Perpetual inventory method definition
/What is the Perpetual Inventory Method?
The perpetual inventory method involves the continual updating of an entity's inventory records with the most recent sales and purchases. These updates typically include additions to and subtractions from inventory for such activities as received inventory items, goods sold from stock, returned goods, and items picked from inventory for use in the production process. This method is the standard inventory tracking system used by any organization that maintains a significant investment in inventory, since it is needed to manage the inventory on a real-time basis.
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Best Practices for a Perpetual Inventory System
It is necessary to adopt the following practices in order to successfully run a perpetual inventory system:
Computer database. Under a perpetual system, a separate record most be maintained to track the additions to and deletions from stock for each inventory item. While it is possible to do so with a manual "card" system, an inventory of any size requires that the flood of associated transactions be handled with a computer database.
Cycle counting. Use cycle counting to continually count small sections of the inventory, and investigate any variances found. This is an excellent technique for maintaining inventory record accuracy.
Location coding. It is impossible to conduct cycle counts if the warehouse staff does not know where to look, so assign a location code to each inventory item, where it is to be stored. It is acceptable to have multiple location codes for a single inventory item.
Restricted access. There is a considerable improvement in inventory record accuracy when access to the inventory being tracked is restricted, such as with fencing and a locked gate. Otherwise, it is too easy for someone to remove goods from storage, or to move goods to a different location.
Perpetual Inventory Transactions
The primary transactions used within the perpetual inventory method are:
Record a purchase. This is a debit to the inventory account and a credit to the payables account.
Record a sale. This is a debit to the cost of goods sold account and a credit to the inventory account.
Record a move. There is no general ledger entry for a locational move between storage locations, though the warehouse management system should record a change in location.
Record a quantity adjustment. This is a debit to the cost of goods sold or inventory shrinkage account and a credit to the inventory account.
Perpetual vs. Periodic Inventory Systems
The perpetual inventory method differs substantially from the other method used for tracking inventory, which is called the periodic inventory method. The periodic method involves compiling all purchases during an accounting period, conducting a physical inventory count at the end of the period, and then using the following calculation to arrive at the cost of goods sold for a period:
Beginning inventory + Purchases - Ending inventory = Cost of goods sold
Some of the differences between the perpetual and periodic inventory systems are as follows:
Account updates. Under a perpetual system, inventory records are updated constantly, while these records are only updated under a periodic system when a physical count is conducted.
Accuracy level. A perpetual inventory system should result in reasonably accurate inventory records, while a periodic system is only accurate on the day when a physical count is taken. At all other times, a company using the periodic system does not know the exact number of units that it has in stock.
Error analysis. A perpetual system stores a massive number of inventory transactions, which makes it easier to investigate errors. This is not the case with a periodic system, where detailed transaction-level records are not kept.
Software requirement. A perpetual system requires the use of inventory tracking software, since so many transactions are being processed every day. This is not necessarily the case for a periodic system, where it may be possible to track inventory using a manual system.
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