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There are two principal systems of inventory accounting, periodic and perpetual.  When the periodic system is employed, only the revenue from sales is recorded each time a sale is made; no entries are made to credit the inventory account or the purchases account for the cost of the merchandise that has been sold.  Consequently, it is only by a detailed listing of the merchandise on hand (called a physical inventory) at the close of an accounting period that the cost of the inventory can be determined.  Ordinarily, it is feasible to take a complete physical inventory only at the end of the fiscal year.  When the merchandise inventory can be determined only by a physical measurement at specified intervals, the system can be characterized as periodic.

In contrast to the periodic system, the perpetual inventory system employs accounting records that continuously disclose the amount of the inventory.  A separate account for each type of merchandise is maintained in a subsidiary ledger.  Increases in inventory items are recorded as debits to the appropriate accounts, and decreases are recorded as credits; the balances of the accounts are called the book inventories of the items on hand.  Regardless of the care with which the perpetual inventory records are maintained, it is necessary to test their accuracy by taking a physical inventory of each type of commodity at least once a year.  The records are then compared with the actual quantities and any discrepancies corrected.

The periodic inventory system of accounting is ordinarily used by retail enterprises that sell a great variety of low unit cost merchandise, such as groceries, hardware, and drugs.  The expense of maintaining perpetual inventory records is likely to be prohibitive in such cases.  Firms selling a relatively small number of high unit cost items, such as office equipment, automobiles, or fur garments, are more likely to employ the perpetual system.

Although much of the discussion that follows is applicable to both systems, the use of the periodic inventory system will be assumed.  Later in this discussion consideration will be given to principles and procedures related exclusively to the perpetual inventory system.