ACCOUNTING FOR

MERCHANDISING BUSINESS
 At the end of the chapter, you should be
able to:
• Distinguish the activities of a service business from those of a
merchandising business.
• Understand the operating cycle of a merchandising business.
• Describe and define the different accounts used by a merchandising
business.
• Analyze and journalize transactions involving the purchase and sale
of merchandise.
• Record transaction involving the purchase and sale of assets other
than merchandise.
• Understand the accounting for discounts, freight, value added tax,
and other income and expense accounts.
• Determine the difference between Periodic Inventory System and
Perpetual Inventory System.
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Nature of Merchandising Business

SERVICE BUSINESS MERCHANDISE BUSINESS

Revenue from service Pxxx Revenue from sales Pxxx

Less: Operating expenses xxx Less: Cost of goods sold xxx
Net Income (loss) P xxx Gross Profit P xxx
Less: Operating expenses xxx
Net Income (loss) P xxx

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 SERVICE BUSINESS
Service Business sells expertise and the revenue activities of which
involves providing services for a fee to customers or clients.
Net income is derived by subtracting the operating expenses incurred in
providing the services to customers from the revenues generated
from services rendered.

Examples of Service businesses:

a. Schools
b. Hospital
c. Beauty parlors
d. Repair shops
e. Internet café

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MERCHANDISING BUSINESS
Merchandising business is a business organization that
involves buying and selling products, goods or
merchandise to customers.
A merchandising business purchases merchandise from
suppliers and then sells them to its customers. When the
merchandise is sold, the revenue is called sales, and its
cost is called cost of goods sold. The cost of goods sold
is subtracted from sales to arrive at gross profit.

Net income is derived by subtracting the operating expenses

from the gross profit.

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Nature of Merchandising Business

SERVICE BUSINESS MERCHANDISE BUSINESS

Revenue from service Pxxx Revenue from sales Pxxx

Less: Operating expenses xxx Less: Cost of goods sold xxx
Net Income (loss) P xxx Gross Profit P xxx
Less: Operating expenses xxx
Net Income (loss) P xxx

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 MERCHANDISING BUSINESS
A merchandising business could be a wholesaler or a retailer.
A Wholesaler buys the finished products or
commodities from the manufacturers then resells to other
merchandising business, known as retailers. Retailers
sell the merchandise to ultimate consumers.

Examples of Merchandising businesses:

a. Department stores
b. Boutiques
c. Drugstores
d. Groceries

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 MERCHANDISING BUSINESS

Merchandise represents the commodities or stock of items

bought by the merchandise for resale to its customer for
profit.

Examples:
a. Canned goods, sugar, and milk of a grocery store
b. Table, chairs and cabinets of a furniture store
c. Clothes, bags, and ladies accessories of a boutique

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 OPERATING CYCLE OF A
MERCHANDISING BUSINESS

Purchases
BUSINESS Sells merchandise/goods to
merchandise/goods from customers
suppliers

Payment to Payment to business

suppliers

SUPPLIERS CUSTOMERS

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GROSS SALES
Sales revenue is the total amount charged to customers for merchandise
sold, either for cash or on account. Under accrual accounting,
revenues from sale of merchandise are considered to be earned in the
accounting period in which the title of goods passes from the seller
to the buyer.
The sales account is a temporary owner’s account in which the revenue
resulting from sale of merchandise is recorded. Only the sale of
merchandise held for resale is recorded in the sales account. Sale of
items other than merchandise is to be recorded in the appropriate
asset account.

Sales is credited for the selling price of all merchandise sold which
consists of the cost of the goods sold and the desired profit by the
seller. The transaction is supported by a source document called a
Sales Invoice from the seller’s point of view or Purchase Invoice
from the buyer’s point of view.
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GROSS SALES
Parts of a sales invoice
• Sold to
• Address
• Date
• Term
• Quantity
• Unit
• Description
• Unit price
• Amount
• Total

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 TERMS OF SALES

Merchandise can be sold on any of the following terms:

1. On Cash basis
2. On Credit basis
3. On Credit basis supported by a Promissory Note
4. With a down payment, and the balance on account
5. With a down payment and the balance is supported by
a promissory note.
6. With a down payment; part of the balance is on account
and the other part, supported by a promissory note.

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TERMS OF SALES

CASH BASIS

On March 1, 2010, Mura Lang Dito Department store sold to

Gandang Pilipina Boutique P150,000 worth of ladies
accessories and dresses for cash.

