Part III

ACCOUNTING FOR A MERCHANDISING BUSINESS

Chapter 5: Merchandising Operations

Objectives
 explain how the financial statements are interrelated
 distinguish between income statements of service and merchandising entities
 illustrate the operating cycle of a merchandising entity
 name the different source documents being used by merchandising entities
 define the various account titles used for a merchandising business
 give the classifications of the various account titles used for a merchandising business
 state the rules of debit and credit positions of the various account titles used for a merchandising business
 prepare journal entries
 prepare financial statements (Income Statement, Balance Sheet, Statement of Changes in Owner’s Equity and
Statement of Cash Flows) of a merchandising business

Relationship among Financial Statements

 The following shows the basic interrelationships among the financial statements:
Date at Beginning of Period Date at End of Period

Time

Balance Sheet Balance Sheet

Income Statement
Statement of Cash Flows

1. The Income Statement reports all income and expenses during the period. The profit or loss is the final figure in this
statement.
2. The Statement of Changes in Equity considers the profit or loss figure from the income statement as one of the
determining factors that explains the change in owner’s equity.
3. The Statement of Financial Position /Balance Sheet reports the ending owner’s equity, taken directly from the
statement of changes in equity.
4. The Statement of Cash Flows reports the net increase or decrease in cash during the period and ends with the cash
balance reported in the balance sheet. This statement is prepared based on information from the income statement
and the balance sheet.

Comparison of Income Statements

 Service entities perform services for a fee. In ascertaining profit, a basic income statement (single-step form income
statement) is all that is needed. Profit is measured as the difference between revenues from services and expenses.
In contrast, merchandising entities earn profit by buying and selling goods. These entities use the same basic
accounting methods as service entities, but the process of buying and selling merchandise required some additional
accounts and concepts. This process results in a more complex income statement (multiple-step form income
statement). In a merchandising business, net sales arise from the sale of goods while cost of sales or cost of goods
sold represents the cost of inventory the entity has sold to customers. The difference between net sales and cost of
sales is called gross profit. Then other operating income is added and other operating expenses (like distribution
costs or selling expenses, administrative expenses and other operating expenses) are deducted from gross profit to
arrive at operating profit. Investment revenues, other gains and losses, and finance costs (interest expense) are
considered to arrive at profit before tax then income tax expense is deducted to have profit from continuing
operations. Finally, profit from discontinued operations (net of tax) is taken to account to get profit for the period.

Service Merchandising
Income Statement Income Statement

Revenue from Services Net Sales

Minus
Cost of Sales
minus Equals
Gross Profit
add or minus
Expenses Income or Expenses
(see details below)
equals Equals
Profit Profit

Operating Cycle of a Merchandising Business Collections Cash

Cash
Accounts
Cash Sales Purchases
Purchases Receivable
Inventory
Sales on Account Inventory
Sales on Account
Cash Sales Sales on Account
Source Documents
 Merchandising business use various business forms and documents to help identify the transactions that should be
recorded in the books. These source documents contain vital information about the nature and amount of the
transactions. Among the more common source documents are:
 Official Receipts  Deposit Slips  Credit Memorandum
 Sales Invoice  Deposit Slips  Purchase Requisition
 Checks  Purchase Order
 Bill of Lading  Receiving Report

Terms of Transactions
A. Kinds of Discounts
1. Trade Discounts - this is a discount is given to encourage patronage.
 Example: less 5%, less 10%
2. Cash Discount or Term Discount - this is a discount given to encourage early payment of account.
 Example: 2/10, n/30; 1/10, n/20
 Under cash or term discounts are:
a) Purchase Discount – given as discount for purchases of merchandise; buyer’s viewpoint
b) Sales Discount – given as discount on sales of merchandise; seller’s viewpoint
B. Period
1. Credit Period - a period of time allowed for payment.
2. Discount Period - the period covered by the discount.

Account Titles Used for Merchandising Business

1. Purchases
 Refer to the cost of merchandise bought.
 Classified as cost.
 It is always recorded in the DEBIT every time merchandise is bought.
 It is presented in the Income Statement.
2. Purchase Returns and Allowances
 Classified as sub-account or contra-account of Purchases.
 It is presented as a deduction of Purchases in the Income Statement.
 It is always recorded in the CREDIT every time there is a return due to damage or due to wrong specification on
purchases of merchandise.
3. Purchase Discounts
 Classified as a sub-account or contra-account of Purchases.
 It is presented as a deduction of Purchases in the Income Statement.
 It is always recorded in the CREDIT every time there is a discount on purchases of merchandise.
4. Sales
 Refer to merchandise sold.
 Classified as Income / Revenue.
 It is always recorded in the CREDIT every time a merchandise is sold.
 It is presented in the Income Statement.
5. Sales Returns and Allowances
 Classified as sub-account or contra-account of Sales.
 It is presented as a deduction from Sales in the Income Statement.
 It is always recorded in the DEBIT every time there is a return due to damage or due to wrong specification on sales
of merchandise.
6. Sales Discounts
 Classified as sub-account or contra-account of Sales.
 It is presented as a deduction from Sales in the Income Statement.
 It is always recorded in the DEBIT every time there is a discount on sales of merchandise.
7. Transportation In / Freight In
 It is classified as cost and is presented in the Income Statement.
 It is always recorded in the DEBIT every time freight is incurred for purchases of merchandise.
8. Transportation Out / Freight Out
 It is classified as selling expense and is presented in the Income Statement.
 It is always recorded in the DEBIT every time freight is incurred for sales of merchandise.

