BIG PICTURE

Unit Learning Outcome (ULO) Week 10 : At the end of the unit, you are expected to:
i. Describe the terms and accounts peculiar to a merchandising type of business entity.
j. Compute Cash and Trade Discounts

BIG PICTURE IN FOCUS: ULO (I) Explain the terms and accounts peculiar to a merchandising type
of business entity. ULO (J ) Compute cash and trade discounts.

METALANGUAGE
In this section, the most essential terms peculiar for a merchandising concern type of business is
presented in order to have a common understanding as to how these terms are being used. Please refer
to these definitions in case you will encounter difficulty in understanding these terms.
1. Merchandise – refers to the goods that are intended for sale of a trading concern.
2. Sales – is a revenue account used to record income derived from the sale of goods or
merchandise of a merchandising or trading concern.
3. Sales Returns and Allowances(POV seller)/Purchase Returns and Allowances(POV buyer) –
refers to an account used to record merchandise returned by the customer or buyer, or an
adjustment to the price of the goods sold/bought. This is called sales returns and allowances
from the point of view of the seller, purchase returns and allowances from the point from of view
of the buyer.
4. Sales Discount (POV seller)/Purchase Discount(POV buyer) –an account title use to record the
amount deducted from the price of the goods as an incentive for prompt payment. This is also
called in accounting as cash discount. From the point of view of the seller it’s called sales
discount, but from the point of view of the buyer it’s called purchase discount. Normally these
documents is recorded in the “General Journal”.
5. Credit period – refers to the term of sale normally express in number of days. Example if the
credit terms is 2/10, n/30, this means that the credit terms is 30 days.
6. Discount period – refers to the period stated in the credit period where a customer or buyer is
given a discount if the account is collected/paid within the agreed discount period. Example in
the terms 2/10, n/30 means a customer or buyer is given 10 days to pay in order to avail of a 2%
discount, if not a customer has to pay the full amount within 30 days.
7. Purchases – is a temporary account used to record the cost of merchandise bought during the
period if the entity uses the periodic method of accounting for inventory.
8. Trade Discounts – refers to discounts given to customers/buyers to encourage them to buy the
products because of low price due to discounts. There is no special accounting treatment of
trade discounts because this is not being recorded unlike cash discounts.
9. Transportation costs – refers to the cost of transporting goods from the seller to the buyer. If the
buyer shoulders the cost the account title use is “Freight In” or “Transportation In”, if the seller
shoulders the cost the account title use is “Freight Out” or “Transportation Out” or “Delivery
Expense”.
10. FOB Destination – (FOB means “Free on Board”) means the seller is responsible of the shipping
costs and the title of goods passes to the buyer at the point of destination.
11. FOB Shipping point – means the buyer is responsible of the shipping costs and the title of goods
passes to the buyer at the point of shipment which means when the goods are shipped from the
seller’s place of business.
12. Merchandise Inventory – an account title used to record the cost of goods that are not sold at
the end of the accounting period.
13. Cost of Goods Sold/Cost of Sales- represents the cost of inventory the entity has sold to
customers.
14. Gross profit – refers to the difference between net sales and cost of goods sold.
15. Distribution Cost- refers to expenses incurred in the distribution or selling the products such as;
salaries of salesmen, commission of salesmen, freight out, advertising expense, rentals of
marketing department and other related expenses in relation with selling the products.
16. Administrative Cost – refers to all other expenses incurred in carrying out business operations
such as salaries of admin employees, Light and water of administration office and many more
that are not related in the distribution of the products.
17. Sales Invoice – is a source documents prepared by the seller of goods and sent to the buyer to
document the revenue of the entity. Normally this is recorded in the “Sales Journal”.
18. Bill of lading – is a source document issued by the carrier ( trucking, shipping or airline) that
details the agreement and terms of delivery such as freight terms, time place and the person
authorize to receive the goods.
19. Statement of Account (SOA) – is a written notice to the debtor specifying the accounts that are
already due. Another form of source documents.
20. Official Receipt – is a source document that supports the receipt of cash by the seller and
normally recorded in the cash receipts journal.
21. Deposit Slips – these are forms owned by the bank to be filled-up by depositor stipulating the
depositor’s name, account number, date and the details of the deposit. These deposit slips when
validated by bank indicates that cash and checks were actually deposited or credited to the
account of the holder (company). This is also a source document.
22. Check – is a source document issued by a depositor ordering the bank to pay the amount stated
in the check from the depositor’s demand deposit to the person indicated in the check ( called
payee). The entity issuing the check is the payor. A check is a document that supports the cash
voucher as a proof that something is being paid. Normally the check is recorded in the “Cash
Disbursement Journal”.
23. Purchase Requisition – is a source document that supports the purchase order requesting the
purchaser of the entity to purchase the requested goods from an employee user.
24. Purchase order (PO)– is a source document made by the buyer authorizing the seller to deliver
the merchandise as detailed in the form.
25. Receiving Report – is a source document containing information about the goods received from a
vendor. This source document is normally supported with vendor’s invoice and the PO of the
entity who made the purchased. This is recorded in the “Purchase Journal”.
26. Credit Memorandum –this is a source document issued by the seller to inform the buyer of any
adjustment made of the buyer’s account which might be caused by return of goods or price
adjustment. This normally recorded in the “general journal”.
 27. Debit Memorandum- this is a source document issued by the buyer to inform the seller of any
adjustment which might be caused by return of goods or price adjustment. This is normally
recorded in the general journal.

