Accounting Procedure for Merchandising/Trading Concern

I. Nature and Definition – An entity engaged in the purchase and sale of goods or merchandise (in their
original form) to earn profit.

II. Wholesale vs. Retail

A. Wholesale – entity that sell its merchandise to retailer and large consumers. Wholesalers buy large
quantities of finished goods from manufacturers and/or importers.
B. Retail – entity that sell its merchandise direct to consumers or end-users. Suppliers of retailers are usually
the wholesalers.

III. Normal Operating Cycle – is the average length of time from which cash is converted back to cash.

IV. Revenue and Expense of Merchandising

1. Revenue – merchandising concern earns income principally from SALES, sale of goods to its customers.

2. Expenses – merchandising concern are divided into two (2) major categories:
A. Cost of Goods Sold or Cost of Sales – is the major expense, this represents total cost of merchandise
sold during the period.

B. Operating Expenses – expenses incurred in the normal process of the operation of the business. Two
major classifications of operating expenses are:
a. Selling expense (Distribution cost) – are expenses which are directly related to advertising,
promoting, selling and delivery of goods to customers. Examples are salesman’s salaries,
salesman commissions, travelling and marketing expenses, advertising, delivery and freight
expenses etc.
b. Administrative expense (General expenses) – expenses incurred of administering the business.
These are expenses not related to selling and cost of goods sold. Examples are office salaries,
expense of general accounting, credit department, taxes etc.

V. Definition of Merchandise or Merchandise Inventory

Merchandise inventory, inventory, or simple goods for sale are goods purchased for the principal purpose of
reselling them in the ordinary course of operation (day-to-day business activity).
! Rule: All goods to which the company has title should be included in the inventory, regardless of location.

VI. Inventories System:

1. Periodic System – also call as Physical System. Inventory count is periodically done to account for the
balance of the inventory since does not maintain continuous record of physical quantities of inventory.
Account titles used related to ACQUISITION of goods are: PURCHASES, FREIGHT-IN, PURCHASE
RETURNS, and PURCHASE DISCOUNTS.
Account titles used related to SALE of goods are: SALES, SALES RETURNS, SALES DISCOUNTS, and
FREIGHT-OUT (which is a selling expense).
Merchandising Concern J. Chio / G. Ong
2. Perpetual System – requires the maintenance of records called stock cards that usually offer a running
summary of the inventory inflow and outflow.
Account titles used related to ACQUISITION of goods are: MERCHANDISE INVENTORY.
Account titles used related to SALE of goods are: SALES, SALES RETURNS, SALES DISCOUNTS,
FREIGHT-OUT (which is a selling expense), COST OF GOODS SOLD.

VII. Account Titles:

1. On the books of the BUYER:
A. Purchases – used in recording buying of inventories (goods for sale), both for cash purchase or credit
purchases.

B. Freight-In / Transportation-In – used in recording the cost of transportation shouldered by the

buyer. In computation for the cost of inventory purchased. This form part of the cost of the goods
acquired.

C. Purchase Returns – used in recording inventories purchased but returned to the supplier due to the
any of the following reasons:
a. goods are damaged or defective,
b. goods are of inferior quality, or
c. goods are not in accord with the purchaser’s specifications.

D. Purchase Discounts – represents CASH discounts received from seller arising from early or prompt
payment. Payment should be made within the discount period (period stated by the seller).

2. On the books of the SELLER:

A. Sales – used in recording selling of inventories (goods for sale), both for cash purchase or credit
purchases.

B. Sales Returns – used in recording inventories previously sold but returned by the customer due to
the any of the following reasons:
a. goods are damaged or defective,
b. good are of inferior quality, or
c. good are re not in accord with the purchaser’s specifications.

C. Sales Discounts – represents CASH discounts granted to customers arising from early or prompt
collection from customer. Collection should be made within the discount period.

D. Freight-Out / Transportation-Out – used in recording the cost of transportation shouldered by the

seller. This is basically a delivery expense. This form part of the selling expense.

VIII. Discounts Terminologies:

Trade Discounts vs. Cash Discounts
Definition Accounting Treatment
1. Trade Discount – deduction from the list or
catalogue price in order to arrive at the
invoice price which is the amount actually No Journal Entry
charged to the buyer. (Trade discounts are not recorded in the books)
" Its purpose is to encourage the buyer to
purchase more.

2. Cash Discount – deduction from the invoice

price when payment is made within the
discount period.
" Its purpose is to encourage the buyer to
pay promptly.
Book of Buyer – recorded as Purchase Discount.
Book of Seller – recorded as Sales Discount.
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Merchandising Concern J. Chio / G. Ong
IX. Shipping Terminologies:
1. F.O.B. shipping point – represent goods placed free on board (FOB) up to place the carrier by the seller.
A. Buyer shoulders freight costs.
B. Freight-In is debited by the buyer.

2. F.O.B. destination – represent goods placed free on board (FOB) up to the place of the buyer by the seller.
A. Seller shoulders freight costs.
B. Freight-Out is debited by the seller.

X. Pro-Forma entry for Buyer using Periodic system:

Transactions Pro-Forma Journal Entry
1. Purchase of goods on account, P20,000. Purchases 20,000
Terms 2/15, n/30. Accounts Payable 20,000

2. Payment of Freight on the purchase, Freight-In 1,000

P1,000 Cash 1,000

3. Return of goods purchased to the supplier, Accounts Payable 2,500

P2,500. Purchase Returns 2,500

4. Pay the invoice in full within 15 days. Accounts Payable 17,500

Discount computed as follows: Purchase discount 350
Cost P20,000 – returns 2,500 = P17,500 Cash 17,150

P17,500 x 2% = P350 Discount

5. If the buyer paid beyond the discount Accounts Payable 17,500

period. Cash 17,150

XI. Pro-Forma entry for Seller using Periodic system:

Transactions Pro-Forma Journal Entry
1. Sale of goods on account, P20,000. Terms Accounts receivable 20,000
2/15, n/30. Sales 20,000

2. Payment of Freight on the sales, P1,000 Freight-Out 1,000

Cash 1,000

3. Return of goods sold by customer, P2,500. Sales Returns 2,500

Accounts receivable 2,500

4. Collected the invoice in full within 15 Cash 17,150

days. Sales discount 350
Discount computed as follows: Accounts receivable 17,500
Cost P20,000 – returns 2,500 = P17,500

P17,500 x 2% = P350 Discount

5. If the collected was made after the Cash 17,500

discount period. Accounts receivable 17,150

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Merchandising Concern J. Chio / G. Ong

XII. Computation of Cost of Sales / Cost of Goods Sold:

Inventory, beginning xxxxx
Purchases xxxxx
Freight-In xxxxx
Gross purchases xxxxx
Purchase returns (xxxxx)
Purchase discounts (xxxxx) (xxxxx)
Net purchases / Cost of goods purchased xxxxx
Total goods available for sale xxxxx
Inventory, ending (xxxxx)
Cost of Sales XXXXX

XIII.Computation of Income:
Sales xxxxx
Sales returns (xxxxx)
Sales discounts (xxxxx) (xxxxx)
Net Sales xxxxx
Cost of Sales (xxxxx)
Gross profit / Gross margin xxxxx
Operating Expense
Selling expenses
Sales salaries xxxxx
Sales commission xxxxx
Store supplies xxxxx
Advertising and promotion xxxxx
Depreciation expense – store equipment xxxxx xxxxx
Administrative expenses
Office salaries xxxxx
Office supplies xxxxx
Utility expense xxxxx
Depreciation expense – office equipment xxxxx xxxxx
Total operating expense (xxxxx)
Net income from operation XXXXX

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