Perpetual vs Periodic Inventory System
Merchandise inventory includes all saleable goods owned, regardless of where they are located. Merchandise inventory can be determined by one of two systems, Perpetual or Periodic.
Periodic Inventory System:
Under the periodic inventory system, the company usually waits until the end of an accounting period to take a physical inventory; it does not maintain detailed records of physical inventory on hand during the period. The cost of goods sold is computed after a physical inventory is taken.
Perpetual Inventory System:
Under the perpetual inventory system, records are kept of the quantity and usually the cost of individual items of inventory throughout the year, as items are bought and sold. The cost of goods sold is recorded as goods are transferred to customers, and the inventory balance is kept current throughout the year, as items are bought and sold.
Updating Inventory Balance in a Periodic Inventory System:
Since the merchandise inventory account is not continuously updated for purchases or sales of inventory items it must be updated through the recording of journal entries. At the end of the accounting period under a periodic inventory system, it is necessary to:
- remove the beginning balance from the Merchandise Inventory account,
- enter the ending balance in the Merchandise Inventory account, and
- enter these two amounts in the Income Summary account to calculate net income.
These objectives are accomplished by debiting Income Summary and crediting Merchandise Inventory for the beginning balance, and debiting Merchandise Inventory and crediting Income Summary for the ending balance.
| Related Accounting Entries | ||||
|---|---|---|---|---|
| Inventory Procedures at End of Period | Debit | Credit | ||
| Transfer the balance of the beginning inventory to the Income Summary account | Income Summary | |||
| Merchandise Inventory | ||||
| Take a physical inventory of the goods on hand at the end of the period, and establish the balance of the ending inventory | Merchandise Inventory | |||
| Income Summary | ||||
There are two ways of accomplishing these effects.
Under the adjusting entry method, the entries are included among the adjusting entries.
Under the closing entry method, the entries are included among the closing entries.
Worksheet for a Merchandising Concern:
The major difference between preparing a work sheet for a merchandising concern and preparing one for a service company is in the accounts relating to merchandising transactions. The accounts necessary to compute the cost of goods sold appear in the Income Statement columns. The Merchandise Inventory account is treated differently under each of the following two methods:
Adjusting entry method:
Under this method, the beginning inventory is debited to Income Summary and credited to Merchandise Inventory in the Adjustments columns—clearing the beginning inventory from the Merchandise Inventory account. Then, the ending inventory is debit to Merchandise Inventory and credited to Income Summary. Both the debit and credit to Income Summary are entered in the appropriate Income Statement columns; and the debit to Merchandise Inventory is entered in the Balance Sheet debit columns.
Closing entry method:
Under this method, the beginning inventory from the trial balance is extended to the debit column of the Income Statement columns, and the ending balance of Merchandise Inventory is inserted in both the credit column of the Income Statement columns and the debit column of the Balance Sheet columns.
Adjusting and Closing Entries for a Merchandising Concern:
The adjusting and closing entries for a merchandising concern are similar to those for a service business. The major difference is in handling merchandise inventory, which is summarized in this table:
| Adjusting Entries | Closing Entries | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Method | Debit | Credit | Debit | Credit | |||||
| Adjusting entry method | |||||||||
| amount of beginning inventory | Income Summary | Follow procedures for service companies | |||||||
| Merchandise Inventory | |||||||||
| amount of ending inventory | Merchandise Inventory | ||||||||
| Income Summary | |||||||||
| Closing entry method | Include among closing entries the following: | ||||||||
| amount of beginning inventory | Follow procedures for service companies | Income Summary | |||||||
| Merchandise Inventory | |||||||||
| amount of ending inventory | Merchandise Inventory | ||||||||
| Income Summary | |||||||||