Inventory systems: perpetual
The following concept map for the perpetual inventory system could be helpful to navigate through the topic:
Perpetual inventory system
Under the perpetual inventory system, inventory and cost of goods sold are updated in real time with every purchase and sale, rather than being determined at the end of the period as under the periodic system.
Journal entries under the perpetual system
Under the perpetual inventory system, a journal entry is generated at each purchase and sale that shows the effects of the transactions to the company’s inventory and cost of goods sold immediately.
The journal entry to record a purchase increases the “inventory” account on the balance sheet instead of a “purchases” account on the income statement. There are then two journal entries every time a sale occurs: one for the sale itself (the same entry used under the periodic system), and one for the cost of goods sold (only recorded under the perpetual system). The second entry reduces the inventory balance and transfers that cost to COGS with each sale.
| Entry | Account | Debit | Credit | Financial statement element |
|---|---|---|---|---|
| JE 1 - record purchase | Inventory | XXX | Asset | |
| Cash or accounts payable | XXX | Asset or liability | ||
| JE 2 - record sale | Cash or accounts receivable | XXX | Asset | |
| Sales revenue | XXX | Revenue | ||
| JE 3 - record COGS | Cost of goods sold | XXX | Expense | |
| Inventory | XXX | Asset |
No year-end entry is needed to compute COGS, because inventory and COGS are updated with every transaction. Companies still take a periodic physical count and record an adjusting entry (debit COGS or inventory shrinkage, credit Inventory) for any shortage between the records and the count.
Inventory worksheet under perpetual system
Unlike the periodic inventory system, which is easily learned using journal entries, the perpetual inventory system is best learned using inventory worksheets, prepared slightly differently for each cost flow assumption.
From here, we can analyze the impacts of each transaction instead of just the ending balances. We will use the same facts in the exercise used in the periodic inventory system to be able to compare the results with the perpetual inventory system.
Example: Below is the summary of inventory movements for the month of April (a period of rising prices) for Achievable:
| Date | Nature | Units | Cost | Total |
| Apr 1 | Beginning inventory | 500 | $2.0 | $1,000 |
| Apr 2 | Purchase | 1,000 | $2.5 | $2,500 |
| Apr 5 | Purchase | 1,000 | $3.0 | $3,000 |
| Apr 9 | Sale (Per unit: $7.00) | (800) | ||
| Apr 15 | Purchase | 1,500 | $4.0 | $6,000 |
| Apr 29 | Sale (Per unit: 8.00) | (1,200) | ||
| Goods available for sale | 4,000 | 12,500 | ||
| Apr 30 | Ending inventory | 2,000 |
FIFO perpetual assumption
Before working through a perpetual worksheet, you should know that FIFO periodic and FIFO perpetual always produce the same ending inventory and COGS balances - $7,500 and $5,000 in this example. That’s because FIFO always assigns the earliest purchases to COGS first, regardless of when each sale happens during the period, so the order in which you match units to costs doesn’t change the outcome. If you’re asked to compute FIFO perpetual, you can use the faster FIFO periodic method (shown in the previous chapter) and arrive at the same result.
LIFO perpetual assumption
LIFO is permitted under U.S. GAAP but prohibited under IFRS; the GAAP-IFRS differences chapter covers this comparison in more detail.
Under LIFO perpetual, each sale draws on the most recent purchases on hand at the time of that sale, so results can differ from LIFO periodic and must be worked out with an inventory worksheet, like the one below.
