The periodic inventory system is the physical counting method for inventory management. It is performed periodically to calculate inventory figures that lead to the cost of goods sold.
A periodic inventory system takes time and effort as it is a laborious activity. Small businesses mostly follow the periodic inventory system with low inventory requirements. However, businesses of all sizes can adopt the periodic inventory system.
Let us discuss a periodic system and how it helps inventory management.
What is The Periodic Inventory System?
The periodic inventory management system refers to the periodic evaluation of inventory. The physical count of inventory is performed after a specific period, such as monthly, quarterly, or annually.
Companies perform the periodic inventory count at the end of one accounting period. The figures for the ending inventory are then used for the next accounting period in the beginning.
Companies following periodic inventory systems only update their general ledger accounts for each physical count’s ending inventory.
All other entries are related to the purchases and accounts payable accounts with subsequent journal entries.
Businesses can maintain freight expenses account as well. It helps them account for the accurate costs for the cost of goods sold.
The account is updated each time the business receives new inventory. The account eventually helps a business to calculate accurate inventory costs.
How Does a Periodic Inventory System Work?
The periodic inventory system performs physical checks of inventory. Most of these tasks are performed manually. Hence, the activity is time-consuming and costly. Businesses with large inventory need to deploy manpower and devote time to conduct the physical count of inventory each time.
The accounting method for a periodic inventory system is different from other systems like perpetual inventory. The accounting for inventory in a periodic system begins with a temporary account for purchases. The inventory account is not debited directly after purchases.
First, the company enters all new purchases into a temporary purchases account. Then, the company performs a physical count of inventory.
The figures from the purchases account are then transferred to the main inventory account. These figures are then reflected in the cost of goods sold calculations.
The cost of goods sold (COGS) is then calculated by using the figures of beginning inventory, adding new purchases, and deducting the ending inventory figures.
The cost of goods sold formula:
COGS = Beginning inventory + New Purchases – Ending Inventory
The company can sometimes use the ending or remaining inventory balance from the previous accounting period instead of beginning inventory.
Accounting Entries for the Periodic Inventory System
As mentioned above, the accounting entries in a periodic system begin with the purchases account before the physical count of inventory.
The first journal entry will be:
The company will debit the purchases account with each new purchase transaction. The accumulated figures are then shifted to the main inventory account at the end of the accounting period.
The company would perform a physical inventory count before shifting the entries to the main inventory account.
The next journal entry for the main inventory account will be:
Since the periodic inventory does not regularly update the main inventory account, it does not require subsets. However, a company may divide the main inventory account into a different subset of work in progress, beginning and ending inventories.
Once the physical inventory count is performed, the company will calculate the cost of goods sold. This will lead to the final accounting entry as below.
|Cost of Goods Sold||XXX|
Both the inventory and the COGS accounts can be combined as well. It will offer the same net figures and similar accounting treatment.
|Cost of Goods Sold||XXX|
A relevant accounting entry when the company makes sales will be recorded as:
Suppose the following data for ABC company is available for its periodic inventory management system.
Beginning Inventory: 100 items at $ 150 = $ 1,500
New Purchases 1,000 items at $ 10 = $ 10,000
Sales made during the period for 900 items at $ 20 = $ 18,000
Ending inventory 200 items at $ 10 = $ 2,000.
The Journal entries for the ABC company will be recorded as below.
|Accounts Payable||$ 10,000|
Next in for sales,
|Accounts Receivable||$ 18,000|
|Ending Inventory||$ 2,000|
|Cost of Goods Sold||$ 9,500|
|Beginning Inventory||$ 1,500|
The calculation for the cost of goods sold is:
COGS = beginning inventory + Purchases – ending inventory
COGS = $ 1,500 + $ 10,000 – $ 2,000 = $ 9,500
When to Use Periodic Inventory System
Businesses of all sizes can use periodic inventory systems. However, since the process is time-consuming and requires additional manpower, it is unsuitable for large businesses with regular inventory updates.
The periodic inventory system does not update the main inventory account directly. It means with changing inventory levels, and the business may not be able to calculate the accurate cost of goods sold.
The periodic inventory system is more suited for small businesses. Businesses with infrequent inventory updates can use the system effectively.
For instance, an automobile showroom business will not need to conduct a physical count of vehicles regularly.
Advantages of Using Periodic Inventory System
The periodic inventory system offers several advantages to a business.
1) Simple and Easy Inventory Accounting System
A periodic inventory system does not require any technical knowledge. Hence, it is simple and easy to implement for any business in no time.
2) Lower Costs of Technology
Since the system relies on the physical count of inventory, it does not require sophisticated technology or software. Hence, the technology costs with a periodic inventory system are also lower.
3) Physical Count of Inventory
By keeping a physical count of inventory, the company can rest assured about the accuracy of its inventory figures. The process should be completed carefully to take full advantage of the physical count.
4) Suitable for Businesses with Lower Inventory Requirements
The system is preferable for small businesses or businesses with lower inventory requirements.
Disadvantages of Using Periodic Inventory System
Despite its simplicity and ease of use, the periodic inventory system also comes with some disadvantages.
1) Time Consuming
A physical count of inventory is a time-consuming activity. It may not be suitable for businesses with changing inventory levels regularly.
2) Errors in Estimation
Most of the physical inventory count is performed physically and manually. Hence, there are more chances of errors in the estimation of inventory counting.
3) Lack of Automation
The periodic inventory system is not inclined towards technology and automation. Most businesses do not use sophisticated technology for automation with this system.
4) Additional Manpower
Although technology costs and requirements are lower, this system may require an additional workforce for physical inventory count.
5) Not Suitable for businesses with Large Inventories
The periodic inventory system is unsuitable for businesses that regularly change inventory levels. Otherwise, the business would need to deploy an additional workforce and devote much time to this system’s physical count of inventory.