Perpetual inventory systems differ from periodic inventory systems, in which a company must instead depend on regularly scheduled physical counts. The perpetual inventory system gives real-time updates and keeps a constant flow of inventory information available for decision-makers. With advancements in point-of-sale technologies, inventory is updated automatically and transferred into the company’s accounting system. This allows managers to make decisions as it relates to inventory purchases, stocking, and sales. The information can be more robust, with exact purchase costs, sales prices, and dates known.
Examples of Inventory Costing Systems
Periodic inventory is normally used by small companies that don’t necessarily have the manpower to conduct regular inventory counts. These companies often don’t need accounting software to do the counts, which means inventory is counted by hand. As such, the system is commonly used by companies that sell small quantities of inventory, including art and auto dealers. Businesses that use a perpetual inventory system typically employ cycle counting or the process of physically counting a portion of inventory to use as a baseline to check the accuracy of the perpetual system. Large companies with a high volume of constantly rotating physical inventory should consider implementing a perpetual inventory system. Companies that don’t meet those criteria now but anticipate growth in the future may want to consider such a system, as well.
What’s the Difference Between a Perpetual Inventory and a Periodic Inventory System?
The ability to estimate COGS continuously also provides a company using a perpetual inventory system the ability to estimate gross profit continuously. That’s because every transaction is recorded in real-time under a perpetual inventory system. If inventory is central to your business, it must be managed, and to do that it, must be measured. Businesses that account for inventory periodically likely use the FIFO method to sell older units first. Retailers that use the perpetual system often make it a practice to count inventory (or at least a sample of inventory) to make adjustments for shrinkage.
2 Compare and Contrast Perpetual versus Periodic Inventory Systems
- As an accounting method, periodic inventory takes inventory at the beginning of a period, adds new inventory purchases during the period, and deducts ending inventory to derive the cost of goods sold (COGS).
- Both are accounting methods that businesses use to track the number of products they have available.
- The Cost of Goods Sold is reported on the Income Statement under the perpetual inventory method.
- A perpetual inventory does not need to be adjusted manually by the company’s accountants, except to the extent that it deviates from the physical inventory count due to loss, breakage, or theft.
- The time commitment to train and retrain staff to update inventory is considerable.
Moreover, the tracking of the cost of goods sold will be more accurate if compare to periodic. The cost of goods will be the total cost of goods being sold during the month, it not the balancing figure between the beginning and ending balance. It makes sense when we look at the formula, the beginning balance plus new purchase less ending must result as the sold item.
Not only must an adjustment to Merchandise Inventory occur at the end of a period, but closure of temporary merchandising accounts to prepare them for the next period is required. Temporary accounts requiring closure are Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. Sales will close with the temporary credit balance accounts to Income Summary.
After a physical inventory count, the company determines the value of its inventory is $400,000 on March 31. COGS for the first quarter of the year is $350,000 ($500,000 beginning + $250,000 purchases – $400,000 ending). The advantage of a perpetual system in providing a rolling estimate of COGS is clear. A company knows, after each transaction, how much it costs to produce products sold at that point. By updating these data on a continuous basis and integrating them with other business systems, the company has actionable information available on a 24/7 basis as a way to respond to increased costs in a timely manner. The use of a perpetual inventory system makes it particularly easy for a company to use the economic order quantity (EOQ) method to purchase inventory.
Perpetual Inventory System
The software you introduce into the workflow will make regressive vs proportional vs progressive taxes it easier for you to update and maintain your inventory. But a company using a periodic inventory system will not know the amount for its accounting records until the physical count is completed. When a company sells products in a perpetual inventory system, the expense account increases and grows the cost of goods sold (COGS).
The cost of goods sold (COGS) is an important accounting metric derived by adding the beginning balance of inventory to the cost of inventory purchases and subtracting the cost of the ending inventory. With a perpetual inventory system, COGS is updated constantly instead of periodically with the alternative physical inventory. Perpetual inventory is computerized, using point-of-sale and enterprise asset management systems, while periodic inventory involves a physical count at various periods of time. The latter is more cost-efficient, while the former takes more time and money to execute. Under the perpetual inventory system, an entity continually updates its inventory records in real time.
Second, perpetual inventory systems are often more expensive consignment accounting than periodic systems. Like we said, it’s pretty much nuts to try to run a perpetual system by hand—meaning you’ll likely have to pay for an inventory management software. And if you opt to simplify the process further with RFID tags or barcodes, you’ll also need to invest in extra equipment (like scanners) and training to help your employees use your system correctly. One of the main differences between these two types of inventory systems involves the companies that use them. Smaller businesses and those with low sales volumes may be better off using the periodic system.
Periodic inventory is done at the end of a period to create financial statements. This method, known as the periodic inventory system, is not as prominent as it once was due to technological advances in accounting software. Read on to learn about periodic inventory and its younger brother, the perpetual inventory system. It can be cumbersome and time-consuming, as it requires you to manually count and record your inventory.
A perpetual inventory system uses point-of-sale terminals, scanners, and software to record all transactions in real-time and maintain an estimate of inventory on a continuous basis. A periodic inventory system requires counting items at various intervals, such as weekly, monthly, quarterly, or annually. When a sales return occurs, perpetual inventory systems require recognition of the inventory’s condition. This means a decrease to COGS and an increase to Merchandise Inventory. Under periodic inventory systems, only the sales return is recognized, but not the inventory condition entry.
The differences between perpetual and periodic inventory systems go beyond how the two systems function, although that is the main point of distinction. The system allows for integration with other areas, including finance and accounting teams. Employees can use perpetual inventory data to provide more accurate customer service regarding the availability of products, replacement parts, and other physical components.
