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.
When to Use the Perpetual Inventory Method
Here are five situations in which the perpetual inventory method should be used:
Large retail operations. Major retailers like supermarkets, department stores, and e-commerce businesses benefit significantly from the perpetual inventory method. With thousands of different products and high transaction volumes, having up-to-the-minute inventory data helps prevent stockouts, manage reordering efficiently, and improve customer satisfaction. Barcodes and point-of-sale systems automate the process, making it easy to track sales and update inventory instantly.
Businesses selling high-value items. Companies dealing in expensive items such as electronics, jewelry, or automobiles should use the perpetual inventory method to reduce the risk of theft, fraud, and loss. With fewer but more valuable items, maintaining accurate inventory records helps in detecting discrepancies quickly and ensures that management has a clear picture of stock levels and the cost of goods sold at all times.
Manufacturing companies. Manufacturers benefit from the perpetual inventory method by tracking raw materials, work-in-progress, and finished goods in real-time. This continuous monitoring allows for better production planning, just-in-time inventory management, and cost control. Accurate inventory data helps manufacturers avoid production delays due to stock shortages and manage supply chain efficiency.
E-commerce businesses. For online retailers, keeping accurate inventory records is crucial to prevent overselling or stockouts. The perpetual inventory method, integrated with e-commerce platforms, ensures that inventory levels are updated instantly with each online sale. This real-time tracking supports better customer experience by providing accurate information on product availability and delivery times.
Pharmacies and healthcare providers. Pharmacies and healthcare facilities must maintain precise control over their inventories due to regulatory compliance requirements and the sensitive nature of their products. The perpetual inventory method helps manage expiration dates, prevent stockouts of critical medicines, and ensure that only valid products are dispensed. Real-time inventory tracking also aids in minimizing waste and managing recalls efficiently.
In these situations, the perpetual inventory method enhances decision-making, minimizes errors, and improves overall inventory management efficiency. Its ability to provide real-time data makes it an essential tool for businesses that need to respond quickly to changes in demand and manage inventory costs effectively.
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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