All the Formulas You Need to Get Started
The guide has everything you need to understand and use a periodic inventory system. You'llfind basic journal entries, formulas, sample problems, guidance, expert advice and helpfulvisuals.
What Is Periodic Inventory?
Periodic inventory is an accounting stock valuation practice that's performed at specifiedintervals. Businesses physically count their products at the end of the period and use theinformation to balance their general ledger. Companies then apply the balance to thebeginning of the new period.
Under a periodic review inventory system, the accounting practices are different than with aperpetual review system. To calculate the amount at the end of the year for periodicinventory, the company performs a physical count of stock. Organizations use estimates formid-year markers, such as monthly and quarterly reports. Accountants do not update thegeneral ledger account inventory when their company purchases goods to be resold. Instead,they debit the temporary account purchases. A temporary account begins each year with a zerobalance. The accountant removes the balance to another account at the end of the year.
Companies make any necessary adjustments from purchasing goods to a general ledger contraaccount. A contra account is meant to be opposite from the general ledger because it offsetsthe balance in their related account and appears in the financial statements. Examples ofcontra accounts include purchases discounts or purchases returns and allowances accounts.Combining these accounts provides the net purchases.
In a periodic inventory control system, companies also keep delivery costs in a separateaccount from the main inventory account. They track delivery costs related to incominginventory Freight In or Transportation In accounts. Eventually, the costs in this accountincrease the value of their inventory. In the journal, the accounts would look like this:
Key Takeaways
- Periodic inventory is an accounting inventory method where inventory and cost of goodssold are calculated at the end of an accounting period rather than on a daily basis.
- Periodic inventory systems can make sense for small to midsized businesses with a lownumber of products sold, while large and growing business opt for the perpetualinventory method and its higher accuracy.
- Periodic tracking is easy to implement but limits the details you know about yourinventory at any given time.
Periodic Inventory Explained
With a periodic inventory system, a company physically counts inventory at the end of eachperiod to determine what’s on hand and the cost of goods sold. Many companies choosemonthly, quarterly, or annual periods depending on their product and accounting needs.
Rather than update their books with current inventory and cost levels on an ongoing basis,businesses take the beginning inventory level, ending inventory and purchases made duringthat period for cost calculations.
Periodic inventory works for businesses that don’t need to accurately know currentinventory levels on a daily basis. It works well for small businesses looking to keep costslow. Growing businesses and larger businesses need more detailed inventory tracking andtypically choose a perpetual inventory system, which is best managed using an ERP inventorymodule.
While it doesn’t give business decision makers real-time data, periodic inventory isjust fine for many small businesses, particularly those with few unique SKUs to update atthe end of each period.
What Is a Periodic Inventory System?
The periodic inventory system is a software system that supports taking a periodic count ofstock. Companies import stock numbers into the software, perform an initial physical reviewof goods and then import the data into the software to reconcile.
These software systems support your current stock-keeping method. You can use them to getpaper inventory lists, import the stock data and calculate the data you need to order morestock and reconcile the stock you have for a new period. Companies can export these figuresand reports to accounting software. A company will choose the software based on its needsand the requirements of its products.
Catherine Milner and Geoff Relph are co-authors of "Inventory Management: Advanced Methods forManaging Inventory within Business Systems(opens in newtab)" and "The Inventory Toolkit: BusinessSystems Solutions". As owners of Inventory Matters, Ltd., they consult with clients andadvise choosing a software system for inventory management that does the upfront work.
Milner explains: "We see many companies trying to implement inventory management businesssystems that do not have the features or requirements they need. The most important thing isto know what you need precisely. When someone comes to sell you a system, their measures ofsuccess may not be the same as your business's measure of success. Whether it is yourbusiness, the sales business or the hosting business, each has a different focus. So ensureyours is the one that drives the sale."
