Inventory refer to goods, either raw, in-process, or finished, that a business intends to sell. Considering that inventory goods represent one of a business’s strongest assets, inventory must be carefully recorded and maintained within a system of records. Otherwise, mismanaged inventories may expire or be lost. When creating this system of records, there are two methods of detailing inventories: the periodic inventory system and the perpetual inventory system.
The periodic inventory system details a business’s inventory only periodically, usually at the end of an accounting period or the end of a fiscal year. The costs of goods sold and on hand are calculated at this point and the costs of goods sold account is not updated until this point. The system is updated and maintained through invoices and purchase orders. This system utilizes the single entry method of accounting, where each transaction is recorded in a single journal. The periodic inventory system is most appropriate for small businesses which do not move much inventory and do not need to maintain frequent inventory logs.
A periodic inventory system utilizes a purchases account, which details purchased items intended to be sold to the public. This account, along with purchase returns and allowances accounts, are regularly updated throughout an accounting period. The cost of inventory at the end of an accounting period is determined by counting inventory and subtracting that sum from the cost of goods available, resulting in cost of goods sold.
The perpetual inventory system details a business’s inventory whenever merchandise is bought or sold. Cost of goods sold is updated whenever a transaction occurs. This system utilizes the double entry method of accounting, where sale value and cost of goods sold accounts are recorded. Because perpetual inventory systems are constantly updated, there is no need for closing entries. Inventory at the end of an accounting period is calculated by adding the receipts to the beginning inventory and subtracting shipments made over the course of that period. The perpetual inventory system is most appropriate for larger businesses which have many transactions over the course of an accounting period and require detailed records.
When determining what counts as inventory, note that unprocessed goods which a business owns but has not yet received count as inventory. On the other hand, inventory merchandise that is sold but not delivered should not be counted as inventory.