Perpetual Inventory Method
The perpetual inventory method is a system of tracking inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management systems. Perpetual inventory provides a highly detailed view of changes in inventory and allows real-time reporting of the amount of inventory in stock.
With the perpetual method, a company records the purchase of inventory items directly into an inventory asset account, and the cost of sold inventory is transferred to a cost of goods sold (COGS) account each time a sale is made. This results in continually updated inventory and COGS balances.
Let’s consider an example:
Imagine a bookstore that uses a perpetual inventory system. When they purchase 100 copies of a new book for $10 each, they immediately record a $1,000 (100 copies x $10/copy) increase in their inventory account. As customers buy copies of this book, the bookstore will simultaneously decrease the inventory account and increase the COGS account for each sale.
So if a customer buys one book, the bookstore immediately records a $10 decrease in inventory and a $10 increase in COGS. If the bookstore sells 20 copies in a day, by the end of the day, the inventory account would have decreased by $200 (20 copies x $10/copy), and the COGS account would have increased by $200.
This allows the bookstore to always know exactly how much inventory they have on hand and how much they’ve sold, as long as there’s no loss, theft, or damage to the inventory not captured by the system. Physical inventory counts are still needed periodically to verify the accuracy of the perpetual inventory system.
Example of the Perpetual Inventory Method
Let’s use a clothing store as an example to illustrate the perpetual inventory method:
- Purchasing Inventory: Let’s say the store buys 100 shirts at a cost of $20 each. This $2000 total cost is immediately added to the inventory asset account. So, if the inventory account initially was $5000, it is now $7000.
- Sale of Inventory: Now, suppose a customer comes in and buys 5 shirts. The point-of-sale system instantly records this transaction, marking a reduction in inventory. At a cost of $20 per shirt, this equates to a $100 reduction in the inventory account (5 shirts * $20/shirt), bringing it down to $6900.
- Recording Cost of Goods Sold (COGS): At the same time, the system records an increase in the COGS account. So, the $100 cost of the 5 shirts sold is added to the COGS. If COGS was initially $2000, it now becomes $2100.
This is a simplified example, but it gives you an idea of how the perpetual inventory method works. Every time there’s a transaction involving the store’s inventory, the inventory and COGS accounts are updated in real-time, allowing the business to always have an accurate and updated understanding of its inventory levels and cost management.
However, physical counts of inventory are still important to account for issues such as loss, theft, or spoilage that might not be captured by the system.