FAR Notes (Finals) Adjusting Entries

© Gwyneth P. Malaga
1. Accrued To take up expenses
Expenses incurred in one period
Adjusting Journal Entries
But remain unrecorded and
Accrual Basis of Accounting unpaid as of the end of the
period
• Requires adjusting entries at the end of
2. Accrued To take up income earned
the period
Income in one period
Revenue Recognized when earned But remain unrecorded and
Earned when: not received as of the end
of the period
▪ service is given
▪ sold goods 3. Prepaid To allocate expenses to two
Expense or more accounting periods
Expenses Recognized when incurred
4. Unearned To allocate income to two
Incurred when: Income or more accounting periods
▪ Service is rendered by the 5. Depreciation To recognize the amount of
other party used economic benefits of
▪ Bought good/supplies a fixed asset.

Cash and Accrual Basis of Accounting 6. Bad debts To recognize the possible
uncollectible amounts due
Generally Accepted Accounting Principles from customers as of the
end of the period
• require business to use accrual basis

Small businesses
1. Prepaid Expenses - Cash Payment
• usually find it more convenient to record
transactions when cash is received or Deferrals
paid (cash basis)
• After, they convert to accrual basis for 1. Asset Method
purposes of preparing financial 2. Expense Method
statements
Asset Method Expense Method
Conversion to accrual basis
Recorded as an asset Initially recorded as an
• necessitates the recording of adjusting expense
journal entries Because service or Entity needs to
benefit will be prepare reports under
received from it in the the accrual basis of
Adjusting Entries future accounting

• Bring assets, liabilities, and equity up to Adjustments needed

date at the statement date - when used or
consumed
Proper amount of revenues and expenses
- expires and becomes
• Reported on the statement of
and expense
comprehensive income after
adjustments Initial Entry Initial Entry
Asset/ Prepayments Expense
Types of Adjusting Entries
Cash Cash
1. Accrued Expenses
2. Accrued Income Adjusting Entry Adjusting Entry
3. Prepaid Expense
Expense Asset/ Prepayments
4. Unearned Income
5. Depreciation Asset/ Prepayments Expense
6. Bad debts
 2. Accrued Revenues

Services/benefits

• already provided

Revenues

• not yet recorded

o On reporting date the need of accrual

basis of accounting reports must be
Initially Recorded as Asset
prepared as required by GAAP
When it expires, it becomes an expense
Initial Entry Adjusting Entry

None Receivable
Unearned Revenues Revenue/Income
1. Liability Method Wala pang cash For the mean time,
received kaya record as recevable
2. Revenue Method
walang entry muna

Liability Method Revenue Method

Cash is received Cash is received

Initially recorded as Initially recorded as

liability revenue

Initial Entry Initial Entry

Cash Cash

Unearned Revenue Revenue

3. Accrued Expenses
Adjusting Entry Adjusting Entry
Services/benefits
Unearned Revenue Revenue
• already received
Revenue Unearned Revenue
Expenses
Nababawasan ang Nadadagdagan ang
unearned dahil unearned dahil di pa • not yet recorded
naeearn na o napoprovide lahat o On reporting date the need of accrual
nabigay na ang ng service basis of accounting reports must be
service prepared as required by GAAP

Initial Entry Adjusting Entry

None Expense

Payable

• Kailangan irecord as payable muna

Liability → Revenue

Revenue → Liability
Garcia Solutions bought office supplies costing Kung mag eextend sa susunod na taon,
P10,000 on September 5. The journal entry to
record the purchase of the supplies. • Need mag adjust dahil may unexpired
portion
Initial Entry

Office Supplies 10,000

Deferral (Asset Method)
Cash 10,000
On Sept 1, Garcia paid P600,000 for a one-year
Office Supplies Cash rental, beginning September 1, 2020.
Debit Credit Debit Credit
10,000 10,000 Initial Entry

Prepaid Rent 600,000

On September 30 (reporting date), supplies on
Cash 600,000
hand amounts to P2,000.
Prepaid Rent Cash
Adjusting Entry
Debit Credit Debit Credit
Supplies Expense 600,000 600,000

Supplies

Office Supplies Supplies Expense Assume the reporting date is December 31,
Debit Credit Debit Credit 2020.
10,000 8,000 8,000
2,000 600,000/12*4 = 200,000

Prepaid Rent Rent Expense

Debit Credit Debit Credit
4. Prepaid Expenses
600,000 200,000 200,000
Payment of cash 400,000

• recorded initially as an asset

Asset Method
Because service or benefit
Initial Entry
• will be received in the future Prepaid Rent 600,000
Cash 600,000

