SPECIAL LECTURE 1

ACCOUNTING FOR A MERCHANDISING

& MANUFACTURING BUSINESS

Learning Objectives:

At the end of this lecture, you should be able to:

1. Differentiate a merchandising and manufacturing concern business.

2. Record business transactions of merchandising type of business.
3. Prepare properly classified financial statements of a merchandising business.
4. Prepare a statement of cost of sales.
5. Differentiate the different cost flow methods used in determining the cost of inventory.
6. Prepare a statement of cost of goods sold of a manufacturing business.

Introduction

There are generally two ways on how to conduct a business; either you provide service or sell
something. Grab, A1 Driving, Globe Telecom, and Bench Fix Salon are some examples of service
provider businesses. On the other hand, Wilcon Depot (retailer of home building supplies) and
Puregold (supermarket) are examples of merchandising business. As you have learned, one of the
main differences between a service and merchandising business is the presence of inventories for a
merchandising business. A third type of business activity is manufacturing, wherein the goods sold
are directly created i.e. manufactured by the seller itself like Toyota (automotive manufacturer) and
Epson. This chapter will focus in accounting for merchandising and manufacturing business.

Merchandising vs. Manufacturing Business

Buys Goods
from A merchandiser usually has a list of suppliers
Supplier where it buys its goods in wholesale to avail
(Wholesale)
of trade and cash discounts. Without
modifying the goods, it sells it in its original
form at a certain markup to recover the
expenses incurred and earn profit in order
Collect Cash
Sells the keep the business running and satisfy the
Goods owner.
or
(Wholesale
Receivable
or Retail)

Figure 1. Merchandising Business Cycle

Ken Gie Anthony G.Cruel, CPA, MBA Page 1

 Buys Raw
Materials
from Supplier
(Wholesale) A manufacturer creates its own goods. It
buys raw materials from its suppliers, and
then converts the various raw materials into
Convert Raw finished goods. In the process of conversion,
Materials to
Collect Cash
Finsihed manpower and other overhead costs are
or Receivable
Goods (Labor incurred. These costs form part of the cost
& Overhead)
of the goods (inventory). Finished goods are
sold to customers for cash or on account and
Sells the
the cycle will start again.
Goods
(Wholesale or
Retail)

Figure 2. Manufacturing Business Cycle

Recording Business Transaction for a Merchandising Business

Illustrative Problem 1

On March 1, 2018, Mr. Xander Cage decided to put up a business of selling plain white t-shirts. The
following transactions occurred during its first month of operations.

Mar. 1 Invested P150,000 to start his business.

2 Paid P10,000 in registering its business and the miscellaneous taxes.
3 Bought office supplies amounting to P3,000 and a laptop for the business, P15,000.
The laptop is expected to be used for 3 years.
4 Paid the rent for the month, P5,000.
5 Bought 500 pcs of white shirts for P50 each from its supplier in Divisoria. The
transportation cost in delivering the goods was P500 which is shouldered by Mr.
Cage.
7 Sold 200 pcs for P150 each to a random customer.
10 Bough additional 100 shirts for P60 each from its supplier. The transportation cost
in delivering the goods was P500 which is shouldered by Mr. Cage.
15 Sold 300 pcs (from the first lot) of shirts for P150 to his friend in a national high
school, on account.
15 Paid the salary of his assistant, P5,000.
16 Returned goods due to defect from March 15 sale, 100 pcs.
18 Called the supplier of shirts and ordered 400 pcs at P65 each. The supplier allowed
Mr. Cage a term of 2/10, net 30, plus it has agreed to deliver the goods with the
term FOB shipping point. Cost of freight was P1,000.
19 The goods have arrived, all in good condition, Mr. Cage paid for the freight to the
carrier.

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 21 Sold 300 shirts with the following details; 100 shirts (from second lot) were sold for
P180 each, and 200 shirts (from the third lot) were sold for P195 each to a local
university for cash.
25 Paid the supplier (Mar. 19 transaction) in full.
27 Sold to his friend, 100 shirts on account for P195 each. Term is 2/10, net 30.
30 Paid the salary of his assistant, P5,000.
31 The inspection of supplies revealed P1,000 worth of remaining supplies.
A physical count of inventories revealed remaining inventories of 100 pcs (costing
P6,750).

Required:

A. Journalize the transactions, including the necessary adjustments at month end.

B. Prepare the income statement with supporting statement of cost of sales.
C. Prepare the balance sheet as of March 31, 2018.

