Financial Accounting: In an Economic Context

CARRYING INVENTORY: PERPETUAL METHOD

Until relatively recently, many companies (especially large retail and manufacturing operations) had difficulty maintaining a continuous record of inventory balances due to the speed with which inventories flowed in and out of the business. The number and variety of transactions were just too great to perpetually maintain an accurate count at a reasonable cost. Consequently, to prepare financial statements (i.e., compute the cost of goods sold and ending inventory), companies were forced to periodically disrupt operations and count their inventories.

Electronic data processing has dramatically reduced the cost of record keeping, and now most companies have moved—or are moving—toward computerized systems that maintain perpetual inventory balances. The bar code systems you see in major grocery stores (e.g., Safeway) and retailers (e.g., Target) are common examples. While these systems do not eliminate the need to periodically count inventories, they offer a much greater level of control over inventories—a key element for the success of manufacturers and retailers. In this section, we describe the perpetual inventory method.

The perpetual inventory method is straightforward. When inventory is purchased, the inventory account is increased by the cost of the purchase; and when an inventory sale is made, the account is decreased by the amount of the cost of the sold inventory. Accordingly, perpetual balances are maintained in the inventory and cost ...