Periodic vs. Perpetual Inventory Systems – Comprehensive Study Notes

Introduction

  • Course/subject context: "Fundamentals of Accountancy, Business, and Management – Part 2: Merchandising Business".
  • Focus of chapter: detailed treatment of Periodic vs. Perpetual Inventory Systems (already introduced briefly in a prior video).
  • Instructor: Noel A. Bergona.

Periodic Inventory System (PIS)

  • Core idea: inventory quantities and costs are not updated continuously; they are determined by physical count at the end of each reporting period.
  • Journal‐entry logic
    • Purchases of merchandise ➔ Debit Purchases.
    • Buyer-paid freight (FOB Shipping Point) ➔ Debit Transportation-In / Freight-In.
    • Purchase returns ➔ Credit Purchase Returns & Allowances.
    • Purchase discounts (when payment is within credit terms) ➔ Credit Purchase Discounts.
  • No direct posting is made to the Inventory account during the period.
  • End-of-period procedure
    1. Physical count determines Ending Inventory.
    2. Cost of Goods Sold (COGS) is computed, not journalized daily:
      \text{Net Purchases}=\text{Purchases}-\text{Purchase Returns\,\&\,Allowances}-\text{Purchase Discounts}+\text{Freight In}
      \text{COGS}=\text{Beginning Inventory}+\text{Net Purchases}-\text{Ending Inventory}
    3. Adjusting/closing entries often use Income Summary as a clearing account to:
    • Remove Beginning Inventory.
    • Insert Ending Inventory.
    • Transfer calculated COGS.
  • Typical users: high-volume, low-price retailers (e.g., groceries, sari-sari stores) lacking barcode/IT tracking.

Perpetual Inventory System (PeIS)

  • Core idea: every inflow/outflow of merchandise is recorded immediately; Inventory and COGS accounts always carry up-to-date balances.
  • Journal‐entry logic (all movements go straight to Inventory):
    • Purchases ➔ Debit Inventory.
    • Buyer freight (FOB Shipping Point) ➔ Debit Inventory.
    • Purchase returns ➔ Credit Inventory.
    • Purchase discounts ➔ Credit Inventory.
  • Sales entries are two-fold:
    1. Revenue side: Debit Cash/Accounts Receivable, Credit Sales.
    2. Expense side: Debit COGS, Credit Inventory (records cost outflow instantly).
  • End-of-period: physical count only used as verification; adjusting entry needed only if a discrepancy (shrinkage, loss) is found.
  • Shrinkage/normal loss: Debit COGS (or Loss if abnormal), Credit Inventory.
  • Typical users: low-volume, high-price items (jewelry, cars) or entities with barcode/RFID tracking.

Side-by-Side Comparison (Essentials)

  • Inventory balance
    • Periodic: updated periodically via count.
    • Perpetual: updated per transaction.
  • COGS recognition
    • Periodic: calculated at period end.
    • Perpetual: recorded with every sale.
  • Accounts utilized
    • Periodic: Purchases, Freight-In, Purchase Returns & Allowances, Purchase Discounts.
    • Perpetual: only Inventory (plus COGS). Auxiliary accounts not needed.
  • Physical count purpose
    • Periodic: determines Ending Inventory.
    • Perpetual: internal control (detects shrinkage/errors).
  • Suitability
    • Periodic: high-volume, inexpensive goods; minimal tech.
    • Perpetual: high-value goods; strong IT support.

Key Journal-Entry Templates

  • Purchase (on account)
    • Periodic: Debit Purchases; Credit A/P.
    • Perpetual: Debit Inventory; Credit A/P.
  • Buyer freight (FOB Shipping Point, cash)
    • Periodic: Debit Freight-In; Credit Cash.
    • Perpetual: Debit Inventory; Credit Cash.
  • Purchase return
    • Periodic: Debit A/P; Credit Purchase Returns & Allowances.
    • Perpetual: Debit A/P; Credit Inventory.
  • Purchase discount (payment within terms)
    • Periodic: Debit A/P; Credit Purchase Discounts & Cash.
    • Perpetual: Debit A/P; Credit Inventory & Cash.
  • Sale (on account)
    • Both: Debit A/R; Credit Sales.
    • PLUS Perpetual: Debit COGS; Credit Inventory.
  • Sales return (selling price perspective)
    • Both: Debit Sales Returns & Allowances; Credit A/R or Cash.
    • PLUS Perpetual: Debit Inventory; Credit COGS (at cost).
  • Shrinkage (Perpetual only)
    • Debit COGS (normal) or Loss (abnormal); Credit Inventory.

Example 1 – BTS Company (100 u. × ₱6 Begin)

  1. Beginning Inventory: ₱600 (100 u. × ₱6) – already on books; no entry.
  2. Purchase: 900 u. × ₱6 = ₱5,400 on account.
    • Periodic: Dr Purchases 5,400 | Cr A/P 5,400.
    • Perpetual: Dr Inventory 5,400 | Cr A/P 5,400.
  3. Sale: 600 u. × ₱12 = ₱7,200 (cost ₱3,600).
    • Both systems (revenue): Dr A/R 7,200 | Cr Sales 7,200.
    • Perpetual (expense): Dr COGS 3,600 | Cr Inventory 3,600.
  4. Ending Inventory (physical): 400 u. × ₱6 = ₱2,400.
    • Periodic Adjustments (two-step Income Summary method):
      • Dr Income Summary 600 | Cr Inventory 600 (remove beginning).
      • Dr Inventory 2,400 | Cr Income Summary 2,400 (set ending).
    • Alternative single entry: adjust Inventory +1,800, close Purchases 5,400 to COGS 3,600.
    • Perpetual: balances already show Inventory 2,400; no entry.
  5. Computed COGS
    • Periodic: 600+5,400-2,400=3,600\text{ (matches Perpetual)}.

