ACCOUNTING CYCLE OF A

MERCHANDISING BUSINESS
A merchandising company is an enterprise that buys
and sells goods to earn a profit.
Merchandise (or merchandise inventory) refers to goods
that are held for sale to customers in the normal course
of business. This includes goods held for resale. For
example:
• Candies, canned goods, noodles sold at a grocery
stores • Juice, biscuits sold in a grocery store
• Medicines sold in a pharmacy
A merchandiser’s primary source of revenue is sales revenue or sales.
• Expenses for a merchandising company are divided into two
categories:
1. Cost of goods sold (COGS) – the total cost of merchandise sold
during the period; and
2. Operating expenses (OP) - expenses incurred in the process of
earning sales revenue that are deducted from gross profit in the
income statement. Examples are sales salaries and insurance
expenses.
Gross profit (GP) is equal to Sales Revenue less the Cost of
Goods Sold. Income measurement process for a merchandiser
follows as:
The Operating Cycles for a merchandiser: Merchandising
Company operating cycle (cash to cash) involves:
1.buy merchandise inventory
2.sell inventory
3.obtain Accounts Receivable
4.receive cash
JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING BUSINESS

In step 1, transactions are identified and measured. At this

stage, the documents used by the business are analyzed to see
whether these transactions have financial impact or effect.

Step 2 is the Preparation of Journal Entries (Journalization)

A merchandising company may use special and general
journals to record its transactions.
SPECIAL JOURNALS

The following are the commonly used special journals:

