Basic Financial

Accounting &
Reporting
Chapter 7 (Part 1)
Merchandising Operation
Prepared by:
Prof. Monette C. Serzo
1st Sem SY 2020-21
 Learning objectives
1. Describe merchandising activities and identify the income components for a
merchandising entity.
2. Distinguish between income statements of service and merchandising entities.
3. Illustrate the operating cycle of a merchandising entity.
4. Be familiar with the different source documents being used by merchandising entities.
5. Compare cash discounts and trade discounts.
6. Summarize the treatment of transportation costs considering the freight terms FOB
Destination, FOB Shipping Point, Freight Prepaid and Freight Collect.
7. Explain the inventory systems of merchandising entities.
8. Analyze and record transactions for merchandising sales under a periodic inventory
system.
9. Analyze and record transactions for merchandising purchases under a periodic inventory
system.
10. Prepare entries showing the effects of value-added tax on merchandising transactions.
11. Compare and contrast the entries needed for the periodic and perpetual inventory
system.
Merchandising
Business
Merchandising Business is a business
engaged in a buying and selling of goods
or products. Also, "trading" and
"retailing" describes a merchandising
business.
The primary product of this business is
the "merchandise" items it
sells. Meaning, there's a presence of
physical products which are being
purchased and sold.
This business in order to earn, the entity
buys goods and adds markup or profit to
the cost of goods then sells them to the
customers.
Benefits of
Merchandising

• Higher profits.
• More satisfied shoppers.
• More engaged buyers (longer
on-site time)
• Faster inventory turnover.
• Increased brand loyalty.
• Increased brand recognition.
 Comparison
of Income
Statements

Fig. 7-1 Components of Income Statements for Service and Merchandising Entities.
Comparison of
Income Statements
In a 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.

The difference between net sales and cost of

sales is called gross profit. Then, other
operating is added and operating expenses (like
distribution costs, administrative expenses and
other operating expenses) are deducted from
gross profit to arrive at operating profit.
Comparison of
Income Statements
Investment revenues, other gains and losses,
and finance costs (e.g. interest expense) are
considered to arrive at profit before tax then
income tax expense is deducted to have
profit from continuing operations.

Finally, profit from discontinued operations

(net of tax) is taken to account to get profit
for the period.
 Christopher Biore Traders
Income Statement
For the year ended Dec. 31, 2020

Net Sales P 2,393,250

Cost of Sales 1,313,600
Gross Profit P1,079,650
Operating Expenses 586,040
Operating Profit P 493,610
Finance Costs 38,400
Profit P 455,210

Exhibit 7-1 Parts of an Income Statement for a Merchandising Entity

Operating Cycle of a Merchandising Company

Cash
P
u
C r
a c
s h
h a
s
e
Inventory s

Cash Sales Sales on Account

Figure 7-2 Operating Cycle of a Merchandiser

Source Documents
Merchandising businesses use various forms and documents to
help identify the transactions that should be recorded in the
books. These source documents contain vital information about
the nature and amount of the transactions.
1. Sales Invoice is prepared by the seller of goods and sent to the
buyer.
Contents:
• Name and address of the buyer
• Date of sale
• Information – quantity, description and price – about the
goods sold.
• Amount of sales,
• Transportation
• Payment terms
2. The Bill of Lading is a document issued by the carrier – a
trucking, shipping or airline – that specifies contractual
conditions and terms of delivery such as freight terms, time,
place, and person named to received the goods.

3. The statement of account is a formal notice to the debtor

detailing the accounts already due.

4. The official receipts evidences the receipt of cash by the

seller or the authorized representative. It notes the invoices
paid and other details of payment.
5. Deposit Slips are printed forms with depositor’s name,
account number and space for details of the deposit.
A validated deposit slip indicates that cash and checks
with the supplied details were actually deposited or
credited to the account holder.

6. A check is a written order to a bank by a depositor to

pay the amount specified in the check form his
checking account to the person named in the check.
The entity issuing the check is the payor while the
receiver is the payee.
7. The purchase requisition is a written request to the
purchaser of an entity from an employee or user
department of the same entity that goods be
purchased.

8. The purchase order is an authorization made by the

buyer to the seller to deliver the merchandise as
detailed in the form.

