What is the Periodic Inventory System?
The periodic inventory system refers to conducting a physical inventory of goods/products on a scheduled basis. Maintaining physical inventories can be costly because the process eats up time and manpower. Thus, many companies only conduct physical inventories periodically. A periodic inventory system is a commonly used alternative to a perpetual inventory system.
How a Periodic Inventory System Works
Because the physical accounting for all goods and products in stock is so time-consuming, most companies conduct them sparingly, which often means once a year, or maybe up to three or four times per year.
In a periodic system, all transactions conducted are listed in a purchase account for the company, which monitors inventory based on deduction of the cost of goods sold (COGS). It doesn’t, however, account for broken, damaged, or lost goods and also doesn’t typically reflect returned items. It is why physical inventories are necessary, to accurately reflect how many tangible goods are in a store or storage area.
After a periodic inventory, purchase account records are changed to reflect an accurate monetary accounting of goods based on the number of goods that are physically present.
Calculations in the Periodic Inventory System
As discussed above, calculating the cost of an inventory is done from one physical inventory to the next, with the time in-between addressed by subtracting the cost of each good sold.
The calculation is fairly simple:
Starting Inventory (based on the last physical inventory) plus the total number of purchases made within the period between the previous physical inventory and the next physical inventory is equal to the total amount of the goods that are available to be sold.
The total – the cost (or total price) of goods that are able to be sold – minus the total number of goods sold between physical inventories is the cost of goods sold.
The periodic inventory system is an integral part of a company’s operations and is the most common type of inventory process followed because, again, physical inventories involve substantial amounts of time which, ultimately, cost money.
While discrepancies are more likely to occur the more time passes between inventories, maintaining at least periodic updates to a company’s goods available for sale typically prevents any major issues in terms of lost goods or lost opportunities for profit.
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