Perpetual Inventory System

Perpetual Inventory 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 & AllowancesPurchase Returns & Allowances

Goods purchased may be damaged, Goods purchased may be damaged, defective, of inferior quality, or they may defective, of inferior quality, or they may not meet purchaser’s specificationsnot meet purchaser’s specifications

Goods may be returned or purchase price Goods may be returned or purchase price may be reduced (an allowance)may be reduced (an allowance)

Entry to record:Entry to record: Cash or Accounts payable 300Cash or Accounts payable 300

Merchandise Inventory (for amount of Merchandise Inventory (for amount of return or adjustment)return or adjustment) 300300

Quantity and Purchase DiscountsQuantity and Purchase Discounts

Quantity discount:Quantity discount: reduction in price reduction in price due to the quantity being purchaseddue to the quantity being purchased

Purchase discount:Purchase discount: reduction in price reduction in price due to early payment of amount duedue to early payment of amount due

Entry to record:Entry to record:

Accounts payable 3500Accounts payable 3500

Merchandise InventoryMerchandise Inventory (for amount of discount) 70(for amount of discount) 70

CashCash 34303430

Freight CostsFreight Costs Purchase agreement indicates when ownership of the Purchase agreement indicates when ownership of the

goods is transferred from buyer to sellergoods is transferred from buyer to seller FOB Shipping Point:FOB Shipping Point:

Buyer accepts ownership at place of shipping and pays Buyer accepts ownership at place of shipping and pays for shipping costsfor shipping costs

Merchandise Inventory 150Merchandise Inventory 150CashCash 150150

FOB Destination:FOB Destination: Buyer accepts ownership when goods are delivered to Buyer accepts ownership when goods are delivered to

buyer’s place of business and seller pays freight costsbuyer’s place of business and seller pays freight costs Seller debits Seller debits Freight OutFreight Out for cost of shipping for cost of shipping

Summary of Purchases

Merchandise Inventory(Purchase) May 4 3800 May 9 300 (Purchase Return)

(Freight) 4 150 14 70 (Purchase Discount)

Bal. 3580

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 TaxesSales Taxes

Collected by merchandising Collected by merchandising companies on the goods that they sellcompanies on the goods that they sell

Periodically remitted to governmentPeriodically remitted to government Sales taxes collected are not revenueSales taxes collected are not revenue

Treated as a liability until paid (as they Treated as a liability until paid (as they are due to the government)are due to the government)

recorded in HST Payable accountrecorded in HST Payable account

Sales Returns & AllowancesSales Returns & Allowances Sales returns:Sales returns: when customers return merchandise to when customers return merchandise to

seller for credit or refundseller for credit or refund Sales allowances:Sales allowances: when seller grants customers a when seller grants customers a

price reductionprice reduction Seller’s entry required:Seller’s entry required: Sales returns and allowances 300Sales returns and allowances 300

Accounts receivable or cash 300Accounts receivable or cash 300 If merchandise returned, additional entry required:If merchandise returned, additional entry required:Merchandise inventory 140 Merchandise inventory 140 (recorded at orig. cost)(recorded at orig. cost)

Cost of goods sold Cost of goods sold 140140To record cost of returned goods.To record cost of returned goods.

Quantity and Sales Quantity and Sales DiscountsDiscounts

Quantity discount:Quantity discount:Reduction in selling price due to the Reduction in selling price due to the

volume of goods purchasedvolume of goods purchasedSale is recorded at reduced priceSale is recorded at reduced price

Sales discount:Sales discount:Discount offered for early payment of billDiscount offered for early payment of billDiscount amount taken is debited to Discount amount taken is debited to Sales Sales

DiscountsDiscounts (a contra revenue account)(a contra revenue account)Original amount in Sales is not changedOriginal amount in Sales is not changed

Journal Entry

Cash 3430

Sales Discount 70

Accounts Receivable 3500

To record collection of invoice #731 within discount period

Summary of Sales Transactions

Sales Sales Returns & Allowances

May 4 3800 May 9 300

Sales Discounts Cost of Goods Sold

May 14 70 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

Completing the Accounting Completing the Accounting CycleCycle

Same types of adjusting entries as a service Same types of adjusting entries as a service companycompany

