Inventory Management Guide PDF

INVENTORY MANAGEMENT
TRAINING GUIDE
Table of Contents
Inventory Quick Facts .............................................................................................................................. 2-4
Policies and Procedures ......................................................................................................................... 5-8
Inventory Valuation................................................................................................................................. 5-6
Cycle Count .............................................................................................................................................. 6-8
Performance Measures ......................................................................................................................... 9-10
Sample Inventory Work Program ...................................................................................................... 11-17
Sample Process Interview Questions ................................................................................................ 18-23
Purchasing ......................................................................................................................................... 18-19
Receiving.................................................................................................................................................... 19
Inventory Management ........................................................................................................................ 19-20
Inventory Management – Warehouse Security ......................................................................................... 20
Production Management ....................................................................................................................... 20-22
Distribution – Quality Control and Shipping ............................................................................................... 22
Inventory Accounting ............................................................................................................................. 22-23
Source: www.knowledgeleader.com 1
INVENTORY QUICK FACTS
Perpetual Inventory
A continuous record of changes in inventory.
Benefits Include:
• Provides a continuous and current record of the balances in the inventory and cost of goods sold
account.
• Annual physical inventory count is not required, but periodic inventory counts are recommended and
all inventory items should be counted at least once annually.
• If there are differences between the inventory counts and the perpetual inventory records, an
inventory shortage account should be debited.
Accounting for Perpetual Inventories
To Record Purchase of Inventory Items:
Debit Credit
Inventory X
Cash/Accounts Payable X
To Record Sale of Inventory:
Debit Credit
Cost of Goods Sold Y
Inventory Y
Cash/Accounts Receivable P
Sales Revenue P
To Record Adjusting Entries for Inventory Shortage:
Debit Credit
Inventory Shortage Z
Inventory Z
Year-End Entry To Close a Cost of Goods Sold Account:
Debit Credit
Income Summary Z+Y
Inventory Shortage Z
Cost of Goods Sold Y
Note: COGS rolls up to the income statement.
Items Included in Inventory

Goods in Transit: Possession of the inventory should be recorded when the legal title passes to the
buyer. Usually record inventory acquisitions as the goods are received. (f.o.b. shipping point – title passes
to buyer when goods are delivered to shipping agent, f.o.b. destination – title passes to buyer when
goods reach the actual destination by the shipping agent)
Consigned Goods: Inventory remains the property of the consignor until the consignee sells the goods
to the end user.
**Two main goals in inventory management: 1) to closely monitor the status and movement of current
stock and 2) the creation of accurate forecasts and delivery plans for future inventory.
Costs to Include in Inventory Valuation

Inventory/Product Cost = The sum of all expenditures required to get inventory items into condition and
location for sale.
• Original purchase price
• Expenditures for freight in, handling and storage
• Applicable insurance and taxes
• Materials and labor used to manufacture inventory
Period Costs: Expenditures not related directly to the acquisition or product of inventory are accounted
for as period expenses (e.g., selling costs, expenses of the purchasing department, cost of handling and
storing goods before sold, interest costs, etc. Note: Interest costs associated with manufacturing assets
for company’s own use or as discrete projects for sale or lease should be capitalized/recorded as part of
the cost of the asset).
Purchase Discounts: Ideally the cost of purchases/inventory are recorded net of the discount offered for
early payment. If discount is foregone, value is recorded in a ‘purchase discounts lost’ account (via a
debit). The account is closed out at year-end to Accounts Payable to correctly record the liability.
Purchase Returns/Allowances: Recorded as a debit to Accounts Payable and a credit to a Purchase

Returns/Allowances account, which is a contra-purchases account.
Manufactured Inventory Costs: Companies can divide the inventories into:

• Raw Materials Inventory: Recorded as the cost to purchase the inventory plus adjustments for
freight in, purchase discounts, and purchase returns/allowances.
• Work-In-Process: Includes raw materials cost, direct labor cost (i.e. the wages of assembly line
workers, supervisor’s salaries, etc.), allocated manufacturing overhead costs (i.e. salary of executive
management over function, indirect materials cost, indirect labor cost, and other overhead costs such
as taxes, insurance, rent and utilities).
• Finished Goods Inventory: Includes raw materials cost, direct labor cost (i.e. the wages of
assembly line workers, supervisor’s salaries, etc.), allocated manufacturing overhead costs (i.e.
salary of executive mgmt over function, indirect materials cost, indirect labor cost, & other overhead
costs such as taxes, insurance, rent & utilities).
Cost Flow and Cost Flow Assumptions:

