BA PLUS 1 AND ACCOUNTING 101

LESSON 7: MERCHANDISING OPERATIONS

COMPONENTS OF INCOME STATEMENTS FOR SERVICE AND MERCHANDISING ENTITIES

SERVICE MERCHANDISING
Revenues from sales Net sales
Minus Minus
Cost of sales
Equals
Gross profit
Minus or add
Expenses Income or expenses
Equals Equals
Profit profit

*In merchandising business, net sales arise from the sale of goods while
cost of sales or cost of goods sold represents the cost of inventory the
entity has sold to customers.

Gross Profit = Net Sales – Cost of Sales

» The merchandising entity purchases inventory, sells the inventory

and uses the cash to purchase more inventory – and the cycle
continues.
» The faster the sale of inventory and collection of cash, the higher
the profits.
OPERATING CYCLE OF A MERCHANDISER

Cash Sales vs. Sales on Account

Cash
Accounts
Receivable Cash

Inventory
Inventory
 BA PLUS 1 AND ACCOUNTING 101

SOURCE DOCUMENT
a.) Sales Invoice
- prepared by the seller of goods and sent to the buyer
- specifies the amount of sales and the transportation
and payment terms

b.) Bill of Lading

- issued by the carrier that specifies contractual
conditions and terms of delivery such as freight
terms, time, place and that person named to receive
the goods
 BA PLUS 1 AND ACCOUNTING 101

c.) Statement of Accounts

- formal notice to the debtor detailing the accounts
already due.

d.) Official Receipt

- evidences the receipt cash by the seller
- notes the invoices paid and other details of payment

e.) Deposit Slips

- A validated deposit slip indicates that cash and
checks with the supplied details were actually
deposited or credited to the account holder.
 BA PLUS 1 AND ACCOUNTING 101

f.) Checks
- Order to a bank by a depositor to pay the amount
specified in the check from his checking account to
the person named in the check.

g.) Purchase requisition

- Request to the purchaser of an entity from an employee
or user department of the same entity that the goods
be purchased.
 BA PLUS 1 AND ACCOUNTING 101

h.) Purchase Order

- Authorization made by the buyer to the seller to
deliver the merchandise as detailed in the form.

i.) Receiving Report

- Containing information about goods received from a
vendor.
- Formally records the quantities and description of
the goods delivered
 BA PLUS 1 AND ACCOUNTING 101

j.) Credit memorandum

- Used by the seller to notify the buyer that his
account is being decreased due to errors or other
factors requiring adjustments.

PROCEDURES WHEN PURCHASING MERCHANDISE

1. When certain items are needed, the user department fills in a
purchase requisition form and sends it to the purchasing
department.
2. The purchasing department then prepares a purchase order after
checking with the price lists, quotations or catalogs of approved
vendors. The purchase order, addressed to the selected vendor,
indicates the quantity, description and price of the merchandise
ordered. It also indicates expected payment terms and
transportation agreements.
3. After receiving the purchase order, the seller forwards an invoice
to the purchaser upon shipment of the merchandise. The invoice –
called a sales invoice by the seller and a purchase invoice by the
purchaser, defines the terms of the transaction.
4. Upon receiving the shipment of merchandise, the purchaser’s
receiving department sees to it that the terms in the purchase
order are complied with and prepares a receiving report.
5. Before approving the invoice for payment, the accounts payable
department compares copies of the purchase requisition, purchase
order, receiving report and invoice to ensure that quantities,
descriptions and price agreed.
 BA PLUS 1 AND ACCOUNTING 101

Credit period

» A period of time allowed for payment. If the credit period is 30

days, then payment is expected within 30 days from the invoice date.
The credit period is usually described as the net credit period or net
terms. Example: n/30 or n/10 eom
Cash Discounts

» Give discounts for prompt payment

» If a trade discount is also offered, a cash discount is computed on

the net amount after the trade discount.
Discount Period

» Period covered by the discount

Illustration: assume that an invoice for P150,000 with terms 2/10, n/30
is to be paid within the discount period with money borrowed for the
remaining 20 days of the credit period. If an annual interest rate of 18%
is assumed, the net savings to the buyer is:
Cash discount of 2% on 150,000 P3,000
Interest for 20 days @18% int on the
Amount due within the discount period:
P147,000 x 18% x 20/360 (1,470)
Savings effected by borrowing P1,530
Trade Discounts

» Encourage the buyers to purchase products because of markdowns from

the list price
» Enables the suppliers to vary prices periodically without the
inconvenience of revising price lists and catalogs
» There is no trade discount account and there is no special
accounting entity for this discount.

