Executive Guide: Best Practices in Achieving Consistent, Accurate
Physical Counts of Inventory and Related Property (01-MAR-02,
GAO-02-447G).
This Executive Guide describes fundamental practices and
procedures used in the private sector to achieve consistent and
accurate physical counts of inventory and related property. The
Guide summarizes the fundamental principles that have been
successfully implemented by companies recognized for their
outstanding record of inventory management. It also explains and
describes leading practices from which the federal government may
be able to draw lessons and ideas. This guide applies to most
forms of federal inventory, but some of the practices discussed
may not be applicable to bulk, natural resource, and nonturning
inventories, such as the Department of Energy's strategic
petroleum reserve.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-447G
ACCNO: A02941
TITLE: Executive Guide: Best Practices in Achieving Consistent,
Accurate Physical Counts of Inventory and Related Property
DATE: 03/01/2002
SUBJECT: Inventory control systems
Private sector practices
Best practices
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GAO-02-447G
United States General Accounting Office
GAO
March 2002
EXECUTIVE GUIDE
Best Practices in Achieving Consistent, Accurate Physical Counts of
Inventory and Related Property
a
GAO-02-447G
Preface
Creating an effective and cost-efficient government has long been a public
expectation. Achieving this goal will require federal agencies to produce
useful, reliable, and timely information that can be used daily by the
Congress, federal managers, and other decisionmakers. Inventory is one of
the major areas in the federal government where useful, reliable, and prompt
data are still generally not available.
To provide a framework and guide that federal managers can use to improve
the accuracy and reliability of the government`s inventory and related
property data, we studied the inventory count processes and procedures of
seven leading-edge private sector companies to identify the key factors and
practices they use to achieve accurate and reliable physical counts.
Physical counts of inventory are only one aspect of inventory control that
contribute to accurate and reliable inventory records. This Executive Guide,
while intended to assist federal agencies in achieving the objectives of the
Chief Financial Officers (CFO) Act of 1990 and subsequent related
legislation, is also applicable to any governmental and nongovernmental
entity holding inventory or property and equipment. This Executive Guide
describes the fundamental practices and procedures used in the private
sector to achieve consistent and accurate physical counts. It summarizes the
fundamental principles that have been successfully implemented by companies
recognized for their outstanding record of inventory management.1 Also, it
explains and describes leading practices from which the federal government
may be able to draw lessons and ideas. This guide applies to most forms of
federal inventory, but certain of the discussed practices may not be
applicable to various types of bulk, natural resource, and nonturning
inventories, such as the Department of Energy`s strategic petroleum reserve.
Many of the concepts and controls for conducting physical counts discussed
in this guide could also be applied to property, plant, and equipment, an
area in which many federal agencies also face data reliability challenges.
This guide was prepared under the direction of Gregory D. Kutz, Director,
Financial Management and Assurance. Other GAO contacts and key contributors
are listed in appendix
VI. Please address any questions or comments to me at (202) 512-2600,
[email protected], or Paul D. Kinney, Assistant Director, by phone, e-mail,
or regular mail at the following:
1 See Appendix II, Objectives, Scope, and Methodology.
Mail: Paul D. Kinney, Assistant Director U.S. General Accounting Office 1244
Speer Blvd., Suite 800 Denver, CO 80204
Phone: (303) 572-7388 Email: [email protected]
Jeffrey C. Steinhoff
Managing Director, Financial Management and Assurance
Contents
Background 5
Identification and Characteristics of Leading-edge Companies 8
Key Factors in Achieving Consistent and Accurate Counts of 10
Physical Inventories
Key Factor 1: Establish Accountability
Performance Goals Level of Accountability Strategies to Consider
Key Factor 2: Establish Written Policies
Strategies to Consider
Key Factor 3: Select an Approach
Strategies to Consider
Key Factor 4: Determine Frequency of Counts
Frequency of Counts Method of Selecting Items Strategies to Consider
Key Factor 5: Maintain Segregation of Duties
Physical Custody of Assets Transaction Processing and Recording
Approval of Transactions
Strategies to Consider
Key Factor 6: Enlist Knowledgeable Staff
Counters Are Knowledgeable about the Inventory Items Counters Are
Knowledgeable about the Count Process Count Personnel Are Well-Trained
Strategies to Consider
Key Factor 7: Provide Adequate Supervision
Strategies to Consider
Key Factor 8: Perform Blind Counts
Strategies to Consider
Key Factor 9: Ensure Completeness of the Count
Cutoff Procedures
Preinventory Activities
Control Methods for Count Completion
Strategies to Consider
12
16 20 24
28
32
36 39 42
Key Factor 10: Execute Physical CountCommunicate Information to the Counter
Verify Item Data and Quantity Capture and Compare the Count Perform
Requisite Number of Counts Complete Counts in a Timely Manner Strategies to
Consider
Key Factor 11: Perform ResearchRequired Research Timely Research Approval
and Referral of Adjustments Strategies to Consider
Key Factor 12: Evaluate Count ResultsPerformance Measures Communication of
Results Modification of Policies and Procedures Strategies to Consider
47
51
55
Appendixes
Appendix I: Implementation Checklist 60
Appendix II: Objectives, Scope, and Methodology 71
Appendix III: Bibliography 73
Appendix IV: Other Related Publications 74
Appendix V: Acknowledgment of Best Practice Participants 75
Appendix VI: GAO Contacts and Staff Acknowledgments 76
Background
Accurate and reliable data are essential to an efficient and effective
operating environment in the private sector as well as in the federal
government. Inventory represents a significant portion of assets in the
federal government and private sector. Therefore, managers and other
decisionmakers need to know how much inventory there is and where it is
located in order to make effective budgeting, operating, and financial
decisions and to create a government that works better and costs less.
In the 1990s, the Congress passed the Chief Financial Officers Act of 1990
and subsequent related legislation, the Government Management Reform Act of
1994, the Government Performance and Results Act of 1993, and the Federal
Financial Management Improvement Act of 1996. The intent of these acts is to
(1) improve financial management, (2) promote accountability and reduce
costs, and (3) emphasize results-oriented management. For the government`s
major departments and agencies, these laws (1) established chief financial
officer positions, (2) required annual audited financial statements, and (3)
set expectations for agencies to develop and deploy modern financial
management systems, produce sound cost and operating performance
information, and design results-oriented reports on the government`s
financial position by integrating budget, accounting, and program
information. Federal departments and agencies work hard to address the
requirements of these laws but are challenged to provide useful, reliable,
and timely inventory data, which is still not available for daily management
needs.
Managing the acquisition, production, storage, and distribution of inventory
is critical to controlling cost, operational efficiency, and mission
readiness. Proper inventory accountability requires that detailed records of
produced or acquired inventory be maintained, and that this inventory be
properly reported in the entity`s financial management records and reports.
For example, detailed asset records are necessary to help provide for the
physical accountability of inventory and the efficiency and effectiveness of
operations. Additionally, the cost of inventory items should be charged to
operations during the period in which they are used. Physical controls and
accountability reduce the risk of (1) undetected theft and loss, (2)
unexpected shortages of critical items, and (3) unnecessary purchases of
items already on hand. These controls improve visibility and accountability
over the inventory, which help ensure continuation of operations, increased
productivity, and improved storage and control of excess or obsolete stock.
Producing and maintaining accurate inventory data is a multifaceted issue.
The ability to accurately count physical inventories is only one factor that
must be considered in improving the reliability of inventory records. The
ability to accurately count physical inventories is critical in verifying
that inventory actually exists and that on-hand balances agree with
financial and logistical records. This Executive Guide is intended to assist
federal agencies and other governmental and nongovernmental entities in
establishing and implementing inventory counting procedures that will
contribute to the accuracy and reliability of inventory data.
In the private sector, the term inventory generally refers to items of
property that are (1) held for sale as finished goods, (2) in the process of
being produced or assembled for sale (i.e., work in process), or (3) raw
materials and supplies used in producing goods, offering services, and
accomplishing operational missions. The practices discussed in this guide
are based on private sector inventories that are comparable in type,
activity, and volume to inventories in the federal government, as listed in
the following table.
Examples of Inventory Types Common to the Private Sector and the Federal
Government
* Aircraft engines and turbines * Aircraft repair parts * Nuts and bolts *
Electronics * Industrial tapes, adhesives, textiles, and fabrics * Medical
supplies, equipment, and cosmetics * Office products * Packaging *
Refrigerators, dishwashers, ovens * Sparkplugs, oil filters, fuels, and oils *
Hydrofluoric acid, dyes, and gases * Insecticides and chemicals * Vehicle
assembly parts * Aviation and vehicle electronic components and infrared
devices
At the beginning of fiscal year 2001 the federal government reported $185
billion in inventory and related property consisting of a variety of
finished goods, work in process, stockpile materials, commodities, seized
and forfeited property, and other operating materials and supplies.
GAO and other auditors have repeatedly found that the federal government
lacks complete and reliable information for reported inventory and other
property and equipment, and can not determine that all assets are reported,
verify the existence of inventory, or substantiate the amount of reported
inventory and property. These longstanding problems with visibility and
accountability are a major impediment to the federal government achieving
the goals of legislation for financial reporting and accountability.
Further, the lack of reliable information impairs the government`s ability
to (1) know the quantity, location, condition, and value of assets it owns,
(2) safeguard its assets from physical deterioration, theft, loss, or
mismanagement, (3) prevent unnecessary storage and maintenance costs or
purchase of assets already on hand, and (4) determine the full costs of
government programs that use these assets. Consequently, the risk is high
that the Congress, managers of federal agencies, and other decisionmakers
are not receiving accurate information for making informed decisions about
future funding, oversight of federal programs involving inventory, and
operational readiness.
An improved physical count process is only one of many corrective actions
that will be required to resolve all of these deficiencies. Although
conducting a physical inventory, comparing the count results to recorded
quantities, researching differences, and determining and posting an accurate
adjustment to the on-hand balance seems like a fairly simple, straight
forward exercise, in reality it is not. There are many factors that can
cause the record of on-hand inventory to differ from the physical quantity
counted, including omission of items from the count, incorrect counts,
errors in cutoff, and improper recording or reconciliation of count results.
This Executive Guide presents processes and controls used by private sector
companies recognized as excelling in their ability to manage inventory and
achieve consistent and accurate counts of physical inventories. Federal
agencies effectively implementing these practices can resolve significant
weaknesses in the federal government`s property and inventory accountability
and financial reporting by improving the accuracy of data being used for
budgeting, financial, and logistical and operational management
decision-making purposes. The practices presented are widely adaptable to a
variety of inventory types, volumes, and dollar values. Management should
determine the extent to which the practices are applied based on their
assessment of the objectives of the count, characteristics of the inventory,
capabilities of the inventory system, effectiveness of the system of
internal controls, and availability of the organization`s resources. The
conceptual issues discussed in this guide are focused on inventory and
related property, and under certain circumstances may be applied to
property, plant, and equipment. Appendix IV lists other related publications
that provide further guidance and information on related topics of financial
management, human capital management, and system controls and requirements.
