CS Basic Financial Accounting & Reporting Merchandising Operations Learning Objectives: after studying this chapter, you should be able to: 1. Describe merchandising activities and ne Identify the income components for a merchandising entity. 2. Distinguish between income statements of service and merchandising ‘entities. 3. Illustrate the operating cycle of a merchandising entity. 4, Be familiar with the different source documents being used by merchandising entities. 5. Compare cash discounts and trade discounts. 6. Summarize the treatment of transportation costs considering the freight terms FOB Destination, FOB Shipping Point, Freight Prepaid and Freight Collect. 7. Explain the inventory systems of merchandising entities. 8, Analyze and record transactions for merchandise sales under a periodic inventory system. : 9, Analyze and record transactions for merchandise purchases under a periodic inventory system. 10. Prepare the entries showing the effects of value-added tax on * merchandising transactions. 11. Compare and contrast the entries needed for the periodic and perpetual , inventory system. Britney Spears—The Queen of Teen! Show business is easy for Spears who is just 18 Years old (when this excerpt was written in 2000). At the age of 9, she was winning talent shows. At 10, she started off-Broadway. At 11, it was the Mickey Mouse Club. At 15, she got a record contract. Last year, prepackaged by her handlers as the girl next door, she sold 11 million copies of her debut album in the U.S., more than any other individual artist. Her 1999 earnings: US$15 million.ollade 308 | asic Fanci! Accounting ond Report PIAS light, bouncy music ears Abo, Credit some of her success to good timing. SPe3 and when there are met teenagers ata time when li ce the babyboomers ye"* ‘teenagers in the U.S.—31 * ‘teens. Credit the rest to drive and perseverance * eee ae buco ome th ar pu. Man steers heb SPN ot ag ext crave creer, Spec two cree 2 2 cornng uc aeoiny te ounwor fr of albums—people Het ans make the fat ask easier. is are aid bres of BUNS PERO deg make up the largest percentage of musi consumers BSTC TT yc are avid buyers of everything, even Britney dol romoter, uarant from them this yar. Keds aso love concerts. So her concert OTT Savane by at least US5200,000 a show for a hundred-show tou. And adverstl OVE Anyone kg love. ‘Spears has deals worth US$6 milion with Cail Mi campaign. ers are negotiating of US$2.2 or more. An album is for release and her managers are negotiating wi for an Increase. Source: The Queen of Teen, by Peter Kafka of Forbes Magazine, March 2000. Mat oye en ed a products and they are usually successful in doing so: That is why they Bet endorsemene deals left and right. The previous chapters illustr ted sccount jictipes! of These products will be sold either wholesale or retail in the same form that they were convert faw materials into finished products through the utilization discussed, COMPARISON OF INCOME STATEMENTS Service et statement is al erform services for a fee. In ascertaining profit, a basic income that is needed. In Figure 7-1, profit is measured as the differer between revenues from services and expenses. In contrast, merchandising entities e by buying and Gatement. TO provide 2 bet ipereransng business is presente wth agar Service Income Statement said ‘Merchandising Operations |_309 v2sure of performance, the income statement of 2 Fewe7-1 Compcrents of come Statements or Serdce and Merchanding Emties ina merchandising business, net sales cost of goods sold represents the co: The difference between net sales and cost of sales is cal rating. Income is" added ang a operating. expenses, administrative expenses and other ope: enees\an at Oe discontinued For the Vear Ended Dec. 31, 2018 arise from the sale of goods while cost of sales or st of inventory the entity has sold to customers. gross profit. Then, other (like distribution costs, ing expenses) are deducted from gross profit, fevenues, other gains and losses, and finance "ed to arrive at profit before tax then income fit from continuing operations. Finally, profit from ‘operations (net of tax) is taken to account to get profit for the period. 2,393,250 3,313,600 71,079,650 Expenses 536,040 fit 433.610 Exhibit7-1 Parts ofan income Statement fora Merchandl 7455210 Entity310_|_ Basic Financial accounting and Reporting by Prof. WIN Ballade a OPERATING CYCLE OF A MERCHANDISING BUSINESS | ity purchases inventory, sells the inventory and uses the cash to ory—and the cycle continues. For cash sales, the cycle is from | back to cash. For sales on account, the cycle is from cash to} S receivable and back to cash. In any industry, the manager strive, | to shorten the cycle. The faster the sale of inventory and the collection of cash, the i | [ higher the profits, The following illustrates the operating cycle of a merchandiser: —, Collections Cane 3 2 G & oo \ 2 $ Accounts} é 8 Receivable Inventory} Miia el? Cash Sales Sales on Account Figure 7-2 Operating Cycle of a Merchandiser SOURCE DOCUMENTS some of these source documents are to be found on the succeeding pages, 1. Sales invoice is prepared by the seller of goods and sent to the buyer. This document? contains the name and address of the buyer, the date of sale and information—quantity,! description and price—about the goods sold. It also specifies the amount of sales, and the transportation and payment terms. 