Periodic Inventory System
Definition
The periodic inventory system, as the name suggests records inventory balance on hand periodically, specifically, at the beginning and end of a set accounting period.
Under the periodic inventory system:
- All purchases made between inventory counts are placed under the purchases account.
- When the next physical inventory count is conducted, the balance from the purchases account is shifted to the inventory account to match the cost of ending inventory.
Calculation of Periodic Inventory System
The cost of goods sold under the periodic inventory system is calculated thus-
Beginning inventory + Purchases = Cost of goods available for sale
Cost of goods available for sale – Ending inventory = Cost of goods sold
A company ABC has:
- Beginning inventory: $100,000
- Purchases made: $150,000
- Ending inventory (after a physical count): $90,000
Now applying the formula:
100,000+150,000−90,000=160,000100,000 + 150,000 - 90,000 = 160,000100,000+150,000−90,000=160,000
Cost of Goods Sold (COGS) = $160,000
Before diving into a detailed comparison with the perpetual inventory system, let’s explore the key advantages and disadvantages of using a periodic inventory system.
Advantages and Disadvantages of the Periodic Inventory System
The periodic inventory system has both advantages and disadvantages depending on the business size, industry, and operational needs.
Advantages of the Periodic Inventory System
- Simple & Cost-Effective – No expensive software or real-time tracking tools are needed.
- Ideal for Small Businesses – Best for businesses with low sales volume and limited SKUs.
- Less Administrative Effort – No need for constant system updates.
- More Control Over Physical Inventory – Since inventory is manually counted, businesses get an accurate picture of available stock.
Disadvantages of the Periodic Inventory System
- Inaccurate Inventory Tracking – Stock levels are only updated at the end of an accounting period, leading to potential discrepancies.
- Higher Risk of Stockouts & Overstocking – Without real-time updates, businesses may run out of stock or over-purchase.
- Time-Consuming – Requires manual inventory counts, which can be labor-intensive and disrupt operations.
- Difficult to Detect Theft or Shrinkage – Since losses are only identified during physical counts, businesses may not realize theft or discrepancies immediately.
Difference between Periodic inventory system and Perpetual Inventory System
Considering periodic inventory system vs perpetual inventory system in that, the former is based on physical counting of inventory at the beginning and end of an accounting period, while the latter uses software like an inventory software to update inventory in real-time.
In the perpetual inventory system, the stock count is updated continuously, meaning with every piece of inventory that arrives or is sold. In contrast, inventory is updated at periodic intervals.
The periodic inventory system provides information about the inventory and cost of goods sold whereas the perpetual inventory system gives information about inventory and sales.
In the perpetual inventory system, any loss of goods is included in the closing inventory. On the other hand, in the periodic inventory system, the same is recorded in cost of goods sold.
In the periodic inventory system, since no software is used, it becomes affordable for smaller businesses who may not be able to invest in sophisticated software, unlike those using a perpetual inventory system.
In the perpetual inventory system, physical counting does not interfere with daily business operations, meaning businesses do not have to shut down to take a stock count in the warehouse.
Conclusion
The periodic inventory system is less expensive when compared with the perpetual inventory system. However, it cannot beat the accuracy of the perpetual inventory system, where inventory is maintained continuously with every purchase and sale. The periodic inventory system is more suitable for small businesses who do not require dedicated software for inventory management due to low sales volume or because they cannot afford it. Yet some companies prefer the periodic inventory system since it is less demanding as warehouse managers do not have to constantly update inventory on the system.