Explain how to record purchases and sales of inventory using a perpetual inventory system.

- In a perpetual inventory system, purchases of inventory are recorded by increasing the inventory account.

- If a purchase discount exists, inventnry is reduced by the amount of the discount taken.

- When a purchased item is returned (purchase return) or a price reduction is granted by the seller (purchase allowance), the inventory item is reduced by the amount of the purchase return or allowance given.

- If transportation costs exist and the shipping terms are FOB shipping point, the transportation costs are considered part of the total cost of purchases and the inventory account is increased.

- If transportation costs exist and the shipping terms are FOB destination, the seller pays these costs and records them as a selling expense on the statement of earnings.

- In a perpetual inventory system, sales require two entries that (1) record the sales revenue and (2) recognize the expense (cost of goods sold) associated with the decrease in inventory.

- If an item is later returned, two entries must also be made: (1) increase Sales Returns and Allowances (a contra-revenue account) and (2) increase the inventory account and decrease Cost of Goods Sold.