Identification and Characteristics of Leading-edge Companies
To help improve the accuracy and reliability of the federal government`s
inventory and related property data, we studied seven companies having
leading-edge inventory count process and procedures to identify the key
factors and practices in achieving consistent and accurate physical counts.
The seven companies we studied were recognized by leading professional
service experts, consultants, and academic and business/trade publications
as having best practices in inventory management. For more information on
the criteria we used to select these companies, see appendix II.
Some of the seven leading-edge companies used more than one counting
approach and allowed us to review their practices and processes at more than
one operating location. A total of 12 separate locations (from the seven
companies) were reviewed.
All 12 locations used one or both of the two primary approaches to counting
inventory-cycle counting, in which a portion of the inventory is counted
either daily, weekly, or monthly until the entire inventory has been counted
over a period of time, and wall to wall counting, in which the entire
inventory is counted at a point in time. Further discussion of these
approaches may be found on page 20, key factor 3. In just one location, and
for only a very small portion of its inventory, was sampling (in which
merely a portion rather than the whole of the inventory was subject to
count) used as a counting approach. At this location, a progressive approach
was used where the location started with wall to wall and then moved to
cycle counting once there was a proven track record of high accuracy and
then moved to sampling. A location was only allowed to implement sampling
after management had proven a strong control environment evidenced by
multiple years of highly accurate cycle counts in which management could be
assured of an accurate system. Once the location had moved to cycle counts
or sampling, the high accuracy rates had to be maintained or the location
was required to return to a wall to wall approach. However, because sampling
was not predominately used by this or the other leading-edge
companies, the key factors contained in this report are discussed as they
relate to cycle and wall to wall methodologies.
This Executive Guide discusses common characteristics and practices used by
leading-edge companies to ensure that the development, execution,
completion, and evaluation of a physical count of their inventories provides
management with useful, reliable, and timely information for decision making
and financial reporting. Specifically, we have identified 12 key factors
common to these leading-edge companies-regardless of the inventory count
methodology or combination of practices they used-which collectively ensure
consistent and accurate count results. In addition, this guide presents
comparative summaries of the goals, practices, and results of certain key
factors, and provides case studies of leading-edge companies.
Key Factors in Achieving Consistent andAccurate Counts of Physical
Inventories
The 12 key factors, presented in the following table are essential to
leading-edge companies achieving consistent and accurate counts of physical
inventories. Overarching all of these factors is top management`s commitment
to an environment that promotes sound inventory control.
The inventory count process is an integral component of an organization`s
internal control environment and management`s commitment is critical to
establishing effective and reliable internal controls. We observed
management`s commitment at every leading-edge company where attitude and
leadership had created unique corporate cultures. A disciplined and
structured culture, which fosters integrity, corporate values, and
commitment to competence, begins with top management and is seeded
throughout the organization at all levels of staff and supervisory
personnel. Characteristics of strong management commitment include:
Top management advocates change and empowers employees to make changes.
Performance measures are aligned with corporate goals.
Technology and systems are invested in and realize a return.
Human capital is developed and retained.
Goals and results are communicated.
These characteristics were not just words in the mission statements of the
leading-edge companies, but were in fact tools and practices employed by
each of the companies to strategically manage change to enhance quality and
profitability. In fact, few, if any, business practices remain static,
including inventory count procedures. Senior representatives of each of the
leading-edge companies discussed the need for and drive to improve cycle
times, reduce costs, and reduce capital requirements by systematically
reviewing their operations and processes. All seven leading-edge companies
used fundamental methodologies to review their
practices: three were active participants in Six Sigma2 and five developed
other internal initiatives, including participative management improvement
groups, benchmarking of practices to industry standards, and -accelerated
work groups" to develop, test, and implement process improvements. As a
result, the 12 key factors are an accumulation of continuously improved
practices and controls for counting inventory and related property.
2 Six Sigma and Breakthrough Strategy are copywritten methods of Six Sigma
Academy to provide companies the tactics and tools for rapid, total business
transformation.
Key Factor 1: Establish Accountability
One of the key factors in developing and implementing an accurate physical
count process is to establish accountability. Establishing accountability
for the inventory physical count process requires setting performance goals
and holding the appropriate level of personnel responsible for the overall
physical inventory process.
Performance Goals
Performance goals establish targets for achieving management`s objectives
and contribute to the overall mission of the organization. Leading-edge
companies set performance goals for the physical count process either
through the establishment of inventory record accuracy goals (i.e., to
measure the degree to which the physical on-hand balance agrees with
inventory records), or other measurable, results-oriented performance
expectations.
Setting high goals for inventory record accuracy rates is one way of
establishing accountability for the physical inventory count. High goals
-stretch" the organization and personnel to perform inventory counts with
increasingly superior precision. Experts agree that inventory record
accuracy goals should be set at 95 percent or higher.3 Six of the eight
leading-edge locations performing cycle counts set performance goals by
establishing inventory record accuracy goals that ranged from 95 percent to
98 percent.
3
Brooks and Wilson, p. 22.
The other two locations performing cycle counts and all four locations
performing wall to wall counts did not establish inventory record accuracy
goals, but instead established other measurable performance expectations.
Other performance expectations, as set forth by management, can also be used
to establish high levels of accountability and measure the results of the
physical count without explicitly setting inventory record accuracy goals.
These other performance expectations measure aspects of the count, such as
adjustments and the number of accurate counts. Targets for these other
performance expectations are established by management and are typically
based on impact to operations, including financial significance, effect on
production or services, and compliance with policies and procedures. The
four leading-edge locations performing wall to wall physical counts and the
two cycle count locations that were not setting goals for inventory record
accuracy established accountability through other performance expectations,
such as dollar value and quantity of adjustments and number of accurate
counts. For example, one leading-edge location set an expectation that net
adjustments resulting from the count would not exceed 2 percent of the
dollar value of the items counted.
Additionally, many of these expectations were also used by the locations
that set goals for inventory record accuracy. Table 1 illustrates the range
of performance goals and expectations used by the 12 leading-edge locations
in establishing accountability.
Level of Accountability
Holding the appropriate level of management responsible and answerable for
the overall inventory process establishes accountability for the physical
inventory and is essential to achieving consistently accurate counts.
Accountability within an organization should exist from the top of the
organization to the lowest level. However, primary responsibility for the
overall physical inventory counts should be specifically designated and
assigned. Accountability for achieving performance goals should be
established in job descriptions and expectations and
enforced through periodic performance evaluations and a reward system that
measures the achievement of performance goals.
Direct accountability for the overall physical inventory count process was
established by the leading-edge companies at the level responsible for
managing the physical count process. The person or persons at this level
were typically supervisors or managers of an inventory group that performed
all counts and research, or a materials area supervisor/manager responsible
for the inventory within his/her area. These individuals had specific
responsibility for (1) planning the count, (2) organizing the count teams,
(3) reviewing counts, (4) reviewing research, and (5) approving adjustments
within established tolerances. The accountable person(s) were held
responsible for achieving the company`s performance goals, including
inventory record accuracy, through personnel performance expectations and
evaluations, which affected bonus and pay decisions.
Case Study
One of the leading-edge locations, a 700,000 square foot distribution
facility, used a separate inventory group that performed all physical counts
and researched all variances. The group consisted of a supervisor, inventory
group leads, and counters/researchers. The supervisor of the inventory group
was responsible for the overall physical count process, including organizing
and supervising the count, performing research, reviewing and approving
adjustments, and evaluating the results of the counts. The company had
established accountability and responsibility for the overall physical count
with the inventory group supervisor and the inventory shipping and receiving
supervisor was responsible and accountable for receiving, storing, and
shipping the inventory. These two supervisors were collectively held
accountable for achieving the company`s established inventory record
accuracy goal of 98 percent based on an accurate physical count and the
accuracy of the inventory records. This goal was included as part of the
supervisors` expectations and evaluations and was used as a tool in
determining merit raises and bonuses.
In addition to holding appropriate management levels responsible and
answerable for the quality of the inventory count process, leading-edge
companies often push accountability to the floor-level personnel performing
the count. Personnel performing the count were held accountable for
performing an accurate physical count of the inventory items, but not the
accuracy of the count agreeing to the inventory records. For example, when a
subsequent recount (discussed in key factor 10) revealed an error in the
first count results, one leading-edge location used this information as an
indicator that the first count team may have performed an inaccurate
physical count, indicating the need for additional training.
Strategies to Consider
To establish accountability for the physical count process, senior
executives could consider the following:
*
Establish performance goals for the physical count that are aligned with the
organization`s mission, strategic goals, and objectives.
*
Establish high measurement goals and continuously assess the organization`s
progress in achieving and maintaining those goals.
*
Identify the line of authority and responsibility from top management to the
level of the organization responsible for accomplishing a consistent,
accurate physical count of inventory and related property.
*
Develop employee/supervisor performance measurement systems to hold
appropriate personnel accountable for achieving the organization`s
performance goals.
Key Factor 2: Establish Written Policies
Establishing and documenting policies and procedures are essential to an
effective and reliable physical count. Policies and procedures demonstrate
management`s commitment to the inventory physical count process and provide
to all personnel clear communication and comprehensive instructions and
guidelines for the count. Establishing written policies and procedures helps
ensure consistent and accurate compliance and application needed to achieve
high levels of integrity and accuracy in the physical count process.
Policies and procedures also become the basis for training and informing
employees.
Well-documented physical count policies and procedures typically pertain to
all aspects of the physical count process, including the activities or tasks
that take place before, during, and after the physical count. Documented
policies and procedures generally include everything an employee needs to
know to complete the requirements of a specific task for the physical count.
Leading-edge locations established written policies and procedures
addressing their physical inventory process. These policies and procedures
include all aspects of the physical count including objectives of the count,
types and timing of counts, instructions for counting and recording, and
researching and adjusting variances. The policies and procedures at the
leading-edge locations were written in sufficient yet succinct detail to
explain the specific procedures and tasks to be performed. A table of
contents from one leading-edge location`s written policies and procedures
manual, presented in figure 1, demonstrates the breadth of the location`s
policies and procedures. Detailed written, specific instructions on all the
tasks involved in the physical count process were included within each of
its sections.
