Describe the differences between the periodic inventory system and the perpetual inventory system.
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Periodic v. Perpetual Inventory
Periodic inventory systems and perpetual inventory systems are two forms of accounting that businesses use to track the number of products that are available. These methods of tracking inventory are used by small and large businesses alike depending on the circumstances. Both have their advantages and disadvantages and must be evaluated for necessity and effectiveness before implementing them.
Periodic inventory systems use physical counts to measure the cost of goods sold and the level of inventory. These quantities are usually updated at the end of a predetermined period (Blystone, 2020), which can be quarterly, annually, monthly, or even weekly. The cost of goods sold under the periodic inventory system is calculated as adding the beginning balance of inventory to the cost of inventory purchases, then subtracting the cost of ending inventory. While this system makes use of manual labor, it can be time-consuming and difficult, especially for a small business owner. For this reason, many business owners do it over longer periods of time like months or years. However, this results in less frequent, less fresh and less accurate counts of the cost of goods sold. Periodic accounting systems are good for smaller businesses with low sales value.
On the other hand, perpetual inventory systems keep track of inventory balances over time and updates automatically when a good is received or sold. The account balance should be continually refreshed and current if there are no extenuating circumstances that affect it. This removes the manual labor of checking inventory and calculating the cost of goods sold since the system updates it with each transaction and in real-time. This type of inventory system is best suited for larger businesses with high sales volumes like grocery stores or department stores. However, the main disadvantage is the failure of technology which can cause an error in inventory levels.
CHOOSING THE BEST INVENTORY SYSTEM: PERPETUAL OR PERIODIC
The perpetual inventory system is when each sale and purchase of merchandise is recorded. Meaning, all the merchandise on hand available for sale and the amount sold are continuously updated in the inventory records. This system consists of the inventory account which is called controlling account and a subsidiary record of each item of inventory that is called subsidiary account. (Warren, 2018). These two accounts need to balance each other out. The sum of the balances in the subsidiary account needs to equal the balance in the controlling account. The perpetual inventory system provides the business owner with a record of detailed sale transactions by item, including where, when and at what price the items were sold (Carlson, 2019).
On the other hand, we have the periodic inventory system which does not show the amount of merchandise available for sale and the amount sold. This allows a company to track its beginning inventory and ending inventory within an accounting period, but it doesn’t track the inventory on a daily basis. That way, companies track their inventory by having employees take a physical inventory count (Carlson, 2019). According to Warren, this physical inventory is used to determine the cost of inventory on hand at the end of the period, which is the amount reported as inventory on the balance sheet.
People who conduct very small businesses can operate using the periodic inventory system since they can just work with a cash register and simple accounting. But as the business is growing, it would be a better option to switch over to a perpetual inventory system since it allows the balancing of an inventory account at any point due to large volume of inventory transactions and the computerized nature of the rest of their financial and accounting systems.