LIFO Accounting for Inventory Can Deliver Immediate and Long-Term Tax Savings

Date February 1, 2023
Authors James Dascenzo
Categories

U.S. Generally Accepted Accounting Principles (GAAP) and the Internal Revenue Code allow businesses to choose one of four methods of accounting for inventory, including Last in First out (LIFO). LIFO has been in use since the 1930s but is often dismissed or overlooked. In periods of inventory growth, or periods of economic inflation, as seen recently, LIFO can provide immediate tax benefits.

LIFO matches current costs against current revenue to provide a better measure of current profit margins. During times of inflation, LIFO values the most recently purchased items in “cost of goods sold” as current deductions, while older lower-cost items remain capitalized in inventory. This means that LIFO transfers current costs from the balance sheet to the income statement, thereby reducing taxable income and creating long-term tax savings.

When prices are rising or inventory is growing—many companies have experienced both over the past couple of years—the increase in LIFO reserves will create immediate tax savings by reducing taxable income. Businesses that have large inventories, such as manufacturers, distributors, retailers, and automobile or equipment dealerships, can benefit from LIFO.

LIFO election options

Companies considering LIFO elections have options. The Inventory Price Index Computation (IPIC) method uses the Consumer or Producer Price Index (CPI or PPI) to measure the inflation used to calculate the annual change in LIFO inventory. Many companies take advantage of this opportunity because it allows them to maximize their LIFO benefits and is far less arduous than calculating via an internal index and manually tracking LIFO layers or specific items of inventory. Calculating an internal index is typically a major undertaking; companies can avoid the hassle if they switch their inventory accounting methods for both book and tax purposes.

Companies already on LIFO may also choose to adopt IPIC for tax purposes while continuing to use internal indexes for internal LIFO calculations. This will result in annual tax differences that should be considered in tax planning. You could generate a higher LIFO expense for tax purposes without increasing the amount of the internal LIFO expense if the internal indexes used for financial reporting are less than the IPIC tax indexes. In many cases, because IPIC is a national measurement, it will create more favorable tax results than internally calculated indices.

The Bureau of Labor Statistics recently released the December 2022 Consumer Price Indexes. While we are beginning to see some declines, most item categories recorded price increases throughout 2022, including the “all items” index, which rose 6.5 percent.

The following manufacturing sectors are typically most likely to elect LIFO:

  • Metals and metal products
  • Chemicals and allied products
  • Rubber and plastic products
  • Processed foods and feeds
  • Lumber and wood products
  • The list is hardly all-inclusive. Other types of manufacturers and many businesses in other industries can also reap significant benefits by electing LIFO.

    If you would like to discuss how LIFO can benefit your company, please contact a member of HBK Manufacturing Solutions at 330-758-8613 or manufacturing@hbkcpa.com.

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    The Top 3 Challenges Facing Contractors

    Date August 8, 2022
    Categories

    The past several years have been marked by unprecedented growth for construction contractors, but also by unprecedented and ongoing challenges. How will your construction company face those challenges and still prosper?

    Labor shortages, lack of a skilled workforce
    Many industries have faced labor shortages, but it has been more challenging for the construction industry. Many workers retired due to the COVID-19 pandemic, and others found less strenuous employment. Those workers are not coming back to the construction industry even though there is more work now than ever before. As well, the construction industry is not attracting talented individuals to meet current demand, and workers are aging or retiring faster than younger people are coming into the industry.

    Some things to consider in dealing with the shortages:

    • Partner with nearby educational facilities: This option has been mostly overlooked, but offering apprenticeships or internships could help cultivate a next generation of workers. Partnering could be a win-win: a student graduating has a job and you have an opportunity to evaluate the skill of the student.
    • Temporary labor: It might not be ideal for many contractors due to the complexities of the contractor’s business, but temporary workers could help fill a gap while you pursue more qualified labor.

    Recession
    When it comes to the dreaded “r” word, construction is unique. Due to existing contracts and other building that needs to be done no matter the circumstances, many contractors have at least a year’s work before what they see as a potential recession and the related slow down in new contracts. Whether a recession is coming is debatable—some think we are already in one—but no matter the circumstance, there are a few things that contractors should not do before a potential recession:

    • Take on more debt: Taking on debt could require using working capital to pay down the newly acquired debt. That working capital will be needed in other areas of the business, such as marketing and payroll, that are necessary to generate leads and retain employees to complete current or new jobs.
    • Cut marketing: Closing down or cutting back marketing efforts that bring in new business just because of their cost is not advisable. If your marketing has been successful in bringing in jobs, don’t stop it. Instead, review your marketing to determine which efforts are productive and which are not and could be changed or cut.
    • Retain break-even or worse profit centers: If the profit center isn’t making money, or is just breaking even or close, it must go. Even if the economy turns around, you’ll need a compelling reason to add back that profit center when your efforts could be directed at increasing profitable work.

