Unit 1 Accounting for Merchandising Business Overview Background
Merchandising business deals primarily with the buying and selling of finished goods. This unit will introduce readers on the different activities done by a trading business. A brief discussion of the perpetual inventory systems is also included.
Purpose
The purpose of Unit I “Accounting for Merchandising Business ” is to illustrate the various buying and selling activities of a trading business. This unit also illustrates the basic entries using perpetual inventory system. A brief discussion of business documents are also included to give readers ideas of what are the basic papers being used that support a merchandising transaction.
In this unit
This unit contains the following topics: Topics Merchandising Business Inventory System Merchandise Accounts Business Documents Proprietor’s Investment and Withdrawal Purchase of Merchandise Purchase Returns and Allowances Discounts on Purchases Sales Sales Returns and Allowances Discounts on Sales Freight on Merchandise Income Statement
See Page 2 of F 3 of F 7 of F 9 of F 14 of F 15 of F 18 of F 20 of F 25 of F 27 of F 28 of F 29 of F 33 of F
Page 1of F
Merchandising Business Overview
An organization that is engaged in the buying and selling of goods or merchandise is a merchandising or trading concern. Merchandise refers to goods purchased for resale in the same form. Unlike businesses rendering services for compensation, a trading concern derives its income through the resale at a profit of the merchandise purchased.
Activities
The activities of a merchandising concern that distinguish it from a service concern cover the following: •
Purchasing. Information as to the kind, quality, quantity, and cost of goods bought should be maintained for the use of management. Records as to supplies or merchandise bought are also maintained.
•
Handling. The costs of transporting and sorting of goods bear an important relation to the prices of goods bought. These should be recorded properly. Transportation costs include freight, express, drayage, and cartage.
•
Returning Of Goods Purchased. Some of the merchandise received may prove unsatisfactory and must be returned to the vendors, or if not returned, may be allowed some deductions from the original purchase price.
•
Selling. Goods purchased are sold at prices above the cost in order to provide adequate margin of profit. It is therefore imperative that the cost of goods bought should be known from the accounting records so that desirable selling prices may be set.
•
Returning Of Goods Sold. The customers may return some of the merchandise sold. Deductions from the original selling prices must be allowed for sales returns. If the goods delivered are defective and no return is made, the customers are granted reduction on the sales price.
•
Maintaining Adequate Stocks On Hand. In order to satisfy orders of customers at all times, a stock of merchandise must be maintained on hand. This is called Merchandise Inventory or Inventory on Hand
Page 2of F
Inventory System Overview
A business firm selling a product must use an inventory record system to value the merchandise on hand at the end of an accounting period. Two different inventory systems may be used to record trading transactions in the accounting records. These systems are the periodic and perpetual inventory system.
Perpetual
In a perpetual inventory system a continual, or perpetual, record of the inventory activity is maintained. Consequently, any items that are sold or otherwise physically removed from inventory must be removed from the Merchandise Inventory account, and items that are purchased are added to the Merchandise Inventory account. This may result in significant extra record keeping as compared to a periodic system. However, a perpetual inventory system does have advantages, and businesses with a relatively low number of high-value transactions often find the extra effort to be worthwhile. Computers are also making it practical for businesses to use perpetual systems than would have been not feasible in the past.
Periodic or Physical
In the periodic inventory system, the ending inventory is determined by a physical count of the merchandise on hand at the end of an accounting period. The periodic inventory system receives its name because the balance in the inventory account is known only at the beginning and at the end of the accounting period. The periodic inventory is the simpler system commonly used in practice and was the only practical alternative for most businesses with large number of transactions before the advent of computers. The periodic inventory system will be used in the illustrations throughout this course unless otherwise stated. Continued on next page
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Inventory System, Continued Transactions in Perpetual Inventory System
As mentioned earlier, a perpetual inventory system attempts to maintain a continual record of the inventory on hand. Thus, if Joseph Labrador purchased merchandise for cash, P50,000, the entry to record this transaction is : Merchandise Inventory Cash To record merchandise bought.
50,000
50,000
On the other hand, if Joseph sold P20,000 worth of merchandise for P40,000, the entry to record this transaction is: Cash Sales To record merchandise sold.
40,000
Cost of Goods Sold Merchandise Inventory To record the transfer of inventory sold to cost of goods sold account.
20,000
40,000
20,000
Assuming this time, Joseph Labrador purchased from Mary Trading merchandise on account, Php 100,000. And at the same time, paid for the freight on the said purchase, Php 2,500. The entries would be: Merchandise Inventory Accounts Payable To record merchandise bought.
100,000
Merchandise Inventory Cash To record freight paid.
2,500
100,000
2,500
Continued on next page
Page 4of F
Inventory System, Continued Transactions in Perpetual Inventory System, con’t.
Let us say, after two days, Joseph returned defective merchandise bought from Mary amounting to Php 5,000. The entry would be: Accounts Payable – Mary Trading 5,000 Merchandise Inventory 5,000 To record returned merchandise. If on the other hand, Joseph Labrador sold to Michael Supermart merchandise worth Php 50,000 on account at gross profit of 50 percent. The entries would be: Accounts Receivable 50,000 Sales 50,000 Sold merchandise on account. Cost of Goods Sold 25,000 Merchandise Inventory 25,000 To record cost of merchandise sold. Let us assume again that after three days, Michael issued a debit memorandum amounting to Php 1,800 for defective goods received from Joseph. The entries to record the return would be: Sales Returns & Allowances Accounts Receivable Received debit memorandum. Merchandise Inventory Cost of Goods Sold To record cost of good returned.
