Under the perpetual method, inventory records are updated each time a transaction involving inventory takes place. Thus, up-to-date information about the quantity and cost of inventory on hand will always be available, enabling the entity to provide better customer service and maintain better control over this essential asset.
Under the periodic method, the amount of inventory is determined periodically by conducting a physical count and multiplying the number of units by a cost per unit to value the inventory on hand.
Important Differences Between Perpetual And Periodic Inventory Methods :
• Purchases are posted directly to the asset account under the perpetual method, and are posted to expense accounts under the periodic method.
• When goods are sold, a second entry is necessary under the perpetual method to transfer the cost of those goods from the inventory account to the expense account, cost of sales.
• When goods are returned to suppliers, the return is adjusted directly to inventory under the perpetual method, and is posted to a purchase returns account under the periodic method.
• When goods are returned from customers, a second journal entry is necessary under the perpetual method to transfer the cost of these goods out of the cost of sales account and back into the inventory account.
• Under the periodic method, freight is normally posted to a separate account. Under the perpetual method, freight is included in the cost of inventory unless the amounts are immaterial, in which case freight costs would be accumulated in a separate expense account.
• If inventory items being returned to the supplier have been paid for, an accounts receivable account would be opened pending a cash refund from the supplier.
• If sales returns have been paid for, an accounts payable entry would be raised to recognize the need to refund cash to the customer.
• Under the periodic method, cash settlement discounts would be posted to a separate ledger account. Under the perpetual method, settlement discounts would be deducted from the cost of inventory
The same gross profit is reported irrespective of the inventory recording method adopted. However, where adjustments are made for damaged or lost inventory, the gross profit will be different under the perpetual method.