Journal entries in a perpetual inventory system:

(1). When goods are purchased:

 (2). When expenses such as freight-in, insurance etc. are incurred:

(3). When goods are returned to supplier:

(4). When goods are sold to customers:

(5). When goods are returned by customers:

(6). When a difference between the balance of inventory account and physical count of
inventory is found:

For further explanation of the concept of perpetual inventory system, consider the following
example:

Example:

(1). On 1st April 2013, Metro company purchases 15 washing machines at $500 per machine on
account. The supplier allows a discount of 5% if payment is made within 10 days of purchase.
The Metro company uses net price method to record the purchase of inventory.

The following journal entry would be made in the books of Metro company to record the
purchase of merchandise:

*Net of discount: ($500 × 15) – $25 discount

(2). On the same day, Metro company pays $320 for freight and $100 for insurance.

The following journal entry would be made to record the payment of freight-in and insurance
expenses:
(3). On April 07, Metro company returns 5 washing machines to the supplier.

The return of washing machines to the supplier decreases the cost of inventory and accounts
payable. The following entry would be made to record this decrease:

 (4). On April 9, Metro sends the payment via online banking system and takes the advantage of
the discount offered by the supplier.

As the payment is made within 10 days, the Metro company is entitled to receive discount. The
following entry would be made to record the payment:

*($7,125 – $2,375)

(5). On April 15, Metro company sells 4 washing machines at $750 per machine. The Metro
company does not allow any discount to customers.

The sale of 4 washing machines transfers the cost of inventory from inventory account to cost of
goods sold account. Two journal entries would be made; one for the sale of 4 washing
machines and one for the transfer of cost from inventory account to cost of goods sold account:
*Cost of 4 machines sold:

[($475 × 10 machines) + $420 expenses]/10 = $517 per machine

$517 × 4 machines = $2,068

To summarize the events of increase and decrease in the cost of inventory, Inventory T-account
of Metro company is given below:

Periodic inventory system

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

Example

The following information belongs to John company, a retailer of high-end fashion products:

Inventory balance on January 1, 2016: $600,000

Purchases made during the year 2016: $1,200,000
Inventory balance on December 31, 2016: $500,000

Required: Compute cost of goods sold for the year 2016 assuming the company uses a
periodic inventory system.

Solution:

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

= $600,000 + $1,200,000 – $500,000
= $1,300,000

Journal entries in a periodic inventory system:

(1). When goods are purchased from supplier:

(2) When expenses are incurred to obtain goods for sale – freight-in, insurance etc:

(3). When goods are returned to supplier:

(4). When payment is made to supplier:

(5). When goods are sold to customers:

(6). When goods are returned by customers:

(7). When cash is collected from customers:

(8). At the end of the period:

Example:

The following information belongs to Paradise Hardware Store:

Beginning inventory: 200 units at $12 = $2,400

Purchases made during the period: 1800 units at $12 = $21,600
Sales made during the period: 1200 units at $24 = $28,800
Ending inventory: 800 units at $12 = $9,600

Required: Make journal entries to record above transactions assuming a periodic inventory

system is used by Paradise Hardware Store.
Solution:

* (21,600 + 2,400) – 9,600

Periodic inventory system is usually used by companies that buy and sell a wide variety of
inexpensive products.

A disadvantage of periodic inventory system is that overages and shortages of inventory are
buried in cost of goods sold because no accounting record is available against which to
compare physical count of inventory.

Perpetual and periodic inventory system – journal entires

The beginning inventory of Beta company consisted of  100 units @ $60 each. The following
transactions occurred during the month of March 2013.

 Mar. 05: Purchased 300 units @ $60 each.

 Mar. 06: Out of 300 units purchased on March 05, 10 units were returned to supplier.
 Mar: 28: Sold 250 units @ $100 each.
On March 31, 2013, 140 units were found by a physical count.

Required: Make journal entries for the month of June assuming the Beta company uses:

1. perpetual inventory system.

2. periodic inventory system.

 Solution:

(1) If perpetual inventory system is used:

March, 05 – entry to record purchase of 300 units on account:

*(300 units × $60) = $18,000

March, 06 – entry to record return of 10 units to supplier:

*(10 units × $60) = $18,000

March, 28 – entries to record sale of 250 units to customers:

a. Entry to realize sales revenue:

*(250 units × $100) = $25,000

b. Entry to update inventory account:

*(250 units × $60) = $15,000

(2). If periodic inventory system is used:

March, 05 – entry to record purchase of 300 units on account:

March, 06 – entry to record return of 10 units to supplier:

March, 28 – entry to record sale of 250 units to customers:

March, 31 – closing entry to create cost of goods sold account and to update inventory
account :
*140 × $60 = 8,400

Periodic inventory system vs perpetual inventory system

The Pharma company is a single product company. The company presents the following
information regarding its activities during the month of December 2013.

 Dec. 01: Beginning inventory; 200 units @ $10 each.

 Dec. 02: Sold 160 units @ $16 each.
 Dec. 12: Purchased 300 units @ $12 each.
 Dec. 18: Sold 240 units @ $17.50 each.
 Dec. 22: Purchased 320 units @ $14 each.
 Dec. 29: Sold 200 units @  $18 each.

