Accounting for a

Merchandising Business
 Merchandising Operations
Merchandising is the business activity of BUYING & SELLING rather than
services. The goods that a merchandiising company sells to its customers are called
INVENTORY or (MERCHANDISE), regardless of the type of the products that the
company sells. Example: Grocery store – wide variety of food products.

Merchandising companies often have large amounts of money invested in

their inventories. In fact, inventory is one of the most costly assets appearing in the
balance sheets of most merchandising companies. Inventory is also relatively liquid
asset – that is usually will be sold within few weeks or months, thereby generating
accounts receivable and cash.

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 Operating Cycle of a Merchandising Company
The operating cycle of a business is different from the accounting cycle. The
series of transactions through which a business generates its revenue and its cash
receipts from customer is called the operating cycle. The operating cycle of a
merchandising company includes the following transactions.
1. Purchase of Merchandise
2. Sale of the Merchandise (often on account)
3. Collection of Accounts Receivable from customers.
As the word “cycle” suggests, this sequence of transactions is repeatedly
consinuously. As this cycle is completed with respect to the sale of specific products,
some of the cash collected from the customer is used to purchase more merchandise,
and new cycle begins.

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 Business Documents
Business documents provide the details of business transactions. Documents
include the following:
1. Invoice is a document, prepared by the seller of merchandise and set to the buyer,
that contains the details of a sale, such as the number of units, unit price, total price
billed, terms of sale, and manner of shipment.
2. Purchase order is a document sent from the purchasing department to a supplier
requesting that merchandise or other items be shipped to the purchaser.
3. Receiving report is a document prepared by the receiving department showing the
descriptions and quantities of items received from a particular shipment.
4. Credit memorandum is a note issued by the seller to the buyer indicating the amount
and the reason for which the customer’s account is to be credited.
5. Debit memorandum is a note issued by the buyer who is returning the merchandise to
the seller indicating the amount he is debiting to the seller’s account.

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 Recording of Sales
In a sales transaction, the seller transfers the legal ownership (title) to goods to
the buyer. The seller usually accompanies the sale by the physical delivery of goods. The
sales are recorded based on a business document called an invoice (usually called the
sales invoice by the seller, and a purchase invoice by the buyer.)

Each time a sale is made: revenue is produced for the company. This revenue
increases a revenue account called SALES. Remember, increase in revenue is credited, so
the Sales account is credited for the amount of the sale.

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 Usually, Sales are for cash or on account. When a sale is for cash, the credit to the
Sales account is accompanied by a debit to Cash. When a sale is on account, the credit to
the Sales account is accompanied by a Debit to Accounts Receivable. For example, a
company records a P5,000 sales for cash as follows:
Cash 5,000
Sales 5,000
To record sale of merchandise for cash

A P5,000 sale on account is recorded as follows:

Accounts Receivable 5,000
Sales 5,000
To record sale of merchandise on account

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 Determining the Gross Selling Price
List price is the original price quoted by the seller to the buyer. Trade discounts
are deductions from the list price by the seller to encourage the buyer to buy more. Gross
invoice price is list price less all trade discounts.
Trade discounts are used to:
1. Reduce the cost of catalog publication. If the business prints list prices in the catalog and
gives separate discount to the sales person whenever price changes, the catalog may be
used for a longer period of time.
2. Grant quantity discounts
3. Allow quotation of different prices to different types of customers, such as retailers and
wholesalers.

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 The seller may show trade discounts on his invoice, but he does not record trade
discounts in his accounting records. He uses it only to calculate the gross selling price. The
purchaser does not record trade discounts on his books also.
To illustrate, assume an invoice contains the following data:
List price, 20 pairs of maong pants at P360 P7,200
Less trade discounts, 25% 1,800
Gross invoice price P5,400
The seller records a sale of P5,400. The purchaser records a purchase of P5,400. In
other words, either the seller or the purchaser does not enter list prices and their discounts
on their books.

