1. The chart of accounts for a merchandising entity
The balance in the merchandise inventory account at
differs from that of a service entity. TRUE
2. The difference between revenues from sales and cost
of sales is operating income. FALSE
3. For cash sales, the operating cycle is from cash to
inventory to accounts receivable and back to cash.
FALSE
4. The bill of lading is a document prepared by the seller
detailing the terms of delivery. FALSE
5. A validated deposit slip indicates that cash and checks
were actually deposited. TRUE
6. Discounts offered to the buyer to encourage early
payment are trade discounts. FALSE
7. Cash discounts are called purchases discounts from
the buyer's viewpoint. TRUE8. The sales discounts
account is a contra-income account and will have a debit
balance. TRUE
9. A credit term of "2/10 n/30" means that the buyer
may deduct 2% from the invoice if payment is made
within 10 days from the end of the month. TRUE
10. Purchases returns and allowances is a deduction
from purchases. TRUE
11. The cost of merchandise purchased during the period
is determined by subtracting from the net purchases the
amount of transportation costs incurred during the
period. FALSE
12. The purchase of equipment not for resale should be
debited to the purchases account. FALSE
13. If the seller is to shoulder the cost of delivery, the
term is stated as F.O.B. destination. TRUE
14. The term freight prepaid or collect will dictate who
shoulders the transportation costs. TRUE15. The two
main systems for accounting for merchandise are
periodic and perpetual. TRUE
16. The perpetual inventory system requires recording
the cost of each sale as it occurs. TRUE
17. There is no need for a physical inventory count in
the perpetual inventory system. FALSE
18. The debit balance of the inventory account in the
trial balance under the periodic inventory system is the
amount of the inventory at the end of the current year.
FALSE
19. The ending inventory of one period is the
beginning inventory of the next period. TRUE
20.
the beginning of the period represents the cost of the
merchandise on hand at that time. TRUE
1. The operating cycle involves the purchase and sale of
inventory as well as the subsequent payment for
purchases and collection of cash. TRUE
2. A business can shorten its operating cycle by
increasing its percentage of cash sales and reducing its
percentage of credit sales. TRUE
3. Merchandise inventory could include goods that are
in transit. TRUE
4. An advantage of using the periodic inventory system
is that it requires less recordkeeping than the perpetual
inventory system. TRUE
5. The periodic inventory system relies on a physical
count of merchandise for its balance sheet amount.
TRUE
6. Under the periodic inventory system, cost of goods
sold is treated as an account. FALSE
7. The periodic inventory system provides an up-to-date
amount of inventory on hand. FALSE
8. Summing ending merchandise inventory and cost of
goods sold gives the cost of goods available for sale.
TRUE
9. A physical inventory is usually taken at the end of the
accounting period. TRUE
10. Under the periodic inventory system, purchases of
merchandise are not recorded in the Merchandise
Inventory account. TRUE
11. An entity would be more likely to know the amount
of inventory on hand if it used the periodic inventory
system rather than the perpetual inventory system.
FALSE
12. Taking a physical inventory refers to making a count
of all merchandise on hand at a particular time. TRUE
13. When the periodic inventory system is used, a
physical inventory should be taken at the end of the
fiscal year, TRUE
14. The income statement of an entity that provides
services only will not have cost of goods sold. TRUE
15. For a merchandising entity, the difference between
net sales and operating expenses is called gross margin.
FALSE
16. Sales Returns and Allowances is described asa
contra-revenue account. TRUE
17. On the income statement of a merchandising
concern, profit is the amount by which net sales exceed
operating expenses. FALSE
18. Transportation Out is included in the cost of goods
sold calculation. FALSE
19. Advertising Expense appears as a selling expense on
the income statement. TRUE
20. Transportation in is considered a cost of
merchandise purchased. TRUE
21. The difference between gross sales and net sales is
equal to the sum of sales discounts, and sales returns
and allowances.
22. When the terms of sale include a sales discount, it
usually is advisable for the buyer to pay within the
discount period. TRUE
23. The terms 2/10, n/30 mean that a 2% discount is
allowed on payments made over 10 but before 30 days
after the invoice date. TRUE24. Terms of 2/10, n/30 is
an example of a trade discount. FALSE
25. Goods should be recorded at their list price less any
trade discounts involved. TRUE
26. FOB shipping point means that the seller incurs the
shipping costs. FALSE
27. Under the perpetual inventory system, the cost of
merchandise is debited to Merchandise Inventory at the
time of purchase. TRUE
28. The Merchandise Inventory account is not affected
when a sales allowance is granted. TRUE
29. Ending merchandise inventory is included inthe
calculation of cost of goods available for sale.