Figure 1: Excerpt from A Leading-Edge Company's Policies and Procedures
Manual
I. Why
A. Objective of the Physical Inventory Process
II. Planning
A. Inventory Methods
B. Record Definitions
C. Timing of Inventory
D. Review of Inventory Procedures
E. Physical Location Preparation
F. Cutoff Data Arrangements
G. Use of Specialists
H. Planning Meetings
III. Observing/Taking
A. Segregation of Duties
B. Forms
C. Recording Information
D. Inventory Movement During Taking
E. Obsolete, Damaged, and Slow-Moving Items
F. Inventories in Off-Site Locations
G. Preliminary Inventories
H. Review and Accountability
I. Bar Coding System
IV. Reconciliation
A. Summarization
B. Reconciliation
C. Timing and Approval of Adjustments
D. Recording of Inventory Adjustments
V. Computer Access and Security
A. System Security
B. Segregation of Duties
C. Processing Controls
D. Disaster Recovery
E. Documentation
F. Master File Changes
VI. Special Situations
A. Consigned Stock, Company Owned
B. Consigned Stock, Vendor Owned
C. Theft Sensitivity
D. Returnable Items
E. Special Materials
VII. Frequency
A. Inventory Type
B. Period
Appendix A Cycle Counts
A. Inventory Classification
B. Inventory Count Process
C. Inventory Accuracy
D. Inventory Tolerance
E. Cycle Count Inventory Adjustments
F. Management Reporting
G. Certification
H. Definitions
I. Checklist
Once policies and procedures have been established and documented, they must
be regularly reviewed and updated. Policies and procedures that are
regularly reviewed and revised to reflect changes in the process and tasks
of the physical count reinforce management`s commitment. Up-to-date policies
and procedures provide a reliable and credible resource to employees,
encourage compliance with management`s directions, and form the basis for a
reliable physical count process.
All the leading-edge locations regularly reviewed and updated their policies
and procedures. The majority of the locations reviewed and revised their
policies every 1 to 2 years, while others revised their policies any time
there was a change in the process or specific tasks of the physical count.
Strategies to Consider
To establish effective written policies and procedures for the physical
count process, senior executives should consider the following:
* Develop broad policies affecting inventories that are designed to attain
management`s goals.
* Develop written procedures for all aspects of the physical count
processes, including
* defining the current process and the individual tasks associated with the
process and
* procedures for and examples of filing and completing required paper work.
* Regularly review and revise policies and procedures for changes in the
process and individual tasks.
Key Factor 3: Select an Approach
The process of counting physical inventory is an essential control for
operational efficiency and financial reporting. A physical count, when
properly executed, verifies the existence of physical assets and the
completeness and accuracy of records. Accurate inventory records are key to
management`s confidence in financial and other information used in
decisionmaking.
The two predominant approaches used by the leading-edge companies to
physically count inventory are cycle counting and wall to wall. Each
approach offers distinct advantages and serves some purposes better than
others. As a result, organizations may choose to use only one approach or a
combination of approaches.
Cycle counting is a method by which a portion of the inventory is counted
either daily, weekly, or monthly until the entire inventory has been counted
over a period of time. Cycle counting serves two purposes: (1) it supports
the reliability of the on-hand inventory quantities used in management
decisions and financial reporting and (2) it normally results in increased
operational efficiency. Cycle counts are used as a control mechanism to
reduce the risk that the inventory process and systems are functioning
incorrectly.
In the wall to wall approach the entire inventory is counted at a point in
time, usually as of the end of an annual or interim period. This method is
primarily used for financial reporting purposes in order to validate the
amount of reported inventory.
Determining which approach or combination of approaches is the most
appropriate for an organization is a key management decision. When selecting
an approach, management should consider the objective and timing of the
count, capabilities of the inventory system, the existing control
environment, and the characteristics of the inventory.
The type of count performed is determined by management based on the reason
for the count. Physical counts can be used to establish a balance on or as
of a certain date for financial reporting, to monitor the accuracy of
records in an inventory system, and to ensure that the proper inventory is
available for operational needs. In determining the objective of the count,
management should consider the time and resources available or needed to
conduct and complete the count. We found that cycle counts were used to
ensure that the balances in the inventory system were continuously correct
for management decisions and financial reporting and to determine that
recorded items were present to meet operational needs for production or
distribution. We found that wall to wall counts were primarily used to
establish a balance on or as of a certain date for financial reporting. In
one instance, the wall to wall approach was used monthly to monitor the
inventory system and meet operational needs.
Another primary consideration is the capability of the inventory system.
There are two general types of inventory systems-perpetual and periodic. A
perpetual inventory system maintains current item balances by recording
receipts and shipments. In contrast, a periodic inventory system tracks
receipts and shipments in a purchases account, and infrequently updates item
balances. For cycle counting, a perpetual system is needed to provide
current balances for reconciliation of the system and physical count
quantities. We found that all of the leading-edge companies had perpetual
inventory systems. Additionally, we found that five of the seven
leading-edge companies used a perpetual inventory system with locator
capability, commonly referred to as a locator system, which identifies the
specific physical location of each individual item in inventory.
The existing control environment over the inventory system and related
processes is also a consideration in selecting the type of count to conduct.
Internal controls over the inventory system and processes should be
effective in providing reliable information for conducting the physical
count. Controls must exist to provide reasonable assurance that all
transactions affecting the inventory balances are properly executed and
recorded in the inventory system. Unless this is the case, balances in the
inventory system do not provide a reasonable basis to compare to the
physical count quantities. Inventory record accuracy rates, based on results
of prior counts, may be an indicator of the strength of the control
environment. A pattern of low accuracy rates or known control weaknesses may
suggest that (1) the recorded balances in the inventory system are not
reliable for conducting cycle counts and (2) a wall to wall count may be
more appropriate to reestablish accurate inventory balances.
Characteristics of the inventory should be considered in selecting an
approach. Management should consider if there are identifiable and distinct
segments of the inventory that may lend themselves better to cycle counting,
wall to wall counting, or a combination of both. Identification of distinct
segments should include considerations of the size, dollar value, turnover,
criticality to operations, and susceptibility to misappropriation, including
theft, of the inventory.
All of the leading-edge companies use cycle counting or wall to wall or both
to count inventory. A majority of these companies used the cycle count
approach. However, some companies used a combination of wall to wall and
cycle for separate identifiable segments of their inventory. Three companies
varied their approach for separate segments of their inventory based on
either the type of material (raw material, work in process, or finished
goods), or by a division`s or location`s operations (distribution,
warehousing, and manufacturing). For example, one company conducted wall to
wall counts until such time as the accuracy of the balances was sufficient
to support cycle counting. Another leading-edge company conducted cycle
counts on work in process materials that were critical to operations and
conducted monthly wall to wall counts on finished products that were a
material portion of the plant`s inventory and were subject to strong
logistical and process controls.
Case Study
One leading-edge company had approximately 80 different facilities within
the United States and manufactured and distributed a wide range of products
from small units to large reels and bundles. This company used a combination
of cycle counting and wall to wall counts based on the existing control
environment and historical accuracy rates at its facilities. Facilities were
allowed to move to cycle counting once the location had completed a wall to
wall annual physical count and had demonstrated the ability to perform cycle
counts by maintaining record accuracy rates above 95 percent and good
inventory process controls for receiving, manufacturing, moving, and
shipping of items. The facility also had to demonstrate adequate training
procedures, processes, and a good system that would support cycle counts
before a cycle count program would be approved. The facility would begin by
cycling through its entire inventory four times per year. As the facility
demonstrated its ability to maintain accurate inventory records by achieving
high record accuracy rates and reliable systems and processes, it could
reduce the number of cycles down to one per year. However, the reduction
from four cycles to one cycle per year took approximately 6 years.
Additionally, if the facility`s inventory record accuracy fell below 95
percent it was required to submit a corrective action plan to address the
causes of the low accuracy and conduct an annual wall to wall physical
count, in addition to the regular cycle counts, until a 95 percent accuracy
rate was once again achieved and maintained.
Strategies to Consider
To select a physical inventory counting approach, senior executives should
consider the following:
* Determine the objectives of performing the physical count
* to establish a balance as of a specific date for financial reporting,
* to monitor the accuracy of the inventory records for financial reporting
and management decisions,
* to ensure the availability of inventory to meet operational needs
including mission readiness,
* to identify excess or obsolete inventory.
* Assess the resources and timing needed to conduct the count.
* Evaluate the capability of the inventory system to
* maintain item balances on a current or periodic basis, and
* maintain balances by item location.
* Evaluate the existing control environment over the inventory system and
processes
* to ensure transactions are properly executed and recorded in the inventory
system,
* to determine that the inventory system provides a reasonable basis for
comparison to the physical count, and
* by considering existing or historical accuracy rates to support the
assessment.
Key Factor 4: Determine Frequency of Counts
Counting an appropriate amount of the total inventory at a point in time or
over a period of time with regular frequency helps to provide accurate
inventory records for operational decisions and financial reporting.
Management should count an appropriate amount of the total inventory by
determining the desired frequency of counts and selecting a method of
choosing individual items or locations to count.
Frequency of Counts
In order to count an appropriate amount of the total inventory, management
must decide which inventory items to count and how frequently those items
should be counted. The most desirable goal would be to count all of the
inventory items at least once a year. However, maintaining accurate
inventory records by counting items takes time and costs money. Since there
are typically limits on these resources, the best way to balance control of
the inventory and cost of the count is to focus on the items determined to
be more important or of higher risk to the organization. Accordingly, it is
not always practical to give the same treatment to each item; it may be
desirable to segment the inventory into identifiable classes and assess the
risk for each segment or class to determine the frequency of counts. For
instance, management may determine that items critical to the production
process, resulting in a high risk to the organization, should be counted
every day, week, or month. In other instances, a segment of inventory that
has little or no movement and does not represent a significant portion of
the inventory, and thus has low risk, may be counted less frequently. The
purpose of classifying items into groups or segments is to establish an
appropriate degree of control over each item. Management should exert the
highest degree of control (frequent counts) on the most important items, and
the least control on less important items. Management may determine that
there are
many degrees of control and importance depending upon the organization`s
needs and inventory characteristics. Management should consider the dollar
amount, criticality to operations, and susceptibility to theft or fraud when
segmenting the inventory and determining the frequency of counts for each
segment.
Leading-edge locations used a variety of frequencies for various segments of
their inventory. Locations performing cycle counts segmented their inventory
by dollar value, activity or turnover, sensitivity or criticality,
historical accuracy rates, or a combination of these elements in determining
how often they would count. The frequency ranged from segments that were not
counted at all, or less than once a year, to segments that were counted
daily, monthly, quarterly, semi-annually, or annually, as shown in table 2.
Locations that segmented their inventory by dollar value counted higher
dollar value items more frequently than lower value items. In other
instances, locations used a combination of dollar value and activity or
turnover of items to segment their inventory, in which the higher dollar
items by activity were counted more frequently, usually four times per year,
than those that had low dollar value by activity, which were counted once a
year. On the other hand, we found that locations performing wall to wall
physical counts typically counted their entire inventory at least once a
year at a point in time. However, we did note that one location performed a
wall to wall physical inventory on one segment of its inventory every month,
due to the dollar value significance of these items to the company`s total
inventory. Table 2 illustrates the frequency of counts for separate
inventory segments at the 12 leading-edge locations.
