Fabm 1 SG 11 Q4 1007

Unit 10: Analyzing Business Transactions: Merchandising Type of Business
Lesson 10.7
Financial Statement Preparation
Contents
Introduction 1
Learning Objectives 2
Quick Look 3
Learn the Basics 4

Review of Perpetual and Periodic Methods 6
Preparation of Financial Statements 9
Formulas for Preparing the Financial Statements 9
Check Your Progress 10
Comprehensive Illustration 13
Purpose of the Gross Profit 16
Keep in Mind 19
Try This 20
Practice Your Skills 21
Challenge Yourself 22
Bibliography 23
Lesson 10.7
Financial Statement Preparation
Introduction
The computation and preparation of the cost of goods sold and gross profit is part of the
summarizing phase of accounting. These two are components of the statement of
operations or the income statement of a merchandising business. In plain terms, you are
supposed to prepare the income statement of a merchandising concern business.
The process is similar to the phases involved in a service-type business. The only difference
is that you must follow a new format for the statement of operations, which will include the
cost of goods sold and the gross profit.
10.7 Financial Statement Preparation 1

Learning Objectives DepEd Competency
Prepares the Statement of Cost of Goods Sold

In this lesson, you should be able to do the
and the Gross Profit. (ABM_FABM11-IVe-j-41)
following:
● Identify differences between the Income
Statements of a service and a
merchandising business.
● Explain the concept of cost of goods sold
and gross profit.
● Prepare the Statement of Goods Sold
and Gross Profit.

Quick Look
Review: Income Statement of a Service Business

Remember this format of the income statement for a service business:
Name of Business
Statement of Operations
For the year ended: December 31, 20xx
Revenues ₱ xxx
Less: Expenses xxx
Net Income ₱ xxx
In this lesson, you will make a major revision to this format in order to determine the net
income of a merchandising business. This format will no longer be applicable because a new
format of computing for the net income is used for merchandising businesses.
Questions to Ponder
1. Why is this format no longer applicable?
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________
2. Where do the amounts of the new format come from?

________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________
3. Are the revenues and expenses data of a service business present in a

merchandising business?
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________

Learn the Basics
You will be using a new format of presenting the net income of a merchandising business.
Here is the complete pro-forma sample (required form) for a business accounted under the
periodic method:
Name of Business
Sales ₱ xxx
Less: Sales discounts ₱ xxx
Sales returns and allowances xxx xxx
Net sales xxx
Less: Cost of goods sold
Inventory, Jan 1 xxx
Add: Net purchases
Purchases ₱ xxx
Less: Purchase discounts xxx
Purchase returns and allowances xxx xxx
Freight-in xxx
Total goods available for sale xxx
Less: Inventory, Dec 31 xxx xxx
Gross Profit xxx
Add: Other income
Rent income xxx
Interest income xxx xxx
Total revenues xxx
Less: Operating expenses:
Utilities Expense xxx
Rent expense xxx
Salaries Expense xxx xxx
Net income ₱ xxx
A Peso sign (₱) should be placed at the first amount of every column and the final amount. A
single rule is applied after a mathematical operation. A double rule is applied below the final
amount.

Here is the complete pro-forma sample for perpetual method:
Name of Business
Sales ₱ xxx
Net sales xxx
Less: Cost of goods sold xxx
Gross Profit xxx
Add: Other income
Rent income xxx
Interest income xxx xxx
Total revenues xxx
Utilities Expense xxx
Rent expense xxx
Salaries Expense xxx xxx
Net income ₱ xxx
These are called multiple-step income statements. In contrast, the “revenues less expenses”
format is known as a single-step income statement. Observe that the first parts contain the
main topics of this lesson: the cost of goods sold and the gross profit and how they are
arrived at.
By simply looking at the pro-forma statement, you can observe that all you have to do is get
the amounts of each relevant item in the pre-closing trial balance and substitute their
balances in the format. The only exception is the ending inventory which is taken from the
post-closing trial balance.
The format for a service business cannot be applied in this case because of disclosure
requirements of Generally Accepted Accounting Principles (GAAP). GAAP requires that
merchandising businesses classify their revenues into two: Sales1 and Other Income2, while
expenses are to be classified into the cost of goods sold and operating expenses.
1
Sales – it is the business’ revenue earned from selling of goods
2
Other Income – this refers to any income account earned from activities other than selling merchandise.