2. The bill of lading is a document issued by the carrier—a trucking, shipping or airline—that specifies contractual conditions and terms of delivery such as freight terms, time, place, and, the person named to receive the goods. _ 3. The statement of account is a formal notice to the debtor detailing the accounts alreatl, due. 4. The official receipt evidences the receipt of cash by the seller or the authorized representative. It notes the invoices paid and other detalls of payment.Deposit slips are printed , & bethe depout “A, validated asset Genesis Name, account number and space for details detalls were actually deposited oy credited tothe want eae eae = nt holder. Acheck is a written order & rom his checking seereeenesletal 2 depositor to pay the amount specified in the check the payor while the receiver isthe gan arma the check The entity issuing the check i |. The purchase requisition i i Zz cera fp ‘ ae sa written request to the purchaser of an entity from an partment of the same entity that goods be purchased. 8, The purchase order is an authorizati ti merchandise as detalled inthe fees” ade bY the buyer to the seller to deliver the 9, Receiving report is a document containin, i information i It formally records the quantities and dex ion about goods received from a vendor. cription of the goods delivered. 1 0) A credit memorandum is a fort ™m used by the sell it i \— being decreased due to errors y ler to notify the buyer that his account is or other factors requiring adjustments. STEPS IN A PURCHASE TRANSACTION Whenever a purchase or sale of merchandise occurs, the buyer and the seller should agree on the price of the merchandise, the payment terms and the party to shoulder the transportation costs. Owners of small merchandising firms may settle these terms informally by phone or by discussion with the vendor's representative. Most large businesses, however, follow certain procedures when purchasing merchandise. The procedures are as follows: 1. When certain items are needed, the user department fills in a purchase requisition form and sends it to the purchasing department. 2. The purchasing department then’ prepares a purchase order after checking with the price lists, quotations, or catalogs of approved vendors. The purchase order, addressed to the selected vendor, indicates the quantity, description, and price of the merchandise ordered. \talso indicates expected payment terms and transportation arrangements. 3. After receiving the purchase order, the seller forwards an invoice to the purchaser upon shipment of the merchandise. The invoice—called a sales invoice by the seller and a purchase invoice by the buyer—defines the terms of the transaction. erchandise, the purchaser's receiving department sees to der are complied with, and prepares a receiving report. 4. Upon receiving the shipment of m« it that the terms in the purchase or: payment, the accounts payable department compares 5. Before approving the invoice for : rtmer purchase order, receiving report and invoice to ensure copies of the purchase requisition, | that quantities, descriptions, and prices agree. siti hase order, invoice, ‘and receiving All of ve forms—purchase requisition, purchase « . : miata ales documents. When the goods are received or when title has passed, the entity should record purchases and a liability (or a cash disbursement). Generally,312 | Basic Financial Accounting and Reporting by Prof. WIN Ballada the seller recognizes the sales transaction in the records when the goods have bee, shipped. ——_—" TERMS OF TRANSACTIONS é Merchandise may be purchased and sold either on credit terms or for cash on delivery, When goods are sold on account, a period of time called the credit period is allowed for payment. The length of the credit period varies across industries and may even vary within an entity, depending on the product. When goods are sold on credit, both parties should have an understanding as to the amount and time of payment. These terms are usually printed on the sales invoice ang constitute part of the sales agreement. If the credit period is 30 days, then payment is expected within 30 days from the invoice date. The credit period is usually described as the net credit period or net terms. The credit period of 30 days is noted as “n/30”. if the invoice is due ten days after the end of the month, it may be marked "n/10 eom." Cash Discounts Some businesses give discounts for prompt payment called cash discounts. If a trade discount is also offered, cash discount is computed on the net amount after the trade discount. This practice improves the seller's cash position by ‘reducing the amount of money in accounts receivable. Cash discount is designated by such notation as “2/10” which means the buyer may avail of a two percent discount if the invoice is paid within ten days from the invoice date. The period covered by the discount, in this case—ten days, is called the discount pe! Cash discounts are called purchase discounts from the buyer's viewpoint and sales discounts from the seller's point of view. It is usually worthwhile for the buyer to take a