Periodic Inventory System

Table of Contents

Title Page No.

Title Page........................................................................................................... 1

Acknowledgements………………………………………………….………….3

An Abstract……………………………………..……………………………….4

Introduction to the Issue……………………………………………….….5 – l4

Practical Study of the Organization……..……..............…………...........14- 18

Data Collection Methods…………………………………………………….19

SWOT…………………………………..………………………………….13 – 15

Conclusion……………………………………………………………………....16

Recommendations……………………………………………………………17

References .........................................................................................................
 Acknowledgement

This report would not have been possible to me without the support and
encouragement of my teacher “Sir FR Tariq” sahib who believed in me and
my capabilities. I am also thankful to the managing director of Nafees
Tiles and Marble manufacturer group who gave me very useful
information for the completion of my report. Further, I am especially
thankful to my family, who has always been a source of great motivation for
me.

Ch. Shahzad Yaqoob.

Abstract
Periodic inventory system is a system of inventory in which updates are
made on a periodic basis. And is very different from perpetual inventory
system where transactions are recorded immediately and inventory is
updated on regular basis.
In this System no effort is made to keep up-to-date records of either the
inventory or the cost of goods sold. Instead, these amounts are determined
only periodically-usually at the end of each year.
As the inventory records are not updated as transactions occur, there is no
need of Inventory Subsidiary Ledger. The foundation of the periodic
inventory system is the taking of a complete physical inventory at year-end.
This physical count determines the amount of inventory appearing in the
balance sheet. The cost of goods sold for the entire year then is determined
by a Short Computation. In my practical study I have seen that this system
is using only small storekeepers, drugstores, grocery stores and in all those
places where seller are selling very small amount goods. Further, this system
is not applicable to multinational companies. Even, today a small and very
small storekeeper would like to use perpetual system because in that system
he aware about the inventory stock every time. But these small storekeepers
are still using the periodic because they want to reduce their expenses and
try to focus on selling. I have also seen that some organizations are interested
in earning profit and are not ready to maintain a good setup of records due
to reason that they don’t want to show their actual income. I am talking
about those organizations which are not register and are working as a small
scale industry. Why I choose NTMG because I belong to west Punjab and
people are there, easily approachable and helpful. NTMG is a manufacturer
of marble tiles and trade in house decoration items also they deals in
sanitary units in bulk. The managing director of this group gave me very
respect and answers all of my questions related to my topic in detail. Also
show me factories of marble cutting. There I saw that they are also polluting
the environment and I give some suggestions also. Finally, I will say that
what we are reading in books people are doing in their practical life. But just
differ in this respect that we will be called an MBA but they will remain as
they are.
 Introduction to the issue

Period
It is a time gap between to actions. It is an amount of time. A time difference during
which something occurs or is expected to occur. It is a definite length of time appears
between to instant. It is a time interval which shows one cycle of repeating phenomenon.
Or it is any length of time. The point at which something ends. For instance, period of
three days; a period of waiting. Ending of a calendar year; the ending of a warranty
period etc…….

Periodic
Happening or recurring at regular intervals recurring or reappearing from time to time;
"periodic feelings of anxiety" Having a structure characterized by periodic sentences.*

Inventory
This word is used in business language for goods and materials that we have to purchase
or we have to acquire for business and held available in our stock. This word is also used
for a list of the contents of a household and for a list for testamentary purposes of the
possessions of someone who has died. And in accounting, we consider inventory as
an asset. Or this term also refers to the stock of resources which have an economic value
at any time. This stock of resources can be either manpower, machines, capital goods or
material at different times during process.

“A company's merchandise, raw materials, and finished and unfinished products which
have not yet been sold is also called inventory These are considered liquid assets, since
they can be converted into cash quite easily. There are various meanings of valuing these
assets, but to be conservative the lowest value is usually used in financial statement” *

System
It can be defined as “all those procedures, methods, routines which are established or
designed to do a specific activity, to perform a duty or to solve a problem”.
 Periodic Inventory System

“All the three concepts given above, now defines that it is a procedure or a method to
design or establish a record of an organization’s goods or stocks in such a
definite and specific manner that repeats itself after an interval of time.”
Although inventory consists a huge portion of the assets of many organizations and it sum
up a greater portion of that organization’s fixed assets in financial statements and people
know that accounts produce the most accurate figures of inventory in the financial
statements. Therefore, its record must be very accurate.

