The following is an excerpt from Accounting Made Simple: Accounting Explained in 100 Pages or Less.
Under GAAP, there are two primary methods of keeping track of inventory: the perpetual method and the periodic method.
Perpetual Method of Inventory
Any business that keeps real-time information on inventory levels and that tracks inventory on an item-by-item basis is using the perpetual method. For example, retail locations that use barcodes and point-of-sale scanners are utilizing the perpetual inventory method.
There are two main advantages to using the perpetual inventory system. First, it allows a business to see exactly how much inventory they have on hand at any given moment, thereby making it easier to know when to order more. Second, it improves the accuracy of the company’s financial statements because it allows very accurate recordkeeping as to the Cost of Goods Sold over a given period. (CoGS will be calculated, quite simply, as the sum of the costs of all of the particular items sold over the period.)
The primary disadvantage to using the perpetual method is, of course, the cost of implementation.
Periodic Method of Inventory
The periodic method of inventory is a system in which inventory is counted at regular intervals (at month-end, for instance). Using this method, a business will know how much inventory it has at the beginning and end of every period, but it won’t know precisely how much inventory is on hand in the middle of an accounting period.
A second drawback of the periodic method is that the business won’t be able to track inventory on an item-by-item basis, thereby requiring assumptions to be made as to which particular items of inventory were sold.