Unit 1
Accounting for Merchandising Business
Overview
Background
Merchandising business deals primarily with the buying and selling of
finished goods. This unit will introduce readers on the different activities done
by a trading business. A brief discussion of the perpetual inventory systems is
also included.
Purpose
The purpose of Unit I “Accounting for Merchandising Business ” is to
illustrate the various buying and selling activities of a trading business. This
unit also illustrates the basic entries using perpetual inventory system. A brief
discussion of business documents are also included to give readers ideas of
what are the basic papers being used that support a merchandising transaction.
In this unit
This unit contains the following topics:
Topics
Merchandising Business
Inventory System
Merchandise Accounts
Business Documents
Proprietor’s Investment and Withdrawal
Purchase of Merchandise
Purchase Returns and Allowances
Discounts on Purchases
Sales
Sales Returns and Allowances
Discounts on Sales
Freight on Merchandise
Income Statement
See Page
2 of F
3 of F
7 of F
9 of F
14 of F
15 of F
18 of F
20 of F
25 of F
27 of F
28 of F
29 of F
33 of F
Page 1of F
Merchandising Business
Overview
An organization that is engaged in the buying and selling of goods or
merchandise is a merchandising or trading concern. Merchandise refers to
goods purchased for resale in the same form. Unlike businesses rendering
services for compensation, a trading concern derives its income through the
resale at a profit of the merchandise purchased.
Activities
The activities of a merchandising concern that distinguish it from a service
concern cover the following:
•
Purchasing. Information as to the kind, quality, quantity, and cost of goods
bought should be maintained for the use of management. Records as to
supplies or merchandise bought are also maintained.
•
Handling. The costs of transporting and sorting of goods bear an important
relation to the prices of goods bought. These should be recorded properly.
Transportation costs include freight, express, drayage, and cartage.
•
Returning Of Goods Purchased. Some of the merchandise received may
prove unsatisfactory and must be returned to the vendors, or if not returned,
may be allowed some deductions from the original purchase price.
•
Selling. Goods purchased are sold at prices above the cost in order to
provide adequate margin of profit. It is therefore imperative that the cost of
goods bought should be known from the accounting records so that
desirable selling prices may be set.
•
Returning Of Goods Sold. The customers may return some of the
merchandise sold. Deductions from the original selling prices must be
allowed for sales returns. If the goods delivered are defective and no return
is made, the customers are granted reduction on the sales price.
•
Maintaining Adequate Stocks On Hand. In order to satisfy orders of
customers at all times, a stock of merchandise must be maintained on hand.
This is called Merchandise Inventory or Inventory on Hand
Page 2of F
Inventory System
Overview
A business firm selling a product must use an inventory record system to
value the merchandise on hand at the end of an accounting period. Two
different inventory systems may be used to record trading transactions in the
accounting records. These systems are the periodic and perpetual inventory
system.
Perpetual
In a perpetual inventory system a continual, or perpetual, record of the
inventory activity is maintained. Consequently, any items that are sold or
otherwise physically removed from inventory must be removed from the
Merchandise Inventory account, and items that are purchased are added to the
Merchandise Inventory account. This may result in significant extra record
keeping as compared to a periodic system. However, a perpetual inventory
system does have advantages, and businesses with a relatively low number of
high-value transactions often find the extra effort to be worthwhile.
Computers are also making it practical for businesses to use perpetual systems
than would have been not feasible in the past.
Periodic or
Physical
In the periodic inventory system, the ending inventory is determined by a
physical count of the merchandise on hand at the end of an accounting period.
The periodic inventory system receives its name because the balance in the
inventory account is known only at the beginning and at the end of the
accounting period. The periodic inventory is the simpler system commonly
used in practice and was the only practical alternative for most businesses
with large number of transactions before the advent of computers. The
periodic inventory system will be used in the illustrations throughout this
course unless otherwise stated.
Continued on next page
Page 3of F
Inventory System, Continued
Transactions in
Perpetual
Inventory
System
As mentioned earlier, a perpetual inventory system attempts to maintain a
continual record of the inventory on hand. Thus, if Joseph Labrador
purchased merchandise for cash, P50,000, the entry to record this transaction
is :
Merchandise Inventory
Cash
To record merchandise bought.
50,000
50,000
On the other hand, if Joseph sold P20,000 worth of merchandise for
P40,000, the entry to record this transaction is:
Cash
Sales
To record merchandise sold.
40,000
Cost of Goods Sold
Merchandise Inventory
To record the transfer of inventory sold
to cost of goods sold account.
20,000
40,000
20,000
Assuming this time, Joseph Labrador purchased from Mary Trading
merchandise on account, Php 100,000. And at the same time, paid for the
freight on the said purchase, Php 2,500. The entries would be:
Merchandise Inventory
Accounts Payable
To record merchandise bought.
100,000
Merchandise Inventory
Cash
To record freight paid.
2,500
100,000
2,500
Continued on next page
Page 4of F
Inventory System, Continued
Transactions in
Perpetual
Inventory
System, con’t.
Let us say, after two days, Joseph returned defective merchandise bought from
Mary amounting to Php 5,000. The entry would be:
Accounts Payable – Mary Trading
5,000
Merchandise Inventory
5,000
To record returned merchandise.
If on the other hand, Joseph Labrador sold to Michael Supermart merchandise
worth Php 50,000 on account at gross profit of 50 percent. The entries would
be:
Accounts Receivable
50,000
Sales
50,000
Sold merchandise on account.
Cost of Goods Sold
25,000
Merchandise Inventory
25,000
To record cost of merchandise sold.