Under this system, stock taking is undertaken at the end of accounting year. Because this
stock taking involves verification of the physical quantities of stores in hand. That’s why
annual stock taking is organized because during production process it is very difficult to
take stocks accurately.
For instance: Automobile dealers or home appliances stores make a limited number of
sales each day and can easily refer to their records at the time of each sale to record the
cost of each car or appliance sold. But it is difficult in case of a drugstore or a general
store that sells a number of products in daily routine and records these sales in his cash
register at marked selling price. However, for those, who sell large volume and low priced
items face a difficulty of determining quickly the cost of each item so that the “cost of
goods sold” can be recorded at the time of each sale. But with the help of computer
system you can do this now easily. But still there are many store keepers and dealers that
sell large volume of low priced items and doesn’t make any effort to record the cost of
goods sold at that time but they wait for the ending of accounting period, whatever they
assigned for their stores. And then taking the physical quantity and its records they
determined the cost of cost of goods sold.

Thus, all these drugstore, home appliances store, medical store, grocery store or
hardware store etc etc, uses a similar procedure, method or a design to determine the cost
of goods they sold during an accounting period is called Periodic Inventory
System.
 Operation of Periodic Inventory Systems

1) - The purchase of inventory

When merchandise is purchased, an account is made entitled “Purchases” and cost of

merchandise is debited to this account rather than debiting “inventory”. If merchandise is
purchased on cash then cash is credited by “cash account” and if it is made on an account
then payables are credited by “accounts payables”.

For example:

 Purchase of 1,000 units on cash and on account at $7 each = $7,000

General Journal
Date Account Titles/Explanation Ref Debit Credit
2009 Purchases $ 7000
Jul Cash $ 7000
(Purchase of 1000 units on cash)
  Purchases   $ 7000
Accounts payable   $ 7000
(Purchase of 1000 units on account)

2) - The sale of inventory

When merchandise is sold on cash. “Cash account” is debited and an account is made
entitled “sales” which is credited by the amount of sale. If merchandise is sold on account
then receivables are debited by “accounts receivables” and sales account is credited in
similar manner.

For example:

 Sale of 1,000 units on cash and on account at $7 each = $7,000

General Journal
Date Account Titles/Explanation Ref Debit Credit
5 cash $ 7000
sales $ 7000
 (sale of 1000 units on cash)
  6 Account receivables   $ 7000
sales   $ 7000
(sale of 1000 units on account)

3) Cost of goods sold:

If a drugstore or any store keeper uses periodic inventory system then he does not record
the cost of items he sold during an accounting period but waits till end. To know the cost
of goods sold at that time, he needs the following information.

a. The cost of goods on hand at the beginning of period

b. The cost of merchandise purchased during the accounting period.

c. The cost of unsold goods at the end of accounting period.

For example: The data has been taken from a grocery store.

Cost of goods on hand at 1st January 2010 = $ 5,000

Cost of purchases during the period = $ 20,000

Cost of goods on hand at 1st June 2010 = $ 4,000

With this information, store keeper will calculate the cost of goods sold as follows.

Cost of goods sold statement

Cost of goods on hand at beginning $ 5,000

Add: purchases 20,000

Cost of goods available for sale $ 25,000

Less: Unsold goods on hand at ending 4,000

Cost of goods sold during period $ 21,000

4) Cost of ending inventory

The merchandise (inventory) at the beginning of an accounting period is called beginning

inventory and that remains at the end of period is always called ending inventory. To
know the cost of this ending inventory, following steps should remember.

a. Count the unsold items in store and stock room.

b. Multiply the count for each type of goods in store by its cost

c. Add the costs of each type of goods. It will be your ending inventory cost.

5) Cost of merchandise purchased

To determine the cost of the merchandise purchased during the accounting period, you
must note the invoice price of merchandise and then subtract it from any discounts,
returns and allowances. After it, you have to add any freight charges or other kind of
transportation costs incurred while purchasing process from shipment of goods to place
of business.

