2 2 Perpetual v. Periodic Inventory Systems Financial and Managerial Accounting

The time commitment to train and retrain staff to update inventory is considerable. In addition, since there are fewer physical counts of inventory, the figures recorded in the system may be drastically different from inventory levels in the actual warehouse. A company may not have correct inventory stock and could make financial decisions based on incorrect data. At the end of the period, a perpetual inventory system will have the Merchandise Inventory account up-to-date; the only thing left to do is to compare a physical count of inventory to what is on the books. A physical inventory count requires companies to do a manual “stock-check” of inventory to make sure what they have recorded on the books matches what they physically have in stock. Differences could occur due to mismanagement, shrinkage, damage, or outdated merchandise.

• A periodic system does allow a company to control costs by keeping track of the individual inventory costs as they are incurred.
• An invoice is generated for the customer and records of inventory levels are automatically decreased.
• The second should record the cost of goods sold by debiting the cost of goods sold account and crediting the inventories account.
• The software recalculates the unit cost after every purchase, showing the current balance of units in stock and the average of their prices.
• At the end of the period, a perpetual inventory system will have the Merchandise Inventory account up-to-date; the only thing left to do is to compare a physical count of inventory to what is on the books.

Overall, the perpetual inventory system is superior because it tracks all data and transactions. However, with a perpetual system, you need to make more decisions to use it successfully. Companies make any necessary adjustments from purchasing goods to a general ledger contra account. A contra account is meant to be opposite from the general ledger because it offsets the balance in their related account and appears in the financial statements.

Perpetual Journal Entries

However, perpetual systems require your staff to perform regular recordkeeping. For example, in a periodic system, when you receive a new pallet of goods, you may not count them and enter them into stock until the next physical count. In a perpetual system, you immediately enter the new pallet in the software so the system can track its life in your business.

Shrinkage is a term

used when inventory or other assets disappear without an

identifiable reason, such as theft. For a perpetual inventory

system, the adjusting entry to show this difference follows. This

example assumes that the merchandise inventory is overstated in the

accounting records and needs to be adjusted downward to reflect the

actual value on hand. Perpetual inventory systems are designed to maintain updated figures for inventory as a whole as well as for individual items. Separate subsidiary ledger accounts show the balance for each type of inventory so that company officials can know the size, cost, and composition of the merchandise. A periodic system is cheaper to operate because no attempt is made to monitor inventory balances (in total or individually) until financial statements are to be prepared.

Advantages and Disadvantages of the Perpetual Inventory System

The company’s inventory is not physically affected by the method selected. The below table shows the final inventory balance for the camping gear at the end of the accounting period. The retailer purchases 200 camping bags for $50 each and starts the accounting period with 100 bags in stock. During the accounting period, it sells 150 bags for a total of $12,000. Where we are not keeping perpetual records of our inventories, it is inappropriate to adjust the “inventory” account (since there are no continuous, accurate records of our inventory levels).

Record your total discount in your journal by combining the inventory sales and the sales discount entries. According to Relph, “When an organization grows such that all items require a SKU (e.g. internet sales), then it is highly likely this business will need to move towards a perpetual inventory system.” You can also use a periodic system if you have a handle on your supply chain process, sell a few products and have eyes on your goods as they flow through your business. A periodic system isn’t useful if you need to investigate to identify missing inventory or unbalanced numbers. This issue will arise as your operation grows and becomes more challenging to control positively. A small company with a low number of SKUs would use a periodic system when they aren’t concerned about scaling their business over time.

Periodic Inventory System: Is It the Right Choice?

A periodic system does allow a company to control costs by keeping track of the individual inventory costs as they are incurred. A periodic inventory system only updates the ending inventory balance in the general ledger when a physical inventory count is conducted. Since physical inventory counts are time-consuming, few companies do them more than once a quarter or year. In the meantime, https://turbo-tax.org/path-act-tax-related-provisions/ the inventory account in the accounting system continues to show the cost of the inventory that was recorded as of the last physical inventory count. The biggest disadvantages of using the perpetual inventory systems arise from the resource constraints for cost and time. This may prohibit smaller or less established companies from investing in the required technologies.

It can be cumbersome and time consuming as it requires you to manually count and record your inventory. And because this is a physical count, there is a higher chance of error. It also isn’t as updated as a perpetual system, as it is done at periodic intervals rather than continuously.