The periodic inventory system is an inventory valuation method for recording in financial reports, in which a physical inventory count is performed at specific intervals or periods. This accounting method is characterized by taking inventory at the beginning of a period.
Later, it adds the new inventory purchases made during that period and subtracts the ending inventory, in order to obtain the cost of the merchandise sold as a result. The periodic inventory system will only update the ending inventory balance in the general ledger when a physical inventory count is performed.
The only time a periodic inventory system is truly up to date is at the end of an accounting period. Although a recurring system saves data entry time, it can actually cost the business money.
Because physical inventory counts are time consuming, few companies do them more than once a quarter or year. Meanwhile, the inventory account in the accounting system will continue to show the cost of inventory that was posted since the last physical inventory count.
In the periodic inventory system the inventory account of the system is not updated with each purchase and each sale. All purchases made between the physical inventory counts are posted to the purchasing account.
When the physical inventory count is performed, the balance in the purchasing account is shifted to the inventory account, which in turn is adjusted to match the ending inventory cost.
At the end of the period, the total in the purchasing account is added to the beginning inventory balance to calculate the cost of the products available for sale.
Ending inventory is determined at the end of the period using a physical count and is subtracted from the cost of products available for sale to calculate the cost of merchandise sold.
Under the periodic inventory system, a company will not know its inventory levels or the costs of merchandise sold until the physical count process is complete.
Differences between periodic and perpetual inventory
The following are the main differences between the periodic and perpetual inventory systems:
– In both systems the inventory account and the cost of goods sold account are used, but in the perpetual inventory system they are continuously updated during the period, while in the periodic inventory system they are updated only at the end of the period.
– Purchase and purchase return accounts are only used in the periodic inventory system and are continually updated. In the perpetual inventory system, purchases are charged directly to the inventory account and returns of purchases are credited directly to the inventory account.
– The sale transaction is recorded through two journal entries in the perpetual system. One of these records the value of the inventory sale, while the other records the cost of the merchandise sold. In the periodic inventory system only one entry is made: the sale of inventory.
– Closing records are only required in the periodic inventory system to update inventory and cost of merchandise sold. The perpetual inventory system does not require closing records for the inventory account.
– The periodic inventory system is most useful for small businesses that maintain minimum amounts of inventory; These companies find it easy to complete a physical inventory count. It is also easy to estimate the cost of the merchandise sold for the middle of the period.
– It is not required to have an automated system to record the data. Inventory can be carried manually, saving the cost of the system and the time to continuously record inventory movements.
– The main problem with a periodic system is that it does not provide real-time data for managers. You are always working with old data from the last update performed.
– It does not provide any information on the cost of merchandise sold or ending inventory balances during the interim period, until a physical inventory count is done.
– It is time-consuming in physical counts and can produce stale numbers, which are less useful to management.
– Generally the system is manual and more prone to human errors. Data can be misplaced or lost.
– Surpluses and shortages of inventory are hidden in the cost of the merchandise sold. There is no accounting record available to compare with the physical inventory count.
– The cost of merchandise sold should be estimated during the intervening periods, which is likely to result in a significant adjustment to the actual cost of the products each time a physical inventory count is completed.
– There is no way to adjust for obsolete inventory or losses due to defective products during the interim periods, so for these problems there tends to be a significant (and expensive) adjustment when a physical inventory count is finally completed.
– It is not a suitable system for large companies that have large investments in inventories, given its high degree of inaccuracy at any time (other than the day the system is updated with the last physical inventory count).
The calculation of the cost of the merchandise sold under the periodic inventory system is:
Cost of products available for sale = starting inventory + purchases
Cost of merchandise sold = cost of products available for sale – ending inventory.
The Milagro Corporation has a starting inventory of $ 100,000 and has paid $ 170,000 in purchases. Your physical inventory count reveals an ending inventory cost of $ 80,000. Therefore, your calculation of your cost of goods sold is:
$ 100,000 beginning inventory + $ 170,000 purchases – $ 80,000 ending inventory
= $ 190,000 cost of merchandise sold
The following information pertains to Tumleh Company, a high-scale fashion retailer:
Inventory balance as of January 1, 2017: $ 600,000
Purchases made during 2017: $ 1,200,000
Inventory balance as of December 31, 2017: $ 500,000
It is required to calculate the cost of the merchandise sold for the year 2017. It is assumed that the company uses a periodic inventory system.
Cost of merchandise sold = starting inventory + purchases – closing inventory
= $ 600,000 + $ 1,200,000- $ 500,000
= $ 1,300,000
- Steven Bragg (2017). Periodic inventory system. Accounting Tools. Taken from: accountingtools.com.
- Investopedia (2018). Periodic Inventory. Taken from: investopedia.com.
- Accounting For Management (2018). Periodic inventory system. Taken from: accountingformanagement.org.
- Jan Irfanullah (2013). Perpetual vs Periodic Inventory System. Accounting explained. Taken from: accountingexplained.com.
- My Accounting Course (2018). What is a Periodic Inventory System? Taken from: myaccountingcourse.com.