Lesson title: Illustrating the operating cycle of a merchandising

Lesson Objectives:
1. Understand the basic concepts of merchandising transactions and check journal
entries pertaining to the operating cycle of the merchandising business.
2. Identify the common source documents used in the merchandising business.

The merchandising business purchases inventory, sells the inventory and uses cash to
purchase more inventory. Good examples of merchandising businesses include retail
clothing, grocery stores and bookstores. Some businesses produce the goods they sell, while
other merchandise businesses buy and sell goods they've purchased wholesale. For cash
sales, the cycle is from cash to inventory and back to cash. For sales on account, the cycle is
from cash to inventory and back to cash.
Example:
Purchases 10,000
Cash 10,000
To record purchases of merchandise for cash

Accounts Receivable 15,000

Sales 15,000
To record sale of merchandise on credit

Cash 15,000
Accounts Receivable 15,000
To record collection of account

Merchandising businesses uses the following

forms and source documents to help identify the
transactions that should be recorded in the
books.
1. Sales Invoice is prepared by the seller of goods and sent to the buyer. It contains
the name and address of the buyer, the date of sale and the quantity, description and
price about the goods sold. It also specifies the amount of sales and the
transportation and payment terms. The cash sales invoice is used for cash sales while
the credit sales invoice is used for sales on account.
2. Official receipt evidences the receipt of cash by the seller or the authorized
representative.
3. Credit memorandum is a form used by the seller to notify the buyer that his
account is being decreased due to sales returns or errors or other factors requiring
adjustments.
4. Delivery receipt is a document that is typically signed by the receiver of a shipment
to indicate that they have in fact received the items being shipped and have taken
possession of.
5. Bill of lading is a document issued by the carrier (shipping company) that specifies
contractual conditions and terms of delivery such as freight terms, time, place, and
the person named to receive the goods. If the carrier is an airline company, the form
is called Airway Bill.
6. Check is a written order to a bank by a depositor to pay the amount specified in the
check from his checking account to the person named in the check.
7. Receiving report is a document containing information about goods received from a
vendor which includes quantities and description of goods received.
8. Debit memorandum is a notification from a buyer to a seller that tells the seller
that a debit was made in the seller’s account on the buyer’s books. It is a way for a
buyer to inform the seller that it wants a refund or discount on its purchase.
 9. Accounts payable voucher is used to record liabilities to individuals or companies
supported by the supplier’s invoice and the company’s receiving report and purchase
order.
10. Check voucher is a kind of document that explains both the nature of payment and
details of the check.

Other business documents that are being used in the operating cycle but are not recorded in
the accounting books are the following:
1. Statement of account is a formal notice to the debtor detailing the accounts already
due.
2. Deposit slips are printed bank forms with depositor’s name, account number and space
for details of the deposit.
3. Purchase requisition is a written request to the purchaser of an entity from an
employee or user department of the same entity that goods need to be purchased.
4. Purchase order is an authorization made by the buyer to the seller to deliver the
merchandise as detailed in the form.

ACTIVITY 1
Directions: Prepare journal entries for the following transactions.

January 1 Cash sales, P230,000.

4 Sales on account, P450,000.
10 Purchased merchandise for cash, P150,000.
15 Purchased merchandise on account, P620,000.
22 Received cash for sales made on account.
28 Paid the amount due for merchandise purchased.

DATE ACCOUNT TITLE DR CR

 DATE ACCOUNT TITLE DR CR

FAQs
1. What does income statement of a service entity differs from that of the
merchandising business?
 To provide a better measure of performance, the income statement of merchandising
business is presented with the following items:

Service Merchandising

Income
Income Statement Statement

Revenue from
Services Net Sales
minus
Cost of Sales
minus equals
Gross Profit
add or minus
Income or
Expenses Expenses

equals equals
Profit Profit

KEY TO CORRECTION
Activity 1:
 DATE ACCOUNT TITLE DR CR
January 1 Cash 230,000
Sales 230,000

4 Accounts Receivable 450,000

Sales 450,000

10 Purchases 150,000

Cash 150,000

15 Purchases 620,000

Accounts Payable 620,000

22 Cash 230,000

Accounts Receivable 230,000

28 Accounts Payable 150,000

Cash 150,000

Lesson title: Recognize discounts, returns and allowances

Lesson Objective:
1. Compute for discounts, returns and allowances on merchandising transactions and
prepare corresponding journal entries.
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 the credit period is allowed for payment.
The length of the credit period varies across industries and may even vary within an entity,
depending on the product.

