One of the challenges of the periodic inventory method is making appropriate updates to the general ledger (GL). With a computerized perpetual inventory system, the GL is updated automatically, but the periodic system doesn’t allow that.

Rather than debiting Inventory, a company using periodic inventory debits a temporary account called Purchases. Any adjustments related to these purchases of goods will later be credited to a GL contra account such as Purchases Discounts or Purchases Returns and Allowances. When the balances of these three purchases accounts (Purchases, Purchase Discounts, and Purchase Returns and Allowances) are combined, the resulting amount is known as net purchases.

When goods are sold under the periodic inventory system, there is no entry to credit the Inventory account or to debit the account Cost of Goods Sold. Hence, the Inventory account contains only the ending balance from the previous year. As a result, the company must compute an inventory amount at the end of each accounting period in order to report the amount of its ending inventory for its balance sheet and the cost of goods sold for its income statement.

Periodic Inventory System

In a periodic system, the Inventory account:

• Has only the ending balance from the previous accounting year.
• Excludes the cost of purchases, purchases returns and allowances, etc. since these are recorded in accounts such as Purchases, Purchases Returns and Allowances, Purchases Discounts, etc.
• Must be adjusted at the end of the accounting year in order to report the costs actually in inventory.
• Requires a physical inventory at least once per year and estimates within the year.
• The periodic inventory system requires a calculation to determine the cost of goods sold.

Perpetual Inventory System

In a perpetual system, the Inventory account:

• Is debited whenever there is a purchase of goods (there is no Purchases account).
• Is credited for the cost of the items sold (and the account Cost of Goods Sold is debited).
• Has a continuously or perpetually changing balance because of the above entries.
• Requires a physical inventory to correct any errors in the Inventory account.
• The cost of goods sold is readily available in the account Cost of Goods Sold.

Computing the Inventory under the Periodic Inventory Method

At the end of an accounting year, the company’s ending inventory is normally computed based on a physical count of its inventory items. Inventory amounts for the monthly and quarterly financial statements are usually estimates.

Under the periodic inventory system, the cost of goods sold is computed as demonstrated with this example of the Geyer Co.:

The following formula is worth committing to memory:

[latex]\text{Beginning inventory}+\text{Purchases}-\text{Ending inventory}=\text{Cost of goods sold}[/latex]

Compare the above calculation to one from the same company if it used the perpetual system where all transactions run through only two accounts: Merchandise Inventory and Cost of Goods Sold:

Companies using the periodic inventory system in their GL accounts often have sophisticated inventory systems outside of the GL for tracking the items they purchase, produce, sell, and have on hand.