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 Sometimes, list price of a product is subject to several trade discounts, called
chain discount. Chain discount exist, for example, when a wholesaler received two trade
discounts because of certain services performed, such as packaging and distributing.
When a business gives more than one discount, it applies each discount to the
declining balance successively. If a product has a list price of P5,000 and is subject to trade
discounts of 20% and 10% the actual price paid by the purchaser would be: P3,600 [P5,000
– (0.2 X P5,000) = P4,000 – (0.1 x P4,000) = P3,600.] We can obtain the same results by
multiplying the list price by the complements of the trade discounts allowed. The
complement of 20% is 80% (100%-20%), and the complement of 10% is 90% (100%-10%).
Thus the gross invoice price is P3,600 (P5,000 x 0.8 x 0.9 = P3,600.)

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 Recording Deductions from Gross Sales
The two common deductions from gross sales are sales discounts and sales
returns and allowances. These deductions are contra accounts to Sales account. Contra
accounts have normal balances that are opposite the balance of the account they reduce.
For example, since the sales account normally has a credit balance, the Sales Discounts
account and sales return and allowances account will be debit balances.
SALES DISCOUNTS
When goods are sold on account, terms of payment must be specified on the
invoice. This term of payment is called credit term. For example, if the stated term of
payment is 30 days after the date of sale, “n/30” is written on the invoice. If the terms read
“n/10/EOM” {EOM means end of the month}, the invoice is due on the 10th day of the
month following the month of sale. Credit terms may vary from industry to industry.

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 Credit terms in some industries include a cash discount to induce the early payment of an
account. A cash discount is a deduction from the gross invoice price that the buyer can take only if he
pays the invoice within a specified period of time. The seller calls a cash discount a sales discounts, and
the buyer calls it a purchase discounts.
Cash discounts are often stated as follows:
⩥ 2/10, n/30- means that the buyer may take a discount of 2% of the gross invoice price of the
merchandise if he pays it within 10 days following the invoice date. The gross invoice price is due
30 days from the invoice date.
⩥ 2/EOM, n/60- means that the buyer may deduct a 2% discount if he pays the invoice price by the
end of the month. The gross invoice amount is due 60 days from the date of the invoice.
⩥ 2/10/EOM, n/60- means that the buyer may deduct a 2% discount if he pays the invoice by the
10th day of the month following the date of sale. The gross invoice amount is due 60 days from the
date of the invoice.

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 Since the cash discount taken by the buyer reduces the amount of cash the seller actually
collects from the sale of goods, the seller must indicate this in the accounting records of the company.
The following illustration shows how to do this.
Assume that on June 12, a business sold merchandise for P2,000 on account; terms 2/10,
n/30. The company received a check on payment of an account on the amount of P1,960, the required
journal entries for the seller are:
June 12 Accounts Receivable 2,000
Sales 2,000
To record sale on account. Terms, 2/10,n/30.

21 Cash 1,960
Sales discounts 40
Accounts Receivable 2,000
To record collection on account, less discount

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 The Sales Discount account is contra revenue to the Sales account. In the
income statement, this account is declined from gross sales. The Sales Discount
account is used (rather than directly reducing the Sales account) so that the owners
can use the Sales Discount figure to evaluate the company’s sales policy. Note that the
sales discount account is not an expense incurred in generating revenue. The purpose
of the account is to reduce the recorded revenue to the amount actually realized from
the sale, which is the net invoice price after the discount.

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 Sales Returns and Allowances
Merchandising companies usually allow a customer to return goods that are
defective and unsatisfactory for variety of reasons, such as wrong color, wrong size,
wrong amounts, or inferior quality. When the seller’s policy is “satisfaction
guaranteed”. Customers are allowed to return simply because the customer does not
like the merchandise. A sales return is merchandise returned by a buyer that is
considered a cancellation of a sale. A sales allowance is granted to a customer if the
customer keeps the merchandise although dissatisfied.

