Fundamentals of ABM 2

HANDOUT 2.1 (Without Problems and Solutions)

STATEMENT OF COMPREHENSIVE INCOME

Results of the Company’s Operations

We continue our study of financial statements with the Statement of Comprehensive Income (SCI). The
SCI is a statement that reports the results of operations of the business for one accounting period. This
statement contains the following information:
a. Revenue generated by operating the business;
b. Costs spent to generate the revenue; and
c. Income, which is the excess of revenue over costs.
For our purpose, the SCI is the same as the Income Statement. The difference between the SCI and the
Income Statement is beyond the scope of high school accounting and will be discussed more in advanced
accounting subjects.
The SCI is described as a "for the period" report. This means that the amounts presented on the report
include only those that occurred within the given period. For example, the SCI in Figure 1 is described as "for
the year ended December 31, 20X1." This means that the reported revenue of ₱1.29 Million was generated from
January 1, 20X1 to December 31, 20X1. Revenues generated in 20X0 or 20x2 were not counted in this particular
report.

ABC Company
Statement of Comprehensive Income
For the year ended December 31, 20X1

Revenues ₱1,290,000
Less: Expenses 890,000
Net income ₱400,000

Figure 1: Statement of Comprehensive Income

Recall from Lesson 1, financial statements are set of interconnected reports. SCI is prepared first. The
bottom line of the SCI is net income (Figure 1). Net Income is transferred out to the Statement of Changes in
Equity to be included in the determination of the Owner's Capital balance as of the end of the year. The capital
balance is transferred to the Statement of Financial Position (SFP). If double entry accounting is implemented
correctly, the SFP will balance. This means that the SFP will show total assets equal to the sum of liabilities and
owner's equity.
Components of the Statement of Comprehensive Income
The SCI is an action-packed financial statement. In contrast, the SFP is a still photograph. The SCI is a
statement that explains some of the changes that occur between two SFPs taken one year apart.
What are the actions reported on the SCI? Income and Expense are the general terms used to describe
the elements of the SCI. Income refers to a transaction that increases assets and/or decreases liabilities leading
to increase in equity resulting from the operations of the business and not from the owner's contribution.
 Fundamentals of ABM 2

Expenses, on the other hand, are transactions that decrease assets and/or increase liabilities leading to decrease
in equity resulting from the operations of the business and not because of distributions to owners.
There are two kinds of income - revenue and gains. Revenues are income generated from the primary
operations of the business. Gains, on the other hand are income derived from other activities of the business.
Sale of merchandise to Diego's customers is an example of revenue. It is because the primary operation of the
store is to sell its inventories. Interest income from the time deposit is considered gains and other income and
not revenue. It is because investment in time deposit is not part of the primary operations of the store.
Classification of income as to revenue and gains is dependent on the nature of the business. For Diego's store,
interest income is not revenue. However, for a bank whose primary operation is to give out loans, interest
income is considered revenue.
Like income there are also two kinds of expenses - expenses and losses. Expenses are related to the
primary operations of the business. Losses are from other activities of the business. Recall that the primary
operation of Diego's store is selling activities. The cost of the merchandise sold by Diego's store is part of the
store's selling activities. Therefore, it is classified as an expense. Interest expense from notes payable is not part
of the selling activities of the store. It is classified as losses and other expenses.
Notice that the primary operation of the business is the main criterion for the classification. This
classification method is to help the readers of the financial statements to understand the operations of the
reporting company. Those items that are from the primary operations of the business are expected to continue
regularly. On the other hand, those from other activities of the business may be of one time or limited
occurrence.

