid by the buyer hence no freight is recorded by the seller.
 Received the account in full. (with discount)
Cash 43,904
Sales Discount (2% x 40,000) 800
Output taxes (800x 12%) 96
Accounts Receivable 44,800
 Sold merchandise worth P 40,000 with freight charges of P 3,000 terms FOB Shipping Point,
freight prepaid, 2/10, n/30.
Accounts Receivable 48,160
Sales 40,000
Output Taxes ( 12% x 40,000) 4,800
Cash (112% x 3,000) 3,360
Note: Because the freight is chargeable to the buyer but prepaid by the seller, the Accounts Receivable is
increased by the amount of freight.
 Received the account in full. (with discount)
Cash 47,264
Sales Discount (2% x 40,000) 800
Output taxes 96
 Accounts Receivable 48,160
 Sold merchandise worth P 40,000 with freight charges of P 3,000 terms FOB Destination, freight
collect, 2/10, n/30.
Accounts Receivable (44,800 – 3,360) 41,440
Freight Out 3,000
Input Taxes (12% x 3,000) 360
Sales 40,000
Output Taxes (12% x 40,000) 4,800
 Received the account in full. (with discount)
Cash 40,544
Sales Discount (2% x 40,000) 800
Output taxes 96
Accounts Receivable 41,440
 Sold merchandise worth P 40,000 with freight charges of P 3,000 terms FOB Destination, freight
prepaid, 2/10, n/30.
Accounts Receivable (112% x 40,000) 44,800
Freight Out 3,000
Input Taxes (12% x 3,000) 360
Sales 40,000
Output Taxes (12% x 40,000) 4,800
Cash 3,360
 Received the account in full. (with discount)
Cash 43,904
Sales Discount (2% x 40,000) 800
Output taxes 96
Accounts Receivable 44,800

Case 4: Sales with Freight Charges (VAT inclusive)

 Sold merchandise worth P 33,600 with freight charges of P 2,240. Terms: FOB Shipping Point,
freight collect, 5/10, n/60.
Accounts Receivable 33,600
Sales (33,600/112%) 30,000
Output Taxes (12% x 30,000) 3,600
Note: The freight is paid by the buyer hence no freight is recorded by the seller.
 Received the account in full. (with discount)
Cash 31,920
Sales Discount (5% x 30,000) 1,500
Output taxes (1,500 x 12%) 180
Accounts Receivable 33,600
 Sold merchandise worth P 33,600 with freight charges of P 2,240. Terms: FOB Shipping Point,
freight prepaid, 5/10, n/60.
Accounts Receivable 35,840
Sales (33,600/112%) 30,000
Output Taxes (12% x 30,000) 3,600
Cash 2,240
Note: The freight is on the account of the buyer but is prepaid by the seller hence the Accounts
Receivable is increased by the amount of the freight.
 Received the account in full. (with discount)
Cash 34,160
Sales Discount (5% x 30,000) 1,500
Output taxes (1,500 x 12%) 180
Accounts Receivable 35,840
 Sold merchandise worth P 33,600 with freight charges of P 2,240. Terms: FOB Destination,
freight collect, 5/10, n/60.
Accounts Receivable (33,600-2,240) 31,360
Freight Out (2,240/112%) 2,000
Input Taxes (12% x 2,000) 240
Sales (33,600/112%) 30,000
Output Taxes (12% x 30,000) 3,600
Note: The freight is on the account of the seller but is paid by the buyer. Hence, the Accounts Receivable
is decreased by the amount of the freight.
 Received the account in full. (with discount)
Cash 29,680
Sales Discount (5% x 30,000) 1,500
Output taxes (1,500 x12%) 180
Accounts Receivable 31,360
 Sold merchandise worth P 33,600 with freight charges of P 2,240. Terms: FOB Destination,
freight prepaid, 5/10, n/60.
Accounts Receivable 33,600
Freight Out (2,240/112%) 2,000
Input Taxes (12% x 2,000) 240
Sales (33,600/112%) 30,000
Output Taxes (12% x 30,000) 3,600
Cash 2,240
Note: The freight is on the account of the seller, hence the freight is recorded by the seller.
 Received the account in full. (with discount)
Cash 31,920
Sales Discount (5% x 30,000) 1,500
Output taxes (1,500 x 12%) 180
Accounts Receivable 33,600

7. VAT Payable

VAT PAYABLE
the excess of the output tax on sales of a VAT-registered seller, over the allowable or creditable input
tax on purchases as evidenced by the sales invoices or official receipts issued to the buyer by other VAT-
registered sellers.

Example: VAT Output P 75,000

VAT Input 25,000
 VAT Payable 50,000
======
To record the payment of VAT Payable:
Output Taxes 75,000
Input Taxes 25,000
Cash 50,000

To record the adjustment of VAT Payable at the end of the accounting period:
Output Taxes 75,000
Input Taxes 25,000
VAT payable 50,000

If VAT Input exceeds VAT Output, an adjusting entry is required:

Example: VAT Output P 25,000
VAT Input 75,000
VAT Payable (P50,000)
========

The required entry:

Output taxes 25,000
Input taxes 25,000

The excess (P 50,000) shall be carried over to and creditable in the succeeding month or quarter. VAT
Payable shall be paid to the BIR, or its authorized agent banks within 20 days after the end of the month
or within 25 days from the end of the quarter.