Accounting Cycle: Part 2

Accounting for Merchandising Businesses

Service vs. Merchandising Operating Cycle

Operating cycle means the cycle in which the company acquires resources, enter into operation and realize
cash from the operation.
 In service businesses, the company performs services to its customers and receives cash from them,
which is to be used for more services to be performed
 In merchandising businesses, the company purchases inventory from suppliers, then sell it to its
customers and collects cash from inventory sales, which will be used to purchase more inventories.

Source Documents
• Contains vital information about the nature and amount of transactions.
• Used in analyzing transactions to be recorded in the books of accounts.

Examples of Source Documents

 Sales invoice
o Prepared by the seller of goods and sent to the buyer
o contains the name and address of the buyer, the date of sale and information-quantity,
description and price-about the goods sold.
o It also specifies the amount of sales, and the transportation and payment terms.
 Bill of lading
o document issued by the carrier (a trucking, shipping or airline) that specifies contractual
conditions and terms of delivery such as freight terms, time, place, and the person named to
receive the goods.
 Statement of account
o formal notice to the debtor detailing the accounts already due
 Official receipt
o Evidences the receipt of cash by the seller or the authorized representative
o Notes the invoices paid and other details of payment.
 Deposit slips
o Printed forms with depositor’s name, account number and space for details of the deposit.
o Once validated, cash was deposited to the account holder
 Checks
o Written order to a bank by a depositor to pay the amount specified in the check from his
checking account to the person named in the check.
o The entity issuing the check is the payor, while the receiver is the payee.
 Purchase requisition
 o written request to the purchaser of an entity from an employee or user department of the same
entity that goods be purchased.
 Purchase order
o authorization made by the buyer to the seller to deliver the merchandise as detailed in the form.
 Receiving report
o document containing information about goods received from a vendor. It formally records the
quantities and description of the goods delivered.
 Credit memorandum
o form used by the seller to notify the buyer that his account is being decreased due to errors or
other factors requiring adjustments.

Purchase Transaction

Note: Steps (3) and (4) may interchange or happen simultaneously depending on the date of occurrence. Note
that buyer records purchases when goods are received or the title passed on to them; while seller records
sales when goods are shipped.

Inventory System
• Perpetual inventory system
• Continuous update of inventory account every time purchases had been made, and a reduction
of inventory account at the time of sale
• Uses “inventory” account for net cost of purchases, and “cost of sales” account for sales
transactions
• Counting is done to ensure no inventory losses or discrepancies have occurred.
• Periodic inventory system*
• Counting of inventories are made periodically (usually at the time of reporting period) to update
the inventory balances
• Uses separate temporary accounts such as purchases, purchases discounts, purchases returns
and allowances and freight in for accumulating the net cost of purchases

Discounts
• Cash discounts – for prompt/early payment
• E.g. 2/10, n/30 (2% discount based on invoice price if paid within 10 days from the invoice date,
and credit period of 30 days/net 30 days)
• Trade discounts – used to encourage buyers to purchase products because of markdowns in the list
price (volume discounts)
• May be given one or in series

Illustrative example:
• Arman Merchandise purchased goods with a list price of P10,000 with trade discount of 10% and 10%.
Payment terms regarding the purchase is 3/10, eom (end of month).
• In this case, the invoice price will be P8,100*, and the cash discount available will be P243**.
• Supporting calculations:
• *P10,000 – (10% of P10,000) – (10% of [P10,000 – 10% of P10,000]); or P10,000 x 90% x 90%
• **P8,100 x 3%

Transportation costs (Freight)

 Freight/Transportation in – costs incurred in purchasing inventory (part of net cost of
purchases/inventory)
 Freight/Transportation out – costs incurred in selling inventory (selling expense/delivery costs)
 Terms Who shoulders the freight cost? Who pays the freight cost?
(shipping point – buyer; destination – (collect – buyer; prepaid –
seller) seller)

FOB shipping point, Freight Buyer Buyer

collect
FOB shipping point, Freight Buyer Seller
prepaid
FOB Destination, Freight Seller Buyer
collect
FOB Destination, Freight Seller Seller
prepaid

Financial Statements of Merchandising Businesses

Note: Only the income statement part will be discussed, other components are the same as to service
businesses.

Sample Pro-forma income statement:

Dizon General Merchandise
Income Statement
For the year ended December 31, 2019
in Pesos

Sales (Net) * xx
Less: Cost of goods sold/cost of sales ** xx
Gross profit xx
Less: Operating and other expenses:
Selling expenses xx
Gen. & Administrative expenses xx
Other expenses (Finance cost) xx xx
Net income xx

Net Sales:
Gross sales xx
Less: Sales discounts xx
Sales returns and allowances xx xx
Net sales xx

Cost of Sales/Cost of goods sold:

Beginning inventory xx
Add: Net cost of purchases:
Gross purchases xx
Less: Purchase returns and allowances xx
Purchase discounts xx xx
Net purchases xx
Transportation/Freight in xx
Net cost of purchases xx
Goods available for sale xx
Less: Ending inventory xx
Cost of sales/Cost of goods sold xx