Why and how do you adjust the inventory account in the periodic method?

Definition of Inventory Account in Periodic Method

Under the periodic method or periodic system, the account Inventory is dormant throughout the accounting year and will report only the cost of the prior year's ending inventory. The current year's purchases are recorded in one or more temporary accounts entitled Purchases. At the end of the accounting year, the beginning balance in the account Inventory must be changed so that it reports the cost (or perhaps lower than the cost) of the ending inventory.

Examples of Adjusting the Inventory Account

When using the periodic method, balance in the inventory account can be changed to the ending inventory's cost by recording an adjusting entry.

To illustrate, let's assume that the cost of a company's beginning inventory (last year's ending inventory) was $35,000. This balance will be the only amount in the account Inventory until the end of the year. Let's assume that at the end of the year a physical count of inventory is taken and it has an actual cost of $40,000. To adjust the Inventory account balance from a debit balance of $35,000 to a debit balance of $40,000, the following adjusting entry will be needed:

  • Debit Inventory for $5,000, and
  • Credit Inventory Change for $5,000

Let's also assume that the Purchases account showed a debit balance of $200,000 for the year.

The account Inventory Change is an income statement account that when combined with the amount in the Purchases account will result in the cost of goods sold. In our example, the $5,000 credit balance in the account Inventory Change will reduce the $200,000 of Purchases, resulting in the cost of goods sold of $195,000 ($200,000 of purchases minus the $5,000 of purchases that were not sold and caused inventory to increase).

As an additional example, let's assume that in the following year the company's ending inventory has a cost of $29,000. However, the inventory account has the debit balance of $40,000 from the prior year. This situation will require the following adjusting entry:

  • Credit Inventory for $11,000, and
  • Debit Inventory Change for $11,000

Let's also assume that the Purchases account showed a debit balance of $230,000 for the year.

The debit balance of $11,000 in the account Inventory Change when combined with the debit balance of $230,000 in the Purchases account will result in the cost of the goods sold of $241,000 ($230,000 of purchases plus $11,000 that was sold from inventory).

Textbooks may change the balance in the account Inventory (under the periodic method) through the closing entries. (One closing entry removes the amount of beginning inventory and one closing entry records the cost of the ending inventory.) We believe that an adjusting entry is more logical and efficient, especially when a company's monthly and year-to-date financial statements are prepared using accounting software.

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