For a merchandising business, one of the most important success factors is the management of inventory. Because the cost and tracking of inventory is so critical, decisions made about inventory can be life and death decisions directly impacting the current and future health of the business.
One fundamental decision to be made is whether to track inventory using the Perpetual Inventory Method or the Periodic Inventory Method
What is Perpetual Inventory?
Under a perpetual inventory method, businesses typically scan merchandise as it comes into the warehouse, scan it as it leaves the warehouse, scan it as it comes into the store, and scan it when it goes through the cash register and out of the store. This allows the business to have an accurate reporting of how many of each item it has available for customers.
What is Periodic Inventory?
Under a periodic inventory method, a business tracks inventory once a month or once a year (periodically) by taking a physical count of all merchandise. The value of the inventory is compared to the previous inventory number and what was purchased. The difference between what was on hand, what was purchased, and what is remaining, provides the amount of inventory sold. Because this method does not provide up-to-date business information, this method is only used by businesses with small amounts of inventory.
For a deeper understanding of Perpetual Inventory and Periodic Inventory methods, watch this video:
Accounting for Perpetual Inventory
Under a Perpetual Inventory Method, merchandise is tracked from Purchase Order to Receipt of Goods to Receipt of Invoice. When the goods are received, they are tracked through the warehouse, onto trucks, and received by the store’s receiving department. When the merchandise is scanned at the store, it enters the store’s inventory.
From there, the shelves are stocked and the merchandise is ready for sale to the customer. When the customer’s purchases are scanned at the register, the merchandise is reduced from the store’s inventory.
A regular physical count of the inventory is done to compare the actual inventory to what the accounting records show for inventory.
Accounting for Periodic Inventory
In accounting for Periodic Inventory, businesses track additions to inventory, for example, purchases. Inventory reductions are not tracked until the end of the accounting period. This means that during the month, a business doesn’t know what it has for inventory without taking a physical count. This method is only feasible for businesses with small amounts of inventory.
Let’s look at an example. We’ll say Terrance, my sidekick, decides to start a side hustle selling T-shirts with his picture on them. He starts out with zero inventory. During the month, he purchases 25 T-shirts to sell. His T-shirts cost $10 a piece. He is using the Periodic Inventory Method. At the end of the month, he does a physical count of his inventory. He has 23 T-shirts left. To determine the cost of merchandise sold, Terrance will start with the information he has and calculate the remaining amount.
| Merchandise Inventory on June 1 | 0 |
| Add Purchases [$10 x 25 T-shirts] | 250 |
| Merchandise Available for Sale | 250 |
| Cost of Merchandise Sold | ??? |
| Ending Inventory on June 30 [$10 x 23 T-shirts] | 230 |
To calculate Cost of Merchandise Sold for June, Terrance would subtract Ending Inventory from Merchandise Available for Sale. Cost of Merchandise Sold for June is $20 [250 – 230]. For a business like Terrance’s Periodic Inventory is appropriate. If his business grew to include more T-shirts in different sizes, styles, and colors, Terrance would (on the advice of his favorite accountant) switch to a Perpetual Inventory Method so he could track how much inventory he has in stock at all times.
For more information on Accounting for Merchandising Businesses, read this article:
-
What is Equity in Accounting and Finance?
In Accounting and Finance, Equity represents the value of the shareholders’ or business owner’s stake in the business. Equity accounts have a normal credit balance. Equity increases on the credit
-
Understanding Financial Statements | Accounting Student Guide
What is a Financial Statement? Financial Statements are a set of reports summarizing the activities of a business or organization. Much like a series of x-rays shows different views of
-
What is Treasury Stock?
Treasury Stock represents a corporation’s stocks that were previously issued and sold to shareholders. The corporation reacquires the stock by purchasing the stock from shareholders. Treasury Stock reduces the number
-
What is Stockholders’ Equity?
Stockholders’ Equity is the difference between what a corporation owns (Assets) and what a corporation owes (Liabilities). Stockholders’ Equity is made up of Contributed Capital and Earned Capital. Contributed Capital
-
What is Paid in Capital?
What is Contributed or Paid-in Capital? Contributed Capital is also called Paid-in Capital. It includes any amounts “contributed” or “paid in” by investors or stockholders through purchasing of stocks or
-
What is the Difference Between Debt Financing and Equity Financing?
When businesses needs funds to expand or grow the business, that capital can come from three sources: Funds from profits Funds from debt Funds from equity Funding business growth from