“Accounting is the process of IDENTIFYING, RECORDING, SUMMARIZING summarization, finalization, and reporting of financial

and COMMUNICATING economic events of an organization to data.

interested users.”

 IDENTIFYING – this involves selecting economic events that are • Accounting is both an art and a discipline. Accounting is the
relevant to a particular business transaction. art of recording, classifying, summarizing and finalizing financial
(select of economic events) data. The word ‘art’ refers to the way something is performed.
It is behavioural knowledge involving a certain creativity and
 RECORDING – this involves keeping a chronological diary of skill to help us attain some specific objectives. Accounting is a
events that are measured in pesos. The diary referred to in the systematic method consisting of definite techniques and its
definition are the journals and ledgers which will be discussed proper application requires skill and expertise. So by
in future chapters. nature, accounting is an art. And because it follows certain
(Record classify, and summarize) standards and professional ethics, it is also a discipline.

 COMMUNICATING – occurs through the preparation and • Accounting deals with financial information and transactions:
distribution of financial and other accounting reports. Accounting records financial transactions and data, classifies
(Prepare accounting reports, analyse and interpret to users) these and finalizes their results given for a specified period of
time, as needed by their users. At every stage, from start to
finish, accounting deals with financial information and financial
NATURE OF ACCOUNTING
information only. It does not deal with non-monetary or non-
financial aspects of such information.
According to Accounting Theory
“Accounting is a systematic recording of financial transactions
• Accounting is an information system: Accounting is
and the presentation of the related information to appropriate
recognized and characterized as a storehouse of information.
persons.”
As a service function, it collects processes and communicates
Based on this definition we can derive the following basic financial information of any entity. This discipline of knowledge
features of accounting: has evolved to meet the need for financial information as
required by various interested groups.
• Accounting is a service activity. Accounting provides
assistance to decision makers by providing them financial FUNCTION OF ACCOUNTING IN BUSINESS
reports that will guide them in coming up with sound decisions.
 Accounting is the means by which business information is
communicated to business owners and stakeholders. The role
• Accounting is a process: A process refers to the method of
of accounting in business is to provide information for
performing any specific job step by step according to the
managers and owners to use in operating the business. In
objectives or targets .Accounting is identified as a process, as it
addition, accounting information allows business owners to
performs the specific task of collecting, processing and
assess the efficiency and effectiveness of their business
communicating financial information. In doing so, it follows
operations. Prepared accounting reports can be compared
some definite steps like the collection, recording, classification,
with industry standards or to a leading competitor to
 determine how the business is doing. Business owners may also tracking business accounts. Luca Pacioli wrote Summa de
use historical financial accounting statements to create trends Arithmetica, the first book published that contained a detailed
for analyzing and forecasting future sales. chapter on double-entry bookkeeping.

Accounting helps the users of these financial reports to see the
true picture of the business in financial terms. In order for a • French Revolution (1700s)
business to survive, it is important that a business owner or -The thorough study of accounting and development
manager be well-informed. of accounting theory began during this period. Social
upheavals affecting government, finances, laws, customs and
business had greatly influenced the development of
HISTORY OF ACCOUNTING accounting.

ACCOUNTING is as old as civilization itself. It has • The Industrial Revolution (1760-1830)

evolved in response to various social and economic needs of Mass production and the great importance of fixed
men. Accounting started as a simple recording of repetitive assets were given attention during this period.
exchanges. The history of accounting is often seen as
indistinguishable from the history of finance and business. • 19th Century – The Beginnings of Modern Accounting in
Europe and America
Following is the evolution of accounting:
-The modern, formal accounting profession emerged in
• The Cradle of Civilization Scotland in 1854 when Queen Victoria granted a Royal
- Around 3600 B.C., record-keeping was already Charter to the Institute of Accountants in Glasgow, creating
common from Mesopotamia, China and India to Central and the profession of the Chartered Accountant (CA). In the late
South America. The oldest evidence of this practice was the 1800s, chartered accountants from Scotland and Britain came
“clay tablet” of Mesopotamia which dealt with commercial to the U.S. to audit British investments. Some of these
transactions at the time such as listing of accountants stayed in the U.S., setting up accounting
accounts receivable and accounts payable. practices and becoming the origins of several U.S. accounting
firms. The first national U.S. accounting society was set up in
• 14th Century - Double-Entry Bookkeeping 1887. The American Association of Public Accountants was the
forerunner to the current American Institute of Certified Public
- The most important event in accounting history is generally Accountants (AICPA). In this period rapid changes in
considered to be the dissemination of double entry accounting practice and reports were made. Accounting
bookkeeping by Luca Pacioli (‘The Father of Accounting’) in standards to be observed by accounting professionals were
14th century Italy. Pacioli was much revered in his day, and promulgated. Notable practices such as mergers, acquisitions
was a friend and contemporary of Leonardo daVinci. The and growth of multinational corporations were developed. A
Italians of the 14th to 16th centuries are widely acknowledged merger is when one company takes over all the operations of
as the fathers of modern accounting and were the first to another business entity resulting in the dissolution of another
commonlyuse Arabic numerals, rather than Roman, for business. Businesses expanded by acquiring other companies.
 These types of transactions have challenged accounting accounting standards developed by standard-setting
professionals to develop new standards that will address bodies. In the Philippines, there is a Council created to
accounting issues related to these business combinations. set these standards.