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 A business could, in theory, record both sales returns and allowances as debits
to the Sales account because they cancel part of the recorded selling price. However,
the amount of sales returns and sales allowances is useful information to owners. The
amount of returns and allowances in relation to goods sold can be an indication of the
quality of the goods (high-return percentage, low quality) or of pressure applied by the
sales persons (high-pressure sales, high returns). Thus sales returns and sales
allowances are recorded in a separate Sales Returns and Allowances account. Sales
Returns and Allowances is a contra revenue account to Sales used to record the selling
price of merchandise returned by buyers or reductions in selling prices granted.

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 For example:
1. Assume that a customer returns a P500 of goods sold on account. If the company has
not yet received payment, the required entry is:
Sales Returns and Allowances 500
Accounts Receivable 500
To record a sales returns and allowances from a customer

2. Assume that the seller sells the goods for cash, and gives the customer a refund, the
credit is to Cash rather than Accounts Receivable.

Sales Returns and Allowances 500

Cash 500
To record a sales return from a cash customer.

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 Reporting of Net Sales
The illustration below contains a partial income statement showing how the
seller would report sales, sales discounts, and sales returns and allowances. Many
times, the income statement published in annual report will begin with “Net Sales”
because the details of this computation are not important to financial statement users
outside the company.
MERCHANDISING COMPANY
Income Statement
For the Year Ended December 31,20X1

Revenue from Sales: P xxx

Gross Sales P xxx
Less: Sales Discounts P xxx xxx
Net Sales P xxx

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 Cost of Goods Sold
Cost of Goods Sold is the cost to the seller of the goods sold to customers. For
a merchandising company, the cost of goods sold can be very large. Since all
merchandising companies usually have goods on hand to sell to customers, they have
merchandise inventory. Merchandise inventory (or inventory) is the quantity of goods
on hand and available for sale at any given time.
The seller determines the cost of goods sold by computing the cost (1)
beginning inventory, (2) the net cost of goods purchased, and (3) the ending inventory.

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 The cost of goods sold section of the income statement is presented as
follows:
Cost of Goods Sold:
Merchandise Inventory, January 1 P xxx
Purchases P xxx
Add: Transportation-in xxx
Delivered cost of merchandise purchased P xxx
Less: Purchase discounts P xx
Purchase Returns and Allowances xx xx xxx
Goods available for sale P xxx
Less: Merchandise inventory, December 31 xxx
Cost of Goods Sold P xxx
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 Accounting for Inventories
An accurate merchandise inventory figures is needed to determine the cost of
goods sold. The two basic methods in determining used in determining the amount of
merchandise inventory are the perpetual inventory system, and the periodic inventory
system.
PERPETUAL INVENTORY SYSTEM
Provides accounting records that continuously disclose the amount of
inventory. Companies that sell merchandise with a high individual unit value, such as
automobiles, furniture, appliances usually use perpetual inventory. Retail companies
selling goods such as these items, maintain records of the cost of each unit of purchased
merchandise, and in turn the cost of each unit sold.

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 Companies using perpetual inventory system design and maintain inventory
records to provide close control over the actual goods on hand. These records show
exactly which goods are on hand at any particular point in time. Merchandise inventory
account is debited for the amount of each purchase and credited for each sale so that
the current balance in the inventory account is shown at all times. At the end of the
accounting period, a physical inventory is taken by actually counting the number of units
on hand. This physical count is compared with the records showing the number of units
on hand.

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PERIODIC INVENTORY SYSTEM
The ending inventory is determined by making a physical measurement of the
goods on hand at the end of the period. Merchandising companies that sell merchandise
with low value per unit often find that the extra costs of record keeping under perpetual
system more than outweigh the benefits. These merchandising companies use the
inventory procedure.
Under the periodic system, the company does not use the inventory account to
record each purchase and sale of merchandise as it is under the perpetual inventory
system. Instead, adjustment to the Merchandise Inventory account is made only at the
end of the accounting period to bring it to its proper balance. Also, records that show
the exact number of units that should be on hand are not maintained. Record keeping is
reduced considerably, but so is the control over inventory system.

