Basheerah Kharva

Task 3: Accounting Project

Inventory valuation
methods in perpetual
and periodic inventory
systems.
Table of Contents
1. Introduction .................................................................................................................. 3
2. Perpetual inventory system .......................................................................................... 4
Specific identification ............................................................................................................ 4
FIFO ...................................................................................................................................... 5
Weighted average................................................................................................................... 7
3. Periodic inventory system............................................................................................. 9
Specific identification ............................................................................................................ 9
FIFO .................................................................................................................................... 10
Weighted average................................................................................................................. 11
4. Comparison and analysis ........................................................................................... 12
5. Conclusion ................................................................................................................. 15
Bibliography ....................................................................................................................... 16
 1. Introduction
An inventory management system is an administrative system
that monitors and records the movement of stock through the
business from the time it is brought to the time it is sold.

The internal control process for inventory should ensure that

stock is managed correctly.

Detailed perpetual or periodic inventory records should be

maintained and any movements of stock should be recorded
promptly.

Inventory must be safe guarded against theft, pilferage and losses

by regular physical stock take.

Lost, stolen or destroyed items must be reported immediately

and should record the annual financial statements.

Access to stocks should be limited and supervised.

 2. Perpetual inventory system
Specific identification
Definition and explanation
A business that sells items that are easily identifiable; unique and
high in value, will use this method of cost calculation.
All cost in purchasing trading stock is included as this would
increase the cost.
Closing stock is the value of what is unsold stock values are
realistic as this is based on the actual cost price; unless stock is
not sold quick enough and becomes obsolete.

Example
A car dealership is an excellent example where the specific
identification method is used.
Each vehicle has a unique serial number and cost so it is easy to
match the actual cost to the item sold.

Advantages disadvantages
• Stock values are realistic • If an item is unsold for a
because they are based long period of time the
on the actual cost price of original cost price might
each item not be covered

• useful for high value; low • Can be time consuming

volume goods where and expensive to manage
differences in cost can be
significant.
FIFO

Definition and explanation

This method is based on the assumption that the older stock is

sold first and the stock on hand will always be the most recently
acquired.
All cost in purchasing the trading stock is included as this will
increase the cost.
This method is more realistic as stock is valued at most recent
prices.

Application in inventory management

The stock on hand is calculated by identifying the batches of the

most recent stock bought and allocating these cost prices to the
number of items on hand
FIFO specific identification
• This method is based on • large, easily identifiable
the order in which stock and unique stock items
is bought and sold. example cars.
example: items which
have a limited shelf life • Each item has its own
due to fashion, seasons, cost price in the invoice.
technology, expiring date
such as clothing, cell • Closing stock is the value
phones and milk. of what is unsold.

• The stock bought first is

sold first.

• Closing stock value

would be the most recent
purchases.

Scenarios

Items which have a limited shelf life due to fashion, seasons,

technology and expiring dates is likely to use this method
Businesses dealing with fast moving consumer goods example
bakery, dairy and fresh farmed produce will also use this method.
Weighted average
Definition and explanation

The average price per unit is calculated.

The value of closing stock is calculated using the average price.
All cost in purchasing trading stock is included as this will
increase the cost.
Suited for similar value stock items purchased regularly and in
large quantities.

Calculation of stock method

Total value of stock = opening stock+ purchases- returns+

carriage on purchases+ import duties+ any additional cost

Total value of stock

number of units = average price per unit

Advantages
With weighted average sporadic price increases are flattered
(leveled)
Small and medium size businesses may choose the weighted
average method for its simplicity
Example: A business that needs to value similar stock items
purchased regularly will use this method (canned food
companies/sports gear manufacturers and textile industry).
 3. Periodic inventory system
Specific identification

Specific identification under the periodic inventory system

Inventory records are not updated continuously in the periodic
inventory system using this method. The business counts its
inventory at the end of an accounting period to determine the
cost of sales. When using the specific identification method with
this system, the actual cost of each item sold during the period is
matched with the revenue.
The business has to keep detailed purchases and sales records
as they need this information at the end of the financial period.
This requires accurate identification of the cost of each specific
unit in stock.