Journal entry:
March 1, 2010 Cash P 150,000
Sales P150,000

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TERMS OF SALES

CREDIT BASIS

On March 2, 2010, Mura Lang Dito Department store sold

P100,000 worth of bags and shoes to Ang Tibay shoe
store on account.

Journal entry:
March 2, 2010 Accounts receivable P 100,000
Sales P100,000

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TERMS OF SALES

CREDIT BASIS SUPPORTED BY A

PROMISSORY NOTE

On March 3, 2010, Mura Lang Dito Department store sold

goods to Kutis worth P50,000. A promissory note was
received from Kutis in relation to the sale

Journal entry:
March 3, 2010 Notes receivable P50,000
Sales P50,000

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TERMS OF SALES

WITH DOWN PAYMENT, AND THE BALANCE ON

ACCOUNT
On March 9, 2010, Mura Lang sold additional ladies
accessories to Gandang Pilipina worth P100,000. A
P50,000 downpayment was collected from the customer,
balance on account.
Journal entry:

March 9, 2010 Cash P 50,000

Accounts receivable 50,000
Sales P100,000
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TERMS OF SALES

WITH DOWN PAYMENT, AND THE BALANCE IS

SUPPORTED BY A PROMISSORY NOTE
On March 12, 2010, Ang Tibay bought additional Shoes and
Bags worth P75,000. The customer paid P30,000 in
cash and issued promissory note for the balance.
Journal entry:

March 12, 2010 Cash P 30,000

Notes receivable 45,000
Sales P75,000

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TERMS OF SALES

WITH A DOWN PAYMENT; PART OF THE BALANCE IS IN

ACCOUNT AND THE OTHER PART, SUPPORTED BY
A PROMISSORY NOTE

On March 15, 2010, Mura Lang sold P120,000 worth of beauty

creams, perfumes and lotion to Kutis. Terms: 50% down 25%
of account; balance supported by a note.

Journal entry:

March 15, 2010 Cash P 60,000

Accounts receivable 30,000
Notes receivable 30,000
Sales P120,000
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SALES DISCOUNTS

There are two common discounts granted to customers, these

are a) trade discounts and b) cash discounts.
Trade discounts are deductions from the list or catalog price
in order to arrive at the invoice price which is the
amount actually charged to the buyer. Trade discounts
are not recorded in the journal; instead, they are directly
deducted from the list price.
The purpose of which is to encourage trading or to increase
sales. Trade discounts also suggest to the buyer the price
at which the goods may be resold.

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SALES DISCOUNTS

There are two common discounts granted to customers, these

are a) trade discounts and b) cash discounts.
Cash discounts are deductions from the invoice price when
payment is made within the discount period.
They are given to customers to encourage prompt payment in
order to reduce receivables and minimize losses arising
from bad accounts.
Cash discounts are recorded as sales discount from the
seller’s point of view and purchase discounts from the
buyer’s point of view.

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SALES DISCOUNTS

When merchandise is sold or purchased on account, the buyer and

seller should agree on how the account will be settled. This
refers to the credit term.
Credit terms include the cash discount to be given, the discount
period, and the credit period.
Credit period is the period during which a customer can pay or
settle its account.
Cash discount is the amount to be deducted from the invoice price
is within the discount period.
Discount period is the number of days given to credit customer to
avail discount.
The terms are usually written in the sales invoice or purchase
invoice.
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ILLUSTRATION

Assume that the list price of a merchandise sold by Ang

Tibay on March is P100,000 less 15% and 10%,
with credit terms of 2/10, n/30.

This means that the trade discounts are 15% and 10%,
and the cash discount is 2% if within 10 days, and
the full amount of the invoice is payable up to a
maximum period of 30 days if the customer decides
not to avail of the cash discount.

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 ILLUSTRATION

List Price P100,000 Journal entries

First discount (100k x 15%) 15,000
March 1, 2010
Total P 85,000
Second disc (P85k x 10%) 8,500 Accounts receivable P76,500
Invoice Price P 76,500 Sales P76,500
Cash discount(76.5k x 2%) 1,530
March 11, 2010
Payment within the discount
Cash P74,970
period P 74,970
Sales discount 1,530
Accounts receivable P76,500
The computation of cash discount is net of goods
returned, sales taxes or freight, if there is any.

