The following video summarizes how to journalize purchases under the perpetual inventory system.

Under the perpetual inventory system, remember we want to constantly update the inventory balance to match what we paid for the inventory and for what we have on hand.  We will be using ONLY 3 accounts for any journal entries as the buyer:

1. Cash
2. Merchandise Inventory (or Inventory)
3. Accounts Payable

Cash and Merchandise Inventory accounts are current assets with normal debit balances (debit to increase and credit to decrease).  Accounts payable is a current liability with a normal credit balance (credit to increase and debit to decrease).  Whenever we are the buyer, use a combination of these 3 accounts only.

Inventory Purchases

To illustrate the perpetual inventory method journal entries, assume that Hanlon Food Store made two purchases of merchandise from Smith Company.

• On May 4, Hanlon purchased $30,000 of merchandise with credit terms of 2/10, n30 and shipping terms FOB Destination.
• on May 21, Hanlon purchased $20,000 of merchandise for cash with shipping terms FOB Shipping Point.

The required journal entries for Hanlon are:

On May 4, we realize credit terms means we have not paid for it yet but will pay for it later (accounts payable)  We are offered a 2% discount but do not record it yet as we do not know if we will make the discount due date.  On May 21, we paid with cash so we do not have credit terms since it has been paid.

 Shipping on Inventory Purchases

We learned shipping terms tells you who is responsible for paying for shipping.  FOB Destination means the seller is responsible for paying shipping and the buyer would not need to pay or record anything for shipping.  FOB Shipping Point means the buyer is responsible for shipping and must pay and record for shipping.

In our example for Hanlon, May 4 was FOB Destination and we will not have to do anything for shipping.  On May 21, shipping terms were FOB Shipping Point meaning we, as the buyer, must pay for shipping.  Under the perpetual inventory system, remember we only use 3 accounts:  Cash, Inventory and Accounts Payable. We want to constantly update the inventory balance to match what we actually paid.  We will debit Inventory for the shipping cost and credit cash or accounts payable depending on if we paid it now or later.  Let’s continue with another example from Hanlon.

On May 22 Hanlon paid We Ship It $200 for shipping on the items purchased May 21. The journal entry would be:

Purchase returns and allowances

A purchase return occurs when a buyer returns merchandise to a seller. When a buyer receives a reduction in the price of goods shipped but does not return the merchandise, a purchase allowance results.

Regardless of whether we have return or allowance, the process is exactly the same under the perpetual inventory system.  Both returns and allowances reduce the buyer’s debt to the seller (accounts payable) and decrease the cost of the goods purchased (inventory). We will debit Accounts Payable and credit Merchandise Inventory.

If Hanlon returned $350 of merchandise to Smith Wholesale on May 6 before paying for the goods, Hanlon would make this journal entry:

The entry would have been the same to record a $ 350 allowance. Only the explanation would change.

If Hanlon had already paid the account, the debit would be to Cash instead of Accounts Payable, since Hanlon would receive a refund of cash. If the company took a discount at the time it paid the account, only the net amount would be refunded. For instance, if a 2% discount had been taken, the return amount would be $350 – (350 x 2%) or $343.  Hanlon’s journal entry for the return would be:

Paying for Inventory Purchased on Credit

When paying for inventory purchased on credit, we will decrease what we owe to the seller (accounts payable) and cash.  If we take a discount for paying early, we record this discount in the merchandise inventory account since it will reduce what we paid for inventory.

Using the purchase transaction from May 4 and no returns, Hanlon pays the amount owed on May 10.  May 10 is within the discount period and Hanlon will take the 2% discount provided in the terms 2/10, n30 (remember, this means 2% discount if paid in 10 days of the invoice date otherwise, full amount is due in 30 days).

We reduce the full amount owed on May 4 and calculate the 2% discount based on this amount.  The cash amount is the amount we owe – discount.

Assume we also had the return on May 6 of $350.  Hanlon pays the amount owed less the return and takes the 2% discount on May 12.  The journal entry for this payment would be:

We reduce the full amount owed on May 4 less the return of $250.  The discount is calculated based on the amount owed less the return x 2%.  The cash amount is the amount we owe – the return – the discount.

Finally, if instead Hanlon did not have any returns and did not pay the invoice within the discount period but paid the invoice from May 4 on May 30.  The entry would be:

 Summary

Under the perpetual inventory method, purchase entries will use a combination of these 3 accounts only: