Page 244 - Accounting Principles (A Business Perspective)

6. Merchandising transactions

Under periodic inventory procedure, the Merchandise Inventory account is updated periodically after a
physical count has been made. Usually, the physical count takes place immediately before the preparation of
financial statements.

Perpetual inventory procedure Companies use perpetual inventory procedure in a variety of business
settings. Historically, companies that sold merchandise with a high individual unit value, such as automobiles,
furniture, and appliances, used perpetual inventory procedure. Today, computerized cash registers, scanners, and
accounting software programs automatically keep track of inflows and outflows of each inventory item.
Computerization makes it economical for many retail stores to use perpetual inventory procedure even for goods of
low unit value, such as groceries.
Under perpetual inventory procedure, the Merchandise Inventory account provides close control by showing the

cost of the goods that are supposed to be on hand at any particular time. Companies debit the Merchandise
Inventory account for each purchase and credit it for each sale so that the current balance is shown in the account
at all times. Usually, firms also maintain detailed unit records showing the quantities of each type of goods that
should be on hand. Company personnel also take a physical inventory by actually counting the units of inventory on
hand. Then they compare this physical count with the records showing the units that should be on hand. Chapter 7
describes perpetual inventory procedure in more detail.
Periodic inventory procedure Merchandising companies selling low unit value merchandise (such as nuts
and bolts, nails, Christmas cards, or pencils) that have not computerized their inventory systems often find that the
extra costs of record-keeping under perpetual inventory procedure more than outweigh the benefits. These

merchandising companies often use periodic inventory procedure.
Under periodic inventory procedure, companies do not use the Merchandise Inventory account to record each
purchase and sale of merchandise. Instead, a company corrects the balance in the Merchandise Inventory account
as the result of a physical inventory count at the end of the accounting period. Also, the company usually does not
maintain other records showing the exact number of units that should be on hand. Although periodic inventory
procedure reduces record-keeping, it also reduces control over inventory items.
Companies using periodic inventory procedure make no entries to the Merchandise Inventory account nor do

they maintain unit records during the accounting period. Thus, these companies have no up-to-date balance against
which to compare the physical inventory count at the end of the period. Also, these companies make no attempt to
determine the cost of goods sold at the time of each sale. Instead, they calculate the cost of all the goods sold during
the accounting period at the end of the period. To determine the cost of goods sold, a company must know:
• Beginning inventory (cost of goods on hand at the beginning of the period).
• Net cost of purchases during the period.
• Ending inventory (cost of unsold goods at the end of the period).
The company would show this information as follows:

Beginning inventory $ 34,000
Add: Net cost of purchases during the period 140,000
Cost of goods available for sale during the period $174,000
Deduct: Ending inventory 20,000
Cost of goods sold during the period $154,000
In this schedule, notice that the company began the accounting period with USD 34,000 of merchandise and
purchased an additional USD 140,000, making a total of USD 174,000 of goods that could have been sold during
the period. Then, a physical inventory showed that USD 20,000 remained unsold, which implies that USD 154,000

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