| Date | Nature | Transactions | Inventory | Cost of goods sold | ||||||
| Units | Cost | Total | Units | Cost | Total | Units | Cost | Total | ||
| Apr 1 | Beginning inventory | 500 | $2.0 | $1,000 | 500 | $2.0 | $1,000 | |||
| Apr 2 | Purchase | 1,000 | $2.5 | $2,500 | 1,000 | $2.5 | $2,500 | |||
| Apr 5 | Purchase | 1,000 | $3.0 | $3,000 | 1,000 | $3.0 | $3,000 | |||
| Apr 9 | Sale (Per unit: $7.00) | (800) | ||||||||
| From Apr 5 purchase | (800) | $3.0 | ($2,400) | 800 | $3.0 | $2,400 | ||||
| Apr 15 | Purchase | 1,500 | $4.0 | $6,000 | 1,500 | $4.0 | $6,000 | |||
| Apr 29 | Sale (Per unit: $8.00) | (1,200) | ||||||||
| From Apr 15 purchase | (1,200) | $4.0 | ($4,800) | 1,200 | $4.0 | $4,800 | ||||
| Apr 30 | Ending inventory | 2,000 | 2,000 | $5,300 | 2,000 | $7,200 | ||||
The difference with FIFO perpetual is that the sales are attributed to the latest inventories purchased.
You will notice that the total inventories ($ 5,300) and the COGS ($ 7,200) are still equal to the cost of goods available for sale of $ 12,500. This will be true for all methods and cost flow assumptions we will discuss.
Moving average assumption
Under the perpetual inventory system, the average method is called the moving average method because for every purchase, the average inventory cost is computed and there is no single average cost of inventory unlike the weighted average method in the periodic inventory system.
| Date | Nature | Transactions | Inventory | Cost of goods sold | ||||||
| Units | Cost | Total | Units | Avg. cost | Total | Units | Avg. cost | Total | ||
| Apr 1 | Beginning inventory | 500 | $2.0 | $1,000 | 500 | $2.0 | $1,000 | |||
| Apr 2 | Purchase | 1,000 | $2.5 | $2,500 | 1,000 | $2.5 | $2,500 | |||
| Apr 5 | Purchase | 1,000 | $3.0 | $3,000 | 1,000 | $3.0 | $3,000 | |||
| Average cost/ accumulated balance | 2,500 | $2.6 | $6,500 | |||||||
| Apr 9 | Sale (Per unit: $7.00) | (800) | (800) | $2.6 | ($2,080) | 800 | $2.6 | $2,080 | ||
| Apr 15 | Purchase | 1,500 | $4.0 | $6,000 | 1,500 | $4.0 | $6,000 | |||
| Average cost/ accumulated balance | 3,200 | $3.26 | $10,420 | |||||||
| Apr 29 | Sale (Per unit: $8.00) | (1,200) | (1,200) | $3.26 | ($3,912) | 1,200 | $3.26 | $3,912 | ||
| Apr 30 | Ending inventory | 2,000 | 2,000 | $6,508 | 2,000 | $5,992 | ||||
Because no sale occurs until April 9, we compute one combined average after the April 5 purchase.
Analysis of the ending balances under the perpetual system
Below is a summary of the ending inventory, sales, cost of goods sold, and gross profit under all cost flow assumptions of the perpetual inventory system. Recall that April is a period of rising prices for the company.
| Units | FIFO | LIFO | Moving ave. | |
| Balance sheet: | ||||
| Ending inventory | 2,000 | $ 7,500 | $ 5,300 | $ 6,508 |
| Income statement: | ||||
| Sales* | 2,000 | $ 15,200 | $ 15,200 | $ 15,200 |
| Cost of goods sold | 2,000 | ($ 5,000) | ($ 7,200) | ($ 5,992) |
| Gross profit | $ 10,200 | $ 8,000 | $ 9,208 |
The amount of sales is the total sales (Apr 9 and Apr 29) from the example.
In a period of rising prices, the example shows the following:
- FIFO method has the highest gross profit because the cost of goods sold are based on the lower priced inventory items of the old purchases
- In effect of above, in a period of rising prices, LIFO has a higher cost of goods sold
- FIFO has the higher cost of ending inventory in the balance sheet because these are based on the higher priced most current purchases
- The average method is expected to be in the middle of both FIFO and LIFO.
Comparing the perpetual and periodic systems, only FIFO produces identical ending inventory and COGS under both; LIFO and the average method generally do not.