Unit 1

Accounting for Merchandising Business

Overview

Background Merchandising business deals primarily with the buying and selling of
finished goods. This unit will introduce readers on the different activities done
by a trading business. A brief discussion of the perpetual inventory systems is
also included.

Purpose The purpose of Unit I Accounting for Merchandising Business is to

illustrate the various buying and selling activities of a trading business. This
unit also illustrates the basic entries using perpetual inventory system. A brief
discussion of business documents are also included to give readers ideas of
what are the basic papers being used that support a merchandising transaction.

In this unit This unit contains the following topics:

Topics See Page

Merchandising Business 2 of F
Inventory System 3 of F
Merchandise Accounts 7 of F
Business Documents 9 of F
Proprietors Investment and Withdrawal 14 of F
Purchase of Merchandise 15 of F
Purchase Returns and Allowances 18 of F
Discounts on Purchases 20 of F
Sales 25 of F
Sales Returns and Allowances 27 of F
Discounts on Sales 28 of F
Freight on Merchandise 29 of F
Income Statement 33 of F

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Merchandising Business

Overview An organization that is engaged in the buying and selling of goods or

merchandise is a merchandising or trading concern. Merchandise refers to
goods purchased for resale in the same form. Unlike businesses rendering
services for compensation, a trading concern derives its income through the
resale at a profit of the merchandise purchased.

Activities The activities of a merchandising concern that distinguish it from a service

concern cover the following:
Purchasing. Information as to the kind, quality, quantity, and cost of goods
bought should be maintained for the use of management. Records as to
supplies or merchandise bought are also maintained.
Handling. The costs of transporting and sorting of goods bear an important
relation to the prices of goods bought. These should be recorded properly.
Transportation costs include freight, express, drayage, and cartage.
Returning Of Goods Purchased. Some of the merchandise received may
prove unsatisfactory and must be returned to the vendors, or if not returned,
may be allowed some deductions from the original purchase price.
Selling. Goods purchased are sold at prices above the cost in order to
provide adequate margin of profit. It is therefore imperative that the cost of
goods bought should be known from the accounting records so that
desirable selling prices may be set.
Returning Of Goods Sold. The customers may return some of the
merchandise sold. Deductions from the original selling prices must be
allowed for sales returns. If the goods delivered are defective and no return
is made, the customers are granted reduction on the sales price.
Maintaining Adequate Stocks On Hand. In order to satisfy orders of
customers at all times, a stock of merchandise must be maintained on hand.
This is called Merchandise Inventory or Inventory on Hand

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Inventory System

Overview A business firm selling a product must use an inventory record system to
value the merchandise on hand at the end of an accounting period. Two
different inventory systems may be used to record trading transactions in the
accounting records. These systems are the periodic and perpetual inventory
system.

Perpetual In a perpetual inventory system a continual, or perpetual, record of the

inventory activity is maintained. Consequently, any items that are sold or
otherwise physically removed from inventory must be removed from the
Merchandise Inventory account, and items that are purchased are added to the
Merchandise Inventory account. This may result in significant extra record
keeping as compared to a periodic system. However, a perpetual inventory
system does have advantages, and businesses with a relatively low number of
high-value transactions often find the extra effort to be worthwhile.
Computers are also making it practical for businesses to use perpetual systems
than would have been not feasible in the past.

Periodic or In the periodic inventory system, the ending inventory is determined by a

Physical physical count of the merchandise on hand at the end of an accounting period.
The periodic inventory system receives its name because the balance in the
inventory account is known only at the beginning and at the end of the
accounting period. The periodic inventory is the simpler system commonly
used in practice and was the only practical alternative for most businesses
with large number of transactions before the advent of computers. The
periodic inventory system will be used in the illustrations throughout this
course unless otherwise stated.

Continued on next page

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Inventory System, Continued

Transactions in As mentioned earlier, a perpetual inventory system attempts to maintain a

Perpetual continual record of the inventory on hand. Thus, if Joseph Labrador
Inventory purchased merchandise for cash, P50,000, the entry to record this transaction
System is :
Merchandise Inventory 50,000
Cash 50,000
To record merchandise bought.

On the other hand, if Joseph sold P20,000 worth of merchandise for

P40,000, the entry to record this transaction is:

Cash 40,000
Sales 40,000
To record merchandise sold.

Cost of Goods Sold 20,000

Merchandise Inventory 20,000
To record the transfer of inventory sold
to cost of goods sold account.

Assuming this time, Joseph Labrador purchased from Mary Trading

merchandise on account, Php 100,000. And at the same time, paid for the
freight on the said purchase, Php 2,500. The entries would be:

Merchandise Inventory 100,000

Accounts Payable 100,000
To record merchandise bought.

Merchandise Inventory 2,500

Cash 2,500
To record freight paid.

Continued on next page

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Inventory System, Continued

Transactions in Let us say, after two days, Joseph returned defective merchandise bought from
Perpetual Mary amounting to Php 5,000. The entry would be:
Inventory
System, cont. Accounts Payable Mary Trading 5,000
Merchandise Inventory 5,000
To record returned merchandise.
If on the other hand, Joseph Labrador sold to Michael Supermart merchandise
worth Php 50,000 on account at gross profit of 50 percent. The entries would
be:
Accounts Receivable 50,000
Sales 50,000
Sold merchandise on account.
Cost of Goods Sold 25,000
Merchandise Inventory 25,000
To record cost of merchandise sold.
Let us assume again that after three days, Michael issued a debit
memorandum amounting to Php 1,800 for defective goods received from
Joseph. The entries to record the return would be:
Sales Returns & Allowances 1,800
Accounts Receivable 1,800
Received debit memorandum.
Merchandise Inventory 900
Cost of Goods Sold 900
To record cost of good returned.

