Inventory Procedures, Documents and Records

For most manufacturers and traders, materials are the biggest single cost and one of the easiest to lose, misuse or misrecord. Good control starts with a clear paper trail: who asked for the goods, who approved the order, what actually arrived, what was paid, and where each item went afterwards.

This topic walks through that trail from the moment a store needs more stock to the moment the stock count is compared with the books.

Examiners ask students to name and explain the documents in the buying cycle, to describe how stores and cost records are kept, and to explain why recorded and actual stock differ and what management can do about it. Each of those is covered here, with a worked example in naira and a full set of practice questions.

Why procedures and documents are needed

Whenever a business buys materials, four things should be provable on paper.

1. The purchase was authorised. A manager with the right authority must approve it, and the document is the evidence of that approval.
2. The goods were received. A record of delivery shows that what was ordered actually came in.
3. The cost is known. The supplier’s invoice, or a receipt in the rare case of a cash purchase, proves what is owed and what the materials cost.
4. The issues are traceable. When goods leave the store, a record should show who took them and how many. Without it, the business cannot say which department or cost centre used which materials.

Taken together, material documentation does three jobs. It confirms that ordering, receiving and paying were done properly, so that errors and fraud are unlikely. It gives the financial accounts a record of purchases. And it gives the cost and management accounts a record of the cost of materials used.

The procurement cycle and its documents

The exact steps depend on the size and structure of the organisation, but the control principles are the same everywhere. In a medium or large firm with a separate buying department and a separate stores department, the cycle usually runs as follows.

Why three documents? The order says what the firm asked for, the GRN says what arrived and the invoice says what the supplier wants to be paid. If the three agree, payment is safe. If they do not, something is wrong: a short delivery, a price change, or an attempt to bill for goods never received.

Recording inventory: bin cards and the inventory ledger

Materials in stock must be kept secure, with systems to stop loss, theft and damage. Alongside the physical store, there are two sets of records.

Stores records: the bin card

The stores department keeps a record for each item, traditionally an inventory record card or bin card. It shows the number of units currently in store, with each receipt and issue. Updating it every time goods come in or go out is called perpetual inventory, because the balance is known continuously. Many firms hold this information on a computer file instead of a paper card.

Cost office records: the inventory ledger

The cost accounting department keeps its own record for each item, the inventory ledger record. It also shows quantities received, issued and in stock, but adds the cost of each: the cost of stock held, the cost of purchases, and the cost of issues to each operating department or cost centre.

In a computerised system the stores and the cost office should use the same record, so that the two cannot disagree.

Issues and returns

Two documents control the movement of materials once they are in store.

• Materials requisition note: a formal request from a user department to the store for a quantity of an item. It records the quantity issued, the department or cost centre receiving it and, in a cost system, its cost.
• Materials returns note: used when a department sends unused materials back to the store.

The inventory records are updated from these notes, so every issue and every return is captured.

What the inventory account records

For each item the cost records give a running picture of:

• purchases and deliveries from suppliers (quantity and cost);
• returns to suppliers (quantity and cost);
• issues to user departments (quantity, cost and which department);
• returns from departments to the store (quantity, cost and which department); and
• the balance in stock (quantity and value).

These item records are combined into a total for all inventory, used in cost statements and income statements. In larger firms the cost records are kept as double entry in a cost ledger, where the individual item accounts feed a single inventory control account. That account is the basis for reports such as the cost of goods manufactured, the cost of sales and the profit for the period.

The inventory records may sit inside a wider cost accounting system, integrated with or separate from the financial ledger. But they must be complete, accurate and reconcilable to the financial accounts.

Monitoring physical inventory

The book record (what the paperwork says should be in the store) and the physical stock (what is actually there) often disagree. There are four main reasons.

The stores manager is responsible for keeping losses from theft, loss, deterioration and damage low. Documents should be accurate, every movement should be supported by a document, and the data on the document should be copied accurately into the records.

The physical count

Even in a good system some differences will arise, so they must be checked from time to time. Stores staff count the quantity of each item and compare it with the record. The records are then corrected to the counted quantity, and the quantity found missing is written off in the accounts as a loss of materials.

When differences are large

Small differences are normal. Large ones point to one of two problems.

• Poor control over stock. Some theft, breakage and deterioration is to be expected, but it should not be large.
• Poor records. If the records are inaccurate, the information prepared from them for management is unreliable.

Either way management must act. The syllabus gives three remedies:

• lock stock away and use closed-circuit television (CCTV) to deter theft
• improve storage conditions to reduce deterioration
• improve recording procedures through better supervision, training and controls

The ideas in more depth

Segregation of duties

The cycle is deliberately spread across several departments. Stores asks, purchasing buys, stores receives, and accounts pays. No one person controls the whole sequence, which makes it hard to commit fraud without collusion. A small business with one or two staff cannot separate the roles fully, but the same documents still help, even if the same person completes several steps.

What each document protects against

Perpetual and periodic systems

Under a perpetual system, the record shows the balance after every movement. Under a periodic system, balances are found only by counting at the end of the period. The cost of issues is worked out as opening stock plus purchases minus closing stock. The perpetual approach gives much better control because it shows a book balance to test against the physical stock at any time.

Treating the count difference in the books

Suppose the count finds fewer units than the book shows. The shortfall in units is valued at cost. The inventory account is credited with that value and the loss is charged against profit as a stock loss, unless part of it is a normal loss that management has already allowed for in the costs. Surpluses are treated the other way round, after checking that no receipt was left out.

Worked example: from order to stock count

1. Three-way match. Order: 500 units. GRN: 480 units accepted.
   Invoice: 500 units at ₦240 = ₦120,000.
   The invoice does not agree with the GRN, so accounts should pay only for the goods accepted, 480 × ₦240 = ₦115,200, and query the ₦4,800 (20 × ₦240) with the supplier.
2. Stock card.
   Opening 100 + received 480 − issued 300 + returned 20 = 300 units book balance.
3. Compare with the count. Physical 294 against book 300 gives a shortage of 6 units.
4. Value the shortage.
   6 × ₦240 = ₦1,440.
   The record is corrected to 294 units and ₦1,440 is written off as a materials loss.
5. Next step. Management should find out why. If the shortage is only 2% of the stock (6 ÷ 300), it may be normal. If it is repeated or larger, it points to weak control or poor recording and needs action.

Common mistakes in the exam

• Confusing a purchase requisition (internal request from stores) with a purchase order (external order to the supplier).
• Confusing a delivery note (the supplier’s document) with a goods received note (the buyer’s own record).
• Saying that the invoice alone is enough to approve payment. It must be matched with the order and the GRN.
• Mixing up the bin card (quantities only) and the inventory ledger (quantities and values).
• Forgetting the materials returns note.
• Writing that a count difference is ignored. It is investigated, the record is corrected and the loss is written off.
• Listing causes of difference without explaining how management can reduce them.

Quick revision

• Documentation proves authorisation, receipt, cost and issue, and supports both financial and cost records.
• Cycle: purchase requisition → purchase order → delivery note → GRN → three-way match with invoice → payment.
• Bin card: quantities (stores). Inventory ledger: quantities and cost (cost office). Updating on every movement = perpetual inventory.
• Issue: materials requisition note. Return: materials returns note.
• Differences between records and stock: errors, omissions, theft or loss, damage or deterioration.
• Remedies: lock and CCTV, better storage, better recording, supervision and training. Count, correct the record, write off the loss.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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