• Specific Identification
• Weighted Average
• Moving Average
• Last In, First Out
• First In, Last Out
• Or variations therein
Terminology:
Bill of Materials (“BOM”): List of all parts, ingredients or materials needed to produce or assemble the
end product and should contain essential information on how those parts will be used in production. Best
Practice companies drop common inventory items from the list and allow the maintenance of such items
be out-sourced to a pre-selected and qualified vendor.
INVENTORY VALUATION
POLICY AND PROCEDURES
PURPOSE
To establish guidelines and set forth the appropriate accounting policies to ensure that inventory will be
properly controlled and costed and prevent losses or shortages.
POLICY
• It is the policy of ABC Company that all inventory be properly controlled and costed to ensure
accuracy of records for materials, work in process and finished or partly finished new or used goods,
spares, and only those supplies which have been acquired for sale or which will become a part of the
merchandise intended for sale. In determining the value of each item of inventory, the "lower of cost
or market" valuation method should be applied to actual inventory quantities; cost being determined
on First In First Out (FIFO) basis. The valuation method for each item of inventory shall remain
consistent from one accounting period to the next accounting period. Changes in value will be applied
against inventory reserve accounts such as shrinkage, excess/obsolete and pricing reserve accounts.
Actual quantities arrived at from cycle counts, not accounting book quantities should be used in
determining inventory value to avoid valuation problems related to shrinkage or variances in shipping
and receiving reports. The following should be considered in determining Inventory value:
− Cost – historical cost or accounting book value for products or materials.