Expense Method
Adjusting Entry
Initial Entry Adjusting Entry
Rent Expense 200,000
Expense Asset/Prepayments
P. Rent 200,000
Cash
Expense

When service or Expense Method

benefit is received
Initial Entry
Rent Expense 600,000
Asset/Prepayments (in Adjusting Entry) Cash 600,000

• Unexpired portion
Adjusting Entry
o Initially, it is wrong. Pero pag
Prepaid Rent 400,000
macoconsume within financial
statement date, pwedeng hindi na R. Exp 400,000
gumawa ng adjusting entry
o January nagrecord ng Dr. Expense Cr.
Cash at sa December, naconsume na
lahat. No need for adjusting entries
Garcia Solutions received P120,000 on Example Problems in Accruals
September 1 from EDT Consultancy as
payment for a 12-month service contract to be Accruals
rendered starting September 1.
1. On September 1, Garcia Solutions entered
Initial Entry into a 1-year contract with GJ company
amounting to P120,000 for providing
Cash 120,000 Management Advisory Services starting
September 1. Payment will be made every
Unearned Revenue 120,000 after 6 months.
120,000/12*4 = 40,000 Initial Entry

No entry (Empty T-acounts)

Adjusting Entry Adjusting Entry
Unearned Revenue 40,000 Accounts Receivable 40,000
Service Revenue 40,000 Service Revenue 40,000
Note: Revenues are earned but not yet Accounts Receivable Service Revenue
received in cash and also not yet recorded. Debit Credit Debit Credit
40,000 40,000
Expenses are incurred but not yet paid in cash
and also not yet recorded.
Accruals

2. On November 1, Garcia Solutions borrowed

Liability Method from RAR Lending Company P500,000 and
Initial Entry signed a three-month, 12%, note.
Cash 120,000 Cash 500,000
Unearned R. 120,000
Notes Payable 500,000

Cash Notes Payable

Adjusting Debit Credit Debit Credit
Entry 500,000 500,000
Unearned 40,000
Revenue
Adjusting Entry
Revenue 40,000
500,000(12%)/12 *2

Revenue Method Interest Expense 10,000

Initial Entry Interest Payable 10,000

Cash 120,000 Interest Expense Interest Payable
Revenue 120,000 Debit Credit Debit Credit
10,000 10,000

Adjusting
Entry 3. Assuming a factory worker receives total
wages of P5,000 for a five-day work week, or a
Revenue 80,000 rate of P1,000 per day and payable every
Unearned 480,000 Friday. Assuming reporting date of December
Revenue 31 falls on a Wednesday.

Salaries Expense 3,000

Salaries Payable 3,000

Salaries Expense Salaries Payable

Debit Credit Debit Credit
10,000 10,000
4. Garcia estimates a bad debt expense of Adjustments (two possibilities))
P600 for the month September.
1. Deferrals
Adjusting Entry • Existing balances are changed
2. Accruals
Bad Debt Expense 600 • New information is entered
Allowance for Bad Debt 600

Bad Debts Expense Allowance for Bad debts After adjusted trial balance,
Debit Credit Debit Credit
10,000 10,000 • Adjustments are combined with
trial balance

5. On September 1, Garcia Solutions Account balances

bought a computer equipment valued at
P50,000. The estimated useful life is 3 years and • Now adjusted
has a salvage value of P5,000. Assuming
reporting date is December 31.

Depreciation Expense, 5,000

Accumulated Depreciation, 5,000

Depreciation Expense Accumulated Dep.

Debit Credit Debit Credit
5,000 5,000

Notes in Discussion

In adjusting entries,

Used portion

• Will be considered as expense

Cash Basis

• Kapag walang bayad, walang entries

• Kapag walang entry, hindi magagawa
ang FS
• Kapag ginamit ito, may problema kasi
tinanggap kaagad ang pera
• Pero may service na hindi pa nabibigay