Let us assume again that after three days, Michael issued a debit
memorandum amounting to Php 1,800 for defective goods received from
Joseph. The entries to record the return would be:
Sales Returns & Allowances
Accounts Receivable
Received debit memorandum.
Merchandise Inventory
Cost of Goods Sold
To record cost of good returned.
Importance
1,800
900
1,800
900
It is important to note that both periodic and perpetual inventory systems will
record the sale of merchandise similarly. The only difference is that under the
perpetual inventory system, there is a second entry that is required to be
recorded together with the sale to indicate the transfer out of the amount sold
from the Merchandise Inventory account to the Cost of Goods Sold account.
It is possible to combine the two entries into a single compound entry with the
same debits and credits. For example:
Cash
Cost of Goods Sold
Sales
Merchandise Inventory
To record merchandise sold.
40,000
20,000
40,000
20,000
Continued on next page
Page 5of F
Inventory System, Continued
Pro-forma
entry
At the end of the year, no further entries may be required if the balance in the
inventory account equals the actual cost of the units on hand. Unfortunately,
this seldom happens. Despite the extra effort necessary to maintain a
perpetual record of the inventory, the facts often differ from the records.
When the facts conflict with the records, the records must be corrected to
reflect the facts. Therefore, an adjusting entry is necessary to record any
missing inventory items and reduce the balance in the Inventory account to
the correct level. The pro-forma entry is:
Merchandise Inventory Short or Over
Merchandise Inventory
To adjust inventory account to actual balance.
xxx
xxx
Merchandise
Inventory
Short or Over
The Merchandise Inventory Short or Over account is an expense account that
reflects the cost of missing inventory items. However, depending on its
materiality and on normal practice within the industry, the inventory
shrinkage amount is often combined with cost of goods sold in the financial
statements.
Net Income
The net income disclosed on the income statements prepared under the two
inventory systems will reflect the same amount. This is also true with the
ending inventory balance reported in the balance sheet. A business that
combined its Merchandise Inventory Shrinkage account with its Cost of
Goods Sold account would prepare an income statement identical to the one
prepared under the periodic inventory system.
Page 6of F
Merchandise Accounts
Overview
The discussions on this topic are the account titles to be used in recording
acquisition and sale of merchandise of a trading business using the periodic
inventory system.
Sales
Sales of merchandise are recorded in this account at selling prices. This is a
temporary or nominal account representing income from selling of
merchandise. This account has a normal credit balance
Sales Returns
and Allowances
This account is debited for all the merchandise returned by customers. The
debit entry is at the original selling price of the merchandise. This account is
also being used for all goods delivered to customers but is found to be
defective or not as ordered and still the buyer desiring to retain the goods as
is. The customer in this case is normally permitted to deduct a certain amount
from the selling prices of the goods delivered.
Sales Discount
This account is debited in the book of the seller whenever the buyer avails of
the cash discounts provided by the seller. This is a deduction from sales
account.
Purchases
This is a temporary account to which the cost of goods bought during the
period is debited. This account usually has a debit balance at the end of the
accounting period.
Purchase
Returns and
Allowances
Goods bought and returned to supplier, or goods bought and received as
defective, or not as ordered, when not returned to the supplier but is
subjected to a certain reductions from their acquisition prices. These
deductions and returns of purchased goods are credited to this account.
Purchase returns and allowances account is a deduction from the Purchases
account.
Continued on next page
Page 7of F
Merchandise Accounts, Continued
Merchandise
Inventory
At the end of every accounting period, a physical count of the unsold
merchandise on hand is taken. The total amount of these goods on hand is
debited to the Merchandise Inventory account.
Purchase
Discount
This account is credited in the books of the buyer whenever the purchaser
avails of the cash discount given by the seller. This is a deduction from
Purchases account.
Freight In or
Transportation
In
If the buyer pays the expenses of transporting the goods from the place of the
seller to his place of business, such expenses are debited to the Freight-in
account.
Freight Out or
Transportation
Out
If the seller pays the expenses of transporting the goods from his place to the
place of the buyer, such expenses are debited to the Freight out account. This
is reported as part of operating expenses under the selling expenses
classification.
Page 8of F
Business Documents
Overview
All business transactions are evidenced or supported by printed forms or
documents. These business papers or oftentimes-called business documents,
furnish the information needed in recording the transactions. Without
business papers, it would be very difficult, if not impossible, to keep accurate
records of these transactions.
Official
Receipts
These are issued every time the business receives cash. They show the date
on which the cash is received, the party from whom the cash is received, the
amount received, the particulars of the transaction, and the signature of the
one who received the cash.
The sample given below is an official receipt of MDV Realty issued to Mayon
Grocery. From the point of view of MDV Realty, there was an increase in
both the asset cash and the income from rent. On the other hand, the asset
cash of Mayon Grocery decreased, while its rental expenses increased, thus
decreasing its proprietorship.
MDV REALTY
150 Rizal Avenue
Manila
OFFICIAL RECEIPT
No. __120____
Date ___June 30, 20X1______
RECEIVED from _____Mayon Grocery________ the sum of
_____Ten Thousand___ pesos (P10,000.00) in payment of ___July rental__.
Cash_____P10,000
Check No._
_________________________
(Cashier)
Continued on next page
Page 9of F
Business Documents, Continued
Sales Invoice
and Purchase
Invoice
After a sale has taken place, the seller fills in the business form called the
invoice. The invoice shows the date of the sale, name and address of the
seller, name and address of the buyer, terms of the sale, list of articles bought
with the unit price and entire cost of each, total amount of the invoice, and
method of shipment. Invoices are numbered and usually made out in triplicate
or quadruplicate. The original is given to the buyer. When the buyer receives
the goods, they are examined. Then the invoice is checked to determine
whether there are any discrepancies in quantity or price and any errors in
calculation. From the point of view of the seller, the invoice is a sales
invoice; from that of the buyer, it is a purchase invoice.
