INVENTORY SYSTEM Records pertaining to quantity and value of inventory in hand can be maintained according to any of the following

two system : (1) Periodic Inventory System (2) Perpetual Inventory System

PERIODIC INVENTORY SYSTEM Periodic inventory is a system of inventory in which updates are made on a periodic basis. In Periodic Inventory System no effort is made to keep up-to-date records of either the inventory or the cost of goods sold. Instead, these amounts are determined only periodically-usually at the end of each year. The periodic inventory system only updates the ending inventory balance when you conduct a physical inventory count. Since physical inventory counts are time-consuming, few companies do them more than once a quarter or year. This system does not provide the information regarding the quantity and value of materials in hand on a continuous basis. As the The foundation of the periodic inventory system is the taking of a complete physical inventory at year-end. This physical count determines the amount of inventory appearing in the balance sheet. The cost of goods sold for the entire year then is determined by a Short Computation. The cost of material used is obtained by adding the total value of the inventory purchased during the period to the value of inventory in hand in the beginning of the period and subtracting the value of inventory at the end of the period. The calculation of the cost of goods sold under the periodic inventory system is: Beginning inventory + Purchases = Cost of goods available for sale Cost of goods available for sale Ending inventory = Cost of goods sold For example, the Alaskan Barrel Company (ABC) has beginning inventory of Rs.100,000, has paid Rs.170,000 for purchases, and its physical inventory count reveals an ending inventory cost of Rs.80,000. The calculation of its cost of material used: Rs.100,000 Beginning inventory + Rs.170,000 Purchases Rs.80,000 Ending inventory = Rs.190,000 Cost of material used

The periodic inventory system is most useful for smaller businesses that maintain minimal amounts of inventory. For them, a physical inventory count is easy to

complete, and they can estimate reasonably accurate cost of goods sold figures for interim periods. However, there are also several problems with the system: It does not yield any information about the cost of goods sold or ending inventory balances during interim periods when there has been no physical inventory count. You must estimate the cost of goods sold during interim periods, which will likely result in a significant adjustment to the actual cost of goods whenever you eventually complete a physical inventory count. There is no way to adjust for obsolete inventory or scrap losses during interim periods, so there tends to be a significant (and expensive) adjustment for these issues when a physical inventory count is eventually completed.

A more up-to-date and accurate alternative to the periodic inventory system is the perpetual inventory system.

PERPETUAL INVENTORY SYSTEM Perpetual inventory or continuous inventory describes systems of inventory where information on inventory quantity and availability is updated on a continuous basis as a function of doing business. Generally this is accomplished by connecting the inventory system with order entry and in retail the point of sale system. In this case, book inventory would be exactly the same as, or almost the same, as the real inventory. It is also known as Automatic Inventory System. The basic object of this system is to make available details about the quantity and value of stock of each item at all times. The system thus provides a rigid control over stock of materials as physical stock can regularly be verified with the stock records kept in stores land cost office. Perpetual inventory system requires : (a) Maintenance of both bin cards as well as stores ledger on perpetual inventory system. Bin cards provides quantitative perpetual inventory while stores ledger provides quantitative cum-value perpetual inventory. (b) Adoption of continuous stock taking. Thus, a perpetual inventory system has the advantages of both providing up-to-date inventory balance information, and requiring a reduced level of physical inventory counts. However, the calculated inventory levels derived by a perpetual inventory system may gradually diverge from actual inventory levels, due to unrecorded transactions or theft, so you should periodically compare book balances to actual onhand quantities with cycle counting.

Difference between PERIODIC INVENTORY SYSTEM AND PERPETUAL INVENTORY SYSTEM There are a number of significant differences between the periodic and perpetual inventory systems. As you may recall, the periodic system relies upon an occasional physical count of the inventory to determine the ending inventory balance and the cost of goods sold, while the perpetual system keeps continual track of inventory balances. The key differences between the two systems are: Accounts: Under the perpetual system, there are continual updates to either the general ledger or inventory journal as inventory-related transactions occur. Conversely, under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold. Computer systems: It is impossible to manually maintain the records for a perpetual inventory system, since there may be thousands of transactions at the unit level in every accounting period. Conversely, the simplicity of a periodic inventory system allows for the use of manual record keeping for very small inventories. Cost of goods sold: Under the perpetual system, there are continual updates to the cost of goods sold account as each sale is made. Conversely, under the periodic inventory system, the cost of goods sold is calculated in a lump sum at the end of the reporting period, by adding total purchases to the beginning inventory and subtracting ending inventory. Cycle counting: It is impossible to use cycle counting under a periodic inventory system, since there is no way to obtain accurate inventory counts in real time (which are used as a baseline for cycle counts). Purchases: Under the perpetual system, inventory purchases are recorded in either the raw materials inventory account or merchandise account (depending on the nature of the purchase), while there is also a unit-count entry into the individual record that is kept for each inventory item. Conversely, under a periodic inventory system, all purchases are recorded into a purchases asset account, and there are no individual inventory records to which any unit-count information could be added. Transaction investigations: It is nearly impossible to track through the accounting records under a periodic inventory system to determine why an inventory-related error of any kind occurred, since the information is aggregated at a very high level. Conversely, such investigations are much easier in a perpetual inventory system, where all transactions are available in detail at the individual unit level.

This list makes it clear that the perpetual inventory system is vastly superior to the periodic inventory system. The only case where a periodic system might make sense is when the amount of inventory is very small, and where you can visually review it without any particular need for more detailed inventory records.