4th Quarter Module

In
Accountancy, Business, and Management 1

Module 11
Accounting Cycle of a Merchandising Business
Content Standards
The learners demonstrate an understanding of the accounting cycle of a merchandising business to include the
following: • journalizing of transactions using the general and special journals, namely: sales, purchase, cash
receipts and cash payments journals.
• posting to the general and subsidiary ledgers
• preparation of trial balance.
• adjusting entries to include pre payments, accrual and deferral
• worksheet preparation
• completing the accounting cycle of a merchandising business
Performance Standards
The learners shall be able prepare journal entries, post to the ledger, prepare the trial balance, worksheet and
adjusting entries, and complete the accounting cycle of a merchandising business.
Learning Objectives:
At the end of this lesson, the learners will be able to:
• describe the nature of a merchandising business and give examples
• record transactions of a merchandising business in the general and special journals
• discuss the importance and use of a trial balance
• prepare adjusting entries
• understand the accounting cycle of a merchandising business
• prepare a statement of cost of goods sold and gross profit
Nature and examples of merchandising company
A merchandising company is an enterprise that buys and sells goods to earn a profit.
Examples of merchandising businesses:
• Mercury Drug
• Puregold
• ACE Hardware
• grocery stores Merchandise (or merchandise inventory) refers to goods that are held for sale to customers in
the normal course of business. This includes goods held for resale.
For example:
• Candies, canned goods, noodles sold at a grocery stores
• Juice, biscuits sold in a grocery store
• Medicines sold in a pharmacy If a grocery store decided to sell an old computer used in the office, this would
not be merchandise because grocery stores do not normally sell computers and the store is simply selling off old
office equipment. But a computer would be merchandise for a computer store who resells computer units.
Merchandise for one firm may be a fixed asset (or property and equipment) for another.
In another example, a pharmacy decided to sell a table used in their display area. This table is not merchandise
of a pharmacy. However, to a retail furniture store a table is merchandise because the business of a furniture
store involves the buying and selling of tables.
A merchandiser’s primary source of revenue is sales revenue or sales.
Expenses for a merchandising company are divided into two categories:
1. Cost of goods sold (COGS) – the total cost of merchandise sold during the period; and
2. Operating expenses (OP) - expenses incurred in the process of earning sales revenue that are deducted from
gross profit in the income statement. Examples are sales salaries and insurance expenses.
Gross profit (GP) is equal to Sales Revenue less the Cost of Goods Sold. Income measurement process for a
merchandiser follows as:

The Operating Cycles for a merchandiser: Merchandising Company operating cycle (cash to cash) involves:
1. buy merchandise inventory
2. sell inventory
3. obtain Accounts Receivable
4. receive cash
JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING BUSINESS
Prior to the discussion on the journal entries, recall the first step in the accounting cycle discussed in previous
chapters (specifically Chapter 10) on financial and non-financial transactions.
In step 1, transactions are identified and measured. At this stage, the documents used by the business are
analyzed to see whether these transactions have financial impact or effect. Recall the rule that only financial
transactions are recorded and that the amount can be measured. These two conditions must exist in order for a
particular transaction to be recognized or recorded. As defined, financial transactions are those activities that
change the value of an asset, liability or equity.
Step 2 is the Preparation of Journal Entries (Journalization)
A merchandising company may use special and general journals to record its transactions.
SPECIAL JOURNALS Some businesses encounter voluminous quantities of similar and recurring transactions,
which may create congestion if these transactions are recorded repeatedly in a single day or monthly in the
general journal. The use of special journals will eliminate this problem.
The following are the commonly used special journals:
1. Cash Receipts Journal –used to record all cash that had been received
2. Cash Disbursements Journal –used to record all transactions involving cash payments
3. Sales Journal (Sales on Account Journal) –used to record all sales on credit (on account)
4. Purchase Journal (Purchase on Account Journal) –used to record all purchases of inventory on credit (or on
account)
INVENTORY SYSTEMS
Maintaining inventory item is a unique set-up in a merchandising business. There are two methods of accounting
for inventory, namely: Perpetual Inventory System and Periodic Inventory System.
Merchandising entities may use either of the following inventory systems:
1. Perpetual System — Detailed records of the cost of each item are maintained, and the cost of each item sold
is determined from records when the sale occurs. For example, a car dealership has separate inventory records
for each vehicle.
• Record purchase of Inventory.
• Record revenue and record cost of goods sold when the item is sold.
• At the end of the period, no entry is needed except to adjust inventory for losses, etc.
2. Periodic System — Cost of goods sold is determined only at the end of an accounting period. This system
involves:
• Record purchase of Inventory.
• Record revenue only when the item is sold.
• At the end of the period, you must compute cost of goods sold (COGS):
1. Determine the cost of goods on hand at the beginning of the accounting period (Beginning Inventory
= BI),
2. Add it to the cost of goods purchased (COGP),
3. Subtract the cost of goods on hand at the end of the accounting period
4. (Ending Inventory = EI) illustrated as follows:

Additional Considerations:
• Perpetual systems have traditionally been used by companies that sell merchandise with high unit values such
as automobiles, furniture, and major home appliances. With the use of computers and scanners, many
companies now use the perpetual inventory system.
• The perpetual inventory system is named because the accounting records continuously — perpetually —show
the quantity and cost of the inventory that should be on hand at any time. The periodic system only periodically
updates the cost of inventory on hand.
• A perpetual inventory system provides better control over inventories than a periodic inventory, since the
records always show the quantity that should be on hand. Then, any shortages from the actual quantity and what
the records show can be investigated immediately.
Note: The periodic inventory system will be used in all illustrations of this chapter while the perpetual system
will be included in the “enrichment” portion of this guide.
PERIODIC INVENTORY SYSTEM
Recording purchases and related transactions under the Periodic Inventory System
PURCHASES OF MERCHANDISE:
PERIODIC SYSTEM
1. When merchandise is purchased for resale to customers, the account, Purchases, is debited for the cost of
goods purchased.
2. Like sales, purchases may be made for cash or on account (credit).
3. The purchase is normally recorded by the purchaser when the goods are received from the seller.
• Each credit purchase should be supported by a purchase invoice.
• A purchase invoice received by the buyer is actually a sales invoice or a charge invoice prepared by
the supplier or vendor.
• Note that only purchases of merchandise are debited to the ‘Purchase’ account. Acquisition (purchases)
of other assets: supplies, equipment, and similar items are debited to their respective accounts.
TO ILLUSTRATE:
Magaling Computer Store started its operations on January 2, 2016. The store is located in Sikat Mall in Bicol.
The owner invested PHP500,000 to start the business. On January 3, 2016, Magaling purchased 20 units of
computers on account for PHP10,000 each. Upon delivery of the units, the supplier, Delta, Inc., issued Charge
Invoice No. 145 to Magaling.
PURCHASE RETURNS AND ALLOWANCES
• A purchaser may find the merchandise received to be unsatisfactory because the goods are:
• damaged or defective
• of inferior quality
• not in accord with the purchaser’s specifications
• The purchaser initiates the request for a reduction of the balance due through the issuance of a debit
memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the seller’s
account has been debited because of unsatisfactory goods.
• A return of the merchandise (a deduction from the purchase price when unsatisfactory goods are kept) is shown
by the entry where Accounts Payable is debited and Purchase Returns and Allowances is credited to show that
the purchaseswas reduced with a return or an allowance.
• The Purchase Returns and Allowances account is a “contra purchases” account when merchandise is returned
to a supplier.
TO ILLUSTRATE:
Out of the 20 computer units purchased last January 3, 2016, it was found after inspection on the same day that
one unit was damaged during shipment. Magaling issued a debit memorandum (DM 01) and informed the
supplier that it will return the one damaged item.

ACCOUNTING FOR FREIGHT COSTS

The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods
to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING
POINT AND FOB DESTINATION.
FOB Shipping Point:
• Goods placed free on board (FOB) the carrier by seller.
• Buyer pays freight costs.
• Freight-In is debited if buyer pays freight.
• Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately.
Accounts Payable would be credited if on account.
• Ownership over the goods is transferred to the buyer once it is out of the premises of the seller.
FOB Destination
• Goods placed free on board (FOB) at buyer’s business.
• Seller pays freight costs.
• Delivery Expense is debited if seller pays freight on outgoing merchandise to a buyer. This is an
operating expense to the seller.
 • Ownership over the goods is transferred to the buyer once the goods are delivered and received by the
buyer.
TO ILLUSTRATE:
Assume the supplier of Magaling is based in Manila. In order to bring the 20 computer units to Bicol, it will cost
PHP3,000 to deliver the goods.
If the term is FOB Shipping Point, the entry to record, assuming Magaling paid the common carrier in cash on
January 4, 2016 is.