Importance
1,800
900
1,800
900
It is important to note that both periodic and perpetual inventory systems will record the sale of merchandise similarly. The only difference is that under the perpetual inventory system, there is a second entry that is required to be recorded together with the sale to indicate the transfer out of the amount sold from the Merchandise Inventory account to the Cost of Goods Sold account. It is possible to combine the two entries into a single compound entry with the same debits and credits. For example: Cash Cost of Goods Sold Sales Merchandise Inventory To record merchandise sold.
40,000 20,000
40,000 20,000
Continued on next page
Page 5of F
Inventory System, Continued Pro-forma entry
At the end of the year, no further entries may be required if the balance in the inventory account equals the actual cost of the units on hand. Unfortunately, this seldom happens. Despite the extra effort necessary to maintain a perpetual record of the inventory, the facts often differ from the records. When the facts conflict with the records, the records must be corrected to reflect the facts. Therefore, an adjusting entry is necessary to record any missing inventory items and reduce the balance in the Inventory account to the correct level. The pro-forma entry is: Merchandise Inventory Short or Over Merchandise Inventory To adjust inventory account to actual balance.
xxx
xxx
Merchandise Inventory Short or Over
The Merchandise Inventory Short or Over account is an expense account that reflects the cost of missing inventory items. However, depending on its materiality and on normal practice within the industry, the inventory shrinkage amount is often combined with cost of goods sold in the financial statements.
Net Income
The net income disclosed on the income statements prepared under the two inventory systems will reflect the same amount. This is also true with the ending inventory balance reported in the balance sheet. A business that combined its Merchandise Inventory Shrinkage account with its Cost of Goods Sold account would prepare an income statement identical to the one prepared under the periodic inventory system.
Page 6of F
Merchandise Accounts Overview
The discussions on this topic are the account titles to be used in recording acquisition and sale of merchandise of a trading business using the periodic inventory system.
Sales
Sales of merchandise are recorded in this account at selling prices. This is a temporary or nominal account representing income from selling of merchandise. This account has a normal credit balance
Sales Returns and Allowances
This account is debited for all the merchandise returned by customers. The debit entry is at the original selling price of the merchandise. This account is also being used for all goods delivered to customers but is found to be defective or not as ordered and still the buyer desiring to retain the goods as is. The customer in this case is normally permitted to deduct a certain amount from the selling prices of the goods delivered.
Sales Discount
This account is debited in the book of the seller whenever the buyer avails of the cash discounts provided by the seller. This is a deduction from sales account.
Purchases
This is a temporary account to which the cost of goods bought during the period is debited. This account usually has a debit balance at the end of the accounting period.
Purchase Returns and Allowances
Goods bought and returned to supplier, or goods bought and received as defective, or not as ordered, when not returned to the supplier but is subjected to a certain reductions from their acquisition prices. These deductions and returns of purchased goods are credited to this account. Purchase returns and allowances account is a deduction from the Purchases account. Continued on next page
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Merchandise Accounts, Continued Merchandise Inventory
At the end of every accounting period, a physical count of the unsold merchandise on hand is taken. The total amount of these goods on hand is debited to the Merchandise Inventory account.
Purchase Discount
This account is credited in the books of the buyer whenever the purchaser avails of the cash discount given by the seller. This is a deduction from Purchases account.
Freight In or Transportation In
If the buyer pays the expenses of transporting the goods from the place of the seller to his place of business, such expenses are debited to the Freight-in account.
Freight Out or Transportation Out
If the seller pays the expenses of transporting the goods from his place to the place of the buyer, such expenses are debited to the Freight out account. This is reported as part of operating expenses under the selling expenses classification.
Page 8of F
Business Documents Overview
All business transactions are evidenced or supported by printed forms or documents. These business papers or oftentimes-called business documents, furnish the information needed in recording the transactions. Without business papers, it would be very difficult, if not impossible, to keep accurate records of these transactions.
Official Receipts
These are issued every time the business receives cash. They show the date on which the cash is received, the party from whom the cash is received, the amount received, the particulars of the transaction, and the signature of the one who received the cash. The sample given below is an official receipt of MDV Realty issued to Mayon Grocery. From the point of view of MDV Realty, there was an increase in both the asset cash and the income from rent. On the other hand, the asset cash of Mayon Grocery decreased, while its rental expenses increased, thus decreasing its proprietorship.
