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PHYSICAL VERIFICATION OF INVENTORIES

 

POLICY PERSPECTIVE

Physical verification of inventories is an important part of the company’s internal controls aver assets. It is intended to verify the accuracy of inventory records, and to assign the proper carrying value to that inventory, so that those assets are properly reflected in the financial records of the Company. Control over inventories is important for all organizations, since inaccuracies in inventory records can cause erroneous management decisions. Since many activities influence and generate input for the inventory records, the necessary checkpoints and controls must be established to assure accuracy. One of the basic tools for this purpose is a physical count of the inventory on hand, which can be compared with the financial records to detect or validate the financial records.

 

POLICY

All organizations (manufacturing organizations, integrated units, and marketing organizations) are required to conduct an annual physical count of all inventories to verify actual inventory quantities and value and ensure the accuracy of related financial records.

1.         Generally, the inventories to be verified include: raw materials, work-in-process, finished equipment (including demonstration equipment),  service parts, feature kits and components, media, and paper. Verification should include inventories in stockrooms, receiving areas, distribution and storage areas, production areas, demonstration areas, Field Engineering, repair areas, as well as in-transit, consigned goods, and any other location containing inventory (i.e. customer evaluation equipment at a customer facility).

2.         A "physical inventory" or "wall-to-wall inventory" is accomplished by taking a complete physical count of all inventory items on hand as of a specified inventory date. During this time, inventory movement should be controlled and, if practical, receiving activities should be delayed until the physical inventory taking process is completed.

3.         Annual physical inventories should generally be conducted in connection with an accounting month end to provide a verifiable general ledger balance. Normally, all accounts/areas should be covered at one time to ensure complete coverage and to reduce problems with cutting off movements between accounts/areas.

4.        AII organizations should submit a "Physical lnventory Verification Plan" annually to their respective Division/Group Office before the end of the first quarter. This report should detail the overall current year physical verification plans including:

          -        Scope - which describes the method being used (wall-to-wall physical or cycle count), the types of inventory included, the 

                timeframe for the physical inventory, and any other comments/     

                concerns which should be addressed by management.

 

-    Financial History - provide an overview of the prior two years' physical inventory results including Gross/Net inventories and 

     final physical inventory adjustments (total dollars and percent of inventory) and corrective actions taken.

-     Physical lnventory Instructions Overview - outlines and summarizes the approach and the counting methods, processing methods, pricing/costing methods, reconciliation approach, and personnel requirements including any special training instructions for employees participating in the inventory.

5.         The final reconciliation of the physical count and the inventory records should be completed within               

             six weeks of the actual count. Where differences are noted between the physical count and the                

             accounting records, these differences should be promptly reflected in the accounting records, the               

             cause of the differences determined, and the appropriate corrective action taken to prevent future         

             differences.

6.         AII net adjustments of over $500,000 (write-up or write-down) require the prior approval of the Group/Division Finance Controller. AII net adjustments (write-up or write-down) of $1,000,000 or more require the approval of the Senior VP Group, Finance. The Senior Group Finance will submit a summary group; adjustment report to the Corporate Controller.

7.        Organizations should provide notification (either directly or through their Division/Group Office, as appropriate) of their inventory verification plans (procedures and timing) to the appropriate internal/external auditing function in order to coordinate any audit observation/testing that is necessary and assure acceptability of their verification of year end inventory balances. Generally, copies of the organization's instruction package should be received by the Auditing organization no later than one month prior to the scheduled physical/cycle inventory date.

8.        A "Final Physical lnventory Results Report" summarizing the physical count and reconciliation activities should be submitted to the Division/Group Office by November 1 of the same year. This report should include:

- Brief overview of the actual conduct of the physical count including the inventories included and

  any problems/comments relating to the physical count.

- Reconciliation Summary including the general ledger accounts reconciled, adjustments made to

  the general ledger, adjustments as a percent of gross and net inventory, and any relevant

  internal/external auditor comments.

 

- Summary of causes/problems resulting in the physical inventory adjustments and corrective

   actions taken or planned.

9.         Any organization which reports an absolute physical inventory adjustment of $1 million or more or 10% of gross inventory (whichever is smaller) is required to submit a copy of their Final Physical lnventory Results Report to the Senior VP Group Finance and Administration and the Corporate Controller. Additionally, such organizations may be required to present their results and corrective action plans to the Corporate Controller and Corporate Auditing.

10.       Specific exemptions from complete, wall-to-wall physical counts may be made in the case of a properly functioning perpetual inventory system accompanied by an effective, approved cycle count program. Such specific exemptions will be granted by the Group/Division Controller, based on requirements established by individual Division/Group policies. The granting of specific exemptions is also subject to review and approval by Corporate Auditing.

POLICY SUPPLEMENT

The following checklist is provided to assure that all important aspects are covered in the physical inventory planning and local instructions. Complete instructions should address most, if not all of the following:

-         Is the date or fiscal month during which the general ledger and/or supportive perpetual records will be updated for physical inventory results clearly stated?

-         Are there any other activities scheduled at that time which would conflict or hamper the physical count?

-         Is there a formal training schedule for employees participating in the physical inventory?

-         Do the written procedures clearly instruct the employees in the proper completion of physical inventory forms (i.e., count sheets)?

-         Do procedures address counting methods for special locations such as off site locations?

-         Is the handling of obsolete inventory clear?

-          Do procedures prohibit or provide for emergency movement of stock (e.g., emergency issues) during inventory time?

-         Is the handling of receivables/payables clear?

-         Will items not to be inventoried (e.g., vendor-owned material on site) be clearly labeled, segregated, or otherwise clearly distinguishable?

-         Do procedures indicate what to do about mixed part numbers stored together?

-         Do procedures indicate how to document calculations made by an inventory taker?

-         Are guidelines for changing, correcting, approving, voiding, and otherwise recording other-than-original count data on inventory tickets provided?

-         Is the specification for completing inventory tags completely consistent with EDP validation and processing requirements?

-         Are procedures for recording unit of measure clear?

-         Are legibility and legibility checking guidelines provided for completed tags, or are they encoded without review?

-         Are procedures for "clearing" an area stated?

-         Are procedures for tag removal stated? If an obvious error is noted during tag removal, how should it be communicated?

-         Are procedures for turning in unused inventory tags clear? Is transferring of tags permitted? If so, how is it controlled?

-         How are all inventory tag numbers accounted for?

-         Are document controls for distinguishing "before inventory" from "after inventory" transactions clearly specified for each type of document?

-         If "checkers" or "auditors" are used to test the accuracy of inventory-taking, are there guidelines or procedures specifying what they should do and how their checks or audits are to be documented?

-         Are the parameters for accuracy (acceptability) of test counts specified?

-         Is the costing of inventory clearly stated (ie., frozen cost, MTP, MLB, ETP)?

-         For manufacturing organizations, is the costing of non-stocked WIP clearly specified? How are incomplete operations to be priced?

-         If specifically created costing files are used, are they clearly described in form and content? Do the costing files have the most current cost/price?

-         Do the reconciliation procedures clearly indicate which inventory accounts are to be reconciled?

-         How will book-to-physical differences be explained?

o       Format of numeric reconciliation

o       Format of analytical comments

o       Materiality ground rules for explanations of book-to-physical differences

  -        Are the inventory processing and validation procedures clearly identified for automated systems? Manual systems?