ACCOUNTING FOR

MERCHANDISING BUSINESS
 MERCHANDISING BUSINESS
• A merchandising business is an entity engaged in the
activities of BUYING and SELLING products.
• The main difference between a merchandising business
and a servicing business is the existence of physical
products sold to customers.
• Merchandising sells products to generate revenue while
servicing renders service to generate revenue.
• Merchandising is also different from manufacturing
because it does not produce its own product for sale. It
obtains products from a manufacturer or a supplier either
at the retail level or the wholesale level.
• In a service provider, the main source of
income is service revenues, while in
merchandising operations, the primary source
of income is the sale of merchandise of simply
Sales
 Account Titles
1. Merchandising Inventory or Inventory- (Real
Account, Debit)
- Assets which are held for sale in the ordinary
course of business.
2. Sales Revenue (Nominal Account, Credit)
-like service revenues, recorded when earned.
Earned means when the goods are transferred
from the seller to the buyer.
Sales may be made on credit or for cash
• Pro-forma entries:
Sales on Account:
Accounts Receivable xx
Sales xx
Cash Sale:
Cash xx
Sales xx
3. Sales Returns and allowances (Nominal
Account, Debit)
Sales returns occur when a dissatisfied customer
returns inferior, defective or damaged
merchandise sold.
The customer may return the goods to the seller
for credit if the sale was on account or for cash
refund if the sale was originally for cash.
• Alternatively, some customer may choose to
keep the merchandise if the seller is willing to
grant an allowance(deduction) from the
selling price, this is known as Sales Allowance.
• To give the customer a sales return or allowance,
the seller normally prepares a credit
memorandum. This document informs a customer
that a credit has been made to the customer’s
accounts receivable for a sales return or
allowance.
• For accounting purposes, sales returns and
allowances are combined in one account, Sales
Returns and Allowances. This account is a contra-
revenue account.
 Pro-forma Entries
• Sales Returns and allowances ( initial sale was
on account)
Sales Returns and Allowances xx
Accounts Receivable xx
• Sales Returns and allowances ( initial sale was
on cash)
Sales Returns and Allowances xx
Cash xx
4. Sales Discounts (Nominal Account, Debit)
-provided by seller to customers on credit for
prompt payment of the balance due.
- This incentive offers advantages to both
parties: The purchaser saves money, and the
seller is able to convert the accounts
receivable into cash earlier.
- This account is a contra- revenue account.
• Different credit terms may be agreed by the
seller and buyer.
• Example;
*2/10, n/30
This term is read as “2% cash discount if paid
within ten days, payable in 30 days”
*1/10 EOM (End-of-month)
This term is read as “1% cash discount within the
first 10 days of the next month.”
• Be aware that the cash discount, discount
period and the maximum time period for
paying the balance due may depend on the
agreement of the buyer and the seller. Also,
any discount is based on the invoice price less
any sales returns and allowances.
ILLUSTRATION
• Assume Domciel Store has an Accounts Receivable
balance of P3,500 from Mr. Sevilla with credit
terms of 2/10, n/30. On May 15, the last day of
discount period, Domciel store received payment
from Mr. Sevilla. The journal entry on May 15 by
Domciel (seller) store will be:
Cash 3,430
Sales Discount 70
Accounts Receivable 3,500
( To record collection within 2/10, n/30
discount period)
5. Purchases (Nominal Account, Debit)
- When merchandise is purchased for resale to customers.
Purchases is debited for the cost of the goods.
-However, not all purchases are debited to purchases
account. Purchases of assets acquired for use and not for
resale , such as supplies , equipment and similar items,
should be debited to specific asset accounts rather than to
purchases.
- Remaining purchased merchandise at the end of the
period will be closed to merchandise inventory account.
5. Purchases (Nominal Account, Debit)
Pro-forma entries ;
• Purchase on account
Purchases xx
Accounts Payable xx
• Cash Purchases
Purchases xx
Cash xx
6. Purchase Returns and allowances ( Nominal
Account, Credit)
-A sales return and allowance on the seller’s
books is recorded as a purchase return and
allowance on the books of the purchaser. The
purchaser initiates the requests for a reduction
of the balance due through the issuance of a
debit memorandum.
 Pro-forma Entries:
• Purchase Returns and Allowances( initial
purchase was on account)
Accounts Payable xx
Purchase Returns and Allowances xx
• Purchase Returns and Allowances( initial
purchase was on cash)
Cash xx
Purchase Returns and Allowances xx
7. Purchase Discounts (Nominal Account, Credit)
- A cash discount may be given to a buyer to pay
on time. The buyer calls this discount a purchase
discount.
 ILLUSTRATION
• Assume Domciel Store has an Accounts Receivable
balance of P3,500 from Mr. Sevilla with credit
terms of 2/10, n/30. On May 15, the last day of
discount period, Domciel store received payment
from Mr. Sevilla. The journal entry on May 15 by
Mr. Sevilla (buyer) store will be:
Accounts Payable P 3,500
Purchase Discounts 70
Cash 3,430
• If payment was made beyond the discount
period, the entry of the buyer would be:
Accounts Payable 3,500
Cash 3,500
8. Trade Discounts

• Are not cash discounts.

