Inventory management accounting is an internal business process that companies use to ensure proper control of inventory. This process is often part of the accounting department and involves the heavy use of the company’s automated accounting software package. Reconciliations are a big part of inventory management accounting, as accountants will need to review the information stored in the computer software program and compare it to the actual inventory in the company’s warehouse. A few different options are available for companies needing to institute a management accounting process for inventory.
One of the first issues a company needs to decide for its inventory management accounting process is to operate a perpetual or periodic inventory system. A perpetual system will update inventory accounts every time the company buys, sells or adjusts inventory items in the accounting software program. This system also ensures the company has an accurate record of inventory in terms of overall dollars. Less reconciliation is necessary during the perpetual inventory process as the system maintains a constant track of inventory.
Periodic inventory systems are less intense than perpetual systems. However, the system is less accurate and requires a full inventory every few weeks or months. Accountants will need to create a record of inventory from their software package and compare it to actual inventory. Major adjustments are often necessary to correct major differences between the two inventory figures.
Another major part of inventory management accounting is to select an inventory valuation system. Common accounting inventory valuation methods include FIFO (first in, first out), LIFO (last in, first out) and weighted average. Many companies use the FIFO method as it is simple and results in older inventory sold first, reducing the chance of write-offs for obsolete inventory. LIFO inventory valuation sells newer inventory first; this often results in higher cost of goods sold and lower net income. Therefore, LIFO will result in lower tax liability for the company at year end.
Internal controls are another part of inventory management accounting. These controls limit the number of employees who can access inventory information or complete adjustments or other accounting activities relating to inventory. For examples, controls will restrict access to the system, create audit trails so managers can see which employee worked on inventory projects, locking physical inventory in secure locations and using periodic audits to provide a third-party opinion on the company inventory process. Other controls may be necessary depending on the company’s operating procedures and industry, such as manufacturing or retail.