ESSENTIAL KNOWLEDGE
The merchandising entity (or in layman’s term buy and sell) buys goods and the goods are sold in the
same form. So, from cash the entity the buy goods, then sell the goods then back to cash-this cycle
continues during the lifetime of the business. For cash sales, the cycle is from cash to inventory and back
to cash.

Cash

s
Purchase
sales
Cash

Inventory

For sales on account, the cycle is from cash to inventory to accounts receivable and back to cash. The
shorter the cycle the better is the business operations. The faster the sale of merchandise and the
collection of cash, the more profits the entity generates. The term use in accounting to describe
movement of merchandise/inventory is called inventory turn-over.
nsc
Collectio

Cash
s
Purchase

Acct. Rec’ble

Inventory

The graphical presentation shows the operating cycle of a merchandising concern. Cash Sales has shorter
operating cycle compared with sales on account or on credit.

How to compute cash discounts?

When the term of the sale is express in this manner “ 2/10, n/30” this means that the credit period is 30
days. If the customer/buyer will pay the account within 10 days a 2% discount is granted.
Example. On March 1, 2020 L Enterprise sold merchandise to M company for P20,000 terms 2/10,
n/30.

If the customer M will pay within March 10, say March 8, an amount equal to 2% of P20,000 or P400
shall be given as a discount, therefore customer M will only pay P19,600 to the vendor.

This is very clear that cash discounts can only be availed to sales on credit. Cash sales has no cash
discounts because it is already paid in cash. Then what do you call discounts availed on cash sales, it is
trade discount which is discuss in the next topic.

How to compute trade discounts?

A trade discount is granted to encourage customer to buy more and sometimes this is a strategy of the
company to attract more customers. There are company who sells their product thru the use of catalog.
It is very costly to print new catalogs every time they change their selling price, so instead they give
trade discount. In accounting trade discount is not recorded only cash discount.

When the sale of goods has a trade discount, may it be sales in cash or on credit, then you have to
compute the invoice price to determine how much amount of sales to be recorded, and how much shall
the vendor collects from the customer. Any merchandise returned by the customer, if stated at list price
should be converted to invoice price in making the adjustment.

Example 1: On March 10, 2020, ABC company sold merchandise to X company in cash for P100,000,
terms: less 5% COD (Cash on Delivery). The selling price of P100,000 is a list price because it is subject to
trade discount. First to convert list price into invoice price. Compute the invoice price.

