Accounting Cycle Accounting CycleAccounting Cycle PDF

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Module No. 4: Analyzing Business Transactions as applied to Accounting Cycle of Service Firm and Merchandising businessLesson 3: Accounting Cycle of a Merchandising BusinessLearning Outcomes:At the end of the topic, you are able to: Determine how a merchandising business functions and how it differs...

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Module No. 4: Analyzing Business Transactions as applied to Accounting Cycle of Service Firm and Merchandising business

Lesson 3: Accounting Cycle of a Merchandising Business Learning Outcomes: At the end of the topic, you are able to: 1. Determine how a merchandising business functions and how it differs to others such as a service business; 2. Understand the different kinds of special journals as to where recording of transactions is made; 3. Prepare a trial balance and an adjusted trial balance; and 4. Prepare a schedule showing the cost of goods sold and gross profit. Time Frame: Week 11 of the Semester

ACTIVITY: Suppose that Timothy allows his buyers to pay within 2 days from the date of sale. How will this change the operating cycle?

Operating Cycle = Days of Inventory + Days of Receivable = 3 + 2 = 5 days

Determine the operating cycle of Carl Company: Average age of inventory = 10 days Average payment period = 15 days Average age of receivables = 20 days

ANALYSIS 1. How service companies differ from merchandising companies? 2. How perpetual inventory system differetiated from periodic inventory system? Give examples of businesses that use the periodic inventory system and perpetual system. 3. Differentiate gross and net method in recording purchases.

4. Differentiate gross and net method in recording Sales.

ABSTRACTION Introduction Businesses are categorized into product-oriented firms, service-oriented firms, or a mix of both. In this chapter, we will focus on product-oriented firms and understand how a merchandising business—a company that sells products—works. An overview on the accounting process of a merchandising firm will be discussed. In the process, new account titles will be encountered with the cost of goods sold being one. Merchandising Business A merchandising business (or a trading business) is a company that buys goods and resells these goods, without making any modifications, at a price higher than its purchase price for the purpose of making profit. This type of business is much common in the Philippines and can range from small- to large-sized entities. Examples would be the neighborhood sari-sari stores, department stores, grocery shops, and those selling in wholesale. Hence, inventory is the most important asset of a merchandising business as this is where the company derives its regular revenues streams. Analyzing Business Transactions The first step in the accounting cycle of a merchandising business involves the analysis of business transactions. This is done to determine whether the economic events will affect the books of an entity. Accounting Cycle of a Merchandising Business How does the accounting cycle of a merchandising business look like? Generally, a merchandising business starts with a purchase of the goods it intends to sell. The purchase may be dealt with immediate cash payments, payment to be made at a future date, or a mix of both. Afterwards, these goods which we now call as inventory are to be stored and sold to the customers. The cash generated from the sale of inventories will then be used to purchase another batch of goods for resale. Here, we shall introduce the concept of an operating cycle which includes the time it takes from the purchase, the resale of inventory, and the subsequent collection of cash related to that sale. Example: Timothy operates a small retail store in Pangasinan. If he purchases snacks and delicacies from his supplier today, these purchased goods take an average of 3 days before being sold. Cash is received immediately upon the sale of the snacks. Determine Timothy’s operating cycle.

Operating Cycle = Days of Inventory + Days of Receivable = 3 days

Inventory Reporting Companies can either use the (1) perpetual or (2) periodic system in reporting their inventories. Perpetual inventory systems keep track of all changes in the inventory account. This system is more expensive as more costs are incurred to make sure that amounts regarding inventory are available at every point of sale. Periodic inventory system, on the other hand, provide data on iventory levels at some points in time. Hence, a physical count is made usually at year-end to provide figures as to how many exist at that point in time. Periodic inventory systems are cheaper to implement. Companies incur costs for having the goods delivered to their intended location. If the delivery fee is paid for the incoming merchandise, such payment forms part of inventory. This is called freight-in. On the other hand, fee paid regarding the transportation to the buyer of the inventory sold by the company, which we call freight-out, is expensed. This forms part of selling expense. Transaction

