Periodic Inventory Method
An inventory valuation system where updating accounting records or Cost of Goods Sold (COGS) is done in designated intervals rather than after each sale.
Periodic Inventory Method Details
The periodic inventory system involves waiting to update financial records instead of after each purchase or sale. Businesses will update their balances quarterly, monthly, or annually. This method adheres to an accounting period when you can determine the final COGS and inventory balances with a physical count instead of the perpetual system of record adjustments at each transaction.
A company can track the beginning and end of its inventory within that accounting period but prefers not to do it on a daily per-sale or purchase basis. All purchases are recorded under a purchase account under this method. Once the physical count is completed, the balances are shifted and adjusted to match the inventory's end cost.
The periodic inventory method allows you to calculate inventory costs by taking the beginning inventory and adding purchases to get stock or goods' total costs. To get the total COGS will involve subtracting ending inventory from the total cost of inventory.
Example of the Periodic Inventory Method
A retailer offering high-end kitchenware has an inventory balance of $800,000 on January 1st, 2019. They have an inventory balance of $500,000 by the end of that year on December 31st. Purchases made for 2019 amounted to $1,600,000; the COGS for that period are calculated using the periodic inventory method.
Computing the COGS for this business will involve taking the beginning inventory of $800,000, adding the annual purchases of $1,600,000, and then subtracting the end inventory balance of $500,000.
$800,000 + $1,600,000 – $500,000 = $1,900,000 COGS for 2019.
If there's no true beginning of inventory, you can calculate it as the remaining stock from the previous period. You can also know if your business product pricing is enough to provide a healthy profit margin by calculating the COGS and factoring in labor and materials.
Significance of the Periodic Inventory Method
The periodic inventory method can work for your business if it's small since the simple accounting procedures only need you to operate with a cash register. Some companies, such as purely service enterprises, don't require an inventory management system unless there is a product aspect to their commerce.
The periodic inventory method is easy to implement; businesses see it as a more straightforward calculation and allow them to make fewer record-keeping transactions. Small inventories can utilize manual record-keeping without investing in computerized accounting or bookkeeping software, which perpetual inventory systems rely heavily upon.
In a larger, more complex business, the periodic inventory method may not be as efficient as it doesn't allow access to inventory balances at any one time. Due to the large volume of transactions and their accounting and financial system's automation, larger corporations use perpetual methods instead of periodic inventory management.
Types of the Periodic Inventory Methods
A business using the periodic inventory method isn't aware of the actual inventory levels before a specific duration has elapsed. An accurate total cost of merchandise is an essential factor that goes into a business's balance sheet and other financial statements. Enterprises that rely on periodic inventory method to record sales and find COGS at the end of the month, quarter, or year include;
- Grocery Stores: Periodic inventory adjustments save small grocery stores labor costs since they stock significant amounts of goods, 45,000 items per week on average. As their inventory often suffers from shoplifting thefts, these businesses use the periodic method for improved records accuracy.
- Clothing Retailers: Clothing stores have a large volume of moderately priced products with a high average sale. They avoid the hassle of recording each item by bookkeeping using the periodic inventory method. Businesses wait until the end of the returns period to update their inventory, keeping their employees free to serve customers.
- Large Discount Stores: Many large discount stores operate out of warehouse-sized spaces, selling a significant amount of goods with a wide variety of selections. Although automated systems that use bar code technology keep their inventories updated, periodic inventory is convenient and less time-consuming for their sales departments.
- Convenience Stores: Just like grocery and discount outlets, convenience stores stock a wide selection of products that sell at relatively low prices. On average, 10,000 transactions are performed per week in many small convenience stores, and the periodic inventory method saves on time and labor costs.
Periodic Inventory Method vs. Perpetual Inventory Management
Perpetual inventory management is the opposite of the periodic method of bookkeeping, where the inventory is updated as sales or purchases are made to determine the COGS. The periodic inventory method is an easy to implement option for small businesses and requires minimal information collection.
However, this system can be risky for small businesses seeing as stock levels aren't updated, and as such, it can delay the identification of errors or other issues. Since there are no exact goods inventory figures, there can be inventory write-offs and challenges with forecasting.
There can also be errors in estimation as periodic inventory relies on a physical audit instead of the automated systems prevalent with perpetual inventory management. Since your business has grown to the point where stock reconciliations hinder your periodic bookkeeping, consider a scalable perpetual inventory method that keeps up with stock levels.