Journal Entries for the Perpetual Inventory Method

As suggested above, the Perpetual method makes use of the Inventory account when Inventory is
purchased sold. Here is a summary of the typical journal entries:
1. When inventory is purchased, a debit is made to the Inventory account and a credit made
to Cash or Accounts Payable. Inventory is a current asset.
Example: Jones purchases $5,000 of Inventory on account, with terms of 2/10, n/30. The
journal entry would be:

2. If merchandise is returned to a supplier, a debit is made to Accounts Payable or Cash, and

a credit is made to the Inventory account.
Example: Jones returns $500 of goods to the supplier because they were defective. The
entry is:

3. When a sale of merchandise occurs, there are two entries. The first entry is a debit to
Accounts Receivable and a credit to Sales. The second entry is a debit to Cost of Goods
Sold and a credit to the Inventory account. The Cost of Goods Sold is considered a type
of expense account, and this second entry transfers the inventory cost out of the asset
section and into Cost of Goods Sold. Remember that the selling amount should be higher
than the cost of the goods, since we are in business to make a profit.
Example: Jones sells $1,000 of Inventory for a price of $1,300, on account, with terms of
2/10, n/30:

4. Depending upon prevailing interest rates, merchandisers may offer a discount if their
customer pays early. Such discounts are expressed something like this: "2/10, n/30",
which means that if the customer pays within 10 days, the customer can deduct 2% of the
amount of their invoice. Suppose Jones pays off the supplier for the inventory purchased
in transaction 1 above. Keep in mind that he originally purchased $5,000 of inventory,
but that he immediately returned $500 to the supplier. He currently owes $4500. If he
pays within 10 days, he can deduct 2% of the invoice amount. Two percent of $4500 is
$90, and he can satisfy the invoice by paying $4410. Here is the journal entry:

Notice that, by paying early, we can reduce the cost of inventory by $90.
5. Similarly, we can offer terms to our customers. Looking back at transaction 3, if Jones
offers terms of 2/10, n/30 on a sale of $1300, the customer can deduct $26, and Jones will
receive a check for $1274 to satisfy the bill:

6. If freight charges are paid on incoming merchandise, such charges are just added to the
inventory cost. For example, if freight of $80 is paid for delivery of inventory to us, the
entry is:

Freight charges are considered an additional cost of inventory from the buyer's point of
view. Note that from the seller's point of view, freight charges are considered a selling
expense (Freight Out).
7. If a customer returns goods to us, such goods are considered a Sales Return. For example,
if a customer returns goods for which $100 was paid, the following entry would be made:

Note: if the goods that are returned to us are unsaleable due to damage or malfunction,
no further entry is necessary. However, if the returned items can be resold, they must be
put back in the Inventory account (at our cost), as follows:

You might think of this situation as an "unsale" of the goods; both the Sale is reversed (by
the debit to Sales Returns and Allowances) and the cost of the sold inventory is moved
from Cost of Goods Sold back into the Inventory account. A convenient summary of
these merchandising transactions appears on page 194 in Illustration 5-5.

The Merchandising Income Statement

As mentioned earlier, the Merchandising Income Statement is illustrated on page 198 in
Illustration 5-11. The general format of this statement is as follows:

This is the format for a multiple step income statement. There are two main calculations (the
steps), as follows:
1. Net Sales - Cost of Goods Sold = Gross Profit
2. Gross Profit - Expenses = Net Income
For simplicity, I've omitted the Other Revenues and Gains, and the Other Expenses and Losses.
Your text also illustrates a single step income statement, in which Cost of Goods Sold is simply
presented as an ordinary expense. This form of statement appears on page 199 in Illustration 512.

Closing Entries for Merchandising

Going back to the T-accounts for the Perpetual Inventory method, the closing entries would be
journalized as follows:
Sales

XXX
Income Summary

Income Summary

XXX

XXX
Sales Discounts
Sales Ret. & All.
Cost of Goods Sold
All Expenses...

Income Summary

XXX
XXX
XXX
XXX

XXX
Capital

Capital

XXX

XXX
Drawing

XXX