Financial Accounting

Perpetual Inventory System in Accounting

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What is Perpetual Inventory System?

A company using a perpetual inventory system keeps a continuous record of the physical quantities in its inventory. It registers the purchase or production, and use of each item of inventory in detailed subsidiary records. However, it often only records units without including costs. A continuous physical system allows management to plan and control the stock and avoid stock-outs.

To help inventory control and the preparation of periodic financial statements, many perpetual systems also incorporate costs. Such systems are becoming much more familiar with today’s computer-based accounting systems.

For example, most retail stores use “point of sale” cash register systems in which each product has a unique code, such as the UPC, that is entered into the system as each unit is sold. Some companies are adopting radio frequency identification technology (REID) to track inventory by attaching RFID tags. Both UPCs and RFID tags enable the retailer to immediately update its Inventory and Cost of Goods Sold accounts as each sale is made. A company maintains these reports as summary accounts, which makes it possible to know the inventory and the cost of goods sold at all times.

The firm usually records purchases returns and allowances, purchases discounts taken and freight-in in separate accounts that it uses to compute the income for the period.

How are perpetual inventory records maintained?

When a company uses a perpetual inventory system, it should take a physical count at least once a year to confirm the balance in the inventory account. Any difference between the physical count and the inventory account balance results from errors in recording, shrinkage, waste, breakage, theft, and other causes. The company adjusts its inventory account and also increases the cost of goods sold (or recognizes a loss) for the cost of the difference in the two quantities.

It is required to ensure that the perpetual records are in agreement with the physical count. The size of the gap provides information for inventory control purposes and is another advantage of the perpetual system.

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