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Merchandising Business
Overview An organization that is engaged in the buying and selling of goods or merchandise is a merchandising or trading concern. Merchandise refers to goods purchased for resale in the same form. Unlike businesses rendering services for compensation, a trading concern derives its income through the resale at a profit of the merchandise purchased.

Activities The activities of a merchandising concern that distinguish it from a service concern cover the following: 1. Purchasing. Information as to the kind, quality, quantity, and cost of goods bought should be maintained for the use of management. Records as to supplies or merchandise bought are also maintained. 2. Handling. The costs of transporting and sorting of goods bear an important relation to the prices of goods bought. These should be recorded properly. Transportation costs include freight, express, drayage, and cartage. 3. Returning Of Goods Purchased. Some of the merchandise received may prove unsatisfactory and must be returned to the vendors, or if not returned, may be allowed some deductions from the original purchase price. 4. Selling. Goods purchased are sold at prices above the cost in order to provide adequate margin of profit. It is therefore imperative that the cost of goods bought should be known from the accounting records so that desirable selling prices may be set. 5. Returning Of Goods Sold. The customers may return some of the merchandise sold. Deductions from the original selling prices must be allowed for sales returns. If the goods delivered are defective and no return is made, the customers are granted reduction on the sales price. 6. Maintaining Adequate Stocks On Hand. In order to satisfy orders of customers at all times, a stock of merchandise must be maintained on hand. This is called Merchandise Inventory or Inventory on Hand. Inventory System Overview A business firm selling a product must use an inventory record system to value the merchandise on hand at the end of an accounting period. Two different inventory systems may be used to record trading transactions in the accounting records. These systems are the periodic and perpetual inventory system.

Perpetual In a perpetual inventory system a continual, or perpetual, record of the inventory activity is maintained. Consequently, any items that are sold or otherwise physically removed from inventory must be removed from the Merchandise Inventory account, and items that are purchased are added to the Merchandise Inventory account. This may result in significant extra recordkeeping as compared to a periodic system. However, a perpetual inventory system does have advantages, and businesses with a relatively low number of high-value transactions often find the extra effort to be worthwhile. Computers are also making it practical for businesses to use perpetual systems than would have been not feasible in the past.

Periodic or Physical In the periodic inventory system, the ending inventory is determined by a physical count of the merchandise on hand at the end of an accounting period. The periodic inventory system receives its name because the balance in the inventory account is known only at the beginning and at the end of the accounting period. The periodic inventory is the simpler system commonly used in practice and was the only practical alternative for most businesses with large number of transactions before the advent of computers. The periodic inventory system will be used in the illustrations throughout this course unless otherwise stated.

Transactions in Perpetual Inventory System

As mentioned earlier, a perpetual inventory system attempts to maintain a continual record of the inventory on hand. Thus, if Joseph Labrador purchased merchandise for cash, P50,000, the entry to record this transaction is : Merchandise Inventory Cash To record merchandise bought. 50,000 50,000

On the other hand, if Joseph sold P20,000 worth of merchandise for P40,000, the entry to record this transaction is: Cash Sales To record merchandise sold. Cost of Goods Sold Merchandise Inventory To record the transfer of inventory sold to cost of goods sold account. 40,000 40,000

20,000 20,000

Assuming this time, Joseph Labrador purchased from Mary Trading merchandise on account, Php 100,000. And at the same time, paid for the freight on the said purchase, Php 2,500. The entries would be: Merchandise Inventory Accounts Payable To record merchandise bought. Merchandise Inventory Cash To record freight paid. 100,000 100,000

2,500 2,500

Transactions in Perpetual Inventory System, cont.

Let us say, after two days, Joseph returned defective merchandise bought from Mary amounting to Php 5,000. The entry would be: Accounts Payable Mary Trading Merchandise Inventory To record returned merchandise. 5,000 5,000

If on the other hand, Joseph Labrador sold to Michael Supermart merchandise worth Php 50,000 on account at gross profit of 50 percent. The entries would be: Accounts Receivable Sales Sold merchandise on account. Cost of Goods Sold Merchandise Inventory To record cost of merchandise sold. 50,000 50,000 25,000 25,000

Let us assume again that after three days, Michael issued a debit memorandum amounting to Php 1,800 for defective goods received from Joseph. The entries to record the return would be: Sales Returns & Allowances Accounts Receivable Received debit memorandum. Merchandise Inventory Cost of Goods Sold To record cost of good returned. 900 900 1,800 1,800

