CONTROL OF INVENTORY
For companies such as Best Buy, good control over inventory must be maintained.
Two primary objectives of control over inventory are safeguarding the inventory and
properly reporting it in the financial statements. These controls can be either preven-
tive or detective in nature. A preventive control is designed to prevent errors or mis-
statements from occurring. A detective control is designed to detect an error or
misstatement after it has occurred.
Control over inventory should begin as soon as the inventory is received. Receiving
reports should be completed by the company’s receiving department in order to es-
tablish initial accountability for the inventory. To make sure the inventory received is
what was ordered, each receiving report should agree with the company’s original
purchase order for the merchandise. Likewise, the price at which the inventory was or-
dered, as shown on the purchase order, should be compared to the price at which the
vendor billed the company, as shown on the vendor’s invoice. After the receiving re-
port, purchase order, and vendor’s invoice have been reconciled, the company should
record the inventory and related account payable in the accounting records.
Controls for safeguarding inventory include developing and using security mea-
sures to prevent inventory damage or customer or employee theft. For example, in-
ventory should be stored in a warehouse or other area to which access is restricted to
authorized employees. When shopping, you may have noticed how retail stores pro-
tect inventory from customer theft. Retail stores often use such devices as two-way
mirrors, cameras, and security guards. High-priced items are often displayed in locked
cabinets. Retail clothing stores often place plastic alarm tags on valuable items such as
leather coats. Sensors at the exit doors set off alarms if the tags have not been removed
by the clerk. These controls are designed to prevent customers from shoplifting.
Using a perpetual inventory system for merchandise also provides an effective
means of control over inventory. The amount of each type of merchandise is always
readily available in a subsidiary inventory ledger. In addition, the subsidiary ledger
can be an aid in maintaining inventory quantities at proper levels. Frequently, com-
paring balances with predetermined maximum and minimum levels allows for the
timely reordering of merchandise and prevents the ordering of excess inventory.
To ensure the accuracy of the amount of inventory reported in the financial state-
ments, a merchandising business should take a physical inventory(i.e., count the mer-
chandise). In a perpetual inventory system, the physical inventory is compared to the
recorded inventory in order to determine the amount of shrinkage or shortage. If the
inventory shrinkage is unusually large, management can investigate further and take
any necessary corrective action. Knowing that a physical inventory will be taken also
helps prevent employee thefts or misuses of inventory.
Most companies take their physical inventories when their inventory levels are the
lowest. For example, most retailers take their physical inventories in late January or early
February, which is after the holiday selling season but before restocking for spring.INVENTORY COST FLOW ASSUMPTIONS
When you arrive in line to purchase a movie ticket, the tickets are sold on a first-in,
first-out (fifo) order. That is, those who arrive first in line purchase their tickets before
those who arrive later. In this section, we will see how this ordering concept is used
to value inventory. This issue arises when identical units of merchandise are acquired
at different unit costs during a period. When the company sells one of these identical268 Chapter 6 Inventories
Summarize and provide
examples of control proce-
dures that apply to
inventories.2
Describe three inventory
cost flow assumptions and
how they impact the
income statement and
balance sheet.