Inventory Accounting

The purpose of inventory tracking is to ensure that while some of your capital must be tied up in inventory, it does not hinder your company's cash flow or waste employee's time. Your business will run best if you have an accurate count of that inventory, procedures for changing it, and an organization scheme that allows fast and efficient access to it.

The processes discussed here are concerned with determining the quantity of inventory in units (unit may include multiple e.g. cases, drums etc.). The dollar data on financial statements are determined by multiplying the units’ information by the cost information, which is subsequently described.

Perpetual Inventory Systems
System of inventory control in which the number of units of any inventory item (and the total value of inventory) on any day can be obtained from the stock records. In this method (1) all additions (purchases) and withdrawals (sales or consumption) are recorded in inventory cards as they occur to provide a running balance of quantity and cost of items, (2) a certain number of items are counted every day (or week or month) so that, by the year end, every item has been actually (physically) counted at least once. If there is any mismatch (due to human error, leakage, pilferage, loss) between the physical quantity and the quantity shown in inventory cards, the records are adjusted accordingly. Also called continuous inventory method.

Perpetual inventory is a method of maintaining inventory records that relies on updating those records in real time. As a result, the information is always current, providing an accurate reflection of goods currently on hand. This contrasts with other systems that rely on periodically counting inventory to determine the total amount of goods in inventory. The perpetual inventory method is extremely popular in retail environments where real time information about inventory status is valuable for maintaining adequate stocks of top selling items.

Manufacturing companies and wholesale distributors use this system mainly tracking inventory of raw materials and finished goods.

Periodic Inventory Systems
System of inventory control in which no continuous record of changes (receipts and issues of inventory items) is kept. At the end of an accounting period, the ending-inventory is determined by an actual (physical) count of every item and its cost is computed by using a suitable method such as FIFO, LIFO, weighted averages, etc. This amount is subtracted from the sum of purchases (or cost of goods manufactured) and the beginning-inventory of the new accounting period to arrive at the cost of goods sold.

A periodic system does not attempt to keep track of each issue and disbursement of items. Instead, a review is made in regular cycles, which might be daily, weekly, or monthly, depending on the nature of the goods, to determine the inventory level and signal the need for replenishment or other action.

Periodic review systems need larger safety stock than continuous review systems, given same variations in demand, as safety stock must cover variations in demand during the replenishment period as well as during the lead-time. The review period is fixed and the order quantity is allowed to vary.  Periodic systems are often used for MRO supply items or for other small, inexpensive parts.

Visual Review Systems
A visual review system is similar to a periodic system in that no perpetual on-hand balances are recorded. However, it is generally a little less formal than a periodic system, with reliance on visual recognition by users for reorder or other actions. The two-bin system of inventory storage is a common method of operating this system.

Visual reviews are often used to manage office supplies, common hardware items and other small, inexpensive MRO supplies.

Four-Wall Inventory Systems
Four-wall systems (also known as wall-to-wall systems) record inventory receipts when they first arrive at a plant or warehouse. However, they are not subtracted from inventory until they leave the location in the form of deliverable finished goods. This technique is often used when materials are received, converted into deliverable form, and shipped within a very short period of time. They may not be held in a storeroom at all.