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 No entries are made to the Merchandise Inventory account during the
accounting period. Thus, there is no up-to-date account balance against which to check
the physical count at the end of the accounting period. Companies using periodic
inventory procedure do not attempt to determine the cost of the goods sold at the time
of each sale. Instead, they determine the cost of all the goods sold at the end of the
period. To do this requires the knowledge of these tree items:
1. Beginning inventory (cost of goods on hand at the beginning of the period)
2. Net cost of purchases during the period
3. Ending inventory (cost of unsold goods on hand at the end of the period)
The main emphasis on this text will be on periodic inventory system since it is
the most widely used method.

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 Purchases of Merchandise
Under the periodic inventory system, a Purchases account is used to record cost of goods
sold or merchandise bought for resale during the current accounting period. The Purchases account
is increased by debits and is listed with the income statement accounts in the chart of accounts.
To illustrate entries affecting the Purchases account, assume that the company made two
purchases of merchandise. The company purchased P3,750 of merchandise cash on May 1, and on
May 10 purchased P4,500 of merchandise on account. The required journal entries are:

May 1 Purchases 3,750

Cash 3,750
To record purchase of merchandise for cash.

10 Purchases 4,500
Accounts Payable 4,500
To record purchase of merchandise on account.
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 Deductions from Purchases
Purchase Discounts and Purchase Returns and Allowances are deducted from
purchases to arrive at net purchases. The buyer records these items in contra accounts to
Purchases.
PURCHASES DISCOUNTS
The buyer often purchases merchandise under credit terms that permit him to
deduct a stated discount if he paid the invoice within a specified period of time. Assume
credit terms for the May 10 purchases are 2/10, n/30. If the merchandise is paid by May 20,
a 2% discount is taken. Thus, only P4,410 is paid for the P4,500 accounts payable. The entry
to record the payment of the invoice on May 20 is:
May 20 Accounts Payable 4,500
Cash 4,410
Purchase Discount 90
To record payment on account w/in the discount period.
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PURCHASES Returns and Allowances
A purchase returns occurs when the buyer returns merchandise to a seller. A
purchase allowance occurs when a buyer receives an allowance (or deduction in the price
of the goods shipped. Both returns and allowances serve to reduce the buyer’s debt to the
seller and to reduce the cost of the goods purchased. The buyer wants to know the amount
of returns and allowances as the first step in controlling the costs incurred in returning
unsatisfactory merchandise or negotiating purchase allowances. For this reason, the buyer
records the purchase returns and allowances in a separate Purchase Returns and
Allowances account. If the company returned P300 of merchandise before paying for the
goods, the following journal entry is made:
May 12 Accounts Payable 300
Purchase Returns and Allowances 300
To record return of defective merchandise to supplier.

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 If the buyer had already paid the account, the debit would be to Cash instead of
Accounts Payable, since he will receive a refund of cash. The buyer’s journal entry for the
return would be:
May 12 Cash 300
Purchase Returns and Allowances 300
To record return of defective merchandise and receipt of cash.

Purchase Returns and Allowances is a contra account to Purchases, and is shown on

the income statement as a deduction from purchases. When both purchase discounts and
purchase returns and allowances are deducted from purchases, the result is net
purchases.

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 Transportation Cost
- an important part of the cost of goods sold. To understand how to account for
transportation cost, the meaning of the following terms is needed:
1. FOB shipping point. The term FOB shipping point means free on board at shipping point.
The buyer incurs all transportation costs after the merchandise is loaded on a railroad
car or truck at the point of shipment. Thus, the buyer is responsible for paying the freight
charges.
2. FOB destination. The term FOB destination means free on board at destination; that is,
the seller ships the goods to their destination without charge to the buyer. Thus, the
seller is responsible for paying the freight charges.
3. Passage of title. Passage of title is a legal term used to indicate transfer of legal
ownership of goods. Title to the goods passes from seller to buyer at the FOB point.
Thus, when the seller ships goods FOB shipping point, title passes to the buyer at
shipping point. When the seller ships goods FOB destination, title passes at destination.

