LESSON NUMBER 2

LESSON TITLE: INTRODUCTION TO ACCOUNTING FOR MERCHANDISING BUSINESS

Lesson Objectives: At the end of the lesson, the students are expected to:

• Learn the difference between the net income for a service business and for a merchandising
business.
• Compute for the Cost of Goods Sold using the periodic Inventory Method.
• Differentiate the periodic system from the perpetual system of recording merchandise inventory.

GETTING STARTED

Aside from a service type of business, the most common type of business is the buying and selling
of goods, also called merchandising. The accounting principles for this type of business are the same as the
service business though some accounts are peculiar such as Purchases, Sales and Merchandise Inventory.
Computation for gross income is a major component in determining net profit for a merchandising business
because of the nature of its operations.

DISCUSSION OF CONTENT / APPLICATION

MERCHANDISING

A person who buys and sells goods or merchandise is called a merchandiser. You buy shoes and
sandals in bulk from Liliw and put up a shoe store. Or you buy a variety of food stuff from food processing
companies and put up a grocery store. A merchandiser may be a wholesaler or a retailer. The manner of
distribution depends on whether the seller is a wholesaler or a retailer. A wholesaler is one who buys in
bulk from a manufacturer or another wholesaler and sells them to other wholesalers or retailers. A retailer
buys goods from a manufacturer or wholesaler and sells them to the ultimate consumers. Refer to the
illustration:

Manufacturer Wholesaler Retailer Consumer

SERVICE BUSINESS AND MERCHANDISING BUSINESS COMPARED

The main difference between these two businesses lies in the sales and cost of sales section as
shown in the illustration below:

LUFFY DELIVERY SERVICE NAMI GROCERY STORE

Service Fees Revenues P 30,000 Sales Revenue P 54,000
Operating Expenses ( 12,000) Cost of Sales ( 30,000)
Operating Profit 18,000 Gross Profit 24,000
Other Revenues and Gains 3,000 Operating Expenses ( 16,000)
Other Expenses and Losses ( 2,000) Operating Profit 8,000
Net Profit P 19,000 Other Revenues and Gains 5,000
Other Expenses and Losses ( 2,000)
Net Profit P 11,000
 Note that side by side, you can identify the major sections of the grocery store and how it differs
from the delivery business. While the service provider uses the title Service Fees Revenues for receipts
coming from clients, the merchandiser uses the title Sales Revenue for receipts coming from goods sold to
customers. It follows that a merchandiser must maintain a stock of goods held for sale called Merchandise
Inventory. Once these goods are sold or delivered to the customers, it is recognized in the income statement
as cost of goods sold or Cost of Sales. Thistitle does not appear in the books of the merchandiser, neither
does the title gross profit.

Gross Profit. The merchandiser has to sell the goods at a price higher than its cost. In the above illustration,
Nami Grocery Store purchased merchandise for 1,000 units with a unit cost of P30 and priced it at 80%
above cost or plus P24. Hence, sales price will be P54 per unit. All units were sold so total sales revenue
is P54,000 while total cost of sales is P30,000. Cost of sales is a major expense representing the cost of the
merchandise sold. The gross profit of P24,000 realized by the merchandiser represents the amount of mark-
up on the cost price. Gross profit or mark-up indicates adequacy of margin of profit set up by the
merchandiser.

Operating Profit. Just like the service provider, expenses such as salaries, rent, utilities, freight and
advertising are necessary to support the operation of the merchandiser. From the gross profit, deduct the
operating expenses to arrive at the operating profit.

Non-Operating Activities. After the operating profit, non-operating activities are considered to arrive at
net profit. These are minor income and expenses not recurring and not part of regular operation. These are
classified into two:

1. Other Revenues and Gains such as rent income, interest income and gain from sale of property.
2. Other Expenses and Losses such as interest expense and loss from sale of property.

If there are no other revenues and other expenses, the operating profit is recognized immediately as the
net profit.

INVENTORY SYSTEM

A merchandiser’s statement of financial position is practically the same as that of a service provider
except that is has a current asset account called Merchandise Inventory for goods available for sale. There
are two methods of accounting for merchandise inventory: Perpetual and Periodic.