• The Present - The Development of Modern Accounting Examples of these financial reports include:
Standards and Commerce • the balance sheet (statement of financial condition)
• income statement (the profit and loss statement, or P&L)
- The accounting profession in the 20th century • statement of cash flows
developed around state requirements for financial statement
audits. Beyond the industry's self-regulation, the government Financial accounting is primarily concerned with
also sets accounting standards, through laws and agencies processing historical data. Although financial accounting
such as the Securities and Exchange Commission (SEC). As generally meets the needs of external users, internal users
economies worldwide continued to globalize, accounting of accounting information also use these information for
regulatory bodies required accounting practitioners to observe their decision-making needs.
International Accounting Standards. This is to assure
transparency and reliability, and to obtain greater confidence  Management (or Managerial) Accounting
on accounting information used by global investors. Management accounting emphasizes the
Nowadays, investors seek investment opportunities all over the preparation and analysis of accounting information
within the organization. The objective of Managerial
world. To remain competitive, businesses everywhere feel the
accounting is to provide timely and relevant
need to operate globally. The trend now for accounting information for those internal users of accounting
professionals is to observe one single set of global accounting information, such as the managers
standards in order to have greater transparency and and employees in their decision-making needs.
comparability of financial data across borders. Oftentimes, these are sensitive information and is not
distributed to those outside the business
BRANCHES OF ACCOUNTING
- for example, prices, plans to open up branches, customer
“Accounting is divided into several branches to better serve the needs list, etc.
of different users with varying information needs. These branches
sometimes overlap and they are often closely intertwined.”
Managerial accounting involves financial analysis,
 Financial accounting is the broadest branch and is budgeting and forecasting, cost analysis, evaluation of
focused on the needs of external users. Financial business decisions, and similar areas.
accounting is primarily concerned with the
recognition, measurement and communication of
economic activities. This information is communicated  Government Accounting - is the process of recording,
in a complete set of financial statements. It is assumed analyzing, classifying, summarizing, communicating
under this branch that the users have one common and interpreting financial information about the
information need. Financial accounting conforms with government in aggregate and in detail reflecting
 transactions and other
economic events involving the receipt, spending,  Cost Accounting
transfer, usability and disposition of assets and liabilities.
This branch of accounting deals with how the funds of Sometimes considered as a subset of
the government are recorded and reported. management accounting, cost accounting refers to
the recording, presentation, and analysis of
 AUDITING manufacturing costs. Cost accounting is very useful in
manufacturing businesses since they have the most
External auditing - refers to the examination of financial complicated costing process. Cost accountants also
statements by an analyze actual and standard costs to help managers
independent CPA (Certified Public Accountant) with determine future courses of action regarding the
the purpose of expressing an opinion as to fairness of company's operations. Cost accounting will also help
presentation and compliance with the owner set the selling price of his products. For
the generally accepted accounting principles (GAAP). example, if the cost accounting records shows that the
The audit does not cover 100% of the accounting total cost to produce one can of sardines is PHP50, then
records but the CPA reviews a the owner can set the selling price at PHP60.
selected sample of these records and issues an audit
report. Independent AUDITOR
 Accounting Education
Internal auditing - deals with determining the -This branch of accounting deals with developing
