ACTG 101/101A

ACCOUNTING
PRINCIPLES/
FUNDAMENTALS
OF ACCOUNTING
TEXTBOOK: SIMPLIFIED ACCOUNTING FOR
BUSINESS (INTERNATIONAL EDITION)
AUTHORS: ZENAIDA VERA-CRUZ AND
MARIBEL VERA-CRUZ

TOPIC 4:
PROCESSING
TRANSACTIONS
OF A
MERCHANDISING
BUSINESS

Coverage
Journalizing or recording various
business transactions by applying the
rules of double entry system with the
use of special journals

NATURE OF MERCHANDISING BUSINESS

An entity engaged in the activities of buying
and selling products
Main difference of merchandising from
service
Merchandising sells products to generate
revenue while service renders service to
generate revenue
Main difference of merchandising from
manufacturing
Merchandising does not produce its own
product for sale
Other terms used
Trading Enterprise

SERVICING AND
MERCHANDISING BUSINESSES
COMPARED
SERVICING
BUSINESS

MERCHANDISING
BUSINESS

Cash

Phase 1:
Render
Service to
Customers

Phase 2:
Collect
from
Custome
rs

Cash

Phase 1:
Buy
Merchandise
Phase 2:
Sell to
custome
rs on
account

Phase 3:
Collect
from
Custome
rs

NOMINAL ACCOUNTS OF
MERCHANDISING BUSINESS

Selling Activities

Purchasing
Activities

Administrative and
Operating
6
Activities

NOMINAL ACCOUNTS OF
MERCHANDISING BUSINESS
Computation of Cost of Sales
Merchandise Inventory, Jan 1 2014
10,000
Add: Net Purchases:

Purchases
P 75,000
Freight In
2,000
Purchase Returns
( 5,000)
Purchase Allowances
( 1,000)
Purchase Discounts
( 1,000)

70,000
Total Goods Available for Sale
80,000

ACCOUNTS OF A SOLE
PROPRIETORSHIP ENGAGED IN
TRADING

ACCOUNTS OF A SOLE
PROPRIETORSHIP ENGAGED IN
TRADING

MAJOR BUSINESS ACTIVITIES OF A

MERCHANDISING FIRM
Purchasing Activities
Refer to buying, procurement or acquisition
of finished products intended for sale
In accordance with the historical cost
principle, cost of the product includes the
purchase price plus all other incidental costs
related to the acquisition of the product
Purchase is perfected upon delivery of the
merchandise bought by the buyer, except
when there is an agreement to the contrary
10

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchases
Under periodic inventory system,
Purchases is used to describe the
products that have been purchased and
intended for sale
Under perpetual inventory system,
account title used to describe the
products for sale is Merchandise
Inventory
11

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchases Illustration
Assume that Eastern Enterprise has a
beginning merchandise inventory
(unsold goods at the start of the period)
of P10,000. It purchased merchandise
intended for sale from Northern
Company amounting to P100,000 on
account payable within 20 days after
delivery. Northern Company grants a
two percent (2%) discount if payment is
made within 10 days from date of

INITIAL JOURNAL ENTRY FOR THE

TRANSACTION

Debit to purchases records an increase in

expense under expense method. This is an
expense method of recording prepayment
because the adjustment at the end of the
period is a debit to merchandise inventory
which is an asset account. If the perpetual
13
inventory system is used, the merchandise
inventory account is used instead of the

INITIAL JOURNAL ENTRY FOR THE

TRANSACTION

Gross method approach of recording

purchases and sales are generally used unless
stated in the discussion that the net method of
recording is used
14

PURCHASES ADDITIONAL EXAMPLE

Purchased merchandise on account,
P200,000. Terms: 3/15, n/30

15

COMMON ACCOUNT TITLES USED IN

PURCHASING ACTIVITIES
Freight In
Account title referring to the
transportation cost incurred in
transferring the merchandise from the
seller to the buyer
Also known as Transportation-in
account
It has a normal debit balance
An adjunct account: usually added to
the related account
It is added to the Purchases account to

COMMON ACCOUNT TITLES USED IN

PURCHASING ACTIVITIES
Illustration: Assuming that Eastern
Company incurred P10,000
transportation cost in buying the
products intended for sale, the journal
entry would be:

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchase Returns
Used when some of the merchandise
purchased are subsequently returned to the
supplier because of defects or noncompliance
with the desired specification
Normal balance is credit
It is a contra account: deduction from the
Purchases account
18

