Accounting for Merchandising Business

Periodic system vs. Perpetual system

 Peculiarity of Merchandising Operation

• The only peculiarity is

the accounting for the
buy-and-sell operation
of a merchandiser.
 Peculiarity of Merchandising Operation

• A merchandising business buys goods (i.e.

inventories) and sells them to customers for a profit.
The goods bought by the merchandising business
from its suppliers are called purchases. The
merchandiser add-up a value (i.e. mark-up or gross
profit) to the purchase prices of goods and charges
the total amount to the customer. The total amount
charged to customers is called sales.
Illustration:

Purchase price (cost) Php 100,000

Plus: Mark-up 25,000
Sales price (Sales) Php 125,000
 The Mark-up is usually expressed either as:

Computation Rate Common Name

Percentage of cost P125,000 / P100,000 125% on cost Billing rate or mark-up rate
Percentage of sales P25,000/P125,000 20% on sales Gross margin or gross profit rate
 Merchandising terminologies:
Seller’s perspective Buyer’s perspective
Agreed selling price of the goods Sales Purchases
Return by the buyer of defective
or non-conforming goods to the Sales return Purchase returns
seller
Agreed reduction in selling price Sales discount Purchase discount
Agreed reduction in selling price
for poor quality goods which the
Sales allowances Purchase allowances
buyer agreed to retake at
reduced price
Transportation cost of bringing
the goods to buyer’s place of Freight-out Freight-in
business
Pricing Terminologies

a. List price – This is an established price determined

by reference to a catalog or general price list
before deducting any discounts.
b. Invoice price – This is list price less any trade
discounts. This is the gross billable amount by the
seller to the buyer. This is the amount that is
indicated in the billing statement of the seller.
Types of Discounts
a. Trade discount – Also called volume discount or quality
discount, trade discount pertains to a direct deduction to
the invoice price on account of volume purchases made
by a buyer. This discount is usually given when the buyer is
a fellow merchandiser in order to allow him profit for the
resale of the good to his customers.
b. Cash discount – Also called settlement discount, this is an
additional discount to the invoice price aside from the
trade discount which is given to the buyer for early
payment.
Discount Period

Discount period is the period of time granted by the seller to

the buyer to settle the latter’s account of him to be entitled
to a cash discount. Only those buyers who pay within the
discount period shall entitle for any cash discount. In
calculating discount days, the first day is excluded while the
last day is included.
Illustration

Assume a ten-day discount period. The buyer bought

merchandise on account on January 2. Subsequently, the
buyer paid his account on January 10. Was the buyer able to
avail of the discount?
Types of Cash Discount Terms:

1. Net 30 or n/30 – Net or simply n means the credit period of

the purchase. A net 30 or n/30 means that the entire
invoice is due within 30 days from the invoice without
discount. An n/60 would also mean that the invoice is due
within 60 days without discount, and so on.
2. 1/15, n/30 – This means that the invoice is due within 30
days but the buyer is entitled to 1% discount if the invoice
is paid within 15 days from invoice date, there will be no
discount on the 16th to 30th day.
Illustration:

Royce Store purchased goods with a list price of P100,000

and a 30% trade discount from a supplier. The supplier billed
the balance 2/10, n/30.
Types of Cash Discount Terms:

3. 2/10, 1/15, n/60 – This means that invoice is due for

payment in 60 days but the buyer will be given a 2% discount
if he makes payment within 10 days or 1% if he makes
payment beyond 10 days but within 15 days. If payment is
made beyond the discount period, no discount shall be
granted.
Illustration:

On January 3, 2016, Royce Store purchased goods with a list

price of P300,000 with terms of 10%, 3/10, 1/15/ n/60 from
Supplier B. On January 4, 2016, merchandise with an invoice
price of P15,000 was returned by Royce. On January 18,
2016, Royce Store paid its account.
Types of Cash Discount Terms:

