Periodic Inventory System Vs Perpetual Inventory System

Periodic Inventory System Vs Perpetual Inventory System is a distinctive technique used to follow the number of goods on hand. The more refined of the two is the perpetual system, however, it requires substantially more record-keeping to keep up.

The periodic system depends upon a physical count of the stock to decide the ending inventory, balance and the cost of the things sold, while the perpetual system monitors stock balances.

There are various differences between the two systems, which are as follows:

Periodic Inventory System Vs Perpetual Inventory System:

  • Computer systems: It is difficult to physically keep up the records for a perpetual inventory system since there might be a huge number of transactions at the unit level in each financial period. On the other hand, the simplicity of a periodic inventory system takes into consideration the utilization of manual record-keeping for extremely little inventories. On the other hand, the simplicity of a periodic inventory system takes into consideration the utilization of manual record-keeping for extremely little inventories.
  • Records: In Perpetual System, there are nonstop updates to either the general record or inventory record transactions happen. On the other hand, under a Periodic Inventory System, there is no expense of products sold record entry at all in a financial period until such time as there is a physical check, which is then used to determine the expense of goods sold.
  • Purchases: In Perpetual System, Inventory purchases are recorded in either the crude materials stock record (based on the idea of the purchase), while there is additionally a unit count entry into the individual record that is kept for each stock item. On the contrary, in the Perpetual Inventory, all purchases are recorded into a purchase asset account, and there are no individual stock records to which any unit-count data could be included.
  • Cost of merchandise sold: In the Perpetual system, there are persistent updates to the expense of products sold record as every deal is made. On the other hand, in the Periodic Inventory System, the expense of products sold is determined in a total amount toward the end of the bookkeeping period, by adding absolute buys to the starting stock and subtracting finishing stock. In the last case, this means it can be hard to get an exact expense of merchandise sold figures prior to the end of the bookkeeping period.

This list clarifies that the Perpetual Inventory system is immensely better than the Periodic Inventory System.

The primary situation where a periodic system may make sense is the point at which the measure of the stock is exceptionally little, and where you can outwardly review it with no specific requirement for more definite inventory records.

The Periodic system can also work admirably when the warehouse staff is inadequately prepared in the uses of a Perpetual Inventory System, since they may accidentally record stock transactions incorrectly in a Perpetual System.

Key Differences:

Periodic Inventory bookkeeping systems are more suitable for private ventures because of the cost of getting the staff and technology to help a Perpetual System. A business, for example, a vehicle vendor or art display, maybe more suited to the Periodic System because of the low sales volume and the simplicity of the following stock physically.

However, the absence of exact data about the expense of merchandise sold or stock balances during the periods when there has been no ongoing physical inventory check could prevent business choices.

Organizations with high deals volume and different retail outlets (like markets or drug stores) need perpetual inventory systems.

The innovative part of the perpetual inventory system has numerous focal points, for example, the capacity to more effectively distinguish stock related mistakes.

The perpetual system can demonstrate all transactions thoroughly at the individual unit level. In the perpetual system, directors can make the proper planning of purchasing with reasonable information on the number of products on hand in different areas.

Having a progressively precise following of inventory dimensions additionally gives a better method for checking issues, for example, burglary.

Difference Between Inventories and Fixed Assets

Introduction

Business is the asset of every businessman and businesswoman, and the assets of the business are the fixed assets and inventory. At the start of the business studies, most students are confused about fixed assets and inventories. 

In actual business, there are clear differences in both of the terminologies.  Here are the definitions and the differences between the inventories and fixed assets.

Fixed Assets

Assets have two big types in the business world, fixed assets, and current assets. Fixed assets are assets that cannot easily convert into cash.  It is used for more than more years.

Fixed assets can be tangible and intangible. Fixed tangible assets are those assets that are touchable and seeable easily like building, furniture, etc. The non-tangible fixed assets are those which cannot be touched like brand and trademark. 

Fixed assets can also be defined as those assets which can and cannot work in the day to day business activates.  The items included in the fixed assets are buildings, machines, cars and trucks, furniture etc.

