6-1
6-2
Service Organizations vs.
Merchandising Companies
Service organizations sell time to earn
revenue
Examples include accounting firms, law
firms, and plumbing services
 These have been our emphasis up to now

Service Company
Income Statement
For the Year Ended December 31, 2019
Service revenues
Expenses
Net income
₱ 150,000
137,500
₱ 12,500
6-3
Service Organizations vs.
Merchandising Companies
Merchandising companies sell products
to earn revenue
Examples include sporting goods, clothing,
and auto parts stores
 These will be our emphasis for the rest of
the semester
Merchandising Company

Income Statement
For the Year Ended December 31, 2019
Sales revenues
Cost of goods sold
Gross margin
Expenses
Net income
₱ 150,000
80,000
70,000
46,500
₱ 23,500
6-4
6-5
Merchandising Companies
Transfers Products
Cash
or
Promise to Pay
Seller
Customer/
Buyer
6-6
Operating Cycle of Merchandising
6-7
Merchandising Companies

Inventory
Products held for sale
 Classified as asset


Sales
Exchange of merchandise for an asset
 Classified as revenue


Cost of Goods Sold (COGS)
Cost of inventory sold during the period
 Classified as expense

6-8
Merchandising Companies
“Channel of Distribution”
Manufacturer
Wholesaler
Retailer
Final
Customer
6-9
Accounting Terminology
Sales Invoice
vs.
Purchase Invoice
What’s the difference?
6-10
Recording and Reporting Sales
Gross sales
Less: Sales discounts
Less: Sales returns and allowances
Net sales
6-11
Recording Gross Sales
On May 13, TCom sold ₱25,000 of
merchandise for cash.
GENERAL JOURNAL
Date Description
May 13 Cash
PR
Debit
Page 74
Credit
25,000
Sales
25,000
To record the sale of
If the
sale hadfor
been
merchandise
cashon account, we would
debit Accounts Receivable instead of Cash.
6-12
Two Types of Discounts
Trade Discounts
A percentage deduction from the list or
catalog price to arrive at the gross selling
(invoice) price
 Not recorded on either seller’s or buyer’s
books!!

Example
FastBan, Inc. offers a 30% trade
discount if you purchase at least
1,000 of their most popular
product known as Zippy. Each
Zippy has a list price of ₱ 5.25.
Quantity sold
1,000
Price per unit
₱ 5.25
Total
5,250
Less 30% discount (1,575)
Invoice price
₱ 3,675
6-13
Two Types of Discounts
Cash Discounts
A deduction from the invoice price granted
to induce early payment of the amount
due
 Two other names for cash discounts

• Sales discounts
• Purchase discounts

Recorded on whose books?
• Both seller’s and buyer’s books

They are pervasive
6-14
Two Types of Discounts
Cash Discounts
A deduction from the invoice price granted
to induce early payment of the amount
due
 Two other names for cash discounts

3/15,n/30
• Sales discounts
• Purchase discounts
 Recorded
on whose
books?
Discount
Number
of
Otherwise,
• Both seller’s
and buyer’s
books
Percent
Days
Net (or
All)
Discount
is
is Due
 They are
pervasive
Available
In This
Number of
Days
6-15
Cash (Sales) Discount Example
On November 8, Borey Co. sold
merchandise to West, Inc. for ₱6,000 on
account; credit terms 2/10, n/30.
General Journal
Date
Description
Nov. 8 Accounts Receivable
Sales
To record the sale on account
PR
Debit
Page 61
Credit
6,000
6,000
6-16
Cash (Sales) Discount Example
On November 14, West, Inc. paid its
account in full.
General Journal
Date Description
Nov. 14
Cash
Sales Discount
PR
Debit
Page 68
Credit
5,880
120
Accounts Receivable
To record cash received on account
Discount = ₱6,000 × 2% = ₱120
6,000
6-17
Other Deductions from Sales

Sales Return
Merchandise returned by the buyer as
unsatisfactory or defective.

