Page 301 - Accounting Principles (A Business Perspective)

7. Measuring and reporting inventories

the account is the cost of the inventory that should be on hand at any date. This entry records the purchase of 10
units on March 2 in Exhibit 56:

Mar. 2 Merchandise Inventory (+A) 85
Accounts Payable (+L) 85
To record purchases of 10 units at $8.50 on
account.
You would also record the 10 units sold on the perpetual inventory record in Exhibit 56. Perpetual inventory
procedure requires two journal entries for each sale. One entry is at selling price—a debit to Accounts Receivable
(or Cash) and a credit to Sales. The other entry is at cost—a debit to Cost of Goods Sold and a credit to Merchandise
Inventory. Assuming that the 10 units sold on March 10 in Exhibit 56 had a retail price of USD 13 each, you would

record the following entries:
Mar. 10 Accounts Receivable (+A) 130
Sales (+SE) 130
To record 10 units sold at $13 each on account.
10 Cost of Goods Sold (-SE) 80
Merchandise Inventory (-A) 80
To record cost of $8 on each of the 10 units sold.
When a company sells merchandise to customers, it transfers the cost of the merchandise from an asset account
(Merchandise Inventory) to an expense account (Cost of Goods Sold). The company makes this transfer because the
sale reduces the asset, and the cost of the goods sold is one of the expenses of making the sale. Thus, the Cost of
Goods Sold account accumulates the cost of all the merchandise that the company sells during a period.
A sales return also requires two entries, one at selling price and one at cost. Assume that a customer returned
merchandise that cost USD 20 and originally sold for USD 32. The entry to reduce the accounts receivable and to
record the sales return of USD 32 is:

Mar. 17 Sales Return and Allowances (-SE) 32
Accounts Receivable (-A) 32
To record the reduction in amount owed by a
customer upon return of goods.
The entry that increases the Merchandise Inventory account and decreases the Cost of Goods Sold account by
USD 20 is as follows:
Mar. 17 Merchandise Inventory (+A) 20
Cost of Goods Sold (+SE) 20
To record replacement of goods returned to
inventory.
Sales returns affect both revenues and cost of goods sold because the goods charged to cost of goods sold are
actually returned to the seller. In contrast, sales allowances granted to customers affect only revenues because the
customers do not have to return goods. Thus, if the company had granted a sales allowance of USD 32 on March 17,
only the first entry would be required.
The balance of the Merchandise Inventory account is the cost of the inventory that should be on hand. This fact

is a major reason some companies choose to use perpetual inventory procedure. The cost of inventory that should
be on hand is readily available. A physical inventory determines the accuracy of the account balance. Management
may investigate any major discrepancies between the balance in the account and the cost based on the physical
count. It thereby achieves greater control over inventory. When a shortage is discovered, an adjusting entry is
required. Assuming a USD 15 shortage (at cost) is discovered, the entry is:
Dec. 31 Loss from Inventory Shortage (-SE) 15
Merchandise Inventory (-A) 15
To record inventory shortage

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