How to reconcile inventory

You reconcile inventory when you compare the inventory counts in your records to the actual amounts on the warehouse shelves, figure out why there are differences between the two amounts, and make adjustments to your records to reflect this analysis. Inventory reconciliation is an extremely important part of cycle counting, since the warehouse staff uses it to continually update the accuracy of its inventory records. Inventory record accuracy is needed to ensure that replacement items are ordered in a timely manner, that inventory is properly valued, and that parts are available for sale or production when needed.

An inventory reconciliation is also needed to ensure that the actual and recorded inventory amounts are the same at the end of the year, so that there will be no issues when the inventory is audited.

Inventory reconciliation is not as simple as adjusting the book balance to match the physical count. There may be other reasons why there is a difference between the two numbers that cannot be corrected with such an adjustment. In particular, you should consider following any or all of these steps:

  • Recount the inventory. It is entirely possible that someone incorrectly counted the inventory. If so, have a different person count it again (since the first counter could make the same counting mistake a second time). Further, if the physical count appears to be significantly lower than the book balance, it is quite possible that there is more inventory in a second location - so look around for a second cache of inventory. Recounting is the most likely reason for a variance, so consider this step first.
  • Match the units of measure. Are the units of measure used for the count and the book balance the same? One might be in individual units (known as "eaches"), while the other might be in dozens, or boxes, or pounds, or kilograms. If you have already conducted a recount and there is still a difference that is orders of magnitude apart, it is quite likely that the units of measure are the problem.
  • Verify the part number. It is possible that you are misreading the part number of the item on the shelf, or guessing at its identification because there is no part number at all. If so, get a second opinion from an experienced warehouse staff person, or compare the item to the descriptions in the item master records. Another option is to look for some other item for which there is a unit count variance in the opposite direction - that could be the part number that you are looking for.
  • Look for missing paperwork. This is an unfortunately large source of inventory reconciliation issues. The unit count in the inventory records may be incorrect because a transaction has occurred, but no one has yet logged it. This is a massive issue for cycle counters, who may have to root around for unentered paperwork of this sort before they feel comfortable in making an adjusting entry to the inventory records. Other examples of this problem are receipts that have not yet been entered (so the inventory record is too low) or issuances from the warehouse to the production area that have not been entered (so the inventory record is too high).
  • Examine scrap. Scrap can arise anywhere in a company (especially production), and the staff may easily overlook its proper recordation in the accounting records. If you see a modest variance where the inventory records are always just a small amount higher than the physical count, this is a likely cause.
  • Investigate possible customer ownership. If you have no record of an inventory item at all in the accounting records, there may be a very good reason for it, which is that the company does not own it - a customer does. This is especially common when the company remodels or enhances products for its customers.
  • Investigate possible supplier ownership. To follow up on the last item, it is also possible that you have items in stock that are on consignment from a supplier, and which are therefore owned by the supplier. This is most common in a retail environment, and highly unlikely anywhere else.
  • Investigate backflushing records. If your company uses backflushing to alter inventory records (where you relieve inventory based on the number of finished goods produced), then the bill of materials and the finished goods production numbers had better both be in excellent condition, or the reconciliation process will be painful. Backflushing is not recommended unless your manufacturing record keeping is superb.
  • Accept the variance. If all forms of investigation fail, then you really have no choice but to alter the inventory record to match the physical count. It is possible that some other error will eventually be found that explains the discrepancy, but for now you cannot leave a variance; when in doubt, the physical count is correct.