What are the main inventory count procedures, and when is a physical count required under periodic vs. perpetual systems?

Great question — even perpetual systems require periodic physical verification. Let me walk through the key procedures and differences.

Periodic vs. Perpetual — Count Mechanics

Under a periodic system, the company does NOT continuously update inventory records for each transaction. Instead, it relies on a physical count at the end of the reporting period to determine ending inventory. Cost of goods sold is then derived as a plug:

COGS = Beginning Inventory + Purchases − Ending Inventory (from physical count)

Under a perpetual system, every purchase and sale is recorded in real time. The ledger always shows a running balance. However, physical counts are still performed — typically annually or quarterly — to reconcile the book balance with what is actually on the shelves.

Why Perpetual Still Needs Physical Counts

Even the best perpetual system cannot capture:

• Theft and pilferage
• Breakage and spoilage
• Receiving errors (e.g., quantity received differs from invoice)
• Misplacement within the warehouse

Worked Example — Harmon Industrial Supply:

Harmon uses a perpetual system. On December 31, the ledger shows ending inventory of $3,420,000. The annual physical count reveals only $3,315,000 on hand.

Harmon records an adjusting entry:

• Debit: Inventory Shrinkage Expense (or COGS) — $105,000
• Credit: Inventory — $105,000

Key Exam Points:

1. Periodic systems — physical count is the ONLY way to determine ending inventory. Without it, COGS cannot be calculated.
2. Perpetual systems — physical count serves as a verification/reconciliation tool.
3. Shrinkage under perpetual is the difference between book and physical. Under periodic, shrinkage is embedded in COGS and cannot be separately identified.
4. Auditors require observation of physical counts as part of their procedures (ISA 501 / AS 2510).

For practice on inventory accounting, check out our CFA Level I question bank.