  6) Purchase Returns and Allowances and Purchase Discounts

“Purchases” normally shows debit balance because it takes place of “Inventory account”.
It has two contra accounts known as "Purchase Discounts" and "Purchase Returns and
Allowances" that reduce it to determine "Net Purchases". The balance of these two
contra accounts is a credit because "Purchases" is a debit. Contra accounts always have
a normal balance that is opposite to what they are contra to. Purchase-type accounts are
temporary accounts (i.e., they are closed at year end) and only appear in a periodic
inventory system. They simply serve to replace the corresponding inventory portion of an
entry that exists in a perpetual inventory system. The following entries illustrate
purchases returns and allowances and purchase discounts in periodic inventory systems:

For example:

 On 1st November 2010, Nafees stores purchases merchandise of $ 5000 on account

with the terms 2/10, n/30.

 At 3rd november, he come to know that merchandise of $1000 were defective. He

returned the defective goods to supplier.
  At 10th of november, he paid the amount to supplier and received a discount
amount.

General Journal
Re Debi Cred
Date Account Titles/Explanation
f t it
201 Purchases $500
0 Accounts payable 0 $
Nov (Purchase of 1000 units on account with 2/10, n/30). 5000
. 1st
// Accounts payable $100
3nd 0
  purchases  
$  1000
(Defective goods returned to supplier)

 These transactions will be recorded in record as follows.

2010 Accounts payable $

Nov. Cash 4000 $ 3200
3rd Purchase discount $ 80
(cash paid to supplier within discount
period)
   
 

Date Account Titles/Explanation Ref Debit Credit

2010 Accounts payable $ 40
Nov. Purchases returns & $ 40
3rd allowances

(Returned defective merchandise

but received purchases allowance)
   
 

 Sometimes supplier offers the purchaser that do not return the goods and get a
discount of 4% on defective goods, the amount of reduction in the cost of goods
will be purchase allowance for the purchaser and he will pass the entry to settle
the account as follows.

 If a supplier agrees to bear the cost of transporting the sold goods to purchaser. In
such a case, the total cost of the goods is that amount which a purchaser must pay
to supplier otherwise purchaser will have to bear these expenses.

 Sometimes, purchaser agrees to bear the transportation expense, in such a case,

the cost of transportation will be added to the cost of goods purchased and per
unit price of goods will increase from the invoice price. Thus it is better to built a
new account as “transportation-In”

Date
Account Titles/Explanation Ref Debit Credit

2010 Transportation – In $ 70
Nov. Cash $ 70
3rd

(Paid expense charges on the

merchandize purchased)

 At the end of the accounting period, the costs of the Purchases, Purchase Return
and Allowances, Purchases Discounts and Transportation-In together generate the
cost of goods purchased. This calculation will be in income statement of any
merchandising company as follows.
Purchases $ xxxxxx

Less: purchases return & allowances $ xxxxxx

Purchase discount xxxxx xxxxx

Net Purchases. $ xxxxxx

Add: Transportation-In xxxx

Cost of goods purchased $ xxxxxx

Closing process of Periodic Inventory System

There are several ways to close the periodic inventory system but best way is to
create a cost of goods sold account. Once this account has been created, company
or a store keeper can close the process of inventory system in the same manner as
in perpetual inventory case.

7) Creating cost of goods sold account:

Cost of goods sold account is always contributed by the costs of two things, cost of
beginning inventory and the cost of purchases during the period. Entry will be passing as
follows.

Date
Account Titles/Explanation Ref Debit Credit

2010 Cost of goods sold account $ xxxxx

Nov. Purchases $ xxxx
3rd Beginning inventory $ xxxx
(To close the account that are was
contributing to the cost of sold
account)
8) To close the cost of goods sold account

As the cost of goods sold account has been closed, the inventories on hand (year ending
inventories) will again be the beginning inventory of the next year. So transferring these
on hand goods for the next year, entry will be pass as follows.

Date
Account Titles/Explanation Ref Debit Credit

2010 Inventory(year end balance) $ xxxxx

Nov. Cost of goods sold $ xxxxx
3rd
(To close the cost of goods sold
account)

Next is preparation of income statement, worksheet, balance sheet and all financial
statement are same like other accounting systems.

Advantages of periodic inventory system

 It is very cheap.

 It is also simple.

 No long calculations required.

 No technical skills are required.

 It keeps the overall value of inventory accurate.