Worksheet

• Not necessarily needed

• Information is based on the ledger Debits and credits in trial balances

Unadjusted Adjustments Adjusted • Should always be equal

Trial Trial
Balance Balance Columns

Accounts Dr Cr Dr Cr 1st and 2nd Unadjusted Trial balance

Assets 3rd and 4th Adjustments

Liabilities 5th and 6th Adjusted Trial balance

Equity 7th and 8th Income Statement

9th and 10th Balance Sheet

 3. Statement of Financial Position

Income Statement

Net Income

• Has credit balance

• There is debit to balance debits and
credits

Balance Sheet

Net Income

• Credited to balance debit and credits

When preparing financial statements,

1. Start with Income Statement 1. Trial Balance

• Balances are from the general ledger

• Order is as follows, A, L, OE, E

2. Adjustments

• Can be inputted after transferring

balances from general ledger

3. Adjusted Trial Balance

• Can now be determined

4. Income Statements

• Nominal Accounts are inputted

5. Balance sheet
2. Statement of Changes in Owner’s Equity
Real accounts

• Extended to the balance sheet columns

Assets and Drawings Liabilities and Capital

Debited credited
Order of Making Financial Statements Depreciation

1st Statement of Comprehensive Income 5. On September 1, Garcia Solutions

bought a computer equipment valued at
2nd Statement of Changes in Owners Equity
P50,000. The estimated useful life is 3 years and
3rd Statement of Financial Position has a salvage value of P5,000. Assuming
reporting date is December 31.

Statement of Comprehensive Income Cost of equipment 50,000

• Where revenues, expenses and net Less. Estimated Scrap Value 5000
income are recorded
Depreciable Cost 45,000
Statement of Changes in Owner’s Equity
Divided by estimated useful 3
Statement of Financial Position life

• Capital Annual Depreciation 15,000

• The ending capital is recorded
Divided by no. of months in 12
a year

Formula Bank Monthly Depreciation 1,250

Formulas (Based on my other book. If gusto Multiplied by nos. of mos 4

niyo lang mag-excel, baka makatulong) from sep 1- dec 31

Notes Receivable/ Payable Depreciation Expense for 4 5,000

months
2. On November 1, Garcia Solutions borrowed
from RAR Lending Company P500,000 and
signed a three-month, 12%, note.

Deferrals
Face Value of Notes Receivable 500,000
Multiplied by Interest rate 12% On Sept 1, Garcia paid P600,000 for a one-year
rental, beginning September 1, 2020. Assume
Interest for one year 60,000 reporting date is st December 31
Multiplied by accrued no. of 2/12 Rent received in advance 600,000
months/12
Divided by number of 12
Accrued interest from nov 1 – 10,000
months covered by the
dec 31
amount received
Monthly 50,000
Kapag days, 360 days lang (Business rule) Multiplied by the number of 4
months from sept 1- dec 31
Earned portion of rent 200,000
received in advance
Closing Entries 2. Close Expenses and Income Summary

Accounts to be closed to income summary

1. Revenue

2. Expenses

3. Get balance of income summary

• Greater credit = net income

• Greater debit = net loss

4. Drawings

• Get balance of drawing account and

close to capital account

Closing Entries 3. Close Income Summary to Drawing Account

Revenue debited

Expenses credited

Drawings credited

Closing Entries

• Done to make balances zero

• To transfer balances to another account

Income Summary Account

• Should also be closed Garcia, Drawings

Debit Credit
Drawings has greater debit
4,000 17,205
• Ang winithdraw ay mas malaki sa kita
• May natira pa na 13,205

Closing entries
4. Close Drawings and Credit Garcia Capital
Drawings

Income

Example of Closing:

1. Close Revenue and Income Summary

Service 26,840
Revenue

Computer 120
repairs

Income 26,960
Summary
Capital Examples:

• Nadagdagan dahil hindi winithhdraw 1. Accrued expenses

lahat ng income
Assuming a factory worker receives total
wages of 5,000 for a five day work week for a
rate of 1,000 per day and payable every Friday.
Post Closing Trial Balance Assuming reporting date of December 31, falls
on a Wednesday.

Dec 31

Salaries 3,000
Expense

Salaries 3,000
Payable

Salaries Expense Salaries Payable

o Post to General Ledger before making a Debit Credit Debit Credit

post closing trial balance
3,000 3,000
Balances in Ledger

• Become zero (nominal accounts)

Real accounts
Reversing entries
• Still has existing balances
Jan 1

Salaries 5,000
Reversing Entries Expense

• Prepared at the beginning of a new Cash 5,000

accounting period, before any of the
regular transactions are recorded
• Exact opposite of some of the adjusting
entries recorded at the close of the Salaries Expense Salaries Payable
accounting period that just ended
Debit Credit Debit Credit
Not strictly required to prepare but preferred to
5,000 3,000 3,000 3,000
do because:

1. Brings about segregation of items

between accounting periods Salaries Payable
2. Simplifies the recording of regular
transcations in the next accounting • 0 na since wala nang payable
period
3. Restores the ledger accounts to their
normal status
2. Accrued Income