Relph adds, "For example, when you buy a car, you know what you want. The salesperson mayhave a vehicle that does not exactly fit your request. His job is to persuade and sell youmore than you need. When you drive away, you realize you cannot operate the vehicleeffectively. As a buyer, beware. You should buy what you need and not an approximation ofwhat you think you want. Whether this happens as a matter of choice or misunderstanding, ithardly matters. This is not a criticism but is reflective of the industry."
Under a periodic system, the software should show the cost of inventory recorded as per thelast physical count — it does not update based on sales. Companies register thepurchasesmade between counts in the purchases account. The software makes journal entries based ontransactions out of the inventory and cost of goods sold (COGS) accounts to user-definedaccounts. Other features of periodic inventory software include:
- User-defined accounts set for different combinations of books and subsidiaries.
- Creation of journal entries in the background based on a scheduled script.
- Custom reports such as Journals Created Today, Journals Not Needed for TransactionsCreated Today, Error Reports and Modified Transactions.
- Customized software roles, such as the Principal Accountant.
What Is the Cost of Sales?
The costs of sales are the direct expenses from the production of goods during a period.These costs include labor and materials costs but exclude any distribution or sales costs.The formula for COGS, or costs of sales, is:
If you do not have a true beginning inventory, calculate the beginning inventory as theremaining stock from the previous period. The accounting period can be in months, quartersor a calendar year. The COGS in a perpetual system is rolling, but you can calculate it fora period.
Let's say our product manager, Cristina, wants to know if she is pricing her company'sgeneric Bismuth subsalicylate high enough to leave a healthy profit margin. If shecalculates the COGS as $10 per 100-mL bottle, she will need to price each bottle higher than$10 so her company can comfortably turn a profit.
Cristina's business uses the calendar year for recording inventory and records the beginninginventory on Jan. 1 and the ending inventory on Dec. 31. The company accountant valued theJan. 1 beginning inventory of generic Bismuth subsalicylate at $49,000, or 4,900 bottles.During the year, generic Bismuth subsalicylate costs the company $40,000 for materials andlabor. On Dec. 31, the company accountants valued the ending inventory at $30,000.Therefore,
When Is a Periodic Inventory System Used?
A small company with a low number of SKUs would use a periodic system when they aren'tconcerned about scaling their business over time. Depending on your products and needs, youcould also use a periodic system in concert with a perpetual system.
Any business can use a periodic system since there's no need for additional equipment orcoding to operate it, and therefore it costs less to implement and maintain. Further, youcan train staff to provide simple inventory counts when time is limited or you have highstaff turnover. For example, seasonal staff may come and go. They can quickly count thegoods they are working with, whereas a perpetual system, which provides a more accurateinventory, requires training staff on electronic scanners and data entry. Learn more about aperpetual system and how it gives a more precise inventory solution by reading our "Guide to PerpetualInventory".
You can also use a periodic system if you have a handle on your supply chain process, sell afew products and have eyes on your goods as they flow through your business. A periodicsystem isn't useful if you need to investigate to identify missing inventory or unbalancednumbers. This issue will arise as your operation grows and becomes more challenging tocontrol positively.
Milner describes periodic systems as "a simple approach to inventory management which isuseful for those small organizations which have a simple approach to inventory management.These businesses don't necessarily have a defined relationship between the raw materials orpurchased items and the final sold product. One example of a business that would use aperiodic system is a food bank. They would frequently count the physical inventory todetermine the closing inventory quantity."
The Benefits of a Periodic Inventory System
The main benefits of employing a periodic inventory system are the ease of implementation,its lower cost and the decrease in staffing needed to run it. It only takes a little time toadd a periodic system to your business. Simple counts on legal paper can suffice forcollecting product data, especially if you only offer a few goods. A basic count during theday or week is often enough for a small business to get an adequate handle on theirinventory. This means there is no need for expensive or complicated equipment, justessential information collection tools – pen and paper.
One big negative, however, is that you are only collecting minimal information, usually justa discrete product count. Further, you do not collect or report this data in "real-time."You update stock numbers at distinct periods and not when you buy or sell them. In fact, youwill not have much information to go on should you need to track your products frombeginning to end or investigate shortfalls or overages. You can't quickly identify thesource of issues.
