Internal controls are reviews, procedures or guidelines to protect and safeguard a company’s business and financial information. Business owners and managers are responsible for developing and implementing internal controls to keep costs down and minimize or avoid problems. Inventory represents an expensive and sizable physical asset for most companies. Internal controls are necessary for inventory, because companies can rarely survive if they consistently lose inventory to theft, spoilage and obsolescence.
Inventory systems are accounting methods for managing the financial transactions relating to a company’s physical inventory items. Two common systems are the periodic and perpetual systems. Periodic inventory systems update the accounting ledger once a month or quarterly. A better and more controlling method is the perpetual inventory system, which updates inventory after each purchase, sale and adjustment. Inventory systems give owners and managers a better idea of inventory cost and its effects on the balance sheet, which is an important part of internal controls.
Internal controls create specific limitations on a company’s inventory ordering process. Owners and managers usually divide inventory ordering duties among multiple employees. This ensures an individual does not order inventory and steal it as it comes into the company’s warehouse. Separating out the purchase order and payment process is also important, since an employee could “order” inventory from a fake company and send the payment to a post office box rented by the employee.
Storage is a physical inventory control procedure. Companies must find secure warehouses and distributors, so inventory is not stolen or damaged. Adequate warehousing also ensures the company has enough space to properly receive and store inventory products. Companies must have enough space for driving forklifts, moving pallets and allowing workers to walk through the warehouse safely without damaging inventory.
Physical counts reconcile the company’s accounting ledger with the actual amount of inventory on hand. Companies typically use cycle counts or an annual inventory count for this process. Cycle counts are ongoing counts where companies require employees to count a specific number of items each week. High value or popular items may be a constant feature of cycle counts to ensure these items are not comprised. Annual physical counts happen once a year, when the company counts its entire inventory at one time rather than a weekly counting process.