Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, the balance in the purchases account is then shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory. The adjustment ensures that only the inventory costs that remain on hand are recorded, and the remainder of the goods available for sale are expensed on the income statement as cost of goods sold. Here we will demonstrate the mechanics used to calculate the ending inventory values using the four cost allocation methods and the periodic inventory system. To implement a periodic inventory accounting system, all you need is a team to perform the physical inventory count and an accounting method for determining the cost of closing inventory. The LIFO (last-in first-out), FIFO (first-in first-out), and the inventory weighted average methods are all promising calculation techniques.
As a highly manual process, periodic inventory can be time-consuming and difficult to scale as a business grows. Performing an inventory count can also cause a bottleneck if it requires all products to be set aside for a significant amount of time. Doing a physical count of all your on-hand inventory items increases the likelihood of human error. The total inventory count may be incorrect or there could be errors in valuation. To prevent this, check for any discrepancies or numbers that seem much higher or lower than expected after taking stock of all inventory.
Benefits of periodic inventory
Temporary accounts requiring closure are Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. Sales will close with the temporary credit balance accounts to Income Summary. As a result, they can quickly count the goods they work with, while the ongoing system, which provides a more accurate inventory, requires staff training in electronic scanners and data entry.
- The total in purchases account is added to the beginning balance of the inventory to compute the cost of goods available for sale.
- Sales will close with the temporary credit balance accounts to Income Summary.
- Periodic inventory is appropriate for businesses that do not require daily accuracy in inventory levels.
- This system allows the company to know exactly how much inventory they have at any specific time period.
- While these systems can offer more accurate and updated inventory data, they also come with higher costs — as you’ll need to invest in hardware, software, and employee training.
- The first-in, first-out method (FIFO) of cost allocation assumes that the earliest units purchased are also the first units sold.
A periodic inventory system is a commonly used alternative to a perpetual inventory system. The term periodic inventory system refers to a method of inventory valuation for financial reporting purposes in which a physical count of the inventory is performed at specific intervals. It is both easier to implement and cost-effective by companies that use when a periodic inventory system is used it, which are usually small businesses. Properly managing inventory can make or break a business, and having insight into your stock is crucial to success. While the periodic method is acceptable for companies that have minimal inventory items or small businesses, those companies that plan to scale will need to implement a perpetual inventory system.
Different between Periodic and Perpetual
Some small businesses may also choose the periodic system because of its affordability. Since it’s a manual process, it doesn’t require complex point-of-sale or inventory tracking software to implement. A periodic inventory system is most suitable for small businesses that have less inventory, making it easier to physically count the units.
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 inventory valuation where you do a physical inventory count at the end of a defined accounting period. A periodic inventory system is best suited for smaller businesses that don’t keep too much stock in their inventory. It’s also far simpler to estimate the cost of goods sold over designated periods of time. In many cases, businesses combine both accounting methods to manage inventory.