The sample given below shows that from the standpoint of the seller,
Diamond Grocery, the invoice price of P1,750 is the gross income from sales,
which covers the cost of the juice sold and the gross profit. There was an
increase in assets in the form of an amount receivable from Mayon Grocery,
there was an increase in cost of merchandise available for sale and an increase
in liabilities (the amount of P1,750 is payable within 30 days).
DIAMOND GROCERY
930 Del Monte Avenue
Quezon City
INVOICE
Sold to: ______Mayon Grocery____
Address __945 Mayon St., Q.C.____
Quantity
50 boxes
DESCRIPTION
Happy Orange Juice Drink
No. ___532___
Date ______June 10, 20X1_____
Term: ___Net 30 days _______
Unit Price
P 60.00
Amount
P 3,000.00
Continued on next page
Page 10of F
Business Documents, Continued
Credit
Memorandum
Whenever the buyer finds an error in an invoice, or when merchandise is
damaged, he should notify the seller at once. If his claim is admitted as valid,
the seller sends him a credit memorandum, which shows the amount by which
his account is reduced. Credit memorandum is often shortened to credit
memo.
The credit memo illustrated below shows that because of the return of two
boxes of Funchum juice drink, the gross income from sales of Diamond
Grocery decreased, and the amount receivable from Mayon Grocery (asset)
decreased. From the point of view of Mayon Grocery, the merchandise
available for sale and also the debt to Diamond Grocery decreased.
DIAMOND GROCERY
930 Del Monte Avenue
Quezon City
CREDIT MEMO
To: ______Mayon Grocery____
__945 Mayon St., Q.C.____
No. ___121___
Date ______June 15, 20X1_____
We have credited your accounts as follows:
Inv. No.
532
Explanation
Return of two boxes of slightly
defective Happy orange juice
drink.
Unit Price
P 35.00
Amount
P 70.00
Continued on next page
Page 11of F
Business Documents, Continued
Promissory
Notes
Php 10,000
A promissory note is a written promise signed by one party, called the maker,
to pay a certain specified sum to another, called the payee, at a certain future
time. The amount to be paid on maturity date may or may not include
interest. The amount due, not including interest, is called the face of the note.
Promissory notes may be received by the business from its debtors, or the
business may give it to its creditors. The following is a sample of a
promissory note.
Quezon City,
May 1, 20X1
Thirty days after date, I promise to pay to the order of Joseph Labrador, Ten
thousand Pesos, payable at COCOBANK, Vito Cruz Branch for value received with
interest at 12%.
(Signed) Maria de Jesus
Bank deposit
For control and safekeeping of cash most businesses maintain checking or
slips and checks current accounts with the banks. They deposit their money in banks and
payments from the deposit are then made by means of checks.
The bank deposit slip is filled in every time the business deposits money in
the bank. It shows the date when the deposit is made, for whose account the
deposit is made, the amount of the deposit classified into currency and checks
received from others, and the signature of the depositor.
Continued on next page
Page 12of F
Business Documents, Continued
Check
An order to the bank signed by the person issuing it, to pay to bearer or order
a certain sum of money. After the bank has paid the payee, the amount is
deducted from the deposit account of the one who issued the check.
Cash register
slips
Some cash registers are operated in such a way that a strip or slip of paper
comes out as evidence that money was received. The slip shows the date and
the amount of cash received.
Miscellaneous
bills
Some businesses, like the Meralco, Philippine Long Distance Telephone Co.,
MWSS, etc., send bills to their customers to notify them of the amounts they
have to pay. Thus, there are advertising bills, light bills, water bills, telephone
bills, and others.
Page 13of F
Proprietor’s Investment and Withdrawal
Overview
Owners of merchandising firms may want to invest merchandise into its
business operations. The following are the entries that would be recorded
under the periodic inventory system if the proprietor invests or withdraws
merchandise.
Investment of
merchandise
Recording of the investment of the owner in the business will be treated in the
same way the recording is done in a service business. The only difference
would be if the owner invested an asset into the business in the form of
merchandise. When merchandise is part of the owner’s initial investment, the
said investment must be debited to the Merchandise Inventory account
whether the company is using perpetual or periodic inventory system. But if
the investment of merchandise was made during the normal operation of the
business, i.e., as an additional investment, the said investment must be debited
to Merchandise Inventory, if the company is using perpetual inventory system
and Purchases if they are using the periodic inventory system.
Pro-forma entry: Initial investment under both methods:
Date Merchandise Inventory xxx
Owner, Capital
xxx
Investment made in the form of merchandise.
Pro-forma entry: Additional investment
Perpetual Method
Periodic Method
Date Merchandise Inventory xxx
Purchases
xxx
Owner, Capital
xxx
Owner, Capital
xxx
Investment made in the form of merchandise.
Page 14of F
Withdrawal of
merchandise
Any subsequent withdrawal made by the owner of any asset/s in the business
(e.g., cash, supplies, etc.) in anticipation of future profits of the company (i.e.,
temporary withdrawal) will be debited to the drawing account. Withdrawals
that are permanent in nature (i.e., the owner has no intention of returning the
said amount into the business) will be debited directly to the capital account.