If the terms is FOB Destination, no entry is recorded in the books of Magaling. The PHP3,000 will be paid by the
seller, in this case Delta, Inc.
PURCHASE DISCOUNTS:
• Credit terms (specify the amount of cash discount and time period during which a discount is offered) may
permit the buyer to claim a cash discount for the prompt payment of a balance due. If the credit terms show 2/10,
n/30 means a 2% discount is given if paid within 10 days (called the discount period); otherwise, the invoice is
due in 30 days.
• The buyer calls this discount a purchase discount.
• A purchase discount is normally based on the invoice cost less returns and allowances, if any.
TO ILLUSTRATE
The credit terms for the purchase of 20 computer units (total cost PHP200,000) is 2/10, n/30. This means that if
Magaling pays on or before January 13, 2016, it is entitled to a 2% discount, otherwise Magaling will have to pay
the full amount on or before February 4, 2016 (30 days after purchase). On January 10, 2016, Magaling paid the
account in full with Delta.

Assuming that instead of paying on January 10, 2016, Magaling paid on February 4, 2016, thus forfeiting the 2%
discount, the entry to record is:
Recording of sales and related transactions under the Periodic Inventory System
SALES TRANSACTIONS:
REVENUE ENTRIES FOR A MERCHANDISER
• Revenues are reported when earned in accordance with the revenue recognition principle, and in a
merchandising company, revenues are earned when the goods are transferred from seller to buyer.
• All sales should be supported by a document such as a cash register tape (to provide evidence of cash sales)
or cash receipt, or office receipt for cash sales, and charge invoice for credit sales, or sales on account.
• One entry is made with each sale:
Debit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which increases assets for the
sales amount Credit — Sales which increases revenues
• The sales account is credited only for sales of goods held for resale. Sales of assets not held for resale (such
as equipment, buildings, land, etc.) are credited directly to the asset account.
TO ILLUSTRATE :
For the month of January, Magaling made the following sale:
1/10/2016 Official Receipt (OR) No. 001 Sold two units for cash to Marie Cruz for PHP36,000 (PHP18,000 per
unit), FOB Destination
1/15/2016 Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500 (PHP19,500
per unit) with terms 3/10, n/ 30, FOB Shipping Point

FREIGHT TERMS: FOB DESTINATION

— SELLER PAYS FREIGHT
• An entry is made when seller pays the freight to deliver goods to a customer or buyer. If the buyer will pay for
the freight, no entry is made.
• Debit — Delivery Expense and credit — Cash or Accounts Payable
TO ILLUSTRATE: On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two units to Marie
Cruz.
SALES RETURNS AND ALLOWANCES:
• Sales Returns result when customers are dissatisfied with merchandise and are allowed to return the goods to
the seller for credit or a refund.
• Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from the selling
price.
• To grant the return or allowance, the seller prepares a credit memorandum to inform the customer that a credit
has been made to the customer’s account receivable.
• Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a reduction
to a particular account.
• A contra account is used, instead of debiting sales, to disclose the amount of sales returns and allowances in
the accounts.
• This information is important to management as excessive returns and allowances suggest inferior
merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in delivery or shipment of
goods.
• The normal balance of Sales Returns and Allowances is a debit.
• One entry is made with each sales return and allowance: The entry to record the sales return or allowance:
• Debit — Sales Return and Allowances which decreases revenues for the amount of the sale
• Credit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets
TO ILLUSTRATE:
On January 16, 2016, Rafael Reyes returned one unit of the computers purchased last January 15, 2016 under
Charge Invoice 001. The unit returned was in good condition. However, Rafael Reyes returned the unit because
it is one unit more than what they need. The return was approved and accepted by Magaling. The price will be
deducted from the account of Rafael Reyes.

