Perpetual Inventory System. Advantages and Disadvantages of Perpetual Inventory System.

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 InventoryDebit
Accounts PayableCredit
  • When Purchase discount is received:
Accounts Payable Debit
Merchandise InventoryCredit

( As Purchase Discount directly reduce the inventory)

  • When Purchase Goods is returned:
Accounts PayableDebit
Merchnadise Inventory 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 ReceivableDebit
SalesCredit

( To record the Sales Revenue)

Cost of Goods SoldDebit
Merchandise InventoryCredit

(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/cDebit
Accounts Receivable Credit
Merchandise InventoryDebit
Costs of Goods SoldCredit

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:

DateTransactionsUnitsUnit Cost ($)
Dec 01Beginning Inventory2,500 80
Dec 06Sales1,800105
Dec 09Purchases4,000 85
Dec 17Sales2,300120
Dec 23Sales1,500120
Dec 27Purchases3,00090

Assume that the XYZ Company using the FIFO Method.

Solution:

DateParticularsEnding Inventory (Units)Ending Inventory ($)
December 01Value of Beginning Inventory is 2,500 x $80 = 200,0002,500200,000
December 06Sales 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
70056,000
December 09Purchase 4,000 units @ $ 85 = $ 340,000
Total Ending inventory is (56,000+340,000) = $ 396,000
4,700396,000
December 17Sales 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
2,400204,000
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
90076,500
December 27 Purchase 3,000 units @ $ 90 = $ 270,000
Total Ending inventory is (76,500+270,000) = $
3,900346,500