If the company uses the periodic inventory system, withdrawals of the owner
in the form of merchandise for personal use will be credited to the Purchases
account at cost. This is done in order to maintain the original balance of the
Merchandise Inventory account, which was computed by means of actual
physical count at the end of the accounting period. On the other hand, the
Merchandise Inventory account is credited if the firm uses the perpetual
inventory system.
Pro-forma entry: Periodic inventory system/Temporary withdrawal
Date
Owner, Drawing
xxx
Cash
xxx
Purchases
xxx
Owner withdrew cash and merchandise for
personal use.
Pro-forma entry: Perpetual inventory system/Temporary withdrawal
Date
Owner, Drawing
xxx
Cash
xxx
Merchandise Inventory
xxx
Owner withdrew cash and merchandise for
personal use.
Pro-forma entry: Permanent withdrawal
Date
Owner, Capital
xxx
Cash
xxx
Owner permanently withdrew an amount in the
business for personal use.
Page 15of F
Purchase of Merchandise
Overview
When a firm sells goods or services, it gives a sales slip or sales invoice to its
customers. This sales invoice becomes a purchase invoice as far as the
purchasing business is concerned. The purchase invoice provides the
objective information used to record purchasing transactions. In small
business firms, the only written document received or handled in purchases of
goods or services is this invoice. For such businesses, authorization for
purchases is given informally by telephone or by having an employee
personally purchases goods or services. In this part, we would be dealing with
transactions affecting the firm’s acquisition of the merchandise for sale. As
we have mentioned earlier, all our business transactions must be properly
supported by business documents.
Purchase
Requisition
Large companies rely on a more careful procedure. As a first step they may
insist that the person or department needing the goods or services to be
purchased fill out a form called a purchase requisition. This completed form,
bearing the signature of some responsible person authorized to approve such
requisitions, is next sent to the purchasing agent or purchasing department of
the company.
Purchase
Order
The purchasing department, after selecting the firm from whom the goods or
services are to be bought, prepares a second business paper called a purchase
order. The original copy of this document is sent to the company from which
the purchase is to be made. This copy gives the selling business authority to
send the purchaser the goods or services ordered.
Purchase
Invoice
About the same time that shipment of the goods is made or services are
supplied to the purchaser, the purchaser is sent an invoice that is the third
business paper. This purchase invoice becomes the basis for recording the
purchase in the journal just as it is in the case of the informal procedure
described for small firms.
Continued on next page
Page 16of F
Purchase of Merchandise, Continued
Purchases
The cycle of a merchandising entity begins with cash, which is used to
purchase inventory. Purchases, in the accounting sense, are only those items
of merchandise inventory that a firm buys to resell to customers in the normal
course of business. For example, a bookstore records in the purchases
account the price it pays for books, school and office supplies, and other items
of inventory acquired for resale. A grocery store debits purchases when it
buys canned goods, meat, frozen food and other inventory.
Below is a sample purchase invoice:
DE ASIS TRADING
2401 Taft Avenue
Manila
Sold to : Labrador Store
Address : Blk 28, Lot 24 St. Charbels, Cavite
How shipped : FOB Destination, prepaid
Quantity
Description
10 dozen
Lady’s Sando
10 dozen
Men’s Undershirt
10 pcs.
Girl’s Dress
Prepared by :
----------------
Checked by :
----------------
Invoice No. 143
Date : Jan. 7, 20X1
Terms 2/10, n/30
Unit Price
Amount
25
P 3,000.00
40
4,800.00
95
950.00
P 8,750.00
=========
Approved by:
-----------------
Continued on next page
Page 17of F
Purchase of Merchandise, Continued
Journal Entries
The purchase made on credit by Labrador Store is recorded in the general
journal as follows:
Jan. 5 Purchases
8,750
Accounts Payable - De Asis Trading
8,750
Purchased under wears and children’s dresses. Terms: 2/10,n/30.
If the above purchase was made on cash basis instead of on credit, then the
journal entry of Labrador Store will be:
Jan. 5 Purchases
Cash
Cash purchases from De Asis Trading.
8,750
8,750
If the above purchase was made with down payment of P4,000 and the
balance on account, then the journal entry of Labrador Store will be:
Jan. 5 Purchases
8,750
Cash
4,000
Accounts Payable
4,750
Various purchases. Terms: 4,000 down, balance, 2/10, n/30.
Merchandise purchased with value added tax (VAT) is recorded using the
following pro-forma journal entry:
Purchases
Input Tax
Accounts Payable
Purchased merchandise on account.
xxxx
xx
xxxx
Page 18of F
Purchase Returns and Allowances
Overview
Merchandise purchased for resale would not always be as what the buyer
expects. In this regard, buyers can return goods purchased due to a lot of
reasons, for example, due to defects, wrong specifications, poor quality, etc.
Debit
Memorandum
When merchandise bought is returned, or an allowance is requested, the buyer
informs the seller in writing. The communication is done usually through the
buyer’s printed business form called debit memorandum. An illustration of
such a form is shown below:
Labrador Store
Blk 28, Lot 24 St. Charbel’s
Dasmarinas, Cavite
No. 8
DEBIT MEMORAMDUM
To
Date : Jan. 8, 20X1
: De Asis Trading
2401 Taft Ave., Manila
We DEBIT your account for the following:
2 pcs.
5 pcs.
1 pc.
Lady’s Sando
Men’s Undershirt
Girl’s dress
P25
40
95
P 50
200
95
-------P 345
=====
Remarks: The above goods were received in damaged-condition as per your
invoice No 143 dated Jan. 5, 2001.
