Perpetual Inventory
System
Perpetual Inventory
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Detailed record of items in stock is kept up to date
on an ongoing basis
As items sold, info. is transferred directly to store’s
central computer which is programmed to make the
appropriate deductions from the inventory and make
accounting entries
Sales returns are generally handled by separate
department
System cannot automatically know when goods are
lost, stolen or broken; therefore have to do manual
check of inventory
Purchases

When goods are purchased for resale, inventory
account is immediately updated by the cost price of
the merchandise. At any time, the business can look
in the general ledger and see the book value of the
inventory on hand. Remember -- this is the book
value and may not be 100% accurate (damaged
goods, theft, clerical errors, etc.).
Merchandise Inventory (at Cost Price) 3800
Bank or A/P
3800
To record the Purchase of Inventory in Perpetual System
Purchase Returns & Allowances
Goods purchased may be damaged,
defective, of inferior quality, or they
may not meet purchaser’s
specifications
 Goods may be returned or purchase
price may be reduced (an allowance)
 Entry to record:

Cash or Accounts payable 300
Merchandise Inventory (for amount
of return or adjustment)
300
Quantity and Purchase Discounts
Quantity discount: reduction in price
due to the quantity being purchased
 Purchase discount: reduction in price
due to early payment of amount due
 Entry to record:

Accounts payable 3500
Merchandise Inventory (for amount of discount) 70
Cash
3430
Freight Costs
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Purchase agreement indicates when ownership of the
goods is transferred from buyer to seller
FOB Shipping Point:
Buyer accepts ownership at place of shipping and pays
for shipping costs
Merchandise Inventory 150
Cash
150
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FOB Destination:


Buyer accepts ownership when goods are delivered to
buyer’s place of business and seller pays freight costs
Seller debits Freight Out for cost of shipping
Summary of Purchases
Merchandise Inventory
(Purchase) May 4
(Freight)
4
3800
150
Bal. 3580
May 9 300 (Purchase Return)
14 70 (Purchase Discount)
Sale of Merchandise (two
journal entries needed)

The first entry identifies the sale at the selling price. A second
entry shows the merchandise going out of the business and the
inventory account decreasing by the cost price of the goods (the
price the business paid for the merchandise).
Step 1
Bank or Accounts Receivable (at Selling Price) 3800
Sales (at Selling Price)
3800
To record the sale of merchandise in a perpetual system
Step 2:
Cost of Goods Sold (at cost price)
2400
Merchandise Inventory (at cost price)
2400
To record the inventory sold at cost price in a perpetual system
Sales Taxes
Collected by merchandising
companies on the goods that they sell
 Periodically remitted to government
 Sales taxes collected are not revenue
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
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Treated as a liability until paid (as they
are due to the government)
recorded in HST Payable account
Sales Returns & Allowances
Sales returns: when customers return merchandise to
seller for credit or refund
 Sales allowances: when seller grants customers a
price reduction
 Seller’s entry required:
Sales returns and allowances 300
Accounts receivable or cash 300
 If merchandise returned, additional entry required:
Merchandise inventory
140 (recorded at orig. cost)

Cost of goods sold
140
To record cost of returned goods.
Quantity and Sales
Discounts

Quantity discount:
Reduction in selling price due to the
volume of goods purchased
 Sale is recorded at reduced price
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Sales discount:
Discount offered for early payment of bill
 Discount amount taken is debited to Sales
Discounts (a contra revenue account)
 Original amount in Sales is not changed
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Journal Entry
Cash
3430
Sales Discount 70
Accounts Receivable 3500
To record collection of invoice #731 within
discount period
Summary of Sales
Transactions
Sales
May 4 3800
Sales Discounts
May 14 70
Sales Returns & Allowances
May 9 300
Cost of Goods Sold
May 4 2400 May 9 140
Bal. 2260
COGS
Cost of beginning inventory + cost of
goods purchased = Cost of goods
available for sale – cost of ending
inventory = cost of goods sold
i.e.42500+143000=185500-36400 =
149100 COGS
 Calculation is completed after each
sale
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Completing the Accounting
Cycle
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Same types of adjusting entries as a service
company
One additional adjustment for inventory
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A physical count is an important control feature
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To ensure the recorded inventory amount agrees with
the actual quantity on hand
A perpetual system indicates what should be there
An inventory count will determine what exists
Additional accounts to be closed: Sales, Sales
Returns and Allowances, Sales Discounts, Cost of
Goods Sold, Freight Out
Merchandise Inventory
Inventory counted at fiscal year-end
 It becomes the beginning inventory figure for
the next fiscal period
 If the amount on hand is different than what
is displayed in the merchandise inventory
account, an adjustment needs to be made

Adjusting Entry
Cost of Goods Sold
500
Merchandise Inventory
500
To record difference between inventory
records and physical units on hand.
Financial Statements
Merchandisers use the classified balance
sheet
 Two forms of income statements are widely
used: multiple-step and single-step

Multiple-Step Income
Statement
Five main steps:
1. Net Sales
2. Gross Profit
3. Income from Operations
4. Non-operating Activities (interest, dividend
revenue, gains from sale of property,
interest expense, losses)
5. Net Income
Multiple-Step Income Statement
H IGH P OIN T E LE CT R ON IC
Inc o m e S ta te m e nt
Y e a r E nd e d M a y 31, 2008
Calculation of Net sales and
Gross profit
Calculation of Income from
operations
Calculation of Non-operating
activities and Net income
Sales revenue
Sales
Less: Sales returns and allowances
Sales discounts
Net sales
Cost of goods sold
Gross profit
Operating expenses
Salaries expense
Rent expense
Utilities expense
Advertising expense
Amortization expense
Freight out
Insurance expense
Total operating expenses
Income from operations
Other revenues
Interest revenue
Gain on sale of equipment
Total non-operating revenue and gain
Other expenses
Interest on expense
Casualty loss from vandalism
Total non-operating expense and loss
Net non-operating revenue
Net income
$
$
$
16,700
4,300
480,000
21,000
459,000
315,000
144,000
45,000
19,000
17,000
16,000
8,000
7,000
2,000
114,000
30,000
$
3,000
600
3,600
$
1,800
200
2,000
$
1,600
31,600
Single-Step Income Statement
HIGHPOINT ELECTRONIC
Income Statement
Year Ended May 31, 2008
Revenues
Net sales
Interest revenue
Gain on sale of equipment
Total Revenues
Expenses
Cost of goods sold
Operating expenses
Interest expense
Casualty loss from vandalism
Total expenses
Net income
$459,000
3,000
600
462,600
$315,000
114,000
1,800
200
431,000
$ 31,600
All data are classified as either
(1) revenues or (2) expenses
Classified Balance Sheet
H IGH POIN T ELECT R ON IC
Ba la nc e She e t (p a rtia l)
Ma y 31, 2008
Assets
Current assets
Cash
Accounts receivable
Merchandise inventory
Prepaid insurance
Total current assets
Property, plant, and equipment
Store equipment
Less: Accumulated amortization
Total assets
$
$ 80,000
24,000
9,500
16,100
40,000
1,800
67,400
56,000
$ 123,400
Merchandise
Inventory
reported as a
current asset
following
Accounts
Receivable
Gross Margin Ratio
The relation between sales and COGS
Gross Margin/Net Sales = Gross Margin Ratio
i.e.
(in millions) $645.1 /$1396.5 = 46.2%
Means that each $1 of sales yields about 46.2
cents in gross margin to cover all other
expenses
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