Learning Packet Finacc1 W4

Ateneo de Zamboanga University
SCHOOL OF MANAGEMENT AND ACCOUNTANCY
DOCUMENT FINACC1 Learning Packet

COVERAGE Accounting for Merchandising Business
WEEKS COVERED Weeks 4
PREPARED BY Julius M. Apeluddin, C.P.A.
Learning Content:
1. Understanding the Merchandising Business
a. Definition of Merchandising Business
b. Types of Merchandising Business
c. Operating Cycle
2. Understanding Inventory
a. Definition and Recognition of Inventory
b. Transactions Involving Inventory
c. Flow of Cost
3. Accounting for the Inventory Systems

a. Periodic Inventory System
b. Perpetual Inventory System
c. Differences Between the Perpetual and Periodic
d. Closing the Cycle
C HA PT ER 1
What is a Merchandising Business?
It is a business engaged in the buying and selling of finished goods to earn profit. One
example is a retailer- selling goods directly to customers for their own consumption
How is it different from a Manufacturing Business?
Merchandising business only purchases their inventory goods for sale from other
business establishments, while Manufacturing business creates or makes its own inventory
goods from raw materials which when finished are sold to customers.
Types of Merchandising Business
A business may take one of the three legal forms:
Retail Wholesale
Owner Title Retailer Wholesaler
Source of Purchased Usually from a wholesaler Usually directly sourced from a
Inventories manufacturer
Inventory Quantities Sells in portions (small Sells in bulk (wholesale) to smaller
Sold quantities) to customers business (i.e., retailers or resellers)
Page 1 of 14
CONFIDENTIAL
All rights reserved. The use of this document as a whole or in part is restricted. This document has been prepared by the Accountancy Department of the Ateneo de
Zamboanga University. The reproduction and circulation of which without the entity’s written consent is strictly prohibited.
Operating Cycle
COLLECTION PURCHASING
Receipt of Inventory
SALE
Delivery of Inventory
The following are the activities within the operating cycle of a merchandising business:
1. Purchasing – is the activity of acquiring finished goods to be added into the

company’s inventory which are to be sold to customers. This include the following
sub-activities:
a. Forwarding of Purchase Orders
A purchase order is a commercial document issued by a buyer (which in this
case is the Merchandising Business) to a seller which documents the details
of goods to be purchased (i.e., description, quantity, etc.) including the agreed
purchase price.
b. Receiving of Goods Delivery

Goods are received through an issued shipping document (Receiving Receipt).
c. Receipt of Seller Invoice

Invoice is a commercial document issued by a seller to a buyer which
documents the details of the purchase to be paid by the Merchandising
Business.
2. Sale– is the activity of delivering finished goods or inventories to customers. This

includes the following sub-activities:
a. Receiving of Sales Orders
A sales order is a commercial document issued by a buyer to the seller (which
in this case is the Merchandising Business) which documents the details of
goods to be purchased (i.e., description, quantity, etc.) including the agreed
purchase price
Page 2 of 14
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b. Delivering of Inventories
c. Issuing Sales Invoice
3. Collection of Accounts – is the activity of receiving customer payments for the

equivalent of the selling price of goods delivered.
C HA PT ER 2
What is Inventory?
According to International Accounting Standards (IAS) 2 – Scoping:
Inventories include assets held for sale in the ordinary course of business (finished
goods), assets in the production process for sale in the ordinary course of business (work in
process), and materials and supplies that are consumed in production (raw materials). As
we are accounting for a Merchandising Business, we only deal with FINISHED GOODS as the
production of the goods are not within the normal operating cycle of the business.
How are Inventories recorded?
1. Initial Recognition
Inventories are recorded at COST. Cost includes all costs INCURRED for the purchase
of the goods i.e., purchase price of the goods, shipping costs, storage costs and other
relevant costs related to the purchase and retention of the inventories.
2. Subsequent Measurement
As a preview to your higher accounting subjects, IAS 2 determines that Inventories
maintained by the company are assessed later on to ensure accuracy of its valuation
since initial recognition. For the subsequent measurement, the Inventories may be
recorded at lower of Cost or Net Realizable Value (LCNRV).
Common Inventory Transactions
As discussed in Chapter 1, the Operating Cycle of a Merchandising Business includes