Continued on next page
Page 19of F
Purchase Returns and Allowances, Continued
Credit
Memorandum
If the return is accepted or the allowance is granted by the seller, the seller
usually sends to the buyer such acceptance or grant in writing through a
printed form called credit memorandum. A credit memorandum may in
similar form as the debit memorandum above except for the change of the
word debit to credit. Upon receipt of this communication, the buyer makes an
entry for the returns or allowances
Illustration
Assume the following transactions:
Jan. 8, 20X1 - Labrador Store returned P343 worth of merchandise to De Asis
Trading. This was accepted by De Asis Trading (see sample
debit memorandum).
Journal entry to record the return:
Jan. 8 Accounts Payable - De Asis Trading
Purchase returns and allowances
Merchandise returned to De Asis Trading.
345
345
Note: As a result of the returns, the debt to De Asis Trading was diminished,
thus, the seller’s account was debited.
The return was credited to purchase returns and allowances account instead of
directly against purchases in order to have the books show total purchases
and total returns and allowances.
If the purchase of January 5 was in cash, the return of goods worth P343 on
Jan. 8 may result in a refund of cash from De Asis Trading. If no cash refund
is made, then Labrador Store will have a receivable from the De Asis Trading
which may be collected or applied to purchases in the future.
Jan. 8 Cash
Purchase returns and allowances
Cash refund for the return of goods
345
345
However, if the return on Jan. 8 was not refunded in cash, then the journal
entry should have been:
Jan. 8 Accounts Receivable - De Asis Trading
345
Purchase returns and allowances
To charge De Asis Trading for goods returned.
345
Page 20of F
Discounts on Purchases
Overview
Buyers of merchandise can avail of two types of discounts, namely, the cash
discount and trade discount. This part will provide readers on how to record
discounts on merchandise purchased.
Cash Discounts
Special deductions from the prices of goods bought granted by the seller to the buyer
to induce the latter to pay within a specified period.
Example:
Jan. 5, 20X1
Labrador Store bought merchandise from De Asis Trading
P8,750. Terms: 2/10, n/30
The terms of the above transaction mean that if the invoice is paid within 10 days
after the date of the invoice (Jan. 6 to 15), Labrador Store may pay the invoice
amount less a discount of 2%. This is computed as follows:
Amount of invoice
Less: 2% thereof
Amount to be paid
P8,750
175
P8,575
======
If payment is not made within 10 days, then Labrador Store should pay the full
amount of the invoice, P8,750, within 30 days from the date of the invoice.
If the invoice remains unpaid after 30 days, it is said to be past due and, usually, the
amount begins to earn interest from the 31st day.
Other examples of terms attached to a credit invoice are:
5/10, n/30
- There is a 5% discount if paid 10 days after invoice date, net
amount if paid beyond the 10 days but within 30 days.
2/10, 1/15, n/30 - There is a 2% discount if paid 10 days after invoice date, 1%
discount if paid within fifteen days, net amount if paid beyond
15 days but within 30 days.
2/5EOM, n/45 - There is a 2% discount if paid 5 days after end of the month, net
amount if paid beyond 5 days after end of month but within 45
days from the invoice date.
2/10, n/EOM
n/60
- There is a 2% discount if paid 10 days after invoice date, net
amount if paid beyond the 10 days but up to end of the month
only.
- No cash discount is offered. The full amount must be paid within
60 days from invoice date.
Cash discounts are computed on the amount of the bill less returns and allowance, if
any. The base amount should be that which pertains only to merchandise.
Discounts are ordinarily not allowed on incidental expenses such as freight,
insurance while in transit, taxes, duties, and other charges.
Continued on next page
Page 21of F
Discounts on Purchases, Continued
Recording of
Cash Discounts
Below are sample transactions involving the recording of cash discounts:
Transactions
20X1
Jan.
4 7 14 18 21 -
31 -
Mary Store purchased merchandise from Uniwide Trading,
P10,000. Terms: 2/10, n/30
Mary Store made a partial payment of P5,000 to Uniwide
Trading
Mary Store paid in full its account to Uniwide Trading
Mary Store purchased merchandise from SM Superstore
worth P25,000. Terms: P10,000 down payment, balance
2/10, 1/15, n/30.
Mary Store returned to SM Superstore P500 cost of
merchandise acquired on Jan. 18. SM Superstore in return
issued a credit memo with the
same amount-signifying
acceptance of the return made by Mary.
Mary Store settled in full its account with SM.
Continued on next page
Page 22of F
Discounts on Purchases, Continued
Recording
con’t
Continuation of the recording of discounts:
Journal Entries:
20X1
Jan.
4 Purchases
10,000
Accounts Payable - Uniwide
Merchandise purchased.
Terms:
2/10,n/30.
7 Accounts Payable - Uniwide
Cash
Partial Payment.
5,000
14 Accounts Payable - Uniwide
Cash
Purchase Discounts
Full payment.
5,000
18 Purchases
Cash
Accounts Payable-SM
Bought merchandise. Terms:
2/10,1/15/n/30.
25,000
21 Accounts Payable - SM
Purchase Returns and Allowances
Received CM for merchandise
returned.
31 Accounts Payable - SM
Purchase Discounts
Cash
Settled account in full.
10,000
5,000
4,800
200
10,000
15,000
500
14,500
500
145
14,355
NOTE: The cash discount in the last entry was computed on the net amount
after deducting the returns.
Continued on next page
Page 23of F
Discounts on Purchases, Continued
Trade
Discounts
Deductions from the list prices of merchandise offered by the seller to the
buyer to encourage the latter to buy in bulk or large volume/quantity. This is
a strategy being adopted by the seller to promote the sale of the merchandise.
