Accountants usually maintain a record of inventory (Goods unsold) to determine the cost of goods sold and their quantity. There are some types of inventory systems.
There is a close relationship between the cost of goods sold and inventory that we can see from the following diagrams.
|Cost of Goods Sold:
Add: Net purchase cost
Cost of goods available for sale
Less: ending inventory
Cost of Goods Sold (COGS)
*Net purchase cost = Purchase + Carriage inward (transportation-in/freight-in) expenses(purchase returns & allowances + purchase discounts)
Types of inventory systems
There are two methods of recording inventory namely:
- Periodic system
- Perpetual system
Periodic inventory system
Under this method, the merchandise company does not maintain a detailed record of inventory for the result the cost of goods sold is calculated at the end of the accounting period (periodically).
- Easier to operate in relatively small firms.
- Lack of control over inventory.
- Less cost to handle the method.
- Does not keep inventory record up-to-date.
- The system applies to those concerns usually that sell low-value items (such as stationery items) in large quantities.
Example: Hallmark may follow this inventory method because they sell low-value items at a large quantity. They need not maintain a record of inventory each purchase or sales is made.
Under the periodic inventory system, we must have good concepts of the following:
- Opening inventory (At the beginning of the accounting period)
- Net purchase cost and
- Ending inventory (At the end of the accounting period)
Perpetual inventory system
Under this method, a detailed record of the cost of inventory is maintained each time a purchase or a sale is made.
As a result, the system consciously shows the up-to-date record of inventory that should be on hand. The cost of goods sold is calculated each time a purchase or a sale is made, not at the end of an accounting period.
- It requires more effort to maintain inventory under this method.
- Close control over inventory
- The method is comparatively costly
- Keeps inventory record up-to-date and decent.
- The method applies to those concerns usually that sell high-value items (Such as car, personal computer, equipment, etc.) not at a large quantity as compared to items under the periodic system.
Example: Volvo Car Overseas Corporation AB Sells Volvo car in Bangladesh. It needs to maintain an inventory record each time the car is sold to a customer.
Notes to the readers:
- Due to computerization, the cost of maintaining inventory under the perpetual system minimizes in recent days. Moreover, the business people feel the necessity to establish continuous control over the cost and the quantity of inventory throughout the year as a large number of transactions occur in the expanding competitive and complex business environment. As a result, the use of the perpetual inventory system is growing popular in practice day by day.
- Continuous control over inventory ensures detailed and decent management of inventory. This is possible only by the perpetual inventory system.
- Under the perpetual inventory system, the merchandise inventory account is debited for each purchase and credited for each sale to show the up-to-date balance of inventory.
- In some perpetual systems, only the number of units sold is recorded at the time of sale, and the amount will be recorded later.
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