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Fundamentals of Accounting Part 1

1
Accounting for Merchandising Operations

Module 008 Accounting for Merchandising


Operations

This module covers the accounting cycle for Merchandising Operations.


Topics to be discussed include the following: Merchandising operations –
operating cycle of a merchandising type of business, additional account titles
for merchandising business, inventory systems, completing the account
cycle for merchandising firm.
After studying the module, the students should be able to
1. Define a merchandising-concern and distinguish it from service-concern
and manufacturing type of business.
2. Define and understand the additional account titles and terminologies for
merchandising.
3. Understand the operating cycle of a merchandising business.
4. Understand the two inventory systems and how to record transactions
under each system.
5. Learn the adjusting and closing entries of a merchandiser.
6. Prepare financial statements of a merchandiser
7. Understand the important ratios for decision making purposes.

Introduction
Modules 6 and 7 have taught us the basics of accounting and the accounting process or
cycle using the service concern business as the model. In this module, we will focus on a
merchandising type of business, its operations, and its accounting cycle, emphasizing
greatly on inventory systems and computations of merchandise inventory end, and cost of
goods purchased and sold.
Merchandising, also called Trading, is a form of business operations involving the
purchase or buying of goods or merchandise and selling the same in its original form.
Others also called merchandising as buy and sell business.
Comparison between Merchandising, Service Type, and Manufacturing type Of
Business
1. Service business rendered services to other people or customers to earn revenue while
merchandising business buys merchandise and sells the same, changing nothing but the
price.
2. Merchandising firm purchases their products/merchandise to be sold as is while
manufacturing company purchases raw materials, convert them to finished products or
goods which they will sell.

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Accounting for Merchandising Operations

3. The output of a manufacturing firm is the merchandise that a trader or merchandiser


will buy and sell.

Additional Terminologies and Account Titles for Merchandising


All the account titles that we have enumerated in Module 5 and used in accounting for
service type of business except Service Income will still be applicable to a merchandising
type of business. Replacing this sole account are many account titles that will help us
understand the accounting process of a merchandiser.
Sales refer to the revenue of a merchandiser earned by selling goods or merchandise
inventory.
Net Sales pertains to the excess of Sales over the sales discounts and sales returns and
allowance granted by the seller to its customers.
Sales Discount is the amount deducted from Accounts Receivable from customers for
paying promptly their accounts. This is a contra account of Sales.
Sales Returns and Allowances, also a contra account of Sales, pertains to the decrease in
receivables from a customer for returning merchandise (due to some defects or maybe out
of specifications by the customer) or for giving allowances to customers from the amount
due them. This is also a contra account of Sales.
Trade Discount refers to direct reduction in selling price of a good or merchandise to
encourage customers to buy. This is not recorded in the books. What is recorded is the
selling price net of trade discount.
Cost of Goods Sold is the cost of the merchandise inventory that the merchandiser has
sold. This is also termed Cost of Sales.
Freight out or Delivery Expense is the account used to record the cost of transporting the
merchandise from the seller to the buyer or costumers.
Gross Profit is the excess of net sales over the cost of goods sold.
Purchases is the account debited for the amount of goods purchased or bought by the
merchandiser from his suppliers for resale to the customers.
Purchase Returns and Allowances refers to the merchandise bought and returned by the
merchandiser to the supplier (maybe due to some defects) or an amount given by the
supplier as a deduction from the total purchases of the buyer. This is a contra account of
Purchases.
Purchase Discounts is the amount deducted from the trade payables of a buyer to his
supplier of goods because of paying on their agreed time. Also, a contra account of
Purchases.
Freight-in or Transportation-in is the cost of transporting the merchandise from the
supplier to the buyer or merchandiser.
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Accounting for Merchandising Operations

Operating Cycle of a Merchandising type of Business


An operating cycle is the aggregate time an entity uses between disbursing money in its
operating activities and collecting cash out of the same activities.
Below is the operating cycle of a merchandising firm:
A. Involving cash sales B. Merchandise sold on credit

Cash Cash

Purchases of merchandise Purchases of Merchandise

Inventory Inventory

Sales of merchandise for Sales of merchandise on account


cash

Accounts Receivable

Collection of Receivables

In every business, the shorter the operating cycle, the better. The faster the merchandise
inventories are being sold and cash are collected, would result to higher profits.

The Inventory Systems


There are two inventory systems in a merchandising business- Periodic Inventory System
and Perpetual Inventory System. An understanding of these two systems will help us in
recording properly the merchandiser’s business transactions. The main purpose of the
inventory systems is to trace or determine the quantity of goods that are still available for
sale.
Periodic Inventory system
Periodic inventory system is a process of determining the merchandise inventory level and
measuring also the cost of goods sold with the physical count of merchandise done
occasionally ( monthly, quarterly, semi-annually, or annually) or at the end of the
accounting period.
The trader’s purchases of merchandise are debited to Purchases account. Discounts given
by the supplier to the buyer is credited to Purchase Discount account and the returned
merchandise to the supplier is recorded by the buyer (remember that during the stage of
purchasing merchandise for resale, the merchandiser can also be referred to as the buyer,