Accrual Concept of Accounting

Let us review the accrual concept introduced in ABM 1. The preparation of the SCI creates complications
in accounting because of its cut-off date. It is because the revenue generation process has many components.
In its simplest forms, these components may all occur simultaneously. At the other end of the spectrum, these
components may occur far apart from each other.
Imagine yourself inside a fast food restaurant. You ordered for a hamburger meal with regular French
fries and regular soft drinks. The crew punches your order on his computer (point of sale) terminal. The
computer then relays the message to the kitchen where your meal is put together. In a few minutes, the crew
gives you the hamburger meal on a tray. He asked you for your payment. You gave him P100. He accepts your
payment and gives you your change. You lift up your tray and join your friends at your table. From order,
delivery, and payment, all the components of your transaction occurred in a span of five to ten minutes. In a
simple transaction such as the one you just had; it is easy to count sales for a calendar-year period. These are
all the meals sold from the opening of the restaurant on January 1 until the last meal sold on closing time at
December 31.
Unfortunately for accountants, not all transactions are as simple as the one you just had. Consider the
same fast food restaurant. This establishment also offers birthday packages. This time, you want to celebrate
your next birthday at this fast food restaurant. Let us agree that your birthday is on January 2, 20X2. Your parents
went to the fast food restaurant on November 28, 20X1 to make the reservation and pay the down payment for
your birthday party. The party, held on January 2, 20X2, was a complete success. Spaghetti, fried chicken, soft
drinks and sundae were served. The famous mascots of the fast food restaurant entertained your guests. At the
end of the party, your parents paid the remaining balance using their credit card. The credit card company paid
the fast food restaurant on January 3. 20X2. We see three important dates in your birthday party package,
namely, November 28. 20X1, January 2, 20X2, and January 3, 20X2. On what date should the restaurant record
the revenue from your birthday party? Finally, on what period should the costs of the foods served and other
items used in your party be reported on the SCI?
Accrual is one of the fundamental concepts of financial accounting. Specifically, is the concept that
dictates when an item must be reported on the SCI. Accrual states that the revenue must be reported on the
accounting period that it was earned. Similarly, expenses must be reported during the same reporting period
they were incurred. But what does it all mean? When are revenue earned and expenses incurred?
 Fundamentals of ABM 2

Generally, revenue is earned upon delivery of goods and service, not when payment is received from the
customer. More specifically, sale of goods is reported on the SCI on the period of delivery. On the other hand,
revenues from services are counted on the period when services are rendered. Neither order from a customer
nor signed contract of service count as sales. More importantly, cash collections are not revenue. Cash may be
received from customers prior to delivery such as in the case of down payments. At this point, it is a liability
called Unearned Income. On the other hand, delivery may come ahead of cash collections such as sales made
on account. This gives rise to an asset called Account Receivable. Recall that we have discussed unearned income
and accounts receivable in Lesson 1. Referring back to your party, the down payment received on November
28, 20X1 is reported on the December 31, 20X1 SFP as Unearned Income. It is not counted as revenue or sales
on the 20X1 SCI. Revenue was earned when the birthday party package was delivered on January 2, 20X2, hence,
the full amount of the contract price of the party package must only be reported as revenue in the 20X2 SCI. So
how will the fast food restaurant account for the collection from the credit card company on January 3, 20X2?
It is definitely not recognized as revenue. To do so will be double counting the revenue from your party. Rather,
the transaction is a collection of a receivable. Upon rendering the services on January 2, 2012, the recording of
revenue will coincide with recording a receivable from the credit card company (recall double entry accounting
from Fundamentals of Accountancy, Business, and Management 1). Therefore, the receipt on January 3, 20X2 is
a collection of that receivable.
We now know when to recognize or not recognize revenue. When do you we record expenses? By
following the concept of accrual, expense is recognized when an item is used to generate revenue. Example, the
food items in the birthday party may have been purchased on December 31, 20X1. At this point, the food items
are raw materials inventory. However, when the food items were served at the party, these were used to
generate revenue. Hence, it ceased being an asset and became an expense on January 2, 20X2. This is referred
to as the Matching Principle. Expenses are "matched" and recorded in the same period that the revenue it
generated was recognized.
If only everything was as simple as the food example above, then reporting expenses would have been
easier. There are expenditure items that are used in the business for more than one year. Take for example the
tables and chairs used in the party. These fixtures are used for many years and for many parties. How do we
match the costs of the tables and chairs to the birthday party? Let us try to estimate it in the best way we can.
How many years do you think the restaurant can use those fixtures before they are too worn out and will need
replacement? Assume that based on previous experiences of the restaurant and according to the manufacturer,
the fixtures are usable for five years. Next, assume further that the fixtures will be used evenly throughout the
five-year period. This means that if we believe there will be 200 parties in one year, the fixtures will be used 200
times in one year or 1,000 times over five years. Simply put, our assumption implies that the fixtures will have
equal usage per year over five years. Well this assumption certainly simplifies things. We can just divide the cost
of the fixtures over five years and we get the estimated peso value of the annual usage. This estimate is our best
effort to "match" the expense used to generate the revenue and is referred to as Rational Allocation. The
principle of rational allocation requires the cost of long-term expenditure to be rationally allocated over the
period of usage based on the expected pattern of usage. An example of expenses estimated using rational
allocation is the depreciation of equipment.
In cases when accountants cannot determine how long the expenditure will benefit the business or if
there is any benefit at all, then conservatism dictates that the cost of the expenditure should be charged to
expense immediately. Why? Because we cannot rationally estimate the "life" of the benefit. Hence, the cost is
charged to expense immediately, generally in the year it was spent. This method is used for costs of advertising.
For example, the inspiration to celebrate your birthday party at the fast food restaurant came from the
television commercial featuring a famous family. We need to consider how long this commercial can inspire
others in the same way it inspired you. Unlike the case of the fixtures, this one is very difficult to estimate.
Moreover, our estimate is also difficult to validate. Rather than be arbitrary, accountants choose to be
conservative and charge the whole costs of a television commercial aired in 20X1 as advertising expense on the
20X1 SCI.
To summarize, we have discussed that revenue is recognized on the period of delivery. Expense, on the
other hand, is recorded in the same period of the revenue it was able to generate. The allocation maybe a direct
 Fundamentals of ABM 2