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SALES RETURNS AND ALLOWANCES

Sales returns and allowances are given by the seller to a discontented

buyer who received damaged or defective merchandise, of
inferior quality or not in accordance with their specifications.
The buyer may return the item and ask for refund if the sale was
made for cash.
The seller may grant an allowance or deduction from selling price of
the account which shall be deducted from the customer’s account
if the same was sold on account.
The return and allowance is recorded as debit to sales returns and
allowances. Like sales discounts, sales returns and allowances is
a contra-income accounts and deducted from gross sales to arrive
at net sales which is the summary figure presented in the
statement of comprehensive income.

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ILLUSTRATION
On March 10, 2010, Ang Tibay returned 5 pairs of defective shoes worth P5,000. Mura
Lang acknowledged the return and issued a check to refund the customer.

Journal entry on March 10, 2010:

Sales returns and allowances P5,000
Cash P5,000

If the buyer bought the goods on account, then instead of cash refund, a credit
memorandum will be issued by the seller to acknowledge the return.

Journal entry would be:

Sales returns and allowances P5,000
Accounts receivable P5,000

A credit memorandum formally informs the buyer that his account was decreased
accordingly for the return made or for the reduction of price requested.

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NET SALES

Format:

Gross sales P xxx

Less:
Sales discount P xxx
Sales returns and allowances xxx xxx
Net sales P xxx

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EXERCISE 1

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Using the available data under each of the following
independent cases, compute for the missing item:

a b c D
Gross Sales 450,000 250,000 623,250 311,750
Sales
discounts 15,000 4,500 9,825 7,870
Sales returns
and
allowances 3,500 2,750 2,275 210
Net sales 431,500 242,750 611,150 303,670

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COST OF SALES

Cost of sales or cost of goods sold is the cost of

inventory that the business has sold to the
customers. This is determined and recorded
using either the Perpetual Method or the
Periodic Method of accounting for
inventories.

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COST OF SALES

Merchandise inventory, beg. (1) P xxx

Add: Net cost of purchases
Purchases (2) P xxx
Add: Freight in/Transportation in (5) xxx
Total cost of goods received P xxx
Less: Purchase discounts (3) Pxxx
Purch. Rets & allows.(4) xxx xxx xxx
Total cost of goods available for sale P xxx
Less: Merchandise inventory, end xxx
Cost of sales/Cost of goods sold P xxx

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MERCHANDISE INVENTORY (1)

PAS 2 defines inventories as assets which are held for sale

in the ordinary course of business, in the process of
production for such sale or in the form of materials or
supplies to be consumed in the production process or
in the rendering of services.

There are two groups of inventory in an accounting period,

namely: the merchandise inventory beginning and
the merchandise inventory end.

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MERCHANDISE INVENTORY

Merchandise inventory beginning refers to the initial

inventory of the business at the start of its operations
or the stocks of goods that were unsold from the
previous accounting period.

It is added to the net cost of purchases made during the

period to arrive at the Cost of Goods available for
Sale.

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MERCHANDISE INVENTORY

Merchandise inventory end refers to the unsold

merchandise at the end of the current period which
eventually becomes the beginning inventory of the
succeeding accounting period.
It is deducted from the cost of goods available for sale to
arrive at the Cost of Goods sold.
This will also be the merchandise inventory reported in the
Statement of Financial Position, presented among the
current asset accounts.

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GROSS PURCHASES (2)

Purchases account is used to record the purchase of

merchandise for resale under the periodic method.
Under periodic inventory method, all purchases of
merchandise are debited to the Purchases account.
Under the perpetual inventory method, all acquisitions of
merchandise for resale are directly debited to the
Merchandise Inventory account.

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GROSS PURCHASES

Purchases account is a temporary owner’s equity account

in which the costs of all merchandise purchased during
the period are recorded.
Purchases of other assets which are not intended for resale
should be recorded in the appropriate asset account.
The purchase of merchandise is evidenced by a business
document known as Purchase Invoice. This document
contains the same information which can be found in a
sales invoice.

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 TERM OF PURCHASES

Merchandise can be purchased on any of the following

terms:
1. On Cash basis
2. On Credit basis
3. On Credit basis supported by a promissory note
4. With a down payment and a balance on account
5. With a down payment and the balance supported by
a note
6. With a down payment; balance, partly on account
and partly through the issuance of a promissory note
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TERMS OF PURCHASES

CASH BASIS

On February 3, 2010 Mr. Kimura, the owner of Mura Lang

Department Store bought P200,000 worth of
merchandise from Mahal Naman for cash.

Journal entry:
Purchases
February 3, 2010 P 200,000
Cash P200,000

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TERMS OF PURCHASES

CREDIT BASIS

Purchased Ladies Apparel from Pasyonista Corporation on

March 3, 2010 worth P100,000 on account.

