Types of Inventory Errors - AccountingTools

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Home >> Inventory Topics

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

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

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

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

O p e r a t i o n a l A c c o u n t i n g T o p i c s

Types of Inventory Errors - AccountingTools

http://www.accountingtools.com/types-of-inventory-errors[3/29/2015 11:12:06 AM]

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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