U N I T THRE E

A CCO U N TI N G F O R M E RCH A N D I S I N G BU S I N E S S E S

3.2.1What is a M erc handising Business?

A merchandising business buys go o ds in finished (tangible go o ds) fo rm who lesalers o r retails fo r
resale to custo mers. These go o ds that a merchandising co mpany sells to its custo mers are called
merchandise inventory.

3.2.2 Compa rison of Financ ial Statements for Merc handising and Servic e Businesses
Income Statement
A mo del inco me statement fo r a merchandising business and ano ther o ne fo r a service business
are sho wn belo w. Co mpare them carefully.

ABC service co mpany XYZ merchandising

Inco me statement Inco me statement
Fo r the year ended Dec.31, 200x Fo r the year ended Dec.31, 200x
Revenue: Revenue:
Service fee……………………...Br 23,200 Net Sales………………………...Br 360,000
Co st o f go o ds so ld……………..(256,000)
Gro ss Pro fit …………………….….104,000
Expenses: Expenses:
Vario us Operating Expenses…..(7120) Vario us Operating Expenses…..(79,400)
Net Inco me…………………..….Br 16080 Net Inco me ………………….…….Br 24,600

Inco me Statements, merchandising co mpanies have to deduct co st o f go o ds so ld in additio n to

o ther o perating expenses fro m their sales revenue to determine their net inco me.
The difference between sales revenue and co st o f go o ds so ld is referred to as gross profit.
Balance Sheet
The Balance Sheet o f a service business and that o f a merchandising business are similar in every
aspect exc ep t o ne thing. The current assets sectio n o f the Balance Sheet o f a merchandising
business includes o ne asset (ending Merchandise invento ry) that service co mpanies do no t have.
3.3 THE PERIODIC AND THE PERPETUAL INVENTORY SYSTEM S
The two alternatives in dealing with this acco unt are:
Periodic Inventory System
Under this system, as the name perio dic suggests, the invento ry acco unt is updated o nly
perio dically i.e., o nly at the end o f a perio d. When go o ds are bo ught, a tempo rary purchases
account is debited instead o f the invento ry acco unt. When go o ds are so ld revenue is reco rded, but
the fact that there is a reductio n in merchandise invento ry is no t reco gnized.
 P hysical inventory means co unting the quantity o f go o ds o n hand.
Perpetual Inventory Systems
To update this acco unt every time go o ds are bo ught and so ld (co ntinuo usly = perpetually)
Under this system, the merchandise inventory account is debited o r credited every time (go o ds)
are bo ught o r so ld. When an item is so ld, its co st is reco rded in a separate co st o f go o ds so ld
acco unt in additio n to reco rding sales.
 No p hysic al inventory fo r ending M. invento ry.

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 3.4 RECORDING PURCHASES AND SALES TRANSACTIONS
3.4.1 Rec ord ing Sales/Purc hases
When a merchandising co mpany transfers go o ds to the buyer, in exchange fo r cash o r a pro mise
to p at a later date, revenue is pro duced to the co mpany. This revenue is sales revenue.

Recording Cash Sales/ Cash Purchase

Fo r the seller when merchandise is so ld o n cash, the cash acco unt is debited and the revenue
acco unt sale is credited. While, fo r the buyer when merchandise is bo ught o n cash, the purchase
acco unt is debited and the cash acco unt is credited.
Example – Ika Co mpany based in Bahir Dar, buys and sells used co mmo dities to XYZ Co mpany. On
January 14. 2001. Ika so ld go o ds fo r Birr 20,000. Reco rd the transactio n.
Ika Co. Seller XYZ Co. Buyer
Jan14, Cash………………………………..20,000 Jan 14, Purchase………………………………..20,000
Sales……………………………………20,000 Cash……………………………………20,000

Recording Credit Sales/ Credit P urchases

The Acco unts Receivable acco unt is debited when go o ds are so ld o n acco unt (fo r credit) at the side
o f seller. While, Acco unt payable acco unt is credited when go o ds are bo ught o n acco unt (fo r
credit) at the side o f buyer.

Example -
Ika so ld go o ds wo rth Birr 35,000 o n acco unt o n January 15, 2001 to XYZ. Reco rd the transactio n.
Ika Co. (Seller) XYZ Co. (Buyer)
Jan15. A/R…………………..35,000 Jan15. Purchase…………………..35,000
Sales…………………………………………35,000 A/P…………………………………………35,000

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 Recording Deductions from Gross Sales/Gross Purchase
A trade discount is a percentage deductio n fro m the specified list price o r catalo gue price o f
merchandise to grant quantity disco unts.

