Perpetual vs.

Periodic Inventory System

Journal Entries
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
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-----
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

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------
 1. Ace Company returned $600 of damaged merchandise and received
a
price reduction allowance of $100 on the portion of the
merchandise
they retained.
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------
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.
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------
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

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------
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.
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------
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.
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------
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.
Inventory Accounting: How to
Use Periodic Inventory
Reporting
Under the periodic inventory system, the amount of inventory on hand is determined
periodically, usually once a year.

Periodic inventory maintains the beginning inventory balance

throughout the year. New inventory purchases are recorded in the
“purchases” account, and at year end an inventory count is taken to
determine the ending inventory balance and the cost of goods sold.

Periodic Inventory and Inventory Cost

(Cost of Goods Sold)
The following formula is used to determine inventory cost of goods
sold:

Beginning Inventory + Purchases – Ending Inventory = COGS

*A Note on Beginning Balances* In accounting, the beginning balance

always refers to the balance as of the beginning of the year before any
new transactions for the year are recorded. Consequently, the
beginning balance for inventory, or accounts receivable, or equity, or
any other real (balance sheet) account is always the same as the
balance as of the end of the prior year, carried forward as the
beginning balance in the new year.

For periodic inventory, this is important because the ending inventory

balance was adjusted to a physical count last year, and carried forward
to the beginning inventory balance. This inventory balance will remain
the same throughout the year, as new products purchased are
recorded in the purchases account, and later adjusted to inventory
based on a new inventory count at year end.
In January, for example, even though Sunny had purchased $4,500 on
the first day of business, January 1, 2010, as listed on the
January sample balance sheet, this amount does not represent the
beginning inventory balance since the ending inventory as of
December 31, 2009 was zero. Rather, this amount is included as part
of total purchases made throughout the year when using periodic
inventory.

Let’s see how Sunny Sunglasses would calculate inventory cost of

goods sold for 2010 using periodic inventory accounting.

Throughout the year, Sunny had net purchases of $48,825 in total

inventory. Ending inventory listed on theaccounting balance sheet
analysis page at year end equaled $5,625. Therefore, we can
calculate inventory cost of goods sold as:

Calculate Inventory Cost of Goods Sold

Total inventory cost of goods available for sale during 2010 was the
beginning inventory plus all purchases made throughout the year less
purchase returns and discounts. Because the ending inventory had a
balance as of December 31, 2010, this amount is subtracted to arrive
at the total cost of goods sold.

Accounting Examples of Inventory Cost

1. If no inventory remained on December 31, 2010, then the cost of goods sold would
be the total of all goods made available for sale, or $48,825.

2. If no sales were made during the year, ending inventory would be the total of all
goods made available for sale, or $48,825, and cost of goods sold would be $0.

Periodic Inventory Accounting Examples

The following journal entries illustrate how companies use periodic
inventory reporting.
Periodic Inventory Accounting Examples: Inventory Purchase and Sale

In the accounting journal entry above, purchases are made and the
items are then sold. Companies using periodic inventory do not adjust
the actual inventory balance until adjusting entries are made at year
end. Companies record an inventory purchase under the periodic
inventory system by debiting the purchases account, and sales are
made with no adjustment to the inventory account. The perpetual
inventory system, by contrast, adjusts the inventory balance when
items are both purchased and sold.

Periodic Inventory Accounting Examples: Inventory Returns

Under periodic inventory reporting, purchase returns are recorded in

a contra account to adjust total purchases. A contra account is an
account that offsets the main account. Since the purchases account is
a debit account, the contra account is a credit account that offsets the
balance to determine net purchases. The purchases account has two
contra accounts: purchase returns and purchase discounts.

In this example, Sunny reduces accounts payable with a debit, and

credits the contra account purchase returns to reduce the purchases
balance.

The purchases account and its contra accounts are simply a

replacement for the inventory account using periodic inventory
reporting. Under the perpetual inventory system, any purchase returns
or discounts reduce the inventory account directly.
Inventory Accounting: Periodic Inventory and Discounts

Similarly, purchase discounts are credited to reduce the purchases

balance. In this example, Sunny purchased product with a 2% discount
when paid within 10 days (2/10), with full payment due within 30 days
(n/30). Discounts encourage quicker payment of items purchased on
credit. Purchase discounts are recorded in the contra account purchase
discounts.

Periodic Inventory Accounting: Inventory Cost (Cost of Goods Sold)

Even though Sunny Sunglasses Shop had no beginning inventory, in

this example it is important to note that any beginning inventory is
closed (credited) to inventory cost of goods sold when using periodic
inventory reporting.

Periodic Inventory Accounting Examples: Closing the Inventory Purchase Accounts

Purchases and its contra accounts, purchase returns and purchase

discounts, are temporary accounts closed to cost of goods sold at year
end. Since the purchases account is a debit account, it is closed with a
credit to the balance. Similarly, the contra accounts are credit
accounts that are closed with debit entries. The balance reflects net
purchases closed to cost of goods sold ($48,825).

Periodic Inventory Accounting Examples: Inventory Count and Ending Inventory

At the end of the year, Sunny takes an inventory count to determine

the ending inventory balance of $5,625. Since this amount reflects
goods available for sale that were not sold, this amount is debited to
inventory to record the amount as an asset, and credited to cost of
goods sold to reduce the amount recorded as cost of goods sold in the
previous entries.

At the beginning of next year, the beginning inventory balance is

$5,625. Cost of goods sold is recorded on the 2010 profit and loss
statement as $43,200.

Inventory Systems: Perpetual or Periodic

Companies may use either the perpetual system or the periodic system to account for

inventory. Under the periodic system, merchandise purchases are recorded in the

purchases account, and the inventory account balance is updated only at the end of each

accounting period. Perpetual inventory systems have traditionally been associated with

companies that sell small numbers of high-priced items, but the development of modern

scanning and computer technology has enabled almost any type of merchandiser to

consider using this system.

Under the perpetual system, purchases, purchase returns and allowances, purchase

discounts, sales, and sales returns are immediately recognized in the inventory account,

so the inventory account balance should always remain accurate, assuming there is no

theft, spoilage, or other losses. Consider several entries under both systems. The
reference columns are removed from the illustration to simplify what you're seeing.

(Note: Ap stands for accounts payable, and AR stands for accounts receivable.)

As the two sets of circled entries indicate, two things happen when there is a sale or a

sales return. First, the sales transaction's effect on revenue must be recognized by

making an entry to increase accounts receivable and the sales account. Second, the flow

of merchandise between inventory (an asset) and cost of goods sold (an expense) is

recorded in accordance with the matching principle. A sales return has the opposite effect

on the same accounts. Under the periodic system, the inventory and cost of goods sold

accounts are updated only periodically, but under the perpetual system, entries that

recognize a transaction's effect on these accounts occur when the revenue from the sale

is recognized.

For convenience, a sale or sales return can be recorded under the perpetual system with

a compound entry that lists all four accounts.

The general journal provides a simple, consistent format to present new information.

However, most companies would record the sale in a sales journal.

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