one to one correspondence or an indirect estimate based on rational allocation. However, should there be no
rational way to allocate, the costs is expensed immediately.

Discussion Questions: Before moving on to the next part, answer the following review questions:
1. What is the accrual concept of accounting?
2. When is revenue reported on the SCI?
3. What are the three acceptable methods of recognizing expense: Explain

Elements of the Statement of Comprehensive Income

We have already discussed income and expenses in the previous sections. Here, we will identify in more
detail the elements of the SCI and we will introduce the different account names under revenues.

Revenue
Service Income
The Service Income account is generally used to describe revenue derived from rendering of services. A
more specific account name may be used to identify the services rendered such as Rental Income, Professional
Fee and Tuition Fee Revenue.
Recall that revenue from services is recognized when they have already been rendered. However,
contract of services may take a long time to complete. For example, when you enrolled in high school sometime
in May or June, you initially signed a service contract for one school-year (June to March). The revenue
generated from this enrolment contract may be reported as Tuition Fee Revenue. If the school follows the
calendar year of reporting, then we will have a problem because of the misaligned time period (Figure 2). Your
enrolment contract is for June of the current year to March of the next year. However, revenue to be reported
in the SCI is for services rendered to students from January to December of the current year. How do we solve
the problem of misaligned time period?
Accountants use the percentage of completion to allocate revenue to the appropriate period. It is
generally assumed that services are rendered evenly throughout the contract period. For example, tuition fee
for one school year is ₱50,000 per student. One school year is equivalent to 10 months (June to March). Then
tuition fee revenue from June to December is ₱35,000 (₱50,000/10 months x 7 months).

