ACCOUNTING CYCLE OF MERCHANDIZING BUSINESS

1. Journalizing of transactions using general and special journals, namely; sales journals, purchase
journals, cash receipts, journals, and cash payments journals.
2. Posting the ledger, namely; general and subsidiary ledgers.
3. Preparation of trial balance.
4. Adjusting entries to include pre-payments, accrual, and deferral.
5. Worksheet preparation, and
6. Completing the accounting cycle of a merchandising business.

A merchandising company is an enterprise that buys and sells goods to earn a profit.
EXAMPLES:
 Mercury Drug
 Puregold
 ACE Hardware
 Grocery stores

Merchandise (or merchandise inventory) refers to the goods that are held for sale to customers in the
normal course of business. This includes goods held for lease.
EXAMPLES:
 Candies, canned goods, and noodles sold at grocery stores
 Juice, and biscuits sold in a grocery store

A merchandiser’s primary source of revenue is sales revenue of sale.

 TWO CATEGORIES OF EXPENSES FOR A MERCHANDISING COMPANY 

1. Cost of goods sold (COGS) – the total cost of merchandise sold during the period.
2. Operating expenses (OP) – expenses incurred in the process of earning sales revenue that is deducted from
gross profit in the income statement. Examples are sales salaries and insurance expenses.

Gross Profit (GP) is equal to Sales Revenue less the Cost of Goods Sold.
 The income measurement process for a merchandiser follows as:
Sales – COGS = Gross Profit – Operating Exp. = Net Income (Loss)

 THE OPERATING CYCLES FOR A MERCHANDISER 

Merchandising Company operating cycle (cash to cash) involves:
1. Buy merchandise inventory
2. Sell inventory
3. Obtain Accounts Receivable
4. Receive cash

JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING BUSINESS

Prior to the discussion on the journal entries, recall the first step in the accounting cycle discussed in the
previous chapter on financial and non-financial transactions.

Step 1. Transactions are identified and measured. At this stage, the documents used by the business are
analyzed to see whether these transactions have a financial impact or effect. Recall the rule that only financial
transactions are recorded and that the amount can be measured.

STEP 2. Is the Preparation of Journal Entries (Journalization)

 A merchandising company may use special and general journals to record its transactions.

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 SPECIAL JOURNALS
Some businesses encounter voluminous quantities of similar and recurring transactions, which may
create congestion if these transactions are recorded repeatedly in a single day or monthly in the
general journal. The use of special journals will eliminate this problem.

THE COMMONLY USED SPECIAL JOURNALS

1. Cash Receipt Journal – used to record all cash that had been received.
2. Cash Disbursements Journal – used to record all transactions involving cash payments.
3. Sales Journal (Sales on Account Journal) – used to record all sales on credit (on account)
4. Purchase Journal (Purchase on Account Journal) – used to record all purchases of
inventory on credit (or on account).

INVENTORY SYSTEMS
 Maintaining inventory items is a unique step in a unique set-up in a merchandising business.
TWO METHODS OF ACCOUNTING FOR INVENTORY
1. Perpetual Inventory System
2. Periodic Inventory System

Merchandising entities may use either of the following inventory systems:

1. PERPETUAL SYSTEM – Detailed records of the cost of each item are maintained, and the cost of each
item sold is determined from records when the sale occurs. For example, a car dealership has separate
inventory records for each vehicle.
 Record purchase of inventory
 Record revenue and record cost of goods sold when the item is sold.

2. PERIODIC SYSTEM – The cost of goods sold is determined only at the end of an accounting period. This
system involves:
 Record Purchase Inventory
 Record revenue only when the item is sold.
 At the end of the period, you must compute the cost of goods sold (COGS)
1. Determine the cost of goods on hand at the beginning of the accounting period (Beginning
Inventory = BI),
2. Add it to the cost of goods purchased (COGP),
3. Subtract the cost of goods on hand at the end of the accounting period
4. (Ending Inventory = EI) illustrate as follows:

BI + COGP = Cost of goods available for sale – EI = COGS

ADDITIONAL CONSIDERATIONS:
 Perpetual systems have traditionally been used by companies that sell merchandise with high
unit values such as automobiles, furniture, and major home appliances. With the use of
computers and scanners, many companies now use the perpetual inventory system.
 The perpetual inventory system is named because the accounting records continuously –
perpetually – show the quantity and the cost of the inventory that should be on hand at any
time. The periodic system only periodically updates the cost of inventory on hand.

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  A perpetual inventory system provides better control over inventories than a periodic inventory
since the record always shows the quantity that should be on hand. Then, any shortages from
the actual quantity and what the records show can be investigated immediately.

PERIODIC INVENTORY SYSTEM

 Recording purchases and related transactions under the Periodic Inventory System.

PURCHASE OF MERCHANDISE; PERIODIC SYSTEM

1. When merchandise is purchased for resale to customers, the account, Purchases, is debited for the cost
of goods purchased.
2. Like sales, purchases may be made for cash or on account (credit).
3. The purchase Is normally recorded by the purchaser when the goods are received from the seller.
 Each credit purchase should be supported by a purchase invoice.
 A purchase invoice received by the buyer is actually a sale invoice or a charge invoice prepared
by the supplier or vendor.
 Note that only purchases of merchandise are debited to the ‘Purchase’ account Acquisition
(purchases) of other assets; supplies, equipment, and similar items are debited to their
respective accounts.