30. Ending merchandise inventory for year 1
automatically becomes beginning merchandise
inventory for year 2. TRUE
31. The calculation of cost of goods available for sale
during the year is not affected by the previous year's
ending inventory. FALSE
32. The change in inventory level from the beginning to
the end of the year affects cost of goods sold. TRUE
33. Transportation in is treated as a deduction in the cost
of goods sold section of the income statement. FALSE
34. Under the periodic inventory system, the Purchases
account is used to accumulate all purchases of
merchandise for resale. TRUE
This is an authorization made by the buyer to the seller
to deliver the merchandises as detailed in the form.
PUCHASED ORDER
It is the discount taken by the buyer for the early
payment of an invoice. PURCHASE DISCOUNTS
The document issued by the seller authorizing the return
of merchandise or the grant of an allowance. CREDIT
MEMORANDUM
This document evidences the receipt of cash by the
seller. OFFICIAL RECEIPT
This transportation arrangement passes ownership to the
goods to the buyer only when the buyer receives the
merchandise. FOB DESTINATION
Under this inventory system, revenues from sales are
recorded when sales are made, but no attempt is made
on the sales date to record the cost of good sold.
PERIODIC INVENTORY SYSTEM
Under this inventory system, both of the sales amount
and the cost of good sold amount are recorded when
each item of merchandise is sold. PERPETUAL
INVENTORY SYSTEM
The document prepared by the seller of goods and sent
to a buyer detailing the specifics of sale. SALES
INVOICE
This discount encourages the buyer to purchase goods
because of markdowns from the list price. TRADE
DISCOUNTS
This is the shipping term if the buyer shoulders the
shipping costs. FOB SHIPPING POINTSOURCE
DOCUMENTS
What is merchandising?
 The word Merchandising came from
Merchant.
 The work of Merchant is to buy and sell.
 So Merchandising is to buy and sell products
in a reasonable price. Merchandising means
trading.
 In common sense in Garments Trade
Merchandising is [Buy (fabrics + accessories)
– Process – Sell]
Who is merchandiser?
The person who deals with Trade, he or she is a
Merchandiser.
The person who deals with the Garments Trade is a
Garments Merchandiser.
Merchandising businesses use various business forms
and documents to help identify the transactions that
should be recorded in the books. These source
documents contain vital information about the nature
and amount of the transactions. The more common
source documents along with their descriptions are
shown next page. Also, samples of some of these source
documents are to be found on the succeeding pages.
1. Sales invoice is prepared by the seller of goods and
sent to the buyer. This document contains the name and
address of the buyer, the date of sale and information-
quantity, description and price-about the goods sold. It
also specifies the amount of sales, and the transportation
and payment terms.
2. The bill of lading is a document issued by the carrier-
a trucking, shipping or airine-tht specifies contractual
conditions and terms of delivery such as freight terms,
time, place, and the person named to receive the goods
3. The statement of account is a formal notice to the
debtor detailing the accounts already due
4. The official receipt evidences the receipt of cash by
the seller or the authorized representative, it notes the
invoices paid and other details of payment.
5. Deposit slips are printed forms with depositor's name,
account number and space for details of the deposit. A
validated deposit slip indicates that cash and checks
with the supplied details were actually deposited or
credited to the account holder.
6. A check is a 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. The entity
issuing the check is the payor while the receiver is the
payee.
7. The purchase requisition is a written request to the
purchaser of an entity from an employee or user
department of the same entity that goods be purchased.
8. The purchase order is an authorization made by the
buyer to the seller to deliver the merchandise as detailed
in the form.
9. Receiving report is a document containing
information about goods received from a vendor. It
formally records the quantities and description of the
goods delivered.
10. A credit memorandum is a form used by the seller to
notify the buyer that his account is being decreased due
to errors or other factors requiring adjustments.
STEPS IN A PURCHASE TRANSACTION
Whenever a purchase or sale of merchandise occurs, the
buyer and the seller should agree on the price of the
merchandise, the payment terms and the party to
shoulder the transportation costs. Owners of small
merchandising firms may settle these terms informally
by phone or by discussion with the vendor's
representative. Most large businesses, however, follow
certain procedures when purchasing merchandise.
The procedures are as follows:
1. When certain items are needed, the user department
fills in a purchase requisition form and sends it to the
purchasing department.
