Lesson Objectives:- Differences between the periodic and perpetual inventory system
- Recording purchases and returns
- Journalizing shipping costs and discounts
Here are two important differences between the periodic inventory system and the perpetual inventory system:
1. There will be no merchandise inventory account since the company is not using a system to track the inventory balances. This is because the merchandise is counted at the end of the accounting period.
2. Since we are not tracking every merchandise transaction, there will not be a cost of goods sold for each transaction.
Let's say the company is using a periodic inventory system and makes a purchase for $5,000. We first have the purchases account, which is considered an asset, that is increasing, therefore it will be debited by the $5,000. Accounts payable is a liability that is also increasing, and would be credited by the same amount.
If the purchase is made on 2/10, net 30 terms, this means that a 2 percent discount is offered if payment is made within 10 days. Otherwise, the company is due to pay the full amount within 30 days.
If the company is paying for the shipping costs on their purchase, they would need to record a journal entry for the transaction. Since we are not using the merchandise inventory account to track the inventory changes, the shipping costs would be recorded using the freight in and cash accounts.
Freight in is the expense that the company must pay for shipping and falls under the expense category, so it would be debited for $120. They are paying cash for the shipping costs, which means the cash would need to be credited. This would be the case of FOB shipping, while there would be no journal entry for FOB destination.
You can think of purchase returns as the opposite of purchases, as the merchandise is being returned to the seller. If the company is returning $650 worth of merchandise, accounts payable would need to be debited for that amount because it is a liability that is decreasing. The purchase returns and allowances account would be the contra account that is credited by $650 to balance out the double entry.
The final type of purchase transaction in the periodic inventory system is discounts. Accounts payable would be decreasing because it is being paid off and since it is a liability, it would be debited by $4,350 since $650 worth of merchandise was returned out of the original $5,000 total.
If the discount was 2 percent for issuing payment within 10 days, the company would pay $4,263 in cash and the purchase discount would be $87. Both accounts would need to be credited.
Many of these accounts such as purchase returns & allowances and purchase discounts will come up in future lessons when we are reviewing the multiple-step income statement preparation again for periodic inventory.