COMMON ACCOUNT TITLES USED IN

PURCHASING ACTIVITIES
Illustration: Assume that Eastern Enterprise found
out that about P7,000 goods purchased did not
meet the specifications of the products orders.
Northern Company agreed for the return of the
merchandise and issued a P7,000 credit memo to
reduce its claim against Eastern. The journal entry
would be:

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchase Allowances
Contra-purchase account which is used
to describe reduction on the acquisition
price due to reasons similar to purchase
returns
No actual physical return of the
merchandise or goods to the seller
because the buyer decides to keep them
as the former agreed to the price
reduction

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Illustration: Assume that Eastern
Enterprise determined that P3,000
worth of merchandise was slightly
damaged. Northern Company issued a
credit memo in this regard. The journal
entry would be:

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchase Discount (Trade & cash discount
discussed thoroughly in slides 50-56)
A cash discount is a method used by the sellers in
order to encourage buyers to pay earlier
purchases made on account.
Granted when the buyer pays within the discount
period as indicated in the terms of contract of
sales
Reduces the acquisition price of merchandise
purchased
Contra asset account
22
Normal balance is credit

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Illustration: Assume that Eastern
Enterprise paid its obligation to Northern
Company within 10 days or within the
discount period allowing a 2% discount.
The journal entry would be:

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Purchase Discount
A trade discount is a purchase reduction from a
published list price that may be granted to retailers
or wholesalers for buying large quantities or for
regularly patronizing the business.
Granted at point of sale hence immediately
deducted from the list price and only the gross
invoice price (balance) will be the basis for invoicing
and recording
Chain of discount may be granted to the customer
Contra asset account
Normal balance is credit

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Illustration: Assume that Eastern
Enterprise bought a cabinet with list price
of P5,000 and was given trade discount of
2% and 1%. The journal entry would be:

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Computation of cash payment:
Purchase price P 100,000
Less: Purchase returns
P 7,000
Purchase allowances
3,000
10,000
Balance before purchase discounts P 90,000
Less: Purchase discounts (90,000 x 2%)
1,800
Cash payment P

88,200

COMMON ACCOUNT TITLES USED

IN PURCHASING ACTIVITIES
Computation of Net Purchases
Purchases
P 100,000
Add: Freight in
10,000
Total Purchases
P 110,000
Less: Purchase returns
P 7,000
Purchase allowance 3,000
Purchase discount
1,800
11,800
Net Purchases

98,200

SAMPLE PURCHASING ACTIVITIES

Several purchase transactions of the Yodelito
Icaro Company are presented below. The
credit terms of the company are 3/10, n/30
Oct 6 Purchased merchandise for cash,
P200,000

SAMPLE PURCHASING ACTIVITIES

Oct 12 Purchased merchandise on
account, P700,000

SAMPLE PURCHASING ACTIVITIES

Oct 12 Returned merchandise purchased
on account, P50,000

SAMPLE PURCHASING ACTIVITIES

Oct 17 Paid supplier the amount due

SAMPLE PURCHASING ACTIVITIES

Oct 19 Paid freight charges of P7,000 on
merchandise acquired last Oct. 6

MAJOR BUSINESS ACTIVITIES OF

A MERCHANDISING FIRM
Selling Activities
Pertains to the act of transferring the title of
ownership over the merchandise from the
seller to the buyer for a consideration either in
money or any other thing of value
Sale is perfected upon delivery of the thing
sold
Special sale is perfected when there has been
a contract of sale and the goods specified
therein have been segregated for that purpose
even if no actual delivery of merchandise was
33
made yet

MAJOR BUSINESS ACTIVITIES OF A

MERCHANDISING FIRM

Selling Activities
Selling activities are based on revenue
principle that revenue is recognized when
realized or realizable and earned
In a trading or merchandising business,
revenue is recorded at the point of sale
In selling, the trader or seller usually adds a
markup to the cost of the product he
purchased. This is called the gross profit
Gross profit will cover the business operating
expenses and the residual amount would 34
either be net income or loss

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES
Sales
Sale of merchandise is recorded by
crediting the revenue account
In merchandising, the revenue account is
described as sales
Account constitutes a recovery of the
cost of merchandise sold as well as the
profit
Normal balance is credit
35

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES
Illustration
Assume that Eastern Enterprise sold to Bin
Ladin a merchandise amounting to P125,000,
including a markup of P50,000 on account,
collectible within 30 days. As Easterns policy,
a cash discount of 3% is granted to customers
if payment is made within 5 days. Entry
would be as follows

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES
Freight Out
Refers to the account title for
transportation cost incurred by the seller in
transporting the merchandise to the buyer
Also known as transportation cost,
transportation expense or delivery expense
Has a normal debit balance

