PERMANENT INVENTORY SYSTEM: CHARACTERISTICS AND EXAMPLE - DUDAS - 2025

The perpetual inventory system is a method of accounting for inventory, which records the sale or purchase of inventory immediately through the use of computerized point-of-sale or order entry systems and enterprise asset management software.

Permanent inventory provides a highly detailed view of inventory changes, with an immediate report of the amount of inventory in the warehouse, thus accurately reflecting the level of available items.

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This inventory system is superior to the older periodic inventory system because it allows immediate tracking of sales and inventory levels of individual items, helping to avoid stockouts.

A perpetual inventory does not need to be manually adjusted by company accountants, except to the extent that the physical inventory count is not in agreement due to loss, breakage, or theft.

Permanent inventory is the preferred method of keeping track of inventory, as if properly managed it can produce reasonably accurate results on an ongoing basis.

characteristics

Permanent inventory describes inventory systems where information on inventory quantity and availability is continually updated as a function of the business.

This is achieved by connecting the inventory system with an order entry system, such as wireless barcode scanners, and in stores, with the point of sale terminal system. Therefore, the book inventory would be exactly the same or almost equal to the actual inventory.

It is less effective when changes are posted to inventory cards, as there is a significant possibility that entries will not be made, will be made incorrectly, or will not be made in a timely manner.

Under the perpetual inventory system, a company continually updates its inventory records to account for inventory additions and subtractions for activities such as:

- Inventory items received.

- Products in stock sold.

- Items moved from one place to another.

- Materials to be used in the production process.

- Discarded items.

The perpetual inventory system formula is very simple: Beginning Inventory (generally taken from a physical count) + Receipts - Shipments = Ending Inventory.

Inventory differences

A perpetual inventory system has the advantage of providing up-to-date inventory balance information and requiring a reduced level of physical inventory counts.

However, the inventory levels that are calculated by this system may gradually differ from the actual inventory levels.

This is due to unrecorded transactions or theft, so the book balances should be compared periodically to the actual amounts available, using cycle counting, and adjusting the book balance as necessary.

Cost of merchandise sold

Under the permanent system, there are continuous updates in the cost of the merchandise sold account as each sale is made. This means that it is easy to obtain an accurate cost of the merchandise sold before the end of the accounting period.

Purchases

Inventory purchases are posted to either the raw materials inventory account or the merchandise account, depending on the nature of the purchase, while there is also an individual record entry that is maintained for each inventory item.

Tracking transactions

Investigations are much easier to track in a perpetual inventory system. In this system all transactions are available in detail at the individual level.

Inventory reports can be accessed online at any time. This makes it easy to manage inventory levels and the cash required to purchase additional inventory.

Since the periodic inventory system is only updated occasionally, managers never have up-to-date and accurate financial information on which to base their purchasing or manufacturing decisions.

Advantages and disadvantages

Advantage

The main advantage is providing managers with relevant statistics on the status of the company, in a timely manner.

The amount of the cost of merchandise sold and the balance of the inventory account are available at any time. This information is very important for improving purchasing policy and preparing short-term financial statements.

Although inventory errors can occur from loss, breakage, theft, incorrect inventory tracking, or scan errors, there are many benefits to using this system:

- Maintain greater control over physical inventories by comparing the actual balance with the book records.

- Detect without delay any problem before it becomes gigantic, such as theft, damage or inventory leaks.

- Prevent stockouts. A lack of stock means that a product is out of stock.

- Provide management with a more accurate understanding of customer preferences.

- Allow management to centralize inventory management system for multiple locations.

- Provide greater accuracy, as each inventory item is recorded separately in the general ledger.

- Reduce physical inventory counts, not requiring to shut down routine business activities during physical count.

Disadvantages

- In the case of manual accounting, the use of the perpetual inventory system is time consuming. This could also lead to many errors in each accounting period. This problem can only be solved by applying a computerized accounting system.

- The use of computers and accounting software can be quite expensive for small businesses.

- Keeping inventory accounts under permanent system is expensive and time consuming.

- Permanent inventory systems can be vulnerable to errors due to overestimations or underestimations. These can occur as a result of theft, breakage, scan errors, or untracked inventory movements, leading to replenishment errors.

Example

An example of a perpetual inventory system is a modern merchandise shipping and receiving department. Each box that is received is scanned into the accounting system and is thus automatically added to the inventory balance.

Products shipped to customers are marked with a barcode and scanned as they leave the shipping dock. This automatically takes them out of the accounting system and causes inventory to decrease.

As can be seen, this modern system is updated in real time. It is not necessary to process the transactions in batches as in a periodic inventory system. Consequently, all reports will always be up-to-date for review by management staff.

References

1. Steven Bragg (2018). Perpetual inventory system. Accounting Tools. Taken from: accountingtools.com.
2. Steven Bragg (2019). The difference between the periodic and perpetual inventory systems. Accounting Tools. Taken from: accountingtools.com.
3. James Chen (2018). Perpetual Inventory. Taken from: investopedia.com.
4. Wikipedia, the free encyclopedia (2019). Perpetual inventory. Taken from: en.wikipedia.org.
5. My Accounting Course (2019). What is a Perpetual Inventory System? Taken from: myaccountingcourse.com.