1. Cash Receipts Journal –used to record all cash that had been received
2. Cash Disbursements Journal –used to record all transactions involving cash
payments
3. Sales Journal (Sales on Account Journal) –used to record all sales on credit
(on account)
4. Purchase Journal (Purchase on Account Journal) –used to record all
purchases of inventory on credit (or on account)
INVENTORY SYSTEMS
Maintaining inventory items is a unique set-up in a merchandising
business. There are two methods of accounting for inventory, namely:
Perpetual Inventory System and Periodic Inventory System. Merchandising
entities may use either of the following inventory systems:
1. Perpetual System — Detailed records of the cost of each item are
maintained, and the cost of each item sold is determined from records
when the sale occurs. For example, a car dealership has separate
inventory records for each vehicle.
• Record purchase of Inventory.
• Record revenue and record cost of goods sold when the item is sold.
• At the end of the period, no entry is needed except to adjust inventory for
losses, etc.
2. Periodic System — Cost of goods sold is determined only at the end of an
accounting period. This system involves:
• Record purchase of Inventory.
• Record revenue only when the item is sold.
• At the end of the period, you must compute cost of goods sold (COGS):
1. Determine the cost of goods on hand at the beginning of the accounting
period (Beginning Inventory = BI),
2. Add it to the cost of goods purchased (COGP),
3. Subtract the cost of goods on hand at the end of the accounting period 4.
(Ending Inventory = EI) illustrated as follows: BI + COGP = Cost of goods
available for sale - EI = COGS
TO ILLUSTRATE:
Magaling Computer Store started its operations on January 2, 2016. The store is
located in Sikat Mall in Bicol. The owner invested PHP500,000 to start the
business. On January 3, 2016, Magaling purchased 20 units of computers on
account for PHP10,000 each. Upon delivery of the units, the supplier, Delta, Inc.,
issued Charge Invoice No. 145 to Magaling.
ENTRY:
PURCHASES P200,000
ACCOUNTS PAYABLE P200,000
To record purchase of 20 units of computers
at PHP10,000 per unit from Delta, Inc. as per
Charge Invoice 145.
PURCHASE RETURNS AND ALLOWANCES
A purchaser may find the merchandise received to be unsatisfactory
because the goods are:
• damaged or defective
• of inferior quality
• not in accord with the purchaser’s specifications
The purchaser initiates the request for a reduction of the
balance due through the issuance of a debit memorandum.
The debit memorandum is a document issued by a buyer to
inform a seller that the seller’s account has been debited
because of unsatisfactory goods.
TO ILLUSTRATE:
Out of the 20 computer units purchased last January 3, 2016, it was found after
inspection on the same day that one unit was damaged during shipment.
Magaling issued a debit memorandum (DM 01) and informed the supplier that it
will return the one damaged item.
ENTRY:
ACCOUNTS PAYABLE P10,000
PURCHASE RETURN & ALLOWANCES P10,000
To record return of 1 unit of computers worth
PhP10,000 from Delta, Inc. as per DM 01
ACCOUNTING FOR FREIGHT COSTS
The sales agreement should indicate whether the seller or the buyer is to pay the
cost of transporting the goods to the buyer’s place of business. The two most
common arrangements for freight costs are: FOB SHIPPING POINT AND FOB DE
FOB Shipping Point:
• Goods placed free on board (FOB) the carrier by seller.
• Buyer pays freight costs.
• Freight-In is debited if buyer pays freight.
• Cash is credited if the goods come on cash on delivery (COD), for example,
and was paid immediately. Accounts Payable would be credited if on account.
• Ownership over the goods is transferred to the buyer once it is out of the
premises of the seller.
FOB Destination
• Goods placed free on board (FOB) at buyer’s business.
• Seller pays freight costs.
• Delivery Expense is debited if seller pays freight on outgoing
merchandise to a buyer. This is an operating expense to the seller.
• Ownership over the goods is transferred to the buyer once the goods
are delivered and received by the buyer.
TO ILLUSTRATE:
Assume the supplier of Magaling is based in Manila. In order to
bring the 20 computer units to Bicol, it will cost PHP3,000 to deliver
the goods.
If the terms is FOB Shipping Point, the entry to record, assuming
Magaling paid the common carrier in cash on January 4, 2016 is:
FREIGHT IN P3,000
CASH P3,000
To record freight costs for the purchase of
20 units of computers
If the terms is FOB Destination, no entry is recorded in the books of
Magaling. The PHP3,000 will be paid by the seller, in this case Delta,
Inc
PURCHASE DISCOUNTS:
• Credit terms (specify the amount of cash discount and time period
during which a discount is offered) may permit the buyer to claim a
cash discount for the prompt payment of a balance due. If the credit
terms show 2/10, n/30 means a 2% discount is given if paid within
10 days (called the discount period); otherwise, the invoice is due in
30 days.
• The buyer calls this discount a purchase discount.
• A purchase discount is normally based on the invoice cost less
returns and allowances, if any.
TO ILLUSTRATE:
The credit terms for the purchase of 20 computer units (total cost PHP200,000)
is 2/10, n/30. This means that if Magaling pays on or before January 13, 2016,
it is entitled to a 2% discount, otherwise Magaling will have to pay the full
amount on or before February 4, 2016 (30 days after purchase). On January 10,
2016, Magaling paid the account in full with Delta.
Accounts Payable P200,000
Purchase Discount P4,000
Cash P196,000
To record full payment of Delta, Charge
Invoice No. 145 with 2% discount
computed as PhP200,000 x 2%
Assuming that instead of paying on January 10, 2016, Magaling paid
on February 4, 2016, thus forfeiting the 2% discount, the entry to
record is:
Accounts Payable 200,000
Purchase Discount 200,000
To record full payment of Delta,
Charge Invoice No. 145
Recording of sales and related transactions under the Periodic Inventory
System:
SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER
• Revenues are reported when earned in accordance with the revenue
recognition principle, and in a merchandising company, revenues are earned
when the goods are transferred from seller to buyer.
• All sales should be supported by a document such as a cash register tape (to
provide evidence of cash sales) or cash receipt, or office receipt for cash sales,
and charge invoice for credit sales, or sales on account.
• One entry is made with each sale: Debit — Accounts Receivable (if a credit
sale) or Cash (if a cash sale) which increases assets for the sales amount Credit
— Sales which increases revenues
• The sales account is credited only for sales of goods held for resale. Sales of
assets not held for resale (such as equipment, buildings, land, etc.) are credited
directly to the asset account.
TO ILLUSTRATE : For the month of January, Magaling made the following sale:
1/10/2016 Official Receipt (OR) No. 001 Sold two units for cash to Marie Cruz for PHP36,000
(PHP18,000 per unit), FOB Destination
1/15/2016 Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500
(PHP19,500 per unit) with terms 3/10, n/ 30, FOB Shipping Point
1/10/2016 Cash 36,000
Sales 36,000
To record OR No. 001 cash sale - Marie Cruz
1/15/2016
Accounts Receivable 97,500
Sales 97,500
To record Charge Invoice No. 001 Rafael Reyes
on account with terms 3/10, n/30
FREIGHT TERMS: FOB DESTINATION — SELLER PAYS FREIGHT
• An entry is made when seller pays the freight to deliver goods to a customer or
buyer. If the buyer will pay for the freight, no entry is made.
• Debit — Delivery Expense and credit — Cash or Accounts Payable
TO ILLUSTRATE:
On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two
units to Marie Cruz.
1/10/16 Delivery Expense 500
Cash 500
To record full payment of Delta Charge Invoice No. 145

