The perpetual inventory system is the process of keeping inventory records in real-time. The company updates its inventory account as and when it makes new inventory purchases.

On the other hand, the periodic system first adds the inventory in the purchases accounts, and after the inventory count, it adds the figures to the inventory account. Both systems offer some discrete advantages to users.

Let us discuss how perpetual and periodic inventory systems work and how do they differ.

 Perpetual Inventory System

The perpetual inventory system updates the inventory records after every transaction. Each time a business adds new inventory or makes sales, its inventory record is updated using automated tools and software.

The perpetual inventory system is an accurate system that does not rely on manual and physical inventory count very often. It updates inventory records in real-time and on an ongoing basis. Thus, it provides reliable accounts of inventory records.

Automation tools and computer software are prerequisites for the perpetual inventory system. Using such tools allows employees to update inventory stocks as and when they’re received in the warehouses.

On the other hand, a perpetual inventory system does not work well without automation tools. Since the system requires regular updates, manual and paper record-keeping will be hard to keep up with the changing inventory levels.

How Does a Perpetual Inventory System Work?

Unlike a periodic system, there is no purchases account for the perpetual inventory system. Thus, any changes to inventory levels are recorded directly to the inventory account.

The first step is to record inventory changes with each transaction. When items are sold or purchased for stocks, the staff will update the records. It will change the inventory levels accordingly in the journal ledger for the inventory account.

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Next, the company will update its cost of goods sold account. Any expenses incurred such as insurance and freight are also included in this step.

The company uses inventory data to update its inventory reorder points. Since the data is updated continuously, the company can adjust its purchase orders quickly as well.

The last step is to monitor changes in the inventory levels continuously. A physical count of inventory can also be performed to verify the inventory levels. Companies often perform inventory audits for more rigorous inventory system management.

 Accounting for Perpetual Inventory System

Let us consider the journal entries for the perpetual inventory system using example figures.

The journal entry in a perpetual inventory system for purchases will be:

AccountDebitCredit
Inventory$ 20,000 
Accounts Payable $ 20,000

If the company incurs any inbound expenses.

AccountDebitCredit
Inventory$ 200 
Cash / Accounts Payable $ 200

To record any returned goods, the journal entry will be:

AccountDebitCredit
Accounts Payable $ 500
Inventory$ 500 

Suppose the company makes sales of $ 5,000 that had the cost of goods sold at $ 2,000.

AccountDebitCredit
Accounts Receivable$ 5,000 
Sales $ 5,000
Cost of goods sold$ 2,000 
Inventory $ 2,000

The perpetual inventory system accounts for the inventory records immediately. However, a company should conduct a physical inventory count regularly. Any discrepancies or shortages of inventory due to theft can be adjusted with the following accounting entry.

AccountDebitCredit
Inventory Shortage$ 500 
Inventory $ 500

Periodic Inventory System

The periodic inventory system accounts for inventory with a physical count. The company maintains a purchases account for recording any inventory transactions.

Each time a company purchases new inventory, the company first updates the purchases account. Then, a physical count of inventory is required to confirm the inventory update. The figures are then shifted to the main inventory ledger account.

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The cost of goods sold (COGS) is then calculated by using the figures of beginning inventory, adding new purchases, and deducting the ending inventory figures.

The cost of goods sold formula:

COGS = Beginning inventory + New Purchases – Ending Inventory

The periodic inventory system relies on manual recording for the inventory records. Thus, it is a time-consuming and slow process as compared to the perpetual system.

Perpetual v Periodic Inventory System

Both systems offer effective inventory management systems. The perpetual system is more inclined towards the automation and use of technology to maintain inventory records in real-time. Contrarily, the periodic system considers the physical count of inventory using manual tools for more accuracy.

Let us consider some key areas in inventory management concerning perpetual and periodic systems.

Updating Accounts

The periodic system updates the purchases account for any inventory transactions. A physical count of inventory confirms the updated figures. Then, the main inventory account is updated.

The perpetual inventory system updates the cost of goods sold and subsequently the inventory account regularly. Each transaction updates the COGS and inventory accounts directly.

Recording Purchases

A periodic inventory system does not account for individual or unit counts for inventory such as raw material or work in progress accounts.

The periodic system records unit accounts separately, such as raw material sub-accounts.

Automation

The perpetual system relies on automation and computer software to update inventory records. Since the inventory account is updated with each transaction, the automation tools become a prerequisite for this system.

On the other hand, the periodic system uses the manual and physical count of inventory. It does not require sophisticated technology or automation tools.

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Calculations for the COGS

The perpetual system updates inventory and cost of goods sold accounts regularly. The COGS account is updated with each sale or purchase transaction.

The periodic system accounts for the COGS with a single transaction after a physical inventory count.

Physical Inventory Count

The periodic inventory system relies on the physical inventory count. While the perpetual system cannot perform the physical inventory count as companies with thousands of inventory transactions widely use it.

Checking for Errors and Omissions

The perpetual system uses automation tools such as barcode scanners. However, it is difficult to account for any errors or omissions used for large inventory houses.

Contrarily, the periodic system relies on the physical count of inventory. Hence, the chances of errors with inventory count are smaller in this system.

Embedding Other Systems

The perpetual system records inventory accounts through software. Thus, it can easily embed other systems such as cyclic accounting methods. Contrarily, the periodic system that does not update records regularly cannot embed support systems easily.

Perpetual v Periodic Inventory System – Pros and Cons

Both inventory management systems provide several discrete advantages and limitations.

The Perpetual Inventory System – Pros and Cons

Pros:

  • Provides accurate and real-time data access
  • Uses automation tools and software
  • Requires less manpower
  • Helps businesses to speed up the inventory management system

Cons:

  • Requires skilled manpower to manage the system
  • It may require sophisticated tools for large inventory systems
  • It can be costly for small businesses
  • It is difficult to implement in the first place

The Periodic Inventory System – Pros and Cons

Pros:

  • Easy to use and install in the first place
  • Does not require software or skilled manpower
  • Less costly to implement
  •  Suitable for small businesses with low inventory levels

Cons:

  • It is a time-consuming inventory management system
  • It is not suitable for large businesses with Changning inventory levels
  • It does not offer access to the inventory data in real-time