− Current market value – In determining current market values for each item of inventory the
following should be considered:
ᵒ Prevailing bid price at inventory date and at similar purchase volume of an average purchase
of product or materials.
ᵒ Current selling price of product or materials less an allowance for a normal profit margin.
ᵒ Reproduction cost should be used to value goods in process and finished goods.
ᵒ Expected future demand for the product or material.
ᵒ Obsolescence of product technology.
ᵒ Scrap or Salvage value of material.
• It is the policy of ABC Company to value contractual purchase commitments related to impaired
liabilities (Supplier/Purchase Order) in order to establish appropriate reserves, on a quarterly basis.
Consigned Inventory
− Consigned inventory items are included in the company’s inventory on the balance sheet. The
designated consignee holds the inventory as an agent to sell it on behalf of the company. When
the consigned goods are sold, the company reports revenue based upon the arrangement
contracted with the consignee.
− All balances of consigned inventory will be reported to the company on a monthly basis.
Reconciliation between consignee inventory balances and company book balances shall be
performed on a consistent basis. Any discrepancies should be reviewed, substantiated and
appropriate adjustments made.
• Inventory Reserves
It is the policy of ABC Company that all adjustments to inventory accounts be made to the appropriate
inventory reserve account. These accounts should include shrinkage, excess/obsolete and pricing.
The reserve accounts should be reconciled as needed, but at a minimum quarterly, to insure that
accurate inventory levels and valuations are reflected on company financial statements.
• Capitalized Cost for Inventory
It is the policy of ABC Company that General and Administrative Costs that either directly or indirectly
benefit the particular production or resale activities of ABC Company be capitalized in inventory.
These General and Administrative costs should include compensation, employee benefits, travel,
departmental supplies and materials, occupancy costs, utilities, telephone and other departmental
overhead. Rework, scrap from production and spoilage costs should also be capitalized.
CYCLE COUNT
POLICY
All company inventory will be cycle counted on a periodic basis in order to substantiate current inventory
balances.
PURPOSE
To establish policies and procedures that manage and control perpetual cycle counting of inventory, and
to provide documentation for the purpose of meeting requirements for audit and financial accountability.
SCOPE
This procedure applies to all Raw Material and Finished Goods inventory.
Definitions
• Class “A” Inventory – High usage items which are defined as having an estimated dollars usage,
which accounts for 80% of the total estimated annual dollar usage.
• Class “B” Inventory – High inventory balance items whose estimated dollar usage value accounts
for 15% of the total estimated annual dollar usage.
• Class “C” Inventory – Lower dollar usage items which comprise the bulk of the part numbers and
are defined as 5% of the total estimated annual dollar usage.
Cycle Count Procedures
• Cycle counts will be performed (daily/monthly/quarterly). Using a random selection process, costed
part numbers to be counted will be selected from the A-B-C lists within the system. Each part number
classified within the A-B-C classification will be counted as follows:
− “A” – Counted at least once (monthly/quarterly).
− “B” – Counted at least once (quarterly/semi-annually).
− “C” – Counted at least once (semi-annually/annually).
• In addition to routine daily cycle counting of A-B-C classes, there may be “special” audit counts of
inventory.
• Designated personnel will request a system generated cycle count list. The counter(s) will perform a
“blind” count of each item. Count results will be loaded into the system in order to generate a variance
report showing discrepancies between system inventory levels and counted inventory levels.
• If a count falls within the designated tolerance limits, the count will be approved by the Inventory
Supervisor. If a count falls outside of designated tolerance limits, a recount will be performed. See
Tolerance Testing below.
Tolerance Testing
Tolerance testing limits are defined as the difference between the quantity counted for each inventory
classification compared to the inventory record. The following quantity tolerances have been established
for each A-B-C inventory classification:
• Class “A” items will be recounted if discrepancies exceed +/- $X, or all items will be recounted 100%.
• Class “B” items will be recounted if discrepancies exceed $X dollars or X units.
• Class “C” items will be recounted if discrepancies exceed $X dollars or X units.
• Tolerance limits for weight counted items will be +/- X%.
Error Investigations/Recounts
• Inventory classifications whose tolerance test results have produced variances that fall outside of the
allowable limits must be recounted. If the original cycle count quantity is not validated by the recount,
additional recounts must be taken until two identical counts are obtained.
• Upon obtaining a satisfactory recount, a tolerance test must be performed again. If the tolerance test
yields variances within the acceptable limits, the cycle count is reported as a pass. If the variance
quantity exceeds the allowable tolerances, the cycle count is reported as failed, a reconciliation must
be performed to determine the cause of the variance.
Variance Reconciliation/Adjustments
• An audit must be conducted to determine the cause of any cycle count variance, which is in excess of
the allowable tolerances, and has been validated by recount (s). Transaction listings, source
documents, and any other relevant data will be reviewed in the attempt to determine the cause of the
variance.
• If the cause of the variance cannot be determined within the area in which it was discovered,
correspondence with the responsible persons in other areas involved in the handling of the discrepant
part number(s) is initiated.
• All inventory adjustments/write offs must be submitted to finance for approval.
Signature Authority
All adjustments to inventory records will be subject to the following approval levels:
• X Supervisor $X – $X
• X Manager $X – $X
• X VP $X – $X
Record Retention
• All records pertaining to Cycle Counts will be retained during the current fiscal year – to – date and
one year back.
• Retention of Cycle Count results and any variance reporting, etc. is the responsibility of X
Department.
PERFORMANCE MEASURES
An effective business process is built on a set of well-defined and clearly stated business objectives.
These key objectives articulate the ideal performance results that the company expects from that
process. To monitor a business process so that it stays focused on reaching the key objectives, the
company chooses appropriate performance measures. In fact, careful selection of the performance
measures takes a company a long way toward improving a business process. Thus, to build and then
continually improve an effective business process, a company establishes:
• Key objectives to articulate the performance results the company expects from the business process.
• Outcome measures to determine whether the company has reached the key objectives.
• Activity measures to monitor the performance of those activities that are instrumental in reaching the
key objectives.
Cycle Time
Formula: Length of time required to produce a single unit of product
Analysis: Meeting consumer demand requires production lines to operate at the highest possible speed
while maintaining consistency and quality. The faster materials flow through a manufacturer's assembly
process, the greater its ability to gain competitive advantage. By measuring and constantly reducing the
amount of time required to produce each unit of product, manufacturers ensure the fastest possible
movement of products to market.
Inventory Turns per Year

Formula: Annual cost of sales/average cost of inventory
Analysis: Inventory turns refer to the number of times inventory "turns over" or is depleted. Inventory
costs manufacturers in terms of storage space and handling and also represents static capital that cannot
be invested for improvement elsewhere throughout the enterprise. Increasing inventory turns holds
inventory to a minimum, reducing its associated costs.
Percentage of Defective Products

