Finance, Accounting and Reporting

MODULE 7: Merchandising Business

MERCHANDISING BUSINESS

● A business entity whose main business is buying and selling goods or merchandise.

COMPARISON OF INCOME STATEMENT

Service Merchandising

Income/Revenue from services xx Net Sales xx

(-) minus (-) minus

Expenses (xx) Cost of Good Sold (COGS) (xx)

(=) equals (=) equals

Net Income/Profit xx Gross Profit/Income xx

(+ or -) add or minus

Income/Expenses (xx)

(=) equals

Net Income/Profit xx

In a merchandising business, net sales

arise from sale of goods or inventory for
sale. Cost of sales also known as “cost
of goods sold” represent the COST of
inventory that has been sold to the
customers. Gross profit is the
difference between Net Sales and Cost
of Sales. Then other operating income is
added and operating expenses like
distribution or selling costs,
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administrative costs and other operating costs 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 income tax, then income tax expense is deducted to have profit
from continuing operations. Finally, profit from discontinued operations (net of tax) is taken into
account to arrive at profit for the period.

OPERATING CYCLE FOR A MERCHANDISING BUSINESS

SOURCE DOCUMENTS FOR A MERCHANDISING BUSINESS

1. SALES INVOICE — prepared by seller given to buyer

➢ This document contains:

○ name and address of buyer
○ date of sale
○ quantity, description, and price of good sold
○ amount of sales, transportation and payment terms

2. BILL OF LADING — issued by carrier (trucking, shipping, airline)

➢ This document contains:

○ contractual conditions
○ terms of delivery e.g. freight terms, time, place and name of person to receive
goods
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3. STATEMENT OF ACCOUNT — formal notice to the debtor detailing the accounts and amount
already due for payment.

4. OFFICIAL RECEIPT — evidences the receipt of cash by the seller or the authorized
representative. It notes the invoices paid and other details of payment.

5. DEPOSIT SLIP — a bank form to be accomplished showing the depositor’s name, account
number and details of the deposit.

➢ A bank-validated deposit slip indicates that the cash and checks have been
deposited and credited to the account of the holder.

6. CHECK — a written order to a bank by a depositor to pay the amount specified in the check
from his checking account to the person named in the check.

➢ Payor — entity issuing the check

➢ Payee — entity named to receive the proceeds of the check

7. PURCHASE REQUISITION — written request to the purchaser or purchasing officer of the

business entity from an employee or user department of the same entity for good/s require for
purchase.

8. PURCHASE ORDER — an authorization made by the buyer to the seller to deliver the
merchandise as detailed in the form.

9. RECEIVING REPORT — a document containing information about goods received from a

vendor. It formally records the quantities and description of goods delivered.

10. CREDIT MEMORANDUM — form used by the seller to notify the buyer that his account is being
reduced due to errors or other factors requiring adjustments.

TERMS OF TRANSACTIONS

A. PAYMENT TERMS
➢ Cash
➢ Credit
○ Credit period — the number of days within which the invoice must be paid.
○ n — represents the number of credit periods in days.
○ n/30 — payment is expected 30 days from the invoice date.
○ n/10 eom — represents the payment is required ten (10) days after the end of
the month.
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B. DISCOUNTS
1. Trade Discount
➢ discount on the list price of the merchandise
➢ vary periodically as list prices do
➢ this is not recorded in the books because accounting for cost of merchandise
will be based on the Invoice Price which is net of trade discounts (List price -
Trade discount)
➢ may be given in series e.g. 20%, 10%

Sample Problem: Pinnacle Technologies quoted a list price of P2,500 for each 64-
gigabyte flash drive, less trade discount of 20%, 10%. If Video Fantastic ordered seven
units, what would be the invoice price?

2. Cash Discount
➢ Discount given for prompt payment
➢ Cash discounts are called purchase discounts from the buyer’s viewpoint and
sales discount from the seller’s point of view.
➢ It is applied on the Invoice Price (List Price minus Trade Discount)
➢ Cash discount is designated by such notation as “2/10” which means that the
buyer may avail of a 2% discount if paid within 10 days from invoice date. The
period covered by the discount, in this case – 10 days, is called the discount
period.