Invoice Price = P100,000 less 5% discount or PP95,000 this is the amount to be recorded as sales for ABC
company, and if X company is another trader, the cost of merchandise purchased by X company will also
be P95,000. The P5,000 trade discount is not recorded.

Example 2: On March 11, 2020 ABC Company sold merchandise to Y Company on credit for P120,000,
terms : less 10%; 2/10, n/30. In this case there are two discounts granted to the customer Y. The 10%
trade discount and 2% cash discount. Determine the invoice price.

Invoice price = P120,000 less 10% discount or P108,000, this is the amount to be recorded as sales for
ABC company. If Y company will pay the account on or before March 21, 2020 a cash discount of 2%
based on the invoice price shall be given to the customer therefore, Y company will only pay ABC
company P105,840 (P108,000 – (.02 x P108,000) ), otherwise beyond this date Y shall pay the full
amount of P108,000.

Example 3. On March 15, 2020 ABC sold merchandise to Z company for P 200,000 terms: less 10%; 5%;
2/10, n/45. This is called series of trade discount. How much is the invoice price?

Invoice Price = P200,000 less 10% or P180,000 less 5% then invoice Price is P171,000.
If Z will pay on or before March 25, 2020, then a cash discount of 2% based on the invoice price of
P171,000 is granted therefore the amount of money to collected from Z company is P171,000 less 2%
discount or P167,580.

In other words trade discount can be availed by customers who buy on credit or in cash.

TRANSPORTATION COST
Accounting for transportation cost is very important because in buy and sell business transportation cost
may form part of the cost of merchandise sold or purchased. An accountant cannot just merely record
the transportation cost as delivery expense, or freight out or freight in if the terms of the transaction
does not say so.

Merchandise is shipped either thru trucking, shipping or airline. A freight bill is prepared by a common
carrier in accordance with the instructions of the party making the shipping arrangements. When the
arrangement is FOB destination, the seller owns the goods in transit, thereby it is the responsibility of
the seller to pay the freight charges. When the arrangement is FOD shipping point, the buyer owns the
goods in transit thereby it is the responsibility of the buyer to pay the freight charges.

However, the responsibility is different from who actually pays the freight. If the arrangement is freight
collect, then the freight is paid by the party who received the goods, while if the arrangement is freight
prepaid, then the freight is paid by the party who shipped the goods. So confusion arise when you are
going to combine the responsibility and the party who actually pays the freight. The matrix below
summarizes the relationship of the these arrangements.

Remember that FOB destination and FOB shipping point tells us who is responsible or will shoulder the
freight cost. But as to who actually pays the freight that is answered thru an arrangement whether its
freight prepaid or freight collect. In number 1 and 2, there is no accounting problem because the party
will just record it either a freight out or freight in. Number 3 and 4 is where a little confusion arises. If the
buyer pays the freight that should be shouldered by the seller then an entry seeking reimbursement
from the seller is made, while the seller shall record that reimbursement as “freight out”. On the other
hand, when the seller seek reimbursement from the buyer, then an entry seeking reimbursement from
the buyer is made, while the buyer shall record that reimbursement as “freight in. “ Freight in account
form part or added to the determination of the cost of goods sold, while freight out is an operating
expenses.

INVENTORY SYSTEMS
One distinct characteristic of a trading concern which cannot be found in a service concern is the
presence of cost of sales. In the determination of cost of sales Merchandise Inventory data is needed.
There are two systems of accounting for merchandise inventory, the periodic inventory system and the
perpetual inventory system.

Periodic Inventory System – is used by business that sell high in volume and low-priced items such as
grocery items, apparels, clothing, medicines, and many more. However, businesses of this type who are
using computerized system use perpetual though they sell high in volume and low-priced items. Under
this system, no entries are made to the inventory account as the merchandise is bought and sold.
Instead, a separate set of accounts like purchases, purchase discounts, purchase returns and allowances
and freight in, is used to accumulate information on the net cost of purchases. At the end of the period
a physical count is made to determine the merchandise inventory.