Sales Allowance
A deduction from the original invoice price
when the customer keeps merchandise
but is dissatisfied with it.
6-18
Sales Returns and Allowances
Example
Before making a payment to you, a customer
returns ₱135 of goods sold on account.
General Journal
Date Description
Sales Returns and Allowances
Accounts Receivable
To record return of defective item.
PR
Debit
Page 68
Credit
135
135
6-19
Partial Income Statement
Gross sales
Less: Sales discounts
Less: Sales returns and allowances
Net sales
Sales discounts and Sales
returns and allowances are
Contra Revenue accounts.
6-20
Inventory Methods
Perpetual Method
Periodic Method
6-21
Perpetual Method
The inventory account is continuously
up-dated as purchases and sales of
inventory occur.
6-22
Perpetual Method
The inventory account is continuously
up-dated as purchases and sales of
inventory occur.
6-23
Periodic Method
Entries are not made to the inventory
account during the year.
At the end of the accounting period, a
physical count of inventory is needed
to update the inventory account and
calculate cost of goods sold.
What is the mechanism for updating the
inventory account?
Closing entries
6-24
Closing Entries for
Merchandising Company
Closing Entry #1
General Journal
Date
Dec. 31
Description
Page 88
PR Debit Credit
Merchandising Inventory (ending)
Sales
XXX
XXX
Purchase Discounts
XXX
Purchase Returns and Allowances
Income Summary
XXX
To close accounts with credit balances and set
up proper balance in ending inventory account.
XXX
6-25
Closing Entries for
Merchandising Company
Closing Entry #2
General Journal
Date
Description
Page 88
PR Debit Credit
Dec. 31 Income Summary
Merchandising Inventory (beginning)
XXX
XXX
Sales Discounts
XXX
Sales Returns and Allowances
XXX
XXX
Other accounts including all expenses
To close accounts with debit balances including
the beginning inventory account.
6-26
Cost of Goods Sold
...is an expense representing the cost of the
inventory sold during the period.
...appears on the income statement.
...must be calculated using a multiple-step
process when using the periodic method.
6-27
Calculation of
Cost of Goods Sold
Multiple-Step Process
Beginning Inventory
+ Purchases
- Purchase Discounts
- Purchase Returns and Allowances
+ Transportation-in
= Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
6-28
Calculation of
Cost of Goods Sold
Formal Income Statement Presentation
Cost of goods sold:
Merchandise inventory, January 1, 2019
Purchases:
Less: Purchase discounts
₱ 3,000
Purchase returns and allowances
8,000
Net purchases
Add: Transportation-in
Net cost of purchases
Cost of goods available for sale
Less: Merchandise inventory, December 31, 2019
Cost of goods sold
₱ 24,000
₱167,000
11,000
156,000
10,000
166,000
190,000
31,000
₱159,000
6-29
Purchase of Merchandise
One May 7, Barbee, Inc. purchased
₱27,000 of merchandise on account;
terms 2/10, n/30.
General Journal
Date
May 7
Description
Purchases
Accounts Payable
Purchase merchandise on account
PR
Debit
Page 26
Credit
27,000
27,000
6-30
Purchase of Merchandise
One May 16, Barbee, Inc. paid for the
purchase of May 7 in full.
General Journal
Date Description
May 16 Accounts Payable
PR
Page 41
Debit
Credit
27,000
Cash
Purchase Discounts
Payment on account
₱27,000 × 2% = ₱540 discount
26,460
540
6-31
Purchase of Merchandise
One May 16, Barbee, Inc. paid for the
purchase of May 7 in full.
General Journal
Date Description
Purchase Discounts is a
May 16 Accounts
Payable
Contra
Purchases
PR
Page 41
Debit
Credit
27,000
account.
Cash
Purchase Discounts
Payment on account
₱27,000 × 2% = ₱540 discount
26,460
540
6-32
Purchase Returns and Allowances
The buyer returns, or accepts a reduction in
invoice price of, merchandise to the seller.
On May 27, Barbee, Inc. returns ₱200 of defective
merchandise purchased on account before
payment is made to the supplier.
6-33
Purchase Returns and Allowances
The buyer returns, or accepts a reduction in
invoice price of, merchandise to the seller.
On May 27, Barbee, Inc. returns ₱200 of defective
merchandise purchased on account before
payment is made to the supplier.
General Journal
Date
May 27
Description
Accounts Payable
Purchase Returns and Allowances
Returned defective merchandise
Page 88
PR Debit Credit
200
200
6-34
Transportation Costs
Transportation-In
Inward freight costs of acquiring
merchandise.
Transportation-In is
part of cost of goods sold!
6-35
Transportation Costs
Transportation Out/Delivery Expense
Outgoing freight costs that must be paid by
the seller.
Delivery Expense is a
selling expense on the
income statement!
6-36
Transportation Costs
Free on Board (FOB) Shipping Point.
 FOB Destination.
 Freight Prepaid
 Freight Collect

Who pays the
freight charges?
6-37
FOB Points
FOB what? (Pick one)
Shipping Point
Destination
ABC Wholesalers
6-38
FOB Points

FOB Shipping Point
“Free on board” at the shipping (selling) point
 Title passes to buyer upon shipment
 Buyer owns en route and...