Under the Perpetual Method, there is a complete or continuous recording of the merchandise from
the time it is purchased to the time it is sold. This method is usually adopted by a business which sells high
priced – low volume goods such as car dealers and real estate companies. Processes involved are:

A) Record merchandise B) Record cost of sales and C) Balance at year end should
inventory sales revenue tally with inventory count

Under the Periodic Method, merchandise bought is recorded as Purchases representing goods
available for sale. No entry is made for the cost of merchandise sold. It is only at the end of the accounting
period that the cost of goods sold will be determined after making an inventory count of the goods that were
not sold. This is commonly used by a business selling low price – high volume goods like the supermarket
and hardware stores where it is difficult to track down every item sold. Processes involved are:
 A) Record purchases B) Record only sales revenue C) Count unsold, record
inventory end
Illustration:

a. During the year, 200 chairs were bought at P250 each or a total purchases of P50,000.
b. At the end of the year, a physical count showed only 70 chairs are still on hand.
c. Merchandise is sold at 50% above cost.

Computations:
Selling Price = P250 + (P250 x 50%) = P375

Sales (130 units x P375) P 48,750

Cost of Sales (130 units x P250) 32,500
Gross Profit P 16,250

Sales is computed as UNITS SOLD multiplied to SELLING PRICE.

COS is computed as UNITS SOLD multiped to COST

The above transactions will be recorded as:

Perpetual Method Periodic Method

Merchandise Inventory 50,000 Purchases 50,000
Cash 50,000 Cash 50,000
To record purchases To record purchases

Cash 48,750 Cash 48,750

Sales 48,750 Sales 48,750
To record sales To record sales
Cost of Sales No cost of sales entry.
Merchandise Inventory 32,500
To record cost of sales 32,500

End of month or year: End of the month or year:

Entry for goods on hand is Merchandise Inventory 17,500
not necessary. Income Summary 17,500
To record goods on hand
at year end.

At the of the accounting period, the sale of 170 chairs amounting to P48,750 and the cost of sales
of P32,500 will be reported in the income statement while the P17,500 balance of the merchandise inventory
will be presented in the statement of financial position representing goods still on hand.

To continue with the illustration: the ending merchandise inventory of 70 chairs will be brought
forward as beginning merchandise inventory in the following year. If another 100 chairs were again
purchased, the total goods available for sale will now be 170. At the end of the year, if 50 chairs are still on
hand, cost of goods sold will be computed as follows:

Merchandise Inventory, Jan 1 (70 x P250) P 17,500

Add: Purchases (100 x P250) 25,000
Total Goods Available for Sales P 42,500
 Less: Merchandise Inventory (50 x P250) 12,500
Cost of Goods Sold (120 x P250) P 30,000

If the 120 chairs are sold at the same selling price of P375 as last year, this will result a total gross
profit of P15,000 as computed below:

Sales (120 x P375) P 45,000

Less: Cost of Goods Sold (120 x P250) 30,000
Gross Profit P 15,000

The diagram below shows the movement of the goods from one period to the next period:

Merchandise Inventory Purchases (100) P25,000

January 1 (70) P17,500 (new stock)
(old stock)

Total Available for Sale

(170) P42,500
(during the year)

Merchandise Inventory Cost of Goods Sold

December31 (50) P12,500 (120) P30,000
(on hand at year end) (sold during the year)

The Merchandise Inventory ledger account, under the perpetual method, will appear as:

MERCHANDISE INVENTORY
Balance
Date Explanation Ref Debit Credit
Debit Credit
2019 Purchased goods 50,000 50,000
Sold goods 32,500 17,500
2020 Purchased goods 25,000 42,500
Sold goods 30,000 12,500

Note that the running balance represents what is unsold at any given date. In contrast, the periodic
method gives an incomplete recording because it does not record the cost of goods sold. The title Purchases
only the stock bought.

ENRICHMENT ACTIVITIES
1. How important it is to have a strong foundation in accounting for non-accounting majors like you?
2. What is your understanding on how accounting for merchandising business differs from accounting for
service business?
3. Is keeping records vital to the success of a business?
4. How can you relate accounting with your course/major?
5. Explain the basic difference between periodic and perpetual inventory system.