 No effort is made to keep up-to-date records of either the inventory or the cost of
goods sold. Instead, these amounts are determined only periodically-usually at the end
of each year.

 There is no need of Inventory Subsidiary Ledger.

 No continuous record of changes (receipts and issues of inventory items) is kept.

 The cost of goods sold for the entire year is determined by a Short Computation.

 At the end of an accounting period, the ending-inventory is determined by an actual

(physical) count of every item and its cost is computed by using a suitable
method such as FIFO, LIFO, weighted averages, etc.

Disadvantages of a Periodic Inventory System

 Total Inventory Value Gap
Every piece of stock has some value. Without constantly check and balance, inventory
worker cannot determine the total value until the scheduled inventory check. This makes
it difficult for the company to budget and assess revenue except around the times for
inventory checks. Also can be a problem if the company experiences a disaster such as
fire or huge theft and needs to file an insurance claim to replace the stock.

 Lack of Constantly Updated Movement Record

In a perpetual inventory system, inventory records get updated every time there is a sale.
This makes it possible to identify quickly how, when and where the inventory moved from
the sale floor or warehouse. In a periodic system, this doesn't happen. The inventory
worker may not know where specific pieces of inventory went or to whom they were sold
between inventory reviews.

 Not Ideal for Expensive Items

Periodic inventory systems operate on the concept that, if a low-value item is lost or
stolen, the inventory owner doesn't take a huge financial hit. In other words, periodic
systems are used when the inventory owner can afford to lose a few pieces of stock. This
type of system becomes impractical for expensive items like appliances companies
and cars companies because the financial loss to the inventory owner can be much
greater.
  Looser Stock Control
Knowing the exact location, value and type of every piece of stock permits a worker to
have much more control over the inventory. For example, if an inventory worker knows
that an employer wants to keep a minimum of 50 hats in stock, and if he also knows that
25 hats are left, then he knows he has to order 25 hats to meet the employer's requests. In
a periodic system, this control is lost because of the lack of an up-to-date, solid inventory
count.

Practical Study Of the Organization

Introduction:
For the practical study of the issue assigned, I choose Nafees Tiles and
Marble manufacturer group (NTMG). The group is involved in the
business of marble tiles and house decoration goods from the last 20 years in
District Rahim Yar Khan in division Bahawalpur. The group started its
working in 1990 from a single store but today has become the well reputed
group in West Punjab. Further, its production capacity fulfilled the
expectations of the management and proved a successful venture. Top
management and employees by hard work and sincere efforts increased the
demand of their marble for furnished houses in West Punjab. Now by the
grace of Allah, it is very successful, leading and dominant group of that area.

History and background:

This group in start was a very simple store and deals only hardware
products up to trading concern. It came into existence in 1990. At that time,
Nafees (GM) was a student of 4th class. His father was a landlord but was
deeply interested in doing some business. Thus, he opened a store at the
name of his son. In start he has to face lots of problems but with the help of
his uncle he takes a start. At that time, Nafees was in his childhood. Nafees
was born in a noble family having four brothers and one sister. He started
his education career from a primary school of the local area. He passed the
matriculation exam in 1998. Being a family member, he feels that what his
father’s vision is. So he decided to join his family business after studies. He
completed his MBA from Punjab University in 2002 and started a
professional career from his own family business. With the dynamic
leadership and his management skills, he changed a small store into a
leading group. It has six branches. All are in different cities of district Rahim
Yar Khan. From the research of this group, I found that they are earning
profit approximately Rs.10, 00,000 per month with an average sale of Rs. 3,
00,000,000.

DATA COLLECTION METHODS

Data collection techniques which I used:

Using available information

Observing

Interviewing (face-to-face)

Focus group discussions

Using Available books

In this method of data collection I used many books and other helping
material which I took from my friends which have done MBA or doing MBA
from other universities.

Observing

In daily life there are too many things which help me to write something on
this topic.

Interviewing (face-to-face)

I take help from the general manager of NTMG through an interview and
questionnaire about the topic which was assigned to me and it was very good
experience.

Online Data Collection

Although, books are enough to understand any topic of syllabus but I also
use Google search engine to clear my concepts about the issue assigned to
me.

Operation of Periodic Inventory System in it.

