Inventory includes raw materials, work-in-progress and finished goods. Your physical inventory count also may include parts and supplies inventory. Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value.
Estimating the value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. For example, the value of work-in-progress inventory includes overhead allocations and, in some cases, may require percentage-of-completion assessments.
A moving target
The inventory count gives a snapshot of how much inventory is on hand at year end. The value of inventory is always in flux, as work is performed and items are delivered or shipped. To capture a static value, it’s essential that business operations “freeze” while the count takes place.
Usually, it makes sense to count inventory during off-hours to minimize the disruption to business operations. Larger organizations with multiple locations may be unable to count everything at once. So, larger companies often break down their counts by physical location.
Planning is the key to minimizing disruptions. Before counting starts, management can:.
- Order (or create) prenumbered inventory tags,
- Conduct a dry run to identify roadblocks and schedule workers,
- Assign workers to count inventory using two-person teams to prevent fraud,
- Write off any unsalable items, and
- Precount and bag slow-moving items.
If your company issues audited financial statements, your audit team will be present during the physical inventory count. They aren’t there to help count inventory. Instead, they’ll observe the procedures, review written inventory processes and cutoffs, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.
Beyond the count
When the inventory count is complete, it’s critical to investigate discrepancies between your computerized accounting records and physical inventory counts. We can use this information to help you evaluate how to stock items more efficiently and safeguard against future write-offs due to fraud, damage or obsolescence.