Journal entry:
March 3, 2010Purchases P 100,000
Accounts payable P100,000

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TERMS OF PURCHASES

ON CREDIT BASIS SUPPORTED BY A

PROMISSORY NOTE

On March 15, 2010, Mura Lang bought from Pasyonista,

additional goods worth P75,000 for which a promissory
note was signed and issued to the latter.

Journal entry:
March 15, 2010Purchases P 75,000
Notes payable P75,000

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TERMS OF PURCHASES

WITH A DOWN PAYMENT AND BALANCE ON

ACCOUNT

On March 20, 2010, Kayganda delivered accessories to Mura Lang in the

amount of P150,000. Terms: 50% down payment, and the balance
on account.

Journal entry:

March 20, 2010Purchases P 150,000

Cash P 75,000
Accounts payable 75,000

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TERMS OF PURCHASES

WITH A DOWN PAYMENT; BALANCE, PARTLY ON

ACCOUNT AND PARTLY THROUGH THE
ISSUANCE OF A PROMISSORY NOTE

On April 1, 2010, Mura Lang bought school supplies for resale in the
amount of P80,000. Terms: 40% down; 20% on account; 40%
supported by a promissory note.

Journal entry:
April 1, 2010Purchases P 80,000
Cash P 32,000
Accounts payable 16,000
Notes payable 32,000
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PURCHASES DISCOUNTS (3)

A seller may offer the buyer credit terms that include a

discount for prompt payment of account.
Discounts made available by the seller to the buyer to
encourage timely payment of accounts are known as
purchase discounts.
The purchase discounts account is recorded as credit
entry, thereby reducing the gross profit account.

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ILLUSTRATION

Using the same data used in the sales discounts

transactions involving Ang Tibay Co.

Assume that the list price of a merchandise purchased to

Ang Tibay on March is P100,000 less 15% and
10%, with credit terms of 2/10, n/30. (buyer’s point
of view)

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 ILLUSTRATION

List Price P100,000 Journal entries

First discount (100k x 15%) 15,000
Total P 85,000 March 1, 2010

Second disc (P85k x 10%) 8,500 Purchases P76,500

Invoice Price P 76,500 Accounts payable P76,500
Cash discount(76.5k x 2%) 1,530
March 11, 2010
Payment within the discount
Accounts payable P76,500
period P 74,970
Cash P74,970
Purchase discounts 1,530
The computation of cash discount is net of goods
returned, sales taxes or freight, if there is any.
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PURCHASE RETURNS AND
ALLOWANCES (4)

If the products delivered to the buyer are defective, damaged or not in

accordance with the specification stated in the purchase order,
the buyer may opt to return the goods to the seller (purchase
returns) or may decide to keep them if the seller will grant
acceptable amount of allowance (purchase allowance).
Purchase returns and allowance account is credited every time an on
account buyer returns to the seller and the same is acknowledged
by the latter through the credit memorandum.
Purchase returns and allowances account is a contra-purchase
account which is deducted from the gross profit account when
determining the net cost of purchases for the period.

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ILLUSTRATION
On March 10, 2010, Mura Lang returned some defective commodities worth
P5,000 to Mahal Naman. Mahal Naman acknowledged the return and
issued a check for the refund

Journal entry on March 10, 2010:

Cash P5,000
Purchase returns and allowances P5,000

If however on March 10, 2010, Mura Lang returned the defective commodities
and Mahal Naman issued a debit memorandum for the returned
commodities, the journal entry would be:

Accounts payable P5,000

Purchase returns and allowances P5,000

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 ACCOUNTING FOR FREIGHT (5)

Freight is the transportation charge the company pays when it receives

goods from a supplier. It is a separate account that is added to
purchases in determining the cost of goods and ending inventory.

TERMS OF SHIPMENT
1. FOB Destination
2. FOB Shipping point
3. Freight Collect
4. Freight Prepaid

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 ACCOUNTING FOR FREIGHT

TERMS OF SHIPMENT

1. FOB Destination (Free on Board/Freight on Board)

This means that the ownership to the merchandise passes to the

buyer upon reaching the point of destination, that is received by
the buyer.

Freight charges on the merchandise will be shouldered by the seller.

These freight charges are recorded in the account Freight-out or

Delivery expense, which is a selling expense or distribution cost.

