 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at the periodic inventory system. Periodic inventory system in contrast to the perpetual inventory system. So at this point, you should be familiar with the perpetual inventory system. If not, look in the description and look for the course link for financial accounting to learn about perpetual. This topic is typically covered in a financial accounting, intermediate accounting, as well as the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus accounting or I think finance and tax lecture. I cover many lectures. If you like, I cover many courses. If you like my lectures, please like them. It doesn't cost you anything. Share them, put them in playlist. If they benefit you, it means they might benefit other people. And please connect with me on Instagram. On my YouTube, you will find additional resources. If you're looking to supplement your studies, especially if you are studying for your CPA exam, you're looking for that extra five, seven, 10 points, please check out my website for additional resources. So the first thing I'm gonna do is go back and talk about the inventory system, the periodic versus perpetual, because that's important to redefine them as we need to discuss the periodic system. The perpetual inventory system, when I cover the perpetual, I told you, think of it as a computerized system. Computerized means it's a smart system. It's constantly updated. It updates your accounting record for each purchase and sale of inventory. So when you buy inventory, your inventory goes up. When you sell your inventory, your inventory goes down. And it keeps track of your cost of goods sold. So when you sell the inventory, the inventory becomes cost of goods sold. Now think of the periodic inventory system as a manual. It can be computerized, but it's not, it doesn't update automatically. So think of it as manual. Think of this as computerized and perpetual. Manual means it updates your records for purchases and sale of inventory only at the end of the accounting period. So you really don't know what is your inventory until you make account. And usually you make that account at the end of the accounting period. Also at the end of the accounting period, you can compute your cost of goods sold versus this system, perpetual inventory system. Your cost of goods sold is continuously updated. Now the best way to illustrate the perpetual versus the periodic and the different accounts that they use is to actually look at journal entries side by side. One is the periodic and one is the perpetual. So starting with the first thing is we're gonna compare is when you make a purchase. What do you debit and what do you credit under a perpetual, which you should be familiar with? You debit merchandise inventory, which is an asset and you credit accounts payable. Under the periodic inventory system, you will debit an account called purchases. So notice there is a difference between merchandise inventory as an asset and purchases, which is considered a cost of goods sold account, which considered technically an expense account. But you're gonna see that purchases will be eventually closed, closed out. Okay, so this is when we make a purchase. Yeah, when we make a payment, remember, sometime we are granted a discount. Let's assume we are granted a 2% discount for this purchase and that the perpetual inventory system, we're gonna get $10 of the bill. So we're gonna debit accounts payable for 500 to remove it. We are going to credit cash only $490 and the difference, which is the discount, we reduce the inventory cost automatically. So notice the inventory cost is reduced under the perpetual because the assumption here is the inventory system is updated continuously, the inventory cost. Under a periodic, we're also going to pay $900, I'm sorry, we're gonna pay $490. The accounts payable will be reduced by 500. We're gonna pay the full amount, 500. However, we are going to have a purchase discount. Notice, this is a new account. It's called a purchase discount. The purchase discount obviously is a contra purchase. It reduces your purchase, the purchase price because you paid 500, you got $10 off. Now it's gonna reduce your purchase cost. What type of account is purchase discount? Think of it as a contra purchase and you're gonna see we're gonna get rid of it at the end, close everything to cost of goods sold. Now let's assume we paid outside the discount period. That's easy. We debit accounts payable 500, credit cash 500. Debit accounts payable 500, credit cash 500 if we paid outside the discount period for that $500 that we owe. Let's assume we were granted an allowance under the perpetual, we debit accounts payable, we credit merchandise inventory. This is for the allowance. Just to reflect that we received production in the bill for defective merchandise. Under the periodic notice, we're gonna debit accounts payable and credit purchase returns and allowances. That's a new account. What type of account? It's a contra purchases too. It reduces your purchases, which in turn is part of your cost of goods sold, which in turn it's closed to cost of goods sold. And you're gonna see what I mean by this at the end. Now let's assume we made a return from a perpetual inventory system. The return and the allowance are the same. Debit accounts payable, credit merchandise inventory because the cost of inventory went down. For the periodic debit accounts payable, again credit purchase returns and allowance is the same account that you did for the allowance. Once again, it's a contra purchase and it reduces your account. It reduces your purchases account. What about when you pay for transportation? When you pay for transportation, FOP shipping under the perpetual inventory system, we learn that transportation in is an asset. Therefore, it's debited directly to meant merchandise inventory. Under the periodic system, we are going to keep track of that separately and we're gonna call it transportation in, which is technically an expense, which is part of your cost of goods sold. And you will see that that account was also closed and eventually it's close to cost of goods sold. So this is the difference between the purchases from a perpetual inventory to a periodic. Now keep in mind those accounts. What accounts am I referring to? The new accounts that we learned about. Purchases has a debit balance. Purchase discount has a credit. It's a contra to purchase. Purchase returns and allowances has a credit. Transportation in has a debit. Why? Because those accounts will need to be closed out eventually. We're gonna see how we close them out. Now let's take a look at the sale. When we make the sale under a perpetual inventory system, and hopefully you know this by heart, we debit account receivable credit sales, debit cost of goods sold and credit inventory. So notice here, we have our cost of goods sold and inventory continuously, continuously updated. This is part of the perpetual inventory system. Now when it comes to periodic, we're gonna debit account receivable credit sales, but there is no entry for updating cost of goods sold, nor an entry updating inventory. Notice there is no second entry. Now let's assume the customer return product. Well, we debit sales returns and allowances, credit cash, if they paid cash, we pay them back the cash. Again, we update our inventory and update our cost of goods sold. Under a periodic