Types of Inventory Errors - AccountingTools

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Types of Inventory Errors

There are a great many types of errors that can result in an incorrect inventory valuation.
The result can be a significant understatement or overstatement of the ending inventory

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changes the reported amount of ending inventory stated in the balance sheet.

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valuation, which
translates into a misstatement of the reported profits of a business. It also

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Here are some of the more common errors to be aware of:

Incorrect unit count. Perhaps the most obvious error, this is when the physical count of
the inventory is incorrect, resulting in an excessively high or low inventory quantity that
is then translated into a valuation error when you multiply it by the unit cost.
Incorrect unit of measure. This is when you count a certain
quantity and enter it into the
accounting records, but the designated unit of measure in the item master file for that
item is different from what you assumed. Thus, you may be counting in individual unit

quantities, but the unit of measure in the computer is set to dozens, so

your quantity is
now incorrect by a factor of twelve. Other variations are using inches instead of
centimeters, or ounces instead of pounds.
Incorrect standard cost. In a standard costing
system, you store the standard cost of an
item in the item master file.
If no one adjusts this number to match actual costs, then
the inventory
will be valued at a cost that does not match actual costs.
Incorrect inventory layering. If you use an inventory cost layering system, such as FIFO
or LIFO,
the system has to assign a cost to an item based on the inventory layer
in
which it is located. System errors are possible here. If you are doing this manually, then
you can assume a large proportion of operator errors.
Incorrect part number. You may assume that something you are counting has a certain
part number, and will assign the inventory count to that part number in the computer
system. But what if it really has a different part number? Then you just made the
double error of imposing the correct count on the wrong part, and of not assigning any

count at all to the correct part number.

Cycle counting adjustment error. A cycle counter may find an error in an inventory count
and makes an adjustment in the accounting
records to fix it. This is a problem if there is
already an entry that has not yet been posted to the system, which would have already

corrected the "error." This transactional delay can cause major problems
when there is
an active cycle counting system in place.
Customer owned inventory. Customers may have some of their inventory at your
location, so you may mistakenly count it as though it is your own inventory.
Consignment inventory. You may have inventory on consignment at retailers, and forget
to count it.
Improper cutoff. Inventory may arrive at the receiving dock
during a physical count, so
you include it in the count. The trouble is, the corresponding supplier invoice may not
yet have reached the accounting department, so you have just recorded inventory for
which there is no cost.
Transfer imbalance. The inventory system may be set up to require you to reduce the
inventory quantity in one department, and separately increase the inventory quantity in

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Types of Inventory Errors - AccountingTools

another department when you are transferring inventory inside the company. If you do
one but not the other, then either you have the same inventory item reported
in two
places at once, or it is not located anywhere at all.
Incorrect scrap relief from backflushing. Backflushing is where you reduce the balances
in inventory records based on the number of units of finished goods produced. It is
based on the assumption that the standard component quantities listed in the bill of
materials are correct; however, if scrap and spoilage is different, then incorrect unit
quantities will be relieved from the inventory records. You need an
excellent scrap
reporting system to mitigate this problem.
If an inventory error has resulted in an increase in the recorded amount of ending inventory,
this means that the cost of goods sold is understated, so that profits are overstated.
Conversely, if an inventory
error has resulted in a decrease in the recorded amount of
ending inventory, this means that the cost of goods sold is overstated, so that
profits are
understated.
Related Topics
Inventory audit procedures
Inventory internal controls
How do I ensure a proper inventory cutoff?
How do I improve inventory record accuracy?
How do I reconcile inventory?

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