PERPETUAL INVENTORY SYSTEMS PERPETUAL INVENTORY SYSTEMS: All of the preceding illustrations were based on the periodic inventory

system, the ending inventory was counted and costs were assigned only at the end of the period. A more robust system is the perpetual system. With a perpetual system, a running count of goods on hand is maintained at all times. Modern information systems facilitate detailed perpetual cost tracking for those goods. PERPETUAL FIFO: The following table reveals the application of the perpetual inventory system for Gonzales -- using a FIFO approach:

Two points come to mind when examining this table. First, there is considerable detail in tracking inventory using a perpetual approach; thank goodness for computers. Second, careful study is needed to discern exactly what is occurring on each date. For example, look at April 17 and note that 3,000 units remain after selling 7,000 units. This is determined by looking at the preceding balance data on March 5 (consisting of 10,000 total units (4,000 + 6,000)), and removing 7,000 units as follows: all of the 4,000 unit layer, and 3,000 of the 6,000 unit layer. Remember, this is the FIFO application, so the layers are peeled away based on the chronological order of their creation. In essence, each purchase and sale transaction impacts the residual composition of the layers associated with the item of inventory. Realize that this type of data must be captured and maintained for each item of inventory if the perpetual system is to be utilized; a task that was virtually impossible before cost effective computer solutions became commonplace. Today, the method is quite common, as it provides better "real-time" data needed to run a successful business. JOURNAL ENTRIES: The table above provides information needed to record purchase and sale information. Specifically, Inventory is debited as purchases occur and credited as sales occur. Following are the entries:

3-5-XX Inventory Accounts Payable Purchased $96,000 of inventory on account (6,000 X $16)

96,000 96,000

4-17-XX Accounts Receivable Sales Sold merchandise on account (7,000 X $22)

154,000 154,000

4-17-XX Cost of Goods Sold Inventory To record the cost of merchandise sold ((4,000 X $12) + (3,000 X $16))

96,000 96,000

9-7-XX Inventory Accounts Payable Purchased $136,000 of inventory on account (8,000 X $17)

136,000 136,000

11-11-XX Accounts Receivable Sales Sold merchandise on account (6,000 X $25)

150,000 150,000

11-11-XX Cost of Goods Sold Inventory To record the cost of merchandise sold ((3,000 X $16) + (3,000 X $17))

99,000 99,000

Let's see how these entries impact certain ledger accounts and the resulting financial statements:

For abnormal loss

For example, assume that Tiki's inventory was destroyed by fire. Sales for the year, prior to the date of the fire were $1,000,000, and Tiki usually sells goods at a 40% gross profit rate. Therefore, Tiki can readily estimate that cost of goods sold was $600,000. Tiki's beginning of year inventory was $500,000, and $800,000 in purchases had occurred prior to the date of the fire. The inventory destroyed by fire can be estimated via the gross profit method, as shown.

For reference: 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 Purchases Sales Ending inventory

100 units @ $6 900 units @ $6

= $

600

= $5,400

600 units @ $12 = $7,200 400 units @ $6 = $2,400

Perpetual Inventory System System

Periodic Inventory

--------------------------------------------------------------------1. Beginning inventory 100 units at $600

--------------------------------------------------------------------Inventory account shows $600 in inventory. | | Inventory account shows $600 in inventory.

--------------------------------------------------------------------2. Purchase of 900 units at $6 per unit

--------------------------------------------------------------------Inventory 5,400 Acc. Payable 5,400 5,400| Acc. Payable 5,400 | Purchases

--------------------------------------------------------------------3. Sale of 600 units at a selling price of $12 per unit

--------------------------------------------------------------------Acc. Receivable Sales 7,200 | Cost of Goods Sold Inventory 3,600 | 3,600| No entry 7,200 | 7,200| Acc. Receivable Sales 7,200

--------------------------------------------------------------------4. End-of-period entry for inventory adjustment

--------------------------------------------------------------------No entry needed. 1,800 The ending balance of inventory | shows $2,400. 5,400 | Cost of Goods Sold 3,600 Purchases | Inventory

--------------------------------------------------------------------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 Net Purchases 600 5,400 -------

Goods Available for Sale Ending Inventory

6,000 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. a price reduction allowance of $100 on the portion of the merchandise they retained. Ace Company returned $600 of damaged merchandise and received

---------------------------------------------------------------------Acc. Payable Inventory 700 700 700 | | Acc. Payable Purch. R&A 700

---------------------------------------------------------------------2. at a cost of $1,000. for the merchandise within the discount period. The credit terms were 2/10, n/30. Ace paid In a previous transaction, Ace purchased merchandise on account

---------------------------------------------------------------------Acc. Payable Inventory 20 Cash 980 980 | Cash 1,000 20 | | Acc. Payable Purch. Disc. 1,000

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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

---------------------------------------------------------------------1. customer Ace. damaged merchandise that Ace retained. merchandise returned to Sam was $400. The original cost of the They also gave Ace a $100 allowance for some of the Sam Company received $600 of damaged merchandise from their

---------------------------------------------------------------------Sales R&A Acc. Receivable 700 | Inventory Cost of Goods Sold 400 | 400 | No entry 700 | 700 | Sales R&A Acc. Receivable 700

---------------------------------------------------------------------2. Sam received a customer payment for a prior sale on account of $1,000 subject to credit terms of 2/10, n/30. payment within the discount period. The customer made

---------------------------------------------------------------------Cash Sales Disc. Acc. Receivable 1,000 980 20 | | 1,000| Cash Sales Disc. Acc. Receivable 980 20

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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.