discount if offered although it may be necessary to borrow the money to make the payment. Mlustration. Assume that an invoice for P150,000 with terms 2/10, n/30, is to be paid within the discount period with money borrowed for the remaining 20 days of the credit period. If an annual interest rate of 18 percent is assumed, the net savings to the buyer is P1,530 which is determined as follows: Cash Discount of 2% on P150,000 P 3,000 Interest for 20 days at an annual rate of 18% on the amount due within the discount period: P147,000* x 18% x 20/360 1,470 Savings-Effected by Borrowing P 1,530 ‘*Amount Due = P150,000 Invoice Price - P3,000 Cash DiscountsMerchandising Operations | 313 G. Detoya Traders Davao City VAT REG. TIN 143-408-777-000 Sales Invoice Received the above articles in good condition. ‘Customer's Signature G. Detoya Traders Davao City VAT REG. TIN 143-408-777-000 Purchase Order “Vendor Date Address Tel. No. — Quantity Total Approved by: Authorized SignatureG. Detoya Traders Davao City VAT REG. TIN 143-408-777-000 _ No. 0513 Statement of Account Date Acct. No. Due Date Cet Address Tel,Nos. Invoice No. Total Amount Dué [ > G. Detoya Traders = Davao City Payment for: VAT REG. TIN 143-408-777-000 Invoice No. No. 0920 Offi = Date Details of Payment: Received fom Fe ‘Cash : the sum of. e ) Credit Card in full/partial payment of. . ‘Authorized SignatureDon Guillermo Torres Development Bank Peso Deposit Slip O Savings Account O Current Account Date 2ToTo[7[s[2]17 ‘Account Number olsTs ‘Account Name G. Detoya Traders Teller’s Validation [Cash Depost——— No. of Pikces Denomination ‘Amount P1,000 500) 100 50. Total Check Deposit: Name of Bank/Branch ‘Chock No ‘Amount “Total Total Deposit “Account Name ' Check No. a G. Detoya Traders H0-051370 0542-0078-27 2 Pay to the Order of $$ Pesos Development Bank Don Guillermo Torres Your Partner in Progress Matina Branch Davao City : i ‘Authorized Signature316 | Basic Financial Accounting and Reporting by Prof. WIN Ballada Trade Discounts Suppliers furnish smaller wholesalers or retailers with price lists and catalogs Showing suggested retail prices for their products. These firms, however, also include a sche, due of trade discounts from the listed prices to enable the customer to determine 4, invoice price to be paid. Trade discounts encourage the buyers to purchase progy¢, because of markdowns from the list price. Trade discounts should not be confused wig, cash discounts. This type of discount enables the suppliers to vary prices Periodicay, without the inconvenience of revising price lists and catalogs. There is no trade discount account and there is no special accounting entry for this discount. Instead, all accounting entries are based on the invoice price which i, obtained by subtracting the trade discount from the list price. Mlustration. Pinnacle Technologies quoted a list price of P2,500 for each 64 gigabyte flash drive, less a trade discount of 20%. If Video Fantastic ordered seven units, the invoice price would be as follows: List Price (P2,500 x 7) P.17,S00 Less: 20% Trade Discount pace 3,500 Invoice Price P 14,000 Trade discounts may be stated in a series. Assume instead that the trade discount given by Pinnacle to Video Fantastic is 20% and 10%, the invoice price will be: List price (P2,500 x 7) . P 17,500 Less: 20% trade discount 3,500 Balance P 14,000 Less: 10% trade discount 1,400 Invoice Price In the first example, both the buyer and the seller would record only the P14,00 invoice price while in the second example, the invoice price will be P12,600. Transportation Costs When merchandise is shipped by a common carrier—a trucking entity or an airline—the carrier prepares a freight bill in accordance with the instructions of the party making the shipping arrangements. The freight bill designates which party shoulders the costs, and whether the shipment is freight prepaid or freight collect. Freight bills usually show whether the shipping terms are FOB shipping point of F0® destination. F.0.B. is an abbreviation for "free on board". When the freight terms® FOB shipping point, the buyer shoulders the shipping costs; ownership over the 60% Passes from seller to the buyer when the inventory leaves the seller's placeMerchandising Operations | 317 pusiness—the shipping point. The buyer already 01 ii and therefore, shoulders the transeorenie sala wns the goods while still in transit y the seller bears the shipping costs. Title . lh Passes only when the goods are received by the buyer at the point of destination; while in transit, the seller is still the owner of the goods so the seller shoulders the transportation costs. In freight prepai sold; while in freigt either party will no’ fhe seller pays the transportation costs before shipping the goods it collect, the freight entity collects from the buyer. Payment by t dictate who should ultimately shoulder the costs. Normally, the party bearing the freight cost pays the carrier. Thus, shipped freight collect when the terms are FOB shipping point; and fr the terms are FOB destination. goods are typically eight prepaid when Sometimes, as a matter of convenience, the firm not bearing the freight cost pays the carrier. When this situation occurs, the seller and buyer simply adjust the amount of the payment