School Year

June 20X1 – March 20X2 April – May 20X2 June 20X2-March 20X3

20X1 January 20X2 – December 20X2 20X3

Calendar Year
Figure 2: Misalignment of School Year and Calendar Year

Sales
The Sales Revenue account is generally used to describe revenue derived from selling of goods. A more
specific account name may be used to identify the goods sold such as Office Supplies Sales, Book Sales, Food
Sales, etc.
Revenue from sales of goods is recognized when goods have been delivered. However, customers are
allowed to return goods that do not meet their quality standards. Recall that we already counted the goods
delivered as Sales on the date of delivery. When goods are returned, it is not deducted from Sales. Rather,
 Fundamentals of ABM 2

normal accounting practice is to report it under the account name Sales Return and Allowances - a Contra Sales
account.
In our Lesson 1 discussion of Accounts Payable, we mentioned that suppliers give discounts to their
customers to encourage early payments. Let us revisit that discussion from the supplier's point of view. We
delivered the goods to the buyer and appropriately recorded Sales Revenue based on full selling price. We gave
the buyer the credit terms of 2/10, n/30. The customer took advantage of the discount and paid within the ten-
day discount period. Accounting practice does not deduct the discount from Sales Revenue. Rather, we use
another Contra-Sales account called Sales Discount.
Only Net Sales is reported on the face of the SCI. Net Sales refer to Gross Sales less Sales Return and
allowances and Sales Discount. (Net Sales = Gross Sales – Sales Return and Allowances – Sales Discount)

Discussion Questions: Before moving on to the next part, answer the following questions:
4. What is the account name for revenue of a service company?
5. How is revenue computed for contractual services?
6. What is the account name for the revenue of a trading company?
7. Identify the components of net sales.
8. What is the meaning of 2/10, n/30?

Cost of sales is part of inventory accounting. Accountants have two ways of keeping records of inventory
- perpetual and periodic inventory system. Perpetual means that the Inventory and Cost of Goods Sold accounts
are "perpetually" updated. The inventory account is increased when goods for sale are required and decreased
when goods are sold. The Cost of Goods Sold account is updated every time a sale is made.
The other method is called periodic inventory system. The inventory account is only “periodically”
updates. “Periodically” means that the inventory account is updates only at end of the year of end of the month.
So what happens when merchandise are acquired or sold? Cost of merchandise acquired is collected using the
Purchases account. We also introduce two contra-Purchase accounts: Purchase Returns and Allowances and
Purchase discount. Returns of defective goods are reported under Purchase Returns and Allowances. Discounts
taken are reported under Purchase Discount. “Net purchases” is equivalent to Purchases less Purchase Returns
and Purchase Discount (Net Purchases = Purchases - Purchase Returns – Purchase Discount). Observe that this
is similar to the accounting practice for sales.
How cost of goods sold is determined in a periodic inventory system? Using the balances of the periodic
inventory system accounts, Cost of Sales is computed as follows:

Beginning Inventory XX
Net Cost of Purchases
Purchases P xx
Less: Purchase Returns xx
Purchase Discount xx
Net Purchases ₱ xx
Freight In xx xx
Cost of Goods Available for Sale P xx
Less: Ending Inventory xx
Cost of Goods Sold P xx
 Fundamentals of ABM 2

Beginning and ending inventory are determined based on the physical count of the merchandise owned
by the company. The ending inventory of the prior-period is also the beginning inventory of the current period.
The “periodic” adjustment updates the inventory account to bring it to the balance based on year-end physical
count.
Operating Expenses
Operating expenses refer to all other expenses related to the operation of the business, other than cost
of sales. These include salaries of employees, supplies, utilities (electricity, telephone and water bills), gasoline
expense, representation, bad debts expense, depreciation and amortization.
Bad debt expense is an operating expense related to accounts receivable. It is an estimated expense.
Recall from Lesson 1, Accounts Receivable is the right to collect payment from customers. However, some
accounts become uncollectible. The accounting rule is (1) to periodically analyze the collectability of Accounts
Receivable and; (2) to immediately charge to expense the amount deemed uncollectible. We will refer to this
account as bad debts expense. We will try our best to estimate bad debts expense using percentage of sales.
This method requires the determination of the historical relationship between bad debts and sales (or credit
sales). We now apply this historical relationship to current sales in order to determine bad debts expense.

