Periodic Inventory System

What Is Periodic Inventory?

A company uses a periodic inventory system (PIS) to physically count inventory at the end of each quarter to determine the quantity and the cost of things sold. Many companies choose monthly, quarterly, or annual terms depending on their revenue and accounting requirements.

Instead of constantly updating their books with current prices and inventory, businesses use initial inventory levels, ending inventory, and purchases made over a while. 

Periodic inventory is appropriate for businesses that do not require daily accuracy in inventory levels. It is ideal for small firms trying to cut expenditures. 

Growing and larger organizations require more precise inventory management and often opt for a perpetual inventory system, which is best managed using an enterprise resource planning inventory module.

While it doesn't provide real-time data for business decision-makers, periodic inventory is sufficient for many small organizations, especially those with few unique SKUs, to update at the real-time end of each quarter.

Understanding the Periodic Inventory System

A periodic inventory system can be software to request a daily inventory forecast. Then, companies enter the warehouse number into the program, check the original reality of the product, and enter the information into the software to perform the reconciliation.

The software is a periodic system that will display the inventory price recorded at the last physical count - it doesn't update sales supported. Purchases made between two counts are credited to the purchase account.

Logging entries are generated by software-assisted transactions from the inventory and cost of goods sold (COGS) accounts to the user-defined accounts. 

Periodic inventory software also has the following features:

• User-defined accounts are created for different combinations of books and subsidiaries. 
• In the background, log entries are generated using a script. 
• Logs created today, logs not required for transactions created today, error reporting, and changed transactions are examples of custom reports. 
• Custom software positions, such as Senior Accountant.

how does a Periodic Inventory System work?

The periodic inventory system is concerned with accounting stock for its valuation after the specified time frame. Warehouse staff performs a physical count of their merchandise regularly.

The data acquired during the physical count is used for accounting and ledger balance. Accountants then apply the balance to the beginning inventory in the following period.

Periodic inventory's ending inventory, earnings, and cost of goods sold are calculated by physically counting goods at the end of the year. Businesses rely on estimates such as monthly, quarterly, and half-yearly reports that are documented a few times a year.

Account in General Ledger when things to be resold are purchased; inventory is not updated. Instead, the purchases on the temporary account are deducted. A temporary account with a zero balance is considered for this purpose. 

After the year, the ending balance is transferred to another account.

Purchased goods are adjusted to the general ledger contra accounts. The amount in the contra account is offset by the balance in the associated account and is considered in the final statement.

Purchase discounts or returns, allowances accounts, and so on are examples of contra accounts. When these accounts are added together, the total amount spent on purchases is calculated.

In addition, freight costs are saved separately from the main warehouse account. Companies track shipping costs related to inventory due in Cash on Delivery and Cash on Due. All these fees will then improve the inventory price.

To understand how the accounts might look in the periodic inventory approach, look at the table below.

What Is the Cost of Goods Sold (COGS)?

In addition, shipping charges are separate from the central inventory account. You keep track of delivery costs related to inventory in your inbound and outbound freight accounts. All these costs will eventually increase the value of the inventory.

The costs incurred in producing a product are:

The beginning inventory of the accounting period must correspond to the ending inventory of the previous period. Therefore, to calculate the beginning cost of inventory at the beginning of the accounting period, add the previous period's cost of goods sold with the ending inventory. 

The total cost of initial inventory = the number of times the original inventory was purchased.

The cost of Goods Sold (COGS) is the price a distributor, manufacturer, or retailer pays for a product. A company's gross profit margin is its sales minus the cost of goods sold.

In accounting, the cost of goods sold is considered an expense and can be recognized on a financial statement called the income statement.

COGS = Overall cost of beginning inventory - Cost of ending inventory

Let's understand this with an example:

A company, ABC, combines an initial inventory of $100,000, paid $150,000 for purchases, and its actual inventory shows a closing inventory cost of $90,000. To calculate the price of sold products, 

$160,000 COGS = 100,000 BI $150,000 P - $90,000 EI

In periodic inventory, your cost of goods sold is the metric that will tell you how effectively you manage your inventory.

The cost flow assumptions in the periodic inventory system have a particular calculation mode. In periodic inventory, there is no continuous record of sales. As a result, the number of general ledgers that record purchases and transactions is unlikely to continue.

