 In this presentation, we will talk about a perpetual inventory system. The perpetual inventory system is the default system we will typically be talking about when referring to an inventory system, but we want to be able to compare and contrast it to a periodic system, one reason being that a periodic system is often used when we don't have a sophisticated system and two, we're going to use a similar cost of goods sold, a same cost of goods sold calculation in both a perpetual system and a periodic system. When considering the perpetual system, we're going to go through a series of transactions, those transactions being the purchase of inventory and the sale of inventory starting with purchase of merchandise on account. Note we have our trial balance over here. We're going to be recording the journal entry on the left side with both a debit and credit column, credits represented with brackets. When we post them over here, however, we're starting with a beginning trial balance that trial balance representing debits and credits only with debits being positive or unbracketed numbers, credits being negative or bracketed numbers. The debits then minus the credits giving us a zero balance showing that debits equal the credits. Nothing is currently in net income. We'll then record the transaction here to see a quick view of the activity, what will happen in each account, as well as account group, asset liability, equity, revenue and expense, assets in green, liabilities in orange, capital and light blue, revenue and expense in the dark blue. So if we purchase merchandise on account, what's going to happen? I would think first is cash affected. No, it's not because we purchased it on account that terminology typically meaning we purchased it on credit or some other fashion. Therefore, I would think about what we got. What we got then is inventory. Inventory is up here. It's in the asset section. Assets have a debit balance. We got more of it. Therefore, it's going to go up. So we're going to do the same thing to it, which is another debit. So we're going to debit the merchandise inventory, 13,000 will be the amount. We will then credit something for 13,000. We know it's not cash. We know we bought it on account, which means accounts payable. Accounts payable has a credit balance and therefore it needs to go up. The bad thing is going up. We owe more money and therefore we're going to do the same thing to it, which in this case is another credit. So we'll credit the accounts payable. If we post this out then, we're going to post this to our worksheet. We started with 10,000 increasing 13,002 merchandise inventory to a total of 23,000 accounts payable then starting at 6,500 increasing by 13,000 in the credit direction gives us a credit balance of 19,500. Note this transaction will be the same under a periodic system and a perpetual system. Note this transaction is what it is. There is no estimate involved here. If we're going to, we are going to pay $13,000 worth of the inventory. Assets have been increased. Liabilities too have increased and there's no effect on equity. Here's the full transaction here with all the other accounts. We can see we are still in balance. We can see that there's no effect in net income. Next transaction. We're going to make a sale for 3,120 and have a cost of 2,400. When we are on a perpetual system as we are doing here, we will do something with both the sales portion and the cost portion as opposed to if we work to the same problem from a periodic system. This would be information we would not be using as we record the system in this point. We would then do a calculation at the end of the period, the month, the year, or the week, whatever the period may be in order to calculate the cost portion. In order to do this side, we typically want to think of the transaction as two transactions, one dealing with the sales half, the second dealing with the cost half. When dealing with the sales half, I would think of a type of company that does not have inventory, remove inventory first, think of a service company and think of the transaction related to it and then add the inventory as we do the second journal entry for the cost. Note that if you see this in software, they won't break out the two journal entries often times. They'll put them together, debit's on top, credit's on the bottom, but conceptually, it makes a lot of sense a lot easier to break them out and when we're doing journal entries by hand, that's the way we would recommend doing it. If we were a service company and we made a sale on account, meaning we did work and we're going to get, we're invoicing someone, then we didn't get cash, we got accounts receivable. So the accounts receivable is a debit balance account. It would then be going up. So we would do the same thing to it, which is a debit. It's going to be for the larger amounts of course, and then we're going to say the credit would be to revenue. If it was a service company, it might be fees earned or something like that, income or revenue. If it's a manufacturing company, same thing, but we just name the revenue account now sales. So sales is a common name for revenue in a merchandising company. It will then be credited. Now remember that sales has a credit balance. It's a credit balance account. It only goes up. Therefore it will go up by doing the same thing to it, another credit. If we post this out, we got the accounts receivable increasing. We got the 6000 plus the debit of 3,120 to get a total of 9,120. We've got the sales of zero and then it goes up in the credit direction by 3,122, 3,120. Then we have the second component starting with the cost of goods sold and the other piece being inventory. Now note that the second component is the new component for a merchandising company. It might be easier to start with the inventory to think about it and say, okay, the second piece, there's the cost, but what's happening? We're selling inventory. So you might want to