operational efficiency of the company regarding the future accountants by creating relevant accounting
protection of the company’s assets, accuracy curriculum. Accounting professionals can become
and reliability of the accounting data, and adherence faculty members of educational institutions.
to certain management policies. It focuses on Accounting educators contribute to the development
evaluating the adequacy of a company's internal of the profession through their effective teaching,
control structure by testing segregation of duties, publications of their research and influencing students
policies and procedures, degrees of authorization, and to pursue careers in accounting. Accounting teachers
other controls implemented by management. share their knowledge on accounting so that students
Dependent AUDITOR are informed of the importance of accounting and its
use in our daily lives.
 Tax Accounting
- helps clients follow rules set by tax authorities. It  AccountingResearch
includes tax planning and preparation of tax returns. It - focuses on the search for new knowledge on the
also involves determination of income tax and other effects of economic events on the process of
taxes, tax advisory services such as ways to minimize summarizing, analyzing, verifying, and reporting
taxes legally, evaluation of the consequences of tax standardized financial information, and on the effects
decisions, and other tax-related matters. of reported information on economic events.
Researchers typically choose a subject area and a
 methodology on which to focus their efforts. The
subject matter of accounting research may include SUMMARY OF THE DIFFERENCES BETWEEN INTERNAL AND
information systems, auditing and assurance, corporate EXTERNAL USERS
governance, financials, managerial, and tax.
Accounting research plays an essential part in creating
Internal users of accounting
new knowledge. Academic accounting research
- information are those who are involved in planning,
"addresses all aspects of the accounting profession"
organizing and running the business. They need more detailed
using a scientific method. Practicing accountants also
information on a timely basis in order to support their decisions.
conduct accounting research that focuses on solving
problems for a client or group of clients. The
Examples of these internal users are managers, employees and
Accounting research helps standard-setting bodies
owners.
around the world to develop new standards that will
address recent issues or trend in global business.
The external users of accounting
- information are those individuals or organizations
outside a company who are interested in its financial
SUMMARY information.
Examples of these external users are potential investors,
1. Preparation of general-purpose financial statements Answer: suppliers , banks, DOLE , BIR and government agencies
Financial
2. Evaluation of the performance of a sales department
Answer : Managerial
3. Develop standards to address a new business set up
Answer: Accounting Research
4. Review tax compliance of the business Answer: Tax
Accounting
5. Evaluate whether a branch of the business complies with
the collection and deposit policy of the company Answer:
Auditing (Internal)
6. Review whether the financial statements are presented
fairly and in compliance with accounting standards Answer:
Auditing (External)
7. Report on the spending of government funds Answer:
Government Accounting
8. Report on the total cost of materials and labor used in the
production Answer: Cost Accounting
9. Conducting lectures on accounting topics Answer:
Accounting Education
3 TYPES OF BUSINESS ORGANIZATIONS 9. Cellphone store
10. Abenson appliances
• Service Business
This type of business offers professional skills, advice and consultations. Key Answers (1) service (2) either merchandising or
Examples: barber shops and beauty parlours, repair shops, banks, manufacturing (3) manufacturing (4) merchandising (5)
accounting and law firms manufacturing (6) service (7)
manufacturing (8) service (9) merchandising (10)
• Merchandising Business merchandising
This type of business buys at wholesale and later sells the products at
retail. They make a profit by selling the merchandise or products at ACCOUNTING PRINCIPLES
prices that are higher than their purchase costs. This type of business is
also known as "buy and sell".
Examples are: book stores, sari-sari stores, hardware stores