4. 2/EOM, n/60 – This means that the invoice is due for

payment in 60 days but the buyer shall be entitled to 2%
cash discount if payment is made on or before the end of
the month of purchase. If payment is not made within the
discount period, the entire invoice price is due 60 days from
the invoice date.
Types of Cash Discount Terms:

5. 2/10 EOM, n/60 – This means that the invoice is due for
payment in 60 days but the buyer is entitled to 2% discount if
he pays on or before the 10th day of the month following the
month of purchase. If payment is not made within the
discount period, the entire invoice price is due 60 days from
the invoice date.
Illustration:

On January 25, 2016, Royce Store purchased goods with a

list price of P250,000 with terms of 2/10 EOM, n/60 from
Supplier B. On February 1, 2016, merchandise with an invoice
price of P5,000 was returned by Royce. On February 10, 2016,
Royce paid its account.
Recording of Merchandising Transactions

To simplify our discussion, let us group merchandising

transactions into:

a. Purchasing and disbursement activities

b. Sales and collections
Purchasing and disbursement activities

Purchasing and disbursements involves related transactions

in the acquisition of goods from suppliers and their
settlement.
Related merchandising accounts:

1. Purchases – An account used to record the cost of goods or

merchandise bought for resale during the current reporting period.
This is normally a debit balance.
2. Freight-in – An account used to record the transport cost of the
goods purchased. This is an adjunct account to the purchases
account; and hence, it has normal debit balance.
3. Purchase discount – An account used for the agreed reduction in
the price of goods. This is normally given by the supplier on account
of early payment. Purchase discount is a contra-account; hence, it
has a normal credit balance.
Related merchandising accounts:

4. Purchase returns and allowances – An account used to record the

cost of merchandise returned to the supplier and including price
reductions to the purchase which is granted by a supplier or
account of unsatisfactory goods delivered. Just like the purchase
discount account, this is normally a credit balance.
5. Advances to supplier – An account used to record advance
payments made to a supplier for goods to be purchased in the
future. This is an asset account and has a normal debit balance.
Purchasing and Disbursement

1. Purchase of goods for cash

2. Purchase of goods on account
3. Payment of freight on purchases
4. Availment of cash discount
5. Return of goods to supplier
6. Payment of advances to suppliers
7. Recoupment of advances to suppliers
Purchasing and Disbursement
• January 1 – Purchased goods for cash, P10,000. The company paid
P500 for the transport of goods to its store.
• January 4 – Purchased P40,000 goods from ABC Company on credit,
with a trade discount of 25% and terms of 2/15 n/60. ABC Company
agreed to shoulder the freight costs of P1,000.
• January 6 – Returned P3,000 worth of goods purchased from ABC
Company because these goods were different from those ordered.
• January 8 – Discovered minor defects on goods purchased from ABC
Company. ABC agreed to provide for P1,000 price reduction
adjustment
• January 19 – Paid the balance due to ABC Company
• January 20 – Paid P5,000 as reservation for goods ordered from
Supplier XYZ at a total price of P20,000
• January 22 - Supplier XYZ delivered the P20,000 goods ordered and
presented a bill for the balance due on January 30.
Sales and Collection Activities

The sale and collection function involves selling of goods and

collecting customers’ accounts.
Related merchandising accounts:

1. Sales – An account used to record the selling price of goods to a

customer. The sales account has a normal credit balance.
2. Freight-out – An account used to record the transport cost of the
goods sold to customers. If good are purchased from the business’
warehouse, customers normally shoulder the freight of their goods.
At times, the seller may accommodate the freight as goodwill to
customers. Freight out is a separate expense account and is not a
contra-account to the sales account. It may be alternatively called
deliver expense.
Related merchandising accounts:
3. Sales discount – An account used to record the agreed reduction in
the price of goods sold to customers. This is the equivalent of
purchase discount in the buyer’s perspective. Sales discount is a
contra-account to the sales account; hence, it has a normal debit
balance.
4. Sales returns and allowances – An account used under periodic
inventory system to record the amount of sales returned by
customers including reductions in selling prices granted to customers
because merchandise was not satisfactory to a buyer. This is also a
contra-account to the sales account and has a normal debit
balance.
5. Advances from customer – An account representing advance
payment made by a customer for goods to be delivered in the
future. This is liability account and has a normal credit balance.
Sales and Collection
• January 3 – Sold good for cash P50,000
• January 7 – Sold goods to ABC Company on credit P50,000 with terms
2/15, 1/30 n/60. ABC Company agreed to shoulder and paid the
P1,000 freight on the goods.
• January 9 - ABC Company returned goods billed for P5,000 due to
defects
• January 10 – ABC Company complained of minor defects on the
goods it purchased. Boyce Store agreed to provide for P3,000 price
reduction for the minor defects.
• January 21 – ABC Company paid the balance of his account
• January 22 – XYZ Company ordered goods with selling price of
P30,000 and made a P5,000 advanced deposit.
• January 27 – Delivered to XYZ Company the P30,000 goods it
ordered. XYZ paid the balance in cash.
Shipping and freight terms in merchandising

SHIPPING TERMS

1. FOB shipping point – ownership to the goods transfer to

the buyer form the moment the goods leave the
warehouse of the seller which is normally the shipping
date or invoice date.
2. FOB Destination – ownership to the goods transfer to the
buyer from the moment the goods arrive at the
warehouse of the buyer which is normally the delivery
receipt date.
Freight Terms

1. Freight prepaid – The freight shall be paid by the seller to the freight
or cargo forwarder upon release of the goods in his premises.

2. Freight collect – the freight shall be paid by the buyer to the freight
or cargo forwarder upon arrival of the deliver in his premises.
Seller’s perspective
Royce Store sold goods on account with selling price of P20,000 to a
customer. The goods will incur P1,000 freight up to the buyer’s
warehouse.
FOB Shipping Point – Freight Prepaid
Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales Accts. Rec. P20,000 No entry
Sales P20,000
Freight Accts. Rec. P1,000 No entry
Cash P1,000

FOB Shipping Point – Freight Collect

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales Accts. Rec. P20,000 No entry
Sales P20,000
Freight No entry No entry
Seller’s perspective
Royce Store sold good on account with selling price of P20,000 to a
customer. The goods will incur P1,000 freight up to the buyer’s
warehouse.
FOB Destination – Freight Prepaid
Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales No entry Accts. Rec. P20,000
Sales P20,000
Freight Freight-out P1,000 No entry
Cash P1,000

FOB Destination– Freight Collect

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales No entry Accts. Rec. P20,000
Sales P20,000
Freight No entry Freight-out P1,000
Accts. Rec. P1,000
Buyer’s Perspective
Royce Store purchased goods with selling price of P20,000 from a
supplier. The goods will be delivered at P1,000 freight

FOB Shipping Point – Freight Prepaid

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales Purchase P20,000 No entry
Accts. Pay. P20,000
Freight Freight-in P1,000 No entry
Accts. Pay. P1,000

FOB Shipping Point – Freight Collect

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales Purchase P20,000 No entry
Accts. Pay P20,000
Freight No entry Freight-in P1,000
Cash P1,000
Buyer’s Perspective
Royce Store purchased goods with selling price of P20,000 from a
supplier. The goods will be delivered at P1,000 freight

FOB Destination – Freight Prepaid

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales No entry Purchases P20,000
Accts. Pay. P20,000
Freight No entry No entry

FOB Destination – Freight Collect

Date of shipment of goods by the seller Date of arrival of the goods to the buyer
Sales No entry Purchases P20,000
Accts. Pay. P20,000
Freight No entry Accts. Pay. P1,000
Cash P1,000
Net Cash Collection
1. On January 5, 2017, Josiah sold merchandise with a list price of
P200,000, terms of 20%, 3/10, 2/15, n/30. On January 8, merchandise
with an invoice price of P10,000 was received from a customer.
Freight of P2,000 was incurred. On January 20, 2017, the customer
paid its account.

