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Accounting for a Merchandising Business

Income Statement:
Sales
Less: Cost of Sales
Gross Profit
Less: Expenses
Net Income (Loss)

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Gross Profit -- difference between sales and cost of sales (cost of goods sold), and is reported as
an intermediate amount in the income statement
Sales -- a revenue account used strictly for sales of merchandise; in the income statement, sales
has to be presented at net, to compute for net sales:
Sales
Less: Sales Returns and Allowances
Sales Discounts

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Net Sales

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Sales are recorded at invoice price , meaning list price less any trade discounts
Occasionally, a customer returns merchandise. When that occurs, the account Sales Returns and
Allowances is debited for the amount of merchandise returned:
If the merchandise that was returned was previously purchased on account, the entry would be:
Sales Returns and Allowances
Accounts Receivable

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If the merchandise that was returned was previously purchased for cash, the entry would be:
Sales Returns and Allowances
Cash

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When merchandise is sold on account, the seller would like to be paid promptly after billing, and may
encourage prompt payment by offering cash discount (also known as sales discount on the seller's part).
To receive the cash discount, the buyer must pay the invoice promptly.
The amount of time one has available to pay is expressed in a unique manner, such as
2/10, n/30 these terms mean that "a 2% discount is available if the invoice is paid within 10 days,
otherwise, the net amount is expected to be paid within 30 days"
If the customer pays the invoice in time to receive the the discount, the entry would be:
Cash (A/R less the cash discount)
Sales Discounts
Accounts Receivable

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If the customer pays too late to get the discount, the payment received should be for the full invoice amount ,
and would be recorded as follows:
Cash

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Accounts Receivable

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Cost of Sales
pertains to the cost of goods sold , and is computed as follows:
Merchandise Inventory, beginning
Add: Net Purchases
Cost of Goods Available for Sale
Less: Merchandise Inventory, ending
Cost of Sales

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Purchases should be stated at net , computed as follows:


Purchases
Add: Freight In (Transportation In)
Total
Less: Purchase Returns and Allowances
Purchase Discounts
Net Purchases

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----> prior period's ending inventory


----> extracted from the ledger
----> from physical count

Purchases
The first phase of the merchandising cycle occurs when the entity acquires goods to be stocked for
resale to customers. The appropriate accounting for this action requires the recording of the purchase.
When a purchase occurs and a periodic inventory system is in use, the entry would be:
Purchases
Accounts Payable

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The Purchases account is unique to the periodic system. The purchases account is not an expense or
an asset, per se.
The balance of the Purchases account represents total inventory purchased during the period, and this
amount shall be ultimately apportioned between cost of goods sold in the income statement, and
inventory on the balance sheet.
When a merchandise is returned to a supplier, the entry would be:
Accounts Payable
Purchase Returns and Allowances

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Gross Method of Recording Purchases/ Discounts


this technique records purchases at their total gross or full invoice
amount: Purchases
Accounts Payable

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If payment is made within the discount period, the entry would be:
Accounts Payable
Purchase Discounts
Cash (A/P less cash discount)

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If payment is made outside the discount period, the entry would be:
Accounts Payable
Cash

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Net Method of Recording Purchases/ Discounts Lost


the initial purchase is recorded for the net amount of the purchase (invoice amount less the available discount):
Purchases (at net amount)
Accounts Payable (at net amount)

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If payment is made within the discount period, the entry would be:
Accounts Payable
Cash

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If payment is made outside the discount period, the lost discounts are recorded on a separate account:
Accounts Payable (at net amount)
Purchase Discounts Lost (amount of the cash discount)
Cash (A/P plus the discount lost)

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Freight Charges (see related discussion on the other hand-out)


If goods are sold FOB Destination, the seller is responsible for costs incurred in moving the goods to their
destination. Freight cost incurred by the seller is called freigh-out , and is reported as a selling expense that is
subtracted from gross profit in calculating net income.
Seller's entry:
Accounts Receivable
Freight-out
Cash (the payment for the freight)
Sales

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Buyer's entry:
Purchases
Accounts Payable

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If goods are sold FOB Shipping Point, the purchaser/ buyer is responsible for paying freight costs incurred
in transporting the merchandise from the point of shipment to its destination. Freight cost incurred by a purchaser
is called freight-in , and is added to purchases in calculating net purchases.
Seller's entry:
Accounts Receivable
Sales

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