Session 6

Merchandising 1
Merchandising Operations
• Comparison of Income Statements
• Operating Cycle of a Merchandising Business
• Purchase Transaction
– Terms of Transactions
• Inventory Systems
• Sales Transactions
– Net Sales/Gross Sales
– Cost of Goods Sold
• Net Purchases
• Operating Cost
 Comparison of Income
Statement
• Net sales arise from the sale of goods
• Cost of goods sold represents the cost of
inventory, the entity has sold to customers
• Gross margin from sales (gross profit)
– Difference between net sales and cost of goods sold
• Operating expenses – other that cost of goods
sold, which are incurred to generate sales
 Operating Cycle of a
Merchandising Business
• Purchases inventory, sells the inventory
and uses the cash to purchase more
inventory
• The faster the sale of inventory and the
collection of cash, the higher the profits
 Source Documents
• Sales invoice
• Bill of landing
• Statement of account
• Official receipt
• Deposit slip
• Check
• Purchase requisition
• Purchase order
• Receiving report
• Credit memorandum
 Steps in purchase transaction
1. Fills a purchase requisition form and sends to
purchasing department
2. Purchasing department prepares a purchase order
after checking descriptions
3. Seller forwards an invoice to the purchaser upon
shipment of the merchandise
4. The purchaser’s receiving department sees to it that
the terms in the purchase order are complied with and
prepares a receiving report
5. Before approval of invoice payment, the AP
department compares copies to the previous
documents
 Terms of Transactions
• Merchandise may be purchased and sold either
on credit terms or for cash on delivery
• When goods are sold on account, a period of
time called credit period is allowed for payment
• If the credit period is 30 days, then payment is
expected within 30 days from the invoice date
• Described as the net credit period on net tems
– 30 days is noted as “n/30”
– 10 days after the end of the month “n/10 eom”
 Cash Discounts
• For prompt payment (called cash discount)
• This practice improves the seller’s cash position
by reducing the amount of money is accounts
receivable
• Designed by such notation as “2/10”
– The buyer may avail of two percent discount if the
invoice is paid within ten days from the invoice date
– 10 days (discount period) covered by the discount
• Cash discounts are called purchase discount
from the buyer’s view point and sales discount
from the seller’s point of view.
 example

Cash Discount of 2% on P150,000 3,000

Interest for 20 days at an annual rate of
18% on the amount due within the
discount period:
P147,000 * 18% * 20/360
Savings effected by barrowing 1,470
Amount due = 150,000 invoice price – 1,530
3,000 cash discounts
 Trade Discount
• Encourage the buyers to purchase products
because of markdown from the list price
• Enables the suppliers to vary prices periodically
without the inconvenience of revising price lists
and catalogs
• There is no trade discount account, instead, all
accounting entries are based on the invoice
price which is obtained by subtracting the trade
discount from the list price
 Transportation Cost
• Freight bill designates which party
shoulders the costs, and whether the
shipment is freight prepaid or freight
collect
• FOB (free on board)
– Shipping point: the buyer shoulders the
shipping costs; ownership over the goods
passes from seller to the buyer.
– Buyer already owns the goods while still in
transit and therefore, shoulders the
transportation cost
• FOB Destination
– The seller bears the shipping cost
– Title passes only when the goods are
received by the buyer at the point of
destination; while in transit
– The seller is still the owner of the goods so
the seller shoulders the transportation costs
• Freight prepaid
– The seller pays the transportation costs
before shipping the goods sold
• Freight collect
– The freight company collects from the buyer

• Payments by either party will not dictate

who should ultimately shoulder the costs
 Who
Who Pays
Freight terms shoulders
the Shipper?
the Tc?