ASSESSMENT ACTIVITY
Record the following transactions using: a) Perpetual and b) Periodic Method
a. During the year, 300 chairs were bought at P150 each or a total purchases of P45,000.
b. At the end of the year, a physical count showed only 140 chairs are still on hand.
c. Merchandise is sold at 50% above cost.

After recording the transactions, determine the following:

a. Cost of Goods Sold
b. Gross Profit
c. Cost of unsold chairs

REFERENCES
1. Manuel, Z.V.C, M.V.C, Simplified Accounting for Business (International Edition 2016)
2. Warren, Reeve, Duchac. Accounting 2E (2nd Edition)
3. Ballada, Win. Basic Accounting Made Easy (18th Edition)
 LEARNING MODULE INFORMATION
I. Course Code EL201
II. Course Title ACCOUNTING FOR IT
III. Module Number 3 (FINAL)
IV. Module Title MERCHANDISING AND INTRODUCTION TO
MANUFACTURING BUSINESS
V. Module Outcomes At the end of this module, the students should be able to:
1. Prepare income statement of a merchandising business.
2. Identify and compute costs and inventories of a manufacturing
business.
3. Identify and compute costs related to different business
concerns
VI. Overview of the module The topics in this module are presented by having a discussion
and application of the lesson at the same time, followed by a
summary of the lesson and enrichment and assessment activities
to test the knowledge and understanding of the students.

LESSON NUMBER 1

LESSON TITLE: ACCOUNTING FOR MERCHANDISING BUSINESS

Lesson Objectives: At the end of the lesson, students are expected to:
• Have a basic understanding on the accounting process of a manufacturing business.

GETTING STARTED

This is the continuation of the accounting process of a merchandising business previously

introduced in the preceding lesson. On this lesson, other components of the accounting process especially
in Sales and Purchases will be explained thoroughly to understand how a merchandising business operates.

DISCUSSION OF CONTENT / APPLICATION

SALES REVENUE

Sales revenue is earned when the merchandiser or seller of the goods transfers the merchandise to
the customer. Remember that revenue results an increase in assets, usually in cash or accounts receivable,
which in turn increases owner’s equity. The sale is supported by a source document called an Invoice. Two
copies are usually prepared by the seller, the original which is given to the buyer who uses it in recording
purchases and the duplicate is kept on file by the seller who uses it in recording sales. Refer to example
below:

ROYAL FURNITURE MART SALES INVOICE

 77 Taft Avenue, Manila 1008
Tel. No. 521-2120
TIN 321 000 498 888 March 1, 2019

Sold to: Jim Perez Furnishers Terms: Cash

Address:1028 Sta. Mesa, Manila
Quantity Description Unit Price Amount
4 Book Cabinets P 1,000 P 4,000
Living Room Set
Dining Set
Bed
Executive Table
Opal Chair
Total P 4,000
Received the above items in good condition.
Jim Perez
Customer’s Signature

SALES DISCOUNT

Two common discounts granted to customers are: 1) trade discounts and 2) cash discounts.

1. Trade Discounts. Merchandisers offer their goods using a catalog where the goods are listed with
their prices. The prices herein are called catalog or list prices. A trade discount which is a
percentage reduction from a published list price may be granted to retailers or wholesalers for
buying large quantities or for regularly patronizing the business. Since a trade discount is granted
at the point of sale, this is immediately deducted from the list price and only the balance called the
gross invoice price will be the basis for invoicing and recording. Using the above illustration, let
us assume that a 2% trade discount was given to Perez. The invoice would now show only a unit
price of P980 which is the difference between the list price of P1,000 and the 2% trade discount of
P20. Total invoice amount would now be P3,920 (P980 x 4 units) which will be the basis in debiting
the cash and crediting the sales.
2. Cash Discounts. When goods are sold on credit, term of payment depends on the custom of the
industry. The usual credit terms which will appear on the invoice are:
a. n/30 – the gross amount is payable within 30 days from the date of sale with no discount.
b. 2/10, n/30–the account is payable within 30 days with a 2% discount given if the account is
paid within 10 days from the date of sale.
c. 3/EOM, n/60 – the account is payable within 60 days with a 3% discount given if the account
is paid until end of the month from the date of sale.
d. 2/10, 1/15, n/30 – the account is payable within 30 days with a 2% discount given if the account
is paid within 10 days from the date of sale, but only 1% discount if the account is paid within
15 days from the date of sale.