for the merchandise. Figure 7-3 shows which party—the buyer or the seller— shoulders the transportation costs and pays the shipper for various freight terms: Freight Terms Who Shoulders the ‘Who Pays the Transportation Shipper? Costs? FOB Destination, Freight Prepaid Seller Seller . FOB Shipping Point, Freight Collect Buyer Buyer FOB Destination, Freight Collect Seller - Buyer FOB Shipping Point, Freight Prepaid Buyer Seller Figure 7-3 Treatment of Transportation Costs The shipping costs borne by the buyer using the periodic inventory system are debited to transportation in account. In accounting, the cost of an asset—the merchandise inventory—includes all costs (e.g. shipping costs) incurred to bring the asset to its intended use. In the cost of sales section of the income statement, the balance in this accourit is added to purchases in computing for the net cost of purchases for the period. Shipping costs borne by the seller are debited to transportation out account. This account which is also called delivery expense, is an operating expense in the income statement.INVENTORY SYSTEMS i termining cost of sales. Baca, M ise I key factor in det Use lerchandise inventory is the key feetevailable for sale, there must be a method merchandise inventory represents gO determining both the quantity and the cost of these goods. bias ee systems available to merchandising entities to record events related fo PCY se Invert the perpetual inventory system and the periodic inventory system. Refer to the appendix of this chapter for the comparative illustrations. Perpetual Inventory System The perpetual inventory system is an alternative to the periodic inventory system, Under the perpetual inventory system, the inventory account Is continuously updated, Perpetually updating the inventory account requires that at the time of purchase, merchandise acquisitions be recorded as debits to the inventory account. At the time of sale, the cost of sales is determined and recorded by a debit to the cost of sales account and a credit to the inventory account. With a perpetual inventory system, both the inventory and cost of sales accounts receive entries throughout the accounting period. Many merchandising entities are now using the perpetual inventory system with point- of-sale equipment. Computers have decreased in prices. These powerful machines have dramatically reduced the time required to manage inventory. Supermarkets and department stores use point-of-sale scanners built into checkout counters to collect transactional data for the cash register and to update their perpetual inventory system. In the absence of point-of-sale scanners, the perpetual inventory system is more advisable for firms that sell low-volume, high-priced goods such as motor vehicles, jewelry and furniture. When an entity uses the perpetual inventory system, the ending inventory should reconcile with the actual physical count at the end of the period assuming that no theft, spoilage, or error has occurred. Even if there is a little chance for or suspicion of inventory discrepancy, most entities make a physical count. At that time, the account is adjusted for any inaccuracies discovered. The count provides an independent check on the amount of inventory that should be reported at the end of the period. Periodic Inventory System . The periodic inventory system is primarily used by businesses that sell relatively inexpensive goods and that are not yet using computerized scanning systems to analyze goods sold. A characteristic of the periodic inventory system is that no entries are mad to the inventory account as the merchandise is bought and sold, When goods a purchased, a separate set of accounts—purchases, purchases discounts, purchase returns and allowances, and transportation in—is used to accumulate information 0” the net cost of the purchases. Only at the end of the period, when the inventory 6 counted, will entries be made to the inventory account to establish its proper balan? The periodic inventory system will be used in the succeeding discussions. To illust'®the major parts of the merchani g.Detoya Traders will be used ising income statement, selected unless otherwise stated, a les is the first “ Part of the merchandising income statement as presented below: Gloria Detoya Traders Partial Income Statement For the Year Ended Dec. 31, 2018 Net Sales Gross Sales P 2,463,500 Less: Sales Returns and Allowances P 27,500 7 Sales Discounts, 42.750 70,250 Net Sales P 2,393,250 Exhibit 7-2 Partial income Statement—Net Sales Gross Sales Under accrual accounting, revenues from the sale of merchandise are considered to be earned in the accounting period in which the title of goods passes—usually at the point of delivery—from the seller to the buyer. Gross sales consist of total sales for cash and on credit during an accounting period. Although cash for the sale is uncollected, the revenue is recognized as earned at the time of the sale. For this reason, there is likely to be a difference between net sales and cash collected from those sales in a given period. As an income account, the sales account is credited whenever sales on account or cash sales are made. Only sales of merchandise held for resale are recorded in the sales account. If a merchandising firm sold one of its delivery trucks, the credit would be made to the delivery equipment account, not to sales account, The journal entry to record the sale of merchandise for cash is as foliows: —Tsept.16 | cash [25,000 Sales | 25,000 To record sale of merchandise for cash. Ee Ifthe sale of merchandise is made on credit, the entry will be: i 25,000 | able 7 Sept. 16 Accounts Receive t = ales To record sale of merchandise on credit Tby Prof. WIN Ballada Sales Discounts ‘Assume that G. Detoya Traders sold merchandise on Sept. 20 for P3,000; terms 2/19, n/60. At the time of sale, the entry is: ~ i 10. Sept. 20 | Accounts Receivable 3,00 Sales To record sales on credit; terms 2/10, n/60. 