ACCOUNTING FOR MERCHANDISING OPERATIONS

This module covers the accounting cycle for MERCHANDISING OPERATIONS.

INTRODUCTION:
In this module we will focus on a merchandising type of business, its operations, and its accounting cycle, emphasizing
greatly on inventory systems and computations of merchandise inventory end, and cost of goods purchased and sold.

Merchandising, also called TRADING is a form of business operations involving the purchase or buying of goods or
merchandise and selling the same in its original form. It is also called buy and sell business.

ADDITIONAL TERMINOLOGIES AND ACCOUNT TITLES FOR MERCHANDISING

Merchandise (or merchandise inventory) refers to goods that are held for sale to customers in the normal course
of business. This includes goods held for resale.
For example: • Candies, canned goods, noodles sold at a grocery stores • Juice, biscuits sold in a grocery store
• Medicines sold in a pharmacy

A merchandiser’s primary source of revenue is sales revenue or sales.

Expenses for a merchandising company are divided into two categories:

1. Cost of goods sold (COGS) – the total cost of merchandise sold during the period; and
2. Operating expenses (OP) - expenses incurred in the process of earning sales revenue that are deducted from
gross profit in the income statement. Examples are sales salaries and insurance expenses.

Gross profit (GP) is equal to Sales Revenue less the Cost of Goods Sold.

Sales - COGS = Gross Profit - Operating Exp. = Net Income (Loss

The Operating Cycles for a merchandiser:

Merchandising Company operating cycle (cash to cash) involves:

1. buy merchandise inventory
2. .sell inventory
3. obtain Accounts Receivable
4. receive cash

SALES- refer to the revenue of a merchandise earned by selling goods or merchandise inventory.
NET SALES- total revenue generated by a business after deducting the cost of goods sold, taxes, and other
expenses.
SALES DISCOUNT- the amount deducted from Accounts Receivable from customers for paying promptly their accounts. This
is a contra account of Sales.
SALES RETURN AND ALLOWANCES- also a contra account of Sales, pertains to the decrease in Receivable from a
customers for returning merchandise( due to some defects) or for giving allowances to the customers from the amount due to
them.
TRADE DISCOUNT- is defined as a type of discount that is cut off the retail or published price of an item, and is
usually for customers who purchase goods in larger quantities. Some of these customers include wholesalers,
retailers, and industrial users.
COST OF GOODS SOLD-the sum of all direct costs associated with making a product. This is also termed as
Cost of Sales.
FREIGHT OUT- or delivery expense, is the account used to record the cost of transporting the merchandise
from the seller to the buyer.
GROSS PROFIT- is the profit a business makes after subtracting all the costs that are related to manufacturing
and selling its products or services. You can calculate gross profit by deducting the cost of goods sold (COGS)
from your total sales.
PURCHASES- is the account debited for the amount of goods purchased or bought by the merchandiser from
his suppliers for resale to the customers.
PURCHASE RETURNS AND ALLOWANCES- contains deductions from purchases for items returned to
suppliers, as well as deductions allowed by suppliers for goods that are not returned
PURCHASE DISCOUNTS- is an offer from the supplier to the purchaser, to reduce the payment amount if the
payment is made within a certain period of time
FREIGHT IN- is the cost of having goods or materials delivered to a business for manufacture or resale. When
the buyer pays for the cost of freight, the buyer records the cost as freight-in.
DISTRIBUTION COST- or selling expense are expenses incurred by the seller in order to place the
merchandise in the hands of the buyer. This maybe related to promotion, sale or delivery of the merchandise ,
sales salaries and commissions, advertising, store equipment, store supplies used, rent on store space, and all
other expenses incurred in the store
ADMINISTRATIVE EXPENSE- or general expense, are expenses incurred by the seller from day to day
operations of the business .Examples are salaries

The following are the commonly used special journals:

1. Cash Receipts Journal –used to record all cash that had been received
2. Cash Disbursements Journal –used to record all transactions involving cash payments
3. Sales Journal (Sales on Account Journal) –used to record all sales on credit (on account)
4. Purchase Journal (Purchase on Account Journal) –used to record all purchases of inventory on credit (or on
account)

JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING BUSINESS

In step 1, transactions are identified and measured. At this stage, the documents used by the business are
analyzed to see whether these transactions have financial impact or effect. Recall the rule that only financial
transactions are recorded and that the amount can be measured. These two conditions must exist in order for a
particular transaction to be recognized or recorded. As defined, financial transactions are those activities that
change the value of an asset, liability or equity. Step 2 is the Preparation of Journal Entries (Journalization) A
merchandising company may use special and general journals to record its transactions.