Formula: (Number of defective units/total number of units produced) x 100
Analysis: Defective products cost manufacturers in terms of additional labor and material expenses
related to disassembly and rework. If a defective product must be scrapped, all the expense incurred in
manufacturing the product is wasted. Manufacturers that accurately measure their percentage of
defective units possess a baseline for improving production processes and reducing costs.
Unit Cost (Process Costing Method)

Formula: Total cost to produce x units/x
Analysis: A primary goal of managing the manufacturing process is continuously reducing the cost of
producing each unit of production. The simplest method of measuring cost per unit is known as process
costing, which can be used whenever the output of production is reasonably uniform or homogenous.
Percentage of On-Time Deliveries (Both Inbound and Outbound)

Formula: (Number of on-time deliveries/total number of deliveries) x 100
Analysis: Generating new customers is far more expensive than retaining existing customers, and
providing consistently on-time deliveries is the best way to keep existing customers loyal. By measuring
the percentage of on-time inbound deliveries, manufacturers track the effectiveness of transportation
providers, which results in strengthened relationships with preferred supply chain partners. Measuring the
percentage of on-time outbound deliveries to customers provides manufacturers with a baseline for
improving their own logistics processes.
INVENTORY WORK PROGRAM
PROJECT TEAM (LIST MEMBERS):

Project Timing Date Comments
Planning
Fieldwork
Report Issuance
Time Project Work Step Initial Index
PRE-AUDIT
Review prior audit report and relevant press releases (acquisitions).
Obtain completed inventory internal control questionnaire from the

plant controller. Document any potential control weaknesses or
unusual practices and investigate upon arrival.
Obtain and document the following as of the audit date:

• Trial Balance
• Manufacturing Statement (YTD)
• Manufacturing Budget (YTD)
• Date of Last Physical
• Cycle Counting Accuracy History
• Inventory Turnover, Days Sales in Inventory, Margin
• Date and Scope external auditor's most recent visit
• Detail of Excess and Obsolete Inventory
• Detail of Inventory held on Consignment
• Detail of Inventory held at Subcontractor and Outside Vendor
• Type of inventory system
• Size of facility (square footage)
• Primary products
• Top 5 customers and competitors
Ensure Financial Statement Trial Balance agrees to the Trial Balance

maintained by the facility. Obtain explanations for any differences
with the plant controller upon arrival.
Obtain and quantify in ACL the following reports as of the audit date:
• Inventory Aging Report
• Perpetual Inventory Listing
• All Open Work Orders
Reconcile Perpetual Inventory Listing to the account balances that

appear on the G/L. Obtain and document explanations for differences
from the Controller upon arrival.
Obtain and document explanations from the Controller for all open
work orders older than two months.
Describe procedures for developing current year material, labor and

overhead standards and the date of the last revision. If a standard
system is not used, obtain and document an explanation from the
Controller and/or Corporate Operations as to why a standard system
has not been implemented.
Compare and document budgeted variances to actual variances for

materials, labor, and overhead. Obtain and document explanations
for significant (5%+) variances from the controller and/or Corporate
operations.
For facilities that do not employ a standard costing system,

recalculate labor and overhead allocations and compare to the
amount capitalized. Obtain and document explanations for significant
(10%+) variances from the controller upon arrival.
Discuss conclusions/observations with the senior associate. Obtain

and document T&B senior management concerns and ensure there
are adequate procedures in the program to address those risks.
RECEIVING
Interview employees associated with the receiving process in order to

gain an understanding. Process map this process and include all
applicable financial journal entries.
Through inquiry and observation, ensure the following controls are in

place and operating effectively and are included on the process map.
Identify all control gaps.
• Goods are received at a designated receiving bay.

• Receipts are checked for quantity and quality.
• All goods received are based on a valid Purchase Order (PO)
number.
• PO is stated on delivery documents and is verified for validity.
• The quantity of goods received is verified to the packing slip and
bill of lading.
• The receiver signs delivery documents.
• All receipts are recorded in a log and can be cross referenced to
the appropriate delivery documents.
• The log is regularly reviewed.
• Receipts are accurately, promptly and completely updated in the
inventory system.
• Raw materials are safeguarded.
• Transfer of raw materials is documented.
• Items not meeting qualifications are kept separate from other
items.
Process map procedures for vendor returns. Through inquiry and