Normal Balances of Various Merchandising Business Accounts

 Summary of DEBIT and CREDIT positions for new account titles (these are ALWAYS recorded in the same side if the
transactions are normal and not as correcting entries for errors)

Normal
Account Titles Effects
Balances
Purchases DEBIT addition to COST for purchases of merchandise
Contra-accounts (opposite of Purchases):
Purchase Returns and Allowances CREDIT deduction to COST for purchases of merchandise
Purchase Discounts CREDIT deduction to COST for purchases of merchandise
Sales CREDIT addition to INCOME for sales of merchandise
Contra-accounts (opposite of Sales):
Sales returns and Allowances DEBIT deduction to INCOME for sales of merchandise
Sales Discounts DEBIT deduction to INCOME for sales of merchandise
ILLUSTRATIVE PROBLEM (Accounting Cycle)

Required:
1. Prepare journal entries for the month of July 2020 for TBA TRADING.
2. Prepare a Trial Balance dated July 31, 2020.
3. Prepare an Income Statement for the month ended July 31, 2020.
4. Prepare Statement of Changes in Owner’s Equity for the month ended July 31, 2020.
5. Prepare a Statement of Financial Position as of July 31, 2020.
6. Prepare Statement of Cash Flows for the month ended July 31, 2020.

Tehillah Babe Alera, a CPA, recently established her own merchandising company that offers grocery products which she
called TBA Trading. The business operations commenced on July 1, 2020. Following are the details of the business and
the transactions that were completed on its first month.

TBA Trading
Chart of Accounts
Balance Sheet Accounts Income Statement Accounts
Account Account
Account Title Account Title
Number Number

Assets Income
110 Cash 410 Sales
120 Accounts Receivable 420 Sales Returns and Allowances
130 Equipment 430 Sales Discounts
Liabilities Costs
210 Accounts Payable 510 Purchases
Owner’s Equity 520 Purchase Returns and Allowances
310 Alera, Capital 530 Purchase Discounts
320 Alera, Withdrawals 540 Freight-in
Expenses
540 Freight-out
550 Salaries Expense
560 Rent Expense

Transactions:

July 2 - Alera invested P950,000 cash in the merchandising business.

3 - Purchased goods for P91,500. Terms: 1/10, n/30.
4 - Returned P1,500 worth of goods purchased in July 3.
5 - Purchased additional goods for P60,000. Terms: 2/10, n/30.
6 - Paid freight of purchases in July 5, P550.
9 - Cash purchases of goods were made amounting to P29,900.
10 - Sold goods for the week, P85,800, cash basis.
11 - Sold goods amounting to P21,300. Terms: 2/10, n/20.
12 - The customer returned P1,300 worth of goods sold in July 11.
13 - Paid account in July 3, less returns in July 4.
15 - Paid salaries amounting to P4,900.
16 - Sold goods amounting to P58,900, cash basis.
17 - Paid freight amounting to P350 of goods sold in July 16.
20 - Collected from customer in July 11, less returns in July 12.
25 - Paid rent amounting to P8,000.
28 - Bought equipment for P35,000, cash.
30 - Len withdrew P7,500 cash in the business, for personal use.
31 - Purchases of goods were made amounting to P77,900, cash
basis.

NOTE: The ending inventory is worth 174,750

Journalizing Merchandising Business Transactions

TBA TRADING J1
DATE
ACCOUNT TITLES AND EXPLANATION P.R. DEBIT CREDIT
2020
July 2 Cash 110 9 5 0 0 0 0 .
Alera, Capital 310 9 5 0 0 0 0
Initial investment.

3 Purchases 510 9 1 5 0 0
Accounts Payable 210 9 1 5 0 0
Terms: 1/10, n/30.

4 Accounts Payable 210 1 5 0 0

Purchase Returns and Allowances 520 1 5 0 0
Returned purchases in July 3.

