Perpetual and Periodic Inventory Systems

Perpetual and Periodic Inventory Systems
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  • 0:01 Inventory Systems
  • 1:05 Systems Defined
  • 1:59 Differences
  • 3:46 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Inventory management is an important part of business success. In this lesson, we will discuss the two types of inventory systems used in accounting today.

Inventory Systems

After months of hard work and planning, Janie is in the final steps of opening her new business, Janie's Boutique. She's already filled the store with inventory, hired employees, and will be opening the doors in just a few days. But she's run into a slight problem. She can't quite decide how to account for her inventory. She knows that she wants to make sure that her financial statements are as accurate as possible, and that will require that her inventory costs and sales be as accurate as possible. But that she doesn't know is what the best way to do this. Since Janie doesn't know what to do, she decides to go see her friend Adam, who is an accountant, and get his advice.

Adam's glad to talk with Janie about this. The first thing he tells her is that she needs to decide what inventory system to use. An inventory system is a system used to monitor the levels of inventory that a business has on hand. He tells her that she has two choices when it comes to inventory systems: periodic or perpetual. Which one is best for her needs, well, she'll just have to decide that.

Systems Defined

Adam explains to Janie that a periodic system is an inventory system that records inventory levels at specific points in time. These points in time are usually at the end of accounting periods. Periodic systems use physical count audits where employees actually count each and every item in the store to get an accurate inventory level. This amount is then compared to sales reports and purchase receipts to verify the amount of goods sold and to see if there are any discrepancies in numbers.

On the other hand, a perpetual system is an inventory system that records inventory into the accounting system on a continuous basis. This type of system relies heavily on automation to instantly track purchases and sales, and update the accounting system immediately. When an item is purchased, it is automatically recorded in the accounting system as an inventory item.

Differences

Janie was confused. What makes one better than the other? Adam tells her that one is not necessarily better than the other, but there are a couple of notable differences between the two.

One major difference is the account each system uses to record the acquisition of inventory-related materials. The periodic system uses the purchases account while the perpetual system uses the inventory account.

Another difference between the two systems is that the periodic system only reports the cost of goods sold at the end of the accounting period, where the perpetual system constantly updates this information at the time of each sale. The importance of the cost of goods sold is that it is the account that reports the direct costs that are attributed to the goods sold by a company. The cost of goods sold is reported on a business' income statement, which is the financial statement that tells how much money a business made or lost in a given time period. The cost of goods sold is deducted from revenue earned from sales to get the total amount of profit or loss that a business had from sales in an accounting period.

A third difference between the two centers on closing entries. Closing entries are entries that are made at the end of the accounting period to update the balances of certain accounts. The periodic system requires closing entries to update the balances in the inventory and cost of goods sold account, where the perpetual system doesn't need closing entries because they always update those accounts.

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