What Are Cost Flow Assumptions?

There are, again, three cost flow assumptions within the PIS:

1. First In, First out
2. Last In, First out
3. Weighted average cost

Let's go through them one by one –

1. FIFO in PIS

This cost flow assumption approach believes in determining the value of your ending inventory by assuming that the things purchased are sold first. As a result, the remaining stock is the inventory from the most recent acquisitions. 

Businesses in periodic FIFO inventory begin by physically counting the inventory.

2. LIFO in PIS

LIFO is a cost flow assumption technique that considers inventory movement so that the most recently purchased things are sold first. Like the FIFO periodic inventory system, the LIFO computation begins with a physical inventory count.

3. WAC in PIS

The average cost method calculations are performed at the end of the accounting period in a periodic inventory system. The weighted average cost is based on the cost of the beginning inventory plus any purchases made during that period. 

This average cost per unit is then applied to sold and inventory units.

The total cost of products available for sale is averaged using the average cost method, and any two units are sold at the average cost.

A company that uses the periodic inventory accounting system might disregard that a sale can occur at the start of a month before final purchases after the same month. 

Using the average cost formula, beginning inventory and purchases are simply summed to calculate the weighted average unit cost.

Pros and Cons of The Periodic Inventory System

Small businesses that don't always have the staff to perform routine inventory counts typically employ periodic inventory. These businesses typically count inventory by hand because they don't require accounting software to do so.

Periodic inventory accounting has several advantages, chief among them being its ease of use and low cost of implementation.

There is more to the periodic inventory system's pros and cons discussed below.

The pros and cons are:

Pros Of Periodic Inventory System

1. Easy Implementation

One of the most significant advantages of having a periodic inventory system is how simple it is to install. This solution can be quickly integrated into your company. It is undeniably less stressful than any other method of keeping track of your inventory. 

Physically counting the inventory is something you can do whenever you want. Most businesses that use this method will implement it once a year. Finally, you are free to define "periodic" as you see fit. 

2. Cheap to Implement 

Again, the periodic inventory method is the way to go if you want the most straightforward system possible. With this alternative, you do not need to invest in expensive software solutions. 

Technically, you don't have to invest anything except for the time it takes to do a physical inventory. Furthermore, your costs will never technically rise as long as you are prepared to put in the effort.

3. Ideal for Smaller Businesses 

As you might expect, tiny enterprises are probably the best fit for a system like this. We're talking about 1-2 individuals, a small inventory, and only a few dozen orders per year. 

Larger firms can also use this approach, although things become more complicated when numerous staff and hundreds of orders are involved.

Cons Of Periodic Inventory System

1. Inaccuracies

One of the worst things you can say about a periodic inventory system is that it can be exceedingly incorrect. Remember that an accounting record is updated at the end of the year to reflect your physical inventory count. 

As a result, the system is fundamentally defective. You cannot guarantee accuracy at all times. Only to a fair degree can you be sure of the correctness. This may not be a problem for certain businesses, especially if we are working with a very tiny business. 

However, larger firms must be aware that mistakes are not the norm while using this system but are also not uncommon.

2. Labour Intensive 

Using the PIS isn't difficult if you have a small inventory and only a few dozen orders for the year. You can even enter data into an Excel document. 

On the other hand, a periodic inventory system can be quite difficult as your organization grows. 

Taking a physical inventory can result in a time commitment that you should avoid. In addition, it can be difficult to find the time and energy to ensure that a periodic inventory system is handled effectively, especially in small firms. 

This is where your errors may begin to show.

3. Exercising control 

Another thing to consider is that exercising control over your inventory will become much more difficult. In addition, determining the level of theft can also become more challenging.

The periodic inventory approach has its advantages, especially when the stakes are low. However, some problematic variables can undermine the system's integrity for larger firms. This is a highly complicated subject.

What Is The Perpetual Inventory System?

As the name implies, the perpetual inventory technique of accounting inventory involves tracking inventory 'perpetually' as it moves through the supply chain. 

Warehouse managers utilize this method to keep track of inventory balances, which means that stock is updated immediately every time an item is received or sold at any point of sale. 