observation, ensure that returns are communicated to the purchasing
department and debit memos are prepared and forwarded to
accounts payable in a timely manner. In most instances, this will
require sampling returns during the audit period.
Through inquiry and observation, ensure that shipment discrepancy

reports are pre-numbered and reviewed by the appropriate
purchasing and accounting personnel in order to ensure that debit
memos have been taken.
PRODUCTION PROCESS/PHYSICAL SECURITY
Interview employees associated with the production process. Map

the production process and include all applicable financial journal
entries. Ensure the following controls are present and are included in
the process map. Identify all control gaps.
• Authorized persons approve material requisitions.
• Material requisitions coincide with the approved production plan.
• Disbursements from stockrooms are allowed only upon receipt of
properly authorized requisition documents.
• Management approval is required for stock issuance of amounts

above the amount necessary to support scheduled production
requirements.
• Approved requisition documents and inventory movement forms
are promptly used to update the inventory records.
• Pre-numbered requisition forms or sequential logs are used to
record issuance of materials from stores and inventory
movement between locations.
• Warehouse/store is properly locked to prevent unauthorized
access and usage.
• Proper segregation of scrap and obsolete inventory.
PHYSICAL COUNTS
Obtain and review information supporting the most recent wall-to-wall

physical inventory. Ensure quantities on hand were not known to
counters prior to the physical. Document compliance with Corporate
Policy.
Complete the physical inventory checklist. Document control gaps, if

any.
Document book to physical adjustments for the past three years.

Inquire as to whether or not the adjustments were investigated prior
to correcting entries being made. Document your understanding of
this process. Determine when and if the adjustments were capitalized
or expensed and if they were approved.
Evaluate propriety of reconciling items between the perpetual

inventory listings and the G/L account balances. Examine supporting
documentation for each item individually greater than 2.5% of the
inventory account balance (or 50% of the items if individually none
exceed 2.5%, but in the aggregate exceed 5%.)
Obtain, review, and document policies and procedures surrounding

cycle counts. Observe 2 cycle counts and document the following:
• What was counted and how it was selected.
• Cycle counter is not aware of quantity on hand prior to his count.
• Agree test counts to perpetual inventory detail.
• Examine adjustment to perpetual inventory detail/general ledger,
if applicable.
• Document historical accuracy rates.
Based solely on the work performed, document observations

regarding the physical security of inventory.
Based on the date and results of the most recent wall to wall physical
count and the applicability of cycle counts, consider performing the
following:
• Agree 10 inventory items per the perpetual to the quantity on
hand.
• Agree 10 inventory items on hand to the perpetual.
INVENTORY VALUATION
For facilities using standard costing system, perform the

following:
• Document procedures for developing current year standards (raw
material, labor, and overhead) and the date of the most recent
development. Document compliance with Corporate Policy.
On a sample basis (minimum of 30), test the accuracy of the

standards by performing the following:
• Examine recent invoices supporting raw material component.
• Examine payroll related information supporting labor component,
if applicable.
• Examine overhead estimate. Recalculate based on available
information.
On a sample basis, examine the method and accuracy of recording

standard to actual variances. As of our audit date, obtain
explanations for standard to actual variances greater than the
budgeted amount. Examine entries to record variances and
document whether the variances were capitalized or expensed.
For facilities not using a standard costing system, perform the

following:
• Document procedures for developing current year labor and
overhead amounts.
Examine (minimum of 30) recent invoices supporting raw materials,

and the raw material component of WIP and FG. Document results
by quantifying unit cost variances and extrapolating to population.
Recalculate labor and overhead calculations and compare to

amounts capitalized. Document limitations in ability to recalculate.
INVENTORY RESERVES
Based on ACL reports, document inventory greater than 180, 270,

and 360 days.
Document method for estimating reserve for excess and obsolete

inventory. Document compliance with Corporate Policy.
Obtain calculation of E&O estimate for most recent quarter-end and

agree to G/L. Agree significant components to supporting
documentation.
Document inconsistencies, if any, between the calculation and aging

analysis.
Ensure authorized persons adequately approve provisions or write-

offs. Review for evidence of approval of inventory write-offs before
they are recorded.
CONSIGNMENT INVENTORY
Document policies and procedures for consigned inventory. At a

