Accounting for Value Added Tax (VAT)

State imposes a tax on the consumer and requires the business to collect the tax from the buyer. The seller acts
as a collection agent for the state and remits the taxes collected from customers to BIR. In the Philippines a 12% VAT is
imposed on the gross selling price of goods and services by a business enterprise that is registered under the value
added tax system. The Output VAT account is used to record the 12% VAT imposed on the sale of goods and services.
While the 12% VAT that is paid by a VAT registered enterprise is known as Input VAT. The Input VAT account is
deducted from Output VAT in determining the tax liability.

Illustrative Problem:

Jan 1 Seller Company sold merchandise to Buyer Enterprise on account terms 5/10, n/30 for P11,200 inclusive of 12%
VAT.

5 Customer was given a credit of P224 which is inclusive of VAT for the return of defective merchandise.

11 Customer settled his account in full.

Journal Entries:

Seller Company Buyer Enterprise

Jan 1 Accounts Receivable 11,200 Jan 1 Purchases 10,000

Sales 10,000 Input VAT 1,200
Output VAT 1,200 Accounts Payable 11,200
(12,000/1.12 x .12)

5 Sales Return and Allowance 200 5 Accounts Payable 224

Output VAT 24 Input VAT 24
Accounts Receivable 224 Purchase Return and Allowance
(224/1.12 x .12)

11 Cash 10,427 11 Accounts Payable 10,976

Sales Discounts 490 Input VAT 59
Output VAT 59 Purchase Discount 490
Accounts Receivable 10,976 Cash 10,427

Balance of AR (11,200-224) P10,976

Less: Sales Discounts:
Sales P10,000
Sales Return and Allowances 200
Net Sales P 9,800
Discount Rate x 5% (490)
Less: Adjustment to VAT
From Sales Discount (490 x 12%) (59)
Amount collectible from buyer P10,427

Accounting Cycle for Merchandising Business

The accounting cycle discussed in the service business is the same in merchandising business. To be able to
complete the cycle in the merchandising business, two other adjustments will be discussed namely; Bad Debts and
adjustment for Merchandise Inventory.
Bad Debts

Whenever merchandise is sold and services are rendered on credit, there is always the risk that such credit may
not be collected. Uncollectible accounts known as Bad Debts Expense. There are two methods of accounting for
uncollectible accounts.

1. Direct Write-off Method Accounts Receivable is written off or cancelled. This method is used when the account
is determined to be really not collectible. Death, bankruptcy or disappearance of the debtor may consider as
reasons for uncollectibility of an account.
Journal entry: Bad Debts Expense xxxx
Accounts Receivable xxxx

If the account previously written off is later recovered and collected in the same period the entries will be:
Accounts Receivable xxxx
Bad Debts Expense xxxx
(To record reinstatement of AR previously written off)

Cash xxxx
Accounts Receivable xxxx
(To record the collection from customer)

2. Allowance Method the estimated amount of uncollectible accounts is deducted from Accounts Receivable and
charged to Bad Debts Expense. However, the Accounts Receivable account is not credited directly at this time
because the specific account that is uncollectible remains unknown. The Accounts Receivable account is reduced
by a contra asset account called Allowance for Bad Debts. This is deducted to Accounts Receivable in order to
present Account Receivable in the balance sheet at Net Realizable Value.
Journal entry: Bad Debts Expense xxxx
Allowance for Bad Debts xxxx

If the accounts receivable becomes worthless because of death, bankruptcy etc. and management decided to
write off the account from the books, the entry will be:
Allowance for Bad Debts xxxx
Accounts Receivable xxxx

In case the account previously written off is recovered, the entries to record the reinstatement and the collection
will be:
Accounts Receivable xxxx
Allowance for Bad Debts xxxx
(To record reinstatement of AR previously written off)

Cash xxxx
Accounts Receivable xxxx
(To record the collection from customer)

Methods in Estimating Bad Debts

1. Percent of Accounts Receivable Method under this method, bad debts is computed as follows:

Required Allowance (Accounts Receivable x % est. uncollectible) xxxx

Add debit balance or deduct credit balance in Allowance for Bad Debts account xxxx
Bad Debts Expense xxxx
 Ex. The following account balances before adjustments were taken from the general ledger of Dixie Trading:

Accounts Receivable P50,000

Allowance for Bad Debts P 1,000
Sales 204,600
Sales Return and Allowances 2,500
Sales Discounts 2,100

Assume that the estimate for bad debts is 3% of Accounts Receivable. Bad Debts Expense is:

Accounts Receivable P 50,000

Rate x 3%
Required Allowance P 1,500
Less: Credit balance in Allowance for Bad Debts 1,000
Bad Debts Expense P 500

The adjusting entry will be:

Bad Debts Expense 500
Allowance for Bad Debts 500

2. Aging of Accounts Receivable Method an aging schedule is prepared by classifying each receivable by its due
date. The number of days an account is past due is determined from the due date to the date of aging schedule is
prepared.