Perpetual

Periodic

1. Purchased inventory worth 10 000 and paid in cash

Inventory Cash

10 000

2. Paid 500 for the delivery fee of the purchased merchandised

Inventory Cash

500

3. Returned defective inventory received worth 2 000; Cash is received upon return of the merchandise

Inventory Cash

2 000

4. Sold 4 000 worth of merchandise; The selling price of the said merchandise is 8 000; Sales are made on account.

A/R

8 000

5. Sales worth 2 500 were returned by customers as wrong products have been delivered.

6. The remaining balance of the receivable related to the sale was collected.

Purchases Cash

10 000

10 000

Freight-in Cash

500

500

2 000

Sales 4 000

Sales Returns A/R

2 500

Inventory A/R

1 250

Cash A/R

A/R 8 000

Cost of Goods Sold Inventory

Cash Purchase Retrurn

10 000

500

2 000 2 000

8 000 Sales

8 000

4 000

2 500

Sales Returns A/R

2 500 2 500

2 500 5 500 5 500

Cash A/R

5 500 5 500

7. Year-end inventory count shows that 5 250 worth of inventory is still within company premises.

No entry. Year-end amounting to 5 750 can be computed from the movements on the inventory account title.

Inventory Cost of Goods Sold Purchase Return Purchases Freight-in

5 750 2 750 2 000 10 000 500

* COGS is determined by Beg Inventory + Net Purchases – End Inventory

Note that for both perpetual and periodic inventory systems, Net Sales = Sales – Sales Returns and Allowances – Sales Discounts. In the previous table, Net Sales = 5 500. Net Purchases = Purchases + Freight-In – Purchase Returns / Allownaces. In the given example, Net Purchases = 8 500. Differences Between Perpetual and Periodic Inventory Systems

• • • •

Perpetual Used for both expensive and inexpensive items More costly to implement Record exists in every movement of inventory. Inventory physical count is made at least once a year.

• • • • •

Periodic Used for inexpensive items Cheaper to implement No record is kept for transactions involving inventory movement. Inventory physical count is made at least once a year. Inventory physical count is made at a yearend to establish ending inventory amounts.

Terms of Sale – Transfer of Ownership Generally, the purchase or sale should be recorded upon the transfer of ownership of inventory (i.e., when the goods are received as cash is paid). However, in most instances, inventories are to be delivered. The question arises as to when the company owns the items; establishes the expense and liability related to it in case of a purchase; or recognizes the revenue and receivable in the case of sale. The most common sale terms that are being used are Freight on Board (FOB) Shipping Point and Freight on Board (FOB Destination. FOB Shipping Point means that the ownership of the goods is transferred when the seller has shipped the goods to the buyers. A journal entry is made upon the point of shipment. As such, the buyer is considered to own the goods even if the goods are on transit and have not been received as the transfer happened on the day the goods were shipped. FOB Destination means that the ownership of the goods is transferred when the goods have reached its destination. A journal entry is made upon the actual receipt of the goods. As

such, the seller still owns the goods as it is being delivered as there is no transfer of ownership yet. ACTIVITY: Answer the following activity Kenpu Enterprise had the following transactions for the year ended 2019. On Dec. 31, 2019, who owns the inventory under each of the following transactions? •

•

Purchased ₱20 000 worth of goods from Czarina Company. These were shipped Dec. 30, 2019. Receiving report of the said goods is dated Jan. 5, 2020. Terms of sale FOB Destination. Purchased goods amounting ₱50 000 on Dec. 29, 2019 from Jadiene Shop. Goods were received one day after. Terms of sale FOB Shipping Point.

Terms of Sale – Discounts Granted Buyers are given cash discounts by the sellers to enable faster collections of receivables and encourage prompt payment. Cash discounts are usually indicated in the sales invoice. An example is 2/15, net 30. This means that a 2% discount is given if the customer pays within 15 days from the date of purchase. Otherwise, the whole amount shall be collected in 30 days. Suppose that the invoice price is ₱50 000. If the amount is paid within 15 days, one is to pay only ₱49 000 which is the sales invoice price less 2& discount. If he/she does not pay within the discount period, the whole invoice price worth ₱50 000 shall be paid. The cash discount is treated by the seller as a sales discount and the buyer as a purchase discount. There are two methods of recording discounts, namely, gross method and net method.