Other negatives with a periodic system include:
- Errors in Estimation: In the periods between stock inventories, youmust estimate the cost of goods sold and which products and quantities are available.This estimate may be far from the actual COGS once you have completed a physical count.
- Significant Adjustments: In the periods between stock-taking, there isno way to account for losses, overages or obsolete goods. This could result insubstantial, costly adjustments after your next physical count. The only time a periodicsystem is current is directly after the stock-taking and the accounting events.
- Inability to Scale: A periodic system does allow for some room to grow,as it is based on your ability to track your goods. However, scaling your business witha periodic system becomes more time-consuming and onerous as you grow and add productsto your inventory.
Challenges of Periodic Inventory
While periodic inventory is easy to implement, it comes with several noteworthy drawbacksaround the level of detail you get and how often your information is updated.
To make good business decisions, most business owners and managers need updated informationon a very regular basis. Most large businesses update inventory automatically with each saleor shipment. This is easily achieved with a modern ERP. Whenever you make a purchase at aretail store or online, the retailer knows exactly what was sold and when so it can makedecisions around restocking.
Businesses with periodic inventory in place may not realize a product is running low until acustomer asks why it isn’t on the shelf. Even worse, you could make an online saleonly to find the item isn’t in stock and backordered with your supplier. Both are farfrom ideal customer experiences and can add extra stress on your staff.
Even many small businesses use inventory tracking systems tied to their point of sales (POS)or online store. When the cashier scans a barcode and a customer walks out with a product,the inventory is automatically updated. Sophisticated businesses may setup automaticreordering so they never run out of stock.
The ongoing information also helps businesses keep more granular information on cost per itemsold, which is a major factor in profit margins and overall profitability. For largebusinesses or growing businesses, operating with a periodic inventory system is akin tooperating your business with blinders. You don't have the full picture until the end of theperiod.
What Is a Perpetual Inventory System?
A perpetual inventorysystem is a software system that continuously collects data about a company'sproducts. A perpetual system tracks every transaction as it happens, including purchases andsales. The system also tracks all information pertinent to the product, such as its physicaldimensions and its storage location.
A perpetual system is more sophisticated and detailed than a periodic system because itmaintains a constant record of the inventory and updates this record instantaneously fromthe point of sale (POS). However, perpetual systems require your staff to perform regularrecordkeeping. For example, in a periodic system, when you receive a new pallet of goods,you may not count them and enter them into stock until the next physical count. In aperpetual system, you immediately enter the new pallet in the software so the system cantrack its life in your business. When there is a loss, theft or breakage, you should alsoimmediately record these updates.
According to Relph, "When an organization grows such that all items require a SKU (e.g.internet sales), then it is highly likely this business will need to move towards aperpetual inventory system."
A perpetual system is superior to a periodic system in many ways, especially for companiesthat are considering their longevity. Implementing a perpetual system earlier in thecompany's inception enables staff to have a long-term record of the inventory and also keepsthe business from growing out of a periodic system one day. A perpetual system can scale, sowhether you have five products (today) or 200 products (tomorrow), a perpetual system caneffectively manage inventory control.
Periodic vs. Perpetual Inventory Systems
Periodic and perpetual inventory systems are different accounting methods for trackinginventory, although they can work in concert. Overall, the perpetual inventory system issuperior because it tracks all data and transactions. However, with a perpetual system, youneed to make more decisions to use it successfully.
"Periodic systems are better with unknowns. Not all periodic systems have computer systemsattached since computer logic does not do well with many unknowns," explains Relph. "Onceyour business grows, you need to define those unknowns to make a perpetual system work. Youmust define the products, assign SKUs and then make decisions about the relationshipsbetween what you buy and sell."
