What is a Perpetual Inventory System? – Definition:
Perpetual inventory system is a method of accounting for inventory where transactions are recorded and reported as soon as they take place. Usually, in this inventory system, computerized systems and software are used to immediately record the sales and purchases.
Before advancements in technology, companies would avoid using a perpetual inventory system, as it would be time-consuming and manual labour that could have been useful somewhere else was preoccupied by this constant record-keeping. Companies would prefer using a periodic inventory system and do accounting and physical counting at the end of one period. However, in recent years, computerized systems and input devices have taken over and made this less burdensome for employees.
Perpetual inventory system correctly reflects the amount of inventory on hand. It’s different from the periodic inventory system where inventory counting is done at the end of an accounting period.
A perpetual inventory system keeps a running balance of both inventory on hand and the cost of goods sold. These balances can be kept in units or in units and dollars. Management is, therefore, always aware of inventory levels and is able to make timely purchases that will ensure the maintenance of desired inventory levels. The use of a perpetual inventory system has been enhanced in recent years through the use of electronic point of sale devices and computers.
However, even with such sophisticated equipment, perpetual records may be kept only in units, with the cost of ending inventories and goods sold determined by the periodic inventory system. For example, optical scanners in markets keep track of inventory quantities, but at the end of the accounting period, a physical inventory is taken to compute the cost of goods sold during the period and the appropriate cost of the ending inventory.
Transactions recorded under the Perpetual Inventory System
Under the perpetual inventory system, a company does inventory counting and records transactions like the following, which reflect the current inventory levels:
- Inventory purchased
- Inventory sold
- Inventory moved out of the warehouses
- Inventory transferred for other production purposes
- Inventory that has become obsolete, or is discarded for various reasons (breakage, theft, etc.)
Therefore, under the perpetual inventory system, the need for physical counting of inventory reduces and the latest inventory balances are reflected instantly.
The perpetual inventory system is easier to maintain than periodic. Accountants don’t have to constantly adjust the changes in the inventory levels, as everything is done by the computer systems for the most part. However, a perpetual inventory system requires manual adjustments in case of theft, breakage or unrecorded transactions, as these cannot be reflected on their own.
For businesses where the above transactions are happening by the second, a perpetual inventory system is the best for keeping track at all times.
The journal entries used for bookkeeping in the perpetual inventory system are different from the ones in a periodic system.
To record purchase of inventory:
To record sale of inventory:
|Cost of goods sold||Debit|
To record theft/breakage:
|Loss of inventory expense||Debit|
Let’s take a look at an example to understand perpetual inventory systems better.
The perpetual inventory system is being used in a warehouse of a post office where shipping and receiving of packages take place. Every parcel that is delivered is first scanned and the balance is added to the current inventory levels. Similarly, the packages being shipped out are scanned for their bar-code and then loaded on to the shipping vehicle. This reduces the inventory level and removes their records from the accounts.
So from this simple example, we can see how this technologically advanced system updates itself in no time. Here the transactions are being checked in bulk like in periodic systems and no need for physical inventory counting is done, unless there are doubts of breakage or theft.
To further understand this system, we’re going to look at an example involving journal entries.
Company A buys inventory worth $5000 on credit from a supplier. This is recorded as follows:
There were freight charges of $400 involved in the inventory the company bought the next day:
The same day, inventory costing $4000 is sold for $5000:
|Cost of goods sold||4000|
Lastly, to record loss of inventory worth $1500 because of breakage:
|Inventory Loss Expense||1500|
Accounting for Perpetual inventories
The accounting for perpetual inventories is shown in the following example.
Assume that a firm started the year with a beginning inventory of pens that cost $10,000. During the quarter, the following summary of transactions occurred.
The appropriate journal entries for the perpetual inventory system are presented below. As inventory is purchased, the Merchandise account is debited. As the inventory is sold, the Merchandise Inventory account is credited, and Cost of Goods Sold is debited for the cost of the inventory sold. One of the features of the perpetual system is to provide the firm with information concerning its inventory levels. The system’s design reflects this goal. As this series of journal entries shows, the balance in merchandise inventory account at a particular time should reflect the actual cost of the goods on hand at that time. In the example, the ending balance in the Merchandise Inventory Account is $13,000, which should represent the actual cost of inventory on hand.
Journal Entries For Merchandise Purchaser – Perpetual Method
We use the word should because the balance in the merchandise inventory account will not always equal the cost of the item remaining in the inventory. this is due to clerical errors, spoilage, theft, and similar problems. Therefore, an actual physical inventory count should be made at specified intervals, usually once a year. The balance on the Merchandise inventory account is then adjusted to the actual ending inventory as determined by the physical count.
A typical perpetual inventory record is presented below. The data shown in the record pertain to the journal entries on the previous page. In this perpetual record, both units and costs are maintained. Furthermore, in order to simplify the illustration, all items are assumed to have had the same cost, $2. As we noted, some perpetual records maintain only a record of units.
Although the perpetual inventory method provides management with a great deal of information, it is costly and time-consuming to maintain unless the firm has completely computerized its inventory control system. Most firms, therefore, use a periodic inventory system.
Difference between Perpetual Inventory System and Periodic inventory system
There are some key differences between the perpetual inventory system and the periodic inventory system. There is no accounting for the cost of goods sold done in a periodic system until the end of the accounting period when cost of goods sold is derived after a physical count. The beginning inventory is added to the sales and closing inventory is deducted to reach the cost of goods sold. It is easier to use manual counting in the periodic inventory system, whereas recording every single transaction as soon as it takes place is tiresome and monotonous for the bookkeepers in a perpetual system so computers and other devices are used. In a periodic inventory system, a purchase account is opened whereas in a perpetual inventory system, depending on the nature of the transactions, either a raw materials account is maintained or a merchandising account.
To conclude, these differences and many others make it clear that it is wiser and easier to use a perpetual system. A periodic system is only helpful if the business is small-scale and the inventory-count is low, or if the workers are inexperienced in terms of handling modern computers or devices. Perpetual systems are efficient, fast, easy and widely used.