Periodic inventory system
Definition
A periodic inventory system is a method of tracking inventory where purchases are recorded in a purchases account and inventory is updated only at the end of a period based on a physical count. Cost of goods sold is calculated as a single figure at period end.
Formula
Cost of goods sold = Beginning inventory + Purchases − Ending inventory
Why it matters
It is simple and inexpensive for businesses with few products or low volume. The tradeoff is that you do not know your exact stock levels or gross profit between counts.
Example
A gift shop starts the quarter with $4,000 of inventory, buys $10,000 more, and counts $3,000 on hand at quarter end. Cost of goods sold is $4,000 + $10,000 − $3,000 = $11,000. An adjusting entry sets the inventory account to $3,000 and records $11,000 of cost of goods sold.
Common questions
Why is shrinkage hidden in a periodic inventory system?
Because cost of goods sold is calculated as whatever is missing after the count, losses from theft or damage are automatically included in cost of goods sold rather than tracked separately.
When does a periodic inventory system make sense?
It suits small businesses with low transaction volume or low-value items where tracking every sale individually is not worth the effort.
Related Terms in Purchasing & Inventory
Inventory Valuation
Determining the monetary value of stock on hand, which sets both the balance-sheet asset and cost of goods sold. The method chosen, FIFO, LIFO or weighted average, changes reported profit when input prices move, so it must be applied consistently.
LIFO (Last In, First Out)
An inventory costing method that charges the most recently purchased stock to cost of sales first. In a rising-price environment it reports higher cost of sales and lower profit than FIFO. Permitted under US GAAP but prohibited under IFRS.
Weighted Average Cost
An inventory method valuing every unit at the average cost of all units available, recalculated as new stock arrives. It smooths the effect of price volatility and is permitted under both GAAP and IFRS.
Perpetual Inventory
An inventory system that updates quantities and cost of sales continuously as each sale and receipt is recorded, so stock figures are available at any moment. Physical counts still matter, but they verify the records rather than create them.
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