How Periodic Inventory System works in Cost Accounting

Inventory record of merchandise inventory is not maintained year-long under this periodic inventory system.

Cost of goods sold is determined at year end. Value of end stock is determined by physical counting of merchandise on the closing date of accounting period.

Under this system cost of goods sold is determined by adding cost of merchandise purchase with cost prices of beginning stock deducting cost price of end-stock from the total.

This can be expressed as.

Beginning stock + purchase – end-stock = cost of goods sold.

Small and retail business concerns such as pharmacy, hard-wire, grocery, cloth store etc. which deal with variety of low-price commodities generally follow periodic inventory system to determine the cost of goods sold and value of inventory.

Use of perpetual inventory system for business concerns like these is expensive and time consuming.

Separate ledger account for merchandise inventory is not maintained under this system rather at the end of the period at a particular date cost of merchandise inventory is determined by multiplying purchase price with quantity of merchandise stock.

This can be expressed as;

Value of internal stock = quantity of merchandise stock x purchase price.

Advantages of Periodic Inventory System

  1. Since no permanent employee is required for physical counting of merchandise inventory under this system it is less expensive.
  2. It is applicable for all business organizations large or small dealing with specific or variety of goods.
  3. Since stock taking is done at the end of a period under this system the normal activities of business are not hampered.
  4. Since stock taking of merchandise is done in a particular date the quantity of stock of merchandise is reliable.

Disadvantages of Periodic Inventory System

  1. On the very day of physical counting of merchandise stock, normal activities of business remain almost suspended.
  2. The act of counting of merchandise stock is to be completed hurriedly due to shortage of time.
  3. Under this system chance of fraud and forgery lies, because here continuous control over merchandise is absent.
  4. Under this system on expiry of particular period the reasons for differences between merchandise at hand and merchandise shown in the books of accounts can hot be sorted out easily.
  5. Under this system stock control device is very weak. There employees get chance to adopt corruption.

Difference between Perpetual Inventory System and Periodic Inventory System

The differences marked between perpetual inventory system and periodic inventory systems are stated below:

  1. Under perpetual inventory system the act of physical counting of merchandise continues throughout the year.But under periodic inventory system act of physical counting of merchandise takes place at the end of an accounting period.
  2. Perpetual inventory system is used in the business organizations where limited items of goods are traded. The application of this system is very expensive.Relatively small organizations dealing with varieties of goods use periodic inventory system in stock-taking. This system is suitable for large number of goods – it minimizes the complexity of work.
  3. A group of experienced permanent employees are needed for application, of perpetual inventory system.But the use of computer scanner has made merchandise stock recording easier.
  4. Under periodic inventory system no separate group of employees are needed for stocking purpose.
  5. Perpetual inventory system is a continuous process. Accounts of inventory stock are maintained throughout the accounting period under this system.
  6. But the quantity and amount of inventory stock can be known at the end of accounting period under periodic inventory system.
  7. Application of perpetual inventory system does not hamper normal operating activities of a business.But application of periodic inventory system hampers normal activities of the business on the day of inventory taking.
  8. Since quantity and condition of merchandise under perpetual inventory can be known throughout the year, timely measures can he taken to remove discrepancy if detected.

But under periodic inventory system since discrepancy of inventory is detected at the end of the accounting period corrective measures are hampered.