When businesses issue audited financial statements, year-end physical inventory counts may be required for retailers, manufacturers, contractors and others that carry significant inventory. Auditors don’t perform the counts themselves, but they observe them to evaluate the accuracy of management’s procedures, verify that recorded quantities exist and assess whether inventory is properly valued.
Even for businesses that aren’t subject to audit requirements, conducting a physical count is a smart end-of-year exercise. It provides an opportunity to confirm that the quantities in your accounting system reflect what’s actually on the shelves, uncover shrinkage or obsolescence, and pinpoint any weaknesses in your internal controls. Regular counts also support better purchasing decisions, more accurate financial reporting and improved cash flow management — making them a valuable exercise for companies of any size. Here are some best practices to help you prepare and maximize the benefits.
Streamlining the process
Planning is critical for an accurate and efficient inventory count. Start by selecting a date when active inventory movement is minimal. Weekends or holidays often work best. Communicate this date to all stakeholders to ensure proper cutoff procedures are in place. New inventory receipts or shipments can throw off counting procedures.
In the weeks before the counting starts, management generally should:
- Clean and organize stock areas,
- Order (or create) prenumbered inventory tags,
- Prepare templates to document the process, such as count sheets and discrepancy logs,
- Assign workers in two-person teams to specific count zones,
- Train counters, recorders and supervisors on their assigned roles,
- Preview inventory for potential roadblocks that can be fixed before counting begins,
- Write off any defective or obsolete inventory items, and
- Count and seal slow-moving items in labeled containers ahead of time.
If your company issues audited financial statements, one or more members of your external audit team will observe the procedures (including any statistical sampling methods), review written inventory processes, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.
Handling discrepancies
Modern technology has made inventory counting far more efficient. Barcode scanners, mobile devices and radio frequency identification (RFID) tags reduce manual errors and speed up the process. Linking these tools to a perpetual inventory system keeps your records updated in real time, so what’s in your system more closely aligns with what’s on your shelves. However, even with automation, discrepancies can still happen.
When your books and counts don’t sync, quantify the magnitude of any inventory discrepancies and make the necessary adjustments to your records and financial statements. Evaluate whether your valuation and costing methods remain appropriate; if not, update them to ensure consistency and accuracy going forward.
Resist the temptation to simply write off the difference and move on. Instead, investigate the root causes, such as human counting errors, system data issues, mislocated items, theft, damage or obsolescence. Use the results to strengthen controls and processes. Possible improvements include revising purchasing and shipping procedures, upgrading inventory management software, installing surveillance in key areas, securing high-risk items, and educating staff on proper inventory handling and reporting procedures.
Also consider ongoing cycle counts that focus on high-value, high-turnover items to help detect issues sooner and reduce year-end surprises. For companies that issue audited financials, cycle counts complement — but don’t replace — year-end physical count requirements.
Formally documenting the inventory counting process, findings and outcomes helps management learn from past mistakes. And it provides an important trail for auditors to follow.
For more information
Physical inventory counts can enhance operational efficiency and financial reporting integrity. With the help of modern technology and advanced preparation, the process can be less disruptive and more valuable. When discrepancies arise, management needs to act decisively and systematically. Contact us for guidance on complying with the inventory accounting rules and optimizing inventory management.
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