and now we're going to learn how to make debits and credits with inventory transactions and this
video we will specifically learn about the perpetual inventory system we have already
learned how to record an income from a service it's just one T account that represents the
total money that came in from what we earned in previous cases it was just one number the
service fee and it represented the price of the service so you previously made a credit to this
income account for exactly what the customer gave you however when we have merchandise that we're
selling we still have an income account that represents the total money that came in from
the customer for merchandise sales but in a case of a merchandise company we're not dealing with
one number in the income section we're really dealing with three numbers the sales price of
the merchandise which will get recorded as a credit to this income account the same way the
income from a service got recorded to the service income account but with merchandise we also have
to consider how much did the merchandise cost you when you bought it because the difference
between the price that you record as income and the cost that you pay for the merchandise will be
your profit now the most important words in this video are the words cost and the words price and
you have to make sure you know the difference between the word cost and the word price cost
means the amount that we paid to purchase the merchandise from the vendor but for that very
same merchandise the word price means the amount we received from the customer when selling the
merchandise and of course the difference is your profit price minus cost equals profit and we all
know that but only if the goods are sold so we therefore have to clarify our definition
we should really say the price of the goods that were sold - the purchase cost of the
goods that were sold is what really equals our profit the price of the goods that are
sold is the value that the customer gives us the cost of the goods that are sold is the value of
what we gave to the customer it's what we paid for the goods that went out the word perpetual
means continuously changing that means if we're using the perpetual inventory method
to record the sale the account inventory asset changes after each transaction that means it
changes after we buy the merchandise and it also changes after we sell the merchandise
now of course in the top right here we have our sales income account this is very similar to the
service income account that we were using in previous videos you record a credit for what
the customer gives you because that's the income that you earned so previously we made a credit
for the price of the service when the customer paid us or when we earn the service income so
now when we deliver the goods we make a credit to sales income for the price of the goods that
are sold because that's the income that we earned and that's a t-account just like service income
however the interesting stuff happens down here in the cost of goods sold account this is not
technically an expense even though it behaves like an expense and even though it has the same effect
on income it would go in the income section as a contra income account not an expense account
because it's part of the income cycle you have to buy then sell then you can subtract your
expenses to find your net income so that explains a little bit about this new account in the bottom
right cost of goods sold and now let's see how to use these accounts when we purchase and sell
merchandise first let's give cash a beginning balance that's not a transaction we're just
pretending that we're starting off with $10,000 cash now here's our first transaction paid 300 to
purchase merchandise well we know if we pay cash as - cash as credit and just like purchasing any
other asset exactly what we paid for the asset becomes a debit to that asset for that date so
this purchase transaction is no different than the ones we've learned before when we purchased other
assets but the interesting part comes here when we sell with perpetual we record it twice once
for the cost and once for the price now that's a lovely little rhyme so let's say it again when
we sell with perpetual we record it twice once for the cost and once for the price let's take
a look at an example let's imagine on January 8th we sold the specific merchandise that we purchased
on January 1 but we sold them for $1,200 so you can see this is the merchandise that we purchased
back on Jan you this is the merchandise sitting here waiting to be sold now if we sold it for
$1200 it means that the customer gave us $1,200 and it also means we've earned $1,200 worth of
income for selling the merchandise so what would be the debits and the credits well if we've earned
$1,200 worth of income for sales and we know that income is credit on January 8th we would have to
credit the sales income account for the $1,200 that we earned on the other hand the customer
gave us $1,200 so we have no choice but to debit cash on January 8th for the $1,200 so this first
step in credit looks just like it looked when we sold the service credit the income and debit
the cash however there is now an extra step for this same January 8th sale for this January 8th
sale we also have to credit inventory because this $300 of inventory is no longer here it went out so
we have to remove it from inventory by making a credit of three hundred so then what would
we debit 300 and of ously the answer is cost of goods sold credit inventory for the merchandise
that went out and debit cost of goods sold for the purchase cost of the specific merchandise that we
gave to the customer can you guess the profit from this particular sale of course the profit
is $900 anybody could figure that out because it was only one sale watch another one let's imagine
on January 20 we purchased $500 more of inventory again that's the easy one we have 500 more of this
asset and on the other hand we have 500 less of cash so we know purchasing under the perpetual
system is very easy debit the inventory that you got and credit the cash now again the interesting
part is when you actually sell let's imagine on January 31 we sold the specific merchandise that
we previously purchased on January 20 and we sold it for $3,300 well here's the merchandise that we
purchased back on January 20 so we know that has to come out of inventory but what should
we do first well we've actually earned $3,300 by receiving that from the customer for giving them
the merchandise so always income is credit for what we earned and if the customer gave us three
thousand three hundred in cash we have to debit cash so the debit and the credit for the price
of the January 31 sale is credit sales income and debit cash but we're not finished this specific
$500 of inventory went out on January 31 so we credit inventory five hundred then what do we
debit five hundred well five hundred dollars was the purchase cost of the goods that we gave the
customer on January 31 the specific goods so here we have the debit and the credit for the cost so
we have four accounts changing when we make a sale credit sales income and debit cash for the price
and the income we earned credit inventory for the cost of the goods that are sold and debit cost of
goods sold now obviously at the end of the month or the end of the period we would get the total
of the sales income and the total of the cost of goods sold we would eventually put them together
to find the profit from our merchandise operation in this case the profit is three thousand seven
hundred but when you're an accountant you're not finished when you calculate the profit
the profit is the result of the income section of our operation we then have to subtract out
all the other expenses that we learned about in previous videos to get the final number the net
income in fact sales income and cost of goods sold are together in the income section of the income
statement and the expenses are at the bottom they're both in the income section because both
buying and selling are part of the revenue cycle and if you have a merchandise business the gross
profit is the result of the income section you then simply record all your other expenses and
subtract them the way you did when you had a service business to find your final net income