When goods are sold on credit, both parties should have an understanding as to the amount
and time of payment. These are usually printed on the sales invoice and constitute part of
the sales agreement. If the credit period is 30 days, then payment is expected within 30
days from the invoice date. The credit period is usually described as the net credit period or
net terms. The credit period of 30 days is noted as “n/30”. If the invoice is due ten days after
the end of the month, it may be marked “n/10 eom”.

Discounts may be categorized as follows:

a. Cash Discounts - are called purchase discounts from the buyer’s viewpoint, and
sales discount from the seller’s point of view. Trade discounts encourage the buyers
to purchase products because of markdowns from the list price.
b. Trade Discounts – encourages buyers to purchase products due to markdowns from
the price list.

Sales Discounts
Example: Assume that Sun Traders sold merchandise on June 20 for P5,000; terms 2/10,
n/30. At the time of sale, the entry is:
June 20 Accounts receivable 5,000
Sales 5,000

The customer may take advantage of the sales discount any time on or before June 30,
which is 10 days after the date of the invoice. If the customer paid on June 30, the entry is:
June 30 Cash 4,900
Sales discounts 100
Accounts receivable 5,000

Sales Returns and Allowances

Buyers may return goods to the seller for credit if the sale was made on account or for cash
refund if the sale was for cash. Each return or allowance is recorded as a debit to an account
called sales returns and allowances.

Example :
May 18 Sales returns and allowances 2,500
Accounts receivable (or Cash) 2,500
To record return or allowance on unsatisfactory merchandise.
Purchase Discounts
Merchandise purchases are usually made on credit and commonly involve purchase
discounts for early payments.

Example: Assume that Jedi Company purchased merchandise on March 10 for P6,000; terms
1/15, n/30. The entry is:
March 10 Purchases 6,000
Accounts payable 6,000

If the company paid on March 20, the entry is:

March 20 Accounts payable 6,000

Purchase discounts 60
Cash 5,940
Purchases Returns and Allowances
Sales Returns and Allowances in the seller’s books are recorded as Purchase Returns and
Allowances in the books of the buyer.

Example:
Nov. 18 Accounts payable 2,500
Purchase returns and allowances 2,500
To record return of damaged merchandise purchased on Nov. 2.

ACTIVITY 2
Directions: Encircle the letter of the correct answer.

1. The entry to record a sale of P7,500 with terms of 2/10, n/30 would include a
a. Debit to Sales Discounts for P150.
b. Debit to Sales for P7,350.
c. Credit to Accounts Receivable for P7,500.
d. Credit to Sales for P7,500.
2. The collection of a P4,000 accout within the 2% discount period would result in a
a. Debit to Sales Discounts for P80.
b. Debit to Accounts Receivable for P3,920.
c. Credit to Cash for P3,920.
d. Credit to Accounts Receivable for P3,920.
3. The collection of a P5,000 account beyond the 2%discount period would result in a
a. Debit to Cash for P4,900.
b. Credit to Accounts Receivable for P5,000.
c. Credit to Cash for P5,000.
d. Debit to Sales Discount for P100.
4. Goods totaling P50,000 were purchased February 2 with terms of 2/10, n/30. Returns of
P10,000 were made on February 10. How much discount, if any, can be availed if the
invoice was paid on February 12?
a. None c. P 800
b. P1,000 d. P 200
5. The entry to record a payment on a P15,000 account within the 2% discount period would
include
a. Debit to Cash for P15,000.
b. Debit to Accounts Payable for P14,700.
c. Credit to Purchase Discounts for P300.
d. Credit to Accounts Payable for P15,000.
6. A P5,000 purchases on account was made. The entry to record the payment on account
after the expiration of the 2% discount period would include a
a. Debit to Accounts Payable for P5,000.
b. Debit to Purchase Discounts for P100.
c. Credit to Cash forP4,900.
d. Credit to Accounts Payable for P4,900.
7. A buyer received an invoice for P6,000 dated June 10. If the terms are 2/10, n/30 and the
buyer paid the invoice within the discount period, what amount will the seller receive?
a. P6,000
b. P5,880
c. P4,800
d. P 120
8. The purchase discounts account is a contra account to
a. Accounts Payable
b. Sales
c. Purchases
 d. Sales Discount
9. The account that appears in the chart of accounts for a merchandising entity but not for a
service entity is
a. Accounts receivable
b. Advertising expense
c. Sales returns and allowances
d. Service revenue
10. Grace Company bought merchandise for P8,000, terms 2/10, n/30. If Grace
returns P2,000 of the goods to the vendor, the entry to record the return should include a
a. Debit to Accounts Payable of P2,000.
b. Debit to Discounts Lost of P40.
c. Credit to Purchase Returns and Allowances of P1,960.
d. Debit to Purchase Returns and Allowances of P1,960.