Recording Purchases – Gross and Net Method Suppose the following events happened in Tuazon Company. Oct 1 Purchased inventory worth ₱100 000. Discounts of 5% will be given if payment is received 10 days from the date of purchase. Gross Method Net Method Inventory 100 000 Inventory 95 000 Accounts Payable 100 000 Accounts Payable 95 000 In gross method, the full cost is debited to the inventory account.

In net method, the amount debited to the inventory is the amount net of discounts.

Oct 7 CASE A: Payment is made in order to avail the purchase discount.

Gross Method Net Method Accounts Payable 100 000 Accounts Payable 95 000 Cash 95 000 Cash 95 000 Inventory 5 000 (or Purchase Discount) Since payment was taken, the cash payment The entry to record the payment is simple as would be net of discounts. The balancing the Accounts Payable was recorded net of figure which will be credited to inventory discounts. (perpetual) or Purchase Discount (periodic) will in effect reduce the cost per unit of the purchased inventory. Oct 20 CASE B: Payment is made after the discount period granted. Gross Method Net Method Accounts Payable 100 000 Accounts Payable 95 000 Cash 100 000 Purchase Discount Lost 5 000 Cash 100 000

Journal entry is straightforward as Accounts The Purchase Discount Lost contains the Payable is recorded using the gross amount. forfeited discount amount. Note that in both perpetual and periodic systems, this account title is to be used. This is treated as a period expense. Recording Sales – Gross and Net Method Suppose the following events happened in Suing Company. Nov 16 Made sales on account with total invoice price of ₱150 000. Discount of 3% is available upon prompt payment (within 15 days). Gross Method Accounts Receivable 150 000 Sales 150 000

Net Method Accounts Receivable 145 000 Sales 145 000

In gross method, the full invoice price is used.

In net method, the amount used is the invoice price net of discounts.

Nov 21CASE A: Payment is received. Customer availed of the sales discount granted. Gross Method Cash Sales Discount Accounts Receivable

145 000 4 500 150 000

Net Method Cash 145 000 Accounts Receivable 145 000

Cash received is net of discounts. The discount granted is debited to the Sales Discount title which is deducted from Sales to arrive at the company’s Net Sales at the end of reporting period.

In the net method, normal journal entry upon collections is made as the Accounts Receivable reflects the amount net of discounts.

Dec 5 CASE B: Payment is received. Customer did not avail of the discount. Gross Method Accounts Payable 100 000 Cash 100 000

Net Method Accounts Payable 95 000 Purchase Discount Lost 5 000 Cash 100 000

Cash received is the whole invoice price. The whole Accounts Receivable amount is simply eliminated.

Sales Discount Forfeited reflects the amount of the discount forgone by the customer. This appears in the Other Income section of the income statement.

Answer the following activities: Activity 1 1. Differentiate gross and net method in recording purchases. 2. Differentiate gross and net method in recording Sales. Activity 2 Journalize the following transactions for Victoria Company using the gross method and net method of recording discounts. Victoria Company uses a perpetual inventory system. Mar 1 Mar 11 Mar 20 Mar 25 Mar 30

Made purchase of inventory on account ₱65 000. Terms of sale are 2/10, net 30. Sales on account amounted to ₱35 000. This customer was given 5% discount if payment is received on or before March 21. Received payment of half of the goods ordered on March 11. Paid in full the obligation incurred on the first day of the month. Received the final payment of the March 11 sale.

Accounting Journals The journal entries which show the effects of financial transactions are recorded in either the general journal or special journal. The general journal or sometimes called as journal, contains all journal entries of a company. A typical journal has columns for date, account titles, debits, and credits. Also, a brief description of each transaction can be included under each journal entry. Date Dec 31

Account Title

Posting Reference

Depreciation Expense Accumulated Depreciation To record the current year depreciation

Debit

Credit

100 000 100 000

However, there are transactions which can be recurring and frequent for one company. In case of a merchandising firm, it is expected that there will be a lot of sales transactions, for one. Hence, an entity may opt to use special journals to facilitate an efficient way of recording specific types of routine transactions. There are four special journals: sales journal, purchases journal, cash receipts journal, and cash payment journal. Special Journals Sales journal is used for recording sales made on account only. The typical sales journal includes a column for date, invoice number, customer name, accounts receivable, and sales.