5 Purchases 510 6 0 0 0 0
Accounts Payable 210 6 0 0 0 0
Terms: 2/10 n/30

6 Freight-in 5 5 0
Cash 5 5 0 .
Paid freight

9 Purchases 510 2 9 9 0 0
Cash 110 2 9 9 0 0 .
Cash purchases.

10 Cash 110 8 5 8 0 0
Sales 410 8 5 8 0 0 .
Sold goods

11 Accounts Receivable 120 2 1 3 0 0

Sales 410 2 1 3 0 0
Terms: 2/10, n/20

12 Sales Returns and Allowances 420 1 3 0 0

Accounts Receivable 120 1 3 0 0
Return of goods sold in July 11.

13 Accounts Payable (91 500 – 1 500) 210 9 0 0 0 0

Purchase discount (91 500 – 1 500 x.01) 110 9 0 0
Cash (91 500 – 1 500 – 900) 8 9 1 0 0 .
Paid account in July 3.

15 Salaries Expense 550 4 9 0 0

Cash 110 4 9 0 0
Paid salaries.

16 Cash 110 5 8 9 0 0 .
Sales 410 5 8 9 0 0
Paid account.

17 Freight – Out 540 3 5 0

Cash 110 3 5 0 .
Paid freight.

20 Cash (21 300 – 1 300 – 400) 110 1 9 6 0 0 .

Sales Discount (21 300 – 1 300 x .02) 430 4 0 0
Accounts Receivable (21 300 – 1 300) 120 2 0 0 0 0
Collected from customer.
 TBA TRADING J2
DATE
ACCOUNT TITLES AND EXPLANATION P.R. DEBIT CREDIT
2020
July 25 Rent Expense 560 8 0 0 0
Cash 110 8 0 0 0 .
Paid rent.

28 Equipment 130 3 5 0 0 0
Cash 110 3 5 0 0 0 .
Bought equipment.

30 Alera, Withdrawals 320 1 3 0 0

Cash 110 1 3 0 0 .
For personal use.

31 Purchases 510 7 7 9 0 0
Cash 110 7 7 9 0 0
Purchase of goods

Preparation of Financial Statements of a Merchandising Business

Income Statement

TBA Trading
Income Statement
For the Month Ended July 31, 2020

Sales P 166,000
Less: Sales returns and allowances P 1,300
Sales discount 400 1,700
Net Sales P 164,300

Less: Cost of Goods sold

Merchandise inventory – July 1, 2020 -
Purchases P 259,300
Less: Purchase returns and allowances P 1,500
Purchase discounts 900 2,400
Net Purchases P 256,900
Freight-in 550
Net cost of purchases 257,450
Goods available for sale P 257,450
Less: Merchandise inventory – July 31, 2020 174,750
Cost of Goods Sold 82,700
Gross Profit on Sales P 81,600
Less: Operating Expenses
Freight-out P 350
Salaries Expense 4,900
Rent Expense 8,000
TOTAL OPERATING EXPENSES 13,250
PROFIT P 68,350
 Statement of Changes in Owner’s Equity

TBA Trading
Statement of Changes in Owner’s Equity
For the Month Ended July 31, 2020

Alera, Capital – 07/01/2020 P 950,000

Add: Additional Investments by Alera P –0–
Profit 68,350 68,350
Total P 1,018,350
Less: Withdrawals 1,300
Alera, Capital – 07/31/2020 P 1,017,050

Statement of Financial Position (Balance Sheet)

TBA Trading
Statement of Financial Position
As of July 31, 2020

Assets
Current Assets
Cash P 867,300
Accounts Receivable 0
Merchandise Inventory - July 31, 2020 174,750
Total Current Assets P 1,042,050
Non-Current Assets
Property and Equipment:
Equipment P 35,000
Total Non-Current Assets P 35,000
TOTAL ASSETS P 1,077,050

Liabilities
Current Liabilities
Accounts Payable P 60,000
Total Liabilities P 60,000

Owner’s Equity
Alera, Capital – 07/31/2020 P 1,017,050
TOTAL LIABILITIES AND OWNER’S EQUITY P 1,077,050

Statement of Cash Flows

TBA Trading
Statement of Cash Flows
For the Month Ended July 31, 2020

Cash Flows from Operating Activities:

Cash received from clients P 164,300
Payment for merchandise bought (196,900)
Payment for transportion of merchandise bought (550)
Payment to employees (4,900)
Payment for rent (8,000)
Payment for transportion of merchandise sold (350)
Net cash provided by (used in) operating activities P (46,400)
Cash Flows from Investing Activities:
Payment to acquire equipment P (35,000)
Net cash provided by (used in) investing activities (35,000)
Cash Flows from Financing Activities:
Cash received as investments by owner P 950,000
Payments for withdrawals by owner (1,300)
Net cash provided by (used in) financing activities 948,700
Net Increase (Decrease) in Cash P 867,300
Cash balance at the beginning of the period -
Cash balance at the end of the period P 867,300