Inventory Valuation: Perpetual vs Periodic Methods Explained

Samreen Info ✅
27 Jul, 2025
Inventory valuation is a fundamental part of financial accounting that determines the cost of goods sold and the value of unsold inventory at the end of a period. For any business—whether it’s a small retailer or a large manufacturer—choosing the right inventory valuation method is essential for maintaining accurate financial statements and making informed decisions.
Inventory Valuation: Perpetual vs Periodic Methods Explained
In this article, we’ll cover: What inventory valuation means and why it matters, The key differences between Perpetual and Periodic inventory systems, How FIFO and Weighted Average Cost methods work under the Perpetual system, Real-life examples to help you apply these methods in practice. By the end, you’ll have a clear understanding of how inventory valuation works and which method aligns best with your business goals and accounting needs.

Introduction

Proper inventory valuation is essential for accurate financial reporting and effective business decision-making. One of the key considerations in inventory accounting is choosing between Perpetual and Periodic inventory systems, each of which influences how businesses track inventory and calculate the Cost of Goods Sold (COGS).

In this guide, we’ll explain the core differences between Perpetual and Periodic methods, illustrate how inventory valuation is performed under each system, and demonstrate practical applications using popular techniques like FIFO and Weighted Average.

By the end of this article, you will have a clear understanding of how each inventory system works, how they affect financial outcomes, and which method may be most suitable for your business operations.

What is Inventory

Inventory refers to the stock of goods and materials that a business holds for the purpose of resale or production. It includes everything from raw materials and work-in-progress (WIP) items to finished goods ready for sale. In accounting, inventory is considered a current asset because it is expected to be converted into cash within the operating cycle.

Types of Inventory in Accounting

In accounting and supply chain management, inventory is typically classified into several key categories based on its stage in the production or sales process. Understanding these types helps businesses manage their stock effectively and optimize production flow, storage, and profitability.

1. Raw Materials

Raw materials are the basic, unprocessed inputs used to create finished products. These materials are purchased from suppliers and are essential for the production process.

Examples
  • Aluminum and steel for automobile manufacturing
  • Flour for bakeries that produce bread
  • Crude oil held by oil refineries
These items have not yet undergone any transformation and are stored for future use in production.

2. Work-in-Progress (WIP)

Work-in-progress (WIP) inventory consists of goods that are in the process of being manufactured but are not yet complete. It includes items that are on the factory floor or in the assembly line.

Also known as: Inventory in production or semi-finished goods

Examples
  • A partially assembled airliner
  • A half-completed yacht at a shipyard
Tracking WIP helps businesses understand how much capital is tied up in ongoing production.

3. Finished Goods

Finished goods are fully manufactured products that are ready for sale to customers. These items have completed the production cycle and are either stored in warehouses or displayed in retail outlets.

Examples
  • Electronics like smartphones and laptops
  • Clothing stocked in fashion stores
  • Cars ready for sale at a dealership
Retailers often refer to finished goods as merchandise inventory.

4. Additional Inventory Categories (IRS Classification)

According to the IRS and some accounting practices, inventory can also include:
  • Merchandise: Goods bought for resale without any production (e.g., wholesale clothing)
  • Supplies: Items used in the production process but not part of the final product (e.g., packaging materials, lubricants)

Inventory Management System

An Inventory Management System is a business process that tracks the flow of goods—right from purchasing raw materials to selling finished products. It ensures that the right amount of inventory is available at the right time, minimizing costs and avoiding both stock outs and overstocking.

Proper inventory management helps businesses:
  • Track available stock
  • Plan purchases
  • Calculate cost of goods sold (COGS)
  • Optimize cash flow
  • Make informed decisions

Types of Inventory Management Systems

There are two main types of inventory management systems:

1. Perpetual Inventory System

  • Continuously updates inventory records in real-time after every purchase or sale.
  • Uses technology like barcode scanners or POS systems to automatically adjust stock levels.
  • Best suited for large businesses, retail chains and e-commerce platforms.

Example

A retail store sells a shirt. As soon as the item is scanned at checkout, the inventory system immediately reduces the stock count and updates COGS.

2. Periodic Inventory System

  • Updates inventory records at specific intervals (monthly, quarterly or annually).
  • Requires a physical count of inventory to calculate ending stock and COGS.
  • Simpler and cost-effective for small businesses.
Example

A small bookstore counts its books at the end of every month to determine how many were sold and how much inventory is left.

Inventory Valuation Methods Under Each System

Both Perpetual and Periodic systems use the following three major inventory valuation methods:

1. FIFO (First-In, First-Out)

  • Assumes the oldest inventory (first purchased) is sold first.
  • Ending inventory consists of the latest purchases.
Example (Perpetual FIFO)
  • Bought 100 units @ $10 → Then 100 units @ $12
  • Sold 50 units
  • COGS = 50 × $10 = $500
Example (Periodic FIFO)
  • Sales and purchases are not tracked in real-time.
  • At the end of the period, assume first-purchased goods were sold first.
Best used when prices are rising: results in lower COGS and higher profit.

2. LIFO (Last-In, First-Out)

  • Assumes the newest inventory (last purchased) is sold first.
  • Ending inventory consists of the oldest items.
Example (Perpetual LIFO)
  • Bought 100 units @ $10 → Then 100 units @ $12
  • Sold 50 units
  • COGS = 50 × $12 = $600
Example (Periodic LIFO)
  • COGS calculated at the end of the period based on latest purchases.
  • Best used when prices are rising: results in higher COGS and lower profit (reduces taxable income in some countries).