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4. Freight prepaid. When the seller pays the freight at the time of shipment, the term freight
prepaid is used.
5. Freight collect. When the buyer pays the freight bill upon the arrival of the goods, the
term freight collect is used.
To illustrate the use of these terms, assume that a company ships certain goods FOB shipping
point, freight collect. Title passes at shipping point. The buyer is responsible for paying the freight costs
and does so. There is no entry for freight charges on the seller’s books. The entry on the buyer’s books
is:
Transportation-in xxx
Cash xxx
To record payment of freight bill on goods purchased.

The transportation-in account is used to record freight costs incurred in the acquisition of
merchandise. Transportation-in is an adjunct account, which is added to net purchases to arrive at net
cost of purchases. An adjunct account is added to the balance of a related account in the financial
statement.
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 If the seller ships goods FOB destination, freight prepaid, he pays the freight bill and
is responsible for it. There is no separate freight billed to the buyer. The buyer does not
require entry on its books. The seller takes into consideration the freight cost in setting
selling prices. The seller requires the following entry on its books:
Delivery Expense xxx
Cash xxx
To record freight cost on goods sold.

Delivery Expense is a selling price recorded by the seller for freight costs incurred
when terms are FOB destination. The seller shows it on the income statement with other
selling expenses.

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 FOB terms are especially important at the end of an accounting period. Goods that
are in transit at the end of an accounting period belong to either the seller or the buyer
and they must it in ending inventory by one of the parties. Goods shipped FOB
destination belongs to the seller while in transit and should be included in the seller’s
ending inventory. Goods shipped FOB shipping point belongs to the buyer while in transit
and the buyer should record it as a purchase and include it in his ending inventory.
For example, assume that the seller shipped the goods on December 30, 20X1,
which arrived at their destination on January 5, 20X2. If terms are FOB destination, the
seller nor the buyer records the exchange transaction until January 5, 20X2. If terms are
FOB shipping point, the buyer includes the goods in its December 31, 20X1, inventory,
and both parties record the exchange transaction as of December 30, 20X1.

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 Sometimes the seller prepays the freight as a convenience to the buyer
even though the buyer is responsible for buying it. In such cases, the buyer merely
reimburses the seller for the amount of freight paid.
The buyer may only take the purchase discounts on the purchase price of goods.
Therefore, if a buyer owes the seller for freight charges, he cannot take discount on the
freight charges owed, even if he makes payment within the discount period.

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 Merchandise Inventories

As stated earlier, merchandise inventory is the cost of goods on hand available for
sale at any given time. Inventory information is needed to determine the cost of goods sold
in any accounting period. The cost of goods on hand at the start of the period (beginning
inventory), the purchases made during the period, and the cost of goods on hand at the
close of the period (ending inventory) must be determined. Since the ending inventory of
the preceding period is the beginning inventory of the current period, the cost of the
beginning inventory is already known. The purchases are recorded throughout the period.
Therefore, only the cost of the ending inventory at the end of the period is to be
determined.

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 Taking a Physical Inventory
Taking a physical inventory consists of counting physical units of each type of
merchandise on hand. To calculate inventory cost, the number of units of each kind of
merchandise is multiplied by its units cost. Then the total cost of the various kinds of
merchandise is determined to provide the total ending inventory cost.
In taking a physical inventory, care must be exercised to ensure that all goods
owned, regardless of their location, are included in the inventory. Thus, goods shipped to a
potential customer “on approval” are not considered sold. The seller must include them in
his inventory. Similarly, consigned goods are goods delivered to another party who will
attempt to sell the goods for the owner at a commission. Such goods should not be
recorded as sold since the goods remain the property of the owner (consignor) until sold by
the consignee. The owner must include such goods in his inventory.