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Importance

It is important to note that both periodic and perpetual inventory systems will record the sale of merchandise similarly. The only difference is that under the perpetual inventory system, there is a second entry that is required to be recorded together with the sale to indicate the transfer out of the amount sold from the Merchandise Inventory account to the Cost of Goods Sold account. It is possible to combine the two entries into a single compound entry with the same debits and credits. For example: Cash Cost of Goods Sold Sales Merchandise Inventory To record merchandise sold. 20,000 40,000 20,000 40,000

Pro-forma entry

At the end of the year, no further entries may be required if the balance in the inventory account equals the actual cost of the units on hand. Unfortunately, this seldom happens. Despite the extra effort necessary to maintain a perpetual record of the inventory, the facts often differ from the records. When the facts conflict with the records, the records must be corrected to reflect the facts. Therefore, an adjusting entry is necessary to record any missing inventory items and reduce the balance in the Inventory account to the correct level. The pro-forma entry is: Merchandise Inventory Short or Over Merchandise Inventory To adjust Inventory account to actual balance. xxx xxx

Merchandise Inventory Short or Over

The Merchandise Inventory Short or Over account is an expense account that reflects the cost of missing inventory items. However, depending on its materiality and on normal practice within the industry, the inventory shrinkage amount is often combined with cost of goods sold in the financial statements.

Net Income

The net income disclosed on the income statements prepared under the two inventory systems will reflect the same amount. This is also true with the ending inventory balance reported in the balance sheet. A business that combined its Merchandise Inventory Shrinkage account with its Cost of Goods Sold account would prepare an income statement identical to the one prepared under the periodic inventory system.

Merchandise Accounts
Overview

The discussions on this topic are the account titles to be used in recording acquisition and sale of merchandise of a trading business using the periodic inventory system.

Sales

Sales of merchandise are recorded in this account at selling prices. This is a temporary or nominal account representing income from selling of merchandise. This account has a normal credit balance

Sales Returns and Allowances This account is debited for all the merchandise returned by customers. The debit entry is at the original selling price of the merchandise. This account is also being used for all goods delivered to customers but is found to be defective or not as ordered and still the buyer desiring to retain the goods as is. The customer in this case is normally permitted to deduct a certain amount from the selling prices of the goods delivered.

Sales Discount This account is debited in the book of the seller whenever the buyer avails of the cash discounts provided by the seller. This is a deduction from sales account.

Purchases This is a temporary account to which the cost of goods bought during the period is debited. This account usually has a debit balance at the end of the accounting period.

Purchase Returns and Allowances Goods bought and returned to supplier, or goods bought and received as defective, or not as ordered, when not returned to the supplier but is subjected to a certain reductions from their acquisition prices. These deductions and returns of purchased goods are credited to this account. Purchase returns and allowances account is a deduction from the Purchases account.

Merchandise Inventory At the end of every accounting period, a physical count of the unsold merchandise on hand is taken. The total amount of these goods on hand is debited to the Merchandise Inventory account.

Purchase Discount This account is credited in the books of the buyer whenever the purchaser avails of the cash discount given by the seller. This is a deduction from Purchases account.

Freight In or Transportation In If the buyer pays the expenses of transporting the goods from the place of the seller to his place of business, such expenses are debited to the Freight-in account.

Freight Out or Transportation Out If the seller pays the expenses of transporting the goods from his place to the place of the buyer, such expenses are debited to the Freight out account. This is reported as part of operating expenses under the selling expenses classification.

BUSINESS DOCUMENTS
Official Receipts These are issued every time the business receives cash. They show the date on which the cash is received, the party from whom the cash is received, the amount received, the particulars of the transaction, and the signature of the one who received the cash.

Sales Invoice After a sale has taken place, the seller fills in the business form called the invoice. The invoice shows the date of the sale, name and address of the seller, name and address of the buyer, terms of the sale, list of articles bought with the unit price and entire cost of each, total amount of the invoice, and method of shipment. Invoices are numbered and usually made out

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in triplicate or quadruplicate. The original is given to the buyer. When the buyer receives the goods, they are examined. Then the invoice is checked to determine whether there are any discrepancies in quantity or price and any errors in calculation. From the point of view of the seller, the invoice is a sales invoice; from that of the buyer, it is a purchase invoice. Credit Memorandum Whenever the buyer finds an error in an invoice, or when merchandise is damaged, he should notify the seller at once. If his claim is admitted as valid, the seller sends him a credit memorandum, which shows the amount by which his account is reduced. Credit memorandum is often shortened to credit memo.

Promissory Notes A promissory note is a written promise signed by one party, called the maker, to pay a certain specified sum to another, called the payee, at a certain future time. The amount to be paid on maturity date may or may not include interest. The amount due, not including interest, is called the face of the note. Promissory notes may be received by the business from its debtors, or the business may give it to its creditors. The following is a sample of a promissory note.