Inventories

Inventory is also called stock which holds in business to sale in the one year period. Inventory is the current asset because it is expected to convert into cash within a year.

There is a different type of Inventories in different business. The raw material is the inventory of the manufacturing company.  Work in progress is also included in the inventory.

Finished goods that are in stock and different components purchased for supplies are the parts of inventory or it is itself the inventories. Too little inventory is also not good because you will lose the profit when demand is so high, and you don’t have inventory or stock.

Inventory targets the profits of the company, the higher the inventory, the higher will be the profit. Inventory can manage the cash flow too because it is easily converted into cash.

Fixed assets Vs Inventories

There are few comparisons which differentiate inventories and fixed assets. 

  • Period of Time

Fixed assets are for a long period of time while inventory is for a short period of time. Because keeping inventory for a long period of time is risky and not profitable.

  • Items and Types of fixed assists and inventories

Fixed Assets and inventories have different items and types. Fixed assets are tangible and non-tangible assets which can be touched or untouched like machinery, cars, trucks, buildings, name of brand and trademark, etc. while inventories are totally different. Inventories are the goods which are in stock ready for sale and it can be a raw material, or the supplies used for goods.

  • Risk Factor

Risk is an important factor in business. Risk is always increasing when keeping inventory for a long period of time or more than one year. Because it is important to sell out all the stock in the years and make new and fresh inventories. Hence, fixed assets are not profitable when it is kept for less than a year. Fixed assets like building, machinery mostly used for the whole life of the same business.

  • Depreciation

Depreciation is the most important part of the fixed assets. Fixed assets are depreciated on annual basis. The cost of deprecation is also calculated in every business. Buildings, machinery, cars, and other fixed assets except land are depreciated annually.  Hence, inventory is not depreciated, and it also not have any depreciation cost.

What Is Periodic Inventory System?

Periodic Inventory System records stock buys at explicit time intervals, an ongoing record of inventory in stock sold to clients. It’s actually what it sounds like.

A periodic system records stock acquisition and deals periodically all through a bookkeeping period. Buy and deal records are normally spared until a particular time interim and input in deals.

Example of Periodic Inventory System:

For instance, a retailer may record deals and buys each Saturday. For about fourteen days the invoices will pile up and afterward enter into the system or refreshed at regular intervals.

This is generally accomplished for comfort. It’s hard to keep up and exact record of stock each and every day continuously if somebody is doing it physically.

This can be a very time taking task. That is the reason they just do it occasionally.

Periodic Inventory System Disadvantages:

The fundamental issue with a periodic system is, it does not give constant information to administrators. Nobody realizes how much stock is on hand by anytime as they are continually working on old information from the last update.

The only time a period stock system is genuinely updated is at the end of a bookkeeping period. Despite the fact that a periodic inventory saves input time, it can really cost the organization cash.

That is the reason practically all modern bookkeeping systems utilize a perpetual inventory system that tracks and updates stock buys, deals, and cost of products sold continuously.

When a bit of inventory is sold, it is expelled from the stock record in the general ledger. In this way, directors can have exceptional data to base their purchasing and selling choices on.

LIFO:

The main difficulty with a periodic inventory system is deciding the estimation of inventory. The stock bookkeeping technique regularly utilized with a periodic system is Last In/First Out (LIFO).

Under LIFO it is expected that the latest buys are the ones that are first utilized. The estimation of the ending stock depends on the most seasoned expenses for the materials still in stock.

Break Down Periodic Inventory:

Under the periodic system, an organization won’t realize its unit stock dimensions nor COGS until the physical count process is finished.

This framework might be adequate for a business with a low number of SKUs in a moderate moving business sector, however, for all others, the perpetual inventory system is viewed as unrivaled for the accompanying principle reasons:

  1. the perpetual system persistently refreshes the stock asset record in an organization’s database framework, giving the administration a quick perspective on stock; the intermittent framework is time taking and can deliver stale numbers that are less valuable to the executives.
  2. the perpetual system keeps refreshed COGS as developments of stock happen; the occasional system can’t give precise COGS figures between counting periods.
  3. the perpetual system tracks single stock so that if there are imperfect things, for instance, the issue can rapidly be identified; the periodic system would probably not take into consideration brief goals.
  4. the perpetual system is tech-based and information can be backed up, sorted out, and controlled to create enlightening reports; the periodic system is manual and inclined towards human mistake, and information can be lost or misplaced.

