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Inventory reconciliation involves two steps: physical and accounting. Physical inventory steps including taking a written inventory record and comparing it to the actual goods in the company’s warehouses. Counting obsolete and damaged products is also a reconciliation activity. Reconciliation steps on the accounting side include verification that all inventory purchases are posted, entering adjustments from the physical count and analyzing the dollar differences between months. How often inventory is reconciled depends on the size, location, and type of inventory in a company’s operations.
The two types of inventory systems that are common in business are periodic and perpetual. Both involve tasks or activities that relate to the physical and accounting methods of reconciliation. The periodic system is somewhat easier, as it only requires for the recording of financial inventory information on a monthly, quarterly, or annual basis. For example, the general ledger will include a starting figure for the quarter. Accountants will add the total inventory purchases for this time period, deduct sales and adjustments, and then present a final figure on the company’s balance sheet.
Physical inventory counts under the periodic method are typically quarterly or annual. More frequent counts may be necessary if theft occurs, or if a significant number of inventory products continually wind up damaged going through the company’s processes.
The perpetual inventory method records and reconciles inventory information after each purchase, sale, or adjustment to the general ledger account. Inventory reconciliation under the perpetual method is much more accurate than the periodic system. Companies with individual or unique inventory products will often use the perpetual system because of the large variety of goods within the company’s warehouse. Physical inventory counts are often annual, although cycle counts may be more frequent. Cycle counts help maintain records on a weekly basis to ensure significant adjustments are not made to the company’s general ledger at one time.
Keeping an accurate inventory count can also affect a company’s tax liability. Federal, state, or local municipalities may assess taxes on the unsold balance of inventory based on the company’s accounting information. Inaccurate balances can result in companies having to pay more money in taxes from faulty inventory information. Additionally, paying taxes on damaged, obsolete, or otherwise unsellable goods results in more money lost from poor inventory figures.
Some industries — such as automobile dealerships or machine manufacturers — may need to conduct an inventory reconciliation to determine when inventory will drop in value based on age. These big ticket items will depreciate “on the lot,” meaning the company can no longer sell them for full price. This results in an extraordinary loss from inventory write downs.