Note a new format of the Income Statement. This format matches particular revenues with respective expenses. For example, Net Sales and Cost of Goods Sold provide information on the difference between the selling price and the cost of goods sold. Such format of the income statement is used to prepare information for financial analysis. Income statements of such kind are called multiple-step income statements.

Multiple-step income statement shows numerous steps in determining a net income (or net loss). Each step provides a different measure of a company's results of operations.

In contrast, a single-step income statement that we had been dealing with before only includes information on total revenues and total expenses.

Single-step income statement shows only one step in determining a net income (or net loss).

One important aspect about the periodic inventory system should be mentioned. The periodic inventory system is known to be used more frequently than the perpetual one. The reason is simple. It is easier to make a few period-end adjusting entries than to adjust accounting records every time a sale or purchase is made (for example, grocery store sales are very frequent). Under the periodic system the cost of goods sold is determined at the end of the period. Purchases or sales of inventory do not affect the inventory account during the period. When goods are purchased, the cost is recorded in the Purchases (Inventory Purchases) account. When goods are sold, a reduction in the Inventory account does not take place. Transportation-outs, purchase returns, and allowances are recorded in separate accounts. The cost of goods sold is calculated by subtracting the amount of ending inventory from the total costs of goods available for sale (see the table below). The ending inventory is determined by performing a period end physical count.

The Schedule of Cost of Goods Sold helps in performing the computations:

Illustration 13: Schedule of cost of goods sold

However, there is one weak point about the periodic system. The point relates to lost, damaged, or stolen merchandise. Because the periodic system determines the cost of goods sold and the ending inventory at the end of the period, it is impossible, during the period, to figure out whether there were any goods stolen, damaged, or lost. It is rather difficult even at the period end because all the goods not available at hand are considered sold.

At the same time, it is quite easy to figure out the damaged, lost, or stolen goods if a company employs the perpetual system. Simple comparison of the physically counted merchandise on hand at the end of the period and the book balance of the Merchandise Inventory account will do the job. If there is a difference between the two, then some goods were damaged, stolen, or lost. In such a case an adjusting entry is needed to record the goods not available any more. The adjusting entry acts to decrease assets and equity. The equity is decreased by increasing an expense account called Inventory Loss (or sometimes directly to Cost of Goods Sold). The assets are decreased by reducing the inventory account.

For example, let us assume a company applies the perpetual inventory system and has the book balance of the Merchandise Inventory account of $1,500. The physical count at the end of the period showed that only $1,300 of goods was on hand. The inventory loss of $200 ($1,500 - $1,300) should be recorded as follows:

Illustration 14: Effect of recording inventory loss in the horizontal model

The entry in the general journal looks like this:

Illustration 15: Journal entry to record the inventory loss