There are two systems of inventory record keeping:
- Periodic inventory system
- Perpetual inventory system
Periodic inventory system
In periodic inventory system, inventory account is not updated continuously. No entry is made in the inventory account when materials are purchased. A separate purchases ledger is created and all purchases and purchase returns, if any, are recorded in the purchases ledger. At the end of the period (e.g. month, quarter, year etc.), two steps are done to work out the cost of goods sold:
- total of purchases account is transferred to the inventory account and from there to cost of goods sold account; and
- closing inventory determined by physical stock count and application of relevant cost flow assumptions (For eg, FIFO, LIFO or weighted average) is subtracted from the cost of goods sold account.
As the name suggests, in periodic system of inventory, cost of goods sold is calculated at the end of the period using the following formula:
Cost of goods sold (bal.) = Opening inventory + Purchases – Closing inventory
| USD | |
| Opening inventory balance | xxx |
| Purchases | xxx |
| Total inventory balance available | xxx |
| Closing inventory balance | xxx |
| Cost of goods sold | xxx |
Periodic inventory system – Journal entries
As explained earlier, in periodic inventory system, two accounts are used for inventory record keeping:
- Purchases account in which all purchases made during the period are recorded.
- Inventory account which is used to record opening inventory and closing inventory values. At the end of the period, total of purchases account is transferred to the inventory account.
Following journal entries will make it more clear how it works:
Inventory purchases
All purchases made during the period are debited in the purchases account.
| Debit | Credit | |
| Purchases account | xxx | |
| Accounts payable | xxx |
Inventory purchase returns
If there are any purchase returns during the period, they are credited in the purchases account.
| Debit | Credit | |
| Accounts payable | xxx | |
| Purchases account | xxx |
Sales
As in periodic system, cost of goods sold is calculated at the end of the period with the help of a closing entry and the cost of goods sold account is not updated continuously, so only one entry is used for recording sales under periodic system which is shown below:
| Debit | Credit | |
| Cash or accounts receivable | xxx | |
| Sales | xxx |
Sales return
Similarly, for sales return as well, only one entry is required which is shown below:
| Debit | Credit | |
| Sales | xxx | |
| Cash or accounts receivable | xxx |
Closing entry
At the end of each accounting period, cost of goods sold needs to be calculated. For this, the total of purchases account is transferred to inventory account. Quantity of closing inventory is determined by physical stock count and its value is determined using an inventory valuation method. Balancing figure as per the following formula is the cost of goods sold:
Cost of goods sold (bal.) = Opening inventory + Purchases – Closing inventory
Closing entry is as follows:
| Debit | Credit | |
| Closing inventory | xxx | |
| Cost of goods sold (balancing figure) | xxx | |
| Opening inventory | xxx | |
| Purchases | xxx |
Perpetual inventory system
In perpetual inventory system, inventory account is updated continuously and all receipts and issuance of inventory are recorded in the inventory account as and when they occur. Purchases are debited and purchase returns are credited in the inventory account. There is no need for a separate purchases ledger as all purchases and purchase returns are recorded directly in the inventory account.
For sales, cost of goods sold are credited in the inventory account. Each issue of inventory is given a cost, either the actual cost if it is possible or using any valuation method (FIFO, weighted average etc.).
Hence at any time, inventory account can give the information about the inventory available and cost goods sold. Unlike periodic inventory system, physical stock count is not required in perpetual inventory system to calculate cost of goods sold. However, an entity using perpetual inventory system should conduct stock counts periodically to ensure the accuracy of the inventory records.
Perpetual inventory system – Journal entries
Inventory purchases
All purchases made during the period are debited in the inventory account.
| Debit | Credit | |
| Inventory account | xxx | |
| Accounts payable | xxx |
Inventory purchase returns
If there are any purchase returns during the period, they are credited in the inventory account.
| Debit | Credit | |
| Accounts payable | xxx | |
| Inventory account | xxx |
Sales
In perpetual inventory system, sales are recorded via two journal entries. The first entry is the same as in the periodic inventory system which is for recording the sales revenue. However, in perpetual inventory system, as the inventory account and cost of goods sold account are to be updated with every transaction, a second entry is also made which records the corresponding cost for the sale made and reduces the inventory balance. These two entries are shown below:
| Debit | Credit | |
| Cash or accounts receivable | xxx | |
| Sales | xxx |
| Debit | Credit | |
| Cost of goods sold | xxx | |
| Inventory account | xxx |
Sales return
Similarly, for sales return, two entries are required which are shown below:
| Debit | Credit | |
| Sales | xxx | |
| Cash or accounts receivable | xxx |
| Debit | Credit | |
| Inventory account | xxx | |
| Cost of goods sold | xxx |