To illustrate: let us assume that on March 1, Royal Furniture sold goods to Jim Perez for P6,000 with a
P2,000 and the balance on term 2/10, n/30. The customer paid on March 8. Entries on the books of Royal
Furniture will appear as:

Date Particulars F Debit Credit

2019
 March 1 Cash on Hand 2,000
Accounts Receivable 4,000
Sales 6,000
Sold goods to J. Perez on terms of P2,000 down, balance 2/10,
n/30.

Cash on Hand 3,920

Sales Discount 80
Accounts Receivable 4,000
Collected the account of J. Perez, net of discount.

The cash discount, recorded as Sales Discount, is a contra revenue account which reduces the
recorded sales when presented in the income statement. Both trade and cash discounts are reductions from
sales except that trade discount is granted at the date of the sale and is immediately deducted before the sale
is recorded.

Note that every company has its own policy in granting cash discounts. Some will grant discount
only when the whole amount is paid within the discount period while others will allow discount on partial
payments or even when the account is paid outside of the discount period.

RETURNS AND ALLOWANCES

A customer may return merchandise if it is defective or if it is not as ordered. Or the customer may
just request for a reduction or allowance in the price, for the same reasons, without returning the
merchandise purchased. Just like discounts, returns and allowances should be debited to the title Sales
Returns and Allowancessince the amount to be paid by the customer will decrease revenue. This is another
contra revenue account.

To illustrate: assume that on March 1, Royal Furniture sold merchandise to Asia Miguel worth
P15,000 for cash. One week later, Asia Miguel returned a chair worth P4,500 because it was defective.
Royal Furniture acknowledged the return and issued a check to refund the customer. Entries in the books
of the seller will appears as:

Date Particulars F Debit Credit

2019
March 1 Cash on Hand 15,000
Sales 15,000
To record cash sales.

8 Sales Returns and Allowances 4,500

Cash in Bank 4,500
Cash refund for sales return made by Asia Miguel.

Under the perpetual method, an entry to record the cost of sales must also be made at the time of
sale. Also, the return on March 8 requires the prior entry of cost of sales to be reversed since there is a
physical movement of goods from buyer back to the seller: debit merchandise inventory and credit cost of
sales.

If the sale was made on account, instead of a cash refund, a credit memorandum will be issued by
the seller to acknowledge the return. A credit memorandum is a business document issued by the seller
informing the buyer that his account was decreased accordingly for the return made or for the reduction of
price requested. Remember that the account of a customer is recorded on the debit side. Any decrease
thereto is credited, hence, a credit memo. An example of a credit memo is shown below:

ROYAL FURNITURE MART

77 Taft Avenue, Manila

CREDIT MEMO
No. 15
March 8, 2019
CUSTOMER: Asia Miguel
ADDRESS:1033 Ortigas, San Juan

We have credited your account for: P 4,500

1 chair @ P4,500
Due to the following reason:
Perlita Torres
Chair legs are wobbling, no more stocks
Sales Manager
available.

Based on the above document, the entries should be:

Date Particulars F Debit Credit

2019
March 1 Accounts Receivable 15,000
Sales 15,000
Sales on account of n/30.

8 Sales Returns and Allowances 4,500

Accounts Receivable 4,500
Credit memo #15 for sales return.

NET SALES

At the end of the accounting period, two accounts are deducted from gross sales to arrive at the net
sales revenue. Taking all the illustrations discussed and using assumed figures, the first section of the
income statement will appear as:

Sales Revenue P 120,000

Less: Sales Discount P 3,500
Sales Returns and Allowances 8,500 12,000
Net Sales P 108,000

Discounts, returns and allowances may be directly debited to Sales to decrease the sales revenue
instead of using separate account titles. However, revised PAS 1 requires proper disclosure of all relevant
information in preparing the financial statements for statement users to be able to make rational decisions.
GROSS PURCHASES

