Definitions and explanations
Periodic inventory system:
A periodic inventory system is a system of inventory accounting in which real time updation of inventory balances are not made. In fact physical counting of inventory determines inventory position on completion of a specified period – usually once a quarter or once a year.
In a periodic inventory system, purchases of inventory are recorded in the purchase account in the books of the enterprise. At the end of the specified period, when a physical count is done, the balance of purchases is moved to the inventory account. The cost of goods sold is subsequently determined by application of a mathematical formula:
Opening Balance of inventory + Cost of Inventory Purchases – Cost of closing balance of inventory = Cost of Goods Sold
The periodic inventory system is preferred by smaller enterprises with lower small volumes where physical inventory counting is more feasible.
The periodic inventory system is less reliable as it provides accurate information only at the time of physical count of inventory. Determination of cost of goods sold in between physical count periods is based on estimation which may lead to several errors. This system is also unable to determine inventory losses until actually identified in physical counting.
Perpetual inventory system:
A perpetual inventory system is a system of inventory accounting that accounts for movement of inventory continuously and on a real time basis.
In perpetual inventory system, the cost of goods sold can be accurately determined at any point of time as purchases and sale of inventory are recorded on a real-time basis. The actual inventory balance is also available in the system at all times.
Differences between periodic and perpetual inventory system:
The differences between periodic and perpetual inventory system have been detailed below:
- Periodic inventory system is a system of inventory accounting in which position of stock in hand and cost of goods sold is determined by physical counting.
- Perpetual inventory system is a system of inventory accounting in which real time tracking of inventory movements is done.
2. Status of accounts updation
- In periodic inventory system, inventory accounts do not reflect accurate picture at all times. The correct inventory position is only updated in accounts at the time of physical counting.
- In perpetual inventory system, inventory accounts are updated on a real time basis.
3. Need for systems
- Periodic inventory system can be maintained manually as it requires updation only at the time of physical counting.
- Perpetual inventory system requires use of computer systems to keep real time track of inventory purchases and sales.
4. Determination of cost of goods sold
- In periodic inventory system cost of goods sold is determined only at the end of specific period on the basis of mathematical formula.
- In perpetual inventory system, cost of goods sold can be determined at any time on the basis of real time records maintained in the system.
5. Cost involved
- Periodic inventory system is simpler and involves lower cost.
- Perpetual inventory system is more complex and requires maintenance of complex systems for real time tracking. It thus involves higher cost.
6. Accuracy and reliability
- Periodic inventory system is less reliable as it cannot determine inventory balance or cost of goods sold at all times. The system also does not account for inventory obsolescence or inventory losses other than at the time of physical counting and is thus less accurate.
- Perpetual inventory system is more accurate and reliable as it accounts for inventory movements continuously as and when they occur.
7. Preferred by
- Periodic inventory system is preferred by smaller enterprises with lower sales volume and where physical counting of inventory is more feasible.
- Perpetual inventory system is preferred by larger enterprises with high sales volume where accurate and real time information of inventory is required.
8. Effect on business functioning
- Periodic inventory system requires closure of business activities at the time of physical counting of inventory to get accurate result.
- Perpetual inventory system does not impact business function or require closure as inventory balances are updated continuously along with regular business operations.
Periodic vs perpetual inventory system – tabular comparison
A tabular comparison of periodic inventory and perpetual inventory system is given below:
|Updation of inventory accounting on physical counting at specified periods||Updation of inventory accounts continuously on real time basis|
|Status of accounts updation|
|Only on physical counting||Continuous|
|Need for systems|
|Manual systems can be used||Computer systems and ERP software|
|Determination of cost of good sold|
|At the end of specific period on application of mathematical formula||Can be determined at any time from inventory system|
|Low cost||High cost|
|Accuracy and reliability|
|Less accurate and reliable||More accurate and reliable|
|Smaller enterprises||Larger enterprises|
|Effect on business functioning|
|Continuity of business operations effected at the time of physical counting||Continuity of business operations not effected|
Conclusion – periodic vs perpetual inventory system:
Inventory management and accounting is an area of significant concern for manufacturing and trading concerns. Enterprises can choose the appropriate inventory accounting system by doing a cost benefit analysis of the two systems. Where higher cost of maintaining inventory system can be absorbed, a perpetual inventory system can be preferred. This system can be preferred over periodic system as it maintains inventory position on a real time basis and provides more accurate information about inventory to management. This can help management make better decisions for inventory management.