Setting up the Inventory Count

Regardless of which costing or tracking method you use for your inventory, you must perform a physical count at the end of the year. Accounting rules require you to do this, but it also makes sense from a management perspective. You want to make certain that you do not have employees walking away with inventory. You also want to make sure that if you have a perpetual inventory tracking system, it's working. If you come up with radically different counts than your system calculates, you know you have an underlying problem that you must solve.

When preparing for your inventory count, you should understand the concept of cut off. You want to make sure that you are counting only the items that are actually in inventory at the end of the year. If you are performing your count the day before or the day after year end, you will need to thoroughly track the sales of those days so that you do not count items that have been sold or miss counting items that are there. To avoid this problem, many retailers shut down for their inventory counts. If your business has a December 31st year end, you will not face this problem, because the next day is generally a holiday. The entire day can be used to count the inventory.

The first step in the process is to prepare the count sheets. On these sheets should be a listing of all types of inventory items. If you are on a perpetual inventory system, you would included a column for the number of units you expect to have. You will leave a blank column for the count itself, followed by a column with the per-unit costs as determined by costing method you are using. The final column is called the extension column. You will extend the count times the per-unit cost into this column.

If you use a manual system, make use of Worksheet 1, a blank inventory count sheet. Photocopy as many as you require to complete your count.

It's always a good idea to have a second person check both your counts and your math, especially when you are dealing with significant amounts of inventory. It's quite easy to make a mistake. If your financial statements are being audited by an outside accounting firm, a representative from the firm will most likely observe the count and perform some test counts on behalf of the firm. It's not that the firm doesn't trust you; it simply has the job of mak­ing sure the count is done correctly.

Now that you have an inventory total, you will make your inventory figures in your books equal that total. If you're on a periodic system, you will always have to do this adjustment at the end of the period. If you're on a perpetual system, the count should be the same as the calculated amount, and no adjustment will be necessary. If it is different, you will still need to adjust to the actual count, then review your tracking system to find out why there are differences.