A list price may be subjected to one or more trade discounts
Illustration
Trade Discounts and Cash Discount Illustrated:
a. Assume a credit invoice of P3,000 less 10. Terms: 2/10,n/30.
List price
Less: trade discounts(3,000x10%)
Net invoice price
Less: Cash discounts(2,700x2%)
Amount due if payment is made with in 10 days
P3,000
300
P2,700
54
P2,646
=====
b. Assume a credit invoice of P5,000 less 10-5. Terms: 2/10,n/30.
List price
Less: First trade discounts(5,000x10%)
Less: Second trade discounts(4,500x5%)
Net Invoice price
Less: Cash discounts(4,275x2%)
Amount due if payment is made w/in 10 days
P5,000.00
500.00
P4,500.00
225.00
P4,275.00
85.50
P4,189.50
========
Continued on next page
Page 24of F
Discounts on Purchases, Continued
Journal Entries
The journal entries on buyer’s book for (b):
At the time of purchase
Purchases
Accounts Payable
Purchased merchandise on account.
4,275.50
Payment within 10 days
Accounts Payable
4,275.50
Purchase discounts
Cash
Settled accounts in full with in discount
period
Payment beyond 10 days
Accounts Payable
Cash
Paid account in full.
Summary
4,275.50
4,275.50
85.50
4,189.50
4,275.50
The purchase invoice is the business document generated by a purchase
transaction. Most merchandising entities offer discounts (i.e. cash and trade
discounts) to their customers. Trade discounts are not recorded in the books
of both buyer and seller. While cash discounts are recorded in the buyer’s
book under the account title Purchase Discount. The Purchase Discount
account, which has a credit balance, is a contra account to Purchases.
Most businesses allow their customers to “return” merchandise that is
defective, damaged in shipment, or otherwise unsuitable. Or if buyer chooses
to keep damaged goods, the seller may deduct an allowance from the amount
the buyer owes. Similar to purchase discount, Purchase Returns and
Allowances, the account title used to record returns and allowance granted, is
also a contra purchases account.
Page 25of F
Sales
Overview
The sale of merchandise may be for cash or on account. An invoice supports
every sale. The seller’s sales invoice is the buyer’s purchase invoice. When
a sale is for cash, the seller receives money in return for his merchandise.
When the sale is made on credit, the seller acquires a receivable or right to
collect from the buyer.
The preceding discussion on methods of recording merchandise inventory
transactions stated that under the periodic inventory method, purchases
represent the cost of merchandise bought. Sales, on the other hand, represent
the selling price of merchandise previously bought and then sold. In the
income statement (See sample on page 36 of F), Sales is shown as an income
item from which the cost of goods sold (consisting of merchandise inventory
beginning and end and net cost of purchases), was deducted, the difference
being the gross profit. Therefore, sales represents income, which covers both
the cost of merchandise, sold and gross profit (or gross loss). In the following
discussions, it was assumed that merchandise is sold normally at a profit, i.e.,
the selling price of the merchandise sold is greater than its cost.
It is very important to note that a purchase and sales transaction involve two
parties; namely, the buyer and the seller. Furthermore, a business acts
sometimes as a buyer and sometimes a seller.
The analysis of a purchase and sale transaction would depend on whether the
business for which the accounting work is being done, is playing the role of a
buyer or that of a seller. The treatment therefore, for cash discount and
returns and allowances on this part will also be similar to that discussed under
purchases, only this time the account titles to be used would be Sales discount
and Sales returns and allowances.
Continued on next page
Page 26of F
Sales, Continued
Cash Sales
Retailers like drug stores, sari-sari stores, department stores and restaurants
will at times sell their merchandise on cash basis. Assuming Mary Store sold
P5,000 worth of merchandise for cash, this cash sale is recorded as follows:
Jan. 10
Sales on
Account
Cash
Sales
Cash Sales.
5,000
5,000
Most business establishments are now extending credit to their customers to
become competitive. In the advent of what we call “plastic money”, i.e.,
credit cards, selling on account has been the current trend whether you are a
manufacturing business, wholesaler or retailer. Assuming Mary Store sold
merchandise worth P7,000 on account. The transaction is recorded as
follows:
Jan. 13
Account receivable
7,000
Sales
7,000
Sold merchandise on account.
The related cash receipt on account is recorded as follows:
Jan. 20
Cash
7,000
Accounts receivable
7,000
Collected account in full.
Merchandise sold with value added tax (VAT) will be recorded using the
following pro-forma journal entry:
Accounts Receivable
Sales
Output Tax
Sold merchandise on account.
xxxx
Page 27of F
xxxx
xx
Sales Returns and Allowances
Overview
When the customer returns goods to the seller or requests for a deduction
from the price of the goods delivered to him, the seller accepts the return or
grants the request through a credit memorandum.
Entries
The effect of a sales return or allowance is to reduce the amount of sales and
the amount of receivable from the customer. If Sales account is debited for
the return or allowance, then, the said account will show only net sales. To
preserve the gross amount of sales and to maintain a separate record for the
returns and allowances, the entry to record sales returns or allowances is:
Sales Returns and Allowances
Accounts Receivable
Return of goods.
xxx
xxx
If a cash sale is made and a return of a part thereof by the customer is
accepted, the seller may refund cash to the customer for which the
entry is:
Sales Returns and Allowances
Cash
Cash refund for good returned.
xxx
xxx
However, if cash is not refunded, then the entry will be
Sales Returns and Allowances
Accounts Payable
Customer credited for goods returned.
xxx
xxx
Page 28of F
Discounts on Sales
Overview
Credit terms encountered in sales are similar to those discussed in accounting
for purchases. The following are illustrations on how to record sales
transactions with cash discount.
