Perpetual Inventory System – Meaning, Advantages And More

Perpetual Inventory System is a method in accounting for calculating inventory immediately after the sale and purchase with the use of computerized point-of-sale systems and enterprise asset management. In simpler terms, such a system tracks the inventory in real-time, i.e., after each transaction.

The accounting manager updates the cost of goods sold (COGS) in accounting records regularly. This is done to ensure complete sync of numbers in a store and the numbers in the accounting books. Perpetual system of inventory tracks the following activities – purchase of goods, sale of goods, goods moved from one location to another, use of items from inventory for production, and items that the company scraps.

Advantage of Perpetual Inventory System

Inventory tracking could get difficult due to breakage, loss, scanning errors and more. However, the use of a perpetual system for inventory could help a business to minimize such errors. Apart from this, there are many more advantages for deploying this system;

  • Alerts on the products that are about to go out of stock.
  • Helps businesses to understand customer preferences.
  • Helps business owners to set up the inventory management system for various locations.
  • Boost accuracy as inventory items is sorted daily.
  • It helps business owners to understand and frame policies across purchases, discounts, and returns.
  • Perpetual Inventory system also reduces the physical inventory counts.

Perpetual vs. Periodic Inventory System

As said before, under the perpetual system, the accounts manager update accounts after each purchase or sale. Similarly, inventory subsidiary ledger and inventory quantities are also updated continuously.

Under the periodic inventory system, an accounts manager records inventory to purchase or sell in the ‘Purchases’ account. Though ‘Purchases’ account gets a continuous update, accounts manager updates “Inventory” periodically, usually at the end of the accounting period (monthly or quarterly). Thus, inventory subsidiary ledger and inventory quantities also don’t get updated continuously.

Let’s understand the difference between the two with the help of an example where a company buys 1,000 units of fabric at $40 per unit. Under the perpetual system, a company would debit the merchandise inventory and $40,000 would go in the accounts payable. Under the periodic inventory system, the company would debit the purchases and credit the accounts payable.

Now, if on a certain date, a company sells 200 units at $50, then the entry under perpetual inventory system would be $10,000 debit to ‘Account Receivables’ and credit to ‘Sales’. Then, a debit of $6000 for ‘Cost of Goods Sold’ and $6000 credit to ‘Merchandise inventory.’

Under Periodic inventory system, $10,000 debit to ‘Account Receivables’ and $10,000 credit to ‘Sales.’ Then at the end of the accounting period, an adjusting entry comes in the ‘Merchandise inventory,’ ‘Purchase’ and ‘Cost of Goods Sold.’

Difference Between the Perpetual Inventory System and Periodic  Inventory System

Technology – for maintaining a perpetual system of inventory, the account managers need to be on their toes. Manually recording might lead to mistakes and error or omission. To speed up and reduce the chances of error, the companies must deploy computers and another technology system. In the periodic system of inventory, however, the role of technology is much less.

Cost of Goods Sold – Organizations that adopt perpetual inventory system continuously adjust the cost of goods sold. On the other hand, companies following the periodic inventory system calculate the total amount at the end of the accounting period. This is done by adding the total purchases to the beginning Inventory and subtracting ending inventory. Therefore, under the periodic inventory system, it might be a little difficult to get the correct cost of goods sold amount before the end of the accounting period. Also, the perpetual inventory system is done in real-time but the periodic inventory system shows the COGS at a specific point in time.

Cycle Counting – Under the periodic inventory update system, it is difficult to use cycle counting method. It is because there is no way the manager can get accurate inventory counts in real-time.

Types of Companies Using These Systems – Since the task of continuously updating the inventory system is not easy, not many organizations adopt it. It is usually the large business who deploy the perpetual inventory system. Also, businesses with expensive products such as jewelry, electronics and so on use such a system for inventory. Other organizations make use of the periodic inventory system.

Investigating a Transaction – Under the periodic inventory system, the task of investigating an error is almost impossible. However, in the perpetual inventory recording system, finding even the smallest of the recording error becomes easier.

Template for Perpetual Inventory System

  • Purchase goods from Supplier

Account          Debit               Credit

Inventory         XXX

Accounts payable                    XXX

  • Record supplier purchase discount

Account                      Debit          Credit

Inventory                                              X

Accounts payable        X

  • To record freight costs

Account                      Debit               Credit

Inventory                       XX

Accounts payable                                XX

  • Purchase return to a supplier

Account                      Debit               Credit

Accounts payable        XYZ

Inventory                                             XYZ

  • Sale of goods to a consumer

Account                                              Debit                           Credit

Cost of goods sold                               XXX

Inventory                                                                                 XXX

Sales                                                                                        XXX

Accounts receivable                            XXX

  • Physical inventory count shortage entry

Account                                              Debit                           Credit

Loss on inventory write down             XXX

Inventory                                                                                 XXX

Economic Order Quantity (EOQ)

Use of a perpetual system allows the company to go for economic order quantity (EOQ) to purchase inventory. EOQ help managers decide when to buy inventory as it considers the cost to hold inventory and cost to order inventory.

Final Words

Since the perpetual system is time taking and expensive, not many companies adopt it. However, with the advent of computers, such a system has got popular. Additionally, the use of radiofrequency identification scanners (RFID), Barcodes, point of sale systems (POS) has made the system more accurate and informational. So, it clear that perpetual system is much superior to the periodic inventory system. However, a periodic system would make sense if a business has a small inventory, or it is easy to review the inventory without going into details. Also, the periodic system will work better where the staff does not have the proper training to use the perpetual system of inventory tracking.

Last updated on : August 8th, 2019
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