Financial Accounting

Perpetual Inventory System in Accounting

What is Perpetual Inventory System?

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.

How are perpetual inventory records maintained?

When a company uses a perpetual inventory system, it should take a physical count at least once a year to confirm the balance in the inventory account. Any difference between the physical count and the inventory account balance results from errors in recording, shrinkage, waste, breakage, theft, and other causes.

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 purposesĀ and is another advantage of the perpetual 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.

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