MDV REALTY 150 Rizal Avenue Manila OFFICIAL RECEIPT No. __120____ Date ___June 30, 20X1______ RECEIVED from _____Mayon Grocery________ the sum of _____Ten Thousand___ pesos (P10,000.00) in payment of ___July rental__. Cash_____P10,000 Check No._
_________________________ (Cashier)
Continued on next page
Page 9of F
Business Documents, Continued Sales Invoice and Purchase Invoice
After a sale has taken place, the seller fills in the business form called the invoice. The invoice shows the date of the sale, name and address of the seller, name and address of the buyer, terms of the sale, list of articles bought with the unit price and entire cost of each, total amount of the invoice, and method of shipment. Invoices are numbered and usually made out in triplicate or quadruplicate. The original is given to the buyer. When the buyer receives the goods, they are examined. Then the invoice is checked to determine whether there are any discrepancies in quantity or price and any errors in calculation. From the point of view of the seller, the invoice is a sales invoice; from that of the buyer, it is a purchase invoice. The sample given below shows that from the standpoint of the seller, Diamond Grocery, the invoice price of P1,750 is the gross income from sales, which covers the cost of the juice sold and the gross profit. There was an increase in assets in the form of an amount receivable from Mayon Grocery, there was an increase in cost of merchandise available for sale and an increase in liabilities (the amount of P1,750 is payable within 30 days).
DIAMOND GROCERY 930 Del Monte Avenue Quezon City INVOICE Sold to: ______Mayon Grocery____ Address __945 Mayon St., Q.C.____ Quantity 50 boxes
DESCRIPTION Happy Orange Juice Drink
No. ___532___ Date ______June 10, 20X1_____ Term: ___Net 30 days _______ Unit Price P 60.00
Amount P 3,000.00
Continued on next page Page 10of F
Business Documents, Continued Credit Memorandum
Whenever the buyer finds an error in an invoice, or when merchandise is damaged, he should notify the seller at once. If his claim is admitted as valid, the seller sends him a credit memorandum, which shows the amount by which his account is reduced. Credit memorandum is often shortened to credit memo. The credit memo illustrated below shows that because of the return of two boxes of Funchum juice drink, the gross income from sales of Diamond Grocery decreased, and the amount receivable from Mayon Grocery (asset) decreased. From the point of view of Mayon Grocery, the merchandise available for sale and also the debt to Diamond Grocery decreased.
DIAMOND GROCERY 930 Del Monte Avenue Quezon City CREDIT MEMO To: ______Mayon Grocery____ __945 Mayon St., Q.C.____
No. ___121___
Date ______June 15, 20X1_____
We have credited your accounts as follows: Inv. No. 532
Explanation Return of two boxes of slightly defective Happy orange juice drink.
Unit Price P 35.00
Amount P 70.00
Continued on next page
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Business Documents, Continued Promissory Notes
Php 10,000
A promissory note is a written promise signed by one party, called the maker, to pay a certain specified sum to another, called the payee, at a certain future time. The amount to be paid on maturity date may or may not include interest. The amount due, not including interest, is called the face of the note. Promissory notes may be received by the business from its debtors, or the business may give it to its creditors. The following is a sample of a promissory note. Quezon City, May 1, 20X1
Thirty days after date, I promise to pay to the order of Joseph Labrador, Ten thousand Pesos, payable at COCOBANK, Vito Cruz Branch for value received with interest at 12%. (Signed) Maria de Jesus
Bank deposit For control and safekeeping of cash most businesses maintain checking or slips and checks current accounts with the banks. They deposit their money in banks and
payments from the deposit are then made by means of checks.
The bank deposit slip is filled in every time the business deposits money in the bank. It shows the date when the deposit is made, for whose account the deposit is made, the amount of the deposit classified into currency and checks received from others, and the signature of the depositor. Continued on next page
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Business Documents, Continued Check
An order to the bank signed by the person issuing it, to pay to bearer or order a certain sum of money. After the bank has paid the payee, the amount is deducted from the deposit account of the one who issued the check.
Cash register slips
Some cash registers are operated in such a way that a strip or slip of paper comes out as evidence that money was received. The slip shows the date and the amount of cash received.
Miscellaneous bills
Some businesses, like the Meralco, Philippine Long Distance Telephone Co., MWSS, etc., send bills to their customers to notify them of the amounts they have to pay. Thus, there are advertising bills, light bills, water bills, telephone bills, and others.
Page 13of F
Proprietor’s Investment and Withdrawal Overview
Owners of merchandising firms may want to invest merchandise into its business operations. The following are the entries that would be recorded under the periodic inventory system if the proprietor invests or withdraws merchandise.
Investment of merchandise
Recording of the investment of the owner in the business will be treated in the same way the recording is done in a service business. The only difference would be if the owner invested an asset into the business in the form of merchandise. When merchandise is part of the owner’s initial investment, the said investment must be debited to the Merchandise Inventory account whether the company is using perpetual or periodic inventory system. But if the investment of merchandise was made during the normal operation of the business, i.e., as an additional investment, the said investment must be debited to Merchandise Inventory, if the company is using perpetual inventory system and Purchases if they are using the periodic inventory system. Pro-forma entry: Initial investment under both methods: Date Merchandise Inventory xxx Owner, Capital xxx Investment made in the form of merchandise. Pro-forma entry: Additional investment Perpetual Method Periodic Method Date Merchandise Inventory xxx Purchases xxx Owner, Capital xxx Owner, Capital xxx Investment made in the form of merchandise.