Purchase and Sale of goods or inventories. As such, there are financial transactions that
involve in the movement of inventories. Refer to the table below for each financial
transaction that is recorded with respect to inventories:
TRANSACTION
DESCRIPTION PURCHASING SALE
Transfer of Goods Ownership Purchase Sale
Return of Goods (due to defect or Purchase Return Sales Return
erroneous goods delivered)
Reduction on the goods price Purchase Discounts Sales Discounts
Delivery or Transit of Goods Freight
Page 3 of 14
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Flow of Cost
The flow of costs for a merchandising company is as follows. Beginning inventory plus the
cost of goods purchased is the cost of goods available for sale. As goods are sold, they are
assigned to cost of goods sold. Those goods that are not sold by the end of the accounting
period represent ending inventory.
Pro forma solution:
Beginning Inventory xxx

Add: Cost of Goods Purchased xxx
Cost of Goods Available for Sale xxx
Less: Cost of Goods Sold xxx
Ending Inventory xxx
To monitor and account for the flow of costs and the inventory transactions relevant to
inventories, companies utilize either of the two (2) inventory systems:
1. Perpetual Inventory System
2. Periodic Inventory System
C HA PT ER 3
PERPETUAL INVENTORY SYSTEM
To ground our minds on understanding the perpetual inventory system, let us first know
what perpetual means and why is it relevant in this inventory system. See screenshot below
As such companies keep detailed records of the cost of each inventory purchase and sale.
These records continuously—perpetually—show the inventory that should be on hand for
every item. Under a perpetual inventory system, a company determines the cost of goods
sold each time a sale occurs.
Page 4 of 14
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Examples where Perpetual Inventory System works best:

1. Automobile
Ford dealership has separate inventory records for each automobile, truck, and van on
its lot and showroom floor.
2. Fully-Automated Supermarkets
SM Supermarket uses bar codes and optical scanners to keep a daily running record of
every product (ranging from canned and packed food, toiletries, and others) that it
buys and sells.
To illustrate, this is how perpetual inventory system affects accounting for inventories:
This means that company will account for every movement of the inventory (from purchase to sale).
Pro-forma (Required Format) Journal Entries in each Financial Transaction:
As accountants, you need to remember that the perpetual inventory system requires
recording of any movement in inventories AT THE MOMENT THEY TRANSPIRE i.e.,
journal entries are recorded at REAL TIME.
TRANSACTIONS BUYER’S BOOKS SELLER’S BOOKS

Purchase merchandise Merchandise Inventory xxx Cash xxx
for cash Cash xxx Sales xxx
Cost of Goods Sold xxx

Merchandise Inventory xxx
Purchase merchandise Merchandise Inventory xxx Accounts Receivable xxx
on account Accounts Receivable xxx Sales xxx

Merch. Inventory xxx
Freight (A) Merchandise Inventory xxx None
Cash xxx
Page 5 of 14
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Purchase Returns and Accounts Payable xxx Sales Returns and

Allowances purchased Merchandise Inventory xxx Allowances xxx
on account (B) Accounts Receivable xxx

Purchase Returns and Cash xxx Sales Returns and
Allowances purchased Merchandise Inventory xxx Allowances xxx
for cash (or Refund) Cash xxx
(B)
Payment on account Accounts Payable xxx Cash xxx
within the discount Cash xxx Sales Discounts xxx
period (C) Merchandise Inventory xxx Accounts Receivable xxx
A. Freight (F.O.B. - Free on board)
Freight terms are expressed as either FOB shipping point or FOB destination. FOB shipping
point means that the seller places the goods free on board the carrier, and the buyer pays
the freight costs. Conversely, FOB destination means that the seller places the goods free on
board to the buyer’s place of business, and the seller pays the freight.
FOB Shipping Point – AS A BUYER FOB Destination – AS A SELLER

Will only impact the company if we’re the Will only impact the company if we’re the
BUYER. Thus, this is important to note for SELLER. Thus, this is important to note for
PURCHASES. SALES.
Transportation (Shipping) Costs will then Transportation (Shipping) Costs will then
be an ADDITION to the cost of our be an EXPENSE INCURRED to fulfill our
INVENTORIES. REVENUES.
Merchandise Inventory or Freight-In xxx Freight-Out or Delivery Expense xxx

