Periodic Versus Perpetual Inventory System

Not only measurement basis and cost flow assumptions have an effect on
inventory valuation but also the way entity is managing the records will greatly
affect inventory’s value at the year end.

Typically entity uses either of the following two systems to record changes in
inventory:

1. Periodic inventory system

2. Perpetual inventory system

1 Periodic Inventory System

Under periodic system inventory records are maintained/updated in intervals

like at the end of every week or month, accountant will sit down and determine
the inventory at hand.

Under periodic inventory system, entity maintains temporary accounts like

purchases, purchases returns, sales and sales return. At the end of the period
the amounts in these temporary accounts are added to determine the amount
of inventory available for sale. Inventory still at hand is usually found by
physically counting the units. The number of units at hand are deducted from
inventory available for sale to compute cost of goods sold and hence the
formula:

CGS = Opening inventory + [Purchases – Purchases returns] – Closing

inventory
But it must be understood that purchases account and Inventory account
are two different things. If entity chooses to regularly update purchases
account it does not necessarily tell how much inventory entity holds at a
particular time. Under periodic system it is the inventory account which is
updated at intervals. Accounting of periodic inventory system will be discussed
later.

To emphasize again, physical inventory count (also called stock taking) at the
period end is mandatory under periodic system. Without such count, cost of
sales (or cost of goods sold) cannot be determined therefore, entities have to
conduct this activity at least once a year or at every period end.

2 Perpetual Inventory System

Under perpetual system, inventory record is updated on run-time basis i.e.

regularly after every transaction. As every purchase, return or sale transaction
is being recorded directly in inventory account, management will know the
amount of inventory at hand and cost of goods sold at any given point in time
as opposed to periodic inventory system where they have to wait until the end
of the period.

Under perpetual inventory system, transactions are recorded directly in

inventory account and no separate or temporary accounts like purchases
and purchases returns are maintained. Every purchase, purchase return,
sale or sales return is recorded in inventory account as and when transaction
takes place.

Difference between Perpetual and Periodic Inventory System

Perpetual Periodic
Inventory Inventory
System System

Recording Inventory Inventory

 records are records are
updated updated
regularly periodically

Ending Ending
inventory is inventory is
Determinatio
determined on determined on
n of ending
the basis of the basis of
inventory
inventory physical stock
records count

Done to
Done to
confirm if units
Stock count determine cost
held are as per
of goods sold
records

High level of No control as

control as management
Control on management is unaware of
inventory knows the quantity until
quantity at the end of the
any given time period

Temporary
No temporary accounts like
accounts are purchases,
maintained. returns and
Temporary
Recording is sales are
accounts
done directly maintained
in inventory that are closed
account at the period
end.

Expensive to
Cheaper to
maintain.
maintain as it
Need
Cost requires less
dedicated
work and
trained
workforce
personnel