Review of Perpetual and Periodic Methods
You will apply the periodic and perpetual accounting methods for inventories. This topic was
taken up in previous lessons. You need to know these methods to understand how the cost
of goods sold and gross profit are computed.
Remember and differentiate the important points:
1. There is a significant difference when accounting for inventories using these two
methods. The perpetual method uses only one nominal account for inventories: the
cost of goods sold. On the other hand, the periodic method uses many nominal
accounts related to inventory: purchases, purchase discounts, purchase returns and
allowances, and freight-in.
2. The business has to choose one to use for a certain inventory class during a specific
period. These methods cannot be mixed or used simultaneously.
3. When the business uses the periodic method of accounting for inventories, the cost
of goods sold can only be computed when the cost of the ending inventory is
determined through an inventory count. This method is ideal for businesses that
carry a large number of inventory units that have small unit values, like a
supermarket.
4. When the business uses the perpetual inventory method, the cost of goods sold is
recognized upon its sale. Conducting an inventory count is not necessary for record
purposes, and its main purpose is to determine if the count matches the amount per
record. This method is ideal for businesses that carry a small number of inventory
units with large unit values, like a car dealer shop.

Closer Look
Preparing the Journal Entries for Buying and Selling

A car dealer sells a particular type of vehicle. It has one unit of this vehicle on
January 1, costing P700,000. It bought 12 more units at P720,000 each during
the year on account. It was able to sell 8 units for P1,000,000 each on account
during the year, with the oldest units sold first. Prepare the journal entries to
record the buying and selling of inventory:
Periodic method
Purchases ₱ 8,640,000
Accounts payable ₱ 8,640,000
To record inventory acquisition.
Accounts receivable (8 x P1M) 8,000,000

Sales 8,000,000
To record the sale of inventory.
Perpetual method
Merchandise Inventory ₱ 8,640,000
Accounts payable ₱ 8,640,000
To record inventory acquisition.
Accounts receivable (8 x P1M) 8,000,000

Sales 8,000,000
To record the sale of inventory.
Cost of goods sold (P700,000) + (7 x P720,000) 5,740,000

Merchandise Inventory 5,740,000
To recognize the cost of sold inventory.

Check Your Progress

1. A grocery store purchased 2 boxes of canned pineapple for resale to
its customers during the year. Each box contains 50 cans. The first
box was bought for ₱2,000 while the second was bought for ₱2,050.
These were to be sold for ₱60 each. There were no beginning
inventories for these inventories. The business was able to sell 70
cans, 30 coming from the first purchase and 40 coming from the
second purchase.
With this set of information, show how each inventory accounting

method can reveal the actual cost of goods sold?

2. Using your knowledge in preparing journal entries for merchandising

business and applying the new classification of revenues and
expenses, perform the following task.
A merchandising business received the following cash revenues

during the year: ₱500,000 from regular customers, ₱20,000 from
selling scrap materials, and ₱4,000 interest from bank deposits. How
much are the (1) revenues and (2) other income?
Preparation of Financial Statements

Cost of Goods Sold (COGS) is the amount incurred by the business that is directly related to
acquisition of goods. As learned in previous lessons, this will include the buying price, net of
any purchase discount, purchase returns, and purchase allowance of the goods and the
freight incurred from supplier’s place to the place of the business. This could also be referred
to as “cost of sales.”
Operating Expenses (OpEx) are costs incurred in operating the business other than those
directly related to acquisition of goods.
Total Goods Available for Sale (TGAS) is the total cost of goods that are offered for sale to
customers. It includes the cost of unsold inventories purchased from prior accounting
periods.
Formulas for Preparing the Financial Statements