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Accounting for Merchandising Operations

hence I used this often at this point of our discussion) by crediting Purchase Returns and
Allowances.
Payment for the cost of transporting goods from the supplier to the buyer is debited to
Freight In or Transportation In.
The inventory account and the cost of goods sold account are updated or adjusted at the
end of the accounting period. The cost of goods sold is calculated by:
Merchandise Inventory, beginning of the accounting period + Net Purchases* +
Freight in - Merchandise Inventory, end of the accounting period**
*Net Purchases = Purchases – (Purchase Discount + Purchase Returns and Allowances)
**Merchandise Inventory, ending is the result of the physical count.
Recording Sales of merchandise under the periodic inventory system is very simple,
without the supplementary entries required for inventory and cost of goods sold.
Sales of merchandise on cash basis is recorded by debiting Cash and crediting Sales while
sales on credit is taken into the books by debiting Accounts Receivable and crediting Sales.
Collection of accounts needs a debit to Cash and credit to Accounts Receivable.
Discounts given to customers are recorded by debiting Sales Discount and crediting
Accounts Receivable. Merchandise returned by customers are debited to Sales Returns and
Allowances and crediting Accounts Receivable.
For businesses with too many kinds of inventories or goods for sale, the physical count is
usually done on an annual basis. This system sometimes results to a different amount of
inventory and cost of goods sold.

Perpetual Inventory System


This perpetual inventory system, on the other hand, provides continuous, transaction-to-
transaction records of the quantity, amount and kind of inventories that a business has.
The perpetual system employs a computerized accounting system where every barcoded
item in the inventory of a business is linked to electronic records that produce a record of
sold items and automatically decreases the inventory after the invoice was entered and
completed.
During the early years, small business selling big items with minimal kept inventory (e.g.
appliance stores, furniture shops) uses the manual stock cards in monitoring their
inventories under the perpetual system.
Recording purchases of inventory (merchandise for resale) under this system requires an
entry debiting Merchandise Inventory and crediting Cash or Accounts Payable (if on account).
Other assets purchased should be recorded using their appropriate account title. If
purchase allowance is granted by the supplier or the buyer returned some purchased
merchandise, the account, Accounts Payable is debited and the account Merchandise
Inventory is credited.
Purchase discount granted to the buyer will be recorded as credit to Merchandise Inventory
upon payment of the account. Transportation cost under this system is recorded by a debit
to Merchandise Inventory.
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Accounting for Merchandising Operations

Selling inventories under the perpetual inventory systems will be recorded as follows:
Debit Cash or Accounts Receivable (for sales on account) and crediting Sales. This will be
followed by an entry for cost of goods sold: debit Cost of Goods Sold and credit Merchandise
Inventory.
Sales returns will be debited to Sales Returns and Allowances and credit to Accounts
Receivable followed by another entry to update the cost of good sold and the inventory:
debit Merchandise Inventory and credit Cost of Goods Sold.
Below is the summary of the similarities and differences between the two inventory
systems.
Periodic Inventory System Perpetual Inventory System
Recordi ng purcha s es of mercha ndi s e Purcha s es PXX Mercha ndi s e Inventory PXX
Ca s h Ca s h
or Accounts Pa ya bl e PXX or Accounts Pa ya bl e PXX

Recordi ng (purcha s e) returns of Accounts Pa ya bl e P XX Accounts Pa ya bl e PXX


mercha ndi s e to the s uppl i er Purcha s e Returns a nd Al l owa nces P XX Mercha ndi s e Inventory P XX

Recordi ng purcha s e di s counts Accounts Pa ya bl e P XX Accounts Pa ya bl e PXX


from s uppl i ers Purcha s e Di s count P XX Mercha ndi s e Inventory P XX

Recordi ng tra ns portation cos t Frei ght In PXX Mercha ndi s e Inventory PXX
Ca s h PXX Ca s h PXX

Recordi ng s a l es of mercha ndi s e Ca s h PXX Ca s h PXX


or Accounts Recei va bl e (i f on a ccount) or Accounts Recei va bl e (i f on a ccount)
Sa l es PXX Sa l es PXX

Cos t of Goods Sol d PXX


Mercha ndi s e Inventory PXX

Recordi ng s a l es returns Sa l es Returns a nd Al l owa nces PXX Sa l es Returns a nd Al l owa nces PXX
Accounts Recei va bl e PXX Accounts Recei va bl e PXX

Mercha ndi s e Inventory PXX


Cos t of Goods Sol d PXX

Recordi ng s a l es a l l owa nces Sa l es Returns a nd Al l owa nces PXX Sa l es Returns a nd Al l owa nces PXX
Accounts Recei va bl e PXX Accounts Recei va bl e PXX

Recordi ng s a l es di s count Sa l es Di s count PXX Sa l es Di s count PXX


Accounts Recei va bl e PXX Accounts Recei va bl e PXX

Recordi ng del i very expens e Frei ght Out PXX Frei ght Out PXX
or Del i very Expens e or Del i very Expens e
Ca s h PXX Ca s h PXX

Kinds of Discount
The two kinds of discount are trade discount and cash discount.
Trade discount is the amount, a manufacturer or a merchandiser, deducted from
the listed selling price or catalog price of a product when it is sold to reseller not to
end-consumer. Trade discounts are not recorded in the accounting books of a seller.
The amount recorded by the seller is the invoice price to the buyer/reseller.
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Accounting for Merchandising Operations

Example: Assuming Mr. Cruz, a reseller, purchased 50 units of electric fan from the
manufacturer listed at P 1,500, less trade discount of 5% and 2%. The amount to be
paid by Mr. Cruz is computed as follows.
List Price (50 units x P1, 500) P 75,000
Less Trade discount (P75, 000 x 5%) 3,750
Basis for second discount of 2% P 71,250
Less second discount (P71, 250 x 2%) 1,425
Cash Paid by Mr. Cruz P 69,825
=======
Mr. Cruz will record the purchases with the entry:
Purchases P 69,825
Cash P69, 825

