ACCOUNTING CYCLE FOR

MERCHANDISING BUSINESS

FUNDAMENTALS OF ACCOUNTANCY AND

BUSINESS MANAGEMENT 2
JANNETTE B. RAMOS, LPT, MBA

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 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.
 A merchandiser’s primary source of
revenue is sales revenue or sales.

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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.

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Gross profit (GP) is equal to Sales
Revenue less the Cost of Goods Sold.
 Income measurement process for a
merchandiser follows as:
SALES
less COGS
= Gross profit
less Operating Expenses
 =Income

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 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

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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.

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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

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 SalesJournal (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)
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INVENTORY SYSTEMS
1. PERPETUAL
2. PERIODIC

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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.

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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.

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INVENTORY SYSTEMS
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):
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 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)

BI + COGP = Cost of goods available for sale – EI =

COGS

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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.

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Aperpetual 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.

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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).

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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.

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Example
 Magaling Computer Store started its
operations on January 2, 2016. The store
is located in Sikat Mall in Bicol. The
owner invested PHP500,000 to start the
business. On January 3, 2016, Magaling
purchased 20 units of computers on
account for PHP10,000 each. Upon
delivery of the units, the supplier, Delta,
Inc., issued Charge Invoice No. 145 to
Magaling.

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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.

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• 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.
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Example
 Out of the 20 computer units purchased
last January 3, 2016, it was found after
inspection on the same day that one unit
was damaged during shipment. Magaling
issued a debit memorandum (DM 01) and
informed the supplier that it will return
the one damaged item.

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 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.

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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.

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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.

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FOB Destination
• Goods placed free on board (FOB) at
buyer’s business.
• Seller pays freight costs.

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 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.

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Example
 Assume the supplier of Magaling is based
in Manila. In order to bring the 20
computer units to Bicol, it will cost
PHP3,000 to deliver the goods.
 If the terms is FOB Shipping Point, the
entry to record, assuming Magaling paid
the common carrier in cash on January 4,
2016 is :

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If the terms is FOB Destination, no entry is
recorded in the books of Magaling. The
PHP3,000 will be paid by the seller, in this
case Delta, Inc.

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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.

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 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.

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Example
 The credit terms for the purchase of 20
computer units (total cost PHP200,000)
is 2/10, n/30. This means that if Magaling
pays on or before January 13, 2016, it is
entitled to a 2% discount, otherwise
Magaling will have to pay the full amount
on or before February 4, 2016 (30 days
after purchase). On January 10, 2016,
Magaling paid the account in full with
Delta.

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Assuming that instead of paying on January 10, 2016,
Magaling paid on February 4, 2016, thus forfeiting the 2%
discount, the entry to record is:

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Recording of sales and related
transactions under the Periodic
Inventory System

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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.

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 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 credited directly to
the asset account.

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Example:
For the month of January, Magaling made the following sale:
1/10/2016 Official Receipt (OR) No. 001 Sold
two units for cash to Marie Cruz for PHP36,000
(PHP18,000 per unit), FOB Destination

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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

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1/15/2016 Charge Invoice (ChI) No. 001 Sold five
units on account to Rafael Reyes for PHP97,500
(PHP19,500 per unit) with terms 3/10, n/ 30, FOB
Shipping Point

Take note that no entry will be made regarding the sale to

Rafael Reyes since the term is FOB Shipping Point.

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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.

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 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.

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• 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.

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 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

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Example
 On January 16, 2016, Rafael Reyes returned one unit of
the computers purchased last January 15, 2016 under
Charge Invoice 001. The unit returned was in good
condition. However, Rafael Reyes returned the unit
because it is one unit more than what they need. The
return was approved and accepted by Magaling. The
price will be deducted from the account of Rafael
Reyes.

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SALES DISCOUNTS
 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.
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Example
 Assume that Magaling purchased on cash,
five units of computers at PHP10,000 per
unit from a supplier on January 17, 2016.
These units were subsequently sold to Jun
Cruz on January 18, 2016 under Charge
Invoice (ChI) No. 002 amounting to
PHP90,000 (PHP18,000 per unit) with
terms 2/10, n/30, FOB Shipping Point. On
January 23, 2016, Cruz paid the said
account in full.

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Notice in the entry on January 23, 2016 that the cash
received from Jun Cruz was net of the 2% discount because
he made the payment within the discount period. Take note
that the discount period in this case was from January 19,
2016 to January 28, 2016 (10 days).
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What If Jun Cruz paid the account on January
30, 2016 instead of January 23, 2016? The
entry would be:

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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.

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 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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REMINDERS
Merchandise Inventory, Ending is
established by conducting a physical count
at the end of the reporting date.
In the periodic inventory system, physical
count is a must.

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