Other Expenses and Other Income

Losses and other expenses as well as gains and other income are reported after the operating section
of the SCI. Line items included under this section are interest income from investments of excess cash, interest
expense from borrowings and gain or loss from sale of equipment (proceeds from sale less net book value of
PPE on date of sale).

Discussion Questions: Before moving on to the next part, answer the following questions:
9. What are the components of net purchases?
10. Explain how cost of goods sold is computed under the periodic method?
11. Differentiate periodic and perpetual method of inventory accounting.
12. Give four examples of operating expenses?
13. What is bad debts expense?

Presentation of Statement of Comprehensive Income

There are two formats for the SCI, namely, the single-step and the multi-step. The single-step is closely
related to the nature of expense format. On the other hand, the multi-step approach is also associated with the
function of expense.
Single-Step Statement of Comprehensive Income
The single-step SCI (Figure 3) groups all revenue items together and all expense items together. It is
called a single-step SCI because net income is computed using only one step, deducting total expenses from
total revenues. Subtotal are not computed and presented on the SCI. This format is generally used by small
businesses and service businesses because of its simplicity.
The single-step SCI is also closely linked to the nature of expense format. It lists down the expenses based
on the source of expenses such as salaries, purchases, supplies, utilities, fuel and depreciation.
Let us focus on the adjustment for increase in inventory. Why is this important? Look at the list of
expenses. Included in this list is Net Purchases which means it was fully deducted as an expense. However, due
to the existence of ending inventory, we know that not all current year purchases were sold. Therefore, we need
an inventory adjustment to
convert net purchases to cost of goods sold. Let us analyze the adjustment needed for this conversion: When
ending inventory is greater than beginning inventory, not all of the current year purchases were sold. This only
 Fundamentals of ABM 2

means that the excess of ending inventory over beginning inventory is from the unsold current year purchases.
We know that we have an over-deduction of expenses because all Net Purchases were deducted without taking
into consideration the unsold portion of the current year purchases. This caused the Net Income to be
understated. To correct this, the increase in inventory should be added back to arrive at the corrected Net
Income. How about if there was a decrease in Inventory? Ending inventory is less than beginning inventory if all
the current year purchases were sold as well as some of the beginning inventory. This time, there was an under
deduction of expenses because only the current year purchases were subtracted from the Net Income. This
caused an overstatement in the Net income and therefore, the sold portion of the beginning inventory should
be deducted.

ABC Company
Statement of Comprehensive Income
For the year ended December 31, 20X1

Service revenue xxx

Rental income xxx
Interest income xxx
Increase in inventory* xxx
Total revenues and income XXX
Net purchases yyy
Depreciation expense yyy
Utilities expense yyy
Salaries expense yyy
Interest expense yyy
Insurance expense yyy
Supplies expense yyy
Total expenses YYY
Net income XXX-YYY
*Increase in inventory = Ending inventory – Beginning inventory

Figure 3: Single-Step Statement of Comprehensive Income

Multi-Step Statement of Comprehensive Income

The multi-step SCI (Figure 4) is characterized by the presentation of several subtotals until net income
is determined. The multi-step SCI is more popularly used in business.
The subtotals are additional information that gives the readers more understanding of the operations of
the business. The first subtotal is gross profit which is computed as Net Sales less Cost of Goods Sold (Net Sales
– Cost of Goods Sold). The next subtotal, Income from Operations, is computed by deducting Operation
Expenses from Gross Profit (Gross Profit – Operating Expenses). Net Income is next determined by adding Other
Income (i.e. interest income) and deducting Other Expenses (i.e. interest expenses) from Income from
Operations.
ABC Company
Statement of Comprehensive Income
 Fundamentals of ABM 2

For the year ended December 31, 20X1

Gross Sales A
Sales returns and allowances B
Sales discounts C
Net Sales D=A–B–C
Cost of Goods Sold E
Gross Profit F=D–E
Operating Expenses:
General and administrative expense G
Selling expense H I=G+H
Income from Operations J=F–I
Interest income K
Interest expense L
Net income J+K–L

