Perpetual Average

Under the perpetual system the Inventory account is constantly (or perpetually) changing. When a retailer purchases merchandise, the costs are debited to its Inventory account; when the retailer sells the merchandise to its customers the Inventory account is credited and the Cost of Goods Sold account is debited for the cost of the goods sold. Rather than stayingdormant as it does with the periodic method, the Inventory account balance under the perpetual average is changing whenever a purchase or sale occurs.

Under the perpetual system, two sets of entries are made whenever merchandise is sold: (1) the sales amount is debited to Accounts Receivable or Cash and is credited to Sales, and (2) the cost of the merchandise sold is debited to Cost of Goods Sold and is credited to Inventory. (Note: Under the periodic system the second entry is not made.)

Under the perpetual system, "average" means the average cost of the items in inventory as of the date of the sale. This average cost is multiplied by the number of units sold and is removed from the Inventory account and debited to the Cost of Goods Sold account. We use the average as of the time of the sale because this is a perpetual method. (Note: Under theperiodic system we wait until the year is over before computing the average cost.) 

Let's use the same example again for the Corner Shelf Bookstore:

Number of Books Cost per Book Total Cost Inventory at Dec. 31, 2010 1 @ $85 = $      85 First purchase (January 2011) 1 @ 87 = 87 Second purchase (June 2011) 2 @ 89 = 178 Third purchase (December 2011) 1 @ 90 =         90 Total goods available for sale 5 $440.00 Less: Inventory at Dec. 31, 2011 4 @ $88.125 - 352.50 Cost of goods sold 1 @ $87.50 $  87.50

Let's assume that after Corner Shelf makes its second purchase, Corner Shelf sells one book. This means the average cost at the time of the sale was $87.50 ([$85 + $87 + $89 + $89] ÷ 4]). Because this is a perpetual average, a journal entry must be made at the time of the sale for $87.50. The $87.50 (the average cost at the time of the sale) is credited to Inventory and is debited to Cost of Goods Sold. After the sale of one unit, three units remain in inventory and the balance in the Inventory account will be $262.50 (3 books at an average cost of $87.50).

After Corner Shelf makes its third purchase, the average cost per unit will change to$88.125 ([$262.50 + $90] ÷ 4). As you can see, the average cost moved from $87.50 to $88.125—this is why the perpetual average method is sometimes referred to as the moving average method. The Inventory balance is $352.50 (4 books with an average cost of $88.125 each).