Determining which approach or combination of approaches is the most appropriate for an
organization is a key management decision. When selecting an approach, management should
consider the objective and timing of the count, capabilities of the inventory system, the existing
control environment, and the characteristics of the inventory.
The type of count performed is determined by management based on the reason for the count.
Physical counts can be used to establish a balance on or as of a certain date for financial
reporting, to monitor the accuracy of records in an inventory system, and to ensure that the
proper inventory is available for operational needs. In determining the objective of the count,
management should consider the time and resources available or needed to conduct and complete
the count. We found that cycle counts were used to ensure that the balances in the inventory
system were continuously correct for management decisions and financial reporting and to
determine that recorded items were present to meet operational needs for production or
distribution. We found that wall to wall counts were primarily used to establish a balance on or
as of a certain date for financial reporting. In one instance, the wall to wall approach was used
monthly to monitor the inventory system and meet operational needs.
Another primary consideration is the capability of the inventory system. There are two general
types of inventory systems-perpetual and periodic. A perpetual inventory system maintains
current item balances by recording receipts and shipments. In contrast, a periodic inventory
system tracks receipts and shipments in a purchases account, and infrequently updates item
balances. For cycle counting, a perpetual system is needed to provide current balances for
reconciliation of the system and physical count quantities. We found that all of the leading-edge
companies had perpetual inventory systems. Additionally, we found that five of the seven
leading-edge companies used a perpetual inventory system with locator capability, commonly
referred to as a locator system, which identifies the specific physical location of each individual
item in inventory.
The existing control environment over the inventory system and related processes is also a
consideration in selecting the type of count to conduct. Internal controls over the inventory
system and processes should be effective in providing reliable information for conducting the
physical count. Controls must exist to provide reasonable assurance that all transactions
affecting the inventory balances are properly executed and recorded in the inventory system.
Unless this is the case, balances in the inventory system do not provide a reasonable basis to
compare to the physical count quantities. Inventory record accuracy rates, based on results of
prior counts, may be an indicator of the strength of the control environment. A pattern of low
accuracy rates or known control weaknesses may suggest that (1) the recorded balances in the
inventory system are not reliable for conducting cycle counts and (2) a wall to wall count may be
more appropriate to reestablish accurate inventory balances.
Characteristics of the inventory should be considered in selecting an approach. Management
should consider if there are identifiable and distinct segments of the inventory that may lend
themselves better to cycle counting, wall to wall counting, or a combination of both.
Identification of distinct segments should include considerations of the size, dollar value,
turnover, criticality to operations, and susceptibility to misappropriation, including theft, of the
inventory.
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GAO-02-447G Best Practices in Inventory Counts