Importance It is important to note that both periodic and perpetual inventory systems will
record the sale of merchandise similarly. The only difference is that under the
perpetual inventory system, there is a second entry that is required to be
recorded together with the sale to indicate the transfer out of the amount sold
from the Merchandise Inventory account to the Cost of Goods Sold account.
It is possible to combine the two entries into a single compound entry with the
same debits and credits. For example:
Cash 40,000
Cost of Goods Sold 20,000
Sales 40,000
Merchandise Inventory 20,000
To record merchandise sold.

Continued on next page

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Inventory System, Continued

Pro-forma At the end of the year, no further entries may be required if the balance in the
entry inventory account equals the actual cost of the units on hand. Unfortunately,
this seldom happens. Despite the extra effort necessary to maintain a
perpetual record of the inventory, the facts often differ from the records.
When the facts conflict with the records, the records must be corrected to
reflect the facts. Therefore, an adjusting entry is necessary to record any
missing inventory items and reduce the balance in the Inventory account to
the correct level. The pro-forma entry is:
Merchandise Inventory Short or Over xxx
Merchandise Inventory xxx
To adjust inventory account to actual balance.

Merchandise The Merchandise Inventory Short or Over account is an expense account that
Inventory reflects the cost of missing inventory items. However, depending on its
Short or Over materiality and on normal practice within the industry, the inventory
shrinkage amount is often combined with cost of goods sold in the financial
statements.

Net Income The net income disclosed on the income statements prepared under the two
inventory systems will reflect the same amount. This is also true with the
ending inventory balance reported in the balance sheet. A business that
combined its Merchandise Inventory Shrinkage account with its Cost of
Goods Sold account would prepare an income statement identical to the one
prepared under the periodic inventory system.

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Merchandise Accounts

Overview The discussions on this topic are the account titles to be used in recording
acquisition and sale of merchandise of a trading business using the periodic
inventory system.

Sales Sales of merchandise are recorded in this account at selling prices. This is a
temporary or nominal account representing income from selling of
merchandise. This account has a normal credit balance

Sales Returns This account is debited for all the merchandise returned by customers. The
and Allowances debit entry is at the original selling price of the merchandise. This account is
also being used for all goods delivered to customers but is found to be
defective or not as ordered and still the buyer desiring to retain the goods as
is. The customer in this case is normally permitted to deduct a certain amount
from the selling prices of the goods delivered.

Sales Discount This account is debited in the book of the seller whenever the buyer avails of
the cash discounts provided by the seller. This is a deduction from sales
account.

Purchases This is a temporary account to which the cost of goods bought during the
period is debited. This account usually has a debit balance at the end of the
accounting period.

Purchase Goods bought and returned to supplier, or goods bought and received as
Returns and defective, or not as ordered, when not returned to the supplier but is
Allowances subjected to a certain reductions from their acquisition prices. These
deductions and returns of purchased goods are credited to this account.
Purchase returns and allowances account is a deduction from the Purchases
account.

Continued on next page

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Merchandise Accounts, Continued

Merchandise At the end of every accounting period, a physical count of the unsold
Inventory merchandise on hand is taken. The total amount of these goods on hand is
debited to the Merchandise Inventory account.

Purchase This account is credited in the books of the buyer whenever the purchaser
Discount avails of the cash discount given by the seller. This is a deduction from
Purchases account.

Freight In or If the buyer pays the expenses of transporting the goods from the place of the
Transportation seller to his place of business, such expenses are debited to the Freight-in
In account.

Freight Out or If the seller pays the expenses of transporting the goods from his place to the
Transportation place of the buyer, such expenses are debited to the Freight out account. This
Out is reported as part of operating expenses under the selling expenses
classification.

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Business Documents

Overview All business transactions are evidenced or supported by printed forms or

documents. These business papers or oftentimes-called business documents,
furnish the information needed in recording the transactions. Without
business papers, it would be very difficult, if not impossible, to keep accurate
records of these transactions.

Official These are issued every time the business receives cash. They show the date
Receipts on which the cash is received, the party from whom the cash is received, the
amount received, the particulars of the transaction, and the signature of the
one who received the cash.
The sample given below is an official receipt of MDV Realty issued to Mayon
Grocery. From the point of view of MDV Realty, there was an increase in
both the asset cash and the income from rent. On the other hand, the asset
cash of Mayon Grocery decreased, while its rental expenses increased, thus
decreasing its proprietorship.

MDV REALTY
150 Rizal Avenue
Manila

OFFICIAL RECEIPT

No. __120____
Date ___June 30, 20X1______

RECEIVED from _____Mayon Grocery________ the sum of

_____Ten Thousand___ pesos (P10,000.00) in payment of ___July rental__.

Cash_____P10,000 _________________________
Check No._ (Cashier)

Continued on next page

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Business Documents, Continued

Sales Invoice After a sale has taken place, the seller fills in the business form called the
and Purchase invoice. The invoice shows the date of the sale, name and address of the
Invoice seller, name and address of the buyer, terms of the sale, list of articles bought
with the unit price and entire cost of each, total amount of the invoice, and
method of shipment. Invoices are numbered and usually made out in triplicate
or quadruplicate. The original is given to the buyer. When the buyer receives
the goods, they are examined. Then the invoice is checked to determine
whether there are any discrepancies in quantity or price and any errors in
calculation. From the point of view of the seller, the invoice is a sales
invoice; from that of the buyer, it is a purchase invoice.
The sample given below shows that from the standpoint of the seller,
Diamond Grocery, the invoice price of P1,750 is the gross income from sales,
which covers the cost of the juice sold and the gross profit. There was an
increase in assets in the form of an amount receivable from Mayon Grocery,
there was an increase in cost of merchandise available for sale and an increase
in liabilities (the amount of P1,750 is payable within 30 days).