Cash Discount is the amount deducted from the invoice amount of the seller. This
discount is given by the seller when the buyer pays the invoice amount earlier or on
the stipulated terms or date. It is sometimes stated as percentage of the total
amount of the invoice.
When the merchandiser is purchasing merchandise, the cash discount is called
purchase discount, while when he is the seller giving discount, it is termed sales
discount.
Example: Assuming on March 1, 2017 Mr. Cruz sold two electric fans to Arman
Santos for P1, 500 each on account. Terms is 2/10 2/30.
The terms 2/10, n/30 means Arman Santos will be given two (2) percent cash
discount if he pays on or before the 10th day after purchase. If Santos failed to pay on
March 10 (10th day), he has to pay on the 30th day the full amount no discount. On
the part of Mr. Cruz, this is sales discount while for Mr. Santos, it is purchase
discount.
The entries on the books of Mr. Cruz are:
Mar 1 Account Receivable P3, 000
Sales P3, 000
Mar 10 (assuming Mr. Santos paid within the discount period)
Cash P2, 940
Sales Discount 60
Accounts Receivable P3, 000

Recording the Business Transactions of a Merchandising Business


The different business activities that we have enumerated and discussed in the service type
of business are also to take effect in a merchandising type of business except the rendering
of services, which is its source of revenue. Additional activities particular to a
merchandising business will be enumerated before we proceed with the recording phase.
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Accounting for Merchandising Operations

1. Purchases of merchandise, either on a cash basis or on account. With this transaction,


are the granting of purchase discount or allowance by the supplier and the possible
return of merchandise by the buyer/merchandiser.
2. If the purchases of merchandise are made on credit, the payment to the suppliers.
3. Selling the merchandise to the consumers, either on cash basis or on account. Relative
to this transaction are the seller/merchandiser’s giving the consumers discount and
allowances or receiving the returned goods by the customers.
4. If the sales transactions in number 3 are on credit, collection of receivables from
consumers follows.
5. (This is an internal transaction) At the end of the accounting period, an inventory of the
merchandise unsold has to be done, usually by a physical count, to determine the
remaining assets to be reported in the balance sheet and the cost of goods sold to be
reported in the income statement.

To aid the recording of transactions, below is a summary of the additional account titles
with its normal balances and type of accounting elements.
Account Titles Type of Accounting Element Normal Balance
 Purchases Cost (Expense) Debit
 Purchase Discount Contra account of Purchases Credit
 Purchase Returns and
Allowances Contra account of Purchases Credit
 Freight in Cost Debit
 Sales Revenue Credit
 Sales Returns and
Allowances Contra account of Sales Debit
 Sales Discount Contra account of Sales Debit
 Freight out or
Delivery Expense Expense Debit
 Merchandise Inventory Asset Debit

Illustrative Problem 8.1 Journalizing Merchandising Transactions


Journalize the transactions of EBC Superstore for the month of March 2017using
both the Periodic inventory system and the perpetual inventory system.
Mar 1 EBC invested P 500,000 cash and a piece of land with a building in a grocery
business. The land and building are worth P 300,000 and P 200,000,
respectively. The building will be used as the store.
Mar 2 Bought for cash furniture, P5, 000 and store supplies, P1, 000.
Mar 4 Purchased merchandise worth P 300,000, paying 1/3 and the balance on
credit terms of 2/10, net eom.
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Accounting for Merchandising Operations

Mar 5 Returned defective merchandise worth P 10,000.


Paid freight for the above purchases, P 5,500.
Mar 6 Sold goods for cash, P 13,500 (cost, P 8,500)
Mar 10 Sales: Cash, P25, 500; on credit P 16,800, terms. 2/10, n/30. (cost of goods
sold (P24, 100)
Mar 11 Received merchandise returned by the customer on credit on March 10, P
2000 (cost P1, 000).
Mar 12 Bought delivery equipment worth P 10,000 on account. Issued a 12% 90-
day note.
Mar 13 Paid the amount due on March 4
Mar 15 Sales for the last five days: Cash P70, 000; on account P 25,000, (cost, P
60,000)
Mar 15 Paid wages of store helpers, P 5,000.
Mar 16 Received delivered purchased merchandise worth P 50,000 on credit. Terms
2/10, n/30.
Mar 17 The supplier on March 16 granted EBC an allowance of P500 for
merchandise with minor defects but were not returned,
Mar 20 Cash Sales from March 16 to March 20, P 100,000 (cost, P 48,500)
Collected the amount due on March 10.
Mar 22 Paid the following expenses: insurance, P 3,000; advertising, P 1,000.
Mar 23 Received ½ of the amount due from customers on March 15.
Mar 26 Sales from March 21 to March 25, P 85,000. 10% of which is on account
(cost, P 55,000)
Mar 27 Received the full amount due on March 15.
Mar 31 Sales from March 26 to Mar 31, P 150,000, 20% of which is on account
where EBC received a 12%, 45-day note (cost, P115, 500)
Mar 31 Paid the following: Salaries, P 6,000; Utilities, P 3,500.
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Accounting for Merchandising Operations

Periodic Inventory System Perpetual Invnetory System


EBC Superstore EBC Superstore
Journal Entries Journal Entries
Date Account titles Debit Credit Date Account titles Debit Credit
2017 2017
Mar 1 Cash P 500,000 Mar 1 Cash P 500,000
Land 300,000 Land 300,000
Building 200,000 Building 200,000
EBC, Capital P1,000,000 EBC, Capital P1,000,000
Investment. Investment.

