Advantages & Disadvantages of Using a Perpetual Inventory System

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A perpetual inventory system is a set of accounting processes that helps a company report financial inventory data. Many companies use this system — especially those using a job order cost accounting system, or selling many different types of inventory. Companies must balance the advantages and disadvantages of a perpetual system prior to implementing it.

Accurate Reporting

Companies often experience more accurate financial reporting with a perpetual inventory system. Accountants update the general ledger after each inventory transaction. This results in a general ledger account that closely mirrors the actual physical inventory on hand. Owners and managers can then make quality decisions based on the accuracy of reporting inventory values. Multiple inventory types also benefit from this method, as accountants accurately track each one through the general ledger.

Electronic Management

Perpetual inventory systems often use electronic methods to record transactions. An example is the barcode system a clothing retailer uses when selling goods. Each scan records data that updates the company’s inventory value. Accountants use this information to balance the general ledger. Companies also use the data to order goods using a just-in-time system. Electronic ordering helps to prevent stock outs and lost sales.

Cost

Many perpetual inventory systems are expensive. The cost for these systems is twofold. The technology necessary to make the system work can be a major capital expense. Updating the system for new changes to the technology is also costly. Training employees to properly use the system is yet another expense. On the administrative side, companies must find accountants who can work the system and manage frequent changes to the general ledger.

Process

Perpetual inventory systems are often time-consuming. Electronic updates to a company's general ledger may result in a need for account reconciliations. Accountants will often spend copious hours each week or month to reconcile inventory. Persistent errors can also cause further complications. Accountants need to correct errors and balance the inventory account prior to closing the company’s books. Reporting inaccurate inventory figures can trigger an audit, resulting in potential problems for the company.

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References

  • "Fundamental Financial Accounting Concepts"; Thomas P. Edmonds, et al.; 2011
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