DIAMOND GROCERY
930 Del Monte Avenue
Quezon City

INVOICE
No. ___532___

Sold to: ______Mayon Grocery____ Date ______June 10, 20X1_____

Address __945 Mayon St., Q.C.____ Term: ___Net 30 days _______

Quantity DESCRIPTION Unit Price Amount

50 boxes Happy Orange Juice Drink P 60.00 P 3,000.00

Continued on next page

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Business Documents, Continued

Credit Whenever the buyer finds an error in an invoice, or when merchandise is

Memorandum damaged, he should notify the seller at once. If his claim is admitted as valid,
the seller sends him a credit memorandum, which shows the amount by which
his account is reduced. Credit memorandum is often shortened to credit
memo.
The credit memo illustrated below shows that because of the return of two
boxes of Funchum juice drink, the gross income from sales of Diamond
Grocery decreased, and the amount receivable from Mayon Grocery (asset)
decreased. From the point of view of Mayon Grocery, the merchandise
available for sale and also the debt to Diamond Grocery decreased.

DIAMOND GROCERY
930 Del Monte Avenue
Quezon City

CREDIT MEMO
No. ___121___

To: ______Mayon Grocery____ Date ______June 15, 20X1_____

__945 Mayon St., Q.C.____

We have credited your accounts as follows:

Inv. No. Explanation Unit Price Amount

532 Return of two boxes of slightly P 35.00 P 70.00

defective Happy orange juice
drink.

Continued on next page

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Business Documents, Continued

Promissory A promissory note is a written promise signed by one party, called the maker,
Notes to pay a certain specified sum to another, called the payee, at a certain future
time. The amount to be paid on maturity date may or may not include
interest. The amount due, not including interest, is called the face of the note.
Promissory notes may be received by the business from its debtors, or the
business may give it to its creditors. The following is a sample of a
promissory note.

Php 10,000 Quezon City,

May 1, 20X1

Thirty days after date, I promise to pay to the order of Joseph Labrador, Ten
thousand Pesos, payable at COCOBANK, Vito Cruz Branch for value received with
interest at 12%.

(Signed) Maria de Jesus

Bank deposit For control and safekeeping of cash most businesses maintain checking or
slips and checks current accounts with the banks. They deposit their money in banks and
payments from the deposit are then made by means of checks.
The bank deposit slip is filled in every time the business deposits money in
the bank. It shows the date when the deposit is made, for whose account the
deposit is made, the amount of the deposit classified into currency and checks
received from others, and the signature of the depositor.

Continued on next page

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Business Documents, Continued

Check An order to the bank signed by the person issuing it, to pay to bearer or order
a certain sum of money. After the bank has paid the payee, the amount is
deducted from the deposit account of the one who issued the check.

Cash register Some cash registers are operated in such a way that a strip or slip of paper
slips comes out as evidence that money was received. The slip shows the date and
the amount of cash received.

Miscellaneous Some businesses, like the Meralco, Philippine Long Distance Telephone Co.,
bills MWSS, etc., send bills to their customers to notify them of the amounts they
have to pay. Thus, there are advertising bills, light bills, water bills, telephone
bills, and others.

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Proprietors Investment and Withdrawal

Overview Owners of merchandising firms may want to invest merchandise into its
business operations. The following are the entries that would be recorded
under the periodic inventory system if the proprietor invests or withdraws
merchandise.

Investment of Recording of the investment of the owner in the business will be treated in the
merchandise same way the recording is done in a service business. The only difference
would be if the owner invested an asset into the business in the form of
merchandise. When merchandise is part of the owners initial investment, the
said investment must be debited to the Merchandise Inventory account
whether the company is using perpetual or periodic inventory system. But if
the investment of merchandise was made during the normal operation of the
business, i.e., as an additional investment, the said investment must be debited
to Merchandise Inventory, if the company is using perpetual inventory system
and Purchases if they are using the periodic inventory system.
Pro-forma entry: Initial investment under both methods:
Date Merchandise Inventory xxx
Owner, Capital xxx
Investment made in the form of merchandise.
Pro-forma entry: Additional investment
Perpetual Method Periodic Method
Date Merchandise Inventory xxx Purchases xxx
Owner, Capital xxx Owner, Capital xxx
Investment made in the form of merchandise.

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Withdrawal of Any subsequent withdrawal made by the owner of any asset/s in the business
merchandise (e.g., cash, supplies, etc.) in anticipation of future profits of the company (i.e.,
temporary withdrawal) will be debited to the drawing account. Withdrawals
that are permanent in nature (i.e., the owner has no intention of returning the
said amount into the business) will be debited directly to the capital account.
If the company uses the periodic inventory system, withdrawals of the owner
in the form of merchandise for personal use will be credited to the Purchases
account at cost. This is done in order to maintain the original balance of the
Merchandise Inventory account, which was computed by means of actual
physical count at the end of the accounting period. On the other hand, the
Merchandise Inventory account is credited if the firm uses the perpetual
inventory system.
Pro-forma entry: Periodic inventory system/Temporary withdrawal
Date Owner, Drawing xxx
Cash xxx
Purchases xxx
Owner withdrew cash and merchandise for
personal use.