• Manufacturing Business
This type of business buys raw materials and uses them in making a
new product, therefore combining raw materials, labour and
expenses into a product for sale later on.
Examples are: shoe manufacturing businesses, car manufacturing
plants

Additional information:
There are businesses that may be classified under more than one type
of business. A bakery, for example, combines raw materials in making
loaves of bread (manufacturing), sells hot pan de sal (merchandising),
and caters customers’ orders in small coffee table servings of
ensaymada and hot coffee (service). • Business entity principle – a business enterprise is separate and
distinct from its owner or investor.
EXERCISE Examples
1. Provides services to customers o If the owner has a barber shop, the cash of the barber shop should
2. Sells goods to customers be reported separately from personal cash.
3. Raw materials are available • Going concern principle – business is expected to continue
4. Goods to be sold are purchased from a supplier indefinitely.
Example: When preparing financial statements, you should assume
5. Goods to be sold are produced by the company itself
that the entity will continue indefinitely.
6. Supplies are used, no goods to be sold
7. Bakery • Time period principle – financial statements are to be divided into
8. Barber shop specific time intervals.
Example Philippine companies are required to report financial expenses
statements annually should not be understated.
• Monetary unit principle – amounts are stated into a single monetary Example: In case of doubt, expenses should be recorded at a higher
unit amount. Revenue should be recorded at a lower amount.
Example: Jollibee should report financial statements in pesos even if
they have a store in the United States. • Materiality principle – in case of assets that are immaterial to make a
difference in the financial statements, the company should instead
• Objectivity principle – financial statements must be presented with record it as an expense.
supporting evidence. Example:
Example : When the customer paid Jollibee for their order, Jollibee A school purchased an eraser with an estimated useful life of three
should have a copy of the receipt to represent as evidence. years. Since an eraser is immaterial relative to assets, it should be
recorded as an expense.
• Cost principle – accounts should be recorded initially at cost.
Example :When Jollibee buys a cash register, it should record the
PRINT 37-40
cash register at its price when they bought it.

• Accrual Accounting Principle – revenue should be recognized when ACCOUNTING EQUATION

earned regardless of collection and expenses should be recognized Determining profit through operation
when incurred regardless of payment. On the other hand, the cash • Accrual basis of accounting vs Cash basis of accounting –
basis principle in which revenue is recorded when collected and accrual basis recognizes revenue when earned and
expenses should be recorded when paid. Cash basis is not the recognizes expenses when
generally accepted principle today. incurred
• Under the expense recognition principle, expenses can be
Example: When a barber finishes performing his services he should recognized either as: (1) matching; (2) systematic allocation,
record it as revenue. When the barber shop receives an electricity bill, or; (3) direct association.
it should record it as an expense even if it is unpaid.
• Profit measures the performance of the company. If the
revenue exceeds expenses, then it is a net profit; otherwise, it is
• Matching principle – cost should be matched with the revenue
a net loss
generated.
Example: When you provide tutorial services to a customer and there For each transaction, tell whether the assets, liabilities and equity will
is a transportation cost incurred related to the tutorial services, it increase (I), decrease (D) or is not affected (NE)
should be recorded as an expense for that period.

• Disclosure principle – all relevant and material information should be

reported.
Example:
The company should report all relevant information.
• Conservatism principle – also known as prudence. In case of doubt,
assets and income should not be overstated while liabilities and
 furniture and fixtures.
• Intangible Assets are non-physical assets such as patents and
trademarks

Current Assets
• Cash is money on hand, or in banks, and other items considered as
medium of exchange in business transactions.
• Accounts Receivable are amounts due from customers arising from
credit sales or credit services.
• Notes Receivable are amounts due from clients supported by
promissory notes.
DEFINE ASSETS, LIABILITIES, OWNER’S EQUITY, INCOME • Inventories are assets held for resale
AND EXPENSE • Supplies are items purchased by an enterprise which are unused as
of the reporting date.
• Prepaid Expenses are expenses paid in advance. They are assets at
• Assets are the resources owned and controlled by the firm.
the time of payment and become expenses through the passage of
• Liabilities are obligations of the firm arising from past events which
time.
are to be settled in the future.
• Accrued Income is revenue earned but not yet collected
• Equity or Owner’s Equity are the owner’s claims in the business. It is
• Short term investments are the investments made by the company
the residual interest in the assets of the enterprise after
that are intended to be sold immediately
deducting all its liabilities.
• Income is the increase in economic benefits during the accounting
Non-Current Assets
period in the form of inflows of cash or other assets or decreases
• Property, Plant and Equipment are long-lived assets which have
of liabilities that result in increase in equity. Income includes revenue
been acquired for use in operations.
and gains.
• Long term Investments are the investments made by the company
• Expenses are decreases in economic benefits during the
for long-term purposes
accounting period in the form of outflows of assets or incidences of
• Intangible Assets are assets without a physical substance. Examples
liabilities that result in decreases in equity.
include franchise and copyright.