think, our inventory is an asset account. It's going down. So I'm going to credit it, build the credit portion of the second piece. Then we know we're going to debit something and we know we can then remember or figure out or see that the we're going to debit the new account cost of goods sold, the account new in that it's an account that's on a merchandising company, not in a service company. So these are the two accounts that are basically there for a merchandiser, which would not be there for a service company. This one is often one that confuses in people because it is an expense and it doesn't have the word expense in it. And when we expense it, we never do anything to cash as we do it. So sometimes that's confusing to people cost of goods sold is an expense because we're consuming the merchandise in order to help generate revenue. And that's what the expense will be. So cost of goods sold and merchandise inventory, if we post the merchandise inventory first, we're going to say that the 23,000 is going to be credited by that 24 that 2400 bringing the balance down to 20,600. Cost of goods sold is going to go up from zero to 2400, 2400 accounting equation effect assets are going up. Now with both of these journal entries, notice it notice it went up by the accounts receivable and then down by merchandise inventory for a net increase liabilities stay the same and equity went up by revenue and down by the increase in expenses because the net income is calculated by revenue minus expenses and the equity includes all of the income statement accounts to see all the accounts here. We have everything lined up. We could see we're back in balance here. We could see the effect on net income being these two items, these two items being the effect on net income and increased by the sales and then it decreased by the cost of goods sold revenue minus expenses 720 is the net increase in the net income same for the assets it increased by 3,120 the AR it decreased by the inventory we gave up a difference of that same 720. Next transaction we're going to say we have another purchase on account for 6000 we're purchasing merchandise and so is cash affected no what did we get then we got merchandise merchandise is an asset has a debit balance therefore we will do the same thing to it which in this case is another debit to increase it then we're going to credit something won't be cash we didn't pay cash instead it will be accounts payable accounts payable has a credit balance indicated by the brackets in this case we need to make it go up the bad things going up we owe more money therefore we do the same thing to it another credit if we post this out then we're going to say this 6000 in merchandise inventory will be going here to merchandise inventory the 20600 and that 6000 will be increasing merchandise inventory to 26600 the accounts payable here will be increasing the accounts payable credit balance 19500 increasing by 6000 to 25500 accounting equation is increasing because the asset account of inventory is going up the liabilities are increasing because the accounts payable liability is increasing no effect on equity if we see all the accounts then we can see everything lines out we're back in balance and there is no effect here on net income we purchased merchandise inventory haven't yet used it we didn't expense it at the time that we purchased it because we haven't consumed it to help generate revenue we will when we sell it in the form of cost of goods sold next transaction we're going to have another sale it's going to be a sale for 3000 120 and a cost of 2400 remember this is the journal tree that will be differentiated from the periodic system the periodic system will not be recording the cost will only be recording the sales half we're going to break this out once again into the sales portion and then the cost portion focusing first on those accounts that would pretty much be there if it was not an inventory a company or not a merchandising company so let's remove the merchandising type transactions think of as if it's a service company prepare that transaction and then add to it the new accounts if it was a merchandising company so first if we made a sale and we were a service company we would say we made it on account we didn't get cash we got instead an iou that being accounts receivable it has a debit balance we're going to make it to go up by doing the same thing to it another debit so we're going to debit accounts receivable we're going to credit something that something being revenue would be called revenue income it could be called fees earned in a service company here it's going to be called sales because we're manufacturers just the name that will change depending on the type of company we are in but it is a revenue account revenue accounts have credit balances they only go up we're going to increase it doing the same thing to it another credit so that's going to be the first half if we post it accounts receivable has a debit balance 9120 and then we're posting this 2004 40 here increasing the amount to 11,460 the sales starts out with 3,120 we're going to increase it by this credit there by 2,340 to 5,460 next component we're going to have here to our journal entry will be that we're going to be recording the merchandise inventory going down cost of goods sold now i usually think of the merchandise inventory first because i think it's easier that it's an asset and the asset has a debit balance we need to make it go down so we credit merchandise inventory and then the other side of it the debit then would be the cost of goods sold so cost of goods sold debit merchandise inventory credit again it might be easier to think about the credits first because most people conceptually just had a little bit harder time knowing exactly what cost of goods sold is merchandise we can visualize merchandise whatever that may be we know it's going down we know merchandise is an asset like cash we probably have a lot of practice