TRADING/MERCHANDISING BUSINESS

FINANCIAL ACCOUNTING AND REPORTING

I. WHAT IS TRADING/MERCHANDISING BUSINESS? inventory. A comparison between the cost of goods

• Trading concern is one that buys and sells goods in the same available for sale (i.e., beginning inventory plus net
form purchased. purchases) and the ending merchandise inventory enables
• The primary distinction between a service business and a the accountant to determine the cost of sales.
trading business is that service businesses sell knowledge • Perpetual System – commonly used where the inventory
and/or skill; while trading businesses sell a particular good, items treated individually represent a relatively large peso
product or group of products. investment such as jewelry and cars.
• The term “merchandise inventory” is generally applied to
DR CR
goods held by a trading concern. 1. Purchase of merchandise on account
• Inventory is defined in Philippine Accounting Standard Merchandise inventory 450,000.00
(PAS) 2 as assets which are held for sale in the ordinary Accounts payable 450,000.00
course of business, in the process of production for such sale
2. Payment of freight on the purchase
or in the form of materials or supplies to be consumed in the
Merchandise inventory 10,000.00
production process or in the rendering of service. Cash 10,000.00

II. ACCOUNTING FOR INVENTORY 3. Return of merchandise purchased to supplier

Accounts payable 60,000.00
• The accounting for a trading business is basically the same as
Merchandise inventory 60,000.00
that of a service business; however, the determination of
profit/loss for trading businesses includes a significant 4. Sale of merchandise on account costing P300,000 at 25% at cost
income statement component known as the “Cost of Sales”. Accounts receivable 375,000.00
Sales 375,000.00
• Cost of sales is the primary cost of a trading business.
• Accounting for inventory may either be periodic system or Cost of sales 300,000.00
perpetual system. Merchandise inventory 300,000.00

• Periodic System – commonly used when individual 5. Return of merchandise sold from customer amounting to P15,000
inventory items have small peso investment, such as Sales returns and allowances 15,000.00
groceries, hardware and auto parts. Accounts receivable 15,000.00
Merchandise inventory 12,000.00
DR CR Cost of sales 12,000.00
1. Purchase of merchandise on account
Purchases 450,000.00 6. Adjustment of ending inventory
Accounts payable 450,000.00 no entry