A major objective of accounting for inventories is the proper determination

of income through the process of matching appropriate cost against
revenues. Gross profit is not sales minus purchases. It is equal to sales minus
cost of goods sold. Therefore, closing stock should be valued and brought
into account very carefully as I saw in my practical study. Also closing stock
becomes the opening stock of the next period and is debited to trading
account along with purchases.

Questionnaire:
This questionnaire is brought to you by the special assistance of general manager of
NTMG

1) Do you use periodic inventory system?

Answer. Yes
2) Why do you use this system?

Answer. We use this system because no longer calculations are

required and it saves our time and money.

3) How you save your money?

Answer. We save money in this sense that we don’t hire personnel

for the maintenance of the proper records of inventory level as no
technical skills are required for it.

4) What is you procedure when you make a sale?

Answer. We debit the cash account and credited the sale’s account in
our general journal if sale is at cash. Otherwise, accounts receivables
are debited.

5) What entry you pass when purchases are made?

Answer. Simply purchases account is debited and accounts payable

account is credited. Because, we often used to purchase on account.

6) Do you have inventory subsidiary ledgers?

Answer. No. we have no such subsidiary ledgers.

7) Do you keep the proper record of receipts and issues of inventory
items?

Answer. No, we don’t have such a system. We send a simple

notepad to storekeeper and he brings the demanded items out of
store. But sometimes in this process, storekeeper brings out extra
units that give us loss.

8) Then how you treat such a loss? I mean how you treat shrinkage,
spoilage or shoplifting?

Answer. Yes, very good question. As I told you we are using

periodic inventory system. So we will include the amount of lost
boxes in the cost of goods sold. For example, we loss 3 boxes of tiles
and the price of each box of tiles is, say Rs. 700. Then we will
include Rs. 2100 in monthly sales. This amount will be included in
total sales. But, it’s Ok. We manage.

9) How you come to know that stock is going to an end?

Answer. The storekeeper is so familiar with the stock that he

knows what type of items has sold and how many left.

10) What procedure you adopt for the purchases and how you made
payments to suppliers.

Answer. First of all, storekeeper counts the whole stock and report
to the branch manager. The branch manager sent a requisition to
head office, I mean to me and I approved the demand and
purchase officer purchases it. After receiving the goods with bill,
the purchase officer prepares Dispatch Advise as per items on the
bills. The purchase officer delivers these documents in the shape of
a complete set to the accountant. The accountant sends it to factory
in the shape of a summary. In the factory, storekeeper receives the
bill and attaches some documents like gate entry pass, store
intimation, gate inspection receipt note which he sends back to
head office after checking the items properly. It is called a

Demand Order Procedure.

 11)Sir, please tell me how you pay for your purchases to suppliers?

Answer. Yes, it is a Payment Voucher.

Payment voucher is made by accountant and the amount of

purchases is paid through cheque. We deposit the money directly
to the supplier’s account through bank or sent a cheque to the
supplier on his address also photo copy of cheque is attached to the
voucher when payment is made through cheque.

And the following entry is passes. Debit.

Credit.

Accounts payable……………………………………Rs. XXXXX

Cash/ bank……………………………Rs. XXXXX

12) What is procedure for the preparation of bank receipt voucher?

Answer. Bank receipt voucher is used when payment is received

and deposited into bank account of the organization. Deposit
receipt is attached to the bank receipt voucher as supporting
document. The general entry is passed as follows.

Debit.
Credit.

Bank Account ………………………………………………Rs. XXXXX

Accounts receivable …………………………................Rs. XXXXX

13) Is there any use of Journal Voucher?

 Answer. Journal Voucher is used when there is no cash or bank is
involved in a transaction. There are so many types of transactions
for which journal vouchers are prepared. For example, when goods
are sold to customers on account.

14) Do you prepare Bank reconciliation statement?

Answer. Along with other financial statements, it is also the

responsibility of accountant that he prepare bank reconciliation
statement to match the balance of cash at the end of accounting
period. Sometimes, some transactions, cash are in transit, many
hidden bank charges and many unpaid, NSF cheque left from
recording so preparation of bank reconciliation is necessary.

