The perpetual inventory method involves the continual updating of an entity's inventory records. These updates typically include to additions to and subtractions from inventory for such activities as received inventory items, goods sold from stock, returned goods, and items picked from inventory for use in the production process. This method is the standard inventory tracking system used by any organization that maintains a significant investment in inventory.
It is necessary to adopt the following practices in order to successfully run a perpetual inventory system:
- Computer database. Under a perpetual system, a separate record most be maintained to track the additions to and deletions from stock for each inventory item. While it is possible to do so with a manual "card" system, an inventory of any size requires that the flood of associated transactions be handled with a computer database.
- Cycle counting. Use cycle counting to continually count small sections of the inventory, and investigate any variances found. This is an excellent technique for maintaining inventory record accuracy.
- Location coding. It is impossible to conduct cycle counts if the warehouse staff does not know where to look, so assign a location code to each inventory item, where it is to be stored. It is acceptable to have multiple location codes for a single inventory item.
- Restricted access. There is a considerable improvement in inventory record accuracy when access to the inventory being tracked is restricted, such as with fencing and a locked gate. Otherwise, it is too easy for someone to remove goods from storage, or to move goods to a different location.
The primary transactions used within the perpetual inventory method are:
- Record a purchase. This is a debit to the inventory account and a credit to the payables account.
- Record a sale. This is a debit to the cost of goods sold account and a credit to the inventory account.
- Record a move. There is no general ledger entry for a locational move between storage locations, though the warehouse management system should record a change in location.
- Record a quantity adjustment. This is a debit to the cost of goods sold or inventory shrinkage account and a credit to the inventory account.
The perpetual inventory method differs substantially from the other method used for tracking inventory, which is called the periodic inventory method. The periodic method involves compiling all purchases during an accounting period, conducting a physical inventory count at the end of the period, and then using the following calculation to arrive at the cost of goods sold for a period:
Beginning inventory + Purchases - Ending inventory
A periodic inventory system relies upon having an accurate inventory count only when a physical count is taken. At all other times, a company using the periodic system does not know the exact number of units that it has in stock, which makes it inferior to the perpetual inventory method.