20X1
Jan. 4
7
10
14
Journal Entries
Sold to Francis Asis merchandise worth P12,000 less 5.
Terms: 2/10, n/30
Francis Asis issued a debit memo worth P500 for defective
items received from Joseph
Made partial payment amounting to P5,000
Francis Asis settled account with Joseph in full
The following are the journal entries:
20X1
Jan.
4 Accounts receivable - Asis
Sales
Sold merchandise. Terms: 2/10,
n/30
7 Sales returns and allowances
11,400
11,400
500
Accounts receivable - Asis
500
Asis was credited for allowance
granted
10 Cash
5,000
Accounts receivable - Asis
5,000
Received partial payment
10 Cash
Sales discount
5,682
218
Accounts receivable - Asis
5,900
Asis settled account in full
Page 29of F
Freight on Merchandise
Overview
Transportation or freight on merchandise purchased or sold is recorded as an
expense in the books of the party who, as per contract, should shoulder the
expense.
Shipping
Terms
Freight-in is the title used in recording the freight or transportation charges
on merchandise bought, and Freight-out, for the freight on merchandise sold.
The term of shipment that is contained in the bill of lading indicates whether
or not the buyer or the seller should assume the burden of the freight expense
(Punzalan, J., Santos, L., 1963). Merchandise may be shipped under the
following terms:
•
F.O.B shipping point means that the goods are free on board up to the
shipping point. Therefore, if the seller is in Davao and the buyer is in
Manila, the seller absorbs all transportation expenses up to the port of
Davao only. This also signifies that title to the goods already passes to the
buyer upon the loading of the goods onto the carrier at Davao.
•
F.O.B destination means that the goods are free on board up to the point of
destination. If the seller is in Davao and the buyer is in Manila, the seller
absorbs all transportation expenses of the goods up to Manila. The title of
the goods passes to the buyer only upon the unloading of the goods from the
carrier in Manila.
•
Freight prepaid means that the seller has paid the shipping company the
transportation expenses up to the point of destination.
•
Freight collect means that the buyer should pay the shipping company upon
the delivery of the goods at the point of destination.
Continued on next page
Page 30of F
Freight on Merchandise, Continued
Illustration
No. 1
Assume Mr. Vic Cruz of Davao sold to Joseph Labrador of Manila on
account. The invoice showed the following:
Price of merchandise
Freight (to Manila)
Total
P 14,000
1,000
P 15,000
======
1. If the purchase is F.O.B shipping point, prepaid, the journal entry of
Joseph is:
Purchases
P 14,000
Freight-in
1,000
Accounts Payable-Cruz
15,000
Purchased merchandise on account. FOB SP, prepaid.
Analysis: The transportation expense to Manila is the expense of Labrador.
In as much as Vic Cruz has advanced the amount of freight, then, the amount
payable to him should include the said amount of freight.
2. If the purchase is F.O.B shipping point, collect, the journal entries
of Labrador are:
Purchases
Account payable-Cruz
Purchased merchandise on account
Freight-in
Cash
Paid freight F.O.B. SP, collect
14,000
14,000
1,000
1,000
3. If the purchase is F.O.B. destination, prepaid, the journal entry of
Labrador is:
Purchases
Accounts payable-Cruz
Purchased merchandise on account.
14,000
14,000
Note: The freight is not reflected in the books of Labrador
because said expense is for the account of Cruz.
Continued on next page
Page 31of F
Freight on Merchandise, Continued
Illustration
No. 1, con’t.
4. If the purchase is F.O.B. destination, collect, the journal entries of
Labrador are:
Purchases
Accounts Payable-Cruz
Purchased merchandise on account.
Accounts Payable-Cruz
Cash
Paid freight F.O.B. destination, collect.
14,000
1,000
14,000
1,000
Note: Labrador is liable to pay Cruz only P13,000 (14,000-1,000).
In the foregoing transactions, the entries presented are all in the
books of the buyer. Now, using the same transactions, the
following are the entries in the books of the seller.
Illustration
No. 2
1. If the sale is F.O.B. shipping point, prepaid, the journal entries of Cruz are:
Account Receivable- Labrador
Sales
Sold merchandise on account.
14,000
Accounts Receivable- Labrador
Cash
Paid freight F.O.B. SP, prepaid
1,000
14,000
1,000
Note: Cruz advanced the amount of freight, which is supposed to
be paid by Labrador. Therefore, the amount receivable from Joseph
should include the amount of freight.
Continued on next page
Page 32of F
Freight on Merchandise, Continued
Illustration
No. 2, con’t.
2. If the sale is F.O.B shipping point, collect, the journal entry of Cruz is:
Accounts Receivable- Labrador
Sales
Sold merchandise on account.
14,000
14,000
Note:
The freight is not reflected in the books of Cruz because the
said expense is for the account of Labrador.
3. If the sale is F.O.B destination, prepaid, the journal entries of Cruz
are:
Accounts Receivable- Labrador
Sales
Sold merchandise on account
Freight-out
14,000
14,000
1,000
Cash
1,000
Paid freight F.O.B. Destination,
Prepaid
4. If the sale is F.O.B. Destination, collect the journal entries of Cruz
are:
Accounts receivable- Labrador
Sales
Sold merchandise on account
Freight-out
Accounts receivable- Labrador
F.O.B. Destination, collect.
