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There are several primary reasons for the importance of inventory record accuracy, and why should we spend the time and money to ensure accurate records, some are;

It will cost less to keep the records accurate than it does to operate under your current conditions.

Your customer service will improve.

You’ll increase revenues through your improved customer service. When you tell a customer that you have the units in stock and can ship them right away, you can be sure that you do have the units in stock and can ship them right away. No more failed promises, frustration, or mad scrambles due to inventory record errors. Your employee satisfaction will grow too, because of this.

Keeping promises is a key element of top-notch customer service. When you keep promises because you know what you have and where it is, customers will notice. They’ll choose you over the competition that can’t make and keep those promises.

By starting with the inventory you have on hand. No matter when you sell product, the value of your inventory will remain constant based on accepted and rational methods of inventory accounting. Those methods include weighted average, first in/first out, and last in/first out.

Weighted average
Weighted average measures the total cost of items in inventory that are available for sale divided by the total number of units available for sale. Typically this average is computed at the end of an accounting period.

Suppose you purchase five widgets (A “widget” is an imaginary item that could be just about any product.) at $10 apiece and five widgets at $20 apiece. You sell five units of product. The weighted average method is calculated as follows:

Total Cost of Goods for Sale at Cost (divided)
Total Number of Units Available for Sale =
Weighted Average Cost per Widget
-
Five widgets at $10 each = $50
Five widgets at $20 each = $100
Total number of widgets = 10
Weighted Average = $150 / 10 = $15
$15 is the average cost of the 10 widgets

First in/first out
First, in, first out means exactly what it says. The first widgets you bring into inventory will be the first ones sold as product. First in, first out, or FIFO as it is commonly referred to, is based on the principle that most businesses tend to sell the first goods that come into inventory.

Suppose you buy five widgets at $10 apiece on January 3 and purchase another five widgets at $20 apiece on January 7. You then sell five widgets on January 30. Using first in, first out, the five widgets you purchased at $10 would be sold first. This would leave you with the five widgets that you purchased at $20, which would leave the value of your inventory at $100.

Last in/first out
This method, commonly referred to as LIFO, and is based on the assumption that the most recent units purchased will be the first units sold. The advantage of last in, first out accounting, or LIFO, is that typically the last widgets purchased were purchased at the highest price and that by considering the highest priced items to be sold first, a business is able to reduce its short-term profit, and hence, taxes.

Suppose you purchase five widgets at $10 apiece on January 4 and five more widgets at $20 apiece on February 2. You then sell five widgets on February 20. The value of your inventory, using LIFO, would be $50, since the most recent widgets purchased, at a total value of $100 on February 2, were sold. You were left with the five widgets valued at $10 each.

A cycle counting report is used by cycle counters to compare inventory records from the accounting database to physical counts in the warehouse. The sample report shown below is usually sorted by warehouse location code, so that counters can verify all items within a small area, which is the most efficient accounting method. The report has space on it to record physical inventory counts, and can also write in any adjustments. Below is a sample of a sample of Inventory Report.

The inventory should be counted in categories. There are ordinarily two levels of categorization:

1. Departments

2. Sections/Sub-departments/Locations

Use of the valuation account retains the cost of the inventory and at the same time reduces the materials inventory for statement purposes to the desired cost or market whichever is lower valuation without disturbing the materials. The preceding entry should result in the following balance sheet presentation:

Material, at cost
Less allowance for inventory decline to market

Materials, at cost or market, whichever is lower



$100,000
5,000
--------






$95,000

The net charge to cost of goods sold may be shown in the cost of goods sold statement or deducted from the ending inventory at cost, the increasing the cost of materials used. Whenever the lower of cost or market procedure is applied to each inventory item and the adjustment of materials to a lower market figure is not burdensome and the data are available early in the next year, the adjustment should be accomplished by dating the entry with the last day of the fiscal period just ended and entering in the balance section the units on hand at the unit price determined for inventory purposes. In such a case, the credit portion of the adjusting entry would be to the materials account.

A further example; Let's assume the Corner Shelf Bookstore had one book in inventory at the start of the year 2009 and at different times during 2009 purchased four identical books. During the year 2009 the cost of these books increased due to a paper shortage. The following chart shows the costs of the five books that have to be accounted for. It also assumes that none of the books has been sold as of December 31, 2009.



Number of Books



Cost per Book



Total Cost

Inventory at Dec. 31, 2008



1



@



$85



=



$ 85

First purchase (January 2009)



1



@



87



=



87

Second purchase (June 2009)



2



@



89



=



178

Third purchase (December 2009)



1



@



90



=



90

Total goods available for sale



5



$440

Less: Inventory at Dec. 31, 2009



5



440

Cost of goods sold



0



$ 0

Note - Usually, the store's computer is used to "receive" purchases into inventory and a scanning system at the checkout subtracts items from inventory as they are sold. With this system, it is often the practice to verify inventory amounts section by section throughout the year ("cycle count"). At this time, this system is cost-effective only for large supermarkets.

The retail method of taking inventory

Most of the inventory should be taken at retail, that is, at its shelf price. This is a practice established by the grocery industry decades ago due to the large number of items in a store.

References:

http://www.principlesofaccounting.com/chapter%208.htm#inventory costing methods

http://www.accountingcoach.com/online-accounting-course/12Xpg01.html

http://managementinventory.info/

http://www.businesstown.com/accounting/basic-inventory.asp

http://accounting-financial-tax.com/2008/12/inventory-forms-and-reports/