Periodic Inventory vs Perpetual Inventory: What’s the Difference?

A perpetual inventory system uses point-of-sale software (POS software) to scan the barcode of each item that the company sells and adjust inventory levels accordingly. So, if you sell one item, the system will reduce your total inventory level by one right after the sale happens. However, more advanced inventory management systems can add costs and complexity to your operations.

1. Inventory refers to any raw materials and finished goods that companies have on hand for production purposes or that are sold on the market to consumers.
2. This system is quite cost-effective because you don’t have to pay for software or assign a dedicated team of inventory handlers.
3. If a business acquires any additional inventory, it is listed under the purchases account in a general ledger.
4. We hope our guide was helpful in understanding the basics of the periodic inventory system.
5. Although a periodic physical count of inventory is still required, a perpetual inventory system may reduce the number of times physical counts are needed.

On the other hand, a periodic inventory system can be quite difficult as your organization grows. There is more to the periodic inventory system’s pros and cons discussed below. In addition, freight costs are saved separately from the main warehouse account. Companies track shipping costs related to inventory due in Cash on Delivery and Cash on Due.

Determining the proper inventory accounting method for your business is a crucial step to financial success. At the end of the day, you’ll have to decide what will work best for your needs. Hence, the system is easier to implement, requires little accounting knowledge, and records changes in inventory through very few simple calculations. At the end of the year, or at the end of any other timing interval businesses choose, a physical inventory count is done, to recognize the amount of remaining inventory. Here are some common questions that business owners have about periodic inventory systems with answers to give you some guidance.

Big data, machine learning and demand forecasting

For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate. As such, they use occasional physical counts to measure their inventory and the cost of goods sold (COGS). Because there is no real-time inventory tracking between periods of physical counting, businesses do not have access to accurate information about their items on hand.

Settlement of Accounts Payable

That said, you can compare recorded sales to beginning and ending counts at the end of a period to ensure products aren’t missing. The periodic inventory system is becoming an old-fashioned method of tracking inventory, and for a good reason. The growing use of cloud accounting software has made inventory tracking incredibly easy and cheap to implement. 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.

For small businesses and entrepreneurs, it’s important to know when to choose simplicity over the latest tech. Given the information we’ve covered up to this point, it’s clear that periodic systems are best suited to small businesses or companies that provide high-end products with a low on-hand inventory. Moreover, they’re an excellent option for companies that aren’t looking to expand their inventory in the future. Thus, you need a periodic inventory system to track your inventory management. At the same time, it prevents a business from planning and forecasting future inventory levels.

Periodic Inventory vs. Perpetual Inventory: What’s the Difference?

Let’s take a closer look at how this system works, some of its benefits and drawbacks, the alternative perpetual inventory system and who typically finds it most useful. So there’s no longer a need for businesses to manually count their merchandise, or write down journal entries by hand. Then, you subtract the previously counted ending inventory from the total cost of goods available for sale, to compute the costs of goods sold. That’s why businesses with high sales volume and multiple sales channels use a perpetual inventory system, instead. At any time between these intervals, all inventory levels are based on estimations and historical data. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

These are the basic journal entries that would be made under the periodic inventory system. It is important to realize that this system requires regular physical counts of inventory to ensure that the inventory accounts are accurate. In a periodic inventory system, the cost of goods sold and ending inventory are determined periodically, often at the end of a financial period. A purchase return or allowance under perpetual inventory systems updates Merchandise Inventory for any decreased cost. Under periodic inventory systems, a temporary account, Purchase Returns and Allowances, is updated. Purchase Returns and Allowances is a contra account and is used to reduce Purchases.

Risk & Operations

Because it doesn’t rely on complex inventory tracking software, the periodic system reduces the need for extensive staff training and technical support. This simplicity is particularly beneficial for businesses with limited staff or those in areas with less access to advanced technology and training resources. The physical count determines the ending inventory, which is the actual inventory available at the end of the period. The process begins with the recorded inventory level at the start of the period, known as the beginning inventory. Because of the time gap and lack of active inventory monitoring for three full months, the discrepancies, if any, between sales records and end-of-quarter physical count, may be difficult to account for. Inventory management is the complex process of tracking a company’s assets from manufacturing to retail stores.

A periodic inventory system is a simplified system for calculating the value of an ending inventory. It 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.

As a business grows, the limitations of the https://business-accounting.net/ become more pronounced. Scaling operations with this system can be challenging due to the increased complexity and volume of inventory. In large retail operations, where inventory turnover is high, and product ranges are vast, the periodic system can be inefficient and impractical, leading to significant management challenges. Businesses may miss out on timely replenishment, capitalizing on trends, or responding effectively to changes in demand, potentially affecting sales and customer satisfaction. If your business prefers annual counting, usually at the end of the fiscal year, it would be set at 365. Similarly, if a company wants to find quarterly numbers, it would be calculated as 91.

But a company using a periodic inventory system will not know the amount for its accounting records until the physical count is completed. The periodic inventory system is simpler and less expensive compared to the perpetual system, making it a suitable choice for smaller businesses or those with limited resources. However, its main limitation is the lack of real-time inventory tracking, which can lead to difficulties in managing stock levels and responding to inventory needs promptly.

Obviously, with more inventory control, you will constantly be aware of the status of your inventory, allowing you to determine how much or how little you require. This may not be a problem for certain businesses, especially if we are working with a very tiny business. Prior to accepting a position as the Director of Operations Strategy at DJO Global, Manu was a management consultant with McKinsey & Company in Houston. He served clients, including presenting directly to C-level executives, in digital, strategy, M&A, and operations projects. This lack of information can result in a loss of possible revenue and sales opportunities.