Why don’t we depreciate inventory?

Introduction

No one can deny the importance of assets in the business world. Because assets create profit and also grow the business from low to a high level.

Assets have a different type but the most important are current and fixed assets. Fixed assets work for a long period of time and current assets work in day to day business operations.

Inventory

 Inventory included in the current asset works for a short period of time. Inventory refers to the finish and final goods. Inventory is the raw material and also goods that work in process.

Inventory works when the demand for the product is increased with the rapid speed and goods are not produced with that speed to handle the increasing demand for the goods.  Hence, Inventory is the stock that can easily supply to handle the increasing demand for the goods.

Deprecation

Depreciation is the wear and tear of the assets. But all the assets are not depreciated. There is the specific cost of the goods calculated annually for which goods are depreciated. This cost is called depreciation cost. 

Why Inventories Are Not Depreciated?

There are some assets that are not depreciated and inventory is one among these assets. Many people ask the question that why inventories are not depreciated.

There are a few reasons as under which explained why inventories are not deprecated.

Inventions Are Current Assets

Inventory is part of the current assets. Current assets are for a short period of time i.e. less than a year. All the current assets which have less than a year or maximum a year time interval are not depreciated.

Inventories Are the Raw Material

Inventories are the raw material and raw material is not deprecated. The raw material is even appreciated due to many reasons like a flood, increasing the cost of material, devaluation of the currency, increasing prices of the goods with the passage of time and many more reasons. That is why inventory is never deprecated.

Inventories are Finished Goods, Ready to Sale

Inventories are the finished goods which are ready for sale. These inventories cannot sell any time when the demand for goods increases. Deprecation is not applied for those inventories or goods which are ready for sale and can be sale any time.

Inventories are the Work in Process      

Inventories are the work in process. The work in process is actually passed from the raw material to get the final shape of the product.

So, those products which are in process deprecation cost do not apply to those products. Because in future the products which are work in the process will increase the cost of the product instead to decrease.

Inventory Has No Wear and Tear

Deprecation is the cost of the wear and tear of the products. Hence, inventory is the raw material and the work in process so there is no wear and tear of the inventory. That is why inventory has no deprecation cost and it is also not depreciated.

Inventory Cost is Increasing Day By Day Due to Devaluation of Money

The cost of inventory is increasing day by day due to the devaluation of the currency. When a currency has devalued the prices of the goods are increased.

Hence, all these goods in which prices are increasing instead of decreasing, depreciation are not applied to those products.

Conclusion

Inventory is one of the assets which increase the profit of the company during the shortage of the product or increase demand for the product. Hence, inventory is appreciated instead of depreciated.

How do Inventories Present in Statement of Cash Flow?

Introduction:

Inventory or stock-in-trade is the goods or commodities held by an entity for the purpose of resale or trade. At the end of an accounting year, companies usually have unsold goods in their warehouses which are referred to as closing inventory or closing stock-in-trade.

This item is not reported in the income statement, but it is recorded in the statement of financial position, and also has effects on the statement of cash flow. In this article, we are going to talk about how changes in inventory affect the statement of cash flow.

Motive of Statement of Cash flow:

The cash flow statement is annually prepared and is audited along with the income statement and statement of financial position. It shows the cash inflow and outflow of the company for a specific time period (a month, a quarter or a year).

The main purpose of this statement is for the shareholders and the public to understand how liquid the company is and how its cash or cash equivalents are managed throughout the year.

Format of Statement of Cash flow:

According to any of the applicable financial reporting framework around the world, a cash flow statement is to be formatted and classified in the following three categories respectively:

  • Operating Activities
  • Investing Activities
  • Financing Activities

The total cash flow from each activity are summed up and then reconciled with the closing cash or cash-equivalent balance.

Hence, the cash flow statement summarizes and identifies each cash transaction that has occurred during the year.

