The periodic and perpetual inventory systems are different methods used to track the quantity of goods on hand. The more sophisticated of the two is the perpetual system, but it requires much more record keeping to maintain.
The periodic system relies upon an occasional physical count of the inventory to determine the ending inventory balance and the cost of goods sold, while the perpetual system keeps continual track of inventory balances. There are a number of other differences between the two systems, which are as follows:
- Accounts. Under the perpetual system, there are continual updates to either the general ledger or inventory journal as inventory-related transactions occur. Conversely, under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold.
- Computer systems. It is impossible to manually maintain the records for a perpetual inventory system, since there may be thousands of transactions at the unit level in every accounting period. Conversely, the simplicity of a periodic inventory system allows for the use of manual record keeping for very small inventories.
- Cost of goods sold. Under the perpetual system, there are continual updates to the cost of goods sold account as each sale is made. Conversely, under the periodic inventory system, the cost of goods sold is calculated in a lump sum at the end of the reporting period, by adding total purchases to the beginning inventory and subtracting ending inventory.
- Cycle counting. It is impossible to use cycle counting under a periodic inventory system, since there is no way to obtain accurate inventory counts in real time (which are used as a baseline for cycle counts).
- Purchases. Under the perpetual system, inventory purchases are recorded in either the raw materials inventory account or merchandise account (depending on the nature of the purchase), while there is also a unit-count entry into the individual record that is kept for each inventory item. Conversely, under a periodic inventory system, all purchases are recorded into a purchases asset account, and there are no individual inventory records to which any unit-count information could be added.
- Transaction investigations. It is nearly impossible to track through the accounting records under a periodic inventory system to determine why an inventory-related error of any kind occurred, since the information is aggregated at a very high level. Conversely, such investigations are much easier in a perpetual inventory system, where all transactions are available in detail at the individual unit level.
This list makes it clear that the perpetual inventory system is vastly superior to the periodic inventory system. The only case where a periodic system might make sense is when the amount of inventory is very small, and where you can visually review it without any particular need for more detailed inventory records. The periodic system can also work well when the warehouse staff is poorly trained in the uses of a perpetual inventory system, since they might inadvertently record inventory transactions incorrectly in a perpetual system.