Review

Types of business according to activities

Accounting Cycle
Example of merchandising
Activities/ Transactions in Merchandising
• buying of stocks or items for resale
• payment of expenses related to operations
• purchase of equipment
• obtaining a loan to finance the business
• investment of owners
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
If a grocery store decided to sell an old computer used in
the office, this would not be merchandise because
grocery stores do not normally sell computers and the
store is simply selling off old office equipment. But a
computer would be merchandise for a computer store
who resells computer units. Merchandise for one firm
may be a fixed asset (or property and equipment) for
another.
In another example, a pharmacy decided to sell a table
used in their display area. This table is not merchandise
of a pharmacy. However, to a retail furniture store a table
is merchandise because the business of a furniture store
involves the buying and selling of tables.
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.
Sales - COGS = Gross Profit - Operating Exp. = Net Income (Loss)
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
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

Additional Considerations:
• Perpetual systems have traditionally been used by companies that sell
merchandise with high unit values such as automobiles, furniture, and
major home appliances. With the use of computers and scanners, many
companies now use the perpetual inventory system.
• The perpetual inventory system is named because the accounting
records continuously — perpetually —show the quantity and cost of
the
inventory that should be on hand at any time. The periodic system only
periodically updates the cost of inventory on hand.
• A perpetual inventory system provides better control over inventories
than a periodic inventory, since the records always show the quantity
that should be on hand. Then, any shortages from the actual quantity
and what the records show can be investigated immediately.
PERIODIC INVENTORY SYSTEM
Recording purchases and related transactions under the
Periodic Inventory System
PURCHASES OF MERCHANDISE: PERIODIC SYSTEM
1. When merchandise is purchased for resale to customers,
the account, Purchases, is debited for the cost of goods
purchased.
2. Like sales, purchases may be made for cash or on account
(credit).
3. The purchase is normally recorded by the purchaser
when the goods are received from the seller.
• Each credit purchase should be supported by a
purchase invoice.
• A purchase invoice received by the buyer is actually a
sales invoice or a charge invoice prepared by the
supplier or vendor.
• Note that only purchases of merchandise are debited
to the ‘Purchase’ account. Acquisition (purchases) of
other assets: supplies,
equipment, and similar items are debited to their
respective accounts.
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.
• A return of the merchandise (a deduction from the
purchase price when unsatisfactory goods are kept) is
shown by the entry where
Purchase Returns and Allowances is credited to show
that the purchases Accounts Payable is debited and
was reduced with a return or an allowance.
• The Purchase Returns and Allowances account is a
“contra purchases” account when merchandise is
returned to a supplier.
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
DESTINATION.
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.
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.
 General Journal
Date Account Title and Explanation Debit Credit
1/3/16 Purchases 200,000
Accounts Payable 200,000
To record purchase of 20 units of computers at
PHP10,000 per unit from Delta, Inc. as per Charge Invoice 145.
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.
 General Journal
Date Account Title and Explanation Debit Credit
1/3/16 Accounts Payable 10,000
Purchase Returns and Allowances 10,000
To record return of 1 unit of computers worth PhP10,000
from Delta, Inc. as per DM 01
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

General Journal
Date Account Title and Explanation Debit Credit
1/4/16 Freight-In 3,000
Cash 3,000
To record freight costs for the purchase of 20 units of
computers
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.
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.
 General Journal
Date Account Title and Explanation Debit Credit
1/10/16 Accounts Payable 200,000
Purchase Discount 4,000
Cash 196,000
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:

General Journal
Date Account Title and Explanation Debit Credit
2/4/16 Accounts Payable 200,000
Purchase Discount 200,000
To record full payment of Delta, Charge Invoice No. 145
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
Recording of sales and related transactions under the Periodic Inventory
System
• 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

General Journal
Date Account Title and Explanation Debit Credit
1/10/16 Cash 36,000
Sales 36,000
To record OR No. 001 cash sale - Marie Cruz
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

General Journal
Date Account Title and Explanation Debit Credit
1/15/16 Accounts Receivable 97,500
Sales 97,500
To record Charge Invoice No. 001 Rafael Reyes on account
with terms 3/10, n/30