On September 1, Garcia Solutions entered into

Prepared for the following adjusting entries a 1 year contract with GJ company
amounting to 120,000 for providing
1. Adjustments for accrued expense Management Advisory Services starting
2. Adjustments for Accrued income September 1. Payment will be made every
3. Adjustments for Prepaid expenses after 6 months
(expense method)
4. Adjustments for Deferred income (under
income method
On December 31 (Reporting date) an
adjusting entry needs to be recorded
Rent Expense Prepaid Rent

Debit Credit Debit Credit

December 31
600,0000 400,000 400,000
Accounts 40,000
Receivable 200,000

Service 40,000
Revenue
• Parang inunahan lang ang mga
pangyayari

A/R Service Revenue

Debit Credit Debit Credit 4. Deferral (Revenue Method)

40,000 40,000 Garcia Solutions received 120,000 on

September 1 from EDT Consultancy as
payment for a 12 month service contract to be
rendered starting September 1.
Reversing Entry

Jan 1
Initial Entry
Service 40,000
Revenue Cash 120,000

Accounts 40,000 Service Revenue 120,000

Receivable

Service revenue
Cash Service Revenue
Icecredit ng 20,000 (this year)
Debit Credit Debit Credit
Dahil ang 40,000, naearn na last year
120,000 120,000

Cash 60,000
Adjusting Entry
Service Revenue 60,000
Assuming the reporting date is December 31,
2020, ( 120,000/ 12 = 10,000) of revenue is
earned each month. (10,000 x 4 )
A/R Service Revenue
Service 80,000
Debit Credit Debit Credit Revenue
40,000 40,000 40,000 60,000 Unearned Service 80,000
Revenue

Unearned S/R Service Revenue

3. Deferral – (Expense Method)
Debit Credit Debit Credit
Assuming the reporting date is December 31,
2020, (600,000/ 12 = 50,000) and expires each 80,000 80,000
month (50,000 x 4)

Prepaid Rent 400,000

Rent Expense 400,000

Reversing entry

Unearned 80,000
Service Revenue

Service 80,000
Revenue

Unearned S/R Service Revenue

Debit Credit Debit Credit

80,000 80,000 80,000

Kapag hindi ginawa ang reversing entries sa

unang period

• Okay lang since hindi required

• Pero magiging adjusting entry naman
sa end of accounting period

Account to be Reversed

1. accrued income
2. accrued expense
3. unearned revenue using the income
method
4. prepaid expense using the expense
method
Merchandising Business Sales

Definition - Sales Returns and Allowances

• Engaged in “buy and sell” activities - Sales Discounts

• Buys products from manufacturers and
sells it at higher prices Net Sales

Owner of the business - Cost of Goods Sold

• May be a wholesaler or retailer Gross Profit

Wholesaler Retailer - Operating Expenses

Buys directly from Buys from wholesalers Operating Income

manufacturers
+ Other Income
Sells to retailers Sells to end-customers
- Other Expenses

- Interest Expense
Merchandising Business Income Statement
Net Income Before Tax
Sales xx
- Income Tax Expense
Less: Sales returns and Allowances xx
Sales Discount xx NetxxIncome After Tax
Net Sales xx
Less: Cost of Sales
Beginning Merchandise Inventory xx
Sales
Add: Net Purchases
Gross Purchases xx • Account used to record sales made by
Add: Freight-in xx the firm
Balance xx • recorded when earned
Less: Purch rets and Allows xx • earned when the goods are delivered
Purchase Disct xx xx from the seller to the buyer
Net Purchases •xx May be sales on cash or sales on
Total Goods Available for Sale xx account
Less: Ending Merchandise Inventory xx
Example 1:
Cost of Sale xx
Gross Profit xx 1, 2019, EGR Co sold P100,000
On December
Less: Operating Expenses worth of merchandise for cash. The entry will
General and Administrative be:xx
Selling xx xx
Net Income Cash xx 100,000

Sales 100,000
From Book of JCD (Bentahan)

Purchases Example 2:

+ Freight- in On December 15, 2019, EGR Co sold goods to

Mr. GJ for P89,600 on account, terms: 2/10,
Gross Purchases n/30. The entry will be:

- Purchase Returns and Allowances Account receivable 80,000

- Purchase Discounts Sales 80,000

Net Purchases Assuming the goods were sold to MrGJ. In

installment, Down payment ofP20,000, then the
+ Beginning Inventory entry will be:
Cost of Goods Available for Sale Account receivable 60,000
- Ending Inventory Cash 20,000
Cost of Goods Sold Sales 60,000
Sales Returns and Allowances 2/10. if the customer pays by the tenth of
EOM, the month following the month of
• Account used when customers return N/60 sale a two percent discount is
merchandise that have been previously provided.
recorded in the Sales account
• Normal balance is debit EOM
• evidenced by the issuance of a credit
memorandum by the seller • means end of month
o example: date of sale is 6/10.
Example: July 1-10 will be the discount
period
On December 18, 2019, Mr. GJ, a
customer, returned defective Beyond this period, the full amount
merchandise with a selling price of P20,000. must be paid (within 60 days from
The entry to record the return will be: the date of sale)
Sales returns and allowances 20,00