INVENTORY SYSTEMS
Maintaining inventory items is a unique set-up in a merchandising business. There are two methods of
accounting for inventory, namely: Perpetual Inventory System and Periodic Inventory System. Merchandising
entities may use either of the following inventory systems:
1. Perpetual System — Detailed records of the cost of each item are maintained, and the cost of each item sold
is determined from records when the sale occurs. For example, a car dealership has separate inventory records
for each vehicle. • Record purchase of Inventory. • Record revenue and record cost of goods sold when the item
is sold. • At the end of the period, no entry is needed except to adjust inventory for losses, etc.
2. Periodic System — Cost of goods sold is determined only at the end of an accounting period. This system
involves:
• Record purchase of Inventory.
• Record revenue only when the item is sold.
• At the end of the period, you must compute cost of goods sold (COGS):
1. Determine the cost of goods on hand at the beginning of the accounting period (Beginning Inventory = BI),
2. Add it to the cost of goods purchased (COGP),
2. Subtract the cost of goods on hand at the end of the accounting period
4. (Ending Inventory = EI) illustrated as follows: BI + COGP = Cost of goods available for sale - EI = COGS

KINDS OF DISCOUNT

TRADE DISCOUNT- is the amount, a manufacturer or a merchandiser, deducted from the listed selling price or
catalog price of a product when it is sold to reseller. It is not recorded in the accounting books of a seller.

Example: Assuming that Mr. Cruz , a reseller , purchase 50 units of electric FAN from the manufacturer listed at
P1,500, less trade discount of 5% and 2% . The amount to pe paid by Mr. Cruz is computed as follow :

List Price (50units x 1500) P 75,000

Less Trade discount (75,000 x 5%) 3,750
Basis for second discount 0f 2% P 71,250
Less second discount(71,250x2%) 1,425
Cash paid by Mr. Cruz P 69,825

Mr. Cruz will record the purchases with the entry:

Purchases P 69,825
Cash P 69,825

CASH DISCOUNT- is the amount deducted from the invoice amount of the seller . This discount is given by the
seller when the buyer pays the invoice amount earlier or in the stipulated terms or date.
When the merchandiser is purchasing merchandise , the cash discount is called purchase discount, while
when he is the seller giving discount, it is termed sales discount.

Example: Assuming on March 1 2017, Mr. Cruz sold two electric fans to ARman Santos for 1,500 each on
account. Terms is 2/10 2/30.

The terms 2/10, n/30 means Arman Santos will be given 2% cash discount if he pays on or before the 10 th day
after purchase. If Santos failed to pay on March 10 (10th day), he has to pay on the 30th day the full amount no
discount . On the part of Mr. Santos, this is sales discount while for Mr. Santos , it is purchase discount.
EOM stands for the end of the month. So, if the payment term is net 30 EOM, it means that the customer has
30 days to pay back, after the end of the month when the invoice was sent.

The entries on the book of of Mr. Cruz are:

March 1 Account Receivable P 3,000

Sales P3,000

March 10 assuming (Mr. Santos paid within the discount period)

Cash P 2,940
Sales discount (3,000 x 2%) 60
Accounts Receivable P 3,000

RECORDING THE BUSINESS TRANSACTIONS OF A MERCHANDISING BUSINESS

1. Purchases of merchandise , either on a cash basis or on account . With this transactions are the granting of
purchase discount or allowance by the supplier and the possible return of merchandise by the buyer or
merchandiser.
2. If the purchase of the merchandise are made on credit , the payment to the suppliers.
3. Selling merchandise to the consumers , either on a cash basis or on account . Relative on this transaction are
the seller/merchandiser’s giving the consumers discount and allowances or receiving the returned goods by the
customers.
4. At the end of the accounting period, an inventory of a merchandise unsold has to be done , usually by a
physical count , to determine the remaining assets to be reported in the balance sheet and the cosy pf good
sold to be reported in the income statement.
JOURNALIZING MERCHANDISING TRANSACTIONS
PERIODIC INVENTORY SYSTEM
Recording purchases and related transactions under the Periodic Inventory System
PURCHASES OF MERCHANDISE:
PERIODIC SYSTEM
1. When merchandise is purchased for resale to customers, the account, Purchases, is debited for the cost of
goods purchased.
2. Like sales, purchases may be made for cash or on account (credit).
3. The purchase is normally recorded by the purchaser when the goods are received from the seller. • Each
credit purchase should be supported by a purchase invoice. • A purchase invoice received by the buyer is
actually a sales invoice or a charge invoice prepared by the supplier or vendor. • Note that only purchases of
merchandise are debited to the ‘Purchase’ account. Acquisition (purchases) of other assets: supplies, equipment,
and similar items are debited to their respective accounts.