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

• Shipping cost borne by the buyer using the
periodic inventory system are debited to
transportation in account
• Shipping cost borne by the seller are
debited to transportation out account, also
called delivery expense, an operating
expense in the income statement
 Inventory Systems
• Key factor in determining cost of goods
sold
• Merchandising inventory represents goods
available for sale, there must be method
of determining both the quantity and the
cost of these goods.
• Periodic Inventory or Perpetual Inventory
 Periodic Inventory System

• Primarily used by businesses that sell relatively

inexpensive goods and that are not yet using
computerized scanning system to analyze good
sold
• No entries are made to the inventory account as
the merchandise is bought and sold
• When goods are purchased, a separate set of
accounts is used to accumulate information on
the net cost of the purchases
• Only at the end of the period, when the inventory
is counted, will entries be made to the inventory
account to establish its proper balance
 Perpetual Inventory System
• Inventory account is continuously updated
• Perpetually updating the inventory account
requires that at the time of purchase,
merchandise acquisitions be recorded as debit
to the inventory account.
• At the time of sale, the cost of goods sold is
determined and recorded by a debit to the cost
of goods sold account and a credit to the
inventory account
• Both the inventory and cost of goods sold
accounts receive entries throughout the
accounting period.
• POS scanners built into checkout counters
to collect transactional data for the cash
register and to update their perpetual
inventory system
• Is more advisable for forms that sell low-
volume, high-priced goods
• The ending inventory should reconcile with
the actual physical count at the end of the
period assuming that no theft, spoilage, or
error has occurred
• account is adjusted for any inaccuracies
discovered
• The count provides as independent check
on the amount of inventory that should be
reported at the end of the period
 Net Sales
• Net sales is the first part of the merchandising
income statement as presented below
Net Sales
Gross Sales 2,463,500
Less: Sales Returns and 27,500
Allowances
Sales Discount 42,750 70,250

Net Sales 2,393,250

 Gross Sales
• Under accrual accounting, revenues form the
sale of merchandise are considered to be
earned in the accounting period in which the title
of goods passes-usually at the point of delivery –
from the seller to the buyer
• Gross sales consist of total sales for cash and
on credit during an accounting period
• Cash for sale is uncollected, the revenue is
recognized as earned at the time of sale
• As an income account, the sales account
is credited whenever sales on account or
cash are made.
• Only sales of merchandise held for resale
are recorded in the sales account
• If the firm sold one of its delivery trucks,
the credit would be made to the delivery
equipment account, not to sales account
9-16 Cash 25,000
Sales 25,000
To record sale of merchandise for
cash

9-16 Accounts Receivable 25,000

Sales 25,000
To record sale of merchandise on
credit
 Sales Discount
• Assume that Corleto delights sold merchandise
on 9-20 for P30,000; terms 2/10, n/60. at the
time of sale, the entry

9-20 Account Receivable 3,000

Sales 3,000
To record sales on credit; terms
2/10, n/60
• The customer may take advantage of the sales
discount any time on or before 9-30, which is 10
days after the date of the invoice
9-30 Cash 2,940
Sales Discounts 60
Accounts Receivable 3,000
To record collection on the 9-20
sale, discounts taken.

• At the end of the accounting period, the sales discounts

account has accumulated all the sales discount for the
period.
• The account is considered a contra-income account and
deducted from gross sales in the income statement.
 Sales Returns and Allowances
• The buyer may return the goods to the seller for
credit if the sale was made on account or for
cash refund if the sale was for cash
• The seller may just grant an allowance or
deduction from the selling price
• A high sales returns and allowances figure is not
commendable because it may signal poor quality
of goods and thus may result to dissatisfied
customers
• Each return or allowance is recorded as a debit to an
account called sales returns and allowances.

9-17 Sales Returns and 760

Allowances
Accounts Receivable (or 760
Cash)
To record return or allowance
on unsatisfactory merchandise

• The seller usually issues the customer a credit

memorandum, which is a formal acknowledgement that the
seller has reduced the amount owned by the customer.
• Sales returns and allowances is a contra-income account
and is accordingly deducted from gross sales in the income
statement
 Transportation Out
• When the freight term is FOB destination,
the seller shoulders the transportation
costs; when the term is FOB shipping
point, the buyer bears the shipping costs
Case1: Assume that an entity sold merchandise
totaling P17,000 FOB destination, freight
prepaid; terms 2/10, n/30. the transportation cost
amounted to P1,900

11-25 Accounts Receivable 17,000

Transportation Out 1,900
Sales 17,000
Cash 1,900
Sales on account; terms 2/10,
n/30; FOB destination, freight
prepaid, P1,900
If the invoice is collected on Dec 5, the sales
discount will be P340 (P17,000 * 2%).
Transportation out is an operating expense.