37

COMMON ACCOUNT TITLES

USED IN SELLING ACTIVITIES
Illustration
Assuming that Eastern Company incurred P2,000
transportation cost in delivering the products to Bin
Laden, the entry would be

Freight Out is not added to sales account because it

is treated as operating expense and not part of sales

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES
Sales Returns
Used when some items of merchandise sold
are returned by the customer because the
items delivered are defective or do not comply
with the orders specification
To document the acceptance of return, the
seller would issue a credit memo
Contra revenue account and has a normal
debit balance
39

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES
Sales Returns Illustration
Assume that Bin Ladin returned some
merchandise amounting to P6,000 because
they do not conform to product specifications
as ordered. Journal entry is as follows:

COMMON ACCOUNT TITLES USED

IN SELLING ACTIVITIES
Sales Allowances
Used to describe reduction on sales
due to reasons similar to sales returns.
However, there is no actual physical
return of the goods to the seller because
the buyer decides to keep them as the
seller allows a price reduction for the
merchandise acquired by the buyer
Contra revenue account and has a
41
normal debit balance

COMMON ACCOUNT TITLES USED

IN SELLING ACTIVITIES
Sales Allowances Illustration
Assume that Bin Ladin some items delivered
to Bin Ladin were damaged. As a result,
Eastern Enterprise granted a sales allowance
of P9,000 per credit memo number 68.
Journal entry is as follows:

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES

Sales Discounts (Trade & cash

discount discussed thoroughly in
slides 50-56).
Cash discount on sales of
merchandise
Usually effected when the buyer
pays within the discount period
Reduces the sales price of
merchandise delivered to the buyer

COMMON ACCOUNT TITLES USED IN

SELLING ACTIVITIES

Illustration

Assume that Bin Ladin paid his

account within 5 days which entitles
him for a 3% discount. Journal entry is
as follows:

COMMON ACCOUNT TITLES

USED IN SELLING ACTIVITIES
Computation of cash collection:
Sales per Invoice
P 125,000
Less: Sales returns
P 6,000
Sales allowances
9,000
15,000
Balance before sales discounts
P
110,000
Less: Sales discounts (110,000 x 3%)
3,300
Cash collection
P 106,700
45

COMMON ACCOUNT TITLES

USED IN SELLING ACTIVITIES
Computation of Net Sales
Sales
P 125,000
Less: Sales returns
P 6,000
Sales allowances
9,000
Sales discount
3,300
18,300
Net Sales
P 106,700

46

SAMPLE SELLING ACTIVITIES

Some of the sales transactions of
Leonila Generales Company whose credit
terms are 2/10, n/30 follows
June 1

Cash sales, P180,000

SAMPLE SELLING ACTIVITIES

June 4

Sales on account, P650,000

SAMPLE SELLING ACTIVITIES

June 7 Received returned merchandise
sold on account, P90,000

SAMPLE PURCHASING ACTIVITIES

June 10 Collected the amount due from
credit sales

TRADE DISCOUNT VS CASH DISCOUNT

Two Kinds of Discount
Trade Discount
Manufacturers and wholesalers often offer a trade
discount to the retailers to attract them to buy in big
quantity. Sometimes called quantity discount
Amount deducted from the suppliers price list or
price catalogue or suggested retail prize to arrive at
the invoice price (cost to the buyer)
Never journalized
Examples of catalogue prizes with trade
discounts
Product
Items to
Purchase
Option

List Price

Terms

P100,000

30, n/30

5 to 10 items

P100,000

30, 10, n/30

More than 10 to 20
items

P100,000

30, 10, 2/15,

n/30

More than 20 items

TRADE DISCOUNT VS CASH DISCOUNT

Illustration of Trade Discount
Assuming that Bush Enterprise sold
merchandise to Bin Company at a list price of
P100,000; trade discount 25, 10; 2/10, n/30.
Computation of Invoice Price would be as
follows:
List Price
P 100,000
Less: First Trade Discount at 25%
25,000
Balance net of first discount P
75,000
Less: Second trade discount at 10%
7,500
Invoice Price
P
67,500

TRADE DISCOUNT VS CASH DISCOUNT

Illustration of Trade Discount
Books of Bush Enterprise (seller)

Books

of Bin Company (buyer)

TRADE DISCOUNT VS CASH DISCOUNT

Two Kinds of Discount

Cash Discount
This discount is offered to encourage
prompt payment
If availed, this is deducted from the
accounts receivable of the seller and the
accounts payable of the buyer
Cash Discount of Seller Sales Discount
Cash Discount of Buyer Purchase Discount
The discount is journalized

