FUNDAMENTALS OF ACCOUNTANCY, BUSINESS AND MANAGEMENT 1

Week 3 (2nd Semester 4th Quarter)

Chapter 3: THE NATURE AND EXAMPLES OF MERCHANDISING

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;
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:

Sales – COGS = Gross Profit – Operating Expenses = Net Income/(Loss)

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

Prior to the discussion on the journal entries, recall the first step in the accounting cycle discussed in previous chapters on financial and non-financial
transactions.

>> 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. Recall the rule that only financial transactions are recorded and that the amount can be measured. These two conditions must exist
in order for a particular transaction to be recognized or recorded. As defined, financial transactions are those activities that change the value of an asset,
liability or equity.
>> Step 2 is the Preparation of Journal Entries (Journalization) A merchandising company may use special and general journals to record its transactions.

SPECIAL JOURNALS
Some businesses encounter voluminous quantities of similar and recurring transactions, which may create congestion if these transactions are recorded
repeatedly in a single day or monthly in the general journal. The use of special journals will eliminate this problem.
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:

Beginning Inventory + COGP = Cost of goods available for sale – Ending Inventory = 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 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.

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 • 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 Accounts Payable is
debited and Purchase Returns and Allowances is credited to show that the purchases 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.

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.

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 directly
credited to the asset account.

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.

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

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.

Determining Cost of Goods Sold under Periodic Inventory System The Cost of Goods Sold under the periodic inventory system is determined at the end of the
period (monthly or yearly) by a short computation, as follows:

In a periodic inventory system, separate ledger accounts are maintained for various items composing the cost of goods sold (Purchases, Purchase Returns &
Allowances, Freight-In, Purchase Discounts). At the end of the accounting period, a physical count of inventory is necessary to establish the ending balance of
the inventory.

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PERPETUAL INVENTORY SYSTEM PURCHASES OF MERCHANDISE: PERPETUAL SYSTEM
• When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is debited for the cost of goods purchased.
• Like sales, purchases may be made for cash or on account (credit).
• 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 Merchandise Inventory. Purchases of other assets: supplies, equipment, and similar items) are
debited to their respective accounts.

PURCHASE RETURNS AND ALLOWANCES

• A purchaser may be dissatisfied with merchandise received because the goods are:
 damaged or defective
 of inferior quality
 not in accordance 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 Accounts Payable is
debited and Merchandise Inventory is credited to show that the cost of the Merchandise Inventory is reduced with a return or an allowance.

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.
 Merchandise Inventory 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 which 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.

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% is discount is given if paid within 10 days (called the discount period);
otherwise the invoice is due in 30 days.
• The buyer records this discount as a reduction to Merchandise Inventory.
• A purchase discount is normally based on the invoice cost less returns and allowances, if any.

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 (provide evidence of cash sales) or cash receipt or office receipt for cash sales, and
charge invoice for credit sales or sales on account.
• Two entries are made with each sale:
The first entry records the 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 second entry records the cost of the merchandise sold:
 Debit — Cost of Goods Sold which increases expenses
 Credit — Merchandise Inventory which decreases assets
• The sales account is credited only for sales of good held for resale. Sales of assets not held for resale (such as equipment, buildings, land,etc.) are credited
directly to the asset account.

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.

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 accounts
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 in the accounts the amount of sales returns and allowances.
• 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.
• Two entries are made with each sale return and allowance:
 The first entry records 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
 The second entry records the increase in Merchandise Inventory:
• Debit — Merchandise Inventory which increases assets
• Credit — Cost of Goods Sold which decreases expenses

SALES DISCOUNTS
1. A sales discount is the offer of a cash discount to a customer to encourage them 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.

Determining Cost of Goods Sold under the Perpetual Inventory System The Cost of Goods Sold under the perpetual inventory system is determined by getting
the running balance in the general ledger of the account. Recall the previous discussion on posting the journal entries to the general ledger. At any point in

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time, you can determine the cumulative cost of goods sold under the perpetual inventory system because in this system a separate general ledger for “Cost of
Goods Sold” is maintained.

THE FLOW OF INVENTORY COSTS

Under the periodic inventory system, physical count is necessary to determine the ending balance of merchandise inventory. After the count, the costs of
these inventory items will be computed. There are instances that the unit prices for merchandise purchased are different. Consider this scenario:

KOLB Company is in the business of buying and selling canned sardines. On January 2016, KOLB had the following transactions:

During the month of January the total sales in units is 7,000. Therefore, the ending inventory in units is 3,000 cans of sardines (1,000+5,000+4,000-7,000). The
problem now is the unit cost that will be used to determine the value of the ending inventory. This is where the cost flow assumption is needed.

The two most commonly used cost flow assumptions are:

• Average Cost
Using the above example, average unit cost is simply computed by dividing the total cost (PHP113,000) by total quantities (1,000+5,000+4,000) 11,000.
Average unit cost is PHP11.30
The cost of merchandise inventory ending is 3,000 x PHP11.30 = PHP33,900

• First in, First Out (FIFO) as the name implies, FIFO involves the assumption that goods sold are the first units that were purchased - that means the oldest
goods on hand. Thus, the remaining inventory is comprised of the most recent purchases.
Applying this to the problem above, the 7,000 units sold were taken from:
1,000 @ PHP10
5,000 @ PHP11
1,000 @ PHP12
- 7,000 units
Therefore, the ending inventory will come from the January 20 purchases: 3,000 @ PHP12 = PHP36,000.

Learning Task 1.3 (click/tap the link)

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Learning Task 2.3

1. Sales Php 600,000
2. Sales Return and allowances 25,000
3. Sales Discounts 10,800
4. Purchases 352,000
5. Purchases Returns and Allowances 10,900
6. Supplies Expense 5,200
7. Salaries Expenses 22,000
8. Merchandise Inventory, beg. 190,100
9. Merchandise Inventory, end. 185,000
10. Purchase Discounts 3,800
11. Freight-in 8,000
12. Rental Expense 7,000
13. Delivery Expense 4,100
14. Utilities Expense 13,000

With the information above, Prepare a schedule of cost of goods sold for the three-month period ended March 31, 2019. Use the template below(2 Column
worksheet): 1 point for heading, 9 points for each amount in the template

Heading 1
Heading 1
Heading 1

Merchandise Inventory, Beginning xxxxx

Add: Net Purchases
Purchases xxxxx
Less: Purchase returns and allowances xxxxx
Purchase Discounts xxxxx
TOTAL xxxxx
Add: Freight-in xxxxx
Cost of goods available for sale xxxxx
Less: Merchandise Inventory, Ending xxxxx
Cost of goods sold xxxxx

Learning Task 3.3 (click/tap the link)

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IMPORTANT NOTE: Create a BACKUP of your learning tasks by taking its PCTURE.