Illustration: Pinnacle Technologies quoted a list price of P2,500 for

each 64-gigabyte flash drive, less trade discount of 20%. IF Video
fantastic ordered seven units, the invoice price would be as follows:
List Price (2,500 x 7) 17,500
Less: 20% trade discount (3,500)
Invoice Price 14,000

Trade discount may be stated in a series. Assume instead that the trade
discount given by Pinnacle to Video Fantastic is 20% and 10%, the invoice
price will be:
List Price (2,500 x 7) 17,500
Less: 20% trade discount (3,500)
Balance 14,000
Less: 10% trade discount (1,400)
Invoice Price 12,600
 BA PLUS 1 AND ACCOUNTING 101

FOB – “free on board”

TREATMENT OF TRANSPORTATION COSTS

Freight Terms Who Shoulders the Who Pays the
Transportation Shipper?
Cost?
FOB Destination, Freight Seller Seller
Prepaid
FOB Shipping Point, Freight Buyer Buyer
Collect
FOB Destination, Freight Seller Buyer
Collect
Freight Shipping Point, buyer Seller
Freight Prepaid

» The shipping costs borne by the buyer using the periodic inventory
system are debited to transportation-in account (incurred to bring
the asset to its intended use; added to purchases).
» Shipping costs borne by the seller is debited to transportation-
out account or delivery expense (operating expense).

Merchandise Inventory – key factor in determining cost of sales

Two Systems Available to Merchandising Entities to Record Events

Related to Merchandise Inventory:
1. Perpetual Inventory System
• Inventory account is continuously updated.
• Perpetually updating the inventory account requires
that at the time of purchase, merchandise
acquisitions be recorded as debits to the inventory
account.
• Used for firms that sell low-volume, high-priced
goods.
2. Periodic Inventory System
• Primarily used by businesses that sell relatively
inexpensive goods and that are not yet using
computerized scanning systems to analyze goods sold.
• No entries are made in inventory account when bought
and sold merchandise.
 BA PLUS 1 AND ACCOUNTING 101

SAMPLE FOR NET SALES FORMAT:

XX Co.
Income Statement
For the Year Ended December 31, 2021

Net Sales:
Gross Sales xx
Less: Sales Returns and Allowances xx
Sales Discounts xx xx
Net Sales xx

Credit Memorandum

» ISSUED BY SELLER TO CUSTOMER TO FORMALLY ACKNOWLEDGE THAT THE

SELLER HAS REDUCED THE AMOUNT OWNED BY THE CUSTOMER.
Sales Returns and Allowances

» Are contra-income account and deducted from gross sales.

Journal Entry:(POV of Seller)

To record sale of merchandise for cash:
Cash xxx
Sales xxx

To record sale of merchandise on credit:

Accounts Receivable xxx
Sales xxx
Sales Discount: Assume that the seller sold merchandise on Sep 20 for
3,000; terms 2/10, n/60. At the time of sale:
Accounts Receivable 3,000
Sales 3,000

If the client paid on Sep 30:

Cash 2,940
Sales discount 60
Accounts Receivable 3,000
 BA PLUS 1 AND ACCOUNTING 101

For sales returns and allowances: (issuance of Credit memo by the seller)
Sales returns and allowances xxx
Accounts Receivable/Cash xxx

CASE 1: For Transportation Out: (FOB destination = Seller; FOB Shipping

point = Buyer). Assume that on Nov 25, the seller sold merchandise
totaling P17,000 FOB destination, freight prepaid; 2/10, n/30. The
transportation costs amounted to P1,900.
Accounts Receivable 17,000
Transportation Out 1,900
Sales 17,000
Cash 1,900
If the invoice is collected on Dec 5,
Cash 16,660
Sales discount 340
Accounts receivable 17,000
CASE 2: Assume FOB shipping point, freight collect.
Accounts receivable 17,000
Sales 17,000
CASE 3: FOB destination, freight collect
Accounts receivable 15,100
Transportation out 1,900
Sales 17,000
CASE 4: FOB shipping point, freight prepaid
Accounts Receivable 18,900
Sales 17,000
Cash 1,900

COST OF SALES
Merchandise Inventory, beginning xx
Purchases xx
Less: Purchase Returns and Allowances xx
Purchase Discount xx xx
Net Purchases xx
Transportation-In xx
Net Cost of Purchases xx
Goods Available for Sale xx
Less: Merchandise Inventory, ending xx
Cost of Sales xx
 BA PLUS 1 AND ACCOUNTING 101

Cost of Sales / Cost of Goods Sold

- The largest single expense of the merchandising
business.
- The cost of inventory that the entity has sold to
customers.
Beginning Inventory
- Merchandise inventory at the beginning of the
accounting period
Ending Inventory
- Merchandise inventory at the end of the reporting
period

Purchases
- When the periodic inventory method is used, all
purchases of merchandise are debited to the
purchases account.

Purchases 15,000

Accounts payable 15,000

Purchase Returns and Allowances

- A contra-account and is accordingly deducted from
purchases in the income statement

Accounts payable 2,000

Purchases returns and allowances 2,000

Purchase Discount
- A contra-account and is accordingly deducted from
purchases in the income statement

Accounts payable 13,000

Purchase discount 260
Cash 12,740

Transportation In: (POV of buyer) Case 1: Assume the buyer made purchases on
Nov 25 totaling P17,000 FOB destination, freight prepaid, terms 2/10,
n/30. Transportation costs amount to P1,900.