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ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination.
Pasyonista paid P1,000 for freight charges.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Cash P25,000
Accounts payable 25,000

March 25 Accounts payable P25,000

Cash P24,500
Purchase discounts 500
(P25,000 x 2%)
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ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination.
Pasyonista paid P1,000 for freight charges.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 25,000
Sales P50,000

Freight out P 1,000

Cash P 1,000

March 25 Cash P24,500

Sales discounts 500 0

Accounts receivable P25,000

ACCOUNTING FOR FREIGHT

TERMS OF SHIPMENT

2. FOB Shipping Point

This means that the ownership to the merchandise shipped passes to

the buyer at the point of shipment or delivery to the carrier.

Freight charges on the merchandise will be shouldered by the

buyer.

These freight charges are recorded in the account Freight-In, which

is an addition to the cost of merchandise purchased.

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ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point. Mura Lang paid P1,000 for freight charges.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Cash P25,000
Accounts payable 25,000

Freight in P 1,000
Cash P 1,000

March 25 Accounts payable P25,000

Cash P24,500
0
Purchase discounts 500
(P25,000 x 2%)
ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point. Mura Lang paid P1,000 for freight charges.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 25,000
Sales P50,000

March 25 Cash P24,500

Sales discounts 500
Accounts receivable P25,000
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ACCOUNTING FOR FREIGHT

TERMS OF SHIPMENT

3. FOB Collect

This means that the buyer is required to pay the freight bill on the
shipment of the merchandise. Normally, the party bearing the
freight cost pays the carrier.

Hence, merchandise is typically shipped freight collect when the terms

are FOB shipping point.

If the term is FOB Destination, freight collect, the freight paid by the
buyer will be charged to the seller or will just be netted on the
accounts receivable due from to the latter.

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ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point, Freight Collect. Freight charges amounted to P1,000.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Cash P25,000
Accounts payable 25,000

Freight in P 1,000
Cash P 1,000

March 25 Accounts payable P25,000

Cash P24,500
Purchase discounts (P25,000 x 2%) 500 0
ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point. Freight Collect. Freight charges amounted to P1,000.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 25,000
Sales P50,000

March 25 Cash P24,500

Sales discounts 500
Accounts receivable P25,000
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ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination,
Freight Collect. Freight charges amounted to P1,000.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Cash P26,000
Accounts payable 24,000

March 25 Accounts payable P24,000

Cash P23,500
Purchase discounts (P25,000 x 2%) 500

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ILLUSTRATION
On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination,
Freight Collect. Freight charges amounted to P1,000.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 25,000
Freight out 1,000
Sales P50,000
Allowance for freight charge 1,000

March 25 Cash P23,500

Sales discounts 500
Allowance for freight charge 1,000 0
Accounts receivable P25,000
Note that the discount is computed without
regard to the term of shipment. It is
computed on the P25,000 balance of the
accounts payable account.

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ACCOUNTING FOR FREIGHT

TERMS OF SHIPMENT

4. Freight Prepaid

This means that the seller pays the freight bill before or at the time of
shipment.

Merchandise is typically shipped freight prepaid when the terms are

FOB Destination.

If the term is FOB shipping point, freight prepaid, the freight paid in
advance by the seller will be charged to the buyer, or will be
deducted from the accounts payable of the buyer.

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ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination,
freight prepaid. Freight charges amounted to P1,000.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Cash P25,000
Accounts payable 25,000

March 25 Accounts payable P25,000

Cash P24,500
Purchase discounts 500
(P25,000 x 2%)
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ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Destination,
freight prepaid. Freight charges amounted to P1,000.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 25,000
Sales P50,000

Freight out P 1,000

Cash P 1,000

March 25 Cash P24,500

Sales discounts 500 0
Accounts receivable P25,000
ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point, freight prepaid. Freight charges amounted to P1,000.

Journal entries of Mura Lang (Buyer)

March 15 Purchases P50,000
Freight-In 1,000
Cash P25,000
Accounts payable 26,000

March 25 Accounts payable P26,000

Cash P25,500
Purchase discounts 500 0
(P25,000 x 2%)
ILLUSTRATION

On March 15, 2010, Mura Lang Dept. Store purchased merchandise from
Pasyonista worth P50,000. Terms: P25,000, balance 2/10, n/30, FOB Shipping
point, freight prepaid. Freight charges amounted to P1,000.

Journal entries of Pasyonista (Seller)

March 15 Cash P25,000
Accounts receivable 26,000
Sales P50,000
Allowance for freight charge 1,000

March 25 Cash P25,500

Sales discounts 500
Accounts receivable P26,000 0
Note that the discount is computed without
regard to the term of shipment. It is
computed on the P25,000 balance of the
accounts payable account.

