What is perpetual inventory?
Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software. Perpetual Inventory provides a very detailed view of changes in inventory with an immediate report of the amount of inventory in stock and accurately reflects the level of goods in stock. In this system, a business makes no effort to maintain detailed product inventory records; rather, purchases of goods are recorded as a debit in the inventory database. The cost of goods sold includes items such as direct labor and materials costs and direct overhead costs from the factory.
A permanent inventory system differs from a periodic inventory system, a method in which a company keeps records of its inventory by regularly scheduled physical counts.
Understanding perpetual inventory
A perpetual inventory system is superior to the old periodic inventory system because it allows immediate monitoring of sales and inventory levels for individual items, which helps to avoid stock-outs. A perpetual inventory does not need to be adjusted manually by the company’s accountants, except to the extent that it does not agree with the physical count due to loss, breakage or theft .
Operation of perpetual and periodic inventory systems
A point-of-sale system causes changes in inventory levels when inventory decreases and the cost of sales, an expense account, increases each time a sale is made. Inventory reports are available online anytime, making it easier to manage inventory levels and the money required to purchase additional inventory. A periodic system requires management to stop doing business and to physically count inventory before posting accounting entries. Companies that sell large dollar items, such as car dealerships and jewelry stores, frequently have to count inventory, but these companies also maintain a point-of-sale system. Inventory counts are done frequently to avoid theft of assets, not to maintain inventory levels in the accounting system.
Key points to remember
- Perpetual inventory systems track product sales immediately through the use of point-of-sale systems.
- The perpetual inventory method does not try to maintain the count of physical products.
- Perpetual inventory systems are in contrast to periodic inventory systems, in which recurring product accounts are used for record keeping.
Taking into account the economic quantity
Using a permanent inventory system makes it much easier for a business to use the Economic Order Quantity (EOQ) to buy inventory. EOQ is a formula used by managers to decide when to buy inventory, and EOQ takes into account the cost of keeping inventory, as well as the cost of the business to order inventory.
Examples of inventory costing systems
Companies can choose from several methods to account for the cost of inventory held for sale, but the total cost of inventory expensed is the same using any method. The difference between the methods is when the cost of inventory is recognized and the cost of inventory sold is recognized in the cost of sales cost account. The first in, first out (FIFO) method assumes that the oldest units are sold first, while the last in, first out (LIFO) method records the most recent units as those sold first. Businesses can simplify the inventory costing process by using a weighted average cost or the total cost of inventory divided by the number of units in inventory.