PERIODIC INVENTORY SYSTEMS Accounting Help

A periodic inventory system is an alternative to a perpetual inventory system. In ,a periodic inventory system, no effort is made to keep up-to-date records of either the inventory or the cost of goods sold. Instead, these amounts are determined only periodically usually at the end of each year.

Operation of a Periodic Inventory System

The foundation of the periodic inventory system is the taking of a complete physical inventory at year-end. This physical count determines the amount of inventory appearing in the balance sheet. The cost of goods sold for the entire year then is determined by a short computation.

Recording Inventory and the Cost of Goods Sold

Special Occasions has now determined its inventory at the end of 2001 and its cost of goods sold for the year. But neither of these amounts has yet been recorded in the company’s accounting records. In a periodic system, the ending inventory and the cost of goods sold are recorded during the company’s year-end closing procedures. (The term “closing procedures” refers to. the end-of-period adjusting and closing, entries.)

Closing Process in a Periodic Inventory System

There are several different ways of recording the ending inventory and cost of goods sold in a periodic system, but they all produce the same results. One approach is to create a Cost of Goods Sold account with the proper balance as part of the closing process. Once this account has been created, the company can complete its closing procedures \ ” °in the same manner as if a perpetual inventory system had been in use.

Creating a Cost of Goods Sold Account

A Cost of-Goods Sold accountis created with two special closing entries. The first entry creates the new account by bringing together the costs contributing toward the cost of goods sold. The second entry adjusts the Cost of Goods Sold account to its proper balance and records the ending inventory in the Inventory account.

The costs contributing to the cost of goods sold include (I) beginning inventory and (2) purchases made during the year. These costs are brought together by closing both the Inventory account (which contains its beginning-of-the-year balance) and the Purchases accourit into a new account entitled Cost of Goods Sold. This year-end closing. entry is:

Qreatlng a Cost of Goods Bold account

Qreatlng a Cost of Goods Bold account

Special Occasions’ Cost of Goods Sold account now includes the cost of all ‘goods available for sale during the year. Of course, not all of these goods were sold: the physical inventory taken at the end orzocc shows that merchandise costing $14,000 is stilI on hand. Therefore, a second closing entry is made transferring the cost of merchandise still on hand out of the Cost of Goods Sold account and info the Inventory account. For Special Occasions, this second closing entry is

and adjusting its balance

and adjusting its balance

With these two entries, Special Occasions has created a Cost of Goods Sold account , with a balance of $132,(){)() ($144,000 – $12,000) and has brought its Inventory account up-to-date.

Completing the Closing Process

Special Occasions may now complete its closing . process in the same manner as a company using a perpetual inventory system. The company will make the usual four closing entries, closing the (I) revenueaccounts, (2) expense accounts (including Cost of Goods Sold), (3) Income Summary account. and (4) Dividends account.

Comparison of Perpetual and Periodic Inventory Systems

Perpetual systems are used when management needs information throughout the year about inventory levels and gross profit. Periodic systems are used when the primary goals arc to develop annual data and to minimize record keeping requirements. A single.business may use different system.to account for different types of merchandise.

Who Uses Perpetual Systems?

When management or employees need up-to-date information about  levels. there is no substitute’ for a perpetual inventory system, Almost all manufacturing companies use perpetual systems. These businesses need current information to coordinate their inventories of raw materials with their production schedules. Most large merchandising companies-and many small ones-also use perpetual systems,

In the days when all accounting records were maintained by hand, businesses that sold many types of ·Iow-cost products had no choice but to use periodic inventory systems. A WalwMart store, for example. may sell several thousand items per hour. Imagine the difficulty of keeping a perpetual inventory system upto- date if the records were maintained by hund. But with today’s point-of-sale terminal .••and bar-coded merctuutdlse, many high-volume retailers now use perpetual inventory systems. In fact. Wal-Mart has’ been fl leader in developing perpetual inventory systems for retailers.

Perpetual inventory systems are,not limited to businesses with point-of-sale terminals. Many small businesses with manual accounting systems also use perpetual inventory systems. However, these businesses may update their inventory .records on a weekly or a monthly basis. rather than at the time of each sales transaction. ‘ Whether accounting records are maintained manually orby computer, most businesses use perpetual inventory systems in accounting for products with a high per-unit cost. Examples include automobiles, heavy machinery, electronic equipment, home appliances, and jewelry. Management has a greater interest in keeping track of inventory’ when’ the merchandise-is expensive. Also, sales volume usually is low enough that a perpetual system can be used. even if ‘accounting records are maintained by hand

Who Uses Periodic Systems?

Periodic systems are used when the need for current information about inventories and sales does not justifY the cost of maintaining aperpet ual system. In a small retail store, for example, the owner may be so familiar with the inventory that formal perpetual inventory records are unnecessary, Most businesses large and small-use periodic- systems for inventories that are immaterial in dollar amount, or when management has little interest in the quantities on hand. As stated previously. businesses thar sell many low-cost items and have manual accounting systems sometimes have no choice but to use the periodic method.

Selecting an Inventory System

Accountants-and business managers-often must select an inventory system appropriatc for a particular situation. Some of the factors usually considered in these decisions. are listed on the following page

Selecting an Inv,entory System

Selecting an Inv,entory System

The Trend is Today’s Business World

Advances in technology are quickly extending . the use of ‘perpetual inventory systems to more businesses and more types of inventory. This trend is certain to continue. Throughout this textbook, you may assume that a perpetual inventory system is in use unless  specifically state otherwise

You as a Buyer for a Retail Business

Assume you are in charge of purchasing merchandise for Acme Hardware Stores ..You are currently making a declslori about the purchase of barbecues for sale during the uP coming summer season. You must decide how many of each brand and type of barbecue to order. Describe the types of accounting information that would be useful in making this decision and where this information might be found

You as a Buyer for a Retail Business

You as a Buyer for a Retail Business

Posted on November 21, 2015 in Accounting for Merchandising Activities

Share the Story

Back to Top
Share This