Periodic Inventory System

This system requires a physical count of all the inventory items on hand at specific times. The calculation of ending inventory on hand is done by taking an actual physical count (or measure or weight) at the end of an accounting period and then quantity on hand is multiplied by the cost per unit. It is because of actual physical count that the system is also called physical inventory system. The cost of goods sold is determined as shown below:

Beginning inventory + Purchases – Ending Inventory = Cost of Goods Sold
    (Known) _________  (Known)           (Counted)

The accounting procedure followed for periodic inventory is the simplest one because this system: (i) record all purchases of inventories as debits to purchase account; (ii) makes no entry at the time of sale for the cost of the goods sold and (iii) only periodically (i.e., at the end of the accounting period) brings the stock of goods account up to date by means of adjusting entries. In short, under periodic inventory system, the balance in Inventory Account remains unchanged throughout the accounting period. This balance shows the beginning inventory determined by the physical count done at the end of the preceding accounting period. Purchases and sales of inventory during the accounting period are not through the inventory account. The account is adjusted only at the end of the accounting period when a new physical count done at the end of the accounting period when a new physical cont is made. Periodic system does not necessarily mean physical count at the end of 12 month accounting period only. It means making a physical count of the stock held at the point in time for which information about inventory is required. The benefits of annual count are:

(a)    Where is physical counting is done on the accounting date, all correction made will ensure the accuracy of the inventory figure shown in the accounts. In fact, where continuous stock-taking regularly shown significant differences, it is essential to make a year-end physical count to ensure the accuracy of the accounts.

(b)    It is less expensive than a continuous inventory system.

Disadvantages:

The following drawbacks of this method may be noted:

(i)    Periodic inventory method is based on the assumption that all goods not accounted of traceable by physical inventory count have been either sold or used. In this manner the losses due to theft, waste, evaporation, etc. are included improperly in the cost of the goods sold.

(ii)    Physical counting at the end of accounting period would adversely affect normal business operations for a number of days. The business units, using this method, often suspend their sales and employ practically the entire staff on the physical count and measurement of the items on hand.

(iii)    In case income statements are required more frequently than once a year. It would be very expensive if the inventory figures are obtained only by physical count.

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