FINANCIAL ACCOUNTING: MADE EASY 0

FINANCIAL ACCOUNTING: MADE EASY 1

FINANCIAL ACCOUNTING: MADE EASY

A Module on

FINANCIAL ACCOUNTING

MARY RUTH O. QUINTERO, MSA, REA, REB

FINANCIAL ACCOUNTING: MADE EASY 2

Unit 1-Introduction to Merchandising Business

Unlike service concern where the business generates income from

rendering of services to customers or clients, in merchandising business, it
generates revenue from sale of goods or commodities that it buys. The business
therefore could be a buyer at one hand and a seller on the other hand. Basically,
there are two (2) major activities that are involved in a merchandising business;
these are the buying and selling activities.

Learning Outcomes

At the end of this unit, you will be able to:

• Record transactions of a merchandising business in the journal.
• Post transactions in the T-accounts and prepare Trial Balance.
• Compute Input and Output Tax.

Pretest

TRUE OR FALSE
Instruction: Write “T” if the statement is correct and “F” if incorrect.

______ 1. Buying and selling are the primary activities of a merchandising business.
______ 2. Under merchandising concern, the business can be a buyer at one hand and a
seller on the other hand.
______ 3. The chart of accounts for merchandising concern is similar to service concern.
______ 4. There is only one ledger account to be maintained as Merchandise Inventory
for beginning and ending.
______ 5. Perpetual and Periodic are the two inventory systems of a merchandising
business.
______ 6. Freight-in is an adjunct to purchase account.
______ 7. Freight-out is neither cost nor asset to the business.
______ 8. Freight-out refers to transportation expense in buying merchandise from a
supplier.
______ 9.Freight-in refers to transportation expense in selling merchandise to a customer.
______ 10. Under periodic inventory system, purchase of merchandise is debited to
“Purchases”.
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Content

Inventory Systems

There are two (2) systems used in keeping of merchandise inventory records.
These are the Periodic and Perpetual Inventory Systems.

Under Periodic Inventory System

This system is characterized by the use of the following account titles:

Asset Accounts
Merchandise Inventory, End – this refers to the unsold merchandise at the end of the
accounting period as determined by physical counting or inventory taking. It is usually
dated December 31. The normal balance of the account is a debit.

Cost Accounts

Merchandise Inventory, Beginning – this refers to merchandise inventory at the

beginning of the period and is usually dated January 1 which will turn from an asset into
costs when such period ended. The account is usually credited in the adjustment.

Purchases – this account is debited when merchandise are purchased either in cash or
credit. This is recorded as follows:

Purchases ₱ xx
Cash/Accounts Payable ₱ xx

Purchase Discounts – this account is credited when there is discount availed from a
supplier for early payment of merchandise purchase on credit. This is recorded as follows:

Accounts Payable ₱ xx
Purchase Discounts ₱ xx
Cash xx

Purchase Returns and Allowances – this account is credited for merchandise

purchased either in cash or on credit that were returned to the supplier for reason of bad
order or does not fit to the description of the merchandise ordered and were not placed
due to non-availability of stocks of merchandise by the supplier. This is recorded as
follows:
Cash ₱ xx
Purchase Returns and Allowances ₱ xx

Freight-in – this account is debited for the freight and handling charges of merchandise
purchased by the buyer or customer and shipped via land, sea and air transportation. This
is recorded as follows:

Freight-in Income Accounts ₱ xx

Cash/Accounts Payable ₱ xx
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Sales – this account is credited for merchandise sold either in cash or on credit. This is
recorded as follows:

Cash/Accounts Receivable ₱ xx
Sales ₱ xx

Sales Discounts – this account is debited for sales discount given to a customer for early
collection from his/her account. The receipt of cash is recorded a follows”

