Periodic Inventory System: Definition, Pros & Cons

The periodic inventory system refers to conducting a physical inventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a count 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 inventory counts 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 intermittently, 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)Cost of Goods Sold (COGS)Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct. 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 count, the purchase account records are changed to reflect the 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 value of an inventory between one physical inventory count to the next, is done by starting with opening balances and adjusting for any accounting additions or subtractions to the account.

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 inventory value is the cost (or total price) of goods that are able to be sold – minus the total number of goods sold between physical inventories.  The physical inventory count is then completed, and compared to the value calculated.  Any differences are then expensed to the cost of goods sold account.

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 profitGross ProfitGross profit is the direct profit left over after deducting the cost of goods sold, or cost of sales, from sales revenue. It's used to calculate the gross profit margin..

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To keep learning, check out the CFI resources below:

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