Ex. Assume that Dixie Trading is preparing an aging schedule as of December 31, 2011. Lets further assume
that Allowance for Bad Debts has a credit balance of P4,000 before any adjustment.

181-
Not yet 31-60 61-90 91-180 Over
Customer Balance 1-30 days 365
due days days days 365
days
Nardo Enterprise P 40,000 P 40,000
Berting Trading 60,000 P 60,000
Lando Store 20,000 P 20,000
Carding Carinderia 50,000 P 50,000
Badong Dress Shop 30,000 P 30,000

TOTAL P 200,000 P 60,000 P 30,000 P 20,000 P 50,000 P 40,000

Age Interval Balance Estimated Uncollectible Accounts

Percent Amount
Not yet due P 60,000 1% P 600
1-30 days past due 30,000 3% 900
31-60 days past due 20,000 5% 1,000
61-90 days past due 50,000 8% 4,000
91-180 days past due 40,000 10% 4,000
181-365 days past due - - -
Over 365 days past due - - -

TOTAL P 200,000 P 10,500

Dixie Trading computations of Bad Debts Expense is as follows:

Required ending balance of Allowance for Bad Debts P 10,500

Less: Credit balance of Allowance for Bad Debts before adjustment 4,000
Bad Debts Expense P 6,500
Journal Entry: Bad Debts Expense 6,500
Allowance for Bad Debts 6,500
 3. Percentage of Sales Method this method estimates Bad Debts Expense by using a percentage of net credit
sales. The percentage used is determined by analyzing the percentage of losses on net sales in past accounting
periods. Any balance in the Allowance for Bad Debts account from prior period is not deducted or added in
determining the amount of Bad Debts.

Ex. The following account balances before adjustments were taken from the general ledger of Dixie Trading:

Accounts Receivable P50,000

Allowance for Bad Debts P 1,000
Sales 204,600
Sales Return and Allowances 2,500
Sales Discounts 2,100

Assume that the estimate for bad debts is 1/2% of Net Sales. Bad Debts Expense is:

Sales P 204,600
Less: Sales Return and Allowances P 2,500
Sales Discounts P 2,100 4,600
Net Sales P 200,000
Rate x %
Bad Debts Expense P 1,000

Journal Entry: Bad Debts Expense 1,000

Allowance for Bad Debts 1,000

Adjustment for Merchandise Inventory

There are two methods of showing the change between beginning and ending merchandise inventory.

1. Adjustment method change between the beginning and ending inventory is shown on the worksheet as an
adjustment that is similar to adjustment made for the Supplies account.

2. Closing entry method change between the beginning and ending inventory is considered as part of the closing
process.

Comprehensive Example (Unadjusted Trial Balance to Post Closing Trial Balance)

The unadjusted trial balance of Mon Store as of December 31, 2011 is presented below:

MON STORE
Unadjusted Trial Balance
December 31,2011

Cash P 93,000
Accounts Receivable 52,500
Merchandise Inventory 160,000
Prepaid Insurance 19,200
Store Supplies 4,300
Store Equipment 100,000
Accumulated Depreciation Store Equipment P 18,000
Accounts Payable 56,300
Mon Bautista, Capital 260,000
Mon Bautista, Drawing 120,000
Sales 602,750
 Sales Returns and Allowances 1,200
Sales Discounts 18,000
Purchases 100,000
Purchase Returns and Allowances 2,380
Purchase Discounts 3,500
Freight-in 3,000
Salaries Expense Selling 164,080
Salaries Expense Office 41,020
Freight-out 1,080
Rent Expense Selling 23,040
Rent Expense Office 5,760
Utilities Expense Selling 29,400
Utilities Expense Office 7,350

