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
The perpetual inventory system provides real-time updates and maintains a steady stream of inventory data for decision-makers. Inventories are automatically updated and transferred into the company’s accounting system due to technological advancements at the point of sale. This enables managers to make decisions regarding purchasing, stocking, and selling inventory. Accurate purchase, sales, and dates can be provided to enhance the information. A periodic physical inventory count is still required, but a perpetual inventory system may reduce the frequency of physical counts.
The biggest disadvantages of using perpetual inventory systems are the cost and time constraints imposed by limited resources. Keeping an automatic inventory system current is expensive. This may prevent smaller or less-established firms from investing in the necessary technologies. Significant time is required to train and retrain personnel to update inventory.
In addition, since there are fewer physical counts of inventory, the figures recorded in the system may differ significantly from the actual warehouse’s inventory levels. A company that does not have accurate inventory data may make financial decisions based on inaccurate information.
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.