3.5: Basic Merchandising Transactions (periodic inventory system)
A merchandising business buys product from vendors, marks it up, and sells it to customers.
Some companies do not keep an ongoing running inventory balance as was shown under the perpetual inventory system. Instead, these companies use the periodic inventory system and choose to wait until the end of the accounting period, just before financial statements are prepared, to conduct a physical inventory count to determine (1) how much ending inventory they still have in stock (counted) and (2) how much inventory they have sold during the period, which is their cost of merchandise sold (calculated).
Transactions 1 through 4 are for purchases under the periodic inventory system. Rather than using the Merchandise Inventory account to record purchases, returns, discounts, and transportation costs, four temporary accounts are used instead under the periodic system: Purchases , Purchases Returns , Purchases Discounts , and Freight-in . These accounts substitute for the Merchandise Inventory accounts during the accounting period and are closed into the Merchandise Inventory account at the end of the period.
-
You purchase 50 items on account for $10 each, terms 2/10, n/30.
Date Account Debit Credit 1 Purchases 500 ▲ Purchases is a temporary account (for an asset) that is increasing . Accounts Payable 500 ▲ Accounts Payable is a liability account that is increasing . -
You pay transportation costs to UPS for merchandise purchases.
Date Account Debit Credit 2 Purchases 500 ▲ Freight-in is a temporary account (for an asset) that is increasing . Accounts Payable 500 ▲ Accounts Payable is a liability account that is increasing . -
Return 10 of the items to the vendor. “Flip” over the previous purchase transaction to undo it. Add the word “Returns” to the account name.
Date Account Debit Credit 3 Accounts Payable 100 ▼ Accounts Payable is a liability account that is decreasing Purchases Returns 100 ▼ Purchases Returns is a temporary account (for an asset) that is decreasing . -
Pay for the purchase (minus return/with the discount).
Date Account Debit Credit 4 Accounts Payable 400 ▼ Accounts Payable is a liability account that is decreasing . Cash 392 ▼ Cash is an asset account that is decreasing . Purchases Discounts 8 ▲ Purchases Discounts is a temporary account (for an asset) that is decreasing . Similar to the perpetual system, at the beginning of the accounting period (such as a year), a merchandising company under the periodic system estimates how much of its sales will be returned during the year. Assume that transaction has been recorded.
The following three transactions are used for sales, actual returns, and receipt of payments from customers under the periodic inventory system.
-
a. Sell 50 items on account for $15 each, n/30.
Date Account Debit Credit 5a Accounts Receivable 750 ▲ Accounts Receivable is an asset account that is increasing . Sales 750 ▲ Sales is a revenue account that is increasing . The estimate account is reduced since some of the returns actually occurred, so less is estimated to occur in the future.
-
a. Customer returns 10 items.
Date Account Debit Debit 6a Allowance for Sales Returns 150 ▼ Allowance for Sales Returns is a contra account that is decreasing . Accounts Receivable 150 ▼ Accounts Receivable is an asset account that is decreasing . -
Receive payment for the sale (minus the return).
Date Account Debit Debit 7 Cash 600 ▲ Cash is an asset account that is increasing . Accounts Receivable 600 ▼ Accounts Receivable is an asset account that is decreasing . Notice that under the periodic system there is no corresponding adjustment for the amount of inventory at the time of a sale or a return. That is what makes this system different from the perpetual system. Running balances for the Cost of Merchandise Sold and Merchandising Inventory accounts are not maintained on an ongoing basis during the accounting period.
Therefore, at the end of the year, an entry must be made to record the total amount of cost of merchandise sold for the year and to adjust the Merchandising Inventory account to its current ending balance. This is done by deducting the ending inventory balance, which includes items that were not yet sold, from the total cost of goods available for sale during the year.
As an example, assume the following about a company’s inventory for the year.
Beginning inventory on January 1 $ 10,000 Purchases 30,000 Freight-in 5,000 Purchases Discounts (1,000) Purchases Returns (2,000) Ending inventory balance on December 31 8,000 Total cost of goods available for sale during the year is $42,000, determined by adding the first five amounts above. Of that $42,000 available for sale, only $8,000 remains in inventory at the end of the year based on a physical inventory count. That means that $34,000 of what was available must have been sold.
The $34,000 is the cost of goods sold amount for the year, and that amount must be journalized so that it ultimately appears on the company’s end-of-year income statement. In the same journal entry, the four temporary accounts used in the periodic inventory system – Purchases, Freight-in, Purchases Discounts, and Purchases Returns – are closed to their related permanent account, Merchandise Inventory . Using the previous data, the journal entry would be as follows:
| Account | Debit | Credit | |
| ▲ Cost of Merchandise Sold | 34,000 | ▲ Cost of Merchandise Sold is an expense account increasing . | |
| ▲ Merchandise Inventory | 8,000 | ▼ Merchandise Inventory is an asset account that is decreasing . | |
| ▼ Purchases Discounts | 1,000 | ▼ Purchases Discounts is a temporary account decreasing . | |
| ▼ Purchases Returns | 2,000 | ▼ Purchases Returns is a temporary account that is decreasing . | |
| ▼ Purchases | 30,000 | ▼ Purchases is a temporary account that is decreasing . | |
| ▼ Freight-in | 5,000 | ▼ Freight-in is a temporary account that is decreasing . | |
| ▼ Merchandise Inventory | 10,000 | ▲ Merchandise Inventory is an asset account that is i ncreasing . |
3.5.1 Inventory Shrinkage
Under the perpetual inventory system, a business keeps a running total of its inventory balance at all times by debiting (adding to) Merchandise Inventory when items are purchased and crediting (subtracting from) Merchandise Inventory when items are sold. With each transaction, the debit balance is updated.
Occasionally businesses will take a physical inventory count to determine if it actually has all items it thinks it has per its accounting records. Inventory shrinkage is the difference that results when the amount of actual inventoryphysically counted is less than the amount of inventory listed in the accounting records. Any shrinkage amount may be due to previous miscounts, loss, or theft.
When a shortage is discovered as a result of a physical inventory count, the following entry would be made to adjust the accounting records:
17. Discover an inventory shortage of $300.
| Date | Account | Debit | Credit | ||
| 17 | Cost of Merchandise Sold | 300 | ▲ Cost of Merchandise Sold is an expense account that is increasing . | ||
| Merchandise Inventory | 300 | ▼ Merchandise Inventory is an asset account that is decreasing . |
This is the same as the entry made when there is a sale; however, this transaction does not “match up” with any particular sale. Further investigation would take place if the amount of the shortage was significant.