Chapter 3
Fundamentals of Merchandising Business
Definition
A merchandising business is actively engaged in buying and selling merchandises.
Merchandise
These are goods on an itemized list that are ready for sale without requiring further
structural changes or additional processing.
Key Features
◦ Merchandise Inventory is the most significant cost of investment.
◦ The primary source of revenue is the selling of goods, often simply called Sales.
◦ The total cost of merchandise includes the purchase price, transportation,
taxes, customs duties, and loading/unloading costs.
Basic Accounting for Purchases and Sales
When a firm acquires or sells goods, the initial recording depends on the transaction
type:
• Purchases: When a firm acquires merchandise, it debits Purchases and credits
Cash or Accounts Payable.
• Sales: When a firm sells merchandise, it debits Cash or Accounts Receivable
and credits Sales.
• Example: On February 10, ABC Co. bought merchandise for Br. 12,000 cash from
XYZ Co.
◦ Buyer (ABC Co.): Debit Purchases; Credit Cash.
◦ Seller (XYZ Co.): Debit Cash; Credit Sales.
Discounts, Returns, and Allowances
Credit Terms
If payment isn't immediate, a credit period is allowed. Terms like 1/10, n/30 mean a
1% discount is given if paid within 10 days; otherwise, the full amount is due in 30
days.
Cash Discounts
Offered to promote prompt payment, resulting in a reduction of gross purchases for
the buyer and gross sales for the seller.
◦ Buyer's Entry: Credits Purchases Discount.
◦ Seller's Entry: Debits Sales Discount.
Returns and Allowances
◦ Sales Return: The buyer returns the goods.
◦ Sales Allowance: The buyer keeps the goods but receives a price reduction due
to defects.
◦ Recording: The buyer credits Purchase Returns and Allowances, while the
seller debits Sales Returns and Allowances.
Transportation Costs (FOB Terms)
Agreements between buyers and sellers must specify who bears delivery costs and
when ownership (title) passes.
FOB Shipping Point
The buyer is responsible for costs once the goods leave the shipping point. The cost
is debited to "Transportation-In" or "Freight-In".
FOB Destination
The seller is responsible for delivery to the destination. The cost is debited to
"Transportation-Out" or "Freight-Out".
Note
If a seller prepays transportation costs on behalf of a buyer under FOB shipping
point terms, that cost is added to the buyer's Accounts Payable.
Sales Taxes and VAT
Sellers act as agents of the government, collecting taxes from consumers at the
point of sale.
Recording Collection
When a tax (e.g., 3% or 15% VAT) is collected, the seller credits Sales Tax Payable.
Recording Remittance
When the seller pays the tax authority, they debit Sales Tax Payable and credit
Cash.
Inventory Systems: Perpetual vs. Periodic
There are two main systems for tracking merchandise:
1. Periodic Inventory System:
◦ Used by smaller firms.
◦ Cost of Merchandise Sold (COGS) is not recorded at the time of sale.
◦ A physical inventory count is mandatory at the end of the period to determine
COGS and ending inventory.
2. Perpetual Inventory System:
◦ Used by larger firms with high variety.
◦ Both revenue and COGS are recorded on the actual date of sale.
◦ Journal Entry for COGS: Debit Cost of Merchandise Sold; Credit Merchandise
Inventory.
Determining Cost of Merchandise Sold (COGS)
Regardless of the system, COGS is calculated using a specific schedule:
• Net Purchases: Purchases minus (Purchase Returns & Allowances + Purchase
Discounts).
• Cost of Merchandise Purchased: Net Purchases plus Transportation-In.
• Total Available for Sale: Beginning Inventory plus Cost of Merchandise
Purchased.
• COGS Formula: Total Available for Sale minus Ending Inventory.
Adjusting Entries for Inventory (Periodic System)
For firms using the periodic system, two specific adjusting entries are required at
year-end to update the inventory account:
1. To remove beginning inventory: Debit Income Summary; Credit Merchandise
Inventory.
2. To record ending inventory: Debit Merchandise Inventory; Credit Income
Summary.