Cash xxx Cash xxx
Page 6 of 14
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B. Returns and Allowances
RETURNS ALLOWANCES
The purchaser may return the goods to the The purchaser may choose to keep the
seller for credit if the sale was made on merchandise if the seller is willing to grant
credit, or for a cash refund if the purchase an allowance (deduction) from the
was for cash. purchase price. This transaction is known as
a purchase allowance
C. Discounts
Trade Discount is a deduction from the list price or catalog price (NOT INVOICE PRICE)
granted to customers to encourage purchase of goods or merchandise in big quantities or
volume. This is NOT RECORDED or SHOWN in the buyer’s or seller’s books. This is used to
conceal the true price of the merchandise from competitors.
Illustrative Problem (Trade Discount)
Spitz Co. bought merchandise from Terrier Co. for cash with a list price of P10,000 less 10%
and 5% trade discount.
Solution (1)
List Price PHP 10,000
Less: 10% Trade Discount (10,000 * 10%) 1,000
Balance 9,000
Less: 5% Trade Discount (9,000 * 5%) 450
Purchase or Sales Price PHP 18,550
Solution (2)
List Price x (100% - Trade Discount) x (100% - Trade Discount) x … = Purchase or Sales Price
PHP 10,000 * (100% - 10%) * (100% - 5%) = PHP 8,550
Journal Entries:
BUYER SELLER
Merchandise Inventory 8,550 Cash 8,550
Cash 8,550 Sales 8,550
Purchased merchandise for cash. Sold merchandise for cash.
*On both the buyer’s and seller’s books the list price and the trade discount were not reflected.
Thus, Trade Discounts are NOT RECORDED AS PURCHASE OR SALES DICOUNT.
Page 7 of 14
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Credit Terms specify the amount of the Cash Discount and time period in which it is offered.
They also indicate the time period in which the purchaser expected to pay the full invoice
price. Unlike, Trade Discounts, credit terms are recorded in the books of the buyer and the
seller, as these are accounted for AFTER the purchase or sale was made.
Below are the typical credit terms used by companies in typical purchase or sales:
• 3/15, 2/20, n/30 = 3% cash discount if paid within 15 days, 2% cash discount if paid
within 20 days and purchase price less returns and allowances if any is payable within
30 days from date of purchase.
• n/30 = no cash discount is available. Purchase price less returns and allowances if any,
is payable within 60 days from date of purchase.
• 2/10 EOM, n/60 = 2% cash discount if paid 10 days after the End Of the Month.
Purchase price less returns and allowances if any, is payable within 60 days from date
of purchase.
• EOM = no cash discount is available. Purchase Price less returns and allowances if any,
is payable at the end of the month.
Illustrative Problem (Credit Term or Cash Discount)
On July 1, Siamese Kat Merchandising purchased good from the Persian Kat Trading for
P70,000. Terms 3/10, 2/15, n/30 and Siamese Kat Merchandising paid on July 16.
3/10 2/15 n/30

3% discount if paid within 2% discount if paid within Discount is unavailable, and
10 days from purchase 15 days from purchase payable to paid in 30 days.
July 1--------------------July 11 July12-------------------July 16 July 17 and Onwards
3% discount 2% discount no discount
Solution
Purchase Price PHP 70,000
Less: 2% Cash Discount (70,000 * 2%) 1,400
Cash to be Paid if within 15 days PHP 68,600
Journal Entries:
BUYER SELLER
Merchandise Inventory 70,000 Accounts Receivable 70,000
Accounts Payable 70,000 Sales 70,000
Purchased merchandise on account. Sold merchandise on account.
Accounts Payable 70,000 Cash 68,600
Cash 68,600 Sales Discount 61,400
Merchandise Inventory Sales 70,000
Or Purchase Discount 61,400 Collected customer account.
Paid accounts payable.
Page 8 of 14
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Advantage and Disadvantage of Perpetual Inventory System
Advantage Disadvantage
Provides better control over inventories Costly
Since the inventory records show the A perpetual inventory system usually
quantities that should be on hand, the requires the use of inventory management
company can count the goods at any time to systems to facilitate efficient
see whether the amount of goods actually implementation which is costly. Example of
on hand agrees with the inventory records which is the use of scanners and barcodes in
groceries.
PERIODIC INVENTORY SYSTEM
For small- to medium- sized entities, the use of periodic inventory system is a more practical
option considering that they may not have the available capital to successfully implement
the system.
In a periodic inventory system, companies do not keep detailed inventory records of the
goods on hand throughout the period. Instead, they determine the cost of goods sold only
at the end of the accounting period—that is, periodically. At that point, the company takes
a physical inventory count to determine the cost of goods on hand.
To determine the cost of goods sold in this inventory system, the following steps are
necessary:
1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.
To illustrate, this is how perpetual inventory system affects accounting for inventories:
Pro-forma (Required Format) Journal Entries in each Financial Transaction:

Page 9 of 14
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Unlike the perpetual system, however, companies do not attempt on the date of sale to
record the cost of the merchandise sold. Instead, they take a physical inventory count at the
end of the period to determine:
1. the cost of the merchandise then on hand; and,

2. the cost of the goods sold during the period.
TRANSACTIONS BUYER’S BOOKS SELLER’S BOOKS