TO ILLUSTRATE:
Magaling Computer Store started its operations on January 2, 2016. The store is located in Sikat Mall in Bicol.
The owner invested PHP500,000 to start the business. On January 3, 2016, Magaling purchased 20 units of
computers on account for PHP10,000 each. Upon delivery of the units, the supplier, Delta, Inc., issued Charge
Invoice No. 145 to Magaling.

PURCHASE RETURNS AND ALLOWANCES • A purchaser may find the merchandise received to be unsatisfactory
because the goods are: • damaged or defective • of inferior quality • not in accord with the purchaser’s
specifications

The purchaser initiates the request for a reduction of the balance due through the issuance of a debit
memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the seller’s
account has been debited because of unsatisfactory goods. • A return of the merchandise (a deduction from the
purchase price when unsatisfactory goods are kept) is shown by the entry where Accounts Payable is debited
and Purchase Returns and Allowances is credited to show that the purchases was reduced with a return or an
allowance. • The Purchase Returns and Allowances account is a “contra purchases” account when merchandise
is returned to a supplier.

TO ILLUSTRATE: Out of the 20 computer units purchased last January 3, 2016, it was found after inspection on
the same day that one unit was damaged during shipment. Magaling issued a debit memorandum (DM 01) and
informed the supplier that it will return the one damaged item.

ACCOUNTING FOR FREIGHT COSTS

The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods
to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING
POINT AND FOB DESTINATION.

FOB Shipping Point: •

Goods placed free on board (FOB) the carrier by seller.
• Buyer pays freight costs.
• Freight-In is debited if buyer pays freight.
• Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately.
Accounts Payable would be credited if on account.
• Ownership over the goods is transferred to the buyer once it is out of the premises of the seller.

FOB Destination
• Goods placed free on board (FOB) at buyer’s business.
• Seller pays freight costs.
• Delivery Expense is debited if seller pays freight on outgoing merchandise to a buyer. This is an operating
expense to the seller.
• Ownership over the goods is transferred to the buyer once the goods are delivered and received by the buyer.

TO ILLUSTRATE: Assume the supplier of Magaling is based in Manila. In order to bring the 20 computer units to
Bicol, it will cost PHP3,000 to deliver the goods. If the terms is FOB Shipping Point, the entry to record,
assuming Magaling paid the common carrier in cash on January 4, 2016 is :

If the terms is FOB Destination, no entry is recorded in the books of Magaling. The PHP3,000 will be paid by the
seller, in this case Delta, Inc.

PURCHASE DISCOUNTS:
• Credit terms (specify the amount of cash discount and time period during which a discount is offered) may
permit the buyer to claim a cash discount for the prompt payment of a balance due. If the credit terms show
2/10, n/30 means a 2% discount is given if paid within 10 days (called the discount period); otherwise, the
invoice is due in 30 days. • The buyer calls this discount a purchase discount. • A purchase discount is normally
based on the invoice cost less returns and allowances, if any

. TO ILLUSTRATE The credit terms for the purchase of 20 computer units (total cost PHP200,000) is 2/10, n/30.
This means that if Magaling pays on or before January 13, 2016, it is entitled to a 2% discount, otherwise
Magaling will have to pay the full amount on or before February 4, 2016 (30 days after purchase). On January
10, 2016, Magaling paid the account in full with Delta.
SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER

Revenues are reported when earned in accordance with the revenue recognition principle, and in a
merchandising company, revenues are earned when the goods are transferred from seller to buyer.
• All sales should be supported by a document such as a cash register tape (to provide evidence of cash sales)
or cash receipt, or office receipt for cash sales, and charge invoice for credit sales, or sales on account.
• One entry is made with each sale: Debit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which
increases assets for the sales amount Credit — Sales which increases revenues

• The sales account is credited only for sales of goods held for resale. Sales of assets not held for
resale (such as equipment, buildings, land, etc.) are credited directly to the asset account.