Case Study
One leading-edge location (location 8 in table 2), manufacturing over 11
million electronic components each year, segmented its work in process
inventory and varied the frequency of counts for each segment in order to
achieve greater coverage of the material segments of the inventory. The work
in process inventory was segmented based on the dollar value multiplied by
activity or turnover, and placed in one of four separate segments. Segment A
represented those items that were in the top 10 percent, segment B were
items in the next 20 percent, segment C were items in the next 30 percent,
and segment D was the remaining 40 percent. Each segment was counted with
either greater or lesser frequency to achieve more coverage of the higher
dollar activity items and less coverage of the lower dollar activity items
each year. Segment A was counted four times, segment B was counted three
times, segment C was counted two times, and segment D was counted once per
year.
Method of Selecting Items
Once management has determined which items to count and how frequently, a
method of choosing individual items or locations must be determined. The
method should ensure that all items within the identified segments are
chosen to achieve the desired frequency and an accurate count. Leading-edge
locations used various methods to select items for count within an
identified inventory segment. The most common method among leading-edge
locations performing cycle counts was to select items sequentially by rows
or geographic area within the warehouse or plant and work their way through
the facility over a period of time. For example, one of the leading-edge
locations divided its warehouse into geographic areas (shipping, receiving,
and warehouse rows) and then selected an area to count each day.
Other methods used by the leading-edge locations to select individual items
or locations for count included a random selection, weighted selection
toward higher dollar volume or value items, and selection based on
management`s discretion. One of the leading-edge locations used a random
method by which the inventory system tracked which items had been counted
and which items still needed to be counted in order to ensure that all items
were counted each year. The inventory supervisor manually entered how many
items to select for count each month, and the inventory system randomly
selected the desired number of items from those not counted. In another
instance, one of the leading-edge locations selected the top 25 items by
dollar value each day from a list of items that had not been counted.
Locations performing wall to wall physical counts counted all inventory at a
point in time by splitting the warehouse or facility into geographic areas
and assigning count teams to each area to ensure that all inventory was
counted.
Strategies to Consider
To determine the frequency of the physical counts, senior executives should
consider the following:
* Assess the resources and timing needed to conduct the count.
*
Identify segments or classes of the inventory and assess each segments risk
to determine the degree of control needed based on
* activity or turnover,
* dollar value,
* sensitive or classified items,
* items critical to production or mission readiness, and
* items susceptible to misappropriation, including theft.
*
Select a frequency to count each segment based on the assessed risk and
degree of control needed such as
* daily,
* weekly,
* monthly,
* semi-annually, or
* annually.
* Determine a method of selecting individual items for count such as
* sequentially by row or area within the warehouse or facility,
* random selection, or
* weighted selection towards higher dollar, higher activity items.
Key Factor 5: Maintain Segregation of Duties
Segregation
of
duties,
a
commonly
used
and
widely accepted internal control and business practice, entails dividing or
segregating key duties and responsibilities among different people.
Implemented effectively, this type of control reduces risk of error and
fraud so that no single individual can adversely affect the accuracy and
integrity of the count.
The key areas of segregation are (1) physical custody of assets, (2)
processing and recording of transactions, and (3) approval of transactions.
Ideally personnel performing any one of the above functions would not also
have responsibilities in either of the other two functions. Thus, where
practical, adequate segregation of duties for the physical count process
includes using personnel who do not have overlapping responsibilities in (1)
custody or access to the inventory items for count, (2) recording
transactions resulting from the count, and (3) authority for approving
adjustments resulting from the count. In situations where segregation of
duties is not practical or cost-effective, other controls should be employed
to mitigate the recognized risk. Such mitigating control procedures include
blind counts (meaning that the counter does not know how many items are
supposed to be there before or during the count process), increased
supervision, and applying dual control by having activities performed by two
or more people.
Physical Custody of Assets
To best accomplish segregation of duties, the normal job activities of the
person performing the physical count should not include custodial activities
such as receiving, shipping, and storing physical assets. We found that the
strongest control employed by leading-edge locations was to
exclude those with asset custody from the counting activity. Five out of the
eight leading-edge locations performing cycle counts accomplished
segregation of duties by using a separate inventory group of dedicated
counters with no other warehouse responsibilities to perform the physical
count. The other three locations use warehouse personnel with normal
warehouse responsibilities, such as shipping, receiving, and storing, to
perform the count. These three locations implemented mitigating controls to
reduce the risk of using warehouse personnel by performing counts in which
the counters did not have knowledge of or access to the on-hand quantity.
This is referred to as a blind count.
The leading-edge locations performing wall to wall physical counts used
warehouse personnel or a combination of warehouse and nonwarehouse personnel
to perform the physical count. This is normal procedure for companies
performing wall to wall inventories, since it is usually an enormous task to
count the entire inventory in a short time, such as a weekend. All four of
these locations had implemented mitigating or dual controls to ensure proper
counts and to reduce the risk caused by the lack of segregation of duties.
These mitigating and dual controls included (1) performing blind counts, (2)
increasing supervision, and (3) using two-member count teams.
Transaction Processing and Recording
Personnel recording transactions that affect the on-hand quantities should
not be responsible for the physical custody of the inventory or approval of
adjustments. Segregation between the duties of recording transactions that
result from the physical count and duties of custody or approval is
essential to provide for the integrity of the physical count process.
Personnel recording inventory adjustments to the on-hand balances at
leading-edge locations did not have custodial responsibilities, such as
shipping, receiving, and storing, and did not have to approve significant
adjustments to the records.
Approval of Transactions
Personnel approving transactions that affect on-hand inventory balances
should not be responsible for the physical custody of the inventory or
recording transactions. Leading-edge locations have controls in place to
manage and limit who has the authority to approve adjustments resulting from
the count. Most locations assigned approval limits to different levels of
management. As the dollar-value of the adjustment increased, the approval
level moved up the management chain to a higher level of management.
Case Study
One leading-edge location, a distributor of prepackaged parts, accomplished
segregation of duties by using a separate inventory group to conduct
physical counts of inventory. In assembling this group and assigning
responsibilities, management implemented the key areas of segregation,
separating the duties of personnel responsible for the custody of the
inventory (warehouse personnel), counting the inventory (cycle counters),
and posting adjustments to the records (cycle count leads). The inventory
group consisted of an inventory control supervisor, six cycle counters and
one cycle count lead for the first shift, four cycle counters and one cycle
count lead on the second shift, and three cycle counters and one cycle count
lead on the third shift. Each counter was responsible for performing
approximately 200 inventory item location counts per day and any necessary
recounts. Responsibilities of the cycle count leads included preparing daily
workload assignments for the counters, posting and monitoring adjustments to
the record on-hand balances, and researching variances. The inventory
control supervisor along with the leads determined the cause of variances
between counted quantities and record on-hand quantities and implemented
solutions to rectify underlying problems causing the variances.
Strategies to Consider
To implement and maintain effective segregation of duties in the physical
count process, senior executives should consider:
*
Determine there are available resources to conduct the count and whether
they have the appropriate knowledge and experience of the inventory and
counting.
*
Analyze the normal job duties of personnel performing the physical count,
considering who has responsibility for
* custody or physical control of the inventory,
* processing and recording of inventory transactions, and
* approval of transactions and adjustments.
*
Determine whether controls may be impaired if any one person has been given
responsibility for more than one activity noted in the previous strategy.
* Perform a risk versus cost analysis of any apparent control risks, and
determine whether
* duties may be reassigned, or
* mitigating controls can be implemented, or
* risk is at an acceptable level.
Key Factor 6: Enlist Knowledgeable Staff
Inventory counters who are knowledgeable about the inventory items being
counted and the inventory counting procedures are critical to performing
effective and accurate physical counts. It is important for inventory
counters to be adequately trained; experienced, knowledgeable inventory
counters increase the accuracy and efficiency of the physical count. In
addition, counters most familiar with the plant layout and daily operations
are more likely to conduct the counts quickly and resolve count
discrepancies without having to conduct excessive research.
Counters Are Knowledgeable about the Inventory Items
Leading-edge companies normally use in-house personnel-whether a dedicated
group or warehouse personnel-who have been chosen expressly because of their
prior experience with and knowledge of inventory items. One major advantage
of this approach is that experienced warehouse personnel are better able to
distinguish between items that look similar but have different technical
specifications. They are also more likely to correctly identify the items
they are counting and provide accurate item descriptions and count
quantities, decreasing the likelihood of needing second or third counts.
Additionally, experienced personnel are more familiar with the layout of
plant and warehouse facilities and the movement of items within and between
these facilities. They are aware of areas where items may be placed, either
intentionally or unintentionally, and thus can more easily locate all the
items that should be counted and potentially reduce misstatements in the
quantities counted. They are knowledgeable about how items are packaged and
stored as well as how items are used in a production line, so they can
quickly and accurately count assigned items.
Eleven of the twelve leading-edge locations use personnel who have prior
work experience and knowledge about the inventory items being counted. A
promotion from the warehouse to the position of cycle counter within a
dedicated count team of one organization was one way in which a leading-edge
location trained, developed, and retained high-performing counters. Another
location, which experienced high turnover and used personnel with varying
degrees of experience, enhanced the knowledge of counters by providing
on-the-job training and teaming new counters with experienced counters.
Counters Are Knowledgeable about the Count Process
Inventory counters should be knowledgeable about the count process to
perform efficient and accurate physical counts. Leading-edge locations
performing cycle counts typically use individuals whose sole function is
conducting physical inventories. These dedicated counters, often designated
as the inventory audit group, usually have considerable experience working
in the warehouse before being promoted to an inventory counter position.
Cycle counters normally have significant prior inventory experience, are
well trained, are dedicated to only counting inventory, and perform counts
routinely. Leading-edge locations performing wall to wall counts typically
use warehouse personnel to perform the counts using effective mitigating
procedures to compensate for the lack of segregation of duties, such as
blind counts and two member count teams. Warehouse personnel may be less
experienced in the count process because wall to wall counts are often
performed only once a year. If personnel with lesser knowledge of the
inventory perform the count, then increased supervision, training, and
instructions are commonly required. One leading-edge location used
administrative or other staff to supplement its count teams, teaming these
employees with experienced warehouse inventory personnel.
Count Personnel Are Well-Trained
Training all counters and supervisors involved in the physical count reduces
the risk of error in performing the count and communicates a consistent way
to perform counts. Counters, supervisors, and individuals involved in
research and adjustment of variances in the leading-edge locations all
received appropriate training. At leading-edge locations this was typically
accomplished through formal classroom training, on-the-job training, or a
mix of the two.
The scope of training is generally dependent on the type of counts
conducted, wall to wall and/or cycle counts. Leading-edge locations
typically train counters on types of inventory, warehouse layout, unit of
measure, recording of counts, computer systems, and use of radio frequency
devices, if applicable. Leading-edge locations that use a separate inventory
group to perform research and/or record adjustments typically provide
training on researching variances, posting adjustments, and operating
computerized inventory systems.
