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 highly detailed view of
changes in inventory with immediate reporting of the amount of inventory
in stock, and accurately reflects the level of goods on hand.
BREAKING DOWN 'Perpetual Inventory'
A perpetual inventory system is superior to the older
periodic inventory systems because it allows for immediate tracking of sales and
inventory levels
for individual items, which helps to prevent stockouts. A perpetual
inventory does not need to be adjusted manually by the company's
accountants, except to the extent it disagrees with the physical inventory count due to loss,
breakage or theft.
How Perpetual and Periodic Inventory Systems Work
A
point-of-sale system drives changes in inventory levels because
inventory is decreased, and cost of sales, an expense account, is
increased whenever a sale is made. Inventory reports are accessed online
at any time, which makes it easier to manage inventory levels and the
cash needed to purchase additional inventory. A periodic system requires
management to stop doing business and physically count the inventory
before posting any accounting entries. Businesses that sell large dollar
items, such as car dealerships and jewelry stores, must frequently
count inventory, but these firms also maintain a point-of-sale system.
The inventory counts are performed frequently to prevent theft of
assets, not to maintain inventory levels in the accounting system.
Factoring in Economic Order Quantity
Using
a perpetual inventory system makes it much easier for a company to use
the economic order quantity (EOQ) to purchase inventory. EOQ is a
formula managers use to decide when to purchase inventory, and EOQ
considers the cost to hold inventory, as well as the firm’s cost 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 inventory cost expensed is the same using
any method. The difference between the methods is the timing of when the
inventory cost is recognized and the cost of inventory sold is posted
to the cost of sales expense account. The first in, first out (FIFO)
method assumes the oldest units are sold first, while the last in, first
out (FIFO) method records the newest units as those sold first.
Businesses can simplify the inventory costing process by using a
weighted average cost, or the total inventory cost divided by the number
of units in inventory.
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