Perpetual and Periodic inventory
a) Describe the difference between the perpetual inventory method and the periodic inventory method.
b) Indicate for what types of inventory would each of the two inventory methods would be appropriate.
Answer:
Perpetual Inventory method:
In perpetual inventory system, companies maintained detailed records of cost of each inventory purchase and sale. These records show the inventory on hand for every item. Under perpetual inventory system, the companies determine the cost of goods sold each time a sale occurs. It gives the ture and real time inventory information.
For example, a Ford dealership has separate inventory records for each automobile, truck, and van on its lot and showroom floor. Similarly, a grocery store uses bar codes and optical scanners to keep a daily running record of every box of cereal and every jar of jelly that it buys and sells. Perpetual inventory systems are best suited to sellers of high-volume products with multiple sales outlets, since performing physical inventory counts in these types of businesses can be time-consuming and costly.
Periodic Inventory method:
In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand throughout the period. They determine the cost of goods sold only at the end of the accounting period-that is, periodically. At that point, the company takes a physical inventory count to determine the cost of goods on hand. Periodic inventory uses regular and random inventory audits to update inventory tracking information.
To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:
1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.
Example:
Some small businesses, such as car dealerships, may be able use a manual perpetual system due to their relatively low sales volume. Periodic inventory systems are best suited for businesses that sell premium-priced, low-volume products that can easily be tracked in person on a daily basis. In addition to a car dealership, art galleries and musical instrument shops are examples of businesses suited to using a periodic system.
There are significant differences between perpetual and periodic inventory method:
Accounts: Under perpetual method there are continual updates to either the general ledger or inventory journal as inventory related transactions occur. Under periodic method there is no entry for cost of goods sold account untills a physical count is done to derive the cost of goods sold.
Computer System: IT is necessary under perpetual inventory method to maintain the data in computers because it is not possible to do it manually as thousand on transactions take place in an organization every day. Whereas periodic method is simpler as the data are consolidated at the end of period and updated in records which can be done manually?
Cycle counting: It is impossible to use cycle counting under periodic method since there is no way to obtain accurate inventory counts in real time.