Under the periodic inventory system, a merchandiser uses the title Purchases whenever
merchandise is bought for resale. It represents an owner’s equity account for goods available for sale by
the business for a particular accounting period. To illustrate, recall that Jim Perez, the proprietor of Jim
Perez Furnisher, bought P4,000 worth of furniture from Royal Furniture on account. From the buyer’s
viewpoint, the invoice received from the seller is called a purchase invoice. The entry in the books of Jim
Perez Furnisher will appear as:

Date Particulars F Debit Credit

2019
March 1 Purchases 4,000
Accounts Payable 4,000
Account purchases on terms of 2/10, n/30.

FREIGHT IN

In buying merchandise, the cost of transporting the goods may be paid by the buyer or by the seller
depending on the term of shipment. If the term of shipment is FOB Shipping Point, it means the title of
ownership passes to the buyer as soon as seller turns over the goods to a common carrier such as cargo ship
for delivery of the goods to the buyer.

Shipping Point Destination

- buyer owns the
goods
Seller’s Buyer’s
point place
- Buyer pays freight
cost

It also means that the buyer, as the owner of the goods, should pay for the freight. The buyer records
Transportation In or Freight In which is added to Purchases to arrive at Gross Purchases. To illustrate,
assume that on August 5, Royal Furniture bought from Cebu Furniture Shop goods worth P50,000 to be
transported by a boat at a cost of P1,000 under the terms 2/10, n/30, FOB Shipping Point, Freight Collect.
The goods were received August 5 and the freight was paid accordingly.

Date Particulars F Debit Credit

Aug. 5 Purchases 50,000
Accounts Payable 50,000
Purchases on terms of 2/10, n/30.

Freight In 1,000
Cash on Hand 1,000
Freight on terms of FOB Shipping Point, freight
collect.

Freight collect means that the buyer must pay the freight in cash either before the seller ships the
goods or upon receipt of the merchandise. Suppose the term is FOB Shipping Point Freight Prepaid? It
means that the freight was initially paid by the seller and the buyer will pay the freight together with the
purchased goods on account.

Entry in the buyer’s book:

Date Particulars F Debit Credit

Aug. 5 Purchases 50,000
Freight In 1,000
Accounts Payable 51,000
Purchases on terms of 2/10, n/30, FOB Shipping
Point, freight prepaid.

Note that the accounts payable increased by P1,000 because the buyer is still liable for the freight
that was advanced by the seller. Using the perpetual method, entry would be: debit merchandise inventory
P51,000 (purchases + freight in) and credit accounts payable P51,000.

Entry in seller’s book:

Date Particulars F Debit Credit

Aug. 5 Accounts Receivable 51,000
Sales 50,000
Cash 1,000
To record sales on terms of 2/10, n/30, FOB Shipping Point,
freight prepaid charged to the buyer.

Note that although the freight increased the accounts receivable because it is collectible by the
seller from the buyer who is liable under the term FOB Shipping Point, it did not increase the sales revenue.

FREIGHT OUT

Freight is not always an obligation of the buyer. If the term is FOB Destination which means free
on board destination, the seller is liable for the freight and is still considered the owner of the goods until it
reaches the buyer.

Shipping Point Destination

- seller owns the goods
until the buyer accepts it
Seller’s Buyer’s
point place
- seller pays freight cost

This time, the freight should be debited by the seller to the account Freight Out or Transportation
Out which is a selling expense. Using prior illustration, if the term is FOB Destination freight prepaid,
seller’s entry will be:

Date Particulars F Debit Credit

Aug. 5 Accounts Receivable 50,000
Sales 50,000
 To record sales on terms of 2/10, n/30, FOB
Destination.

Freight Out 1,000

Cash on Hand 1,000
Paid freight for goods sold.

Upon receipt of the goods, the buyer makes an entry only for the cost of the goods bought: debit
purchases (periodic) or merchandise inventory (perpetual) P50,000 and credit accounts payable P50,000.

