There are two main systems of inventory accounting: periodic and perpetual.
The periodic inventory system involves no continuous record of the merchandise inventory account. The inventory balance remains the same throughout the accounting period, and no entry is made for the cost of goods sold. Instead, physical inventory must be taken periodically to determine the cost of inventory on hand and goods sold. This system is less costly to maintain but provides management with less information about the current status of merchandise. It is often used by retail enterprises that sell many kinds of low unit cost merchandise, such as groceries, drugstores, and hardware.
The perpetual inventory system, on the other hand, continuously discloses the amount of inventory. The inventory balance is not constant throughout the accounting period, as all increases are debited to the merchandise inventory account and all decreases are credited to the same account. There are no separate accounts for purchases and purchase returns and allowances. The cost of goods sold is recorded at the time of sale, and the cost of inventory and goods sold can be determined from the accounting records without the need for physical counting. This system is often used by companies that sell items of high unit value, such as appliances or automobiles. It is typically more effective for keeping track of quantities and ensuring optimal customer service.
Management must choose the system or combination of systems that is best for achieving the company's goals. Both systems have their advantages and disadvantages, and the appropriate system will depend on the nature and size of the business and its needs.