Chapter 8

Processing Transactions for a Merchandiser

MERCHANDISING BUSINESS
A business that is engaged in the buying and selling of goods or merchandise is a
merchandising or trading concern. Merchandise refers to goods purchased for resale in the
same form. Merchandiser derives its income through there sale at a profit of the merchandise
purchased.

Merchandisers are often identified as either wholesalers or retailers. A wholesaler is an

intermediary that buys products from manufacturers or other wholesalers and sells them to
retailers or other wholesalers. On the other hand a retailer is an intermediary which buys
products from manufacturers or wholesalers and sells them to consumers.

The activities of a merchandising business cover the following:

 Purchasing Information as to the kind, quality, quantity, and cost of goods

bought should be maintained for the use of management. Records as to supplies or
merchandise bought are also maintained. Purchases may be made for cash or on
account. Each cash purchase should be supported by a cash register receipt
indicating the items purchased. Each credit purchases should be supported by a
purchase invoice indicating the total purchase price and other relevant information.
The buyer does not prepare a separate purchase invoice. Instead, the copy of the
sales invoice sent by the seller becomes a purchase invoice to the buyer.

 Handling The costs of transporting and sorting of goods bear an important

relation to the prices of goods bought. These should be recorded properly.

 Returning of Goods Purchased Some of the merchandise received may prove

unsatisfactory and must be returned to the vendors, or if not returned, may be
allowed some deductions from the original purchase price. A debit memorandum or
debit memo is a document issued by a buyer to inform a seller that a debit has been
made to the seller’s account.

 Maintaining Adequate Stocks on Hand In order to satisfy orders of customers

at all times, a stock of merchandise must be maintained on hand. This is called
merchandise Inventory or Inventory on Hand.

 Selling Goods purchased are sold at prices above the cost in order to provide
adequate margin of profit. It is therefore imperative that the cost of goods bought
should be known from the accounting records so that desirable selling prices may
be set. Sales may be made on credit or for cash. Cash register tapes provide
evidence of cash sales. A sales invoice provides support for a credit sale.

 Returning of Goods Sold The customers may return some of the merchandise
sold. Deductions from the original selling prices must be allowed for sales returns. If
the goods delivered are defective and no return is made, the customers are granted
reduction on the sales price. The seller normally prepares a credit memorandum or
credit memo that informs a customer that a credit has been made to the customer’s
account receivable for a sales return or allowance.

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Processing Transactions for a Merchandiser

 Inventory System
A business firm selling a product must use an inventory record system to value the
merchandise on hand at the end of an accounting period. Two different inventory systems
may be used to record trading transactions in the accounting records. These systems are
the periodic and perpetual inventory system.

 Periodic (Physical) – In the periodic inventory system, the ending inventory is

determined by a physical count of the merchandise on hand at the end of an
accounting period. The periodic inventory system receives its name because the
balance in the inventory account is known only at the beginning and at the end of
the accounting period. The periodic inventory is the simpler system commonly used
in practice and was the only practical alternative for most businesses with large
number of transactions before the advent of computers.

 Perpetual – In a perpetual inventory system a continual, or perpetual, record of the

inventory activity is maintained. Consequently, any items that are sold or otherwise
physically removed from inventory must be removed from the merchandise
Inventory account, and items that are purchased are added to the merchandise
Inventory account. This may result in significant extra record keeping as compared
to a periodic system. However, a perpetual inventory system does have
advantages, and businesses with a relatively low number of high-value transactions
often find the extra effort to be worthwhile. Computers are also making it practical
for businesses to use perpetual systems than would have been not feasible in the
past.

 Merchandising Accounts
The following are the account titles used in recording purchase and sale of merchandise of
a merchandising business using the periodic inventory system:

 Purchases – This is an account to which the cost of goods bought during the period
is debited.

 Purchase Returns and Allowances – Goods bought and returned to supplier, or

goods bought and received as defective, or not as ordered, when not returned to the
supplier but is subjected to a certain reductions from their acquisition prices. These
deductions and returns of purchased goods are credited to this account. This is a
deduction from the purchases account.

 Purchase Discounts – This account is credited in the books of the buyer whenever
the purchaser avails of the cash discount given by the seller. This is deduction from
purchases account.

 Freight-In (Transportation-In) – If the buyer pays the expenses of transporting the

goods from the place of the seller to his place of business, such expenses are
debited to this account. This is an addition to the purchases account.

