Accounting Principles

Page 225 Describe the internal controls that must be applied when taking a physical count of inventory.

With today's technology it is very easy to maintain inventory records under a perpetual inventory system because each sale and purchase can be updated automatically. However, the actual inventory can vary greatly compared to the ideal inventory. The ideal inventory would equal the beginning inventory plus inventory received minus any recorded sales or transfers out. However, rarely does a company operate under ideal conditions or in ideal scenarios.

Many times the actual usage is very different from the ideal. There are many external and internal factors that can cause the actual inventory to be different than the ideal inventory. One such internal factor is known as internal inventory theft. One such external factor can be as simple as an accidental shortage on an inventory shipment. Similar factors can result in unaccounted overages as well. Taking a regular physical count of inventory enables businesses to identify such shortages or overages in order to correct or take corrective action.

Certain internal controls should be implemented before a physical count of inventory takes place. For instance, counts should be made by someone that has no connection or self-interest in the outcomes of the physical count. In other words, the inventory counter(s) should be from outside the company or at least from a different department that is not directly affected by inventory control. It is also important for the counter(s) to inspect the inventory for its value not only in count, but in legitimacy and condition as well. A pre-numbered inventory ticket should be issued to the assigned inventory counters and each ticket must be returned and accounted for after the physical count. Additionally, it is prudent to perform a separate inventory count by a different counter to validate the accuracy of the initial count (Wild, 2007, page 225).

References

Chiappetta, Larson, Wild, Fundamental Accounting Principles, 18th Ed., McGraw-Hill 2007.