2 Furniture 5,000 2 Furniture 5,000


Store Supplies 1,000 Store Supplies 1,000
Cash 6,000 Cash 6,000
Bought furniture and store supplies. Bought furniture and store supplies.

4 Purchases 300,000 4 Merchandise Inventory 300,000


Cash 100,000 Cash 100,000
Accounts Payable 200,000 Accounts Payable 200,000
Purchased merchandise. Purchased merchandise.

5 Accounts Payable 10,000 5 Accounts Payable 10,000


Purchase Returns and Allowances 10,000 Merchandise Inventory 10,000
Returned merchandise to supplier. Returned merchandise to supplier.

Freight In 5,500 Merchandise Inventory 5,500


Cash 5,500 Cash 5,500
Paid freight. Paid freight.

6 Cash 13,500 6 Cash 13,500


Sales 13,500 Sales 13,500
Sold Merchandise. Sold Merchandise.

10 Cash 25,500 Cost of Goods Sold 8,500


Accounts Receivable 16,800 Merchandise Inventory 8,500
Sales 42,300
Sold Merchandise. 10 Cash 25,500
Accounts Receivable 16,800
11 Sales Returns and Allowances 2,000 Sales 42,300
Accounts Receivable 2,000 Sold Merchandise.
Received returned merchandise.
Cost of Goods Sold 24,100
12 Delivery Equipment 10,000 Merchandise Inventory 24,100
Notes Payable 10,000
Bought delivery equipment on account. 11 Sales Returns and Allowances 2,000
Accounts Receivable 2,000
13 Accounts Payable 190,000 Received returned merchandise.
Cash 186,200
Purchase Discount 3,800 Merchandise Inventory 1,000
Paid account on March 4. Cost of Goods Sold 1,000

15 Cash 70,000 12 Delivery Equipment 10,000


Accounts Receivable 25,000 Notes Payable 10,000
Sales 95,000 Bought delivery equipment on account.
Sold merchandise.
13 Accounts Payable 190,000
15 Wages Expense 5,000 Cash 186,200
Cash 5,000 Merchandise Inventory 3,800
Paid wages of store helpers. Paid account on March 4.

16 Purchases 50,000 15 Cash 70,000


Accounts Payable 50,000 Accounts Receivable 25,000
Purchased merchandise on account. Sales 95,000
Sold merchandise.
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Accounting for Merchandising Operations

Mar 17 Accounts Payable 500 Mar 15 Cost of Goods Sold 60,000


Merchandise Inventory 60,000
Purchase Returns and Allowances 500
Allowance for unreturned merchandise. Wages Expense 5,000
Cash 5,000
20 Cash 100,000 Paid wages of store helpers.
Sales 100,000
16 Merchandise Inventory 50,000
Sold merchandise. Accounts Payable 50,000
Purchased merchandise on account.
20 CAsh 14,504
17 Accounts Payable 500
Sales Discount 296 Merchandise Inventory 500
Accounts Receivable 14,800 Allowance for unreturned merchandise.
Collection from customers on March 10.
20 Cash 100,000
Sales 100,000
22 Prepaid Insurance 3,000 Sold merchandise.
Advertising Expense 1,000
Cash 4,000 Cost of Goods Sold 60,000
Merchandise Inventory 60,000
Paid insurance and advertising.
20 CAsh 14,504
23 Cash 12,500 Sales Discount 296
Accounts Receivable 12,500 Accounts Receivable 14,800
Collection from customers on March 10.
Partial collection of March 15 credit sales.
22 Prepaid Insurance 3,000
26 Cash 76,500 Advertising Expense 1,000
Accounts Receivable 8,500 Cash 4,000
Paid insurance and advertising.
Sales 85,000
Sold merchandise. 23 Cash 12,500
Accounts Receivable 12,500
27 Cash 12,500 Partial collection of March 15 credit sales.

Accounts Receivable 12,500 26 Cash 76,500


Collection of the March 15 balance. Accounts Receivable 8,500
Sales 85,000
31 CAsh 120,000 Sold merchandise.

Notes Receivable 30,000 Cost of Goods Sold 65,000


Sales 150,000 Merchandise Inventory 65,000
Sold merchandise.
27 Cash 12,500
Accounts Receivable 12,500
31 Wages Expense 6,000 Collection of the March 15 balance.
Utilities Expense 3,500
Cash 9,500 31 CAsh 120,000
Notes Receivable 30,000
Paid wages and utilities.
Sales 150,000
Sold merchandise.

Cost of Goods Sold 115,500


Merchandise Inventory 115,500

31 Wages Expense 6,000


Utilities Expense 3,500
Cash 9,500
Paid wages and utilities.
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Accounting for Merchandising Operations

The difference in recording the transactions under the periodic inventory system
and the perpetual inventory system can be seen in journalizing the purchases and
sales of merchandise together with the related transactions as summarized on page
5.

