What Is Periodic Inventory?
The periodic inventory system is a method of inventory valuation for financial reporting purposes in which a physical count of the inventory is performed at specific intervals. This accounting method takes inventory at the beginning of a period, adds new inventory purchases during the period and deducts ending inventory to derive the cost of goods sold (COGS).
Understanding Periodic Inventory
Under the periodic inventory system, a company will not know its unit inventory levels nor COGS until the physical count process is complete. This system may be acceptable for a business with a low number of SKUs in a slow-moving market, but for all others, the perpetual inventory system is considered superior for the following main reasons:
- The perpetual system continuously updates the inventory asset ledger in a company's database system, giving management an instant view of inventory; the periodic system is time-consuming and can produce stale numbers that are less useful to management.
- The perpetual system keeps updated COGS as movements of inventory occur; the periodic system cannot give accurate COGS figures between counting periods.
- The perpetual system tracks individual inventory items so that in case there are defective items—for example, the source of the problem can quickly be identified; the periodic system would most likely not allow for prompt resolution.
- The perpetual system is tech-based and data can be backed-up, organized and manipulated to generate informative reports; the periodic system is manual and more prone to human error, and data can be misplaced or lost.
Special Considerations: COGS
The cost of goods sold, commonly referred to as COGS, is a fundamental income statement account, but a company using a periodic inventory system will not know the amount for its accounting records until the physical count is completed.
The COGS will vary dramatically with inventory levels, as it is often cheaper to buy in bulk—if you have the storage space to accommodate.
Suppose a company has a beginning inventory of $500,000 on January 1. The company purchases $250,000 of inventory during a three-month period, and after a physical inventory account, it determines it has ending inventory of $400,000 at March 31, which becomes the beginning inventory amount for the next quarter. COGS for the first quarter of the year is $350,000 ($500,000 beginning + $250,000 purchases - $400,000 ending).
Due to the time discrepancies, it becomes the onus of the manager or business owner responsible for monitoring period inventory if it makes sense to their bottom line to allocate hours to count inventory daily, weekly, monthly, or yearly.