MODULE – PROCESSING TRANSACTIONS FOR A MERCHANDISER (CON’T)

GROSS PURCHASES

Under the periodic inventory system, a merchandiser uses the title Purchases whenever
merchandise is bought for resale. It represents an owner’s equity account for goods available for sale
by the business for a particular accounting period. To illustrate, recall that Jim Perez. the proprietor of
Jim Perez Furnisher, bought P4,000 worth of furniture from Royal Furniture on account. From the
buyer’s viewpoint the invoice received from Royal Furniture is called a purchase invoice. The entry in the
books of Jim Perez Furnisher will appear thus:

Date Accounts & Explanation F Debit Credi

t
March Purchases 4,00
10 0
Accounts Payable 4,000
Account purchases on terms of
2/10/n30

FREIGHT IN

In buying merchandise, the cost of transporting the goods may be paid by the buyer or by the
seller depending on the term of shipment. If the term of shipment is FOB Shipping Point, it means that
title of ownership passes to the buyer as soon as seller turns over the goods to a common carrier such
as a cargo ship for delivery of the goods to the buyer.

It also means that the buyer, as owner of the goods, should pay for the freight. The buyer debits
Transportation In or Freight In. This is added to Purchases to arrive at Gross Purchases. To illustrate,
assume that on August 5 Royal Furniture bought from Cebu Furniture Shop goods worth P50,000 to be
transported by boat at a cost of P1,000 under the terms 2/10, n/30., FOB Shipping Point. Freight Collect.
The goods were received August 5 and the freight paid accordingly.

Date Accounts & Explanation F Debit Credit

Aug Purchases 50,00
5 0
Accounts Payable 50,00
0
Purchases on terms 2/10, n/30

5 Freight In 1,000
Cash on Hand 1,000
Freight on terms of FOB Shipping Point Freight
Collect
 Suppose the term is FOB Shipping Point Freight Prepaid? It means that the buyer should pay for
the freight which was advanced by the seller.

Entry in the buyer’s book:

Date Accounts & Explanation F Debit Credit

Aug Purchases 50,00
5 0
Freight In 1,000
Accounts Payable 51,00
0
Purchases on terms of 2/10,n/30 FOB Shipping Point Freight
paid

Entry in the seller’s book:

Date Accounts & Explanation F Debit Credit

Aug Accounts Receivable 50,00
5 0
Sales 50,00
0
To record sales on terms of 2/10, n/30, FOB shipping point, freight
prepaid
5 Accounts Receivable 1,000
Cash 1,000
Charged buyer for freight prepaid

Note that the accounts receivable increased because the freight is collectible by the seller from the
buyer who is liable under the term FOB Shipping Point. Also note that although freight increased
accounts receivable, it did not increase sales revenue.

FREIGHT OUT

Is freight always an obligation of the buyer? No. If the term is FOB Destination which means free
on board at destination, the seller is liable for the freight and is still considered owner of the goods until
it reaches the buyer.

This time the freight should be debited by the seller to the account Freight Out or
Transportation Out which is a selling expense. If the term is FOB Destination freight prepaid , seller’s
entry will be:

Date Account & Explanation F Debit Credit

Aug Accounts Receivable 50,00
5 0
Sales 50,00
0
Term : 2/10, n/30 FOB
Destination
5 Freight Out 1,000
Cash 1,000
Paid freight for goods sold

Upon receipt of the goods the buyer makes an entry only for the cost of the goods bought

Date Particulars F Debit Credit

Aug Purchases ( or Merchandise 50,00
5 Inventory) 0
Accounts Payable 50,00
0

PURCHASE RETURNS AND ALLOWANCES

Goods may be returned to the seller for being defective or not as ordered. Instead of returning
buyer may just ask that the price be reduced. This will decrease the cost of the purchases and decrease
the liability to be paid. To decrease purchases, a contra account called Purchase Returns and
Allowances is credited with a corresponding debit to accounts payable if purchased on credit. This can
be directly credited to the purchase account but maintaining a separate account enables management
to control operations more effectively. Excessive returns because of defects on goods purchased may
mean, for example, that management should look for other suppliers. Using the preceding illustration
assume that when the P50, 000 goods bought on account were received, P5, 000 were found defective
and were returned. The journal entries of the buyer will be:

Date Accounts & Explanation F Debit Credit

Aug Purchases 50,00
5 0
Accounts Payable 50,00
0
Purchases made on terms of 2/10, n/30
7 Accounts Payable 5,000
Purchase Returns and 5,000
Allowances
Returned defective chairs.
 Recall that a credit memo will be received by the buyer from the seller as an acknowledgement
of the return made by the buyer.

*Using the perpetual method, merchandise inventory is debited instead of purchases and
merchandise inventory is credited instead of purchase returns and allowances.

If the purchase was on cash basis, then a return or an allowance would require a cash refund in
which case cash will be debited by the buyer with a corresponding credit to purchase returns and
allowances.

