Periodic Inventory System (Appendix 5A)
🎯 Learning Objectives
- Understand the difference between perpetual and periodic inventory systems
- Identify when each system is appropriate for different business types
- Calculate Cost of Goods Sold using the periodic system formula
- Understand Goods Available for Sale and its components
- Prepare adjusting entries for inventory in periodic systems
- Analyze the trade-offs between perpetual and periodic systems
📚 Background & Principles
The periodic inventory system determines inventory quantities and costs only at specific intervals, typically at the end of each accounting period. Unlike perpetual systems that track inventory continuously, periodic systems rely on physical counts to determine ending inventory and calculate Cost of Goods Sold.
The Scanner vs. The Clipboard
Analogy: The Scanner
Used by Walmart and modern retailers. Every "beep" at checkout updates inventory instantly. You always know what you have.
- Real-time inventory tracking
- COGS known after each sale
- Requires technology (barcodes, scanners)
- Higher implementation cost
Analogy: The Clipboard
Used by small shops and lemonade stands. You count what's left at the end to figure out how many you sold.
- Periodic physical counts
- COGS calculated at period end
- Simple manual process
- Lower implementation cost
- High transaction volume
- Expensive inventory items
- Need real-time data
- Automated reordering needed
- Technology infrastructure exists
- Low transaction volume
- Low-value items (nails, bolts)
- Simple business operations
- Limited technology budget
- Physical count is easy
| Feature | Perpetual System | Periodic System |
|---|---|---|
| Inventory Update | Instant (with every sale) | Period-end (by physical count) |
| COGS Calculation | Known continuously | Calculated at period end |
| Inventory Account | Always shows current balance | Shows beginning balance until adjusted |
| Purchases Account | Not used (direct to Inventory) | Accumulates all purchases |
| Typical Business | High-volume, high-tech (Walmart) | Low-volume, manual (Small shops) |
| Cost of Implementation | Higher (technology needed) | Lower (simple counting) |
🔑 Key Concepts
An inventory system where inventory quantities and costs are determined only at the end of each accounting period through physical count, not continuously updated.
In periodic systems, this temporary account accumulates all inventory purchases during the period. Debited for all purchases, credited for returns and allowances.
Beginning Inventory + Net Purchases. The total cost of all inventory that could have been sold during the period.
The process of counting, weighing, or measuring all inventory on hand at period end. Essential for periodic systems to determine ending inventory.
Purchases - Purchase Returns and Allowances - Purchase Discounts. The actual cost of inventory acquired during the period.
Beginning Inventory + Net Purchases - Ending Inventory (from physical count). Cannot be known until the physical count is complete.
🔍 Deep Dive
Explore periodic inventory concepts at different levels of depth:
🟢 Foundational Level
Understanding the basic periodic system concept and COGS formula.
The Lemonade Stand Analogy
Scenario: You run a small lemonade stand. You don't scan every cup sold—you just count cups at the end of the day.
You start with 50 cups. (Beginning Inventory = 50)
You buy 100 more cups. (Purchases = 100)
You sell cups throughout the day but don't track each one.
You count and have 30 cups left. (Ending Inventory = 30)
Cups Sold = Beginning + Purchases - Ending
Cups Sold = 50 + 100 - 30 = 120 cups
If each cup cost $0.10, COGS = 120 × $0.10 = $12.00
🟡 Standard Level
Understanding the accounting entries and complete COGS calculation.
Complete COGS Calculation
Scenario: A small bookstore uses periodic inventory. Year-end data:
Jan 1 inventory balance: $10,000
From previous period's ending count.
Total purchases during year: $50,000
All inventory purchases, regardless of payment status.
Returns to suppliers: ($2,000)
Goods returned reduce net purchases.
Early payment discounts: ($1,000)
Discounts taken reduce net purchases.
$50,000 - $2,000 - $1,000 = $47,000
Periodic COGS Calculator
Journal Entries in Periodic System
During the period:
| Transaction | Debit | Credit |
|---|---|---|
| Purchase inventory | Purchases $5,000 | Accounts Payable $5,000 |
| Return inventory to supplier | Accounts Payable $500 | Purchase Returns $500 |
| Pay within discount period | Accounts Payable $4,900 | Cash $4,900 |
At period end (adjusting entry):
| Transaction | Debit | Credit |
|---|---|---|
| Close Beginning Inventory | Income Summary $10,000 | Inventory $10,000 |
| Record Ending Inventory | Inventory $12,000 | Income Summary $12,000 |
| Close Purchases | Income Summary $47,000 | Purchases $47,000 |
🔴 Advanced Level
Understanding inventory valuation methods, errors, and analysis.
