6.7 Appendix: Analyze and Record Transactions for Merchandise Purchases and Sales Using the Periodic Inventory System

Merchandise Purchases and Sales in the Periodic Inventory System

The periodic inventory system tracks merchandise by recording purchases and sales in separate temporary accounts throughout the period, then calculating inventory and cost of goods sold only at period-end. This contrasts with the perpetual system, which updates inventory in real time. The periodic approach means simpler day-to-day entries, but it requires a careful end-of-period calculation to determine what was actually sold.

Periodic Inventory Journal Entries

In the periodic system, you never touch the Inventory account during the period. Instead, all purchases go into a Purchases account, and all sales go into a Sales account. The Inventory account only gets updated through adjusting/closing entries at period-end.

Purchasing merchandise on account:

When you buy goods on credit, you record the cost in Purchases and the obligation in Accounts Payable.

• Debit Purchases (cost of merchandise acquired)
• Credit Accounts Payable (liability to the supplier)

For example, if you buy $\$5{,}000$ of merchandise from ABC Company on account, you debit Purchases $\$5{,}000$ and credit Accounts Payable $\$5{,}000$.

Purchasing merchandise with cash:

• Debit Purchases (cost of merchandise acquired)
• Credit Cash (immediate payment)

Selling merchandise on account:

Notice that in the periodic system, you only record the revenue side. There's no entry for cost of goods sold at the time of sale.

• Debit Accounts Receivable (amount owed by the customer)
• Credit Sales (revenue earned)

Selling merchandise for cash:

• Debit Cash (payment received)
• Credit Sales (revenue earned)

Recording transportation costs on purchases:

Freight costs to get merchandise to your business are tracked in their own account rather than lumped into Purchases.

• Debit Transportation-In (also called Freight-In)
• Credit Cash or Accounts Payable

End-of-period closing entries:

At period-end, all these temporary accounts get closed to Income Summary. The cost of goods sold is calculated using the periodic inventory formula:

$\text{COGS} = \text{Beginning Inventory} + \text{Net Purchases} + \text{Transportation-In} - \text{Ending Inventory}$

Where Net Purchases = Purchases − Purchase Returns and Allowances − Purchase Discounts.

Cash vs. Credit in Periodic Systems

The distinction between cash and credit transactions affects which balance sheet account you use on the other side of the entry, but the Purchases and Sales accounts work the same way regardless.

Cash transactions involve immediate payment or receipt of money:

• Purchasing for cash: Debit Purchases, Credit Cash
• Selling for cash: Debit Cash, Credit Sales

Credit transactions create a receivable or payable that will be settled later:

• Purchasing on account: Debit Purchases, Credit Accounts Payable
• Selling on account: Debit Accounts Receivable, Credit Sales

The key point: whether you pay cash or buy on credit, the Purchases account records the same amount. The periodic system doesn't care how you paid; it cares what you bought and what you sold.

Discounts and Returns for Periodic Inventories

In the periodic system, discounts and returns are tracked in their own contra accounts rather than adjusting Purchases or Sales directly. This gives you better visibility into how much you're returning, how many discounts you're earning, and so on.

Purchase discounts are earned when you pay a supplier early on a credit purchase. A common term is 2/10, n/30, meaning you get a 2% discount if you pay within 10 days; otherwise the full amount is due in 30 days.

• Debit Accounts Payable (reduces what you owe)
• Credit Purchase Discounts (contra-purchases account)

For example, if you owe $\$5{,}000$ with terms 2/10, n/30 and pay within 10 days, you'd pay $\$4{,}900$: debit Accounts Payable $\$5{,}000$, credit Cash $\$4{,}900$, credit Purchase Discounts $\$100$.

Purchase returns and allowances occur when you send defective or unwanted merchandise back to the supplier, or the supplier grants a price reduction.

• Debit Accounts Payable (reduces what you owe)
• Credit Purchase Returns and Allowances (contra-purchases account)

Sales discounts are offered to your customers to encourage early payment. Terms like 1/10, n/30 mean the customer gets a 1% discount for paying within 10 days.

• Debit Sales Discounts (contra-revenue account)
• Credit Accounts Receivable (reduces what the customer owes)

Sales returns and allowances occur when customers return merchandise or you grant a price reduction for damaged goods.

• Debit Sales Returns and Allowances (contra-revenue account)
• Credit Accounts Receivable (reduces what the customer owes)

Trade discounts are different from purchase/sales discounts. A trade discount is deducted from the list price before you record the transaction. You never record the list price or the trade discount in the journal; you simply record the net amount.

At period-end, all contra accounts are closed to Income Summary along with Purchases and Sales to determine net sales and net purchases.

Inventory Systems and Merchandising Companies

Merchandising companies buy goods and resell them to customers. They choose between two inventory systems:

The periodic system works well for businesses with high volumes of low-cost items where tracking each unit in real time isn't practical. The perpetual system gives you up-to-date inventory information at any point but requires more detailed record-keeping.