SU 4: INVENTORY CYCLE: INTERNAL CONTROLS
AN page 12/3-12/17 excluding 12/11-12/14
LEARNING OUTCOMES;
describe the business risks associated with inventories;
describe the annual stock take / inventory count in its
entirety with specific reference to:
the planning and preparation;
the design of stationary;
the client’s written instructions for the stock taking exercise; and
the controls to be in place whilst conducting the inventory count
Identify weaknesses of a stock take controls in a given case study; and
apply any of the above-mentioned in a case study
INTRODUCTION:
Characteristics of the cycle:
The heart of the business
Material effect on the financial statements (COST) – cost of sales, gross profit, net profit,
retained earnings, inventory balance at year-end
Movement (from receiving bay to dispatch)
Physical asset
Classes of transactions:
Raw materials (RM)
Work in progress (WIP)
Finished goods (FG)
Consumable stores (CS)
Retailer Manufacturer Service provider
Merchandise (FG) – Clothes & RM – Sugar, FG - Cell phone,
shoes water laptop
CS – Cleaning materials WIP – Drink CS – Stationary
mixture
FG – Coke in
can
Cost of inventory = purchase cost + cost to convert (conversion cost) + other cost (present
location & condition)
Cost formulas: How cost is allocated to inventory in order to determine the cost of sales & closing
value of inventory
First-in, first-out (FIFO)
Weighted average (WA)
Specific identification (SI)
Standard costing
Retail method = lower cost/NRV
Inventory @ year end:Inventory is carried at the lower of:
COST, OR
NET REALISABLE VALUE (NRV)
Estimated selling price less cost to complete (WIP) & selling costs
i.e. (SP per unit – CTC-SC) x units at hand (YE)
WAREHOUSING: FUNCTION, DOCUMENTS, RISKS AND CONTROL ACTIVITIES
AN page 12/7 - 12/8
Function Documents/records Business risks
The purpose of the function is to: Goods receiving Goods received from
1. Control the transfer of notes suppliers are not
transferred into the
goods in and out of all Material
warehousing facilities, for warehouse timeously or
(components)
example, goods received at all (stolen)
requisitions
from ‘receiving’ to the Inventory (in whatever
Picking slip
warehouse for storage or from) is stolen or lost
finished goods received Material
Inventory deteriorates in
from production into the (components)
value due to:
finished goods store issue note
Inadequate
2. Physically protect inventory Delivery note
physical
in all warehouses. Inventory Transfer to controls, for
in production will also need finished goods example, gets
protection but this is likely to
Perpetual wet
be responsibility of
production personnel inventory Its nature, for
records example,
Inventory count foodstuffs,
documentation chemicals
No record is created of
goods or components
physically moved
The goods or
components issued are
incorrect resulting in lost
sales or production
delays
The transfer of the
materials may be
recorded inaccurately in
terms of quantities and
item codes
Inventory shortages
(including theft) are
concealed
Transfers are recorded
that did not take place
Control activities including brief explanatory comments
Controlling the movement of goods, components and finished goods:
1. No movement of inventory should take place without the authorising document, for
example, picking slip,material requisition
2. No movement of inventory should take place without the movement being recorded, for
example, a delivery note and material issue note
3. Whenever there is a transfer of inventory between sections, for example, receiving section
to warehouse, production to finished goods, both the deliverer and receiver should
acknowledge the transfer by, for example, signing the transfer document after having
checked the description, quality and quantity of the items being transferred against the
source documents. For example, warehouse personnel and production clerks to sign the
material issue note after checking the quality, quantity and description of goods being
transferred (isolation of responsibilities)
4. Documents should be sequenced and filed numerically
5. Documents must be sequenced checked and missing documents investigated, for
example,a missing GRN in the warehouse will probably indicate that the goods have not
been transferred to the warehouse
6. The recording of the inventory on the perpetual inventory system should be checked by the
accountant to ensure it has been accurately and completely recorded
Controlling damage, theft and loss of inventory in all forms,i.e., in warehouse and during
production:
1. Physical controls:
Entry and exit points – Minimum entry and exit points
Controlled access – swiping cards, biometric readers,gate control, security guards
Restricted entry – e.g. buying clerks not permitted to enter warehouse
unaccompanied
Secure building – minimum windows, solid structureEnvironmental – dry area,
clean, neatly packed,temperature controlled
Surveillance – camera/video recording over production, receiving bay and
dispatch areas
2. Comparisons and reconciliations:
Physical inventory (in all forms) its compared to theoretical inventory per the
perpetual inventory
Actual production is compared to the manufacturing or production schedules
Actual production is compared to budgets
All material variances should be investigated
INVENTORY COUNTS:
Procedures:
1. Timing of each count should be planned at the start of the year – Time & date
2. Items to be counted must be identified.
3. There are a number of ways in which this selection can be done (SAMPLE – for cycle
counts only):
o Random samples can be selected from the inventory records
Items which are susceptible to theft or have some other identifying characteristic
o can be chosen
o High value items can be selected
o Entire inventory population (100% COUNT) - can be divided into sections so that all
items are counted at regular intervals during the year
o Particular section of the warehouse.
4. Method of counting – e.g. counted twice, tagging and marking, etc.
5. Physical count compared to theoretical count- On perpetual inventory records,
discrepancies on inventory adjustment form
6. All discrepancies must be investigated- documented on inventory adjustment form,
warehouse manager review and sign
7. Adjustment to records- Independent clerk
8. Senior warehouse personnel – Review records
Planning and preparation: this must take place timeously and should cover:
Date and time of count
Method of counting: how the inventory will be counted and recorded, for example, tag
system, all items counted twice
Staff requirements: how count teams are made up, for example, one person of the
warehouse and one person independent of the warehouse (e.g. accounting department),
how many teams are necessary as well as how many people are necessary
Supervision: who will act as count controller
Preparation of warehouse: tidying racks, unpacking half empty boxes onto racks, marking
damaged goods, stacking like goods together
Drafting of warehouse floor plan to identify count areas for count teams
Identifying all locations and categories of inventory
Design of stationery (documents) - various documents are used and should be designed along
standard stationery design principles
Inventory sheets: printed, numerically sequenced, reflect the inventory item number,
category and location in warehouse, and have columns for first count, second count ,
discrepancies and columns for prices and extensions.
In theory, quantities per the perpetual inventory should not be entered in the inventory sheet
prior to the count (this forces counters to actually count to arrive at a quantity) but it may not
be practical due to time constraints
Inventory tags
Inventory adjustment forms
Written instructions:
1. Identification of count teams and the responsibilities of each member of the team.
2. Method of counting to be used e.g. tags, double counts, marking counted inventory in two
colours (reflecting inventory was counted twice).
3. Identification of slow moving or damaged inventory as well as consignment inventory in
transit.
4. Controls over issues to and return of inventory sheets to the count controller.
5. Procedures to be adopted if problems arise during count
6. Detailed instructions concerning dates, times, locations
Execution of count.
1. Count staff should be divided into teams of two (1 independent from inventory)
2. All teams should be given a floor plan of the warehouse which indicate inventory
a. locations they are to be held accountable.
3. Inventory should be counted twice.
4. Items counted should be neatly marked by the counters. e.g. different colour markers.
a. Alternatively, the tag system
5. Count teams identify damaged/dusty inventory on the inventory sheets (potential write
downs)
6. Boxes selected at random in each section and the contents compared with the description
on the label to confirm that the contents
7. Independent count controller tasks - walkthrough warehouse to make sure all items were
counted 2 times, examine count sheets, instruct recount if differences are noted
8. No despatch of inventory during inventory count
9. Inventory received during/after count kept separate
10. Draw lines on open spaces on count sheets
11. Counters sign each count sheet and alterations that are made
12. No counter can leave without formal dismissal