A. The journal entries will appear as follows:

GENERAL JOURNAL PAGE J1

Date Account Title & Explanation Ref. Debit Credit

Mar. 1 Cash 150,000
Cage, Capital 150,000

2 Taxes & Licenses 10,000

Cash 10,000

3 Supplies 3,000
Cash 3,000

Computer 15,000
Cash 15,000

4 Rent Expense 5,000

Cash 5,000

5 Purchases 25,000
Freight In 500
Cash 25,500

7 Cash 30,000
Sales 30,000

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10 Purchases 6,000
Freight In 500
Cash 6,500

15 Accounts Receivable 45,000

Sales 45,000

Salaries Expense 5,000

Cash 5,000

16 Sales Return 15,000

Accounts Receivable 15,000

19 Purchases 26,000
Freight In 1,000
Accounts Payable 26,000
Cash 1,000

21 Cash 57,000
Sales 57,000

25 Accounts Payable 26,000

Cash 25,480
Purchase Discount 520

27 Accounts Receivable 19,500

Sales 19,500

30 Salaries Expense 5,000

Cash 5,000

31 Supplies Expense 2,000

Supplies 2,000

Depreciation Expense 416.67

Accumulated Depreciation-Computer 416.67

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B. Income Statement with supporting Statement of Cost of Sales

Xander Cage
Income Statement
For the month ending March 31, 2018 Gross Sales 151,500
Sales Return ( 15,000)
Net Sales 136,500 Net Sales 136,500

Less: Cost of Sales* 51,730

Gross Income 84,770
Less: Operating Expenses
Salaries Expense 10,000
Taxes & Licenses 10,000
Rent Expense 5,000
Supplies Expense 2,000
Depreciation Expense 416.67 27,416.67
Net Income (before tax) 57,353.33

*Supporting Statement of Cost of Sales

The Net Purchases was computed as
Merchandise Inventory Beg. 0 follows:
Add: Net Purchases 58,480
Total Cost of Good Available for Sales 58,480 Purchases 57,000
Freight In 2,000
Less: Merchandise Inventory End 6,750 Purchase Discount ( 520)
Cost of Sales 51,730 Net Purchases 58,480

Important Notes:

1. The business used the periodic system because of the nature of its product (white shirts). It
is the most applicable inventory system (refer to your AP 1 book for discussion related to
inventory systems).
2. The cost of inventory as you have noticed was increasing which is what is actually happening
in the real market. In such cases, the selling of inventory generally should be on a first in,
first out basis just like in our illustration. In higher accounting subjects, you will be
discussing in detail the different cost flow assumptions specifically FIFO (first in, first out),
LIFO (last in, first out) and average method. In the Philippines, only the FIFO and average
method are allowed to be used.

3. Net Sales

The formula to compute for the net sales is as follows:

Gross Sales xx
Sales Returns & Allowances (xx)
Sales Discounts (xx)
Net Sales xx

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 4. Net Purchases
The formula to compute for the net sales is as follows:

Gross Purchases xx
Freight In xx
Purchase Returns & Allowances (xx)
Purchase Discounts (xx)
Net Purchases xx

COST FLOW METHODS - FIFO vs. AVERAGE METHOD

Let us have a brief comparison of the two cost flow assumptions. In this illustration, we will assume
that no freight costs were incurred in any of the purchases to make the discussion easier. Meaning,
disregard any freight cost given in the previous illustration. Under the FIFO method, all goods that
were purchased first should be sold first. I will use the given in our illustration (except all freight in):

Inventory-FIFO Periodic
Date Trans Units Price Cost
Mar. 5 Purchase 500 50 25,000.00
7 Sale -200 50 (10,000.00) Inventory Beg. 0
Balance 300 50 15,000.00 Net Purchases:
15 Sale -300 50 (15,000.00) Purchases 57,000
Balance 0 - Purchase Disc ( 520) 56,480
Goods Available for sale 56,480
10 Purchase 100 60 6,000.00 Inventory end ( 6,500)
21 Sale -100 60 (6,000.00) Cost of sales 49,980
Balance 0 -
19 Purchase 400 65 26,000.00
21 Sale -200 65 (13,000.00)
Balance 200 65 13,000.00
27 Sale -100 65 (6,500.00)
Balance 100 65 6,500.00
Note: Excluding the cost of freight

Take note that based on physical

Important Notice count, 100 pcs of shirts remained
with P6,500 cost (based on the
illustration). But that is actually the
FIFO cost of the ending inventory
(100 pcs).

