The meaning of perpetual inventory is that it deals with the record of the physical quantities of the stocks and its valuation. There are two principles to determine the inventory of a firm, which are the periodic inventory system and the perpetual inventory record system.
The perpetual inventory system records the stocks continuously. Under the perpetual inventory system, the inventory gets recorded after each issue or receipt or purchase of the raw materials, work in progress, final goods, etc. The perpetual inventory system cost of goods sold are updated on a day to day basis.
For ensuring the accuracy of the perpetual inventory transactions, the physical counts of the inventory are carried out many times in a year. This ensures that the inventory is cross-checked and the validity and the accuracy of the perpetual inventory accounting is checked as well. According to the perpetual inventory system, the value of the closing stock is determined by the cost of goods that are issued and the cost of goods that are sold. The equation given below refers to the closing inventory valuation.
Opening Stock (known value) + Purchases during the year (known) – COGS (known) = Closing Stock (balancing figure)
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The advantages of the perpetual inventory record system are given as follows:
It helps in avoiding the time-consuming practices of the regular stock taking. According to the perpetual inventory management system, the stocks are counted only a few times in the year.
The management keeps a daily record of the valuation and quantity of the closing stock which helps in the distribution and the production management.
There is also a system of internal check which dissuades misappropriation or thefts. The records of different departments like stores, purchases, and manufacturing are checked against each other.
There is no requirement to halt the process of production for taking physical stock count often.
According to the periodic inventory system, the verification of the inventory is carried out by the physical count of the inventory on a given date. Hence, for determining the closing stock the physical count of the inventory including the weight, numbers, etc. are taken. Firms usually tend to carry this out around the end of the accounting year.
The valuation of the inventory or the closing stock is done with the help of either of the inventory pricing methods like Average Cost, FIFO, LIFO, etc. In this method, the cost of the goods sold are calculated using the following equation:
Opening Stock (known value) + Purchases during the year (known) – Closing Stock (counted) = COGS (balancing figure)
Disadvantages of the Periodic Inventory System
The disadvantages of the periodic inventory system are mentioned below:
Firms tend to do a physical count more than one time in a year and generally make quarterly or monthly installments that need frequent inventory counting.
For carrying out a physical count, the normal manufacturing and several other activities are suspended which eventually leads to losses for the firm or business.
COGS is regarded as a balancing figure which means that it cannot be accounted for the losses due to any kind of damages or abnormal losses.
The periodic inventory system also does not provide any kind of inventory control systems or methods.
1. What is a Perpetual Inventory System in Cost Accounting?
Ans: The perpetual inventory recording system is a type of method of inventory accounting which tends to record the purchase or the sale of the inventory immediately via using the computerized point-of-sale systems as well as enterprise asset management software.
The perpetual inventory system provides a detailed view of the changes in the inventory with an immediate report of the amount of inventory in the stock and reflects the goods level on hand accurately. The company does not make any effort within this system to keep detailed inventory records of the products on hand. However, the purchases of the goods are rather recorded as a debit to the database of the inventory. The cost of the goods that are sold include elements like material costs, direct labour, and the direct factory overhead costs.
2. How Does Perpetual Inventory System in Cost Accounting Work?
Ans: In the perpetual inventory record system, the POS system tends to automatically make changes to the inventory levels. The inventory reports can also be accessed online anytime which makes it easier for managing or purchasing the inventory.
However, these perpetual inventory record systems are not correct entirely all the time. There are several factors which can affect the accuracy of the inventory levels of the firm. The transaction or any kind of employee theft at the firm can be forgotten to record. Hence, it is advised to occasionally check the inventory quantities for comparing the total amounts.
The calculations according to the perpetual inventory system are done typically through the POS systems for frequently counting the inventory.