Case Study
The dedicated inventory counter occupation in the inventory audit group of
one leading-edge location is a well-paid, prestigious position. Candidates
for this position are selected primarily from warehouse personnel with years
of experience and an in-depth knowledge of the inventory items. The
inventory audit group`s commitment to excellence is such that newly
recruited counters receive several weeks of formalized on-the-job training.
New counters shadow experienced counters, who supervise hands-on training in
specific areas, in accordance with a formal list of tasks and functions. The
progress of each new counter is monitored by the group`s supervisor and,
before being allowed to conduct counts on their own, they must demonstrate
mastery of the required tasks and functions. Once the new counter is on
his/her own, their work is subject to increased supervisory review,
including follow-up test counts by more experienced counters, until the
employee meets required performance standards.
Strategies to Consider
To enlist knowledgeable staff in the physical count process, senior
executives should consider:
* The amount of resources available to conduct the count.
* Experience and knowledge of the inventory and count process of the count
team.
* Frequency of counts or time necessary to complete the count.
* Establishing a separate inventory group of dedicated counters.
* Assigning or promote personnel with prior experience in the warehouse and
knowledge of the inventory a counting position.
* Providing on-the-job and classroom training of the count process to
counters, supervisors, and personnel researching variances on aspects such
as
* types of inventory,
* warehouse layout,
* unit of measure,
* RF devices,
* computer system,
* research (if applicable), and
* supervision (if applicable).
Key Factor 7: Provide Adequate Supervision
Supervision, a key factor of the count process, includes directing the
efforts of personnel and determining that the objectives of the inventory
count have been accomplished. Elements of supervision include providing
instructions and training, solving problems, and reviewing the work
performed. Adequate supervision increases the likelihood of accurate and
consistent counts and reduces the overall risk of incorrect or unreliable
counts. Supervisor responsibilities include: (1) ensuring that counters are
available to count, (2) selecting count team members, (3) assigning count
team responsibilities, and (4) ensuring that the count is completed on time.
Counters also make sure that needed supplies and equipment, such as count
sheets, calculators, tape measures, scales for weighing, and forklifts are
available. Supervision includes providing instructions and guidance to
counters prior to and during the count and making sure that counters are
following instructions. Supervisors also ensure that all inventory items are
counted and that counters record counts on count sheets or other control
devices.
Supervision can be applied at different levels and degrees depending upon
the experience of the inventory counters and other controls that are in
place. The level of supervision is typically either direct, on-the-floor
supervision during the count, or indirect supervision in which the
supervisor is not on the floor during the count, but instead uses controls
that are in place to monitor count performance. Increased supervision in the
form of direct supervision may be used as a mitigating control in instances
where (1) the counts are infrequent, (2) there is a lack of segregation of
duties, and/or (3) the counters are less experienced and knowledgeable about
the inventory or count process.
The use of direct or indirect supervision at the leading-edge locations was
generally dependent upon management`s determination of the adequacy of
segregation of duties. (See key factor 5.)
All leading-edge locations performing wall to wall physical counts used
direct, on-the-floor supervision as one of their controls to reduce the
risks discussed above. On the other hand, all leading-edge locations
performing cycle counts used indirect supervision, some also using
additional control mechanisms to monitor performance.
For example, as discussed in key factor 5, the strongest of controls for
segregation of duties, found at five locations, was accomplished by using a
separate inventory group of dedicated counters. These separate, dedicated
counters were highly specialized and independent of routine inventory
responsibilities. Because of their years of experience and knowledge of
counting, their performance was not directly monitored by the supervisors.
Supervisors monitored the number of counts being performed and the number of
variances. They also concentrated on identifying the causes of variances
between the counts and recorded on-hand quantities in order to identify
solutions to correct the causes of the errors. The remaining three locations
performing cycle counts used warehouse personnel to perform cycle counts
without direct supervision. These locations reduced their risk of impaired
segregation of duties by using personnel who were experienced and
knowledgeable about the inventory and count process and by performing blind
counts.
Case Study
One leading-edge location, an electronic component manufacturer producing
49,000 units per day with two warehouses totaling over 1 million square
feet, performed daily cycle counts on the raw materials used on the
production line and performed monthly wall to wall counts on the finished
goods. The location used a dedicated inventory group to conduct its daily
cycle counts, which included an inventory group supervisor and 14 dedicated
counters. These dedicated counters attained their position through prior
warehouse experience and as a result, were highly knowledgeable about the
inventory and count process. Because of the experience and knowledge of
these counters, the inventory group supervisor did not directly supervise
the performance of the counts, but instead monitored the cycle counts by
reviewing count cards for accuracy and completeness, to ensure that all
items were counted.
Once a month, the location performed a wall to wall count on its entire
inventory of finished goods. The location used the dedicated inventory group
that performs cycle counts as well as warehouse employees to conduct the
wall to wall count. There were a total of 24 counters and each warehouse
person was teamed with one of the dedicated cycle counters. There were three
supervisors on the floor during the wall to wall physical count to directly
monitor the count to ensure that the count teams were following instructions
and that all items were properly and promptly counted. The degree of
supervision was significantly increased for the monthly wall to wall counts
because of the increase in the number of counters and to mitigate
segregation of duties problems due to the use of warehouse personnel as
members of the count team.
Strategies to Consider
To provide adequate supervision over the physical count process, senior
executives should consider the following:
* The number of resources or teams performing the physical count.
* Frequency of the counts or the time necessary to complete the count.
* Knowledge and experience of the personnel performing the count.
* Whether there is adequate segregation of duties from responsibilities of
asset custody.
* The assigned responsibilities of the supervisor such as
* the availability of count personnel,
* selection of count team members,
* assignment of count responsibilities,
* monitoring of performance, and
* ensuring counters are following procedure and complete counts in a timely
manner.
* Size of the warehouse or area subject to count.
* The number and complexity of items to be counted.
* Other controls that may be in place during the count, such as the
performance of blind counts.
Key Factor 8: Perform Blind Counts
A blind count refers to the performance of a physical inventory count
without the knowledge of, or access to, the on-hand quantity balance in the
inventory records. Counters are provided the part number, description,
location, and other information necessary to perform the count but not the
item quantity information. Inventory items are counted and compared to the
on-hand balance in the inventory records. If the blind count agrees with the
record on-hand balance, there is a high level of confidence that both the
count and the record on-hand balance are accurate.
Blind counts offer the greatest degree of assurance of accurate and reliable
counts. If the record on-hand quantity is provided to the counters, there is
a risk that the counters will not actually perform the count. They may
visually look at the inventory, conclude that it agrees with the record
on-hand quantity, and record the on-hand balance amount as the physical
count. The counters may be influenced by the record on-hand quantity
provided to them and make assumptions that are incorrect. For example, if
there is a box of 20 items and the record on-hand shows the quantity as 1,
the counters may be influenced to record the count as 1 instead of recording
the correct unit measure count as 20.
We found that blind counts were one of the strongest control measures used
at leading-edge locations. Counters did not have access to record quantity
during the count at 10 of the 12 leading-edge locations. Specifically, six
of the eight locations performing cycle counts and all four of the locations
performing wall to wall counts performed blind counts.
An important consideration in deciding whether or not to perform blind
counts is the strength of control provided by segregation of duties, as
discussed in key factor 5. Counts at all locations performing wall to wall
inventory were completed by warehouse personnel having potentially
conflicting custodial duties. However, management at these locations
mitigated that increased risk by using blind counts and other controls.
Conversely, the two locations performing cycle counts, in which the quantity
was provided to the counters before or during the count, used a dedicated
count team whose members had no other conflicting custodial duties.
Management at these two locations asserted that this approach added to their
efficiency by allowing counters the opportunity to solve variances often
while they were at the inventory item location. They stressed, however, that
the combination of segregated duties along with other control measures, such
as maintaining a history of who performed counts by item and location and
supervisory review, balanced the increased risk of providing the counters
with quantity information.
Case Study
One leading-edge company with over 700 warehouse and distribution centers
performed daily cycle counts. The company used warehouse personnel with
normal warehouse responsibilities, including asset custody, to perform all
first and second counts. A separate inventory control group was responsible
for coordinating and overseeing their physical count(s), performing any
third counts, and researching and reconciling variances. To reduce the risk
of error or fraud increased by the counters having asset custody
responsibilities, the company strengthened controls by using blind counts,
and by restricting access to on-hand balances prior to and during the count.
Strategies to Consider
To effectively use blind counts during the physical count, senior executives
should consider the following:
* Tools used to perform the count (count cards, count sheets, or RF Guns).
* Capability of the inventory system to not provide quantities on count
cards or sheets, and restrict access to on-hand balances prior to and during
the performance of the count, except for authorized personnel.
* Personnel performing the physical count and whether there is segregation
of duties between the responsibilities of asset custody and physical counts.
* Personnel`s experience and knowledge of the inventory items and the count
process.
Key Factor 9: Ensure Completeness of the Count
A complete count requires that (1) the inventory being counted include all
the items that should be present and not include items that are not part of
the inventory and (2) control of the count process is maintained so that all
inventory items that should get counted do in fact get counted. To
facilitate the inventory being completely accounted for and accurately
counted, there are a number of considerations that need to be made before
the actual count begins. These considerations fall into three major
categories:
* Cutoff procedures,
* Preinventory count activities, and
* Control methods for count completion.
Cutoff Procedures
Cutoff is the process of (1) controlling the movement of items between
locations, such as in shipping, receiving, production, and rewarehousing and
(2) coordinating the timing and verifying the movement of items with the
related quantity changes in the inventory system. Cutoff is an essential
procedure to ensure the existence and ownership of inventory. Cutoff can be
achieved in a variety of ways, but the easiest way, in addition to verifying
and coordinating the movement of items and the inventory records, is to
conduct the count when operations are shut down or during a period when
there is limited movement of inventory, such as the graveyard shift or
weekends. All leading-edge locations performing wall to wall counts shut
down their warehouse operations during the physical count.
One of the advantages of performing cycle counts is that companies do not
have to shut down their entire operation, as is normally the case for wall
to wall physical counts. The leading-edge
locations performing cycle counts typically do not stop the movement of
inventory but instead use other controls to ensure that items are not
erroneously omitted, included, or counted twice. These controls include (1)
counting during a slow period of operations when there is little movement,
(2) preventing any movement of the inventory items to be counted on the day
the items are selected for counting, and (3) using system-generated
transaction histories to trace the movement of items and reconcile the
count.
Case Study
One leading-edge location addressed cutoff issues in its distribution center
inventory by using a perpetual inventory system with locator capability. The
difficulties of getting an accurate location count without shutting down
operations were significantly reduced by stopping movement into and out of
locations for the specific items selected for count that day. When the
inventory system selected the items for that day`s count, a -HOLD" indicator
was placed by the system in the record for those items. Warehouse personnel
were thus notified that, with certain exceptions, they were not to pick
items from or store items in those locations until the -HOLD" is released.
Inventory counters are required to complete all counts on the day scheduled
and release -HOLDs" as the counts are completed, including any necessary
recounts and research for variances between the quantity counted and record
on-hand balances.
