Chapter 8 NATURE AND ACCOUNTING FOR MERCHANDISING BUSINESS

Unlike service concern where the business generates income from rendering of services to
customers or clients, in merchandising business, it generates revenue from sale of goods or
commodities that it buys.

Learning Objectives: After studying this chapter, the student will be able to:

1. Understand the purchasing and selling activities as well as their respective entries with
recognition to value-added tax;

2. Differentiate between periodic and perpetual inventory system;

3. Calculate Cost of Goods Sold, Net Sales, and and Gross Profit. The revenue generating activities of a
merchandising business involve the buying and selling of merchandise (items bought for resale in its
original form such as goods, groceries, books, appliances, drugs, clothing, etc.).

When the merchandise is sold, the revenue is reported as Sales and its cost is recognized as
expense called Cost of Goods Sold, which is subtracted from sales to arrive at the Gross Profit. Other
expenses are then deducted to arrive at the net profit. Unsold merchandise at the end of a given period
is called Merchandise Inventory.

Sales – Cost of Goods Sold = Gross Profit – Operating Expenses = Net Profit

Accounting for Purchases of Merchandise There are two methods of accounting or recording for
merchandise purchases:

1. Periodic Inventory Method – Under this method every time a purchase of merchandise is
made, it is charged or recorded (debited) to an account called PURCHASES. When a sale is made. A
revenue account called SALES is recorded (Credited) At the end of a given period, an inventory ( physical
count of the goods unsold - called MERCHANDISE INVENTORY- END) is made to determine the cost of
goods sold. This ending inventory will then be carried forward to the next period and will become the
MERCHANDISE INVENTORY-BEGINNING. This method of accounting is used by a merchandising concern.

2. Perpetual Inventory Method – Under this method, an account called MERCHANDISE

INVENTORY (instead of Purchases) is used to record acquisition of merchandise. When a sale is made,
two entries will be made; the first is to record the revenue account called sales and the second is to
record the cost by charging or debiting to an account called COST OF GOODS SOLD. In this manner,
the merchandise inventory account will have a running balance and there is no need to make a physical
count. If ever a physical count or an inventory will be made, it is only for the purpose of checking the
accuracy of recording but not for the purpose of determining the ending balance of the merchandise
inventory. This method is normally used by a manufacturing concern. In normal business practices,
before purchases are made by the purchasing department, it will require an approved Purchase
Requisition before it is authorized to issue a Purchase Order for the requested merchandise.
Nature and Accounting for Merchandising Business

Purchase Requisition Form – is a written request form to buy a certain item or items. Purchase
requisition forms are generally pre-numbered consecutively to prevent misuse or loss.

Purchase Order Form – is a buyer’s formal order form indicating therein the merchandise requested in
the purchase requisition form. The pre-numbered purchase order and requisition forms will support the
purchase evidenced by an Invoice.

Purchase Discount – is a discount given to the buyer for early payment of a purchase made on credit.

Discount Period – is the period of time within which an invoice must be paid to be entitled to a discount.

Trade Discount - is a special discount (outright deduction) from the list price offered by a seller to
buyers if the order is in large quantity.

Terms of Purchases

Cash or COD (Cash on Delivery) – this means that payment is required at the time the merchandise is
delivered.

2/10, n/30 – this means that a 2% discount of the gross invoice price is allowed if payment is made
within 10 days after the invoice date, and the gross price is due 30 days from the invoice date.

2/EOM, n/60 – this means that a 2% discount of the gross invoice price is allowed if payment is made up
to the end of the month and the gross price is due 60 days from the invoice date.
2/10/EOM, n/60 – this means that a 2% discount of the gross invoice price is allowed if payment is
made by the 10th of the following month, and the gross price is due 60 days from the invoice date.

Credit Term – is the term when payment for the merchandise is to be made as agreed upon by the seller
and the buyer.

Credit Period – is the time in which the buyer is allowed to pay.

Transportation Costs

Freight In – this represents the transportation costs and other costs incidental to the purchase of the
merchandise.