Pro-forma entry: Perpetual inventory system/Temporary withdrawal

Date Owner, Drawing xxx
Cash xxx
Merchandise Inventory xxx
Owner withdrew cash and merchandise for
personal use.
Pro-forma entry: Permanent withdrawal
Date Owner, Capital xxx
Cash xxx
Owner permanently withdrew an amount in the
business for personal use.

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Purchase of Merchandise

Overview When a firm sells goods or services, it gives a sales slip or sales invoice to its
customers. This sales invoice becomes a purchase invoice as far as the
purchasing business is concerned. The purchase invoice provides the
objective information used to record purchasing transactions. In small
business firms, the only written document received or handled in purchases of
goods or services is this invoice. For such businesses, authorization for
purchases is given informally by telephone or by having an employee
personally purchases goods or services. In this part, we would be dealing with
transactions affecting the firms acquisition of the merchandise for sale. As
we have mentioned earlier, all our business transactions must be properly
supported by business documents.

Purchase Large companies rely on a more careful procedure. As a first step they may
Requisition insist that the person or department needing the goods or services to be
purchased fill out a form called a purchase requisition. This completed form,
bearing the signature of some responsible person authorized to approve such
requisitions, is next sent to the purchasing agent or purchasing department of
the company.

Purchase The purchasing department, after selecting the firm from whom the goods or
Order services are to be bought, prepares a second business paper called a purchase
order. The original copy of this document is sent to the company from which
the purchase is to be made. This copy gives the selling business authority to
send the purchaser the goods or services ordered.

Purchase About the same time that shipment of the goods is made or services are
Invoice supplied to the purchaser, the purchaser is sent an invoice that is the third
business paper. This purchase invoice becomes the basis for recording the
purchase in the journal just as it is in the case of the informal procedure
described for small firms.

Continued on next page

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Purchase of Merchandise, Continued

Purchases The cycle of a merchandising entity begins with cash, which is used to
purchase inventory. Purchases, in the accounting sense, are only those items
of merchandise inventory that a firm buys to resell to customers in the normal
course of business. For example, a bookstore records in the purchases
account the price it pays for books, school and office supplies, and other items
of inventory acquired for resale. A grocery store debits purchases when it
buys canned goods, meat, frozen food and other inventory.
Below is a sample purchase invoice:

DE ASIS TRADING
2401 Taft Avenue
Manila

Sold to : Labrador Store Invoice No. 143

Address : Blk 28, Lot 24 St. Charbels, Cavite Date : Jan. 7, 20X1
How shipped : FOB Destination, prepaid Terms 2/10, n/30
Quantity Description Unit Price Amount
10 dozen Ladys Sando 25 P 3,000.00
10 dozen Mens Undershirt 40 4,800.00
10 pcs. Girls Dress 95 950.00
P 8,750.00
=========

Prepared by : Checked by : Approved by:

---------------- ---------------- -----------------

Continued on next page

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Purchase of Merchandise, Continued

Journal Entries The purchase made on credit by Labrador Store is recorded in the general
journal as follows:
Jan. 5 Purchases 8,750
Accounts Payable - De Asis Trading 8,750
Purchased under wears and childrens dresses. Terms: 2/10,n/30.

If the above purchase was made on cash basis instead of on credit, then the
journal entry of Labrador Store will be:
Jan. 5 Purchases 8,750
Cash 8,750
Cash purchases from De Asis Trading.

If the above purchase was made with down payment of P4,000 and the
balance on account, then the journal entry of Labrador Store will be:
Jan. 5 Purchases 8,750
Cash 4,000
Accounts Payable 4,750
Various purchases. Terms: 4,000 down, balance, 2/10, n/30.

Merchandise purchased with value added tax (VAT) is recorded using the
following pro-forma journal entry:
Purchases xxxx
Input Tax xx
Accounts Payable xxxx
Purchased merchandise on account.

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Purchase Returns and Allowances

Overview Merchandise purchased for resale would not always be as what the buyer
expects. In this regard, buyers can return goods purchased due to a lot of
reasons, for example, due to defects, wrong specifications, poor quality, etc.

Debit When merchandise bought is returned, or an allowance is requested, the buyer

Memorandum informs the seller in writing. The communication is done usually through the
buyers printed business form called debit memorandum. An illustration of
such a form is shown below:

Labrador Store
Blk 28, Lot 24 St. Charbels
Dasmarinas, Cavite
No. 8
DEBIT MEMORAMDUM
Date : Jan. 8, 20X1
To : De Asis Trading
2401 Taft Ave., Manila

We DEBIT your account for the following:

2 pcs. Ladys Sando P25 P 50

5 pcs. Mens Undershirt 40 200
1 pc. Girls dress 95 95
--------
P 345
=====

Remarks: The above goods were received in damaged-condition as per your

invoice No 143 dated Jan. 5, 2001.