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 SUMMARY RULES ON SHIPMENT
TERMS
FREIGHT PARTY LIABLE PARTY WHO REMARKS
TERMS FOR THE INITIALLY
FREIGHT SHOULDERS
FREIGHT

FOB Destination, Freight Seller Seller Seller debits the Freight out
Prepaid account

FOB Destination, Freight Seller Buyer Seller debits the Freight out
Collect account. Seller owes the buyer
the cost of the freight

FOB Shipping point, Buyer Buyer Buyer debits Freight In

Freight Collect account

FOB Shipping point, Buyer Seller Buyer debits Freight In

Freight Prepaid account. Buyer owes the seller
for the cost of the freight

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EXERCISE 2

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COST OF SALES

Merchandise inventory, beg. (1) P xxx

Add: Net cost of purchases
Purchases (2) P xxx
Add: Freight in/Transportation in (5) xxx
Total cost of goods received P xxx
Less: Purchase discounts (3) Pxxx
Purch. Rets & allows.(4) xxx xxx xxx
Total cost of goods available for sale P xxx
Less: Merchandise inventory, end xxx
Cost of sales/Cost of goods sold P xxx

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 Using the data under each of the following
independent cases, compute the cost of goods sold:

CASE A CASE B CASE C CASE D CASE E

Merchandise P0 120,000 150,000 300,000 50,000

inventory, beg.
Purchases 300,000 250,000 450,000 500,000 250,000

Freight in 5,000 3,000 7,500 10,000 2,500

Purchase returns
& allowances 2,500 2,250 5,500 7,200 1,500

Purchase
discounts 1,500 2,500 4,250 3,700 1,250
Merchandise
inventory, end 180,000 220,000 120,000 280,000 45,000
COST OF
121,000 148,250 477,750 519,100 254,750
SALES

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Compute net sales and gross profit for
each of the cases below:
a b c D
Sales 450,000 1,650,000 193,500 767,100
Sales
discounts 15,500 52,500 2,800 12,500
Sales returns
and
allowances 60,000 18,000 15,800 2,800
Net sales 374,500 1,579,500 174,900 751,800
Cost of goods
sold 238,000 985,000 72,000 387,500
Gross profit 136,500 594,500 102,900 364,300

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Using the data given below, prepare the schedule to compute the
following: 1,240,500
Net sales: 506,000
Net Purchases: 806,000
Cost of Goods Available for sale: 556,000
Cost of Goods Sold: 684,500
Gross Profit:
Merchandise inventory, end P250,000
Purchases 500,000
Freight out 15,000
Transportation In 17,000
Sales discount 5,000
Purchase returns and allowances 6,000
Sales returns and allowances 4,500
Purchase discounts 5,000
Sales 1,250,000
Merchandise inventory, beginning 300,000
Doubtful accounts expense 11,000
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Salaries expense 80,000
STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS
The following are the major components of Statement of
Comprehensive Income of a merchandising business:

Net sales P xxx

Less: Cost of sales xxx
Gross Profit P xxx
Add: Other income xxx
Total
Less: Operating expenses
Selling expenses P xxx
Administrative expense xxx xxx
Operating income P xxx
Less: Interest income xxx
NET INCOME P XXX
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STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS

NET SALES

This line item refers to the excess of gross sales over the contra-sales
accounts. It is computed as follows:

Gross sales P xxx

Less: Sales returns and allowances Pxxx
Sales discounts xxx xxx
Net sales P xxx

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STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS
COST OF SALES

This line item includes the cost of goods sold to the customers. It is determined as
follows:

Merchandise inventory, beg. P xxx

Add: Net cost of purchases
Purchases P xxx
Add: Freight in/Transportation in xxx
Total cost of goods received P xxx
Less: Purchase discounts Pxxx
Purch. Rets & allows. xxx xxx xxx
Total cost of goods available for sale P xxx
Less: Merchandise inventory, end xxx
Cost of sales/Cost of goods sold P xxx
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STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS

OTHER INCOME

This line item includes all income sources other than sales. A sample
computation is shown below:

Service income P xxx

Referral income xxx
Commission income xxx
Interest income xxx
Total Other income P xxx

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STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS

OPERATING EXPENSES

Operating expenses are expenses incurred in relation to the operation

of the business. They are classified as selling expenses and
administrative expenses.

Selling expenses are those expenses incurred directly in selling the

merchandise.

Administrative expenses are expenses incurred in the general

administration of the business.