Adjusting the accounts of a Merchandising Business


Adjusting entries for merchandising are similar to what we have prepared for service
concern. The following discussions will focus on periodic inventory system.
We will skip the posting to the ledger and the preparation of worksheet. The trial balance
below was derived after getting the balances of the accounts used in journalizing for EBC
Superstore.
EBC Superstore
Trial Balance
March 31, 2017

Account Titles Debit Credit


Cash P 628, 804
Accounts Receivable 8,500
Notes Receivable 30,000
Store supplies 1,000
Prepaid Insurance 3,000
Land 300,000
Building 200,000
Furniture 5,000
Delivery Equipment 10,000
Account Payable P 49, 500
Notes Payable 10,000
EBC, Capital 1,000,000
Sales 485,800
Sales Returns and Allowances 2,000
Sales Discount 296
Purchases 350,000
Freight In 5,500
Purchase Returns and Allowances 10,500
Purchase Discount 3,800
Wages Expense 11,000
Utilities Expense 3,500
Advertising Expense 1,000
Total P1,559,600 P1,559,600

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Accounting for Merchandising Operations

Adjustment data provided on March 31, 2017:


1. The note issued on March 12 was due on April 26, 2017 (use 360-day year)
2. Store supplies on hand, P200.
3. The insurance paid was intended for 5 months.
4. The building has a remaining estimated useful life of 8 years and salvage value of P
50,000.
5. Furniture will be depreciated at 2% per month.
6. The delivery equipment has an estimated scrap value of P1, 000 and useful life of 5
years.
7. Accrued wages, P2, 000.
8. Unpaid utilities, P1, 500.
9. P 30,000 worth of merchandise from the March 31 cash sales will be delivered on April
2, 2017
10. A physical count of merchandise inventory revealed P55, 000 worth still on hand.

The adjusting entries for EBC Superstore are given below:


EBC Superstore
Adjusting Entries

Date Account Titles Debit Credit


2017
Mar 31 1) Interest Expense P 63.33
Accrued Interest Expense P 63.33

2) Store Supplies Expense 800


Store Supplies 800
3) Insurance Expense 600
Prepaid Insurance 600
4) Depreciation-Building 1,562.50
Accumulated Depreciation-Building 1,562.50

5) Depreciation-Furniture 100
Accumulated Depreciation-Furniture 100
6) Depreciation-Delivery Equipment 150
Accumulated Depreciation-Delivery Equipment 150
7) Wages Expense 2,000
Accrued Wages Expense 2,000
8) Utilities Expense 1,500
Accrued Utilities Expense 1,500
9) Sales 30,000
Unearned Sales 30,000
10) Merchandise Inventory 55,000
Cost of Goods Sold 55,000
To set up the merchandise inventory,
end.
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Accounting for Merchandising Operations

Note: if there is Merchandise Inventory, beginning, (say, if the business is on its


second accounting period), it will be adjusted or closed to Cost of goods sold by an
entry: Debit Cost of Goods Sold and credit Merchandise Inventory, beginning.

If the Perpetual Inventory system is being used, all the adjusting entries will be the
same except for merchandise inventory. Under this system, the inventory is always
current theoretically. A physical count is also conducted at the end of the period
(usually, annually) to determine if the amount of inventory on hand tallied with the
amount of inventory on record.

If a difference between the physical count and the record appears due to errors,
theft losses, damages, this difference will be adjusted.

Assuming, that ABC Trading has a P 50,000 worth of merchandise inventory on


December 31, 2016 (using the perpetual inventory system) and the physical count
revealed that there was only P 49,500 merchandise on hand. The difference will be
recorded by an adjusting entry:

Dec. 31 Cost of Goods Sold P 500


Merchandise Inventory P500

This entry will bring the Merchandise Inventory and the Cost of Goods Sold to the
correct balances.

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The Adjusted Trial Balance for EBC Superstore after the adjusting entries are posted
in the ledger follows:
EBC Superstore
Adjusted Trial Balance
March 31, 2017

Account Titles Debit Credit


Cash P 628,804
Accounts Receivable 8,500
Notes Receivable 30,000
Merchandise Inventory 55,000
Store Supplies 200
Prepaid Insurance 2,400
Land 300,000
Building 200,000
Accumulated Depreciation-Building P 1,562.50
Furniture 5,000
Accumulated Depreciation-Furniture 100
Delivery Equipment 10,000
Accumulated Depreciation-Del. Equip. 150
Accounts Payable 49,500
Notes Payable 10,000
Accrued Interest Expense 63.33
Unearned Sales 30,000
Accrued Wages Expense 2,000
Accrued Utilities Expense 1,500
EBC, Capital 1,000,000
Sales 455,800
Sales Returns and Allowances 2,000
Sales Discount 296
Purchases 350,000
Freight In 5,500
Purchase Returns and Allowances 10,500
Purchase Discount 3,800
Wages Expense 13,000
Utilities Expense 5,000
Insurance Expense 600
Advertising Expense 1,000
Store Supplies Expense 800
Interest Expense 63.33
Depreciation Expense-Building 1,562.50
Depreciation Expense-Furniture 100
Depreciation Expense-Delivery Equipment 150
Cost of Goods Sold 55,000
Total P 1,619,976 P 1,619,976
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Accounting for Merchandising Operations