Continued on next page

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Purchase Returns and Allowances, Continued

Credit If the return is accepted or the allowance is granted by the seller, the seller
Memorandum usually sends to the buyer such acceptance or grant in writing through a
printed form called credit memorandum. A credit memorandum may in
similar form as the debit memorandum above except for the change of the
word debit to credit. Upon receipt of this communication, the buyer makes an
entry for the returns or allowances

Illustration Assume the following transactions:

Jan. 8, 20X1 - Labrador Store returned P343 worth of merchandise to De Asis
Trading. This was accepted by De Asis Trading (see sample
debit memorandum).
Journal entry to record the return:
Jan. 8 Accounts Payable - De Asis Trading 345
Purchase returns and allowances 345
Merchandise returned to De Asis Trading.
Note: As a result of the returns, the debt to De Asis Trading was diminished,
thus, the sellers account was debited.

The return was credited to purchase returns and allowances account instead of
directly against purchases in order to have the books show total purchases
and total returns and allowances.
If the purchase of January 5 was in cash, the return of goods worth P343 on
Jan. 8 may result in a refund of cash from De Asis Trading. If no cash refund
is made, then Labrador Store will have a receivable from the De Asis Trading
which may be collected or applied to purchases in the future.

Jan. 8 Cash 345

Purchase returns and allowances 345
Cash refund for the return of goods
However, if the return on Jan. 8 was not refunded in cash, then the journal
entry should have been:
Jan. 8 Accounts Receivable - De Asis Trading 345
Purchase returns and allowances 345
To charge De Asis Trading for goods returned.

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Discounts on Purchases

Overview Buyers of merchandise can avail of two types of discounts, namely, the cash
discount and trade discount. This part will provide readers on how to record
discounts on merchandise purchased.

Cash Discounts Special deductions from the prices of goods bought granted by the seller to the buyer
to induce the latter to pay within a specified period.
Example:
Jan. 5, 20X1 Labrador Store bought merchandise from De Asis Trading
P8,750. Terms: 2/10, n/30
The terms of the above transaction mean that if the invoice is paid within 10 days
after the date of the invoice (Jan. 6 to 15), Labrador Store may pay the invoice
amount less a discount of 2%. This is computed as follows:
Amount of invoice P8,750
Less: 2% thereof 175
Amount to be paid P8,575
======
If payment is not made within 10 days, then Labrador Store should pay the full
amount of the invoice, P8,750, within 30 days from the date of the invoice.
If the invoice remains unpaid after 30 days, it is said to be past due and, usually, the
amount begins to earn interest from the 31st day.
Other examples of terms attached to a credit invoice are:
5/10, n/30 - There is a 5% discount if paid 10 days after invoice date, net
amount if paid beyond the 10 days but within 30 days.
2/10, 1/15, n/30 - There is a 2% discount if paid 10 days after invoice date, 1%
discount if paid within fifteen days, net amount if paid beyond
15 days but within 30 days.
2/5EOM, n/45 - There is a 2% discount if paid 5 days after end of the month, net
amount if paid beyond 5 days after end of month but within 45
days from the invoice date.
2/10, n/EOM - There is a 2% discount if paid 10 days after invoice date, net
amount if paid beyond the 10 days but up to end of the month
only.
n/60 - No cash discount is offered. The full amount must be paid within
60 days from invoice date.
Cash discounts are computed on the amount of the bill less returns and allowance, if
any. The base amount should be that which pertains only to merchandise.
Discounts are ordinarily not allowed on incidental expenses such as freight,
insurance while in transit, taxes, duties, and other charges.

Continued on next page

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Discounts on Purchases, Continued

Recording of Below are sample transactions involving the recording of cash discounts:
Cash Discounts

Transactions
20X1
Jan. 4 - Mary Store purchased merchandise from Uniwide Trading,
P10,000. Terms: 2/10, n/30
7 - Mary Store made a partial payment of P5,000 to Uniwide
Trading
14 - Mary Store paid in full its account to Uniwide Trading
18 - Mary Store purchased merchandise from SM Superstore
worth P25,000. Terms: P10,000 down payment, balance
2/10, 1/15, n/30.
21 - Mary Store returned to SM Superstore P500 cost of
merchandise acquired on Jan. 18. SM Superstore in return
issued a credit memo with the same amount-signifying
acceptance of the return made by Mary.
31 - Mary Store settled in full its account with SM.

Continued on next page

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Discounts on Purchases, Continued

Recording Continuation of the recording of discounts:

cont

Journal Entries:
20X1
Jan. 4 Purchases 10,000
Accounts Payable - Uniwide 10,000
Merchandise purchased. Terms:
2/10,n/30.
7 Accounts Payable - Uniwide 5,000
Cash 5,000
Partial Payment.

14 Accounts Payable - Uniwide 5,000

Cash 4,800
Purchase Discounts 200
Full payment.
18 Purchases 25,000
Cash 10,000
Accounts Payable-SM 15,000
Bought merchandise. Terms:
2/10,1/15/n/30.
21 Accounts Payable - SM 500
Purchase Returns and Allowances 500
Received CM for merchandise
returned.
31 Accounts Payable - SM 14,500
Purchase Discounts 145
Cash 14,355
Settled account in full.
NOTE: The cash discount in the last entry was computed on the net amount
after deducting the returns.

Continued on next page

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Discounts on Purchases, Continued

Trade Deductions from the list prices of merchandise offered by the seller to the
Discounts buyer to encourage the latter to buy in bulk or large volume/quantity. This is
a strategy being adopted by the seller to promote the sale of the merchandise.
A list price may be subjected to one or more trade discounts

Illustration Trade Discounts and Cash Discount Illustrated:

a. Assume a credit invoice of P3,000 less 10. Terms: 2/10,n/30.