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STATEMENT OF COMPREHENSIVE
INCOME OF A MERCHANDISING
BUSINESS
Sample Computation of Operating expenses:

Selling expenses
Sales salaries P xxx
Salesmen commission xxx
Rent-store xxx
Freight out xxx
Store supplies xxx
Depreciation-store equipment xxx
Depreciation-store furniture & fixtures xxx
Utilities-store xxx
Insurance-store xxx P xxx
Administrative expenses
Office salaries P xxx
Utilities-office xxx
Doubtful accounts xxx
Office supplies xxx
Depreciation-office equipment xxx
Depreciation-office furniture & fixture xxx
Insurance-office xxx 0
Rent-office xxx xxx
Total Operating Expenses P xxx
ACCOUNTING FOR VALUE ADDED TAX
(VAT)

Value Added Tax is an indirect tax levied by the government to both

the buyer and seller. Under the Philippine Tax System, a 12% tax
is levied on all purchases and sales of services, unless otherwise
exempted by law.

Input tax, is debited for the amount of VAT on purchases.

Output tax, is credited for the VAT charged on sales.

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ACCOUNTING FOR VALUE ADDED TAX
(VAT)

At the end of the accounting period, the two accounts are offset against
each other.

If the Input Tax is higher than Output Tax, the difference will be
debited to a Prepaid Tax account representing the VAT
refundable for the period which can be offset against future
output tax.

If the Output Tax is higher than Input Tax, the difference will be
credited to VAT payable and will be remitted to the
government through the Bureau of Internal Revenue.

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ILLUSTRATION
Journalize the following transactions:

February 3 Purchased merchandise for cash worth P100,000 plus

12% VAT.

Purchase P 100,000
Input tax (P100,000 x 12%) 12,000
Cash P 112,000

February 5 Sold merchandise for cash P110,000 plus 12% VAT.

Cash P123,200
Sales P110,000
Output tax (P110,000 x 12%) 13,200 0
ILLUSTRATION
Journalize the following transactions:

February 28 Mura Lang offset the Input Tax against the Output
Tax.

Output tax P 13,200

Input tax P12,000
VAT payable 1,200

March 15 The VAT payable is remitted to the BIR.

VAT payable P1,200

Cash P1,200
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ILLUSTRATION

To illustrate the effect of the cash discounts on the value

added tax, let us assume that the purchase made by
Mura Lang Department Store on February 3
amounting to P100,000 is subject to the credit terms
2/10, n/30, and the account is paid within the
discount period.

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ILLUSTRATION
February 3 Purchases P 100,000
Input tax (P100,000 x 12%) 12,000
Accounts payable 112,000

February 13
Accounts payable P112,000
Purchase discount (P100,000 x 2%) 2,000
Input tax (P2,000 x 12%) 240
Cash 109,760

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PURCHASES ANS SALES OF ASSETS
OTHER THAN MERCHANDISE

PAS 16 states that Property, Plant and Equipment shall be initially

recorded at cost.

Cost is the amount of cash or cash equivalent paid and the fair value of
the consideration given to acquire an asset at the time of acquisition.

It comprises the purchase price, delivery and handling cost and all
other costs incurred in acquiring and preparing it for its intended
use.

Discount on early payment of account on purchased asset will be credited

directly to the asset account. Allowances granted by the seller for
any defect or damage on the asset are likewise credited or deducted
from the cost of the particular asset.
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PURCHASES ANS SALES OF ASSETS
OTHER THAN MERCHANDISE

The acquisition of an asset can be done either by cash or by

the incurrence of a liability or a combination of both.
If an interest bearing liability is incurred, the interest cost is
treated as an expense and should form part of the
acquisition cost of the asset. The same shall be
amortized over the credit term.

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ILLUSTRATION
On March 30, 2010, Mura Lang Department Store bought equipment with a list
price of P100,000. Terms: 10% trade discount, 50% down; balance 2/10, n/30.
Additional costs incurred upon acquisition which were paid in cash are as
follows: delivery and handling cost of P5,000 and installation cost, P1,000.

Journal entries are:

Equipment (P100,000 x 90%) P 90,000

Cash P45,000
Accounts payable 45,000

Equipment P6,000
Cash P6,000
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ILLUSTRATION
To record the payment within the discount period:

Accounts payable P 45,000

Cash P 44,100
Equipment (P45,000 x 2%) 900

Take note that the cash discounts availed due to prompt payment is credited
directly to the equipment account and not to purchase discounts account.