The change or movement of inventories during the period is normally present in the statement of cash flow under the operating activities section and under the changing in the working capital categories. We will discuss in detail below how it is affected the statement of cash flow.

And before we start discussing on how it is present it is present in the statement of cash flow, let us discuss about the accounting treatment of inventories first.

Accounting treatment of closing inventory:

The closing inventory is reported through the cost of goods sold in the income statement. The cost of goods sold is calculated as follows:

Opening Inventory               xx

Add: Purchases                     xx

Less: Closing inventory       (xx)

Cost of Sales                          xxx

As we can see, the closing inventory is reducing the amount of cost of sales and as a result increasing the net profit.

However, in the balance sheet, closing inventory is reported as a current asset.

Effect on Statement of Cash flow:

Any changes in stock in trade are adjusted in the operating activities section of the cash flow statement. The operating activities section reports all the principal business activities that occurred during the year and accounts for any working capital changes.

Any increase in stock-in-trade is subtracted from the profit or loss before tax whereas any decrease in stock-in-trade is added to the profit or loss before tax for the year in order to get the net amount of cash flow from operating activities. I’ll explain the logic through the following example:

Assume that a business was commenced this year with no cash and received $100,000 against sales made during the year. The cost of goods sold for such sales was $50,000.

Even though the purchases made during the year were worth $100,000 the business only sold the stock of $50,000 resulting in a closing inventory of $50,000. So, the net profit for the year would be $50,000 and the balance summary becomes as follows:

  Closing Opening
Cash balance
Stock in trade $50,000

Hence, we conclude that in order to obtain the cash balance the increase in stock in trade shall be deducted from the net profit since only $50,000 were charged to the income statement even though $100,000 were spent on purchases.

Let’s take this example further to the next year and assume that the business did not make any purchases but used last year’s inventory.

Cash sales for the year amounted to $100,000 and the cost of goods sold was $50,000. So, the net profit for the year would be $50,000 and the balance summary would be as follows:

  Closing Opening
Cash balance $100,000
Stock in trade $50,000

Thus, we conclude that, decrease in stock in trade would be added in the net profit in order to get the net cash flow because the amount of stock in trade charged to the income statement was paid in the preceding year.

Hence, the net cash balance would be the amount received against the sales of $100,000 instead of net profit of $50,000.

Audit procedures for testing inventories

Overview:

There are many audit procedures and approach that auditors could use to perform during their detail testing the inventories that report by management in the financial statements. Before to go to detail on the procedure, it is good to start with the overview of inventories first.

Inventories are the current assets that reporting in the entity balance sheet at the end of the reporting period. These inventories could ranks from trade inventories to non-inventories.

Non-trading inventories are the inventories that entity make or purchases for their own use and normally have a useful life for less than one year.

Trading inventories are the inventories that make or purchase for trading. These include raw material that entity purchases from suppliers, work in progress and finish goods that are ready for sales or delivery.

Inventories are normally considered as significant accounts per audit perspective. This is because inventory normally has large amounts at the reporting date as well as nature is sensitive compared to other assets. The fraud over inventories is likely to happen by staff or managements due to this sensitivity.

In this article, we will write about the auditor procedure for testing inventories in the entity’s financial statements. We will also explain the assertion that auditors should confirm, common risks related to inventories, and the procedures to address the assertion and risks.

Understanding Control:

As the best audit practice and as required by the standard, the auditor should performance an understanding of key control over financial reporting. And if we want to perform an audit of inventories in entity’s financial statements, we should start by trying to obtain as much as information related to the control of over inventories.

It could be rank from understanding the system that the entity uses to control its inventories, key people who managing, and how inventories are physically controlled.

Others key control including reviewing and delivering inventories should also clearly confirm. Key authorization over inventories also importance for auditors and it is subject for review.

Once auditor understood these key controls, auditors will be able to tailor the audit procedure effetely for them to address the risks at less effort.

