Question

What are the two methods to record purchases of inventory

Answer 1

Two methods of recording purchase of inventory are:

1. Perpetual inventory system

Under this system stock is continuously recorded. All the purchases/ receipts, issue of raw materials, final goods, work in progress etc. is recorded. Records are updated on daily basis.

Physical stock count is done a couple of times in a year. As a result the accuracy of the system can be checked. In perpetual inventory system, the value of the closing stock is calculated as per below formula:

Opening Stock (known) + Purchases during the year (known) – COGS (known) = Closing Stock (Balancing Figure)

Advantages of a Perpetual Inventory System:

• Daily information about the quantity and valuation of closing stock is available which helps management in decisions about production and distribution
• Over-investment in stock is avoided and thus reducing the carrying cost

2. Periodic inventory system

Under this system, physical count of the inventory is done at any given date and the inventory is verified. The closing stock can be determined by physically counting the inventory (numbers, weight etc.). It is generally done near the accounting year end.

The closing stock is valued using one of the following methods: LIFO, FIFO, Average Cost etc. the value of the closing stock is calculated as per below formula:

Opening Stock (known) + Purchases during the year (known) – Closing Stock (counted) = COGS (balancing figure)

Disadvantages of the Periodic Inventory System:

• Normal manufacturing and other activities are halted during stock counting thus resulting in losses
• Abnormal losses cannot be accounted