Under periodic inventory system inventory account is not updated for each purchase and each sale. All purchases are debited to purchases account. At the end of the period, the total in purchases account is added to the beginning balance of the inventory to compute cost of goods available for sale. The ending inventory is then subtracted from the cost of goods available for sale to compute cost of goods sold. The ending inventory is computed at the end of the period by a physical count.

The general formula to compute cost of goods sold under periodic inventory system is given below:

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

Journal entries in a periodic inventory system:

(1). When goods are purchased from supplier:

Purchases xxxx
     Accounts payable xxxx

(2) When expenses are incurred to obtain goods for sale – freight-in, insurance etc:

Freight-in xxxx
Insurance xxxx
     Cash/Bank xxxx

(3). When goods are returned to supplier:

Accounts payable xxxx
     Purchases returns xxxx

(4). When payment is made to supplier:

Accounts payable xxxx
     Cash/Bank xxxx

(5). When goods are sold to customers:

Accounts receivable xxxx
     Sales xxxx

(6). When goods are returned by customers:

Sales returns
     Accounts receivable

(7). At the end of the period:

Inventory (ending) xxxx
Cost of goods sold (B.F) xxxx
     Purchases xxxx
     Inventory (beginning) xxxx

Example:

The following information belongs to a hardware store.

Inventory – 1st January 2012 200 units at $12 $2,400
Purchases during the years 2012 1800 units at $12 $21,600
Sales during the years 2012 1200 units at $24 $28,800
Inventory 31st December 2012 800 units at $12 $9,600

Required: Make journal entries to record the above transactions using periodic inventory system.

Solution:

Purchases 21,600
     Accounts payable 21,600
———————————-
Accounts receivable 28,800
     Sales 28,800
———————————-
Inventory – ending 9,600
Cost of goods sold (B.F.) 14,400*
     Purchases 21,600
     Inventory – beginning 2,400

* [(21,600 + 2,400) - 9,600]

Periodic inventory system is usually used by companies that buy and sell a wide variety of inexpensive products.

A disadvantage of periodic inventory system is that overages and shortages of inventory is buried in cost of goods sold because no accounting record is available against which to compare physical count of inventory.