PURCHASE DISCOUNTS

Recall that a trade discount given to the buyer is immediately deducted from the list price and
only the balance appears in the invoice. On the other hand, a cash discount is offered when one buys on
account and is granted only when the account is paid within the discount period. A discount is recorded
by debiting to decrease the liability and crediting the contra purchase account called Purchase Discount
to decrease the value of the merchandise purchased.

Illustration 1: Assume that on May 1 Alonzo Shoes of Cebu bought goods from Marikina Shoe Factory for
P20,000. A 2% trade discount was granted and the term of the purchase was 2/15, n/30. FOB Shipping
Point, Freight Collect P1,000. Alonzo paid for the freight upon receipt of the shipment and paid for the
account on May 15. Entries will appear thus:

Date Accounts & Explanation F Debit Credit

May Purchases 19,60
1 0
Accounts Payable 19,60
0
Purchases on terms of 2/15, n/30

1 Freight In 1,000
Cash In Bank 1,000
Paid on terms of FOB Shipping Point Freight
Collect

15 Accounts Payable 19,60

0
Purchase Discount 392
Cash In Bank 19208
Issued a check for account

Take note of the purchases and the accounts payable recorded at the gross invoice price net of
trade discount on May 1. On May 15, which is 14 days after purchase but still within the 15 day discount
period, a cash discount of 2% of P19,600 was given. Using perpetual method, substitute the title
Merchandise Inventory for Purchase, Freight In and Purchase Discount accounts.
If the term is FOB Shipping Point, Freight Prepaid, the entries will appear thus:
Date Accounts & Explanation F Debit Credit
May 1 Purchases 19,60
0
Freight In 1,000
Accounts Payable 20,60
0
Goods bought on term of 2/15, n/30 FOB Shipping Point, Freight
Prepaid by Marikina

15 Accounts Payable 20,60

0
Purchase Discount 392
Cash In Bank 20,20
8
Pad in full of account net of discount

The supporting computation is as follows:

List Price P20,000
Less 2% trade discount 400
Invoice Price 19,600
Freight Prepaid 1,000
Gross Invoice Price 20,600
Less Cash Discount of
2% of P19,600 392
Net Invoice Price to be paid
Within the discount period P20,208

Take note that a cash discount is computed based only on the value of the purchases excluding freight,
returns and other incidental expenses such as insurance and taxes.

Illustration 3. Using illustration 1, but that Alonzo paid P10,000 and returned P2,000 as defective on May
10 and paid the remaining balance on May 15. Entries will be as follows:

Date Accounts & Explanation F Debit Credit

May Purchases 19,60
1 0
Freight In 1,000
Accounts Payable 20,60
0
Goods bought on term of 2/15, n/30 FOB Shipping
Point

10 Accounts Payable 10,00

0
Cash In Bank 10,00
0
Partial payment of account and freight

10 Accounts Payable 2,000

Purchase Returns and Allowances 2,000
Returned defective goods

15 Accounts Payable 8,600

Purchase Discount 352
Cash In Bank 8,248
Full payment of account to Marikina

The creditor’s ledger card and postings in the books of Alonzo Shoes will appear thus:

Supplier : Marikina Shoe Factory

Address : Marikina, Metro Manila

Date Explanation F Debit Credit Balanc

e
May Purchase Invoice #9, 2/15, 20,60 20,600
1 n/30 0
10 Partial Payment 10,00 10,600
0
Credit Memo 2,000 8,600
15 Full payment 8,600 0
*Note that the discount of P352 is computed based on the total amount of purchases of P17,600
(excluding freight and purchases returns) x 2%

Gross Invoice Price P20,600

Freight (1,000 )
Returns (2,000 )
Amount subject to discount P17,600

If it is the company’s policy to grant discounts on partial payments, entries on May 10 and May 15
payments will change as follows:

Date Accounts & F Debit Credi

Explanation t
May Accounts Payable 10,00
10 0
Purchase Discount 180
Cash In Bank 9,820

15 Accounts Payable 8,600

Purchase Discount 172
Cash In Bank 8,428

Note that on May 10 the discount was based on P9,000 excluding freight of P1,000. Again, let us review
all the rules for cash discounts:

1. It is given only when sales or purchase is on credit term.

2. Freight, returns and allowances should be deducted before computing for the discount.
3. Companies may take up discounts differently on their policies for partial payments.

NET COST OF PURCHASES

From Gross Purchases, Freight In is added to arrive at Total Cost of Delivered Goods. From Total
Cost of Delivered Goods, purchase returns and allowances and purchase discounts are deducted to
arrive at Net Cost of Purchases. The calculation for this based on the Alonzo problem will appear as
follows:

Purchase 19,600
Add Freight In 1,000
Total cost of goods delivered 20,600
Less: Purchase Returns & Allowances 2,000
 Purchase Discount 352 2,352
Net Cost of Purchases 18,248