Periodic Versus Perpetual Inventory System

Not only measurement basis and cost flow assumptions have an effect on inventory valuation but also the way entity is managing the records will greatly affect inventory’s value at the year end.

Typically entity uses either of the following two systems to record changes in inventory:

  1. Periodic inventory system
  2. Perpetual inventory system



1 Periodic Inventory System

Under periodic system inventory records are maintained/updated in intervals like at the end of every week or month, accountant will sit down and determine the inventory at hand.

Under periodic inventory system, entity maintains temporary accounts like purchases, purchases returns, sales and sales return. At the end of the period the amounts in these temporary accounts are added to determine the amount of inventory available for sale. Inventory still at hand is usually found by physically counting the units. The number of units at hand are deducted from inventory available for sale to compute cost of goods sold and hence the formula:

CGS = Opening inventory + [Purchases – Purchases returns] – Closing inventory

But it must be understood that purchases account and Inventory account are two different things. If entity chooses to regularly update purchases account it does not necessarily tell how much inventory entity holds at a particular time. Under periodic system it is the inventory account which is updated at intervals. Accounting of periodic inventory system will be discussed later.

To emphasize again, physical inventory count (also called stock taking) at the period end is mandatory under periodic system. Without such count, cost of sales (or cost of goods sold) cannot be determined therefore, entities have to conduct this activity at least once a year or at every period end.

2 Perpetual Inventory System

Under perpetual system, inventory record is updated on run-time basis i.e. regularly after every transaction. As every purchase, return or sale transaction is being recorded directly in inventory account, management will know the amount of inventory at hand and cost of goods sold at any given point in time as opposed to periodic inventory system where they have to wait until the end of the period.

Under perpetual inventory system, transactions are recorded directly in inventory account and no separate or temporary accounts like purchases and purchases returns are maintained. Every purchase, purchase return, sale or sales return is recorded in inventory account as and when transaction takes place.

Unlike periodic inventory system, physical inventory count is not required as inventory record can tell the number of units at any given time.

3 Difference between Perpetual and Periodic Inventory System

Perpetual Inventory SystemPeriodic Inventory System
RecordingInventory records are updated regularlyInventory records are updated periodically
Determination of ending inventoryEnding inventory is determined on the basis of inventory recordsEnding inventory is determined on the basis of physical stock count
Stock countDone to confirm if units held are as per recordsDone to determine cost of goods sold
Control on inventoryHigh level of control as management knows the quantity at any given timeNo control as management is unaware of quantity until the end of the period
Temporary accountsNo temporary accounts are maintained. Recording is done directly in inventory accountTemporary accounts like purchases, returns and sales are maintained that are closed at the period end.
CostExpensive to maintain. Need dedicated trained personnelCheaper to maintain as it requires less work and workforce

A detailed discussion on accounting under both inventory systems will be done in another section, however, for understanding purposes lets go through a simple example that explains the difference in record keeping under both inventory systems

Example Perpetual Vs Periodic Inventory System

“Marvel” sell different products including “Deadpool”. The following information is provided about transactions that took place during the period:

Inventory at the start of the year:200 units @ $10/unit
Purchases during the year:1000 units @ $10/unit
Sales during the year:500 units @ $20/unit
Purchases return during the year:25 units @ $10/unit
Inventory at the end of the year:675 units @ $10/unit

Required: Show records of Marvel’s inventory under Perpetual and Periodic inventory system

Solution:

Periodic Inventory SystemPerpetual Inventory System
Starting inventory
Inventory account with debit balance of 2000Inventory account with debit balance of 2000
Purchase of 1000 units @ $10/unit
Debit: Inventory a/c 10,000
Credit: Trade payables a/c 10,000
Debit: Purchases a/c 10,000
Credit: Trade payables a/c 10,000
Sales of 500 units @ $20/unit
Debit: Trade Receivable a/c 10,000
Credit: Inventory a/c 10,000Debit: Cost of Goods sold a/c 5,000
Credit: Inventory a/c 5,000
(Cost of 500 units sold @ $10/unit
Debit: Trade receivable a/c 10,000
Credit: Sales a/c 10,000[No entry relating cost of goods sold]
Purchases returns of 25 units @ $10/unit
Debit: Trade payables a/c 250
Credit: Inventory a/c 250
Debit: Trade payables a/c 250
Credit: Purchases returns a/c 250
Closing Entries at the end of the period – 675 units @ $10/unit

[No entries required]

Cost of goods sold account and inventory account are already complete

CGS and Ending inventory value can be determined from the balance of respective accounts

CGS: 5000
Inventory: 2000 + 10,000 – 5000 – 250 = 6750

– Physical count will be done
– Following closing entry will be made:Debit: Inventory a/c 6750
Debit: Cost of Goods sold a/c (b/f) 5000
Debit: Purchases return a/c 250
Credit: Purchases a/c 10,000
Credit: Inventory (opening) a/c 2000Cost of Goods sold figure will be a balancing figure of Inventory’s account

It is important to note however, that it is not always the case that ending inventory value and cost of goods sold figure is same under both systems. Under certain circumstances the combination of cost flow assumptions, inventory recording system and measurement basis may change the values.