TO ILLUSTRATE : For the month of January, Magaling made the following sale: 1/10/2016 Official Receipt (OR)
No. 001 Sold two units for cash to Marie Cruz for PHP36,000 (PHP18,000 per unit), FOB Destination 1/15/2016
Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500 (PHP19,500 per unit)
with terms 3/10, n/ 30, FOB Shipping Point

FREIGHT TERMS: FOB DESTINATION — SELLER PAYS FREIGHT

An entry is made when seller pays the freight to deliver goods to a customer or buyer. If the buyer will pay for
the freight, no entry is made. • Debit — Delivery Expense and credit — Cash or Accounts Payable

TO ILLUSTRATE: On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two units to Marie
Cruz.
SALES RETURNS AND ALLOWANCES:

Sales Returns result when customers are dissatisfied with merchandise and are allowed to return the goods to
the seller for credit or a refund.
• Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from the selling
price.
• To grant the return or allowance, the seller prepares a credit memorandum to inform the customer that a
credit has been made to the customer’s account receivable.
• Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a
reduction to a particular account.
• A contra account is used, instead of debiting sales, to disclose the amount of sales returns and allowances in
the accounts.
• This information is important to management as excessive returns and allowances suggest inferior
merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in delivery or shipment of
goods.
• The normal balance of Sales Returns and Allowances is a debit. • One entry is made with each sales
return and allowance:

The entry to record the sales return or allowance:

• Debit — Sales Return and Allowances which decreases revenues for the amount of the sale
• Credit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets

TO ILLUSTRATE:
On January 16, 2016, Rafael Reyes returned one unit of the computers purchased last January 15, 2016 under
Charge Invoice 001. The unit returned was in good condition. However, Rafael Reyes returned the unit because
it is one unit more than what they need. The return was approved and accepted by Magaling. The price will be
deducted from the account of Rafael Reyes.

SALES DISCOUNTS
1. A sales discount is the offer of a cash discount to encourage customers to pay the balance at an earlier date.
2. An example of a discount term is commonly expressed as: 2/10, n/30, which means that the customer is
given 2% discount if payment is made within 10 days. After 10 days there is no discount, and the balance is due
in 30 days. 3. Sales Discounts is a contra revenue account with a normal debit balance.

TO ILLUSTRATE: Assume that Magaling purchased on cash, five units of computers at PHP10,000 per unit from
a supplier on January 17, 2016. These units were subsequently sold to Jun Cruz on January 18, 2016 under
Charge Invoice (ChI) No. 002 amounting to PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB
Shipping Point. On January 23, 2016, Cruz paid the said account in full.
Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the 2% discount
because he made the payment within the discount period. Take note that the discount period in this case was
from January 19, 2016 to January 28, 2016 (10 days).

What If Jun Cruz paid the account on January 30, 2016 instead of January 23, 2016? The entry would be:

In a periodic inventory system, separate ledger accounts are maintained for various items composing the cost of
goods sold (Purchases, Purchase Returns & Allowances, Freight-In, Purchase Discounts). At the end of the
accounting period, a physical count of inventory is necessary to establish the ending balance of the inventory.

PRACTICE
COMPLETE ACCOUNTING CYCLE FOR A MERCHANDISING BUSINESS
Agila Merchandising, owned by Lito Agila, sells ready-to-wear shirts and dresses to its customers. It started its
operations on January 1, 2016. The company issues the following documents :
• Official Receipts - for all cash collections
• Charge Sales Invoice – for all sales on account
• Check Voucher – for all cash disbursements

Step 1 & 2 –Understanding and Journalizing the transactions For the month of January 2016, the special
journals of Agila are shown below:
Step 3 – Posting to the General Ledger. From the summary of transactions in the special journals and general
journals, the entries will now be posted in each general ledger account
Step 4 & 5– Prepare the unadjusted trial balance, and preparation of worksheet. The balances in the general
ledger for each account will be extended to the first two money columns of the worksheet.
The unadjusted trial of Agila is:

AGILA MERCHANDISING
Worksheet For the month ending January 30, 2016

Step 6 – Prepare adjusting entries.

Recall in Chapter 11, the five basic sources of adjusting entries:
1. Depreciation expense
2. Deferred expenses or prepaid expenses
3. Deferred income or unearned Income
4. Accrued expenses or accrued liabilities 5. Accrued income or accrued assets

Identify transactions in the books of Agila that will require adjustments:

• Depreciation of transportation equipment purchased on January 2, 2016
Monthly Depreciation = (Cost – Salvage or Residual Value) / 120 months = (150,000-0) / 120 = 1,250

Adjusting entry : Depreciation Expense 1,250 Accum. Deprn- Transpo Eqpt 1,250
Deferred or Prepaid Expenses
In the cash disbursement journal, the rental payment made on January 2, 2016 is for the month of January and
February 2016 amounting to PHP10,000. The entire amount was charged to rental expense which is not proper
because one half (1/2) of the said payment is considered as an advance payment of rental. Thus, an asset
should be recognized. The adjusting entry is:
Prepaid Expenses 5,000
Rental Expense 5,000

• Accrued Expenses On January 30, 2016, fuel expenses incurred amounting to PHP2,180 should be recorded as
an expenses and liability. The entry to adjust is:

Fuel Expenses 2,180

Accrued Expenses 2,180

Step 7 - Preparation of Financial Statements.

