Definition of Perpetual Inventory System
Perpetual Inventory System is the system where an entity continuously updates its inventory records to know the inventory balance instantly.
Under this method, an entity added the materials in its inventory records when it is purchased and subtract the materials when goods sold from stock, for an internal transfer from one department to another, for the scrapped item and for other issues. This method is also known as Continuous Inventory taking method.
Perpetual inventory or Continuous Inventory system records all inventory transaction when the transaction is incurred, hence the accounting system can display the current inventory balance at any point in time.
The perpetual inventory formula is:
| Beginning Inventory | **** |
| Add: Purchased/other receipts | *** |
| Less: Issued/Other Transfer/Sold of Inventory | *** |
| Ending Inventory | **** |
Journal Entries of Perpetual Inventory System
- When Inventory is Purchased:
| Merchandise Inventory | Debit |
| Accounts Payable | Credit |
- When Purchase discount is received:
| Accounts Payable | Debit |
| Merchandise Inventory | Credit |
( As Purchase Discount directly reduce the inventory)
- When Purchase Goods is returned:
| Accounts Payable | Debit |
| Credit |
(As Purchase Return reduce the inventory)
- When the Inventory Sale:
When an inventory is sold, there is two journal entry to be made. First Journal entry to be made to record the ” Sales Revenue” and Second Journal entry to be made to record the Cost of goods of sold and to reduces the inventory balance. The two journal entries are as follows:
| Accounts Receivable | Debit |
| Sales | Credit |
( To record the Sales Revenue)
| Cost of Goods Sold | Debit |
| Merchandise Inventory | Credit |
(Merchandise Inventory Transferred to Cost of Goods Sold)
- When the Sales is returned:
Two Journal to be made for Sales Return. Such as:
| Sales Return A/c | Debit |
| Accounts Receivable | Credit |
| Merchandise Inventory | Debit |
| Costs of Goods Sold | Credit |
Advantages of Perpetual Inventory System
- It helps to quick valuation of closing inventory
- It protects the entity to make a larger investment in materials because management always know the inventory position.
- As the levels of inventory is already determined, management may easily formulate a purchase policies.
- It helps to detect the theft, wastage and leakages of materials due to continuous taking.
- Cost of Goods Sold and Cost of Production can easily determine
- Financial Statement is not delayed for the closing inventory issues as inventory always updated.
- The closing stock of merchandise can be known at any time
- It reduces the inventory holding costs
- Proper control over inventory is possible due to continuous update
- All experienced persons are engaged to record the transactions
Disadvantages of Perpetual Inventory System
- This is a time-consuming method
- Expensive due to needed additional staff to record the transactions
But now-a-days Inventory software and electronics scanner make it much easier and most of the entity using this method and getting instant update of Inventory movement.
Example of Perpertual Inventory System
XYZ Ltd has made the following transactions during December:
| Date | Transactions | Units | Unit Cost ($) |
| Dec 01 | Beginning Inventory | 2,500 | 80 |
| Dec 06 | Sales | 1,800 | 105 |
| Dec 09 | Purchases | 4,000 | 85 |
| Dec 17 | Sales | 2,300 | 120 |
| Dec 23 | Sales | 1,500 | 120 |
| Dec 27 | Purchases | 3,000 | 90 |
Assume that the XYZ Company using the FIFO Method.
Solution:
| Date | Particulars | Ending Inventory (Units) | Ending Inventory ($) |
| December 01 | Value of Beginning Inventory is 2,500 x $80 = 200,000 | 2,500 | 200,000 |
| December 06 | Sales 1,800 Units @ $ 105. Sales value is (1,800 x $105) = 189,000. Cost of Goods Sold (COGS) is (1,800 x $80) = 1,44,000. Hence, the Closing Inventory is $ (200,000 – 144,000) = $ 56,000 | 700 | 56,000 |
| December 09 | Purchase 4,000 units @ $ 85 = $ 340,000 Total Ending inventory is (56,000+340,000) = $ 396,000 | 4,700 | 396,000 |
| December 17 | Sales 2,300 units @ $120 = 276,000 Cost of Goods Sold: 700 units @ 80 = 56,000 1,600 units @ $ 85 = 136,000 Total COGS = 192,000 Hence, Ending Inventory is (3,96,000 – 192,000) = 204,000 | 2,400 | 204,000 |
| December 23 | Sales 1,500 units @ $120 = 180,000 Cost of Goods Sold: 1,500 units @ $ 85 = 127,500 Total COGS = 127,500 Hence, Ending Inventory is (204,000 – 127,500) = $76,500 | 900 | 76,500 |
| December 27 | Purchase 3,000 units @ $ 90 = $ 270,000 Total Ending inventory is (76,500+270,000) = $ | 3,900 | 346,500 |