SALES DISCOUNTS
1. A sales discount is the offer of a cash discount to encourage customers to pay the balance at an earlier date.
2. An example of a discount term is commonly expressed as: 2/10, n/30, which means that the customer is given
2% discount if payment is made within 10 days. After 10 days there is no discount, and the balance is due in 30
days.
3. Sales Discounts is a contra revenue account with a normal debit balance.
TO ILLUSTRATE: Assume that Magaling purchased on cash, five units of computers at PHP10,000 per unit from
a supplier on January 17, 2016. These units were subsequently sold to Jun Cruz on January 18, 2016 under
Charge Invoice (ChI) No. 002 amounting to PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB
Shipping Point. On January 23, 2016, Cruz paid the said account in full.
Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the 2% discount because
he made the payment within the discount period. Take note that the discount period in this case was from January
19, 2016 to January 28, 2016 (10 days).
What If Jun Cruz paid the account on January 30, 2016 instead of January 23, 2016? The entry would be:

Determining Cost of Goods Sold under Periodic Inventory System

The Cost of Goods Sold under the periodic inventory system is determined at the end of the period (monthly or
yearly) by a short computation, as follows:

In a periodic inventory system, separate ledger accounts are maintained for various items composing the cost
of goods sold (Purchases, Purchase Returns & Allowances, Freight-In, Purchase Discounts). At the end of the
accounting period, a physical count of inventory is necessary to establish the ending balance of the inventory.
PRACTICE
COMPLETE ACCOUNTING CYCLE FOR A MERCHANDISING BUSINESS
Agila Merchandising, owned by Lito Agila, sells ready-to-wear shirts and dresses to its customers. It started its
operations on January 1, 2016. The company issues the following documents:
• Official Receipts - for all cash collections
• Charge Sales Invoice – for all sales on account
• Check Voucher – for all cash disbursements
Step 1 & 2 –Understanding and Journalizing the transactions
For the month of January 2016, the special journals of Agila are shown below:
In addition to the above special journals, the company maintains a general journal. The General Journal had the
following entries for January

Additional Information:
• The delivery vehicle purchased in January 2, 2016 is estimated to be useful for 10 years with no residual or
salvage value. • A physical count of merchandise inventory was conducted on January 30, 2016. The cost of the
inventory on hand was PHP438,700.
• On January 30, 2016, Agila received a statement of account from Gus Oil Center reflecting a total bill of
PHP2,180, representing fuel purchases on January 2016 that were still unpaid as of the said date.
Step 3 – Posting to the General Ledger. From the summary of transactions in the special journals and general
journals, the entries will now be posted in each general ledger account:
Step 4 & 5– Prepare the unadjusted trial balance, and preparation of worksheet. The balances in the general
ledger for each account will be extended to the first two money columns of the worksheet. The unadjusted trial
of Agila is: AGILA MERCHANDISING Worksheet for the month ending January 30, 2016

Step 6 – Prepare adjusting entries. Recall in Chapter 11, the five basic sources of adjusting entries:
1. Depreciation expense
2. Deferred expenses or prepaid expenses
3. Deferred income or unearned Income
4. Accrued expenses or accrued liabilities
5. Accrued income or accrued assets
Identify transactions in the books of Agila that will require adjustments:
• Depreciation of transportation equipment purchased on January 2, 2016
Monthly Depreciation = (Cost – Salvage or Residual Value) / 120 months
= (150,000-0) / 120
= 1,250
Adjusting entry :
Depreciation Expense 1,250
Accum. Deprn- Transpo Eqpt 1,250

Deferred or Prepaid Expenses In the cash disbursement journal, the rental payment made on January 2, 2016
is for the month of January and February 2016 amounting to PHP10,000. The entire amount was charged to
rental expense which is not proper because one half (1/2) of the said payment is considered as an advance
payment of rental. Thus, an asset should be recognized. The adjusting entry is:
Prepaid Expenses 5,000
Rental Expense 5,000
Note: With this entry, the correct rental expense of PHP5,000 and a prepaid expense of PHP5,000 ( an asset
account) are recognized.
• Accrued Expenses On January 30, 2016, fuel expenses incurred amounting to PHP2,180 should be recorded
as an expenses and liability. The entry to adjust is:
Fuel Expenses 2,180
Accrued Expenses 2,180
Step 7 - Preparation of Financial Statements. The first statement prepared is the income statement. All income
statement accounts are extended to the appropriate column. Using the periodic inventory system, the beginning
balance of merchandise inventory account is also extended to the debit side, while the result of the physical
count to determine the ending inventory is reflected on the credit side. The total debit and total credit are
determined and if credit balance is higher than the debit side, the difference is added to the debit side. The
difference is actually the income for the period. However, if the total debit side exceeds the total credit side, the
difference is added to the credit side and this is the net loss of the business. The statement of financial position
is then prepared. All assets, liabilities and equity accounts are extended. The ending merchandise inventory is
extended to the debit side.
The worksheet for these two financial statements are presented below:
The proper format of the income statement and the schedule of cost goods sold of Agila for January 2016 are
presented below:
AGILA MERCHANDISING
Schedule of Cost of Goods Sold
For the month ended January 30, 2016