3,000, IL The customer may take advantage of the sales discount any time on or before Sept. 30, which is 10 days after the date of the invoice. If the client paid on Sept. 30, the entry is; Sept. 30 | Cash 2,940 Sales Discounts 60 ‘Accounts Receivable |__ 3,000 To record collection on the Sept. 20 : 1 sale, discounts taken. At the end of the accounting period, the sales discounts account has accumulated all the sales discounts for the period. The account is considered a contra-income account and deducted from gross sales in the income statement (see Exhibit 7-2). Sales Returns and Allowances Buyers may be dissatisfied with the merchandise received either because the goods are damaged or defective, of inferior quality or not in accordance with their specifications. In such cases, the buyer may return the goods to the seller for credit if the sale was made on account or for cash refund if the sale was for cash. Alternatively, the seller may just grant an allowance or deduction from the selling price. A high sales returns and allowances figure is not commendable because it may signal poor quality of goods and thus may result to dissatisfied customers. Each return or allowance is recorded as a debit to an account called sales returns and allowances. An example of such transaction follows: Sept. 17 | Sales Returns and Allowances 760 Accounts Receivable (or Cash) 760 To record return or allowance on unsatisfactory merchandise. | The seller usually issues the customer a credit memorandum (i.e. Accounts Receivable or Cash is credited), which is a formal acknowledgment that the seller has reduced the amount owed by the customer. Sales returns and allowances is a contra-income account and is accordingly deducted from gross sales in the income statement (see Exhibit 7-2).Merchandising Operations | 321 ransportation Out tr case No. 1. Assume that G. Deto) destination, freight prepaid; terms p1,900. The entry to record this tra va Traders sold mi 2/10, n/30. The t insaction would be: erchandise totaling P17,000 FOB ransportation costs amounted to Nov. 25 | Accounts Receivable Transportation Out -E ano Sales tt Sales on account; terms 2/10, n/30; FOB destination, freight prepaid, P1,900, 1 If this invoice is collected on Dec. 5, the sales discount will ‘i : be P340 (P17,000 x 2%). Transportation out is an operating expense, Dec. 5 | Cash Sales Discounts Accounts Receivable 16,660 340 17,000 Case No. 2. Assume that G. Detoya Traders sold merchandise totaling P17,000 FOB shipping point, freight collect; terms 2/10, n/30. The transportation costs amounted to P1,900. The entry to record this transaction would be: + Nov. 25 | Accounts Receivable 17,000 | Sales 17,000 ‘Sold merchandise on account; terms 2/10, n/30; FOB shipping point, freight collect. There is no debit to transportation out account since the shipping term provided that the buyer should shoulder the transportation costs. ‘if this invoice is collected on Dec. 5, the sales discount will be P340 (P17,000 x 2%). The entry would be: = Dec. 5 | Cash 16,660 Sales Discounts 340 Accounts Receivable 17,000 Case No. 3. Now, assume that G. Detoya Traders sold merchandise totaling P17,000 FOB destination, freight collect; terms 2/10, n/30. The transportation costs amounted to P1,900. The entry to record this transaction would be: Nov. 25 | Accounts Receivable 35,100 tation Out x aes 77068 ‘Sales on account; terms 2/10, n/30; FOB destination, freight collect, Pa,900.1g by Prof. WIN Ballada 322 | Basic Financial Accounting and Reportin. Accounts receivable is decreased by the transportation charges paid by the buyer fo, the benefit of the seller, If this invoice is collected on Dec. 5, the sales discount wil je 340 (P17,000 x 2%) since the discount applies to total sales. [14,760 Dec. 5 | Cash 760 Sales Discounts ‘Accounts Receivable 15,100 Case No. 4. Assume further that G. Detoya Traders sold merchandise totaling P17,00) FOB shipping point, freight prepaid; terms 2/10, n/30. The transportation costs amounted to P1,900. The entry to record this transaction would be: a i Nov. 25 | Accounts Receivable 18,900 Sales 17,000 Cash 1,900 ‘Sales on account; terms 2/10, n/30; FOB iL shipping point, freight prepaid, P1,900. If this invoice is collected on Dec: 5, the sales discount will be P340 (P17,000 x 2%). The discount only applies to total sales. [__Dec. 5 | Cash. 18,560, Sales Discounts : 340 ‘Accounts Receivable 18,900 COST OF SALES Cost of sales or cost of goods sold is the largest single expense of the merchandising business. It is the cost of inventory that the entity has