Periodic inventory: record purchases now, work out cost of goods sold at year end
In a periodic inventory system, the Inventory account sits still all year. Purchases, returns, discounts and freight are collected in their own temporary accounts. At year end, a physical count shows what is left, and cost of goods sold is worked out from the totals. This page explains how the system works, shows each entry with real numbers, and walks through the year-end calculation step by step.
How a periodic system works
"Periodic" means the inventory record is brought up to date only at the end of a period, usually the year. During the year the business does not track the cost of each item sold. Sales are recorded at the selling price only. There is no Cost of Goods Sold line at the time of the sale.
Instead, every cost of buying merchandise is recorded in a set of temporary accounts:
- Purchases (debit balance): the invoice cost of merchandise bought for resale.
- Freight-In (debit balance): shipping paid to bring the merchandise in.
- Purchase Returns and Allowances (credit balance): goods sent back to suppliers, or price reductions for damaged goods.
- Purchase Discounts (credit balance): discounts earned by paying suppliers early.
Keeping these separate gives the business a clear view of what it bought, what it sent back and what it saved. At year end, all four are closed out and turned into one number: cost of goods sold.
The cost of goods sold formula
The year-end calculation follows the flow of goods. You start with what was on hand, add what came in, and subtract what is still there. Whatever is missing must have been sold (or lost).
| Step | Calculation |
|---|---|
| Net purchases | Purchases − Purchase Returns and Allowances − Purchase Discounts |
| Cost of goods purchased | Net purchases + Freight-In |
| Cost of goods available for sale | Beginning inventory + cost of goods purchased |
| Cost of goods sold | Cost of goods available for sale − ending inventory (from the count) |
Notice the signs. Returns and discounts reduce what the goods cost, so they are subtracted. Freight-in adds to what the goods cost, so it is added.
Entries during the year
Worked example 1: a purchase on account
Northside Print Shop bought merchandise for resale costing $4,480.00 on account. It uses a periodic inventory system.
| Account | Debit | Credit |
|---|---|---|
| Purchases | $4,480.00 | |
| Accounts Payable | $4,480.00 |
Inventory is not touched. The Purchases account collects every merchandise purchase until the year-end count.
Worked example 2: paying within the discount period
Juniper Landscaping owes a supplier $6,200.00 for merchandise bought on terms 1/10, n/30, meaning a 1% discount if paid within 10 days. It pays within the discount period.
Discount: $6,200.00 × 1% = $62.00Cash paid: $6,200.00 − $62.00 = $6,138.00
| Account | Debit | Credit |
|---|---|---|
| Accounts Payable | $6,200.00 | |
| Purchase Discounts | $62.00 | |
| Cash | $6,138.00 |
Worked example 3: a return and freight-in together
Copperleaf Studio returned damaged merchandise costing $2,462.11 to a supplier it owes on account, and paid a carrier $430.80 in cash for freight-in on another delivery. Both go in one compound entry:
| Account | Debit | Credit |
|---|---|---|
| Accounts Payable | $2,462.11 | |
| Freight-In | $430.80 | |
| Purchase Returns and Allowances | $2,462.11 | |
| Cash | $430.80 |
Worked example 4: cost of goods sold at year end
Pine Street Dental uses a periodic inventory system. At year end its accounts show:
| Account | Balance |
|---|---|
| Inventory (beginning of year) | $31,030.00 |
| Purchases | $72,810.00 |
| Purchase Returns and Allowances | $632.65 |
| Purchase Discounts | $473.88 |
| Freight-In | $1,073.89 |
The year-end count values the merchandise on hand at $11,320.00. Follow the formula one line at a time:
| Step | Amount |
|---|---|
| Purchases | $72,810.00 |
| Less purchase returns and allowances | ($632.65) |
| Less purchase discounts | ($473.88) |
| Net purchases | $71,703.47 |
| Add freight-in | $1,073.89 |
| Cost of goods purchased | $72,777.36 |
| Add beginning inventory | $31,030.00 |
| Cost of goods available for sale | $103,807.36 |
| Less ending inventory (count) | ($11,320.00) |
| Cost of goods sold | $92,487.36 |
The year-end entry
One compound entry does three jobs. It replaces the old Inventory balance with the counted amount, closes the four purchase accounts to zero, and records Cost of Goods Sold as the balancing figure. Each account is closed by putting its balance on the opposite side:
| Account | Debit | Credit |
|---|---|---|
| Inventory (ending, from the count) | $11,320.00 | |
| Purchase Returns and Allowances | $632.65 | |
| Purchase Discounts | $473.88 | |
| Cost of Goods Sold | $92,487.36 | |
| Inventory (beginning) | $31,030.00 | |
| Purchases | $72,810.00 | |
| Freight-In | $1,073.89 |
Check it: the debits total $104,913.89, and so do the credits. Inventory, which was debited $11,320.00 and credited $31,030.00, now shows the counted $11,320.00. The four temporary accounts are all at zero, ready for next year.