Cash ₱ xx
Sales Discounts xx
Accounts Receivable ₱ xx

Sales Returns and Allowances – this account is debited for merchandise sold either in
cash or on credit but were returned by the customer for reason of bad order or does not
fit the description of the merchandise ordered and were not replaced due to non-
availability of stock. This is recorded as follows:

Sales Returns and Allowances ₱ xx

Cash/Accounts Receivable ₱ xx

Expense Account
Freight-out – this account is debited for freight and handing charges of merchandise sold
to customers and shipped via land, sea and air transportation. This is recorded as follows:

Freight-out ₱ xx
Cash/Accounts Payable ₱ xx

There is only one (1) account for Merchandise Inventory in the General Ledger
under both periodic and perpetual inventory system. Under periodic, being an asset or
cost can only be identified by indicating Merchandise Inventory, end or Merchandise
Inventory, beginning.

Under Perpetual Inventory System

This is characterized by the use of Merchandise Inventory account as an asset
with the following debit and credit postings:
Merchandise Inventory
Debit Credit
1. To record purchases 1. To record purchase returns and
2. To record freight-in allowances
3. Excess of actual inventory 2. To record purchase discounts
against stock card 3. To record actual cost of goods sold
4. Excess of stock card against actual
inventory
Under this system, the use of stock card is a must. There is a continuous updating
of the ins and outs in the stock card every time there are purchases and sale of
FINANCIAL ACCOUNTING: MADE EASY 5

merchandise. The quantity and amounts of the stock cards are being filled-up throughout
the accounting period or even the whole year round. It facilitates better control because it
provides information of merchandise inventory on hand.

The sample of filled-up stock card of only one (1) item is presented on Table 1.

Table 1

Sample Filled-up Stock Card

Supplier : Saranggani Cattle Ranch

Description : TOP ROUND BEEF
Unit RECEIVED ISSUED BALANCE
Date
Cost Quantity Amount Quantity Amount Quantity Amount
Jan. 1 ₱240 50 kgs. ₱12,000
8 240 100 ₱24,000 150 kgs. 36,000
20 80 kgs. ₱19,200 70 kgs. 16,800

Cost of Sales Ending

Inventory

Therefore, if perpetual inventory system is used, there is no need to establish

ending inventory because the stock cards reflect both the cost of sales of ₱19,200 and
the inventory at the end in the amount of ₱16,800. However, physical inventory count may
still be conducted to check the accuracy of the stock cards or control cards. If the quantity
and amount per stock card will not reconcile with that of the physical inventory count, the
inventory per physical count will prevail. An adjustment will be made so that inventory per
stock card will reconcile with that of the balance per physical count.
Moreover, there are two (2) things that you should be reminded of under Perpetual
Inventory System, and these are as follows:

1. In recording Sales, there are two (2) entries that must be prepared.

1st Entry:

Accounts Receivable ₱ xx
Sales ₱ xx

2nd Entry:

Cost of Sales ₱ xx
Merchandise Inventory ₱ xx

The second entry reduces the actual cost of gods sold.

2. In recording Sales Returns and Allowances, there must also be another two (2)
entries:
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1st Entry:

Sales Returns & Allowances ₱ xx

Accounts Receivable ₱ xx

2nd Entry:

Merchandise Inventory ₱ xx
Cost of Sales ₱ xx

In the second entry, Merchandise Inventory was debited to increase

the Goods Available for Sale and credited Cost of Sales to effect reduction
of the Cost of Goods Sold.

Cash Discounts and Trade Discounts

The term Cash Discounts has two connotations. It can either be a purchase
discounts or sales discounts depending upon from whose point of view the term is used.
From the viewpoint of the buyer, it is called purchase discounts and from the seller’s
viewpoint, it is called sales discounts. In either way, cash discounts are inducements to
both buyer and seller for prompt payment or prompt collection of account purchase and
account sales. Both purchase discounts and sales discounts are recorded in the books of
the business.

Example: Amount of merchandise, ₱50,000 and 2% cash discount is given if

paid/collected within 10 days. The deadline for payment was met.

