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When using the periodic inventory system, a temporary account, Purchases, is used to accumulate the purchases transactions for the year. Inventory is not adjusted until the end of the accounting period. At the end of the accounting period, inventory is physically counted and cost of goods sold is determined by adding beginning inventory and purchases and then subtracting ending inventory. The inventory is then adjusted, cost of goods sold is recorded and the purchases account is closed.
The periodic inventory system is easy to use in that when goods are sold, the cost of goods sold does not have to be determined. Cost of goods sold is calculated by determining goods available for sale and then subtracting the actual ending inventory.
One of the primary disadvantages of the periodic system is that the business owner has no account of the amount of lost, stolen or damaged goods. Also, it is difficult to determine the amount of inventory on hand throughout the accounting period, since there is no running balance in the inventory account.
It is necessary to take a physical inventory at the end of the accounting period. That is the only way to determine the amount of ending inventory except for some estimation techniques.