HANDOUT PART 6

ANALYZING AND RECORDING BUSINESS TRANSACTIONS

OF A MERCHANDISING BUSINESS

A merchandising business generates revenues from the selling of

merchandise or goods that it purchases from other companies. Its major
activities consist of buying and selling of merchandise. The merchandise
purchased from a manufacturer or a wholesaler is sold in the same form at a
profit.

Journalizing Transactions Using the General Journal

The chart of accounts of a merchandising business differs from that of a

service business as it contains additional accounts as follows:

Purchases – is the account used to record purchases of merchandise.

Purchase Returns and Allowances – is used when the merchandise

received from the supplier are defective or do not conform to the specifications of
the buyer. The buyer may opt to return the goods to the seller (purchase return)
or may decide to keep them and the seller will grant an allowance (purchase
allowance). However, the two terms have been combined, thus, Purchase
Returns and Allowances. In this case, the buyer issues a debit memorandum
informing the seller or supplier that it has debited or reduced the supplier’s
account and the reason for the return of the merchandise or for the purchase
allowance.

Purchase Discount – refers to the reduction in the amount to be paid

due to prompt or early payment of an account.

Sales – is the revenue derived from selling goods or merchandise.

Sales Returns and Allowances – refers to the deductions from the

invoice prices due to damages, defects or errors in the kind or quality of
merchandise delivered to customers. Sales returns account is used when there
is a physical return of goods, while Sales Allowances account is used when
damages/defects on goods delivered are settled by a reduction in the invoice
price. However, these two accounts are combined, thus, Sales Returns and
Allowances. In this case, the seller issues a credit memorandum.

Sales Discount – represents the deductions allowed to customers

because of prompt or early collection from them.

Freight in - refers to the transportation cost of the merchandise when

purchased.
 Freight out or Delivery expense – represents the cost of the gasoline
and oil used and other related expenses incurred in transporting the goods to the
customers.

Merchandise Inventory – refers to the goods unsold as of a given date.

There are two terms used such as Merchandise Inventory, beginning which
refers to the merchandise at the start of the accounting period and Merchandise
Inventory, ending which refers to the value of the goods unsold at the end of
the accounting period.

Cost of sales – otherwise termed as Cost of Goods Sold, is an expense

account where the cost of the merchandise sold is transferred.

Purchase of Merchandise

Merchandise refers to goods or commodities bought by the business for

resale at a certain amount of profit. There are two methods of accounting for
merchandise:

1. the Perpetual Inventory Method and the Periodic Inventory Method.

Under the Perpetual Inventory Method, the Merchandise Inventory
account is used when there are purchases and is reduced if there is a
sale of merchandise. The Cost of Goods Sold and value of inventory at
the end can be determined even without a physical counting.

2. When the Periodic Inventory method is used, the value of the ending
inventory is determined by physically counting the unsold items and
valuing it at cost. The Purchases account is used when merchandise is
purchased. The Periodic inventory method will be used in the succeeding
discussions. Merchandise can be purchased on cash basis or on
account.

A. Cash Purchases

Illustration: Bought merchandise costing P3,000 Terms: Cash

Date Account Tiles/Explanation Debit Credit

Purchases 3,000
Cash 3,000

Since the periodic inventory system is used, the Purchases account is

debited.

Purchases on Account. Payment will be made in the future although

merchandise will be received on the date of purchase.

Illustration: Assume that goods were purchased on account, P5,000.

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 Date Account Tiles/Explanation Debit Credit
Purchases 5,000
Accounts Payable 5,000

It may also happen that the buyer is asked to make a down payment and the
balance on account.

Illustration: Assume that merchandise costing P8,000 were purchased. Terms:

20% down, balance on account.

Date Account Tiles/Explanation Debit Credit

Purchases 8,000
Cash 1,600
Accounts Payable 6,400

If a promissory note is issued, Notes Payable account should be credited

instead of Accounts Payable account.

B. Freight on Merchandise

Freight in is the account used to record the transportation charges on

merchandise purchased.

Freight out is the freight on merchandise sold. The terms of shipment indicate
whether the buyer or seller should shoulder the freight expenses.

