 Hello and welcome to the session. This is Professor Farhad in which we would look at an example that illustrates the perpetual versus a periodic inventory system. As an accountant student, as a CPA candidate, you want to know the difference between those two inventory methods. So the best way to illustrate it, although I explained it in the prior recording, is to work an example. And we're going to look at Adam Beverage Company, ABC Company, purchase the soft drinks from producers and sell them to retailer. The beginning inventory for Adam Company was $110,000 on hand. This is the beginning inventory. That means this is the inventory that we had from the prior period. There's no journal entry to make at this point. There's nothing we do now, but this is just no, this is beginning inventory. Just make a note of it. Purchases of inventory on account totaled $600,000 with the terms 2 slash 10 and 30. Adam purchases $600,000 worth of inventory. The terms are, if they paid within 10 days, they will get 3%. Otherwise, the full amount is due in 30 days. So they purchase them on credit. So let's start by journalizing the purchase. Under a perpetual inventory system, we will debit inventory, increasing inventory, and we will credit accounts payable. Under the periodic inventory system, what we do is we debit purchases rather than inventory, and we increase accounts payable. So notice the difference. In a perpetual, we update the inventory automatically under purchase, under the periodic inventory system, what we're going to do, we're going to park our purchases in a purchase account, then eventually we'll transfer them to inventory at the end of the period. ABC paid $15,000 for freight cost. Well, this is transportation in freight cost, it means they purchased, they paid to transport dose merchandise. Well, under a perpetual inventory system, we will debit inventory for $15,000. Simply put, under the perpetual inventory system, we will update our inventory cost by debiting inventory and we credit cash. Under the periodic inventory system, we don't update our inventory automatically, what we do is we debit an account called freight end. Eventually freight end will be closed to the inventory and the cost of goods sold. But for now we'll keep the freight end separately, and obviously we paid cash. Cash will go down. This is the journal entry under both perpetual and periodic. Merchandise inventory with a cost of $10,000 was returned to suppliers for credit. Simply put, $10,000 of the merchandise, we did not like, something wrong with it, whatever the reason is, we returned it. What is the journal entry under perpetual and periodic? Under perpetual, it's the opposite of the purchase. Notice we're going to debit account spable credit inventory, and guess what? Under the periodic, it's also the opposite of a purchase. Debit account spable credit purchase return. However, notice quite... So the entry under perpetual inventory, it's basically exact opposite of the purchase. Debit account spable credit inventory. Under the periodic inventory system, we're going to reduce account spable, but we are going to credit an account called a purchase return. Now, the purchase return is a contra purchase. It's going to reduce our purchases. Nevertheless, we keep track of the purchase return separately. So notice what's happened. Think of the perpetual inventory system where it's keeping track of our inventory cost constantly. Now, all purchases on account were paid within the discount period. The discount period was within 10 days, and we're going to get 3% off. How much do we owe the supplier? Well, we originally purchased $600,000 worth of merchandise. Then we returned $10,000. Remember, you only take the discount based on what's left, which is $590,000. We're going to take $590,000. You can multiply it by .97, or we're going to multiply it by .03 first, .03, and that's going to give us a discount of $17,700. Now, you could also take $590,000. You can take $590,000 multiplied by .97. It means we have to pay 97% of the bill, and that's going to give us $590,000 times .97, and that's going to give us, we have to pay $572,300, which is $17,000 less than the amount. However, you would like to compute the discount, it's up to you, but the point is you could just compute the discount. We need both numbers. Why do we need both numbers? Because under the inventory system, we're going to have to pay cash $572,300. We're going to credit cash. That's why if you take $590 times .97, it's going to give you the cash amount. How much do you have to pay? Now, we're going to debit accounts payable for the full amount. Although we only paid $572,300, however, we paid our bill. Why? Because the promise is if we pay within 10 days, our bill is basically zeroed out. Our bill is $500, the remaining bill is $590,000. Now, the difference obviously is the discount. Under the perpetual inventory system, automatically we credit the discount. What does that mean? It means we reduce the cost of our inventory. Our inventory cost is reduced. Under a periodic inventory system, the cash paid is the same. Also, you're going to debit the accounts payable for $590,000. We started with $600,000. We started with $600,000, reduced it by $10,000. We're down to $590,000. Now, we're reduced it by $590,000. It's down to zero. However, we're going to keep track of purchase discounts separately. Purchase discount is $17,700. So, those are the purchases. What