Purchase merchandise Purchase xxx Cash xxx
for cash Cash xxx Sales xxx
*No entry YET relating to Cost of

Sales at the date of the transaction*
Purchase merchandise Purchase xxx Accounts Receivable xxx
on account Accounts Receivable xxx Sales xxx

Freight Freight-In xxx None
Cash xxx
Purchase Returns and Accounts Payable xxx Sales Returns and

Allowances purchased Purchase Returns and Allowances xxx
on account Allowances xxx Accounts Receivable xxx

Purchase Returns and Cash xxx Sales Returns and

Allowances purchased Purchase Returns and Allowances xxx
for cash (or Refund) Allowances xxx Cash xxx

Payment on account Accounts Payable xxx Cash xxx
within the discount Cash xxx Sales Discounts xxx
period Purchase Discount xxx Accounts Receivable xxx
Page 10 of 14
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Normal Balances Check for New Account Titles Learned!
Account Title Normal Balance Treated As

Purchase Debit Asset
Freight In Debit Adjunct Asset
Purchase Returns and Allowances Credit Contra Asset
Purchase Discounts Credit Contra Asset
Sales Returns and Allowances Debit Contra Revenue
Sales Discount Debit Contra Revenue
* Adjunct accounts provide additional value to accounts.
DIFFERENCES BETWEEN PERPETUAL AND PERIODIC
ITEMS PERPETUAL PERIODIC

Recording of Purchases Recorded on a Purchase account
Recording of Purchase Recorded on a Purchase Returns
returns and allowances Recorded on Merchandise and Allowances account
Recording of Purchase Inventory account Recorded on a Purchase Discount
Discounts account
Recording of Freight Recorded on a Freight-In account
Recording of Cost of At the date of sale At year-end date
Goods Sold
CLOSING THE ACCOUNTING CYCLE
Adjusting Entries
A. Perpetual Inventory System
A merchandising company generally has the same types of adjusting entries as a service
company (Refer to Module 1). However, a merchandiser using a perpetual system will
require one additional adjustment to make the records agree with the actual inventory on
hand.
Why? At the end of each period, for control purposes, a merchandising company that uses a
perpetual system will take a physical count of its goods on hand. The company’s unadjusted
balance in Inventory usually does not agree with the actual amount of inventory on hand.
The perpetual inventory records may be incorrect due to recording errors, theft, or waste.
Thus, the company needs to adjust the perpetual records to make the recorded
inventory amount agree with the inventory on hand.
Page 11 of 14
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Illustrative Problem:
PW Audio Supply has an unadjusted balance of $40,500 in Inventory. Through a physical

count, PW Audio Supply determines that its actual merchandise inventory at December 31
is $40,000.
Adjusting Journal Entry:
Dec 31 Cost of Goods Sold 500.00

Merchandise Inventory 500.00
Adjusted inventory to physical count.
B. Periodic Inventory System
As discussed beforehand, inventory movements are not recorded at the date of sale (hence,
no cost of goods are recognized at the end of a calendar year). As such, we would have to
enter our adjusting entries to record the Cost of Goods Sold attributable for the calendar
year. The following pro-forma solution and journal entry are to be used:
Pro forma solution:

Normal Balance
Beginning Inventory xxx Debit
Add: Cost of Goods Purchased
Purchase xxx Debit
Freight-In xxx Debit
Purchase Returns and Allowances (xxx) Credit
Purchase Discounts (xxx) xxx Credit
Cost of Goods Available for Sale xxx
Less: Ending Inventory xxx Debit
Cost of Goods Sold xxx Debit
Adjusting Journal Entry:
Dec 31 Merchandise Inventory, Ending xxx

Purchase Discounts xxx
Purchase Returns and Allowances xxx
Merchandise Inventory, Beginning xxx
Purchases xxx
Freight-In xxx
Adjusted for cost of goods sold.
* In this adjusting journal entry, we are recording the Ending Inventory Balance, and Cost
of Goods Sold by closing all account relating to the inventory that are not reflective of the
total goods sold.
Page 12 of 14
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To simplify, imagine the following simple entries:
Dec 31 Cost of Goods Sold 10,000

Merchandise Inventory, Beginning 10,000
Recognizing all inventories kept in records as if all
have been sold.
Dec 31 Merchandise Inventory, Ending 2,000
Cost of Goods Sold 2,000
Reducing cost of goods for the inventories that are
still unsold per inventory count.
Pro-forma Solution T-Account
Cost of Goods Sold