Preparation of Financial Statements of a Merchandising Business


Income Statement
The income statement of a merchandising business reports net sales, cost of goods sold,
gross profit, operating expenses, and net profit. It also presents other revenue and other
expenses separately.
Net Sales (Revenue) is gross sales less the sales returns and allowances and sales discount.
Cost of goods sold is the basic cost of the merchandise that the trader sold to its customers.
It is the supplier’s price of the merchandise plus any other additional costs that maybe
incurred by the merchandiser in bringing the goods to his inventory and have them ready
for sale.
Gross profit is arrived at by deducting cost of goods sold from net sales.
Operating expenses are expenses, other than cost of goods sold, that the merchandiser
incurred in its primary business line or operations. Some operating expenses are
categorized by some companies into two: Selling expenses and general expenses. Selling
expenses are those expenses associated with the marketing and promotion of the firm’s
products. Examples are sales salaries, commissions, advertising, promotions, and
depreciation of store building, store equipment, store supplies, and delivery expense.
General expenses, on the other hand, are expenses that are not directly related to the selling
of the products. This includes office salaries, depreciation of office building, office
equipment, rent of office, utilities incurred for the offices, etc.
Operating income is gross profit less operating expenses plus any other operating income.
Other revenues are income earned by the firm outside its normal operations. Examples gain
on sale of non-current asset of the business, interest earned on interest-bearing notes from
customers.
Other expenses are expenses incurred by the business entity outside its major operations.
Examples are loss on sale of non-current asset of the firm, interest expense paid on notes
issued.
Forms of Income Statement
There are many formats of income statement, but we will be dealing with the traditional
income statement styles: Multi-step income statement and the single-step income
statement.
Multi-step income statement takes several layers of deductions (subtraction) from the
revenue to arrive at the net profit or net income. It is usually split into operating and non-
operating portions. Operating section reflects the principal or normal operations of the
business while non-operating portion refers to other revenues and other expenses by the
business. Under the multi-step income statement is a condensed income statement with
supplementary notes.
Single- Step income statement is an income statement where all the revenues are grouped
and totaled, all expenses are listed and totaled and deducted from the total revenue. There
is only one subtraction made.

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Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

Bear in mind that no matter what format of income statement is used, the bottom-line
figure will remain the same.
Following is the income statement of EBC Superstore in different formats:
Multi-step Income Statement Format
EBC Superstore
Income Statement
For the Month Ended March 31, 2017

Sales P 455,800
Less: Sales Returns and Allowances P 2,000
Sales Discount 296 2,296
Net Sales P 453,504
Less: Cost of Goods Sold
Purchases P 350,000
Add:Freight In 5,500
Total P 355,500
Less: Purchase Returns and Allowances P 10,500
Purchase Discount 3,800 14,300
Cost of goods available for sale P 341,200
Less: Merchandise Inventory, end 55,000
Cost of goods sold 286,200
Gross Profit P 167,304
Less: Operating Expenses
Wages Expense P 13,000
Utilities Expense 5,000
Depreciation Expense-Building 1,562.50
Advertising Expense 1,000
Store Supplies Expense 800
Insurance Expense 600
Depreciation Expense-Delivery Equipment 150
Depreciation Expense-Furniture 100
Total operating expenses 22,212.50
Operating Income P 145,091.50
less: Other expense - Interest 63.33
Net Profit P 145,028.17
Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

Condensed Income Statement Format


EBC Superstore
Income Statement
For the Month Ended March 31, 2017

Net Sales (Note 1) P 453,504


Less: Cost of Goods Sold (Note 2) 286,200
Gross Profit P 167,304
Less: Operating Expenses (Note 3) 22,212.50
Operating Income P 145,091.50
Less: Other Expense-Interest 63.33
Net Profit P 145,028.17

Note 1: Net Sales


Sales P 455,800
Sales Returns and Allowances (2,000)
Sales Discount (296)
Net Sales P 453,504

Note 2: Cost of Goods Sold


Net Purchases (Note 2A) P 341,200
Merchandise Inventory, end (55,000)
Cost of goods sold P 286,200

Note 2A: Net Purchases


Purchases P 350,000
Freight In 5,500
Purchase Returns and Allowances (10,500)
Purchase Discount (3,800)
Net Purchases P 341,200

Note 3: Operating Expenses


Wages Expense P 13,000
Utilities Expense 5,000
Depreciation Expense-Building 1,562.50
Advertising Expense 1,000
Store Supplies Expense 800
Insurance Expense 600
Depreciation Expense-Delivery Equipment 150
Depreciation Expense-Furniture 100
Total operating expenses P 22,212.50

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Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

Single-Step Income Statement


EBC Superstore
Income Statement
For the Month Ended March 31, 2017

Revenues:
Sales (net of sales returns and allowances ,
P2,000 and sales discount, P296)
P 453,504.00
Expenses:
Cost of Goods Sold P 286,200.00
Wages Expense 13,000.00
Utilities Expense 5,000.00
Depreciation Expense-Building 1,562.50
Advertising Expense 1,000.00
Store Supplies Expense 800.00
Insurance Expense 600.00
Depreciation Expense-Delivery Equipment 150.00
Depreciation Expense-Furniture 100.00
Interest Expense 63.33
Total expenses P 308,475.83
Net Income P 145,028.17

Statement of Owner’s Equity of a merchandising is the same with service type of


business. It shows the capital balances after adding the net profit or deducting net loss and
withdrawal, if any.
Below is the statement of owner’s equity of EBC Superstore:
EBC Superstore
Statement of Changes in Owner's Equity
For the Month Ended March 31, 2017

EBC, Capital, March 1, 2017 P 1,000,000.00


Add: Net Profit 145,028.17
EBC, Capital, March 31, 2017 P 1,145,028.17

Balance Sheet or Statement of Financial Position shows the financial position of the
business. It reports the financial status of assets, liabilities, and capital. It only differs from
service type in the sense that merchandising business’ current assets includes merchandise
inventory while service concern has none.
Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

Forms of Balance Sheet Presentation


Report Form –where the assets, liabilities, and capital are presented in successive
order.
Account Form – This follows the accounting equation. The assets are on the left side
and the liabilities and capital on the right side.
Below is the Account form of balance sheet of EBC Superstore.
EBC Superstore
Statement of Financial Position
March 31, 2017