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 Sales – An account representing revenue from selling of merchandise. This account

has a normal credit balance.

 Sales Returns and Allowances – This account is debited for all the merchandise
returned by customers. This account is also being used for all goods delivered to
customers but is found to be defective or not as ordered and still the buyer desiring
to retain the goods as is. This is a deduction from sales account.

 Sales Discounts – This account is debited in the book of the seller whenever the
buyer avails of the cash discounts provided by the seller. This is a deduction from
sales account.

 Merchandise Inventory – At the end of every accounting period, a physical count

of the unsold merchandise on hand is taken. The total amount of these goods on
hand is debited to this account.

 Freight-Out – If the seller pays the expenses of transporting the goods from his
place to the place of the buyer, such expenses are debited to the freight-out or
transportation-out account. This is reported as part of operating expenses under the
selling expenses classification.

ILLUSTRATION OF ACCOUNTING FOR MERCHANDISING BUSINESS

 Purchase of Merchandise for Cash
January 5, Generic Drug Store bought merchandise from Vista Pharma Inc., P14,500. The
journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.5 Purchases 14,500 Jan.5 Merchandise Inventory 14,500
Cash 14,500 Cash 14,500

 Purchase Returns and Allowances

January 8, Generic Drug Store returned P1,425 worth of merchandise to Vista Pharma Inc.
This was accepted by Vista Pharma. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.8 Cash 1,425 Jan.8 Cash 1,425
Purchase Returns Merchandise
and Allowances 1,425 Inventory 1,425

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Processing Transactions for a Merchandiser

 Purchase Discount
There are two common types of discounts encountered in purchasing of goods. They are
the cash discount and trade discount.

 Trade discount is dependent on the volume or size of order from the customer,
usually given to promote sales. This is deducted in the list price. Trade discount is
not entered in the accounting records.

 Cash discount is reduction in the selling price, allowed if payment is received within
a special period, usually offered to customers to encourage prompt payment. Cash
discounts are computed on the amount of the bill less returns and allowance, if any.
Cash discount is entered in the accounting records

Examples of amounts due under varying credit terms

The following chart shows the amounts a buyer would pay under various credit terms for
merchandise bought for P4,000 and an authorized return of P500 of goods.

Amount
Credit terms Brief description to be paid

Net 30 days The net amount is due within 30 days of the

invoice date. P3,500

2/10, n/30 If paid within 10 days of the invoice date, the

buyer may deduct 2% from the net amount. 3,430

2/10, n/30 If paid in 30 days of the invoice date, the net

amount is due. 3,500

Net EOM 10 The net amount is due within 10 days after

the end of the month (EOM). In other words,
Credit period
payment for any purchase made in June is 3,500
due by July 10.
Discount period

Cash discount

 Purchase of Merchandise on Credit

January 9, Generic Drug Store purchased merchandise from Abbott Laboratories P7,500,
terms 1/15, n/30, FOB shipping point, freight collect. The journal entry to record the
transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.9 Purchases 7,500 Jan.9 Merchandise Inventory 7,500
Accounts Payable Accounts Payable
- Abbott Labs. 7,500 - Abbott Labs. 7,500

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Processing Transactions for a Merchandiser

January 12, Generic Drug Store returned to Abbott Laboratories P1,000 worth of
merchandise acquired on January 9. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.12 Accounts Payable Jan.12 Accounts Payable
- Abbott Labs. 1,000 - Abbott Labs. 1,000
Purchase Returns Merchandise Inventory 1,000
and Allowances 1,000

January 19, Generic Drug Store paid in full its account to Abbott Laboratories. The journal
entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.19 Accounts Payable Jan.19 Accounts Payable
- Abbott Labs. 6,500 - Abbott Labs. 6,500
Cash 6,435 Cash 6,435
Purchase Discount 65 Merchandise Inventory 65

 Purchase of Merchandise on Credit with Trade and Cash Discount

January 20, Generic Drug Store bought merchandise from Philusa Corporation, P12,000,
terms 5% trade discount, 2/10, n/30. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.20 Purchases 11,400 Jan.20 Merchandise Inventory 11,400
Accounts Payable Accounts Payable
- Philusa Corp. 11,400 - Philusa Corp. 11,400

January 25, Generic Drug Store returned to Philusa Corporation P2,000 worth of
merchandise acquired on January 20. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.25 Accounts Payable Jan.25 Accounts Payable
- Philusa Corp. 2,000 - Philusa Corp. 2,000
Purchase Returns Merchandise Inventory 2,000
and Allowances 2,000

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Processing Transactions for a Merchandiser

January 30, Generic Drug Store paid in full its account to Philusa Corporation. The journal
entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Jan.30 Accounts Payable Jan.30 Accounts Payable
- Philusa Corp. 9,400 - Philusa Corp. 9,400
Purchase Discounts 188 Merchandise Inventory 188
Cash 9,212 Cash 9,212

 Freight-In
Freight-in is the title used in recording the freight or transportation charges on merchandise
bought. Freight terms are expressed as either FOB shipping point or FOB destination. The
letters FOB means free on board.