PURCHASES RETURNS AND ALLOWANCES

Similar to sales returns, goods may be returned to the seller for being defective or not as ordered.
Instead of returning, buyer may just ask that the price be reduced. This will decrease the cost of the
purchases and likewise decrease the liability to be paid. A contra account called Purchase Returns and
Allowance is credited with a corresponding debit to cash or accounts payable depending on the purchase
transaction. This can also be directly credited to Purchases account but maintaining a separate account
enables management to control operations more effectively. Excessive returns due to defective goods may
mean, for example, that the management should look for other suppliers. Using the preceding illustration,
assume that when the P50,000 goods bought on account were received, P5,000 were found defective and
were returned. Entries in buyer’s book will be:

Date Particulars F Debit Credit

Aug. 5 Purchases 50,000
Accounts Payable 50,000
Purchases made on terms of 2/10, n/30.

7 Accounts Payable 5,000

Purchase Returns and Allowances 5,000
Returned defective chairs.

Recall that a credit memo will be received by the buyer from the seller as an acknowledgment of
the returned goods. If it was a cash purchase, the return or an allowance would require a cash refund.
Furthermore, using perpetual method, merchandise inventory is debited instead of purchases and
merchandise inventory is credited instead of purchase returns and allowances.

PURCHASE DISCOUNTS

Remember that a trade discount given to the buyer is immediately deducted from the list price
and only the balance appears in the invoice. On the other hand, a cash discount is offered when one buys
on account and is granted only when the account is paid within the discount period. A discount is
recorded by debiting the liability and crediting the contra purchase account called Purchase Discount
which decrease the value of the merchandise purchased.

Illustration 1. Assume that on May 1, Alonzo Shoes of Cebu bought goods from Marikina Shoe Factory for
P20,000. A 2% trade discount was granted and the term of the purchase was 2/15, n/30, FOB Shipping
Point, Freight Collect P1,000. Alonzo paid for the freight upon receipt of the shipment and paid for the
account on May 15. Entries in the books of Alonzo will appear as follows:

Date Particulars F Debit Credit

 May 1 Purchases 19,600
Accounts Payable 19,600
Purchases on terms of 2/15, n/30.
Freight In
Cash on Hand 1,000
Paid on terms FOB Shipping Point, freight collect. 1,000

15 Accounts Payable 19,600

Purchase Discount 392
Cash in Bank 19,208
Issued a check for the account.

Take note of the purchases and accounts payable recorded at the gross invoice price net of trade
discount on May 1. On May 15, which is 14 days after the purchase but still within the 15-day discount
period, a 2% cash discount of P392 was given. Using perpetual method, Purchases, Freight In and Purchase
Discount accounts will be substituted by Merchandise Inventory account.

If the term is FOB Shipping Point, Freight Prepaid, the entries will be:

Date Particulars F Debit Credit

May 1 Purchases 19,600
Freight In 1,000
Accounts Payable 20,600
Goods bought on terms of 2/15, n/30, FOB Shipping Point,
freight prepaid by Marikina.

15 Accounts Payable 20,600

Purchase Discount 392
Cash in Bank 20,208
Paid the account in full, net of discount.

Detailed computation is shown below:

List Price P 20,000

Less: Trade Discount (2% x P20,000) 400
Invoice Price P 19,600
Freight Prepaid 1,000
Gross Invoice Price P 20,600
Less: Cash Discount (2% x 19,600) 392
Net Invoice Price to be paid within the discount period P 20,208

Illustration 3: Using illustration 1, but Alonzo paid P10,000 and retuned P2,000 as defective on May 10
and paid the remaining balance on May 15. Entries will be:

Date Particulars F Debit Credit

May 1 Purchases 19,600
Freight In 1,000
Accounts Payable 20,600
Goods bought on terms of 2/15, n/30, FOB Shipping
Point.
 10 Accounts Payable 10,000
Cash in Bank 10,000
Partial payment of account and freight.

Accounts Payable 2,000

Purchase Returns and Allowances 2,000
Returned defective goods.

15 Accounts Payable 8,600

Purchase Discount 352*
Cash in Bank 8,248
Full payment of account.

*The purchase discount of P352 is computed based on the actual amount of goods purchased less purchase
returns and allowances [(P19,600 – P2,0000 x 2%].

Let us review all the rules for cash discounts:

1. It is given only when sales or purchase is on credit term.

2. Freight, returns and allowances should be deducted before computing for the discount.
3. Companies may take up discounts differently depending on their policies for partial payments.

