Perpetual Inventory System Cost of Goods Sold

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Perpetual Inventory In a Nutshell

Unlike a Periodic Inventory system, where the Inventory account is commonly updated or adjusted at the end of the year, perpetual inventory systems are continuously updated. The Inventory account itself is increased with actual costs from purchased merchandise (from suppliers). The account is reduced as merchandise is sold to customers. In this model, there is no need to create purchases accounts.

Perpetual Inventory System Cost of Goods Sold

The perpetual inventory system DOES require a Cost of Goods Sold (COGS) account which is debited at upon each sale transaction for the true cost of the merchandise sold.

The perpetual inventory system creates two journal entries for each sale:

  1. records the sale and the cash or accounts receivable
  2. reduces inventory and increases COGS

Depending on you cost flow assumptions, there are up to 3 perpetual inventory systems:

Perpetual FIFO

In a perpetual FIFO system, the first (most aged) costs are moved first from Inventory accounts and then debited to the COGS account.

Perpetual LIFO

In a perpetual LIFO system, the last (least aged) costs are moved first from Inventory accounts and then debited to the COGS account. For a LIFO perpetual inventory system to work, entries must be recorded at the time of the sale.

Translation: if costs rise continually throughout the course of your fiscal year, a perpetual LIFO system will yield a low COGS and a high net income, compared to a periodic system. Usually this equates to higher income taxes (this is the point where you stop reading blogs and talk to your accountant!)

Perpetual Average

In a perpetual AVERAGE system, the cost of all items in inventory, as of the date of the sale, are averaged out. This cost is then multiplied by the quantity of items/units sold, and is then taken out of the Inventory account and credited to the Cost of Goods Sold account.

You Might Want To Talk To Your Accountant

In most cases, if you do the math, application of the Perpetual LIFO system will result in lower profits. In the United States, that means (in most cases) much lower income taxes will be owed by the company. While this sounds beneficial, the effort it takes to track costs and assign them to COGS accounts + on-hand itemization often outweighs the benefits. At this point, we tip our hat and encourage you to talk with a CPA…

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