Computation:

Amount of Merchandise ₱ 30,000

Less: 2% Cash Discount (30,000 x 2%) 600
Net Amount paid/collected ₱ 29,400

Unlike cash discounts, Trade Discounts are spot discounts or outright discounts
from cash or account sales that a buyer or seller can avail but are not recorded in the
books of the business.

Example: 2% trade discount on merchandise purchased/sold amounting to

₱30,000.

Computation:

List Price ₱ 30,000

Less: Trade Discount (2% x 30,000) 600
Invoice Price ₱ 29,400

The Use of Freight-in and Freight-out Accounts

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Freight or transportation expense on merchandise purchased is recorded as a

debit to freight-in or transportation-in while merchandise sold is recorded as a debit to
freight-out or transportation-out. Freight-in is considered as part of cost and being added
to purchases account to arrive at the gross purchase while freight-out is considered as
business expenses.

Pro-forma Journal Entry

Buyer/Customer’s Book Seller/Supplier’s Book

Freight-in ₱ xx Freight-out ₱ xx
Cash in Bank/Accounts Payable ₱ xx Cash in Bank/Accounts Payable ₱ xx

Discount Terms

The following are the common discount terms both for purchases and sales.
a. 2/10, N/30 – this means that if the account is paid/collected within 10 days from
the date of the invoice, a 2% discount can be availed or given and no discount if
the account is paid/collected after the 10th day or from the 11th to 30th days.

2/10, 1/20, N/30 – this means that a 2% discount can be availed or given if the
account is being paid/collected within 10 days from the invoice date, 1% if
paid/collected from the 11th to 20th days and no discount if paid/collected from the
21st to the 30th day.

b. 2/10, EOM – this means that a 2% discount can be availed or given if the account
is paid/collected 10 days after the End of the Month.

Credit Memorandum and Debit Memorandum

The use of the business term credit memorandum and debit memorandum
depends upon whose viewpoint the terms are used. Credit memorandum is taken from
the viewpoint of the seller or supplier who is the creditor. Since the merchandise sold on
account was recorded by the seller/supplier as a debit to Accounts Receivable in its book,
the merchandise returned by the buyer will be recorded as a credit to the same account
to effect reduction of receivable. Hence, the document issued to is called credit
memorandum.

Debit memorandum is taken from the viewpoint of the buyer/customer who is the
debtor. Since the merchandise bought on account was recorded by the buyer/customer
as a credit to Accounts Payable in its book, the merchandise returned by the
buyer/customer will be recorded as a debit to the same account to effect the reduction of
payable. The comparative journal entries are shown in Table 2.

Table 2
Comparative Journal Entries of Credit and Debit Memo
COMPARATIVE JOURNAL ENTRIES
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Seller or Supplier’s Book (Credit Memo) Buyer or Customer’s Book (Debit Memo)

Upon sale of merchandise: Upon purchase of merchandise:

Accounts Receivable ₱xx Purchases ₱xx
Sales ₱xx Accounts Payable ₱xx

Upon return of the merchandise sold: Upon return of the merchandise purchased:
Sales Returns and Allowances ₱xx Accounts Payable ₱xx
Accounts Receivable ₱xx Purchase Returns & Allowances ₱xx

CREDIT MEMORANDUM DEBIT MEMORANDUM

We credit your account for the return of We debit your account for the return of
merchandise sold on account. merchandise purchase on account.

Supplier/Creditor Customer/Debtor

Accounting for Value-Added Tax

VAT is not entirely a new concept of business taxation but is just another form of
tax levied on a wide range of goods and services. Specifically, it means “tax on the value-
added” by every seller to purchase of goods and services. The approval of R.A. 9337 No.
14-2005, removes the VAT exemption of several formerly, exempt section of our economy.
Thus, the burden of taxation is now shared more equitably. The approval has increased
VAT from 10% to 12% effective February 2006.