NET COST OF PURCHASES

At the end of a given period or the accounting period, the Net Cost of Purchases will be computed
in the income statement when presenting the Cost of Goods Sold. The calculation based on the latest Alonzo
illustration will be:

Purchases P 19,600
Add: Freight In 1,000
Total cost of goods delivered P 20,600
Less: Purchase Returns & Allowances P 2,000
Purchase Discounts 352 2,352
Net Cost of Purchases P 18,248

ENRICHMENT ACTIVITIES

On April 1, Banzai Interior Designs purchased 500 units of dining tables at a unit cost of P1,500 with freight
cost of P5,000 on terms of 2/10, n/30, FOB Shipping Point. Banzai paid its account in full on April 8.

Requirement:
1. Compute for Gross and Net Purchases.
2. Who pays for the freight cost?
3. Compute for the total amount paid by Banzai.

ASSESSMENT
Chopper Co. distributes backpacks to retail stores at a price of P1,600 each and extends credit terms of
1/10, n/30 to all customers. It sold 100 units to Toothless Store on June 1 and 200 units to Hiccup Botique
on June 8. Toothless paid its account in full on June 13 while Hiccup paid on June 16.

Requirement:
1. Compute for Gross and Net Sales.
2. Who has availed the sales discount?
3. Compute for the total amount received by Chopper.

REFERENCES

1. Manuel, Z.V.C, M.V.C, Simplified Accounting for Business (International Edition 2016)

LESSON NUMBER 2

LESSON TITLE: INCOME STATEMENT FOR MERCHANDISING BUSINESS

Lesson Objective: At the end of the lesson, the students are expected to prepare income statement for
merchandising business using the function of expense form.

GETTING STARTED

In order to determine whether a business is successful or not, its performance must be assessed and
regularly reviewed. The information that will be used in the assessment is provided by the income statement
which summarizes the operating activities of the business. This particular lesson will define and make the
students understand revenues and expenses and will show how these items will affect the accounting
elements.

DISCUSSION AND APPLICATION

Income Statement is also known as the statement of operations, profit and loss statement, and
statement of earnings. It is one of a company's main financial statements. The purpose of the income
statement is to report a summary of a company's revenues, expenses, gains, losses, and the resulting net
income that occurred during a year, quarter, or other period of time.

Examples of Items Appearing in the Income Statement:

1. Revenues, which are the amounts earned through the sale of goods and/or the providing of
services.
2. Expenses, which include the cost of goods sold, selling, general & administrative expenses, and
interest expense.
3. Gains and losses, such as the sale of a noncurrent asset for an amount that is different from its
book value.
 4. Net income, which is the result of subtracting the company's expenses and losses from the
company's revenues and gains.

The illustration below is an example of an Income Statement.

Mugiwara General Merchandise

Income Statement
For the period ended December 31, 2019

Sales P 120,000
Cost of Sales ( 70,000)
Gross Profit P 50,000
Selling Expenses ( 15,000)
Administrative Expense ( 12,000)
Interest Expense ( 10,000)
Net Income P 13,000
The presentation of the income statement above is called the “Function of Expense Form”, which
shows the costs and expenses according to function: cost of sales, selling expenses, administrative expense
and finance cost. Computation of Net Sales and Net Purchases were already discussed in the prior lesson,
components of costs and expenses are presented below:

1. Cost of Sales

Merchandise Inventory, beginning P xxx

Net Purchases ( xxx)
Cost of Goods Available for Sales P xxx
Merchandise Inventory, ending ( xxx)
Cost of Sales P xxx

2. Selling Expenses – these are all distribution-related expenses which includes Sales Salaries,
Advertising, Rent Expense – Warehouse, Freight Out, Store Supplies Expense, etc.

3. Administrative Expenses – these includes Office Salaries, Rent Expense – Office, Bad Debts,
Depreciation – Office Equipment, Office Supplies Expense, etc.