12-5 Cash 16,600

Sales Discount 340
Accounts Receivable 17,000
Case2: Assume that an entity sold merchandise
totaling P17,000 FOB shipping point, freight
collect; terms 2/10, n/30. the transportation cost
amounted to P1,900

11-25 Accounts Receivable 17,000

Sales 17,000
Sold merchandise on account;
terms 2/10, n/30; FOB shipping
point, freight collect.
If the invoice is collected on Dec 5, the sales
discount will be P340 (P17,000 * 2%).

12-5 Cash 16,600

Sales Discount 340
Accounts Receivable 17,000
Case3: Assume that an entity sold merchandise
totaling P17,000 FOB destination, freight collect;
terms 2/10, n/30. the transportation cost
amounted to P1,900

11-25 Accounts Receivable 15,100

Transportation out 1,900
Sales 17,000
Sales on account; terms 2/10,
n/30; FOB destination, freight
collect, P1,900
If the invoice is collected on Dec 5, the sales
discount will be P340 (P17,000 * 2%) since the
discount applies to total sales

12-5 Cash 14,760

Sales Discounts 340
Accounts Receivable 15,100
Case4: Assume that an entity sold merchandise
totaling P17,000 FOB shipping point, freight
perpaid; terms 2/10, n/30. the transportation cost
amounted to P1,900

11-25 Accounts Receivable 18,900

Sales 17,000
Cash 1,900
Sales on account; terms 2/10,
n/30; FOB shipping point,
freight prepaid, P1,900
If the invoice is collected on Dec 5, the sales
discount will be P340 (P17,000 * 2%) since the
discount applies to total sales

12-5 Cash 18,560

Sales Discounts 340
Accounts Receivable 18,900
 Cost of Goods Sold
• Or cost of sales is the largest single
expense of the merchandising business
• Cost of inventory that the entity has sold to
customers
• Goods available for sale during the year =
merchandise inventory at the beginning of
the year + net purchases during the period
• Entity sold all goods available for sale
during a given acctg period, cost of goods
sold = goods that had been available for
sale
• Actual cost of goods sold = goods
available for sale - merchandise inventory
at the end of the period
 Corleto Delights
Partial Income Statement
For the Year Ended Dec. 31, 2000
Cost of Goods Sold
Merchandise Inventory, 1/1/00 528,000
Purchases 1,264,000
Less: Purchases Returns and Allowances 56,400
Purchases Discounts 21,360 77,760
1,186,240
Transportation In 82,360
Net Purchases 1,268,600

Goods Available for Sale 1,796,600

Less: Merchandise Inventory, 12/31/00 483,000

Cost of Goods Sold 1,313,600

 Merchandise inventory
• Consists of goods purchased for resale.
• Beginning inventory = merchandise
inventory at the start of the acctg period
• Ending inventory = inventories at the end
– Merchandise inventory to be reported in the
balance sheet
– Beginning inventory of the next acctg period
 Net Purchases
• Under periodic inventory method
– Net purchases = GP – (Pdra) + Tc
• GP: gross purchases
• Pdra: purchases discounts, returns, allowances
• Tc: transportation costs
• Purchases
– Purchases account, a temporary account, is
used only for merchandise purchased for
resale
– Purpose: accumulate the total cost of
merchandising purchased during an
accounting period
– At invoice price is known as the gross price
method of recording purchases
All purchases of merchandise are debited to the purchases
account as shown below

11-12 Purchases 15,000

Accounts Payable 15,000
To record purchases of
merchandise; term 2/10, n/30.
• Purchases Returns and Allowances
– Is a contra account and is accordingly
deducted from purchases in the income
statement
– Cost that cannot be recovered, or lost sales
resulting from poor ordering or unsaleable
goods
Sales R&A in the seller’s books are recorded as purchases
returns and allowances in the books of the buyer