ASSETS
LIABILITIES
• Current Assets are assets that can be realized (collected, sold, used
- are the debts and obligations of the company to another entity.
up) one year after year-end date. Examples include Cash, Accounts
Receivable, Merchandise Inventory, Prepaid Expense, etc.
Current Liabilities. Liabilities that fall due (paid, recognized as revenue)
• Non-current Assets are assets that cannot be realized (collected,
within one year after year-end date. Examples include Accounts
sold, used up) one year after year-end date. Examples include
Payable, Utilities Payable and Unearned Income.
Property,Plant and Equipment (equipment, furniture, building, land),
Non-current Assets are liabilities that do not fall due (paid, recognized
long term investments, etc.
as revenue) within one year after year-end date. Examples include
• Tangible Assets are physical assets such as cash, supplies, and
Notes Payable, Loans Payable, Mortgage Payable, etc.
Current Liabilities The following is a sample lecture for setting up a Chart of Accounts:
• A chart of accounts is a listing of the accounts used by companies in
 Accounts Payable are amounts due, or payable to, suppliers their financial records.
for goods purchased on account or for services received on • The chart of accounts helps to identify where the money is coming
account. from and where it is going.
 Notes Payable are amounts due to third parties supported by • The chart of accounts is the foundation of the financial statements.
promissory notes.
 Accrued Expenses are expenses that are incurred but not yet
paid (examples: salaries payable, taxes payable)l BOOKS OF ACCOUNTS
 Unearned Income is cash collected in advance; the liability is
the services to be performed or goods to be delivered in the
future. JOURNAL is referred to as the book of original entry
GENERAL JOURNAL is the most basic journal.
Non-Current Liabilities  complete effects of a transaction.
 Loans Payable  chronological record of transactions.
 Mortgage Payable  Locate errors in every debit and credit transactions.

OWNER’S EQUITY The Following Are The Commonly Used Special Journals:
- the residual interest of the owner from the business. It can be • Cash Receipts Journal – used to record all cash that has been
derived by deducting liabilities from assets. received
 Capital is the value of cash and other assets invested in the • Cash Disbursements Journal – used to record all transactions
business by the owner of the business. involving cash payments cash ( payments are recorded)
 Drawing is an account debited for assets withdrawn by the • Sales Journal (Sales on Account Journal) – used to record all sales on
owner for personal use from the business. credit (on account)
• Purchase Journal (Purchase on Account Journal) – used to record all
INCOME purchases of inventory on credit (or on account)
-is the Increase in resources resulting from performance of
service or selling of goods. LEDGER is accounting book in which the accounts and their related
amounts as recorded in the journal are posted periodically and also
Service revenue for service entities, Sales for merchandising and called the ‘book of final entry”
manufacturing companies
SUBSIDIARY LEDGER is a group of like accounts that contains the
EXPENSE independent data of a specific general ledger .
-is the decrease in resources resulting from the operations of
business.
Salaries Expense, Interest Expense, Utilities Expense
EXERCISE Answer: Accounting transactions are first recorded in the general
1. Collected PHP10,000 from a customer in payment of his account. journal and in order of their occurrence. A general ledger contains
Answer: Cash Receipts Journal a summary at the account level of every transaction that a
2. Bought 100 pieces of mugs to be sold in the store amounting to business has engaged in. The general journal records all the
PHP1,500 on account. transactions whereas the general ledger the effect of these journal
Answer: Purchase Journal. entries to every account title. The general journal is called the
3. Sold five pieces of mugs to X, PHP320 cash. book of original entry while the general ledger is called the book
Answer: Cash Receipts Journal (the learner may answer Sales of final entry.
Journal (SJ), correct them as this transaction is a cash sale, SJ is
applicable only to “ on account” transactions. Types of transaction recorded in the cash receipts journal:
4. Sold two pieces of mugs to Y, PHP112 cash • cash received from a charge (on account) customer
Answer: Cash Receipts Journal 5. Purchased office supplies for • cash received from a charges (on account) customer less a cash
cash, PHP500. Answer: Cash Disbursement Journal (the learner discount
may answer Purchase Journal (PJ). Correct them as this • cash sales
transaction is a cash purchase; PJ is applicable only to “on • cash received from sale of other assets
account” transactions. • all other transactions that require the issuance of a Cash receipt or
5. Paid PHP20,000 monthly rental. Official Receipt document
Answer: Cash Disbursements Journal Sales journal is used when two conditions are met:
6. Paid salary of staff, PHP15,000 • merchandise is sold
Answer: Cash Disbursement Journal • the sale is on account
7. Sold 100 pieces of mugs to Unicup, Inc., PHP5,600 on account Cash disbursements journal (cash payments journal) is used to record
Answer: Sales Journal the following transactions:
8. Sold 500 pieces of mugs to Bugsmore Corp. for PHP15,300 payable • purchase of merchandise for cash
one month after delivery. • payment to creditor, vendors or suppliers
Answer : Sales Journal • all cash payments
9. Purchase on account 1,000 pieces of mugs for PHP12,400
Answer: Purchase Journal ALL SPECIAL JOURNALS.
• Cash Receipts Journal
1. Differentiate General Ledger from a Subsidiary Ledger Suggested • Cash Disbursement Journal
• Purchase Journal (Purchase Journal on account)
Answer: A subsidiary ledger contains the details supporting the • Sales Journal (Sales Journal on account)
balance in the general ledger account. For example, a subsidiary
ledger is maintained for all receivables from customers; the sum of Print 76-79
balances per customer should equal the balance of Accounts
Receivable Account in the general ledger account.
2. Differentiate General Journal from a General Ledger
TYpes of businesses according to activities and ask
them to differentiate the following:
• service business
• merchandising business
• manufacturing business