• Ultimately bears the cost of the freight
• Assumes risk of loss in transit

FOB Destination
“Free on board” at the destination point
 Seller owns en route and...

• Ultimately bears the cost of the freight
• Assumes risk of loss in transit
6-39
Transportation Cost Summary
Terms
FOB Shipping Point - Freight Prepaid
FOB Shipping Point - Freight Collect
FOB Destination
- Freight Prepaid
FOB Destination
- Freight Collect
Initially
Pays
Ultimately
Bears
Expense
Seller
Buyer
Seller
Buyer
Buyer
Buyer
Seller
Seller
6-40
Transportation Cost Summary
Terms
FOB Shipping Point - Freight Prepaid
FOB Shipping Point - Freight Collect
FOB Destination
- Freight Prepaid
FOB Destination
- Freight Collect
Initially
Pays
Ultimately
Bears
Expense
Seller
Buyer
Seller
Buyer
Buyer
Buyer
Seller
Seller
6-41
Periodic Method
Prepare the journal entries for Jackson Co. Use
the periodic inventory method.
July 5, 2019
Purchased 1,000 units of inventory
for ₱25,000 cash.
July 9, 2019
Sold 300 units of inventory to a
customer on account for ₱35 per
unit.
6-42
Periodic Method
GENERAL JOURNAL
Date Description
July 5 Purchases
Cash
To record inventory purchases
PR
Debit
Page 1
Credit
25,000
25,000
At Cost
6-43
Periodic Method
GENERAL JOURNAL
Date Description
July 5 Purchases
PR
Debit
Page 1
Credit
25,000
Cash
25,000
To record inventory purchases
July 9 Accounts Receivable
Sales
To record inventory sales
300 units × $35 = $10,500
10,500
10,500
At Retail
6-44
6-45
Classified Income Statement:
Revenue
Earned from the sale of inventory
Sales
Less: Sales Discounts
Sales Ret. & Allow.
Net Sales
₱ 250,000
₱
3,000
1,500
4,500
₱ 245,500
Alternative way to express income
statement relationships?
Net sales = Gross sales - (Sales disc.+ SR&A)
6-46
Classified Income Statement:
Cost of Goods Sold
Three approaches to Cost of Goods Sold:
(1) Simplified Income Statement Approach
Beginning Inventory (BI)
“Purchases” (P)
Cost of Goods Avail. for Sale (GAS)
Less: Ending Inventory (EI)
Cost of Goods Sold (COGS)
(2) Equation Approach
COGS = BI + P - EI
₱ 55,000
176,500
231,500
64,000
₱167,500
6-47
Classified Income Statement:
Cost of Goods Sold
(3) Formal Income Statement Approach
Beginning Inventory
₱ 55,000
Purchases
₱ 175,000
Less: Purchase Discounts ₱ 6,000
Purchase Ret. & Allow. 2,500
8,500
Net Purchases
₱ 166,500
Add: Transportation-in
10,000
Net Cost of Purchases
176,500
Cost of Goods Avail. for Sale
₱ 231,500
Less: Ending Inventory
64,000
Cost of Goods Sold
₱ 167,500
6-48
Classified Income Statement:
Gross Margin
Gross Margin = Net Sales - COGS
Gross Margin is also called Gross Profit
Net Sales
Cost of Goods Sold
Gross Margin
₱ 245,500
167,500
₱ 78,000
6-49
Classified Income Statement:
Types of Operating Expenses
Selling Expenses
Administrative Expenses
6-50
Classified Income Statement:
Income from Operations
Gross margin
Operating expenses:
Selling expenses:
Sales salaries
₱ 26,000
Delivery expense
3,000
Advertising expense
2,000
Rent - store building
4,000
Depreciation - store equip.
2,500
Administrative expenses:
Executive salaries
29,000
Rent - office building
1,600
Insurance expense
1,500
Supplies expense
1,100
Total operating expenses
Income from operations
₱ 78,000
37,500
33,200
70,700
₱ 7,300
6-51
Classified Income Statement:
Types of Nonoperating Items
Nonoperating Revenues
Nonoperating Expenses
Income from operations
₱
Nonoperating revenues and expenses
Nonoperating revenues:
Interest revenue
Rent Revenue
Nonoperating expenses:
Interest expense
Safe deposit box rental
Net income
₱
7,300
400
2,000
(700)
100
9,100
6-52
Gross Margin Percentage
Percentage of each sales dollar available
to cover expenses and a profit
GROSS MARGIN
GM% = NET SALES
6-53