FOB Shipping Point – Freight Prepaid

FOB Shipping Point – Freight Collect

Net Cash Collection
1. On January 5, 2017, Josiah sold merchandise with a list price of
P200,000, terms of 20%, 3/10, 2/15, n/30. On January 8, merchandise
with an invoice price of P10,000 was received from a customer.
Freight of P2,000 was incurred. On January 20, 2017, the customer
paid its account.

FOB Destination – Freight Prepaid

FOB Destination – Freight Collect

Adjusting Entries
Objectives:

At the end of this section:

1. Identify adjusting events
2. Compare adjustments and prepare adjusting entries
3. Prepare correcting entries
Adjusting the records: An introduction

The Journalizing stage of accounting normally captures transactions

that have observable change on element: assets, liability, equity,
income and expense.

There are, however, events that cause silent or gradual changes on

the elements of financial statements.
Remember these?
• Accrued income
• Accrued expense
• Deferred income
• Prepaid expense

• Depreciation
• Supplies
• Bad debt expense
• Accounting errors
Bad debts

There are two methods of recording bad debts expense:

1. Direct write-off method

2. Allowance method
Direct write-off method
Illustration:

In 2016, the business sold P400,000 worth of good from various clients.
P100,000 of which is on account wherein 2% is expected to be non-
collectible. In 2017, P1,400 were actually proven to be non-collectible
Date Account Debit Credit
Dec 31, 2017 Bad debt Expense P1,400
Accounts receivable P1,400
To record bad debt expense

Does not result in receivables being stated at net realizable value in the
statement of financial position.
Allowance method

• Bad debt expense is estimated and recorded as expense in the year the
business sells the goods or services on account.
• this method is justified because the business incurs loss at the moment it
sells goods or services to non-paying customers
Methods of estimating bad debts under the allowance method

Method Description
% of account sales method Bad debt expense is equal to % of account sales or revenues
made on credit.
% of receivables method The required balance of allowance for bad debts is computed
as a percentage of the ending receivable balance. Bad debt
expense is determined based on the change in the balance of
the allowance account.
Aging of accounts method Each individual customer account is aged and an estimate of
uncollectibility is assigned based on previous experience on
each age of receivable accounts turning to be bad debts. The
balance computed is the required ending balance of allowance
for bad debts. Bad debt expense is then determined based on
the change in the balance of the allowance account.
Entries under the allowance method
The adjusting entry for estimated bad debts expense is recorded as follows:

Date Account Debit Credit

XXX Bad debt Expense P XXX
Allowance for bad debts P XXX
To record estimated bad debt expense

The write-off of worthless or uncollectible accounts is recorded as follows:

Date Account Debit Credit
XXX Allowance for bad debts P XXX
Accounts receivable P XXX
To record writing off of accounts receivable
If the business recovered accounts previously written-off, the journal entries
are:

Date Account Debit Credit

XXX Accounts receivable P XXX
Allowance for bad debts P XXX
To record the re-establishment of accounts previously written off

Cash P XXX
Accounts receivable P XXX
To record collection of accounts previously written off
Net Realizable value = Accounts receivable – Allowance for bad debts
Income in merchandising is determined as follows:

Net sales P xxx,xxx

Less: Cost of sales xxx,xxx
Gross profit P xxx,xxx
Less: Expenses xxx,xxx
Net Income P xxx,xxx
Net Sales
Net Sales or revenue in merchandising is computer as follows:

Sales (gross) P xxx,xxx

Less: Sales discount P xxx,xxx
Sales returns & allowances P xxx,xxx xxx,xxx
Net Sales P xxx,xxx
Cost of Sales
As merchandising business sells, the sale is reported as revenue, the cost
of goods sold must also be expensed in line with the Matching Principle
of accounting.