EXAMPLE
1. car mechanic / repair - service
2. car parts store - merchandising
Step 1 – Analyzes Transactions
3. car making - manufacturing
Identification and measurement of external transactions and internal
events. At this stage, the
Business Transactions and Their Analysis
documents used by the business are analyzed whether it has financial
as Applied to the Accounting Cycle of a
Service Business impact or effect.

Business documents
SERVICE - business provides a needed service for a fee. In general, used:
service businesses actually have no physical product sold to clients 1. Official Receipt or Cash Receipt
physical product sold to clients. This document is used when a business receives money or a
check
Examples of Service Businesses 2. Charge Invoice or Sales Invoice
• offices of practicing doctors, lawyers and other professionals A charge invoice is a document used when a service has
• repairs of TV and other electrical equipment been rendered, but the client
• auto repair shop will be billed only after a certain number of days from the date
• laundry shop of service.
• dressmaker 3. Check or Cash Voucher
The check voucher is a document used when a check is issued
Review the discussion on five major accounts, to pay a certain supplier or
vendor
• Assets are resources owned by a business.
• Liabilities are claims against the assets of the business. Step 2 - Preparation of Journal Entries (journalization)
• Equity (capital) is the claim of the owner or owners. Step 3 – Posting - The journal entries are then posted to the general
• Income are increases in the equity or capital resulting from business ledger where a summary of all transactions to individual accounts can
activities entered into. be seen.
• Expenses are decreases in the equity or capital resulting from
Step 4 - Unadjusted Trial Balance-At the end of the accounting period
business activities. It may include (which may be quarterly, monthly, or yearly depending on the
company), a total balance is calculated for the accounts.
Step 5 – Worksheet -When the debits and credits on the trial balance for a specific period of time. This can be prepared on a monthly,
don’t match, the bookkeeper must look for errors and make quarterly or yearly basis.
corrective adjustments that are tracked on a worksheet.
3. Statement of Changes in Equity (SCE) - This statement is prepared
Step 6 – Adjusting Entries prior to preparation of the Statement of Financial Position in order to
At the end of the company’s accounting period, adjusting entries obtain the ending balance of the equity to be used in the SFP. All
must be posted to account for accruals and deferrals. changes, whether increases or decreases to the owner’s interest on
the company during the period, are reported here
 Revenue Recognition – accounting standards require that
revenue is recognized when it is earned and the amount 4. Cash Flow Statement - Provides an analysis of inflows and/or
outflows of cash from/to operating, investing and financing activities
can be measured reliably. To illustrate
 Matching Principle - this principle directs a business to report an
Step 8 Closing Journal Entries
expense on its income statement within the same
period as its related income. To illustrate: The revenue and expense accounts are closed and zeroed out for the
next accounting cycle.All of the nominal revenue accounts should be
There are five basic sources of adjusting closed to the income summary account by a Debit to revenue and a
entries: Credit to income summary.
1. Depreciation expense
2. Deferred expenses or prepaid expenses PRINT 112- 117
3. Deferred Income or unearned income
4. Accrued expenses or accrued liabilities Accounting Cycle of a Merchandising Business
5. Accrued income or accrued assets

