How does return of merchandise affect periodic inventory system?

A periodic inventory system only updates the ending inventory balance in the general ledger when a physical inventory count is conducted. Since physical inventory counts are time-consuming, few companies do them more than once a quarter or year. In the meantime, the inventory account in the accounting system continues to show the cost of the inventory that was recorded as of the last physical inventory count.

Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, the balance in the purchases account is then shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory.

The calculation of the cost of goods sold under the periodic inventory system is:

Beginning inventory + Purchases = Cost of goods available for sale

Cost of goods available for sale – Ending inventory = Cost of goods sold

For example, Milagro Corporation has beginning inventory of $100,000, has paid $170,000 for purchases, and its physical inventory count reveals an ending inventory cost of $80,000. The calculation of its cost of goods sold is:

$100,000 Beginning inventory + $170,000 Purchases - $80,000 Ending inventory

= $190,000 Cost of goods sold

Periodic Inventory Accounting

Under a periodic inventory system, inventory purchases made by a company are initially stored in a purchases (asset) account with the following journal entry:

 DebitCreditPurchasesxxx      Accounts payable xxx

There may be a number of these entries during an accounting period, which gradually increases the amount in the purchases account. At the end of the accounting period, the entire balance in the purchases account is shifted into the inventory (asset) account. This means that the purchases account is really an accumulation account for a single accounting period, rather than an account that holds a balance over multiple periods. The entry at the end of the period is:

 DebitCreditInventoryxxx      Purchases xxx

Notice that there is no particular need to divide the inventory account into a variety of subsets, such as raw materials, work-in-process, or finished goods. The reason is that the level of inventory tracking is so infrequent that there is no point in using additional inventory accounts, since the balance in any one account will likely be inaccurate in comparison to the actual inventory count at any given time.

The final periodic inventory entry in an accounting period arises immediately after the physical count of the inventory, when the accounting staff establishes the actual cost of the inventory on hand at the end of the month. It then subtracts this actual ending inventory cost from the cost that has accumulated in the inventory account, and charges the difference to the cost of goods sold account with this entry:

A variation on the last two entries is to not shift the balance in the purchases account into the inventory account until after the physical count has been completed. By waiting, you can then merge the final two entries together and apportion the balance in the purchases account between the inventory account and the cost of goods sold, using the following entry. The end result is the same, but with fewer entries.

An additional entry that is related to the periodic inventory system, but which does not directly impact inventory, is the sale transaction. The following entry shows the transaction that you record under a periodic inventory system when you sell goods. There is not a corresponding and immediate decline in the inventory balance at the same time, because the periodic inventory system only adjusts the inventory balance at the end of the accounting period. Thus, there is not a direct linkage between sales and inventory in a periodic inventory system.

Periodic Inventory System Advantages and Disadvantages

The periodic inventory system is most useful for smaller businesses that maintain minimal amounts of inventory. For them, a physical inventory count is easy to complete, and they can estimate cost of goods sold figures for interim periods. However, there are several problems with the system:

There are many inventory valuation methods available for businesses to use, and picking the right valuation method can have long-lasting effects. One of the more common and simplistic valuation methods is a periodic inventory system.

Periodic inventory systems are commonly used by startups and small businesses, and you might be wondering if it’s the right method for you. In this article, we’ll take a look at what periodic inventory is, how to implement it, and how it can benefit your business.

What is periodic inventory?

Periodic inventory is a system of inventory valuation where the business’s inventory and cost of goods sold (COGS) are not updated in the accounting records after each sale and/or inventory purchase. Instead, the income statement is updated after a designated accounting period has passed.

How does periodic inventory work?

In a periodic system, businesses don’t keep a continuous record of each sale or purchase; inventory balance updates are only recorded in a purchases account over a specified period of time (e.g., each month, quarter, or year).

At the end of the accounting period, the final inventory balance and COGS is determined through a physical inventory count.

What is the difference between the periodic inventory and perpetual inventory systems?

A periodic inventory system measures the level of inventory and cost of goods sold through occasional physical counts. In contrast, the perpetual inventory system is a method that continuously monitors a business’s inventory balance by automatically updating inventory records after each sale or purchase.

The periodic inventory system is ideal for smaller inventories and order volumes, whereas fast-growing or midsize to large businesses usually resort to a perpetual system for more accurate and real-time records.

How do you calculate periodic inventory?

It’s straightforward to calculate the cost of goods sold using the periodic inventory system. First, we’ll walk through the elements needed and then an example.

Cost of Goods Sold (COGS) = (Beginning Inventory + Cost of Inventory Purchases) – Closing Inventory

Periodic inventory formula

As periodic inventory is an accounting method rather than a calculation itself, there is no formula. However, we will use the formulas for calculating cost of goods sold and cost of goods available.

To calculate the cost of goods available, add the account total for purchases to the inventory’s initial balance.

Cost of Goods Sold (COGS) = Cost of Goods Available – Closing Inventory

Then, at the end of an accounting period, take a physical count of each item. This will be your ending inventory balance.

Finally, subtract the ending inventory balance (or closing inventory) from the cost of goods available to determine the COGS.