Totals P 942,930 P 942,930

Adjustment Data:

a. Insurance expired is P6,400. The fire insurance was taken for the Store Equipment.
b. The Store Equipment was acquired January 1,2009 with no salvage value
c. Accrued Salaries: Selling P1,100, Office P500
d. A physical inventory shows P2,100 of Store Supplies unused as of December 31,2011
e. Merchandise Inventory at December 31, 2011 is P78,000

Mon Store
Worksheet.xlsx
Preparation of worksheet (click the icon to download)

Preparation of Financial Statements:

Mon Store
Income Statement
For the year ended December 31, 2011

Sales P 602,750
Sales Returns and Allowances P 1,200
Sales Discounts 18,000 19,200
Net Sales 583,550
Cost of Goods Sold (see note 1) 179,120
Gross Profit P 404,430
Operating Expenses:
Selling Expenses:
Salaries 165,180
Freight-out 1,080
Rent 23,040
Utilities 29,400
Insurance 6,400
Depreciation 9,000
Store Supplies 2,200 236,300
Administrative Expense:
Salaries 41,520
Rent 5,760
Utilities 7,350 54,630
Net Income P 113,500
 Note 1 Cost of Goods Sold

Merchandise Inventory, 01/01/2011 P 160,000

Add Net Purchases:
Purchases P 100,000
Freight-in 3,000
Purchase Returns and Allowances (2,380)
Purchase Discounts (3,500) 97,120
Cost of Goods Available for Sale P 257,120
Merchandise Inventory, 12/31/2011 (78,000)
Cost of Goods Sold P 179,120

_________________________________________________________________________________________________

Mon Store
Statement of Changes in Owners Equity
For the year ended December 31, 2011

Mon Bautista, Capital. 01/01/2011 P 260,000

Add: Net Income 113,500
Total 373,500
Less: Mon Bautista, Drawing 120,000
Mon Bautista, Capital, 12/31/2011 P 253,500

Mon Store
Balance Sheet
December 31, 2011

ASSETS

Cash P 93,000
Accounts Receivable 52,500
Merchandise Inventory 78,000
Prepaid Insurance 12,800
Store Supplies 2,100
Store Equipment P 100,000
Less: Accumulated Depreciation 27,000 73,000
Total Assets P 311,400

LIABILITIES & OWNERS EQUITY

Accounts Payable P 56,300

Salaries Payable 1,600
Total Liabilities P 57,900
Mon Bautista, Capital 253,500
Total Liabilities & Owners Equity P 311,400

Adjusting Entries Journalized and Posted

When the worksheet is complete, the adjusting entries are journalized and posted to the General Ledger
accounts. The information for adjustments is obtained from the worksheet.

Closing Entries Journalized and Posted

The same procedures are followed in closing of the books of merchandising business as followed in services
business. The main difference is the inclusion of more accounts like merchandise inventory beginning and end,
purchases, sales returns and allowances, etc.
The closing entries for Mon Store are shown below:

Merchandise Inventory 78,000

Sales 602,750
Purchase Returns and Allowances 2,380
Purchase Discounts 3,500
Income Summary 686,630
(To record the ending inventory and to close nominal accounts with credit balances)

Income Summary 573,130

Merchandise Inventory 160,000
Sales Returns and Allowances 1,200
Sales Discounts 18,000
Purchases 100,000
Freight-in 3,000
Salaries Expense Selling 165,180
Salaries Expenses Office 41,520
Freight-out 1,080
Rent Expense Selling 23,040
Rent Expense Office 5,760
Utilities Expense Selling 29,400
Utilities Expense Office 7,350
Insurance Expense 6,400
Depreciation Expense 9,000
Office Supplies Expense 2,200
(To close the beginning inventory and nominal accounts with debit balances)

Income Summary 113,500

Mon Bautista, Capital 113,500
(To close Income Summary account)

Mon Bautista, Capital 120,000

Mon Bautista, Drawing 120,000
(To close the owners drawing account)

Post Closing Trial Balance it will contain only real accounts

Mon Store
Post Closing Trial Balance
December 31, 2011

Cash P 93,000
Accounts Receivable 52,500
Merchandise Inventory 78,000
Prepaid Insurance 12,800
Store Supplies 2,100
Store Equipment 100,000
Accumulated Depreciation Store Equipment P 27,000
Accounts Payable 56,300
Salaries Payable 1,600
Mon Bautista, Capital 253,500
TOTALS P 338,400 P 338,400