The first statement prepared is the income statement. All income statement accounts are extended to the
appropriate column. Using the periodic inventory system, the beginning balance of merchandise inventory
account is also extended to the debit side, while the result of the physical count to determine the ending
inventory is reflected on the credit side. The total debit and total credit are determined and if credit balance is
higher than the debit side, the difference is added to the debit side. The difference is actually the income for the
period. However, if the total debit side exceeds the total credit side, the difference is added to the credit side
and this is the net loss of the business. The statement of financial position is then prepared. All assets, liabilities
and equity accounts are extended. The ending merchandise inventory is extended to the debit side. The
worksheet for these two financial statements are presented below:

The proper format of the income statement and the schedule of cost goods sold of Agila
for January 2016 are presented below:
Step 8 – Closing Entries.
The closing journal entries consist of the following: • All of the nominal revenue accounts should be closed to
the income summary account by a Debit to revenue and credit to income summary. • All of the nominal expense
and cost of goods sold accounts should be closed to the income summary by a Credit to expense and a debit to
income summary.

The Merchandise Inventory, Beginning is closed to Income summary account by a debit to Income Summary
and a credit to Merchandise Inventory.
• The Merchandise Inventory, Ending is set up in the books by a debit to Merchandise Inventory, Ending and a
credit to Income Summary. The amount that will be used is the result of the physical count.
• The balance in the income summary account should now reflect the net income for the accounting period. The
next journal entry should close the income summary account to the equity or capital account. If there is a net
profit this entry will be a debit to income summary and a credit to owner’s capital account.

Once the closing journal entries have been entered into the general journal, the information should be posted to
the general ledger. When this is accomplished, all of the nominal accounts in the general ledger should have
zero balances. To double check on this, we prepare another trial balance based on the new balances in the
general ledger. If we have any nominal accounts with positive balances, a mistake was made along the way and
will need to be corrected before proceeding to the next accounting period. The closing entries of Agila are:
Practice Set 1

Listed below are some of the accounts relating to the income of Leather Plus (owned by Abner Bravo) for the
three month period ended March 31, 2016:

SALES 500,000
SALES RETURN AND ALLOWANCES 15,000
SALES DISCOUNT 7,800
PURCHASES 302,000
PURCHASE RETURN AND ALLOWANCES 4,900
SUPPLIES EXPENSE 1,200
SALARIES EXPENSE 18,000
MERCHANDISE INVENTORY , BEGINNING 170,100
MERCHANDISE INVENTORY ,END 165,000
PURCHASE DISCOUNT 1,800
FREIGHT IN 5,000
RENTAL EXPENSE 5,000
DELIVERY EXPENSE 2,100
UTILITIES EXPENSE 8,000

Instructions:
1. Prepare a schedule of cost of goods sold for the three-month period ended March 31, 2016.
2. Prepare a statement of income for the period ended March 31, 2016.
3. Prepare closing entries.

PRACTICE SET 2

Canto Merchandising sells facsimile, copiers and other types of office equipment. Transactions during the month
of September 2016 are as follows:

Sept 1 Purchased five units of copiers on account from Machina Corp at a cost of PHP8,000 per unit.
Payment is due 30 days after. Borrowed from Nation Bank, PHP50,000 at 10% interest per annum due in three
months . Canto issued a promissory note for this borrowing. Paid one –year insurance covering the period Sept
1, 2016 – August 31, 2017 for PHP24,000
Sept 2 Purchased 10 units of facsimile machines on cash from Tiktac Corp for a total price of
PHP20,000.
Sept 7 Sold three units of copiers to Jane Nay on account for a total amount PHP45,000. The terms of
the sale is 2/10, n 30.
Sept 10 Paid PHP5,600 for office supplies
Sept 14 Collected from Jane Nay the full amount relating to September 7 sales.
Sept 15 Paid PHP10,000 salaries of office staff
Sept 20 Sold on cash, two units of facsimile machines to Juan for PHP5,000
Sept 30 Purchased delivery truck worth PHP300,000 with an estimated useful life of 10 years with no
residual value. Canto paid PHP200,000 cash and balance payable 30 days after

Instructions:
1. Prepare journal entries to record the above transactions, assuming Canto uses periodic inventory system.
2. Prepare necessary adjusting entries on September 30, 2016.