• Key Functions of an Inventory System
  • Perpetual Inventory System: Benefits and Drawbacks

An inventory system is how a business keeps its record of inventory up to date. OpenStax's Principles of Accounting defines merchandise inventory as "goods held for sale at a given point in the period" and describes two systems. A perpetual system "automatically updates and records the inventory account every time a sale or purchase of inventory occurs". A periodic system "updates and records the inventory account at certain, scheduled times at the end of an operating cycle". Both systems end with a physical count, and both are used to work out cost of goods sold.

Billed publishes this page. Definitions are quoted from OpenStax, Principles of Accounting, Volume 1: Financial Accounting, chapters 6 and 10, opened on October 30, 2026.

Key Functions of an Inventory System

  • Recording purchases and sales. OpenStax's section 6.2 says: "When a company uses the perpetual inventory system and makes a purchase, they will automatically update the Merchandise Inventory account. Under a periodic inventory system, Purchases will be updated, while Merchandise Inventory will remain unchanged until the company counts and verifies its inventory balance."
  • Checking the record against a physical count. OpenStax's chapter 6 key terms define a physical inventory count as a "manual stock check of inventory to make sure what is recorded on the books matches what is actually in the warehouse and on the sales floor". Section 6.2 adds: "after the merchandise inventory has been verified with a physical count, its book value is adjusted upward or downward to reflect the actual inventory on hand, with an accompanying adjustment to the COGS."
  • Working out cost of goods sold. For a periodic system, section 6.2 says: "To determine the value of Cost of Goods Sold, the business will have to look at the beginning inventory balance, purchases, purchase returns and allowances, discounts, and the ending inventory balance."

Perpetual Inventory System: Benefits and Drawbacks

From OpenStax section 6.2:

  • Benefits: "The perpetual inventory system gives real-time updates and keeps a constant flow of inventory information available for decision-makers." It also says: "Although a periodic physical count of inventory is still required, a perpetual inventory system may reduce the number of times physical counts are needed."
  • Drawbacks: "The biggest disadvantages of using the perpetual inventory systems arise from the resource constraints for cost and time. It is costly to keep an automatic inventory system up-to-date."

Periodic Inventory System: Benefits and Drawbacks

From OpenStax section 6.2:

  • Benefits: "The periodic inventory system is often less expensive and time consuming than perpetual inventory systems. This is because there is no constant maintenance of inventory records or training and retraining of employees to upkeep the system."
  • Drawbacks: "However, the need for frequent physical counts of inventory can suspend business operations each time this is done. There are more chances for shrinkage, damaged, or obsolete merchandise because inventory is not constantly monitored."

Cost Methods Used With Either System

OpenStax's chapter 10 key terms describe the cost allocation methods that chapter covers:

  • Specific identification: "traces actual cost of each specific item, whether sold or held in inventory; usually used for customized or differentiated products".
  • First-in, first-out (FIFO): "assumes the earliest acquired inventory items are the first to be sold".
  • Last-in, first-out (LIFO): "assumes the latest acquired inventory items are the first to sell".
  • Weighted average: "calculates the average value inventory items by weighting each purchase lot’s goods available for sale, before dividing by the total number of units of that item".

Which method your business uses for its books and tax return is a question for your accountant.

Worked Example: One Quarter for a Shop (sample figures)

These are sample figures for a fictional shop, invented for this example. There are no purchase returns, allowances or discounts.

  • Beginning inventory: $4,000.00
  • Purchases during the quarter: $10,500.00
  • Goods available for sale: $4,000.00 + $10,500.00 = $14,500.00
  • Ending inventory from the physical count: $3,200.00

Periodic system. Cost of goods sold is worked out at the end of the quarter: $14,500.00 − $3,200.00 = $11,300.00.

Perpetual system. The records already show $11,050.00 of cost of goods sold from each sale, so the book inventory is $14,500.00 − $11,050.00 = $3,450.00. The physical count finds $3,200.00, which is $3,450.00 − $3,200.00 = $250.00 less. The book value is adjusted down by $250.00, and cost of goods sold becomes $11,050.00 + $250.00 = $11,300.00.

Both systems end the quarter at the same cost of goods sold, $11,300.00. The perpetual system also showed the $250.00 difference between the records and the count. Cost of goods sold and average inventory are also the inputs to the inventory turnover ratio.

Where Billed Fits

Billed's invoice software page says you can "save the products and services you sell so you can pull them into an invoice instead of retyping them", and "See which products and services are selling and create offers for your customers." Billed's financial reporting page lists "Top Selling Products" among its built-in reports.

When This Guide Isn't for You

If you make products from raw materials, hold inventory in more than one location, or need to choose an inventory method for your tax return, ask your accountant.

Related Guides

FAQ

What is the difference between a perpetual and a periodic inventory system?

OpenStax says a perpetual system "automatically updates and records the inventory account every time a sale or purchase of inventory occurs". A periodic system "updates and records the inventory account at certain, scheduled times at the end of an operating cycle".

Does a perpetual system still need a physical count?

Yes. OpenStax says: "Although a periodic physical count of inventory is still required, a perpetual inventory system may reduce the number of times physical counts are needed."

How is cost of goods sold worked out under a periodic system?

Add purchases to beginning inventory to get the goods available for sale, then subtract the ending inventory from the physical count. In this page's sample, $4,000.00 + $10,500.00 − $3,200.00 = $11,300.00.

What is merchandise inventory?

OpenStax defines merchandise inventory as "goods held for sale at a given point in the period".

Share

Was this article helpful?