How periodic inventory systems work in QuickBooks
If you use a periodic inventory system, you set up an Other Current Asset type account called Inventory. Then, whenever you purchase inventory, you categorize the inventory purchase as falling into this fake inventory account. (The account is called a “fake” inventory account because it isn’t a real inventory account to QuickBooks.)To record your cost of goods sold each month, you use a journal entry to move an appropriate portion out of the fake inventory account and into your cost-of-goods-sold account. How do you know what portion you should move? Good question. In a nutshell, you guess based on your historical cost-of-goods-sold percentage.
Here’s an example of how this works: Suppose that since time immemorial, your cost of goods sold has run 45 percent of your sales revenue, and that last month, you sold $10,000 worth of stuff. In this case, you’d figure that 45 percent of $10,000 ($4,500) equals the cost of the inventory that you sold. Accordingly, you’d move $4,500 out of the fake inventory account and into cost of goods sold.
Predictably, this rough-and-ready approach means that your inventory and cost-of-goods-sold numbers are going to be wrong. So at the end of the year, you still perform a physical inventory count to figure out exactly what you truly hold in inventory. At that point, you’d adjust the inventory and cost-of-goods-sold balances so that they match what your physical inventory shows.
It may be that over the course of the year, your rough 45 percent number has meant that you moved $5,000 too much from inventory to cost of goods sold. In this case, you’d move $5,000 out of cost of goods sold and back to inventory. Or you may find that you moved $5,000 too little from inventory to cost of goods sold. To fix that problem, you move another $5,000 from inventory to cost of goods sold.A final quick point about using a periodic inventory: You don’t use inventory items if you’re using a periodic inventory. So what you put on invoices or sales receipts is just a generic, noninventory part item.
The good and bad of a periodic inventory
A periodic inventory system is good for some types of businesses. If you have too many items to track with the QuickBooks Item list, for example, the approach described here can be a lifesaver.Periodic inventory systems create some problems, however. Here are the four biggest and baddest problems:
- You won’t really know which items are selling well and which aren’t because you won’t be tracking sales by inventory items. This means that you can’t stock more of the hot-selling stuff and less of stuff that’s not selling.
- You won’t know what you really hold in your inventory except when you take that year-end physical inventory. (You won’t know how many dollars’ worth of inventory you’re holding or which item quantities you’re holding.)
- Because you won’t make item-level adjustments based on your physical inventory, you won’t know which items are prone to shrinkage from problems such as theft, breakage, and spoilage.
- You’ll need to make the journal entries that record the dollars moving out of inventory and into cost of goods sold. These journal entries aren’t terribly difficult, but they can be a little bit tricky to figure out the first few times.