3. Average Cost (Weighted Average)

  • Takes the weighted average of all inventory units available.
  • Every unit is assumed to have the same average cost.
Formula: Weighted Average Cost = Total Cost of Goods Available ÷ Total Units Available

Example
  • Bought 100 units @ $10 = $1,000
  • Bought 100 units @ $12 = $1,200
  • Total = 200 units, $2,200
  • Average Cost = $11 per unit
If 50 units sold
  • COGS = 50 × $11 = $550
Used under both Perpetual and Periodic systems.

Perpetual Inventory Management System Format

The Perpetual Inventory Management System continuously tracks inventory transactions in real-time. Every purchase and sale is immediately recorded, providing up-to-date information on inventory levels and cost of goods sold (COGS). This method allows businesses to maintain accurate inventory records without needing a physical count for each transaction.
Perpetual Inventory Management System Format
In the following section, we will demonstrate the Perpetual Inventory Format using practical examples. We'll apply inventory valuation methods such as FIFO (First-In, First-Out) and Weighted Average Cost, showing how each method affects the inventory ledger.

Let’s begin with the format and move step-by-step through the calculations using sample transactions.

Question-

The Neo Company had the following inventory record for the month of January 2023:

Date Item Description Quantity Unit Price
01/01/2023 M1 Beginning Inventory 5 units Tk. 20
05/01/2023 M2 Sales 2 units -
11/01/2023 M3 Purchases 9 units Tk. 12
28/01/2023 M4 Sales 7 units -

Assuming a perpetual inventory system is used and the store manager determined the cost of goods sold and ending inventory using the following methods:

Method of Inventory Cost of Goods Sold Ending Inventory
FIFO Tk. 148 Tk. 60
LIFO Tk. 124 Tk. 84
Weighted Average Tk. 138 Tk. 70

Required
  • As a professional accountant, can you agree with the above report of the store manager?
  • Determine the cost of goods sold and the ending inventory for FIFO and Weighted Average method under Perpetual Inventory System.
Solution

FIFO Method (Perpetual Inventory System)

Date Purchase Sales Balance (After Transaction)
Unit Cost Amount Unit Cost Amount Unit Cost Amount
01/12/29 — — — — — — 5 20 100
2 20 40 3 20 60
05/12/29 9 12 108 — — — 3 20 60
9 12 108
28/12/29 — — — 3 20 60
4 12 48 5 12 60
Total Sales 148



  • The cost of goods sold is Tk. 148, and the ending inventory is Tk. 60, which matches the store manager’s report.
  • Therefore, I agree with the report under the FIFO method.
Weighted Average Method (Perpetual Inventory System)

Date Purchase Sales Balance
Unit Cost Amount Unit Cost Amount Unit Cost Amount
01/01/23 5 20 100
06/01/23 2 20 40 3 20 60
11/01/23 9 12 108 12 14 168
28/01/23 7 14 98 5 14 70
Total:
138 70
  • The cost of goods sold is Tk. 138, and the ending inventory is Tk. 70, which matches the store manager’s report.
  • Therefore, I agree with the report under the Weighted Average method.

Periodic Inventory Management System Format

The Periodic Inventory System is an accounting method where inventory records are updated at specific intervals—such as weekly, monthly, quarterly, or yearly—rather than continuously. Under this system, businesses do not track inventory in real-time. Instead, they perform a physical count of inventory at the end of each period to determine the Closing Stock.
Periodic Inventory Management System Format
This method is simple and cost-effective for small businesses but may lack real-time inventory control. The Cost of Goods Sold (COGS) is calculated at the end of the period using the formula:

COGS = Cost of Goods Available for Sale – Closing Inventory

Let’s understand this with a step-by-step example.

Process of Periodic Inventory Valuation-FIFO Method (with Example)
  • (First) – Calculate Cost of Goods Available for Sale (COGAFS)
Date Particulars Unit Cost Amount
01 Beginning Inventory 5000 2 10,000
02 Purchase 6000 3 18,000
03 Purchase 7000 4 28,000
Total 18000 56,000
✅ Total Units Available for Sale = 18,000
✅ Total Cost of Goods Available for Sale = 56,000
  • (Second) – Identify Closing Inventory Units
Suppose physical count shows Closing Inventory = 5500 units
  • (Third) – Calculate Closing Inventory Value (e.g., using FIFO method)
For FIFO (First-In, First-Out), the closing inventory is taken from the most recent purchases.
Date Particulars Unit Cost Amount
03 Purchase 5500 4 22,000
✅ Closing Inventory = 22,000
✅ COGS = 56,000 – 22,000 = 34,000

Conclusion

Understanding inventory accounting through real-world examples is essential for making accurate financial decisions. Whether you're using the FIFO or Weighted Average method under the Perpetual Inventory System, tracking inventory and COGS ensures that your books stay balanced and compliant.

Have you used the FIFO or Average method in your accounting practice?
Which inventory system do you prefer — Perpetual or Periodic?
👉 Drop your comments below, share your thoughts, and let’s discuss more real-world inventory problems together!

Thank you
Samreen Info. 

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