Take note that no entry will be made regarding the sale to Rafael Reyes since the
term is FOB Shipping Point.
SALES RETURNS AND ALLOWANCES:
• Sales Returns result when customers are dissatisfied with merchandise and are allowed to
return the goods to the seller for credit or a refund.
• Sales Allowances result when customers are dissatisfied, and the seller allows a deduction
from the selling price.
• To grant the return or allowance, the seller prepares a credit memorandum to inform the
customer that a credit has been made to the customer’s account receivable.
• Sales Returns and Allowances is a contra revenue account to the Sales account. A contra
account is a reduction to a particular account.
• A contra account is used, instead of debiting sales, to disclose the amount of sales returns
and allowances in the accounts.
• This information is important to management as excessive returns and allowances suggest
inferior merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes
in delivery or shipment of goods.
• The normal balance of Sales Returns and Allowances is a debit. • One entry is made with
each sales return and allowance: The entry to record the sales return or allowance: • Debit —
Sales Return and Allowances which decreases revenues for the amount of the sale • Credit —
Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets
TO ILLUSTRATE: On January 16, 2016, Rafael Reyes returned one unit of the
computers purchased last January 15, 2016 under Charge Invoice 001. The unit
returned was in good condition. However, Rafael Reyes returned the unit
because it is one unit more than what they need. The return was approved and
accepted by Magaling. The price will be deducted from the account of Rafael
Reyes.
Entry:
1/10/16 Sales Return & Allowances 19,500
Accounts Receivable 19,500
To record return of one unit of computers from
Rafael Reyes under Charge Invoice 001
SALES DISCOUNTS
1. A sales discount is the offer of a cash discount to encourage
customers to pay the balance at an earlier date.
2. An example of a discount term is commonly expressed as: 2/10,
n/30, which means that the customer is given 2% discount if
payment is made within 10 days. After 10 days there is no
discount, and the balance is due in 30 days.
3. Sales Discounts is a contra revenue account with a normal debit
balance.
TO ILLUSTRATE: Assume that Magaling purchased on cash, five units of computers at
PHP10,000 per unit from a supplier on January 17, 2016. These units were subsequently sold
to Jun Cruz on January 18, 2016 under Charge Invoice (ChI) No. 002 amounting to
PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB Shipping Point. On January
23, 2016, Cruz paid the said account in full.
1/17/16 Purchases 50,000
Cash 50,000
To record purchased on cash five units of computers
1/18/16 Accounts Receivable 90,000
Sales 90,000
To record sales on account under Charge
Invoice No. 002 to Jun Cruz with terms 2/10, n/30
1/23/16 Cash 88,200
Sales Discount 1,800
Accounts Receivable 90,000
To record collection of accounts receivable
from Jun Cruz net of 2% sales discount
Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the
2% discount because he made the payment within the discount period. Take note that the
discount period in this case was from January 19, 2016 to January 28, 2016 (10 days)
What If Jun Cruz paid the account on January 30, 2016 instead of January 23,
2016? The entry would be:
1/30/16 Cash 90,000
Accounts Receivable 90,000
To record collection of accounts receivable from Jun Cruz