Inventory: Merchandising Transactions
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Chapter 7 Appendix
Appendix 7A: The Periodic Inventory System
As mentioned, the periodic inventory system determines the quantity of inventory on hand only
periodically. A physical count is taken at the end of the period to determine the value of the ending
inventory and cost of goods sold.
Thus, a periodic inventory system does not update the inventory account on a regular basis, only
when a physical count is taken. On a regular basis, the periodic inventory system updates a new list
of income statement accounts which are used to calculate cost of goods sold.
Consider the differences between the perpetual
and the periodic inventory system. Figure 7A.1
illustrates the perpetual inventory system. A
business that has the technology to properly
implement the perpetual inventory system will
record purchases, discounts, allowances and other
adjustments into the inventory asset account.
Inventory is then transferred to cost of goods
sold when a sale is made. Cost of goods sold is
immediately matched to sales and gross profit is
reported every month, although gross profit may
be slightly incorrect if an inventory count is not
performed.
A business that does not have the technology to
constantly update inventory like in the perpetual inventory system must instead use the periodic
inventory system. Figure 7A.2 illustrates the periodic inventory system. Inventory shows an
opening value at the beginning of the period, but is only adjusted up or down at the end of the
period when an inventory count is performed. All purchases, discounts, allowances and other
adjustments are recorded directly into the income statement as part of cost of goods sold.
If purchases were recorded in the inventory
account on the balance sheet, they would always
remain in inventory since inventory is not
transferred to cost of goods sold when a sale
is made. This would leave a large amount of
inventory remaining on the balance sheet and no
cost of goods sold on the income statement. It
is more practical to record purchases directly on
the income statement, and adjust the inventory
account only at year end.
Keep the concept of the periodic inventory system
in mind as the journal entries are presented.The
transactions are very similar to the perpetual
inventory system, except that income statement accounts are affected instead of inventory.
SALES RETURNS & ALLOWANCES
INCOME STATEMENT
GROSS PROFIT
OPERATING EXPENSES
SALES REVENUE
COST OF GOODS SOLD
BALANCE SHEET
OPERATING INCOME
CURRENT ASSETS
CASH
INVENTORY
ACCOUNTS
RECEIVABLE
PREPAID
EXPENSES
PROPERTY, PLANT
& EQUIPMENT
LONG-TERM
ASSETS
ACCOUNTS
PAYABLE
BANK LOAN
CURRENT LIABILITIES
UNEARNED
REVENUE
LONG-TERM
LIABILITIES
OWNER’S EQUITY
OWNER’S
CAPITAL
____________
figure 7A.1
SALES RETURNS & ALLOWANCES
INCOME STATEMENT
GROSS PROFIT
OPERATING EXPENSES
SALES REVENUE
COST OF GOODS SOLD
BALANCE SHEET
OPERATING INCOME
CURRENT ASSETS
CASH
INVENTORY
ACCOUNTS
RECEIVABLE
PREPAID
EXPENSES
PROPERTY, PLANT
& EQUIPMENT
LONG-TERM
ASSETS
ACCOUNTS
PAYABLE
BANK LOAN
CURRENT LIABILITIES
UNEARNED
REVENUE
LONG-TERM
LIABILITIES
OWNER’S EQUITY
OWNER’S
CAPITAL
____________
figure 7A.2
