Learnings Objectives:

At the end of this chapter, the learners should be able to:

1. describe the nature of transactions in a merchandising business;
2. record transactions of a merchandising business in the general and special journals;
3. post transactions to the general and subsidiary ledgers;
4. prepare a trial balance;
5. prepare adjusting entries; and
6. complete the accounting cycle of a merchandising business.
OPENING CASE
Jose Mercado’s photocopying business has been profitable. It has attracted a lot of clients and Jose has
already bought another photocopying machine and has requested his good friend Maria Lopez to help
out in business Seeing how successful his friend’s business has been, Maria also wanted operations to
set up her own business. She has decided to rent the vacant space beside Jose’s photocopying center,
but is still undecided on what type of business she is to put up. One day, while helping out at the
photocopying center, Maria overheard a group of students having the following conversation:
Student 1: How I wish the school bookstore would sell notebooks with the face of my favorite celebrity
on the cover!
Student 2: I agree with you. I wish they would also sell other school supplies with cool designs and cute
characters.
Student 3: And I don’t get why they run out of stock most of the time. Remember how we had to rush
after our class to ride a tricycle and go to the nearest mall in order to buy worksheets for our accounting
class the next day?
Student 1: Yes, I remember. That was really tiring, but right now, I’m hungry
Student 3: Oh, the photocopies are done! Lets go buy some snacks on our way home.
INTRODUCTION
The conversation she had just heard had given Maria the idea to open a Store which will sell school and
office supplies. She asked the assistance of Jose in accomplishing the requirements for a new business.
Two months later, Maria Merchandising started its operations.
In Chapter 8, you have learned the accounting cycle of a service l business, such as Jose’s photocopying
business. In this chapter, you will be oriented with the accounting cycle of a merchandising business,
such as Marias Merchandising. The following are the steps in the accounting cycle of a merchandising
business:
1. analyzing business transactions from source documents
2. journalizing
3. posting to the ledger
4. preparing trial balance
5. gathering adjustments then preparing a work sheet
6. preparing financial statements
7. journalizing and posting adjusting entries
8. journalizing and posting closing entries
9. preparing a post-closing trial balance
10. journalizing and posting reversing entries
Let us go through each step in the accounting cycle.

Step 1
Analyzing Business Transactions from Source Documents
Definition and Nature of Merchandising Business
Recall from Chapter 4 that merchandising business is one of the three forms of business organizations
according to activities. The primary purpose ot a merchandising business is to engage in the buying and
selling of goods or merchandise. Its normal operations consist of buying merchandise, selling
merchandise, billing customers, and collecting customer accounts. The cash collected from customers
would be used to buy a new set of merchandise so the process repeats.
Merchandise refers to an item bought by a business for the purpose of reselling it. It is referred to as
goods. For Maria Merchandising, its merchandise would be the supplies that it would be selling. The
merchandise would include notebooks, pens, rulers, folders, worksheets, and other school-related and
office-related supplies. Note that if Maria Merchandising would use these supplies in its business
operations, these would be considered as supplies of the business and not merchandise.
Merchandise that remains unsold at the end of the accounting periods known as merchandise inventory,
end which is more commonly referred to as stocks Ending merchandise is classified as a current asset in
the statement of financial position because it is expected to provide future benefits by being sold within
a period of one year. Once l sold, the business expects to receive cash from the customer.
Merchandise inventory, beginning refers to merchandise that remains unsold from the previous
accounting period and is expected to be sold this period. If sold within the previous accounting period,
beginning merchandise inventory forms part of cost of goods sold in the income statement. Cost of
goods sold or cost of sales is the amount of merchandise sold by the business for a given period of time.
It is computed by adding the net cost of purchases to beginning inventory to get the cost of goods
available or sale from which the ending inventory is deducted from. Net cost of Purchases is the total
amount of merchandise bought including shipping costs, but net of returns and discounts. Cost of goods
available for sale refers total amount of merchandise that the business can sell to its customers Or a
given period of time

The formula to compute for cost of goods sold presented below:

Merchandise Inventory, beginning XX
Add: Net cost of purchases XX
Cost of goods available for sale XX
Less: Merchandise Inventory, end XX
Cost of goods sold XX

In the income statement for a merchandising business, cost of goods

Sold is deducted from sales revenue in order to get gross profit. Operating expenses are then deducted
from gross profit to get the net income or loss for the period. Below is a comparison of this format with
the income statement format for a service business.

