Inventory is the sum of the costs required to get a product ready to sell to customers. Some of the key included costs are the cost of purchase (materials, parts, etc.), the cost of shipping the materials on site, the insurance, and taxes.
The Cost of Goods Sold (COGS) is the cost of inventory related to products that have been sold and where revenue has been recorded.
In accounting, there are two different methods available to record inventory costs: the Perpetual Inventory System and the Periodic Inventory System.
Perpetual Inventory
Periodic Inventory
Immediately records increases and decreases to the inventory account as the purchase or sale occurs.
Inventory fluctuates with each related transaction.
If there are issues with the inventory records, the inventory account will have to be adjusted.
Records the purchase of new inventory in a separate ‘Purchases‘ account on the Income Statement.
Periodically (monthly, quarterly, annually), the Inventory is checked and the Purchases account reviewed for errors. Once confirmed, the inventory account is updated in bulk.
Both systems are acceptable under the GAAP standards.
There are some differences in how transactions are recorded depending on the inventory method selected. See the several examples below.
Please note that the use of BS (Balance Sheet) and IS (Income Statement) is for educational purposes only. They are not typically included in a journal entry.
We are aware that the credited accounts should be indented on the tables below; however our website platform does not allow us to indent or space within a table.
Initial Purchase of Inventory
Abbott Company purchases 250 units of inventory on March 1, for $250.00 in cash.
Perpetual
Date
Accounts
Debit
Credit
March 1
Inventory (BS)
$250.00
Cash (BS)
$250.00
Periodic
Date
Accounts
Debit
Credit
March 1
Purchases (IS)
$250.00
Cash (BS)
$250.00
The Cost of Purchases is recorded directly on the Income Statement rather than the Balance Sheet; there will be no COGS entry when the products are sold.
Purchase Discount
Abbott Company purchased 250 units of inventory on March 1 for $250.00 on credit. Terms were 3/10, n/30. The amount was paid on March 7.
Discount Deadline: March 10 Discount (3%): $7.50 Total Due: March 30
Perpetual
Date
Accounts
Debit
Credit
March 7
Accounts Payable (BS)
$250.00
Cash (BS)
$242.50
Inventory (BS)
$7.50
Inventory is recorded at cost, since the price paid was only $242.50, adjust the inventory down to the correct amount to record the discount.
Periodic
Date
Accounts
Debit
Credit
March 7
Accounts Payable (BS)
$250.00
Cash (BS)
$242.50
Purchase Discount (IS)
$7.50
Similar to the Perpetual approach, except instead of crediting the Inventory account, credit Purchase Discount, a contra Purchases account.
Purchase Returns & Allowances
Abbott Company realizes that another $50.00 of the new inventory is damaged but usable. They keep the goods and receive a $10.00 refund.
Perpetual
Date
Accounts
Debit
Credit
March 7
Cash (BS)
$10.00
Inventory (BS)
$10.00
Periodic
Date
Accounts
Debit
Credit
March 7
Cash (BS)
$10.00
Purchase Returns & Allowances (IS)
$10.00
Purchase Returns & Allowances is a contra Purchases account.
Sale of Inventory
Abbott Company sold 250 units of inventory on June 15 for $400.00 in cash.
Perpetual
Record the Sales Revenue
Record the Cost of Goods Sold
Date
Accounts
Debit
Credit
June 15
Cash (BS)
$400.00
Sales Revenue (IS)
$400.00
June 15
Cost of Goods Sold (IS)
$250.00
Inventory (BS)
$250.00
Periodic
Record the Sales Revenue
There is no record for COGS/Inventory because the purchase was already recorded directly on the IS.
Date
Accounts
Debit
Credit
March 1
Cash (BS)
$400.00
Sales Revenue (IS)
$400.00
Sales Discount
Abbott Company sold 250 units of inventory on March 1 for $250.00 on credit. Terms were 3/10, n/30
Discount Date: March 10 Discount (3%): $7.50 Total Due: March 30
In this case, the Perpetual and Periodic approach have the same entry.
Sales Discount
Date
Accounts
Debit
Credit
June 15
Cash (BS)
$242.50
Sales Discounts (IS)
$7.50
Accounts Receivable (BS)
$250.00
Sales Return & Allowance
Abbott Company sells 250 Units for $250.00 on credit on March 1. The cost of inventory was $125.00. The customer complains that the units are not what they wanted.
Perpetual Return – Sellable @ the Original Price
The customer returns the products and Abbott Company determines the products could be re-sold at the original price.
Date
Accounts
Debit
Credit
March 15
Sales Returns & Allowances (IS)
$250.00
Accounts Receivable (BS)
$250.00
March 15
Inventory (BS)
$125.00
Cost of Goods Sold (IS)
$125.00
Perpetual Return – Not Sellable @ the Original Price
The customer returns the products but they are not sellable at the original price. Abbott Company estimates a loss of $75.00.
Date
Accounts
Debit
Credit
March 15
Sales Returns & Allowances (IS)
$250.00
Accounts Receivable (BS)
$250.00
March 15
Inventory (BS)
$50.00
Loss on Defective Inventory (BS)
$75.00
Cost of Goods Sold (IS)
$125.00
Periodic Return
The customer returns the products and Abbott Company determines the products could be re-sold at the original price.
Because with the Periodic Inventory Method, the inventory sale was not recorded in the inventory and cost of goods accounts, the company does not have to reverse that entry.
Date
Accounts
Debit
Credit
March 15
Sales Returns & Allowances (IS)
$250.00
Accounts Receivable (BS)
$250.00
Allowance
The customer decides not to return the units, but Abbott Company pays them a refund of $10.00.
In this case, the Perpetual and Periodic approach have the same entry.
Date
Accounts
Debit
Credit
March 15
Sales Returns & Allowances (IS)
$10.00
Cash (BS)
$10.00
Follow Us for More Useful Materials
Disclaimer: The information provided in this article does not, and is not intended to, constitute legal advice. All information is for general informational purposes only. Information may not constitute the most up-to-date legal or other information. Readers should contact their attorney to obtain advice with respect to any legal matter. No reader should act or refrain from acting based on information on this site without first seeking legal advice from counsel in the relevant jurisdiction. Only your individual attorney can provide assurances that this information (or your interpretation) is applicable or appropriate to your particular situation. Note that no attorney-client relationship is created between a reader and the author or contributors.
