Inventory Methods Used in Accounting

Periodic and Perpetual Systems for Tracking Supplies

May 15, 2009 James Hutchinson

In accrual accounting, items are expensed in the period when they are used, not when they are paid. If an item such as a supply is bought but not used in a month, the item is placed in inventory, and expensed when used. Inventory is listed as a current asset, with the assumption that the item will be used in the next twelve months.

Types of Inventories

There are two main methods of maintaining inventories.

• Periodic inventory is placed on the books when paid and valued at the end of the period by taking a physical count of the inventory then. Changes are made to the value of inventory at the end of the period, usually at month end.

• Perpetual inventory is maintained and valued each time a change in the inventory occurs. This requires a system that counts items when they are added or taken from the inventory. The person managing the system will know at any time how many items are in the inventory. For large inventories, this will be a computerized system, but even a manual system that tracks daily changes in inventory can be perpetual.

A physical count is still needed for a perpetual inventory in order to verify the accuracy of the daily transactions. Any adjustments needed are analyzed to see where errors occur. Periodic inventories are used more often for items that are not used often, where it is not necessary to know how many items are on hand at all times.

Examples of Inventory Management

For instance, a small company keeps an inventory of cases of copy paper. The company may use one or two cases a week, and has five on hand at the end of January.

In February, the company buys four cases, charges them to inventory. At the end of February, the company has three cases remaining. Therefore, six were used, and an entry is made to expense six cases in February. For the small amount of supplies, the person keeping the inventory can determine by visual inspection if they in danger of running out.

A larger company might use hundreds of cases per month. It is important to know how many on hand at all times so there are no stock-outs. This would be a good case for a perpetual inventory.

For example, if the inventory is 50 cases at the end of January and five cases are used on February 1, the perpetual system will register that and show that there are 45 cases left. If 10 cases are added on February 2, the system is updated to show 55 cases.

The size and complexity of the inventory will determine whether a business can justify using a perpetual inventory versus the simpler periodic inventory.