Beginning Inventory 10,000 Dr. Cr.
Add: Cost of Goods Purchased - 10,000
Cost of Goods Available for Sale 10,000 2,000
Less: Ending Inventory 2,000 8,000
Cost of Goods Sold 8,000
Closing Entries
A merchandising company generally has the same types of adjusting entries as a service
company (Refer to Module 1). Additional focus is just provided to closing the COST OF
GOODS SOLD RELATING TO THE TOTAL SALES as an EXPENSE.
Pro-forma Closing Entries:
Dec 31 Sales xxx

Income Summary xxx
Closed revenue accounts to income summary.
Dec 31 Income Summary xxx
Cost of Sales xxx
Operating Expenses xxx
Administrative Expenses xxx
Closed expense accounts to income summary.
Dec 31 Income Summary xxx
Capital xxx
Closed income summary with net income.
Dec 31 Capital xxx
Income Summary xxx
Closed income summary with net loss.
Page 13 of 14
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Worksheet
REF ER E NC ES
Vera Cruz – Manuel, Z. (2014). 21st Century Accounting Process: Basic Concepts and
Procedures. Manila, Philippines: Zenaida Vera Cruz – Manuel.
Warren, C., Reeve, J., Duchac, J. (2015). Accounting (25th ed.). Pasig City, Philippines:
Cengage Learning Asia Pte Ltd..
Weygandt, J., Kimmel, P., Kieso, D. (2015). Accounting Principles (12th edition). Wisconsin,
USA.
Page 14 of 14
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Ateneo de Zamboanga University

SCHOOL OF MANAGEMENT AND ACCOUNTANCY

DOCUMENT FINACC1 Learning Packet

3. Accounting for the Inventory Systems

What is a Merchandising Business?

How is it different from a Manufacturing Business?

Types of Merchandising Business

A business may take one of the three legal forms:

1. Purchasing – is the activity of acquiring finished goods to be added into the

b. Receiving of Goods Delivery

c. Receipt of Seller Invoice

2. Sale– is the activity of delivering finished goods or inventories to customers. This

3. Collection of Accounts – is the activity of receiving customer payments for the

According to International Accounting Standards (IAS) 2 – Scoping:

How are Inventories recorded?

Common Inventory Transactions

As discussed in Chapter 1, the Operating Cycle of a Merchandising Business includes

Pro forma solution:

Beginning Inventory xxx

PERPETUAL INVENTORY SYSTEM

Examples where Perpetual Inventory System works best:

Pro-forma (Required Format) Journal Entries in each Financial Transaction:

TRANSACTIONS BUYER’S BOOKS SELLER’S BOOKS

Cost of Goods Sold xxx

Cost of Goods Sold xxx

Purchase Returns and Accounts Payable xxx Sales Returns and

Merchandise Inventory xxx

A. Freight (F.O.B. - Free on board)

FOB Shipping Point – AS A BUYER FOB Destination – AS A SELLER

Merchandise Inventory or Freight-In xxx Freight-Out or Delivery Expense xxx

B. Returns and Allowances

Illustrative Problem (Trade Discount)

PHP 10,000 * (100% - 10%) * (100% - 5%) = PHP 8,550

Thus, Trade Discounts are NOT RECORDED AS PURCHASE OR SALES DICOUNT.

Illustrative Problem (Credit Term or Cash Discount)

3/10 2/15 n/30

Advantage and Disadvantage of Perpetual Inventory System

PERIODIC INVENTORY SYSTEM

Pro-forma (Required Format) Journal Entries in each Financial Transaction:

1. the cost of the merchandise then on hand; and,

TRANSACTIONS BUYER’S BOOKS SELLER’S BOOKS

*No entry YET relating to Cost of

*No entry YET relating to Cost of

Purchase Returns and Accounts Payable xxx Sales Returns and

*No entry YET relating to Cost of

Purchase Returns and Cash xxx Sales Returns and

*No entry YET relating to Cost of

Normal Balances Check for New Account Titles Learned!

Account Title Normal Balance Treated As

DIFFERENCES BETWEEN PERPETUAL AND PERIODIC

ITEMS PERPETUAL PERIODIC

CLOSING THE ACCOUNTING CYCLE

A. Perpetual Inventory System

PW Audio Supply has an unadjusted balance of $40,500 in Inventory. Through a physical

Adjusting Journal Entry:

Dec 31 Cost of Goods Sold 500.00

B. Periodic Inventory System

Pro forma solution:

Adjusting Journal Entry:

Dec 31 Merchandise Inventory, Ending xxx

To simplify, imagine the following simple entries:

Dec 31 Cost of Goods Sold 10,000

Pro-forma Solution T-Account