Step 8 – Closing Entries. The closing journal entries consist of the following:
• All of the nominal revenue accounts should be closed to the income summary account by a Debit to revenue
and credit to income summary.
• All of the nominal expense and cost of goods sold accounts should be closed to the income summary by a
Credit to expense and a debit to income summary.
• The Merchandise Inventory, Beginning is closed to Income summary account by a debit to Income Summary
and a credit to Merchandise Inventory.
• The Merchandise Inventory, Ending is set up in the books by a debit to Merchandise Inventory, Ending and a
credit to Income Summary. The amount that will be used is the result of the physical count.
• The balance in the income summary account should now reflect the net income for the accounting period. The
next journal entry should close the income summary account to the equity or capital account. If there is a net
profit this entry will be a debit to income summary and a credit to owner’s capital account.
Once the closing journal entries have been entered into the general journal, the information should be posted
to the general ledger. When this is accomplished, all of the nominal accounts in the general ledger should have
zero balances. To double check on this, we prepare another trial balance based on the new balances in the
general ledger. If we have any nominal accounts with positive balances, a mistake was made along the way and
will need to be corrected before proceeding to the next accounting period.
The closing entries of Agila are:

ENRICHMENT
As mentioned above, there are two methods in accounting for inventory: the periodic inventory system and
perpetual inventory system.
PERPETUAL INVENTORY SYSTEM
Recording Purchases and related transactions under the Perpetual Inventory System
PURCHASES OF MERCHANDISE: PERPETUAL SYSTEM
• When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is debited for
the cost of goods purchased.
• Like sales, purchases may be made for cash or on account (credit).
• The purchase is normally recorded by the purchaser when the goods are received from the seller.
• Each credit purchase should be supported by a purchase invoice.
• A purchase invoice received by the buyer is actually a sales invoice or a charge invoice prepared by
the supplier or vendor.
• Note that only purchases of merchandise are debited to Merchandise Inventory. Purchases of other
assets: supplies, equipment, and similar items) are debited to their respective accounts.
TO ILLUSTRATE:
Magaling Computer Store started its operations on January 2, 2016. The store is located in Sikat Mall in Bicol.
The owner invested PHP500,000 to start the business. On January 3, 2016, Magaling purchased 20 computer
units on account for PHP10,000 each. Upon delivery of the units, the supplier Delta, Inc. issued a Charged
Invoice No. 145 to Magaling.
Entry:

PURCHASE RETURNS AND ALLOWANCES

• A purchaser may be dissatisfied with merchandise received because the goods are:
• damaged or defective
• of inferior quality
• not in accordance with the purchaser’s specifications
• The purchaser initiates the request for a reduction of the balance due through the issuance of a debit
memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the seller’s
account has been debited because of unsatisfactory goods.
• A return of the merchandise (a deduction from the purchase price when unsatisfactory goods are kept) is
shown by the entry where Accounts Payable is debited and Merchandise Inventory is credited to show that the
cost of the Merchandise Inventory is reduced with a return or an allowance.
TO ILLUSTRATE: Out of the 20 units of the computers purchased last January 3, 2016, it was found out after
inspection on the same day that one unit was damaged during shipment. Magaling issued a debit memorandum
(DM 01) and informed the supplier that it will return the one damaged unit.
Entry:

ACCOUNTING FOR FREIGHT COSTS

The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods
to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING
POINT AND FOB DESTINATION.
FOB Shipping Point
Goods placed free on board (FOB) the carrier by seller.
• Buyer pays freight costs.
• Merchandise Inventory is debited if buyer pays freight.
• Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately.
Accounts Payable would be credited if on account.
• Ownership over the goods is transferred to the buyer once it is out of the premises of the seller.
FOB Destination
• Goods placed free on board (FOB) at buyer’s business.
• Seller pays freight costs.
• Delivery Expense is debited if seller pays freight on outgoing merchandise to a buyer which is an operating
expense to the seller.
• Ownership over the goods is transferred to the buyer once the goods are delivered and received by the buyer.
TO ILLUSTRATE:
Assuming the supplier of Magaling is based in Manila and in order to bring the 20 computer units to Bicol it will
cost PHP3,000 to deliver the goods.
1. If the term is FOB Shipping Point, the entry to record, assuming Magaling paid in cash the common carrier on
January 4, 2016 is:
Entry:

2. If the term is FOB Destination, no entry is recorded in the books of Magaling. The PHP3,000 will be paid by
the seller, in this case Delta, Inc.
PURCHASE DISCOUNTS:
• Credit terms (specify the amount of cash discount and time period during which a discount is offered) may
permit the buyer to claim a cash discount for the prompt payment of a balance due. If the credit terms show 2/10,
n/30 means a 2% is discount is given if paid within 10 days (called the discount period); otherwise the invoice is
due in 30 days.
• The buyer records this discount as a reduction to Merchandise Inventory.
• A purchase discount is normally based on the invoice cost less returns and allowances, if any.
TO ILLUSTRATE
The credit terms for the purchased of 20 computer units (total cost PHP200, 000) is 2/10, n/30. This means that
if Magaling pays on or before January 13, 2016, it is entitled to a 2% discount. Otherwise, they will have to pay
the full amount on or before February 4, 2016 (30 days after purchase). On January 10, 2016, Magaling paid in
full the account with Delta.
Entry:
Assuming that instead of paying on January 10, 2016, Magaling paid on February 4, 2016, thus forfeiting the 2% discount,
the entry to record is:

Recording of Sales and related transactions under the Perpetual Inventory System
SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER
• Revenues are reported when earned in accordance with the revenue recognition principle; and in a
merchandising company, revenues are earned when the goods are transferred from seller to buyer.
• All sales should be supported by a document such as a cash register tape (provide evidence of cash sales) or
cash receipt or office receipt for cash sales, and charge invoice for credit sales or sales on account.
• Two entries are made with each sale:
The first entry records the sale:
• Debit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which increases assets
for the sales amount
• Credit — Sales which increases revenues
• The second entry records the cost of the merchandise sold:
• Debit — Cost of Goods Sold which increases expenses
• Credit — Merchandise Inventory which decreases assets
• The sales account is credited only for sales of good held for resale. Sales of assets not held for resale (such
as equipment, buildings, land, etc.) are credited directly to the asset account.
TO ILLUSTRATE:
Assume that no freight costs were incurred when the 20 computer units were purchased.
For the month of January, Magaling made the following sale:
1/10/2016 Official Receipt (OR) No. 001 Sold two units for cash to Marie Cruz for PHP36, 000 (PHP18,000 per
unit), FOB Destination
1/15/2016 Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500 (PHP19,500
per unit) with terms 3/10, n/ 30, FOB Shipping Point.
Entry:
FREIGHT TERMS: FOB DESTINATION — SELLER PAYS FREIGHT
• An entry is made when seller pays the freight to deliver goods to a customer or buyer. If the buyer will pay for
the freight, no entry is made.
• Debit — Delivery Expense and credit — Cash or Accounts Payable.
TO ILLUSTRATE:
On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two units to Marie Cruz