with cash and therefore we can say merchandise is going down we need to credit it so we credit that debit something else and then we just have to know it's going to be the new account that we're adding to the income statement portion cost of goods sold then you want to think about that you want to remember okay cost of goods sold is an expense it's an expense related to the merchandise inventory being consumed all expenses have debit balances we need to make it go up because expenses typically only go up therefore we will do the same thing to it in this case another debit if we post this out then we're going to say the merchandise inventory here here's the merchandise inventory here it's got 26600 in it we're posting this credit there 8 out 1800 bringing the balance down to 24800 then we're going to post this cost of goods sold debit here and we started with 2400 we are increasing it by 1800 to a balance of 4200 the assets are going up because the accounts receivable went up merchandise went down but the net is an increase and then the liabilities stay the same and the equity is going up because revenue is going up although the expenses are going up as well bringing down net income it's a net increase the net income and therefore also an increase to total equity if we see everything planned out here this is all the accounts we can see we are back in balance we can see the effect on net income is an increase in revenue an increase in expense resulting in the difference between those being the net increase in net income of 5500 and 40 that being also the increase in equity the increase in assets being the increase in the receivable minus the decrease in merchandise inventory also tying out to that same 540 now it's important to note that even though we did a perpetual system and we basically have the merchandise inventory and the cost of goods sold numbers here that should be correct because we've been recording them as we make the sale meaning we've been every time we make a sale we don't just record the sale we record the decrease in the inventory and the related cost of goods sold at that point in time in a periodic system we might wait until the end and then count how many are left in order to do that calculation now in the in the perpetual system it's important to note that although we are tracking these items perpetually we still need to do the same calculation we still need to count ending inventory and double check what it is and it's still important to know the cost of goods sold calculation so we're going to take a look at that if we said that we counted the end ending inventory and it came out to be 24800 then we know that we didn't lose anything basically we had the perfect ending inventory we'll talk about a scenario a scenario that's very common which we do lose something which there's some type of shrinkage in inventory which would be theft or spoilage or breaking or lost or something like that happening but we're going to tie this out perfectly right now and just be able to see this formula so that we can see how it works and we and we'll explain later of course why or in what situation we would definitely need it in order to see what that shrinkage is what the loss is and we'd also need it in this case to prove that there wasn't one so cost of goods sold is going to be the beginning inventory in our problem it started with 10 000 if we went back to the first uh journal entry we would see that 10 000 in our first uh account here if you had the general ledger account of course the beginning balance would be the beginning balance in the gl the general ledger for the inventory account then we would look at the purchases we had two purchases throughout this problem which would add up to 19 000 again if you looked at the gene general ledger account that's where we could pull this in in practice what the purchases were and this again there's no guessing in this number this number is not an estimate that's what we're actually going to pay for the inventory then if we add those two up uh the 10 and the 19 we get to 29 000 that's what we could sold sell throughout the period it's not necessarily what we did sell we'll figure that out by counting what we have at the end but that or we are we already actually in a perpetual system have it here we've been calculating it as well but that's what we could have sold and it's not what we had at any given point throughout the month or the year or the period that we're calculating for but if we accumulated all the all the inventory that we had in possession at any given time throughout that time period it would add up to 29 000 meaning we could have sold up to 29 000 dollars worth of inventory but we could not have sold anymore because we didn't have any more than that at any given time and then if we subtract out any inventory which we're getting from the physical count here so we're counting the inventory to be at 24 800 quick note here that the 24 800 represents the dollar amount in this case and obviously if we counted the inventory it would be in units and we have to do some type of conversion we'll talk about the conversion problem later uh so just note that we would count it and then we'd have to do a conversion just like some kind of currency conversion or any kind of measurement conversion from units to dollars to get to the dollar amount and then if we subtract this out we're saying this is what we could have sold throughout the time period this is what we have left then uh we get that 4200 and again if everything works perfectly if everything is correct then of course this cost of goods sold will tie out to our cost of goods sold here and the physical count that we count at the end of the time period will match the physical I mean what is on the books for our perpetual system and uh but there will be times when that is not the case and this formula will be important whether we use the perpetual or periodic system will match this up to a periodic system