At the end of December, there were 220 units on hand according to a physical count of
inventory.

Pharma company uses a first-in, first-out (FIFO) cost flow assumption. All purchases and sales
are made on account.

 Required:

1. Prepare journal entries and compute gross profit assuming the company uses a periodic
inventory system.
2. Prepare journal entries and compute gross profit assuming the company uses
a perpetual inventory system.

Solution:

(1). If periodic inventory method is used:

(a). Journal entries:

 *Balancing figure: (2,000 + 8,080) – 3,080 = 7,000

(b). Computation of gross profit:

Gross profit = Sales – Cost of goods sold

= $10,360* – $7,000**

= $3,360

*(2,560 + 4,200 + 3,600)

**See last journal entry in part ‘a’

(2). If perpetual inventory method is used:

(a). Journal entries:

(b). Computation of gross profit:

Gross profit = Sales – Cost of goods sold

 = $10,360* – $7,000**

= $3,360

*(2,560 + 4,200 + 3,600)

**(1,600 + 2,800 + 2,600)

Notice that cost of goods sold and gross profit of the Pharma company are same under both
periodic and perpetual inventory methods. It is because of the use of FIFO cost flow
assumption.

FIFO, LIFO and average cost method in periodic inventory system

The Delta company uses a periodic inventory system. The beginning balance of inventory and
purchases made by the company during the month of July, 2016 are given below:

 July 01: Beginning inventory, 500 units @ $20 per unit.

 July 18: Inventory purchased, 800 units @ $24 per unit.
 July 25: Inventory purchased, 700 units @ $26 per unit.

The Delta company sold 1,400 units during the month of July.

Required: Compute inventory on July 31, 2016 and cost of goods sold for the month of July
using following inventory costing methods:

1. First in, first out (FIFO) method

2. Last in, first out (LIFO) method
3. Average cost method

 Solution:

Number of units in ending inventory:

Ending inventory = Beginning inventory + Purchases made during the month – Units sold during
the month

= 500 units + *1,500 units – 1,400 units

= 600 units

*800 units + 700 units = 1,500

(1) First in, first out (FIFO) method:

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under FIFO:

b. Computation of cost of goods sold (COGS) for July 31, 2016 under FIFO:

Alternatively, we can compute cost of goods sold (COGS) using earliest cost method as
follows:
(2) Last in, first out (LIFO) method:

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under LIFO:

b. Computation of cost of goods sold (COGS) for July 31, 2016 under LIFO:

Alternatively, we can compute cost of goods sold (COGS) using most recent cost method as
follows:
 (3) If average cost method is used:

[(500 units × $20) + (800 units × $24) + (700 units × $26)]/500 units + 800 units + 700 units

= $47,400/2,000 units

= $23.70

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under average cost
method:

Ending inventory = 600 units × $23.70

= $14,220

b. Computation of cost of goods sold (COGS) for July 31, 2016 under average cost
method:

Cost of goods sold (COGS) = 1,400 × $23.70

= $33,180

Alternatively, we can compute cost of goods sold (COGS) by deducting ending inventory from
cost of goods available for sale:

Cost of goods sold (COGS) = Cost of goods available for sale – Ending inventory

Cost of goods sold (COGS) = [{(500 units × $20) + (800 units × $24) + (700 units × $26)}
– $14,220*]

= $47,400 – $14,220

= $33,180
*See part a

method of recording purchases

(Purchase Discounts)

The Eastern trading company presents the following transactions relating to purchasing
activities during the month of June 2016.

 June 05: Purchased goods for $30,000; cash discount terms: 2/12, n/30.
 June 08: Purchased goods for $26,400; cash discount terms: 2/15, n/20.
 June 11: Cash paid for goods purchased on June 05.
 June 20: Purchased goods for $20,000; cash discount terms: 2/20, n/45.

The Eastern company uses net of discount method of recording purchases. Any discount lost is
treated as financial expense. The financial statements are prepared on June 30.

Required: Make journal entries to record above transactions. Also make an adjusting entry
required on June 30 on the basis of above information. Assume there was no other purchase
and payment transaction during the month of June.

Solution:

General journal entries:
Adjusting entry required on June 30, 2016:

The following adjusting entry is needed to record the discount lost on the purchases made on
June 8, 2016.

method of recording purchases RETURN

The United company made the following transactions during the month of March:

 Mar.05: Purchased merchandise worth $21,600; credit terms were 2/20, n/45.
 Mar.08: Returned merchandise to vendor worth $5,000 (gross).
 Mar.20: Payment made for merchandise purchased on March 5.

The company uses gross method of recording purchases.

Required: Prepare journal entries to record the above transactions assuming the United
company uses:

1. Perpetual inventory method

2. Periodic inventory method

 Solution:

(1) Journal entries if perpetual inventory method is used:

*21,600 × 0.02 = 432
**21,600 – 432 = 21,168

(2) Journal entries if periodic inventory method is used:

*21,600 × 0.02 = $432

**21,600 -432 = $21,168

FIFO and LIFO under periodic and perpetual system

The Breeze trading company discloses the following information for the month of August 2016.