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Withdrawal of merchandise
Any subsequent withdrawal made by the owner of any asset/s in the business (e.g., cash, supplies, etc.) in anticipation of future profits of the company (i.e., temporary withdrawal) will be debited to the drawing account. Withdrawals that are permanent in nature (i.e., the owner has no intention of returning the said amount into the business) will be debited directly to the capital account. If the company uses the periodic inventory system, withdrawals of the owner in the form of merchandise for personal use will be credited to the Purchases account at cost. This is done in order to maintain the original balance of the Merchandise Inventory account, which was computed by means of actual physical count at the end of the accounting period. On the other hand, the Merchandise Inventory account is credited if the firm uses the perpetual inventory system. Pro-forma entry: Periodic inventory system/Temporary withdrawal Date
Owner, Drawing xxx Cash xxx Purchases xxx Owner withdrew cash and merchandise for personal use.
Pro-forma entry: Perpetual inventory system/Temporary withdrawal Date
Owner, Drawing xxx Cash xxx Merchandise Inventory xxx Owner withdrew cash and merchandise for personal use.
Pro-forma entry: Permanent withdrawal Date
Owner, Capital xxx Cash xxx Owner permanently withdrew an amount in the business for personal use.
Page 15of F
Purchase of Merchandise Overview
When a firm sells goods or services, it gives a sales slip or sales invoice to its customers. This sales invoice becomes a purchase invoice as far as the purchasing business is concerned. The purchase invoice provides the objective information used to record purchasing transactions. In small business firms, the only written document received or handled in purchases of goods or services is this invoice. For such businesses, authorization for purchases is given informally by telephone or by having an employee personally purchases goods or services. In this part, we would be dealing with transactions affecting the firm’s acquisition of the merchandise for sale. As we have mentioned earlier, all our business transactions must be properly supported by business documents.
Purchase Requisition
Large companies rely on a more careful procedure. As a first step they may insist that the person or department needing the goods or services to be purchased fill out a form called a purchase requisition. This completed form, bearing the signature of some responsible person authorized to approve such requisitions, is next sent to the purchasing agent or purchasing department of the company.
Purchase Order
The purchasing department, after selecting the firm from whom the goods or services are to be bought, prepares a second business paper called a purchase order. The original copy of this document is sent to the company from which the purchase is to be made. This copy gives the selling business authority to send the purchaser the goods or services ordered.
Purchase Invoice
About the same time that shipment of the goods is made or services are supplied to the purchaser, the purchaser is sent an invoice that is the third business paper. This purchase invoice becomes the basis for recording the purchase in the journal just as it is in the case of the informal procedure described for small firms. Continued on next page
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Purchase of Merchandise, Continued Purchases
The cycle of a merchandising entity begins with cash, which is used to purchase inventory. Purchases, in the accounting sense, are only those items of merchandise inventory that a firm buys to resell to customers in the normal course of business. For example, a bookstore records in the purchases account the price it pays for books, school and office supplies, and other items of inventory acquired for resale. A grocery store debits purchases when it buys canned goods, meat, frozen food and other inventory. Below is a sample purchase invoice: DE ASIS TRADING 2401 Taft Avenue Manila
Sold to : Labrador Store Address : Blk 28, Lot 24 St. Charbels, Cavite How shipped : FOB Destination, prepaid Quantity Description 10 dozen Lady’s Sando 10 dozen Men’s Undershirt 10 pcs. Girl’s Dress
Prepared by : ----------------
Checked by : ----------------
Invoice No. 143 Date : Jan. 7, 20X1 Terms 2/10, n/30 Unit Price Amount 25 P 3,000.00 40 4,800.00 95 950.00 P 8,750.00 ========= Approved by: -----------------
Continued on next page
Page 17of F
Purchase of Merchandise, Continued Journal Entries
The purchase made on credit by Labrador Store is recorded in the general journal as follows: Jan. 5 Purchases 8,750 Accounts Payable - De Asis Trading 8,750 Purchased under wears and children’s dresses. Terms: 2/10,n/30. If the above purchase was made on cash basis instead of on credit, then the journal entry of Labrador Store will be: Jan. 5 Purchases Cash Cash purchases from De Asis Trading.
8,750
8,750
If the above purchase was made with down payment of P4,000 and the balance on account, then the journal entry of Labrador Store will be: Jan. 5 Purchases 8,750 Cash 4,000 Accounts Payable 4,750 Various purchases. Terms: 4,000 down, balance, 2/10, n/30. Merchandise purchased with value added tax (VAT) is recorded using the following pro-forma journal entry: Purchases Input Tax Accounts Payable Purchased merchandise on account.
xxxx xx
xxxx
Page 18of F
Purchase Returns and Allowances Overview
Merchandise purchased for resale would not always be as what the buyer expects. In this regard, buyers can return goods purchased due to a lot of reasons, for example, due to defects, wrong specifications, poor quality, etc.
Debit Memorandum
When merchandise bought is returned, or an allowance is requested, the buyer informs the seller in writing. The communication is done usually through the buyer’s printed business form called debit memorandum. An illustration of such a form is shown below:
Labrador Store Blk 28, Lot 24 St. Charbel’s Dasmarinas, Cavite
No. 8
DEBIT MEMORAMDUM To
Date : Jan. 8, 20X1
: De Asis Trading 2401 Taft Ave., Manila
We DEBIT your account for the following: 2 pcs. 5 pcs. 1 pc.
Lady’s Sando Men’s Undershirt Girl’s dress
P25 40 95
P 50 200 95 -------P 345 =====
Remarks: The above goods were received in damaged-condition as per your invoice No 143 dated Jan. 5, 2001.