9. Receiving report is a document containing information

about goods received from a vendor. It formally records
the quantities and description of the goods delivered.
10. A credit memorandum is a form used by the seller to
notify the buyer that his account is being decreased due
to error or other factors requiring adjustments.

11. A debit memorandum, or "debit memo," is a document

that records and notifies a customer of debit adjustments
made to their individual bank account. ... The reasons
a debit memorandum would be issued relate to bank
fees, undercharged invoices, or rectifying accidental
positive balances in an account. (Source..
www.Investopedia.com)
Sample of a Sales Invoice Sample of a Bill of Lading
Official Receipt
Deposit Slip

Bank Check
 Purchase or sale of merchandise, buyer and seller
should agree on:

➢Price of the merchandise

Steps in ➢The payment terms
➢The party to shoulder the transportation
Purchase costs
Transactions
Owners of small merchandising firms may settle
these terms informally by phone or by discussion
with the vendor’s representative.
Steps in Purchase Transactions

Most large businesses,

however, follow certain
procedures when purchasing
merchandise.
The procedures are as follows:
1. Purchase requisition form
and send it to the
purchasing department.
Steps in Purchase Transactions

2. The purchasing department --> prepares a purchase order after

checking with the price lists, quotations, or catalogs of approved
vendors.
• Quantity
• Description
• Price of the merchandise ordered.
• Payment terms
• Transportation arrangements
Steps in Purchase Transactions

3. After receiving the PO, the seller forwards an invoice to the

purchaser upon shipment of the merchandise.
The invoice defines the terms of the transaction.
• Sales invoice – seller
• Purchase invoice - buyer
Steps in Purchase Transactions

4. Upon receiving the shipment of merchandise, the purchaser’s

receiving department sees to it that the terms in the PO 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 prices agree.
 Merchandise may be purchased and sold either on credit
terms or for cash on delivery (COD).
Terms of When goods are sold on account, a period of time called
Transactions the credit period is allowed for payment. The length of
the credit period varies across industries and may even
vary within an entity, depending on the product.
 When goods are sold on credit, both parties (buyer
and seller) should have an understanding as to the
amount and time of payment. These terms are
usually printed on the sales invoice and constitute
part of the sales agreement.
Terms of If the period is 30 days, then payment is expected
within 30 days from the invoice date.
Transactions The credit period is usually described as the net
credit period or net terms. Sample due dates:
✓ due in 30 days is noted as “n/30”
✓ due in 10 days after the end of the month is
noted as “n/10 eom”
Cash Discount

Cash discounts – discounts given for

prompt payments.
Cash discounts is designated by
If a trade discount is also offered, such notations as “2/10” which
cash discount is computed on the net means the buyer may avail of two
amount after the trade discount. (2) percent discount if the invoice
is paid within 10 days from the
This practice improves the seller’s invoice date.
cash position by reducing the amount
of money in accounts receivable. The period covered by the
discount, say ten days, is called the
discount period.
Cash Discount

Buyer – Purchase discounts Seller – Sales discounts

It is usually worthwhile for the buyer to take a discount if offered

although it may be necessary to borrow the money to make the payment.
Cash Discount

Illustration: Assume that an invoice for P150,000 with terms 2/10, n/30,
is to be paid with the discount period with money borrowed for the
remaining 20 days of the credit period.

If annual interest rate of 18% is assumed, the net savings to the buyer is
P1,530 which is determined as follows:
Cash Discount of 2% on P150,000 3,000
Interes for 20 days at an annual rate
of 18% on the amount due within
the discount period:
* 147000 x 18% x 20/360 1,470
Saving effected by Borrowings 1,530

* 150,000 invoice price - P3,000 Cash discount

 Trade discount is the reduction in price a
manufacturer or wholesaler gives a wholesaler
or retail when they buy a product or group of
products. In other words, a trade discount is a
certain percentage a manufacturer is willing to
Trade reduce its list price for wholesalers or retailers.
Discounts
Trade discounts encourage the buyers to
purchase products because of its markdowns
from the list price.
Illustration:
Pinnacle Technologies quoted a list price of P2,500 for each 64 gigabyte
flash drive, less a trade discount of 20%. If Video Fantastic ordered 7
units, the invoice price would be as follows:

List Price (P2,500 x 7) 17,500

Less: 20% Trade Discount 3,500
Invoice Price 14,000

Trade discounts 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 (P2,500 x 7) 17,500

Less: 20% Trade Discount 3,500
Balance 14,000
Less: 10% Trade Discount 1,400
Invoice Price 12,600
Different Modes Transportation in moving the Merchandise
 • When merchandise is shipped by a common
carrier – a trucking entity or an airline – the carrier
prepares a freight bill in accordance with the
instructions of the party making the shipping
arrangements.