Why the count matters so much
In a periodic system, the ending inventory figure comes entirely from the physical count. There is no running record to compare it against. That makes the count the single most important number in the calculation.
Look at how it flows through. Cost of goods sold is cost of goods available for sale minus ending inventory. If Pine Street Dental's count had missed a shelf worth $1,000.00, ending inventory would be $1,000.00 too low and cost of goods sold $1,000.00 too high. Gross profit and net income would both be understated by $1,000.00. And because this year's ending inventory becomes next year's beginning inventory, the error would flip the other way next year.
This is also why a periodic system has no separate shrinkage entry. Goods that were stolen, damaged or lost are simply not there at the count, so they end up inside cost of goods sold automatically. The business cannot tell how much of its cost of goods sold was real sales and how much was loss. That is one of the trade-offs of the system.
How cost of goods sold reaches the income statement
On a merchandising company's income statement, cost of goods sold comes straight after net sales. The difference is gross profit, which shows how much the business earns on its goods before operating expenses such as rent and wages. Many income statements for periodic businesses show the full calculation, from beginning inventory down to cost of goods sold, in a short schedule like the one above. Learning to build that schedule is the same skill as making the year-end entry: both start from the account balances and the count.
A quick routine for periodic inventory questions
- During the year, never touch Inventory. Choose the temporary account that matches the event: Purchases, Freight-In, Purchase Returns and Allowances or Purchase Discounts.
- For a payment inside a discount period, credit Purchase Discounts for the discount and Cash for the rest.
- At year end, compute net purchases, add freight-in, add beginning inventory, then subtract the counted ending inventory.
- Write the closing entry: debit ending inventory and the two credit-balance accounts, credit beginning inventory, Purchases and Freight-In, and debit Cost of Goods Sold to balance.
- Check that debits equal credits and that the four temporary accounts are now zero.
Common mistakes and how to avoid them
These are the mistakes our exercises check for. Most of them come from mixing periodic and perpetual habits.
Debiting Inventory for a purchase
That is the perpetual way. In a periodic system, debit Purchases. Inventory is updated only after the year-end count.
Debiting Cost of Goods Sold for a purchase
Buying goods is not the same as selling them. Nothing has been sold yet, so the cost goes to Purchases. Cost of goods sold is worked out at year end.
Ignoring the discount
If the payment falls inside the discount period, cash paid is the invoice minus the discount. Paying the full $6,200.00 misses the $62.00 saving.
Crediting Inventory for a discount or return
Again, that is the perpetual way. In a periodic system, discounts go to Purchase Discounts and returns go to Purchase Returns and Allowances.
Charging freight-in to Delivery Expense
Delivery Expense is for shipping goods to customers. Shipping to bring merchandise in is part of its cost, so it goes to Freight-In.
Leaving freight-in out of cost of goods sold
Freight-in is part of what the goods cost. If it is forgotten at year end, cost of goods sold comes out at $91,413.47 instead of $92,487.36, and Freight-In is never closed. Credit Freight-In and include it.
Adding returns and discounts
Returns and discounts have credit balances and reduce the cost of purchases. Close them with debits and subtract them. Adding them instead gives $94,700.42, which overstates cost of goods sold.
To compare, see how the same purchases, discounts and returns go straight into Inventory in perpetual inventory journal entries.
Frequently asked questions
What is the main difference between periodic and perpetual inventory?
Timing. A perpetual system updates Inventory and Cost of Goods Sold at every purchase and sale. A periodic system records purchases in temporary accounts and works out cost of goods sold once, from a count at the end of the period.
Is Purchases an asset or an expense?
Neither, strictly. It is a temporary account that collects the cost of merchandise bought during the period. At year end it is closed into the cost of goods sold calculation.
Where does shrinkage go in a periodic system?
It is already included in cost of goods sold. Anything not on the shelf at the count is treated as sold, whether it was sold, lost or damaged.
How are sales recorded in a periodic system?
At the selling price only: debit Cash or Accounts Receivable and credit Sales Revenue. There is no cost line, because the cost of what was sold is not known until the count.
Does freight to customers go into cost of goods sold?
No. Shipping goods out to customers is Delivery Expense, an operating expense. Only freight to bring goods in becomes part of their cost.
Why does the year-end entry credit beginning inventory?
The beginning balance has been sitting in Inventory all year. Crediting it removes the old figure, and the debit for the counted amount puts the new figure in its place.