Two Types of Inventory Systems – Perpetual and Periodic Inventory System



INVENTORY SYSTEMS

Merchandise inventory is the key factor in determining cost of sales. Because merchandise inventory represents goods available for sale, there must be a method of determining both the quantity and the cost of these goods. There are two systems available to merchandising entities to record events related to merchandise inventory: the perpetual inventory system and the periodic inventory system.

PERPETUAL INVENTORY SYSTEM

The perpetual inventory system is an alternative to the periodic inventory system. Under the perpetual inventory system, the inventory account is continuously Perpetually updating the inventory account requires that at the time of purchase, merchandise acquisitions be recorded as debits to the inventory account. At the time of sale, the cost of sales is determined and recorded by a debit to the cost of sales account and credit to the inventory account. With a perpetual inventory system, both the inventory and cost of sales account receive entries throughout the accounting period.

Many merchandising entities are now using the perpetual inventory system with point-of-sale equipment. Computers decreased in prices.  These powerful machines have dramatically reduced the time required to manage inventory. Supermarkets and department stores use point-of-sale scanners built into checkout counters to collect transactional data for the cash register and to update their perpetual inventory system. In the absence of point-of-sale scanners, the perpetual inventory is more advisable for firms the sell low-value, high priced goods such as motor vehicles, jewelry and furniture.

When a company uses the perpetual inventory system, the ending inventory should reconcile with actual physical account at the end of the period assuming, that no theft, spoilage, or error has occurred. Even if there is a little chance for or suspicion of inventory discrepancy, most entities make a physical count. At that time, the account is adjusted for any inaccuracies discovered. The count provides an independent check on the amount inventory that should be reported at the of the period.




The features of the Perpetual System:

  1. Merchandise purchased for resale or purchase of raw materials for production are debited to the "Merchandise Inventory" account rather than to Purchases account.
  2. Freight-in, purchase returns and allowances, and purchase discounts are also recorded in "Merchandise Inventory".
  3. After each sale, Cost of goods sold is recorded by debiting the account Cost of Goods Sold, and crediting Merchandise Inventory.
  4. Merchandise Inventory is a control account supported by a subsidiary ledger of itemized records of inventory. The subsidiary ledger shows the quantity and cost of each type of inventory that is on hand.

PERIODIC INVENTORY SYSTEM

The periodic inventory system is primarily used in businesses that sell relatively inexpensive goods and that are not yet using computerized scanning system (or bar code system) to analyze goods sold. Periodic inventory counts are made to determine the amount of inventory still on hand, and the amount of inventory that is sold.

A characteristic of the periodic inventory system is that no entries are made to the inventory account as the merchandise bought and sold. When goods are purchased, a separate set of accounts­­­­­—purchases, purchases discounts, purchases returns and allowances, and transportation in—is used to accumulate information on the net cost of the purchases. Only at the end of the period, when the inventory is counted, will entries be made to the inventory account to establish its proper balance.

Accounts Used in the Periodic Inventory System:

  1. Purchases - account used to record the purchase of merchandise inventory.
  2. Purchase discounts - account used to record cash discounts availed by the entity.
  3. Freight in or Transportation in - account used to record cost of delivery shouldered by the entity to acquire the goods.
  4. Purchase Returns - account used to record returns of merchandise to suppliers.
  5. Purchase discount lost - account used to record discounts that were not taken under the net method.

PERIODIC and PERPETUAL INVENTORY SYSTEM COMPARED

This will demonstrate the entries typically used with the periodic system, contrasted to the entries used with the perpetual inventory system. Assume that the beginning inventory for the year is P250, 000.



 

Journal Entries for the Periodic Inventory System

Transaction #1: Sold merchandise on account costing P8, 000 for P10, 000; terms were 2/10, n/30.

periodic inventory system

Transaction #2: Customer returned merchandise costing P400 that had been sold on account for P500 (part of the P10, 000) sale.

periodic inventory systemTransaction #3: Received payment from customer for merchandise sold above [cash discount taken: (P10, 000 sale P500 return) x2% discount = P190].

periodic inventory systemTransaction #4: Purchased on account merchandise for resale for P6, 000; terms were 2/10, n/30 (purchases recorded at invoice price).

perpetual vs periodic

Transaction #5: Paid P200 freight on the P6, 000 purchase; terms were FOB shipping point, freight collect.

periodic vs perpetual inventory systemTransaction #6: Return merchandise costing P300 (part of the P6, 000 purchase).

periodic vs perpetualTransaction #7: Paid for merchandise purchased, refer to no. 4 [cash discount taken: (P6, 000 purchase- P300 return) x2% discount = P114].

periodic vs perpetualTo transfer the beginning inventory balance to the income summary account (part of the closing entries under the periodic system.)

periodic vs perpetualTo record the ending inventory balance (Part of the closing entries under the periodic system)

perpetual vs periodicTo adjust the ending inventory balance for the shrinkage during the year.

*Shrinkage already affected in the previous entry.

Journal Entries for the Perpetual Inventory System

Transaction #1: Sold merchandise on account costing P8, 000 for P10, 000; terms were 2/10, n/30.

perpetual vs periodic

Transaction #2: Customer returned merchandise costing P400 that had been sold on account for P500 (part of the P10, 000) sale.

perpetual vs periodicperiodic vs perpetual inventory systemTransaction #3: Received payment from customer for merchandise sold above [cash discount taken: (P10, 000 sale P500 return) x2% discount = P190].

periodic vs perpetualTransaction #4: Purchased on account merchandise for resale for P6, 000; terms were 2/10, n/30 (purchases recorded at invoice price).

periodic vs perpetualTransaction #5: Paid P200 freight on the P6, 000 purchase; terms were FOB shipping point, freight collect.

peridic vs perpetualTransaction #6: Return merchandise costing P300 (part of the P6, 000 purchase).

periodic vs perpetual

Transaction #7: Paid for merchandise purchased, refer to no. 4 [cash discount taken: (P6, 000 purchase- P300 return) x2% discount = P114].

perpetual vs periodicTo transfer the beginning inventory balance to the income summary account (part of the closing entries under the periodic system.)
No Entry
To record the ending inventory balance (Part of the closing entries under the periodic system)
No Entry
To adjust the ending perpetual inventory balance for the shrinkage during the year.

periodic vs perpetual



Assuming the transactions (nos.1 to 7) were the only transactions for the entire year, the balance in the inventory account at the year-end under the periodic inventory system is P250, 000 (beginning inventory). The year-end balance in the inventory account under the perpetual inventory system is P231, 860.

Under the perpetual system, the inventory account is increased by purchases, transportation in, and sales returns and is decreased by the cost of sales, purchases returns and allowances, and purchases discount.

At year-end, the physical inventory is taken, and it revealed that the actual inventory on hand is P231, 500. The year-end journal entries (nos.8 to 10) are then made to bring the inventory account balance into agreement with the amount of the physical inventory. When posted to the general ledger, both the periodic and perpetual inventory systems result in the same ending inventory amount, P231, 500.

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