When managing inventory, businesses have two main options for recording stock levels and the cost of goods sold (COGS): a periodic inventory system or a perpetual inventory system. A perpetual inventory system tracks stock levels and COGS in real-time, offering more up-to-date and accurate financials. However, many businesses may not fully understand how the COGS is recorded under a perpetual inventory system.
Simply put, a perpetual inventory system provides a continuous record of stock levels and COGS. When stock is purchased or sold, the system automatically updates inventory and COGS figures. With this in mind, it’s essential for businesses using this system to accurately record inventory costs to ensure that COGS figures are recorded correctly in their financials. This article will delve deeper into the COGS calculation process and how perpetual inventory systems can better manage inventory and financials.
Understanding the Perpetual Inventory System
The perpetual inventory system is one of the two inventory tracking systems used in accounting. Unlike the periodic inventory system, where a physical inventory count is conducted at the end of each accounting period to calculate the cost of goods sold (COGS), the perpetual inventory system tracks inventory levels in real-time. This helps businesses stay on top of their inventory levels and make informed purchasing and sales decisions.
In the perpetual inventory system, inventory levels are updated automatically when sales are made, and purchases are recorded. This ensures that the inventory balance reflects the current stock available, and businesses can quickly identify any discrepancies or issues. The perpetual inventory system also makes it easier to calculate COGS, as the cost of each item sold is recorded at the time of sale. This makes it easier for businesses to monitor their expenses and determine their profitability.
The Basics of Cost of Goods Sold
The cost of goods sold (COGS) is the cost that a business incurs to produce or acquire the goods it sells. In other words, it is the direct cost of the goods that were sold during a specific period. COGS includes the cost of materials, labor, and overhead expenses that were used in the production process. The cost of goods sold is an important metric for business owners as it is used to calculate gross profits and determine profitability.
The COGS formula for a perpetual inventory system is quite simple: beginning inventory + net purchases – ending inventory = cost of goods sold. This means that the cost of goods sold is calculated as the sum of the cost of inventory at the beginning of the period, plus the cost of inventory purchased during the period, minus the cost of the ending inventory. By using a perpetual inventory system, businesses can track their inventory levels in real-time, which enables them to quickly calculate their COGS. This helps businesses make informed decisions about pricing, inventory management, and overall financial performance.
How Perpetual Inventory Affects Cost of Goods Sold
How Perpetual Inventory Affects Cost of Goods Sold:
Perpetual inventory is a continuous inventory counting method that allows businesses to accurately track inventory levels as products are bought and sold. This method allows businesses to update their inventory counts in real-time as every sales transaction is recorded and every product shipment is received. This differs from a periodic inventory system, where inventory counts are only updated at the end of a specific time interval.
By tracking inventory levels in real-time, the perpetual inventory system can accurately calculate the cost of goods sold (COGS) for a particular period. The system assigns the cost of each unit sold based on the cost of that unit in inventory at the time of sale. This helps businesses to accurately determine the cost of their products sold, which is an important figure in calculating gross profit and other profitability metrics. Overall, the perpetual inventory system provides businesses with better control over their inventory levels and allows them to make timely, informed decisions based on accurate inventory data.
Calculating Cost of Goods Sold in a Perpetual Inventory System
Calculating the cost of goods sold (COGS) in a perpetual inventory system requires a bit of patience and attention to detail. The principle is straightforward – the COGS is the cost of the products sold by a business during a specific period. However, implementing this principle can become challenging when the business uses a perpetual inventory system.
To calculate the COGS, a business using a perpetual inventory system needs to maintain accurate records of each sale and purchase throughout the accounting period. The first step is to calculate the cost of the inventory purchased during the period. This can be calculated by adding the cost of the beginning inventory to the cost of the purchases made during the period. Then, the cost of the ending inventory is subtracted from this total to arrive at the COGS. By accurately calculating the COGS, businesses can make informed decisions, such as pricing strategies, that help improve profitability.
Benefits and Drawbacks of Using a Perpetual Inventory System
Benefits:
Using a perpetual inventory system can provide numerous benefits to a business. Firstly, it provides real-time visibility into inventory levels and helps in maintaining adequate stock levels. This ensures that businesses have the right products available to fulfill customer orders, which can lead to improved customer satisfaction. Secondly, it can help in minimizing the risk of stockouts and overstocking, thereby reducing the holding costs and improving cash flow. Thirdly, it can help in identifying any discrepancies or theft in the inventory easily and quickly.
Drawbacks:
While the perpetual inventory system offers several benefits, there are also some drawbacks. Firstly, it can be costly to implement and maintain the system, especially for small businesses. Secondly, the accuracy of the system relies largely on the accuracy of the data entered into it. Any errors or omissions in recording transactions can result in inaccurate inventory levels and financial reports. Thirdly, the system may be susceptible to cyber threats and data breaches, which can lead to loss of information and financial damage to the business.
Best Practices for Managing Cost of Goods Sold Under the Perpetual Method
Best Practices for Managing Cost of Goods Sold Under the Perpetual Method
When using a perpetual inventory system, it is crucial to implement certain best practices for managing the cost of goods sold. Firstly, it is important to maintain an accurate inventory count. This can be achieved by scheduling regular inventory audits and reconciliations. Doing so will help ensure that the inventory value on the books matches the actual inventory on hand, resulting in accurate cost of goods sold calculations.
Secondly, it is essential to properly classify expenses. This means separating direct costs, such as materials and labor, from indirect costs, such as overhead expenses, to get a more accurate picture of the true cost of producing goods. By accurately classifying expenses, businesses can adjust pricing strategies and control costs to maximize profitability. Overall, following these best practices will lead to more accurate financial statements and better decision-making.
Real-World Examples of Cost of Goods Sold Calculations Using Perpetual Inventory
Real-world examples of cost of goods sold calculations using perpetual inventory can provide a better understanding of the concept. One example is a grocery store, which keeps a perpetual inventory of its products, such as fruit, vegetables, and canned goods. When a customer purchases a product, the sale is recorded, and the cost of the sold item is deducted from the inventory value, updating the cost of goods sold in real-time.
Another example is a manufacturer that produces electronics. The company uses a perpetual inventory system to track the components used in their products. The cost of the components is added to the cost of goods sold when the product is manufactured and recorded in real-time as the items are sold. This helps the manufacturer to calculate their cost of manufacturing, determine profit margins, and make informed business decisions.
Final Thoughts
In a perpetual inventory system, the cost of goods sold is recorded systematically with the help of technology such as barcodes and scanners. This ensures that the cost of goods sold is consistently accurate and up-to-date. This system helps businesses track their inventory levels and monitor their stock, thereby reducing the chances of stock shortages and backlogs that can lead to lost sales and unhappy customers.
In conclusion, using a perpetual inventory system can be beneficial for businesses of all sizes. By accurately tracking inventory levels and recording the cost of goods sold, businesses can make informed decisions about stock levels, pricing, and other aspects of their operations. In the long run, this can help businesses improve their bottom line and ultimately grow their business.