- Illustrate how inventory counts are used as an internal control under a perpetual system
In the prior section, we discussed internal controls on periodic inventory:
- authorized purchase orders and a tracking system for those POs
- verifying receipt of inventory
- a process to approve the payment to the vendor
- inventory management such as:
- reorder points
- quality control
- shipping and billing procedures
In addition to these controls, one of the main internal controls over inventory when using the perpetual system is the physical count. Unlike periodic inventory, where we count at the very end of the accounting period in order to calculate COGS, under perpetual inventory we constantly take test counts. We don’t count everything all at once though. In January, we count one class of items or category, and then another in February, and so on, or at random times, unannounced.
Ideally, the physical count and the accounting records will be the same, but sometimes they are not, in which case we make an adjusting journal entry AND we assess our other internal controls to see if we are lax in some area. Maybe something got broken, missed in the count, or stolen. In our sound system warehouse example, we might consider installing webcams to watch over our employees, reducing the opportunity for theft.
Here is our official inventory list from our accounting records (this is the subsidiary ledger):
|Product ID||Description||Cost||Quantity in Stock||Total Inventory Value|
|CAB 500||HQ Speakers||58.00||500||29,000.00|
|CAB 600||HQ Speakers||99.00||15||1,485.00|
|MMM 333||GPS enabled sound system||1,255.50||64||80,352.00|
|Rel 5||HQ Speakers||110.00||100||11,000.00|
|RFS-212||GPS enabled sound system||650.00||150||97,500.00|
|XPS-101||GPS enabled sound system||102.375||160||16,380.00|
|Total Inventory Value||$ 238,687.00|
Under the perpetual inventory system, when the actual physical counts don’t agree with the accounting records, we have to make an adjustment to the accounting records. It’s usually not “swelling,” which means there is more inventory on hand than in the records. It’s usually “shrinkage.” Let’s say the actual physical count revealed there were only 63 MMM 333 in stock. We would probably post the shrinkage to COGS:
|Dec 19||Cost of goods sold||1,255.50|
|Dec 19||To adjust inventory subsidiary ledger to physical count|
If shrinkage was significant, we should do two things:
- Find out why by more closely monitoring the at-risk items.
- Record shrinkage in a separate GL account in order to more closely monitor the materiality of the loss.
Sometimes things just break or are damaged and it’s just a cost of doing business, but sometimes we can and should mitigate that loss—that’s what internal controls are all about.