List price P3,000

Less: trade discounts(3,000x10%) 300
Net invoice price P2,700
Less: Cash discounts(2,700x2%) 54
Amount due if payment is made with in 10 days P2,646
=====

b. Assume a credit invoice of P5,000 less 10-5. Terms: 2/10,n/30.

List price P5,000.00

Less: First trade discounts(5,000x10%) 500.00
P4,500.00
Less: Second trade discounts(4,500x5%) 225.00
Net Invoice price P4,275.00
Less: Cash discounts(4,275x2%) 85.50
Amount due if payment is made w/in 10 days P4,189.50
========

Continued on next page

Page 24of F
Discounts on Purchases, Continued

Journal Entries The journal entries on buyers book for (b):

At the time of purchase

Purchases 4,275.50
Accounts Payable 4,275.50
Purchased merchandise on account.

Payment within 10 days

Accounts Payable 4,275.50
Purchase discounts 85.50
Cash 4,189.50
Settled accounts in full with in discount
period

Payment beyond 10 days

Accounts Payable 4,275.50
Cash 4,275.50
Paid account in full.

Summary The purchase invoice is the business document generated by a purchase

transaction. Most merchandising entities offer discounts (i.e. cash and trade
discounts) to their customers. Trade discounts are not recorded in the books
of both buyer and seller. While cash discounts are recorded in the buyers
book under the account title Purchase Discount. The Purchase Discount
account, which has a credit balance, is a contra account to Purchases.
Most businesses allow their customers to return merchandise that is
defective, damaged in shipment, or otherwise unsuitable. Or if buyer chooses
to keep damaged goods, the seller may deduct an allowance from the amount
the buyer owes. Similar to purchase discount, Purchase Returns and
Allowances, the account title used to record returns and allowance granted, is
also a contra purchases account.

Page 25of F
Sales

Overview The sale of merchandise may be for cash or on account. An invoice supports
every sale. The sellers sales invoice is the buyers purchase invoice. When
a sale is for cash, the seller receives money in return for his merchandise.
When the sale is made on credit, the seller acquires a receivable or right to
collect from the buyer.
The preceding discussion on methods of recording merchandise inventory
transactions stated that under the periodic inventory method, purchases
represent the cost of merchandise bought. Sales, on the other hand, represent
the selling price of merchandise previously bought and then sold. In the
income statement (See sample on page 36 of F), Sales is shown as an income
item from which the cost of goods sold (consisting of merchandise inventory
beginning and end and net cost of purchases), was deducted, the difference
being the gross profit. Therefore, sales represents income, which covers both
the cost of merchandise, sold and gross profit (or gross loss). In the following
discussions, it was assumed that merchandise is sold normally at a profit, i.e.,
the selling price of the merchandise sold is greater than its cost.
It is very important to note that a purchase and sales transaction involve two
parties; namely, the buyer and the seller. Furthermore, a business acts
sometimes as a buyer and sometimes a seller.
The analysis of a purchase and sale transaction would depend on whether the
business for which the accounting work is being done, is playing the role of a
buyer or that of a seller. The treatment therefore, for cash discount and
returns and allowances on this part will also be similar to that discussed under
purchases, only this time the account titles to be used would be Sales discount
and Sales returns and allowances.

Continued on next page

Page 26of F
Sales, Continued

Cash Sales Retailers like drug stores, sari-sari stores, department stores and restaurants
will at times sell their merchandise on cash basis. Assuming Mary Store sold
P5,000 worth of merchandise for cash, this cash sale is recorded as follows:
Jan. 10 Cash 5,000
Sales 5,000
Cash Sales.

Sales on Most business establishments are now extending credit to their customers to
Account become competitive. In the advent of what we call plastic money, i.e.,
credit cards, selling on account has been the current trend whether you are a
manufacturing business, wholesaler or retailer. Assuming Mary Store sold
merchandise worth P7,000 on account. The transaction is recorded as
follows:
Jan. 13 Account receivable 7,000
Sales 7,000
Sold merchandise on account.
The related cash receipt on account is recorded as follows:
Jan. 20 Cash 7,000
Accounts receivable 7,000
Collected account in full.
Merchandise sold with value added tax (VAT) will be recorded using the
following pro-forma journal entry:
Accounts Receivable xxxx
Sales xxxx
Output Tax xx
Sold merchandise on account.

Page 27of F
Sales Returns and Allowances

Overview When the customer returns goods to the seller or requests for a deduction
from the price of the goods delivered to him, the seller accepts the return or
grants the request through a credit memorandum.

Entries The effect of a sales return or allowance is to reduce the amount of sales and
the amount of receivable from the customer. If Sales account is debited for
the return or allowance, then, the said account will show only net sales. To
preserve the gross amount of sales and to maintain a separate record for the
returns and allowances, the entry to record sales returns or allowances is:

Sales Returns and Allowances xxx

Accounts Receivable xxx
Return of goods.

If a cash sale is made and a return of a part thereof by the customer is

accepted, the seller may refund cash to the customer for which the
entry is:
Sales Returns and Allowances xxx
Cash xxx
Cash refund for good returned.

However, if cash is not refunded, then the entry will be

Sales Returns and Allowances xxx
Accounts Payable xxx
Customer credited for goods returned.

