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Inventory reconciliation is a process where a company balances its physical inventory with the figures in its accounting books. Two types of systems are available for reconciling inventory. Companies can either use a periodic or perpetual inventory system to conduct this activity. Like the names imply, a periodic inventory system requires an inventory reconciliation at several different times a year, such as each quarter; the perpetual method does not have this requirement as an annual inventory is sufficient. Under each system, a physical count of inventory is necessary to compare actual items to the accounting reports so accountants can make adjustments as necessary.
Under each inventory system, the process starts with the same early steps. An individual from the accounting department typically goes out and counts all physical items listed as inventory. A copy of the book inventory from the computer may help guide the accountant while counting physical inventory. Any differences between the inventory listed on the computer printout and actual inventory needs a mark on the report. All inventories need counting before the reconciliation process starts.
Once the physical count is complete, accountants can begin the inventory reconciliation process. This process requires the accountant to compare his or her physical counts against the items listed in the accounting system. Any differences and the resulting dollar differences must have clear notation on the reconciliation report. The accountant needs to find the reason for these differences and track down any wayward inventory. For example, inventory sold but not yet recorded in the accounting ledger can result in an inventory difference during the reconciliation process.
The purpose behind the inventory reconciliation process is twofold. First, a company reports more accurate figures on its financial statements, both the income statement and balance sheet. Proper accounting statements and reports reflect the true value of the company and allow stakeholders to make better judgments. Second, an accurate inventory balance can prevent overpaying taxes. Government agencies may charge taxes on unsold inventory at the end of each year; too much inventory at year-end increases these taxes.
Inventory reconciliation can help a company prove it has proper internal controls. Theft, spoilage, and damaged inventory can increase a company’s cost of doing business significantly. Failure to properly control the costs associated with inventory can quickly eat into a company’s profits. Auditors often look at internal controls as part of a company’s external review process. National accounting standards may also require compliance with inventory reconciliation procedures for certain types of companies.