Between the two accounting systems, there are differences in how you update the accounts andwhich accounts you need. In a perpetual system, the software is continuously updating thegeneral ledger when there are changes to the inventory. In the periodic system, the softwareonly updates the general ledger when you enter data after taking a physical count. In aperpetual system, the COGS account is current after each sale, even between the traditionalaccounting periods. This method also makes the calculations less time-consuming. In theperiodic system, you only perform the COGS during the accounting period.
One other key difference between the two systems is the accounts you use. In a perpetualsystem, you record purchases or inventory under the merchandise or raw materials accountwhen you make them, updating the unit count entry for the individual record, whereas in aperiodic system, you document purchases into a purchase asset account, which means anindividual record for unit counts isn't available.
Examples of Periodic Transaction Journal Entries
In a periodic inventory system, you update the inventory balance once a period. Typicaljournal entries for this system are simple. You can assume that both the sales and thepurchases are on credit and that you are using the gross profit to record discounts.
The gross profit method is an estimate of the ending inventory in the period. You can usethis in the interim period, the time between physical counts, or to estimate how much stockyou lost in the case of a catastrophic event. This calculation is an estimate. Accountantsdo not consider it as an airtight method to determine the annual inventory balance, as it isnot precise enough for financial statement reporting.
Follow these steps to calculate the gross profit estimate:
- Calculate the cost of goods available for sale (COGAFS): Add thebeginning inventory (BI) and the cost of purchases (P) for the period (COGAFS = BI + P).
- Estimate the cost of goods sold (COGS): Multiply the sales (S) for theperiod by [1 – the expected gross profit % (EGP%)]. This calculation gives youCOGS = S* (1-EGP%).
- Estimate the ending inventory: Subtract the COGS from the COGAFS, orstep #1 – step #2 (EI = COGAFS – COGS).
In a periodic system, you enter transactions into the accounting journal. This journal showsyour company's debits and credits in a simple column form, organized by date.
Record the purchase of inventory in a journal entry by debiting the purchase account andcrediting accounts payable.
Record the purchase discount by debiting the accounts payable account and crediting thepurchase discount account.
Record the total accounts payable purchase and accompanying discount in an entry togetherthat debits the accounts payable and credits the purchase discounts account.
Record the purchase returns by debiting the accounts payable or accounts receivable accountand crediting the purchase returns account.
Record inventory sales by crediting the accounts receivable account and crediting the salesaccount.
Record sales discount by debiting the sales discount account and crediting the accountsreceivable account.
Record your total discount in your journal by combining the inventory sales and the salesdiscount entries.
Record your sales return by debiting your sales returns account and crediting your accountsreceivable or accounts payable.
Complete the closing entry at the end of the accounting period, after the physical count. Youcan calculate the COGS by using a balancing figure or the COGS formula. In this entry, thedebits are in the ending inventory rows and the COGS row, and the credits are in thebeginning inventory and the purchases rows.
Example of Periodic Systems
Periodic system examples include accounting for beginning inventory and all purchases madeduring the period as credits. Companies do not record their unique sales during the periodto debit but rather perform a physical count at the end and from this reconcile theiraccounts.
Cost flow assumptions are inventory costing methods in a periodic system that businesses useto calculate COGS and ending inventory. Beginning inventory and purchases are the input thataccountants use to calculate the cost of goods available for sale. They then apply thisfigure to whichever cost flow assumption the business chooses to use, whether FIFO, LIFO orthe weighted average.
Cost Flow Assumption Diagram
Periodic FIFO
FIFO means first-in, first-out and refers to the value that businesses assign to stock whenthe first items they put into inventory are the first ones sold. Products in the endinginventory are the ones the company purchased most recently and at the most recent price. Ina periodic FIFO inventory system, companies apply FIFO by starting with a physicalinventory. In this example, let's say the physical inventory counted 590 units of theirproduct at the end of the period, or Jan. 31. Purchases over this period are in thefollowing table.
Over January, this company had 1,950 units from the beginning inventory and purchases. Aperiodic system doesn't track each sale during this period. Therefore, 1,950 units –590units from the physical count = 1,360 units. This number is how many units you expect havebeen sold and should expect to be in COGS.