Page 28of F
Discounts on Sales

Overview Credit terms encountered in sales are similar to those discussed in accounting
for purchases. The following are illustrations on how to record sales
transactions with cash discount.

20X1
Jan. 4 Sold to Francis Asis merchandise worth P12,000 less 5.
Terms: 2/10, n/30
7 Francis Asis issued a debit memo worth P500 for defective
items received from Joseph
10 Made partial payment amounting to P5,000
14 Francis Asis settled account with Joseph in full

Journal Entries The following are the journal entries:

20X1
Jan. 4 Accounts receivable - Asis 11,400
Sales 11,400
Sold merchandise. Terms: 2/10,
n/30
7 Sales returns and allowances 500
Accounts receivable - Asis 500
Asis was credited for allowance
granted
10 Cash 5,000
Accounts receivable - Asis 5,000
Received partial payment
10 Cash 5,682
Sales discount 218
Accounts receivable - Asis 5,900
Asis settled account in full

Page 29of F
Freight on Merchandise

Overview Transportation or freight on merchandise purchased or sold is recorded as an

expense in the books of the party who, as per contract, should shoulder the
expense.

Shipping Freight-in is the title used in recording the freight or transportation charges
Terms on merchandise bought, and Freight-out, for the freight on merchandise sold.
The term of shipment that is contained in the bill of lading indicates whether
or not the buyer or the seller should assume the burden of the freight expense
(Punzalan, J., Santos, L., 1963). Merchandise may be shipped under the
following terms:
F.O.B shipping point means that the goods are free on board up to the
shipping point. Therefore, if the seller is in Davao and the buyer is in
Manila, the seller absorbs all transportation expenses up to the port of
Davao only. This also signifies that title to the goods already passes to the
buyer upon the loading of the goods onto the carrier at Davao.
F.O.B destination means that the goods are free on board up to the point of
destination. If the seller is in Davao and the buyer is in Manila, the seller
absorbs all transportation expenses of the goods up to Manila. The title of
the goods passes to the buyer only upon the unloading of the goods from the
carrier in Manila.
Freight prepaid means that the seller has paid the shipping company the
transportation expenses up to the point of destination.
Freight collect means that the buyer should pay the shipping company upon
the delivery of the goods at the point of destination.

Continued on next page

Page 30of F
Freight on Merchandise, Continued

Illustration Assume Mr. Vic Cruz of Davao sold to Joseph Labrador of Manila on
No. 1 account. The invoice showed the following:
Price of merchandise P 14,000
Freight (to Manila) 1,000
Total P 15,000
======

1. If the purchase is F.O.B shipping point, prepaid, the journal entry of

Joseph is:
Purchases P 14,000
Freight-in 1,000
Accounts Payable-Cruz 15,000
Purchased merchandise on account. FOB SP, prepaid.
Analysis: The transportation expense to Manila is the expense of Labrador.
In as much as Vic Cruz has advanced the amount of freight, then, the amount
payable to him should include the said amount of freight.
2. If the purchase is F.O.B shipping point, collect, the journal entries
of Labrador are:
Purchases 14,000
Account payable-Cruz 14,000
Purchased merchandise on account

Freight-in 1,000
Cash 1,000
Paid freight F.O.B. SP, collect

3. If the purchase is F.O.B. destination, prepaid, the journal entry of

Labrador is:

Purchases 14,000
Accounts payable-Cruz 14,000
Purchased merchandise on account.
Note: The freight is not reflected in the books of Labrador
because said expense is for the account of Cruz.

Continued on next page

Page 31of F
Freight on Merchandise, Continued

Illustration 4. If the purchase is F.O.B. destination, collect, the journal entries of

No. 1, cont. Labrador are:

Purchases 14,000
Accounts Payable-Cruz 14,000
Purchased merchandise on account.

Accounts Payable-Cruz 1,000

Cash 1,000
Paid freight F.O.B. destination, collect.
Note: Labrador is liable to pay Cruz only P13,000 (14,000-1,000).
In the foregoing transactions, the entries presented are all in the
books of the buyer. Now, using the same transactions, the
following are the entries in the books of the seller.

Illustration 1. If the sale is F.O.B. shipping point, prepaid, the journal entries of Cruz are:
No. 2

Account Receivable- Labrador 14,000

Sales 14,000
Sold merchandise on account.

Accounts Receivable- Labrador 1,000

Cash 1,000
Paid freight F.O.B. SP, prepaid
Note: Cruz advanced the amount of freight, which is supposed to
be paid by Labrador. Therefore, the amount receivable from Joseph
should include the amount of freight.

Continued on next page

Page 32of F
Freight on Merchandise, Continued

Illustration 2. If the sale is F.O.B shipping point, collect, the journal entry of Cruz is:
No. 2, cont.

Accounts Receivable- Labrador 14,000

Sales 14,000
Sold merchandise on account.
Note: The freight is not reflected in the books of Cruz because the
said expense is for the account of Labrador.
3. If the sale is F.O.B destination, prepaid, the journal entries of Cruz
are:
Accounts Receivable- Labrador 14,000
Sales 14,000
Sold merchandise on account
Freight-out 1,000
Cash 1,000
Paid freight F.O.B. Destination,
Prepaid
4. If the sale is F.O.B. Destination, collect the journal entries of Cruz
are:
Accounts receivable- Labrador 14,000
Sales 14,000
Sold merchandise on account

Freight-out 1,000
Accounts receivable- Labrador 1,000
F.O.B. Destination, collect.
Note: The total receivable of Cruz from Labrador will be 13,000
only (14,000-1,000), since the payment of freight was advanced by
Labrador.