14,000
1,000
14,000
1,000
Note:
The total receivable of Cruz from Labrador will be 13,000
only (14,000-1,000), since the payment of freight was advanced by
Labrador.
Reminder
It should be noted that both freight-in and freight-out represent expense.
However, freight-in is shown as an addition to net purchases because it is a
direct cost of procuring the merchandise bought. On the other hand, freightout is listed among the selling expenses
Page 33of F
Income Statement
Overview
A merchandising business prepares its income statement using the functional.
The functional income statement contains several sections, subsections and
subtotals. The amount of the details presented in this section, e.g., the selling
expenses, general and administrative expenses, etc., varies from company to
company
Income
Statement
Terminologies
Below are the terms used in the income statement:
•
Revenue from Sales. The total amount charged to customers for
merchandise sold, for cash and on account, is reported in this section. Sales
returns and allowances and Sales discounts are deducted from this to yield
Net Sales.
•
Cost of Goods (Merchandise) Sold. The cost of merchandise sold during
the period may also be called Cost of Goods Sold or the Cost of Sales. It is
computed by adding to the beginning inventory the net cost of purchases to
yield Total Goods Available for Sale. The ending inventory is deducted
from the Total Goods Available for Sales to yield the Cost of Goods
(Merchandise) Sold.
The net purchases amount is computed by deducting purchase discount and
purchase returns and allowances from purchases. Net cost of purchases is
computed by adding freight-in to the net purchases amount.
•
Gross Profit. The excess of net sales over the cost of goods sold is called
gross profit. It is sometimes called gross profit on sales or gross margin.
.
Continued on next page
Page 34of F
Income Statement, Continued
Income
Statement
Terms, con’t
Con’t
•
Operating Expenses. Most merchandising businesses classify operating
expenses as either distribution expenses, administrative expenses or other
operating expenses. However, depending on the decision-making needs of
managers and other users of the financial statements, other classifications
could be used.
Expenses that are incurred directly in the selling of merchandise are
distribution expenses. They include such expenses as salespersons’
salaries, store supplies used, depreciation of store equipment, and
advertising.
Expenses incurred in the administration or general operations of the
business are administrative expenses. Examples of these expenses are
office salaries, depreciation of office equipment, and office supplies used.
Expenses that are related to both administrative and selling functions may
be divided into the two classifications. In small businesses, however, such
expenses as rent, insurance, and taxes are commonly reported as
administrative expenses. Transactions for small, infrequent expenses are
often reported as Miscellaneous Selling Expense or Miscellaneous
Administrative Expense.
Expenses that cannot be traced directly as selling or administrative expenses
are identified as other expenses. Examples of these are the losses incurred
in the disposal of plant and other assets and Discount lost on the purchase
of plant assets.
Interest expense that results from financing activities is included in the
operating expenses after the other expenses as finance costs.
Continued on next page
Page 35of F
Income Statement, Continued
Income
Statement
Terms, con’t
Con’t
•
Other Income. Revenues from sources other than the primary operating
activity of a business are classified as other income or non-operating
income. In a merchandising business, these items include income from
interest, rent, and gains resulting from the sale of plant and other assets.
•
Net Income. The final figure on the income statement is called the net
income (or net loss). It is the net increase (or net decrease) in the owner’s
equity as a result of the period’s profit-making activities.
Continued on next page
Page 36of F
Income Statement, Continued
Illustration
Below is an illustration of a functional form income statement:
Net sales revenue
Cost of sales
Gross profit
Other income
Total income
Operating expenses:
Distribution expenses
Administrative expenses
Other expenses
Finance Cost
Net income
Notes to the
Functional
Form
Note
1
2
P
P
(40,000)
18,000
P
3
4
5
6
7
P
200,000
(145,000)
55,000
3,000
58,000
P 14,000
24,000
800
1,200
The following are the notes to the functional form income statement:
Note 1 - Net sales revenue
Gross sales
Less: Sales Returns & Allowances
Sales Discount
P
P
207,000
5,000
2,000
Net sales revenue
7,000
P
200,000
Continued on next page
Page 37of F
Income Statement, Continued
Notes to the Functional Form (continued)
Note 2 - Cost of sales
Merchandise Inventory, Jan. 1
Add: Net cost of purchases
Purchases
Less: Purchase Returns & Allowances
Purchase Discounts
Net purchase
Add: Freight-in
Cost of goods available for sale
Less: Merchandise Inventory, Dec. 31
Cost of sales
Note 3 - Other income
Rent Income
Dividend Income
Interest Income
Gain on Sale of Furniture & Fixtures
Total other income
Note 4 - Distribution expenses
Salesmen's Salaries and Commissions
Representation and Entertainment
Depreciation - Store Equipment
SSS & Philhealth Premiums - distribution
Freight-out
Miscellaneous Distribution Expense
Total distribution expenses
Note 5 - Administrative expenses
Salaries Expense
Light, Water and Telephone
Uncollectible Accounts Expense
Depreciation Expense
SSS & Philhealth Premiums - Administrative
Miscellaneous Administrative Expense
Total administrative expenses
Note 6 - Other expenses
Loss on Sale of Equipment
P
P 3,000
2,000
P
175,000
P
5,000
170,000
1,000
P
P
P
P
P
P
P
P
5,000
171,000
176,000
31,000
145,000
1,500
800
500
200
3,000
9,000
1,200
1,000
900
800
1,100
14,000
15,000
3,500
2,000
1,500
1,300
700
24,000
P
800
==========
Note 7 – Finance Cost
Interest Expense
Discount Lost
Total finance cost
P
P
Page 38of F
1,000
200
1,200