Types of Internal Controls for Inventory & Production

For manufacturing businesses, inventory comprises one of the largest assets owned by the company. This inventory consists of raw materials, work in process and finished goods. The production process converts the raw material inventory into finished goods inventory. Manufacturing companies need to control their production process and manage the inventory in order to safeguard it. These companies incorporate internal controls to manage inventory and control production.

Documentation makes up a primary component in any company’s internal control structure. In the inventory warehouse, these documents include using receiving documents, shipping documents and intercompany transfer documents. These provide a paperwork trail that allows any employee or manager to locate the inventory within the facility, whether the inventory is in the warehouse or on the production line. Each type of document should be sequentially numbered, which allows missing documents to be immediately identified and investigated. The documents also should be matched to other documents. For instance, receiving documents should be matched with vendor invoices to confirm that the company received the same quantity it is being billed for.

Employee theft, outside theft and mistaken documentation allow inventory to be missing from its assigned location. Security cameras provide a video record of all the activity that occurs in the warehouse and on the production line. When a discrepancy occurs between the recorded level of inventory and the actual quantity, management can review the video footage looking for physical inventory movement and comparing that movement to the recorded inventory movement. Management can review video footage of the production line comparing inventory production with the recorded production. Cameras allow management to catch employees engaging in unethical behavior as well as deter unethical behavior by employees who know they are being watched.

Some employees create scrap products or classify good products as scrap in order to take it home with them. Proper internal controls related to scrap handling eliminate this possibility. The company should have policies in place regarding the classification and treatment of scrap products. One policy should include having multiple employees verify that a specific item lacks the quality level of good product and should be considered scrap. Another policy involves separating the responsibilities. For instance, one employee identifies the scrap and another employee disposes of the scrap. The company should manage disposing of scrap by choosing an outside company to handle the disposal rather than handling it internally.

Companies conduct physical inventory counts periodically and compare the inventory counted to the inventory recorded in the system. This allows the company to identify any discrepancies. The company can investigate these discrepancies to determine if an error occurred or if there was a fraud.