Chapter 4: Appendix P5

Periodic vs. Perpetual Inventory Systems: Recording and Comparing Merchandising Transactions Merchandising companies can use either the periodic or perpetual inventory system to manage their inventory and track costs. Both systems have distinct methods for recording purchases, sales, and cost of goods sold (COGS). 1. Periodic Inventory System In the periodic inventory system, the inventory account is updated only at the end of the period. Throughout the period, purchases are recorded in separate temporary accounts, such as Purchases, Purchases Returns and Allowances, and Transportation-In. At the end of the period, a physical count of inventory is conducted to calculate the ending inventory, and COGS is determined using the formula: COGS=Beginning Inventory+Net Purchases−Ending Inventory\text{COGS} = \text{Beginning Inventory} + \text{Net Purchases} - \text{Ending Inventory}COGS=Beginning Inventory+Net Purchases−Ending Inventory • • • Purchases: Debited when merchandise is purchased. COGS: Only recorded at the end of the period after a physical count of inventory. No inventory shrinkage tracking: Inventory loss is implicitly included in the COGS calculation. Example Transactions in a Periodic System: • • • • Credit Purchase with Discount (2/10, n/30): o November 2: Z-Mart purchases merchandise for $500. o Entry:  Debit Purchases $500  Credit Accounts Payable $500 Payment within Discount Period: o Entry:  Debit Accounts Payable $500  Credit Cash $490  Credit Purchases Discounts $10 Purchases Return: o Entry:  Debit Accounts Payable $50  Credit Purchases Returns and Allowances $50 Transportation-In (FOB Shipping Point): o Entry:   Debit Transportation-In $75 Credit Cash $75 At the end of the period, the Purchases, Purchases Discounts, Purchases Returns, and Transportation-In accounts are closed to calculate net purchases, and COGS is determined based on the physical inventory count. 2. Perpetual Inventory System In the perpetual inventory system, inventory and COGS are continuously updated as transactions occur. Every time merchandise is bought or sold, the Merchandise Inventory account is adjusted, and COGS is recorded at the time of sale. • • • Purchases: Directly recorded in the Merchandise Inventory account. COGS: Recorded with each sale. Shrinkage tracking: Adjusted at the end of the period for inventory shrinkage (e.g., due to theft, loss). Example Transactions in a Perpetual System: • • • • Credit Purchase with Discount (2/10, n/30): o November 2: Z-Mart purchases merchandise for $500. o Entry:  Debit Merchandise Inventory $500  Credit Accounts Payable $500 Payment within Discount Period: o Entry:  Debit Accounts Payable $500  Credit Cash $490  Credit Merchandise Inventory $10 (reflecting the discount) Purchases Return: o Entry:  Debit Accounts Payable $50  Credit Merchandise Inventory $50 Transportation-In (FOB Shipping Point): o Entry:  Debit Merchandise Inventory $75  Credit Cash $75 For each sale, the Merchandise Inventory and COGS accounts are updated simultaneously to reflect the reduction in inventory and the associated cost. 3. Key Differences Between Periodic and Perpetual Systems Aspect Inventory Updates Cost of Goods Sold (COGS) Purchases Tracking Shrinkage Tracking Journal Entry Complexity Periodic Inventory System Perpetual Inventory System Updated continuously with each Updated only at the end of the period. transaction. COGS is calculated at the end of the period COGS is recorded immediately after physical count. with each sale. Uses temporary accounts like Purchases, Directly updates the Purchases Returns and Allowances, and Merchandise Inventory Transportation-In. account. Shrinkage is recorded as a Shrinkage is included in the COGS separate adjusting entry at calculation implicitly. period-end. More detailed and complex Simpler during the period, but more throughout the period, but complex at the end due to closing entries. simpler at the end. 4. Example of Recording Sales: Periodic vs. Perpetual Credit Sale Example ($1,000 sales, $300 cost of goods sold): Periodic System: • • Only the revenue side of the transaction is recorded immediately. Entry (for sale): o Debit Accounts Receivable $1,000 o Credit Sales $1,000 At the end of the period, COGS is calculated and recorded based on the physical inventory count. Perpetual System: • • Both the revenue and cost sides are recorded immediately. Entry (for sale): o Debit Accounts Receivable $1,000 o Credit Sales $1,000 o Debit Cost of Goods Sold $300 o Credit Merchandise Inventory $300 5. Adjusting Entries for Inventory Shrinkage Only the perpetual system requires adjusting entries for inventory shrinkage because it continuously tracks inventory levels. For example, if a physical count reveals that $250 worth of inventory is missing: • Perpetual System Adjusting Entry: o Debit Cost of Goods Sold $250 o Credit Merchandise Inventory $250 In the periodic system, inventory shrinkage is not recorded directly. Instead, the difference between the calculated COGS and the actual inventory count will implicitly include any shrinkage. 6. Closing Entries In the periodic system, closing entries involve updating the Merchandise Inventory account with the new ending inventory, and closing the temporary accounts like Purchases and Transportation-In. Perpetual system closing entries are simpler because the Merchandise Inventory and COGS accounts are continuously updated, and no Purchases accounts need to be closed. Conclusion: Choosing Between the Systems • • Periodic Inventory System: Best suited for smaller businesses with lower transaction volumes, as it simplifies day-to-day record-keeping but requires more work at the period's end. Perpetual Inventory System: Preferred by larger businesses or those with high inventory turnover. It provides more up-to-date information, which can be crucial for decision-making and inventory management, but requires more detailed tracking and systems support. Both systems are viable, but the perpetual system offers more timely and accurate tracking of inventory, whereas the periodic system is simpler but lacks real-time visibility.