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Michal Kováč | January 10, 2023

Physical inventory (assets, inventories) as a determination of the true state of assets

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The topic of inventory tends to be repeatedly discussed near the end of the accounting period and for many companies it is an annual menace that is both time-consuming and organisationally demanding. It is the responsibility of every company that has any stock, assets or cash registers to perform a physical inventory taking. This obligation is imposed on us by article 6(3) of the Accounting Act (hereinafter the AA). If the accounting entity fails to perform inventory taking, the accounts are deemed to be inconclusive based on article 8(4) of the AA.

The legal framework, on which we can rely regarding the issue of inventories, can be found in articles 29 and article 30 of the AA, which, in addition to physical inventory, also deals with documentary inventory. As such, the inventory does not always need to be taken on balance sheet date to be effective, but can be taken 4 months before and 2 months after the balance sheet date. However, it is necessary to keep in mind that once we take inventory on a date other than the balance sheet date, we must be able to substantiate the balances from the inventory date to the balance sheet date by, for example, performing a roll-up or roll-down from the inventory date to the balance sheet date. In other words, the accounting entity must reliably document all movements (additions and disposals) during that period. It is also important to bear in mind that the accounting entity must be able to demonstrate that a physical inventory has been performed for a period of 5 years from the end of the accounting period, to which the physical inventory relates.

So what is the main objective of physical inventory taking?

It should be a determination of the actual balances of assets, inventories, cash, liquid valuables, etc. This is done by various methods such as counting, measuring, weighing, expert estimation, etc. At the same time, we identify any variance that we have recorded in the accounts. We do this mainly in order to ensure correct valuation of assets and inventories in the accounting, i.e. we do not only examine the quantity, but also the wear and tear and usability of inventories and assets.

Each inventory taking should have predetermined rules that are established in the Inventory Guideline reflecting the following:

  • basic principles for inventory of assets and liabilities,
  • inventory schedule,
  • appointment of inventory committees and responsible staff,
  • the moment the inventories are taken,
  • establishing a system for controlling and performing the inventory in terms of completeness, accuracy and quality,
  • determination of natural shrinkage within the standards, if existing,
  • familiarisation and training of responsible staff,
  • inventory lists,
  • evaluation of inventory results (identification of inventory differences, substitutions and shortfalls to the standard) and subsequent settlement of inventory differences within the accounting for the period, for which the physical inventory is performed.

The scope of the guideline can then be tailored to the needs of every company. This guideline should not only serve to fulfil an obligation but should be a tool for a good internal control system and it should help us to perform the inventory correctly and accurately.

Evaluation of the inventory count

The result of each inventory is the so-called inventory list, the form of which is specified in article 30 of the AA.

Specifically, it is:

  • identification of inventoried assets and liabilities, indication of quantity,
  • the signature record of the person responsible for establishing the facts referred to in the previous point and the signature record of the person responsible for performing the inventory taking,
  • the method of ascertaining the actual balances,
  • valuation of assets and liabilities in a periodic inventory taking as of balance sheet date or, if the accounting entity has determined one, as of the reference date,
  • valuation of the assets in the interim inventory as of the date of completion of the inventory taking, or as of the reference date, if the accounting entity has determined one,
  • the point in time, at which the financial statements are compiled,
  • the reference date, if the accounting entity has determined one,
  • the moment of commencement and the moment of completion of the inventory.

We will now look at some of the specifics of physical inventory count of stock and assets.

Physical inventory count of stock

During physical inventory taking, we mainly check the actual stock in units of measure, but it is equally important to check for obsolescence, expiry or damage to individual stocks.

Before the start of the inventory, when we have compiled a guideline, trained staff, established inventory committees, and the accounting office has accounted for all inventory movements as of the date of the inventory taking, we identify all locations, where we have stored inventory, including all consignment warehouses, which we must not forget to subject to inventory taking as well. At the same time, we must also take inventory of the stock that is, for example, at a trade fair or in a showroom (whether on or off the company premises) at the time of the inventory taking. We also need to be careful about stock that we have stored in a warehouse but do not have in our possession. These stocks may be owned by our supplier or we may store goods for third parties. The inventory items in question are not subject to the company’s inventory taking and should be marked specially or stored separately, in order to prevent them from being counted in the inventory.

The inventory process may be individual, depending on the nature of the inventory and its units of measurement. The actual recording of inventories can be varied, some prefer printed “blind” reports (not containing the quantity of stock) on paper, where the quantity is then written down, other companies prefer inventories using readers, where it is necessary to provide the necessary support and cooperation with regard to the technical aspect of the inventory and its evaluation. When planning and organising inventory taking, we must not forget about technical progress, i.e. fully automated warehouses, without the presence of a warehouseman (physical person) and without the possibility of an inventory committee entering the warehouse.

The result of the inventory will be an inventory list, which should contain the elements described above.

Physical inventory of assets

The inventory of assets is in many ways the same as the inventory of stock. It is also necessary to define in advance the assets that the company does not own. This is often the case, for example, with machinery or cars purchased on lease. For assets, in addition to finding out the actual state, the overall condition of the asset should also be looked at. This is mainly in terms of whether the equipment is more worn out than anticipated when it was classified, or whether the asset is damaged and no longer serves its purpose. If any of these facts are discovered during the inventory taking, they must be reflected in the accounting itself, i.e. by removing and depreciating the assets from the inventory or by adjusting the related accounting depreciation plan or by creating/adjusting the value of a valuation allowance.

The process and outcome of the asset inventory is be the same as with the inventory of stock.

Physical inventory of cash, liquid valuables

Inventories of cash and liquid valuables should not be neglected in physical inventory taking. Cash balances should not merely be transcribed from the cash books but should be properly converted according to the individual currencies at the end of the accounting period. The same rules apply to liquid valuables. The results of the inventory taking are also recorded in the inventory lists.

Physical inventory and the presence of an auditor

If the accounting entity is mandatorily audited, or has its financial statements audited voluntarily, or if the company undergoes some form of merger/acquisition, an auditor is required to participate in the actual physical inventory of the area he/she has assessed as significant or even risky. Thus, the auditor participates in the counting/weighing/measurement etc. on the date of the physical inventory taking, but only as an observer. The auditor therefore only supervises the course of the inventory, keeping his own records of the quantities found, and then makes an overall assessment from his own perspective and compares his results with the conclusions of the accounting entity.  

What to say to conclude….

When performing or monitoring inventory taking, we may discover some weaknesses, such as securing inventory against loss, theft, damage, etc. It helps us to detect unnecessary stock for sale or production. For spare parts or specific items in the company’s inventory, on the other hand, there may be a paradoxical situation that, according to the inventory aging, the stock may be obsolete, but yet it is “priceless” for the company because it is no longer available.

Physical inventory taking is a complex process, where, with the correct procedure not only of performing it, but also of the subsequent evaluation, the company can obtain valuable information, among other things, for the future development (optimization) of its business activities, and therefore it should not be underestimated.

We wish you good luck with this year’s inventory taking.

Author: Michal Kováč, Petra Stumpfová