Purchases, freight-in, returns and discounts; COGS = opening + net purchases − closing

The same purchase, periodically

A periodic system does not keep Inventory current. The Inventory account sits all year at the opening figure, and the year's buying activity is collected in four accounts of its own. Bramble Lane Outfitters Ltd.'s April headlamps (L8.2), recorded periodically:

Apr 3   Purchases                          3,600
            Accounts Payable                       3,600
Apr 5   Freight-In                           150
            Cash                                     150
Apr 8   Accounts Payable                     360
            Purchase Returns and Allowances          360
Apr 12  Accounts Payable                   3,240
            Purchase Discounts                        64.80
            Cash                                   3,175.20

Purchases is a temporary account — an expense-like collector, closed at year end. Freight-In adds to it; Purchase Returns and Allowances and Purchase Discounts are its contra accounts. Nothing touches Inventory until the count. And at the sale on 20 April there is one entry — Dr Accounts Receivable / Cr Sales Revenue 4,800 — and no cost entry at all, because the store does not know the cost of what it sold until it knows what is left.

Cost of goods sold, from the count

At year end the count gives ending inventory (corrected for transit and consignment, L8.3): 41,150. Bramble Lane's year:

Inventory, 1 January                              38,200
Purchases                            214,600
Less: purchase returns and allowances  (3,900)
      purchase discounts               (2,150)
Add: freight-in                         4,700
Net purchases                                    213,250
Cost of goods available for sale                 251,450
Less: inventory, 31 December                     (41,150)
Cost of goods sold                               210,300

The logic is a stock-and-flow: what you started with plus what you bought is what you could have sold; whatever is not still here must have gone out the door — sold, or stolen, or broken, the periodic system cannot tell. That is why shrinkage is invisible under periodic: it is simply inside cost of goods sold.

$$\text{Net purchases}=\text{Purchases}-\text{Returns and allowances}-\text{Discounts}+\text{Freight-in}$$

$$\text{COGS}=\text{Opening inventory}+\text{Net purchases}-\text{Ending inventory}$$

On net sales of 340,000, gross profit is 340,000 − 210,300 = 129,700, a gross margin of 38.1 %.

Why a small company still does this

The case company on an AFM 191 paper is small and private. A hardware store with a paper ledger and no item-level scanner cannot make the perpetual system's cost entry at each sale, because it does not know the unit cost of the thing at the till. For such a business the count is the inventory figure and the formula above is cost of goods sold. The two systems produce the same cost of goods sold when there is no shrinkage; perpetual's advantage is not accuracy of the total but the ability to see the total's parts during the year.

At year end the periodic accounts are closed and Inventory is reset from 38,200 to 41,150 as part of closing — the mechanics vary by textbook, and a case will not test them; it tests the schedule.