This company pulled into COGS the full purchases and costs from 1/1/2019 and 1/2/2019 andonly pulled what they required from the 1/7/2019 purchase to meet their calculated COGSamount from above (110 units). In a FIFO system, this company uses the first inventory inbefore they move to more recent inventory (and prices). It put leftover units into theending inventory, making it 590 units at $2,960 that it will also put into the beginninginventory for the next period.
This company will list the following figures on its monthly income statement:
Periodic LIFO
LIFO means last-in, first-out, and refers to the value that businesses assign to stock whenthe last items they put into inventory are the first ones sold. The products in the endinginventory are either leftover from the beginning inventory or those the company purchasedearlier in the period. LIFO in periodic systems starts its calculations with a physicalinventory. In this example, we also say that the physical inventory counted 590 units oftheir product at the end of the period, or Jan. 31. We use the same table (inventory card)for this example as in the periodic FIFO example.
Over January, this company had 1,950 units from the beginning inventory and purchases. Youdon't worry about tracking each sale during this period. Therefore, 1,950 units – 590unitsfrom the physical count = 1,360 units. This amount is the number of units that you expectare sold and should expect to be in COGS.
Different from a FIFO system, a LIFO system pulls the latest purchases into the COGScalculation. The accountant took the purchases last made 1/10/2019, 1/7/2019, and 660 unitsfrom 1/2/2019 and put them into COGS with their accompanying costs. Leftover items goinginto the ending inventory were 90 units from the 1/2/2019 purchase and what was in thebeginning inventory, giving the 590 units. This company counted the total cost of $3,130,which will go into the beginning inventory for the next period. Here's how they will listthe following figures on their monthly income statement:
Periodic Weighted Average Costing (WAC)
Weighted average cost (WAC) in a periodic system is another cost flow assumption and uses anaverage to assign the ending inventory value. Using WAC assumes you value the inventory instock somewhere between the oldest and newest products purchased or manufactured.
The formula is WAC = BI + P / units for sale
To maintain consistency, we'll use the same example from FIFO and LIFO above to the calculateweighted average. In this example, the physical inventory counted 590 units of their productat the end of the period, or Jan. 31. The same table for this is below.
Before going further, the company calculates the weighted average of the purchases over theperiod from the total cost divided by the total units over the period, or $11,150/1,950units = $5.72 per unit. From this figure, it would incorporate the physical inventory thecompany counted of 590 units. Here is how it will list the following figures on its monthlyincome statement:
As you can see, weighted average in a periodic system is a calculation done outside of theledger. In this method, you calculate an average for the period instead of movingtransactions over when the company bought or sold something during the period.
Perpetual FIFO
In a perpetual FIFO system, the company includes the sales as they happen in the ledger. Thecompany should still perform physical inventories, but only to confirm the accuracy of theledger's data. They would perform these either yearly or by cycle counting. The biggestdifference in the ledger in a perpetual system as compared to a periodic system is that thebalance is a running tally of not only the units but the value (or total cost) of thoseunits. The unit cost moved over in the balance is based on when the stock sold comes in.Stock maintains the value the company purchased it for throughout its lifecycle in thecompany. For example, stock purchased on 1/4/2019 for $6.00 per unit maintains that valuethrough its sale. See the running tally in the chart below.
At the end of the period, the ending inventory is already calculated as the last entry. Forthis period, it is 1,000 units at a total cost of $7,700.00. The cost per unit is $6.50, orthe last purchase unit cost for the period. You'd calculate COGS from this ledger by goingto the Total Cost in the Sales column and adding the figures for what the company soldduring that period. These are the figures in red, or $2,000 + $1,000 + $4,800 + $3,600 =$11,400.
Perpetual LIFO
In a perpetual LIFO system, the company also uses the running ledger tally for purchases andsales, but they sell the inventory that they last purchased before moving to olderinventory. In other words, the cost of what they sell is the same as what they most recentlypaid for that inventory. See the same activities from the FIFO card above in the LIFO cardbelow.