FOB Shipping Point – this means Free on Board up to the shipping point. Freight charges will be
shouldered by the seller up to the shipping point before loading to a common carrier. Once the goods
are loaded, the buyer will pay for the freight charges.

FOB Destination – this means Free on Board up to the point of destination. The seller will pay for the
freight charges up to the buyer’s destination.

Freight Collect – this means that the buyer is to pay the freight when the merchandise arrives. If the
term is FOB destination, the buyer can deduct the cost of the freight when paying the invoice.

Nature and Accounting for Merchandising Business

Payment June 17 – Accounts Payable 11, Cash 11,

Example 4: June 2 – Purchased merchandise with a price of P10,000 on account per Credit Invoice No.
1860. Terms: 2/10, n/30.
Entry: June 2 – Purchases 10, Vat Input Tax 1, Accounts Payable 11,

Payment June 12 – Accounts Payable 11, Cash 11, Purchase Discount 200

Note : Discount is computed based on the merchandise cost without VAT. If the invoice is paid after June
12, there will be no more cash discount.

Example 4a: If Term is: 2/EOM, n/60.

Payment June 30 – Accounts Payable 11, Cash 11, Purchase Discount 200

Note : If the invoice is paid after June 30, there will be no more cash discount.

Example 4b: If Terms is: 2/10 EOM, n/60.

Payment July 10 – Accounts Payable 11, Cash 11, Purchase Discount 200

Note: If the invoice is paid after July 10, there will be no more cash discount.

Example 5: June 4 – Purchased merchandise with a list price of P10,000 on account per Credit Invoice No
1865. Trade discount is 20% and 10%. Terms: 2/10, n/30.

Entry: June 4 – Purchases (10,000 x 80% x 90%) 7, Vat Input Tax (12% x 7,200) 864 Accounts Payable 8,

Payment June 14 – Accounts Payable 8, Cash 7, Purchase Discount (7,200 x 2%) 144
Note : If the invoice is paid after June 14, there will be no more cash discount.

Example 6: June 6 – Bought merchandise costing P10,000 on account per Credit Invoice No. 1870. FOB
Shipping Point, Freight Prepaid by the seller, P1,000. Terms: 2/10, n/30.

Entry: June 6 – Purchases 10,

Nature and Accounting for Merchandising Business

Freight In 1, Vat Input Tax 1, Accounts Payable 12,

Payment June 16 – Accounts Payable 12, Cash 12, Purchase Discount 200 Note : Freight or
transportation cost is not included in computing the discount. Example 7: June 6 – Bought merchandise
on account, P 10,000 Credit Invoice No. 1870. FOB Shipping Point, Freight Collect, P 1,000, Terms:
2/EOM, n/60.

Entry: June 6– Purchases 10, Vat Input Tax 1, Accounts Payable 1,

Freight In 1, Vat Input Tax (12% x P 1,000) 120 Cash 1,

Payment June 30 – Accounts Payable 11, Cash 11, Purchase Discount 200

Example 8: June 8 – Bought merchandise costing P10,000 on account per Credit InvoiceNo. FOB
Destination, Freight Prepaid, P1,000. Terms: 2/10, n/30.

Entry: June 8 – Purchases 10, Vat input Tax 1, Accounts Payable 11,
Payment June 18 – Accounts Payable 11, Cash 11, Purchase Discount 200

Example 9: June 8 – Bought merchandise costing P10,000 on account per Credit Invoice No. FOB
Destination, Freight Collect, P1,000. Terms: 2/10 EOM, n/30.

Entry: June 8 – Purchases 10, Vat Input Tax 1, Accounts Payable 10, Cash 1,

Payment July 10 – Accounts Payable 10, Cash 10, Purchase Discount 200

Note: The freight paid is deducted from accounts payable and the discount is computed based on the
invoice cost of the merchandise.

