When to use periodic inventory system

A periodic Inventory System is defined as an inventory valuation method in which inventories are physically counted at the end of a specific period to determine the cost of goods sold.

• That means ending inventoryEnding InventoryThe ending inventory formula computes the total value of finished products remaining in stock at the end of an accounting period for sale. It is evaluated by deducting the cost of goods sold from the total of beginning inventory and purchases.read more balance is updated only at the end of the period instead of a perpetual inventory systemA Perpetual Inventory SystemPerpetual Inventory System in accounting means maintaining real-time purchase and sale of inventory using an automated computerized system and readily calculates Cost of Goods Sold (COGS) for a manufacturing concern. It eradicates the efforts earlier consumed in the physical verification of stock.read more where inventories are counted frequently.
• “Generally Accepted Accounting Principle” allows firms to accept any model.
• The periodic system can be used in small and retail businesses where the inventory quantity is generally high, but the value is on the lower side. This way, businesses can save time and resources.

Table of contents

• Periodic Inventory System Definition
  • Steps involved in the Periodic Inventory System
  • Periodic Inventory System Journal Entries
  • Examples
  • Periodic vs Perpetual Inventory System
  • Which Companies use the Periodic Inventory System?
  • Advantages
  • Disadvantages
  • Recommended Articles

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Steps involved in the Periodic Inventory System

Below are the steps involved in the periodic inventory system –

1. The Beginning and Ending Inventory is physically counted in a given period in this system.
2. The company will also account for total purchases made for inventory in that period to find out the “Cost of Goods Available for SaleThe cost of goods available for sale refers to the cost of total goods produced during the year after accounting for the cost of finished goods inventory at the beginning of the year and is available for sale to the end-users.read moreThe cost of goods available for sale refers to the cost of total goods produced during the year after accounting for the cost of finished goods inventory at the beginning of the year and is available for sale to the end-users.read more.”
3. Cost of Goods available for Sale = Beginning Inventory + Purchases
4. So, Cost of Goods Sold for that periodThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read moreThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more will be:
5. Cost of Goods Sold= Cost of Goods Available for Sale – Ending Inventory.

Periodic Inventory System Journal Entries

Let’s say you are running a retail business, in which your firm must purchase inventory almost every day to run your day-to-day business. Suppose your company has adopted the Periodic Inventory system for calculating the “cost of goods sold.” Now, on a given day, your firm needs ten units of inventory costing $1 each and has purchased that in the current accounting period through cash. In total, the purchase made $10. Of course, some of that inventory can become” Finished Goods” and be sold during the period, but your accountant doesn’t need to worry about that. Instead, a “purchase account” will be created in a periodic system for each bought inventory, which is an ‘asset.’ All the inventory purchases are stored in this account.

Periodic Inventory System Journal Entries for the same will be as follows:

Same as above, let’s say for the accounting period, you purchased inventory for a total of $100(100 units of $1 each). Below will be the journal entries for the Periodic Inventory System –

At the end of the accounting period, you need to determine your firm’s actual ending inventory and “cost of goods sold.” At first, his $100 will be shifted from Purchase Account to Inventory Account. This purchase account can be a temporary account to hold all the inventory purchases for a given accounting period.

At the end of the accounting period, below will be the process.

Examples

So, in this example of a periodic inventory system, your current period beginning inventory account was $1,000, and since at the end of a period, $100 was also added to that account. So, the inventory account now will be $1,100. This will be yours. “Cost of goods available for sale.”

Cost of Goods available for Sale = 1000+100 =$1100

We are having the final “Cost of Goods Available for Sale” as per our books. But the firm still doesn’t know the amount of inventory sold in the period. At the end of the period, your company will physically check the inventory. Let’s say the Ending inventory count is 1,050 units. Each unit costs $1, so the physical checked ending inventory is $1,050. To reconcile the physical inventory count with the inventory accounts in books, we will have to shift $50 from the inventory account to “Cost of goods sold.”

We can say the same as the below equation:

Cost of Goods Sold = Cost of Goods available for Sale -Ending inventory.

Here, we have not accounted for “Work in Progress,” “Raw Material,” etc. We are physically counting inventory only at the end of the period and reconciling that with the inventory recorded in the books.

Periodic vs Perpetual Inventory System

• Inventory is not tracked daily for the periodic system, while it is physically tracked regularly after each transaction in the perpetual system.
• A Perpetual system is a costlier and more time-consuming process.
• In a perpetual system, goods count is limited, but they are highly valued. The periodic system is inventory count on the larger side with a lower value per unit value.
• Companies need a separate workforce for tracking inventory in the Perpetual system, which is not needed in the Periodic system since it is done occasionally.
• In a perpetual system, inventory quantity and condition can be known for the whole period, which is impossible in the periodic system.

Which Companies use the Periodic Inventory System?

• The periodic Inventory system is useful for small and retail businesses.
• Companies where the quantity of inventory is quite high but per-unit priceUnit PriceUnit Price is a measurement used for indicating the price of particular goods or services to be exchanged with customers or consumers for money. It includes fixed costs, variable costs, overheads, direct labour, and a profit margin for the organization.read more is lower.
• Where companies cannot stop this daily routine to inspect inventory regularly physically;

Advantages

• Since no physical counting was needed between the periods, a lesser workforce was required. That means it is cheaper.
• Regular work does not get hampered because of physical checking only at the end of the period.
• Quantity is physically inspected at the end of the period, so it is reliable in verifying the end-of-period accounting.
• No need to verify “Work in progress” or “raw materials” in between the periods;

Disadvantages

• It will not provide any information about the Cost of Goods Sold in the interim period.
• Since there is minimal information between the periods, there can be a significant adjustment that needs to be made at the end.
• The chances of fraud are quite high.
• For large companies, this system is not suitable.

Recommended Articles

This has been a guide to the Periodic Inventory System and its definition. Here we discuss the steps to the Period Inventory System and its journal entries and practical examples. You may learn more about it from the following articles –

What kind of businesses use periodic inventory systems?

Why is it good to use periodic inventory method explain briefly?