Examine the pro-forma income statement. To calculate the Total Goods Available for Sale
(TGAS), the following formula is used:

TGAS = (Beginning Inventory + Net Purchases + Freight-in)
By looking at the pro-forma income statement under periodic method, the formula to
compute for the Cost of Goods Sold (COGS) is:
COGS = (Beginning Inventory + Net Purchases + Freight-in – Ending Inventory)

or
COGS = (TGAS – Ending Inventory)
As the journal entries reveal, the periodic method is the one that allows the use of this
formula.
Again, by observing the income statements, the formula to compute the gross profit is:
Gross Profit = (Net Sales – Cost of Goods Sold)
It should be noted that you need to present the income statement in good form whenever
financial statements are required. Presenting in good form means following the pro-forma
statements presented earlier.
Check Your Progress
Using your knowledge in preparing journal entries for merchandising

business and the applying the new classification of revenues and expenses,
answer the following questions:
1. A business bought goods amounting to ₱75,000. It also paid a ₱3,000

shipping fee for transport of the bought goods from the warehouse
of the supplier to the store of the business. It was able to sell this to a
customer for ₱100,000 and paid a ₱2,000 shipping fee for transport
of the sold goods from store premises of the business to the house
of the customer. How much would be the cost of goods sold and the
operating expenses?

2. A business has unsold goods at the beginning of the year amounting

to P40,000. Purchases during the year amounted to ₱370,000 while
the ending inventory amounted to ₱30,000. What is the amount of
total goods available for sale during the year?

Closer Look
What to Note During Inventory Counts

You are in charge of conducting an inventory count of the store’s ending
inventory. When you entered the store premises, you saw the different types of
inventories in the display racks and the stockroom. What are the important
things you should record during the physical inventory taking?
The objective of the inventory count is to get the cost of the inventory. So, the
important items to take note of are:
1. The complete description of all types of products to allow tracing of its

cost from the records.
2. The number of units of each type of product.
After obtaining these, the next step to complete the count is to multiply the unit
cost of each product, usually taken in the purchase records, in order to sum
them up. The result then is the total cost of the inventory.

Comprehensive Illustration
Examine the pre-closing trial balance for Sunny Day presented below.
Sunny Day Mini-Grocery

Pre-closing Trial Balance
December 31, 2021
Cash ₱ 180,000 ₱
Accounts Receivable 100,000
Merchandise Inventory, Jan 1 500,000
Supplies 15,000
Equipment 230,000
Furniture and Fixtures 150,000
Prepaid Insurance 6,000
Accounts Payable 16,000
Loan payable 400,000
Ms. Day, Drawings 240,000
Ms. Day, Capital 1,467,000
Sales 900,000
Purchases 1,200,000
Utilities Expense 12,000
Rent expense 30,000
Salaries Expense 120,000 _
₱ 2,783,000 ₱ 2,783,000
You must take note of this additional information: the inventory in the pre-closing trial
balance refers to the inventory count for 2020. The inventory count for 2021 revealed the
ending inventory amounts to ₱800,000.
It is important to remember that the presence of the purchases account indicates that Sunny
Day is using the periodic system of inventory.

Closer Look
Understanding the Income Statement and Income Summary

Account
Review the income statement and income summary account of a service
business and consider the following questions.
1. Can you accurately compute the business’ net income using the revenues
less expenses format?
Answer: No, the inventory account makes the use of this format not
advisable.
2. Can you tell which inventory accounting method was used?

Answer: Yes. It was the periodic method that was used because of the
presence of the purchases account.
3. What principles can you apply from past lessons to compute the net
income?
Answer: The net income can be derived through the balance of the
income summary account.

