Periodic Inventory vs. Perpetual Inventory: An Overview
Inventory refers to any raw materials and finished goods that companies have on hand for production purposes or that are sold on the market to consumers. Two types of inventory are periodic and perpetual inventory. Both are accounting methods that businesses use to track the number of products they have available. But they are inherently different. Periodic inventory is one that involves a physical count at various periods of time while perpetual inventory is computerized, using point-of-sale and enterprise asset management systems. The former is more cost-efficient while the latter takes more time and money to execute.
- The periodic inventory system uses an occasional physical count to measure the level of inventory and the cost of goods sold.
- The perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold.
- Periodic inventory accounting systems are better suited to small businesses that have easy-to-manage inventories or those with low sales volumes.
- Businesses with larger inventories, high sales volumes, and multiple retail outlets need perpetual inventory systems.
- There is a greater margin of error with the periodic system as opposed to the perpetual system because it relies on a physical count.
The periodic inventory system is often used by smaller businesses that have easy-to-manage inventory and may not have a lot of money or the opportunity to implement computerized systems into their workflow. As such, they use occasional physical counts to measure their inventory and the cost of goods sold (COGS).
COGS is an important accounting metric, which, when subtracted from revenue, shows a company's gross margin. The COGS under the periodic inventory system is calculated as follows:
COGS = Beginning Balance of Inventory + Cost of Inventory Purchases - Cost of Ending Inventory
Companies may not necessarily be aware of the inventory they hold before they conduct counts, which are done at regular intervals—weekly, monthly, or quarterly. Here's how the process works:
- The party responsible for the count records all the available inventory at the end of the period
- Merchandise purchases are recorded in the purchases account
- This is moved to the inventory account after the count
- This new balance is then applied to the beginning of the new period, after which the process starts again
Since businesses often carry products in the thousands, performing a physical count can be difficult and time-consuming. Imagine owning an office supply store and trying to count and record every ballpoint pen in stock. Now multiply that for an office supply chain. This is why many companies perform a physical count only once a quarter or even once a year. For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.
The cost of goods sold includes elements like direct labor and materials costs and direct factory overhead costs.
The perpetual inventory system keeps track of inventory balances continuously. This is done through computerized systems using point-of-sale (POS) and enterprise asset management technology that record inventory purchases and sales. It is far more sophisticated than the periodic system of inventory management.
Perpetual inventory is a highly detailed system. Changes in inventory are accurate (as long as there is no theft or damage to any goods) and can be easily accessed immediately. The COGS account is also updated continuously as each sale is made. The information collected digitally is sent to central databases in real-time.
Because it involves the use of technology, it requires very little effort from businesses (if at all):
- Products are given barcodes, which keep track of their movement and how long they've been on the shelf.
- Computer software is added to the mix, which takes care of updating the inventory that goes in and out of a company through the point-of-sale system.
- Separate ledgers keep information about purchases, COGS, and remaining stock.
This type of inventory system can be very costly because of the cost associated with implementing and maintaining the infrastructure. Using the system is much easier and simpler than the periodic system. Not only does it allow for real-time monitoring, but perpetual inventory is also much more accurate than physical counts. And since each product has a barcode attached, companies can get more detailed information about everything that goes in and out of their warehouses.
At a grocery store using the perpetual inventory system, when products with barcodes are swiped and paid for, the system automatically updates inventory levels in a database.
One of the main differences between these two types of inventory systems involves the companies that use them. Smaller businesses and those with low sales volumes may be better off using the periodic system. In these cases, inventories are small enough that they are easy to manage using manual counts.
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 technological aspect of the perpetual inventory system has many advantages such as the ability to more easily identify inventory-related errors and can show all transactions comprehensively at the individual unit level.
Some of the other main differences between these two types of inventory management are:
- Recording Methods: Perpetual systems use computers and software that automatically update a company's ledgers with information about products that are sold and the remaining inventory. Periodic systems, though, require manual recording.
- Margin of Error: There is a greater chance of error with periodic systems because the counts are done manually. Assuming there is no chance of theft or damage to a company's inventory, perpetual systems are often
- Effort: Companies aren't required to put in too much effort with perpetual systems once the software and related infrastructure are installed. That's because everything is done electronically. Periodic systems require physical counts and can often be cumbersome, especially if there are any recounts that need to be done.
- COGS Accounting: There are no continual entries under the COGS account associated with periodic inventory systems. as there are with perpetual systems. Rather, it is calculated using a lump sum at the end of the interval when the count is conducted.
Under the perpetual system, managers are able to make the appropriate timing of purchases with a clear knowledge of the number of goods on hand at various locations. Having more accurate tracking of inventory levels also provides a better way of monitoring problems such as theft.
What Is More Effective, Perpetual Inventory or Periodic Inventory?
The perpetual system is generally more effective than the periodic inventory system. That's because the computer software companies use makes it a hands-off process that requires little to no effort. Products are barcoded and point-of-sale technology tracks these products from shelf to sale. These barcodes give companies all the information they need about specific products, including how long they sat on shelves before they were purchased. Perpetual systems also keep accurate records about the cost of goods sold and purchases.
Should My Business Use Perpetual Inventory or Periodic Inventory?
The nature and type of business you have will factor into the kind of inventory you use. It may make sense to use the periodic system if you have a small business with an easy-to-manage inventory. You can make updates to your accounts manually using this system. 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.
What Are the Disadvantages of a Periodic Inventory System?
There are several disadvantages of using a periodic inventory system. It can be cumbersome and time consuming as it requires you to manually count and record your inventory. And because this is a physical count, there is a higher chance of error. It also isn't as updated as a perpetual system, as it is done at periodic intervals rather than continuously.
Does Amazon Use Periodic or Perpetual Inventory?
Amazon uses a perpetual inventory system. That's because of the sheer volume of goods that go in and out of its warehouses.