Accounts Receivable 20,000 When the seller elects not to offer a cash
discount for prompt payment,
Cash Refund Credit terms
• Made for a sales return or allowance on • will specify only the maximum time
a cash sale period for paying the balance due
• for example, n/30 or n/60
Transaction
n/30 purchase price must be paid by the
• recorded by debiting sales returns and
customer within 30 days from date
allowances and crediting cash
of sale

n/60 purchase price must be paid by the

Sales Discount customer within 60 days from date
of sale
• Cash discount included in the terms of a
credit sale
• Given to encourage customers to pay
Accounting for Sales Discounts
their accounts promptly
• Term used to call the amount of the Sales Discount
reduction
• Account debited when cash discounts
Common Examples are taken by the customers
2/10, two percent may be deducted from Sales Discount and Sales Returns and
n/30 the amount due Allowances
if the customer pays within 10 days • Deducted from Sales account to arrive
from the date of sale at net sales to be presented in the
Income Statement
Discount period
Example:
• period during which the
customer can avail the discount On December 22, 2019, ERG Co received full
o 10 days in the example payment from Mr. GJ related to the sale made
in December 15, 2019. The amount received is
If the customer does not pay within
computed as follows:
10 days, he/she must pay the full
price within 30 days from the date Sales-December 15, 80,000
of sale
Less: Returns on Dec. 18 20,000

Amount due before the discount 60,000

Less: 2% discount (P60,000x 2%) 1,200

Net of discount 58,800

Journal Entry to record the return A/R or Cash 58,800

Cash 58,800 Sales 60,000

Sales Discount 1,200

Financial Statement Presentation
A/R 60,000
As contra-revenue accounts,

Trade Discounts Sales returns and allowances and sales

discounts
List Price • are deducted from sales in the income
• Also called catalog price statement to arrive at net sales
• not the item’s intended selling price
An example of the sales revenue section of
Intended selling price the income statement (based on assumed
data) is as follows:
• List price minus a given percent called a
trade discount
Sales P180,000
Trade Discounts Less: Sales Return and
Allowances P 20,000
• used to reduce the list price to actual Sales Discounts 1,200 21,200
NET SALES P158,800
sales price
• smay be due to the volume of
transaction

Cost of Goods Sold

Accounting for Trade Discounts
• the total cost of merchandise sold
Trade Discounts during the period
• This expense is directly related to the
• not recorded, either in the books of the revenue recognized from sale of the
seller or the books of the buyer goods
When a sale or purchase is made, Gross Profit
Amount recorded • Sales Revenue minus cost of goods sold
• always net of the trade discount • also called gross profit (or gross margin)
on sales
Example:
Merchandise Inventory
Visual Co. sold to Ciudad Company
merchandise with a list price of P52,000 (before • includes the goods purchased for the
VAT) and with trade discounts of 20% and 10%. principal purpose of selling them in the
The sales price will be computed as follows: ordinary course of business operations

Merchandiser
List price P52,000.00
Less: First discount (20% x • keeps its inventory in stock before
10,400.00
P52,000) making a sale to a customer
Balance after discount P41,600.00
Cost of goods sold Vs. Merchandise Inventory
Less: Second discount (10% x
4,160.00
P41,600)
Cost of goods sold Merchandise Inventory
Net sales price P37,440.00
expense (sold) asset (unsold) portion of
portion of goods held goods held for sale
Shortcut: for sale

• 52,000(0.80)(0.90) = 37,440

Journal Entry:
Inventory Systems Used For Merchandising Periodic Inventory System
Transactions
• requires updating the inventory
1. Periodic Inventory System account only at the end of the period
2. Perpetual Inventory System to reflect the quantity and cost of
goods both available and sold
Periodic Perpetual
Cost of merchandise
When cost of goods is maintains detailed
determined only at records of the cost of • recorded in a temporary Purchases
the end of an each inventory item account
accounting period
When a company sells merchandise,
To determine the cost continuously show the
• it records revenue but not the cost of
of goods sold, it is inventory that should
the merchandise sold
necessary to be on hand
The cost of merchandise available

