What Is the Periodic Inventory System?

The periodic inventory system is an accounting method businesses use to value inventory for financial reporting. This approach involves performing a physical count of inventory at predetermined intervals. It allows companies to determine the amount of inventory on hand and the cost of goods sold during an accounting period. This system is one of several methods available for managing inventory and related financial figures.

How the Periodic System Functions

The periodic inventory system involves specific steps rather than continuous tracking. Businesses using this system do not update inventory records with every sale or purchase. Instead, they rely on a physical count of all inventory items at the end of an accounting period, which might be monthly, quarterly, or annually. This physical count is crucial for accurately determining both the ending inventory balance and the Cost of Goods Sold (COGS).

During the accounting period, all new inventory acquisitions are recorded in a “purchases” account, not directly in the inventory asset account. This means the inventory account in the general ledger remains unchanged until the physical count is completed. Once the physical count provides the ending inventory figure, COGS can be calculated using the formula: Beginning Inventory + Purchases – Ending Inventory. This calculation allows for the adjustment of the inventory account and the determination of the period’s COGS.

Distinctive Characteristics

A defining feature of the periodic inventory system is its reliance on physical counts, meaning inventory balances are only updated after these counts occur. This method does not provide real-time information regarding inventory levels or the Cost of Goods Sold throughout the accounting period. Consequently, businesses operating under this system will not have an up-to-the-minute view of their stock.

Inventory shrinkage, which includes losses from damage, obsolescence, or theft, is implicitly handled. Since the system calculates COGS based on beginning inventory, purchases, and the final physical count, any uncounted items are automatically absorbed into the COGS figure. This means shrinkage is not separately identified or tracked, but rather increases the total Cost of Goods Sold. The periodic system is often simpler and less costly to implement, making it suitable for smaller businesses or those with a high volume of low-value items where continuous tracking is not economically practical.

Periodic Versus Perpetual Inventory

The periodic inventory system updates inventory records only at the end of an accounting period, after a physical count. In contrast, the perpetual system continuously updates inventory records with every transaction, providing real-time data on stock levels and Cost of Goods Sold.

The periodic system offers no real-time insights into inventory quantities or costs during the period, requiring businesses to estimate these figures until the next count. The perpetual system provides immediate, up-to-the-minute data, which is beneficial for managing stock across multiple locations or for businesses with high transaction volumes.

The periodic system is simpler and less expensive to set up and maintain, often not requiring specialized software or equipment. The perpetual system involves higher initial and ongoing costs due to its reliance on technology like barcode scanners and integrated inventory management software.

Under the periodic system, shrinkage is implicitly included in the Cost of Goods Sold calculation. The perpetual system allows for the identification of shrinkage through reconciliation between recorded balances and physical counts. The choice between the two systems depends on factors such as business size, inventory volume and value, and the need for real-time data. The periodic system suits smaller operations, while the perpetual system is preferred by larger businesses that benefit from detailed, continuous tracking.