1. A perpetual system continually updates the inventory and accounting records every time a purchase or sale is made. This is the more up to date option of the two methods and is more suitable in the long run for businesses with larger inventory levels.
2. A periodic system relies on a physical inventory count at the end of a period, usually on a monthly, quarterly, or yearly basis to adjust the records. Purchases should be tracked, however, and compared against the counted ending balance to determine the amount sold. As it does not provide any interim details, this method is most suited for smaller businesses with less inventory.
INVENTORY COST LAYERING
Cost layering determines which inventory items to expense when a sale is made. There are three common methods used for cost layering.
Cost layering determines which inventory items to expense when a sale is made. This is important because items are often purchased as different amounts over time and “layers” build up as inventory accumulates before being sold. The three most common methods are:
FIFO or First In First Out assumes that the oldest purchases on hand are sold first. This usually most closely reflects reality and is the most commonly adopted method.
LIFO or Last In First Out assumes that the most recent purchases are sold first and the oldest inventory remains in stock. This method is only used in the United States for income tax savings purposes. Assuming that costs increase over time means that expensing recently purchased inventory first will generate higher costs in the
present and thus lower taxes.
The Weighted Average method does away with layers all together and simply averages the total cost of all purchased inventory. Thus the average cost per unit can increase or decrease over time with new additions.
In a retail operation many products will inevitably become obsolete and won’t sell for their original listed values. There are three ways to account for this.
In a retail operation, many products will inevitably become obsolete and won’t sell for their original listed values. There are three options for accounting for the expected loss from old inventory.
The Expected Disposition Method is the most accurate as it sets up a loss reserve account based on detailed records of the assumed disposition values for all obsolete inventory. The loss from the reserve is adjusted based on the eventual disposition price
The Reserve Method is based more on an estimate of historical obsolescence levels. Typically a percentage of the total inventory balance is taken as the reserve balance which is then adjusted upon disposition
Finally, the Expensing Method is most applicable when inventory is only a minor business investment. No loss reserve is set up and the loss is simply recognized when ite