Preinventory Activities
Preinventory activities, primarily physical location preparation, are
accomplished prior to the physical count in order to increase the efficiency
and effectiveness of the count. Physical location preparation typically
includes (1) organizing work areas and storage locations, (2) identifying
and segregating items, (3) ensuring that all inventory items have labels or
identification, (4) verifying that items are in the correct location, (5)
precounting slow moving items, and (6) identifying excess/obsolete
inventories. In the well run warehouses of the leading-edge locations we
visited, most of these activities were part of their daily routine. Other
preinventory activities needing consideration include the timing of the
inventory, staffing and equipment requirements, review of inventory
procedures, and instructions to and training of counters.
Control Methods for Count Completion
There should be a system to ensure that all inventory items are considered
for count, including items on the receiving dock, in the warehouse, in the
shipping area, in tractor-trailers, and at outside locations, such as owned
or leased warehouses, public storage, or any other locations having
inventory owned by the organization. For inventory outside the direct
control of the organization, management may consider making arrangements to
have the inventory counted by its own employees or by the people responsible
for safeguarding the inventory. If its own employees are not used to count
the inventory, management should consider making arrangements to have its
personnel at the site to observe and verify that the count is preformed
accurately and completely. Leading-edge locations used three primary methods
for determining the quantities of inventory items stored at outside
locations: (1) they count the inventory as part of their physical count
program, (2) they obtain written confirmation and/or monthly statements from
the parties responsible for storing the inventory, or (3) they send
representatives to observe the physical counting of the inventory.
Case Study
One leading-edge location with 20 distribution centers and 80 manufacturing
facilities maintained inventory items in several different locations. Raw
materials, work in process, and finished goods were stored in tank cars,
trucks, pipelines, drums, bins, and racks. Additionally, inventory was
stored at off-site locations controlled by the company and public warehouses
outside the control of the company. To maintain the integrity of the
inventory records, this location counted all inventory items within the
company`s control at least twice a year, and all inventory outside of its
control was physically verified once a year. To verify completeness,
inventory items within the company`s manufacturing, distribution, and
off-site locations were physically counted through regular cycle counts
using prenumbered count sheets that were reviewed by supervisors. In
addition, a company representative was sent to observe and verify the annual
physical count of inventory items held at a public warehouse, and thus
outside the control of the company.
As shown in table 5, control tools are used to determine that every
inventory item gets counted. A manual system, such as count tags or count
sheets, or a computerized inventory locator system that tracks an item`s
location, may be used to verify that every inventory item gets counted once
and only once. Operations without inventory locator systems commonly use
prenumbered count tags, sheets, or cards to ensure that all items are
counted. For example, during a typical wall to wall physical inventory,
personnel count the inventory item, record the count on the upper and lower
part of the tag, and attach one part of the tag to the inventory item and
give the other part to the control desk. The control desk accounts for all
the prenumbered tags and compares the count to the record on-hand
quantities. At the end of and during the inventory count process, the
supervisor walks through the warehouse and visually inspects that a count
tag is attached to every inventory item, which offers some assurance that
all inventory items have been counted. The count tags attached to the
inventory items also ensure that the inventory is not counted twice. A
second check is done by the control desk crosschecking that all the
inventory items recorded on the books have a physical inventory count
recorded. Operations with inventory locator systems rely heavily on their
systems to report any inventory items not counted and where the items are
located.
Leading-edge locations rely on their computerized inventory systems to
ensure that all recorded inventory items are counted. Those performing cycle
counts generally have their computer systems generate a list of items (count
sheets) to be counted each day. The system keeps track of all items counted
and entered into the system. If an item is not counted, the system carries
the item forward and repeatedly lists the item until it is counted.
Supervisors can generate a report
(aging list) to list all items scheduled for a count but not counted. Some
companies have their systems generate locations to be counted, and again the
system tracks all locations that have not been counted. Nine of the twelve
leading-edge locations also test the completeness of their systems by
performing location counts4 in addition to their regular cycle and wall to
wall counts. In other words, they test for the possibility of inventory
items existing on the floor that are not reflected in the records. They
perform these procedures by selecting inventory items in the warehouse and
tracing those items back to the record on-hand balances in the system.
4
Location counts are physical counts used by the leading edge locations to
check the accuracy of their "floor to record" quantities, whereby all items
in a location or area in the warehouse are counted and compared to the
inventory records to ensure the proper recorded quantity and location of an
item.
Strategies to Consider
To ensure completeness of the physical count, senior executives should
consider:
* The organization`s operating environment, time of operations, and it`s
ability to
* suspend operations during the physical count,
* perform counts when there is limited movement of the inventory, such as
nights or weekends, and
* prevent movement of items subject to count on the day of count only.
* Reliability of the inventory system to accurately capture and track
transactions affecting the on-hand balances.
* Existence of slow moving or excess obsolete inventory items that could be
segregated and precounted.
* Existence of inventory stored at outside locations and the personnel or
organization responsible for verifying its physical existence.
* Use of prenumbered count sheets or tags and reconciliation of the numbers
issued to the numbers returned.
* Reconciliation of items selected for count to actual items counted.
* Performance of additional counts where items are selected from the floor
and compared to the inventory system.
Key Factor 10: Execute Physical Count
Practices discussed in earlier key factors lay the foundation for completion
of physical count procedures. Properly executing the count provides accurate
results for (1) comparison of the count to the recorded balances and (2) the
posting of adjustments to the inventory records for financial and
operational decision making. There are five key areas of consideration when
executing the physical count including (1) communication of proper
information to the counters, (2) verification of correct item information,
(3) appropriate method to capture and compare the physical count to the
inventory records, (4) determination of the number of requisite counts to
perform before a count is accepted as final, and (5) timely completion of
the count.
Communicate Information to the Counter
Communication of appropriate information ensures that counters have the
necessary information to perform the count (i.e., items to be counted).
Leading-edge location`s communication to counters is usually in the form of
a list of items to count, such as count sheets, or assigned zones to count,
usually including stock location, stock number, description, and unit of
measure. In instances where blind counts are not being performed, the
quantity to be counted would also be included. This information is normally
provided to the counters on count lists, sheets, cards, or on RF Guns (radio
frequency devices).5
5
RF Guns are handheld units that receive and transmit information to and from
the inventory system. The counter usually scans a bar code for the item or
location for count and the RF Gun displays the information for the item or
location (i.e., unit of measure, stock number, location). The counter then
Verify Item Data and Quantity
Verification of data supplied to the counter ensures that the significant
information in the inventory record is consistent with the physical
information about the item. The data verified by counters at leading-edge
locations typically included stock location, stock number, description, and
quantity in instances where nonblind counts are being performed.
Capture and Compare the Count
The physical count includes the instrument or method used by the counter to
record the results of the physical count for comparison to the on-hand
balance in the inventory system. The leading-edge locations used a number of
techniques to record the results of the physical count-some used traditional
methods, such as manual count sheets or cards, while others used technical
tools, such as RF Guns. When count sheets or cards are used, the actual
physical count is recorded on the sheet or card and is then manually input
into the computer system for comparison to the inventory record. When RF
Guns are used, information is automatically uploaded into the computer
system to capture the count for comparison to the inventory record on-hand
quantities. The comparison of the actual count to the record on-hand balance
determines the variance between the two and the need for recounts or
research. The inventory record on-hand balances are typically not adjusted
until recounts and research are complete. See key factor 11 for a discussion
of adjustments to the record on-hand balance. The majority of the locations
(cycle and wall to wall) used count sheets to record the physical count.
Perform Requisite Number of Counts
Number of counts refers to the number of times an item will be counted
before a final count is accepted. The number of counts by leading-edge
locations ranged from as few as one to any number determined by management
to be appropriate. Counts performed past the first count can be based on any
of the following: a difference between the count and record on-hand balance
(variance), judgment of supervisors or management, variances exceeding
established tolerances, and until two counts agree. There was no minimum
number of counts required past the first count by the leading-edge
locations. The maximum number of required counts varied from two counts up
to the necessary number of counts until two counts agreed. Typically, two or
three counts were performed.
If there is a variance between the count and the record on-hand balance, a
second count is required. Segregation of duties should be reconsidered in
assigning the personnel performing any additional counts. One of the
leading-edge locations used a different count team to perform the second
count. In this leading-edge location, the second count was accepted as the
final, accurate count, after which personnel responsible for recording
transactions, research variances and adjust the record on-hand quantity with
the appropriate approval. Some leading-edge locations perform multiple,
subsequent counts until such time as two counts conclude with the same
quantities.
enters the physical count quantity directly into the RF Gun and the count is
automatically transmitted and captured in the inventory system for
comparison to the on-hand balance.
Complete Counts in a Timely Manner
Timely counts are important due to management`s reliance on the information
in the inventory system for making operational decisions. Whether completing
a single count or multiple counts, the leading-edge locations expected their
count teams to complete their assignments as quickly as possible. The
majority of the leading-edge locations expected the initial count and any
necessary recounts to be completed within 24 hours.
Case Study
One leading-edge location, a 710,000 square foot distribution facility
maintaining over 20 million finished products, performed its counting
procedures with the precision of a well-trained military exercise. Its
-army" of over a dozen dedicated counters cycled through the warehouse
performing counts daily. Warehouse locations were mapped on an Excel
spreadsheet, and the inventory group supervisor assigned zones (warehouse
aisles) to each counter. Counters were provided via RF Gun (radio frequency
device) data on individual items in his/her zone including stock location,
part number, and unit of measure and description. An item`s quantity was not
obtainable by the counter. By scanning the bar-coded location number
contained on a preprinted location marker and entering the item number from
the container, the counter verifies the accuracy of item data contained in
the perpetual record. Once the counter verified that the description was
correct, he/she performed the count and enters the quantity into the RF Gun.
These data are automatically uploaded into the inventory system to capture
the count, at which time a real-time comparison of the counted quantity and
the system balance was made. Any variance is reported to the supervisor via
an on-screen or printed variance report. For inventory items having
variances, second counts are required to be performed within 8 hours by a
different counter. If after the second count, the variance remains greater
than $400, then all locations in the warehouse containing that inventory
item are counted on the next shift to ensure location and total item
quantity accuracy.
Strategies to Consider
To effectively execute the physical count, senior executives should:
* Determine the data to be verified by the count by considering
* knowledge and experience of the personnel performing the count,
* the item data maintained in the inventory system or on location labels,
and
* whether blind counts are to be performed, requiring the restriction of
access to on-hand balances.
* Determine the method to be used to capture and compare the count, such as
count cards, sheets, or RF Guns, by considering
* the capability of the inventory system, and
* ability to use RF devices.
* Determine number of counts to perform by considering
* resources necessary to perform additional counts,
* personnel performing additional counts and their segregation of duties
from asset custody and their knowledge and experience of the inventory and
count process,
* time necessary to complete additional counts promptly, and
* characteristics of the inventory (unit of measure, size, dollar value,
classification, and size of variance in quantity and dollar value) to
establish tolerances for additional counts.