The difference between out Output Tax, the tax on our sales and Input Tax, the
tax on our purchases is our VAT Payable which will then be remitted to the Bureau of
internal Revenue within 25 days after the end of each month. Input Tax and Prepaid Tax
are presented in the Current Asset section of the Balance Sheet while Output Tax and
VAT Payable are presented in the Current Liability section of the Balance Sheet Date.
The revenue regulation also emphasizes that VAT Input/Output should be shown
separately in the invoices.

Purchasing Activity

Application of VAT on purchases and related accounts

For Cash Purchases

1) Bought merchandise for cash from P. Tao Grocery, 100,000 plus 12% VAT.
Journal Entry:

Purchases 100,000
Input Tax 12,000
Cash in Bank 112,000

Observation:
FINANCIAL ACCOUNTING: MADE EASY 9

The actual cost of merchandise purchased was 100,000. However, our

supplier added 12% VAT to the cost of what we purchased which is ₱12,000
(100,000 x 12% = 12,000). Thus we pay 112,000 (100,000 + 12,000). The amount
of 12,000 which our supplier added to the cost of our purchases is called Input
Tax. It has a normal balance of debit because it is an Asset.

For Account Purchases

2) Bought merchandise on account from J. Alegado Mall, ₱75,000 plus 12% VAT.
Term: 2/10, N/30.
Journal Entry:

Purchases 75,00
Input Tax 9,000
Accounts Payable 84,000

Return of Merchandise Purchased in Cash

3) Return ₱5,000 cost of merchandise bought for cash from P. Tao Grocery for not
conforming with order and was not replaced. VAT is 12%.
Journal Entry:

Cash in Bank 5,600

Purchase Returns and Allowances 5,000
Input Tax 600

Observation:
When we returned the ₱5,000 cost of what we purchased because there
was no replacement, we should also remove the 12% VAT therefrom. Since Input
Tax has a normal balance of a debit, it is also being credited by 600 to effect the
decrease (₱5,000 x 12% =₱600).

Return of Merchandise Purchased on Account

4) Return ₱10,000 cost of merchandise bought on account from J. Alegado Mall for
not conforming with the order and was not replaced. VAT is 12%.

Journal Entry:

Accounts Payable 11,200

Purchase Returns and Allowances 10,000
Input Tax 1,200
Payment of Account with a Discount

5) Payment of account with J. Alegado Mall within the discount period.

FINANCIAL ACCOUNTING: MADE EASY 10

Journal Entry:

Accounts Payable 72,800

Purchase Discounts 1,300
Input Tax 156
Cash in Bank 71,344

Observation:
The purchase discount availed is ₱1,300 (₱75,000-₱10,000=₱65,000x
2%=₱1,300) and VAT Input Tax is ₱156 (₱1,300 x 12%). As a result, Input Tax
registers a debit balance of ₱19,044 (₱12,000+9,000-1,200-156=₱19,044) or it
can be gleaned from the T-account:

Input Tax
1) 12,000 600 3)
2) 9,000 1,200 4)
156 5)
21,000 1,956
19,044

Selling Activity

Application of VAT on Sales and the Related Accounts

For Sales on Cash

1) Sold merchandise for cash to Matero Convenience Center, ₱190,000 plus 12%
VAT.
Journal Entry:

Cash in Bank 212,800

Sales 190,000
Output Tax 22,800

Observation:
The actual amount of merchandise we sold is ₱9,000. However, we add 12% VAT
to our sales which is ₱22,800 (₱190,000 x 12%). Thus, we collect ₱212,800 (₱190,000 +
₱22,800). The amour of ₱22,800 which we add to our Sales is called an “Output Tax”. It
has a normal balance of a credit being a liability account.

For Sales on Account

2) Sold merchandise on account to E. Detoya & Sons, ₱180,000 plus 12% VAT.
Term: 2/10, N/30.

