COST OF GOODS SOLD ADJUSTING ENTRY
in a PERIODIC inventory system

I. Introduction

When merchandise is sold, two things happen: (1) Something comes in (e.g. cash or accounts receivable); and (2) something goes out (inventory). The something that comes in is the revenue. The cost of the inventory that goes out is the expense. In a perpetual system, these two events are recorded at the time of sale:

Perpetual Entry:

(1) Cash or A/R xxx
Revenue xxx
(2) Cost of Goods Sold xxx
Inventory xxx

 

When a periodic system is used, the (1) entry occurs at the same time as the sale, but the (2) entry is postponed until the end of the accounting period. It also becomes more complicated…

II. Accounts Used in a Periodic System

The inventory account is debited or credited ONLY at the time of the end of period adjusting entry. Therefore, it just sits there all during the accounting period. It was the ending inventory of the last time period and is the beginning inventory of the current time period. When inventory is purchased, the account that the purchase is recorded in is purchases. Purchases are reduced by purchase returns and allowances and by purchase discounts and are increased by freight-in (transportation-in).

So, if you started with some inventory, then added some more purchases, the two together would be the cost of all the inventory you could possibly sell, which is called goods available for sale. If there is nothing left, then this goods available for sale is the cost of the things you sold. However, usually there is some left, called ending inventory. If you subtract this from goods available for sale, this produces cost of goods sold.

III. The unadjusted trial balance of a company using a periodic system will include inventory, purchases, purchase discounts, purchase returns and allowances, and freight-in (if the last three exist.) as in the following example. Remember that inventory in the unadjusted trial balance is the beginning inventory.


Unadjusted Trial Balance
(selected accounts)

dr. cr.
Inventory 20,000
Purchases 40,000
Purchase returns 3,000
Purchase discounts 800
Freight-in 1,500

The Adjusting Entry empties all these accounts into a Cost of Goods Sold account by debiting credit balances and crediting debit balances. This makes the balances zero. (The following is only the first step in the entry.)

Cost of Goods Sold 57,700 ???
Purchase discounts 800
Purchase returns 3,000
Inventory 20,000
Purchases 40,000
Freight-in 1,500

This entry effectively says," We started with inventory costing $20,000, bought some costing $40,000, paid $1,500 to ship it in. But we returned some that cost $3,000 and we took some discounts so we paid less by $800, so if we sold all this stuff, our cost would be $57,700. (20+40+1.5-3-.8)

But let’s assume there is still inventory in the warehouse that cost $22,000 that we didn’t sell. That means we didn’t sell stuff costing all $57,700, but only that costing $35,700. Also, remember that now the inventory account says zero because it started at $20,000 but we just dumped all that into COGS above. We can fix COGS and inventory by adjusting our entry as follows:
Cost of Goods Sold 35,700
Inventory(ending) 22,000
Purchase discounts 800
Purchase returns 3,000
Inventory 20,000
Purchases 40,000
Freight-in 1,500

Notice that all the accounts are now zero except for COGS with a debit balance of $35,700 and inventory with a debit balance of $22,000. This is the new ending inventory that will just sit there and become beginning inventory for the next accounting period.

 

IV. Closing

 

Cost of goods sold is an expense that gets emptied into income summary during the closing process, as follows:

Income Summary 35,700
Cost of Goods Sold 35,700

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