What Is Periodic Inventory and How Does It Work?

A periodic inventory system accounts for goods through physical counts at specific, predetermined intervals. It focuses on determining inventory levels and the cost of goods sold at the close of an accounting period, simplifying daily record-keeping by not requiring real-time updates.

How Periodic Inventory Works

Businesses using a periodic inventory system do not continuously update inventory records. Acquired goods are recorded in a temporary “Purchases” account. The balance sheet’s inventory account reflects the ending balance from the previous accounting period.

The system does not track the cost of goods sold (COGS) at the time of each sale. Sales revenue is recorded when transactions occur, but merchandise cost is determined only at period end. A physical count of all remaining merchandise ascertains the true inventory balance and COGS. This count is typically conducted after business hours or during low activity for accuracy.

Once the physical count establishes ending inventory value, COGS for the period is calculated. This involves beginning inventory, plus net purchases, minus ending inventory. Net purchases include gross cost, adjusted for freight-in, and reduced by returns, allowances, or discounts. The final COGS figure is recorded, and the inventory account is updated.

Inventory Valuation Approaches

After a physical inventory count, businesses assign a cost to remaining items. This process, inventory valuation, uses specific costing methods to allocate the total cost of goods available for sale between ending inventory and COGS. These methods assume a particular cost flow, even if the physical flow of goods differs.

One common method is First-In, First-Out (FIFO), which assumes the first units purchased are the first sold. The ending inventory cost is based on the most recently purchased items. This method generally aligns with the physical flow of most businesses, especially for perishable goods.

Conversely, the Last-In, First-Out (LIFO) method assumes the last units purchased are the first sold. Under LIFO, the ending inventory cost reflects the earliest purchased items still on hand. While permitted under U.S. GAAP, LIFO is generally not allowed under International Financial Reporting Standards (IFRS).

Another approach is the Weighted-Average Cost method, which calculates an average cost for all goods available for sale. This average unit cost is determined by dividing total cost of goods available by total units. Both ending inventory and COGS are then valued using this average cost per unit.

Practical Applications of Periodic Inventory

The periodic inventory system applies to businesses where continuous tracking benefits do not outweigh administrative effort and cost. It suits operations handling a high volume of low-value inventory items. Examples include small retail stores, convenience stores, or businesses dealing in bulk commodities like sand, gravel, or certain agricultural products.

For these businesses, high transaction volume and low item cost make continuous, real-time tracking impractical and expensive. Implementing a system that updates inventory records with every sale or purchase would require significant investment in technology and labor. The periodic system’s simplicity reduces the need for complex tracking software and constant data entry.

Smaller businesses or those with limited resources often prefer the periodic method due to its lower administrative burden. It requires less detailed record-keeping, allowing staff to focus on sales and operations. A physical count is necessary, but manageable for businesses with smaller, less diverse inventories, making it a cost-effective choice.