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HUA SIONG
COLLEGE OF ILOILO

FINANCIAL ACCOUNTING AND REPORTING ACCOUNTING CYCLE FOR A MERCHANDISING

BUSINESS PART 4 of 4
 Perpetual Inventory System
Accounting cycle – is a sequence of operations used to account business transactions during a
specific period.
1. Analysis of transactions.
2. Recording of the transactions in the journal. (Journalizing)
3. Posting of the journal entries to the ledger. (Classifying)
4. Preparation of the unadjusted trial balance.
5. Compilation of data needed to adjust the accounts.
6. Preparation of a worksheet and adjusted trial balance.
7. Preparation of financial statements.
8. Journalizing and posting of adjusting entries.
9. Journalizing and posting of closing entries.
10. Preparation of post-closing trial balance.
11. Journalizing and posting of reversing entries.
The inventory of a merchandising business consists of goods on hand and is available for sale to customers.
The merchandise inventory on hand at the beginning of the accounting period is called beginning inventory,
while merchandise inventory on hand at the end of the period is called ending inventory. The merchandise
inventory at the end of one accounting period is the merchandise inventory at the beginning of the next
accounting period. The ending inventory is reported in the current asset portion of the balance sheet.

Perpetual Inventory System:

The perpetual inventory system requires the maintenance of records called “stock cards” that usually offer a
running summary of the inventory inflow and outflow. The inventory account is continuously updated. It is a
system of keeping an up-to-date record of the cost of inventory on hand and the cost of goods sold. This
system can tell us how much inventory is on hand without counting the inventory. The perpetual inventory
procedure is commonly used where inventory items treated individually represent a relatively large peso
investment. This procedure is designed for control purposes. When the perpetual is used, a physical count of
units on hand should at least be made once a year or at a frequent interval to confirm the balances appearing
on the stock card. Because the Inventory account is regularly updated, no adjusting entry is needed for the
inventory account and because the Cost of Sales account is also maintained, it is closed at the end of the
accounting period together with all the expense accounts.
Illustration:

Periodic Inventory System Perpetual Inventory System

Cash Sales

Cash 10,000 Cash 10,000

Sales 10,000 Sales 10,000

Cost of Sales 8,000

Inventory 8,000

Sale on account

Accounts Receivable 10,000 Accounts Receivable 10,000

Sales 10,000 Sales 10,000

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Cost of Sales 8,000

Inventory 8,000

Customer returned damaged merchandise

Sales Return and Allowances 5,000 Sales Return and Allowances 5,000

Accounts Receivable 5,000 Accounts Receivable 5,000

Inventory 4,000

Cost of Goods Sold 4,000

Periodic Inventory System Perpetual Inventory System

Received payment from a customer

Cash 9,000 Cash 9,000

Sales Discount 1,000 Sales Discount 1,000

Accounts Receivable 10,000 Accounts Receivable 10,000

Cash Purchases

Purchases 10,000 Inventory 10,000

Cash 10,000 Cash 10,000

Purchases on Account

Purchases 10,000 Inventory 10,000

Accounts payable 10,000 Accounts payable 10,000

Payment of Freight in

Freight in 1,000 Inventory 1,000

Cash 1,000 Cash 1,000

Returned merchandise to the seller

Accounts payable 4,000 Accounts payable 4,000

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Purchase Ret. and Allow. 10,000 Inventory 4,000

Paid supplier on account within the cash discount period

Accounts payable 10,000 Accounts payable 10,000

Purchase Discount 2,000 Inventory 2,000

Cash 8,000 Cash 8,000

Adjusting entry to close the beginning inventory.

Income Summary 7,000 No entry required.

Inventory 7,000

Adjusting entry to set-up ending inventory to be reported in the balance sheet.

Inventory 10,000 No entry required

Income Summary 10,000

Under the Perpetual Inventory System the following are the transactions that can affect the Inventory and Cost
of Sales account:

Cost of Sales
 Sale of  Sales Return
merchandise

Exercise:

The following are the transactions of Unlimited Trading:

2012
Jan 2 Purchased merchandise for cash, P 20,000.
3 Paid freight for the merchandise purchased, P 2,000.
5 Sold merchandise on account, P 30,000 to Luke, terms: 2/10, n/30. The cost of the goods
related to the sale was P 20,000
6 Purchase merchandise on account, P 40,000 from Paul, terms: 2/10, n/30.
8 Received full payment of Luke.
15 Paid his full account to Paul.
16 Sold merchandise on account to Timothy, P 60,000. The cost of goods related to the sale
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was P 40,000.
18 Purchase merchandise on account, P 10,000 from James, terms: 2/10, n/30.
20 Received damage merchandise returned by Timothy. The sales price and the related cost
of goods sold are P 5,000 and P 2,000 respectively.
21 Returned P 4,000 worth of merchandise to James.

