Lesson 28: Periodic vs. Perpetual Inventory Systems
In this lesson,
we will define periodic and perpetual inventory systems. We will talk about how
each system is used and how we calculate the cost of goods sold. We will finish
by giving examples of each system.
The two types of inventory systems that merchandising companies use are
periodic and perpetual systems. You will need to understand these inventory
systems before you start recording journal entries for merchandise operations.
The way that assets are recorded will differ significantly depending on the
type of system used.
Perpetual is the most complex inventory system as every single inventory
transaction is recorded. For example, if a piece of inventory is sold, the
company will keep track of the inventory leaving the business and the inventory
will be counted. This concept also applies when inventory is purchased as the
company will record the increase in inventory.
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Companies use their technology systems in
order to
keep track of the inventory levels and ensure they have constant visibility of
their in-house counts and activity. These systems can be fairly advanced
software programs that are often custom developed based on business needs.
In contrast, the periodic system is much simpler as when the company makes a
sale, the inventory will still leave the business when sold but it won't
necessarily be recorded at that time.
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The company will perform an inventory count at the end of the accounting period
in order to find out their counts, instead of keeping track of the count at all
times. They will still have the ability to calculate the cost of goods sold but
not after every individual transaction. This would be calculated by taking the
beginning inventory and adding any additional products purchased to come up
with the available goods. The ending inventory figure would then be deducted to
calculate the cost of goods sold for that time period which we will talk about
towards the end of this lesson.
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The graphic above explains how different types of transactions are
recorded with the periodic system versus the perpetual system. We will break
down the journal entries in more detail for each system in the next few
lessons, but for the purpose of this lesson, we will talk about how to
calculate the cost of goods sold.
The cost of goods sold is essentially the expense associated with selling the
merchandise inventory.
With the perpetual inventory system, you are recording the cost of goods sold
for each individual transaction since you are always recording the activity
when a sale is made. The periodic system does not have a running count for the
cost of goods sold, therefore it will not be recorded for each transaction
because the figures are only tracked at the end of the accounting cycle.
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We use the formula above to
calculate the cost of goods sold for a periodic inventory system.
The company can take the inventory left after sales during a given time period
and subtract that from the available goods to come up with the cost of goods
sold. That total expense of cost of goods sold can then be recorded on the
income statement.