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 Determining Cost of Goods Sold
When the company knows the beginning and ending inventories and the various
items making up the net cost of purchases, the cost of goods sold can be determined.
To illustrate, assume the following account balances for Heavens Grocery Store as
of January 1, 20X1:
Merchandise inventory, January 1, 20X1 P 47,100
Purchases 291,000
Purchase Discounts 1,200
Purchase returns and allowances 900
Transportation-in 7,800

After taking a physical inventory, the company determines that the merchandise
inventory on December 31, 20X1 is P39,600. The cost of goods sold is calculated as
follows:
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 Cost of Goods Sold:
Merchandise inventory, Jan 1, 20X1 P 47,100
Purchases P 291,000
Less: Purchase discounts P 1,200
Purchase returns and allowances 900 2,100
Net Purchases P288,900
Add: Transportation-in 7,800 296700
Cost of goods available for sale P 343,800
Less: Merchandise inventory, Dec 31, 20X1 39,600
Cost of goods sold P 304,200

As shown above, the ending inventory cost appears in the income statement as a
deduction from the cost of goods available for sale to compute cost of goods sold. The
ending inventory cost (merchandise inventory) is also reported as a current asset in the end-
of-period balance sheet.
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 Lack of Control under Periodic Inventory System
The periodic inventory system is used for its simplicity and relatively low cost,
but it provides little control over inventory. Any items not included in the physical count
of inventory at the end of the period are assumed to have been sold. Thus, even if items
have been stolen, they are assumed to have been sold and their costs are included in
the cost of goods sold.
To illustrate, assume the cost of goods sold available for sale was P150,000, and
ending inventory is P45,000. These figures suggest that the cost of goods sold was
P105,000. Assume that P3,000 of goods were actually shoplifted, the ending inventory
would have been P48,000, and the cost of goods sold only P102,000. Thus, the P105,000
cost of goods sold calculated under the periodic inventory procedure includes both the
cost of merchandise delivered to customers and the cost or merchandise stolen.

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 The WORK SHEET for a Merchandising Company
The illustration of the following page shows a work sheet for a merchandising
company. Except for the merchandise related accounts, the work sheet for a merchandising
company is the same as for a service company. Recall that use of work sheet assists in the
preparation of the adjusting and closing entries. The work sheet also contains all of the
information needed for the preparation of the financial statements.
Note that the amount of the ending inventory must replace the inventory at the
beginning of the period. This is accomplished by two adjusting entries:

Income Summary 47,100

Merchandise Inventory 47,100
To close beginning inventory.

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 Merchandise Inventory 39,600
Income Summary 39,600
To record the ending inventory.

The first entry removes the debit balance from the inventory account and
transfers the beginning inventory to Income Summary. The second entry reinstates the
inventory balance for the ending amount. It is credited to Income Summary because as
shown in the computation of the cost of merchandise sold, the ending inventory is a
deduction from the merchandise available for sale.

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40
 Financial Statement for a Merchandising Company
Once the worksheet is completed, the financial statements are prepared. Next, the
adjusting and closing entries are recorded in the journal and posted to the ledger. This
process clears the accounting records for the next accounting period.
CLASSIFIED INCOME STATEMENT
In preceding chapters, only an unclassified income statement was illustrated. An
unclassified income statement has only two categories of items- revenues and expenses. In
contrast, a classified income statement divides both revenues and expenses into operating
and non-operating items.
The first analysis is referred to as the nature of expense method. Expenses are
aggregated in the income statement according to their nature, (for example, depreciation,
purchases of materials, transportation costs, employee benefits and advertising costs), and
are not reallocated among various functions within the entity.
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 This method may be simple to apply because no allocations of operating expenses
between functional classifications are necessary. An example of classification using the
nature of expense method is as follows:
Revenue XX
Other income XX
Changes in inventory XX
Raw material and consumables used XX
Employee benefits costs XX
Depreciation and amortization expense XX
Other expenses XX
Total expenses XX
Profit XX