sold to customers. Every merchandising business has goods available for sale to customers. The goods available for sale during the year is the sum of two factors—merchandise inventory at the beginning of the year and net cost of purchases during the period. If an entity is able to sell all the goods available for sale during a given accounting period, the cost of sales would then equal goods that had been available for sale. |n most cases, however, the business will have goods still unsold at the end of the year. To find the actual cost of sales, the merchandise inventory at the end of the period is subtracted from the goods available for sale. Exhibit 7-3 showed goods costing P1,796,600 as available for sale—G. Detoya started with P528,000 in beginning merchandise inventory and net cost of purchases (or cost of goods purchased) of P1,268,600 during the year. At the end of the year, P483,000 of goods were left unsold; this amount should appear as the merchandise inventory in the balance sheet. When this ending merchandise inventory is subtracted from good available for sale, the resulting cost of salesis P1,313,600. :Merchandising Operations | 323 Gloria Detoya Traders Partial Income Statement For the Year Ended Dec. 31, 2018 Cost of Sales Merchandise Inventory, 1/1/2018 P 528,000 Purchases P 1,264,000 Less: Purchases Returns and Allowances 56,400 ; Purchases Discounts 21,360 77,760 Net Purchases 86,2407 Transportation In 82,360 Net Cost of Purchases 1,268,600 Goods Available for Sale P 1,796,600 Less: Merchandise Inventory, 12/31/2018 483,000 Cost of Sales Pp 300. Exhibit 7-3. Partial Indome Statement—Cost of sales ny CC. r ; Net Cost of Beginning Inventory ‘y, Purchases , ‘ ue — ais Goods Ay able for Sale “os rae ‘ i. Cost of gf Goods Sold, Figure 1 Goods Available for Sale ds ial di st of sales section. In summary, goot igure 7~ ictorial diagram of the co: He fae uring ‘a period come from beginning inventory i iter af tT tee ods are either sold during the period or remain iad te Bes the arid ie ee ‘available for sale will eventually turn to expense for the p le period. Goods wentory. cost of sales or to asset—as merchandise in ry:324 | Bosic Financial Accounting and Repo! ing by Prof. WIN Ballada of sales, it is necessary to examine the detai, To understand fully the concept of cost st of purchases. affecting merchandise inventory and net co: Merchandise Inventory The inventory of a merchandising entity consists of goods purchased for resale. Fo, , grocery store, inventory would be made up of meats, vegetables, canned goods, ang other items. For a lumber and hardware, would be plywood, nails, paints, iron sheets cement, tools, and other items. Merchandising entities purchase their inventories fron, manufacturers, wholesalers and other suppliers. at the beginning of the accounting period is called the the merchandise inventory at the end of the ventory. As presented in Exhibit 7-3, beginning ing cost of sales in the income statement, tement will be the merchandise inventory the ending inventory of the curren The merchandise inventory beginning inventory. Conversely, accounting period is called the ending in and ending inventories are used in calculati The ending inventory shown in the income stat to be reported in the balance sheet. Effectively, period will be the beginning inventory of the next period. Net Cost of Purchases tiodic inventory method, net cost of purchases consist of gross purchases Under the pe! allowances equals net purchases, minus purchases discounts and purchases returns and plus transportation costs. Purchases When the periodic inventory method is used, all purchases of merchandise are debited to the purchases account as shown below: Nov. 12 | Purchases 15,000 Accounts Payable 15,000 To record purchases of merchandise; terms 2/10, n/30. The purchases account, a temporary account, is used only for merchandise purchased for Fesale. Its sole purpose is to accumulate the total cost of merchandise purchased during an accounting period. Purchases of other assets such as equipment should be recorded in the appropriate asset accounts. Recording merchandise purchases 2 invoice price is known as the gross price method of recording purchases. Purchases Returns and Allowances Sales returns and allowances in the seller’s books are recorded as purchases returns and allowances in the books of the buyer. This should be recorded as follows:Merchandising Operations | 325 Nov. 14 | Accounts Payable Purchases Returns and Allowances | Return of damaged merchandise = purchased on Nov. 12, chases returns an ‘< sahases Wie Rone 's 2 contra account and is accordingly deducted from ent = i account be used to record pure (see Exhibit 7-3). It is important that a separate § hases returns an needs the information for decision making ind allowances because management be ve : : i It oe es be return merchandise. There are costs that cannot be recovered suc mn ead = 'S, accounting costs, transportation costs, and interest on the money in the goods. There may also be lost sales resulting from poor ordering or ee Goods. Frequent returns may call for new purchasing procedures or suppliers. : Purchases Discounts Merchandise purchases are usually made on credit and commonly involve purchases discounts for