Assets Liabilities and Owner's Equity


Current Assets
Cash ₱ 628,804.00 Liabilities
Accounts Receivable 8,500.00 Accounts Payable ₱ 49,500.00
Notes Receivable 30,000.00 Notes Payable 10,000.00
Merchandise Inventory 55,000.00 Accrued Interest Expense 63.33
Store Supplies 200.00 Unearned Sales 30,000.00
Prepaid Insurance 2,400.00 Accrued Wages Expense 2,000.00
Total current ₱ 724,904.00 Accrued Utilities Expense 1,500.00
Plant Assets : Total liabilites ₱ 93,063.33
Land ₱ 300,000.00
Building ₱ 200,000.00
Less:Accumulated Depreciation-Building 1,562.50 198,437.50
Furniture ₱ 5,000.00
Less:Accumulated Depreciation-Furniture 100.00 4,900.00 Owner's Equity
Delivery Equipment ₱ 10,000.00 EBC, Capital, March 1, 2017 ₱ 1,000,000.00
Less: Accumulated Depreciation-Del. Equip. 150.00 9,850.00 Add: Net Profit 145,028.17
Total Plant Assets 513,187.50 EBC, Capital, March 31, 2017 1,145,028.17
Total Assets ₱1,238,091.50 Total Liabilities and Owner's Equity ₱ 1,238,091.50

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Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

The Report form of balance sheet of EBC Superstore:


EBC Superstore
Statement of Financial Position
March 31, 2017

Assets
Current Assets
Cash ₱ 628,804.00
Accounts Receivable 8,500.00
Notes Receivable 30,000.00
Merchandise Inventory 55,000.00
Store Supplies 200.00
Prepaid Insurance 2,400.00
Total current ₱ 724,904.00
Plant Assets :
Land ₱ 300,000.00
Building ₱ 200,000.00
Less:Accumulated Depreciation-Building 1,562.50 198,437.50
Furniture ₱ 5,000.00
Less:Accumulated Depreciation-Furniture 100.00 4,900.00
Delivery Equipment ₱ 10,000.00
Less: Accumulated Depreciation-Del. Equip. 150.00 9,850.00
Total Plant Assets 513,187.50
Total Assets ₱1,238,091.50

Liabilities and Owner's Equity


Liabilities
Accounts Payable ₱ 49,500.00
Notes Payable 10,000.00
Accrued Interest Expense 63.33
Unearned Sales 30,000.00
Accrued Wages Expense 2,000.00
Accrued Utilities Expense 1,500.00
Total liabilites ₱ 93,063.33
Owner's Equity
EBC, Capital, March 1, 2017 ₱ 1,000,000.00
Add: Net Profit 145,028.17
EBC, Capital, March 31, 2017 1,145,028.17
Total Liabilities and Owner's Equity ₱1,238,091.50

The owner’s equity section can be simplified by just showing the capital, end from the
Statement of changes in Owner’s Equity.
Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

We can also prepare a condensed format of balance sheet.


EBC Superstore
Statement of Financial Position
March 31, 2017

Assets Notes
Current Assets 1 ₱ 724,904.00
Non-current Assets 2 513,187.50
Total Assets ₱ 1,238,091.50

Liabilities and Owner's Equity


Liabilities 3 ₱ 93,063.33
Owner' Equity 4 1,145,028.17
Total Liabilities and Owner's Equity ₱ 1,238,091.50

Note 1. Current Assets


Cash ₱ 628,804.00
Accounts Receivable 8,500.00
Notes Receivable 30,000.00
Merchandise Inventory 55,000.00
Store Supplies 200.00
Prepaid Insurance 2,400.00
Total current ₱ 724,904.00

Note 2. Non-current Assets


Land ₱ 300,000.00
Building 200,000.00
Less:Accumulated Depreciation-Building 1,562.50
₱ 198,437.50
Furniture 5,000.00
Less:Accumulated Depreciation-Furniture 100.00
₱ 4,900.00
Delivery Equipment 10,000.00
Less: Accumulated Depreciation-Del. Equip. 150.00
₱ 9,850.00
Total Plant Assets ₱ 513,187.50

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Accounting for Merchandising Operations

Note 3. Liabilities
Accounts Payable ₱ 49,500.00
Notes Payable 10,000.00
Accrued Interest Expense 63.33
Unearned Sales 30,000.00
Accrued Wages Expense 2,000.00
Accrued Utilities Expense 1,500.00
Total liabilites ₱ 93,063.33

Note 4. Owner's equity


EBC, Capital, March 1, 2017 ₱ 1,000,000.00
Add: Net Profit 145,028.17
EBC, Capital, March 31, 2017 ₱ 1,145,028.17

Closing Entries for Merchandising Business


The principles of closing the accounts for a merchandising business are similar to a service
type of business. All nominal accounts (income statement accounts) should be closed using
a controlling account, Revenue and Expense Summary.
The Closing Entries for EBC Superstore follows:
EBC Superstore
Closing Entries
Date Account Titles Debit Credit
2017
Mar 31 Sales P 455,800
Sales Returns and Allowances P 2,000
Sales Discount 296
Revenue and Expense Summary 453,504

Revenue and Expense Summary 341,200


Purchase Returns and Allowances 10,500
Purchase Discount 3,800
Purchases 350,000
Freight In 5,500

Revenue and Expense Summary 22,275.83


Wages Expense 13,000
Utilities Expense 5,000
Insurance Expense 600
Advertising Expense 1,000
Store Supplies Expense 800
Interest Expense 63.33
Depreciation Expense-Building 1,562.50
Depreciation Expense-Furniture 100
Depreciation Expense-Delivery Equipment 150

Merchandise Inventory 55,000


Revenue and Expense Summary 55,000

Revenue and Expense Summary 145,028.17


EBC, Capital 145,028.17
Fundamentals of Accounting Part 1
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Accounting for Merchandising Operations

We will skip the post-closing trial balance and the reversing entries; anyway, they are just
similar to the service type. But if you want to work on them, here are the pointers:
For the Post-Closing Trial Balance: List all real accounts (balance sheet accounts) and their
balances in a trial balance form.
For the reversing entries, reverse the adjusting entries for Insurance, Accrued Salaries,
Accrued Utilities, and Unearned Sales.