Observe that there are additional steps in the computation of net income for a merchandising business.
That is the reason why the l income statement format commonly used by merchandising l businesses is
known as the multi-step income statement while that of a service business is known as the single-step
income statement.
The multi-step income statement or commonly referred to as the functional form income statement
classifies costs and expenses according to their function or use. This means that salaries paid to
employees working in the office are office expenses, while salaries paid to employees working in the
store are store expenses. For purposes of income statement presentation, we group together all office
expenses in one category and all store expenses in another category.

The single-step income statement or commonly referred to as the natural form income statement
classifies costs and expenses according to their nature. This means that salaries paid to employees,
regardless of where employees work are combined in one Salaries Expense account for purposes of
income statement presentation. Sales revenue or sales is the amount of merchandise sold by a business
for a specific period of time. It is computed by multiplying the quantity of merchandise sold by the
selling price. Since a merchandising business is into buying and selling of merchandise, sales revenue is
the primary source of revenue in this kind of business. Gross profit is the difference between net sales
revenue and cost of goods sold. It refers to the income of the business after deducting cost of goods sold
but before deducting any other expenses. Service businesses do not need information on the gross
profit in its income statement because they do not need to buy a raw material or merchandise before
they can render service. They rely instead
On employees skills and talents in order to provide service, which means that service businesses also
incur operating expenses. Operating expenses refer to expenses incurred by businesses in their day-to-
day operations. Common examples relate to salaries, utilities, rent, supplies, insurance , transportation,
depreciation, delivery, and advertising. These are deducted from gross profit in order to determine the
net income or loss for a given period.
In a multi-step income statement, operating expenses are typically clasified into two. These are
distribution costs and administrative expenses. Distribution costs or selling expenses are expenses
incurred by the seller in order to place the merchandise in the hands of the buyer. These may be related
to the promotion, sale or delivery of the merchandise. Common examples of distribution costs are sales
salaries and commissions, advertising, depreciation on store equipment, store supplies used, rent on
store space, store utilities, delivery, and all other expenses incurred in the store.
Administrative expenses or general expenses are expenses incurred by the seller from day-to-day
operations of the business but are not directly related to selling activities. Common examples of
administrative expenses are office salaries, insurance on building, depreciation on office equipment,
office supplies used, rent on office space, office utilities and all other expenses incurred in the office.
Note that salaries, depreciation, supplies used, rent and utilities have been separately identified into
distribution costs and administrative expenses for purposes of income statement presentation.
Transaction: Merchandising Business
The transactions for a service business are similar to those in a merchandising business. Both types of
business generate revenues, incur expenses, collect bills, pay-off ligations, and enter into transactions
with individuals or other businesses. However, because of the differing nature of principal activity in
these businesses, the recording of transactions that relate to the primary source of revenue and related
costs are also different. The following transactions for a merchandising business are discussed in this
section:
1. purchase of merchandise
2. purchase returns and allowances
3. payment of freight
4. partial payment of account with supplier
5. full payment of account with supplier
6. sale of merchandise
7. sales returns and allowances
8. partial collection of customer account
9. full collection of customer account
10. purchase of supplies
11. purchase of property, plant, and equipment
12. incurrence of expenses
13. payment of expenses
14, Owner's investment of merchandise
15.owners withdrawal of merchandise
Purchase of merchandise.
In order to generate revenue in a merchandising
business, the business must be able to sell its merchandise. However, selling would not be possible if
there is no merchandise to sell in the first place. business merchandise may have been invested by the
owner into the business or may have been bought by the business from suppliers
Let us assume that there is no investment ot merchandise made by the Owner. This means that the
business has to purchase the merchandise from a supplier in order to make a sale. Suppliers provide the
business with merchandise that can be sold to its Customers. These can be manufacturers of the
merchandise, wholesalers, or retailers. Wholesalers are those who sell only in large quantity while
retailers may sell in smaller quantity. Both wholesalers and retailers are into merchandising businesses.
Can you think of examples of wholesalers and retailers?
In accounting, to purchase means to buy. In a merchandising business, There are two systems of
maintaining inventory. These are the periodic and the perpetual inventory systems.
The periodic inventory system is traditionally used by businesses selling many inexpensive goods.
Examples of these businesses would be supermarkets, convenience stores, hardware stores, and sari-
sari stores. Under this system, the updating of inventory is done periodically which is usually once or
twice a year through physical counting.
On the other hand, under a perpetual inventory system, the updating
Of inventory is done every tinme there are changes in the quantity of the goods. This system is
traditionally used by businesses selling few expensive goods. Examples of these businesses would be
jewelry stores, car dealers and furniture shops.