Date

Invoice No

Customer Debited

Jun 10 Jun 15 Jun 30

234 235

Sacdalan Gonzales

Posting Reference

Dr. Accounts Receivable Cr. Sales 50 000 15 000 65 000

Purchases journal is used for recording credit purchases. The typical purchases journal includes a column for date, supplier name, invoice date, terms of sale, inventory/purchases, and accounts payable. Some companies can include other columns for purchases (equipment, supplies, etc.) on account made. But for this chapter, we will be using a journal containing a column for inventory only as this is the most recurring transaction for this type of business. Date

Supplier Name

Invoice Due Date

Terms

Aug 1 Aug 3 Aug 27

Lim Traders Santos Store Roderos Bakery

Aug 31 Sep 17 Sep 11

1/15, net 30 Net 45 2/5, net 15

Aug 31

Posting Reference

Dr. Accounts Receivable Cr. Sales 8 000 15 000 65 000 88 000

Cash receipts journal is used for recording any transaction involving receipt of cash. The typical cash receipts journal contains columns for date, account title, cash, sales, accounts receivable, and others.

Date

Account Title

Jul 10 Jul 15 Jul 17 Jul 31

Interest Income Gonzales

Posting Reference

Dr. Cash

Cr. Accounts Receivable

3 000 2 000 15 000 20 000

Cr.S ales

Others

3 000 2 000 15 000 15 000

3 000

2 000

Cash disbursement journal is used for transactions involving a decrease in the cash account or payments of cash. Columns on a typical cash disbursement journal include date, check number, account title, cash, accounts payable, and others.

Date

Check No.

Account Title

Sep 10 Sep 15 Sep 17 Sep 30

1010 1011 1012

Santos Store Rent Expense Purchases

Posting Reference

Cr. Cash

15 000 2 500 1 500 19 000

Dr. Accounts Payable 15 000

15 000

Others

2 500 1 500 4 000

Posting to the Ledger Accounts Once the journal entries have been made, the next step is to transfer them to the respective ledger accounts. There are two types of ledgers: general ledger and the subsidiary ledger. The general ledger, or sometimes called ledger, is a register containing all general or main accounts. These accounts are those that appear in financial statements. General ledger is divided into five: assets, liabilities, equity, revenue, and expense. Below is an example of transferring the columns total from the sales journal to the ledger in order to update its amount as at end of period.

Date

Invoice No

Customer Debited

Jun 10 Jun 15 Jun 30

234 235

Sacdalan Gonzales

Posting Reference

Dr.Accounts Receivable Cr.Sales 50 000 15 000 65 000

Suppose that no other transactions happened within the period involving the accounts receivable and sales account, the general ledger postings would look like this:

General Ledger

Accounts Receivable Jun 01 5 000 Adjustment 65 000 Jun 30 70 000

Sales Jun 01 Adjustment Jun 30

50 000 65 000 115 000

Note that the column totals are the ones being transferred to the general ledger. Subsidiary ledgers, on the other hand, are additions to the company’s general ledger. Subsidiary ledgers contain a detailed list of transactions or events of some account title listed in the general ledger. Examples of subsidiary ledgers are accounts receivable subsidiary ledgers, wherein it is divided as per customer to enable easier recording and monitoring in the increase and decrease of that specific customer account. The accounts receivable subsidiary ledger for the sales journal when posted would look like this: Accounts Receivable Subsidiary Ledger Gonzales – Accounts Receivable Date Jun 15

Invoice No 235

Posting Reference Sales Journal

Debit 15 000

Credit

Total 15 000

Sacdalan – Accounts Receivable Date May 31 Jun 15

Invoice No 233 234

Posting Reference Sales Journal Sales Journal

Debit 10 000 50 000

Credit

Total 10 000 60 000

Preparing an Unaudited Trial Balance One all transactions for the year have been posted to their respective ledgers accounts, its totality is checked by using what we call an unadjusted trial balance. A trial balance is a listing of general ledger accounts together with their respective debit and credit ba...