TRADE DISCOUNT VS CASH DISCOUNT

Two Kinds of Discount

Illustration
Based on the illustration above,
assume that Bin Company paid within
10 days. Computation of actual cash
payment to the Bush Enterprise would
be:
Invoice Price
P 67,500
Less: Cash discount (67,500 x 2%)
1,350
Actual cash payment
P 66,150

TRADE DISCOUNT VS CASH DISCOUNT

Illustration of Cash Discount
Books of Bin Company (buyer)

Books

of Bush Enterprise (Seller)

TRADE DISCOUNT VS CASH DISCOUNT

Cash Discounts Not Taken
It is managements responsibility to take
advantage of a cash discount to employ
further profitability
Purchaser who takes advantage of a 2%
cash discount for payment is effectively
earning an interest rate of 36.5% per annum,
computed as follows:
Cash discount rate
2%
Divide by days use of funds over number
of days in a year
20/365
Effective earning rate per annum for

INVENTORY ACCOUNTING SYSTEMS

Different ways to record amount of
inventory on hand and the cost of
inventory sold:
Periodic Inventory System
Perpetual Inventory System

Periodic Inventory System

Company does not maintain a continuous
record of the physical quantities (or costs) of
inventory on hand.
All inventory acquired during an accounting
period is recorded by debiting the
purchases account, not the inventory
account

INVENTORY ACCOUNTING SYSTEMS

Periodic Inventory System
Quantity and amount of ending inventory is
determined by conducting a physical count at
the end of the period (hence, the term
periodic)
Ending inventory is deducted from the total
cost of good available for sale during the
period to arrive at Cost of Goods Sold
Cost of Goods Sold is the residual amount
that is dependent on the amount of the
ending inventory
Used for relatively low value inventory items

INVENTORY ACCOUNTING SYSTEMS

Perpetual Inventory System
Maintains a continuous record of the changes
of the physical quantities in its inventory
Each product has its own subsidiary ledger in
which the inventory units and cost balances
are maintained
Merchandise Inventory, rather than
purchases, is debited when the merchandise is
acquired
When there is a sale, the Cost of Goods Sold
is debited and the inventory account is
credited equivalent to the cost of merchandise
sold

INVENTORY ACCOUNTING SYSTEMS

Perpetual Inventory System
Cost of Goods Sold account is deducted from
the total inventory account to determine the
ending inventory
No physical count required to determine the
ending balance but all inventory items should
be counted at least once a year to verify the
perpetual inventory balance
Costly but facilitates better inventory
planning and control for it provides information
of inventory on hand anytime

COMPARATIVE ENTRIES PERIODIC

AND PERPETUAL SYSTEMS
Assume that Dipolog Company provided the
following summary of inventory transactions
for the year 200x:
a) Beginning inventory: 1,000 units at P50 per
unit
b) Purchases on account: 2,000 units at P50
per unit
c) Freight on purchase, P2,000
d) Purchase returns, 20 units
e) Units sold: 2,100 at P100 each
f) Sales returns, 10 units
g) Number of units per count (end of year):

COMPARATIVE ENTRIES PERIODIC AND

PERPETUAL SYSTEMS Journal Entries
b) Purchases

on account: 2,000 units at P50

per unit

c) Freight

on purchase, P2,000

COMPARATIVE ENTRIES PERIODIC AND

PERPETUAL SYSTEMS Journal Entries
d) Purchase

e) Units

returns, 20 units x P50

sold: 2,100 at P100 each unit

COMPARATIVE ENTRIES PERIODIC AND

PERPETUAL SYSTEMS Journal Entries
f)

Sales return, P1,000 (10 units x

P100)

COMPARATIVE ENTRIES PERIODIC AND

PERPETUAL SYSTEMS Journal Entries
g) Number

of units per count (end of year):

800 units

Inventory short or over account is the account

that absorbs inventory shortage or overage
resulting from shrinkage, breakage, shoplifting,
incorrect recording, etc.
Eventually closed to the Cost of Goods Sold
account

COMPARATIVE ENTRIES PERIODIC AND

PERPETUAL SYSTEMS Journal Entries
Computation of shortage:
Beginning Inventory
P 50,000
Purchases
100,000
Freight in
2,000
Sales returns
500
Total
P 152,500
Less: Cost of Sales
P 105,000
Purchase returns
1,000
Merchandise per record (perpetual)
Less: Merchandise per physical count
Shortage merchandise
P

106,000
P 46,500
40,000
6,500