Periodic and perpetual inventory systems

Every business that sells goods needs two figures: what the goods it sold cost (cost of sales) and what the goods it still holds cost (closing inventory). There are two ways to keep the records.

Perpetual system. The inventory account is updated with every movement. Purchases are debited to Inventory; each sale records two entries — the revenue, and the cost of the goods leaving (debit Cost of sales, credit Inventory). The ledger always shows what should be on the shelves, which supports re-ordering and margin reporting. Most businesses with a point-of-sale or ERP system run perpetually.

Periodic system. Purchases are collected in a purchases account during the year and inventory is left at its opening balance. Cost of sales is worked out only at the period end:

> cost of sales = opening inventory + net purchases (including freight-in, less purchase returns) − closing inventory (from a physical count)

It's cheap to run but gives no cost of sales until the count, and theft or breakage is hidden inside cost of sales. (Our learning chart has no separate Purchases account, so in exercises periodic purchases are debited to Cost of sales, which plays the purchases role until the year-end inventory adjustment.)

What goes into the cost of inventory (IAS 2.10–11): purchase price, import duties and non-recoverable taxes, and transport and handling to bring the goods to their present location (freight-in), less trade discounts and rebates. Recoverable VAT is excluded; so is freight-out to customers (a selling cost) and storage after purchase, unless storage is a necessary production step.

The count matters under both systems. Under a periodic system it produces closing inventory. Under a perpetual system it tests the records: if the count is lower than the book balance, the difference is shrinkage (theft, damage, errors), written off to cost of sales. Either way, the two systems give the same cost of sales for the year once the count is taken into account — the difference is how much information you have during the year. US GAAP (ASC 330) uses the same mechanics.