What is a Periodic Inventory System + When to Use it

Perpetual inventory systems bring a lot of advantages to the
table, yet there are still some things you need to look out for. We touched on perpetual inventory above, but let’s take a closer look before we start wrapping things up. Inventory shrinkage refers to the difference between how many items should be remaining (based on sales) and how many actually are. These discrepancies can happen as a result of employee theft, shoplifting, or vendor mistakes. Business owners subtract the cost of goods sold from total revenue to get their gross profit, which is a measurement of the business’s profitability.

Beginning inventory simply equals the ending inventory from the previous time period. Sometimes, a business will experience goods lost in transit, purchase returns, product recalls, and the like. With periodic inventory, https://www.bookstime.com/articles/what-is-periodic-inventory-system however, there’s no way to account for these unexpected changes. The perpetual inventory system of accounting uses electronic mediums such as computers to track the inventory transactions of a business concern.

Shipping on Inventory Purchases

In a perpetual system, the software is continuously updating the general ledger when there are changes to the inventory. In the periodic system, the software only updates the general ledger when you enter data after taking a physical count. In a perpetual system, the COGS account is current after each sale, even between the traditional accounting periods. In the periodic system, you only perform the COGS during the accounting period. Periodic inventory systems are valued for their simplicity, and all it takes is some time to physically count your starting inventory at scheduled intervals throughout the year. Without complicated calculations or multiple accounting records, a periodic inventory method can be implemented without major planning or preparation.

Contra accounts generally consist of purchase discounts or purchases returns, allowances accounts,etc.. General Ledger account Inventory is not updated whenever the purchases of goods to be resold are made. For this, a temporary account is considered that begins each year with a zero balance. And the ending balance is removed to another account at the end of the year. The total unit cost transferred over to the balances happens when the stock sold comes in.

Adjusting and Closing Entries for a Perpetual Inventory System

There are some key differences between perpetual and periodic inventory systems. When a company uses the perpetual inventory system and makes a purchase, they will automatically update the Merchandise Inventory account. Under a periodic inventory system, Purchases will be updated, while Merchandise Inventory will remain unchanged until the company counts and verifies its inventory balance. This count and verification typically occur at the end of the annual accounting period, which is often on December 31 of the year.

Hence, the ledger tally accounts for purchases, and transactions are not kept running. A periodic inventory system measures the level of inventory and cost of goods sold through occasional physical counts. In contrast, the perpetual inventory system is a method that continuously monitors a business’s inventory balance by automatically updating inventory records after each sale or purchase. The periodic and perpetual inventory systems are different methods used to track the quantity of goods on hand. The more sophisticated of the two is the perpetual system, but it requires much more record keeping to maintain. If you run an e-commerce business that does not require you to physically keep items in stock, going the periodic inventory route is not necessary.

Periodic Inventory System

Learn more about a perpetual system and how it gives a more precise inventory solution by reading our «Guide to Perpetual Inventory». The periodic inventory system is used by many smaller retailers as it requires only the recording of purchases during the accounting period. The cost of goods sold expense is calculated at the end of the period using the actual ending inventory value. A perpetual inventory tracking system records adjustments to inventory balances after every transaction through point-of-sale inventory systems. Periodic inventory systems start by taking a physical inventory count at the beginning of a specific period. Aside from this initial record, no other updates are made to the inventory ledger until the next period.

Here the cost of goods sold is calculated after a certain period and not after every sale. Small businesses like retailers having grocery shops, pharmacies, Cloth stores, etc., follow this inventory system, but large businesses that need to check the inventory avoid using it regularly. Click the button below to learn how our team can help with fulfillment for your ecommerce business. Using the periodic inventory method, the total cost of goods sold for the period comes to $350,000.

How does periodic inventory work?

Every parcel that is delivered is first scanned, after which the balance is added to the current inventory levels. Consider a perpetual inventory system that is used in a post office warehouse, which ships and receives packages each day. This involves computing the cost of goods sold during the period and the appropriate cost of the ending inventory.

Imagine owning an office supply store and trying to count and record every ballpoint pen in stock. This is why many companies perform a physical count only once a quarter or even once a year. For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.

The difference between the periodic and perpetual inventory systems

In other words, the cost of what they sell is the same as what they most recently paid for that inventory. Companies make any necessary adjustments from purchasing goods to a general ledger contra account. A contra account is meant to be opposite from the general ledger because it offsets the balance in their related account and appears in the financial statements.

Although a periodic physical count of inventory is still required, a perpetual inventory system may reduce the number of times physical counts are needed. At the end of the period, a perpetual inventory system will have the Merchandise Inventory account up-to-date; the only thing left to do is to compare a physical count of inventory to what is on the books. A physical inventory count requires companies to do a manual “stock-check” of inventory to make sure what they have recorded on the books matches what they physically have in stock. Differences could occur due to mismanagement, shrinkage, damage, or outdated merchandise. Shrinkage is a term used when inventory or other assets disappear without an identifiable reason, such as theft. For a perpetual inventory system, the adjusting entry to show this difference follows.

Business Operations

By the time a physical count is completed, there may be inventory reconciliations needed to address stock discrepancies. Recordkeeping in a periodic inventory system may also become more time-consuming as your business grows and you add more inventory items. You might want to consider ecommerce accounting software and automated methods, such as the perpetual inventory system, if your business is growing fast. Accounting and forecasting are definitely easier when a periodic inventory system is used. What these company owners are not aware of is that the full implementation of such systems is not so easy.

However, they significantly reduce the amount of time, payroll costs and hassle you’ll face if you have a sizable on-hand inventory. Eating the upfront costs of a perpetual system can result in money-saved down the line. Perpetual inventory systems, as the name suggests, continuously update inventory accounts to adjust for individual sales.

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«Periodic systems are better with unknowns. Not all periodic systems have computer systems attached since computer logic does not do well with many unknowns,» explains Relph. The ongoing information also helps businesses keep more granular information on cost per item sold, which is https://www.bookstime.com/ a major factor in profit margins and overall profitability. For large businesses or growing businesses, operating with a periodic inventory system is akin to operating your business with blinders. The guide has everything you need to understand and use a periodic inventory system.

• Finally, you need to establish procedures for when inventory is counted and how it is recorded.
• Shrinkage will happen whether you use a real-time perpetual inventory system complete with code scanning or a periodic system with manual count.
• After researching in great depth, I finally found the case study of Sulfo Rwanda Industries.
• There are again three types of cost flow assumptions in periodic inventory system – FIFO, LIFO, and WAC.