UNIVERSITY OF SAINT LOUIS

Tuguegarao City

SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY

First Semester
A.Y. 2020-2021

Lesson 11: Accounting Cycle of a Merchandising Business

Topic: A. Inventory
B. Inventory systems
C. Recording in the General and Special journals
D. Posting to the General and Subsidiary ledgers
E. The accounting cycle of a merchandising business

Learning Outcomes: At the end of this module, you are expected to:
1. Elaborate the different inventory systems
2. Explain the accounting treatment for various peculiar transaction for a
merchandising business
3. Identify and explain the basic steps in the accounting process of a
Merchandising Business.
4. Record accountable business transactions
5. Prepare a statement of cost of goods sold
6. Prepare financial statements and closing entries of a Merchandising
Business.

WHAT IS A MERCHANDISING BUSINESS?

A merchandising business, sometimes called merchandisers, is
one of the most common types of businesses we interact with
daily. It is a business that purchases finished products and resells
them to consumers.
Merchandising is the promotion of goods and/or services that are
available for retail sale. Merchandising includes the determination
of quantities, setting prices for goods and services, creating
display designs, developing marketing strategies, and
establishing discounts or coupons.
Merchandising companies purchase goods that are ready for sale
and then sell them to customers. Merchandising companies
include auto dealerships, clothing stores, and supermarkets, all of
which earn revenue by selling goods to customers.
In a merchandising sales transaction, the seller sells a product
and transfers the legal ownership (title) of the goods to the buyer.
A business document called an invoice (a sales invoice for the
seller and a purchase invoice for the buyer) becomes the basis
for recording the sale.
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ACCT 1026- Financial Accounting and Reporting | 2
SERVICE BUSINESS VS. MERCHANDISING BUSINESS

 Inventory is the term for the goods available for sale and raw materials
used to produce goods available for sale. Inventory represents one of
the most important assets of a business because the turnover of
inventory represents one of the primary sources of revenue
generation.

 Inventory refers to all the items, goods, merchandise, and materials

held by a business for selling in the market to earn a profit.
Inventories are assets:
 held for sale in the ordinary course of business
 in the process of production for such sale, or
 in the form of materials or supplies to be consumed in the
production process or in rendering of services

Inventory types:
 raw materials
 work in progress
 finished goods inventory
 merchandise inventory

The cost of inventories comprises:

 costs of purchase
 costs of conversion
 other costs incurred in bringing the inventories to their present
location and condition.

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INVENTORY SYSTEMS
There are two main types of inventory systems, the
perpetual inventory system and the periodic inventory
system. The main difference between the two systems
is how often inventory data is updated.
The perpetual inventory method is one in which
inventory data is updated continuously. When an order is
placed or received, that data immediately is entered into
the system to update the quantity and inventory
availability right away. This is where the term perpetual
comes from. Data is entered perpetually, or continuously,
as opposed to the periodic system, where data is updated
according to a set interval of time.
A periodic inventory system only updates the ending
inventory balance in the general ledger when a physical
inventory count is conducted. Since physical inventory
counts are time-consuming, few companies do them
more than once a quarter or year. In the meantime, the
inventory account in the accounting system continues to
show the cost of the inventory that was recorded as of the
last physical inventory count.
Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a
purchases account. When a physical inventory count is done, the balance in the purchases account is then
shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory.
Perpetual or periodic?
 Choice is merely a record-keeping choice, not a reporting choice
 Nature of inventory
 Computer system technology, e.g. optical scanners.
 Management objectives
 Cost
ACCT 1026- Financial Accounting and Reporting | 4
 Perpetual Inventory Method Periodic Inventory System
A method of controlling inventory that maintains A method of calculating inventory that uses data on
continuous records on the flow of units of inventory beginning inventory, additions to inventory, and an
for all transactions. end-of-period count to deduce the COGS.
Provides better control and is more costly than the Purchases account:
periodic method. used to record purchases of inventory.
Stock losses more easily determined. Purchase returns and allowances account:
purchasing company returns goods to supplier or
receives a price reduction.

MARCH 6 Purchased inventory on credit P750.