Below is how the amount of net income will be derived from the journal entries.
Sales ₱1,500,000
Income summary ₱ 1,500,000
To close revenue accounts.
Income summary 1,362,000

Purchases 1,200,000
Rent expense 30,000
Salaries Expense 120,000
To close expense accounts.
Income summary 500,000

Merchandise inventory 500,000
To close the beginning inventory.
Merchandise inventory 800,000

Income summary 800,000
To set up ending inventory.
Total debits to the income summary ₱ 1,862,000

Total credits to the income summary 2,300,000
Income Summary balance, credit ₱ 438,000

Below is how the net income is presented under the new format.
Sunny Day Mini-Grocery

For the year ended: December 31, 2021
Sales ₱ 1,500,000
Less: Cost of Goods sold
Inventory, Jan 1 ₱ 500,000
Add: purchases 1,200,000
TGAS 1,700,000
Less: Inventory, Dec 31 800,000 900,000
Gross Profit 600,000
Rent expense 30,000
Salaries Expense 120,000 162,000
Net income ₱ 438,000
Purpose of the Gross Profit

The gross profit is used to recover operating expenses, then generate income for the owner
when expenses are fully recovered. Using data from Sunny Day, here is a sample of this
concept:
As observed, the gross profit of ₱600,000 was first reduced by the operating expense of
₱162,000. This information will activate the recovery of the cost of operating the business.
The remaining ₱438,000, which is labeled net income, is the amount earned by the owner.
This is usually the maximum amount allowed to be withdrawn without the business
suffering a decrease in invested capital.
Check Your Progress
You have reached the final stage of the accounting process: the preparation
of financial statements. The procedure to construct a statement of Financial
Position is the same as that with a service business, only the Statement of
Operations is different.

Construct the Statement of Operations and Statement of Financial Position

using the following trial balance.
Parable Dry-Goods
Trial Balance
As of December 31, 2021
Debit Credit
Cash ₱ 45,000
Accounts Receivable 150,000
Equipment 200,000
Furniture and fixture 100,000
Accounts payable ₱ 120,000
Max, Capital 325,000
Sales 500,000
Cost of goods sold 300,000
Rent expense 60,000
Salary expense 90,000 _
Totals ₱ 945,000 ₱ 945,000


Keep in Mind
● The income statement format of a merchandising business is different from a

service business.
● The revenue and expense items have to be further classified into two classes each in
order to compute the cost of goods sold and the gross profit.
● There are two ways to record inventory, periodic and perpetual methods. These two
affect how the cost of goods sold is computed.
● The cost of goods sold and gross profit are part of the income statement but could
be presented separately if it satisfies a need of the business.
Inventory, Beginning ₱ xxx

Add: Net purchases
Purchases ₱ xxx
Less: Purchase discounts xxx
Purchase returns and allowances xxx xxx
Freight-in xxx
Total goods available for sale xxx
Less: Inventory, Ending xxx
Cost of Goods Sold xxx
Sales ₱ xxx
Net sales xxx
Less: Cost of goods sold xxx
Gross Profit xxx

Try This
True or False. Write true if the statement is correct. Otherwise, write false.
________________ 1. Sales less cost of sales results in net sales.
________________ 2. Beginning inventory plus purchases results in total goods available

for sale.
________________ 3. Sales less sales discounts result in gross profit.
________________ 4. Delivery costs from the supplier’s warehouse to the business

premises are treated as operating expenses.
________________ 5. Gross profit less operating expense results in net income
________________ 6. The computation of the total cost of goods available for sale in the
current period is affected by the ending inventory of the previous
period.
________________ 7. The computation of the cost of sales in the current period is

affected by the ending inventory of the previous period.
________________ 8. The cost of goods sold is a major expense of a merchandising

business.
________________ 9. Gross profit from sales is the income the business would have
made if it had sold all goods available during the period.
________________ 10. Supplies are the inventory account generally applied to goods
intended for resale held by a trading/merchandising business.

Practice Your Skills
Gracias Enterprises
The following transaction on inventory was revealed by the accounting records of Gracias
Enterprises.
● The ending inventory last year amounts to ₱500,000.
● Purchases for the year totaled ₱1,100,000.
● There was ₱200,000 worth of purchase returns to suppliers due to factory defects.
● ₱20,000 worth of purchase discounts was allowed due to the business making early
payments.
● Total freight-in paid amounts to ₱250,000.
● The actual inventory count revealed that this year's ending inventory amounts to
₱300,000.
Compute the cost of goods sold and the gross profit.

