Periodic Inventory System
Definition & Example
The Periodic inventory system is also called a traditional inventory system. According to this system, the physical counting of inventory is made at the end of a certain period. This is the traditional costing system. After determining the cost of goods sold, cost of inventory is determined to deduct the cost of goods sold from the cost of goods available for sale. Under the periodic inventory system, it is difficult to determine the surplus and spoil of the inventories. Also, the cost of goods sold and the cost of ending inventory are the transactions they cannot be determined under this system. However, this system is easy to adopt and competitively this system has a low cost of operation.
In case of saving and dis-saving of tax generally, Last-in-First-Out (LIFO) method provides less tax to the company. However, the tax saving depends upon the units cost of inventories purchased by the firm. There are some cases arises
Case-1 – When there is unit cost of inventory is continuous increases (e.g. Rs. 2, 5, 6, 8, & so on) in that case LIFO method provides less tax to the company.
Case- 2 – When there is unit cost of inventory is continuous decreases (e.g. Rs. 8, 6, 5, 3) in that case the FIFO method provides less tax to the company.
Last, Case-3 – Similarly, when there is unit cost of inventory is sometimes increases or decreases (e.g. Rs. 2, 7, 4, 6, 9) in that case either LIFO or FIFO method provides less tax to the company. It means that it is necessary to calculate manually.
Also, note that: having a higher cost of goods sold method provides less tax. To clarify it may we illustrate it as below:
Example: calculation of the cost of ending inventory and cost of goods sold using periodic inventory system.
Example: In case of Increasing unit cost
The following information was found in the books of ABC Company for the month of January, 2019.
There were 400 units beginning inventory at Rs. 4 per unit.
The purchase of the month are as follows:
| Date | Units | Unit Cost |
| January 3 | 800 | 5 |
| January 19 | 1,000 | 7 |
| January 26 | 400 | 9 |
During the month ABC Company sold 2000 units @ Rs. 12 per unit. The corporate tax rate is 30%, and the administrative expenses are Rs. 2,000.
Required:
i. Using the periodic inventory system determine the ending inventory and the cost of goods sold using: a. Weighted average method, b. FIFO method, c. LIFO method
ii. By preparing a income statement determine which method provides less tax?
Solution:
i.
Using Periodic Inventory System
Calculation of cost of goods available for sale
| Date of purchase | Units purchased | Unit Cost | Total Cost Rs. |
| Beginning inventory January 3 January 19 January 26 | 400 800 1,000 400 | 4 5 7 9 | 1,600 4,000 7,000 3,600 |
| Total | 2,600 | Rs. 16,200 |
a.
Here, Cost of goods available for sale = Rs. 16,200
Units available for sale = 2,600 units
Units sold = 2,000 units
Units on hand = Units available for sale – Units sold = 2,600 – 2,000 = 600 units
We have,
Weighted average Cost (WAC) = Cost of goods available for sale / Units available for sale = 16,200 / 2,600 = Rs. 6.23
Cost of goods sold = WAC * Units sold = 6.23 * 2,000 = Rs. 12,460
Cost of ending inventory = WAC * Units on hand = 6.23 * 600 = Rs. 3,738
b.
Cost of goods sold schedule
Under the FIFO method
| Date of purchase | Units sold | Unit cost | Total cost Rs. |
| Beginning inventory January 3 January 19 | 400 800 800 | 4 5 7 | 1,600 4,000 5,600 |
| Total | 2,000 | Rs. 11,200 |
Cost of Ending Inventory
Under the FIFO method
| Date of purchase | Units on hand | Unit Cost | Total Cost Rs. |
| January 26 January 19 | 400 200 | 9 7 | 3,600 1,400 |
| Total | 600 | Rs. 5,000 |
c.
Cost of goods sold schedule
Under the LIFO method
| Date of purchase | Units sold | Unit cost | Total cost Rs. |
| January 26 January 19 January 3 | 400 1,000 600 | 9 7 5 | 3,600 7,000 3,000 |
| Total | 2,000 | Rs. 13,600 |
Cost of ending inventory
Under the LIFO method
| Date of purchase | Units on hand | Unit cost | Total cost Rs. |
| January 3 Beginning inventory | 200 400 | 5 4 | 1,000 1,600 |
| Total | 600 | Rs. 2,600 |
ii.