Transportation • The freight bill designates which party shoulders

the costs, and whether the shipment is freight
Costs prepaid or freight collect.

• Freight bills usually who whether the shipping are

FOB shipping point or FOB destination.

• F.O.B is the abbreviation for “free on board”

 Transportation Costs
FOB shipping
point, the buyer
shoulders
shipping costs;
ownership over
the goods FOB
passes from destination, the
seller to the seller bears the
buyers when shipping costs;
the inventory ownership over
leaves the the goods
seller’s place of passes only
business – the when the goods
shipping point are received by
the buyer at the
point of
destination.
Transportation Costs
In freight prepaid,
In freight collect,
the seller pays the
the freight entity
transportation cost
collects from the
before shipping the
buyer.
goods sold.

Normally, the party bearing the freight costs pays the carrier. Thus, goods are
typically shipped freight collect when the terms are FOB shipping point; and freight
prepaid when the terms are FOB destination.

Sometimes, as a matter of convenience, the firm not bearing the freight cost pays
the carrier. In this case, the seller and buyer adjust the amount of the payment for
the merchandise.
Transportation Costs

Who Shoulders the Who Pays the

Freight Terms Transportation Costs? Shipper?

FOB Destination, Freight Prepaid Seller Seller

FOB Shipping Point, Freight Collect Buyer Buyer
FOB Destination, Freight Collect Seller Buyer
FOB Shipping Point, Freight Prepaid Buyer Seller

Figure 7-3 Treatment of Transportation Costs

 The transportation borne by the buyer using
the periodic inventory system are debited to
Transportation Transportation in account.
Costs In accounting, the cost of an asset – the
merchandise inventory – includes all costs.
(e.g. shipping costs) incurred to bring the
asset to its intended use.
Shipping costs borne by the seller are debited
to transportation out. This account which is
also called delivery expense, is an operating
expense in the income statement.
 Merchandise inventory is the key factor in
determining cost of sales. Because
merchandise inventory represents goods
available for sale, there must be a method
of determining both the quantity and the
Inventory cost of these goods.
Systems
There are two inventory systems available
for merchandising entities:
1. Perpetual inventory system and
2. Periodic inventory system
 Under the perpetual inventory system, the inventory
count is continuously updated.
= > Time of Purchase:
Debits to the Inventory Account

= > Time of Sale:

Debit to Cost of Sales, Credit to Inventory
Account

With perpetual inventory system, both the

inventory and cost of sales accounts receive
entries throughout the accounting period.
Many merchandising
entities are using the
perpetual inventory system
with point-of-sale (POS)
equipment. Computers have
decreased in prices. These
powerful machines have
dramatically reduced the
time required to mange
inventory.
In the absence of point-of-sale
scanners, the perpetual inventory
system is more advisable for firms
that sell low-volume, high priced
goods such as motor vehicles,
jewelry and furniture.
When an entity uses the perpetual
inventory system, the ending
inventory should reconcile with
the actual physical count at end of
the period assuming that no theft,
spoilage, or error has occurred.
Even if there is a little chance for
or suspicion of inventory
discrepancy, most entities make a
physical count.
At the time, the account is
adjusted for any inaccuracies
discovered. The count provides an
independent check on the amount
of inventory that should be
reported a the end of the period.
Periodic Inventory System
The periodic inventory system is primarily used by
businesses that sell relatively inexpensive goods and
that are not yet using computerized scanning system to
analyze goods sold.
A characteristic of the periodic inventory system is that
no entries are made to the inventory account a the
merchandise is bought and sold. When goods are
purchased, a separate set of accounts – purchases,
purchases discounts, purchases returns and allowances,
and transportation in – is used to accumulate
information on the net cost of the purchases.
Only at the end of the period, when an inventory is
counted, will entries be made to the inventory account
to establish its proper balance.
Periodic and Perpetual Inventory Systems Compared
We will demonstrate the entries typically used with periodic inventory
system, contrasted to the entries used with the perpetual inventory
system:
Assumptions:
1) Beginning Inventory P250,000
2) Year-end balance in inventory account under perpetual inventory
system is P231,860;
3) Physical count revealed P231,500 balance
4) 1-7 are the only transactions for the entire year
5) 8-10 journal entries are made at the end of the year to bring the
inventory account balance into agreement with the amount of the
physical inventory.
 Exhibit 7-4