Notice the difference in the unit cost of the sales and what carries over to the balance. Thesales transaction on 1/7/2019 is most notable. The FIFO card noted two separate transactionsof sales (for 200 units at $5.00/unit and 800 units at $6.00/unit) under two differentcosts. In the LIFO card, there was enough inventory at the most recent cost ($6.00 per unit)to fulfill the sales request by the single entry. This entry is for the most recentlypurchased inventory at the most recent price.
Tally the ending inventory shown at the bottom of the card. It is 1,200 at three differentunit costs, adding up to $7,200 for the period. Calculate the COGS by adding the Total Costsin the Sales column (the figures in red). COGS reflect what the company sold by the actualprices the units sold for. Therefore, COGS = $2,000 + $6,000 + $3,900 = $11,900.
Perpetual Weighted Average Costing
In a perpetual weighted average calculation, the company keeps a running tally of thepurchases, sales and unit costs. The software recalculates the unit cost after everypurchase, showing the current balance of units in stock and the average of their prices. Thenext sales transaction reflects this newly calculated unit cost. See the same activitiesfrom the FIFO and LIFO cards above in the weighted average card below.
Notice the difference in the unit cost after every purchase. The system recalculates the unitcost and value of total cost based on the average of what is still in stock and what thecompany has added in their purchase. The ending inventory figure is the last numbers on thecard: 1200 units at $7,476.00. Calculate COGS by adding the total costs of what the companysold (in red). COGS = $2,000 + $5,890 + $3,900 = $11,790.
Specific Identification
The specific identification method is the same in both a periodic system and perpetualsystem. Although not widely used, this method requires an extremely detailed physicalinventory. The company must know the total units of each good and what they paid for eachitem left at the end of the period. In other words, the company attaches the actual cost toeach unit of its products. This is simple when the products are large items, such as cars orluxury technology goods, because the company must give each unit a unique identificationnumber or tag.
The example below has the same activities as above, except the company tracks each unitindividually and what it purchased. Then, it performs a detailed physical inventory,reporting back each unit sold by the date the purchase was made.
They report the ending inventory for each purchase date first, then add them up. The endinginventory for this period is $2,520 for 440 units. Calculate COGs for each line item, andthen add them together to get the period's COGS. In this example, COGS is $8,630.00.
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Properly managing inventory can make or break a business, and having insight into your stockis crucial to success. While the periodic method is acceptable for companies that haveminimal inventory items or small businesses, those companies that plan to scale will need toimplement a perpetual inventory system. Regardless of the type of inventory control processyou choose, decision makers need the right tools in place so they can manage their inventoryeffectively. NetSuite offers a suite of native tools for tracking inventory in multiplelocations, determining reorder points and managing safety stock and cycle counts. Find theright balance between demand and supply across your entire organization with the demandplanning and distribution requirements planning features.
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Periodic Inventory FAQs
What is periodic inventory system with an example?
A periodic inventory system is an accounting method where inventory tracking is updatedmanually at the end of a specific period. For example, a small retail store with onelocation may choose periodic inventory to make record keeping simpler and may choose toupdate their inventory records on a quarterly basis for estimated tax calculations.
What is periodic inventory taking?
Periodic inventory taking is the physical count of inventory that takes place on a periodicschedule when using a periodic inventory method. Even businesses using perpetual inventorymay want to take a physical inventory count periodically to account for shrinkage (theft,broken, and lost items).
What is the difference between periodic and perpetual inventory?
Businesses using periodic inventory update their inventory records on a regular schedule,often monthly, quarterly, or annually. Perpetual inventory requires regular updates butoffers more in-depth and timelier inventory information.
Who would use a periodic inventory system?
Periodic inventory systems are best for smaller businesses with just a few products totrack. As businesses grow and track more unique SKUs, periodic inventory systems become lessviable.
