Businesses can choose to use either a perpetual period periodic inventory system to calculate their cost of goods sold (COGS). A periodic inventory system calculates the COGS following a physical inventory count at period-end, whereas a perpetual inventory system calculates the COGS after each sale.
Most businesses would love to have updated inventory and COGS balances provided with a perpetual inventory system. However, constraints like difficulty in maintaining records and the need for powerful accounting software hinder some small businesses from using the perpetual inventory system. As discussed below, the accounting in a periodic inventory system is far simpler than a perpetual inventory system.
Inventory system vs cost flow assumption: Perpetual and periodic are inventory systems that determine when you calculate COGS. Cost flow assumptions like last-in, first-out (LIFO), first-in, first-out (FIFO), and average cost determine how you allocate costs among identical units of inventory. Companies must choose both an inventory system and a cost flow assumption.
Perpetual Inventory Is Better For
- Businesses with accounting software that includes inventory accounting: The perpetual inventory system requires a computerized accounting system to record COGS efficiently for every sales transaction. QuickBooks Online is our best small business accounting software that can handle a perpetual inventory system with a LIFO cost flow assumption. Moreover, you can also check Xero, one of our best QuickBooks alternatives, for perpetual inventory with the average cost method.
- Businesses that can afford inventory management systems: An inventory management system (IMS) is software that tracks your inventory throughout the supply chain. Using a perpetual inventory system in conjunction with an IMS creates a synchronized flow of information.
- Businesses with multiple retail outlets or branches: Periodic physical counts interrupt normal operations. For retail outlets, it would be inefficient to count the goods periodically due to inventory volume and costs. That’s why a perpetual inventory system can benefit retailers since it can report COGS and ending inventory without conducting a count.
- Businesses selling high turnover goods that are susceptible to theft or breakages: Under a periodic inventory system, you can’t detect inventory shortages since COGS is based on ending inventory. The cost of goods stolen or broken cannot be separated from the COGS. In a perpetual inventory system, differences between inventory per books and per count may provide information about inventory losses due to breakages or shoplifting.
Periodic Inventory Is Better For
- Small businesses in general: Since the periodic system is easier to implement, this method is easier for small businesses as it doesn’t require constant recordkeeping.
- Businesses with small percentages of revenues from inventory sales: Businesses with small inventory sales can benefit from a periodic system since inventory quantities aren’t significant.
- Businesses with a stable level of inventory: The difference between COGS and current-year purchases is the change in inventory. If a business has a stable level of inventory, then purchases are very close to COGS and the simple periodic method will net the same results as the more time-consuming perpetual method.
Perpetual vs Periodic Inventory at a Glance
Perpetual | Periodic | |
|---|---|---|
Real-time Inventory and COGS Balances | ✔ | X |
Difficulty in Maintaining | Difficult | Easy |
Accounting Software With per Unit Inventory Costing | Required | Not required |
Account Debited for Goods Purchased | Inventory | Purchases (COGS) |
Account Debited for Goods Sold | COGS | n/a |
Account Debited for Freight Charges | Inventory | Freight-in (COGS) |
Account Credited for Goods Returned | Inventory | Purchases returns |
Account Credited for Discounts | Inventory | Purchases discounts |
End-of-Period Adjustment | Not Needed | Needed |
Need for a Physical Count | Annual | End of period |
Deducted from inventory records | Buried in the COGS |
In the following section, we’ll illustrate the difference between the periodic inventory system and perpetual inventory system by showing the journal entries while using the FIFO cost flow assumption. You can visit our in-depth analysis of the average cost method and LIFO method to see how they’re implemented with both periodic and perpetual systems.
Periodic Inventory Details and Features
The periodic inventory system is the easiest system to implement for small businesses. It doesn’t require constant recordkeeping and it makes everyday transactions easier, making it great for self-employed individuals and solopreneurs. Here are the key features of a periodic system:
- All inventory purchases are recorded in the Purchases account, which is shown in the COGS section of the income statement.