Purchases and returns are automatically recorded in the inventory count in the perpetual inventory system.

To track inventory in real-time, perpetual inventory systems use barcode scanners, radio frequency identification (RFID) scanners, inventory management software coupled with POSes, CRMs, and MarketPlaces like Amazon FBA, and purchase, order, and return management software.

Because of the ability of new cloud-based inventory management software to interact with all systems, the perpetual inventory system becomes more realistic. As a result, it enables firms to expedite their financial and accounting processes.

 Inventory is an important asset for businesses, and a permanent inventory system allows accounting teams to prepare more accurate tax and regulatory reports.

The Pros and Cons of the Perpetual Inventory System

A few of the pros and cons are:

Pros Of Perpetual Inventory System

1. Tighter Inventory Control 

Continuous monitoring gives firms complete control over their inventory, allowing them to know what comes in and what goes out.

2. Preventing Stock-outs or Overstocking 

Obviously, with more inventory control, you will constantly be aware of the status of your inventory, allowing you to determine how much or how little you require. 

As a result, the perpetual inventory system allows you to avoid overstocking and stock-outs by alerting you when products require refilling.

3. Saving Inventory and Storage Costs

Because you'll constantly be up to date on inventory counts, you won't have to stock more than necessary, supposing sales are greater. 

Consider how much capital and storage costs you can save by keeping only the essential inventory! In summary, you will save money on inventory carrying costs.

Cons Of Perpetual Inventory System

1. Time-consuming 

The perpetual inventory system cannot be manually maintained since it requires continual inventory tracking. In addition, because it is critical to register each order immediately, managers are constantly on the lookout for syncing inventory on the system.

2. Discrepancies Can Always Arise

Continuous inventory tracking appears to be a smart method, but what if there are errors while updating the inventory count? 

Because the perpetual inventory system does not allow for regular physical inventory counting, inventory levels may differ from real inventory in the warehouse.

3. Expensive for Small Businesses 

Small firms may believe that implementing a perpetual inventory system will necessitate the purchase of inventory management software, IT infrastructure, and other specialist equipment. Employee training on how to use them is an added cost.

When is a Periodic Inventory System Used?

Small businesses with fewer Stock Keeping Units (SKUs) use a regular system when they don't want to grow their business over time. Depending on the product and needs, periodic systems can also be combined with permanent systems.

No additional equipment or coding is required to operate, so any business can use the bike system, which means lower implementation and maintenance costs. You can also train your employees to provide simple inventories when time is limited or staff turnover is high. 

For example, seasonal workers can come and go. As a result, they can quickly count the goods they work with, while the ongoing system, which provides a more accurate inventory, requires staff training in electronic scanners and data entry.

You can also use a periodic system if you are familiar with your supply chain process, sell specific products, and monitor your goods as they move through your business. However, the periodic table isn't useful when you need to research to identify missing inventory or imbalanced numbers. 

This problem occurs when your process grows, making it difficult to steer it positively. Milner describes the periodic system as "a simple approach to inventory management useful for small organizations with a simple approach to inventory management." 

These activities do not necessarily have a definite relationship between the raw materials or items purchased and the finished goods sold. An example of a business that uses a regular system is a food bank. They often do a total count to determine the amount of closing inventory.

To summarise, you should adopt PIS when you don't have a lot of items to handle, you want to keep things simple, you're just trying to survive in the market right now, and overnight growth isn't on your radar.

Which Inventory System should you choose?

Which inventory system to choose, either periodic or perpetual, depends on your situation. 

As previously noted, both inventory systems have advantages and disadvantages, and choosing between the two is dependent on your organization.

However, the fundamental fact is that maintaining accurate inventory levels is impossible without a physical inventory count. At different locations, 40% of large organizations will utilize a perpetual inventory system, but at their core, they will employ the periodic method.

Scalability is another consideration. If your company has been progressively growing and regular inventory counts are becoming complex, you can use the perpetual inventory system to simplify inventory management.

A perpetual inventory system may make life easier for e-commerce businesses that sell on many channels, run multiple warehouses, and want to go omnichannel. However, regardless of the size of your company, you will need to conduct a physical inventory count at some point.

Researched and authored by Kavya Sharma | Linkedin

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

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• Accrued Interest
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