Perpetual Inventory - Purchases: Videos & Practice Problems

In a perpetual inventory system, businesses continuously update their inventory records with each purchase and sale, providing real-time insights into stock levels. This system is particularly relevant for merchandising companies that buy goods in bulk to sell individually. For instance, a t-shirt company focuses solely on its inventory of t-shirts, distinguishing it from other assets like office supplies or equipment, which are categorized separately.

When a company makes an inventory purchase, it records the transaction by debiting the inventory account. For example, if TOS Company purchases 500 units at $5 each, the total cost amounts to $2,500. This amount is added to the inventory, reflecting an increase in assets. The journal entry for this transaction would involve debiting the inventory account by $2,500.

Since the purchase is made on account, meaning the company has not yet paid cash but has incurred a liability, the corresponding credit entry is made to accounts payable. This entry also totals $2,500, indicating the amount owed to the supplier. Thus, both the inventory and accounts payable increase by the same amount, maintaining the balance in the accounting equation: Assets = Liabilities + Equity.

Understanding these transactions is crucial for managing inventory effectively and ensuring accurate financial reporting. The perpetual inventory system allows businesses to track their inventory levels and costs in real-time, facilitating better decision-making regarding purchasing and sales strategies.

When a company decides to return goods to a supplier due to dissatisfaction, this transaction is referred to as a purchase return. In a perpetual inventory system, this process involves adjusting both the inventory and accounts payable accounts to reflect the return accurately.

For instance, if TOS Company returns 100 units of goods that were originally purchased at $5 each, the total value of the return amounts to:

\($100 \times 5 = \$500\)

This return necessitates a decrease in inventory since the goods are no longer in possession. The accounting entries for this transaction would include a credit to inventory and a debit to accounts payable. The credit to inventory reduces the total inventory value by $500, reflecting the return of the 100 units. Simultaneously, the debit to accounts payable decreases the amount owed to the supplier, as the company no longer needs to pay for the returned goods.

Initially, TOS Company had an inventory value of $2,500 for 500 units. After returning 100 units, the new inventory value is:

\($2,500 - \$500 = \$2,000\)

Consequently, the accounts payable also adjusts from $2,500 to $2,000, reflecting the reduced obligation to the supplier. This adjustment ensures that the financial records accurately represent the current inventory of 400 units, valued at $2,000.

In summary, the purchase return process involves carefully adjusting both inventory and accounts payable to maintain accurate financial statements, ensuring that the company’s liabilities and assets are correctly represented after the return of goods.

A purchase allowance occurs when a buyer retains goods but negotiates a better price due to issues such as low quality. This adjustment affects both inventory valuation and accounts payable. For instance, consider a scenario where a company, TOS, orders 500 items at $5 each, totaling $2,500. Upon receiving low-quality goods, the supplier agrees to reduce the price to $2 per item, bringing the total value of the inventory down to $1,000.

Initially, TOS records the purchase by debiting inventory and crediting accounts payable for the full amount of $2,500. This entry reflects the increase in inventory and the corresponding liability. However, with the new price, TOS must adjust the inventory value. The difference between the original inventory value ($2,500) and the new value ($1,000) is $1,500. To correct this, TOS makes a second entry: debiting accounts payable by $1,500 and crediting inventory by the same amount. This adjustment reduces the accounts payable to $1,000, aligning it with the new inventory value.

In summary, the purchase allowance allows the company to keep the goods while adjusting the financial records to reflect the new, lower price. The final balances show inventory valued at $1,000 and accounts payable also adjusted to $1,000, demonstrating the impact of the purchase allowance on the company's financial statements.