Subject 3. Periodic versus Perpetual Inventory System

The perpetual inventory system updates inventory accounts after each purchase or sale. Inventory quantities are updated continuously. When there is a sale, inventory is reduced and COGS is calculated.

The periodic inventory system records inventory purchase or sale in the "Purchases" account. The "Inventory" account is updated on a periodic basis, at the end of each accounting period (e.g., monthly, quarterly). Cost of goods sold or cost of sale is computed from the ending inventory figure.

With perpetual FIFO, the first (or oldest) costs are the first moved from the Inventory account and debited to the Cost of Goods Sold account. The end result under perpetual FIFO is the same as under periodic FIFO. In other words, the first costs are the same whether you move the cost out of inventory with each sale (perpetual) or whether you wait until the year is over (periodic).

With perpetual LIFO, the last costs available at the time of the sale are the first to be removed from the Inventory account and debited to the Cost of Goods Sold account. Since this is the perpetual system, we cannot wait until the end of the year to determine the last cost. An entry must be recorded at the time of the sale in order to reduce the Inventory account and increase the Cost of Goods Sold account.

If costs continue to rise throughout the entire year, perpetual LIFO will yield a lower cost of goods sold and a higher net income than periodic LIFO. Generally this means that periodic LIFO will result in lower income taxes than perpetual LIFO.

Example

Date....................................Units....Price
12.31.2008........Beginning Inventory....1.......85
1.1.2009..........Purchase...............1.......87
2.1.2009..........Purchase...............2.......89
6.1.2009..........Sales..................1.......89
12.1.2009.........Purchase...............1.......90

Under perpetual LIFO the following entry must be made at the time of the sale: $89 will be credited to Inventory and $89 will be debited from Cost of Goods Sold. If that was the only item sold during the year, at the end of the year the Cost of Goods Sold account will have a balance of $89 and the cost in the Inventory account will be $351 ($85 + $87 + $89 + $90).

Under periodic LIFO we assign the last cost of $90 to the one item that was sold. (If two items were sold, $90 would be assigned to the first item and $89 to the second item.) The remaining $350 is assigned to inventory. The $350 of inventory cost consists of $85 + $87 + $89 + $89. The $90 assigned to the item that was sold is permanently gone from inventory.

User Contributed Comments 3

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fmhp: pas compris le 2 février.
moneyguy: we should keep comments in English as the entire exam and prep materials are in English. Thanks. (although French is a very beautiful language) :)
johntan1979: NOTE that it says that GENERALLY, perpetual LIFO results in lower COGS, higher NI than periodic LIFO.

What will cause the end result to be similar?

Assuming on one item was sold the whole accounting period, the end result will be the same for both perpetual and periodic LIFO if the date of sale was the last day of the period, or if the purchase price (cost) of the most recent item purchased is the same as the purchase price of the previous item purchased.