What is the 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).
BREAKING DOWN 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: 1) 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; 2) the perpetual system keeps updated COGS as movements of inventory occur; the periodic system cannot give accurate COGS figures between counting periods; 3) 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; 4) 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.
Calculating COGS Under the Periodic Inventory System
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.
Suppose a company has beginning inventory of $500,000 at 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).