🧾Financial Accounting I Unit 6 Review

Under the perpetual inventory system, every purchase of merchandise is recorded directly to the Merchandise Inventory account the moment it happens. This keeps your inventory balance and cost of goods sold current at all times, which is why most modern businesses prefer it. The key idea throughout this topic: in a perpetual system, Merchandise Inventory is the account that gets debited for purchases, adjusted for discounts, and credited for returns.

Journal Entries for Merchandise Purchases

There are two basic scenarios for recording a purchase, depending on how you pay.

Cash purchase — you pay immediately:

Debit Merchandise Inventory (increases the asset)
Credit Cash (decreases your cash on hand)

Example: You buy $\$1{,}000$ of merchandise with cash.

Account	Debit	Credit
Merchandise Inventory	$\$1{,}000$
Cash		$\$1{,}000$

Credit purchase — you'll pay the supplier later:

Debit Merchandise Inventory (increases the asset)
Credit Accounts Payable (records the liability you now owe)

Example: You buy $\$2{,}000$ of merchandise on credit terms of n/30.

Account	Debit	Credit
Merchandise Inventory	$\$2{,}000$
Accounts Payable		$\$2{,}000$

Freight-in (transportation costs paid by the buyer): These costs get added to the cost of inventory, not expensed separately. Debit Merchandise Inventory and credit Cash (or Accounts Payable if you'll pay the shipping later).

Example: You pay $\$100$ cash for freight on a merchandise shipment.

Account	Debit	Credit
Merchandise Inventory	$\$100$
Cash		$\$100$

The purchase invoice is your source document for all of these entries. It shows quantity, unit price, total, and credit terms.

Journal entries for merchandise purchases, Cost of Goods Sold: Periodic System | Financial Accounting

Accounting for Purchase Discounts, Returns, and Allowances

Each of these adjustments reduces the cost recorded in Merchandise Inventory. That's the perpetual system's defining feature: the Inventory account always reflects the true, current cost.

Purchase Discounts

Suppliers offer discounts to encourage early payment. A common term is 2/10, n/30, which means you get a 2% discount if you pay within 10 days; otherwise the full amount is due in 30 days.

Under the gross method (the standard approach in most intro courses), you record the purchase at the full invoice price. The discount is only recorded when you actually pay early.

Steps to record payment with a discount taken:

Debit Accounts Payable for the full invoice amount (eliminates the liability).
Credit Merchandise Inventory for the discount amount (reduces inventory cost).
Credit Cash for the net amount you actually paid.

Example: You originally purchased $\$1{,}000$ of merchandise on credit (2/10, n/30). You pay within 10 days.

Discount = $\$1{,}000 \times 0.02 = \$20$
Cash paid = $\$1{,}000 - \$20 = \$980$

Account	Debit	Credit
Accounts Payable	$\$1{,}000$
Merchandise Inventory		$\$20$
Cash		$\$980$

If you pay after the discount period, you simply debit Accounts Payable and credit Cash for the full $\$1{,}000$ . No discount is recorded.

Purchase Returns

When you send defective or unwanted merchandise back to the supplier, you reverse part of the original entry:

Debit Accounts Payable (reduces what you owe)
Credit Merchandise Inventory (removes the returned goods from your inventory)

Example: You return $\$500$ of defective merchandise.

Account	Debit	Credit
Accounts Payable	$\$500$
Merchandise Inventory		$\$500$

Purchase Allowances

Sometimes you keep the defective merchandise but negotiate a price reduction. The entry looks the same as a return because the effect on your accounts is identical: you owe less, and your recorded inventory cost goes down.

Debit Accounts Payable for the allowance amount
Credit Merchandise Inventory for the allowance amount

Example: You receive a $\$200$ allowance for keeping slightly damaged goods.

Account	Debit	Credit
Accounts Payable	$\$200$
Merchandise Inventory		$\$200$

Quick pattern to remember: In the perpetual system, discounts, returns, and allowances all credit Merchandise Inventory. They reduce the cost of your inventory directly rather than going to a separate contra account.

Journal entries for merchandise purchases, Double Entry Bookkeeping System | Accounting for Managers

Types of Merchandise Purchase Transactions (Summary)

Transaction Type	Debit	Credit	When Recorded
Cash purchase	Merchandise Inventory	Cash	At purchase
Credit purchase	Merchandise Inventory	Accounts Payable	At purchase
Freight-in	Merchandise Inventory	Cash or A/P	When freight is incurred
Purchase discount taken	Accounts Payable	Merch. Inventory + Cash	At payment
Purchase return	Accounts Payable	Merchandise Inventory	When goods are returned
Purchase allowance	Accounts Payable	Merchandise Inventory	When allowance is granted

Comparison with the Periodic Inventory System

In the perpetual system, purchases go directly to the Merchandise Inventory account. In the periodic system, purchases are recorded in a separate Purchases account (along with contra accounts like Purchase Returns and Allowances, Purchase Discounts, and Freight-In).
The periodic system only updates the Merchandise Inventory balance at the end of the period, after a physical count. The perpetual system keeps it current after every transaction.
Cost of goods sold is tracked continuously under the perpetual method. Under the periodic method, it's calculated at period-end using the formula: $\text{Beginning Inventory} + \text{Net Purchases} - \text{Ending Inventory} = \text{COGS}$ .

The biggest takeaway: if you see Merchandise Inventory being debited and credited for every purchase-related transaction, you're in the perpetual system. If you see a Purchases account instead, that's the periodic system.

🧾Financial Accounting I Unit 6 Review