PURCHASE RETURNS AND ALLOWANCES

 A purchaser may find the merchandise received to be unsatisfactory because the goods are:
 Damaged or defective
 Of inferior quality
 Not in accord with the purchaser’s specifications.
 The purchaser initiates the request for a reduction of the balance due to the issuance of a debit
memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the
seller’s account has been debited because of unsatisfactory goods.
 A return merchandise (A deduction from the purchase price when unsatisfactory goods are Kept) is
shown by the entry where ACCOUNTS PAYABLE is debited and PURCHASE RETURNS AND ALLOWANCE
is credited to show that the purchases were reduced with a return or an allowance.
 The Purchase Returns and Allowances account is a “contra purchases” account when merchandise is
returned to a supplier.

ACCOUNTING FOR THE FREIGHT COSTS

 The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting
the goods to the buyer’s place of business. The two most common arrangements for freight costs are
FOB SHIPPING POINR and FOB DESTINATION.
SHIPPING POINT
 Goods placed free on board (FOB) by the carrier by the seller.
 Buyer pays freight costs
 Freight-in is debited if the buyer pays freight.
 Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately.
Accounts Payable would be credited if on the account.
 Ownership over the goods is transferred to the buyer once it is out of the premises of the seller

FOB DESTINATION
 Goods placed free on board (FOB) at the buyer’s business.
 Seller pays freight costs
 Delivery Expense is debited if the seller pays freight on outgoing merchandise to a buyer. This is an
operating expense to the seller.
 Ownership over the goods is transferred to the buyer once the goods are delivered and received by
the buyer.
Recording sales and related transactions under the Periodic Inventory System.
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 SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER
 Revenues are reported when earned per the revenue recognition principle, and in a merchandising
company, revenue is earned when the goods are transferred from seller to buyer.
 All sales should be supported by a document such as a cash register tape (to provide evidence of cash
sales) or cash receipt, or official receipt for cash sales, and change invoice for credit sales, or sales on
account.
 One entry is made with each sale:
 DEBIT – Account Receivable (if a credit sale) or Cash (is a cash sale) which increases assets for
the sales amount
 CREDIT – Sales that increase revenues
 The sales account is credited only for sales of goods held for resale. Sales of assets not held for resale
(such as equipment, buildings, land, etc.) are credited directly to the asset accounts

FREIGHT TERMS: FOB DESTINATION – SELLER PAYS FREIGHT

 An entry is made when a seller pays the freight to deliver goods to a customer or buyer. If the buyer
will pay for the freight, no entry is made.
 DEBIT – Delivery Expense and Credit – Cash or Accounts Payable.

SALES RETURNS AND ALLOWANCES:

 Sales returns result when customers are dissatisfied with merchandise and are allowed to return the
goods to the seller for credit or funds.
 Sales Allowance results when customers are dissatisfied, and the seller allows a deduction from the
selling price.
 To grant the return and allowance , the seller prepares a credit memorandum to inform the customer
that a credit has been made to the customer’s account receivable.
 Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a
reduction to a particular account.
 A contra account is used, instead of debiting sales, to disclose the number of sales returns and
allowances in the accounts.
 This information is important to management as excessive returns and allowances suggest inferior
merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in the delivery of
shipments of goods.
 The normal balance of Sales Returns and Allowances is a debit.
 One entry is made with each sales return and allowance.

The entry to record the Sales Returns and Allowances:

 DEBIT – Sales Return and Allowances which decreases revenues for the amount of the sale.
 CREDIT – Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets.

SALES DISCOUNTS
1. A Sale Discount is the offer of a cash discount to encourage customers to pay the balance at an earlier
date.
2. An example of a discount term is commonly expressed as 2/10, n/30, which means that the customer
is given a 2% discount if payment is made in 10 days. After 10 days there is no discount, and the
balance is due in 30 days.
3. Sales Discounts is a contra revenue account with a normal debit balance.

Determining the Cost of Goods Sold under the Periodic Inventory System
 The Cost of Goods Sold under the periodic inventory system is determined at the end of the period
(monthly or yearly) by a short computation,

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 In a periodic inventory system, separate ledger accounts are maintained for various items composing
the cost of goods sold (Purchases, Purchase Returns and Allowances, Freight-in, and Purchase
Discount). At the end of an accounting period, a physical count of inventory is necessary to establish the
ending balance of the inventory.

COMPLETE ACCOUNTING CYCLE FOR A MERCHANDISE

AGILA MERCHANDISING - owned by LITO AGILA, sells ready-to-wear shirts and dresses to its
customers. It started its operations on January 1, 2016.

 The company issues the following documents:

 OFFICIAL RECEIPTS - for all cash collections.
 CHARGE SALES INVOICE - for all sales on account.
 CHECK VOUCHER - for all cash disbursement.
 Note that only purchases of merchandise are debited to Merchandise Inventory. Purchases of
other assets: (supplies, equipment, and similar items) are debited to their respective accounts.

THE FLOW OF INVENTORY COSTS

 Under the periodic inventory system, a physical count is necessary to determine the end balance of
merchandise inventory. After the count, the cost of these inventory items will compute. There are
instances that the unit prices for merchandise purchased are different.

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