 FOB shipping point means the buyer pays shipping costs and accepts ownership
of goods when the seller transfer ownership of goods when the seller transfers
goods to carrier. Therefore, if the seller is in Cebu and the buyer is in Manila, the
seller absorbs all transportation expenses up to the port of Cebu only. This also
signifies that title to the goods already passes to the buyer upon the loading of the
goods onto the carrier at Cebu.

 FOB destination means the seller pays shipping costs and buyer accepts
ownership of goods at the buyer’s place of business. If the seller is in Cebu and the
buyer is in Manila, the seller absorbs all transportation expenses of the goods up to
Manila. The title of the goods passes to the buyer only upon the unloading of the
goods from the carrier in Manila.

 Freight prepaid means the seller initially paid for the freight of the merchandise
upon shipment. However, freight collect means the freight company collects the
cost of transportation from the buyer.

February 3, Generic Drug Store paid freight on the merchandise bought from Abbott
Laboratories P1,300. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.3 Freight-In 1,300 Feb.3 Merchandise Inventory 1,300
Cash 1,300 Cash 1,300

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Processing Transactions for a Merchandiser

 Sale of Merchandise for Cash

February 4, Generic Drug Store sold merchandise to Robin Maniego, P9,000. The
merchandise cost P4,500. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.4 Cash 9,000 Feb.4 Cash 9,000
Sales 9,000 Sales 9,000

No entry Cost of Goods Sold 4,500

Merchandise Inventory 4,500

 Sales Returns and Allowances

February 6, Generic Drug Store accepted the return of P1,200 of merchandise sold to
Robin Maniego on February 4, the cost of which was P600. The journal entry to record the
transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.6 Sales Returns and Feb.6 Sales Returns and
Allowances 1,200 Allowances 1,200
Cash 1,200 Cash 1,200

No entry Merchandise Inventory 600

Cost of Goods Sold 600

 Sale of Merchandise on Credit

February 7, Generic Drug Store sold merchandise to Karla Parulan, P24,000, terms 1/10,
n/30, FOB destination, freight prepaid. The merchandise cost P12,000. The journal entry to
record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.7 Accounts Receivable Feb.7 Accounts Receivable
- Karla Parulan 24,000 - Karla Parulan 24,000
Sales 24,000 Sales 24,000

No entry Cost of Goods Sold 12,000

Merchandise Inventory 12,000

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February 9, Generic Drug Store accepted the return of P3,000 of merchandise sold to
Karla Parulan on February 7, the cost of which was P1,500. The journal entry to record the
transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.9 Sales Returns and Feb.9 Sales Returns and
Allowances 3,000 Allowances 3,000
Accounts Receivable Accounts Receivable
- Karla Parulan 3,000 - Karla Parulan 3,000

No entry Merchandise Inventory 1,500

Cost of Goods Sold 1,500

 Sales Discounts
February 17, Generic Drug Store received full payment from Karla Parulan. The journal
entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.17 Cash 20,790 Feb.17 Cash 20,790
Sales Discounts 210 Sales Discounts 210
Accounts Receivable Accounts Receivable
- Karla Parulan 21,000 - Karla Parulan 21,000

 Freight-Out
Freight-out or delivery expense is the title used in recording the freight or transportation
charges on merchandise sold.