2. Payment of freight on the purchase

Freight-in 10,000.00 o When the perpetual inventory system is used, accounting
Cash 10,000.00 records that continuously disclose the amount of
inventory are maintained. A separate subsidiary ledger
3. Return of merchandise purchased to supplier
contains a separate account for each type of inventory
Accounts payable 60,000.00
item. Increases in particular inventory item are debited
Purchase return and allowances 60,000.00
directly to ‘Merchandise inventory’ account while
4. Sale of merchandise on account costing P300,000 at 25% at cost corresponding decreases due to sales or returns of
Accounts receivable 375,000.00 inventory are credited directly to ‘Merchandise inventory’.
Sales 375,000.00 Thus, the balance in the individual subsidiary ledger
5. Return of merchandise sold from customer account at any moment in time represents the actual
Sales returns and allowances 15,000.00 amount of that particular product on hand. Unlike the
Accounts receivable 15,000.00 periodic system, ‘Purchases’ account is not maintained in
6. Adjustment of ending inventory a perpetual system.
Merchandise Inventory - end 150,000.00
Income summary 150,000.00 III. FREIGHT TERMS
• Definition of Terms
o When the periodic inventory system is used, purchases of o FOB Destination – the ownership of the goods
inventory would include a debit to ‘Purchase’ account. purchased is vested in the buyer upon receipt thereof. The
Upon sale, no additional entry is made in either the seller is still the owner of the goods in transit and shall be
‘Merchandise inventory’ account or the ‘Purchases’ legally responsible for freight charges and other expenses
account to recognize the cost of the items sold. up to the point of destination
Periodically, a physical inventory is taken (normally done
on year-end) to determine the cost of the ending
 o FOB Shipping Point – the ownership of the goods • Net Method – records the accounts payable and purchases
purchased is vested in the buyer upon shipment thereof. at net (i.e., invoice price less cash discount) amount of
The buyer is already the owner of the goods in transit and invoice.
shall be legally responsible for freight charges and other
expenses from the point of shipment to the point of BUYER'S BOOKS DR CR
destination 1. Purchases on account, P100,000, 5/10, n/30
o Freight Collect – the freight charge on the goods shipped Purchases 95,000.00
is not yet paid. The common carrier shall collect the same Accounts payable 95,000.00
from the buyer. Hence, freight is actually paid by the 2. Assuming payment is made within the discount period
buyer. Accounts payable 95,000.00
o Freight Prepaid – the freight charge on the goods shipped Cash 95,000.00
is already paid by the seller. 3. Assuming payment is made beyond the discount period
• The terms “FOB Shipping Point” and “FOB Destination Accounts payable 95,000.00
Point” determine ownership of the goods in transit and the Purchase discount lost 5,000.00
party who is supposed to pay the freight and other expenses Cash 100,000.00
from point of shipment to point of destination
SELLER'S BOOKS DR CR
• The terms “Freight Collect” & “Freight Prepaid” determine 1. Sale on account, P100,000, 5/10, n/30
the party who actually paid the freight charge but not the Accounts receivable 95,000.00
party who is supposed to legally pay the freight charge. Sales 95,000.00
2. Assuming collection is made within the discount period
IV. DISCOUNTS
Cash 95,000.00
• Types of Discounts Accounts receivable 95,000.00
o Cash discounts – reductions in the invoice price allowed
3. Assuming collection is made beyond the discount period
only when payment is made within the discount period.
Cash 100,000.00
Cash discounts are recorded in the books and its purpose
Accounts receivable 95,000.00
is to encourage prompt payment.
Sales discount forfeited 5,000.00
o Trade discounts – reductions in the list price or catalog
price in order to get the invoice price or the amount
actually charged to the buyer. Trade discounts are not V. SOME IMPORTANT COMPUTATIONS TO REMEMBER
recorded in the books and its purpose is to encourage • Net Sales
trading or promote sales. Sales P 375,000.00
• The methods of recording cash/prompt payment discount Less: Sales Discounts P 3,000.00
may either be gross or net method. Sales Returns and Allowances 15,000.00 18,000.00
• Gross Method - records the accounts payable and purchases Net Sales P 357,000.00
at gross amount of the invoice.
BUYER'S BOOKS DR CR • Net Purchases
1. Purchases on account, P100,000, 5/10, n/30 Purchases P 450,000.00
Purchases 100,000.00 Add: Freight-In 10,000.00
Accounts payable 100,000.00
Subtotal P 460,000.00
2. Assuming payment is made within the discount period Less: Purchase discounts P 5,000.00
Accounts payable 100,000.00 Purchase Returns and Allowances 60,000.00 65,000.00
Cash 95,000.00 Net Purchases P 395,000.00
Purchase discount 5,000.00
3. Assuming payment is made beyond the discount period • Cost of Sales
Accounts payable 100,000.00 Beginning Inventory P 50,000.00
Cash 100,000.00 Add: Net Purchases 395,000.00
Total Goods Available For Sale P 445,000.00
SELLER'S BOOKS DR CR
1. Sale on account, P100,000, 5/10, n/30 Less: Ending Inventory 150,000.00
Accounts receivable 100,000.00 Cost of Sales P 295,000.00
Sales 100,000.00
• Gross Profit
2. Assuming collection is made within the discount period
Cash 95,000.00 Net Sales P 357,000.00
Sales discount 5,000.00 Less: Cost of Sales 295,000.00
Accounts receivable 100,000.00 Gross Profit P 62,000.00
3. Assuming collection is made beyond the discount period
Cash 100,000.00
Accounts receivable 100,000.00
 QUIZZER 7. Which of the following items should be included in inventory
at the end of the reporting period?
1. Cost of goods sold is equal to a. Goods in transit which were purchased FOB destination
a. The cost of inventory at the beginning of a period plus b. Goods in transit to a customer which were sold to the
net sales minus the cost of inventory at the end of the customer FOB shipping point
period c. Goods received from another entity on consignment
b. The cost of inventory at the end of a period plus net d. Goods in transit which were purchased FOB shipping
purchases minus the cost of inventory at the beginning point
of a period
c. The cost of inventory at the beginning of a period plus 8. Which of the following generally would not be separately
net purchases minus the cost of inventory at the end of accounted for in the computation of cost of sales?
a period a. Trade discounts applicable to purchases
d. The cost of inventory at the beginning of a period minus b. Cash discounts taken during a period
net purchases plus the cost of inventory at the end of a c. Purchase returns and allowances during the period
period d. Cost of transportation for merchandise purchased