Journal Entry:
FINANCIAL ACCOUNTING: MADE EASY 11

Accounts Receivable 201,600

Sales 180,000
Output Tax 21,600

Received Merchandise Sold for Cash and Returned by a Customer

3) Received ₱6,000 worth of merchandise returned by Matero Convenience Center

due to bad order. It was not replaced, so it is refunded. VAT is 12%
Journal Entry:

Sales Returns & Allowances 6,000

Output Tax 720
Cash in Bank 6,720

Observation:
When we received the ₱60,000 worth of merchandise returned by our customer,
we also have to remove the 12% VAT therefrom. Since Output Tax has a normal balance
of a credit being a liability, it is also being debited by ₱720 to effect the decrease (₱6,000
x 12%).

Received Merchandise Sold on Account and Returned by a Customer

4) Received 10,000 worth of merchandise returned by E. Detoya & Sons and was not
replaced. VAT is 12%

Journal Entry:

Sales Returns & Allowances 10,000

Output Tax 1,200
Accounts Receivable 11,200

Collected the Account with a Discount

5) Collected the account of E. Detoya & Sons within the discount period.
Journal Entry:

Cash in Bank 186,592

Sales Discounts 3,400
Output Tax 408
Accounts Receivable 190,400
Observation:
The sales discount availed is ₱3,400 (₱180,000 – ₱10,000=₱170,000 x 12% =
₱3,400) and Output Tax is ₱408 (₱3,400 x 12%). As a result, Output Tax registers a credit
FINANCIAL ACCOUNTING: MADE EASY 12

balance of ₱42,072 (₱22,800+21,600-720-1,200-408) or it can gleaned from the T-

account:
Output Tax
3) 720 22,800 1)
4) 1,200 21,600 2)
5) 408
2,328 44,400
42,072

Closing of the Input Tax against Output Tax

The Input Tax of ₱19,044 is closed against Output Tax of ₱42,072 and the
difference of ₱23,028 is the VAT Payable. In an instance wherein Input Tax shows a bigger
balance than the Output Tax, the amount of difference is called is called Prepaid Tax. This
is being brought forwarded to the next month. No remittance until Output Tax exceeds
Input Tax.
Journal Entry:

Output Tax 42,072

Input Tax 19,044
VAT Payable 23,028

Remittance of VAT Payable to the Bureau of Internal Revenue

VAT Payable of ₱23,028 represents the amount that we should remit to the Bureau
of Internal Revenue.
Journal Entry

VAT Payable 23,028

Cash in Bank 23,028

Net Sales and Gross Profit

When there are Sales Returns & Allowances and Sales Discounts during the
period, these are being deducted from Sales. The difference is called Net Sales. The
account Sales is sometimes termed as Gross Sales so that it can be differentiated from
Net Sales. If there are no Sales Returns & Allowances and Sales Discounts, the account
Sales is understood to mean Net Sales.
FINANCIAL ACCOUNTING: MADE EASY 13

To illustrate:
During the period of 2020, the business has generated Sales amounting to
₱100,000. The Sales Returns & Allowances and Sales Discounts were 2,000 and 3,000,
respectively.

Based on the given data, Net Sales is computed as follows:

Sales ₱100,000
Less: Sales Returns & Allowances ₱2,000
Sales Discounts 3,000 5,000
Net Sales ₱ 95,000

The excess of Sales or Net Sales over the Cost of Sales or Cost of Goods Sold is
called “Gross Profit”. Combining together the given amount of Net Sales and
corresponding Cost of Sales, equals Gross profit of 2020 computed as follows:

Net Sales
Sales ₱ 100,000
Less: Sales Returns & Allowances ₱ 2,000
Sales Discounts 3,000 5,000
Net Sales ₱ 95,000

