The Periodic Inventory System is a very simple way for businesses to keep track of their inventory and COGS (Cost of Goods Sold). Instead of updating your inventory every time something is bought or sold (known as the Perpetual Inventory System), the periodic system only updates things every so often—usually at the end of the month, quarter, or year. This article explains how the periodic inventory system works and includes a simple example with journal entries, so you can easily understand the process and apply it to your own business.
Understanding the Periodic Inventory System
What is it?
The periodic inventory system checks your inventory at the end of a set period, rather than tracking every sale and purchase as they happen. That “period” could be monthly, quarterly, or yearly—whatever works best for the business.
Once the period ends, you use a few simple numbers to figure out how much inventory was sold and what it cost. This is also how you calculate the Cost of Goods Sold (COGS), which is important for understanding your profit and reporting income on your taxes.
Why use it?
Because it’s easy and low-maintenance. You don’t need fancy software or someone updating inventory every day. It’s a great fit for small businesses or anyone selling a manageable number of products.
How does it work?
With this system, you only need to track three things:
- Beginning Inventory – what you had at the start of the period
- Purchases – what you bought during the period
- Ending Inventory – what’s left at the end (based on a physical count)
Then, you plug those into a simple formula to calculate your COGS:
COGS = Beginning Inventory + Purchases – Ending Inventory
This shows how much it costs to sell your products during the period, which is key for figuring out your profit and your taxable income.
In a nutshell
The periodic inventory system helps you keep things simple while still giving you the information you need to see how your business is doing. It shows you how much you sold, what it cost, and how much you really earned without having to track every single transaction all year long.
In the sections below, we’ll walk through two simple examples. First, we’ll look at an “easier version” that covers just the basics. Then, we’ll go through a more practical example that includes things like purchase returns and shipping costs—real-life stuff. Both examples come with journal entries and explanations to help you see how it all works in action.
Journal Example 1: The Simple Version
Let’s go through a very basic example using a fictional boutique called Her Mess, which sells fashionable handbags.
- On January 1, the boutique had five handbags in stock, each originally purchased for $30.
- → Beginning Inventory = $150 ($30*5)
- During the year, ten more handbags were purchased at $30 each.
- → Purchases = $300 ($30*10)
- By the end of the year, twelve handbags were sold at $75 each.
- → Sales Revenue = $900 ($75*12)
- On December 31, a physical count showed three handbags remaining.
- → Ending Inventory = $90 ($30*3)
Using this information, we will be able to calculate the COGS:
COGS = Beginning Inventory + Purchases – Ending Inventory = 150 + 300 – 90 = 360
Using COGS, we can calculate the gross profit, which is $900 (Sales)—$360 (COGS) = $540.
Keep in mind, this isn’t your final taxable income—you’ll still need to subtract operating expenses (like rent, utilities, marketing, etc.) from your gross profit of $540.
Below are the journal entries needed:
- Debit Purchases: In the periodic system, we don’t update the Inventory account right away. Instead, we use a temporary Purchases account (an asset account) to track what we’ve bought during the period. (This account will be closed at the year-end – refer to the last adjustment entry)
- Credit Cash or Accounts Payable: This shows either you paid right away (cash) or you still owe the supplier (accounts payable).
- Debit Cash or Accounts Receivable: Records the money collected or expected from customers.
- Credit Sales Revenue: Increases your total revenue from sales.
- Debit Inventory: Updates the inventory account to reflect what you actually have on hand at year-end.
- Debit COGS: Records the total cost of the items you sold during the year.
- Credit Inventory (Beginning): Removes the starting balance from the inventory account.
- Credit Purchases: Clears the temporary Purchases account as it’s already been used in the COGS calculation.
Here is a summary of account balances at the end of the year:
Journal Example 2: With Purchase Returns and Freight
Now let’s look at a more realistic version of the same example, adding:
- A purchase return of 2 handbags to the supplier because of defects from the factory. Note this isn’t a sales returns from customers (more explained in the section below)
- A freight-in charge of $20 for obtaining/receiving the inventory
Updated Information:
- Beginning Inventory (1/1): 5 handbags @ $30 = $150
- Purchases: 10 handbags = $300
- Purchase Returns: 2 handbags @ $30 = -$60
- Freight-In: $20
- Sales: 12 handbags @ $75 = $900
- Ending Inventory (12/31): 1 handbags @ $30 = $30
Updated COGS Calculation:
COGS=Beginning Inventory+(Purchases−Returns+Freight)−Ending Inventory=150+(300−60+20)−30=380
Here are the journal entries:
- Debit Purchases: This tracks how much inventory you bought during the year. As previously mentioned, this is a temporary account that will be closed at the year-end.
- Credit Accounts Payable or Cash: You either pay or owe this amount to your supplier.
- Debit Cash or Accounts Payable: Reduces how much you owe since you returned part of the purchase from the supplier (or increase cash in the event the refund is already collected from the supplier)
- Credit Purchase Returns: A temporary asset account that reduces the total value of your purchases. It will also be closed out at the year-end.
- Debit Freight-In: In the periodic system, shipping costs are added to the total inventory cost. This is also a temporary asset account that will be closed out at the year-end.
- Credit Cash or Accounts Payable: The amount you paid or owe the shipping company.
- Debit Cash or AR: Records the money you earned from customers.
- Credit Sales Revenue: Adds to your total revenue for the period.
- Debit Inventory: Updates the inventory balance to match the actual physical count at year-end.
- Debit COGS: Records how much it costs to sell your products during the year.
- Debit Purchase Returns: To close out the temporary account after being used to calculate COGS
- Credit Inventory (Beginning): Clears out the beginning balance.
- Credit Purchases and Freight-In: These are also temporary accounts that are cleared to zero after being used in the COGS calculation.
Here is a summary of account balances at the end of the year:
What about Sales Returns?
The COGS calculation above illustrates a purchase return (e.g., defective products returned to the manufacturer). However, when a customer returns a product that was previously sold to them, you don’t need another temporary account to calculate COGS. The returned products are simply added back to inventory, resulting in a different ending inventory balance when recording the year-end adjustment.
As for the journal entry, you can simply reverse the original sales journal entry, or use a contra-revenue account such as Sales Returns and Allowances. For example, if a customer returns a handbag:
- Debit Sales Revenue or Sales Return: Records the reduction in the total sales revenue
- Credit Cash or Accounts Payable: Records how much the store needs to refund the customer
Key Takeaways
- The Periodic Inventory System only updates inventory at specific intervals (like monthly, quarterly, or yearly), not after every transaction.
- It’s a good fit for small businesses or anyone with a manageable number of products and limited resources to track inventory daily.
- Instead of constantly updating inventory, you only need to track three things:
- Beginning Inventory – what you had at the start of the period
- Purchases – what you bought during the period
- Ending Inventory – what you still have at the end (based on a physical count)
- These three numbers help you calculate COGS (Cost of Goods Sold) using this formula: COGS= Beginning Inventory +Purchases −Ending Inventory
- COGS is important because:
- It tells you how much it costs to sell your products
- It helps you calculate your gross profit
- It’s used when filing your income tax, since COGS reduces your taxable income
- In the journal entries, you use temporary accounts like:
- Purchases – to track goods bought during the period
- Purchase Returns – to reduce purchases for returned items
- Freight-In – to include shipping costs as part of inventory value
- Sales Returns do not need a temporary account, the returned items will be counted in the ending inventory
- At the year-end, you do an adjustment entry to:
- Record the ending inventory
- Calculate and record COGS
- Clear out temporary accounts so you’re ready for the next period