 Aug. 01: Beginning inventory, 600 units @ $5 each each.

 Aug. 10: Sold 400 units @ $12 each.
 Aug. 11: Purchased 1,600 units @ $6 each.
 Aug. 15: Sold 1,000 units @ $12.50 each.
 Aug. 20: Purchased 1,000 units @ $6.50 each.
 Aug. 27: Sold 600 units @ $13.50 each.

Required:

1. Assume the Breeze trading company uses periodic inventory system, compute cost of
goods sold (COGS), ending inventory and gross profit under:
(a). FIFO
(b). LIFO
2. Assume the Breeze company uses perpetual inventory system, compute cost of goods
sold (COGS), ending inventory and gross profit under:
(a). FIFO
(b). LIFO
3. Explain the reason of higher gross profit under FIFO than LIFO?
Solution:

(1) If Breeze trading company uses periodic inventory method:

Ending inventory in units = Beginning inventory + Purchases – Sales

= 600 units + 2,600 units – 2,000 units

= 1,200 units

a. FIFO method:

i. Cost of ending inventory under periodic-FIFO

ii. Cost of goods sold under periodic-FIFO:

OR
iii. Gross profit under periodic-FIFO:

*(400 units × $12) + (1,000 units × $12.50) + (600 units × $13.50)

 (b). LIFO method:

i. Cost of ending inventory under periodic-LIFO

ii. Cost of goods sold under periodic-LIFO:

iii. Gross profit under periodic-LIFO:

(2) If Breeze trading company uses perpetual inventory method:

(a). Perpetual-FIFO:

We need to prepare a perpetual inventory card using FIFO method to find ending inventory, cost
of goods sold and gross profit.
i. Cost of ending inventory under perpetual-fifo:

$7,700 (see last row of balance column).

ii. Cost of goods sold under perpetual-fifo:

$2,000 + $5,800 + $3,600 = $11,400 (total of sales column)

iii. Gross profit under perpetual-fifo:

Sales – Cost of goods sold

= $25,400 – $11,400

= $14,000

(b). Perpetual-LIFO:

We need to prepare a perpetual inventory card using LIFO method to find ending inventory, cost
of goods sold and gross profit.
i. cost of ending inventory under perpetual-lifo:

$7,200 (see last row of balance column)

ii. Cost of goods sold under perpetual-lifo:

$2,000 + $6,000 + $3,900 = $11,900 (total of sales column)

iii. Gross profit under perpetual-lifo:

Sales – cost of goods sold

= $25,400 – $11,900

= $13,500

3. The reason of higher gross profit under FIFO than LIFO:

Under LIFO cost flow assumption, the most recent costs are matched against revenues,
whereas under FIFO cost flow assumption, the oldest costs are matched against revenues. In
inflationary environment (an economic situation where prices continuously rise), the FIFO
produces higher gross profit than LIFO. The reverse is true in a deflationary environment (an
economic situation where prices continuously decrease).

In this exercise, the prices are rising therefore the FIFO produces a higher gross profit than
LIFO.
Computation of ending inventory under FIFO and LIFO

The Alpha merchandising company purchases product DX-5 directly from manufacturers and
sell it to small retailers as well as customers. The following transactions occurred during the last
month of  2016:

 Dec. 01: 800 units on hand @ $40 each.

 Dec. 08: 600 units sold @ $76 each.
 Dec. 14: 1,200 units purchased @ $50 each.
 Dec. 18: 1,080 units sold @ $76 each.
 Dec. 30: 800 units purchased @ $60 each.

Required:

1. Assuming the Alpha merchandising company uses periodic inventory method, compute
the cost of inventory on hand at December 31, 2016 under the following cost flow
assumptions:
(a). First in, first out (FIFO)
(b). Last in, first out (LIFO)
2. Assuming the Alpha merchandising company uses a perpetual inventory method,
compute the cost of inventory on hand at December 31, 2016 under the following cost
flow assumptions:
(a). First in, first out (FIFO)
(b). Last in, first out (LIFO)

Solution:

(1) Periodic inventory method:

Number of units on January 31, 2013 = Units in beginning inventory + Units purchased during
the month – Units sold during the month

= 800 units + *2,000 units – **1,680 units

= 1,120 units

*1,200 + 800

**600 + 1,080

a. FIFO method:

Cost of inventory on January 31, 2016 = (800 units × $60) + (320 units × $50)

= $48,000 + $16,000

= $64,000
b. LIFO method:

Cost of inventory on January 31, 2016 = (800 units × $40) + (320 units × $50)

= $32,000 + $16,000

= $48,000

(2). Perpetual inventory method:

We can determine the value of ending inventory by preparing two perpetual inventory cards –
one using FIFO method and one using LIFO method.

a. FIFO method:

Under perpetual-fifo, the cost of inventory on December 31, 2016 is $64,000 (see last row of
balance column).
b. LIFO method:

Under perpetual-lifo, the cost of inventory on December 31, 2016 is $62,000 (see last row of
balance column)