Key Factor 11: Perform Research
Even with a strong control environment and sound physical count procedures,
it is not unusual for there to be differences in quantities between the
physical count and the record. Research of the cause, sometimes referred to
as -root cause analysis," and reconciliation of the difference is an
essential element of an effective physical count process. Research, when
properly conducted, provides support for adjustment to the inventory
records, identifies the causes of variances between the physical count and
the inventory records, and provides management with information with which
to implement corrective actions. The process of research includes performing
the required analysis, promptly completing research, and referring variances
to management for approval and/or security for investigation.
Required Research
Research is the process of investigating a discrepancy, often referred to as
a variance, between the physical count and the on-hand balance. Variances
may indicate that something is wrong with the inventory system or the
warehouse operations that affect inventory balances. In order to reduce the
potential for future errors in the inventory records, it is important to
identify and correct the causes of variances. Management determines which
variances to research and the extent of research necessary to identify the
causes of the variances.
Management`s determination of which variances to research includes
consideration of dollar value, type of item, and the effect of the variance
on the operations of the organization. As the impact of variances on the
financial records or on the operation of the organization increases, it
becomes more important to conduct extensive research. Management may also
determine that the impact of certain variances is insignificant by
establishing a low dollar or quantity tolerance
and allowing adjustment to the on-hand balance in the inventory system
without requiring research. Leading-edge locations researched variances
based on criteria established by management. The criteria established by
management usually included setting quantity or dollar value tolerances.
Tolerances ranged from zero, in which all variances were researched, to 5
percent, in which only those variances exceeding the established dollar
value or quantity tolerance were researched. Others relied on the judgment
of the researcher. Some locations used a combination of tolerances and
researcher judgment depending upon the type of inventory or its impact to
operations. Three of the eight leading-edge locations performing cycle
counts had a zero tolerance for error for all inventory items and researched
all variances. The remaining five locations researched variances that
exceeded established dollar value or quantity variances by type of item,
and/or on the basis of the researcher`s assessment of the impact to
operations. Two of these five locations had established tolerances ranging
from zero to five percent based on product type. Locations performing wall
to wall physical counts researched variances based on established dollar and
quantity tolerances, as well as the judgment of the researcher. If a
variance did not meet management`s criteria for research, the on-hand
balance in the inventory system was usually adjusted to reflect the actual
physical count. Table 6 shows the established criteria for researching
variances at leading-edge locations.
Table 6: Criteria For Variances Researched
Cycle count Wall to wall count
Established criteria locations locations
2 7 8 9 10 11 12
Zero tolerance (all variances 1 3 4 5 6
researched)
Variances > $100 !
Variances > $1000
Variances > 3-5 percent quantity
variance
Judgment of researcher (based on
impact on operations)
Note: Indicates applicability to the 12 locations studied from the 7 companies
selected.
Once management determines which variances to research, it is essential to
(1) correctly adjust the change in inventory balances to accurately reflect
the physical on-hand quantity and (2) identify the cause of the variance.
The extent of research may include reviewing (1) transaction histories, (2)
shipping and receiving records, and (3) production usage records. We found
that all of the leading-edge locations researched transaction histories,
movement of items during the count, and shipping and receiving documents to
ensure proper adjustment of the inventory records and identify causes of
variances. After research was completed on the selected variances, an
adjustment was posted to the on-hand balance in the inventory system to
reflect the actual physical count.
Identifying the causes of variances is useful in detecting weaknesses in the
underlying controls and individual processes that affect the inventory
system record. Grouping and tracking the nature or type of errors into
assigned codes is an effective tool for analyzing causes of variances and
implementing corrective actions to reduce future errors. For example, a
leading-edge location`s assignment of error codes enabled the company to
implement corrective actions and process improvements, which increased the
location`s inventory record accuracy and decreased operating costs. We found
that four of the locations performing cycle counts assigned and tracked
error codes. The number of error codes used by the leading-edge locations to
identify causes of variances averaged 22 and included codes for incorrect
entries, leaks or spills, wrong location, receipt error, stock picking
error, and shipping error.
Case Study
One leading-edge location with over 113,000 stock numbers and approximately
$222 million in inventory used a separate inventory group to research
variances. Its research included reviewing transaction histories, shipping
and receiving records, and documenting in-transit items to identify causes
of variances. Also, management at the location had established criteria to
determine what level of research was required for each type of item. The
inventory was segmented into two primary types of items-type -A" and -B." A
zero tolerance was established for type -A" items, for which all variances
were researched. A 3 percent quantity tolerance for type -B" items was
established for which only quantity variances in excess of 3 percent of the
record on-hand balance were researched.
Timely Research
Prompt completion of required research is key to identifying and correcting
the causes of variances. As the amount of time between the discovery of an
error in the inventory records and research increases, the more difficult it
is to identify the cause of the error. Adjustments posted promptly to the
inventory and financial records provide reliable information for use by
management. We found that the majority of the leading-edge locations
performed and completed research either the same day as the original count
or by the end of the following day. This allowed for timely adjustments to
the inventory records and immediate corrective action to prevent future
errors.
Approval and Referral of Adjustments
Approval of adjustments by management and referral of potential fraud or
theft to investigators helps ensure reliable counts and research. We found
that all of the leading-edge locations routinely referred adjustments to
management for approval. As the dollar amount of the adjustment increased,
the approval level within the company increased. The approval levels
progressed from the lead or supervisor of the researcher up to the location
or plant manager. Although the leading-edge locations indicated that they
did not have significant problems with fraud or theft, some locations
regularly reviewed adjustments and trends on items susceptible to fraud or
theft in case referral to security or law enforcement was necessary.
Strategies to Consider
To effectively research variances arising from the physical count, senior
executives could:
* Establish tolerances or criteria for selection of variances to research
such as
* effect on operations or mission readiness,
* quantity and dollar value, and
* characteristics of the items with the variance, such as sensitive,
classified, or items susceptible to fraud or theft.
* Develop processes for how to perform research, such as procedures for
reviewing movement of items during the count, transaction histories, and
shipping and receiving documents, by considering
* reliability of the inventory system to accurately capture transactions
affecting the on-hand balance,
* time necessary to complete the research promptly, and
* knowledge of the personnel performing the research.
* Establish error codes that would identify the cause of variances.
* Set approval levels for adjustments that move up the chain of management
as the dollar value increases or the nature of the item requires a higher
level of approval.
* Define responsibility for reviewing adjustments and trends on sensitive
and classified items and items susceptible to fraud or theft, and notify
security or law enforcement.
Key Factor 12: Evaluate Count Results
Evaluating the results of the physical count is essential to an accurate and
effective physical count process. The evaluation of the results gives
management the necessary information for measuring the effectiveness of (1)
the physical count and (2) corrective actions or improvements to the
inventory process and system. Evaluation includes measuring the results of
the count, communicating the results, and modifying existing policies and
procedures.
Performance Measures
The results of the physical count can be measured several ways. Calculating
an inventory record accuracy rate, summarizing the number and dollar value
of adjustments, errors, or items counted, and tracking and analyzing error
code frequencies are three ways to measure results.
A common method of measuring the results of the physical count is the
calculation of an inventory record accuracy rate. Inventory record accuracy
rates measure the degree of agreement between the balance in the inventory
records and the physical count. When calculating inventory record accuracy,
it is necessary to define what will be considered an error. An error can be
defined in various ways, including (1) any error in the item record, such as
location, description, and quantity or (2) quantity errors exceeding
established tolerances. Tolerance is a range within which an actual value or
quantity can disagree with the inventory record and still be considered
accurate for the purposes of calculating inventory record accuracy.
Tolerances are typically based on an item`s or a segment of item`s usage or
volume, dollar value, lead-time, and criticality to production or
operations. The range of tolerance may be as low as zero, in which all
quantity differences are considered errors, upward to -X" percent, in which
quantity differences only in excess of that amount are considered errors.
Once the definition of
what constitutes an error has been established, the inventory record
accuracy rate can be calculated. There are multiple ways of calculating
inventory record accuracy; however, the common method is:
Number of accurate items or records x 100% = record accuracy rate Number of
items or records counted
Leading-edge locations evaluated the results of physical counts using
various performance measures, including inventory record accuracy
calculations. Six of the eight leading-edge locations performing cycle
counts measured inventory record accuracy. Locations measuring inventory
record accuracy defined an error as either (1) any error in the inventory
record (quantity and location) or (2) any quantity error exceeding
established tolerances. Established tolerances ranged from 0 to 5 percent;
however, four of the six locations had a zero quantity tolerance for all
items or segments of items. Three locations performing cycle counts had
established separate tolerances for identifiable segments of their inventory
based on type of item, dollar value, activity, or criticality of an item to
operations. For example, one location (shown as location 3 in table 7)
segmented its inventory by type of items (type -A" and -B"). It established
a zero tolerance for the -A" segment, in which any difference in the
inventory record counted as an error. It established a 3 percent tolerance
for any quantity differences exceeding 3 percent of the on-hand balance for
the -B" segment of inventory. Table 7 illustrates leading-edge locations`
measurement of inventory record accuracy, definition of errors, and
tolerances established by management for use in calculating inventory record
accuracy.
Table 7: Performance Measures
Cycle count Wall to wall count
Performance measures locations locations
1 2 3 4 5 6 7 8 9 10 11 12
Inventory record accuracy
Other performance measures
Error definition
Any error in the inventory record
(location, quantity, stock number)
Quantity errors
Zero tolerance (all quantity
differences are errors)
!
Greater than 0 but less than
5-percent tolerance (quantity
differences exceeding the tolerance
are errors)
Note: Indicates applicability to the 12 locations studied from the 7 companies
selected.
The leading-edge locations performing wall to wall counts and two of the
companies performing cycle counts did not calculate inventory record
accuracy rates but instead measured the results of the physical count using
other methods. These other methods included (1) total quantity adjustments,
(2) total dollar value of adjustments, and (3) number of errors by error
code. Quantity and dollar values of adjustments were measured in both gross
(sum of the absolute value of adjustments) and net (mathematical sum of the
adjustments). These other performance measures were also used by locations
calculating inventory record accuracy rates in evaluating their physical
count, as shown in table 7.
Communication of Results
Communicating the results of each physical count is essential to achieving
and maintaining accurate, reliable counts and records and improving the
results of future physical counts. The results of a count should be
communicated to the people doing the work, including counters and warehouse
employees, and to management. Communication of results to the counters
reinforces the results of their work and the importance of reliable counts.
Likewise, communication to warehouse employees makes them aware of the
effect they have on the results of the count as they perform their daily
activities and the importance of doing their jobs correctly. Communicating
the results of the count conveys the importance of accurate records to all
personnel and enforces management`s dependence on personnel to achieve
accurate records. Communicating the results to management ensures that
management is informed and can then assess the impact on operations and
implement corrective action.
