Finance Books. Operations Books. Articles Topics Index Site Archive. About Contact Environmental Commitment. What is a Periodic Inventory System? Debit Credit Purchases xxx Accounts payable xxx. Debit Credit Inventory xxx Purchases xxx Notice that there is no particular need to divide the inventory account into a variety of subsets, such as raw materials, work-in-process, or finished goods. 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: Debit Credit Cost of goods sold xxx Inventory xxx A variation on the last two entries is to not shift the balance in the purchases account into the inventory account until after the physical count has been completed.
Debit Credit Cost of goods sold xxx Inventory xxx Purchases xxx An additional entry that is related to the periodic inventory system, but which does not directly impact inventory, is the sale transaction.
Debit Credit Accounts receivable xxx Sales xxx Periodic Inventory System Advantages and Disadvantages The periodic inventory system is most useful for smaller businesses that maintain minimal amounts of inventory.
However, there are several problems with the system: Minimal information. It does not yield any information about the cost of goods sold or ending inventory balances during interim periods when there has been no physical inventory count. A purchase return or allowance under perpetual inventory systems updates Merchandise Inventory for any decreased cost. Under periodic inventory systems, a temporary account, Purchase Returns and Allowances, is updated.
Purchase Returns and Allowances is a contra account and is used to reduce Purchases. When a purchase discount is applied under a perpetual inventory system, Merchandise Inventory decreases for the discount amount. Under a periodic inventory system, Purchase Discounts a temporary, contra account , increases for the discount amount and Merchandise Inventory remains unchanged. When a sale occurs under perpetual inventory systems, two entries are required: one to recognize the sale, and the other to recognize the cost of sale.
Under periodic inventory systems, this cost of sale entry does not exist. The recognition of merchandise cost only occurs at the end of the period when adjustments are made and temporary accounts are closed. Under periodic inventory systems, only the sales return is recognized, but not the inventory condition entry.
A sales allowance and sales discount follow the same recording formats for either perpetual or periodic inventory systems. Adjusting and Closing Entries for a Perpetual Inventory System You have already explored adjusting entries and the closing process in prior discussions, but merchandising activities require additional adjusting and closing entries to inventory, sales discounts, returns, and allowances.
At the end of the period, a perpetual inventory system will have the Merchandise Inventory account up-to-date; the only thing left to do is to compare a physical count of inventory to what is on the books. Differences could occur due to mismanagement, shrinkage, damage, or outdated merchandise. Shrinkage is a term used when inventory or other assets disappear without an identifiable reason, such as theft.
For a perpetual inventory system, the adjusting entry to show this difference follows. This example assumes that the merchandise inventory is overstated in the accounting records and needs to be adjusted downward to reflect the actual value on hand.
If a physical count determines that merchandise inventory is understated in the accounting records, Merchandise Inventory would need to be increased with a debit entry and the COGS would be reduced with a credit entry. The adjusting entry is:. To sum up the potential adjustment process, after the merchandise inventory has been verified with a physical count, its book value is adjusted upward or downward to reflect the actual inventory on hand, with an accompanying adjustment to the COGS.
Not only must an adjustment to Merchandise Inventory occur at the end of a period, but closure of temporary merchandising accounts to prepare them for the next period is required. Sales will close with the temporary credit balance accounts to Income Summary. Note that for a periodic inventory system, the end of the period adjustments require an update to COGS. To determine the value of Cost of Goods Sold, the business will have to look at the beginning inventory balance, purchases, purchase returns and allowances, discounts, and the ending inventory balance.
Figure summarizes the differences between the perpetual and periodic inventory systems. There are advantages and disadvantages to both the perpetual and periodic inventory systems.
Advancements in point-of-sale POS systems have simplified the once tedious task of inventory management. POS systems connect with inventory management programs to make real-time data available to help streamline business operations. One such POS system is Square. Square accepts many payment types and updates accounting records every time a sale occurs through a cloud-based application.
Square, Inc. This enhanced product allows businesses to connect sales and inventory costs immediately. A business can easily create purchase orders, develop reports for cost of goods sold, manage inventory stock, and update discounts, returns, and allowances. With this application, customers have payment flexibility, and businesses can make present decisions to positively affect growth.
The perpetual inventory system gives real-time updates and keeps a constant flow of inventory information available for decision-makers. This allows managers to make decisions as it relates to inventory purchases, stocking, and sales. The information can be more robust, with exact purchase costs, sales prices, and dates known. Although a periodic physical count of inventory is still required, a perpetual inventory system may reduce the number of times physical counts are needed.