One additional adjustment for inventoryOne additional adjustment for inventory To ensure the recorded inventory amount agrees with To ensure the recorded inventory amount agrees with

the actual quantity on handthe actual quantity on hand A physical count is an important control feature A physical count is an important control feature

A perpetual system indicates what should be thereA perpetual system indicates what should be there An inventory count will determine what existsAn inventory count will determine what exists

Additional accounts to be closed: Additional accounts to be closed: Sales, Sales Sales, Sales Returns and Allowances, Sales Discounts, Cost of Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight OutGoods 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 Sales2. Gross Profit3. Income from Operations4. Non-operating Activities (interest, dividend

revenue, gains from sale of property, interest expense, losses)

5. Net Income

Multiple-Step Income StatementMultiple-Step Income Statement

Sales revenueSales 480,000$ Less: Sales returns and allowances 16,700$ Sales discounts 4,300 21,000

Net sales 459,000 Cost of goods sold 315,000 Gross profit 144,000

Operating expenses Salaries expense 45,000$ Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Amortization expense 8,000 Freight out 7,000 Insurance expense 2,000

Total operating expenses 114,000 Income from operations 30,000

Other revenuesInterest revenue 3,000$ Gain on sale of equipment 600

Total non-operating revenue and gain 3,600 Other expenses

Interest on expense 1,800$ Casualty loss from vandalism 200

Total non-operating expense and loss 2,000 Net non-operating revenue 1,600

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

Year Ended May 31, 2008Sales revenue

Sales 480,000$ Less: Sales returns and allowances 16,700$ Sales discounts 4,300 21,000

Net sales 459,000 Cost of goods sold 315,000 Gross profit 144,000

Operating expenses Salaries expense 45,000$ Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Amortization expense 8,000 Freight out 7,000 Insurance expense 2,000

Total operating expenses 114,000 Income from operations 30,000

Other revenuesInterest revenue 3,000$ Gain on sale of equipment 600

Total non-operating revenue and gain 3,600 Other expenses

Interest on expense 1,800$ Casualty loss from vandalism 200

Total non-operating expense and loss 2,000 Net non-operating revenue 1,600

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

Year Ended May 31, 2008

Calculation of Net sales and Calculation of Net sales and Gross profitGross profit

Calculation of Income from Calculation of Income from operationsoperations

Calculation of Non-operating Calculation of Non-operating activities and Net incomeactivities and Net income

Single-Step Income StatementSingle-Step Income Statement

All data are classified as eitherAll data are classified as either

(1) revenues or (2) expenses(1) revenues or (2) expenses

RevenuesNet sales $459,000Interest revenue 3,000Gain on sale of equipment 600

Total Revenues 462,600

ExpensesCost of goods sold $315,000Operating expenses 114,000Interest expense 1,800Casualty loss from vandalism 200

Total expenses 431,000

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

Year Ended May 31, 2008Revenues

Net sales $459,000Interest revenue 3,000Gain on sale of equipment 600

Total Revenues 462,600

ExpensesCost of goods sold $315,000Operating expenses 114,000Interest expense 1,800Casualty loss from vandalism 200

Total expenses 431,000

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

Year Ended May 31, 2008

Classified Balance SheetClassified Balance Sheet

Current assetsCash 9,500$ Accounts receivable 16,100 Merchandise inventory 40,000 P repaid insurance 1,800

Total current assets 67,400 P roperty, plant, and equipment

Store equipment 80,000$ Less: Accumulated amortization 24,000 56,000

Total assets 123,400$

HIGHPOINT ELECTRONICBalance Sheet (partial)

May 31, 2008

AssetsCurrent assets

Cash 9,500$ Accounts receivable 16,100 Merchandise inventory 40,000 P repaid insurance 1,800

Total current assets 67,400 P roperty, plant, and equipment

Store equipment 80,000$ Less: Accumulated amortization 24,000 56,000

Total assets 123,400$

HIGHPOINT ELECTRONICBalance Sheet (partial)

May 31, 2008

Assets

Merchandise Merchandise Inventory Inventory reported as a reported as a current asset current asset following following Accounts Accounts ReceivableReceivable

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