Challenge Yourself
Using the concepts of gross profit and cost of goods sold, examine the following situation,
then analyze and answer the questions.
Your business bought merchandise worth ₱5,000 and established a selling price of ₱8,000
to pay the ₱3,000 monthly rental of your store. A regular customer approaches you and
offers to buy the merchandise for ₱7,000. There is an abundant supply of this inventory in
the market, and it can easily be purchased.
1. If you have the final say on the matter, would you accept or reject the offer? What
would be your reasons for making your decision?
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
2. Aside from the lost income, what are the risks you are taking if you reject this offer?
Name some consequences of rejecting the offer that could have a major impact on
your business?
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
3. Why is abundancy of supply important in this case? How does it affect your
relationship with your customers?
__________________________________________________________________________________________
__________________________________________________________________________________________

__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
Bibliography
Ballada, Win. Basic Financial Accounting and Reporting, Made Easy. Metro Manila: DomDane
Publishers & Made Easy Books, 2021.
Uberita, Conrado. Practical Financial Accounting 1. Manila: GIC Enterprises & Co., Inc., 2013.
Valix, Conrado, et. al. Practical Financial Accounting. Metro Manila: GIC Enterprises & Co.,
Inc., 2021.

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Unit 10: Analyzing Business Transactions: Merchandising Type of Business

Learn the Basics 4

Practice Your Skills 21

10.7 Financial Statement Preparation 1

Learning Objectives DepEd Competency

Prepares the Statement of Cost of Goods Sold

10.7 Financial Statement Preparation 2

Review: Income Statement of a Service Business

2. Where do the amounts of the new format come from?

3. Are the revenues and expenses data of a service business present in a

10.7 Financial Statement Preparation 3

Learn the Basics

10.7 Financial Statement Preparation 4

Here is the complete pro-forma sample for perpetual method:

10.7 Financial Statement Preparation 5

Remember and diﬀerentiate the important points:

10.7 Financial Statement Preparation 6

Preparing the Journal Entries for Buying and Selling

Accounts receivable (8 x P1M) 8,000,000

Accounts receivable (8 x P1M) 8,000,000

Cost of goods sold (P700,000) + (7 x P720,000) 5,740,000

10.7 Financial Statement Preparation 7

Check Your Progress

With this set of information, show how each inventory accounting

10.7 Financial Statement Preparation 8

2. Using your knowledge in preparing journal entries for merchandising

A merchandising business received the following cash revenues

Preparation of Financial Statements

Formulas for Preparing the Financial Statements

10.7 Financial Statement Preparation 9

TGAS = (Beginning Inventory + Net Purchases + Freight-in)

COGS = (Beginning Inventory + Net Purchases + Freight-in – Ending Inventory)

Gross Proﬁt = (Net Sales – Cost of Goods Sold)

Check Your Progress

Using your knowledge in preparing journal entries for merchandising

1. A business bought goods amounting to ₱75,000. It also paid a ₱3,000

10.7 Financial Statement Preparation 10

2. A business has unsold goods at the beginning of the year amounting

10.7 Financial Statement Preparation 11

What to Note During Inventory Counts

1. The complete description of all types of products to allow tracing of its

10.7 Financial Statement Preparation 12

Sunny Day Mini-Grocery

10.7 Financial Statement Preparation 13

Understanding the Income Statement and Income Summary

2. Can you tell which inventory accounting method was used?

10.7 Financial Statement Preparation 14

Income summary 1,362,000

Income summary 500,000

Merchandise inventory 800,000

Total debits to the income summary ₱ 1,862,000

10.7 Financial Statement Preparation 15

Sunny Day Mini-Grocery

Purpose of the Gross Proﬁt

Check Your Progress

10.7 Financial Statement Preparation 16

Construct the Statement of Operations and Statement of Financial Position

10.7 Financial Statement Preparation 17

10.7 Financial Statement Preparation 18