• computed by relating the quantities

1) record purchases
counted to the purchase records that
of merchandise
show each item’s original cost
2) determine the cost • will then be used to compute cost of
of goods purchased goods sold

3) determine the cost Inventory account

of goods on hand at
• then adjusted to reflect the amount
the beginning and
computed from the physical count of
end of the period
inventory
Has separate journal
entry to record
decrease in inventory Accounting for Purchases and Related
balance Accounts

Purchases

Mechanics of A traditional periodic inventory • account debited for the cost of the
system operates as follows: goods bought for resale
• may be made for cash or on account
a. When goods for resale are purchased,
(credit
Purchases account
• is debited at the amount of acquisition Classified as:
cost
Cost of Goods Sold Merchandising inventory
b. Upon making a sale,
upon sale If unsold
Income

• recognized by crediting sales, based

o Purchases account at the end of the
on the selling price of the goods
fiscal period appears in the Income
c. No separate entry is prepared to record the statement
decrease in the inventory balance as a result
of sale

Inventory ledger balance

• need not be updated as the buying

and selling transactions occur
Purchase If cash purchase, journal entry is:

• normally recorded by the purchaser Purchases 160,000

when the goods are received from the
Cash 160,000
seller

Every purchase
And if only P20,000 was paid as down payment
• should be supported by business the entry will be:
document that provide written
Purchases 160,000
evidence of the transaction
Cash 20,000
Each cash purchase
A/P 140,000
• should be supported by a cancelled
Purchase Returns and Allowances
check or cash register receipt indicating
the items purchased • Returns made and recorded by the
buyer
Accounting for Purchases Sales return or sales Purchase return or

Cash purchases
allowance on the = allowance on the
seller’s books purchaser’s books
• recorded by a debit to Purchases and a
credit to Cash
Possible reasons for returns
For credit purchases,
1. Defective products
• each transaction should be supported
2. Damaged due to shipment
by a purchase invoice indicating the
3. Wrong set of products delivered
total purchase price and other relevant
information (such as discounts offered) Purchase Allowance

The purchaser • happens when the company is still

willing to accept the said goods, but
• does not prepare a separate purchase
with a reduction in price
invoice
• the copy of the sales invoice sent by the
seller becomes a purchase invoice to Accounting for Purchase Returns and
the buyer Allowances

12% Value Added Tax (input tax) The purchaser

• normally incorporated in the price and • initiates the request for a reduction of
entries the balance due through the issuance
of a debit memorandum
Example:
Debit memorandum
On December 6, 2019, ERG CO. purchased
goods from RR Co. for P160,000 terms: 2/10, • a document the purchaser issues to
n/30. Input Tax is 12% of the purchase price. inform the supplier of a debit made to
the supplier’s account, including the
Journal entry:
reason for the return or allowance
Purchase 160,000
Purchase Returns and Allowances
Accounts Payable 160,000
• Recorded by debiting accounts
payable and crediting purchase returns
and allowances
Example: On December 8, 2019, ERG Co. returned to RR
Co. P10,000 worth of defective goods.
On December 8, 2019, ERG Co. returned to RR
Co. P10,000 worth of defective goods. Journal Entry

Journal Entry A/P 10,000

A/P 10,000 Purchase R/A 10,000

Purchase R/A 10,000

Payment made within the discount period

Purchase Discounts If payment was made to RR Co. within the

discount period (for example, if payment was
• Based on the invoice cost less returns made on December 15, 2019), the 2% discount
and allowances, (if any) shall be deducted from the amount due to
National Co., as follows:

Accounting for Purchase Discounts Purchases-December 6 160,000

Purchase Discount Less: December 8 returns (10,000)

Amount Due 150,000
• Account used to record the amount
Less: 2% discount (3000)
saved by paying promptly
• contra account having a normal credit Net Purchases 147,000
balance

Similar to purchase returns and allowances, Journal Entry

• it is a deduction from the purchases A/P 150,000

account
• closed to Income Summary account at Purchase Discount 3,000
the end of the period Cash 147,000

Alternative Methods of accounting for

purchase discounts:
1. Gross Price Method Payment made outside the Discount Period
2. Net Price Method
If payment was made outside the discount
3. Allowance Method
period, the full price of purchased goods
(excluding returns) and input tax thereon shall
Gross Price Method be paid.