we're going to do next, we're going to go ahead and look at the sales transaction. What happened when we sell those inventory and how do we compute cost of goods sold? Now, before we look at the next section, I have a public announcement from my company. For-Hat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Myles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. No obligation. No credit card required. So, let's take a look at sales. Sales on account totaled $800,000. Let's process the sales and let's, since we are giving sales and cost of goods sold, let's do it together. And the cost of the soft drink sold was $527,300. Under a perpetual inventory system, we're going to debit account receivable credit sales for the sales amount. We're going to debit cost of goods sold and credit inventory for the cost that's giving to us. Basically, the cost is giving. Under a periodic inventory system, we're going to debit account receivable credit sales revenue. No entry for cost of goods sold. Why? Because for the periodic inventory system, when do you know your cost of goods sold? When you compute your ending inventory, you will back into cost of goods sold. But let me also show you. You need to be familiar with the formula on computing cost of goods sold anyway. That's important for you. Think about it. What happened in this company? We started with $100,000 and $10,000 in beginning inventory. Then we purchased $600 worth of merchandise. Then we incurred. Let me see how much freight ended we incurred. We incurred $15,000 of freight in. $15,000 of freight in. Then we returned $10,000 of merchandise. So, this is the goods that was available for sale. Let me go ahead and compute this. $110,000 plus $600,000. One more time. $110,000. We also got the discount. $17,700 minus $17,700. $110,000, which is the beginning inventory, plus purchases of $600,000 plus the freight in minus the return of $10,000 minus the discount of $17,700. That's going to give us basically goods available for sale. $6,000, $97,300. Basically, this part here, which is purchases plus the freight minus the discount minus the return. This is called net purchases. Now, what we do, we subtract ending inventory. How do we come up with ending inventory? Ending inventory is counted. The company will count ending inventory, and we subtract ending inventory from this minus $170,000. That's going to give us $5,7300. Notice the number is giving, but I wanted to show you how we came up with this number. Next, we are going to look at the journal entry. Simply put, for my perpetual inventory system, there is no entry to make at the end of the period because the cost of goods sold was already computed, and ending inventory, it's already automatically computed as well because we kept track of our ending inventory. Now, when it comes to the periodic inventory system, we have to take this, all this information that I just showed you and put it in a journal entry. Well, the first thing is we have the beginning inventory. Remember the beginning inventory? Let me change colors now to kind of indicate I'm going to the periodic. The beginning inventory was $110,000. The beginning inventory is gone. Therefore, we credit beginning inventory, inventory beginning. Then purchases. Purchases is a temporary account. We get root of purchases because purchases will have to end up being inventory. We credit purchases. We also credit freight because freight has to go and go into because freight eventually closed into inventory. Credit freight. Now, remember we counted the inventory and now the new inventory is $170. We debit inventory $170. So notice, we removed the old inventory. This is the old number. Let me use a different color because this is blue. We removed. This is the old. We removed the old. $110 is removed and we debited the new. Okay, debited the new. Also, our purchase return needs to be gone. It has a credit balance. We need to debit because all these accounts, let me show you all these accounts. Let me go back here. Purchases, freight in, purchase return, purchase discounts. They need to be gone at the end of the year. They are temporary account. And this is what I'm doing now. So I, I removed the purchases. I also have to remove the purchase discount of $17,700. And at this point, cost of goods sold becomes a plug and the plug that I need is $527,300. And let me double check. Make sure my debit is equal to my credits. $110 plus $600 plus $15 equal to $725. Now $725 minus $527.3 minus $170 minus $10 minus $177 also $725. Therefore, I made sure my journal entry equal to each other. But let me just point out one more thing for you. Just the differences. Notice what we did. Just kind of show you the differences is this, the main differences under a perpetual inventory system. Everything is posted to inventory automatically. Whatever we have a purchase, a return, a purchase discount versus under a periodic inventory system, we have more accounts to keep track of purchase discount, purchase return, freight and purchases. But all these accounts eventually get get closed into inventory, which eventually turn into cost of goods sold, so on and so forth. And this is what we saw in this example. So knowing the difference between perpetual and periodic inventory system is important, whether you are a student or a CPA candidate. Don't shortchange yourself. Invest in yourself. Invest in your career. Good luck. Study hard. And of course, stay safe.