Continued on next page
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Purchase Returns and Allowances, Continued Credit Memorandum
If the return is accepted or the allowance is granted by the seller, the seller usually sends to the buyer such acceptance or grant in writing through a printed form called credit memorandum. A credit memorandum may in similar form as the debit memorandum above except for the change of the word debit to credit. Upon receipt of this communication, the buyer makes an entry for the returns or allowances
Illustration
Assume the following transactions: Jan. 8, 20X1 - Labrador Store returned P343 worth of merchandise to De Asis Trading. This was accepted by De Asis Trading (see sample debit memorandum). Journal entry to record the return: Jan. 8 Accounts Payable - De Asis Trading Purchase returns and allowances Merchandise returned to De Asis Trading.
345
345
Note: As a result of the returns, the debt to De Asis Trading was diminished, thus, the seller’s account was debited. The return was credited to purchase returns and allowances account instead of directly against purchases in order to have the books show total purchases and total returns and allowances. If the purchase of January 5 was in cash, the return of goods worth P343 on Jan. 8 may result in a refund of cash from De Asis Trading. If no cash refund is made, then Labrador Store will have a receivable from the De Asis Trading which may be collected or applied to purchases in the future. Jan. 8 Cash Purchase returns and allowances Cash refund for the return of goods
345
345
However, if the return on Jan. 8 was not refunded in cash, then the journal entry should have been: Jan. 8 Accounts Receivable - De Asis Trading 345 Purchase returns and allowances To charge De Asis Trading for goods returned.
345
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Discounts on Purchases Overview
Buyers of merchandise can avail of two types of discounts, namely, the cash discount and trade discount. This part will provide readers on how to record discounts on merchandise purchased.
Cash Discounts
Special deductions from the prices of goods bought granted by the seller to the buyer to induce the latter to pay within a specified period. Example: Jan. 5, 20X1 Labrador Store bought merchandise from De Asis Trading P8,750. Terms: 2/10, n/30 The terms of the above transaction mean that if the invoice is paid within 10 days after the date of the invoice (Jan. 6 to 15), Labrador Store may pay the invoice amount less a discount of 2%. This is computed as follows: Amount of invoice Less: 2% thereof Amount to be paid
P8,750 175 P8,575 ====== If payment is not made within 10 days, then Labrador Store should pay the full amount of the invoice, P8,750, within 30 days from the date of the invoice. If the invoice remains unpaid after 30 days, it is said to be past due and, usually, the amount begins to earn interest from the 31st day. Other examples of terms attached to a credit invoice are: 5/10, n/30
- There is a 5% discount if paid 10 days after invoice date, net amount if paid beyond the 10 days but within 30 days.
2/10, 1/15, n/30 - There is a 2% discount if paid 10 days after invoice date, 1% discount if paid within fifteen days, net amount if paid beyond 15 days but within 30 days. 2/5EOM, n/45 - There is a 2% discount if paid 5 days after end of the month, net amount if paid beyond 5 days after end of month but within 45 days from the invoice date. 2/10, n/EOM
n/60
- There is a 2% discount if paid 10 days after invoice date, net amount if paid beyond the 10 days but up to end of the month only. - No cash discount is offered. The full amount must be paid within 60 days from invoice date.
Cash discounts are computed on the amount of the bill less returns and allowance, if any. The base amount should be that which pertains only to merchandise. Discounts are ordinarily not allowed on incidental expenses such as freight, insurance while in transit, taxes, duties, and other charges. Continued on next page
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Discounts on Purchases, Continued Recording of Cash Discounts
Below are sample transactions involving the recording of cash discounts: Transactions 20X1 Jan. 4 7 14 18 21 -
31 -
Mary Store purchased merchandise from Uniwide Trading, P10,000. Terms: 2/10, n/30 Mary Store made a partial payment of P5,000 to Uniwide Trading Mary Store paid in full its account to Uniwide Trading Mary Store purchased merchandise from SM Superstore worth P25,000. Terms: P10,000 down payment, balance 2/10, 1/15, n/30. Mary Store returned to SM Superstore P500 cost of merchandise acquired on Jan. 18. SM Superstore in return issued a credit memo with the same amount-signifying acceptance of the return made by Mary. Mary Store settled in full its account with SM. Continued on next page
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Discounts on Purchases, Continued Recording con’t
Continuation of the recording of discounts:
Journal Entries: 20X1
Jan.
4 Purchases 10,000 Accounts Payable - Uniwide Merchandise purchased. Terms: 2/10,n/30. 7 Accounts Payable - Uniwide Cash Partial Payment.
5,000
14 Accounts Payable - Uniwide Cash Purchase Discounts Full payment.
5,000
18 Purchases Cash Accounts Payable-SM Bought merchandise. Terms: 2/10,1/15/n/30.
25,000
21 Accounts Payable - SM Purchase Returns and Allowances Received CM for merchandise returned. 31 Accounts Payable - SM Purchase Discounts Cash Settled account in full.
