What Is Periodic Inventory System? How It Works and Benefits

Because of this, the method requires keeping personal accounts for beginning inventory, purchases and on-hand inventory. A periodic inventory system is an inventory management valuation method to determine the cost of goods sold (COGS) for accounting and financial reporting purposes. As its name implies, this solution requires physically taking inventory levels at designated periods. A periodic inventory system is an accounting method where inventory tracking is updated manually at the end of a specific period.

For example, XYZ Corporation has a beginning inventory of $100,000, has $120,000 in outgoings for purchases and its physical inventory count shows a closing inventory cost of $80,000. Periodic inventory systems are best for smaller businesses with just a few products to track. As businesses grow and track more unique SKUs, periodic inventory systems become less viable. Periodic system examples include accounting for beginning inventory and all purchases made during the period as credits. Companies do not record their unique sales during the period to debit but rather perform a physical count at the end and from this reconcile their accounts.

Connect With a Financial Advisor

To make good business decisions, most business owners and managers need updated information on a very regular basis. Most large businesses update inventory automatically with each sale or shipment. Whenever you make a purchase at a retail store or online, the retailer knows exactly what was sold and when so it can make decisions around restocking. Companies make any necessary adjustments from purchasing goods to a general ledger contra account.

Since the update of the periodic inventory system can only happen after a specific interval, tracking a fast-moving commodity could be hard. In the garment industry, there are a lot of shirt styles for different seasons. The periodic inventory system is an inventory managing method, which determines the inventory count at the end of a period. Although this method requires one less entry, the cost of goods sold is not specifically determined. Once the ending inventory and cost of goods sold are clarified, the accounts require adjustment to reflect the ending inventory balance and the cost of goods sold.

What is the purpose of determining the cost of goods sold and ending inventory?

By waiting, you can then merge the final two entries together and apportion the balance in the purchases account between the inventory account and the cost of goods sold, using the following entry. The periodic inventory system is commonly used by businesses that sell a small quantity of goods during an accounting period. These companies often find it beneficial to use this system because it is easy to implement and because it is cost-effective, as it doesn’t require any fancy software. But a company using a periodic inventory system will not know the amount for its accounting records until the physical count is completed.

• It only takes a little time to add a periodic system to your business.
• Now that we’ve established the basic process of a periodic inventory system, we can check out some of the individual methods used under these solutions.
• The accountant removes the balance to another account at the end of the year.
• This differs from perpetual inventory systems, where updates are made as seen fit.

The periodic inventory system eliminated the need to continuously track inventory and instead used what was essentially a once-a-year “batch” system of inventory accounting. And, under a periodic system, companies record purchases of merchandise in the purchases account rather than the inventory account. Also, in a https://kelleysbookkeeping.com/how-letters-of-credit-work/ periodic system, purchase returns and allowances, purchase discounts, and freight costs on purchases are recorded in separate accounts. A periodic inventory system is an accounting method in which the cost of goods sold is determined periodically, usually annually and typically not more frequently than quarterly.

What Is Periodic Inventory System? How It Works and Benefits

The result, called Just In Time (JIT) delivery, is reduced costs and increased customer satisfaction. While the periodic inventory system works well for some types of businesses, in particular those with high sales volume, it does have some disadvantages. These include not knowing stock levels, a lack of detail, the potential for a loss of revenue, and not collecting useful sales information. Consequently, there are no merchandise inventory account entries during the period.

Companies with few team members, limited inventory value, and a modest number of orders placed throughout the year may have better success using a periodic approach to inventory control. If your business is small, using periodic inventory management may work for you because you can operate with just a cash register and simple accounting procedures. Even with a perpetual inventory management system, the company still needs What Is The Periodic Inventory System? to shut down at least once each year to do a periodic, manual inventory count. According to generally accepted accounting principles (GAAP), companies can choose to use either a periodic or perpetual inventory system. As periodic inventory is an accounting method rather than a calculation itself, there is no formula. However, we will use the formulas for calculating cost of goods sold and cost of goods available.

Who Should Use This Method?

How have you successfully implemented an inventory management strategy? Let us know your thoughts on periodic inventory systems in the comments below. Given the information we’ve covered up to this point, it’s clear that periodic systems are best suited to small businesses or companies that provide high-end products with a low on-hand inventory.

One other key difference between the two systems is the accounts you use. Periodic and perpetual inventory systems are different accounting methods for tracking inventory, although they can work in concert. Overall, the perpetual inventory system is superior because it tracks all data and transactions. However, with a perpetual system, you need to make more decisions to use it successfully. Let’s suppose the value of a company’s inventory is $500,000 on January 1. The company purchases $250,000 worth of inventory during a three-month period.