2. The purchasing department then prepares a purchase
order after checking with the price lists, quotations, or
catalogs of approved vendors. The purchase order,
addressed to the selected vendor, indicates the quantity,
description, and price of the merchandise ordered. It
also indicates expected payment terms and
transportation arrangements.
3. After receiving the purchase order, the seller forwards
an invoice to the purchaser upon shipment of the
merchandise. The invoice-called a sales invoice by the
seller and a purchase invoice by the buyer-defines the
terms of the transaction.
4. Upon receiving the shipment of merchandise, the
purchaser's receiving department sees to it that the terms
in the purchase order are complied with, and prepares a
receiving report.
5. Before approving the invoice for payment, the
accounts payable department compares copies of the
purchase requisition, purchase order, receiving report
and invoice to ensure that quantities, descriptions, and
prices agree.
All of the above forms-purchase requisition, purchase
order, invoice, and receiving report--are source
documents. When the goods are received or when title
has passed, the entity should record purchases and a
liability (or a cash disbursement). Generally, the seller
recognizes the sales transaction in the records when the
goods have been shipped.
TERMS OF TRANSACTIONS
Merchandise may be purchased and sold either on credit
terms or for cash on delivery. When goods are sold on
account, a period of time called the credit period is
allowed for payment. The length of the credit period
varies across industries and may even vary within an
entity, depending on the product.
When goods are sold on credit, both parties should have
an understanding as to the amount and time of payment.
These terms are usually printed on the sales invoice and
constitute part of the sales agreement. If the credit
period is 30days, then payment is expected within 30
days from the invoice date. The credit period is usually
described as the net credit period or net terms. The
credit period of 30 days is noted as "n/30". If the invoice
is due ten days after the end of the month, it may be
marked "n/10 eom."
Cash Discounts
Some businesses give discounts for prompt payment
called cash discounts. If a trade discount is also offered,
cash discount is computed on the net amount after the
trade discount. This practice improves the seller's cash
position by reducing the amount of money in accounts
receivable. Cash discount is designated by such notation
as “2/10" which means the buyer may avail of a two
percent discount if the invoice is paid within ten days
from the invoice date. The period covered by the
discount, in this case--ten days, is called the discount
period.
Cash discounts are called purchase discounts from the
buyer's viewpoint and sales discounts from the seller's
point of view.
It is usually worthwhile for the buyer to take a discount
if offered although it may be necessary to borrow the
money to make the payment.
Trade Discounts
Suppliers furnish smaller wholesalers or retailers with
price lists and catalogs showing suggested retail prices
for their products. These firms, however, also include a
schedule of trade discounts from the listed prices to
enable the customer to determine the invoice price to be
paid.
Trade discounts encourage the buyers to purchase
products because of markdowns from the list price.
Trade discounts should not be confused with cash
discounts. This type of discount enables the suppliers to
vary prices periodically without the inconvenience of
revising price lists and catalogs.
There is no trade discount account and there is no
special accounting entry for this discount. Instead, all
accounting entries are based on the invoice price which
is obtained by subtracting the trade discount from the
list price.
Transportation Costs
When merchandise is shipped by a common carrier--a
trucking entity or an airline-the carrier prepares a freight
bill in accordance with the instructions of the party
making the shipping arrangements. The freight bill
designates which party shoulders the costs, and whether
the shipment is freight prepaid or freight collect.
Freight bills usually show whether the shipping terms
are FOB shipping point or FOB destination. F.O.B. is an
abbreviation for "free on board". When the freight terms
are FOB shipping point, the buyer shoulders the
shipping costs; ownership over the goods passes from
seller to the buyer when the inventory leaves the seller's
place of business--the shipping point. The buyer already
owns the goods while still in transit and therefore,
shoulders the transportation costs.
If the terms are FOB destination, the seller bears the
shipping costs. Title passes only when the goods are
received by the buyer at the point of destination; while
in transit, the seller is still the owner of the goods so the
seller shoulders the transportation costs. in freight
prepaid, the seller pays the transportation costs before
shipping the goods sold; while in freight collect, the
freight entity collects from the buyer. Payment by either
party will not dictate who should ultimately shoulder the
costs. Normally, the party bearing the freight cost pays
the carrier. Thus, goods are typically shipped freight
collect when the terms are FOB shipping point; and
freight prepaid when the terms are FOB destination.
The shipping costs borne by the buyer using the periodic
inventory system are debited to transportation in
account. In accounting, the cost of an asset--the
merchandise Inventory--includes all costs (e.g. shipping
costs) incurred to bring the asset to its intended use. In
the cost of sales section of the income statement, the
balance in this account is added to purchases in
computing for the net cost of purchases for the period.
