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
      ----------------------------------------------------------------------
      1.  Beginning inventory 100 units at $600
      ----------------------------------------------------------------------
          Inventory account shows         |  Inventory account shows
          $600 in inventory.              |  $600 in inventory.
      ----------------------------------------------------------------------
      2.  Purchase of 900 units at $6 per unit
      ----------------------------------------------------------------------
          Inventory            5,400      |  Purchases           5,400
             Acc. Payable            5,400|     Acc. Payable           5,400
      ----------------------------------------------------------------------
      3.  Sale of 600 units at a selling price of $12 per unit
      ----------------------------------------------------------------------
          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|
      ----------------------------------------------------------------------
      4. End-of-period entry for inventory adjustment
      ----------------------------------------------------------------------
          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
      -----------------------------------------------------------------------
      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
      -----------------------------------------------------------------------

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 |
      -----------------------------------------------------------------------
      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
      -----------------------------------------------------------------------

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.