Sales Disc ou nts and Purc hase Disc ounts

Sales disco unts and purchase disco unts are the same thing seen fro m different sides. They are
generally called cash discounts to gether. A cash disco unt is, therefo re, deductio n fro m o riginal
invo ice/purchase price fo r early payment when go o ds are so ld at the side o f seller and bo ught at
the side o f buyer o n credit (o n acco unt). A contra acco unt o f sales o r purchase.
Depends o n the c red it terms:
“n/30” o r “Net 30” – means there is no disco unt even if the custo mer pays befo re the payment
date.
2/10, n/30 –means the due date o f the payment is after 30 days o f the sale. But if the custo mer
pays within 10 days she will get a 2% disco unt.

Sales Returns and Allowances and Purc hase Returns and Allowances
Sales returns and allo wances o r purchase returns and allo wances are the same thing seen fro m
different sides. Custo mers can return merchandise they have bo ught if they find it to be defective
o r o f the wro ng mo del, o r unsatisfacto ry fo r a variety o f reaso ns. A sales return is merchandise
returned by a buyer. The buyer wo uld be paid back her mo ney if she has already paid. A sales
allowance is a deductio n fro m the o riginal invo ice/purchase price when the custo mer keeps the
merchandise but is dissatisfied. A purchase return o ccurs when a buyer returns merchandise to a
seller. A purchase allowance is a reductio n o n the price o f go o ds bo ught fo r dissatisfactio n o n the
side o f the buyer. Bo th purchase returns and purchase allo wances are reco rded in a co ntra
purchase acco unt likewise sales returns and allo wances are reco rded in a co ntra sales acco unt.
Example:
IKA Co mpany so ld merchandise wo rth Birr 15, 000 o n February 3, 2001 to XYZ Co mpany o n
acco unt terms 2/10, n/30. On February 5, the buyer returned a po rtio n o f the go o ds wo rth Birr
5,000 as they were fo und to be o f the wro ng mo del. The buyer then paid o n February 13, 2001.
Reco rd the necessary jo urnal entries o n February 3,5 and 13.

IKa Co (Seller) XYZ Co (Buyer)

Feb 3 A/R……………………………………...15,000 Feb 3 Purchase………………………….15,000

Sales ………………………………..….15,000 A/P ………………………………….….15,000
Feb5 Sales Returns and Allo wances ..5,000 Feb5 A/P…………………….……………….5,000
A/R…………………….………………….5,000 Purchase Returns and Allo wances..5,000
Feb 13 Cash……………………………………..9800
Sales Disco unt ………………….……200 Feb 13 A/P………………………….…….10,000
A/R………………………..…….………10,000 Purchase Disco unt..……………….......200
Cash……..………………………………98,000

Here, the buyer paid/ seller co llected within the disco unt perio d. Therefo re, the amo unt that
wo uld be co llected is:
15,000 – 5,000 = 10,000
Deduct: 2% Cash disco unt (200)
Cash co llected/paid 9800

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 Transportation costs
Once merchandise has been bo ught it has to be mo ved fro m the seller’s place to the buyer’s place.
A third party co mes in to the scene here: the transportation c ompany who mo ves the go o ds
between the two places. On the agreement between the buyer and seller. The agreements are
usually stated in the either o f these two terms:
FOB Destination – means “free o n bo ard at destinatio n “.It simply means the seller pays
transpo rtatio n co st. FOB Destinatio n means go o ds are shipped to their destinatio n (to the buyer)
with o ut transpo rtatio n charge to the buyer.
FOB shipping P oint –means “ free o n bo ard at shipping po int”. the buyer, which pays to the
transpo rtatio n co mpany when the go o ds reach the buyer (their destinatio n) briefly, when the
terms are FOB Shipping Po int the buyer pays transpo rtatio n co sts.

Transpo rtatio n co sts paid by a buyer o f merchandise inc rease the c ost of merc hand ise. They are
reco rded in a separate Transportation-In/ Freight-in acco unt that is used to reco rd freight co sts
incurred in the acquisitio n o f merchandise.
Example
IKA Co mpany bo ught go o ds wo rth Birr 85,000 o n acco unt, terms 2/10,n/60 FOB shipping po int
o n March 2, 2001.Transpo rto in co st o f Birr 1,500 was paid o n March 2. Ika Co mpany paid o n
March 31, 2001. Reco rd the necessary jo urnal entries
Solution:
Here, since the terms are FOB Shipping Po int, the buyer (Ika) pays transpo rtatio n.