1. Sold merchandise on account costing P8,000 for P10,000; terms were 2/10, n/30

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Accounts Receivable 10,000 Accounts Receivable 10,000

Sales 10,000 Sales 10,000

Cost of Sales 8,000

Inventory 8,000
 Exhibit 7-4

2. Customer returned merchandise costing P400 that had been sold on account for P500 (part
of the P10,000)

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Sales Returns & Allowances 500 Sales Returns & Allowances 500
Accounts Receivable 500 Accounts Receivable 500

Inventory 400
Cost of Sales 400
 Exhibit 7-4

3. Received payment from customer for merchandise sold above (cash discount taken:
(10,000 sales – P500 return) x 2% discount = P190).

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Cash 9,310 Cash 9,310

Sales Discount 190 Sales Discount 190

Accounts Receivable 9,500 Accounts Receivable 9,500

 Exhibit 7-4

4. Purchase on account merchandise for resale for P6,000; terms ere 2/10, n/30 (purchase
recorded at invoice price).

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Purchases 6,000 Inventory 6,000

Accounts Payable 6,000 Accounts Payable 6,000

 Exhibit 7-4

5. Paid P200 freight on the P6,000 purchase: terms were FOB shipping point, freight collect:

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Transportation in 200 Inventory 200

Cash 200 Cash 200

 Exhibit 7-4

6. Returned merchandise costing P300 (part of the P6,000 purchase):

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Accounts Payable 300 Accounts Payable 300

Purchases Returns & Inventory 300

Allowances 300
 Exhibit 7-4

7. Paid for merchandise purchased, refer to no. 4 {cash discount taken: (P6,000 purchase – P300
return) x 2% discount = P114}

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Accounts Payable 5,700 Accounts Payable 5,700

Purchases Discount 114 Inventory 114

Cash 5,586 Cash 5,586
 Exhibit 7-4

8. To transfer beginning inventory balance to the Income Summary account (part of the closing
entries under the periodic inventory system):

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Income Summary 250,000 - No entry required -

Inventory 250,000
 Exhibit 7-4

9. To record the ending inventory balance (part of the closing entries under the periodic
inventory system):

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

Inventory 231,500 - No entry required -

Income Summary 231,500

 Exhibit 7-4

10. To adjust the ending perpetual inventory balance for the shrinkage during the year:
(Balance inventory account P231,860 less the balance per physical account P231,500 = P360)

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

- Shrinkage already effected in the no 9 entry - Cost of Sales 360

Inventory 360
Next …. Net Sales and cost of sales
1. The chart of accounts for a merchandising entity
differs from that of a service entity.

TRUE
2. The Income Statement of an entity that provides
services only will not have cost of goods sold.

TRUE
3. For a merchandising entity, the difference between
net sales and operating expenses is called gross
margin.

FALSE
Not operating expenses but Cost of sales
4. When the terms of sale include a sales discount, it
usually is advisable for the buyer to pay within the
discount period.

FALSE
5. The term 2/10, n/30 mean that a 2% discount is
allowed on payments made over 10 but before 30
days after the invoice date.

FALSE
6. Term 2/10, n/30 is an example of a trade discount.

FALSE
7. Goods should be recorded at their list price less any
trade discounts involve.

TRUE
8. FOB Shipping point means that the seller incurs the
shipping costs.

FALSE
9. Under the perpetual inventory system, the cost of
merchandise is debited to Merchandise Inventory
at the time of purchase.

TRUE
10. A physical inventory is usually taken at the end of
the accounting period.

TRUE
1. In the periodic inventory system, all purchase of
merchandise during the period is recorded in the
_______________________ account.

Purchases
2. A continuous record of inventory is kept in a
____________ ____________ system.

perpetual inventory
3. The ending inventory of one period becomes the
___________ next period.

beginning inventory
4. Ending inventory represents goods not ______ .

sold
5. Beginning Inventory plus Net Purchases equals
__________________________ .

Goods Available for Sale