Bank deposit slips and checks For control and safekeeping of cash most businesses maintain checking or current accounts with the banks. They deposit their money in banks and payments from the deposit are then made by means of checks. The bank deposit slip is filled in every time the business deposits money in the bank. It shows the date when the deposit is made, for whose account the deposit is made, the amount of the deposit classified into currency and checks received from others, and the signature of the depositor.
An order to the bank signed by the person issuing it, to pay to bearer or order a certain sum of money. After the bank has paid the payee, the amount is deducted from the deposit account of the one who issued the check. Some cash registers are operated in such a way that a strip or slip of paper comes out as evidence that money was received. The slip shows the date and the amount of cash received. Some businesses, like the Meralco, Philippine Long Distance Telephone Co., MWSS, etc., send bills to their customers to notify them of the amounts they have to pay. Thus, there are advertising bills, light bills, water bills, telephone bills, and others.

Check

Cash register slips Miscellaneous bills

PROPRIETORS INVESTMENT AND WITHDRAWAL

Investment of merchandise Recording of the investment of the owner in the business will be treated in the same way the recording is done in a service business. The only difference would be if the owner invested an asset into the business in the form of merchandise. When merchandise is part of the owners initial investment, the said investment must be debited to the Merchandise Inventory account whether the company is using perpetual or periodic inventory system. But if the investment of merchandise was made during the normal operation of the business, i.e., as an additional investment, the said investment must be debited to Merchandise Inventory, if the company is using perpetual inventory system and Purchases if they are using the periodic inventory system.

Withdrawal of merchandise Any subsequent withdrawal made by the owner of any asset/s in the business (e.g., cash, supplies, etc.) in anticipation of future profits of the company (i.e., temporary withdrawal) will be debited to the drawing account. Withdrawals that are permanent in nature (i.e., the owner has no intention of returning the said amount into the business) will be debited directly to the capital account. If the company uses the periodic inventory system, withdrawals of the owner in the form of

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merchandise for personal use will be credited to the Purchases account at cost. This is done in order to maintain the original balance of the Merchandise Inventory account, which was computed by means of actual physical count at the end of the accounting period. On the other hand, the Merchandise Inventory account is credited if the firm uses the perpetual inventory system.

PURCHASE OF MERCHANDISE
Purchase Requisition Large companies rely on a more careful procedure. As a first step they may insist that the person or department needing the goods or services to be purchased fill out a form called a purchase requisition. This completed form, bearing the signature of some responsible person authorized to approve such requisitions, is next sent to the purchasing agent or purchasing department of the company.

Purchase Order The purchasing department, after selecting the firm from whom the goods or services are to be bought, prepares a second business paper called a purchase order. The original copy of this document is sent to the company from which the purchase is to be made. This copy gives the selling business authority to send the purchaser the goods or services ordered.

Purchase Invoice About the same time that shipment of the goods is made or services are supplied to the purchaser, the purchaser is sent an invoice that is the third business paper. This purchase invoice becomes the basis for recording the purchase in the journal just as it is in the case of the informal procedure described for small firms.

Purchases The cycle of a merchandising entity begins with cash, which is used to purchase inventory. Purchases, in the accounting sense, are only those items of merchandise inventory that a firm buys to resell to customers in the normal course of business. For example, a bookstore records in the purchases account the price it pays for books, school and office supplies, and other items of inventory acquired for resale. A grocery store debits purchases when it buys canned goods, meat, frozen food and other inventory.

PURCHASE RETURNS AND ALLOWANCES

Debit Memorandum When merchandise bought is returned, or an allowance is requested, the buyer informs the seller in writing. The communication is done usually through the buyers printed business form called debit memorandum.

Credit Memorandum If the return is accepted or the allowance is granted by the seller, the seller usually sends to the buyer such acceptance or grant in writing through a printed form called credit memorandum. A credit memorandum may in similar form as the debit memorandum above except for the change of the word debit to credit. Upon receipt of this communication, the buyer makes an entry for the returns or allowances

DISCOUNTS ON PURCHASES
Cash Discounts

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Special deductions from the prices of goods bought granted by the seller to the buyer to induce the latter to pay within a specified period. Example: Jan. 5, 20X1 Labrador Store bought merchandise from De Asis Trading P8,750. Terms: 2/10, n/30