- Periodic physical counts are essential and are used to determine the cost of ending inventory.
- Inventory on the balance sheet is adjusted to the actual cost based on the physical inventory count.
- COGS is calculated as purchases during the year plus beginning inventory minus ending inventory.
Pros and Cons of the Periodic Inventory System
| PROS | CONS |
|---|---|
| It’s easy to implement for small businesses. | It doesn’t reveal inventory shrinkage since there are no book inventory quantities to compare with the physical count. |
| It requires simple recordkeeping and minimal accounting. | There may be possible operational interruptions during periodic physical counts. |
| It can be implemented with or without an accounting software program or inventory management system. | COGS may not completely present proper matching of costs with revenues since it also contains inventory shrinkage |
Periodic Inventory System Journal Entries
The periodic and perpetual inventory systems require different journal entries. Let’s first go over the periodic method journal entries then segue into the perpetual inventory system afterward. In our illustration, let’s use sample data from a fictitious company called FitTees.
FitTees, a ready-to-wear clothing store in New York, uses the FIFO method of costing inventory. On its December 31, 2021, balance sheet, it reported merchandise inventory of $4,958. The details of the a merchandise inventory account are presented in the inventory quantity report as of January 1, 2022:
FitTees INVENTORY QUANTITY REPORT As of January 1, 2022 | |||
|---|---|---|---|
Description | Quantity | Cost | Total |
FitTees - Designer Shirts | 125 | $28 | $3,500 |
FitTees - Jeans | 54 | $27 | $1,458 |
BEGINNING INVENTORY | $4,958 | ||
On January 2, FitTees purchased 2,000 units of designer shirts from a new supplier, FRESH Distributors, Inc. for cash at $20 per unit.
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 2 | Purchases (COGS) | 40,000 | |
Cash | 40,000 | ||
On January 3, FitTees purchased 2,000 units of jeans at $23 per unit from SMRE Company on account, meaning they can pay the invoice later, say 30 days. We record this transaction as follows:
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 3 | Purchases (COGS) | 46,000 | |
Accounts payable (A/P) - SMRE Company | 46,000 | ||
FitTees sold 700 units of designer shirts and 900 units of jeans at $39 each. All of these are cash sales.
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 7 | Cash | 62,400 | |
Sales | 62,400 | ||
Since we are using the periodic system, we don’t make a journal entry to record the COGS.
FitTees sold 1,200 units of designer shirts and 800 units of jeans at $35 each to WP Clothing, a reseller in California.
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 7 | Accounts receivable (A/R) - WP Clothing | 70,000 | |
Sales | 70,000 | ||
FitTees conducts a monthly physical count to determine existing goods on hand.
During the physical count, FitTees found that there are 225 units of designer shirts and 354 units of jeans on hand.
Designer shirts (225 units x $20) | $ 4,500 |
Jeans (354 units x $23) | 8,142 |
Ending inventory | 12,642 |
At the count date, the remaining units on hand for designer shirts cost $20 and $23 for jeans. Since we’re using the FIFO method, the first units purchased are the first units sold. Therefore, the units in ending inventory are the most recent units purchased.
In the periodic inventory system, we need to update our inventory records after the physical count. But first, let’s compute the COGS by using the COGS formula:
Beginning inventory (based on inventory report) | 4,958 |
Purchases (40,000 + 46,000) | 86,000 |
Cost of goods available for sale | 90,958 |
Ending inventory as counted | ( 12,642) |
COGS | 78,316 |
The journal entries to adjust our records are as follows:
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 31 | Merchandise inventory (ending cost) | 12,642 | |
COGS (balancing figure) | 73,316 | ||
Purchases | 116,000 | ||
Merchandise inventory (beginning cost) | 4,958 | ||
Perpetual Inventory Details and Features
In a perpetual inventory system, we keep subsidiary ledger records for every item of inventory. The major benefit of having multiple ledgers is that you can keep track of inventory balances and COGS throughout the year. Moreover, you aren’t required to perform frequent inventory counts because perpetual records always provide the latest information.
