Controlling Inventory

Read this section, which focuses on internal controls, perpetual verses periodic counting, conducting a physical inventory, and the impact of measurement error.

Internal Controls

Inventory internal controls ensure that a company has sufficient resources to meet its customers' needs without having too much goods.


LEARNING OBJECTIVES

Explain how a company would use storage, inventory management systems, and inventory counts to control inventory


KEY TAKEAWAYS

Key Points
  • Companies should store inventory in secure spacious warehouses so that inventory is not stolen or damaged. Goods and resources of the same or similar type should be kept in the same general area of the warehouse to minimize confusion and to ensure accurate counts.
  • An inventory management system is a series of procedures, often aided by computer software, that tracks assets progression through inventory. A properly used and maintained inventory management system allows management to be able to know how much inventory it has at any given time.
  • Detailed physical inventory counts are a way of ensuring that a company's inventory management system is accurate and as a check to make sure goods are not being lost or stolen. A physical count of a company's entire inventory is generally taken prior to the issuance of a company's balance sheet.
  • To conduct a cycle count, an auditor will select a small subset of inventory, in a specific location, and count it on a specified day. The auditor will then compare the count to the related information in the inventory management system to ensure the information in the system is correct.

Key Terms
  • cycle counts: Process by which an auditor selects a small subset of inventory and counts it to ensure that it matches the information in the company's inventory management system. Meant to test the accuracy of inventory system.
  • physical inventory count: Physical inventory is a process where a business physically counts its entire inventory. A physical inventory may be mandated by financial accounting rules or the tax regulations to place an accurate value on the inventory, or the business may need to count inventory so component parts or raw materials can be restocked. Businesses may use several different tactics to minimize the disruption caused by physical inventory.
  • internal auditor: one who conducts an independent, objective assurance and consulting activity designed to add value and improve an organization's operations

Internal controls over a company's inventory are meant to ensure that management has an accurate count of what materials and goods it has available for sale and to protect those goods from being spoiled, stolen or otherwise made unavailable for sale. In short, inventory internal controls are meant to ensure that a company always has sufficient resources to produce and sell goods to meet its customers' needs without having oversupply.

This process is affected by the company's structure, its employees, and its informational systems. Since a company's inventory is directly tied to the business's ability to generate profit, the internal controls must be comprehensive and require significant thought when being designed.


Storage

Companies should store inventory in secure, spacious warehouses so that inventory is not stolen or damaged. Goods and resources of the same or similar type should be kept in the same general area of the warehouse to minimize confusion and to ensure accurate counts.


Inventory Management Systems

An inventory management system is a series of procedures, often aided by computer software, that tracks assets progression through inventory. For example, assume a set amount of raw material is acquired by the company. When the company receives that material, the amount should be noted in the inventory management system. As the material is processed into the goods for resale, the amount of raw material used should be deducted from the "raw material inventory" and the amount of goods that result from the process should be added to the "finished goods inventory". As each finished item is sold, the "finished goods inventory" should be decreased by that amount.

The benefit of a properly used and maintained inventory management system is that it allows management to be able to know how much inventory it has at any given time.


Physical Inventory Count

Physical inventory counts are a way of ensuring that a company's inventory management system is accurate and as a check to make sure goods are not being lost or stolen. A detailed physical count of a company's entire inventory is generally taken prior to the issuance of a company's balance sheet, to ensure that the company accurately report its inventory levels.

 

Keeping track of Inventory: Clerk conducting physical inventory count using a handheld computer in a Tesco Lotus supermarket in Sakon Nakhon, Thailand


Cycle Counts

Companies usually conduct cycle counts periodically throughout an accounting period as a means to ensure that the information in its inventory management system is correct. To conduct a cycle count, an auditor will select a small subset of inventory, in a specific location, and count it on a specified day. The auditor will then compare the count to the related information in the inventory management system. If the counts match, no further action is taken. If the numbers differ, the auditor will take additional steps to determine why the counts do not match.

Cycle counts contrast with traditional physical inventory in that a full physical inventory may stop operation at a facility while all items are counted at one time. Cycle counts are less disruptive to daily operations, provide an ongoing measure of inventory accuracy and procedure execution, and can be tailored to focus on items with higher value, higher movement volume, or that are critical to business processes. Cycle counting should only be performed in facilities with a high degree of inventory accuracy.



Source: Boundless, https://courses.lumenlearning.com/boundless-accounting/chapter/controlling-inventory/
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