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Lesson 4 of 13The Accounting Cycle: Merchandising Business
Unit 3 · Lesson 4 of 13

Periodic vs. Perpetual Inventory

A business can track how much merchandise it has either by counting it (periodic) or by updating a running balance with every transaction (perpetual) — most modern stores use both together.

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Key things to remember

  1. 1Periodic system: Merchandise Inventory is only updated at period end, based on a physical count.
  2. 2Perpetual system: Merchandise Inventory updates continuously, transaction by transaction.
  3. 3A physical inventory count is a count of all goods actually on hand.
  4. 4A point-of-sale terminal (electronic register + computer) makes a true perpetual system practical.
  5. 5Even perpetual systems still count inventory physically, to catch shrinkage.

You now know that Purchases and Sales record the flow of merchandise in and out — but neither account, by itself, tells you how much inventory is actually sitting on the shelf right now. A business needs a system for answering that question, and there are two.

AThe Periodic Inventory Method
  • Requires that a count be made of all inventory at the end of the fiscal period for valuation purposes
  • Merchandise Inventory account is only updated once, at period end
  • Cost of Goods Sold is calculated with a formula, not tracked transaction by transaction
  • Cheaper to run — no scanner or computer system required
  • Common in small businesses with simple, low-volume inventory
BPerpetual Inventory
  • A continuous record of all merchandise on hand
  • Merchandise Inventory is updated with every purchase AND every sale, in real time
  • Cost of Goods Sold is updated automatically with each sale
  • Requires a point-of-sale terminal (an electronic cash register linked to a computer) and bar codes
  • Standard in large or high-volume retailers (grocery stores, big-box stores)

A Physical Inventory is a count of all goods on hand — someone literally walks the shelves and counts, or scans, everything the business owns. Even a business running a perpetual system still performs a physical inventory count periodically, because a computer record can drift away from reality through theft, breakage, spoilage, or data-entry error. The physical count is the reality check; the perpetual record is the prediction.

Periodic
Perpetual
Inventory known
only after a physical count
continuously, after every sale/purchase
Recorded at point of sale
revenue only
revenue AND cost of goods sold
Pros
simple to keep day-to-day
always know inventory on hand
Cons
no up-to-date figure; needs a count
needs point-of-sale / software support
Fig 1Periodic vs. perpetual inventory: when Merchandise Inventory actually changes
Point-of-sale terminals
A Point-of-Sale Terminal is an electronic cash register linked to a computer. Every time it scans a bar code at checkout, it does two things at once: records the sale, and reduces Merchandise Inventory (and increases Cost of Goods Sold) by the cost of that specific item. This is exactly what makes a true perpetual system possible in a store selling thousands of different items.
Shrinkage
When a perpetual system's book balance for Merchandise Inventory does not match what a physical count actually finds, the difference is called shrinkage — usually caused by theft, damage, or counting errors. The perpetual balance is corrected down to match the physical count, with the difference charged to an expense.

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
Lakeside Electronics uses a perpetual inventory system. Its Merchandise Inventory account shows a book balance of $52,000 at year end. A physical inventory count finds only $50,300 of goods actually on the shelves. Journalize the adjustment needed.
Example 2
A small hardware store uses the periodic method. It does not touch Merchandise Inventory all year — it just records Purchases as goods arrive and Sales as goods leave. At year end, the physical count values inventory on hand at $38,000. Explain what happens to the Merchandise Inventory account at that point.

Where marks get lost

  • Thinking a periodic system means a business never counts inventory — it counts LESS OFTEN, but the count is still mandatory (at least once, at year end).
  • Believing a perpetual system never needs a physical count — shrinkage can only be discovered by actually counting the goods.
  • Assuming a point-of-sale terminal is only about ringing in sales — its real accounting power is updating Merchandise Inventory automatically.
  • Debiting Merchandise Inventory for every purchase under a periodic system — that account is untouched until period end under periodic.

Flashcards 5

The Periodic Inventory Method
Perpetual Inventory
Physical Inventory
Point-of-Sale Terminal
+ 1 more

Practice

1
Which system updates Merchandise Inventory only once, at the end of the fiscal period?
2
A point-of-sale terminal is essential for running which inventory system efficiently for a large store?
3
What do we call a count of all goods physically on hand?
4
A perpetual system shows a book Merchandise Inventory balance of $61,000. A physical count finds $58,750 actually on hand. What is the shrinkage?
$
5
Even a business using the perpetual system should still perform a physical inventory count because:
6
Give one advantage of the periodic method over the perpetual method for a very small business.

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