Nature and Accounting for Merchandising Business

Return June 4 – Accounts Payable 2, VAT Input Tax 240 Purchase Returns and Allowances 1,

Payment June 12 – Accounts Payable 8, Cash 8,

If paid after the discount period, the entry would be:

Payment June 30 – Accounts Payable 8, Purchase Discount Lost 160 Cash 8,

Accounting for Sales

The merchandise in stock will be sold and new items will be purchased to replace the items sold.
Merchandise sales are credited to the Sales account. Sales can be made on cash or credit basis under the
different terms similar to the terms of purchases discussed earlier. For every sale made, a 12% VAT
Output Tax is recorded. The difference between the VAT Output Tax and the VAT Input Tax (normally a
credit balance) represents the liability of the business to the government.

Sales Invoice - is a document that the seller gives to the buyer listing the items ordered as per the P.
(purchase order of the buyer), together with the quantity, price, description, value added tax, the terms,
and the total price of the items ordered.

Credit Memo – is a form used by the seller to notify the buyer that his account is credited (the amount is
reduced) for the return of defective merchandise or allowance for damaged merchandise.

Sales Discount – is a discount granted by the seller for early collection on a credit sale.

Sales Returns and Allowances – are reductions in sales, resulting from merchandise being returned by
the customer or from seller’s reduction in the original sales price.

Freight Out – this represents the cost of transporting the merchandise sold from the seller’s place to the
buyer’s place which is to be shouldered by the seller (business).

Recording Sales and Collection of Accounts:

Note: For simplicity, the amount P15,000 for the sale of merchandise (exclusive of the 12% Value-added
Tax ) is used for all the examples.

Example 1: June 2 – Sold merchandise worth P15,000 per Cash Sales Invoice No. 1001.

Entry: June 2 – Cash (112% x 15,000) 16, Sales 15, Vat Output Tax (12% x 15,000) 1,
Note: If the amount of the invoice is VAT inclusive, divide the amount by 1 than multiply by .12 to
determine the VAT Output Tax.

Nature and Accounting for Merchandising Business

If the sale were a non-vat transaction, the entry would be:

Entry: June 2 – Cash 15, Sales 15,

Example 2: June 3 – Sold merchandise worth P15,000 per Credit Invoice No. 101. Terms: n/15..

Entry: June 3 – Accounts Receivable 16, Sales 15, Vat Output Tax 1,

Collection June 18 – Cash 16, 800 Accounts Receivable 16,

Note: If the sale were a non-vat transaction, the entries would be:

Entry: June 3 – Accounts Receivable 15, Sales 15,

Collection June 18 – Cash 15, Accounts Receivable 15,

Example 3: June 4 – Sold merchandise worth P15,000 per Credit Invoice n. 102. Terms: 2/10, n/30.

Entry: June 4 – Accounts Receivable 16, Sales 15, Vat Output Tax 1,

Collection June 14 – Cash 16, Sales Discount (2% x 15,000) 300 Accounts Receivable 16,
Note: If the sale were a non-vat transaction, the entries would be:

Entry: June 4 – Accounts Receivable 15, Sales 15,

Collection June 14 – Cash 14, Sales Discount (2% x 15,000) 300 Accounts Receivable 15,

Example 4: June 5 – Sold merchandise worth P15,000 per Credit invoice No. 103. FOB Shipping Point,
Freight Collect, P1,000. Terms: 2/10, n/30.

Entry: June 5 – Accounts Receivable 16, Sales 15, Vat Output Tax 1,

Collection June 15 – Cash 16, Sales Discount 300 Accounts Receivable 16,

Nature and Accounting for Merchandising Business

Collection June 14 – Cash 13, Sales Discount 300 Accounts Receivable 14,

Example 7 June 8 – Sold merchandise worth P15,000 per Credit Invoice No. 106. FOB Destination Point,
Freight Prepaid, P1,000. Terms: 2/10, n/30. Merchandise was received on June 10.