ABC Company
Comparative Income Statement
| Details | FIFO | LIFO | WAC |
| Sales revenue (2,000 units @ 12 per unit) Less: Cost of goods sold | 24,000 11,200 | 24,000 13,600 | 24,000 12,460 |
| Gross Profit Less: Administrative expenses | 12,800 2,000 | 10,400 2,000 | 11,540 2,000 |
| Net income before tax Less: Tax @ 30% | 10,800 3,240 | 8,400 2,520 | 9,540 2,862 |
| Net income | Rs. 7,560 | Rs. 5,880 | Rs. 6,678 |
The LIFO method provides less tax because the cost of goods sold is higher than the other methods.
Example: In case of Decreasing unit cost
Modified Question
Following information’s are available in the book of ABC Company at the time of January 2019.
Purchases during the month,
| Date | Units | Unit Cost |
| January 1 | 400 | 9 |
| January 3 | 800 | 7 |
| January 19 | 1,000 | 5 |
| January 26 | 400 | 4 |
The company sold 2,000 units during the month @ Rs. 12 each. The administrative expenses Rs. 2,000 and the corporate tax is 30%.
Required: Calculate the cost of goods sold and cost of ending inventory using FIFO, LIFO, and WAC method under the periodic inventory system. And determine which method provides less tax?
Solution:
Using the Periodic Inventory System
Calculation of cost of goods available for sale
| Date of purchase | Units purchased | Unit cost | Total Cost |
| Beginning inventory January 3 January 19 January 26 | 400 800 1,000 400 | 9 7 5 4 | 3,600 5,600 5,000 1,600 |
| Total | 2,600 | Rs. 15,800 |
Calculation of COGS and cost of ending inventory
Using the FIFO method
Cost of goods sold schedule
| Date of purchase | Units sold | Unit cost | Total cost |
| Beginning inventory January 3 January 19 | 400 800 800 | 9 7 5 | 3,600 5,600 4,000 |
| Total | 2,000 | Rs. 13,200 |
Cost of Ending inventory
| Date of purchase | Units on hand | Unit cost | Total cost |
| January 26 January 19 | 400 200 | 4 5 | 1,600 1,000 |
| Total | 600 | 2,600 |
Using the LIFO method
Cost of goods sold schedule
| Date of purchase | Units sold | Unit cost | Total cost |
| January 26 January 19 January 3 | 400 1,000 600 | 4 5 7 | 1,600 5,000 4,200 |
| Total | 2,000 | Rs. 10,800 |
Cost of Ending inventory
| Date of purchase | Units in hand | Unit cost | Total cost |
| January 3 Beginning inventory | 200 400 | 7 9 | 1,400 3,600 |
| Total | 600 | Rs. 5,000 |
Under the weighted average cost (WAC) method
Weighted average cost (WAC) = Cost of goods available for sale / Units available for sale = 15,800 / 2,600 = Rs. 6.08
Cost of goods sold (COGS) = WAC * Units sold = 6.08 * 2,000 = Rs. 12,160
Cost of ending inventory = WAC * Units on hand = 6.08 * 600 = Rs. 3,648
ABC Company
Comparative Income Statement
| Particulars | FIFO | LIFO | WAC |
| Sales revenue (2,000 units @ Rs. 12 each) Less: Cost of goods sold | 24,000 13,200 | 24,000 10,800 | 24,000 12,160 |
| Gross profit Less: Administrative expenses | 10,800 2,000 | 13,200 2,000 | 11,840 2,000 |
| Net income before tax Less: Tax @ 30% | 8,800 2,640 | 11,200 3,360 | 9,840 2,952 |
| Net income/ profit | Rs. 6,160 | Rs. 7,840 | Rs. 6,888 |
The FIFO method provides less tax. It is because it has the higher cost of goods sold (COGS) than other methods.