early payment. In relation to the Nov. 12 and 14 transactions, the payment is recorded as follows: Nov. 22 | Accounts Payable 13,000 Purchases Discounts (P13,000 x 2%) 260 Cash : I 12,740 like purchases returns and allowances, purchases discounts is a contra account that is deducted from purchases on the income statement. If the entity makes a partial payment on an invoice, most creditors will allow the entity to take the discount applicable to the partial payment. The discount does not apply to transportation or other charges that might appear on the invoice. Transportation In Case No. 1, Assume that G. Detoya Traders made purchases totaling P17,000 FOB destination, freight prepaid; terms 2/10, n/30.. Transportation costs amounted to P1,900. The entry would be: Nov. 25 | Purchases [_]__ 17,000 a ‘Accounts Payable ( Purchased merchandise on account; terms 2/10, n/30; FOB destination, freight prepaid. in account since the shipping term provided that the & i rtation i There 18 no debit to transee! in addition, the seller prepaid the seller should shoulder the transportation costs.freight. If this invoice is paid on Dec. 2%). The entry would be: 5, the purchases discount wil 17,000 Dec. 5 | Accounts Payable ia] = _| Purchases Discounts a =| Cash 16,660 Case No. 2. Assume that G. Detoya ma: point, freight collect; terms 2/10, n/30. TI The entry to record this transaction would de purchases totaling P17,000 FOB shippi, he transportation costs amounted to P1 99, be: Nov. 25 | Purchases 17,000 | Transportation In 1,900 ‘Accounts Payable + 17,000 Cash 1,900 Purchases on account; terms 2/10, n/30; FOB shipping point, freight collect, P1,900. I ” if this invoice is paid on Dec. 5, the purchases discount will be P340 (P17,000 x 2%), Transportation in will form part of the net cost of purchases. Dec. 5 | Accounts Payable 17,000 Purchases Discounts 340 Cash 16,660 Case No. 3. Now, assume that G. Detoya Traders made purchases totaling P17,000 FOB destination, freight collect; terms 2/10, n/30. The transportation costs amounted to P1,900. The entry to record this transaction would be: | Nov. 25 | Purchases 17,000 ‘Accounts Payable 15,100 Cash 1,900 Purchases on account; terms 2/10, n/30; FOB destination, freight collect, P1,900. d Accounts payable is decreased by the transportation charges paid by the buyer for the benefit of the seller. If this invoice is paid on Dec. 5, the purchases discount will be P340 (P17,000 x 2%) because the discount applies to total purchases, Dec. 5 | Accounts Payable 15,100 Purchases Discounts 340 Cash 14,760 Case No. 4. Assume further that G. Detor FOB shipping point, freight prepaid; terms 2/10, 1/30. amounted to P1,900. The entry to record tl ya Traders made purchases totaling P17,000 n The transportation costs his transaction would be:Purchases Transportation in 17,000 Accounts Payable 1,900 Purchased merchandl 28,500, ndise on account; - 2/10, n/30; freight prepaid, Pi 30, “ms I | : invoice is paid : hes le ack eee a i Bika discount will be P340 (P17,000 x 2%). The ich fe transportation costs. Discounts apply only ta Dec. 5 | Accounts Payable Purchases Discounts 18.200) 0 Cash = 18,560 Itwill be useful to contrast these ‘Trang; er ied * 7 portation In’ y - entries discussed earlier, entries to the Transportation Out’ VALUE-ADDED TAX ENTRIES The foregoing entries for sales and purchases did not incorporate the effect of value- added taxes on the transactions to simplify the illustrations. But the learning will not be complete without the following illustration. Knowledge gained from this section will prove useful in accomplishing the supplement to this text, Kashato Shirts: A Practice Set for Basic Accounting. Illustration. Remedios Palaganas Feeds based in Pangasinan trades specialty feeds for race horses, fighting cocks, aquarium fish, zoo animals and other animals generally considered as pets. On May 13, 2018, Remedios Palaganas Feeds purchased on account specialty feeds with a total amount payable of P784,000. A wholesaler operating in the region bought for cash all of the available feeds on May 25, 2018; amount of cash received was P1,120,000. Remedios Palaganas Feeds paid the value-added tax due by month end not minding the actual deadline. The entries related to value-added tax are as follows: ay : i 700,000 | May 13 | Purchases 00.000 [input Tax x ‘Accounts Payable 784,000 ae 1,120,000 May25 | cast 1,000,000 +f — Ses ae a t 0iN Ballada i wi 328 | Basic Financial Accounting and Reporting by Prof 120,000 L May 31 | Output Tax 84,000 Input Tax 36,000 VAT Payable 36,000 May 31 | VAT Payable ~ 36,000 Cash In Bank Input tax increased the amount to be paid but has no effect on the cost of the purchases. Output tax also increased the amount collected but not necessarily, the sales figure. The value of goods or properties sold and subsequently returned or for which allowances were granted by a VAT-registered person may be deducted from the gross sales or receipts for the quarter in which the refund is. made or a credit memorandum is issued. Sales discounts granted or indicated in the invoice at the time of sale may be excluded from the gross sales within the same quarter it was given. Mlustration. Assume that the wholesaler purchased the feeds from Dela Cruz on account and