An inventory recording system has to deal with the recording of physical quantities of stock and its valuation. Now there are two principal systems for determining the inventory of a firm – the perpetual inventory system and the periodic inventory system. Let us learn about them both.
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Perpetual Inventory System
As the name hints in the perpetual inventory system require continuous recording of the stock. This means the inventory is recorded after every issue or purchase/receipt of raw materials, final goods, work in progress etc. So these records will need updating on a daily basis.
To ensure the accuracy of the perpetual inventory system, physical counts of the inventory are done a few times in a year. This helps us cross-check the inventory and check the accuracy and validity of the perpetual inventory system. In the perpetual inventory system, the value of the closing stock will be determined by the cost of goods issued and cost of goods sold. The following equation will help you understand the valuation of the closing inventory:
Opening Stock (Value known) + Purchases during the year (known) – COGS (known) = Closing Stock (Balancing Figure)
Advantages of a Perpetual Inventory System
- Helps avoid the time-consuming practice of regular stock taking. In this system, we physically count stock only a few times a year.
- Management has daily information about the quantity and valuation of closing stock. This helps in the production and distribution management.
- There is a system of internal check that dissuades theft or misappropriation. We check records of different departments like purchasing, stores, manufacturing against each other.
- Also, there is no need to halt the production process to take physical stock count ever so often.
- Helps avoid over-investment in stock and reduce the carrying cost of the inventory.
Periodic Inventory System
In the periodic inventory system, the inventory verification is done by an actual physical count of the inventory on any given date. So to determine the closing stock a physical count of the inventory (numbers, weight etc.) will be taken. Firms usually do this near the end of the accounting year.
The valuation of the inventory/closing stock is done using one of the various inventory pricing methods, i.e. LIFO, FIFO, Average Cost etc. In this method we will calculate the cost of goods sold using a similar equation as above:
Opening Stock (known) + Purchases during the year (known) – Closing Stock (counted) = COGS (balancing figure)
Disadvantages of the Periodic Inventory System
This system suffers from many limitations. Let us take a look,
- Firms usually do a physical more than once a year. They usually make quarterly or even monthly statements which will require frequent counting of the inventory.
- To do a physical count we have to suspend normal manufacturing and other activities. This leads to losses for the firm.
- Since COGS is a balancing figure we cannot account for loss due to damage or any such abnormal losses.
- This system does not provide any inventory control methods or systems
Solved Question on Inventory Recording System
Q: Periodic Inventory System is more suitable for small enterprises. True or False?
Ans: The given statement is true. A periodic inventory system is suitable to small and micro enterprises, where physical counting of inventory is not a tedious process. Any medium or large scale enterprise will not be able to cope without an inventory control system which is only possible in a Perpetual Inventory System.