6 1: Adjusting Entries for a Merchandising Company Business LibreTexts

The Company maintains a reserve for obsolete inventory and generally makes inventory value adjustments against the reserve. Notice how the ending inventory balance equals physical inventory of $31,000 (unadjusted balance $24,000 + net purchases $166,000 – cost of goods sold $159,000). The account Inventory Change is an income statement account that when combined with the amount in the Purchases account will result in the cost of goods sold. Under the periodic method or periodic system, the account Inventory is dormant throughout the accounting year and will report only the cost of the prior year’s ending inventory.

The inventory account’s balance may be updated with adjusting entries or as part of the closing entry process. The first adjusting entry clears the inventory account’s beginning balance by debiting income summary and crediting inventory for an amount equal to the beginning inventory balance. The periodic inventory methods has TWO additional adjusting entries at the end of the period. The first entry closes the purchase accounts (purchases, transportation in, purchase discounts, and purchase returns and allowances) into inventory by increasing inventory.

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Now we will look how the remaining steps are used in a merchandising company. Those wonderful adjusting entries we learned in previous sections still apply. On the other hand, periodic inventory relies on a physical inventory count to determine cost of goods sold and end inventory amounts. With periodic inventory, you update your accounts at the end of your accounting period (e.g., monthly, quarterly, etc.). When using the periodic method, balance in the inventory account can be changed to the ending inventory’s cost by recording an adjusting entry. If you are operating a production facility, then the warehouse staff will pick raw materials from stock and shift it to the production floor, possibly by job number.

1. On the other hand, periodic inventory relies on a physical inventory count to determine cost of goods sold and end inventory amounts.
2. When expenses are prepaid, a debit asset account is created together with the cash payment.
3. We spent the last section discussing the journal entries for sales and purchase transactions.
4. To follow this principle, adjusting entries are journal entries made at the end of an accounting period or at any time financial statements are to be prepared to bring about a proper matching of revenues and expenses.
5. Let’s take a look at a few scenarios of how you would journal entries for inventory transactions.

When expenses are prepaid, a debit asset account is created together with the cash payment. The adjusting entry is made when the goods or services are actually consumed, which recognizes the expense and the consumption of the asset. Generally, adjusting journal entries are made for accruals and deferrals, as well as estimates. Sometimes, they are also used to correct accounting mistakes or adjust the estimates that were previously made.

Finished goods inventories are stated at the lower of standard cost, which approximates actual cost using the first-in, first-out method, or net realizable value. Raw materials are stated at the lower of cost (first-in, how to professionally ask for payment from clients template first-out method) or net realizable value. The Company periodically reviews the value of items in inventory and records write-downs or write-offs based on its assessment of slow moving or obsolete inventory.

Perpetual and periodic inventory options

However, in practice, revenues might be earned in one period, and the corresponding costs are expensed in another period. Also, cash might not be paid or earned in the same period as the expenses or incomes are incurred. To deal with the mismatches between cash and transactions, deferred or accrued accounts are created to record the cash payments or actual transactions. In accrual accounting, revenues and the corresponding costs should be reported in the same accounting period according to the matching principle. The revenue recognition principle also determines that revenues and expenses must be recorded in the period when they are actually incurred.

An asset is physical or non-physical property that adds value to your business. As you know by now, debits and credits impact each type of account differently. Prepaid insurance premiums and rent are two common examples of deferred expenses. If the rent is paid in advance for a whole year but recognized on a monthly basis, adjusting entries will be made every month to recognize the portion of prepayment assets consumed in that month. A physical inventory is typically taken once a year and means the actual amount of inventory items is counted by hand.

For example, depreciation expense for PP&E is estimated based on depreciation schedules with assumptions on useful life and residual value. It just depends on how you want to capture the data for your own internal and external reporting purposes. Assessing LCNRV by class also reduced ending inventory, which reduced gross profit and net income https://www.quick-bookkeeping.net/invoice-templates-for-word-and-excel/ (third column). Debit your Cost of Goods Sold account and credit your Finished Goods Inventory account to show the transfer. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs.

We will look at the how the merchandise inventory account changes based on these transactions. The physical inventory count of $31,000 should match the reported ending inventory balance. Under the periodic inventory method, we do not record any purchase or sales transactions directly into the inventory account.

Record Finished Goods

The perpetual inventory method has ONE additional adjusting entry at the end of the period. This entry compares the physical count of inventory to the inventory balance on the unadjusted trial balance and adjusts for any difference. Similar to an accrual or deferral entry, an adjusting journal entry also consists of an income statement account, which can be a revenue or expense, and a balance sheet account, which can be an asset or liability.

The write-offs reflect inventories related to discontinued product lines, excess repair parts, product rejected for quality standards, and other non-performing inventories. Debit your Finished Goods Inventory account, and credit your Work-in-process Inventory account. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com. Additional entries may be needed besides the ones noted here, depending upon the nature of a company’s production system and the goods being produced and sold.

If you sell products at your business, you likely have some form of inventory. Knowing how much inventory you have on hand, as well as how much you need to have in stock, is a crucial part of running your business. To help keep track of inventory, you need to learn how to record inventory journal entries.