Example 2 – Comprehensive Transaction Set

(Assume 2/10, n/30 terms; FOB Shipping Point.)

  1. SALE on account: Selling price ₱10,000, cost ₱8,000.
    • Revenue entry (both): Dr A/R 10,000 | Cr Sales 10,000.
    • Expense entry (perpetual only): Dr COGS 8,000 | Cr Inventory 8,000.
  2. SALES RETURN: Returned SP ₱500 (cost ₱400).
    • Both: Dr Sales R&A 500 | Cr A/R 500.
    • Perpetual: Dr Inventory 400 | Cr COGS 400.
  3. COLLECTION within discount period (after return):
    • Net receivable = 10,000 – 500 = 9,500.
    • 2 % discount = ₱190; cash received = ₱9,310.
    • Entry (both): Dr Cash 9,310; Dr Sales Discount 190; Cr A/R 9,500.
  4. PURCHASE on account: ₱6,000 (2/10, n/30, FOB-SP).
    • Periodic: Dr Purchases 6,000 | Cr A/P 6,000.
    • Perpetual: Dr Inventory 6,000 | Cr A/P 6,000.
  5. BUYER FREIGHT paid: ₱200.
    • Periodic: Dr Freight-In 200 | Cr Cash 200.
    • Perpetual: Dr Inventory 200 | Cr Cash 200.
  6. PURCHASE RETURN: ₱300 (inferior quality).
    • Periodic: Dr A/P 300 | Cr Purchase R&A 300.
    • Perpetual: Dr A/P 300 | Cr Inventory 300.
  7. PAYMENT within discount period: outstanding A/P = 6,000 – 300 = 5,700.
    • 2 % discount = ₱114; cash paid = ₱5,586.
    • Periodic: Dr A/P 5,700 | Cr Purchase Discount 114; Cr Cash 5,586.
    • Perpetual: Dr A/P 5,700 | Cr Inventory 114; Cr Cash 5,586.
  8. Beginning Inventory (Periodic only): ₱25,000 closed via Income Summary.
  9. Ending Inventory (physical): ₱23,150.
    • Periodic: Dr Inventory 23,150 | Cr Income Summary 23,150.
    • Perpetual: no entry (Inventory already equals ₱23,150).
  10. SHRINKAGE discovered (Perpetual only): ₱360 shortage.
    • Dr COGS 360 | Cr Inventory 360.

COGS Computation – Example 2

Periodic:

  • \text{Net Purchases}=6,000-300-114+200=5,786
  • \text{COGAS}=25,000+5,786=30,786
  • \text{COGS}=30,786-23,150=7,636
    Perpetual:
  • Running entries: 8,000 (sale) – 400 (return) + 360 (shrinkage) = ₱7,960 COGS.

Shrinkage, Normal vs. Abnormal

  • Normal (expected) losses (e.g., evaporation of liquor) ➔ Dr COGS / Cr Inventory.
  • Abnormal (theft, accident) ➔ Dr Loss on Inventory / Cr Inventory.
  • Only Perpetual systems require such adjusting entries; Periodic counts already absorb shrinkage into COGS calculation.

Practical / Ethical / Control Implications

  • Perpetual provides real-time data for pricing, reordering, & theft detection; supports sophisticated POS/barcode systems.
  • Periodic is simpler and cheaper but risks outdated information and undetected losses until year-end.
  • Ethical duty: accurate inventory protects stakeholders (owners, creditors, taxing authorities) and prevents fraud.
  • Physical counts remain necessary under both systems for assurance, audit evidence, and detection of inaccuracies.

Key Formulas & Reference Sheet

  • Net Purchases: \text{NP}=P-PR- PD+FI
  • Cost of Goods Available for Sale: \text{COGAS}=BI+NP
  • COGS (Periodic): \text{COGS}=COGAS-EI
  • Sales Discount (percentage of allowable receivable): \text{Discount}=\text{Gross Receivable}\times\text{Discount Rate}
  • Payment Amount (after discount): \text{Cash Paid}=\text{A/P}-\text{Discount}

Choosing Between Systems – Decision Factors

  • Volume & unit price of merchandise.
  • Availability/cost of technology (e.g., barcodes, ERP systems).
  • Desired accuracy and timeliness of inventory & profit data.
  • Regulatory/audit expectations (some industries mandate perpetual tracking).
  • Internal control objectives (perpetual aids segregation of duties, shrinkage monitoring).

Connections to Earlier / Future Lectures

  • Continues service-business closing process (Income Summary) adapted for merchandising.
  • Builds on Incoterms discussion (FOB Shipping Point vs. Destination) and credit-terms notation (2/10, n/30).
  • Lays groundwork for later topics: inventory valuation methods (FIFO, LIFO, Weighted Average) and financial-statement analysis.

Quick Self-Check Questions

  • Describe how a purchase discount is recorded under each system.
  • How does a sales return affect COGS in Perpetual but not in Periodic?
  • Compute COGS given BI, purchases, returns, discounts, freight-in, EI.
  • Explain why physical counts are still performed under a perpetual system.