Inventory (AS 2) and the systems of inventory

Inventory (AS 2). “Inventories are assets (a) held for sale in the ordinary course of business, (b) in the process of production for such sale, or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services” (AS 2, para 3.1). They include goods bought for resale, finished goods, work in progress, raw materials, stores and loose tools, but not spare parts and standby equipment that qualify as property, plant and equipment.

Systems of inventory. There are two: the periodic (physical) system and the perpetual system.

1. Periodic system. Stock is found by a physical count on a given date, usually at the end of the year, and the cost of goods sold is worked out as opening inventory + purchases − closing inventory counted.

• Advantages: simple for a small business, and cheaper, since it needs no software or training.
• Disadvantages: losses from theft, waste or evaporation are hidden in the cost of goods sold; the count disrupts business for some days; frequent statements become costly; and inventory control is not possible.

2. Perpetual system. The stock balance is recorded after every receipt and issue, on a card or sheet for each item, and physical checks are compared with the records.

• Advantages: business need not stop for stock-taking; stock-outs are avoided; and losses are easy to control, since the records show what should be on hand.
• Disadvantages: it is costly to set up and run (equipment, software, labour), and entry or scanning errors can make the records misleading.

The perpetual system suits large enterprises; small businesses may use the periodic system.