Perpetual Inventory
Periodic inventory management is tracked manually, counting at the end of an accounting period. Perpetual inventory is for larger businesses using point-of-sale technology. With perpetual LIFO, the last costs available at the time of the sale are the first to be removed from the Inventory account and debited to the Cost of Goods Sold account.
A more accurate understanding of customer preferences can guide which items a business stocks and when they place them on the sales floor. If a company has several locations, a perpetual inventory system centralizes this management. It amalgamates all information and places it in one consolidated and accessible place. Overall, this automated system is more accurate and accurate information can be very valuable to a business owner.
Applying LIFO on a perpetual basis during the accounting period, results in different ending inventory and cost of goods sold figures than applying LIFO only at year-end using periodic inventory procedure. For this reason, if LIFO is applied on a perpetual basis during the period, special inventory adjustments are sometimes necessary at year-end to take full advantage of using LIFO for tax purposes. Economic Order Quantity inventory management method is one of the oldest and most popular. EOQ lets you know the number of inventory units you should order to reduce costs based on your company holding costs, ordering costs and rate of demand. Businesses use one of two ways to manage inventory – periodic and perpetual.
Therefore, periodic and perpetual inventory procedures produce the same results for the specific identification method. Under the perpetual system the Inventory account is constantly (or perpetually) changing. Rather than staying dormant as it does with the periodic method, the Inventory account balance under the perpetual average is changing whenever a purchase or sale occurs. With a real-time system updating constantly, there are many advantages to the business owner.
The USD 509 cost of goods sold is an expense on the income statement, and the USD 181 ending inventory is a current asset on the balance sheet. The specific identification costing method attaches cost to an identifiable unit of inventory. The method does not involve any assumptions about the flow of the costs as in the other inventory costing methods. Conceptually, the method matches the cost to the physical flow of the inventory and eliminates the emphasis on the timing of the cost determination.
The difference between the methods is the timing of when the inventory cost is recognized, and the cost of inventory sold is posted to the cost of sales expense account. The first in, first out (FIFO) method assumes the oldest units are sold first, while the last in, first out (LIFO) method records the newest units as those sold first. Businesses can simplify the inventory costing process by using a weighted average cost, or the total inventory cost divided by the number of units in inventory. Periodic inventory accounting systems are normally better suited to small businesses, while businesses with high sales volume and multiple retail outlets (like grocery stores or pharmacies) need perpetual inventory systems.
What is perpetual inventory?
With perpetual FIFO, the first (or oldest) costs are the first moved from the Inventory account and debited to the Cost of Goods Sold account. The end result under perpetual FIFO is the same as under periodic FIFO.
In other words, the first costs are the same whether you move the cost out of inventory with each sale (perpetual) or whether you wait until the year is over (periodic). Under the perpetual system, there are continual updates to the cost of goods sold account as each sale is made. Conversely, under the periodic inventory system, the cost of goods sold is calculated in a lump sum at the end of the accounting period, by adding total purchases to the beginning inventory and subtracting ending inventory. In the latter case, this means it can be difficult to obtain a precise cost of goods sold figure prior to the end of the accounting period. Under the perpetual system, there are continual updates to either the general ledger or inventory ledger as inventory-related transactions occur.
To illustrate, assume that the company in can identify the 20 units on hand at year-end as 10 units from the August 12 purchase and 10 units from the December 21 purchase. The company computes the ending inventory as shown in; it subtracts the USD 181 ending inventory cost from the USD 690 cost of goods available for sale to obtain the USD 509 cost of goods sold. Note that you can also determine the cost of goods sold for the year by recording the cost of each unit sold.
- Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software.
How Perpetual and Periodic Inventory Systems Work
As long as there is no theft or damage, the inventory account balance should be accurate. The cost of goods sold account is also updated continuously as each sale is made. Perpetual inventory systems use digital technology to track inventory in real time using updates sent electronically to central databases. Since businesses often carry products in the thousands, performing a physical count can be difficult and time-consuming.
Imagine owning an office supply store and trying to count and record every ballpoint pen in stock. For these reasons, many companies perform a physical count only once a quarter or even once a year. For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.
What is the perpetual inventory method?
Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software.
During periods of inflation, LIFO shows the largest cost of goods sold of any of the costing methods because the newest costs charged to cost of goods sold are also the highest costs. Those who favor LIFO argue that its use leads to a better matching of costs and revenues than the other methods. When a company uses LIFO, the income statement reports both sales revenue and cost of goods sold in current dollars. The resulting gross margin is a better indicator of management ‘s ability to generate income than gross margin computed using FIFO, which may include substantial inventory (paper) profits.
It can assess if customers were responsive to discounts, their purchasing habits, and if they returned any items. Unlike periodic inventory systems, the perpetual module reduces the need for frequent, physical inventory counts. By contrast, the perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold. Purchases and returns are immediately recorded in the inventory account.
Conversely, under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold. Companies can choose from several methods to account for the cost of inventory held for sale, but the total inventory cost expensed is the same using any method.
Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software. Perpetual inventory provides a highly detailed view of changes in inventory with immediate reporting of the amount of inventory in stock, and accurately reflects the level of goods on hand.
It is a proactive way to prevent stock from running out as when stock is low it can be instantly identified and stock can be reordered. It also gives business owners a better understanding of customer buying patterns and their purchasing behavior.
Understanding Periodic Inventory vs. Perpetual Inventory
Within this system, a company makes no effort at keeping detailed inventory records of products on hand; rather, purchases of goods are recorded as a debit to the inventory database. Effectively, the cost of goods sold includes such elements as direct labor and materials costs and direct factory overhead costs.