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Perpetual inventory system and periodic inventory systems are the two systems of keeping records of inventory.
In perpetual inventory system, merchandise inventory and cost of goods sold are updated continuously on each sale and purchase transaction. Some other transactions may also require an update to inventory account for example, sale/purchase return, purchase discounts etc. Purchases are directly debited to inventory account whereas for each sale two journal entries are made: one to record sale value of inventory and other to record cost of goods sold. Purchases account is not used in perpetual inventory system.
In periodic inventory system, merchandise inventory and cost of goods sold are not updated continuously. Instead purchases are recorded in Purchases account and each sale transaction is recorded via a single journal entry. Thus cost of goods sold account does not exist during the accounting period. It is determined at the end of accounting period via a closing entry.
Perpetual means continuous. This is a system where a business keeps continuous, moment-to-moment records of the number, value and type of inventories that it has at the business.
A computerized accounting system – where each item of inventory is linked to the electronic accounting records – creates a perpetual system. Products that have barcodes are automatically recorded as having been sold at tills in a supermarket when they are ‘swiped.’ Inventory levels are automatically decreased as soon as the invoice has been entered and completed at the till.
Periodic Inventory System
Where one does periodic inventory counts (such as once a month, or at the beginning and end of each year), and does not have an accurate record of the inventories in between these points – well, this is a periodic system. This system does not keep continuous, moment-to-moment records of inventories. Accurate records are only kept periodically – meaning, at certain points in time – in this case, when the actual counts are done.