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 Now, take a look if the average method was used.

Inventory
Date Trans Units Price Cost
Mar. 5 Purchase 500 50 25,000.00 Inventory Beg. 0
10 Purchase 100 60 6,000.00 Net Purchases:
19 Purchase 400 65 26,000.00 Purchases 57,000
Purchase Disc ( 520) 56,480
Balance 1000 57 57,000.00 Goods Available for sale 56,480
Note: Excluding the cost of freight Inventory end ( 5,700)
Cost of sales 52,780

This is the average cost of

Important Notice
all inventories purchases
(P57,000/1,000 pcs)
100 pcs x P57

Accounting for a Manufacturing Business

The journal entries pertaining to a manufacturing business will be discussed lengthily in your higher
accounting subject particularly in cost accounting. In this kind of business, products are made from
various raw materials (direct and indirect) which is created by laborers (people) in combination or
with the aid of machines/equipment. This activity is called the conversion process.

Final Product
Raw Materials or
Finished Good

Figure 3. Conversion Process

From the figure above it can be inferred that the cost of the final product consists of three
components as enumerated below:

1. Direct Material Costs

It is the cost of raw materials used in creating the product. These are the tangible materials
which form part of the final product e.g. the leather in shoes, steel in a car, or the foam in a
bed. It is called direct material because it can be clearly identified as part of the product just
by looking at it. Without a doubt, this cost is included in the total cost of inventory.

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 2. Direct Labor Costs

It is the cost of compensation (salaries or wages) paid to the people who are directly
involved in the creation of the product. For example; in making a shoe, the compensation
paid to the one who cut the leather and put it together; the one who inserted the frame of a
car; or the one who stitched the sheet cover of the bed. All of these payments are direct
labor costs and forms part of the cost of the inventory.

3. Factory Overhead Costs

All indirect materials and indirect labor costs are included in the overhead cost. In a shoe,
the indirect material could be the adhesive (Rugby) used; in a car, it could be the small bolts;
and in our bed example, it could be the thread used in stitching its sheet cover. In addition,
all other costs used in manufacturing the product should be included in the inventory e.g.
gasoline or electricity used in operating the machines. The salary of the factory supervisor,
guard on duty in the factory, quality control personnel and even the depreciation of the
factory is included in the overhead cost. Therefore, it is also part of the cost of inventory.

Total Manufacturing Costs

The sum of the three constitutes the total cost of the inventory and is crucial in the success of the
business. Failure to account properly for the cost of inventory (product cost) will lead to overpriced
goods and misstated financial statements.

Direct Material Direct Labor Overhead

Costs Costs Costs

Figure 4. Total Manufacturing Costs or Cost of Inventory

Inventory of a Manufacturer

Unlike a merchandiser, the inventory presented in the balance sheet of a manufacturer may consist
of three items as follows: Figure 5.

Raw Materials Work in Process Finished Goods

Inventory Inventory Inventory

These are the unused These are the These are the
raw materials as of unfinished goods as of completed goods as of
the reporting date. the reporting date. the reporting date.

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Cost of Goods Sold

The statement of cost of goods sold of a manufacturer is formatted as follows:

Statement of Cost of Goods Sold

Raw Material Inventory Beginning 100,000.00

Net Purchases 1,000,000.00
Raw Materials Available for Use 1,100,000.00
Raw Material Inventory Ending (600,000.00)
Direct Material Costs (Used) 500,000.00 Total Inventory in the Balance
Direct Labor Costs 700,000.00 Sheet
Factory Overhead 400,000.00
Raw Material s End P600,000
Total Manufacturing Costs 1,600,000.00
Work In Process End 800,000
Work in Process Inventory Beginning 1,200,000.00
Finished Goods End 1,500,000
Total Cost of Goods in Process 2,800,000.00 Total Inventory P2,900,000
Work in Process Inventory Ending (800,000.00)
Cost of Goods Manufactured 2,000,000.00
Finished Goods Inventory Beginning 1,000,000.00
Goods Available for Sale 3,000,000.00
Finished Goods Inventory Ending (1,500,000.00)
Cost of Goods Sold 1,500,000.00

Note: All amounts presented are assumed values.

---End of Lecture---

I hope this lecture will aid you in higher accounting subjects. If you wish to have another set of lecture
regarding any topic in basic accounting or financial accounting. You may directly send your request in my
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At your service,

Ken Gie Anthony G.Cruel, CPA, MBA Page 9