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 An increase in the inventory during the period represents a decrease in the cost of
goods sold, hence it is a deduction from the total operating expenses, or it may be
presented immediately following revenue. However, the presentation should not imply that
such amount represents income.
The second form of analysis is the function of expense or “cost of sales” method
and classifies expenses according to their function as part of cost of sales, or, for example,
the cost of distribution (selling) or administrative activities. At a minimum, an entity
discloses its cost of sales under this method separately from other expenses.
This method can provide more relevant information to users than the classification
of expenses by nature, but allocating costs to functions may require arbitrary allocations and
involve considerable judgment. An example of a classification using the function of expense
method is as follows:

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 Revenue XX
Cost of sales XX
Gross profit XX
Other income XX
Distribution (selling) costs XX
Administrative expenses XX
Other expenses XX
Profit XX

Enterprises classifying expenses by function shall disclose additional information on

the nature of expenses, including depreciation and amortization expense and employee
benefit expense.
The choice between the function of expense method and the nature of expense
method depends on historical and industry factors and the nature of the entity. Because
each method of presentation has merit for different types of entities, this Standard requires
management to select the most relevant and reliable presentation.
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 The major headings in a classified income statement include:
1. Operating revenues- generated by the major activities of the business- usually the sale of
a product or services or both.
2. Cost of goods sold- is the major expense in merchandising companies. The cost of goods
sold section of the classified income statement has been discussed earlier. It is a common
to highlight the goods sold in the top part of the income statement. Gross margin or gross
profit is the excess of the net sales over the cost of goods sold.
3. Operating expenses- for a merchandising company are those expenses other than cost of
goods sold incurred in the normal course of business. Operating expenses are usually
classified as distribution or selling expenses, and general or administrative expenses.
Selling expenses are expenses incurred in the selling and marketing efforts.
Examples include salaries and commissions for salespersons, expenses for sales
person’s travel, delivery, advertising, rent and utilities on sales building, sales
supplies used, and depreciation on equipment used in sales
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 Administrative expenses are expenses incurred in the overall management of a
business. Examples include office salaries, rent and utilities on administrative
building, insurance expense, office supplies used, and depreciation on office
equipment.

Certain operating expenses may be related partly to selling function and

partly to the administrative function. For example, a company may incur rent,
taxes, and insurance on a building for both sales and administrative purposes.
Expenses covering both selling and administrative functions are analyzed and
prorated between the two functions in the income statement. For instance, if
P1,000 of the depreciation expense related 60% to selling and 40% to
administrative, P600 is shown as a selling expense and P400 as administrative expense.

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4. Non-Operating revenues- (other revenue) are revenues not related to the sale of
the products or services regularly offered for sale by a business. An example of non-
operating revenue is interest that a business earns on notes receivable. Non-
operating expense (other expenses) are expenses not related to the acquisition and
sale of the products or services regularly offered for sale. An example of a non-
operating expense in interest incurred on money borrowed by the company.

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An example of a classified income statement using nature of expenses method:

48
49
50
 An example of
a classified income
statement using
functions of expenses
method is:

This form of an income

statement is also called a
multiple-step income
statement because of its
numerous sections and
subsections and
intermediate summary
figures.
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 Statement of Changes in Owner’s Equity – the statement of changes in owner’s
equity is a financial statement that summarizes the transactions affecting the owner’s
capital account balance. In the illustration, the statement shows an increase in owner’s
equity resulting from the net income and a decrease in equity resulting from the owner’s
withdrawals.

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 Balance Sheet –
contains the assets,
liabilities, and owner’s
equity items taken from the
work sheet. Note that the
ending inventory is shown as
a current asset. The owner’s
capital account balance
comes from the statement
of changes in owner’s
equity.

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The End!!!

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