Take note that no entry will be made as to the sale to Rafael Reyes since the term is FOB Shipping Point.
SALES RETURNS AND ALLOWANCES:
• Sales Returns result when customers are dissatisfied with merchandise and are allowed to return the goods to
the seller for credit or a refund.
• Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from the selling
price.
• To grant the return or allowance, the seller prepares a credit memorandum to inform the customer that a credit
has been made to the customer’s accounts receivable.
• Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a reduction
to a particular account.
• A contra account is used, instead of debiting sales, to disclose in the accounts the amount of sales returns and
allowances.
• This information is important to management, as excessive returns and allowances suggest inferior
merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in delivery or shipment of
goods.
• The normal balance of Sales Returns and Allowances is a debit.
• Two entries are made with each sale return and allowance:
• The first entry records the sales return or allowance:
• Debit —Sales Return and Allowances which decreases revenues for the amount of the sale
• Credit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets
• The second entry records the increase in Merchandise Inventory:
• Debit — Merchandise Inventory which increases assets
• Credit — Cost of Goods Sold which decreases expenses
TO ILLUSTRATE:
On January 16, 2016, Rafael Reyes returned one unit of the computers purchased last January 15, 2016 under
Charge Invoice 001. The unit returned was in good condition. However, Rafael Reyes returned the unit because
it is one unit more than what they need. The return was approved and accepted by Magaling. The price will be
deducted from the account of Rafael Reyes.
Entry:

SALES DISCOUNTS
1. A sales discount is the offer of a cash discount to a customer to encourage them to pay the balance at an
earlier date.
2. An example of a discount term is commonly expressed as: 2/10, n/30, which means that the customer is given
2% discount if payment is made within 10 days. After 10 days there is no discount, and the balance is due in 30
days.
3. Sales Discounts is a contra revenue account with a normal debit balance.
TO ILLUSTRATE:
Assume Magaling purchased five units of computers on cash for PHP10,000 per unit from a supplier on January
17, 2016 that were subsequently sold to Jun Cruz on January 18, 2016 under Charge Invoice (ChI) No. 002
amounting to PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB Shipping Point. On January 23, 2016,
Cruz paid the said account in full.

Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the 2% discount because
he made the payment within the discount period. Take note that the discount period in this case is from January
19, 2016 to January 28, 2016 (10 days).
What If Jun Cruz paid the account on January 30, 2016 instead of January 23, 2016? The entry should be:
Determining Cost of Goods Sold under the Perpetual Inventory System
The Cost of Goods Sold under the perpetual inventory system is determined by getting the running balance in
the general ledger of the account. Recall the previous discussion on posting the journal entries to the general
ledger. At any point in time, you can determine the cumulative cost of goods sold under the perpetual inventory
system because in this system a separate general ledger for “Cost of Goods Sold” is maintained.
THE FLOW OF INVENTORY COSTS Under the periodic inventory system, physical count is necessary to
determine the ending balance of merchandise inventory. After the count, the costs of these inventory items will
be computed. There are instances that the unit prices for merchandise purchased are different. Consider this
scenario:

During the month of January the total sales in units is 7,000. Therefore, the ending inventory in units is 3,000
cans of sardines (1,000+5,000+4,000-7,000). The problem now is the unit cost that will be used to determine the
value of the ending inventory. This is where the cost flow assumption is needed.
The two most commonly used cost flow assumptions are:
• Average Cost Using the above example, average unit cost is simply computed by dividing the total cost
(PHP113,000) by total quantities (1,000+5,000+4,000) 11,000. Average unit cost is PHP11.30 The cost of
merchandise inventory ending is 3,000 x PHP11.30 = PHP33,900
• First in, First Out (FIFO) As the name implies, FIFO involves the assumption that goods sold are the first units
that were purchased - that means the oldest goods on hand. Thus, the remaining inventory is comprised of the
most recent purchases. Applying this to the problem above, the 7,000 units sold were taken from:

Therefore, the ending inventory will come from the January 20 purchases: 3,000 @ PHP12 = PHP36,000

References:
Joselito G. Florendo. Fundamentals Of Accountancy, Business, and Management 1 First Edition. (Manila Rex
Book Store, 2016).
Anastacio, Ma. Flordeliza. Fundamentals of Financial Management (with Industry Based Perspective). ( Manila:
Rex Book Store, 2011).
Gilbertson, Claudia. Fundamentals of Accounting. 8th ed. (Australia: Cengage Learning, 2010).
Padillo, Nicanor, Jr. Financial Statements Preparation, Analysis and Interpretation. (Manila: GIC Enterprises,
2011).
Pefianco, Erlinda C. The Accounting Process: Principles and Problems. (Makati: Goodwill Trading, 1996).
Young, Felina C. Principles of Marketing. (Manila: Rex Book Store, 2008).