10,000
5,000
4,800 200
10,000 15,000
500
14,500
500
145 14,355
NOTE: The cash discount in the last entry was computed on the net amount after deducting the returns. Continued on next page
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Discounts on Purchases, Continued Trade Discounts
Deductions from the list prices of merchandise offered by the seller to the buyer to encourage the latter to buy in bulk or large volume/quantity. This is a strategy being adopted by the seller to promote the sale of the merchandise. A list price may be subjected to one or more trade discounts
Illustration
Trade Discounts and Cash Discount Illustrated: a. Assume a credit invoice of P3,000 less 10. Terms: 2/10,n/30. List price Less: trade discounts(3,000x10%) Net invoice price Less: Cash discounts(2,700x2%) Amount due if payment is made with in 10 days
P3,000 300 P2,700 54 P2,646 =====
b. Assume a credit invoice of P5,000 less 10-5. Terms: 2/10,n/30. List price Less: First trade discounts(5,000x10%) Less: Second trade discounts(4,500x5%) Net Invoice price Less: Cash discounts(4,275x2%) Amount due if payment is made w/in 10 days
P5,000.00 500.00 P4,500.00 225.00 P4,275.00 85.50 P4,189.50 ========
Continued on next page
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Discounts on Purchases, Continued Journal Entries
The journal entries on buyer’s book for (b): At the time of purchase Purchases Accounts Payable Purchased merchandise on account.
4,275.50
Payment within 10 days Accounts Payable 4,275.50 Purchase discounts Cash Settled accounts in full with in discount period Payment beyond 10 days Accounts Payable Cash Paid account in full. Summary
4,275.50
4,275.50
85.50 4,189.50
4,275.50
The purchase invoice is the business document generated by a purchase transaction. Most merchandising entities offer discounts (i.e. cash and trade discounts) to their customers. Trade discounts are not recorded in the books of both buyer and seller. While cash discounts are recorded in the buyer’s book under the account title Purchase Discount. The Purchase Discount account, which has a credit balance, is a contra account to Purchases. Most businesses allow their customers to “return” merchandise that is defective, damaged in shipment, or otherwise unsuitable. Or if buyer chooses to keep damaged goods, the seller may deduct an allowance from the amount the buyer owes. Similar to purchase discount, Purchase Returns and Allowances, the account title used to record returns and allowance granted, is also a contra purchases account.
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Sales Overview
The sale of merchandise may be for cash or on account. An invoice supports every sale. The seller’s sales invoice is the buyer’s purchase invoice. When a sale is for cash, the seller receives money in return for his merchandise. When the sale is made on credit, the seller acquires a receivable or right to collect from the buyer. The preceding discussion on methods of recording merchandise inventory transactions stated that under the periodic inventory method, purchases represent the cost of merchandise bought. Sales, on the other hand, represent the selling price of merchandise previously bought and then sold. In the income statement (See sample on page 36 of F), Sales is shown as an income item from which the cost of goods sold (consisting of merchandise inventory beginning and end and net cost of purchases), was deducted, the difference being the gross profit. Therefore, sales represents income, which covers both the cost of merchandise, sold and gross profit (or gross loss). In the following discussions, it was assumed that merchandise is sold normally at a profit, i.e., the selling price of the merchandise sold is greater than its cost. It is very important to note that a purchase and sales transaction involve two parties; namely, the buyer and the seller. Furthermore, a business acts sometimes as a buyer and sometimes a seller. The analysis of a purchase and sale transaction would depend on whether the business for which the accounting work is being done, is playing the role of a buyer or that of a seller. The treatment therefore, for cash discount and returns and allowances on this part will also be similar to that discussed under purchases, only this time the account titles to be used would be Sales discount and Sales returns and allowances. Continued on next page
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Sales, Continued Cash Sales
Retailers like drug stores, sari-sari stores, department stores and restaurants will at times sell their merchandise on cash basis. Assuming Mary Store sold P5,000 worth of merchandise for cash, this cash sale is recorded as follows: Jan. 10
Sales on Account
Cash Sales Cash Sales.
5,000
5,000
Most business establishments are now extending credit to their customers to become competitive. In the advent of what we call “plastic money”, i.e., credit cards, selling on account has been the current trend whether you are a manufacturing business, wholesaler or retailer. Assuming Mary Store sold merchandise worth P7,000 on account. The transaction is recorded as follows: Jan. 13
Account receivable 7,000 Sales 7,000 Sold merchandise on account. The related cash receipt on account is recorded as follows: Jan. 20
Cash 7,000 Accounts receivable 7,000 Collected account in full. Merchandise sold with value added tax (VAT) will be recorded using the following pro-forma journal entry: Accounts Receivable Sales Output Tax Sold merchandise on account.
xxxx
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xxxx xx
Sales Returns and Allowances Overview
When the customer returns goods to the seller or requests for a deduction from the price of the goods delivered to him, the seller accepts the return or grants the request through a credit memorandum.
Entries
The effect of a sales return or allowance is to reduce the amount of sales and the amount of receivable from the customer. If Sales account is debited for the return or allowance, then, the said account will show only net sales. To preserve the gross amount of sales and to maintain a separate record for the returns and allowances, the entry to record sales returns or allowances is: Sales Returns and Allowances Accounts Receivable Return of goods.
xxx
xxx
If a cash sale is made and a return of a part thereof by the customer is accepted, the seller may refund cash to the customer for which the entry is: Sales Returns and Allowances Cash Cash refund for good returned.
xxx
xxx
However, if cash is not refunded, then the entry will be Sales Returns and Allowances Accounts Payable Customer credited for goods returned.
xxx
xxx
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Discounts on Sales Overview
Credit terms encountered in sales are similar to those discussed in accounting for purchases. The following are illustrations on how to record sales transactions with cash discount.
