The distinction means that companies needing a regular or daily COGS will use perpetual accounting. Some companies may use cycle counting as a stop-gap between periods to “true-up” the counts, but it’s still less accurate than perpetual. Some companies don’t wait until the end of an accounting period to track inventory.
- A periodic inventory system does not account for individual or unit counts for inventory, such as raw material or work in progress accounts.
- For a perpetual inventory system, the adjusting entry to show this difference follows.
- Discrepancies can be detected only at the end of the accounting period.
Periodic inventory is normally used by small companies that don’t necessarily have the manpower to conduct regular inventory counts. These companies often don’t need accounting software to do the counts, which means inventory is counted by hand. As such, the system is commonly used by companies that sell small quantities of inventory, including art and auto dealers. The last step is to monitor changes in the inventory levels continuously. A physical count of inventory can also be performed to verify the inventory levels.
The Benefits of a Periodic Inventory System
Purchase Returns and Allowances is a contra account and is used to reduce Purchases. The periodic and perpetual inventory systems require different journal entries. Let’s first go over the periodic method journal entries then segue into the perpetual inventory system afterward. In our illustration, let’s use sample data from a fictitious company called FitTees. A perpetual inventory system uses point-of-sale terminals, scanners, and software to record all transactions in real time and maintain an estimate of inventory on a continuous basis. A periodic inventory system requires counting items at various intervals—i.e., weekly, monthly, quarterly, or annually.
Businesses that account for inventory periodically likely use the FIFO method to sell older units first. Retailers that use the perpetual system often make it a practice to count inventory (or at least a sample of inventory) to make adjustments for shrinkage. Changes in inventory are accurate (as long as there is no theft or damage to any goods) and can be easily accessed immediately.
Order fulfillment status includes receipt, packing, shipping, and delivery status. For production houses, a perpetual inventory system gives real-time data about raw materials, work in progress, and finished goods. In specific identification, businesses are entered goods with a unique identification like batch or lot number and keep records of which goods are left based on its identification number. In this way, you easily manage expired dates and can minimize spoilage for both expirable and perishable goods because here you ensure sales that products will expire fast or rot first. Under a periodic inventory system, inventory is counted at the end of a period.
So, it helps you to optimize inventory levels and helps to minimize overstocks and understocks. In this method, some products spoil, and the loss, for this reason, will be recovered with profits of sold items. Periodic inventory systems can be a good choice for businesses with low or high inventory turnover rates, as long as the business is able to accurately count its inventory on a regular basis.
If you have a larger company with more complex inventory levels, you may want to consider implementing a perpetual system. The software you introduce into the workflow will make it easier for you to update and maintain your inventory. Businesses can choose to use either a perpetual period periodic inventory system to calculate their cost of goods sold (COGS).
Perpetual inventory is the system in which company keeps track of each inventory item level since it was purchase and sold to the customer. Cost of goods sold is calculated using the FIFO method, and inventory is decreased by that amount. The 10 units from June 1 and four of the June 5 units are included ((10 x https://business-accounting.net/ $10) + (4 x $10.12)). FitTees conducts a monthly physical count to determine existing goods on hand. FitTees sold 1,200 units of designer shirts and 800 units of jeans at $35 each to WP Clothing, a reseller in California. Since we are using the periodic system, we don’t make a journal entry to record the COGS.
What Are the Advantages of a Periodic Inventory System?
This method, known as the periodic inventory system, is not as prominent as it once was due to technological advances in accounting software. Read on to learn about periodic inventory and its younger brother, the perpetual inventory system. While each inventory system has its own advantages and disadvantages, the more popular system is the perpetual inventory system. The ability to have real-time data to make decisions, the constant update to inventory, and the integration to point-of-sale systems, outweigh the cost and time investments needed to maintain the system. The ability to estimate COGS continuously also provides a company using a perpetual inventory system the ability to estimate gross profit continuously.
However, it is important to weigh the advantages and disadvantages of this type of system before deciding whether or not to use it. The cost of goods sold in that period is counted by taking the inventory status at the beginning of a period, adding new inventory purchases during the period, and deducting the ending inventory. If inventory is central to your business, it must be managed, and to do that it, must be measured. It also wouldn’t make sense for small businesses that sell their inventory as a side project to use perpetual inventory.
The information collected digitally is sent to central databases in real-time. The inventory records are kept in Bin Card (Stores Keeper) and Stores Ledger (Cost Accounting Department). To ensure accuracy, physical verification perpetual vs periodic inventory of stock takes place at regular intervals, and they are compared with the recorded figures. If there is any shortage due to loss or theft, then it can be easily located, and corrective actions can also be taken immediately.
If the company utilizes a perpetual inventory system, COGS is available on a continuous basis. With a periodic inventory system, COGS is calculated at the end of an inventory period. The periodic system updates the purchases account for any inventory transactions. The perpetual system is more inclined towards the automation and use of technology to maintain inventory records in real-time. Contrarily, the periodic system considers the physical count of inventory using manual tools for more accuracy.
Adjusting and Closing Entries for a Perpetual Inventory System
It also isn’t as updated as a perpetual system, as it is done at periodic intervals rather than continuously. The perpetual system may be better suited for businesses that have larger, more complex levels of inventory and those with higher sales volumes. For instance, grocery stores or pharmacies tend to use perpetual inventory systems. The choice between perpetual and periodic inventory systems depends on the size, complexity, and nature of your small business.
Perpetual v/s Periodic Inventory Systems:
When you take a look at a periodic system, a single entry is fed into the purchase account and the total purchase amount. On the other hand, the perpetual systems will record the total amount of stock purchased, along with the recording of the total number of units that have been purchased. The perpetual inventory system keeps continual track of inventory balances and requires much more record keeping to maintain. Whenever a product is received or sold, updates are made automatically. Purchases and returns are immediately recorded in the inventory account.
Should My Business Use Perpetual Inventory or Periodic Inventory?
The first in, first out (FIFO) method assumes that the oldest units are sold first, while the last in, first out (LIFO) method records the newest units as those sold first. Businesses can simplify the inventory costing process by using a weighted average cost, or the total inventory cost divided by the number of units in inventory. A perpetual inventory system maintains a continuous tally of transactions, making the COGS available at any time. By contrast, a periodic inventory system calculates the COGS only after conducting a physical inventory. The differences between perpetual and periodic inventory systems go beyond how the two systems function, although that is the main point of distinction. The periodic inventory system is commonly used by businesses that sell a small quantity of goods during an accounting period.