Pros and Cons of the Perpetual Inventory System
| PROS | CONS |
|---|---|
| Inventory balances and COGS are tracked in real-time | Maintaining subsidiary ledgers can be difficult and costly for small businesses. |
| There is no need to perform frequent physical counts in a year. Physical counts can be performed once or twice a year only. | Businesses must have a powerful accounting software program to implement a perpetual system. |
| Timely information about existing inventory balances can optimize inventory reorder volumes and prevent stockouts. | Using perpetual records is not worth the effort for businesses with very little inventory. |
| The perpetual inventory system can reveal inventory shrinkages. | |
To illustrate the perpetual system, let’s use the same data from FitTees.
On January 2, FitTees purchased 2,000 units of designer shirts from a new supplier, FRESH Distributors, Inc. for cash worth at $20 per unit.
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 2 | Merchandise Inventory | 40,000 | |
Cash | 40,000 | ||
Notice that in the perpetual inventory system, we directly record our purchases in the inventory account rather than the COGS – Purchases account.
On January 3, FitTees purchased 2,000 units of jeans at $23 per unit from SMRE Company on account, meaning they can pay the invoice later, say 30 days. We record this transaction as follows:
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 2 | Merchandise Inventory | 46,000 | |
A/P - SMRE Company | 46,000 | ||
FitTees sold 700 units of designer shirts and 900 units of jeans at $39 each. All of these are cash sales. The total COGS under the FIFO method is $35,916.
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 7 | Cash | 62,400 | |
Sales | 62,400 | ||
COGS | 35,916 | ||
Merchandise inventory | 35,916 | ||
COGS Computation: | |
125 designer shirts @ $28 each | $ 3,500 |
575 designer shirts @ $20 each | 11,500 |
54 jeans @ $27 each | 1,458 |
846 jeans @ 23 each | 19,458 |
Total COGS | $ 35,916 |
In the perpetual system, we need to record the COGS at the same time as we record the sale. The entry highlighted depicts the costs transferred from inventory to COGS. This entry must be made every time there is a sale, which is why the perpetual system should only be used with accounting software that will make the necessary calculations.
FitTees sold 1,200 units of designer shirts and 800 units of jeans at $35 each to WP Clothing, a reseller in California. The COGS under the FIFO method is $42,400
GENERAL JOURNAL | |||
|---|---|---|---|
Date | Description | Debit | Credit |
Jan. 7 | A/R - WP Clothing | 70,000 | |
Sales | 70,000 | ||
COGS | 42,400 | ||
Merchandise inventory | 42,400 | ||
COGS Computation: | |
1,200 designer shirts @ $20 each | $ 24,000 |
800 jeans @ $23 each | 18,400 |
Total COGS | $ 42,400 |
View COGS and Inventory
In a perpetual inventory system, we always update our COGS account with every transaction. Therefore, there’s no adjusting journal entry at the end of the period. Our COGS and Inventory under the perpetual method are determined by the journal entries already made.
Period Totals | |||
|---|---|---|---|
Date | Description | Inventory | COGS |
Jan 1 | Beginning balance | $4,958 | -0- |
Jan 2 | Purchase | $40,000 | |
Jan 3 | Purchase | $46,000 | |
Jan 7 | Sale | ($35,916) | $35,916 |
Jan 7 | Sale | ($42,400) | $42,400 |
Period-end Total | $12,642 | $78,316 | |
Bottom Line
The choice between perpetual and periodic inventory systems depends on the size, complexity, and nature of your small business. Even if you’re a small business, that doesn’t mean that the perpetual inventory system isn’t beneficial to you. In choosing an inventory system, you have to weigh the costs and benefits. As long as the benefits exceed the cost, you can use any of the two inventory systems.