2. In a periodic system, the beginning inventory is 9. The use of purchase discount account implies that the
a. Total goods available for sale minus net purchases recorded cost of a purchased inventory item is
b. Total goods available for sale minus cost of sales a. Invoice price
c. Net purchases minus cost of sales b. Invoice price less the purchase discount allowable
d. Net purchases minus ending inventory whether or not taken
c. Invoice price less the purchase discount taken
3. Which of the following is not true of the perpetual inventory d. Invoice price plus any purchase discount lost
method?
a. The entry to record a sale includes a debit to cost of 10. When the current year’s ending inventory is overstated
goods sold and a credit to inventory a. The current year’s total assets are understated
b. Purchases are recorded as debit to the inventory account b. The current year’s net income is overstated
c. After a physical inventory count, inventory is credited c. The next year’s net income is overstated
for any missing inventory d. The current year’s cost of sales is overstated
d. Purchase returns are recorded by debiting accounts
payable and crediting purchase returns and allowances 11. Goods in transit at year-end purchased FOB shipping point
were appropriately recorded in the purchase account but
4. Which of the following is a characteristic of a perpetual were incorrectly excluded from the ending inventory. What
inventory system? effect will this omission have on assets, liabilities and capital
a. Inventory purchases are debited to a purchases account at year-end?
b. Inventory records are not kept for every item a. Understated, no effect, understated
c. Cost of sales is recorded with each sale b. Understated, no effect, overstated
d. Cost of sales is determined as the amount of purchases c. No effect, no effect, understated
less the change in inventory d. No effect, no effect, overstated

5. Goods shipped FOB shipping point in the last day of the year 12. A merchandising company’s physical count of inventories is
should be ordinarily be included in lower than the inventory quantities in the perpetual records.
a. The seller’s inventory balance This could be the result of a failure to record
b. The buyer’s inventory balance a. Purchases
c. Both the buyer’s and the seller’s inventory balance b. Sales
d. Neither the buyer’s nor the seller’s inventory balance c. Purchase discounts
d. Sales discounts
6. An entry debiting inventory and crediting cost of sales would
be made when 13. What is the cost of sales to be reported in the statement of
a. Merchandise is returned and the perpetual inventory comprehensive income of Pace Company given the following
method is used information available for calendar year 2019:
b. Merchandise is returned and the periodic inventory Disbursements for purchases P 1,160,000.00
method is used Increase in trade accounts payable 100,000.00
c. Merchandise is sold and the periodic inventory method Decrease in merchandise inventory 40,000.00
is used
d. Merchandise is sold and the perpetual inventory method a. 1,300,000
is used b. 1,220,000
c. 1,100,000
d. 1,020,000
14. How much is the total inventoriable cost?
Merchandise purchased for resale P 400,000.00
Freight-in 10,000.00
Freight-out 5,000.00
Purchase returns 2,000.00
Sales discount given to customers 1,000.00

a. 400,000
b. 408,000
c. 412,000
d. 413,000

15. On June 1, 2019, Peachy Corp. sold merchandise with a list

price of P50,000 to Ritchie Corp on account. Peachy Corp
allowed trade discounts of 30%, 20%, and 10%. Credit terms
2/15, n/40 and the sale was made FOB destination. Ritchie
Corp paid P2,000 delivery costs. On June 12, 2019, how
much did Peachy Corp receive from Ritchie Corp as full
payment?
a. 22,696
b. 24,696
c. 26,656
d. 26,696

16. Paco Company reported the following balances at December

31, 2019 and 2018
12/31/2019 12/31/2018
Inventory P 2,600,000.00 P 2,900,000.00
Accounts Payable 750,000.00 500,000.00

The Company paid its suppliers P4,900,000.00 during the

year ended December 31, 2019. How much should Paco
report as cost of sales in its December 31, 2019, statement of
comprehensive income?

a. 4,350,000
b. 4,850,000
c. 4,950,000
d. 5,450,000