Under this method, Purchases-December 6, 160,000

Less: December 8 returns (10,000)
Purchases and Accounts Payable
(before input tax)
• recorded at gross Amount Due (before 150,000
input tax)
Purchase discounts

• recorded only when taken

Journal Entry
Example:
Accounts Payable 150,000
On December 6, 2019, ERG purchased
goods from RR Co. for P160,000 terms: 2/10, Cash 150,000
n/30. The journal entry is:

Purchases 160,000

A/P 160,000
Net Price and Allowance Methods Point when ownership transfers from the seller
to the buyer
Net Price Method
• determines who pays transportation
Purchases and Accounts Payable costs (and other incidental costs of
transit such as insurance)
• recorded at net of the discounts offered
• can be derived from the freight terms
Purchase discounts lost account agreed between the seller and the
buyer
• used to record purchase discounts
which have been forfeited Freight terms: FOB Shipping Point and FOB
• presented either as part of operating Destination
expenses or as part of finance cost
Cost of Shipping the Merchandise
(interest expense)
• May be shouldered by the buyer or
Allowance Method
seller
Purchases • depending upon the arrangements
made prior to the purchase or sale of
• recorded at net the merchandise
Accounts payable Shipping Arrangements
• Recorded at gross (Purchase discounts • FOB destination
are recorded when taken) • FOB shipping point

Allowance method FOB destination FOB shipping point

Seller shoulders costs Buyer shoulders costs
• like a combination of the two previous
methods

For basic accounting purposes, only the Net FOB destination

Price Method shall be illustrated in the next
Seller Buyer/ Purchaser
page. The Allowance method is covered in
intermediate accounting courses. has agreed to pay all receives title to the
the shipping costs goods at point of
destination

Shipping Charges on Merchandise Purchased Record of Shipping

or Sold Charges
Debited to Freight-
Buyer and Seller must agree on Out or Transportation
Out
1. who is responsible for paying any freight
costs
Considered as selling
2. who bears the risk of loss during transit for expense listed
merchandising transactions among the operating
expenses in the
o To know what point ownership transfers
Income statement
from the seller to the buyer

Point of Transfer of Ownership

Since the seller still has title to the goods while
• sometimes called the point of passage the same are in transit,
of title
Shipping cost

• properly an expense of the seller

Example: Assuming payment is made on January 9,
entries will be:
On January 3, 2019, goods with a selling price
of P30,000 are purchased by Manila Co. from Manila Company Books
Cebu Trading, a company in Cebu City. Terms (buyer)
are 2/10, n/30, FOB Manila. Amount of freight Accounts payable 28,400
cost is P1,600.
Purchase Discount 600
Journal Entries
Cash 27,800
Manila Company Books
(buyer)
Purchases 30,000 Bicol Company Books
Accounts payable 30,000 (seller)
Cash 27,800
No journal entry for the freight cost. Sales Discount 600
Accounts Receivable 28 400
Bicol Company Books
(seller)
FOB Shipping Point
A/R 30,000
Sales 30,000
Buyer/ Purchaser

Freight out 1,600 • has agreed to shoulder all the shipping

Cash 1,600 costs
• receives title to goods at shipping point
The entries assumed that the seller paid the Shipping charges with terms FOB shipping point
shipping company (FOB destination, freight
prepaid) • additional costs of the purchased goods
• debited to an account called
FOB destination, FOB destination, freight Transportation In or “Freight In” in the
freight prepaid collect books of the buyer,
• shown in the Income Statement as an
means that the freight cost is addition to the cost of merchandise
purchased
freight cost is chargeable to the seller
chargeable to the but the buyer has to Example:
seller who pays the pay the shipping
Assume that on January 4, 2019, Atlas Co.
shipping company company upon receipt
located in Manila purchased goods with a
of the goods
selling price of P40,000 from Davao Co. Freight
cost was P3,000.
Journal Entry for FOB destination, freight collect Assume that the terms are 2/10, n/30, FOB
Manila Company Books shipping point, freight collect. The entries to
(buyer) record the transactions are as follows:
Purchases 30,000 Atlas Company Books
Accounts payable 30,000 (buyer)
Accounts payable 1,600 Purchases 40,000
Cash 1,600 Accounts payable 40,000
Freight-In 3,000
Bicol Company Books Cash 3,000
(seller)
A/R 30,000 Davao Company Books
Sales 30,000 (buyer)
Accounts Receivable 40,000
Freight out 1,600 Accounts payable 40,000
A/R 1,600 No entry for the freight cost
If the terms are FOB shipping point, freight Determining the Cost of Goods Purchased
prepaid,
Remember:
• all the shipping cost is for the account of
the buyer Account Normal Balance
Purchases Debit
• but the seller advanced the payment to
Purchase returns &
the shipping company allowances Credit
Purchase discounts Credit
Journal Entries:
Freight in Debit
Atlas Company Books
(buyer)
The procedure for determining the cost of
Purchases 40,000 goods purchased is as follows:
Accounts payable 40,000
Freight-In 3,000 1. Get Net Purchases
Accounts payable 3,000
Purchases

