WHOLESALE & MANUFACTURING UPDATE:

ANALYZING INVENTORY DISCREPANCIES -
ASK "WHY" BEFORE YOU ADJUST!

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Far too often inventory is routinely adjusted to match physical counts without an analysis of why the adjustments were needed. Investigating the root cause of the discrepancy is a vital step in 1) ensuring that the system is adjusted to the correct balance and 2) changing your procedures in order to improve future inventory accuracy. Let's examine each of these in more detail. In this issue we will focus on the first of these issues, with a follow-up article in the next issue to focus on improving future inventory accuracy.

Ensuring that the system is adjusted to the correct balance: Before making an adjustment to the computer system quantities, it's important to make sure that the quantity counted is the correct quantity, and that the system truly needs to be adjusted in order to reflect the correct quantity. A discrepancy between the quantity of a product counted in the warehouse and the quantity indicated in the computer system could possibly be the result of inadequate count procedures or an inadequate reconciliation of the count to the system. In other words, there may be a discrepancy because the count is wrong, rather than the system. In our last newsletter we discussed the steps necessary to ensure an accurate count. If appropriate count procedures are not followed, the quantities counted may not be accurate.

Once an accurate count of the physical quantities is determined, the counts must be reconciled to the system quantities to determine if an adjustment is actually needed. This reconciliation step is necessary in order to account for all of the "floating" paperwork and "moving" inventory. In a perfect world, all paperwork would be processed before beginning a count, and there would be no inventory movement until the count was completed. In reality, there will always be some outstanding transactions that need to be taken into account - inventory receipts that haven't been entered into the system yet, returned merchandise that hasn't been entered yet, inventory that's physically in the warehouse, but wasn't entered because it's going to be returned to the vendor, goods pulled from the shelf to fill an order, but not shipped yet… the list goes on. It can be more time consuming to reconcile the count that it was to actually take the count.

John Schreibfeder of Effective Inventory Management recommends the following procedures to use in cycle counting in order to simplify the reconciliation process:

. 1. Early each morning the counter should place a temporary label on each warehouse location bin containing a product to be counted that reads "Product Being Cycle Counted." The counter also places a card in the bin to record all material movement of the product before the cycle counting process is completed. This card contains a header listing the date, item and bin location. Four columns on the card allow anyone removing material or placing stock in the bin to record that transaction:

• Time
  
• Type of Transaction (Normal Order, Handwritten Order, Confirmed Order, Stock Receipt, Sample, etc.)
  
• Order Number
  
• Quantity

2. After the cards and labels have been distributed, the counter should note the time and print the count sheet to record the quantities of the items being cycle counted. He or she will then proceed to count the items.

3. Whenever an employee fills an order or puts away a stock receipt for an item being counted, he or she will note the time, type of transaction, order number, and quantity involved on the card that was previously placed in the bin.

4. As an item is cycle counted, the cycle counter will look at the transactions listed on the card, comparing the time of each transaction to the time of the count:

• Quantities on customer orders, work orders, outgoing transfers, and other material disbursements removed from the bin before the count was taken will be added to the quantity actually counted. The result represents the on-hand quantity of the product when the cycle counting process began. The computer's on-hand quantity for these orders has not yet been reduced, but the material has been removed from the shelf.
  
• Quantities on stock receipts placed in the bin before the count is taken will be subtracted from the count quantity. These quantities were not included in the computer's on-hand quantity at the beginning of the cycle counting process.
  
  

5. If there is a discrepancy between the quantity listed on the cycle count sheet and the on-hand quantity, the cycle counter will note the discrepancy, not the actual quantity on hand. For example, he or she might note "-2 pieces" if the sheet says there should be 42 pieces and the actual on-hand quantity is 40 pieces. Noting the difference rather than the actual quantity will allow the perpetual inventory system to be updated any time after the cycle count has been completed, even after additional transactions for the item have been processed!

6. As the counter finishes the count of each item, he or she will remove the count label and count card from the bin.

7. If there are discrepancies between the computer's perpetual on-hand quantity and the quantity actually counted, the counter will proceed to the staged orders, will call, and tag and hold areas of the warehouse. All paperwork for these filled but still-open orders should be kept in one place. The counter will look through the orders looking for any quantities of items that were counted that day but not yet confirmed in the system. These quantities will be added to the quantity he or she actually counted. If this process is cumbersome and time consuming, consider developing a computer report that lists, by part number, all outstanding orders.

Incorporating these procedures into your cycle counting procedures should simplify the reconciliation process and improve the accuracy of the count. We will see in the next issue how a further analysis of why adjustments were needed will lead to improvements in materials handling procedures in order to minimize the need for future adjustments. If you would like to learn more about improving your cycle count, count reconciliation or overall inventory procedures, please contact the Inventory Specialists at Berntson Porter & Company, PLLC.

- Kim Gregoris, CPA, MS (Tax)
Inventory Group Leader