How to Use Perpetual and Periodic Inventory Methods
Two major types of inventory systems exist: perpetual and periodic. Larger retailers have electronic cash registers (ECRs). If you’ve ever used the self-checkout, you’ve used one. The checkout features a glass window with a red beam of light.
You run the bar code of a product over the red beam, and the price of the item automatically records as a sale for which you are charged and the business records revenue.
If the business also uses a point-of-sale system, which means transactions at the register automatically update all accounting records, the inventory count is updated constantly, or perpetually, as the ECR records the item sold. This means that the cost of the item sold is taken out of the asset inventory account and moved to cost of goods sold.
With point-of-sale inventory, transactions taking place at the cash register update all purchase, inventory, COGS, and sales information throughout the system in real time as the transactions occur.
Say that you go into Target and buy a birthday card for a friend. As you check out, the point-of-sale software is updating the greeting card department records to show that one less birthday card is available for sale. The software is also updating COGS, showing the cost for the card, and it’s updating revenue to reflect the retail price (what you just paid) for the birthday card.
Instead of this incessant updating of accounting records taking place when using the perpetual system, when using the periodic system, the physical inventory is taken periodically. The resulting figure is used to adjust the balance sheet inventory asset account.
Retail shops that use periodic inventory usually take inventory at their particular year-end. However, inventory can be taken more often, such as quarterly or at the end of every heavy sales season (such as Valentine’s Day, Mother’s Day, and the December holidays).
Here’s how the periodic system works:
The business takes ending inventory and comes up with a dollar amount for all unsold inventory as of the last day of the accounting period. Next, the company’s accounting department subtracts ending inventory totals from the beginning inventory after adding in all inventory purchases made during the period.
The resulting number is cost of goods sold (COGS). The balance sheet inventory account is reduced and the income statement expense account COGS is increased by that number to match revenue with expenses.
Using the periodic system, cost of goods sold can be determined with accuracy approaching 100 percent only after the physical inventory is taken.