Merchandising company is an enterprise that buys and sells goods to

STEP 7 Financial Statements/ Balance Sheet earn a profit
E.A
Financial Statements: The balance sheet, income statement and cash Mercury Drug ,Puregold , ACE Hardware ,grocery stores
flow statement can be prepared using the correct balances.
Merchandise (or merchandise inventory) refers to goods that are held
for sale to customers in the normal course of business. This includes
The following are the financial statements to be prepared:
goods held for resale.
For example:
1. Statement of Financial Position (SFP) - Also known as the balance
sheet. This statement includes the amounts of the company’s total • Candies, canned goods, noodles sold at a grocery stores
assets, liabilities and owner’s equity which in totality provides the • Juice, biscuits sold in a grocery store
financial position of the company on a specific date. • Medicines sold in a pharmacy

2. Statement of Comprehensive Income (SCI) – Also known as the Expenses for a merchandising company are divided into two
income statement. Contains the results of the company’s operations categories:
 1. Cost of goods sold (COGS) – the total cost of merchandise sold 1. Cash Receipts Journal –used to record all cash that had been
during the period received
2. Operating expenses (OP) - expenses incurred in the process of 2. Cash Disbursements Journal –used to record all transactions
earning sales revenue that are deducted from gross profit in the involving cash payments
income statement. Examples are sales salaries and insurance 3. Sales Journal (Sales on Account Journal) –used to record all sales
expenses. on credit (on account)
4. Purchase Journal (Purchase on Account Journal) –used to record
Gross profit (GP) is equal to Sales Revenue less the Cost of Goods Sold. all purchases of inventory on credit (or on account)
Income measurement process for a merchandiser follows as:
Sales - COGS = Gross Profit - Operating Exp. = Net Income (Loss) INVENTORY SYSTEMS Maintaining inventory items is a unique set-up in a
merchandising business.

The Operating Cycles for a merchandiser: Merchandising entities may use either of the following inventory
Merchandising Company operating cycle (cash to cash) involves: systems: 1. Perpetual System — Detailed records of the cost of each
1. buy merchandise inventory item are maintained, and the cost of each item sold is determined
2. sell inventory from records when the sale occurs
3. obtain Accounts Receivable . For example, a car dealership has separate inventory records for
4. receive cash each vehicle
• Record purchase of Inventory.
JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING • Record revenue and record cost of goods sold when the item is sold.
BUSINESS • At the end of the period, no entry is needed except to adjust
inventory for losses, etc.
Step 1- Transactions are identified and measured. At this stage, the 2. Periodic System — Cost of goods sold is determined only at the end
documents used by the business are analyzed to see whether these of an accounting period. This system involves:
transactions have financial impact or effect. • Record purchase of Inventory.
Step 2 - Preparation of Journal Entries (Journalization) A merchandising • Record revenue only when the item is sold.
company may use special and general journals to record its • At the end of the period, you must compute cost of goods sold
transactions. (COGS):
1. Determine the cost of goods on hand at the beginning of the
SPECIAL JOURNALS accounting period (Beginning Inventory = BI),
Some businesses encounter voluminous quantities of similar and 2. Add it to the cost of goods purchased (COGP),
recurring transactions, which may create congestion if these 3. Subtract the cost of goods on hand at the end of the
transactions are recorded repeatedly in a single day or monthly in the accounting period.
general journal. BI + COGP = Cost of goods available for sale - EI = COG
The use of special journals will eliminate this problem. S
ales - COGS = Gross Profit - Operating Exp. = Net Income (Loss) Print 126-172
. The following are the commonly used special journals:
 Income statement. Presents the revenues, expenses, and
profits/losses generated during the reporting period. This is usually
considered the most important of the financial statements, since it
presents the operating results of an entity.

 Balance sheet. Presents the assets, liabilities, and equity of the

entity as of the reporting date. Thus, the information presented is as
of a specific point in time.

 Statement of cash flows. Presents the cash inflows and outflows

that occurred during the reporting period. This can provide a useful
comparison to the income statement, especially when the amount
of profit or loss reported does not reflect the cash flows
experienced by the business.

 Statement of retained earnings. Presents changes in equity during

the reporting period. The report format varies, but can include the
sale or repurchase of shares, dividend payments, and changes
caused by reported profits or losses. This is the least used of the
financial statements, and is commonly only included in the audited
financial statement package.