There are numerous inventory valuation methods available to firms, and selecting the proper valuation method might have long-term consequences. The most common ones are the periodic and perpetual inventory systems with the periodic inventory system as the most frequent and straightforward valuation procedure.
Periodic inventory systems are popular among startups and small enterprises, and you may be wondering if it’s the best method for you. In this post, we’ll discuss what periodic inventory is, how to use it, and how it may help your organization.
What Is Periodic Inventory?
Periodic inventory is a stock valuation process that is performed at regular intervals in accounting. At the end of the quarter, businesses physically count their products and use the information to balance their general ledger. The balance is then applied at the start of the new period by the companies.
Accounting methods differ between a periodic review inventory system and a perpetual review system. The corporation conducts a physical stock count at the end of the year to compute the quantity for periodic inventory. Estimates are used by organizations for mid-year milestones such as monthly and quarterly reports. When a company purchases products to resell, accountants do not update the general ledger account inventory. They instead debit the temporary account purchases. Every year, a temporary account starts with a zero balance. At the end of the year, the accountant transfers the sum to another account.
Companies that use a periodic inventory control system also retain delivery charges distinct from the main inventory account. They keep track of delivery charges associated with Freight In or Transportation In accounts for incoming inventory. The costs in this account eventually raise the worth of their inventory.
What Is the Meaning of a Periodic Inventory System?
The periodic inventory system is a software system that allows you to take a stock count on a periodic basis. Companies enter stock numbers into the program, do an initial physical inspection of the goods, and then input the data into the software to reconcile.
The software in a periodic system should display the cost of inventory recorded as of the last physical count — it does not alter based on sales. Purchasing made between counts is recorded in the purchases account. Journal entries are generated by the software based on transactions from the inventory and cost of goods sold (COGS) accounts to user-defined accounts. Periodic inventory software also has the following features:
- User-defined accounts created for various combinations of books and subsidiaries.
- In the background, diary entries are created based on a script.
- Journals Created Today, Journals Not Required for Transactions Created Today, Error Reports, and Modified Transactions are examples of custom reports.
- Software positions that have been customized, such as the Principal Accountant.
How Periodic Inventory Works
A corporation uses a periodic inventory system to physically count inventory at the end of each quarter to ascertain what’s on hand and the cost of items sold. Depending on their product and accounting demands, many businesses pick monthly, quarterly, or annual periods.
Rather than continually updating their books with current inventory and cost levels, firms use the beginning inventory level, ending inventory, and purchases made during that period to calculate costs.
While it does not provide real-time data to corporate decision-makers, periodic inventory is sufficient for many small organizations, particularly those with few unique SKUs to update at the end of each quarter.
| Debit | Credit | |
| Purchases | xxx | |
| Accounts payable | xxx |
A physical inventory count is performed at the end of the year to establish the closing inventory balance and the cost of goods sold.
| Debit | Credit | |
| Inventory | xxx | |
| Purchases | xxx |
How Does the Periodic Inventory System Calculate Cost of Goods Sold?
To calculate the cost of products available for sale, the sum in the purchases account is added to the beginning balance of the inventory.
The ending inventory is determined at the end of the period by a physical count of each item, and its cost is computed using inventory calculation methods such as FIFI, LIFO, and weighted averages.
To calculate the cost of products sold, subtract this amount from the cost of items available for sale (or the cost of goods made).
The following is the general formula for calculating the cost of items sold under the periodic inventory system:
Beginning inventory + Purchases – Closing inventory = Cost of goods sold (COGS).
For example, XYZ Corporation has a $100,000 beginning inventory, a $120,000 outgoing for acquisitions, and a physical inventory count that displays an $80,000 closing inventory cost.
Its cost of goods sold is calculated as follows:
Cost of Goods Available = Beginning inventory + Purchases
$100,000 + $120,000 = $220,000
Cost of Goods Sold = Cost of Goods Available – Inventory Closure
$220,000 – $80,000 = $140,000
When Should You Use a Periodic Inventory System?
When a small company with a small number of SKUs isn’t concerned with scaling their business over time, they’ll adopt a periodic system. You might also utilize a periodic system in conjunction with a perpetual system, depending on your products and demands.
A periodic system can be used by any business because it requires no additional equipment or coding to operate and hence costs less to develop and maintain. Furthermore, when time is limited or staff turnover is significant, you can train employees to provide simple inventory counts. Seasonal workers, for example, may come and go. They can swiftly count the items they are working with, whereas a perpetual system, which provides a more precise inventory, necessitates staff training on electronic scanners and data entry.
If you have a hold on your supply chain process, sell a few products, and keep an eye on your goods as they pass through your organization, you can also employ a periodic system. A periodic system is ineffective if you need to investigate missing inventory or imbalanced numbers. This problem will occur as your business expands and gets more difficult to manage positively.
Using the Periodic Inventory System to Account for Purchases
When employing a periodic inventory system, purchases are not added to inventory but rather to a “assets” account for accounting purposes. When you conduct a physical inventory, the balance in the “assets” account is transferred to the “inventory” account. In practice, the “assets” account is an accumulation account. It totals the cost of all purchases for an accounting period. When the amount is moved to the inventory account at the end of the accounting period, it is totally empty.