Cost of Goods Sold

Merchandise Inventory, Beg. ₱ 10,000
Purchases ₱80,000
Freight-in 2,500
Gross Purchase ₱82,500
Less: Purchase Returns & Allowances ₱ 4,000
Purchase Discounts 3,000 7,000 75,500
Cost of Goods Available for Sale ₱ 85,500
Less: Merchandise Inventory, End 30,000
Cost of Goods Sold 55,500
Gross Profit ₱ 39,500

Determination of Ownership of the Merchandise

The determination of who has the ownership over the merchandise is important. Does
the ownership of merchandise remains to the seller or has already been transferred to the
buyer? It can be resolved through the following shipping terms:

a) F.O.B. Shipping Point – the ownership of merchandise is transferred from the

seller to the buyer at the moment the merchandise is loaded to the vessel at the
shipping point or point of origin regardless of the invoice date of the seller.
b) F.O.B. Destination – the ownership of merchandise is transferred from the seller
to the buyer at the moment the merchandise is unloaded from the vessel upon
reaching the destination. F.O.B. stands for free on board.

To illustrate:
Cebu Plaza Fair (seller) shipped merchandise to Davao Metro Mall (buyer) and the
merchandise was loaded to the vessel, Super Ferry on December 28, 2019. The vessel
FINANCIAL ACCOUNTING: MADE EASY 14

arrived at the port of Davao on December 31, 2019 but the merchandise was unloaded
from the vessel on January 1, 2020. Both Cebu Plaza and Davao Metro Mall used calendar
accounting period which ends on December 31, 2019.

Question: Who has the ownership of the merchandise as of December 31, 2019?
Answers:
a) Under the Shipping term F.O.B. Shipping Point, the ownership of the merchandise
belongs to Davao Metro Mall. Thus, Purchases is recorded by Davao Metro Mall
and Sales is recorded by Cebu Plaza Fair. Since the merchandise is still in transit
on December 31, 2019, it was not included by Davao Metro Mall in its physical
counting of merchandise to determine the Merchandise Inventory, End. It must be
included or added to merchandise which have already been counted.
b) Under the shipping term F.O.B. Destination, the ownership of merchandise is
retained by Cebu Plaza Fair (seller) because it was unloaded from the vessel on
January 1, 2020 already. Therefore, as of December 31, 2019, the merchandise
is still included in the inventory of Cebu Plaza Fair and will be recorded as Sales
in January 1, 2020. Davao Metro Mall will record this as Purchases also in January
2020.

Who shoulders the freight?

F.O.B. Shipping Point – it is the buyer who shoulders the freight.

a) Freight Prepaid – usually the seller (shipper) pays in advance the freight in
behalf of the buyer. The respective journal entries in the book of the seller and
the buyer follows:

Book of the Seller Book of the Buyer

1. Upon Payment of the freight: 2. Upon receipt of goods:
Accounts Receivable – Buyer 100 Freight-in 100
Cash 100 Accounts Payable 100

3. Upon receipt of reimbursement by buyer 4. Upon reimbursement to seller:

Cash 100 Accounts Payable – Seller 100
Accounts Receivable 100 Cash 100
b) Freight Collect – usually the seller (shipper) instructs the carrier in charge that
payment of freight will be upon arrival at buyer’s place.

Book of the Seller Book of the Buyer

2. Upon arrival of carrier:
NO ENTRY Freight-in 100
Cash 100

F.O.B. Destination – it is the seller who shoulders the freight.

a) Freight Prepaid – the seller pays its own freight on shipment.

Book of the Seller Book of the Buyer

Freight Out 100 NO ENTRY
Cash 100
FINANCIAL ACCOUNTING: MADE EASY 15

b) Freight Collect - usually the seller (shipper) instructs the carrier in charge that
payment of freight will be upon arrival at the buyer’s place.