• These are deductions from the list price in
order to arrive at the invoice price which is the
amount actually charged to the buyer.
• Trade discounts are not recorded.
• Trade discounts are made by sellers to
persuade customers to buy their products
while cash discount is given to promote prompt
payment.
 Example
List Price P700,000
First Trade discount (30%x 700,00) (210,000)
490,000
Second trade discount (10%x490,000) (49,000)
Invoice Price 441,000
Cash discount (4%x441,000) (17,640)
Payment within the discount period P 423, 360
• Upon purchase, the journal entry will be:
Purchases 441,000
Accounts Payable 441,000
• Payment of purchase on account within the
discount period:
Accounts Payable 441,000
Cash 423,360
Purchase Discount 17,640
9. Freight Costs
-The seller or buyer must have a sales
agreement on who should pay the delivery
costs. Freight terms are expresses as either FOB
Shipping point or FOB destination.
-The letters FOB mean free on board.
• FOB SHIPPING POINT- means that the goods are placed
free on board the carrier by the seller, and the BUYER
pays the freight costs.
• FOB DESTINATION- means that the goods are placed free
on board at the buyer’s place of business and the seller
pays the freight.
• When a purchaser directly incurs freight costs, the
account FREIGHT-IN (TRANSPORTATION-IN) is debited. In
contrast, freight cost incurred by the seller on outgoing
merchandise are operating expenses to the seller. The
costs are debited to FREIGHT-OUT (DELIVERY EXPENSE).
• Pro-forma entries (freight costs)
Payment of freight, FOB shipping point
Freight-In xx
Cash xx
Payment of freight on goods sold, FOB Destination
Freight-Out xx
Cash xx
 Nominal Accounts of Merchandising Business
• Pro-forma Income Statement:
ABC Merchandising
Income Statement
For the Period ended December 31, 2017
Sales P 100,000
Less: Sales Returns and allowances P20,000
Sales Discounts 5,000 25,000
Net Sales P 75,000
Less: Cost of Sales* 60,000
Gross Profit P 15,000
Less: Operating Expenses:
Salaries Expense P6,000
Supplies Expense 1,500
Freight-Out 500 8,000
Net Income P7,000
• The cost of sales using periodic inventory system is computed
as follows:
Merchandising Inventory, Jan. 1, 2017 P xx
Add: Net purchases:
Purchases xx
Freight In xx
Purchase returns and allowances xx xx
Total Goods Available for Sale P xx
Less: Merchandise Inventory, Dec 31, 2017 xx
Cost of Sales P xx
Accounting for Inventories
There are two ways to record inventories:
• PERIODIC SYSTEM
• PERPETUAL SYSTEM
 PERIODIC INVENTORY SYSTEM

• This method is used when items being sold

have small peso value and have fast turnover.
• Business that usually use this method are
grocery stores, hardware and school/office
supplies store.
• The physical counting is done every end of the
accounting period.
• A. Periodic inventory system. Under this system the amount appearing in
the Inventory account is not updated when purchases of merchandise are
made from suppliers. Rather, the Inventory account is commonly updated or
adjusted only once—at the end of the year. During the year the Inventory
account will likely show only the cost of inventory at the end of the previous
year.
• Under the periodic inventory system, purchases of merchandise are
recorded in one or more Purchases accounts. At the end of the year the
Purchases account(s) are closed and the Inventory account is adjusted to
equal the cost of the merchandise actually on hand at the end of the year.
Under the periodic system there is no Cost of Goods Sold account to be
updated when a sale of merchandise occurs.
• In short, under the periodic inventory system there is no way to tell from the
general ledger accounts the amount of inventory or the cost of goods sold.
 PERPETUAL INVENTORY SYSTEM

• This method is used when items being sold have large

peso value and usually have slow turnover.
• This method is commonly used by car dealers and
jewelers.
• When using this method, records are maintained
through the use of stock cards. Stock cards show the
running balance of inventories flow.
• This system has greater internal control compared to
periodic system; however it would be very costly for
small retailers to use this method.
• B. Perpetual inventory system. Under this system the Inventory
account is continuously updated. The Inventory account is
increased with the cost of merchandise purchased from
suppliers and it is reduced by the cost of merchandise that has
been sold to customers. (The Purchases account(s) do not exist.)
• Under the perpetual system there is a Cost of Goods Sold
account that is debited at the time of each sale for the cost of
the merchandise that was sold. Under the perpetual system a
sale of merchandise will result in two journal entries: one to
record the sale and the cash or accounts receivable, and one to
reduce inventory and to increase cost of goods sold.
 PERIODIC PERPETUAL
A. Purchase of merchandise on account, P150,000
Purchases P150,000 Merchandise Inventory P150,000
Accounts Payable P150,000 Accounts Payable P150,000
B. Paid freight on the purchased goods, P10,000
Freight-In 10,000 Merchandise Inventory 10,000
Cash 10,000 Cash 10,000

C. Defective merchandise purchased returned to supplier, P15,000

Accounts Payable 15,000 Accounts Payable 15,000
Purchase returns and allowances 15,000 Merchandise inventory 15,000

D. Sale of merchandise on account, P200,000. Gross profit is 30%

Accounts Receivable 200,000 Accounts Receivable 200,000

Sales 200,000 Sales 200,000
Cost of Goods sold 140,000
Merchandise Inventory 140,000
(*The gross profit is 30%, which implies that 70% is
the cost of goods sold computed as 200,000x .70)
 PERIODIC PERPETUAL
E. Received returned goods from customer, 12,500. The cost of merchandise when sold is 70% or P8,750
Sales Returns and Allowances 12,500 Sales Returns and Allowances 12,500
Accounts Receivable 12,500 Accounts Receivable 12,500
Merchandise Inventory 8,750
Cost of goods sold 8,750
F. At the end of the period, physical count for inventory is to be adjusted to P32,500.
Merchandise Inventory, End 32,500 If all recording is made properly, no adjustment is
Income and Expense Summary 32,500 necessary since inventory count will reflect the
ending balance when posted.