Is merchandise inventory used in periodic inventory system?
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March 28, 2019  A periodic inventory system is a form of inventory valuation where the inventory account is updated at the end of an accounting period rather than after every sale and purchase. The method allows a business to track its beginning inventory and ending inventory within an accounting period. What this article covers:
NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area. How Does a Periodic Inventory System Work?In a periodic inventory system, no continuous record of changes is kept. The yearly inventory purchases are recorded in the purchases account, which is a ledger listing all inventory purchases and their costs.
At the end of the year, a physical inventory count is done to determine the ending inventory balance and the cost of goods sold.
How Do You Calculate Cost of Goods Sold Using the Periodic Inventory System?The total in purchases account is added to the beginning balance of the inventory to compute the cost of goods available for sale. The ending inventory is determined at the end of the period by a physical count of every item and its cost is computed using inventory calculation methods such as FIFI, LIFO and weighted averages. This amount is subtracted from the cost of goods available for sale (or the cost of goods manufactured) to compute the cost of goods sold. The general formula to compute the cost of goods sold under the periodic inventory system is given below: Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory For example, XYZ Corporation has a beginning inventory of $100,000, has $120,000 in outgoings for purchases and its physical inventory count shows a closing inventory cost of $80,000. The calculation of its cost of goods sold is: Cost of Goods Sold = Cost of Goods Available – Closing Inventory Advantages of the Periodic Inventory SystemEasier to ImplementSince the periodic system involves fewer records and simpler calculation than the perpetual system, it is easier to implement. The simplicity also allows for the use of manual record keeping for small inventories. Ideal for Small BusinessesThe periodic inventory system is ideal for smaller businesses that maintain minimum amounts of inventory. The physical inventory count is easy to complete, small businesses can estimate the cost of goods sold figures for temporary periods. While the system may work for smaller businesses, it can prove to be highly problematic for large businesses due to its high level of inaccuracy. Since the periodic system is manual, it’s prone to human error and the inventory data can be misplaced or lost. The periodic inventory system doesn’t provide real-time data about the cost of goods sold or ending inventory balances. This makes it harder to ascertain the inventory on hand at any point in time. Most accounting software use a perpetual inventory system to track and update inventory purchases, sales and the cost of goods in real time. This way business owners are able to keep track of accurate COGS figures and adjust for obsolete inventory or scrap losses. RELATED ARTICLES A periodic inventory system only updates the ending inventory balance in the general ledger when a physical inventory count is conducted. Since physical inventory counts are time-consuming, few companies do them more than once a quarter or year. In the meantime, the inventory account in the accounting system continues to show the cost of the inventory that was recorded as of the last physical inventory count. Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, the balance in the purchases account is then shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory. The calculation of the cost of goods sold under the periodic inventory system is: Beginning inventory + Purchases = Cost of goods available for sale Cost of goods available for sale – Ending inventory = Cost of goods sold For example, Milagro Corporation has beginning inventory of $100,000, has paid $170,000 for purchases, and its physical inventory count reveals an ending inventory cost of $80,000. The calculation of its cost of goods sold is: $100,000 Beginning inventory + $170,000 Purchases - $80,000 Ending inventory = $190,000 Cost of goods sold Periodic Inventory AccountingUnder a periodic inventory system, inventory purchases made by a company are initially stored in a purchases (asset) account with the following journal entry: There may be a number of these entries during an accounting period, which gradually increases the amount in the purchases account. At the end of the accounting period, the entire balance in the purchases account is shifted into the inventory (asset) account. This means that the purchases account is really an accumulation account for a single accounting period, rather than an account that holds a balance over multiple periods. The entry at the end of the period is:
The final periodic inventory entry in an accounting period arises immediately after the physical count of the inventory, when the accounting staff establishes the actual cost of the inventory on hand at the end of the month. It then subtracts this actual ending inventory cost from the cost that has accumulated in the inventory account, and charges the difference to the cost of goods sold account with this entry:
Periodic Inventory System Advantages and DisadvantagesThe periodic inventory system is most useful for smaller businesses that maintain minimal amounts of inventory. For them, a physical inventory count is easy to complete, and they can estimate cost of goods sold figures for interim periods. However, there are several problems with the system:
What accounts are used in a periodic inventory system?Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, the balance in the purchases account is then shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory.
What are the accounts used in merchandising businesses using periodic inventory system?Rather than using the Merchandise Inventory account to record purchases, returns, discounts, and transportation costs, four temporary accounts are used instead under the periodic system: Purchases, Purchases Returns, Purchases Discounts, and Freight-in.
What are the most common inventory costing methods used under periodic system?The four methods included are: specific identification, weighted average cost, first-in first-out (FIFO), and last-in first-out (LIFO).
What types of businesses are most likely to use a periodic inventory system?Seasonal businesses, start-ups, businesses that sell high ticket items, and companies with a low inventory turnover are most likely to use periodic inventory systems. This is because these businesses have less need for accurate and up-to-date inventory information.
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