LIFO
The most difficult aspect of a periodic inventory system is determining inventory value. Last In/First Out is the most often utilized inventory accounting method with a periodic inventory system (LIFO). LIFO assumes that the most recent purchases are the ones that are used first. The ending inventory is valued based on the oldest costs for the materials remaining in inventory.
Benefits of the Periodic Inventory System
#1. Simpler to Implement
The periodic system is simpler to implement than the perpetual system because it includes fewer records and simpler calculations. For modest stockpiles, the simplicity enables manual record keeping.
#2. Perfect for Small Businesses
The periodic inventory system is excellent for smaller businesses with limited inventory. The physical inventory count is simple to do, and small businesses can estimate the cost of goods sold statistics for short periods of time.
Disadvantages of the Periodic Inventory System
While the periodic inventory system works effectively for some organizations, particularly those with significant sales volumes, it has some drawbacks. These include not knowing stock levels, a lack of detail, the possibility of revenue loss, and failing to collect important sales information.
The periodic inventory system was developed to track inventory in high-volume businesses. Prior to computer technology, barcodes, and RFID tags, it was hard to track inventory continually in organizations where sales volume was high and inventory turnover was rapid. The periodic inventory system did away with the requirement to continuously track inventory in favor of a once-a-year “batch” system of inventory accounting.
#1. Stock Levels Are Unknown
It is critical to know what is in stock at each stage of the manufacturing process when employing lean manufacturing processes. Lean manufacturing frequently involves low inventory levels and the use of visual indicators known as Kanban cards to “pull” products through the manufacturing process. Kanaban enables a just-in-time supply of materials and supplies, with customer demand driving the requirement. Planning for changes in demand, identifying the optimal level of inventory, and optimizing production all necessitate knowledge about current inventory levels, including work-in-progress.
#2. Inadequate Detail
When inventory levels are determined infrequently, often only once a year, errors and missed opportunities are possible. A once-a-year inventory, for example, results in a lack of specificity, making it difficult to identify and decrease components that contribute to inventory expenses, such as shipping, purchasing, and handling charges. On the other hand, due to the lack of information, opportunities such as seasonal increases in demand may be missed.
#3. Potential Revenue Losses
With the periodic inventory system, it can be difficult to detect inventory shrinkage due to theft, damage, or just lost products (employee error). Losses resulting from the exchange of a defective product may go unreported. Without maintaining current inventory levels and knowing what is coming in and out of inventory, not knowing what is going on in the warehouse opens the door to a range of potential income losses.
#4. Not Gathering Important Information
Many of the periodic inventory system’s drawbacks arise from a lack of information. With the advent of technology that enables tracking material flows straightforward and relatively inexpensive, information that aids in cost reduction and the identification of business prospects can be gathered. Problems, such as a faulty product, can be identified and remedied before they affect a large number of customers. Inventory shrinkage becomes more visible. And new business prospects emerge, such as increased seasonal sales.
What Is a Perpetual Inventory System?
A perpetual inventory system is a software system that collects data on a company’s products on a continuous basis. Every transaction, including purchases and sales, is tracked in real-time by a perpetual system. The system also keeps track of all essential product information, such as physical measurements and storage location.
A perpetual system is more sophisticated and detailed than a periodic system since it keeps a constant inventory record and updates it instantly from the point of sale (POS). Perpetual systems, on the other hand, necessitate regular recordkeeping by your employees. In a periodic system, for example, you may not count and enter a new pallet of products into stock until the next physical count. In a perpetual system, you enter the fresh pallet into the software right away so that the system can track its life in your business. When there is a loss, theft, or breakage, you should also report these updates as soon as possible.
In many aspects, a perpetual system outperforms a periodic system, particularly for businesses concerned with long-term viability. Implementing a perpetual system earlier in the company’s life cycle allows employees to preserve a long-term record of inventory while also preventing the organization from outgrowing a periodic system one day. A perpetual system is scalable, so whether you have five products now or 200 products tomorrow, a perpetual system can manage inventory control effectively.
Periodic vs. Perpetual Inventory Systems
Although they can function together, periodic and perpetual inventory systems are different accounting approaches for tracking inventory. The perpetual inventory system is superior in general since it tracks all data and transactions. However, in order to operate a perpetual system successfully, you must make more judgments.
There are changes in how the accounts are updated and which accounts are required between the two accounting systems. When the inventory changes in a perpetual system, the software continuously updates the general ledger. The program only updates the general ledger in the periodic system when you enter data after doing a physical count. The COGS account in a perpetual system is current after each sale, even between standard accounting periods. This method also reduces the time required for the calculations. The COGS are only performed during the accounting period under the periodic system.
The accounts you utilize are another significant difference between the two systems. When you make a purchase or inventory in a perpetual system, you record it under the merchandise or raw materials account, updating the unit count entry for the individual record, whereas in a periodic system, you document it into a purchase asset account, which means an individual record for unit counts isn’t available.
Periodic Inventory System FAQs
What is periodic FIFO?
A cost flow tracking system that is employed within a periodic inventory system is known as periodic FIFO. The ending inventory balance in a periodic system is only updated when there is a physical inventory count.
How do you calculate LIFO periodic inventory?
Determine the cost of your most current inventory to compute COGS (Cost of Goods Sold) using the LIFO method. Divide it by the quantity of inventory sold.
What are the two systems of maintaining inventory?
There are two inventory accounting systems: the perpetual system and the periodic system. The inventory account in the perpetual system is updated after each inventory buy or sale.