that a 2% sales discount is available if the account is settled within 10 days from invoice date. Dela Cruz was able to collect the account on May 30. The related entry follows: May 30 | Cash 1,097,600 | Output Tax 2,400 Sales Discounts 20,000 ‘Accounts Receivable L {L_1,120,000 Remedios Palaganas, because of the sales discounts granted, will pay value-added ta due of P33,600 only. Extensive discussion of Value-Added Tax is in another text, Transfer and Business Taxation Made Easy by the same authors. OPERATING EXPENSES Operating expenses make up the third major part of the income statement for a merchandising entity. These are expenses, other than the cost of sales, which are incurred to generate profit from the entity's major line of business—merchandising. It is customary to group operating expenses into useful categories. Distribution costs, administrative expenses and other operating expenses are the categories. Distribution costs or selling expenses are those expenses related directly to the entity's efforts to generate sales. These include sales salaries and commissions, and the related employer payroll expenses; advertising and store displays; traveling expenses; st” supplies used; depreciation of store property and equipment, and afareparestlon out.Merchandising Operations | 329 administrative expenses are those ex pusiness. These include officer. ‘Penses related to the general administration of the 'S al + penses; office supplies used; d nd office salaries, and the related employer payroll foxes; professional services; fein ion of office property and equipment; business expenses. le accounts expense and other general office other operating expenses are those expenses that are operations of the business. These are expenses and losses fi transactions of the enterprise; for example, property and equipment. . Not related to the central rom peripheral or incidental loss on sale of investments or loss on sale of APPENDIX PERIODIC and PERPETUAL INVENTORY SYSTEMS COMPARED This appendix will demonstrate the entries typically used with the periodic inventory system, contrasted to the entries used with the perpetual inventory system, Assume that the beginning inventory for the year is P2S0,000. Assuming the transactions (nos. 1 to 7) were the only transactions for the entire year, the balance in the inventory account at year-end under the periodic inventory system is P250,000 (beginning inventory). The year-end balance in the inventory account under the perpetual inventory system is 231,860. Under the perpetual inventory system, the inventory account is increased by purchases, transportation in, and sales returns and is decreased by the cost of sales, purchases returns and allowances, and purchases discounts. At year-end, the physical inventory is taken, and It revealed that the actual inventory on hand is P231,500. The year-end Journal entries (nos. 8 to 10) are then made to bring the inventory account balance into agreement with the amount of the physical inventory. When posted to the general ledger, both the periodic and perpetual inventory systems result In the same ending Inventory amount, P231,500. Exhibit 7-4 PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM. 1. Sold merchandise on account costing P8,000 for P10,000; terms were 2/10, n/30: 10,000 Accounts Receivable 10,000 nee eee eer 10,000 Sales 10,000 Cost of sales 8,000 Inventory 8,000IN Ballada wit 330 | Basic Financial Accounting and Reporting by Prof. account for PSOO (part of 2. Customer retuned merchandise costing P400 that had been sold on the P10,000 sale): 500 Sales Returns & 500 ee Allowances ai wounts Receivable 00 Accounts Receivable 500 ae 4 : Inventory ad Cost of sales 400 2 (P 3. Received payment from customer for merchandise sold above [cash discount taken: (P10,000 sale. 500 return) x 2% discount = P190]: cash 9,310 cash a0 Sales Discounts 190 Sales Discounts . : Accounts Receivable 9,500 ‘Accounts Receivable $00 4, Purchased on account merchandise for resale for P6,000; terms were 2/10, n/30 (purchases recorded at invoice price): Purchases 6,000 Inventory 6,000 ‘Accounts Payable 6,000 ‘Accounts Payable 6,000 S. Paid P200 freight on the P6,000 purchase; terms were FOB shipping point, freight collect: Transportation In 200 Inventory 200 Cash 200 Cash 200 6. Returned merchandise costing P300 (part of the P6,000 purchase): : Accounts Payable 300 Accounts Payable | 300 | Purchases Returns & 300 Inventory 300 Allowances : 7. Paid for merchandise purchased, refer to no. 4 {cash discount taken: (P6,000 purchase - P30 return) x 2% discount = P114): Accounts Payable "5,700 Accounts Payable “*' — §,700 “purchases Discounts > « e114 Inventory + 8 Cash 5,586 cash sober ne 5,586 8. To transfer the beginning inventory balance to the Income Summa: account »f the closing entries under the periodic inventory system): mM wae Income Summary 250,000 (No entry required) Inventory 250,000, : 9. To record the ending inventory balance (part of the closing system): inventory i entries under the periodi Inventory H 231,500 eee Income Summary 231,500 (No entry required) 410. To adjust the ending perpetual inventory balance for the shrinkage during the year: Shrinkage already effected ~ Co: in the no. 9 entry st Of sales 360 Inventory 360