inventory system, we debit sales returns and allowances, credit cash, no inventory and cost of goods sold entry. We don't compute our inventory and cost of goods sold till the end. And you're gonna see what do I mean till the end shortly. That's what we need to do. Now under, let's assume we had a sales allowance. Under the sales allowance, we have sales returns and allowances, $10, credit cash, $10. Well, what happened under the periodic? Same thing, sales returns and allowances then cash then. So if we gave them $10 for sales returns and allowances, we don't have inventory entry under the perpetual. We don't have an inventory entry obviously under the periodic because under the perpetual, we did not really get back the inventory, we just gave them an allowance. Now, haven't said so. The last thing we're gonna look at is the closing. And hopefully you understand the closing from a perpetual inventory system. We have four steps. One, close sales to income summary. Two, close temporary accounts on the income statements such as expenses, cost of goods sold, sales returns and allowances and sales discount to income summary. Then three, close income summary to retained earnings and hopefully you know how to do this. Four, close dividend to retained earnings. So those are the four steps that we take for a perpetual inventory system. Now, the same steps we have to take for periodic except we have technically different accounts and you're gonna see why do we do it a little differently but the point is the same. What do we have to close? Here's what we have to close. We have to close sales. We have to close merchandise inventory ending. So I'm sorry, we're not close. We have to establish. We have to establish not close. We have to establish. So at the end of the accounting period we debit sales establish ending inventory. Now, what do you mean by establish ending inventory? How do we establish ending inventory? We are going to count the inventory and we determine that we have 21,000 on the box. Therefore, we have to establish this account. Establish the balance. We have to remove purchase discount. Remember it has a credit. Now we need to remove it. We have to remove purchase returns and allowances. It has a credit. Remember we have to debit and we credit the total of income summary. Then the other thing is we close all the expenses. Now what we have to do, we have to close merchandise inventory beginning. Remember at the beginning of the period we have a beginning inventory from the prior period. The prior period they counted the inventory and last year was 19,000. That number is no longer valid. Why? Because the new balance is, I just told you, the new balance is 21. We establish that balance. Therefore, we have to remove the old balance. Remember under a perpetual, you don't update your inventory. You started with 19 and you don't touch this account until the end of the period when you count the inventory. When you find you have 21, you have to debit 21, take out the 19. Then you have to remove purchases because remember they were debit. We have to credit them and you have to credit transportation in the word debit. You have to credit them, close them. Then you close income summary, just the usual thing and you close retained earning. Now the last thing you need to do, you need to learn is how to compute cost of goods sold. Now, why is this important? Because this is gonna show you how this whole thing fits together. Now notice under the perpetual inventory system, cost of goods sold was continuously updated and it was 230,400. Now what I'm gonna do, I'm gonna flip to the Excel sheet and show you how you would compute your periodic inventory system using cost under the periodic inventory system how to compute cost of goods sold. Now to be more specific, I'm going to highlight in yellow the accounts I'm gonna be using. So notice those accounts that I highlighted in yellow, I'm gonna move them to the Excel sheet and show you how to compute cost of goods sold under the periodic. You don't have to do that under the perpetual because it's continuously updated. Okay, let's take a look at these numbers. Those are the numbers that I basically grabbed from the closing entries. We have beginning inventory was 19, purchases 235,800, transportation and purchase discount, purchase returns and allowances and ending inventory. Now you have to be familiar with this important formula. If not, well, you have to be familiar with it. That's why I am going to go through it. So how do you compute cost of goods sold? There's a formula. The first thing with the formula is you start with beginning inventory and beginning inventory happens to be 19,000. How do you know your beginning inventory? Your beginning inventory is last year inventory. So, and beginning inventory is giving. If not, it's last year inventory. Then you have to compute net purchases. Not just purchases, you have to compute net, the net purchases. Now, how do you compute net purchases? Well, you have purchases. If you have purchases, you add to it transportation in, then you deduct any purchase discount, any purchase returns and allowances. So simply put, you will start with purchases plus transportation in, minus purchase discount minus, minus purchase returns and allowances. And this is how you compute your purchases. So that's the second number. This is how you would do it. Purchases plus transportation minus discount, minus allowance. Now, your beginning inventory, what you started with plus what you purchase, it's gonna give you an account called, a number called goods available for sale. Simply put, you had 251,400 of total goods available for sale. That's good. Now, at the end of the period, remember, the periodic inventory system, you count your inventory. What does it mean I count my inventory? I physically count the inventory and I find out I still have 21,000. Well, if I had 251,400 available for the whole year and at the end of the year I only have 21, it means I sold 230,400 of my inventory. The amount that I sold is called cost of goods sold. So notice this number here, 23,400, that's the same cost of goods sold under the perpetual and they should equal to each other. The only difference is under the perpetual inventory system, all these computation and updates were taken place continuously. Under the periodic, you have to know this formula. And what is this formula? Let me write it down for you, you have to know it. Basically, it's beginning inventory. So the formula is the following. You go beginning, that's too thick, let's use this. It's beginning inventory plus net purchases. Now, what is net purchases? It's your purchases plus transportation is minus return, minus allowances. And this is gonna give you goods available for sale. And from goods available for sale, you count your inventory and you deduct ending inventory. And after you deduct your ending inventory, whatever's not there is cost of goods sold. And this is how you compute your cost of goods sold. Now, as always, if you like this recording, I would like to remind you to please like the recording. It doesn't cost you anything, like the recording, share it, put it in playlist. And if you're looking for additional resources, please visit my website. You may need extra five to seven points to pass your CPA exam. It's a 30 to 40 year investment in your career. Take it seriously, study hard, good luck. I'm always here to help you.