February 18, Generic Drug Store paid freight on the shipment of merchandise sold to Karla
Parulan, P1,800. The journal entry to record the transaction would be:

Periodic inventory system Perpetual inventory system

Date Account Titles Debit Credit Date Account Titles Debit Credit
Feb.18 Freight-Out 1,800 Feb.18 Freight-Out 1,800
Cash 1,800 Cash 1,800

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Processing Transactions for a Merchandiser

Exhibit 1 Income Statement for Merchandising Business

Generic Drug Store

Income Statement
Month Ended February 28, _____

Sales……………………………………………………………………………. P 600,000
Less: Sales Returns and Allowances………………………………………. 2,000
Sales Discounts………………………………………………………. 500
Net sales……………………………………………………………………….. 597,500

Cost of Goods Sold

Inventory, February 1…….………..………………….. P 70,000
Purchases…………………………………. P190,000
Less: Purchase Returns and Allowances 800
Purchase Discounts……………… 3,500
Net purchases……………………………. 185,700
Add: Freight-In…………………………. 300
Cost of Goods Purchased………………………………. 186,000
Goods Available for Sale……………………………….. 256,000
Less: Inventory, February 28 .………..……………… 20,000
Cost of Goods Sold……………………………………………..… 236,000
Gross Profit…………………………………………………………………… 361,500

Operating Expenses
Selling Expenses:
Store Salaries Expense……………………. 50,000
Advertising Expense………………………. 10,200
Utilities Expense – Store…………………… 6,000
Freight-Out…………………………………. 1,800
Total Selling Expenses……………………………….. 68,000
Administrative Expenses:
Office Salaries Expense…………………… 30,000
Utilities Expense – Office…………………. 5,000
Insurance Expense……………………….. 4,000
Total Administrative Expenses……………………… 39,000
Total Operating Expenses……………………………………… 107,000
Net Income P 254,500

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Chapter 8
Processing Transactions for a Merchandiser

ILLUSTRATION OF ADJUSTING THE MERCHANDISE INVENTORY ACCOUNT

The type of adjustment required for the inventory account depends on whether a periodic or a
perpetual inventory system is used. When the periodic inventory system is used, physical
inventories must be taken at the end of the period to determine the inventory to be reported on
the balance sheet and the cost of goods sold to be reported on the income statement. When
perpetual inventory system is maintained, the ending inventory and the cost of goods sold
balances appear in the ledger. An adjustment is necessary only to correct the recorded
balances for any spoilage or theft or bookkeeping errors that may have occurred, as determined
by a physical count of the inventory. Refer to Figure 12-1.

GENERAL JOURNAL
Date Account Titles Debit Credit

Method (1)
Feb. 28 Income Summary 70,000
Merchandise Inventory Feb. 1 70,000
~ To close beginning inventory ~

28 Merchandise Inventory Feb. 28 20,000

Income summary 20,000
~ To record ending inventory ~

Method (2)
28 Cost of Goods Sold 236,000
Purchase Returns and Allowances 800
Purchase Discounts 3,500
Purchases 190,000
Freight-In 300
Merchandise Inventory 50,000
~ To adjust inventory, cost of goods sold
and related accounts ~

ILLUSTRATION OF CLOSING ENTRIES FOR MERCHANDISING BUSINESS

Each of the required steps in the accounting cycle applies to a merchandising company. For
merchandising company like service enterprise, all accounts that affect the determination of net
income are closed to income summary. Data for the preparation of closing entries may be
obtained from the adjusted trial balance or from financial statements. Refer to Figure 12-1.

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Processing Transactions for a Merchandiser

GENERAL JOURNAL
Date Account Titles Debit Credit
Method (1)
Feb. 28 Sales 600,000
Purchase Returns and Allowances 800
Purchase Discounts 3,500
Income Summary 604,300
~ To close accounts with credit balances ~

28 Income Summary 299,800

Sales Returns and Allowances 2,000
Sales Discounts 500
Purchases 190,000
Freight-In 300
Store Salaries Expense 50,000
Advertising Expense 10,200
Utilities Expense - Store 6,000
Freight-Out 1,800
Office Salaries Expense 30,000
Utilities Expense - Office 5,000
Insurance Expense 4,000
~ To close accounts with debit balances ~

28 Income Summary 254,500

Brian Aguila, Capital 254,500
~ To transfer net income to capital ~

Method (2)
Feb. 28 Sales 600,000
Income Summary 600,000
~ To close accounts with credit balances ~

28 Income Summary 345,500

Cost of Goods Sold 236,000
Sales Returns and Allowances 2,000
Sales Discounts 500
Store Salaries Expense 50,000
Advertising Expense 10,200
Utilities Expense - Store 6,000
Freight-Out 1,800
Office Salaries Expense 30,000
Utilities Expense - Office 5,000
Insurance Expense 4,000
~ To close accounts with debit balances ~

28 Income Summary 254,500

Brian Aguila, Capital 254,500
~ To transfer net income to capital ~

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