Updated July 10, 2023
Definition of Periodic Inventory System
The periodic inventory system refers to the system of determining the amount of inventory by counting the number of items present in the inventory physically at the end of specific intervals, such as after the end of every accounting period, rather than calculating it after every purchase and sale of stock items included in the inventory.
Explanation
It is the type of inventory valuation in which the inventory is valued per the physical count method of inventory valuation. In a periodic inventory system, the stock is valued after the physical counting of the inventory. This can be beneficial as well as harmful for the organization. It is beneficial as the physical inventory count is done regularly, and proper checks are followed. On the other hand, it is harmful as the pilferage of inventory cannot be tracked as the perpetual system is not followed.
How Does It Work?
It works as under:
The purchases made during the year are not recorded in the computer system as most periodic inventory systems users maintain accounts on a single entry basis. Instead, the purchases are entered as purchases account debit, and payable account credit and inventory are valued by the physical count method. Under this method, the opening inventory is the value of last year’s closing inventory, purchases are recorded, and closing stock is valued based on a physical count. Accordingly, the cost of goods sold is calculated by adding opening inventory and purchases by subtracting closing inventory from it.
Example
An Ltd has the opening stock having a value of $ 500,000. The purchases made during the year are $ 2,500,000, and after physical verification, it is found that the company had an inventory of $ 650,000 as the company follows the periodic inventory system. Calculate the COGS and suggest how the sales can be derived, and verify that there is any pilferage or loss of inventory.
Solution:
As the company follows the periodic inventory system, the value of the closing stock as of the end of the year becomes the opening stock for next year. Calculation of COGS is as follows:
COGS = Opening Stock + Purchases – Closing Stock
- COGS = $ 500,000 + $ 2,500,000 – 650,000
- COGS = 2,350,000
In COGS, the profit margin is to be added to arrive at the sales, and the sales value is to be compared with the actual sales; if there is any discrepancy, then it shows that the inventory valuation is improper.
When is the Periodic Inventory System Used?
It is used in the following circumstances:
- When the business organization is small, the periodic inventory system proves beneficial as the small business does not maintain double-entry books or a perpetual inventory system.
- It is beneficial for large organizations only if the number of stock-keeping units is low to apply the relevant controls and ensure the proper valuation.
Periodic Inventory System vs Perpetual Inventory System
- The inventory valuation is done per the physical count method in a periodic inventory system. In contrast, in the perpetual inventory system, inventory valuation is done by entering the stock data into the accounting system.
- The pilferage of inventory is difficult to track in the periodic inventory system as no records in the system are maintained, and it counts physical stock available at the end of the period. In contrast, pilferage or any other inventory loss can be easily tracked in the perpetual inventory system by reconciling the inventory with the physical count.
- It does not give real-time data because of the valuation of the inventory in intervals. In contrast, the perpetual inventory system gives real-time data of inventory units along with valuation of any day or period as the records are properly maintained in the system.
- It is useful for small organizations, whereas the perpetual inventory system benefits large organizations.
Advantages
Some of the advantages are as follows:
- It is cost-effective as it is easy and certainly inexpensive to implement the periodic inventory system; for; implementing a periodic inventory system, businesses are not required to invest their money in hiring professionals and in the purchase of costly Software, and only the time is required to be invested.
- It is most beneficial for businesses that do not work at a large level because they have limited orders and a limited number of employees.
- Since inventory calculation is done at the end of a certain period in the periodic inventory system, it does not disturb normal business activities.
Disadvantages
Some of the disadvantages are as follows:
- The chances of errors and fraud exist in a periodic inventory system because the continuous check on the presence of inventory is not there in this system.
- Under this system, inventory value is unknown during the interim periods because the physical inventory count is not there. So to get the figures, users must wait for that specific period of inventory calculation.
- This inventory system is inadequate for the industries with large investments in the inventory because, in such a business, physical counting of the large inventory level at a single point is very time-consuming and cumbersome and can hamper the organization’s normal business during that interval.
- Under the periodic inventory system, if any differences arise between the book value of inventory and the value of inventory after physical account, such differences are very difficult to reconcile.
Conclusion
Thus, It refers to the system where the physical count of the inventory is done at the end of a particular period and not regularly after the business does every purchase and sale. Here the cost of goods sold is calculated after a certain period and not after every sale. Small businesses like retailers having grocery shops, pharmacies, Cloth stores, etc., follow this inventory system, but large businesses that need to check the inventory avoid using it regularly.
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This is a guide to Periodic Inventory System. Here we also discuss the introduction and example along with advantages and disadvantages. You may also have a look at the following articles to learn more –
