What Is Periodic Inventory System? How It Works and Benefits

Deploying a periodic inventory system can prove advantageous, especially for smaller companies. It’s undoubtedly cheaper to implement and maintain than a perpetual inventory system, and because of its simplicity, it doesn’t require extensive employee training. The accounts that contribute to the cost of goods sold include (1) the beginning of the year balance of inventory and (2) purchases made for the year. Small inventory levels and limited stock won’t take more than a couple of hours to count, and the cost of goods sold can be estimated through very few simple calculations. This simplicity in use also makes the system more cost-effective, as it can be managed manually, and businesses won’t need to hire a trained bookkeeper or invest in expensive accounting software. The periodic inventory approach is primarily used by small businesses that deal with very few transactions, or companies that only have a limited number of inventory.

Under a https://business-accounting.net/, any change in inventory is recorded periodically, typically at the end of the month or year. Finally, subtract the ending inventory balance (or closing inventory) from the cost of goods available to determine the COGS. Whichever method a business applies, the ending inventory is then subtracted from the cost of goods available for sale to arrive at the total cost of goods sold (COGS). The term inventory refers to the raw materials or finished goods that companies have on hand and available for sale.

This means that the inventory valuation in the accounting records will be inaccurate, except when a physical count is performed. This can be acceptable in cases where management is not overly concerned about the inventory valuation on a day-to-day basis. Briefly explained in our previous article on perpetual inventory are the differences between the two inventory tracking methods. The perpetual inventory system involves continuous, computerised updates of any inventory-related purchases and sales through the use of point-of-sales machines and barcoding systems.

1. As a result, it enables firms to expedite their financial and accounting processes.
2. Eating the upfront costs of a perpetual system can result in money-saved down the line.
3. Smaller businesses and those with low sales volumes may be better off using the periodic system.
4. The company purchases $250,000 worth of inventory during a three-month period.

Explore insights that can help you grow, drive sales, and optimize your operations management strategy. Visit the PayPal Resource Center for detailed guides designed for small medium businesses. When every dollar and cent counts in the search for profitability, deploying an effective inventory management system can be a huge benefit. At the end of the month, the company counts its inventory and determines that 300 units remain on hand.

The total in purchases account is added to the beginning balance of the inventory to compute the cost of goods available for sale. The beginning inventory of the accounting period must correspond to the ending inventory of the previous period. Therefore, to calculate the beginning cost of inventory at the beginning of the accounting period, add the previous period’s cost of goods sold with the ending inventory. The data acquired during the physical count is used for accounting and ledger balance. Accountants then apply the balance to the beginning inventory in the following period. A periodic inventory system is most suitable for small businesses that have less inventory, making it easier to physically count the units.

The main difference is that assets are valued at net realizable value and can be increased or decreased as values change. While the system may work for smaller businesses, it can prove to be highly problematic for large businesses due to its high level of inaccuracy. Since the periodic system is manual, it’s prone to human error and the inventory data can be misplaced or lost.

What is a Periodic Inventory System?

The selection of a specific method often depends on factors such as industry norms, tax regulations, and management preferences. Note that for a periodic inventory system, the end of the period adjustments require an update to COGS. To determine the value of Cost of Goods Sold, the business will have to look at the beginning inventory balance, purchases, purchase returns and allowances, discounts, and the ending inventory balance. A perpetual inventory system may make life easier for e-commerce businesses that sell on many channels, run multiple warehouses, and want to go omnichannel. However, regardless of the size of your company, you will need to conduct a physical inventory count at some point.

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But the periodic inventory system can still be a good option if your small business has limited resources and straightforward inventory needs. And miscounting items or transposing numbers can lead to inaccuracies in the inventory records. The periodic inventory system is a great solution for many small businesses. Since the periodic system involves fewer records and simpler calculation than the perpetual system, it is easier to implement. The simplicity also allows for the use of manual record keeping for small inventories. 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.

What is the Periodic Inventory System?

First, you add the inventory amount at the beginning of the year to the amount reflected on the Purchases account, to figure out the total cost of goods available for sale. If your business doesn’t have a clearly defined beginning inventory amount, you can use the remaining stock number from the end of the previous period. When merchandise is sold, an entry is made to record the sales revenue, but none to record the cost of goods sold, or to reduce the inventory. That’s why, by comparison, the periodic inventory system is way more tiresome, time-consuming, and prone to error than the perpetual inventory, as everything is done manually. Merchandising businesses that deal with hundreds of transactions a day, such as grocery stores or pharmacies, can’t possibly maintain their inventory through a periodic inventory system. That’s why a periodic inventory system is only mainly used by small businesses with limited inventory and few financial transactions.

Businesses in the retail, healthcare, logistics, and IT industries have benefited from using it. periodic inventory systems don’t calculate COGS until after the business has counted all items at the end of a quarter (or the interval of their choice). It’s hard to account for shrinkage in a periodic inventory system, as the counting is done several months apart. Shrinkage is determined by counting the actual stock and comparing it with the inventory list. So, if the actual items on hand is lower than the hypothetical inventory, it indicates shrinkage.

Periodic inventory systems account for inventory at regular time-based intervals, while perpetual systems continuously update inventory after every transaction. The perpetual inventory system keeps track of inventory balances continuously. This is done through computerized systems using point-of-sale (POS) and enterprise asset management technology that record inventory purchases and sales. It is far more sophisticated than the periodic system of inventory management. This method is generally considered simpler and less expensive to implement than perpetual inventory systems, making it a popular choice for smaller businesses or those with lower transaction volumes.

Having more accurate tracking of inventory levels also provides a better way of monitoring problems such as theft. At a grocery store using the perpetual inventory system, when products with barcodes are swiped and paid for, the system automatically updates inventory levels in a database. The system can be particularly beneficial for financial clarity at the end of the fiscal year. Since inventory is counted and valued at specific times, it provides a clear picture of inventory levels and the cost of goods sold at crucial financial reporting periods.

Should My Business Use Perpetual Inventory or Periodic Inventory?

That’s because the computer software companies use makes it a hands-off process that requires little to no effort. Products are barcoded and point-of-sale technology tracks these products from shelf to sale. These barcodes give companies all the information they need about specific products, including how long they sat on shelves before they were purchased. Perpetual systems also keep accurate records about the cost of goods sold and purchases. The periodic inventory system refers to conducting a physical inventory count of goods/products on a scheduled basis. Maintaining physical inventories can be costly because the process eats up time and manpower.

If a business acquires any additional inventory, it is listed under the purchases account in a general ledger. Changes in inventory are accurate (as long as there is no theft or damage to any goods) and can be easily accessed immediately. The information collected digitally is sent to central databases in real-time. For businesses with seasonal fluctuations in inventory, the periodic system may not provide the agility needed to adjust stock levels in response to seasonal changes effectively. Nest Egg, an intelligent inventory management system, has proved to be an effective solution for small and big companies. It helps users stay on top of logistics through simplified data entry and effective data organization.