Entry: June 10 – Accounts Receivable 16, Freight Out 1, Sales 15, Vat Output Tax 1, Cash 1,

Collection June 20 – Cash 16, Sales Discount 300 Accounts Receivable 16,

Note: If the sale were a non-vat transaction, the entries would be:
Entry: June 10 – Accounts Receivable 15, Freight Out 1, Sales 15, Cash 1,

Collection June 20 – Cash 14, Sales Discount 300 Accounts Receivable 15,

Example 8: June 9 – Sold merchandise worth P15,000 per Credit Invoice No. 107. Terms: 2/10, n/30.
June 10 – Received merchandise returns from the customer, P2,000 and issued credit memorandum No.
001. (Assume VAT Excluded)

Entry: June 9 – Accounts Receivable 16, Sales 15, Vat Output Tax 1,

Return June 10 – Sales Returns & Allowances 2, Vat Output Tax 240 Accounts Receivable 2,

Collection June 19 – Cash 14, Sales Discount 260 Accounts Receivable 14,

Note: If the sale were a non-vat transaction, the entries would be:

Entry: June 9 – Accounts Receivable 15, Sales 15,

Nature and Accounting for Merchandising Business

Return June 10 – Sales Returns & Allowances 2, Accounts Receivable 2,

Collection June 19 – Cash 12, Sales Discount 260 Accounts Receivable 13,

Chart of Accounts for a Merchandising Business:

The chart of accounts for a merchandising business should include the different account titles used in
the preceding examples to record the purchases and sales of merchandise.

Sales and Related Accounts:

Sales – this revenue account represents the merchandise sold to customers valued at selling price
whether for cash or on credit.

Sales Returns and Allowances – this represents the merchandise returned by customers or the price
adjustments allowed for damaged merchandise valued at selling price. This is to be subtracted from
sales.

Sales Discount – this represents the cash discounts granted by the seller to the customers for early
payments of their accounts.

Freight Out - This represents the cost of transporting the merchandise sold to the buyer’s place. This is
considered an expense of the seller.

Purchases and Related Accounts:

Purchases – this represents the cost of merchandise purchased from vendors or suppliers whether for
cash or on credit.

Purchase Returns & Allowances – this represents merchandise returned to vendors or suppliers or price
adjustments for damaged merchandise valued at purchase cost.

Purchase Discount – this represents cash discounts granted by the suppliers to the buyers for early
payments of their accounts.
Freight In – this represents the cost of transporting the merchandise purchased up to the buyer’s place.
This is added to the cost of the merchandise purchased by the buyer.

Merchandise Inventory – this represents the unsold merchandise valued at cost as of a given date.

Nature and Accounting for Merchandising Business

SOLUTION – Example Problem

Rich Appliance Store - December 31, Trial Balance

Cash P 255,430. Account Title Debit Credit

Accounts Receivable 275,600.

Notes Receivable 60,000.

Merchandise Inventory 1,578,650.

Office Supplies 6,250.

Prepaid Insurance 12,000.

Vat Input Tax 22,400.

Delivery Equipment 500,000.

Accumulated Depreciation P 50,000.

Store Equipment 150,000.

Accumulated Depreciation 15,000.

Office Equipment 50,000.

Accumulated Depreciation 10,000.

Accounts Payable 945,650.

Notes Payable 100,000.

Vat Output Tax 30,800.

Richie Rich, Capital 1,505,945.

Richie Rich, Drawing 60,000.

Sales 3,760,600.

Sales Returns & Allowances 37,500.

Sales Discounts 50,650.

Purchases 2,625,250.

Purchases Returns & Allowances 26,250.

Purchases Discounts 40,560.

Freight In 60,250.

Sales Salary Expense 215,675.

Advertising Expense 33,000.

Commission Expense 75,250.

Delivery Expense 112,500.

Misc. Selling Expense 12,450.

Office Salary Expense 125,900.

Rent Expense 110,000.

Insurance Expense 12,000.

Office Supplies Expense 16,800.

Tax Expense 10,250.

Misc. General Expense 6,200.

Interest Income 1,200.

Interest Expense 12,000.

Totals P 6,486,005 P 6,486,005.

