Fundamentals of Accountancy,

Business and Management 1

Quarter IV - Module 2
 Target

A Stairway to Accounting – GO, CPA!!

We begin our study of Merchandising Business with the most commonly accepted
definition of it:
“Merchandising Business is an entity engaged in buying and selling finished
products.”

The accounting cycle for a service business is the same with that of a
merchandising business.

Figure 1.
Source: https://sites.google.com/a/ohsd.net/sunderwood/modules/module-8

After going through this module you are expected to:

1. Describe the nature of transactions in a merchandising business. (ABM_FABM11-
IVe-j-35)

Before going on, check how much you know about this topic.
Answer the pre-test on the next page in a separate sheet of paper.
 Jumpstart

Activity 1: Read me! Select me!

Directions: Choose your answer from the given choices. Use separate paper. 10
minutes to finish.
Do you want to have your own merchandising business? Which of the following
is/are the possible activities or transactions in a merchandising business set-up.

• 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

Then, write also if there’s any merchandising business in your community. If none,
leave this blank.

Discover

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;
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.
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.

In 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.
• 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:

COST OF GOOD SOLD:

Merchandise Inventory, Beginning 100,000
Purchases 250,000
Less: Purchases returns & allowances 5,000
Purchases discounts 2,000 7,000
Net Purchases 243,000
Add; Freight-in 6,000
Cost of goods purchased 249,000
Cost of goods available for sale 349,000
Merchandise Inventory, Ending 118,750
Cost of Good Sold 230.250

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.

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 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:

1/1/16 Merchandise inventory on hand 1,000 cans @ PhP 10,000

PHP10/can
1/10/16 Purchased 5,000 cans @ PHP11 /can 55,000
1/20/16 Purchased 4,000 cans @ PHP12/can 48,000
Total PhP 113,000

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.

*Discovery part shall be finished in 1 hour.

 Explore
Here are some enrichment activities for you to work on to master and
strengthen the basic concepts you have learned from this lesson.

Listed below are some of the accounts relating to the income of JEON JUNG KOOK
Inc. (owned by Kay Owen Boado) for the three month period ended March 31, 2019:

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

Describe the following accounts with their normal balances. Use a 2-column
worksheet. 15 minutes to finish.

Great job! You have understood the lesson.

Get ready to summarize!
 Deepen

With the same information above (Explore), Prepare a schedule of cost of goods sold
for the three-month period ended March 31, 2019. Use a 2-column worksheet. 20
minutes to finish.
 Gauge

Directions: Read carefully each item. Use a separate sheet for your answers. Write
only the letter of the best answer for each test item. 15 minutes to finish.

1. What is an enterprise that buys and sells goods to earn a profit?

A. Merchandising Company B. Merchandising
C. Service Company D. Service

2. What are these goods that are held for sale to customers in the normal course of
business?
A. Merchandising Company B. Merchandise Inventory
C. Service Company D. Service

3. What inventory system that has 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?
A. Periodic B. Perpetual C. Conventional D. Non-conventional

4. What inventory system that records revenue only when the item is sold?
A. Periodic B. Perpetual C. Conventional D. Non-conventional

5. What accounting for freight cost that the buyer pays for the freight costs?
A. Allowance for bad debts B. FOB Destination
C. FOB Shipping Point D. Prepayments

6. What is normally based on the invoice cost less returns and allowances, if any?
A. Purchase Discounts B. Purchase Returns and allowances
C. Sales Discounts D. Sales Returns and Allowances

7. If the buyer will pay for the freight, what will be the journal entry?
A. 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
B. Debit — Delivery Expense and credit — Cash or Accounts Payable
C. 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
D. No entry is made.

8. What is the offer of a cash discount to encourage customers to pay the balance at
an earlier date?
A. Purchase Discounts B. Purchase Returns and allowances
C. Sales Discounts D. Sales Returns and Allowances

9. At the end of the accounting period of periodic inventory system, what is necessary
to establish the ending balance of the inventory?
A. Journal Entry of Inventory B. Physical count of Inventory
C. Worksheet D. Revenue
10. Revenues are reported when earned in accordance with what accounting
concepts and principles, and in a merchandising company, revenues are earned
when the goods are transferred from seller to buyer?
A. Accrual Concept B. Going-on concern
C. Business entity concept D. Revenue recognition principle

11. What document issued by a buyer to inform a seller that the seller’s account has
been debited because of unsatisfactory goods?
A. Credit memorandum B. Deposit-in-transit
C. Debit memorandum D. Outstanding Check

12. What 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?
A. Purchase Discounts B. Purchase Returns and allowances
C. Return of merchandise D. Sales Returns and Allowances

13. What inventory system that provides better control over inventories than a
periodic inventory, since the records always show the quantity that should be on
hand?
A. Periodic B. Perpetual C. Conventional D. Non-conventional

14. Which of the following special journals that is used to record all sales on credit
(on account)?
A. Cash Disbursements Journal B. Cash Receipts Journal
C. Purchase Journal D. Sales Journal

15. What is Sales Revenue less Cost of Goods Sold?

A. Cost of Goods available for sale B. Gross Profit
C. Income before tax D. Net Income

Great job! You are almost done with this module.

 Answer Key

Jumpstart: All are possible answers.

Explore:
1. Credit
2. Debit
3. Debit
4. Debit
5. Credit
6. Debit
7. Debit
8. Debit
9. Credit
10. Credit
11. Debit
12. Debit
13. Debit
14. Debit

Deepen:

Jeon Jung Kook Inc.

Schedule of Cost of Goods Sold
For the three-month period, March 31, 2019

Merchandise Inventory, Beginning Php 190,100

Less: Net Purchases
Purchases 352,000
Less: Purchase returns and allowances 10,900
Purchase Discounts 3,800 337,300
Add: Freight-in 8,000
Cost of goods available for sale 535,400
Less: Merchandise Inventory, Ending 185,000
Cost of goods sold Php 350,400

Gauge:
1. A
2. B
3. B
4. B
5. C.
6. A.
7. D.
8. C.
9. B.
10. B.
11. B.
12. C.
13. B.
14. D.
15. B.