Shipping costs borne by the seller are debited to
transportation out account. This account, which is also
called delivery expense, is an operating expense in the
income statement.
INVENTORY SYSTEMS
Merchandise inventory is the key factor in determining
cost of sales. Because merchandise inventory represents
goods available for sale, there must be a method of
determining both the quantity and the cost of these
goods. There are two systems available to
merchandising entities to record events related to
merchandise inventory: the perpetual inventory system
and the periodic inventory system. Refer to the appendix
of this chapter for the comparative illustrations.
Perpetual Inventory System The perpetual inventory
system is an alternative to the periodic inventory
system. Under the perpetual inventory system, the
inventory account is continuously updated. Perpetually
updating the inventory account requires that at the time
of purchase, merchandise acquisitions be recorded as
debits to the inventory account. At the time of sale, the
cost of sales is determined and recorded by a debit to the
cost of sales account and a credit to the inventory
account. With a perpetual inventory system, both the
inventory and cost of sales accounts receive entries
throughout the accounting period.
Many merchandising entities are now using the
perpetual inventory system with point- of-sale
equipment. Computers have decreased in prices. These
powerful machines have dramatically reduced the time
required to manage inventory. Supermarkets and
department stores use point-of-sale scanners built into
checkout counters to collect transactional data for the
cash register and to update their perpetual inventory
system. In the absence of point-of-sale scanners, the
perpetual inventory system is more advisable for firms
that sell low-volume, high-priced goods such as motor
vehicles, jewelry and furniture.
When an entity uses the perpetual inventory system, the
ending inventory should reconcile with the actual
physical count at the end of the period assuming that no
theft, spoilage, or error has occurred. Even if there is a
little chance for or suspicion of inventory discrepancy,
most entities make a physical count. At that time, the
account is adjusted for any inaccuracies discovered. The
count provides an independent check on the amount of
inventory that should be reported at the end of the
period.
Periodic Inventory System
The periodic inventory system is primarily used by
businesses that sell relatively inexpensive goods and
that are not yet using computerized scanning systems to
analyze goods sold. A characteristic of the periodic
inventory system is that no entries are made to the
inventory account as the merchandise is bought and
sold. When goods are purchased, a separate set of
accounts ---purchases, purchases discounts, purchases
returns and allowances, and transportation in-is used to
accumulate information on the net cost of the purchases.
Only at the end of the period, when the inventory is
counted, will entries be made to the inventory account
to establish its proper balance. The periodic inventory
system will be used in the succeeding discussions. To
illustrate
Gross Sales
Under accrual accounting, revenues from the sale of
merchandise are considered to be earned in the
accounting period in which the title of goods passes --
usually at the point of delivery--from the seller to the
buyer. Gross sales consist of total sales for cash and on
credit during an accounting period. Although cash for
the sale is uncollected, the revenue is recognized as
earned at the time of the sale. Forthis reason, there is
likely to be a difference between net sales and cash
collected from those sales in a given period.
As an income account, the sales account is credited
whenever sales on account or cash sales are made. Only
sales of merchandise held for resale are recorded in the
sales account. If a merchandising firm sold one of its
delivery trucks, the credit would be made to the delivery
equipment account, not to sales account.
Sales Returns and Allowances
Buyers may be dissatisfied with the merchandise
received either because the goods are damaged or
defective, of inferior quality or not in accordance with
their specifications in such cases, the buyer may return
the goods to the seller for credit if the sale was made on
account or for cash refund if the sale was for cash.
Alternatively, the seller may just grant an allowance or
deduction from the selling price, A high sales returns
and allowances figure is not commendable because it
may signal poor quality of goods and thus may result to
dissatisfied customers. Each return or allowance is
recorded as a debit to an account called sales returns
and allowances.
The seller usually issues the customer a credit
memorandum (i.e. Accounts Receivable or Cashis
credited), which is a formal acknowledgment that the
seller has reduced the amount owed by the customer.
Sales returns and allowances is a contra-income account
and is accordingly deducted from gross sales in the
income statement (see Exhibit 7-2).
COST OF SALES
Cost of sales or cost of goods sold is the largest single
expense of the merchandising business. Itis the cost of
inventory that the entity has sold to customers. Every
merchandising business has goods available for sale to
customers. The goods available for sale during the year
is the sum of two factors--merchandise inventory at the
beginning of the year and net cost of purchases during
the period.
If an entity is able to sell all the goods available for sale
during a given accounting period, the cost of sales
would then equal goods that had been available for sale.
