Question

We are studying the perpetual inventory system and the periodic inventory system. Some questions: what is the difference between the two systems? What is involved with using each system? Which do you think is more common and why? How does FIFO, LIFO and Weighted Average differ?

How are they alike?

Why don't companies use specific identification more often? Why is this method rare?

Answer 1

The amount of gross profit earned by a company influenced by the amount of cost allocated between cost of goods sold and the ending inventory. Companies use either perpetual or periodic inventory systems to determine the cost of goods sold and ending inventory. Perpetual inventory system helps in keeping a detailed record of the cost of inventory on hand. Under this system, accounting records are updated after each purchase and sale transaction so that cost of inventory sold can be determined. In the case of periodic inventory system, no detailed record of the cost of inventory on hand is maintained and the accounting records are updated at the end of accounting period with the cost of inventory sold after physical count of inventory on hand. Perpetual inventory system is the most widely used system because it provides better control over inventories when compared to periodic inventory system. Companies calculate the cost of inventory sold using the First-in, first-out (FIFO), Last-in, last-out (LIFO), average cost or specific identification method. In the case of FIFO cost flow, it is assumed that the inventory purchased earliest is sold first. Under the LIFO cost flow on the other hand it is assumed that the inventory sold is from the latest purchases. Weighted-average unit cost of inventory is used to determine the cost of inventory sold under average-cost method. The only purpose of these cost flow assumptions is to determine the cost of inventory sold and ending balance of inventory. The specific identification method is not often used when compared to other methods because it is often impractical and costly proposition.