Book of the Seller Book of the Buyer

Upon shipment of the goods 1. Upon receipt of goods:
NO ENTRY Accounts Receivable 100
Cash 100

2.Upon receipt of buyers’ bill: Reimbursement of seller for freight

Advanced by buyer:
Freight Out 100 Cash 100
Accounts Payable 100 Accounts Receivable 100

Accounts Payable 100

Cash 100

Merchandise Inventory

There are two classes of merchandise inventory: the Merchandise Inventory at the
start of the period which is called Merchandise Inventory, Beg. and the Merchandise
Inventory at the end of the period which is called Merchandise Inventory, End.
Merchandise Inventory is priced at cost and not at selling price.

Cost of Sales

If you remember, under the periodic inventory system, the merchandise that we
purchased is debited to Purchases which is a Cost by nature. At the end of the period, a
physical counting of goods remaining unsold is conducted and we call this physical
inventory count. The unsold goods are originally recorded at cost upon purchase. The
portion of the goods that are sold is called Cost of Sales or Cost of Goods Sold.

Flow of Goods

Beginning Inventory at ₱1,000 = ₱ 8,000

(8 units)
+

Purchases at ₱1,000 = 6,000

(6 units)
=

Available for Sale at ₱1,000 = 14,000

(14 units)
FINANCIAL ACCOUNTING: MADE EASY 16

Cost of Sales or
Cost of Goods Sold at ₱1,000 = 4,000
(4 units)
=

Ending Inventory
at ₱1,000 = ₱ 10,000

To simplify the illustration: (10 units)

Quantity Cost Amount
Beginning Inventory 8 at ₱1,000 = ₱ 8,000
+ Purchases 6 at 1,000 = 6,000
= Available for Sale 14 ₱14,000
- Cost of Sales 4 4,000
= Ending Inventory 10 ₱10,000

Based on the above illustration, the illustration, the ending inventory of merchandise
is computed as follows:

10 units at ₱1,000 = ₱10,000

The ₱10,000 ending inventory of let’s say Dec. 31, 2019 will eventually become the
beginning inventory on January 1, 2020.

Let us assume further that during 2020, the business had made total purchases of
₱80,000 and had incurred Freight-in of ₱2,500. It had also recorded Purchase Returns &
Allowances and Purchase Discounts of ₱4,000 and ₱3,000 respectively. At the end of
2020, the cost of merchandise left on hand is ₱30,000.

Cost of Sales

Based on the given data, the Cost of Sales or Cost of Goods Sold is computed as
follows:

Cost of Goods Sold:

Merchandise Inventory, Beg. ₱10,000

Purchases ₱ 80,000
Add: Freight-In 2,500
Gross Purchase ₱ 82,500
Less: Purchase Returns & Allowances ₱4,000
Purchase Discounts 3,000 7,000 75,500
FINANCIAL ACCOUNTING: MADE EASY 17

Goods Available for Sale ₱85,500

Less: Merchandise Inventory, End 30,000
Cost of Sales or Cost of Goods Sold ₱55,500

Operating Expenses

Under merchandising concern, operating expenses are classified into two: Selling
or Distribution Expenses and General and Administrative Expenses. Selling expenses are
those incurred in storing, promoting, packaging and delivery of merchandise, such as
freight-out, sales, salaries, advertising and sales commission while General and
Administrative expenses consist of expenses needed in the general administration of the
office, such as office salaries, uncollectible account expense, office supplies, rent
expense, taxes and licenses, utilities expense, insurance expense, etc.

Profit or Loss

When total expenses are deducted from Gross Profit, the result will either be Profit or
Loss depending upon the following situations:
a) If the amount of expenses incurred during the period is smaller than the Gross
Profit, the result is profit.
b) If the amount of expenses is bigger than the Gross Profit, the result is a Loss.

Merchandise Inventory Valuation and Estimation

The most common method of inventory valuation that the accountants usually
apply is to follow the cost flow assumptions from purchases to cost of goods sold. The
generally accepted methods are the first-in, first-out (FIFO) method and the weighted
average method.