20X1 Jan. 4 7 10 14 Journal Entries
Sold to Francis Asis merchandise worth P12,000 less 5. Terms: 2/10, n/30 Francis Asis issued a debit memo worth P500 for defective items received from Joseph Made partial payment amounting to P5,000 Francis Asis settled account with Joseph in full
The following are the journal entries: 20X1 Jan.
4 Accounts receivable - Asis Sales Sold merchandise. Terms: 2/10, n/30 7 Sales returns and allowances
11,400
11,400
500
Accounts receivable - Asis
500
Asis was credited for allowance granted 10 Cash
5,000
Accounts receivable - Asis
5,000
Received partial payment 10 Cash
Sales discount
5,682 218
Accounts receivable - Asis
5,900
Asis settled account in full
Page 29of F
Freight on Merchandise Overview
Transportation or freight on merchandise purchased or sold is recorded as an expense in the books of the party who, as per contract, should shoulder the expense.
Shipping Terms
Freight-in is the title used in recording the freight or transportation charges on merchandise bought, and Freight-out, for the freight on merchandise sold. The term of shipment that is contained in the bill of lading indicates whether or not the buyer or the seller should assume the burden of the freight expense (Punzalan, J., Santos, L., 1963). Merchandise may be shipped under the following terms: •
F.O.B shipping point means that the goods are free on board up to the shipping point. Therefore, if the seller is in Davao and the buyer is in Manila, the seller absorbs all transportation expenses up to the port of Davao only. This also signifies that title to the goods already passes to the buyer upon the loading of the goods onto the carrier at Davao.
•
F.O.B destination means that the goods are free on board up to the point of destination. If the seller is in Davao and the buyer is in Manila, the seller absorbs all transportation expenses of the goods up to Manila. The title of the goods passes to the buyer only upon the unloading of the goods from the carrier in Manila.
•
Freight prepaid means that the seller has paid the shipping company the transportation expenses up to the point of destination.
•
Freight collect means that the buyer should pay the shipping company upon the delivery of the goods at the point of destination. Continued on next page
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Freight on Merchandise, Continued Illustration No. 1
Assume Mr. Vic Cruz of Davao sold to Joseph Labrador of Manila on account. The invoice showed the following: Price of merchandise Freight (to Manila) Total
P 14,000 1,000 P 15,000 ======
1. If the purchase is F.O.B shipping point, prepaid, the journal entry of Joseph is: Purchases P 14,000 Freight-in 1,000 Accounts Payable-Cruz 15,000 Purchased merchandise on account. FOB SP, prepaid. Analysis: The transportation expense to Manila is the expense of Labrador. In as much as Vic Cruz has advanced the amount of freight, then, the amount payable to him should include the said amount of freight. 2. If the purchase is F.O.B shipping point, collect, the journal entries of Labrador are: Purchases Account payable-Cruz Purchased merchandise on account Freight-in Cash Paid freight F.O.B. SP, collect
14,000
14,000
1,000
1,000
3. If the purchase is F.O.B. destination, prepaid, the journal entry of Labrador is: Purchases Accounts payable-Cruz Purchased merchandise on account.
14,000
14,000
Note: The freight is not reflected in the books of Labrador because said expense is for the account of Cruz. Continued on next page
Page 31of F
Freight on Merchandise, Continued Illustration No. 1, con’t.
4. If the purchase is F.O.B. destination, collect, the journal entries of Labrador are: Purchases Accounts Payable-Cruz Purchased merchandise on account. Accounts Payable-Cruz Cash Paid freight F.O.B. destination, collect.
14,000
1,000
14,000
1,000
Note: Labrador is liable to pay Cruz only P13,000 (14,000-1,000). In the foregoing transactions, the entries presented are all in the books of the buyer. Now, using the same transactions, the following are the entries in the books of the seller.
Illustration No. 2
1. If the sale is F.O.B. shipping point, prepaid, the journal entries of Cruz are: Account Receivable- Labrador Sales Sold merchandise on account.
14,000
Accounts Receivable- Labrador Cash Paid freight F.O.B. SP, prepaid
1,000
14,000
1,000
Note: Cruz advanced the amount of freight, which is supposed to be paid by Labrador. Therefore, the amount receivable from Joseph should include the amount of freight. Continued on next page
Page 32of F
Freight on Merchandise, Continued Illustration No. 2, con’t.
2. If the sale is F.O.B shipping point, collect, the journal entry of Cruz is: Accounts Receivable- Labrador Sales Sold merchandise on account.
14,000
14,000
Note: The freight is not reflected in the books of Cruz because the said expense is for the account of Labrador. 3. If the sale is F.O.B destination, prepaid, the journal entries of Cruz are: Accounts Receivable- Labrador Sales Sold merchandise on account Freight-out
14,000
14,000
1,000
Cash
1,000
Paid freight F.O.B. Destination, Prepaid 4. If the sale is F.O.B. Destination, collect the journal entries of Cruz are: Accounts receivable- Labrador Sales Sold merchandise on account Freight-out Accounts receivable- Labrador F.O.B. Destination, collect.
