Chapter 8
Inventory Valuation
232
Some of this paperwork can take time using a manual system. Computer scanning software can
eliminate much of the paperwork and time involved in recording the movement of goods in
inventory. Whether items are coming in or moving out, a swipe of the scanner can immediately
track their location and status while in inventory.
The Physical Inventory Count
A company must take a physical count of its inventory accounts at least once a year. Companies
using the periodic inventory system must take a physical count as it is the only way to determine
the amount on hand at the end of a period. Companies using the perpetual inventory system count
inventory to ensure the accuracy of their records. While a business may have its own policies and
procedures for the process of taking a physical inventory count, the following steps are generally
included.
1. Designate an area to a specific person.
2. Count and record each item on pre-numbered sheets that are distributed and controlled by the
accounting department.
3. Completed sheets are returned to the accounting department where items are valued and
summarized.
4. Where a perpetual system is used, the inventory record (ledger account) is compared to the
physical count. Differences are noted and adjustments are recorded accordingly.
5. Where major differences occur between the inventory record and the physical count, further
investigation is required.
Effect of Inventory Errors
Inventory is a type of asset that differs somewhat from other assets we have discussed in previous
chapters. Unlike cash, the value of which is quite definitive (except when it comes to exchange rates
between currencies), or accounts receivable which is also quite definitive, the value of inventory can
be subjective to a certain extent.
Attaching a value to inventory involves a different kind of challenge. A warehouse can be full of
various products which were bought at a certain price and will be sold at another price, with no
clarity as to which items moved when. As we have demonstrated, the choice of valuation system
often settles the matter. However, even a valuation system only creates a snapshot in time, one
which management can influence by choosing one valuation system over another.
In other words, matching physical items in inventory to specific dollar values using any valuation
method can be complicated. This is why the process is prone to errors, and errors can have an
impact on the way a company presents its financial figures—both internally and externally. Next,
examine the impact that an inventory error can have on gross margin percentage and other aspects
of financial reporting.