in the perpetual system inventory and cost of goods sold are

updated at point of sale, allowing continuous tracking of specific
items.
in the periodic system updates occur only at the end of the
financial year requiring accurate recording to identify when
specific inventory items you are sold
FIFO

Application in periodic inventory system

Unsold items are calculated exactly the same as in the perpetual

inventory system
The closing stock is also calculated exactly the same as in the
perpetual inventory system

The cost of sales is calculated using the formula opening stock+

purchases+ carriage purchases+ custom duty-closing stock

The gross profit is calculated in the trading account using the

formula (sales+ closing stock)-(opening stock+ purchases+
carriage on purchases+ custom duties)

Challenges benefits

• No records at the point of • fewer complex

sale may lead to calculations as cost of
inaccuracy, if inventory sale adjustments are
records are not made only at the end of
maintained regularly the financial year

• May not accurately reflect • Assists in reflecting

the sales in the period; correct flow of inventory
During price fluctuation sold especially in
businesses where older
stock is sold first
 Weighted average
Application in periodic inventory system
under the periodic inventory system, the weighted average cost
per unit is calculated once at the end of the accounting.
The average cost is based on the total cost of good available for
sale divided by the total number of units available during that
period.
The same average cost is then use to calculate the units sold and
units remaining in inventory.
Weighted average cost per unit=
Total cost of goods available for sale
Total units available for sale
Limitations advantages

• The average is calculated • It is easy to calculate the

at the end of the cost of units and
financial year, therefore simplifies other
price changes during the accounting processes.
year is not reflected.

• Businesses what • Businesses with

frequent fluctuation in interchangeable items
inventory prices may find will benefit from using
the weighted average the weighted average
method inaccurate. method
 4. Comparison and analysis
Perpetual inventory Periodic inventory

• Used when trading of • Used when trading in

individual, easily large volume low value
recognizable items. goods.

• Transactions are • Transactions recorded in

recorded in the trading purchases account.
stock account
• Cost of sales is
• A stock count is calculated periodically,
performed to validate usually at the end of the
stock records and accounting.
determine losses.
• A physical stock count
• Additional costs like must be done at the end
carriage on purchases are of the accounting to
debited to the trading determine the value of
stock account closing stock.

• The cost of sales is then

calculated using the
closing stock amount.

• Additional expenses like

carriage on purchases are
recorded separately in a
nominal account.
 Perpetual inventory
Strengths Weaknesses

• stock on hand is • it is expensive to

available in the records. implement due to need
for technology and
• It is accurate and systems.
realistic
• Requires constant
• To find stocks surplus or updates and monitoring.
deficit you can compare
records to physical • May be affected by
accounts technical errors or data
entry mistakes

Periodic inventory
Strengths weaknesses
• less accurate as it only
• This method is cheaper updates at intervals.
and easier to use
• It is difficult to identify
• you do not need to inventory lost like theft
calculate the cost of and damages
sales every day immediately.

• Time consuming because

physical counts are
required

• Cannot provide real time

inventory data
 The impact of each method on financial statements

FIFO will result in lower cost of sales and higher gross profit in
inflationary periods.
this means higher net income and taxes.

Weighted average will produce a moderate profit and is less

affected by price swings.

Specific identification can skew financial results depending on

which items are sold. (cheaper or more expensive ones)

Recommendations for businesses

Use FIFO if the company is selling perishable goods.

Use specific identification if your company is selling high valued

or custom items like cars and jewelry.

Use weighted average for bulk, exchangeable goods or where

prices are inconsistent.

Perpetual systems are better for businesses that need tighter

control and real time data.

Periodic system may suit smaller or less tech dependent

operations.
 5. Conclusion
Businesses must choose an inventory method based on the
goods sold.
Each method has unique characteristics, with advantages and
disadvantages that may affect gross profit and taxation
obligations to SARS.
A business may not change from one method to another without
permission from SARS, as a business may not be able to compare
financial results if they change from one method to another.

Choosing the right inventory valuation method improves accuracy

in financial management.
This will contribute to the company’s long term success.
 Bibliography
1. Mind the gap study guide accounting Grade 12

2. https://wcedeportal.co.za

3. www.wozamatrics.co.za

4. https://wcedeportal.co.za

5. Study and Master Accounting, Grade 12

6. accounting compiled by Mrs. cw Brimblecombe