The biggest disadvantages of using the perpetual inventory systems arise from the resource constraints for cost and time. It is costly to keep an automatic inventory system up-to-date. This may prohibit smaller or less established companies from investing in the required technologies. The time commitment to train and retrain staff to update inventory is considerable. In addition, since there are fewer physical counts of inventory, the figures recorded in the system may be drastically different from inventory levels in the actual warehouse.
Record sales discount by debiting the sales discount account and crediting the accounts receivable account. Record your total discount in your journal by combining the inventory sales and the sales discount entries.
Record your sales return by debiting your sales returns account and crediting your accounts receivable or accounts payable. Complete the closing entry at the end of the accounting period, after the physical count. In this entry, the debits are in the ending inventory rows and the COGS row, and the credits are in the beginning inventory and the purchases rows.
Periodic system examples include accounting for beginning inventory and all purchases made during the period as credits. Companies do not record their unique sales during the period to debit but rather perform a physical count at the end and from this reconcile their accounts.
Cost flow assumptions are inventory costing methods in a periodic system that businesses use to calculate COGS and ending inventory. Beginning inventory and purchases are the input that accountants use to calculate the cost of goods available for sale. FIFO means first-in, first-out and refers to the value that businesses assign to stock when the first items they put into inventory are the first ones sold.
Products in the ending inventory are the ones the company purchased most recently and at the most recent price. Purchases over this period are in the following table. Over January, this company had 1, units from the beginning inventory and purchases. This number is how many units you expect have been sold and should expect to be in COGS. In a FIFO system, this company uses the first inventory in before they move to more recent inventory and prices.
LIFO means last-in, first-out, and refers to the value that businesses assign to stock when the last items they put into inventory are the first ones sold. The products in the ending inventory are either leftover from the beginning inventory or those the company purchased earlier in the period.
LIFO in periodic systems starts its calculations with a physical inventory. In this example, we also say that the physical inventory counted units of their product at the end of the period, or Jan. We use the same table inventory card for this example as in the periodic FIFO example.
This amount is the number of units that you expect are sold and should expect to be in COGS. Weighted average cost WAC in a periodic system is another cost flow assumption and uses an average to assign the ending inventory value.
Using WAC assumes you value the inventory in stock somewhere between the oldest and newest products purchased or manufactured. In this example, the physical inventory counted units of their product at the end of the period, or Jan. The same table for this is below. From this figure, it would incorporate the physical inventory the company counted of units. Here is how it will list the following figures on its monthly income statement:. As you can see, weighted average in a periodic system is a calculation done outside of the ledger.
In this method, you calculate an average for the period instead of moving transactions over when the company bought or sold something during the period.
In a perpetual FIFO system, the company includes the sales as they happen in the ledger. They would perform these either yearly or by cycle counting. The biggest difference in the ledger in a perpetual system as compared to a periodic system is that the balance is a running tally of not only the units but the value or total cost of those units.
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 the company. See the running tally in the chart below. At the end of the period, the ending inventory is already calculated as the last entry. In a perpetual LIFO system, the company also uses the running ledger tally for purchases and sales, but they sell the inventory that they last purchased before moving to older inventory.
In other words, the cost of what they sell is the same as what they most recently paid for that inventory. Notice the difference in the unit cost of the sales and what carries over to the balance. This entry is for the most recently purchased inventory at the most recent price.
Tally the ending inventory shown at the bottom of the card. COGS reflect what the company sold by the actual prices the units sold for. In a perpetual weighted average calculation, the company keeps a running tally of the purchases, sales and unit costs. The software recalculates the unit cost after every purchase, showing the current balance of units in stock and the average of their prices.
The next sales transaction reflects this newly calculated unit cost. Notice the difference in the unit cost after every purchase. The system recalculates the unit cost and value of total cost based on the average of what is still in stock and what the company has added in their purchase.
The entries will track the number of items purchased, how much they cost, the date and vendor. After the physical count has taken place, it will show how much inventory is in stock. A business can then calculate the ending balance, which shows how much the inventory is actually worth. For this reporting period, it is then necessary to subtract the ending balance, from the costs of goods for sale.
The company can determine how much inventory was sold during this reporting period and for how much money. This final number is referred to as the cost of goods sold COGS. Periodic inventory systems are often adopted by small businesses.
It is a very economical form of accounting and can be executed with a cash register and basic accounting methods. Additionally, if a company sells a service, a large inventory management system may not be necessary.
Other inventory management can be utilized as a business grows and the demand for inventory data evolves over time. It is important for a company to analyse their inventory demands and find the best system to meet their needs. Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists.
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