Calculating cost of goods sold in a perpetual inventory system?

Feb 19

Inventory is key to your business. The inventory you keep in stock must be enough to meet customer demand, but not so much that storage costs are too high. To lower storage costs, you need to implement a systematic inventory system. Real-time inventory tracking is made possible with the perpetual inventory system. In this article, we will learn what perpetual inventory listing is and how you can record the data of goods sold at your store using the perpetual inventory method.

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What is Perpetual Inventory?

Businesses track sales and purchases immediately with perpetual inventory using computerized point-of-sale systems. This feature allows businesses to maintain accurate records of their inventory levels. Reports the quantity of inventory in stock right away and ensures consistency in updating your inventory.

The company records purchases as debits in the inventory database, so it does not keep detailed inventory records on hand. Direct costs such as labor and materials, as well as overhead costs, can be included in the cost of goods sold. Different from perpetual inventory systems are periodic inventory systems, which conduct regular physical counts to track inventory.

Understanding Perpetual Inventory listing

Periodic inventory systems are less reliable in tracking sales trends and inventory levels, so stock-outs can be avoided with perpetual inventories. A perpetual inventory does not need to be manually adjusted by an accountant unless physical inventory counts differ due to theft, loss, or breakage. The inventory management system also uses a perpetual listing method to provide stock owners with stock-out alerts.

When Would You Use a Perpetual Inventory System?

Those who need constant knowledge of margins and profitability benefit from perpetual inventory systems. Generally, a perpetual inventory system is utilized by large businesses or companies that want to grow their emerging business over time as perpetual inventory systems become cheaper and more accessible to small businesses. They are expected to become the future, particularly for product companies.

When the company purchases new inventory or makes a sale, the software records the change into a sales revenue account. Accounting records are then updated accordingly, ensuring that the accounts in question reflect an accurate balance. Charges are also recorded via the software.

Perpetual systems require you to know the sale price, purchase price and accounts affected when recording transactions. A customer pays a selling price when purchasing items from a merchant. In addition to the product's purchase price, the product's shipping and storage costs are also included.

Sales records are recorded in Perpetual Inventory using formulas

You can use inventory management formulas to figure out several things. Including when more inventory should be ordered, how much more to order, how long it will take to process your order, and how much stock you will need to store.

Economic order quantity

According to Economic Order Quantity (EOQ), one has to take into account how much it costs to store goods along with their actual cost. To minimize expenses, inventory needs to be manufactured or purchased in such a way as to minimize costs.

EOQ= 2DS/ 2

D= Demand in units for this year

S= Cost of each order

H= The annual holding cost per unit

The Cost of Goods Sold (COGS)

The expense account increases, and sales costs increase when products are sold using a perpetual inventory system. This is the direct expense of producing goods during a given time period. In these costs, labor and material costs are included, but distribution and sales costs are not considered. COGS is calculated as follows.

COGS= BI+P-I

BI = Inventory at the beginning

P= The purchase amount for the period

EI= Final inventory

If you do not have a real beginning inventory, you can use whatever stock is left from the previous period to calculate your beginning inventory.

A calendar year can be divided into quarters, months, or quarters and quarters. COGS counts as a rolling total and is recalculated after each transaction, but you can calculate it for an entire period using the COGS formula.

Gross profit

Calculating gross profit requires the use of the following formula. Business profits are determined by subtracting all the costs associated with producing and selling their products or services from their gross profits.

Gross profit= Revenue - COGS

Gross Profit Method

Sometimes, when preparing financial statements or if stock is destroyed, you will need to estimate the ending inventory for a period in a perpetual system. Start by estimating inventory at the beginning of the period and the purchase cost during that time.

Consider the situation where your ending inventory from the current month needs to be estimated. To calculate it, you'll need to know the gross profit, expressed as a percentage of sales, and the total sales for that period. You'll also need to know what the beginning inventory was for the period and what the purchases were during that time.

What Is FIFO Perpetual Inventory Method?

According to FIFO (first-in, first-out), a company will value its inventory based on the first items placed on the inventory shelf. Consequently, at the end of the period, the inventory left is that which was most recently purchased or produced.

The cost flow assumption is an inventory accounting method that calculates the value of an ending inventory based on the original prices of products at the beginning and new purchases during that period. Three cost flow assumptions are used by businesses here: FIFO, LIFO, and Weighted Average Cost (WAC).

What Is LIFO Perpetual Inventory Method?

The last item placed in inventory becomes the first item sold, using the last-in-first-out (LIFO) principle. After the period ends, the oldest production or purchase will be left in inventory. By debiting the last available cost at the time of sale, the perpetual LIFO system transfers costs from inventory to COGS.

In what way does the Weighted Average Cost Perpetual Inventory Method work?

A business values its inventory using the Weighted Average Cost (WAC), an assumption of cost flow. WAC represents the cost of goods sold over a period of time. Accounting professionals use this method differently in a perpetual system from a periodic system, also known as moving average cost.

When you make a sale or purchase, you should use the WAC to set a standard average price for every item you have in inventory. With a perpetual system, you wouldn't use a formula to calculate WAC over a specific period of time. It is possible to calculate a period's average unit cost, COGS, and ending inventory by using WAC. Here is the formula to calculate WAC:

WAC= Cost of goods available for sale/ Units available for sale

It should be noted that the WAC lists goods available only for a limited period of time.

Conclusion

Your business can succeed or fail based on the accuracy of your stock levels determined by the perpetual inventory method. The right tools must be available for the management of inventory, regardless of the type of inventory control system chosen.

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