KEY TO CORRECTION
Activity 2:
1. D 6. A
2. A 7. B
3. B 8. C
4. C 9. C
5. C 10. A

Lesson title: Understand Periodic and Perpetual Inventory System

Lesson Objectives:
1. Describe and differentiate the periodic and perpetual inventory systems
2. Differentiate the journal entries made in the two types of inventory systems

Merchandise inventory is the key factor in determining cost of sales. Because merchandise
inventory represents goods available for sale, there must be a method of determining both
the quantity and the cost of these goods. There are two systems available to merchandising
entities to record events related to merchandise inventory: the perpetual inventory system
and periodic inventory system.

The periodic and perpetual inventory systems are different methods used to track the
quantity of goods on hand. The more sophisticated of the two is the perpetual system, but it
requires much more record keeping to maintain.

INVENTORY ACCOUNTING SYSTEM

Periodic Inventory System

 Under a periodic inventory system, there is no continuous record of the movement of
the physical quantities of inventory on hand.
 In the system, no entries are made to the inventory account as the merchandise is
bought and sold.
 When goods are purchased, a separate set of accounts (purchases,
purchase discounts, purchase returns and allowances, and transportation) 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.
(Illustrative Problem)

Assume that the beginning inventory for the year is P250,000 and the only transactions for
the entire year are numbers 1 to 7.The balance in the inventory account at year end under
the periodic inventory system is P250,000.

At year-end, the physical inventory is taken, and it revealed that the actual inventory on
hand is P231,500. The year-end journal entries (numbers 8 to 10) are then made to bring the
inventory account balance into agreement with the amount of the physical inventory. When
posted to the general ledger, the ending inventory amounts to P231,500.

Sold merchandise on account costing P8,000 for P10,000; terms were 2/10, n/30:
Accounts receivable 10,000
Sales 10,000

Customer returned merchandise costing P400 that had been sold on account for P500:
Sales returns and allowance 500
Accounts receivable 500

Received payment from customer for merchandise sold above:

Cash 9,310
Sales discounts 190
Accounts receivable 9,500

Purchased on account merchandise for resale for P6,000; terms were2/10, n/30:
Purchases 6,000
Accounts payable 6,000

Paid freight on the P6,000 purchase; terms were FOB shipping point, freight collect:
Transportation in 200
Cash 200

Returned merchandise costing P300:

Accounts payable 300
Purchase returns and allowances 300

Paid for merchandise purchased:

Accounts payable 5,700
Purchase discounts 114
Cash 5,586

To transfer the beginning inventory balance to the Income Summary account:

Income Summary 250,000
Inventory 250,000

To record the ending inventory balance:

Inventory 231,500
Income Summary 231,500

Perpetual Inventory System

 Under the perpetual inventory system, the inventory account is continuously updated
with the movement in inventory.
 Perpetually updating the inventory account requires that at the time of purchase, the
merchandise inventory account is debited.
  At the time of sale, the cost of sales is determined and recorded by a debit to the
cost of sales account and a credit to the inventory account.
 With a perpetual inventory system, both the inventory and cost of sales accounts
receive entries throughout the accounting period.
 When a company uses the perpetual inventory system, 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.
 The account is adjusted for any inaccuracies discovered.
 The count provides an independent check on the amount of inventory that should be
reported at the end of the period.

