Perpetual inventory system is an inventory management method that records when stock is sold or received in real-time through the use of an inventory management system that automates the process.
A perpetual inventory system will record changes in inventory at the time of the transaction. It is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point of sale systems and Enterprise Asset Management software.
It provides a highly detailed view of changes in inventory with immediate reporting of the amount of inventory in stock, and accurately reflects the level of goods on hand.
Within the system, a company makes no effort at keeping detailed inventory records of product on hand, rather, purchases of goods are recorded as a debit to the inventory database.
Effectively, the cost of goods sold includes such elements as direct labour and material costs and direct factory overhead cost.
Example : Purchases and returns are immediately recorded in your inventory accounts. For example, a grocery store may use a perpetual inventory system.
Each time a product is scanned and purchased, the system updates the inventory levels in a database.
How does the perpetual inventory system work ?
Perpetual inventory system works by updating inventory count continuously as goods are bought and sold. This inventory accounting method provides a more accurate and efficient way to account for inventory then a periodic inventory system.
Here is a step-by-step overview of how this type of inventory systewoworks.
1. Point of Sale System updates inventory levels
Whenever a product is sold, the inventory management system attached to the point of sale system immediately applies the debit to the main inventory across all sales channels.
Bar codes or radio frequency identification scanners make this process quick and easy.
2. Cost of goods sold is updated automatically
Whenever a product is sold or received the cost of goods sold gets recalculated.
3. Reorder points are adjusted frequently
Based on historical data, a perpetual inventory system will automatically update reorder points as sales increases or decreases to keep on optimal level of inventory at all times.
4. Purchase orders are automatically generated
Whenever an item hits its reorder point, the system generates a new purchase order and sends it to your supplier with no human intervention.
5. Received products are scanned into inventory
When inventory is sent to your warehouse a warehouse employee will scan product using a warehouse management software so they appear in your inventory management dashboard and make them available for purchase on all or select sales channels.
Advantages of a perpetual Inventory System
1. Records data in real time
A perpetual system records inventory updates and movements as they happen. This means you can trust your inventory counts to be accurate at all times.
2. Provides a detailed paper trail
A perpetual inventory system tracks inventory movements and interactions throughout your E-Commerce supply chain. This data will give you more insights about bottlenecks in your procedures so you find ways to optimise your supply chain.
3. Decreases inventory management costs
With real-time updates inventory holding cost and inventory replenishment are controlled and minimised. Since perpetual inventory systems automate many processes that would be manual it can save on labour costs.
4. Calculates end of year inventory balance
Since a perpetual inventory system accounts for inventory continuously, your end of year inventory balance is calculated instantaneously when the year ends. This helps to make sure you have accurate inventory numbers to report on for accounting purposes.
5. Forecasts demand more accurately
A real-time inventory system makes forecasting demand simple. Historical inventory and sales data can be used to predict future sales cycles and ensure that you have an optimal amount of inventory during different times in the season such as the holidays.
What is the Periodic Inventory System?
The periodic inventory system also called a noncontinuous system, is a method companies use to account for their products. Based on a specified accounting period, periodic inventory does not keep a continuous tally of goods, purchases, sales and their associated costs.
This system works by the company accountant recording all purchases into a purchase account. The company that makes a count of the physical inventory and the accountant shifts any balance in the Purchases into the inventory account.
Next, the accountant adjusts the inventory account to match the cost of the ending inventory. A hallmark of a periodic system is the physical count of goods.
This number is critical since the company does not track unique transactions. Whether the company performs it weekly, monthly, quarterly or annually, this inventory kicks off the records reconciliation.
In the periodic system, companies calculate Cost of Goods Sold directly after a physical inventory, as they do not keep it on a rolling basis, nor do they update it continuously after each transaction.
They do not keep an inventory account in a periodic system since they debit all purchases to a purchase account. Once the period is complete, the company adds the purchase account totals to the inventory’s beginning balance.
Then, the company can also compute the cost of goods available for sale for the new period.
Perpetual vs. Periodic Inventory Systems
1. Updating your Accounts
In a perpetual system, updates to the general ledger and inventory ledger are continuous with every transaction. In a periodic system, updates to the general ledger only occur when there is a physical count, not based upon transaction.
2. Calculating Cost of Goods Sold
Under a perpetual system, the software system maintains a running tally of transactions so it is always able to provide COGS.
A periodic inventory system calculates a physical inventory, in a lump sum at the end of an accounting period. It is not possible to calculate a precise COGS before the end of the accounting period.
3. Record Transactions
In a perpetual system, it is not possible to maintain records manually, because there could be thousands of transactions to track, a perpetual inventory system requires software.
A periodic system, however does not require software. You could manually track your inventory in a periodic inventory system.
4. Recording Purchases
In a perpetual system you record purchases in the raw materials inventory account or the merchandise account.
In a periodic system you log purchases into the Purchase asset account without adding any unit count information.