Inventory Accounting System

A business can account for its inventory using an inventory accounting system. There are two main systems to consider.

1. Periodic inventory accounting system
2. Perpetual inventory accounting system

The period inventory system is less time consuming to maintain but does not provide details of the inventory and costs of sales during the financial period. In contrast, the perpetual inventory system requires details of each inventory movement to be recorded. It is ideal in situations such as a retail environment, where accurate levels of inventory are required at all times. Perpetual inventory systems are normally only used in a computerized inventory system environment.

Periodic Inventory Accounting System

In the periodic inventory accounting system, the balance on the inventory account is not changed throughout the accounting period, but remains at its beginning balance until the end of the accounting period. At the end of the accounting period, the inventory is counted and the balance is adjusted to the physical count.

It is important to realize that under the periodic inventory accounting system, we record the purchases on the purchases account.

The movement of inventory resulting from a sale is not recorded under this system, and the cost of sales is calculated only at the end of the accounting period using the formula:

Cost of sales = Beginning inventory + Purchases - Ending inventory

Our periodic inventory journal entries reference section illustrates further examples of the journals.

Although the system is simple to maintain, under the periodic inventory accounting system details of the inventory levels and cost of sales transactions during the accounting period are not available from the accounting records.

Perpetual Inventory Accounting System

The perpetual inventory accounting system shows all inventory movements during an accounting period on the inventory account.

In this case we record the purchases in the inventory account, and do not use a purchases account.

Under this system the movement on inventory resulting from a sale is recorded using a cost of sales account, which is debited each time a sale is made.

Each time a sale is made, the cost of sales is recorded direct to the inventory account.

Our perpetual inventory system journal entries reference section illustrates further of the examples..

Although more time consuming to record, using perpetual inventory, the detail of the inventory and cost of sales are available throughout the accounting period.

Inventory Systems and Costing Methods

Both the periodic and perpetual inventory accounting systems are methods of recording and accounting for inventory, they say nothing of the costing method used to value the inventory.

Each of the accounting systems can use one of three main costing methods to determine which inventory has been sold and therefore the cost of the sale and the value of the inventory remaining.

1. FIFO – first in first out
2. LIFO – last in first out
3. Average – weighted average
4. Specific identification

The format of the bookkeeping journals to record the inventory movements are determined by the inventory accounting system (periodic or perpetual), whereas the amount used in each journal is determined by the choice of inventory costing system (FIFO, LIFO, or Average).