minimum address the following items:
• Existence of perpetual detail.
• Method of reporting, recording, and verifying changes (e.g.
quarterly reports of inventory balances are obtained from
consignees for reconciliation to the facilities’ perpetual records
and that non-reconciling items are investigated and followed-up
promptly).
• Method of accounting for scrap.
• Results of recent physical counts.
Document compliance with Corporate Policy on consigned

inventories.
SCRAP
Document method for accounting for inventory scrap. At a minimum

address the following:
• Method used to quantify.
• Method used to cost.
• Method used to dispose.
Through inquiry and observation, ensure that scrap proceeds are

collected from the scrap vendor promptly after the collection of scrap
materials.
Through inquiry and observation, ensure that approval is granted

before materials are sent to scrap.
Through inquiry and observation, ensure that accounting and the

warehouse verify the weight of the scrap materials.
Through inquiry and observation, verify that scrap vendors are

selected through a bidding process.
SHIPPING AND RECEIVING (INCLUDING RETURNS)
For the most recent quarter-end, obtain the last and first 3 shippers
and receivers and agree pertinent data to accounts receivable and
inventory records ensuring that transactions are recorded in the
proper period.
Explain the facility’s procedures for ensuring proper cut-off.
GENERAL
Through inquiry and observation confirm that Management

Corrective Action Plans have been implemented. If not, obtain
explanation(s) and consider the necessity of including in current year
audit report.
Complete Global Best Practices checklist.
Complete inventory diagnostic.
SAMPLE PROCESS INTERVIEW QUESTIONS
Purchasing
• Policies and procedures?
• Organizational chart?
• Personnel
− Headcount and associated roles?
− Do purchasing personnel have access to the A/P system?
− Do purchasing personnel specialize in a product category for which they acquire goods?
• Systems
− What is the system used for purchasing?
− Is the purchasing system electronically linked to the G/L, A/P, inventory, and supplier systems?
• Placing the Order
− Do you practice vendor managed inventory – where the vendor is responsible for monitoring the
inventory levels? How is the demand for inventory communicated to vendors?
− How are inventory needs communicated to the procurement department?
− Which department is responsible for monitoring material lead times, machine capacity, etc.?
− What is the process followed to place orders with vendors?
− What documentation and approvals are required?
− Are there system or process controls in place that would prevent the placement of an
unauthorized purchase order?
− Has an authorization matrix been established to determine the level of management authorization
that is required to place the order? Please provide a copy.
− How is the procurement department notified when inventory levels sink below threshold levels?
− Have threshold levels been established?
− How are inventory needs communicated to suppliers? (E-procurement, fax, phone, EDI, mail,
system-automated)
− How is the purchasing process expedited (e.g. use of long term contracts, blanket purchase
orders, etc.)?
• Who monitors open POs?
• Does anyone monitor purchasing activities?
• Indicate the number of suppliers that contribute 80% of total purchases.
• Office supplies & MRO (maintenance, repair, and operations) supplies
− Does anyone have procurement cards? Who?
− What are the authorized spending limits?
− Who orders office supplies and MRO supplies?
− Who approves the requisitions?
− Centralized purchasing?
Receiving
• Describe the receiving processes and location.
• What is the process followed to ensure that all items ordered are properly received? Is this process
automated?
• Who is responsible for stocking received items? Where are the received items sent?
• Quality check
− How are raw materials checked for quality?
− What is the process to return the materials to the vendor in cases where the quality standards are
not met?
− How is the return of materials communicated to accounting?
Inventory Management
• Which inventory cost-flow method do you use for operational and financial purposes?
• How is inventory classified? Do you utilize bar coding or scanning equipment?
• How are raw material, work-in-progress (WIP) and finished goods stored and monitored?
• How are location numbers assigned? Outline of location number definitions?
• What systems are used for monitoring the distribution of inventory? Does the system interface with all
of the plants – or do the plants manually submit inventory updates to accounting?
• What are the procedures followed to verify current inventory levels and managing inventory needed
for upcoming work orders?
• How do you identify, value, and dispose of obsolete, damaged, and/or slow-moving inventory?
• How do you determine appropriate reserves and safety stock levels?
• Cycle counts
− How often are cycle counts performed?
− What products are given priority or a low variance threshold?
− Are cycle counts performed for raw materials, WIP and finished goods?
− Are random cycle counts periodically conducted?
− What is the process followed to perform inventory counts?
− Who is responsible for conducting the cycle counts (independent of accounting function)?
− How are the employees trained to perform this function?
− Have policies/procedures/instructions for cycle counts been established and documented?
− Who performs the validation of the counts (should be independent of receiving/production
functions)? Any approvals required?
− What are the documentation requirements for the cycle counts?
− Are the cycle count documents pre-numbered to keep track of all outstanding documents?
− How are cycle counted items marked?
− What is the process followed to research and resolve discrepancies if any are noted during the
cycle count process?
− What is the variance threshold above which items must be researched?
− Are the causes of the discrepancies tracked and evaluated?
− What is the single greatest cause of inventory errors? (Clerical error, equipment failure?)
− Who is responsible for making adjustments to the system for discrepancies noted during the
cycle count process?
− Is an annual physical inventory performed?
Inventory Management – Warehouse Security

