Advantages and Disadvantages of Perpetual Inventory System
A perpetual inventory system automatically records and updates the inventory account whenever inventory is sold or purchased.
You can think of this as “recording as you go” because each sale or purchase is recognised immediately after it occurs. A company using a perpetual inventory system keeps a continuous record of the physical quantities in its inventory. It registers the purchase or production and use of each inventory item in detailed subsidiary records.
However, it often only records units without including costs. A continuous physical system allows management to plan and control the stock and avoid stock-outs. Many perpetual systems also incorporate costs to help inventory control and prepare periodic financial statements. Such systems are becoming much more familiar with today’s computer-based accounting systems. For example, most retail stores use “point of sale” cash register systems in which each product has a unique code, such as the UPC, that is entered into the system as each unit is sold. These items are then checked at different locations over time and reported to the company’s central database to determine how many units of each item remain in stock.
Some companies are adopting radio frequency identification technology (REID) to track inventory by attaching RFID tags. Both UPCs and RFID tags enable the retailer to immediately update its Inventory and Cost of Goods Sold accounts as each sale is made. A company maintains these reports as summary accounts, making it possible to know the inventory and the cost of goods sold.
The firm usually records purchases returns and allowances, purchases discounts taken, and freight-in in separate accounts to compute the income for the period.
What Happens at the Year End in Perpetual Inventory System
A perpetual inventory system will have the Merchandise Inventory account up-to-date at the end of the period; all that remains is to compare a physical inventory count to what is recorded. A physical inventory count necessitates a manual “stock-check” of inventory to ensure that what is recorded on the books corresponds to what is physically on hand. Discrepancies may result from improper inventory management, product shrinkage, deterioration, or expiration. When inventory or other assets disappear for no discernible reason, such as theft, this is known as shrinkage.
The company adjusts its inventory account and increases the cost of goods sold (or recognises a loss) for the difference in the two quantities. It is required to ensure that the perpetual records agree with the physical count. The gap size provides information for inventory control purposes and is another advantage of the perpetual system.
Advantages and Disadvantages of the Perpetual Inventory System
One of the biggest advantages of the perpetual inventory system is that it allows businesses to keep a more accurate and up-to-date record of their inventory levels. This can help to reduce the risk of stockouts and overstocks, as businesses can more effectively manage their inventory levels based on actual sales data. Additionally, the system can help businesses to identify trends and patterns in customer demand, which can inform purchasing and marketing decisions.
Another advantage of the perpetual inventory system is that it can save time and reduce labour costs associated with manual inventory tracking. Rather than having to count inventory regularly manually, the system automatically updates inventory levels in real-time. This can help businesses to operate more efficiently and effectively, freeing up time and resources to focus on other aspects of the business.
However, there are also some potential disadvantages to the perpetual inventory system. One potential issue is that the system relies on accurate data entry and regular updates. If there are errors in data entry or updates are not made regularly, the system may not accurately reflect inventory levels. This can lead to stockouts or overstocks, which can be costly for the business.
Another potential disadvantage of the perpetual inventory system is that it can be more expensive to implement and maintain than a periodic inventory system. Businesses must invest in specialized software and hardware to track inventory levels in real time, and ongoing costs may be associated with maintaining and updating the system.
Summary
A perpetual inventory system is a system of accounting in which the inventory account is updated continuously to reflect the latest changes in the quantity of inventory on hand. Under a perpetual inventory system, the balance in the inventory account always represents the quantity of inventory on hand. A perpetual inventory system is used in a business where the cost of goods sold (COGS) will not equal the revenue from sales.