Perpetual Inventory System – is used by businesses that sell low-volume but high-priced goods such as
motor vehicle, jewelry, appliances, computers, furniture and other related goods. However, with the
advent of technology businesses who are using computerized system use perpetual inventory system
even if they sell high volume, low-priced items. Such as supermarkets and department stores using
point-of-sale scanners.
Under this system, the inventory is updated every time there is a sale and purchase of goods. At the time
of sale, the cost is computed and recorded by a debit to cost of sales account and a credit to the
inventory account. Journal entries to recognized the inventory and the cost of sales accounts are made
throughout the accounting period. At the end of the period a physical count of merchandise inventory is
made to reconcile the actual count with what is in the record.

Sales Discount and Sales Returns and Allowance – these are contra income accounts that are deducted
from gross sales to determine the net sales.

Purchase Discounts and Purchase Returns and Allowance – these are contra cost accounts that are
deducted from the gross purchases to determine the net purchases.
SELF-HELP: You can also refer to the sources below to help you further understand the
lesson.

 Textbook: Lopez, Rafael, (2019-2020), Fundamentals of Accounting, MS Lopez Printing &

Publishing; Don Julian Maa Davao City.

 Ballada, Win & Ballada, Susan (2019), Basic Financial Accounting and Reporting. Sampalok
Manila: Domdane Publisher & Made Easy Books.
 Heintz, James A. (2017). College Accounting 22nd Edition. Australia: Cengage Learning
 Philips,Fred (2016). Fundamentals of Accounting. McGraw Hill Education
 Warren, Carl S.(2016). Accounting 26th Edition. Australia: Cengage Learning
 Wild, John J. (2016). Fundamentals Accounting Principles. New York NY: McGraw Hill
Education.
LET’S CHECK
Activity 27. Understanding the terms and concepts is your first step in recording transactions
involving merchandising or trading concern type of business. On the space provided you are
required to write the correct term as described.
1. ______ is an account title used to accumulate the goods that are intended for sales
during the period under the periodic inventory system.
2. Under periodic inventory system, _________ account remain unchanged.
3. Transportation in or freight in is normally ____________ to the cost of goods sold.
4. Net Sales less cost of goods sold equals ________________.
5. __________ is a document prepared by the carrier detailing the terms of delivery.
6. __________ incentive offered to customer/buyer to encourage early payment of goods
bought on credit.
7. The term “2/10, n/30” means that the buyer may deduct 2% from the invoice price if
payment is made within 10 days from the ______________.
8. The term freight prepaid or collect will dictate who ___________ the transportation
cost.
9. Under this transportation arrangement the seller is responsible for the transportation
costs, this is called ______________.
10. When goods in transit are included in the inventory this must be shipped under
_____________ transportation arrangement.
11. This is a document made by the buyer authorizing the seller to deliver the goods as
stated in the form.______________
12. This document is prepared by the seller of goods and sent to the buyer to document
items sold is called ________________.
13. Under this inventory system, both the sales amount and the cost of goods sold amount
are recorded every time the items are sold. This is ___________________.
14. This is a shipping term where the buyer shoulder the shipping costs. _______________.
15. This type of transportation arrangement whereby ownership of goods passes to the
buyer only when the buyer receives the merchandise. _________________.
16. ___________ is the document evidences the receipt of cash by the seller.
17. This a document containing details of the goods received from a vendor is called
_______.
18. These are expenses incurred in relation to the distribution of the product. ________.
19. An account title use to record the revenue of a trading concern. _________.
20. It is a discount that encourages the customer to buy more because of big discounts from
the list price. __________________.
21. Periodic inventory system are commonly used by businesses who sell ___________.
22. Purchase returns and Allowance is deduction of ______________ account.
23. __________ Inventory system that provide an up-to-date amount of inventory on hand.
24. __________ is a transportation costs that is part of the operating expenses.
25. Accounting treatment for an FOB destination, freight collect arrangement is _______.

