How to deal with inventory and stocktaking

One of the key activities in the year-end closing and financial statements preparation is stocktaking. Finding out the actual balances of assets and liabilities and comparing them with accounting records is one of the basic prerequisites for the quality of financial statements. Attention paid to the inventory count process may indicate procedural shortcomings or possible improvements in the company's management, internal controls, as well as in its bookkeeping. In the article, there are the common issues that are associated with the inventory count process in practice.

Physical inventory

A physical count of stock and assets cannot be carried out by claiming that reality corresponds to the balances generated from the accounting records. Where possible, the balances must always be identified and verified physically. Making it appear that an inventory was taken, lacks its purpose, which is to find out the actual quantities. Physical count is not considered to be copying the balances on stock cards. The aim of the physical inventory is therefore not to copy the stock level from a pre-printed report or to reconcile the balances defined in this way, but to find out the actual level and possible differences from accounting records using various methods (counting pieces, weighing, measuring, combining processes, etc.). Therefore, we recommend that you always use blank reports where the inventory committee will not see the balances recorded in the accounts.

Replacement of physical inventory with the so-called book inventory is usually not possible, as is sometimes said in practice. For example, for cash in hand which should be physically recalculated, it is not enough to match the balance with other (accounting) records, for example, a cash book, but in this case it is necessary to physically add up individual coins and banknotes and compare them with accounting.

The demand for the independence of the inventory committee is also something to consider. Will the warehouse manager, who has signed an agreement on material liability, be interested in finding out the actual quantities, or will he/she prefer a “trouble-free” inventory taking without any consequences? Or as they say: trust, but verify. It is not appropriate that there should be a “chain of reliance of one link on the previous one…”. On the contrary, the whole system, the quality and efficiency of the inventory is strengthened by the pre-announced system of random checks by inventory sub-committees, recalculation and verification of identified quantities and balances.

Book inventory

Missing book inventory is a common problem for smaller or newly emerging entities with a small accounting team. The priority in the hectic time around the end of the reporting period is the inventory count of stock or tangible fixed assets; as a result, the obligation of the book inventory, which is imposed by the Accounting Act in par. 2, Section 30, letter b, is sometimes neglected:

“The actual balances of an entity’s assets and liabilities during the inventory count shall be determined by (a) a physical inventory of tangible assets or intangible assets, or (b) a book inventory of liabilities and receivables, or of other components of assets for which a physical inventory cannot be taken.”

The book inventory consists essentially of verifying the correctness and clear supportability of the final balance of the relevant account (including off-balance sheet accounts) on the basis of documents that verify or document the individual items (accounting entries) that make up this final balance (actual balance).

In addition, it is appropriate to identify or confirm other facts characteristic of the relevant type of asset or liability, such as in the case of receivables, whether their existence has been agreed with the debtors or whether the amount of the provision against receivables corresponds to the entity’s methodology for provisioning against bad debts, overdue receivables, etc.

Part of the book inventory is also a potential correction of balances and adjustments arising from the errors identified in the physical inventory.

Inventory plan

The starting point for the whole inventory count process should be a correctly compiled internal regulation with a timetable and a factual description of the process. The stocktaking and inventory plan must be drawn up before the first inventory starts, and the book inventories should not be omitted.

Do you know about the possibility of continuous stocktaking?

Continuous stocktaking may be carried out throughout the entire reporting period, but only in respect of stock for which records are kept by type, by place of storage or by persons materially liable, as referred to in paragraph 2, Section 29 of the Accounting Act.

As legislation suggests, it is particularly important to consider the nature of the stock. In the case of stock records by type, an inventory count shall be carried out on a specific type of stock, even if it is stored in individual stores or warehouses. The storage location for a stationery retail can be one particular store with the placement of stock on the shelves. It can be used even if there are more responsible persons who manage stock, e.g. managers of individual stores.

It is therefore desirable to organise the continuous stocktaking properly, for example by issuing an internal regulation by the management of the entity. An annual written plan, in which the subject and deadlines of the inventory count are determined, is also necessary and serves to specify, for example, the individual types of stock and the date on which their stocktaking is carried out – but this also applies to a periodic inventory count. Continuous stocktaking may only work if warehouse records are kept properly, the entity has “order” in the warehouses and there are no transfers of inventory, etc.  This avoids possible problems when in the month of June there is a shortage in stock A and in the month of July there is a surplus of the same type of material in the same amount in stock B.

Continuous stocktaking may also be suitable for tangible fixed assets which, due to the function they perform in the entity, are in continuous motion and do not have a permanent place where they belong (e.g. wagons/containers). It is advisable to consider it in the case of a large number of fixed assets or inventories, where, in addition, there is a movement of assets and no shutdown due to the inventory count is appropriate for technical or business reasons.

The benefit is also a smaller burden for the company and the distribution of the process throughout the year, as well as a smaller number of employees needed to implement it. All types of stock and tangible assets indicated must be inventoried at least once per reporting period.

Inventory and Covid-19

The presence of the pandemic in the last two years complicates not only the regular operation of entities but also the inventory count process. However, the current situation should not be a reason to avoid it and not to carry out stocktaking. Nor can it be assumed that Covid will disappear anytime soon.

In this context, entities are all the more considering the transition to continuous stocktaking. Among other things, this could reduce the risk of quarantine or a high employee sickness rate affecting the organisation and logistics of inventories.

Let us also not forget the fact stated in Section 30 (6) (b) of the Accounting Act, according to which it is possible to carry out (start and end) a periodic inventory count in the interval of up to 4 months before the balance sheet date and up to 2 months after the balance sheet date. Thus, even at the time of the issue of our article, there is still more than a month left to complete the physical inventory! Of course, this entails the need to prove the balances by rolling forward the balances identified from the inventory date to the balance sheet date.

Despite the unfavourable situation, it is necessary to inform your auditor in a timely manner and in advance.  Even if the participation of the auditor seems impossible for security reasons. For example, the auditor shall consider the use of modern methods and techniques to monitor the progress of the inventory or plan possible alternative procedures (including an extraordinary inventory or recalculation of inventories outside the physical inventory deadlines) to verify the balances and existence of inventories.

Financial Statements Czech Accounting dReport newsletter

Upcoming events

Seminars, webcasts, business breakfasts and other events organized by Deloitte.

    Show morearrow-right