March 2 -Purchase…………………..85,000
A/P…………………….…..85,000
-Transpo rtatio n In…….....1500
Cash………..…………………1500
March 31 A/P………………………..…85,000
Cash………………………..85,000
What wo uld the (seller) reco rd? No entry
Chec k Your Progress Exerc ise -9
1. What if the terms were FOB destinatio n?
Example:
IKA Co mpany so ld go o ds wo rth Birr 135,000 terms 1/15, n/EOM o n February 1, 2001. FOB
Destinatio n. It also paid transpo rtatio n co sts o f Birr 800 o n Feb. 1. The custo mer paid IKA o n
February 16, 2001. Reco rd the relevant Jo urnal entries.
Answers:
F eb 1 A/R……………………..135,000
Sales…………………………..135,000
F eb 16
Cash………………………….133,650
Sales disco unt …………...….1,350
A/R……………………………135,000
Delivery Expense……….……800
Cash…………………………………800
The Delivery Expense/Freight out /Transp ortation ou t acco unt sho w ho w much was incurred
to deliver go o ds so ld to custo mers. It is, therefo re, sho wn o n the inco me statement as a selling
e x p e ns e .
What wo uld the custo mer (buyer) reco rd? No entry

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 Summary
Let’s o nce again present the mo del Inco me Statement that we saw at the beginning o f this chapter.
This time aro und, ho wever, it is a bit detailed. Please study the relatio nship between each item o n
the Inco me Statement carefully. Also try to remember ho w each item was reco rded in jo urnal
entry fo rm when the transactio ns affecting these acco unts happened.
XYZ Merc handising Co.
Inc ome statement
For the year ended Dec . 31,2001

Gro ss Sales …………………………………………………………………………………….Br 400,000

Less: Sales Disco unts (15,000)
Sales Ret &All (25,000)……… …………………………………………... (40,000)
Net sales……………………………………………….………………………………..……...Br 360,000
Co st o f go o ds so ld:
Beginning merchandise invento ry (January 1, 2001)…10,000
Add: Purchases……………………...210,000
Less: Purchase Disc………………....(5,000)
Purchase Ret & All………….(5,000)
Net purchase…………………………………………..………………200,000
Add: Transpo rtatio n –In…………………………………………………….66,000
To tal co st o f go o ds Available fo r sale……………………………………………..276,000
Less: Ending M.I (Dec. 31,2001)……………………………………………………………..(20.000)
Co st o f go o ds so ld……………………………………………..…………………..Br (256,000)
Gro ss pro fit…………………………………………………………………….…………….104,000
Less: Vario us Selling and Administrative Expenses …………..…………………….(79,400)
Net Inco me………………………………………………………………………………..Br 24,600
Note: Under a perio dic invento ry system
Summary of Important Relationships on the Income Statement
1. Net sales = Gro ss sales- (Sales Disco unts + Sales Returns and allo wances)
2. Net purchases = Purchases – (Purchase Disc. + Purchase Ret. & allo wance)
3. To tal co st o f Purchase = Net purchase + Transpo rtatio n –In
4. Co st o f go o ds so ld = Beg invento ry + To tal co st o f purchase –Ending invento ry
5. Gro ss pro fit = Net sales – Co st o f go o ds so ld
6. Net Inco me = Gro ss Pro fit – o perating (i.e., selling & administrative) expenses.
Closing entries
Beg M.I (Jan1)………………………………..10,000
Sales…………………………………….…......400,000
Purchase disco unt………………..………....,5000
Purchase Return &Allo wance………….5,000
Purchase………………………………...……..…210,000
. Tran-In co st…………………………………..…….66,000
Sales disco unt…………………………….……….15,000
Sales Return & Allo wance…………………….25,000
Selling and Administrative Expenses…….79,400
Ending M.I (Dec31)…………………………..….20,000
I/Summery................... .... ... .... ... .... ... .... ... .... ... .... ....24,600
- Inco me summary………………….24,600
Yibeltal Capital……………………..…24,600
- Yibeltal Capital…………………..…..2,000
Yibeltal Drawings……...…...………….2,000
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