Financial AccountingInventory Recording Systems

Inventory Recording Systems
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In accounting, all the purchases made for inventory and stock are recorded initially in the Purchase / Journal day book and then transferred to the purchase ledger. At the end of the accounting period the balance of purchase ledger is transferred to the debit side of the Inventory Ledger. Moreover, the determined value of closing stock is entered in the credit side of the inventory ledger and carried forward as the opening balance of next accounting period, whereas the difference of opening Stock at the beginning of current period plus purchases during the period and aforementioned closing stock, is transferred to the profit and Loss account as Cost of Goods Sold (COGS).

The equation form of the above paragraph will be as follows:

Opening Inventory + Purchases during the period – Closing Stock= Consumption OR Cost of Goods Sold (COGS)l 

In the above equation the value of

Opening stock is brought forwarded from the last Financial Year, whereas

The value of purchases is transferred from the Purchase ledger.

However, the value of closing stock is determined from the records maintained separately.

The value of closing inventory is determined by the following two ways:

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1.   Periodic System of Inventory Recording:

At the end of each period (depending on business policies, may be weekly, monthly, quarterly or annually), all stock is physically counted to ascertain the quantity of the inventory. Then the value of each item is assigned and multiplied to the total quantity of the inventory.

The process of physically counting the stock is called stock taking. In larger organizations, stock taking may span over a few weeks and to avoid any disruptions during the stock taking, the in and out for the particular items is stopped.

This system of counting and recording inventories periodically, is simple and requires no regular staff for stock keeping.

However, the periodic system of recording inventories is not suitable for large organizations especially in trading and manufacturing businesses. The process of stock taking can last for weeks and even months due to the large quantities of many types of inventories available. Hence, it becomes difficult to halt in and out of inventory for so long.

Further, in periodic accounting systems, the loss of inventory due to wastage and theft cannot be determined. This is because no regular record for consumption or issuance for production is maintained in this system of recording inventories, thus all the difference between opening stock plus purchases during the period and closing stock by stock taking is assumed as “stock consumed” during the period. The consumption so calculated may include both actually consumed stock and any loss due to wastage and theft.

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2.   Perpetual System of Inventory Recording

In contrast to the periodic accounting for inventory where inventory is recorded only at the end of a period, perpetual recording systems require every in and out of inventory shall be recorded. Each new purchase and issuance of every inventory item is recorded in the inventory register.

As each inventory movement is perpetually recorded, thus the closing balance of inventory is always readily available. This record of closing stock is then compared with physical stock by stock taking hence any loss of inventory items due to the wastage and/ or theft can easily be determined.

Further, as a system of recording each movement of inventory is in place, there is no need to stop the inventory movements during the stock take process.

However, implementation of a perpetual recording system for inventories requires deployment of resources (Human and computer equipment), which may require heavy costs to be incurred by the business.

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The decision, which inventory recording system shall be applied depends upon the needs of a business and any decision shall be reached after weighing cost benefits of each system. For Example a small business engaged in providing service e.g. consultancy does not need to have a perpetual recording system for inventory as the quantity of inventory is very small, however a large manufacturing or a retail business cannot afford to rely on a periodic inventory recording system.

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