PERIODIC AND PERPETUAL INVENTORY SYSTEM COMPARED

(Illustrative Problem)

Assume that the beginning inventory for the year is P250,000 and transactions 1 to 7 were
the only transactions for the entire year. The balance in the inventory account at year-end
under the periodic inventory system is P231,500. The year-end balance in the inventory
account under the perpetual inventory system is P231,860.

Under the perpetual inventory system, the inventory account is increased by purchases,
transportation in and sales returns and is decreased by the cost of sales, purchase returns
and allowances and purchase discounts.

At year-end, the physical inventory is taken, and it revealed that the actual inventory on
hand is P231,500. The year-end journal entries (nos. 8 to 10) are then made to bring the
inventory account balance into agreement with the amount of the physical inventory. When
posted to the general ledger, the perpetual inventory system results in the same ending
inventory amount, P231,500.

Comparison of journal entries under the two inventory systems:

PERIODIC INVENTORY SYSTEM PERPETUAL INVENTORY SYSTEM

1. Sold merchandise on account costing P8,000 for P10,000; terms were 2/10,n/30:
Accounts receivable 10,000 Accounts receivable
10,000
Sales 10,000 Sales
10,000
Cost of sales 8,000
Inventory 8,000

2. Customer returned merchandise costing P400 that had been sold on account for P500:
Sales returns and allowances 500 Sales returns and allowances
500
Accounts receivable 500 Accounts receivable 500

Inventory 400
Cost of sales 400

3. Received payment from customer for merchandise sold above (cash discount taken)
Cash 9,310 Cash 9,310
Sales discounts 190 Sales discounts 190
Accounts receivable 9,500 Accounts receivable 9,500
4. Purchased on account merchandise for resale for P6,000; terms were 2/10, n/30
Purchases 6,000 Inventory 6,000
Accounts payable 6,000 Accounts payable 6,000

5. Paid P200 freight on the P6,000 purchase; terms were FOB shipping point, freight collect
Transportation in 200 Inventory 200
Cash 200 Cash 200
6. Returned merchandise costing Php300
Accounts payable 300 Accounts payable 300
Purchase returns Allowances 300 Inventory
300

7. Paid for merchandise purchased

Accounts payable 5,700 Accounts payable 5,700
Purchase discounts 114 Inventory 114
Cash 5,586 Cash 5,586

8. To record the ending inventory balance

Income Summary 250,000
Inventory 250,000 No entry required

9. To record ending inventory balance

Inventory 231,500 No entry required
Income Summary 231,500

10. To adjust the ending perpetual inventory balance for the shrinkage during the year
Cost of sales 360
No entry required Inventory 360
Directions: Journalize the following transactions. Use the answer sheet below.

Sun Company entered into the following transactions during the month of June 2021:
June 2 Purchased 1,000 tires at a cost of P600 per tire. Terms of payment: 1/10, net 45.
4 Paid trucking firm P8,000 to ship the tires purchased on June 2.
5 Purchased 600 tires at a cost of P600 per tire. Terms of payment: 2/10,net 30.
6 Paid trucking firm P5,000 to ship the tires purchased on June 5.
7 Returned 150 of the tires purchased on June 2 because they were defective. Received a
credit on open account from the seller.
11 Paid for tires purchased on June 2.
13 Sold 700 tires from those purchased on June 2. The selling price was P900 per tire. Terms:
1/10, net 30.
22 Received cash from sale of tires on June 13.
30 Paid for tires purchased on June 5.

DATE ACCOUNT TITLE AND EXPLANATION DR CR