A perpetual inventory system tracks inventory continuously. It adds up all the purchases in the "inventory" or “merchandise inventory” account, and moves them to the "cost of goods sold" account as they are sold. However, a periodic inventory system provides a balance of the inventory account only at the end of an accounting period. At year end, the inventory balance is adjusted to reflect the physical count through two entries: first, remove the beginning inventory to a temporary "income summary" account and second, enter the physical inventory balance.
Remove the beginning merchandise inventory balance. In a periodic inventory system, this balance is kept steady until an actual physical count that, due to the costs involved, usually only happens at fiscal year-end. Debit or increase the income summary account and credit or remove the merchandise inventory account. In other words, move the inventory balance to the income summary account.
Enter the ending merchandise inventory balance, which is the physical count. Credit or decrease income summary and debit or increase merchandise inventory.
Calculate the cost of goods sold. In a periodic system, purchases of new merchandise inventory and sales are tracked in the "purchases" and "sales" accounts respectively. Add purchases to the beginning inventory, which is the prior period's ending inventory, to get the goods available from sale. Subtract the ending merchandise inventory to get the cost of goods sold. For example, if the beginning merchandise inventory balance is $1,000 and purchases during the period are $500, then goods available for sale equals $1,500 ($1,000 + $500). If the ending merchandise inventory is $900, then the cost of goods sold is $600 ($1,500 - $900).
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.