A business can account for its inventory using an inventory accounting system. There are two main systems to consider.
- Periodic inventory accounting system
- 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 accounting period. In contrast, the perpetual inventory system requires details of each inventory movement to be recorded, but 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.
Under the periodic inventory accounting system, purchases are recorded to 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
Further examples of journals can be found in our periodic inventory journal entries reference section.
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.
Purchases are recorded to the inventory account, and a purchases account is not used.
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.
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Each time a sale is made, the cost of sales is recorded direct to the inventory account.
Further examples of journals can be found in our perpetual inventory system journal entries reference section.
Although more time consuming to record, using the perpetual inventory accounting system, the detail of the inventory and cost of sales are available throughout the accounting period.
Inventory Accounting 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.
- FIFO – first in first out
- LIFO – last in first out
- Average – weighted average
- Specific identification
The format of the accounting 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).
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.