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Perpetual Inventory

Inventory Methods
Perpetual Method
If you use the Perpetual Method you have to maintain detail records pertaining to each and every purchase and sale of inventory. A grocery store is an example of a business that often uses a perpetual inventory system. As you may or may not be aware most grocery store products have what is called a bar code (code that identifies the product description, price, cost, etc.). This code allows purchases to be scanned in when delivered to the store. As goods are sold, the fancy check out counters now have scanners that scan the products and automatically update the sales and inventory records.

Thank goodness for automation ! Can you imagine trying to do this by hand with manual inventory cards ?

Many types of businesses are almost "forced" to maintain a perpetual inventory system in order to properly serve their customers. A business that I'm familiar with is a John Deere dealership. When your mower breaks a belt and you call the dealer to see what part you need and whether they have it which dealer would you rather deal with ? The one who can call it up on their computer and determine immediately if they have any and give you the price or the dealer that puts you on hold and has to look around his store and try to physically locate the item and determine the price. Don't get me wrong, even the dealer with a perpetual inventory should after looking it up on their records should verify that they actually do have the part. Perpetual Inventory Systems are only as good as the people who maintain it.

Detailed Records Maintained With A Perpetual System
  • Merchandise Inventory Subsidiary Ledger is maintained on Inventory Stock Record Cards (Manual System) or Computer Software that monitors your inventory or a complete computer accounting/bookkeeping software product that includes Inventory Management. The total costs of all the subsidiary ledger cards should equal the balance maintained in the Merchandise Inventory-Control Account.
  • Count and Costing Sheets used when performing a Physical Inventory Count.
Wait a minute, why do I need to actually count my inventory when I'm using the Perpetual Inventory
System ? Shucks the answer is easy. We're human and unfortunately we make mistakes (not me). As I stated earlier our Perpetual Inventory System is only as good as the people who maintain it. We use the physical count to verify the accuracy of our perpetual records and make any required adjustments resulting from errors.
  • Source Documents Used To Maintain The Inventory:
    • Purchase Orders and Invoices from Suppliers are used to record (update our detail stock records) the quantities and the cost of the items received
    • Our Sales Invoices along with information from our subsidiary ledger cards (cost information) are used to record (update our detail subsidiary ledger (stock records) ) the quantities and costs of the items sold

Accounting and Bookkeeping Procedures For Perpetual Inventory System

Sale of Products-Recording of Revenue Earned and Associated Taxes and Cost Of Goods Sold

Of course when we sell a product we need to record the increase in our assets either Cash or Accounts Receivable and the corresponding increase in our revenue Sales and the increase to our Sales Tax Liability.
Recording the revenue and associated tax liability is done the same way as if we had used the Periodic Inventory Method of maintaining our Retail Inventory.

What's different from the Periodic Inventory System is that we also record the Cost of the Goods Sold and the resulting decrease in our Merchandise Inventory Account at the same time (time of the Sale).

Entries Needed To Record The Sales Transaction:
Sale of merchandise inventory in the amount of $1000 was made
Sales Tax Rate of 10%
Cost of items sold is $600 arrived at from the inventory detail records maintained

The first entry records the asset acquired (received) and the revenue earned.
Cash or Accounts Receivable1100
   Sales Tax Payable
The second entry records the decease in the merchandise inventory and the cost of the items sold.
Cost Of Goods Sold600
   Merchandise Inventory Control
Journal Used:
Cash Sale would be recorded in the Cash Receipts Journal as a debit to our Cash Account, a credit to our Sales Account, and a credit to our Sales Tax Liability Account.

Charge(On Account) Sale would be recorded in the Sales Journal as a debit to our Accounts Receivable Control Account, a credit to our Sales Account, and a credit to our Sales Tax Liability Account.

To record the Cost of the Items Sold and the reduction in the value of the Merchandise Inventory, you can use the Cash Receipts or Sales Journal where you recorded the revenue resulting from the sale to record the cost portion of the entry or create a Special Cost Of Goods Sold Journal and use it to record the cost of the items sold.

Purchase Items

The Merchandise Inventory Control Account is the account used to maintain a summary of the cost of merchandise bought to be sold (Purchases) to your customers and the costs of the merchandise sold and transferred to the Cost of Goods Sold Account. The balance of this Control Account, after all the transactions for the period have been posted, represents the current balance of our inventory.

Entry Needed To Record The Purchase Transaction:
Purchase of merchandise inventory for resale in the amount of $600 was made
Merchandise Inventory Control
  Cash or Accounts Payable    
Journal Used:
Cash Purchase would be recorded in the Cash Disbursements Journal as a debit to our Inventory Control Account and a credit to our Cash Account

Charge(On Account) Purchases would be recorded in the Purchases Journal as a debit to our Inventory Control Account and a credit to our Accounts Payable Control Account.

Purchases using the Perpetual Method are directly charged to the Merchandise Inventory Account instead of the Purchases Account that was used for recording purchases using the Periodic Method. Of course, the Inventory Subsidiary Ledger (stock card) is also updated with the quantity received and the cost of the items received.

Remember, the balance of the Merchandise Inventory Account using the Periodic Method is the balance of the inventory at the beginning of the year (period) and a physical inventory must be taken and adjusting journal entries made to adjust the account to the current balance.

Determine Cost Of Products Sold and Ending Inventory Values
As stated earlier, the Cost Of Goods Sold is a special account that records the cost of the goods that were sold to your customers. When you use the Perpetual Inventory System, an entry is made to the Cost Of Goods Sold Account and Merchandise Inventory Account for the cost of the items sold at the time of each sale.

We also need to update our detail inventory records at the time of the sale. What detail record do we need to update ?

Our Subsidiary Inventory Ledger (stock card) needs to also be posted with the quantity sold and the costs assigned to the items sold.

The Cost of the Products Sold used to update our Cost Of Goods Sold and Merchandise Inventory Accounts is obtained from the Detail Inventory Records that are maintained when the Perpetual Inventory System is used.

Although the Perpetual Inventory Method should maintain a current, actual inventory balance, losses from theft, obsolescence, damage, etc. may reduce the actual inventory available. As stated previously, performing Actual Physical Inventory counts and adjusting your detail records ensures the accuracy of your perpetual records and discloses areas that may require further investigation. In addition, for U.S. taxpayers, the IRS requires an annual physical inventory.

What's Next ?

Inventory Comparisons
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