Inventory Systems

Accounting Examples - Inventory Systems

Inventory Systems – Perpetual and Periodic

There are two systems companies use to maintain inventory records

  1. Perpetual
    The perpetual system is used by most companies especially now that computerized record-keeping systems that tie inventory and sales together are widely available.
  2. Periodic
    The periodic system is generally used by small businesses that have minimal inventories.

As shown in the examples given later, the accounts used and the accounting entries made in each system differ slightly.

The following table summarizes the differences between Perpetual vs Periodic:

Transaction or Activity Perpetual Periodic
Inventory purchases are… Debited to Inventory Debited to Purchases
Freight, purchase discounts, and returns and allowances are… Debited to Inventory Debited to individual accounts (Transportation In, Purchase Discounts, and Purchase Returns & Allowances
Cost of Goods is recorded… At the time of each sale with a debit to Cost of Goods Sold At the end of the period (see example of entry below)
Physical Inventory Count has done… At least once a year to account for breakage, errors, theft, etc. At least once a year (more often for more current information) to determine inventory levels.

The Perpetual System

Under the perpetual inventory system, an up-to-date (really an up-to-transaction) running balance is kept of the inventory on hand and of the cost of goods sold.

The example below shows the journal entries in a perpetual system for the following transactions:

  • Purchase of 1,000 units on account at $7 each = $7,000
  • Sale of 800 units on account at $13 each = $10,400
General Journal Page: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jul

5

Inventory

Accounts Payable

Purchase of 1000 units

7000 7000

6

Accounts Receivable

Sales

Cost of Goods Sold (800 x $7)

Inventory

Sale of 800 units

10400
5600
10400
5600

Using this system, there is no need to make an entry at the end of the period in order to bring the Inventory and Cost of Goods Sold accounts up to date; they already show the correct balance.

If a difference exists between the perpetual balance and the physical count balance then an adjustment should be made. In the case of a physical count that is lower than the perpetual inventory balance, a journal entry is made debiting an Inventory Over and Short account and crediting inventory. If the physical count shows more inventory on-hand that what the perpetual balance shows then Inventory is debited and Inventory Over and Short is credited.

The Periodic System

Under the periodic inventory system, physical counts of inventory are periodically conducted and then the accounts are brought up to date. The example below uses the same transactions as were used in the perpetual system example above:

  • Purchase of 1,000 units on account at $7 each = $7,000
  • Sale of 800 units on account at $13 each = $10,400
General Journal Page: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jul

5

Purchases

Accounts Payable

Purchase of 1000 units

7000 7000

6

Accounts Receivable

Sales

Sale of 800 units

10400 10400

31

Inventory (ending – 200 x $7)

Cost of Goods Sold (800 x $7)

Purchases

End of period entry

1400

5600

 

7000

As you can see, using the periodic system requires that an end-of-period entry be made to bring the Inventory and Cost of Goods accounts up to date.

It should be noted that in the examples above it was assumed that there was no beginning inventory. To determine the value of Cost of Goods Sold when there is a beginning balance, the following formula is used (using the information from the examples above and a beginning inventory of 100 units at $7 = $700):

 

Beginning Inventory

$700.00

Net purchases

7,000.00

Cost of Goods Available for Sale

7,700.00

Less:
Ending Inventory (300 units x $7)*

 

2,100.00

Cost of Goods Sold

$5,600.00

* Note that this quantity includes the 200 units purchased this month but that was not sold plus the beginning balance of 100 units.

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