The following are the freight terms:

F.O.B. Shipping Point means that the seller is responsible for the
transportation expenses up to the point of shipment only. F.O.B means
free on board. Upon shipment, ownership of the goods is transferred
to the buyer, thus transportation expenses from the shipping point
to the buyer’s place will be shouldered by the buyer.

F.O.B. Destination means that the goods are free on board to the point
of destination. Ownership of the goods remains to the seller until the point
of destination, and as such, transportation expense is shouldered by
the seller.

Illustration: Assume that Hajie Food Products (VAFP) located in Paoay, Ilocos
Norte sells chichacorn to Neryl Commercial located in Metro
Manila.

The goods are to be shipped through Florida Bus from Batac City (Shipping
Point) to Metro Manila (Point of Destination) at a rate of P100 per carton. On
February 25, 2014, 10 cartons of chichacorn were shipped.

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 F.O.B. Shipping Point. This means that the freight expenses should be
shouldered by the buyer.

On the part of the buyer:

Date Account Tiles/Explanation Debit Credit

Freight in 1,000
Cash 1,000

The seller will not be affected by this transaction.

F.O.B. Destination. This means that the expense should be shouldered

by the seller.

The buyer will not be affected by this transaction.

C. Purchase Returns and Allowances

When goods purchased are defective, of inferior quality or of wrong

specification, the buyer can return the merchandise back to the seller. When
such would happen, the account Purchase Return will be used. Should the
buyer decide to keep the merchandise, a reduction in the amount due to the
seller is to be done. If there is no physical flow of merchandise from the buyer
back to the seller, the appropriate account to be used is Purchase Allowances.
In most cases, however, the Purchase Returns and Allowances account is
used.

If the goods were originally purchased on cash basis, the buyer is entitled
to a cash refund.

Illustration: AX Trading, returned defective goods worth P2,000 originally

purchased on cash basis.

Date Account Tiles/Explanation Debit Credit

Cash 2,000
Purchase Returns and Allowances 2,000

If the goods were originally purchased on account, the buyer is entitled to

a reduction in the liability

Illustration: AX Trading returned defective goods originally purchased on

account.

Date Account Tiles/Explanation Debit Credit

Accounts Payable 2,000

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 Purchase Returns and Allowances 2,000

D. Payment of Accounts

When purchases are made on account, the terms of purchase should be

considered in determining whether the buyer is entitled to a discount or not.

Payment within the Discount Period

If the buyer pays his account within the discount period, he is granted a
cash discount. The cash discount reduces the amount of cash to be given in
payment of a liability and it decreases the cost of purchases.

Illustration: Purchase merchandise worth P10,000 on account on March 21

under the terms 2/10, n/30.

The credit term for the purchase of merchandise (total cost P10,000) is 2/10,
n/30. This means that if the buyer pays on or before March 30, he is entitled to a
2% discount, otherwise he will have to pay the full amount on or before April 20
(30 days after purchase). On March 30, the buyer paid the account in full.

Date Account Tiles/Explanation Debit Credit

Accounts Payable 10,000
Purchase Discount 200
Cash 9,800

E. Sales

A trading business derives income mainly from the sale of goods. The
account title Sales is used to record the sale of goods. This account records
sale of merchandise at selling prices. All terms of purchases of merchandise are
also applicable to sale of goods.

Illustration: Assume that JoeLander Trading sold P60,000 worth of goods on

cash basis.

Date Account Tiles/Explanation Debit Credit

Cash 60,000
Sales 60,000

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 When goods are sold on credit or on account, Accounts Receivable
should be debited instead of cash. However, if a promissory note was received,
the account to be debited should be Notes Receivable.

Sales Returns and Allowances

When the buyer returns or complains about goods that are defective or of
wrong specification, the seller grants a reduction on the invoice price of the
merchandise sold. Goods which are actually returned by the customer and
received by the seller are considered as Sales Returns by the seller. In cases
where there is no actual receipt of merchandise, but only a reduction in the
invoice price is to be effected, this is called Sales Allowances.

The Sales Returns and Allowances account is used to reduce the

previously recorded sales.

Illustration: JoeLander Trading received merchandise worth P2,000 returned

by the buyer, Juju Trading.

Date Account Tiles/Explanation Debit Credit

Sales Returns and Allowances 2,000
Cash 2,000

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