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ILLUSTRATION
The cost of the equipment is computed as follows:

List Price P 100,000

Less: 10% trade discount (P100,000 x 10%) 10,000
Invoice Price P 90,000
Less: 2% Cash discount (P45,000 x 2%) 900
Cost of equipment before incidental costs P 89,100
Add: Delivery and handling cost 5,000
Installation cost 1,000
Total cost of equipment P 95,100

The cost of equipment which is P95,100 will be the basis for the computation of
depreciation.
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PURCHASES ANS SALES OF ASSETS
OTHER THAN MERCHANDISE

On the other hand, the seller cannot use the revenue title Sales on the sale
of assets other than the merchandise of the business since the asset
sold is not the usual asset that it sells.

Thus, the asset account is credited and cash proceed and the related
contra-asset accounts (accumulated depreciation) are debited.

The difference between the selling price and the carrying value of the
asset is debited to a loss on sale of asset account or credited to
gain on sale of asset account.

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ILLUSTRATION
Assume that after 3 months, Mura Lang sold the equipment for P90,000 cash to a
second hand equipment retailing. Assume further that the carrying value of the
equipment at the time of sale is determined at P91,100.

Journal entry on July 1, 2010:

Cash P 90,000
Accumulated depreciation-equipment 4,000
Loss on sale-Equipment 1,100
Equipment P 95,100

The cash received is less than the carrying value of the asset sold, hence, a loss on sale is
recognized which will be included among the other expenses in the income statement.

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ILLUSTRATION
The loss is computed as follows:

Selling price P 90,000

Less: Carrying value
Cost P95,100
Less: Accumulated depreciation 4,000 91,100
Loss on sale of equipment P 1,100

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ILLUSTRATION
On the other hand, if the equipment is sold for P92,000, then the following entry is
necessary:

Cash P 92,000
Accumulated depreciation-equipment 4,000
Equipment P 95,100 Gain on sale-equipment 900

The cash received is more than the carrying value of the asset sold, hence, the
difference is treated as a gain on sale which will be treated as an addition to
other income in the income statement.

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ILLUSTRATION
The gain is therefore computed as follows:

Selling price P 92,000

Less: Carrying value
Cost P95,100
Less: Accumulated depreciation 4,000 91,100
Gain on sale of equipment P 900

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INVENTORY SYSTEMS

There are two main types of inventory accounting system used by a merchandising business:
the periodic inventory system and the perpetual inventory system.

The periodic system is used by businesses that sell inexpensive goods like canned goods,
apparel and school supplies. The system calls for the physical counting of goods on
hand at the end of the accounting period to determine quantities unsold. Quantities
then are multiplied by the corresponding unit costs to get the ending inventory
value.

The merchandise when bought is recorded as purchases and becomes part of cost of goods
available for sale along with the merchandise inventory beginning. No entries are
made to the inventory account as the merchandise is bought and sold. It is only at the
end of the period when inventory is counted and entries are made for the inventory
account. Cost of sales for the period is determined based on the inventory count
at the end of the accounting period.

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COST OF SALES

Merchandise inventory, beg. P xxx

Add: Net cost of purchases
Purchases P xxx
Add: Freight in/Transportation in xxx
Total cost of goods received P xxx
Less: Purchase discounts Pxxx
Purch. Rets & allows. xxx xxx xxx
Total cost of goods available for sale P xxx
Less: Merchandise inventory, end xxx
Cost of sales/Cost of goods sold P xxx

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INVENTORY SYSTEMS
There are two main types of inventory accounting system used by a merchandising business:
the periodic inventory system and the perpetual inventory system.

The Perpetual system requires the maintenance of records called stock cards that usually
show a running summary of the inventory inflow and outflow. Inventory increases
and decreases are reflected in the stock cards and the resulting balance
represents inventory.

At the time of purchase, merchandise bought will be debited to merchandise inventory

account and at the time of sale, two entries are necessary, one to record the revenue
earned, and the other one to recognize the related cost of goods sold. The cost of
sales is recorded by debiting cost of sales or cost of goods sold, and crediting
Merchandise Inventory account.

At the end of the accounting period, a physical inventory must be made to reconcile the
inventory per record with the actual physical count and vouch for the accuracy of the
amount indicated in the inventory subsidiary ledger. The difference is often called
Inventory shrinkage or inventory shortage, and will be recorded by debiting cost
of sales and crediting inventory account.

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SAMPLE OF A STOCK CARD

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End of Chapter 8
God bless you!

Assignment:
8-14
8-18
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