• What controls are in place to limit access to the warehouse and inventory supplies (e.g. cameras,
guards, restricted access areas, etc.)?
• How often are access levels reviewed (i.e. to eliminate access to terminated employees, etc.)?
• Have safety procedures for the warehouse been documented and communicated to employees?
• How is the warehouse organized (i.e. more expensive products locked in cages, items separated and
clearly labeled)?
• Is damaged, obsolete, scrap and consigned inventory segregated to prevent confusion during the
cycle counts?
• How are movements of inventory monitored to ensure that it is properly safeguarded? What
documentation is required?
• Are there instances when inventory would be transferred among inventory locations? How is the
inventory accounted for?
• Approximately how many days/months worth of inventory is stored within current warehouses? Any
changes in the aging over the last few months?
• Do you store consigned inventory for customers or consign inventory to others? If so, how is it
controlled and recorded?
• How do you determine which inventory is obsolete? What is the process for determining excess and
obsolete inventory? Have policies been established?
• What procedures are performed for the scraping of obsolete inventory? Is this done in a timely
manner? Does the scrapping of materials require authorization?
• Do you receive any payment for scrapped goods? How is this recorded within the financials?
• What is the process for stocking overages when orders are closed? How is this communicated to
accounting to ensure that the inventory aging is accurate?
• What type of management reporting is performed?
• Are inventory performance metrics monitored on a regular basis, i.e. inventory turns?
Production Management
• BOM
− What is the process followed to establish a standard bill of materials?
− How does the process differ if a part is new or existing?
− Who approves the bill of materials?
− Who is responsible for entering the BOM into the system?
− What is the process for reviewing and monitoring variances between the standard bill of materials
and the actual costs?
− How often are management reports prepared?
− Do the management reports contain the appropriate level of detail to identify root causes for the
variance?
• Standard costs
− How are the standard labor hours by product determined?
− How are standard machine hours determined? Set up and run times?
− How are labor charges applied to the cost of inventory?
− How are the costs of labor checked for accuracy, completeness, etc?
− What is the process to update standard costs based on current procurement and production
costs?
− How often are the standard costs updated?
• Pre-production
− What forecasting model is utilized for inventory needs?
− Who performs such forecasting procedures and how often is it performed?
− What is the process to create, manage and close work orders?
− What process if followed to forecast future work order needs?
− Are work orders pre-numbered?
− How and when are materials allocated to the production work orders?
− How are inventory requests from the manufacturing floor transacted?
− When materials are needed, what triggers the picking process – system generated pick list?
− How are items moved from the warehouse to the production floor?
• Production
− How are the actual materials, labor hours, and set up and run times monitored and recorded?
− Are the actual labor hours reviewed and approved by responsible management?
− What is the process followed if a customer calls to cancel an order?
− How is the product/inventory associated with that order handled?
− Sold off to other customers?
− How are these items recorded in the system?
− Are customers required to pay despite the order cancellation?
− How are work-in-progress products evaluated for quality?
− What happens to a WIP item if it does not meet quality standards?
• Post-production
− What is the process to close work orders?
− Are completed products reconciled to the originated work orders?
− If only partial spools of yarn are utilized, how is the partial usage recorded?
− How are scrap materials handled?
Distribution: Quality Control and Shipping