In most cases, however, the business will have goods
still unsold at the end of the year. To find the actual cost
of sales, the merchandise inventory at the end of the
period is subtracted from the goods available for sale.
Merchandise Inventory
The inventory of a merchandising entity consists of
goods purchased for resale. For a grocery store,
inventory would be made up of meats, vegetables,
canned goods, and other items. For a lumber and
hardware, it would be plywood, nails, paints, iron
sheets, cement, tools, and other items. Merchandising
entities purchase their inventories from manufacturers,
wholesalers and other suppliers.
The merchandise inventory at the beginning of the
accounting period is called the beginning inventory.
Conversely, the merchandise inventory at the end of the
accounting period is called the ending inventory. As
presented in Exhibit 7-3, beginning and ending
inventories are used in calculating cost of sales in the
income statement. The ending inventory shown in the
income statement will be the merchandise inventory to
be reported in the balance sheet. Effectively, the ending
inventory of the current period will be the beginning
inventory of the next period.
Net Cost of Purchases Under the periodic inventory
method, net cost of purchases consist of gross purchases
minus purchases discounts and purchases returns and
allowances equals net purchases; plus transportation
costs.
Purchases
When the periodic inventory method is used,
allpurchases of merchandise are debited to the purchases
account as shown below: 15,000 15,000 Nov. 12
Purchases Accounts Payable To record purchases of
merchandise; terms 2/10, n/30. The purchases account, a
temporary account, is used only for merchandise
purchased for resale. Its sole purpose is to accumulate
the total cost of merchandise purchased during an
accounting period. Purchases of other assets such as
equipment should be recorded in the appropriate asset
accounts.
Recording merchandise purchases at invoice price is
known as the gross price method of recording
purchases.
Purchases Returns and Allowances
Sales returns and allowances in the seller's books are
recorded as purchases returns and allowances in the
books of the buyer. This should be recorded as follows:
Purchases returns and allowances is a contra account
and is accordingly deducted from purchases in the
income statement (see Exhibit 7-3). It is important that a
separate account be used to record purchases returns and
allowances because management needs the information
for decision making. It may be very costly to return
merchandise. There are costs that cannot be recovered
such as ordering costs, accounting costs, transportation
costs, and interest on the money invested in the goods.
There may also be lost sales resulting from poor
ordering or unsaleable goods. Frequent returns may call
for new purchasing procedures or suppliers.
Case No. 1. Assume that Christopher Biore Traders
made purchases totaling P17,000 FOB destination,
freight prepaid; terms 2/10, n/30. Transportation costs
amounted to P1,900. The entry would be: 17,000 17,000
Nov. 25 Purchases Accounts Payable Purchased
merchandise on account; terms 2/10, n/30; FOB
destination, freight prepaid. There is no debit to
transportation in account since the shipping term
provided that the seller should shoulder the
transportation costs. In addition, the seller prepaid the
VALUE-ADDED TAX ENTRIES
The foregoing entries for sales and purchases did not
incorporate the effect of value- added taxes on the
transactions to simplify the illustrations. But the
learning will not be complete without the following
illustration. Knowledge gained from this section will
prove useful in accomplishing the supplement to this
text, Kashato Shirts: A Practice Set for Basic
Accounting. illustration. Remedios Palaganas Feeds
based in Pangasinan trades specialty feeds for
OPERATING EXPENSES
Operating expenses make up the third major part of the
income statement for a merchandising entity. These are
expenses, otherthan the cost of sales, which are incurred
to generate profit from the entity's major line of
business--merchandising. It is customary to group
operating expenses into useful categories. Distribution
costs, administrative expenses and other operating
expenses are the categories. Distribution costs or selling
expenses are those expenses related directly to the
entity's efforts to generate sales. These include sales
salaries and commissions, and the related employer
payroll expenses; advertising and store displays;
traveling expenses; store supplies used; depreciation of
store property and equipment; and transportation out.

Purchases Discounts

Merchandise purchases are usually made on credit and

commonly involve purchases discounts for early
payment. In relation to the Nov. 12 and 14 transactions,
the payment is recorded as follows: 13,000 Nov. 22
Accounts Payable Purchases Discounts (P13,000 x 2%)
Cash 260 12,740 Like purchases returns and allowances,
purchases discounts is a contra account that is deducted
from purchases on the income statement. If the entity
makes a partial payment on an invoice, most creditors
will allow the entity to take the discount applicable to
the partial payment. The discount does not apply to
transportation or other charges that might appear on the
invoice.

Transportation in