At the end of an accounting period (month, year, etc.) the inventory account is adjusted so that the balance sheet will report the cost (or lower) of the goods actually owned by the company.
When an adjusting entry is used, the related income statement account will be a cost of goods sold account. An example of such an account is Inventory Change or Inventory (Increase) Decrease.
To illustrate the inventory adjustment, let's assume that the cost of a company's actual inventory at the end of the year is $40,000. However, its general ledger asset account Inventory has a debit balance of $35,000. The company's inventory adjusting entry will 1) debit Inventory for $5,000 and 2) credit Inventory Change for $5,000. [You can think of the $5,000 credit balance in this income statement account as a reduction of the company's debit balance in its Purchases account. In other words, not all of the purchases should be matched with the period's sales since we know that the inventory has increased by $5,000.]
Next, let's assume that another company's cost of its actual ending inventory is $62,000. However, its inventory account has a debit balance of $70,000. This will require an adjusting entry to 1) credit Inventory for $8,000 and 2) debit Inventory Change for $8,000. The $8,000 debit in this income statement account will be an addition to the cost of the goods purchased. In other words, not only was it necessary to match the cost of purchases with sales, it was also necessary to match the additional $8,000 of cost that was removed from inventory.
Textbooks often change the balance in the account Inventory (under the periodic method) through closing entries. (One closing entry removes the amount of beginning inventory and one closing entry records the cost of the ending inventory. ) We believe that an adjusting entry is more logical and efficient, especially when monthly and year-to-date financial statements are prepared using accounting software.