Inventory, beginning P xxx,xxx

Add: Net purchases xxx,xxx
Total goods available for sale P xxx,xxx
Less: Inventory, end xxx,xxx
Cost of sales or cost of goods sold P xxx,xxx
Note on Inventory:

The inventory appearing on the adjusted trial balance is not the final
ending inventory for the period but is actually the beginning inventory.
The ending inventory as counted at the end of the current period shall
be set-up to the records during the closing of the books.
Net Purchases
Net purchases in merchandising shall be computed as follows:

Purchases (gross) P xxx,xxx

Add: Freight-in xx,xxx
Less: Purchase discounts P xxx,xxx
Purchase ret. & allowances P xxx,xxx xxx,xxx
Net Purchases P xxx,xxx
 Determine the missing items:

E co. F co. G co. H co.

Merchandise inventory, beginning P 250,000 P 360,000 P ? P 600,000
Purchases (gross) 400,000 ? 714,000 1,000,000
Freight-in 20,000 30,000 24,000 100,000
Purchase returns and allowances 8,000 0 5,000 0
Purchase discounts 4,000 12,000 0 8,000
Merchandise inventory, end 360,000 330,000 300,000 ?
Cost of Sales ? 478,000 703,000 800,000
Determine the missing items:

E co. F co. G co. H co.

Merchandise inventory, beginning P 250,000 P 360,000 P 270,000 P 600,000
Purchases (gross) 400,000 430,000 714,000 1,000,000
Freight-in 20,000 30,000 24,000 100,000
Purchase returns and allowances 8,000 0 5,000 0
Purchase discounts 4,000 12,000 0 8,000
Merchandise inventory, end 360,000 330,000 300,000 892,000
Cost of Sales 298,000 478,000 703,000 800,000
Closing of Merchandising Accounts: Periodic Inventory System

1. Closing of Sales Revenue

Date Account Debit Credit
xxx Sales P xxx
Sales discount P xxx
Sales returns and allowances xxx
Profit or loss summary xxx
to close sales and related accounts
Closing of Merchandising Accounts: Periodic Inventory System

2. Closing of inventory accounts

a. Closing of beginning inventories

Date Account Debit Credit

xxx Profit or loss summary P xxx
Beginning inventory P xxx
to close sales and related accounts
Closing of Merchandising Accounts: Periodic Inventory System

2. Closing of inventory accounts

b. Closing of purchase related accounts

Date Account Debit Credit
xxx Profit or loss summary P xxx
Purchase discounts xxx
Purchase returns and allowance xxx
Purchases P xxx
Freight-in xxx
to close purchases and related accounts
Closing of Merchandising Accounts: Periodic Inventory System

2. Closing of inventory accounts

c. To set-up ending inventory

Date Account Debit Credit

xxx Ending inventory P xxx
Profit or loss summary P xxx
to close sales and related accounts
Closing of Merchandising Accounts: Periodic Inventory System

3. Closing expenses

Date Account Debit Credit

xxx Profit or loss summary P xxx
Freight-out P xxx
Expenses xxx

to close freight-out and other expense accounts

 Periodic system vs. Perpetual system
POINT OF DIFFERENCES PERIOD SYSTEM PERPETUAL SYSTEM
Purchase of goods Purhcases Inventory
Cash or A/P Cash or A/P
Incurrence of freight-in Freight-in Inventory
Cash or A/P Cash or A/P
Purchase discounts Accounts Payable A/P
Purchase discounts Inventory
Cash Cash
Purchase returns and Accounts payable A/P
allowances Purchase returns Inventory
Sale of goods Cash or A/R Cash or A/R
Sales Sales
Cost of sales
Inventory
Closing of inventory accounts Inventory end
Purchase ret & allow.
Purchase disc.
Inventory beginning No entry
Purchases
Freight-in
At he beginning of January 1, 2016, Puksa Company has 4,000
inventories costing P40 per unit. The following transactions in
chronological order transpired during the year:
1. Purchased on account 6,000 units of inventory at P40 per unit
2. Sold on account 2,500 units of inventory for P100 per unit
3. Purchased on account 8,000 units of inventory at P40 per unit
4. Sold on account 6,000 units of inventory for P100 per unit.
5. Paid employee salary of P20,000, the only expense for the period.
6. On December 31, 2016, physical count revealed that 7,000 units
were on hand.