Accounting for Merchandising Business

Nature of a Merchandising Business

Merchandising Business- is an entity engaged in the activities of buying and sellingof

products.

The main difference between merchandising and the servicing business is the existence of
physical products sold to the customers. Merchandising sells products to generate revenue while
servicing renders service to generate revenue.

Merchandising is also different from manufacturing business because it does not produce its
own product for sale. It obtains products from manufacturer or supplier, either at the retail level
or the wholesale level.

Others terms used to describe merchandising business are trading enterprise, trading firm, or
buy and sell business.

The revenues activities of a merchandising business involve the buying and selling of
merchandise. Before a merchandising firm can make a sale, it must first purchase merchandise
to sell to its customer. When the merchandise is sold the revenue is reported as Sales and its
costs is recognized as expense called Cost of Goods (Merchandise) Sold which is subtracted
from sales to arrive at Gross Profit before deducting Operating Expense to arrive at Net
Income. A merchandising business normally has merchandise unsold that is called
Merchandise Inventory.

Sales – Cost of Goods Sold = Gross Profit

Gross Profit – Operating Expenses = Net Income

Merchandise – goods,such as books, clothing, groceries, or appliances, bought for resale to

customer.

Merchandise Inventory – items of merchandise the business has in stock or on hand and
available for sale.

Cost of Goods Sold – the cost of goods sold may also be called Cost of Merchandise Sold or
Cost of Sales.
 Two Merchandising Business Inventory Systems

 Periodic Inventory System– a system of accounting for merchandise when inventory is counted
only at the close of an accounting period. The general ledger account Merchandise Inventory
contains only the beginning balance in inventory while inventory purchases for the period are
recorded in a separate Purchases account.
- “Purchases” Account

 Perpetual Inventory System– a system of accounting for merchandise in which a running tool of
inventory quantities and values are maintained in the Merchandise Inventory account. Instead of
recording each purchase in a Purchase account, a debit is made to the Merchandise Inventory
account. When a sale is recorded, the cost is debited to Cost of Goods Sold and Merchandise
Inventory is credited.
- “Merchandise Inventory” Account.

Major Business Activities of a Merchandising Business

The two major activities of a merchandising business are:

A. Purchasing Activities – refers to the buying, procurement or acquisition of finished products

intended for sale. In accordance with the historical cost principle, the cost of the product
acquired includes the purchase price plus all other incidental costs related to the acquisition of
the product.

The common account titles used in the purchasing activities are:

1. Purchases- refers to merchandise acquired for resale. These are the goods a business buys
for the sole purpose of selling them to its customers.
- This represents merchandise purchased from vendors or suppliers for cash or credit

 Under periodic inventory systems, the account title “purchases” is used to describe
the products that have been purchased and intended for sale.
 If the perpetual inventory systemis used, the account title used to describe the
product for sale is “merchandise inventory”.

2. Freight –In – refers to the account title for transportation cost incurred by the buyer in
transferring the merchandise from the seller. It is also known as “transportation – in”
account.

- This represents the transportation costs of merchandise purchased.

 Two Merchandising Business Inventory Systems

The common account titles used in the purchasing activities are:

 Under periodic inventory systems, the account title “freight-In” is used to describe the
transportation cost and added to Purchases.

 If the perpetual inventory systemis used, the account title used to describe the
transportation cost and added to Purchases is “merchandise inventory”.

3. Purchases Returns and Allowances – are reductions in purchases, resulting from

merchandise being returned to the seller or from seller’s reduction in the original purchase
price.

 Under periodic inventory systems, the account title “purchases returns and
allowances” is used to describe the merchandise returned and subtracted to Purchases.

 If the perpetual inventory system is used, the account title used to describe the
merchandise returned and subtracted to Purchases is “merchandise inventory”.

4. Purchase Discounts – is a discount taken by the buyer for early payment of a purchase made
on credit.

A “cash discount” is method usually used by the seller in order to encourage buyers to pay
earlier purchases made on account. It is granted when a buyer pays within the discount period as
indicated in the terms of contract of sales.

 Under periodic inventory systems, the account title “purchases discounts” is used to
describe the cash discounts granted and subtracted to Purchases.

 If the perpetual inventory system is used, the account title used to describe the cash
discounts granted and subtracted to Purchases is “merchandise inventory”.
 Two Merchandising Business Inventory Systems

The two major activities of a merchandising business are:

B. Selling Activities - pertains to the act of transferring the title of ownership over the merchandise
from seller to the buyer for a consideration either in money or any other thing of value.

The common account titles used in the selling activities are:

1. Sales – the sale of merchandise, like the sale of service, is recorded by crediting the
revenue account. In merchandising business, the revenue account is described as
“Sales”. This account constitutes a recovery of the cost of merchandise sold as well
as the profit.
-this represents merchandise sold to customers for cash or credit.

2. Freight – Out – refers to the account title for transportation cost incurred by the seller in
transporting the merchandise to the buyer. It is also known as “transportation-out”,
“transportation expense”, or “delivery expense” account.
- this represents the transportation costs of merchandise sold and shouldered by the
business.

3. Sales Returns and Allowances – are reductions in sales, resulting from merchandise
being returned by the customer or from seller’s reduction in the original sales price. It is a
contra-sales account reported as a deduction from sales on the income statement.

4. Sales Discount – is a discount granted by the seller for early collection of a sale made on
credit. Sales discount encourage customers to make early or prompt payment of their
accounts. It is a contra-sales account reported as a deduction from sales on the income
statement.