11-14 Accounts Payable 2,000

Purchases R&A 2,000
Return of damaged
merchandise purchased on Nov
12.
• Purchases Discounts
– Purchases are usually made on credit and
commonly involve purchases discounts for
early payment
– Is a contra account that is deducted from
purchases on the income statement
– Does not apply to transportation or other
charges that might appear on the invoice
In relation with the purchase last Nov 12, discount terms
2/10, n/30, and Nov 14 Purchases R&A

11-22 Accounts Payable 13,000

Purchases discount 260
Cash 12,740
Record Purchases discount of
(P13,000 * 2%)
Transportation IN

Case1: Assume that an entity made purchases

totaling P17,000 FOB destination, freight
prepaid; terms 2/10, n/30. the transportation cost
amounted to P1,900
11-25 Purchases 17,000
Account Payable 17,000
Purchased merchandise on
account; terms 2/10, n/30; FOB
destination, freight prepaid
No debit to transportation in account since the
shipping term provided that the seller should
shoulder the transportation cost.
If the invoice is paid on Dec 5, the purchases
discount will be P340 (P17,000 * 2%).

12-5 Accounts Payable 17,000

Purchase Discount 340
Cash 16,600
Case2: Assume that an entity purchases
merchandise totaling P17,000 FOB shipping
point, freight collect; terms 2/10, n/30. the
transportation cost amounted to P1,900

11-25 Purchases 17,000

Transportation In 1,900
Accounts Payable 17,000
Cash 1,900
Purchase merchandise on
account; terms 2/10, n/30; FOB
shipping point, freight collect.
If the invoice is paid on Dec 5, the purchases
discount will be P340 (P17,000 * 2%).
Transportation in will form part of net purchases.

12-5 Accounts Payable 17,000

Purchases Discounts 340
Cash 16,660
Case3: Assume that an entity made purchases
totaling P17,000 FOB destination, freight collect;
terms 2/10, n/30. the transportation cost
amounted to P1,900

11-25 Purchases 17,000

Account Payable 15,100
Cash 1,900
Purchases on account; terms
2/10, n/30; FOB destination,
freight collect, P1,900
Accounts payable is decreased by the
transportation charges paid by the buyer for the
benefit of the seller
If the invoice is paid on Dec 5, the purchases
discount will be P340 (P17,000 * 2%) since the
discount applies to total purchases

12-5 Accounts Payable 15,100

Purchases Discounts 340
Cash 14,760
Case4: Assume that an entity purchases
merchandise totaling P17,000 FOB shipping
point, freight prepaid; terms 2/10, n/30. the
transportation cost amounted to P1,900

11-25 Purchases 17,000

Transportation In 1,900
Accounts Payable 18,900
Purchased merchandise on
account; terms 2/10, n/30; FOB
shipping point, freight prepaid,
P1,900
If the invoice is paid on Dec 5, the purchases
discount will be P340 (P17,000 * 2%) since the
discount applies to total sales
Buyer not entitled to discounts on the
transportation costs.
Discounts apply only to total purchases.

12-5 Accounts Payable 18,900

Purchases Discounts 340
Cash 18,560
 Operating Expenses
• Make up the third major part of the income
statement for a merchandising entity
• Expenses other than the cost of goods
sold, which are incurred to generate
income from the entity’s ,major line of
business-merchandising
• Categories: Selling, Administrative, Other
operating expenses
• Selling: related directly to the entity’s efforts
to generates sales
– Payroll accounts, advertising, traveling, store
supplies used, depreciation, transportation out
• Administrative: related to the general
administration of the business
– Officers and office salaries, office supplies,
depreciation, business taxes, professional
services, uncollectible accounts and other
general office expenses
• Other operating: are not related to the
central operations of the business
– Expenses and loses from peripheral or
incidental transactions of the enterprise; for
example, loss on sale of investments or loss
on sale of property and equipment