Effect of Inventory Valuation Methods on COGS
In periodic systems, three methods determine which costs flow to COGS:
Effect on COGS: Lower during inflation (older, cheaper costs flow to COGS).
Effect on Ending Inventory: Higher (newer, more expensive costs remain).
Financial Impact: Lower COGS → Higher Net Income → Higher Taxes.
Effect on COGS: Higher during inflation (newer, expensive costs flow to COGS).
Effect on Ending Inventory: Lower (older, cheaper costs remain).
Financial Impact: Higher COGS → Lower Net Income → Lower Taxes.
Note: LIFO is not allowed under IFRS.
Formula: Total Cost of Goods Available ÷ Total Units Available.
Effect: COGS and Ending Inventory fall between FIFO and LIFO.
Best For: Homogeneous products where individual item costs don't differ much.
Common Periodic System Errors
- COGS is overstated by $5,000 (because Ending is subtracted)
- Net Income is understated by $5,000
- Assets and Equity are understated on Balance Sheet.
Fix: Adjust inventory to correct amount before closing.
- No ending inventory balance
- COGS = Goods Available (100% of purchases)
- Net Income severely understated
Fix: Complete physical count immediately and adjust.
- COGS is understated by $3,000
- Net Income is overstated by $3,000
- Assets are overstated on Balance Sheet.
Fix: Recount and adjust to correct amount.
- Use pre-numbered count sheets
- Have two-person counting teams (one counts, one records)
- Count after hours when operations stop
- Segregate counting duties from custodians
- Perform surprise counts periodically throughout the year
🎨 Interactive: Perpetual vs Periodic System Simulator
Experience how the same transaction flows through both inventory systems. Adjust values and see how journal entries and account balances differ.
📦 Transaction Simulator
Select a transaction type and enter details to see how both systems record it
👆 Select a transaction type above, then enter details below
📊 Key Differences
🎯 Quick Check
After purchasing 100 units at $10 each, what's the Inventory balance in each system?
🚫 Common Misconceptions & Professional Tips
✅ Reality: Periodic systems are still widely used by small businesses, service businesses, and organizations with low-value, high-volume inventory (hardware stores, auto parts shops, craft stores). They're simple and cost-effective.
✅ Reality: In periodic systems, Purchases is a temporary expense account (similar to Cost of Goods Sold). It's closed at period end. The asset account is "Inventory," which shows only the beginning balance until adjusted.
✅ Reality: Physical counts are essential in periodic systems. The entire COGS calculation depends on accurate ending inventory from physical count. No count = no COGS number = no financial statements.
✅ Reality: The cost flow assumption (FIFO, LIFO, Weighted Average) is the same concept in both systems. The difference is timing: perpetual updates COGS continuously while periodic waits until year-end to apply the assumption.
🧠 Memory Aids & Quick Reference
BPNG = Beginning + Purchases - Net (returns/discounts) - Goods Available
Goods Available - Ending = COGS
PRD = Purchases - Returns - Discounts
This net amount is added to beginning inventory for goods available.
Inventory: Shows only beginning balance until year-end adjustment
Purchases: Temporary account accumulating all purchases
Purchase Returns: Contra-purchases, reduces net purchases
Purchase Discounts: Contra-purchases, reduces net purchases
Net Purchases = Purchases - Returns - Discounts
Goods Available = Beginning Inventory + Net Purchases
COGS = Goods Available - Ending Inventory
Perpetual: Real-time, continuous, tech-based
Periodic: Periodic count, simple, manual
Both valid; choose based on business needs
1. Physical count of ending inventory
2. Calculate COGS using formula
3. Adjust Inventory account to count amount
4. Close all temporary accounts
📖 Glossary
An inventory system where inventory quantities and costs are determined only at the end of each accounting period through physical count.
A temporary account in periodic systems that accumulates all inventory purchases during the period.
The total cost of inventory that could have been sold: Beginning Inventory + Net Purchases.
The process of counting, weighing, or measuring all inventory on hand at period end. Essential for periodic systems.
Purchases minus Purchase Returns and Purchase Discounts. The actual cost of inventory acquired.
A contra-purchases account that records the cost of inventory returned to suppliers.
A contra-purchases account that records discounts taken for early payment.
An alternative system where inventory is continuously updated with each purchase and sale transaction.
🎯 Final Knowledge Check
Test your understanding of Periodic Inventory Systems:
Question 1: In a periodic system, when inventory is purchased, which account is debited?
Question 2: What is the formula for Cost of Goods Sold in a periodic system?
Question 3: Net Purchases equals:
Question 4: What is essential for a periodic system to calculate COGS?
Question 5: Beginning Inventory = $15,000, Purchases = $60,000, Returns = $3,000, Discounts = $2,000, Ending Inventory = $20,000. What is COGS?