Sample Problem: Assume that the invoice for P150,000 with terms 2/10, n/30, is to be
paid within the discount period with money borrowed for the remaining 20 days of the
credit period. If an annual interest rate of 18% is assumed, what would be the net
savings to the buyer?
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C. TRANSPORTATION COST

Freight bills usually show whether the shipping terms are FOB shipping point or FOB
destination. F.O.B. is an abbreviation for “free on board”.

1. Free on Board (FOB) Shipping Point BUYER

➢ Buyer shoulders the shipping costs
➢ Ownership passes from seller to buyer when the inventory leaves the
seller’s place of business or shipping point.
➢ Buyer owns the inventory while still in transit and therefore shoulders
the transportation costs.

2. Free on Board (FOB) Destination SELLER

➢ Seller shoulders the shipping costs
➢ Ownership passes from seller to buyer when the inventory is received
by the buyer at the point of destination.
➢ Seller owns the inventory while still in transit and therefore shoulders
the transportation costs.

3. Freight Prepaid SELLER

➢ Seller pays transportation costs before shipping the goods sold
➢ Normally, FOB Destination because seller shoulders transportation
cost until inventory is received by buyer

4. Freight Collect BUYER

➢ Buyer pays transportation costs upon receipt of goods inventory
leaving the place of business of the seller.
➢ Normally, FOB shipping point because buyer shoulders transportation
once the inventory leaves the place of business of the seller
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INVENTORY SYSTEMS
● Inventory determines the Cost of Goods Available for Sale and Cost of Goods Sold

1. PERIODIC SYSTEM
● primarily used by businesses that sell relatively inexpensive goods and are not
yet using computerized scanning systems to analyze goods sold. Under this
system no entries are made to the inventory account as the merchandise is
bought and sold. The following set of accounts are used:

➢ Purchases
➢ Purchase Discounts
➢ Purchase Returns & Allowances
➢ Transportation In
➢ Cost of Sales is computed

Only at the end of the period, when the inventory is counted, when entries are
made to the inventory account to establish its proper balance. Inventory per
books vs. physical inventory is closed to the Income Summary account.

2. PERPETUAL INVENTORY SYSTEM

● used by firms that sell low-volume, high priced goods (such as motor vehicles,
jewelry, and furniture) and by companies with point of sale scanners. Under
this system the inventory account is continuously updated.

✓ Inventory Account is used to record Purchases

✓ Cost of Sales Account is recorded when inventory is sold
✓ Ending Inventory is determined through Physical Count
✓ Cost of Sales is determined through General Ledger
✓ Inventory account is INCREASED by:
1. Purchases
2. Transportation In
3. Sales Returns
✓ Inventory account is DECREASED by
1. Cost of Sales
2. Purchase returns and allowances
3. Purchase Discount
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SAMPLE TRANSACTIONS AND JOURNAL ENTRIES FOR SALES USING PERIODIC INVENTORY SYSTEM

Sale of merchandise in cash for P25,000

Journal Entry:
Cash 25,000
Sales 25,000

Sale of merchandise on account for P25,000

Journal Entry:
Accounts Receivable 25,000
Sales 25,000

Sales on Account with discount terms

Sept 20 - Sold merchandise for P3,000; terms 2/10, n/60

Journal Entry:
Accounts Receivable 3,000
Sales 3,000

Sales Discount: Sept 30 - Received payment from sale on account of Sept 20

Journal Entry:
Cash 2,940
Sales Discount 60
Accounts Receivable 3,000

Sales Return: October 01 – Returned merchandise sold on Sept 20 P760

Journal Entry:
Sales Returns 760
Accounts Receivable 760

Transportation Out – Case 1:

Nov 25 - Sold merchandise totaling P17,000 with terms FOB Destination, Freight Prepaid
P1,900; terms 2/10, n/30
Journal Entry:
Accounts Receivable 17,000
Transportation Out 1,900
Sales 17,000
Cash 1,900
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Transportation Out – Case 2:

Nov 25 – Sold merchandise totaling P17,000 FOB shipping point, Freight collect P1,900; terms
2/10, n/30
Journal Entry:
Accounts Receivable 17,000
Sales 17,000

