Periodic Inventory vs. Perpetual Inventory – Overview
Periodic and perpetual inventory systems are two contrasting accounting methods that companies use to track the number of products they have available. In general, the perpetual inventory system offers many benefits over the periodic system and is now used by all major retailers. However, a small business owner should consider whether the benefits of installing a perpetual inventory system will outweigh the additional expenses.
- The periodic inventory system uses an occasional physical count to measure inventory level and cost of goods sold (COGS).
- The perpetual system tracks inventory balances on an ongoing basis, with updates made automatically each time a product is received or sold.
- Periodic inventory accounting systems are typically best suited for small businesses, while businesses with high sales volume and multiple outlets (such as supermarkets or pharmacies) need perpetual inventory systems.
The periodic system uses an occasional physical count to measure inventory level and cost of goods sold (COGS). Merchandise purchases are posted to the purchasing account. The inventory account and the cost of goods sold account are updated at the end of a set period; this could be once a month, once a quarter, or once a year. Cost of goods sold is an important accounting metric that, when subtracted from revenue, shows a company’s gross margin.
The cost of goods sold under the periodic inventory system is calculated as follows:
Beginning Inventory Balance + Cost of Inventory Purchases – Cost of Ending Inventory = Cost of Goods Sold
Since companies often sell products in the thousands, conducting a physical count can be difficult and time-consuming. Imagine running an office supply store and trying to count and record all the pens in stock. Now multiply that for an office supply chain. For these reasons, many companies perform a physical count only once a quarter or even once a year. For businesses under a periodic system, this means that the inventory count and cost of goods sold figures are not necessarily very recent or accurate.
In contrast, the perpetual system tracks inventory balances on an ongoing basis, with updates made automatically each time a product is received or sold. Purchases and returns are immediately posted to the inventory account. As long as there is no theft or damage, the inventory account balance must be accurate. The cost of goods sold account is also continually updated as each sale is made. Perpetual inventory systems use digital technology to track inventory in real time using updates sent electronically to central databases.
In a grocery store using the perpetual inventory system, when barcoded products are passed through and paid for, the system automatically updates inventory levels in a database.
Recurring inventory accounting systems are typically better suited to small businesses due to the cost of acquiring the technology and personnel to support a perpetual system. A business, such as a car dealership or art gallery, might be better suited to the periodic system due to low sales volume and the relative ease of manually tracking inventory.
However, the lack of accurate information on cost of goods sold or inventory balances during periods when there has not been a recent physical inventory count could hamper business decisions.
Businesses with a high volume of sales and multiple points of sale (such as supermarkets or pharmacies) need permanent inventory systems. The technology aspect of the perpetual inventory system has many advantages, such as the ability to more easily identify inventory-related errors. The perpetual system can display all transactions comprehensively at the individual unit level.
Under the perpetual system, managers can make purchases at the right time with a clear knowledge of the amount of goods available in various places. Having more accurate tracking of inventory levels also provides a better way to monitor issues like theft.