Nature and Accounting for Merchandising Business

Operating Cycle of a Merchandising Business

A merchandising entity buys inventory, sells the inventory to its customers and uses the cash to
purchase more inventory to repeat the cycle.

a. Cash Purchases and Cash Sales b. Purchases and Sales on Account

Accounting Cycle for a Merchandising Business – The accounting cycle for a merchandising business is
the same as that of a service business as follows:

Collection of raw data from the source documents (such as invoices, vouchers, bills, official receipts,
credit memoranda, etc.) according to dates.

Analysis of the transaction to determine the effect on the accounting values or elements. 3**.**
Journalization – the process of recording the transactions in the book of original entry (journal).

Posting – the process of recording in the book of final entry (ledger).

Preparation of the preliminary trial balance.

Journalizing and posting the adjustments.

Preparation of the worksheet (optional).

Preparation of the classified financial statements.

Journalizing and posting the closing entries.

Preparation of the post-closing trial balance.

Ruling the ledger.

Journalizing and posting the opening entry.

Journalizing and posting the reversing entries required.

Nature and Accounting for Merchandising Business

Multiple Choice

Instruction: For each item, choose the letter that corresponds to your answer. Encircle the

letter that corresponds to your answer.

This business derived its incomes from rendering of services to its clients or customers. a. Merchandise
company b. Service concern c. Sole proprietorship d. Hybrid company

It generates income from buying and selling of merchandise. a. Partnership business b. Merchandising
business c. Periodic d. None of these

A method of inventory keeping where it is characterized by the use of stock cards. a. Perpetual b. Casual
c. Periodic d. None of these

Aside from selling activity, what other activity can a merchandising business perform? a. Manufacturing
activity b. Purchasing activity c. Buy and sell d. None of these

Purchase discounts and sales discounts are termed both for— a. Trade discounts b. Cash discounts c.
Discount term d. None of these

Which of the following is “cost”? a. Merchandise inventory, end b. Freight out c. Freight-in d. Shipping
term

Which of the following is an adjunct account? a. Freight-in b. Freight out c. Merchandise inventory d.
Shipping term

When we buy goods, purchase price includes the tax which is passed on or shifted to us by the seller a.
Percentage tax b. Sales tax c. Input tax d. Output tax

Which of the following is an expense accounts? a. Freight out b. Prepaid expense c. Fright-in d. Accrued
expense

Nature and Accounting for Merchandising Business

Where do we present Input Tax in the financial statements? a. Balance sheet b. Income statement c.
Statement of Changes in owner’s Equity d. Statement of Cash Flows
The merchandise left on hand and unsold at the end of the period a. Merchandise inventory b.
Purchases c. Sales d. Gross profit

A physical inventory count is usually conducted a. At the end of the year b. At the beginning of the year
c. At the middle of the year d. None of the above

A merchandising business who has started its operation, must likely does not have a. License to operate
b. Merchandise inventory, beg c. Books of accounts d. Purchase

The cost of merchandise that are sold is referred to a. Cost of sales b. Merchandise inventory, beg c.
Merchandise inventory, end d. None of the above

Which of the following is a component of Cost of sales? a. Purchase discounts b. Merchandise inventory
c. Purchases d. All of the above

Which of the following is not a component of Cost of sales? a. Freight out b. Purchase discounts c.
Merchandise inventory, end d. Freight-in

Which of the following is an expense account? a. Freight out b. Trade discounts c. Purchase discounts d.
Sales discount

The usual term for merchandise that is already shipped out by the seller but has not yet reach the buyer
a. Merchandise inventory b. Purchased c. Merchandise in transit d. F.O. shipping point

The shipping term wherein the buyer shoulders the freight on shipment of merchandise a. FOB shipping
point b. FOB destination c. COD, freight collect d. COD, freight prepaid

The company made purchases of P30,000 and sales of P45,000 with P5,000 left in inventory. If the
company has no beginning inventory, how much is cost of sales?