Collection with Sales Discount

Dec 5 – Collected the account from the customer
Journal Entry:
Cash 16,660
Sales Discount 340
Accounts Receivable 17,000

Transportation Out – Case 3:

Nov 25 – Sold merchandise totaling P17,000 FOB Destination, Freight collect P1,900; terms
2/10, n/30
Journal Entry:
Accounts Receivable 15,100
Transportation Out 1,900
Sales 17,000

Collection with Sales Discount

Dec 5 – Collected the account from the customer
Journal Entry:
Cash 14,760
Sales Discount 340
Accounts Receivable 15,100
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Transportation Out – Case 4:

Nov 25 – Sold merchandise totaling P17,000 FOB Shipping Point, Freight prepaidP1,900; terms
2/10, n/30
Journal Entry:
Accounts Receivable 18,900
Sales 17,000
Cash 1,900

Collection with Sales Discount

Dec 5 – Collected the account from the customer
Journal Entry:
Cash 18,560
Sales Discount 340
Accounts Receivable 18,900

SAMPLE TRANSACTIONS AND JOURNAL ENTRIES FOR PURCHASES USING PERIODIC INVENTORY
SYSTEM

Purchase of merchandise in cash for P15,000

Journal Entry:
Purchases 15,000
Cash 15,000

Purchase of merchandise on Nov 12 on account for P15,000 with terms 2/10, n/30
Journal Entry:
Purchases 15,000
Accounts Payable 15,000

Purchase Returns: Nov 14 – Returned merchandise purchased P2,000

Journal Entry:
Accounts Payable 2,000
Purchase Returns 2,000
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Payment of Purchase on Account with Discount terms

Purchase Discount: Nov 22 – Paid in full the account
Journal Entry:
Accounts Payable 13,000
Purchase Discount 260
Cash 12,740

Transportation Case 1:

Nov 25 – Purchased merchandise totaling P17,000 with terms FOB Destination, Freight Prepaid
P1,900; terms 2/10, n/30
Journal Entry:
Purchases 17,000
Accounts Payable 17,000

Payment with Discount: Dec 5 – Paid the account in full

Journal Entry:
Accounts Payable 17,000
Purchase Discount 340
Cash 16,660

Transportation – Case 2:

Nov 25 – Purchased merchandise totaling P17,000 FOB shipping point, Freight collect P1,900;
terms 2/10, n/30
Journal Entry:
Purchases 17,000
Transportation In 1,900
Accounts Payable 17,000
Cash 1,900

Payment with Purchase Discount: Dec 5 – Paid the account in full

Journal Entry:
Accounts Payable 17,000
Cash 16,660
Purchase Discount 340

NOTE: The DISCOUNT is applied on the TOTAL PAYABLES.

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Transportation Out – Case 3:

Nov 25 – Sold merchandise totaling P17,000 FOB Destination, Freight collect P1,900; terms
2/10, n/30
Journal Entry:
Purchases 17,000
Accounts Payable 15,100
Cash 1,900

Payment with Purchase Discount: Dec 5 – Paid the account in full

Journal Entry:
Accounts Payable 15,100
Purchase Discount 340
Cash 14,760

Transportation Case 4:

Nov 25 – Purchased merchandise totaling P17,000 FOB Shipping Point, Freight prepaid P1,900;
terms 2/10, n/30
Journal Entry:
Purchases 17,000
Transportation In 1,900
Accounts Payable 18,900

Payment with Purchase Discount: Dec 5 – Paid the account in full

Journal Entry:
Accounts Payable 18,900
Purchase Discount 340
Cash 18,560

NOTE: The DISCOUNT is still applied on the TOTAL Purchases not on the balance of the Accounts
Payable EVEN IF THE PAYABLE BALANCE HAS BEEN INCREASED BY THE FREIGHT CHARGES PAID BY THE
BUYER. FREIGHT CHARGES IS ADDED TO THE PAYABLE.
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EXERCISE ON THE COMPARATIVE JOURNAL ENTRIES FOR PERIODIC AND PERPETUAL INVENTORY
SYSTEMS

Assume that the beginning inventory for the year is P250,000. If the transactions (1-7) were the only
transactions for the entire year, the balance in the inventory account at year-end under the periodic
inventory system is P250,000 (beginning inventory). The year-end balance in the inventory account
under the perpetual inventory system is P231,860. At year-end, the physical inventory was taken, and
it revealed that the actual inventory on hand was P231.500.