Reminder It should be noted that both freight-in and freight-out represent expense.
However, freight-in is shown as an addition to net purchases because it is a
direct cost of procuring the merchandise bought. On the other hand, freight-
out is listed among the selling expenses

Page 33of F
Income Statement

Overview A merchandising business prepares its income statement using the functional.
The functional income statement contains several sections, subsections and
subtotals. The amount of the details presented in this section, e.g., the selling
expenses, general and administrative expenses, etc., varies from company to
company

Income Below are the terms used in the income statement:

Statement
Terminologies Revenue from Sales. The total amount charged to customers for
merchandise sold, for cash and on account, is reported in this section. Sales
returns and allowances and Sales discounts are deducted from this to yield
Net Sales.
Cost of Goods (Merchandise) Sold. The cost of merchandise sold during
the period may also be called Cost of Goods Sold or the Cost of Sales. It is
computed by adding to the beginning inventory the net cost of purchases to
yield Total Goods Available for Sale. The ending inventory is deducted
from the Total Goods Available for Sales to yield the Cost of Goods
(Merchandise) Sold.
The net purchases amount is computed by deducting purchase discount and
purchase returns and allowances from purchases. Net cost of purchases is
computed by adding freight-in to the net purchases amount.
Gross Profit. The excess of net sales over the cost of goods sold is called
gross profit. It is sometimes called gross profit on sales or gross margin.
.

Continued on next page

Page 34of F
Income Statement, Continued

Income Cont
Statement
Terms, cont Operating Expenses. Most merchandising businesses classify operating
expenses as either distribution expenses, administrative expenses or other
operating expenses. However, depending on the decision-making needs of
managers and other users of the financial statements, other classifications
could be used.
Expenses that are incurred directly in the selling of merchandise are
distribution expenses. They include such expenses as salespersons
salaries, store supplies used, depreciation of store equipment, and
advertising.
Expenses incurred in the administration or general operations of the
business are administrative expenses. Examples of these expenses are
office salaries, depreciation of office equipment, and office supplies used.
Expenses that are related to both administrative and selling functions may
be divided into the two classifications. In small businesses, however, such
expenses as rent, insurance, and taxes are commonly reported as
administrative expenses. Transactions for small, infrequent expenses are
often reported as Miscellaneous Selling Expense or Miscellaneous
Administrative Expense.
Expenses that cannot be traced directly as selling or administrative expenses
are identified as other expenses. Examples of these are the losses incurred
in the disposal of plant and other assets and Discount lost on the purchase
of plant assets.
Interest expense that results from financing activities is included in the
operating expenses after the other expenses as finance costs.

Continued on next page

Page 35of F
Income Statement, Continued

Income Cont
Statement
Terms, cont Other Income. Revenues from sources other than the primary operating
activity of a business are classified as other income or non-operating
income. In a merchandising business, these items include income from
interest, rent, and gains resulting from the sale of plant and other assets.
Net Income. The final figure on the income statement is called the net
income (or net loss). It is the net increase (or net decrease) in the owners
equity as a result of the periods profit-making activities.

Continued on next page

Page 36of F
Income Statement, Continued

Illustration Below is an illustration of a functional form income statement:

Note
Net sales revenue 1 P 200,000
Cost of sales 2 (145,000)
Gross profit P 55,000
Other income 3 3,000
Total income P 58,000
Operating expenses:
Distribution expenses 4 P 14,000
Administrative expenses 5 24,000
Other expenses 6 800
Finance Cost 7 1,200 (40,000)
Net income P 18,000

Notes to the The following are the notes to the functional form income statement:
Functional
Form

Note 1 - Net sales revenue

Gross sales P 207,000
Less: Sales Returns & Allowances P 5,000
Sales Discount 2,000 7,000
Net sales revenue P 200,000

Continued on next page

Page 37of F
Income Statement, Continued

Notes to the Functional Form (continued)

Note 2 - Cost of sales

Merchandise Inventory, Jan. 1 P 5,000
Add: Net cost of purchases
Purchases P 175,000
Less: Purchase Returns & Allowances P 3,000
Purchase Discounts 2,000 5,000
Net purchase P 170,000
Add: Freight-in 1,000 171,000
Cost of goods available for sale P 176,000
Less: Merchandise Inventory, Dec. 31 31,000
Cost of sales P 145,000
Note 3 - Other income
Rent Income P 1,500
Dividend Income 800
Interest Income 500
Gain on Sale of Furniture & Fixtures 200
Total other income P 3,000
Note 4 - Distribution expenses
Salesmen's Salaries and Commissions P 9,000
Representation and Entertainment 1,200
Depreciation - Store Equipment 1,000
SSS & Philhealth Premiums - distribution 900
Freight-out 800
Miscellaneous Distribution Expense 1,100
Total distribution expenses P 14,000
Note 5 - Administrative expenses
Salaries Expense P 15,000
Light, Water and Telephone 3,500
Uncollectible Accounts Expense 2,000
Depreciation Expense 1,500
SSS & Philhealth Premiums - Administrative 1,300
Miscellaneous Administrative Expense 700
Total administrative expenses P 24,000
Note 6 - Other expenses
Loss on Sale of Equipment P 800
==========

Note 7 Finance Cost

Interest Expense P 1,000
Discount Lost 200
Total finance cost P 1,200

Page 38of F