The inventory record consisting of business operation transactions such as merchandise purchases and purchase returns may be simple or complex, given the size and type of business and the resources available to the accounting department. The key is to start with a well-accounted for beginning inventory and tracking it all the way to the ending inventory. The needs of financial statement users and applicable accounting principles such as GAAP also factor into the recordation process. In fact, inventory will be one of the largest accounts on the balance sheet. The perpetual and periodic inventory systems are viable options for recordkeeping purposes, and each system has advantages and disadvantages when it comes to merchandise inventory.
Perpetual Inventory System
If a business needs a system that tracks physical inventory counts in real-time, then perpetual inventory systems are the best choice. These systems provide the total cost of inventory, inventory balances, inventory purchases, and the purchases account when decision-makers need the information the most. Perpetual systems typically involve automation when recording costs, however, this is not always the case. Accountants and bookkeepers may be responsible for recording invoices and other important data on a daily basis to meet reporting requirements of small businesses.
Periodic Inventory System
Periodic systems are just the opposite of perpetual systems. Instead of sinking resources into the real-time recording of inventory transactions, data is tracked periodically. Source documents are batched at regular intervals and are entered into the general ledger system. However, these batches are prepared to keep transactions in the right accounting period, especially when using the accrual basis of accounting. Periodic systems may be easier for smaller accounting departments to maintain, especially if there is a lack of resources or automated reporting through inventory software.
The largest difference between the two systems is the timeliness of reporting. Under the perpetual system, users can review cost of goods sold data, which can be found on the income statement, in real-time data. Purchases are recorded immediately, allowing for interim analysis of financial statements and adjustments to inventory accounts, if needed. The periodic system is less timely, but it doesn’t mean that financial records are less accurate when prepared at month-end, year-end, or end of the period. Both systems facilitate a physical count of inventory, but the perpetual system makes it easier to perform during interim periods.
The resources available to businesses and accounting departments directly impact the use of perpetual or periodic systems. Often, business owners with fewer resources opt for the periodic system, which is a temporary account, because they can allocate work proportionately when scarce resources are best utilized. Car dealerships and art galleries would be two types of businesses that would probably opt for the periodic system due to a typically small sales volume. Below are specific advantages of each inventory system or inventory accounting method.
Perpetual Inventory Method
- Real-time reporting and analytics
- Better managerial oversight and control
- Quick identification of errors and oversights
- Accurate interim financial reports
- Better control over purchasing function
Periodic Inventory Method
- Batch reporting
- Less resources required to maintain system
- Reallocation of resources during interim periods
- Less maintenance of computerized tracking
- Retain the ability to control and track inventory costs.
Recording inventory is a process that impacts financial reporting and operational effectiveness, making it important to understand the nuances of inventory management systems. Both the perpetual and periodic systems have advantages but use different approaches to valuing inventory items and inventory levels. Auditing the cost of goods sold cogs is key for validating both systems. Staff must integrate into their routines for the inventory management system to function as designed and produce an accurate inventory account showing the quantity and cost of inventory. Any discrepancies are usually accounted for during the verification process at the end of the accounting period. Accuracy is essential to all financial aspects of a business.