How does the Periodic Inventory System work?
Does managing inventory feel like multiple tasks, including tracking incoming stock, managing outgoing stock, and keeping records up-to-date? The periodic inventory system offers a simpler, cost-effective path by counting inventory at set times. Let’s walk through how it works, its strengths and weaknesses, and whether it suits your business model.
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What Is a Periodic Inventory System?
A periodic inventory system is a method where you don’t update inventory counts with every sale or purchase. Instead, you conduct a physical count at specific times, like monthly, quarterly, or annually. Through this system, you’ll know your inventory levels and cost of goods sold (COGS) only after these counts. It’s an ideal choice for businesses that don’t require up-to-the-minute stock data.
Step-by-Step: How the Periodic Inventory System Works
Using the periodic stock system is simple:
- Start with Beginning Inventory: Note the stock value at the start of the period.
- Record Purchases: Over the period, record all inventory purchases in a “Purchases” account—without adjusting inventory levels each time.
- Count Inventory at the End: At the end of the period, physically count what’s left.
- Update Inventory Records: Now, adjust your general ledger to show the actual ending inventory and record COGS.
Until that final count, your records only show starting inventory and purchases—not the exact quantities on hand.
Choosing an Inventory Valuation Method
Even within a periodic system, you need a way to value inventory. Popular methods include:
- FIFO (First In, First Out): Assumes items bought first are sold first. The ending inventory value reflects the latest purchased items.
- LIFO (Last In, First Out): Assumes the newest stock is sold first, so remaining inventory reflects older costs.
- Weighted Average Cost: The total cost of goods available divided by the number of units gives an average per-unit value.
Your choice affects how profit and inventory are reported once counts are done.
Journal Entry Examples in a Periodic System
Whenever you buy inventory:
- Debit Purchases
- Credit Cash or Accounts Payable
At period end, after counting and calculating:
- Debit Inventory (ending balance)
- Debit Cost of Goods Sold
- Credit Purchases
- Credit Beginning Inventory (to zero it out)
This moves the purchases into inventory and figures in the right cost for COGS.
Advantages of Using a Periodic Inventory System
- Simple and low cost: You don’t need fancy software, often paper or basic spreadsheets do the job.
- Easy to start: You can pick inventory count intervals that fit your schedule.
- Great for small operations: Ideal when you have few items or low sales volume.
- Good for occasional audits: The physical count provides a clear snapshot of stock, revealing any damage, loss, or theft.
Disadvantages to Consider
- Not up to date: You won’t know stock levels until after the count, which can lead to ordering mistakes.
- Time-consuming counts: Large inventories require more effort and may disrupt operations when counting.
- Less control over losses: If items are stolen or damaged between counts, you won’t notice until much later.
- Unsuitable for growing businesses: As the scale or complexity increases, this system can become risky and outdated.
Periodic vs. Perpetual Inventory: Which to Choose?
Here’s a simple comparison of the periodic and perpetual inventory systems:
| Feature | Periodic System | Perpetual System |
|---|---|---|
| Record Updates | At set intervals | Continuous, real-time |
| Inventory Visibility | Only after count | Always current |
| Cost & Tech Needs | Low | Higher |
| Best for Business Size | Small | Medium to large |
Periodic systems are easy and cost-effective, making them ideal for small setups. Perpetual systems, in contrast, provide accurate real-time data through technology and automation, making them ideal for larger businesses with more complex operations.
Is the Periodic Inventory System Right for You?
Ask yourself these questions:
- Do you track only a few products and don’t need daily stock numbers?
- Are you a small business with limited resources or tech setup?
- Can you schedule physical counts without disrupting work?
- Is accuracy of mid-period stock less critical?
If you answered “yes” to these, the periodic inventory system likely fits your needs. You can add simple stock tracking and still keep costs low. As your business grows, you can later move to a system that offers real-time tracking through software or point-of-sale tools.
In Summary
The periodic inventory system is a time-tested, simple method for businesses that don’t need constant inventory updates. It uses occasional physical counts and basic math to figure out costs and stock levels. When speed and tech aren’t a priority, it offers a practical way to stay in control. As your business expands or needs more detail, you can reassess and upgrade. For now, periodic might just be the right fit.
I am a chartered accountant with over 14 years of experience. I understand income tax, GST, and balancing financial records. I analyze financial statements and tax codes effectively. However, I also have a passion for writing, which is different from working with numbers. Recently, I started writing articles and blog posts. My goal is to make finance easier for everyday people to understand.