PERPETUAL 750 PERIODIC
Dr INVENTORY 750 Dr PURCHASES 750

Cr ACCOUNTS PAYABLE 750 Cr ACCOUNTS PAYABLE 750

MARCH 11 Received a credit note for inventory returned P50.
PERPETUAL 750 PERIODIC
Dr ACCOUNTS PAYABLE 50 Dr ACCOUNTS PAYABLE 50

Cr INVENTORY 50 Cr PURCHASE RETURNS

and ALLOWANCES 50

Recording of payments are the same for either inventory method (assume P7 discount)

Accounts payable 700

Cash 693
Purchase Discount 7

Sale- MARCH 20 Sold inventory on credit for P1050. Cost of inventory sold, P525.

PERPETUAL PERIODIC
Dr Accounts receivable 1 050 Dr Accounts receivable 1 050

Cr Sales 1 050 Cr Sales 1 050

Dr Cost of goods sold 525 NO ENTRY

Cr Inventory 525

ACCT 1026- Financial Accounting and Reporting | 5

Differences in Valuing Cost of Goods Sold

What Is Inventory Cost?

 Inventory costs comprise of all expenditures both direct and indirect, relating to acquisition, preparation,
and placement for sale.
 Discounts can change the total inventory costs.
 Trade Discounts
 Convert the catalog price to the actual price.
 Record inventory at discounted price.
 Cash Discounts
 Granted for payment of invoices within a limited time period.
 Record inventory using the net method or gross method.

FINANCIAL STATEMENT PRESENTATION

 All inventory is in a saleable condition (e.g. supermarket).

 Therefore one balance sheet item called ‘inventory’ is sufficient.

Error in Measuring Inventory

• Overstatement of ending inventory leads to:

– understatement of cost of goods sold
– overstatement of profit.

• Understatement of ending inventory leads to:

– overstatement of cost of goods sold
– understatement of profit.

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PROBLEM 1

Eversoll Inc. uses the periodic inventory system.

June 1 On hand, 50 units @ P15.00 each P 750.00

5 Purchased 115 units @ P15.00 each 1,725.00
14 Purchased 75 units @ P15.00 each 1,125.00
Total cost of goods available for sale P3,600.00
30 On hand, 90 units

How many units did Eversoll, Inc. sell during June? ANSWER: 50+115+75-90= 150 UNITS

PROBLEM 2

Adam Inc. uses a perpetual inventory system.

Jan. 1 On hand, 10 units at P8 each P 80.00

4 Sold 8 units for P10 each 80.00
22 Purchased 50 units at P8 each 400.00
26 Sold 48 units for P10 each 480.00

How much is the ending inventory on January 31? ANSWER: 10-8+50-48= 4 UNITS

PROBLEM 3

During the current period, Audix Corp. sold products to customers for a total of P76,000. Due to defective
products, customers were given P2,800 in refunds for products that were returned and another P3,500 in
reductions to their account balances. Discounts in the amount of P5,500 were given for early payment of account
balances.

Prepare the Net Sales section of Audix’s income statement.

ANSWER:

Sales revenue P 76,000

Less: Sales returns and allowances (6,300)
Sales discounts (5,500)
Net sales P 64,200

PROBLEM 4

Based upon the following data, determine the cost of merchandise sold for April.

Merchandise Inventory April 1 P 85,560

Merchandise Inventory April 30 96,330
Purchases 373,880
Purchases Returns & Allowances 14,760
Purchases Discounts 10,900
Freight In 4,135

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ANSWER:

Cost of merchandise sold:

Merchandise Inventory April 1 P85,560
Purchases P373,880
Less: Purchases Returns and Allowances P14,760
Purchases Discounts 10,900 (25,660)
Net Purchases P348,220
Add Freight-In 4,135
Cost of merchandise purchased 352,355
Merchandise available for sale 437,915
Less merchandise inventory, April 30
(96,330)
Cost of merchandise sold P341,585

Purchases Returns and Allowances- is an account that is paired with and offsets the purchases account in a
periodic inventory system. The account contains deductions from purchases for items returned to suppliers, as
well as deductions allowed by suppliers for goods that are not returned.

Purchases Discounts- is a deduction that a company may receive if the supplier offers it and the company pays
the supplier's invoice within a specified period of time. The purchase discount is also known as a cash discount
or early-payment discount.

Freight-in- The shipping cost to be paid by the buyer of merchandise purchased when the terms are FOB
shipping point.