Nature and Accounting for Merchandising Business

8 The following sales were reported by LINCOLN Traders during 200B:

Invoice Date Date collected Terms List Price Jan. 6 a. Jan. 6 20%TD, COD P 120, Feb b. Feb. 2 5% TD, n/30
P 150, Feb c. March 1 10%, 5%,TD, n/EOM P 300, Mar. 31 d. April 12 2/10. n/30 P 200, April 22 e. May 3
2/10, 1/15,n/40 P 350, May 18 f. June 12 2/EOM, n/60 P 125, July 2 g. July 4 2/10 EOM P 140, Aug. 9 h.
Aug. 7 10% TD, 2/10, n/30 P 160, Aug i. Sept. 1 3/10,2/15,n/40 P 180,

Required: Record the Sale & Collection in the general journal.

8 The following selected transactions of ERASERHEADS Traders were completed during March:

March 2 - Bought merchandise from Orange Company P 18,000 terms 10% trade discount, COD
exclusive of freight of P 1,200 which was also paid. 3 - Returned defective merchandise to Orange
Company P 1,500 and was given a cash refund. 6 - Purchased merchandise from Apple Traders, P 10,000
terms 2/10, n/ and paid freight of P 500. 7 - A credit memo was received from AppleTraders for
defective merchandise returned,P 2,000. 9 - Made a partial payment to Apple Traders, P 5,000. 16 - Paid
the account of Apple Traders in full.

Required: Journalize the above transactions.

8 The following selected transactions of Gray Trading were recorded for the month of August:

August 3 - Cash sales, P 50,000 with trade discount of 8%-5%. Freight paid P 4,000. 6 - Gave a cash
refund for defective merchandise returned, P 2,000. 7 - Sold merchandise to Twinkle valued at P 35,000
terms, 2/10, 1/15, n/45. 8 - Defective merchandise returned by Twinkle, P 5,000 for which a credit
memo was given to her. 11 - Twinkle made a partial payment of P 10,000. 22 - Collected the account of
Twinkle in full.

Required: Journalize the above transactions.

Nature and Accounting for Merchandising Business

8 The following selected transactions were completed by Sammy Trading during July of the current year.
Assume a 12% VAT.

July 01 Purchased merchandise from Manila Sales Company, P40,000, terms: 2/10, n/eom, FOB shipping
point, freight prepaid, P1,250. 10 Paid Manila Sales Company the invoice of July 1 less discount. 13
Purchased merchandise from Davao Wholesalers Co. P25,000, terms: 1/10, n/30, FOB destination. 15
Returned defective merchandise to Davao Wholesalers P7,500. 17 Bought merchandise from Bacolod
Trading Co. P57,500, terms: n/eom, FOB shipping point. 18 Paid freight charges on merchandise
purchased from Bacolod Trading, P1, 19 Purchased merchandise from Mercury Sales Co. P37,500, terms:
2/10, n/30, FOB destination. 23 Paid Davao Wholesalers Co. in full. 29 Paid Mercury Sales Co. in full. 30
Paid Bacolod Trading Co. in full.

Note: In the above transactions, VAT is not yet included.

Required: Journal entries to record the above transactions.

8 The following selected transactions were completed by Assuming Sales Company during August of the
current year: Assume a 12% VAT is already included in the applicable transactions. Aug 2 Sold
merchandise on account to Peter Pan, P3,360, terms: 2/10, n/eom, FOB shipping point. 3 Sold
merchandise for cash to various customers, P9,800. 5 Sold merchandise on credit to Robin Hood,
P7,280, terms: 2/10, n/30, FOB shipping point, freight prepaid, P672. 11 Collected from Peter the sales
invoice of August 2 less discount. 11 Sold merchandise to Alice’s Store, P11,760, terms: 1/10, n/30, FOB
destination. 14 Paid transportation costs on shipment to Alice’s Store, P448. 12 Collected from Robin
Hood the invoice of August 5 less discount. 17 Received defective merchandise sold to Alice’s Store,
P1,120. 22 Sold merchandise to Thirdee Medroso, P5,376, terms 2/10, n/30, FOB shipping point, freight
prepaid, P224. 23 Received check of P5,000 from Alice’s Store as partial payment of account. 24
Received check from Alice’s Store in full payment of account. 30 Received check from Thirdee Medroso
in full payment of account.

Required: Journal entries to record the above transactions.