Cost of Goods Available = Beginning Inventory + Purchases

A periodic inventory example

Now we’ll take a look at how you’d practically apply periodic inventory to your business. Let’s say you run an ecommerce store and:

• You start off with  inventory worth $200,000.
• Your business spends $250,000 on inventory purchases over the accounting period.
• When you conduct a physical inventory count at the end of the period, your closing inventory is worth $100,000.

As mentioned, we need to calculate the cost of goods sold using this formula:

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

Plugging the values in, we get:

COGS = $200,000 + $250,000 – $100,000

COGS = $350,000

Using the periodic inventory method, the total cost of goods sold for the period comes to $350,000.

What are the advantages of using a periodic inventory system?

Periodic inventory allows a business to track its beginning inventory and ending inventory within an accounting period for their financial statements. Here are some of the ways it can benefit your business.

1. Easy to implement

Periodic inventory systems are relatively simple to implement as it requires fewer records than other valuation methods. The calculations are easy too.

2. Great option for small business

A periodic inventory system is best suited for smaller businesses that don’t keep too much stock in their inventory. For such businesses, it’s easy to perform a physical inventory count. It’s also far simpler to estimate the cost of goods sold over designated periods of time.

That means companies with a high inventory turnover rate, large SKU count, multichannel inventory management needs, or that need real-time data are better suited for alternative methods.

3.  Requires minimal information

While a perpetual system requires comprehensive information about each sale and purchase, periodic systems don’t need to monitor each transaction. Periodic inventory systems are very simple in the world of ecommerce bookkeeping and can compute the cost of goods sold and available for small inventories using a few data points.

What are the drawbacks of using a periodic inventory system?

The periodic inventory system can be risky for many businesses as stock levels are not up to date, leading to delays in issues being identified, inventory write-offs, and major challenges with inventory forecasting as you don’t always have exact figures on finished goods inventory, or the total stock available for customers to purchase.

Periodic inventory can also be more prone to human error as it relies on physical inventory audits rather than a more automated system that’s tracked digitally. By the time a physical count is completed, there may be inventory reconciliations needed to address stock discrepancies. Recordkeeping in a periodic inventory system may also become more time-consuming as your business grows and you add more inventory items. You might want to consider ecommerce accounting software and automated methods, such as the perpetual inventory system, if your business is growing fast.

Think beyond periodic inventory tracking with ShipBob

ShipBob pushes for a more accurate, real-time approach to inventory management by not only storing your inventory and picking, packing,a and kitting your orders but providing the tools needed to stay ahead.

“I felt like I couldn’t grow until I moved to ShipBob. Our old 3PL was slowing us down. Now I am encouraged to sell more with them. My CPA even said to me, ‘Thank God you switched to ShipBob.’ ShipBob provides me clarity and insight to help me make business decisions when I need it, along with responsive customer support.”

Courtney Lee, founder of Prymal

ShipBob makes it easy to track inventory days on hand and other metrics like:

• Historical stock levels at any point in time in any location
• Days left until a SKU will be out of stock
• Sales frequency across channels
• Product demand compared to previous periods
• Best-selling and slowest-moving items
• And much more

“We have access to live inventory management, knowing exactly how many units we have with ShipBob in Texas vs. Chicago vs. Dallas. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year. ShipBob made that entire process very simplified for our accountants and us.”

Matt Dryfhout, Founder & CEO of BAKblade

Beyond periodic inventory tracking features, ShipBob’s world-class inventory management software offers the ability to set up automatic reorder point notifications that alert you when it’s time to reorder specific SKUs. Click the button below to learn how our team can help with fulfillment for your ecommerce business.

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Periodic inventory FAQs

Here are some common questions that business owners have about periodic inventory systems with answers to give you some guidance.

What is a periodic inventory system?

A periodic inventory system is a method of inventory valuation where the account is periodically updated. In other words, the factor that determines changes to recorded inventory balance is not triggered by each new order but rather an overall time period.

How are periodic and perpetual inventory systems different?

A periodic inventory system measures the inventory levels periodically through physical counts. The perpetual method continuously updates inventory records after each sale or purchase, monitoring the inventory balance. Small business owners with less inventory benefit more from periodic systems than larger merchants.

How to do periodic inventory systems

To implement a periodic inventory accounting system, all you need is a team to perform the physical inventory count and an accounting method for determining the cost of closing inventory. The LIFO (last-in first-out), FIFO (first-in first-out), and the inventory weighted average methods are all promising calculation techniques.

How to record periodic inventory systems

For the periodic inventory method, there’s no need to continually record the inventory levels. Only the beginning and ending balances are needed, often completed by a physical count to calculate inventory value. Because updates are so infrequent in a periodic inventory system, no effort is made to keep real-time records of customer sales, inventory purchases, and the cost of goods sold.

Is merchandise inventory used in periodic inventory system?

Under a periodic inventory system, Purchases will be updated, while Merchandise Inventory will remain unchanged until the company counts and verifies its inventory balance. This count and verification typically occur at the end of the annual accounting period, which is often on December 31 of the year.

What are the limitations of the periodic inventory system?

While the periodic inventory system works well for some types of businesses, in particular those with high sales volume, it does have some disadvantages. These include not knowing stock levels, a lack of detail, the potential for a loss of revenue, and not collecting useful sales information.