Figure 4: Multi-Step Statement of Comprehensive Income

The multi-step approach is also associated with the function of expense format. The function of expense
classifies operating expenses into three categories based on usage. The categories are Cost of Sales, General
and Administrative Expenses and Selling Expenses or Distribution Costs (Figure 4). General and Administrative
Expenses refer to those incurred in the daily operations and management of the business. On the other hand,
Selling Expenses or Distribution Costs are costs related to marketing, selling and distributing the company's
merchandise.
How are operating expenses classified into functions? Take the case of Salaries Expense. It is a line item
in the nature of expense SCI. This expense refers to the services rendered by the employees of the company.
Assume the company has four employees, namely, manager, Secretary, store clerk and delivery van driver. The
manager and the secretary are involved in the daily management of the business. Hence, their salaries are
reported as General and Administrative Expenses when the function of expense is used. The store clerk and the
delivery van driver are involved in the selling activities of the business. Their salaries are presented as Selling
Expenses. We perform the same analysis for all the operating expenses under the nature of expense and classify
them as to their function in the business operations (Figure 5).

ABC Company ABC Company

Income Statement Income Statement
For the year ended December 31, 20X1 For the year ended December 31, 20X1

Sales Sales
Less: Less: Cost of goods sold
Purchases Gross profit
Inventory adjustment Less: Operating expenses:
Salaries expense General and administrative expenses
Utilities
Depreciation Selling expenses
Supplies
 Fundamentals of ABM 2

Representation
Operating income Operating income
Other income Other income
Other expenses Other expenses
Net income Net income
Nature of Expense Function of Expense

Figure 5: Comparison of Nature and Functions of Expense Format

Normal Balances
Recall our discussion of normal balances in Lesson 1. An account is increased by an entry on the side of
its normal balance. Similarly, it is decreased by an entry on the opposite side of its normal balance. The normal
balance of equity accounts is credit. Recall the effect of income and expenses on equity. Income increases equity
and expenses decreases equity. Combined together – income increases equity and equity is increased by credit.
Therefore, the normal balance of all income accounts is credit. The same analysis is true for expenses. Expenses
decrease equity and equity is decreased by debit. Therefore, the normal balance of all expense accounts is debit.
Expense Account

Ending Balance = Debits - Credits

Expense Account
1,900 990
Ending Balance ₱910

Figure 6: Analysis of Expense Account using a T-Account

Take the case of an expense account. Expenses have normal debit balances. During the year, the total
debit and credit entries amount to ₱1,900 and ₱990, respectively. This expense account will have an ending
balance of ₱910 (Figure 6).
We will analyze a revenue account in the next example. Total debit entries amounted to ₱900 and credit
entries amounted to ₱1,990 during the year. Recall that the normal balance of a revenue account is credit.
Hence, credit entries will increase this account. As a result, the revenue account will have an ending balance of
₱1,090 (Figure 7).

Revenue Accounts

Ending Balance = Credits - Debits

Revenue Account
900 1,990
Ending Balance ₱1,090

Figure 7: Analysis of Revenue Account using a T-Account

Look back at our example of income and expense. Observe that there are no beginning balances in both
examples. Recall that income and expenses are measured "for the year ended." This means that income and
 Fundamentals of ABM 2

expense accounts really have no balances at the beginning of the accounting period. The ending balance is a
measure of the activities that occur during the year. After the preparation of the SCI, income and expense
accounts are "closed". This prepares the accounts for the measurement of the activities of the next year. The
process of "closing" the accounts will be discussed in detail in Lesson 8. The SCI accounts are also called nominal
accounts because it is closed at the end of the year. On the contrary, the Statement of Financial Position
accounts are real accounts.
Discussion Questions: Before moving on to the next part, answer the following questions:

14. Name two formats of the SCI?

15. What is the normal balance of revenue accounts?

16. What is the normal balance of expense accounts?

17. Explain why income and expense accounts have no beginning balances.

End of Lesson Summary

1. The SCI is a statement that reports the results of operations of the business for one period. The SCI is
described as a "for the period" report.
2. Income refers to a transaction that increases assets and/or decreases liabilities leading to increase in
equity resulting from the operation of the business and not from the owner's contribution.
3. Expenses are transactions that decrease assets and/or increase liabilities leading to decrease in equity
resulting from the operations of business and not because of distributions to owners.
4. There are two kinds of income - revenue and gains.
a. Revenues are income generated from the primary operations of the business.
b. Gains are income derived from other activities of the business.
5. There are also two kinds of expenses - expenses and losses.
a. Expenses are related to the primary operations of the business.
b. Losses are from other activities of the business.
6. Revenue is earned upon delivery of goods and services.
7. There are three approaches in recognizing expense:
a. The matching principle requires that expenses should be recorded in the same period in which the
revenue, to which those expenses relate, is recognized.
b. The principle of rational allocation requires the cost of long-term expenditure to be rationally
allocated over the period of usage based on expected pattern of usage.
c. Expenditures are charged immediately to expense if the period and the pattern of usage is not clear
such that there is no rational way to allocate.
8. Two kinds of revenue were discussed:
a. Service Income, used by service operations, is recorded based on percentage of completion of
contractual services.
b. Sales Revenue, used by trading operations, is recognized when goods are delivered.
i. Sales Returns and Allowances is a contra-sales account used to report the selling price of
goods returned by customers.
ii. Sales Discount is a contra-sales account used to report the amount of discount taken by
customers.
iii. Net sales is computed as gross sales less sales returns and allowances and sales discount.
9. Cost of sales refers to the cost of inventories sold. There are two kinds of inventory accounting.
a. Perpetual inventory accounting means that the Inventory account is "perpetually" updated for goods
purchased and sold.
 Fundamentals of ABM 2

b. Periodic inventory accounting does not update the inventory account for purchases and sales.
i. A separate account, Purchases, is used to report acquisitions of merchandise for sale.
ii. Purchase Returns and Allowances is a contra-purchase account that reports the costs of
goods returned to suppliers.
iii. Purchase Discount is a contra-purchase account that reports the amount of discount taken
by the company.
iv. Freight-in refers to shipping cost necessary to bring inventory purchased from the seller to
the premises of the company.
v. Net Purchases is gross purchases plus Freight-In less Purchase Returns and Allowance and
Purchase Discount.
vi. Inventory is determined by actual physical count of merchandise owned.
vii. Cost of sales is determined as follows: Beginning inventory + Net purchases - Ending Inventory
= Cost of goods sold
10. Operating expenses refer to all other expenses related to the operation of the business, other than cost
of sales. Examples are salaries and utilities.
11. Bad debts expense is the estimated amount of loss resulting from uncollectible accounts receivable.
12. Losses and other expenses as well as gains and other income are reported separately after the operating
section of the SCI.
13. There are two acceptable formats of the SCI:
a. Single-step SCI
i. Groups all revenue together and groups all expenses together. Net income is simply
computed as total revenues - total expenses.
ii. Expenses are listed based on the source of the expense such as salaries, purchases, supplies,
utilities, fuel and depreciation.
b. Multi-step SCI
i. Revenue and expenses are classified and presented on the following sections: gross profit,
operating section and non-operating section. Subtotals are presented at the end of each
section, namely, gross profit, operating income and net income.
ii. Expenses are listed based on usage or function of expense. Operating expenses are
categorized into cost of sales, general and administrative expenses and selling expenses.
14. The normal balance of revenue accounts is credit.
15. The normal balance of expense accounts is debit

References

Main Source:

Salazar, Dani Rose C. (2017). Fundamentals of accountancy, business, and management 2, Quezon City: Rex Printing
Company, Inc.

Other Source:

Monfero, R. P. P., Andres, C. S., Salazar D. R. C., Honorario C. B. (2016). Teaching guide for senior high school:
fundamentals of accountancy, business and management 2, Quezon City: Commission on Higher Education