3. Perpetual vs Periodic

Let's talk about keeping track of our inventory. There are two ways to keep track of your inventory. One is the perpetual method, and the other is the periodic method. Now, before we do any accounting, you know I like to say that words have meaning. So perpetual, what does perpetual actually mean? Well, it means always or all the time or constantly.

So this is not related to accounting at all. This is just the word perpetual. Contrast that with periodic. What does periodic mean? Periodic means sometimes. It means every now and then. Or it means at an interval. So with that in mind, let's look at how that applies to accounting. Both of these systems keep track of inventory. Perpetual system and the periodic system keep track of inventory. But what's different is this question: When do we know how much inventory we have?

And we've already laid out the answers right up here. These words all answer this question. So let's read it over here on the perpetual side. Under the perpetual system, when do we know how much inventory we have? Always, all the time, constantly. Under the periodic system, when do we know how much inventory we have? Sometimes, every now and then, at an interval, or at the end of some period. So when you see this on the test, you should look at the word perpetual and think, "I'm smart. I know what the word perpetual means. It means constantly, all the time, forever. I know what the word periodic means.

It means on some interval." And these words don't change just 'cause we're talking about accounting. But the question that they're answering is: When do we know how much inventory we have? So what does this actually mean? Under the perpetual inventory method, if we're supposed to always know how much inventory we have, then we must keep track of it.

Because how are we gonna know if we don't keep track of it? If we wanna know what it is today, we wanna know what it was yesterday and the day before, we have to have been keeping track of that inventory. Now, on the periodic side, we don't keep track of it, we just count it.

We just count it per period. So whatever the period is, and it could be probably a year, we just count it at the end of the year, and we come up with our inventory number. The other thing that this leads us to is cost of goods sold. So we could also say, when do we know cost of goods sold?

And the answer would be the same. Under the perpetual method, we always know the cost of goods sold. Under the perpetual method, we know the cost of goods sold all the time and constantly. Under the periodic method, we know the cost of goods sold sometimes, every now and then, and at the interval at which we're counting the inventory. Let's take a look and see why that is.

Over here on the perpetual side, if we're constantly keeping track of inventory, what does that functionally look like? So let's say that we make a sale, and we get cash of $1,000, and we get revenue of $1,000. Okay, well, that's part of it. That's one entry, but we didn't touch inventory at all. So the other part of this sale entry is where you decrease the inventory, right? So let's say the cost was $600 to buy whatever we sold for $1,000, and the matching debit for that credit is cost of goods sold.

So if we're doing the perpetual system, we have these two entries, one for the revenue side and two for the expense side. So in this entry alone, in this number two entry right here, what we've done is we've perpetually tracked inventory, so we know from one moment to the next how inventory has changed, and we also know from one moment to the next how cost of goods sold has changed. Contrast that with the periodic system. We still do the revenue portion of this journal entry. That doesn't change. But because on the periodic side we don't adjust inventory directly, there's no room for this cost of goods sold entry, right?

We can't have a $600 debit without a $600 credit. So then what happens at the end of the period? We record the sale, and that's it on the periodic side. Then at the end of the period, let's say we've got some inventory account, and it had $10,000 to start the year, and then we added $20,000 throughout the year, and we'll go over this in more detail in another video. I just wanna give you a quick overview. So we had $10,000 beginning, $20,000 of purchases, and then we have an accounting company come out at the end of the year and count our inventory and find out we have $5,000 in ending inventory.

Well, that's 30, that's 5, so 25. So that's how much inventory we sold. So then at the end of the year, we have an entry that just looks like this: cost of goods sold, 25,000; inventory, 25,000. So now you'll believe me that as often as you know your inventory is as often as you know your cost of goods sold. If you always know your inventory, well, that's because you're keeping track of it, and the other half of that journal entry is cost of goods sold. And if you sometimes know your inventory only when you count it, that means you're not keeping track of it. So those two entries that we had on the perpetual side, we just don't have on the periodic side, and we rely on this formula at the end of the year to figure out our inventory sold, which is our cost of goods sold.