Question

What are the differences between Perpetual Inventory System and Periodic Inventory System?

Answer 1

Periodic Inventory vs. Perpetual Inventory: An Overview

Periodic and perpetual inventory systems are two contrasting accounting methods that businesses use to track the number of products they have available. Overall, the perpetual inventory system offers many benefits over the periodic system and is now used by all major retailers. However, a small business owner must still take into account whether the benefits of installing a perpetual inventory system will outweigh the additional expense.

• The periodic inventory system uses an occasional physical count to measure the level of inventory and the cost of goods sold (COGS).
• The perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold.
• Periodic inventory accounting systems are normally better suited to small businesses, while businesses with high sales volume and multiple retail outlets (like grocery stores or pharmacies) need perpetual inventory systems.

Periodic Inventory

The periodic system uses an occasional physical count to measure the level of inventory and the cost of goods sold (COGS). Merchandise purchases are recorded in the purchases account. The inventory account and the cost of goods sold account are updated at the end of a set period—this could be once a month, once a quarter, or once a year. Cost of goods sold is an important accounting metric, which, when subtracted from revenue, shows a company's gross margin.

Cost of goods sold under the periodic inventory system is calculated as follows:

Beginning Balance of Inventory + Cost of Inventory Purchases - Cost of Ending Inventory = Cost of Goods Sold

Since businesses often carry products in the thousands, performing a physical count can be difficult and time-consuming. Imagine owning an office supply store and trying to count and record every ballpoint pen in stock. Now multiply that for an office supply chain. For these reasons, many companies perform a physical count only once a quarter or even once a year. For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.

Perpetual Inventory

By contrast, the perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold. Purchases and returns are immediately recorded in the inventory account. As long as there is no theft or damage, the inventory account balance should be accurate. The cost of goods sold account is also updated continuously as each sale is made. Perpetual inventory systems use digital technology to track inventory in real time using updates sent electronically to central databases.

Key Differences

Periodic inventory accounting systems are normally better suited to small businesses due to the expense of acquiring the technology and staff to support a perpetual system. A business, such as a car dealership or art gallery, might be better suited to the periodic system due to the low sales volume and the relative ease of tracking inventory manually.

However, the lack of accurate information about the cost of goods sold or inventory balances during the periods when there has been no recent physical inventory count could hinder business decisions.

Businesses with high sales volume and multiple retail outlets (like grocery stores or pharmacies) need perpetual inventory systems. The technological aspect of the perpetual inventory system has many advantages such as the ability to more easily identify inventory-related errors. The perpetual system can show all transactions comprehensively at the individual unit level.

Under the perpetual system, managers are able to make the appropriate timing of purchases with a clear knowledge of the quantity of goods on hand at various locations. Having more accurate tracking of inventory levels also provides a better way of monitoring problems such as theft.

Differences are listed as below :

• Accounts. Under the perpetual system, there are continual updates to either the general ledger or inventory ledger as inventory-related transactions occur. Conversely, under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold.

• Computer systems. It is impossible to manually maintain the records for a perpetual inventory system, since there may be thousands of transactions at the unit level in every accounting period. Conversely, the simplicity of a periodic inventory system allows for the use of manual record keeping for very small inventories.

• Cost of goods sold. Under the perpetual system, there are continual updates to the cost of goods sold account as each sale is made. Conversely, under the periodic inventory system, the cost of goods sold is calculated in a lump sum at the end of the accounting period, by adding total purchases to the beginning inventory and subtracting ending inventory. In the latter case, this means it can be difficult to obtain a precise cost of goods sold figure prior to the end of the accounting period.

• Cycle counting. It is impossible to use cycle counting under a periodic inventory system, since there is no way to obtain accurate inventory counts in real time (which are used as a baseline for cycle counts).

• Purchases. Under the perpetual system, inventory purchases are recorded in either the raw materials inventory account or merchandise account (depending on the nature of the purchase), while there is also a unit-count entry into the individual record that is kept for each inventory item. Conversely, under a periodic inventory system, all purchases are recorded into a purchases asset account, and there are no individual inventory records to which any unit-count information could be added.

• Transaction investigations. It is nearly impossible to track through the accounting records under a periodic inventory system to determine why an inventory-related error of any kind occurred, since the information is aggregated at a very high level. Conversely, such investigations are much easier in a perpetual inventory system, where all transactions are available in detail at the individual unit level.