Accounting Cycle of a Merchandising Business

Introduction

A merchandising business is one that buys and sell goods without changing their physical form. Also, we
will discuss some concepts that are applicable to a merchandising business but not to a service business.

Inventory

The main difference between a merchandising business and a service business is that a merchandising
business necessarily holds inventory of physical goods for sale.

In this context, inventory simply refers to the goods that a merchandising business has purchased and
primarily intended for resale, normally in their original form and without any further processing.

Inventory

Inventories are accounted for using either of the following inventory systems:

1. Perpetual inventory system; or

2. Periodic inventory system

Perpetual Inventory system

Under this system, the “Inventory” account is updated each time a purchase or sale is made. Thus, the
“Inventory” account shows a continuing or running balance of the goods on hand.

Moreover, records called “stock cards” and “stock ledger cards” are maintained under this system, from
which the quantities and balances of goods on hand and goods sold can be determined at any given
point of time without the need of performing a physical count of inventories.

All increases and decreases in inventory, such as purchases, freight-in, purchase returns, purchase
discounts, cost of goods sold, and sales returns are recorded in the “Inventory” account. “Cost of goods
sold” is also updated each time a sale or sale return is made.

The perpetual inventory system is commonly used for inventories that are specifically identifiable and
are relatively high valued, such as cards, machineries, furniture and heavy equipment.
Periodic Inventory system
Under this system, the “Inventory” account is updated only when a physical count of inventory is
performed. Thus, the amounts of inventory and cost of goods sold are determined periodically.

Under this system, the business does not maintain records that show the running balances of inventory
on hand and cost of goods sold as at any given point of time. To determine this information, a physical
count of quantity of goods on hand must be performed periodically (e.g., on a daily, weekly, monthly or
annual basis). The quantity counted is then multiplied by the unit cost to get the balance of the
“Inventory” account. This amount is then used to compute for the “Cost of goods sold”, which is the
residual amount in the formula below.

Beginning inventory XXX

Add: Net Purchases* XXX

Total goods available for sale XXX

Less: Ending inventory (Physical count) (XXX)

Cost of Goods Sold XXX

*Net purchases Is computed as follows:

Purchases (Invoice price) XXX

Add: Freight-in XXX

Less: Purchase Returns (XXX)

Purchase Discounts (XXX)

Net Purchases XXX

Purchases- account used to record purchases of inventory under the periodic system.

Freight-In- cost of delivery of goods from supplier to business.

Purchase returns- the account used to record returns of purchased goods to the supplier

Purchase discounts- the account used to record cash discounts availed on the purchased goods.
Under the periodic inventory system, purchases of inventory are debited to the “Purchases” account,
shipping costs are debited to the “Freight-in” account, purchase returns are credited to the “Purchase
returns” accounts and purchase discounts are credited to the “Purchase discounts” account. No entry
is made to recognize cost of goods sold when inventory is sold.

Because the “Inventory” account is updated only after a physical count, prior to the count, the balance
of the inventory accounts represents the beginning balance or the balance from the last physical count.
Consequently, the balance of “Cost of goods sold” prior to a physical count is zero.

The periodic inventory system is commonly used for inventories that are normally interchangeable,
relatively low valued, and have a fast turnover rate, such as grocery items, medicines, electrical parts,
and office supplies.

Example 1 for PERIODIC SYSTEM: By UNIT

At the start of the day, you have 1 apple. During the day you purchased 5 apples, If at the end of the
day, you have 2 apples left, how many apples have you sold?

Apples (in units)

Beginning inventory 1

Add: Net Purchases* 5

Total goods available for sale 6

Less: Ending inventory (Physical count) 2

Cost of Goods Sold 4

Example 2 for PERIODIC SYSTEM: By PRICE/AMOUNT

At the start of the day, you have 1 apple costing Php10. During the day you purchased 5 apples for
Php10 each. You returned 1 apple to the supplier because it was rotten. If at the end of the day, you
have 2 apples left, how much is your Cost of goods sold?

(in Php) PRICE

Purchases (5 x Php10) 50

Add: Freight-in 0

Less: Purchase Returns (1 x Php10) (10)

Purchase Discounts (0)

Net Purchases 40
 Beginning inventory (1 x Php10) 10

Add: Net Purchases* 40

Total goods available for sale 50

Less: Ending inventory (2 x Php10) (20)

Cost of Goods Sold 30

Sample Journal Entries

Perpetual System Periodic System

1. Purchased of goods worth Php10,000 on account

Inventory 10,000.00 Purchases 10,000.00

Accounts Payable 10,000.00 Accounts Payable 10,000.00

2. Paid shipping costs of Php1,000 on the purchased goods

Inventory 1,000.00 Freight In 1,000.00

Cash 1,000.00 Cash 1,000.00

3. Returned damaged goods worth Php2,000 to the supplier

Accounts Payable 2,000.00 Accounts Payable 2,000.00

Inventory 2,000.00 Purchase Returns 2,000.00

4. You sold goods costing Php5,000 for Php20,000 on account

Accounts receivable 20,000.00 Accounts receivable 20,000.00

Sales 20,000.00 Sales 20,000.00

Cost of goods sold 5,000.00 No entry

Inventory 5,000.00

5. A customer returned goods with sale price of Php800 and cost of Php200

Sales Returns Sales Returns 800.00

 800.00

Accounts Receivable 800.00 Accounts Receivable 800.00

Inventory 200.00 No entry

Cost of Goods Sold 200.00

Gross Profit

Gross profit (gross income, gross margin, or sales profit) is simply “Net sales minus Cost of Goods Sold”

Net Sales XXX

Less: Cost of Goods Sold (XXX)

Gross Profit XXX

Gross Profit represents the profit a business earns after deducting the cost of the goods sold or service
rendered, but before deducting other expenses

Profit (Net Profit) is different from gross profit. Profit is the amount derived after deducting all other
expenses from the gross profit. This is illustrated below:

Net Sales* XXX

Cost of goods sold (XXX)

Gross Profit XXX

Expenses (XXX) iisa – isahin lahat ng expense. Ex: salaries, utilities, etch

Profit (Net Profit) XXX

*Net sales is Sales net of returns and discounts. This shown in the formula below:

Sales XXX

Less: Sales Return (XXX)

Sales Discount (XXX)

Net Sales XXX

Sales- include both cash sales and credit sales

Sales returns- the account used to record goods returned by customers

Sales discounts- the account used to record cash discount given to customers

Recording in the General and Special journals

1. Special journals
a. Sales journal- used to record sales on account
b. Purchases journal- used to record purchases of inventory on account
c. Cash receipts journal – used to record all transactions involving receipts of cash
d. Cash disbursements journal- used to record all transactions involving payments of
cash.

2. General journal