The Periodic Inventory Method
Back in the Bad Old Days, that is before computers, accountants and business owners had to rely upon the magic inventory equation to calculate cost of goods sold:
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold for the period
The value of inventory at any point in time is cost * quantity. That is the value in the inventory asset account as of the first of the year or our “Beginning Inventory”.
As you operate throughout the period (month, quarter, year) all inventory purchases are coded to purchases (usually a cost of goods sold account).
At the end of the period, a physical inventory is performed. Who doesn’t just love physical inventories? The count is then valued to arrive at the “Ending Inventory”. The company would make an entry to adjust the inventory on the balance sheet and the resultant amount left in the purchases account is the cost of goods sold for the period.
So, depending on how long the period was business owners were flying blind regarding their profitability until the next physical inventory!
This Periodic method was as good as it got before the advent of the “Machine”.
Perpetual Inventory Method
Thanks to our friends, the computer and innovative software publishers such as Fishbowl Inventory, today’s business owner knows how much they made on each sale at the time of sale.
Fishbowl Inventory tracks each purchase of inventory as a costing layer and the dollars flow to the balance sheet as an inventory asset. As each item is sold from inventory that transaction is assigned a cost based upon one of the following costing algorithms:
|Average Cost||Total Cost of on-hand inventory divided by the quantity on hand|
|Standard Cost||A fixed cost established by the accounting department in co-operation with Operations|
|FIFO||First in First Out The oldest costing layer is presumed to be sold first|
|LIFO||Last in First Out The newest costing layer is presumed to be sold first|
|FISH||First in Still Here – Just kidding – an old accounting joke|
Using a perpetual inventory system gives the business owner instant visibility as to gross profits and is much preferable to the periodic inventory method.