• What is the process followed to evaluate finished goods for quality control?
• What happens to items that do not pass quality standards?
• How is rejected material stored – in a separate/caged area?
• How are packing slips generated – system generated or manual?
Inventory Accounting
• How is inventory recorded on the general ledger? Is a reconciliation performed which ensure that all
inventory held is recorded?
• In cases where materials were returned due to unsatisfactory quality, how is this communicated to
accounting? How is this recorded?
• What is the process followed to track inventory items that are on consignment?
• How often are the inventory count results reconciled to the general ledger?
• If discrepancies are noted during the cycle count, how is this communicated to accounting? Who is
responsible for making adjustments to the system for discrepancies noted during the cycle count
process? What accounts are used in the journal entry transaction?
• Who is authorized to create and post any adjusting journal entries? What level of management review
is required prior to posting the journal entries? What system controls are in place to prevent
unauthorized access to the G/L?
• How are cycle counts validated by accounting?
• Is the period end cut off date communicated to shipping, receiving, customer returns and accounts
payable to ensure accurate inventory records?
• Are unrealized losses accounted for on work in process products by periodically comparing total
costs-to-date and estimated costs-to-complete to net realizable value (estimated selling price less
reasonably predictable costs of completion & disposal)?
• What is the process followed to estimate and account for inventory reserves (i.e. aged inventory,
obsolete inventory, etc.)? Are there any policies written for this procedure? Who is responsible for
preparing and posting the journal entry?
• How is the disposal of obsolete or excess inventory communicated to accounting? How is the
disposal recorded?
• How ensure that the inventory aging is correct when items (i.e. from cancelled orders) are restocked?
How is the restocking of such items communicated to accounting?

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INVENTORY MANAGEMENT

Accounting for Perpetual Inventories

To Record Purchase of Inventory Items:

To Record Sale of Inventory:

Cost of Goods Sold Y

To Record Adjusting Entries for Inventory Shortage:

Income Summary Z+Y

Cost of Goods Sold Y

Note: COGS rolls up to the income statement.

Items Included in Inventory

Costs to Include in Inventory Valuation

Purchase Returns/Allowances: Recorded as a debit to Accounts Payable and a credit to a Purchase

Manufactured Inventory Costs: Companies can divide the inventories into:

Cost Flow and Cost Flow Assumptions:

− Cost – historical cost or accounting book value for products or materials.

• Capitalized Cost for Inventory

POLICY AND PROCEDURES

Inventory Turns per Year

Percentage of Defective Products

Unit Cost (Process Costing Method)

Percentage of On-Time Deliveries (Both Inbound and Outbound)

PROJECT TEAM (LIST MEMBERS):

Time Project Work Step Initial Index

Review prior audit report and relevant press releases (acquisitions).

Obtain completed inventory internal control questionnaire from the

Obtain and document the following as of the audit date:

Ensure Financial Statement Trial Balance agrees to the Trial Balance

Reconcile Perpetual Inventory Listing to the account balances that

Describe procedures for developing current year material, labor and

Compare and document budgeted variances to actual variances for

For facilities that do not employ a standard costing system,

Discuss conclusions/observations with the senior associate. Obtain

Interview employees associated with the receiving process in order to

Through inquiry and observation, ensure the following controls are in

• Goods are received at a designated receiving bay.

Process map procedures for vendor returns. Through inquiry and

Through inquiry and observation, ensure that shipment discrepancy

PRODUCTION PROCESS/PHYSICAL SECURITY

Interview employees associated with the production process. Map

• Management approval is required for stock issuance of amounts

Obtain and review information supporting the most recent wall-to-wall

Complete the physical inventory checklist. Document control gaps, if

Document book to physical adjustments for the past three years.

Evaluate propriety of reconciling items between the perpetual

Obtain, review, and document policies and procedures surrounding

Based solely on the work performed, document observations

For facilities using standard costing system, perform the

On a sample basis (minimum of 30), test the accuracy of the

On a sample basis, examine the method and accuracy of recording

For facilities not using a standard costing system, perform the

Examine (minimum of 30) recent invoices supporting raw materials,

Recalculate labor and overhead calculations and compare to

Based on ACL reports, document inventory greater than 180, 270,

Document method for estimating reserve for excess and obsolete

Obtain calculation of E&O estimate for most recent quarter-end and

Document inconsistencies, if any, between the calculation and aging

Ensure authorized persons adequately approve provisions or write-

Document policies and procedures for consigned inventory. At a

Document compliance with Corporate Policy on consigned

Document method for accounting for inventory scrap. At a minimum

Through inquiry and observation, ensure that scrap proceeds are

Through inquiry and observation, ensure that approval is granted