Inventory Adjustment: Meaning, Types, Benefits And Steps
Updated 29 September 2022
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A company's inventory may have inconsistencies due to various reasons. This makes it important that the inventory managers adjust and manage the records to maintain parity. Understanding stockroom adjustment can enable you to apply changes in your original supply count and help to keep an accurate business registry and minimise supply chain disruptions. In this article, we define inventory adjustment, share its importance, discuss how to calculate them and some tips to help you do it effectively.
What Is Inventory Adjustment?
An inventory adjustment is a sudden increase or decrease in inventory that explains theft, broken products and losses. These adjustment entries clarify the variance between the recorded price and the actual inventory cost. Companies typically notice these changes during annual supply counts or occasional account entries. These adjustments may also result from other departments besides sales. These include:
Waste: Expired food products or similar goods
Breakage: Damaged goods that are illegal to sell
Shrinkage: Products that are stolen
Write-offs: Inventory that is lost because of unknown reasons
Internal Use: Items used or consumed by the company instead of selling to the customer
It may be difficult to detect such changes through manual inventory management methods. In such cases, your accounting team may implement stock adjustments to maintain a clean financial record. They alter the initial balance in the inventory record to display the latest cost at the end of the accounting period.
Related: What Is An Inventory Manager? (Plus How To Become One)
What Are Overstated And Understated Inventory?
There are two types of stockroom malfunctioning situations, namely overstated and understated inventories. Your accounting team may notice these two terms while making changes in the stock record. It is because overstated and understated inventories determine the type of inventory problem which occurred. Overstated inventory is when there are more inventory products than the actual stock count. It typically occurs because of damage, human errors or deception. An understated inventory is when inventory products are less than the actual stock count. These situations may arise because of inefficient product monitoring, consuming illegally or accidentally deleting product details.
Importance Of Stockroom Adjustments
Inventory or stockroom adjustments can contain every product detail, including what products went missing or expired, how much they cost and how many of them the company did not sell. These facts are essential to highlight how effectively an organisation manages their inventory. These modifications are essential to minimise inventory fluctuations. If the inventory level on record is lower than the actual count, the cost of goods sold (COGS) increases. Similarly, if the recorded count is higher than the original count, COGS decreases artificially.
Types Of Inventory Modifications
You can execute inventory alterations in the following three ways, depending on your stock count:
Increasing quantity: The management adjusts the price of a product when the stock quantity is higher than the original recorded amount.
Decreasing quantity: The company alters the value of an item when the stock quantity is lower than the original recorded amount.
Reevaluation: The company changes the product's cost and total price to match the inventory count.
Related: What Are The Functions Of Accounting? (Definition And Types)
How To Implement This Method
Whenever the management identifies an overstated or understated inventory, it is important for them to adjust it promptly to ensure having access to precise financial details and make business decisions based on them. You can adjust your inventory by calculating the cost of sold goods (COGS) with the formula below:
COGS = Beginning inventory + Purchases - Ending inventory
This is how to obtain the information and implement the method:
Collaborate with your accounts team and find the company's beginning inventory amount for a specified period.
Find the total amount of purchases made for that period. You may add that value with the beginning inventory balance.
Determine the amount of ending inventory from company records for the same period.
Add the amount of beginning inventory with the total amount of purchases made. Subtract the amount of the ending inventory from the last value.
The result obtained is the cost of goods sold, which can indicate whether your inventory is overstated or understated.
Related: Understand Cost Of Goods Sold (With Formula And Methods)
Examples Of Inventory Adjustment
Here are a few examples of different inventory amendments:
Suppose a clothing brand has a beginning inventory of ₹50,000. At the end of the year, they made another ₹50,000. The ending inventory balance matches that of the beginning inventory. It implies the company has an accurate report of gross and net profit and income statements. According to the formula, COGS amounts to ₹50,000.
The same clothing brand invests ₹50,000 as the initial inventory for a year. They made a total purchase of ₹50,000. At the end of the year, the inventory record shows an amount of ₹55,000. The team finds more products in the store because of a counting error. It implies an overstatement of ₹5,000 in the final inventory amount. The company may reduce the product price by ₹5,000 to adjust the extra cost.
According to the formula:
COGS = ₹ (50,000+50,000) - ₹ 55,000 = ₹45,000
Related: Management Skills: Definition And Examples
The clothing brand again uses another ₹50,000 as the beginning inventory and a total purchase value of ₹50,000. However, because of unknown reasons, a few products got lost in transit. At the end of the year, the closing inventory amounts to ₹45,0000. It means there is an understated amount of ₹5,000. The company requires increasing the product price by the same amount to compensate for the lost products.
According to the formula:
COGS = ₹ (50,000+50,000) - ₹45,000 = ₹55,000
Significance Of Automation And Artificial Intelligence In Stock Management
Cloud-based software or procurement solutions enable seamless monitoring and managing of adjustments to inventory. It allows you to store all information in a cloud-based location with complete visibility and accessibility. They can help manage inventory, transaction data and supply chain management. Automation provides periodic alerts and sends automatic instructions regarding crucial goods. Along with automation, data analytics present suggestions that ask you to take fast action. It allows you to be in complete control while still achieving your targets and profits.
Lastly, inventory management software links with your accounting system. It supports you in analysing reports and accurate calculations. You can be confident about your operations, knowing your information is complete and precise. This data reflects your actual stock count and other monetary details. You can use these facts at your convenience to produce the value necessary for the company's growth.
Related: 8 Inventory Management Software Solutions (With Benefits)
Tips For Making Supply Adjustments
Here are several tips for you to make accurate stockpile changes:
You can check your inventory details occasionally. This practice can help you identify inventory inconsistencies better and faster. It reduces your efforts and makes it easier to calculate and adjust the goods index by the end of the given period.
Related: How To Calculate Variable Cost In 3 Steps (With Examples)
Use software applications
Software applications manage and organise data and inventory details well. Unlike manual documentation, these applications require less time and minimise human error. They can perform multiple tasks like documenting income statements, maintaining balance sheets and stock account adjustments. Some applications also provide detailed insights into your products.
Communicate and update
Communication skills are crucial to eliminating stock discrepancies and avoiding inventory accidents. You can use various software applications to notify and update your team regarding these alterations. Maintain a master sheet with pre-written formulas to automate the informing process of all team members of any essential inventory changes.
Learn from mistakes
Analysing earlier mistakes in these adjustments can give insights into the adjustments necessary and the remedies you can apply to prevent similar reoccurrences. Identifying the source of these mistakes can help you create standard operating procedures (SOPs) to streamline your stock management practices. You can take preventive measures to track your goods. You may encourage better communication amongst your team members, efficient documentation of inventories and proper training for your employees.
Monitor your products
If you monitor your products consistently, you can minimise such unexpected accidents. You may record the cost of the product, its package number, barcode data, supplier details, countries of origin and expiry dates. Such double-checking strategies allow you to lower the losses and streamline supply chain operations.
Related: 14 Types Of Inventory (Plus Effective Management Tips)
Maintain consistency in receiving stocks
Following a specific procedure can prevent confusion and make it convenient for you to match the products with your purchase orders. It is important to maintain accuracy to ensure minimising operational redundancies or inefficiencies. You may share guidelines that may encourage your team to follow consistent receiving protocols and maintain a record of them.
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