Transportation Costs
Before, we finally end this module; let me add some notes regarding transportation cost of
the merchandise. Who will absorb the cost?
The cost of transporting the merchandise to the supplier to the merchandiser is also a
significant issue. We call it Freight-in or Transportation-in. there are cases where the
purchase agreement specifies FOB terms to make it clear on who will pay the shipping
charges, specifically if the merchandise will come from far places that it will be shipped by
air (through airplane) or by sea ( using cargo vessels)
FOB means free on board. It regulates two things: 1) who will pay the freight? And 2) when
will the legal title or ownership of the goods passes from the supplier/seller to the
buyer/merchandiser (or from merchandiser/seller to the customer/buyer).
There are two FOB terms:
1. FOB shipping point terms – here, the title to the goods was given to the buyer on the
time the merchandise leaves the seller’s point or area (shipping point). So, the buyer
owns the goods even if it is still in transit. The buyer will pay the transportation cost.
2. FOB destination terms – The ownership of the goods passes to the buyer, only when it
reach its destination. The seller pays the freight.
The cost of an asset includes all costs that will be incurred in bringing the assets to its
intended usage, that is why, we add freight-in to Purchases or to Inventory (if Perpetual
Inventory system is used)

Important Ratios for Decision-making purposes of a Merchandiser


Merchandise inventory is usually placed next to receivable or third from cash, but for a
merchandiser, it is the most important current asset. In managing the business, attention is
much given to purchasing and selling inventories. In evaluating merchandising business
operations, some ratios are being employed.
1. Merchandise Inventory turnover or Inventory Turnover – This is the ratio of cost of goods
sold over the average merchandise inventory. This ratio indicates how fast or how often
the merchandise is being sold and how many times the inventory is replenished during
the accounting period. Inventory turnover is normally calculated on a yearly basis. The
average inventory is taken from the beginning and the ending inventories. The higher
the turnover rate the higher the profits.
Formula: Inventory Turnover = Cost of Goods Sold / Average Inventory
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Accounting for Merchandising Operations

Where, Average Inventory = (Beginning Inventory + Ending Inventory) / 2


For EBC Superstore, the Inventory turnover = P 286,200 / (P0+P55, 000)/2
= 10.40 times
Since it is the first month of operations of EBC, we can consider the ending inventory
only as the denominator.
So, the Inventory turnover = P286, 200/ P55, 000 = 5.20 times

2. Gross profit percentage, also called the gross margin ratio, is one of the determinants of
profitability. It shows how much profit contributes to the recovery of fixed cost and
realization of net profit.
Formula: Gross Profit (GP) Ratio = Gross profit / Net Sales
EBC’s GP ratio = P167, 304 /P 453,504 = 36.89%

We will be discussing more of these ratios in our succeeding modules and courses.

Glossary
Freight-in: the cost of transporting merchandise from the supplier or seller to the
merchandiser or buyer.
Inventory System: the system or method of monitoring and keeping records of
merchandise for resale.
Merchandising: a form of business where the seller/merchandiser buys the goods or
merchandise for resale in its original form.

References and Supplementary Materials


Books and Journals
Cabrera, ME. B. (2010). Fundamentals of Accounting 1.Manila, Philippines: GIC
Enterprises and Co., Inc.

Horngren, C. T., Harrison, W. T. Jr., Bamber, L. S., (2002). Accounting (International


Edition). New Jersey, USA: Prentice Hall

Garcia, P.C., Mojar, B.Q. & Gemanil, B. A. (2006).Basic Accounting Concepts and
Procedures. Quezon City, Philippines: Rex Book Store, Inc.

Kimwell, M. B. (2009). Fundamentals of Accounting (Second Edition). Manila, Philippines.


GIC Enterprises and Co., Inc.

Online Supplementary Reading Materials


Fundamentals of Accounting Part 1
25
Accounting for Merchandising Operations

Inventory and Cost of Goods Sold | Explanation | AccountingCoach


https://www.accountingcoach.com/inventory-and-cost-of-goods-sold/explanation
Accessed: March 20, 2017

[PDF]Accounting for Merchandising Companies: Journal Entries


ww2.nscc.edu/swanson_l/Acct%201010%20Web/.../MerchandisingCompanyrev.pdf
Accessed: March 20, 2017
[DOC]Lesson 6: Accounting for Merchandising Activities - Sun Yat-sen ...
jpkc.sysu.edu.cn/kuaiji/05/enja/Lesson%20notes%20for%20lesson%2014.doc
Accessed: March 20, 2017

Online Instructional Videos


Merchandising Operations and Inventory in Accounting - Videos ...
study.com/academy/.../merchandising-operations-and-inventory-in-accounting.html
Accessed: March 20, 2017
Merchandising Operations: Operating Cycle, Inventory, Purchase ...
https://www.youtube.com/watch?v=col_eHVJhcg
Accessed: March 20, 2017

Course Module