Alright, so now let's summarize everything we've discussed about purchases in a perpetual system. Throughout a period, we're purchasing inventory and selling product in a merchandising business. At the end of the period in a perpetual system, we have to calculate the ending balance in inventory. We've been making all these journal entries as we go for the purchases, for the sales, and in perpetual, we're also making entries for the cost of goods sold as we go. So we will know what that should be when the period ends. We're going to use this standard base equation, beginning plus addition minus subtraction equals ending, to figure out the ending balance in inventory. We start with our beginning balance, add the additions which are the purchases, and then subtract from the inventory account things like purchase discounts when we receive a discount, the purchase returns, and the allowances that we discussed, as well as COGS (Cost of Goods Sold). These are all the subtractions and generally, in most questions, you are not going to deal with purchase discounts or purchase returns and allowances. Those are usually special cases where these issues come up. So generally, the only subtraction is COGS, but you are aware of how to deal with purchase discounts and purchase returns and allowances from other videos. These can also decrease our inventory account in a perpetual system.
Let's look at all of these things in a T account, because I think a T account is the easiest way to think about our base equation. We would have some T account for the inventory and we would start with our beginning balance in inventory. There would be some amount that we own at the beginning of the period, then during the period we would purchase more inventory, which increases, that's a debit, and increases the balance of inventory. But there are also subtractions, the things that decrease inventory, like purchase discounts, purchase returns, and purchase allowances. If we bought something and then received a discount when we paid or if we return some of it, all of these things decrease the inventory value and then the last thing is COGS. COGS is the last thing that will decrease our inventory value and once we calculate the beginning, the additions, subtract all these things, we get to our ending balance down here, which would be what's left at the end of the period.
In a perpetual system, we're accounting for all these things as we go, perpetually updating the inventory account. So, we would know the beginning balance, the purchases, the purchase discounts, the returns, the allowances, and COGS. We know all those numbers and then we solve for the ending balance. Consider this example: a company has the following inventory records from the past month. They provide us with inventory data for July 1st, COGS, purchases during July, purchase discounts, and purchase returns, and they ask us to calculate the inventory at the end of the month. Notice, nowhere in here did they tell us what the ending balance in inventory is. The data on the ending balance in accounts payable and the beginning balance does not affect this problem because the accounts payable doesn't really tell us anything about the inventory account per se by itself.
So, we're going to take the information we do know. I'm going to rewrite our T account here for the inventory and then use this one that we have in the top right corner as our guide as we fill out this T account. The first thing we have is our beginning balance. On July 1st, we had our beginning balance of $55,000. Then we add the purchases to the account, and notice it tells us there were purchases during July of $25,000. So, we're going to increase our inventory with those purchases. We would have made some sort of debit to inventory for $25,000 and a credit to accounts payable or something similar when we purchased it. Then we have these discounts, purchase discounts when we paid our suppliers quickly; we got a discount and that's going to decrease the value of inventory. So, they sum them together, $1,500 and that is our returns and allowances is there, $1,500. The last thing is COGS, which is another thing that comes out of our inventory, and it told us that that's $40,000. We've used all of these numbers and then the accounts payable stuff that was just there to throw you off to give you extra information. Now, all that's left is to solve for our ending balance down here and to do that, we're just going to add our debits, subtract our credits, and see what's left over. We start with $55,000 plus $25,000 in purchases and then we're going to subtract everything on the right-hand side, minus $650 minus $1,500 minus $40,000. This gets us to a value of $37,850. That is the final balance in our inventory account and that's what it asks us to calculate. We used all the information that we had throughout the period to calculate the ending balance. That's how it works in a perpetual system.
Let's move on to the next video.
