Having an effective inventory system is essential for companies that operate with a significant level of inventory. The objective of both perpetual and periodic inventory systems is to determine the ending inventory balance and the cost of goods sold. The key difference between perpetual and periodic inventory system is that perpetual inventory system is a method of accounting for the increase or decrease in inventory immediately following a sale or purchase whereas periodic inventory system values inventory on a periodic basis on regular intervals, generally on a monthly, quarterly or an annual basis.
CONTENTS
1. Overview and Key Difference
2. What is a Perpetual Inventory System
3. What is a Periodic Inventory System
4. Side by Side Comparison – Perpetual vs Periodic Inventory System
5. Summary
What is a Perpetual Inventory System?
A perpetual inventory system is a method of accounting for the increase or decrease in inventory immediately following a sale or purchase. This system keeps continuous track of inventory balances and provides complete details of changes in inventory through immediate reporting.
The main advantage of perpetual inventory system is that it demonstrates how much inventory is available at any given point of time and prevents stock outs. Further, since inventory levels are updated on a real time basis, the balance in the inventory account and the cost of goods sold account remains correct throughout the accounting year. This is vital since inventory is one of the most significant current assets and ratios such as the inventory turnover ratio should be calculated for working capital management decision making. At the year end, the perpetual system will compare the physical inventory balance with the accounting records to investigate whether there are any inconsistencies.
E.g. XYZ Company uses a perpetual inventory system and records each purchase and sale as it occurs for the month of April 2017
What is a Periodic Inventory System?
A periodic inventory system is an inventory system that values inventory on a periodic basis on regular intervals, generally on a monthly, quarterly or an annual basis. At the end of the period, accounting records will be compared with physical inventory balance to investigate whether there are any inconsistencies. The cost of goods sold under this method can be calculated as per below under this method.
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
This is a much less time consuming and less costly method compared to the perpetual method and is easy to conduct. However since the inventory records are only updated at the end of the period, the balance in the inventory account and the cost of goods sold account remains unchanged throughout the accounting year, which is incorrect. As a result, reliable inventory ratios cannot be calculated.
Figure 01: Inventory management is especially vital for companies that deal with large amounts of inventory
What is the difference between Perpetual and Periodic Inventory System?
Perpetual vs Periodic Inventory System |
|
| Perpetual inventory system is a method of accounting for the increase or decrease in inventory immediately following a sale or purchase. | Periodic inventory system is an inventory system that values inventory on a periodic basis on regular intervals, generally on a monthly, quarterly or an annual basis. |
| Control over Inventory | |
| Perpetual inventory system exerts better control over inventory due to frequent valuation. | Periodic inventory system is less effective as far as control over inventory is considered. |
| Cost and Time | |
| Perpetual inventory system is more costly and time consuming to implement. | Periodic inventory system is less costly and saves a significant amount of time compared to the perpetual inventory system. |
| Usage | |
| Perpetual inventory system is not commonly used in companies. | Periodic inventory system is the widely used method in companies. |
Summary – Perpetual vs Periodic Inventory System
The difference between perpetual and periodic inventory system mainly depends on the way that inventory is valued. If the company adopts a system where the inventory is valued on a continuous basis, then the company adopts a perpetual inventory system. If the stock valuation is done once in a predetermined period, then it is a periodic inventory system. Both systems have their merits and demerits and share the same end result, i.e. there is no change in the value of the inventory calculated under both method and companies are given the option to choose either method under Generally Accepted Accounting Principles (GAAP).
Reference:
1. Sharon Long. “Chapter 6 Financial 3 Ed.” LinkedIn SlideShare. N.p., 15 Jan. 2014. Web. 18 May 2017. <https://www.slideshare.net/SharonLong/ippt-chap006-30054242>.
2. “The Advantages of the Perpetual Inventory System.” Chron.com. Chron.com, 26 Oct. 2016. Web. 18 May 2017. <http://smallbusiness.chron.com/advantages-perpetual-inventory-system-3223.html>.
3. “Periodic Inventory System.” Graphic Products Info. N.p., 27 Feb. 2017. Web. 18 May 2017. <https://www.graphicproducts.com/articles/periodic-inventory-system/>.
Image Courtesy:
1. “Stock Chemical Storage Container Storage” (Public Domain) via Max Pixel