All of the leading-edge locations communicated the results of the physical
counts to management, counters, and/or warehouse personnel. Management was
forwarded the results of the physical count in the form of reports
containing inventory record accuracy, amount of adjustments, and trend
analysis of error codes. Weekly and monthly meetings were held with the
managers responsible for the physical count, warehouse operations, and other
areas affecting the inventory. The meetings were used to discuss the results
of the count, including inventory record accuracy, amount of adjustments,
and trends or error codes in order to identify the impact to the company`s
operations and address problems. The results of the physical counts were
communicated to counters and warehouse employees in the form of display
boards or scorecards published for areas of the warehouse, which were
displayed around the warehouse in highly visible locations. At one of the
leading-edge locations, the results of the physical count and the impact
each employee had on the accuracy of inventory records was discussed during
a quarterly meeting with all employees.
Modification of Policies and Procedures
Once the results of the physical count have been evaluated and communicated,
it is useful to -close the loop" of the physical count by considering
indicated changes to the inventory count and management process and making
appropriate modifications to policies and procedures. Management`s
assessment of the results of the physical count and employee feedback is
useful in determining the effectiveness of the physical count. The results
may indicate the need to count a particular item more frequently due to high
errors. Conversely, an item that has not had any errors and little activity
may be counted less frequently. In other instances, the makeup of the
inventory or the operations of the organization may have changed, in which
case management may need to reconsider the significance of items and the
frequency with which they should be counted. It is important that lessons
learned from each physical count result in changes that improve the physical
count process and inventory management process. We found that the
leading-edge locations routinely updated policies and procedures for the
physical count process as a result of changes to processes or systems, and
at a minimum reviewed the adequacy of documented and performed procedures
every 1 to 2 years.
Case Study
One leading-edge location, a 710,000-square foot distribution center with
over 380 employees, used a variety of methods to evaluate and communicate
the results of its physical count. Results were measured with a combination
of an inventory record accuracy rate, dollar value and quantity of
adjustments, number of accurate counts, and analysis of error codes assigned
to variances. A daily report was sent to the inventory managers and
supervisors summarizing the number of items counted, accuracy rate, and
dollar value of adjustments. Once a week the results of the count were
published and posted in the warehouse summarizing the current accuracy rate
and trends, as well as successes and problem areas. The location also held
weekly and biweekly meetings with operation managers, the inventory group
supervisor, inventory managers for material returns and receiving, quality
control, engineering, and the director of operations to discuss the results
of the count and causes of the variances-the purpose of which was to correct
problems and improve operations on a -real-time" basis.
Strategies to Consider
To evaluate the results of the physical count process, senior executives
should consider the following:
* Establish performance measures that are aligned with organizational
objectives and strategies and that are useful in evaluating the results of
the physical count.
* Determine the methods to be used to measure performance of the count by
* defining an error for purposes of measuring performance, and
* establishing tolerances based on characteristics of the inventory and the
quantity or dollar value of the variances to be considered in error.
* Establish mechanisms to communicate results and performance measures to
counters, warehouse personnel, and managers.
* Establish routine meetings with managers from all aspects of the inventory
process including the physical count, receiving, shipping, ordering,
stocking, and production, to discuss results and measures and evaluate the
causes of the errors to identify corrective actions and assign
responsibility for those actions.
* Use results and performance measures as a basis to make changes to the
process and modify existing policies and procedures to reflect changes in
the processes.
Appendix I: Implementation Checklist
Planning, Conducting, Researching, and Evaluating a Count of Physical
Inventory
(An Implementation Checklist)
This checklist is provided as an aid to making and documenting decisions in
the planning, conducting, and/or auditing of the inventory count process and
researching and evaluating its results. It is presented in the chronological
order of the major steps of the process. References are provided to the 12
key factors in the body of the report, which provide guidance in considering
the issues and factors involved in the decision-making processes.
The checklist is segregated into the following four major sections, with
eleven steps to consider categorized in the numbered subtitles, as follows:
Planning 1) Select an approach to the count 2) Determine count frequency 3)
Organize the count team(s)
Counting 1) Accomplish appropriate cutoff 2) Perform pre-inventory activities
3) Count the inventory
Research and Adjustments 1) Perform research 2) Adjust the record
Evaluation of Results 1) Determine the record accuracy rate 2) Consider other
performance measures 3) Communicate the results of the count
Appendix II: Objectives, Scope, and Methodology
To determine the principles fundamental to achieving consistent, accurate
counts of physical inventories, our objectives were to (1) identify
inventory counting procedures that have been successfully implemented by
private sector companies recognized as leaders in inventory accuracy and (2)
provide examples (case studies) of counting procedures used by these
companies that might help federal agencies improve the accuracy and
reliability of their inventory and property records.
To fulfill our objectives, we identified 80 companies, 77 of which were
Fortune 500 companies, with large inventories that are considered to be
leaders in inventory management. In order to identify these companies, we
consulted with experts in the field of inventory management. Our contacts
included professionals from the major accounting firms of KPMG Peat Marwick
and Ernst and Young, LLP, and professors at the Massachusetts Institute of
Technology and Ohio State University. We also researched publications issued
by CIO 100, Industry Week, and the American Productivity and Quality Center
(APQC), and we considered companies that were winners of the prestigious
Malcolm Baldridge National Quality Award.
From these 80 companies, we identified 22 companies having best practices in
inventory management. Our selection was based on the company receiving
recognition for outstanding inventory management practices by at least three
of the above named sources. In order to confirm our selections as best
practice companies, we sent a survey to each company to obtain information
on inventory record accuracy rates, policies and procedures, physical count
methods, research, training, and willingness to participate in our study.
Eleven of the twenty-two companies returned the survey; from the pool of
eleven we selected seven companies willing to participate in our study. Our
selection was based on (1) reported accuracy rates, (2) size and types of
inventory, and (3) existing count procedures and controls. Based on these
criteria, we selected the following companies:
Some of the selected companies employed more than one counting methodology
and allowed us to review their practices and processes at more than one
operating location. A total of 12 separate locations from the seven
companies were studied.
To gather the data needed from each company, we developed a structured
interview checklist to cover the following areas: planning, execution,
research, evaluation, training, and policies and procedures for the physical
inventory count process. We consulted professional guidance issued by the
American Institute of Certified Public Accountants and an accounting firm in
designing the structured interview.
During each site visit, we completed our structured interview checklist
through interviews with officials responsible for inventory management and
record accuracy. We also toured the companies` warehouses, distribution
centers, and production and assembly plants to obtain an understanding of
how inventory counting procedures were implemented at these locations. We
relied on company officials to describe their processes to us. We did not
verify the accuracy of their statements or any information provided to us,
but, wherever possible, we obtained and reviewed company documents
describing the inventory counting and verification processes. The
documentation we obtained was consistent with the information we reported.
Based on the information we obtained from each of our site visits, we
consolidated and refined the inventory counting principles and practices to
those presented in this guide. We asked officials at each of the seven
private sector companies we studied to confirm the accuracy and completeness
of the information presented in the report and incorporated their comments
as appropriate. However, we did not independently verify the accuracy of the
information the officials provided.
Appendix III: Bibliography
Brooks, Roger B., and Wilson, Larry W. Inventory Record Accuracy: Unleashing
the Power of Cycle Counting. Essex Junction: Oliver Wight Publications,
Inc., 1993.
Edwards, Douglas J. -The Best 100." Industry Week (August 16, 1999)
Taninecz, George. -IW`s Ninth-Annual Honor Roll." Industry Week (October 19,
1998)
-Practicing Judgment." CIO Magazine, August 1, 1995.
Appendix IV: Other Related Publications
Financial Management
U.S. General Accounting Office. Executive Guide: Creating Value Through
World-class Financial Management. AIMD-00-134. Washington, D.C.: April,
2000.
U.S. General Accounting Office. Standards for Internal Control in the
Federal Government. GAO/AIMD-00-21.3.1. Washington, D.C.: November, 1999.
U.S. General Accounting Office. Managing for Results: Strengthening
Regulatory Agencies` Performance Management Practices. GGD-00-10.
Washington, D.C.: October, 1999
U.S. General Accounting Office. Program Measurement and Evaluation:
Definitions and Relationships. GAO/GGD-98-26. Washington, D.C.: April, 1998.
U.S. General Accounting Office. Executive Guide: Effectively Implementing
the Government Performance and Results Act. GAO/GGD-96-118. Washington,
D.C.: June, 1996
Human Capital Management
U.S. General Accounting Office. Human Capital: Key Principles From Nine
Private Sector Organizations. GAO/GGD-00-28. Washington, D.C.: May, 1998.
Systems Requirements and Checklists
U.S. General Accounting Office. Property Management Systems Requirements:
Checklist for Reviewing Systems Under the Federal Financial Management
Improvement Act. GAO-02-171G. Washington, D.C.: December, 2001.
U.S. General Accounting Office. Core Financial System Requirements:
Checklist for Reviewing Systems Under the Federal Financial Management
Improvement Act. AIMD-00-21.2.2. Washington, D.C.: February, 2000.
U.S. General Accounting Office. System Requirements for Managerial Cost
Accounting Checklist: Systems Reviewed Under the Federal Financial
Management Improvement Act of 1996. AIMD-99-21.2.9. Washington, D.C.:
January, 1999.
U.S. General Accounting Office. Inventory System Checklist: Systems Reviewed
Under the Federal Financial Management Improvement Act of 1996. Exposure
Draft, AIMD-98-21.2.4. Washington, D.C.: May, 1998.
U.S. General Accounting Office. Business Process Reengineering Assessment
Guide. GAO/AIMD-10.1.15. Washington, D.C.: April, 1997.
U.S. General Accounting Office. Framework for Implementation: Job Process
Reengineering. GAO/OIMC-95-8. Washington, D.C.: May, 1995.
Appendix V: Acknowledgment of Best Practice Participants and Advisors
We would like to acknowledge and thank the following companies whose
management and staff provided advice and assistance throughout this project.
Leading-edge Companies
The Boeing Company Seattle, Washington
DaimlerChrysler AG Stuttgart, Germany
E. I. DuPont De Nemours and Company Wilmington, Delaware
FedEx Corporation Memphis, Tennessee
General Electric Company Fairfield, Connecticut
Honeywell International Inc. Morristown, New Jersey
Minnesota Mining & Manufacturing Company St. Paul, Minnesota
Project Advisors
The Gillette Company Boston, Massachusetts
Private Sector Council Washington, DC
Raytheon Company Lexington, Massachusetts
Samsonite Corporation Denver, Colorado
Appendix VI: GAO Contacts and Staff Acknowledgments
GAO Contacts
Paul D. Kinney (303) 572-7388 Stephen W. Lipscomb (303) 572-7328
Acknowledgments
In addition to those named above, Letha C. Angelo and Robert A. Sharpe made
key contributions to this report.
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