When you are shipping freight to your customers, the cost of making that delivery is an expense that comes out
of your ledger as a debit. This is considered a selling expense and is known as freight-out. When you make a
purchase and the supplier bills you for shipping that is referred to as freight-in.

PROBLEM 4

Hound Dog Bisquits reported the following financial data for 2019 and 2020:

2019 2020
Sales P700,000 P600,000
Sales returns and allowances (10,000) (D)
Net sales 690,000 580,000
Cost of goods sold:
Inventory, January 1 30,000 E
Net purchases A 340,000
Goods available for sale 250,000 380,000
Inventory, December 31 (40,000) (30,000)
Cost of goods sold B F
Gross profit C G
====== ======

Provide the answer for each missing letter above.

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ANSWER:

A) P220,000 (P250,000 - P30,000)

B) P210,000 (P250,000 - P40,000)
C) P480,000 (P690,000 - P210,000)
D) P20,000 (P600,000 - P580,000)
19 P40,000 (from 2013 ending inventory)
F) P350,000 (P380,000 - P350,000)
G) P230,000 (P580,000 - P350,000)

PROBLEM 5

The following data are available for Carlton Products:

Beginning Ending Operating

Year Sales Inventory Inventory Expenses
2018 P 93,600 P16,000 P24,000 P 8,000
2019 124,800 24,000 34,000 18,000
2020 156,000 34,000 26,000 12,000

Compute the purchases and the net income of Carlton for 2018, 2019, and 2020, assuming that the firm sells
its merchandise at 25 percent above cost.

ANSWER:
2018 2019 2020
Cost of goods sold (sales/1.25) . P74,880 P 99,840 P124,800
Ending inventory ................ 24,000 34,000 26,000
Goods available for sale ........ P98,880 P133,840 P150,800
Less beginning inventory ........ 16,000 24,000 34,000
Purchases ....................... P82,880 P109,840 P116,800

Sales ........................... P93,600 P124,800 P156,000

Less cost of goods sold ......... 74,880 99,840 124,800
Gross profit on sales ........... P18,720 P 24,960 P 31,200
Operating expenses .............. 8,000 18,000 12,000
Net income ...................... P10,720 P 6,960 P 19,200

Service Business Merchandising Business

Income Statement: Income Statement
Revenues Sales
Less: Operating Expenses Less Cost of Merchandise Sold
Equals: Net Income Equals: Gross Profit
Less: Operating Expenses
Equals: Net Income

Balance Sheet: Balance Sheet:

No Merchandise Inventory Account Includes Merchandise Inventory
Account in the Current Assets Section

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PROBLEM 6

Truffles Company purchased merchandise on account from a supplier for P6,500, terms 2/10, net 30. Truffles returned
P1,500 of the merchandise and received full credit. Truffles Company paid for the merchandise within the discount period.

Under a perpetual inventory system, record all of the journal entries required for the above transactions.

ANSWER:

(a) Merchandise Inventory 6,500

Accounts Payable 6,500

(b) Accounts Payable 1,500

Merchandise Inventory 1,500

(c) Accounts Payable 5,000

Cash 4,900
Merchandise Inventory 100

PROBLEM 7

The following data were extracted from the accounting records of Marcus Gallery for the year ended February 28, 2020.

Merchandise Inventory, March 1, 2019 P450,000

Merchandise Inventory, February 28, 2020 225,000
Purchases 175,000
Purchase Returns and Allowances 25,000
Purchase Discounts 10,000
Sales 680,000
Sales Returns 20,000
Transportation In 5,000

Prepare the cost of merchandise sold section of the income statement for the year ended February 28, 2008, using
the periodic system. Also determine gross profit.

ANSWER:
Marcus Gallery
Income Statement
For the Year Ended February 28, 2020
Sales P680,000
Less: Sales returns 20,000
Net Sales P660,000
Cost of Merchandise Sold
Merchandise inventory, March 1, 2019 450,000
Purchases 175,000
Less: Purchases returns and allowances P25,000
Purchase discounts 10,000 35,000
Net Purchases 140,000
Plus: Transportation in 5,000
Cost of Merchandise Purchased 145,000
Merchandise available for sale 595,000
Less merchandise inventory, February 28, 2008 225,000
Cost of merchandise sold 370,000
Gross profit P290,000

*** END of LESSON 9***

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