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A. The Sale and Purchase of Products
Perpetual inventory systems show all changes in inventory in the "Inventory"
account. Purchase accounts are not used in a perpetual inventory system.
Periodic inventory systems keep the inventory balance at the same
value that it was at the beginning of the year. At year end, the inventory
balance is adjusted to a physical count. To account for inventory purchases
in a periodic inventory system, an account called "Purchases" is used rather
than debiting "Inventory".
Example: (Unit cost is held constant to avoid the necessity of a using
a cost flow assumption)
Beginning inventory 100 units @ $6 = $ 600
Purchases 900 units @ $6 = $5,400
Sales 600 units @ $12 = $7,200
Ending inventory 400 units @ $6 = $2,400
Perpetual Inventory System | Periodic Inventory System
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1. Beginning inventory 100 units at $600
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Inventory account shows | Inventory account shows
$600 in inventory. | $600 in inventory.
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2. Purchase of 900 units at $6 per unit
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Inventory 5,400 | Purchases 5,400
Acc. Payable 5,400| Acc. Payable 5,400
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3. Sale of 600 units at a selling price of $12 per unit
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Acc. Receivable 7,200 | Acc. Receivable 7,200
Sales 7,200| Sales 7,200
|
Cost of Goods Sold 3,600 | No entry
Inventory 3,600|
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4. End-of-period entry for inventory adjustment
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No entry needed. | Inventory 1,800
The ending balance of inventory | Cost of Goods Sold 3,600
shows $2,400. | Purchases 5,400
----------------------------------------------------------------------
Note: The periodic inventory adjustment in transaction 4 adjusts
inventory to the physical count, closes out any purchase accounts,
and runs any difference through cost of goods sold.
B. Cost of Goods Sold in a Periodic Inventory System
Perpetual inventory systems record cost of goods sold and keep inventory at its
current balance throughout the year. Therefore, there is no need to do a
year-end inventory adjustment unless the perpetual records disagree with the
inventory count. In addition, a separate cost of goods sold calculation is
unnecessary since cost of goods sold is recorded whenever inventory is sold.
The inventory account in a periodic inventory system keeps its beginning balance
until the end of period adjustment to the physical inventory count. Therefore,
a separate cost of goods sold calculation is necessary. The following
calculation shows the calculation for the preceding example.
Beginning Inventory 600
Net Purchases 5,400
-------
Goods Available for Sale 6,000
Ending Inventory 2,400
-------
Cost of Goods Sold 3,600
=======
C. Purchase Returns and Allowances and Purchase Discounts
"Purchases" has a normal debit balance since it replaces the debit to "Inventory".
It has two contra accounts known as "Purchase Discounts" (Purch. Disc.) and
"Purchase Returns and Allowances" (Purch. R&A) that reduce it to determine
"Net Purchases". The balance of these two contra accounts is a credit because
"Purchases" is a debit. Remember that contra accounts always have a normal balance
that is opposite to what they are contra to. Purchase-type accounts are temporary
accounts (i.e., they are closed at year end) and only appear in a periodic inventory
system. They simply serve to replace the corresponding inventory portion of an
entry that exists in a perpetual inventory system. The following entries illustrate
purchase returns and discounts in perpetual and periodic inventory systems:
Perpetual Inventory System | Periodic Inventory System
-----------------------------------------------------------------------
1. Ace Company returned $600 of damaged merchandise and received a
price reduction allowance of $100 on the portion of the merchandise
they retained.
-----------------------------------------------------------------------
Acc. Payable 700 | Acc. Payable 700
Inventory 700 | Purch. R&A 700
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2. In a previous transaction, Ace purchased merchandise on account at
a cost of $1,000. The credit terms were 2/10, n/30. Ace paid for
the merchandise within the discount period.
-----------------------------------------------------------------------
Acc. Payable 1,000 | Acc. Payable 1,000
Inventory 20 | Purch. Disc. 20
Cash 980 | Cash 980
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D. Sales Returns and Allowances and Sales Discounts
Sales has two contra accounts known as "Sales Discounts" (Sales Disc.) and
"Sales Returns and Allowances" (Sales R&A) that reduce it. The normal
balance for these two contra accounts is a debit. Sales and its contra
accounts may appear with either a perpetual or periodic inventory system.
The following entries illustrate the accounts in perpetual and periodic
inventory systems. The entries assume the gross method.
Perpetual Inventory System | Periodic Inventory System
-----------------------------------------------------------------------
1. Sam Company received $600 of damaged merchandise from their customer
Ace. They also gave Ace a $100 allowance for some of the damaged
merchandise that Ace retained. The original cost of the merchandise
returned to Sam was $400.
-----------------------------------------------------------------------
Sales R&A 700 | Sales R&A 700
Acc. Receivable 700 | Acc. Receivable 700
|
Inventory 400 | No entry
Cost of Goods Sold 400 |
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2. Sam received a customer payment for a prior sale on account of $1,000
subject to credit terms of 2/10, n/30. The customer made payment
within the discount period.
-----------------------------------------------------------------------
Cash 980 | Cash 980
Sales Disc. 20 | Sales Disc. 20
Acc. Receivable 1,000| Acc. Receivable 1,000
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Sales on the income statement should be shown net of its contra accounts.
For example, if a company has $980,000 in sales, $3,400 in sales returns and
allowances, and $2,200 in sales discounts; net sales would be $974,400.
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