Transaction No. 1 – Sold merchandise on account costing P8,000 for P10,000; terms 2/10, n/30
Periodic System
Accounts Receivable 10,000
Sales 10,000

Perpetual System
Accounts Receivable 10,000
Sales 10,000

Cost of Sales 8,000

Inventory 8,000

Transaction No. 2 – Customer returned merchandise costing P400 that had been sold on account for
P500 (part of the P10,000 sale)

Periodic System
Sales Returns 500
Accounts Receivable 500

Perpetual System
Sales Returns 500
Accounts Receivable 500

Inventory 400
Cost of Sales 400
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Transaction No. 3 – Received payment from customer for merchandise sold above cash discount
taken:

(P10,000 sale – 500 return) x 2% discount = 190)

Periodic System
Cash 9,310
Sales Discount 190
Accounts Receivable 9,500

Perpetual System
Cash 9,310
Sales Discount 190
Accounts Receivable 9,500

Transaction No. 4 – Purchased merchandise on account for resale for P6,000; terms were 2/10, n/30
(purchase is recorded at invoice price)

Periodic System
Purchases 6,000
Accounts Payable 6,000

Perpetual System
Inventory 6,000
Accounts Payable 6,000

Transaction No. 5 – Paid freight of P200 on the P6,000 purchase; terms were FOB Shipping point,
freight collect

Periodic System
Transportation In 200
Cash 200

Perpetual System
Inventory 200
Cash 200
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Transaction No. 6 - Returned merchandise costing P300 (part of the P6,000 purchase)

Periodic System
Accounts Payable 300
Purchase Returns 300

Perpetual System
Accounts Payable 300
Inventory 300

Transaction No. 7 – Paid for merchandise purchased (refer to transaction 4) cash discount taken
(6,000 Purchase – 300 Return) x 2% Discount = P114

Periodic System
Accounts Payable 5,700
Cash 5,586
Purchase Discount 114

Perpetual System
Accounts Payable 5,700
Cash 5,586
Inventory 114

Closing Entry 1 – To transfer the beginning inventory balance to the Income Summary
Account (part of closing entry under the periodic system)

Periodic System
Income Summary 250,000
Inventory 250,000

Perpetual System
No entry required
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Closing Entry 2 – To record the ending inventory balance (part of closing entries under the periodic
system

Periodic System
Inventory 231,500
Income Summary 231,500

Perpetual System
No entry required

Closing Entry 1 – To adjust the ending inventory balance for the shrinkage during the year

Periodic System
No entry anymore since this has already been considered when the physical count was undertaken
and when the ending inventory was recorded

Perpetual System
Cost of Sales 360
Inventory 360

Ending Inventory per book 231,860

Physical count balance 231,500

Shrinkage or Loss 360

Points to remember:
➢ Sales Discount is based on “Net Sales” = Sales Minus Sales Returns
➢ Sales returns are generally acknowledged by sellers by issuing a Credit Memorandum in favor
of the buyer/customer
➢ Ensure to track or follow the flow of transactions to determine whether a sales return is
applicable as a deduction from sales for computing the sales discount.
➢ Transportation Out – FOB Destination; Seller; Part of Selling Expense
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➢ Transportation In – FOB Shipping Point; Buyer; Part of Net Cost of Purchases & Cost of Goods
Sold
➢ Transportation or Freight Charges must be recorded at point of sale or purchase if silent.
➢ Track the transactions to determine freight charges
➢ Payment for transportation is depending on freight terms i.e. collect or prepaid; if silent,
accounts payable; payable to the carrier

THE FINANCIAL STATEMENTS

Income Statement

Exhibit 7-1 shows the income statement of Gloria Detoya Traders using the periodic inventory system
under the function of expense method.