14,000
1,000
14,000
1,000
Note: The total receivable of Cruz from Labrador will be 13,000 only (14,000-1,000), since the payment of freight was advanced by Labrador. Reminder
It should be noted that both freight-in and freight-out represent expense. However, freight-in is shown as an addition to net purchases because it is a direct cost of procuring the merchandise bought. On the other hand, freightout is listed among the selling expenses
Page 33of F
Income Statement Overview
A merchandising business prepares its income statement using the functional. The functional income statement contains several sections, subsections and subtotals. The amount of the details presented in this section, e.g., the selling expenses, general and administrative expenses, etc., varies from company to company
Income Statement Terminologies
Below are the terms used in the income statement: •
Revenue from Sales. The total amount charged to customers for merchandise sold, for cash and on account, is reported in this section. Sales returns and allowances and Sales discounts are deducted from this to yield Net Sales.
•
Cost of Goods (Merchandise) Sold. The cost of merchandise sold during the period may also be called Cost of Goods Sold or the Cost of Sales. It is computed by adding to the beginning inventory the net cost of purchases to yield Total Goods Available for Sale. The ending inventory is deducted from the Total Goods Available for Sales to yield the Cost of Goods (Merchandise) Sold. The net purchases amount is computed by deducting purchase discount and purchase returns and allowances from purchases. Net cost of purchases is computed by adding freight-in to the net purchases amount.
•
Gross Profit. The excess of net sales over the cost of goods sold is called gross profit. It is sometimes called gross profit on sales or gross margin.
. Continued on next page
Page 34of F
Income Statement, Continued Income Statement Terms, con’t
Con’t •
Operating Expenses. Most merchandising businesses classify operating expenses as either distribution expenses, administrative expenses or other operating expenses. However, depending on the decision-making needs of managers and other users of the financial statements, other classifications could be used. Expenses that are incurred directly in the selling of merchandise are distribution expenses. They include such expenses as salespersons’ salaries, store supplies used, depreciation of store equipment, and advertising. Expenses incurred in the administration or general operations of the business are administrative expenses. Examples of these expenses are office salaries, depreciation of office equipment, and office supplies used. Expenses that are related to both administrative and selling functions may be divided into the two classifications. In small businesses, however, such expenses as rent, insurance, and taxes are commonly reported as administrative expenses. Transactions for small, infrequent expenses are often reported as Miscellaneous Selling Expense or Miscellaneous Administrative Expense. Expenses that cannot be traced directly as selling or administrative expenses are identified as other expenses. Examples of these are the losses incurred in the disposal of plant and other assets and Discount lost on the purchase of plant assets. Interest expense that results from financing activities is included in the operating expenses after the other expenses as finance costs. Continued on next page
Page 35of F
Income Statement, Continued Income Statement Terms, con’t
Con’t •
Other Income. Revenues from sources other than the primary operating activity of a business are classified as other income or non-operating income. In a merchandising business, these items include income from interest, rent, and gains resulting from the sale of plant and other assets.
•
Net Income. The final figure on the income statement is called the net income (or net loss). It is the net increase (or net decrease) in the owner’s equity as a result of the period’s profit-making activities. Continued on next page
Page 36of F
Income Statement, Continued Illustration
Below is an illustration of a functional form income statement:
Net sales revenue Cost of sales Gross profit Other income Total income Operating expenses: Distribution expenses Administrative expenses Other expenses Finance Cost Net income Notes to the Functional Form
Note 1 2
P
P
(40,000) 18,000
P
3 4 5 6 7
P
200,000 (145,000) 55,000 3,000 58,000
P 14,000 24,000 800 1,200
The following are the notes to the functional form income statement:
Note 1 - Net sales revenue Gross sales Less: Sales Returns & Allowances Sales Discount
P P
207,000
5,000 2,000
Net sales revenue
7,000 P
200,000
Continued on next page
Page 37of F
Income Statement, Continued Notes to the Functional Form (continued) Note 2 - Cost of sales Merchandise Inventory, Jan. 1 Add: Net cost of purchases Purchases Less: Purchase Returns & Allowances Purchase Discounts Net purchase Add: Freight-in Cost of goods available for sale Less: Merchandise Inventory, Dec. 31 Cost of sales Note 3 - Other income Rent Income Dividend Income Interest Income Gain on Sale of Furniture & Fixtures Total other income Note 4 - Distribution expenses Salesmen's Salaries and Commissions Representation and Entertainment Depreciation - Store Equipment SSS & Philhealth Premiums - distribution Freight-out Miscellaneous Distribution Expense Total distribution expenses Note 5 - Administrative expenses Salaries Expense Light, Water and Telephone Uncollectible Accounts Expense Depreciation Expense SSS & Philhealth Premiums - Administrative Miscellaneous Administrative Expense Total administrative expenses Note 6 - Other expenses Loss on Sale of Equipment
P P 3,000 2,000
P
175,000
P
5,000 170,000 1,000
P P P
P P
P P
P
5,000
171,000 176,000 31,000 145,000 1,500 800 500 200 3,000 9,000 1,200 1,000 900 800 1,100 14,000 15,000 3,500 2,000 1,500 1,300 700 24,000
P 800 ==========
Note 7 – Finance Cost Interest Expense Discount Lost Total finance cost
P P
Page 38of F
1,000 200 1,200