Purchases 17,000
Accounts payable 17,000

On Dec. 5, the invoice was paid.

Accounts payable 17,000
Purchase discount 340
Cash 16,660
 BA PLUS 1 AND ACCOUNTING 101

Case 2: FOB shipping point, freight collect.

Purchases 17,000
Transportation in 1,900
Accounts payable 17,000
Cash 1,900

Case 3: FOB destination, freight collect.

Purchases 17,000
Accounts payable 1,900
Cash 15,100

Case 4: FOB shipping point, freight prepaid.

Purchases 17,000
Transportation In 1,900
Accounts payable 18,900
 BA PLUS 1 AND ACCOUNTING 101

Operating Expenses
- Make up the third (3rd) major part of the income
Statement for a merchandising entity.

» Distribution Cost or Selling Expenses – expenses related

directly to the entity’s effort to generate sales.
 Sales salaries and commissions
 Related employer payroll expenses
 Advertising and store displays
 Depreciation of store property and equipment
 Travelling expenses
 Store supplies used
 Transportation-out
» Administrative Expenses – expenses related to the general
administration of the business.
 Officers and office salaries and related payroll
expenses
 Office supplies used
 Depreciation of office property and equipment
 Business taxes
Professional services
 Uncollectible accounts expense
 Other general office expense
» Other operating expenses – expenses that are not related to
the central operations of the business
- Expenses and losses from peripheral or incidental
transactions of the enterprise
 Loss on sale of investment
 Loss on sales of property and equipment
 BA PLUS 1 AND ACCOUNTING 101

Periodic Vs Perpetual

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

1. SOLD MERCHANDISE ON ACCOUNT COSTING

1. SOLD MERCHANDISE ON ACCOUNT COSTING 8,000 FOR 10,000, TERMS WERE 2/10,
8,000 FOR 10,000, TERMS WERE 2/10, N/30:
N/30:
A/R 10,000
A/R 10,000 SALES 10,000
SALES 10,000
COST OF SALE 8,000
INVENTORY 8,000
2. CUSTOMER RETURNED MERCHANDISE 2. CUSTOMER RETURNED MERCHANDISE
COSTING 400 THAT HAD BEEN SOLD ON COSTING 400 THAT HAD BEEN SOLD ON
ACCOUNT FOR 500 (PART OF THE 10,000 ACCOUNT FOR 500 (PART OF THE 10,000
SALE) SALE)
SRA 500
A/R 500 SRA 500
A/R 500

INVENTORY 400
COS 400
3. RECEIVED PAYMENT FROM CUSTOMER 3. RECEIVED PAYMENT FROM CUSTOMER
(10,000 – 500 = 9,500 X 2% DISCOUNT (10,000 – 500 = 9,500 X 2% DISCOUNT
= 190) = 190)

CASH 9,310 CASH 9,310

SALES DISC 190 SALES DISC 190
ACCOUNTS REC 9,500 ACCOUNTS REC 9,500

4. PURCHASE ON ACCOUNT MERCHANDISE FOR 4. PURCHASE ON ACCOUNT MERCHANDISE FOR

RESALE FOR 6,000, TERMS 2/10, N/30 RESALE FOR 6,000, TERMS 2/10, N/30

PURCHASES 6,000 INVENTORY 6,000

ACCOUNTS PAY 6,000 ACCOUNTS PAY 6,000

5. PAID P200 FREIGHT ON THE 6,000 5. PAID P200 FREIGHT ON THE 6,000
PURCHASE, TERMS FOB SHIPPING POINT, PURCHASE, TERMS FOB SHIPPING POINT,
FREIGHT COLLECT FREIGHT COLLECT

TRANSPORTATION IN 200 INVENTORY 200

CASH 200 CASH 200

6. RETURNED MERCHANDISE COSTING 300 6. RETURNED MERCHANDISE COSTING 300

(PART OF 6,000 PURCHASE) (PART OF 6,000 PURCHASE)

ACCOUNTS PAY 300 ACCOUNTS PAY 300

PRA 300 INVENTORY 300

7. PAID THE MERCHADISE PURCHASE WITHIN 7. PAID THE MERCHADISE PURCHASE WITHIN
THE DISCOUNT PERIOD. THE DISCOUNT PERIOD.

ACCOUNTS PAY 5,700 ACCOUNTS PAY 5,700

PUR DISC 114 INVENTORY 114
CASH 5,586 CASH 5,586

8. TRANSFER BEG INVENTORY TO THE INC 8. TRANSFER BEG INVENTORY TO THE INC
SUMMARY SUMMARY

INCOME SUMMARY 250,000 NO ENRTY REQUIRED

BEG INVENTORY 250,000

9. TO RECORD THE ENDING INV BALANCE 9. TO RECORD THE ENDING INV BALANCE
NO ENTRY REQUIRED
INVENTORY 231,500
INCOME SUMMARY 231,500