Illustration:
The following data was gathered from Product 357 on December 31, 2019:

Quantity Unit Cost Total Cost

Inventory, Beg. 250 ₱25 ₱ 6,250
1st Purchase 300 26 7,800
2nd Purchase 150 27 4,050
Goods Available for Sale 700 ₱18,100
Inventory, End (240)
Cost of Goods Sold 460

First-in, First-out (FIFO)

FIFO assumes that the units sold come from the earliest acquisition so that the
unsold units must have come from the latest acquisition. The unsold units of 240 should
be computed in the following manner.

Quantity Unit Cost Total Cost

From 2nd Purchase 150 ₱ 27 4,050
FINANCIAL ACCOUNTING: MADE EASY 18

From 1st Purchase 90 26 2,340

Inventory, End 240 ₱ 6,390

On December 31, 20A, the adjusting entry to set-up inventory at the end follows:

2019
Dec. 31 Merchandise Inventory, End 6,390
Income & Expense Summary 6,390
To set up inventory at the end.

After the ending inventory has been determined, the cost of goods sold can be
computed as follows:
Goods Available for Sale ₱18,100
Less: Inventory, End 6,390
Cost of Goods Sold ₱ 11,710

Here are the details of the Cost of Goods Sold:

Quantity Unit Cost Total Cost
Inventory, Beg. 250 ₱ 25 ₱ 6,250
1st Purchase (300-90) 210 26 5,460
Cost of Goods Sold 460 ₱11,710

It is important to emphasize that under the periodic system, the Cost of Goods Sold
cannot be computed without first computing the cost of ending inventory.

Weighted Average Method

The weighted average method assumes that the units on hand and units sold must
have come from the beginning inventory, and then combined with what has been
purchased during the period. If the weighted average cost flow is assumed, the 240 units
on hand as of the end of the period are valued at the average unit cost of the period. The
weighted average is computed as follows:

Total Cost of Goods Available for Sale = Weighted Average

Number of Units Available for Sale Cost per Unit

₱ 18,100 = ₱ 25.857
700 units

Using the weighted average method, the cost assigned to the ending inventory of
240 units is computed as follows:

240 units x ₱25.857 = ₱ 6,206

On December 31, 2019, the adjusting entry to set-up inventory at the end follows:

2019
Dec. 31 Merchandise Inventory, End 6,206
Income & Expense Summary 6,206
To set up inventory at the end.
FINANCIAL ACCOUNTING: MADE EASY 19

The Cost of Goods Sold is computed as follows:

Goods Available for Sale ₱ 18,100
Less: Inventory, End 6,206
Cost of Goods Sold ₱ 11,894

Gross Profit Rate Method

This method approximates the valuation of ending inventory using the past year’s
gross profit rates which are assumed to be more or less the same. This method is also
helpful in estimating inventory value of merchandise lost through robbery, floods, fire and
other calamities. The gross profit rate is computed as follows:
Gross Profit Rate = Gross Profit
Net Sales

To illustrate:
At the end of March 30, 2020, a grocery store was ransacked and robbed with
many grocery items of undetermined amount. A physical inventory was conducted right
after the incident and found out to be on hand ₱ 1,425,000 cost of merchandise.

The record shows the following:

Beg. Inventory, Jan. 1, 2020 ₱ 2,050,000

Purchases-Jan. 1 to March 29 3,260,000
Sales as of March 29 5,000,000

Gross Profit Rate is 25%

1. Compute the estimated inventory as of March 29.

2. Determine the value of inventory lost due to robbery.

Solution:

Beg. Inventory, Jan. 1, 2020 ₱ 2,050,000

Purchases- Jan. 1 to March 29 3,260,000
Goods Available for Sale ₱ 5,310,000
Cost of Goods Sold:
Sales as of March 29 ₱ 5,000,000
Less: Gross Profit (25%) 1,250,000 3,750,000
1,560,000

Estimated Inventory, End ₱ 1,560,000

Less: Actual Inventory after robbery 1,425,000
Lost due to robbery ₱ 135,000