Perpetual Inventory System

12th May 2021 2 By indiafreenotes

Perpetual inventory system provides a running balance of cost of goods available for sale and cost of goods sold. Under this system, no purchases account is maintained because inventory account is directly debited with each purchase of merchandise. The expenses that are incurred to obtain merchandise inventory increase the cost of merchandise available for sale. These expenses are, therefore, also debited to inventory account. Examples of such expenses are freight-in and insurances etc. Each time the merchandise is sold, the related cost is transferred from inventory account to cost of goods sold account by debiting cost of goods sold and crediting inventory account.

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. 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.

A perpetual inventory system is a method of inventory management that records real-time transactions of received or sold stock through the use of technology generally considered a more efficient method than a periodic inventory system.

A perpetual inventory system is distinguished from a periodic inventory system, a method in which a company maintains records of its inventory by regularly scheduled physical counts.

The perpetual inventory system is a more robust system than the periodic inventory system, which is where a company undertakes regular audits of stock to update inventory information.  These audits include regular physical inventory counts on a scheduled and periodic basis. The major difference between perpetual and periodic inventory systems is that the former has a system that updates inventory information in real-time while the latter uses a more manual process.

Perpetual inventory systems in the past were not widely used, as it was difficult to record and process the large amounts of data quickly and accurately.

In recent years, however, the technology capability has increased and has improved business and accounting practices, inventory tracking systems can now be managed through the use of computers and scanners, perpetual inventory tracking has become less burdensome.

Perpetual vs. Periodic Inventory Systems

Most small and medium-sized companies use the periodic inventory system, which involves scheduled inventory audits throughout every year. In most cases, periodic inventory counts are conducted a few times per year or even at the end of every month.

The primary issue that companies face under the periodic inventory system is the fact that inventory information is not up to date, and may be unreliable. This means that managers don’t have accurate demand forecasts or inventory levels to ensure that stockouts don’t occur.

Perpetual inventories are the solution to such an issue, giving accurate and updated information about inventory levels, COGS, allows them to check on discrepancies in real-time.

Since the periodic inventory system is only updated occasionally, managers never have current and accurate financial information to base their purchasing or manufacturing decisions on.

Perpetual inventory systems fix this problem. As soon as an inventory transaction takes place, it is entered into the system and inventory balances and costs are updated automatically. Managers can use current inventory reports any time because the system always keeps a real time balance of inventory.