Assertions:

  • Existing: Auditor should confirm this assertion whether the inventories that recording in the entity balance sheet really exists.
  • Valuation: Value of inventory is really important especially the slow-moving and high tech inventories.
  • Ownership: It is important to review the ownership of inventories that records in the financial statements and store in the entity’s warehouse.
  • Accuracy: Check whether inventories amount and value are correctly calculated in the financial statements.
  • Cut off: Whether inventories records are properly cut off. Example, inventories that should be recorded in 2016 were recorded in 2016 and the inventories that should be recorded in 2017 were recorded in 2017.
  • Occurrence: Auditor might want to test whether inventories that purchases and sold during the year have really occurred.
  • Completeness: Test whether inventories are completely recording in the list as well as financial statements.
  • Right and Obligation: Check whether the entity has the right to manage the inventories.

Common Risks Related Inventories:

Fraud over the inventories that committed by entity staff frequently happens to most of the entity’s inventories, based on my experiences.

It was sometime committed by normal staff and sometimes it is committed by the management of the entity and sometimes the collusion among the key players. Auditors should also consider the review and assess the fraud risks related to this area.

Understand of inventories are the common key concerning areas for auditors and they have to make sure that the risks are address in the procedures.

Audit Procedures:

Confirm existing of inventories:

Inventories are the accounting balance in the balance sheet. And if auditor decided to perform their review on the entity’s inventories, existence is one of the financial statements assertions that auditor needs to confirm.

Physical verification is one of the procedure that auditor use to confirm this assertion. The auditor may consider to join the observation of a client’s year-end inventories count or perform their own sampling.

Physical verification is not only helping the auditor to confirm the existence of inventories that report in the balance sheet, but it also helps auditors to assess the condition of inventories, physical controls and asses the procedures that client use to perform their year-end counts.

When auditor assesses the counting procedures that perform by its client, auditors should focus on three main areas including the procedures before the count, during the count, and the procedure after the count.

These procedures are really important for the client to ensure that any error to the quantity of inventories report is identified and reflected financial statements.

Review ownership:

Inventories are the current assets and entity could recognize the inventories in its financial statements only if those inventories meet the definition provided by IFRS Conceptual Framework.

Normally, auditor review the ownership (Right and Obligation) of the entity over the inventories by reviewing the Contracts, Quotation, Invoices, and Delivery Noted. Term and Condition in the contract are very important for ownership verification.

Assess the value of inventories:

IAS 2 is the current standard that issued by IFRS for dealing with inventories measurement, recognition, and disclosure and so on. Measurement of inventories should be at the lowest of cost and net realizable value.

Normally, the cost of inventories including cost of acquisition, cost of conversion, and others related cost that bring inventories into their present location and condition. Auditor should:

  • Review the costing method and accounting policy that uses by the entity to value its inventories.
  • For raw material, review the cost of purchasing and other related delivery costs.
  • For WIP and finish goods, review the cost of conversion that brings raw material into WIP and Finishes goods.
  • Review if there any other costs that not related to inventories or not allow by IAS 2 are included in the cost of inventories.

The LIFO method is not allowed by IAS 2.

Review cut off:

Cut off is very important because if there is any problem in cut off, there will be a problem in the total amount of inventories at the reporting date. In this point, the auditor should review and confirm inventories are records in the period that they are belonging to.

Goods received noted at the client’s warehouse and goods delivery noted that provided by client’s suppliers are the important documents to verify cut off.

Shipping documents and any others form that prove the delivery and receive date are importance for auditors to review cut off.

Analytical review:

The auditor should perform an analytical review on inventories to identify the unreasonable event or transactions related to inventories including the slow-moving, unreasonable low & high amount of inventories, and unreasonable adjustments.

This analytical review will help the auditor to have a better picture to perform the additional review to that the risks related to inventories more efficiently.

Reviewing the trend of sales revenues against the cost of goods sold as well as purchases might help auditors get a better understanding of what happens to the inventories during the period and where to test it.

Others Procedure to consider:

  • Review Consign Inventories: Some inventories that store in the entity warehouse maybe not belong to the entity. And some inventories that including in the inventories list, as well as financial statements, are not in the entity warehouse. These types of inventories called consigned inventories. Auditors should also review this.
  • Inventories in transit. Inventories in transit are sometimes large and sometimes small amount.
  • Review inventories are written off during the year