Lesson Objectives:- Definition of periodic and perpetual systems
- How each inventory system is used
- Calculating the cost of goods sold
- Examples of each system
The two types of inventory systems that merchandising companies use are periodic and perpetual systems. You will need to understand these inventory systems before you start recording journal entries for merchandise operations. The way that assets are recorded will differ significantly depending on the type of system used.
Perpetual is the most complex inventory system as every single inventory transaction is recorded. For example, if a piece of inventory is sold, the company will keep track of the inventory leaving the business and the inventory will be counted. This concept also applies when inventory is purchased as the company will record the increase in inventory.
Companies use their technology systems in order to keep track of the inventory levels and ensure they have constant visibility of their in-house counts and activity. These systems can be fairly advanced software programs that are often custom developed based on business needs.
In contrast, the periodic system is much simpler as when the company makes a sale, the inventory will still leave the business when sold but it won't necessarily be recorded at that time.
The company will perform an inventory count at the end of the accounting period in order to find out their counts, instead of keeping track of the count at all times. They will still have the ability to calculate the cost of goods sold but not after every individual transaction. This would be calculated by taking the beginning inventory and adding any additional products purchased to come up with the available goods. The ending inventory figure would then be deducted to calculate the cost of goods sold for that time period which we will talk about towards the end of this lesson.
The graphic above explains how different types of transactions are recorded with the periodic system versus the perpetual system. We will break down the journal entries in more detail for each system in the next few lessons, but for the purpose of this lesson, we will talk about how to calculate the cost of goods sold.
The cost of goods sold is essentially the expense associated with selling the merchandise inventory.
With the perpetual inventory system, you are recording the cost of goods sold for each individual transaction since you are always recording the activity when a sale is made. The periodic system does not have a running count for the cost of goods sold, therefore it will not be recorded for each transaction because the figures are only tracked at the end of the accounting cycle.
We use the formula above to calculate the cost of goods sold for a periodic inventory system.
The company can take the inventory left after sales during a given time period and subtract that from the available goods to come up with the cost of goods sold. That total expense of cost of goods sold can then be recorded on the income statement.