Record the above transactions assuming the company is using the (A) Periodic Inventory System and (B)
Perpetual Inventory System. Compute the net income assuming the operating expenses during the period is P
5,000 using the (A) Periodic Inventory System and (B) Perpetual Inventory System. The beginning inventory is
P 10,000 while the inventory count at the end of the period is P 19,200.

Periodic Inventory System Perpetual inventory System

2012 Dr Cr 2012 Dr Cr
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Sales
Sales Ret./Allow. Inventory
Sales Discount
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net Income

Beginning Inventory
*Cost of Purchases
TGAS
Ending Inventory
Cost of Sales

*Cost of Purchases Cost of Sales

Purchases
Purchase Discount
Purchase Ret. and Allow.
Net Purchases
Freight in
Cost of Purchases

Exercise:

The following is a simple example of a stock card of Unlimited Trading. Unlimited Trading is selling each unit
of its product at P 30 each. Record the transactions of Unlimited Trading in the journal and compute the Net
Income assuming its operating expense during the period was P 5,000 under the Perpetual Inventory system.
Inventory count at the end of the period was P 15,280. All sales and purchases are on account.

Date Transaction Inventory Sold Inventory Balance

Units Unit cost Total cost Units Unit cost Total cost

Jan 1 Balance forwd. 800 20 16,000

8 Sales 500 20 10,000 300 20 6,000
18 purchase 700 21 14,700
20 sales 300 20 6,000
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500 21 10,500 200 21 4,200
22 purchase 500 22 11,000
23 Purch ret. (20) 21 (420)
180 21 3,780
500 22 11,000
24 Sales ret. (25) 20 (500) 25 20 500

Sales
Sales Ret./Allow.
Inventory Sales Discount
Net Sales
Cost of Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net Income

Freight on Merchandise (Transportation

costs)

Terms of Freight:

Whenever goods are purchased, costs will be

incurred to deliver them to the buyer.

I. FOB Shipping Point and Destination - determines whether it is a debit to Freight in – buyer; or Freight
out – seller

The term FOB Shipping Point means free on board at the shipping point; that is, the buyer incurs or has
the obligation to pay all transportation costs after the merchandise is loaded on cars or trucks at the
point of shipment. The buyer will be debiting Freight in, in this case.

The term FOB Destination means free on board up to the destination, that is the seller incurs all
transportation charges to the destination of the shipment. The seller will be debiting Freight out in this
case.

In general, title to the good passes from the seller to the buyer at the point at which the buyer becomes
responsible for the transportation charges.

II. Freight Prepaid and Collect - determines whether the seller or buyer will credit cash for the freight

Freight is prepaid if it is paid before goods are transported or shipped. That is to say, the seller will
credit cash to pay the freight, regardless of whether it is FOB Shipping Point or Destination.

Freight collect means that payment for freight is made upon the delivery of goods. That is to say, the
buyer will credit cash to pay the freight, regardless of whether it is FOB Shipping Point or Destination.

Merchandise may be billed to the buyer on one of the following basis:

Terms Responsible to pay Who paid? (Cr. Cash)

1. FOB Shipping Point, Freight Collect Buyer (Freight in) Buyer
2. FOB Destination, Freight Prepaid Seller (Freight out) Seller
3. FOB Shipping Point, Freight Prepaid Buyer (Freight in) Seller
4. FOB Destination, Freight Collect Seller (Freight out) Buyer

Exercise:

A. Sky sold merchandise to Walker on account. The invoice showed the following:

Price of merchandise P 20,000

Freight 2,000

Record the entries on the books of the seller (Sky) and the buyer (Walker), using the following freight terms:
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1. FOB Shipping Point, Freight Collect
2. FOB Destination, Freight Prepaid
3. FOB Shipping Point, Freight Prepaid
4. FOB Destination, Freight Collect
BUYER SELLER
1. FOB Shipping Point, Freight Collect

2. FOB Destination, Freight Prepaid

3. FOB Shipping Point, Freight Prepaid

4. FOB Destination, Freight Collect

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B. Johnny sold merchandise to Bravo on account. The invoice showed the following:

Price of merchandise P 50,000

Freight 5,000

Record the entries on the books of the seller (Johnny) and the buyer (Bravo), using the following freight terms:

1. FOB Shipping Point, Freight Collect

2. FOB Destination, Freight Prepaid
3. FOB Shipping Point, Freight Prepaid
4. FOB Destination, Freight Collect

BUYER SELLER
1. FOB Shipping Point, Freight Collect

2. FOB Destination, Freight Prepaid

3. FOB Shipping Point, Freight Prepaid

4. FOB Destination, Freight Collect

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