SWOT Analysis
Strengths
The quality of marble is very good. The tiles and other house decoration
items are good and usually found non defective. The dimensions of marble
tiles and other item are always accurate as per demand. All the branches
are at corner and getting edge of the local market. The personnel are very
honest and sincere to the firm. Good control of general manager to other
branch managers. Management policies are strict. Warehouses and stores
are in city area and is proper management control. Although inventory
method is not accurate and management doesn’t seems interested in proper
records of inventory but they are running the business with full confidence.
You can say that it is a small scale industry.

Weakness
The major weakness is this, that, this group is working up-to district area.
They are not expanding their business to further cities of Pakistan that’s
why the name of the organization is not regarded and familiar on national
level. In this age of technology, they should use the latest methods of
inventory control and new software to reduce the workload on employees.
Production capacity is low, which needs to be increased for better
competition. Management doesn’t seem interested in inventory control.
Price of marble tiles and other decoration units remain always high from
the local market. That’s why they are losing many loyal customers and their
respect. Company does not have its own carriage vehicles to deliver the tiles
to customers at home and losing a big source of income.

Opportunities
They can easily expand their business by getting loan on low mark-up from
government. They can earn money from their own carriage vehicles. They
can increase the number of customers by lowering the price of items. They
can get better inventory control by using perpetual inventory system. They
can be socially responsible by proper wastage system of factory’s wastage.

Threats
If they will not expand their business, competitors can get edge by investing
more capital because competitors are the big threats for a company. Due to
increasing population, factory area could come in the centre of a city. Then
they will have to shift it to some other place because they are polluting the
environment by noise pollution and from its wastage.

Conclusion.

To see the application of periodic inventory system, I visit different

organizations but I found that a very few companies are using this system.
All are using perpetual inventory system. The reason I got is that periodic
invent- tory system is used in small, very small like whole sale stores,
retailers general stores, grocery stores, drugstores, hardware stores, home
appliances stores, car dealers and in merchandising businesses, because need
for current information about inventories and sales is not so much
important. Further, perpetual system is costly. You are required to hire an
accountant who maintains these records up-to-date. All the goods are
available at the sale site and sometimes owner may be so familiar with the
stock that there is no need of perpetual system. Many stores, either large or
small, sell so low cost items and have old traditional manual systems because
they have no other choice but to use periodic system having no deep interest
in inventories on hand.
Here are some factors that prompt these storekeepers and proprietors to use
a periodic inventory system to operate.
a. There are many stores and some companies also, that are run by a single
person, or owner called “proprietor”.
b. There is no need of current information and accounting records, of
inventories and low cost items on hand, in their daily routine works. This
kind of information only helps them at the year end to calculate the cost
of goods sold and for tax returns.
c. It also allows businesses to focus on selling inventory, rather than using
personnel to continually count the inventory for accuracy.
Finally, I concluded that the use of periodic inventory system is very rare.
In this age of technology, where organizations are in competition, and
technology made the business so easy that now at just a single “click”
you can buy anything at anywhere. Organizations are so much interested
about their inventory stocks and keep their stocks up-to date that any
time they can tell you about their inventory stock. Thus the use of period
inventory system is very rare and is used only to run the small stores and
shopkeepers.

Suggestions
The most important liquid asset in the balance sheets of the organizations
are inventories. Thus, due to large size of inventory and different types of
products may be stored in the different location of ware houses where
chances of error and error in the valuation of inventories may not be
 readily acceptable. Even a small mistake in valuation of inventory may
cause a material effect of the company’s income statement. Also, ending
inventory of an accounting period is the beginning inventory of the next
period so error in valuation of inventories will carry over into the
financial statements of the following year. That’s why I recommend that
Nafees group should use perpetual inventory system and should be
interested about their stocks. They should also use other methods of
inventory control like gross profit method or the retail methods for the
operation of their business. They should expand their business by getting
loan from government on low mark-up and increase their production
capacity. They should have their own carriage vehicles for loading and
unloading the materials for selling or purchasing purposes. They should
also be socially involved to keep the environment better and
clean………………

References:
1- Financial & managerial accounting (14th edition) by William, Haka,
Bettner, Carcello

2- A text book of Cost Accounting by Kashif Saeed.

3- Fundamental accounting principles (12th edition) Kermit D. Larson

(The University of Texas at Austin)

4- Basic Accounting by Javid Akther

5- Mr. Nafees. GM (NTMG)

6- www.google.com