LET’S ANALYZE

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Activity 28. Getting acquainted with the essential terms in the study of accounting is not
enough, what also matters is you should be able to demonstrate your understanding by
applying the concepts in a real life situation. For every situation cited below, you are going to
explain, the correct approach or method to be used in dealing with the situation.

1. ABC Enterprise is a grocery store that sells high volume but relatively low-priced items. The
entity has a computerized system (point-of-sale scanner) to account efficiently all items sold.
The accountant decided to use the periodic inventory system because the entity sells high
volume and low-priced items, anyway at the end of the period a physical count of goods has
to be made to establish the unsold items (merchandise inventory end). Do you agree with
the accountant? If Yes why, if No support your answer.

2. On April 5, 2020 Company A sell merchandise to Company L for P50,000 under the terms:
2/10, n/30 FOB Shipping point freight prepaid. Company A being the shipper paid the freight
amounting to P2,000. On April 12, Company L paid in full the account amounting to P50,960.
Company A notify Company L that the amount to be paid is not P50,960 but P51,000. Whose
claim do you think is correct A or L? Explain

3. On April 10, 2020, B Trading sold merchandise to EFC Co. Limited for P130,000 under the
terms: less: 5%; 2/10, n/30 FOB destination freight collect. EFC Co. Limited paid the freight of
P5,000. On April 15, EFC Co. Limited returned to B Trading defective merchandise worth
P10,000 (stated at list). EFC Co. Limited paid the account within the discount period
amounting to P106,230. B Trading notify. EFC Co. Limited that the amount that they should
pay is P106,720. Whose claim do you think is correct B or EFC? Explain

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4. On April 18, 2020, C Company purchased merchandise from Z Company amounting to
P80,000 under the terms; 2/15, n/45 FOB Shipping Point freight Prepaid. Z Company paid
freight amounting to P3,000. On April 20, 2020, C Company returned defective goods to Z
Company amounting to P6,000. C Company paid the account within the discount period to
avail of a discount. The accountant of C Company when he computed the cost of
merchandise purchased told the manager that the total cost was P 72,520. On the other side,
the accountant of Z Company reported a net sales of P69,520. In this situation, there might
be one or the 2 companies are wrong. Who do you think is not reporting the correct value C
or Z? Explain.

5. Using the data in no. 4, in case both of them are wrong, what is the correct cost of
merchandise purchased for C Company and the correct net sales for Z Company?. Present
your answer with an explanation why such answer is correct.

IN A NUTSHELL

YOUR TURN
Activity 29. Transactions for a merchandising concern is quite challenging compared with the
service concern. Aside from the terms, that you are going to master, you have to do some
computations because of freight terms, discounts and transportation arrangement that
applicable to a merchandising concern. In this activity, you are going to determine the amount
to be paid or collected as may be the case, applying the freight terms, discounts and
transportation arrangement.
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QUESTION AND ANSWER PORTION:
Using the table provided list down all your concern/questions that require further clarification.
You may raise this question thru LMS or forum. List down the answer on the opposite side of
the questions/concern raised.
Do you have any questions for clarification?
Question/Issues Answers
1.
2.
3.

KEYWORDS INDEX
1. Source Documents 7. Sales
2. Inventory Turn-over 8. Purchases
3. Transportation Arrangements 9. Discount Period
4. Transportation Cost 10. Credit Period
5. Trade discount 11. Merchandise Inventory
6. Cash Discount 12. Inventory System

SCHEDULES
Activity Date of Submission Where to Submit
Let’s Check : Activity 27 TBA LMS
Let’s Analyze: Activity 28 TBA LMS
In a Nutshell: Activity 29 TBA LMS
Q&A TBA Chat or Forum
Virtual Session No. 10 TBA

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