Periodic inventory systems are the most common inventory accounting systems for companies using manual accounting systems. In a periodic system, your company updates inventory balances at the end of each month during the monthly closing process by a physical count of inventory. Inventory account systems use a combination of temporary and permanent accounts to determine the cost of the inventory sold during the period. Understanding the way costs flow these accounts can help you implement a periodic accounting system in your company.
The purchases account is unique to the periodic inventory system. This account acts as holding pen for inventory purchases until you perform the inventory count at the end of the month. Using a periodic inventory system, when you purchase inventory, debit the purchases account for the cost of the inventory. At the same time, you will credit the cash or accounts payable account. The cash account is appropriate if you pay the supplier at the time of the purchase. If you purchase on credit, then you should use the accounts payable account. At the end of the accounting period, remove the balance in the purchases account and move it into the inventory and cost of goods sold accounts.
The cost of goods sold account represents the company's accumulated costs for goods sold to customers during the current accounting period. As with all temporary accounts, at the end of each period you reset the cost of goods sold account to zero. Periodic inventory accounting rules calculate the balance of the cost of goods sold account once a month. This usually occurs at the end of the period. To determine cost of goods sold, you will need to conduct a count of the inventory on hand. This will tell you the amount of inventory balance. In addition, you will need to reduce the purchases account to zero. The difference between these two figures is the cost of goods sold. For example, say you have $100 of inventory on hand at the beginning of the period and you purchase $500 of additional inventory throughout the month. After completing the monthly inventory count, you determine you have $200 worth of inventory on hand. This means that you sold $400 worth of inventory during the period. In this case, cost of goods sold would be $400.
The revenue, or sales, account accumulates sales made to customers throughout the accounting period. At the end of the period, you reset this account to zero. Unlike the cost of goods sold account, transactions in the revenue account take place at selling price. For example, when you record a sale of one shirt that cost $10 when you purchased the shirt from the supplier, the cost of goods sold is $10. However, the sales amount recorded is the sales price, which should be greater than the cost of $10. The difference between the sales price and the cost of goods sold is called gross margin. Gross margin is often used to assess the profitability of merchandising and manufacturing companies.
Though inventory is not a temporary account, it is integral to proper accounting in a periodic inventory system. Because it is a permanent account, you never reset the balance of the inventory account at the end of the accounting period. Instead, this account provides a running total of the cost of the amount of inventory your company has on hand. In a periodic system, you update this total at the end of the accounting period during the monthly inventory count.