Davao Company Books (Purchase Discounts)

(seller)
(Purchase Returns and Allowances)
Accounts Receivable 40,000
Sales 40,000 Net Purchases
Accounts Receivable 3,000
Cash 3,000
2. Get Cost of Goods Purchased
The payment made by the seller to the
Net Purchases
shipping Co. will be charged to the account of
Atlas Co. hence the debit to Account Freight-In
Receivable in the books of the Davao Co.
Cost of goods purchased
Assume that the payment is made on January
9, within the discount period: Example:

Atlas Company Books XYZ Co. shows the following balance for the
above accounts: Purchases P350,000;
(buyer)
Purchase Return and Allow. P10,000; Purchase
Accounts Payable 43,000 Discounts P6,000; and Freight In P 5,000.
Cash 42,200
Purchases 350,000
Less; Purchase R/A 10,000
Purchase Discount 800
Less. Purchase Discounts 1,600
Net Purchases 338,400
Add. Freight-In 5,000
Davao Company Books Cost of Goods Purchased 343,400
(seller)
Cash 42,200

Sales Discount 800

Accounts Receivable 43,000

Mechanics of the Perpetual Inventory System

Under the perpetual inventory system,

Records

• are kept of the quantity and cost of

each item as it is bought, held in
inventory and sold

Because of the detailed information available

under this system,

Management is able to:

• respond to inquiries of salespersons and

customers about merchandise
availability,
• maintain optimum inventory levels
• avoid running out of stock

Under the Perpetual system,

a. Cost of each item

• debited to the Merchandise Inventory

account upon purchase

b. At the time of sale, the cost of each item

• is transferred from the Merchandise

Inventory account to the Cost of Goods
Sold account
• By debiting cost of goods sold and
crediting merchandise inventory

Therefore, at all times

Cost of Goods = Cost of Merchandise

Sold Sold
Merchandise = Cost of Merchandise
Inventory on Hand

All increases and decreases related to

merchandise

• are recorded directly in the

Merchandise Inventory account under
the Perpetual Inventory System

Therefore,

These accounts are NOT used:

1. Purchases
2. Purchase return and allowances
3. Purchase discounts
4. Freight-In
Comparison of Entries Between Periodic And Perpetual Inventory System

1. Purchased merchandise worth P80,000, terms 2/10, n/30, FOB shipping point.
Periodic System Perpetual System

Purchases 80,000.00 Mdse. Invty 80,000.00

Accounts payable 80,000.00 Accounts payable 80,000.00

2. Paid the shipping company (FOB shipping point, collect) P2,000.

Periodic System Perpetual System
Freight-in 2,000.00 Mdse. Invty 2,000.00
Cash 2,000.00 Cash 2,000.00

3. Returned defective Merchandise with price of 13,440.

Periodic System Perpetual System

Accounts payable 12,000.00 Accounts payable 12,000.00

Purch Ret. & Allow 12,000.00 Mdse. Invty 12,000.000

Sale Price is 13,440 (may tax na ito)

Cost of Goods Purchased is 13,440/1.12 = 12,000

4. Paid Merchandise purchased in No. 1 less discount.

Periodic System Perpetual System

Accounts payable 76,160.00 Accounts payable 76,160.00

Purch Discounts 1,360.00 Mdse. Invty 1,360.00
Cash 74,800 Cash 74,800.00

5. Sold merchandise costing P20,000 for P26,880, terms: 2/10, n/30.

Periodic System Perpetual System

Accounts receivable 24,000.00 Accounts receivable 24,000.00

Sales 24,000.00 Sales 24,000.00
No entry to record the cost of Cost of Goods Sold 20,000
goods sold at the time of sale Mdse. Invty 20,000

Note: Under the periodic system, an adjusting entry at the end of the accounting period is made to
record the costs of goods sold after a physical count of unsold merchandise.

6. Merchandise costing P2,000 and sold at P2,688 is returned by the customer.

Periodic System Perpetual System

Sales R/A 2,400.00 Sales R/A 2,400.00

Accounts Receivable 2,400 Accounts Receivable 2,400.00
No entry to record the cost of goods returned Mdse. Invty 2,000
(by customers) at the time of sale Cost of Goods Sold 2,000

Reference/ Source: Beticon, J., Hinayon, M., and Ireneo, S. (2017). Fundamentals of Accounting.
Manila: FCA Publishing.