Illustration. Alonzo Shoe Store sells different kinds of shoes in their store in Calamba City. At year-end
2019, their books showed the following balances:

Particulars Amount
Gross Sales P 1,750,000
Sales Returns & Allowances 7,500
Sales Discount 20,000
Merchandise Inventory, Jan. 1 30,000
Purchases 950,000
Freight In 5,000
Purchase Returns & Allowances 3,000
Purchase Discount 7,000
 Sales Salaries 54,000
Advertising 50,000
Rent – Warehouse 20,000
Freight Out 5,000
Store Supplies Expense 3,000
Office Salaries 30,000
Rent – Office 20,000
Depreciation – Office Equipment 5,500
Office Supplies Expense 3,600
Interest Expense 2,000

Computations:

1. Net Sales
Gross Sales P
1,750,000
Less: Sales Returns & Allowances P 7,500
Sales Discount 20,000
27,500
Net Sales P
1,722,500

2. Cost of Sales
Merchandise Inventory, Jan. 1 P
30,000
Add Net Purchases:
Purchases P 950,000
Add Freight In 5,000
Total Cost of Goods Delivered P 955,000
Less: Purchase Returns & Allowances P3,000
Purchase Discount 7,000 10,000
945,000
Total Goods Available For Sale P
975,000
Less: Merchandise Inventory, Dec. 31
40,000
Cost of Sales P
935,000

3. Selling Expenses
Sales Salaries P 54,000
Advertising 50,000
Rent – Warehouse 20,000
Freight Out 5,000
Store Supplies Expense 3,000
Total P 132,000
 4. Administrative Expenses
Office Salaries P 30,000
Rent – Office 20,000
Depreciation – Office Equipment 5,500
Office Supplies Expense 3,600
Total P 59,100

Thus, the Income Statement will be presented as follows:

Alonzo Shoe Store

Income Statement
For the period ended December 31, 2019

Net Sales P 1,722,500

Cost of Sales ( 935,000)
Gross Profit P 787,500
Selling Expenses ( 132,000)
Administrative Expense ( 59,100)
Interest Expense ( 2,000)
Net Income P 594,400

The advantage of using the Function of Expense Form is that it facilitates assessment of operating
performance of the different departments or functions in a business organization.

SUMMARY OF THE LESSON

• Income Statement is also known as the statement of operations, profit and loss statement, and
statement of earnings.
• The purpose of the income statement is to report a summary of a company's revenues, expenses,
gains, losses, and the resulting net income that occurred during a year, quarter, or other period of
time.
• Items appearing in an Income Statement are revenues, expenses, gains and losses and net income.
• Income Statement of a merchandising business is recommended to be presented using the “Function
of Expenses Form” wherein costs and expenses are classified according to their functions such as
cost of sales, selling, administrative and finance cost.

ENRICHMENT

Using the following accounts, classify each of them as part of cost of sales (COS), selling expense (SE),
administrative expense (AE) or finance cost (FC).

1. Depreciation Expense – Office Equipment

 2. Freight In
3. Rent Expense – Warehouse
4. Sales Discount
5. Taxes & Licenses
6. Freight Out
7. Pag-ibig Premium Expense
8. Sales Returns & Allowances
9. Commission Expenses
10. Purchase Discount
11. Interest Expense
12. Rent Expense – Admin Office

ASSESSMENT

The following information were taken from the books of Fishman Island Sport Store that sells different
kinds of swimming gears and accessories:

Sales Returns & Allowances 4,000 Purchase Discount 6,000

Freight In 8,000 Communication Expense 45,000
Commission Expense 30,000 Sales 540,000
Purchase Returns & Allowances 7,500 Purchases 112,000
Merchandise Inventory, Dec. 31 95,000 Sales Discount 25,000
Freight Out 11,000 Rent Expense – Showroom 20,000
Merchandise Inventory, Jan. 1 78,500 Sales Salaries Expense 91,300
HDMF Premium Expense 1,826 Taxes & Licenses 10,170
SSS Premium Expense 3,088 Depreciation Expense – Office Furniture 16,500
PHIC Premium Expense 1,200 Interest Expense 3,500

Requirement:
1. Compute for Cost of Sales, Selling Expenses and Administrative Expenses.
2. Present the Income Statement using Function of Expense method.

REFERENCES

1. Manuel, Z.V.C, M.V.C, Simplified Accounting for Business (International Edition 2016)