The terms of the above transaction mean that if the invoice is paid within 10 days after the date of the invoice (Jan. 6 to 15), Labrador Store may pay the invoice amount less a discount of 2%. This is computed as follows: Amount of invoice Less: 2% thereof Amount to be paid 175 P8,575 ====== If payment is not made within 10 days, then Labrador Store should pay the full amount of the invoice, P8,750, within 30 days from the date of the invoice. If the invoice remains unpaid after 30 days, it is said to be past due and, usually, the amount begins to earn interest from the 31st day. Other examples of terms attached to a credit invoice are: 5/10, n/30 - There is a 5% discount if paid 10 days after invoice date, net amount if paid beyond the 10 days but within 30 days. P8,750

2/10, 1/15, n/30 - There is a 2% discount if paid 10 days after invoice date, 1% discount if paid within fifteen days, net amount if paid beyond 15 days but within 30 days. 2/5EOM, n/45 - There is a 2% discount if paid 5 days after end of the month, net amount if paid beyond 5 days after end of month but within 45 days from the invoice date. 2/10, n/EOM - There is a 2% discount if paid 10 days after invoice date, net amount if paid beyond the 10 days but up to end of the month only. - No cash discount is offered. The full amount must be paid within 60 days from invoice date.

n/60

Cash discounts are computed on the amount of the bill less returns and allowance, if any. The base amount should be that which pertains only to merchandise. Discounts are ordinarily not allowed on incidental expenses such as freight, insurance while in transit, taxes, duties, and other charges. Recording of Cash Discounts Below are sample transactions involving the recording of cash discounts:

Jan.

4 - Mary Store purchased merchandise from Uniwide Trading, P10,000. Terms: 2/10, n/30 7 - Mary Store made a partial payment of P5,000 to Uniwide Trading 14 - Mary Store paid in full its account to Uniwide Trading 18 - Mary Store purchased merchandise from SM Superstore worth P25,000. Terms: P10,000 down payment, balance 21 2/10, 1/15, n/30. Mary Store returned to SM Superstore P500 cost of merchandise acquired on Jan. 18. SM Superstore in return issued a credit memo with the same amount-signifying acceptance of the return made by Mary.

8 31 - Mary Store settled in full its account with SM.

Trade Discounts
Deductions from the list prices of merchandise offered by the seller to the buyer to encourage the latter to buy in bulk or large volume/quantity. This is a strategy being adopted by the seller to promote the sale of the merchandise. A list price may be subjected to one or more trade discounts Summary The purchase invoice is the business document generated by a purchase transaction. Most merchandising entities offer discounts (i.e. cash and trade discounts) to their customers. Trade discounts are not recorded in the books of both buyer and seller. While cash discounts are recorded in the buyers book under the account title Purchase Discount. The Purchase Discount account, which has a credit balance, is a contra account to Purchases. Most businesses allow their customers to return merchandise that is defective, damaged in shipment, or otherwise unsuitable. Or if buyer chooses to keep damaged goods, the seller may deduct an allowance from the amount the buyer owes. Similar to purchase discount, Purchase Returns and Allowances, the account title used to record returns and allowance granted, is also a contra purchases account.

SALES
Overview
The sale of merchandise may be for cash or on account. An invoice supports every sale. The sellers sales invoice is the buyers purchase invoice. When a sale is for cash, the seller receives money in return for his merchandise. When the sale is made on credit, the seller acquires a receivable or right to collect from the buyer. The preceding discussion on methods of recording merchandise inventory transactions stated that under the periodic inventory method, purchases represent the cost of merchandise bought. Sales, on the other hand, represent the selling price of merchandise previously bought and then sold. In the income statement (See sample on page 36 of F), Sales is shown as an income item from which the cost of goods sold (consisting of merchandise inventory beginning and end and net cost of purchases), was deducted, the difference being the gross profit. Therefore, sales represents income, which covers both the cost of merchandise, sold and gross profit (or gross loss). In the following discussions, it was assumed that merchandise is sold normally at a profit, i.e., the selling price of the merchandise sold is greater than its cost. It is very important to note that a purchase and sales transaction involve two parties; namely, the buyer and the seller. Furthermore, a business acts sometimes as a buyer and sometimes a seller. The analysis of a purchase and sale transaction would depend on whether the business for which the accounting work is being done, is playing the role of a buyer or that of a seller. The treatment therefore, for cash discount and returns and allowances on this part will also be similar to that discussed under purchases, only this time the account titles to be used would be Sales discount and Sales returns and allowances.

Cash Sales
Retailers like drug stores, sari-sari stores, department stores and restaurants will at times sell their merchandise on cash basis.

Sales on Account
Most business establishments are now extending credit to their customers to become competitive. In the advent of what we call plastic money, i.e., credit cards, selling on account has been the current trend whether you are a manufacturing business, wholesaler or retailer.