    Supply chain issues
    You don’t have to be a contractor to be aware of the impact of today’s supply chain interruptions. Your lead times for completing work can extend well beyond what they have been in the past when you can’t get your hands on the resources you need. Price volatility has added to this problem causing some construction contractors to try to stockpile certain resources, which could lead to other problems. A substantially increased inventory might not be covered by the builder’s risk policy if not locked up in a certain way, and could require additional insurance and the related cost. Excessive inventories also can tie up cash you need for other activities and operations. There is hope that supply chain issues will lessen in the later part of 2022, but 2023 could still be a bumpy start when it comes to resources.

    Options for dealing with supply chain issues include:

    • Talk with your network and share data: Communication is key for businesses internally but also externally. Partnering with your suppliers and sharing relevant data could help everyone in the chain.
    • Increase inventory minimums: As mentioned, adding inventory can cause cash flow or insurance problems. But using just-in-time methodology can leave you sitting idly waiting for supplies to complete a job. Analyze your data and make determinations as to what levels of increased purchases might not cause cash flow issues. Advance planning could keep you from having to use funds from one job to pay for another, which as contractors know, usually results in the demise of the business.

    Contractors need to take a hard look at their businesses and make some determinations on the labor they have and will need moving forward, how to ensure they can stay afloat if a recession occurs, and how to keep jobs moving and stay profitable when their supply of materials could be limited. Construction currently is going strong in many parts of the country, but with all the issues contractors face now and could face moving forward, they must be careful not to overpromise and under-deliver. Harming your reputation could be more damaging than all three of the challenges we have discussed.

    Consulting a trusted financial advisor can help you make good financial decisions and work to ensure you are here for many years to come. The construction industry experts at HBK Construction Solutions can help. You can contact me with your question or concerns at 772-287-4880, or by email at rmishock@hbkcpa.com.

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    Recording Cannabis Inventory: From Seed to Sale

    Date March 23, 2022
    Authors Gabrielle Vizard, CPA, Senior Associate
    Categories

    Companies operating in the cannabis industry, especially cannabis cultivators, are no strangers to IRS Code Section 280E and its provision that businesses legally cultivating or distributing marijuana products can only deduct costs-of-goods-sold when calculating federally (and some state) taxable income. General and administrative expenses such as salaries, rent, and advertising aren’t deductible.

    So, if costs-of-goods-sold is the only category of expense eligible to be deducted, how can businesses ensure they are maximizing their deductions? By accurately recording inventory from seed to sale.

    All states that have authorized the production and sale of marijuana, whether for medical or adult use, require the use of seed-to-sale tracking software. The software is mandated by the states to ensure compliance with cannabis laws. While seed-to-sale software enables cannabis businesses to update inventory as it moves from stage to stage and maintains a log of all employees who have handled the inventory at each stage, the software has presented cultivators with challenges, including:

    • Accurately recording harvested plants moved to the drying rooms
    • Appropriately updating the weight of work-in-process inventory after it has been removed from the drying room and before it has been packaged as a finished good
    • Appropriately tracking inventory physically still in work-in-process inventory but moved to “finished goods” in the seed-to sale software prior to packaging
    • Producing historical reports

    Such challenges can lead to the improper recording of inventory and non-compliance with relevant state regulations. The following procedures can be used to mitigate those risks:

    • Save reports from the seed-to-sale system daily.
    • Perform cycle counts of all inventories:
      • Once a week for all raw materials
      • Once a week for work in process inventory
      • Three times a week for finished goods
    • Keep a physical inventory sheet in each room to be signed by employees as they make updates and a digital copy outside the seed-to-sale software with the same information.
    • Reconcile reports from the internal spreadsheets with reports produced by the seed-to-sale system after each internal cycle count is performed.
    • In the rooms containing work-in-process inventory, physically separate and label the inventory being regarded as finished goods in the seed-to-sale system.

    It is important to remember that while seed-to-sale software helps track inventory, the software is still subject to human error.

    The importance of properly recording cannabis inventory should not be underestimated. It is the key to understanding operations and consumer patterns, and correct financial reporting, as well as compliance with regulations.

    For additional inquiries or cannabis consultations please contact HBK Cannabis Solutions at 856-486-2299.

    Register for the next cannabis webinar on April 8, 2022 here.

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    Five Ways to Protect Your Manufacturing Business when Severe Weather Arrives

    Date July 23, 2021
    Authors Amy M. Reynallt
    Categories

    Severe weather can affect all areas of the country. Tornadoes, snowstorms, wind, thunderstorms, and hurricanes affect us all and can have a major impact on our businesses.

    For instance, the 2021 hurricane season has already begun with five active storms, including Hurricane Elsa, which made landfall in the United States earlier this month. The National Oceanic and Atmospheric Administration (NOAA) expects between 13 and 20 named storms this year, with about 6 to 10 of those storms anticipated to become hurricanes.

    The effects of these storms on manufacturers can be wide-reaching, regardless of where a manufacturer is located. If a manufacturer’s supplier is located in an area affected by a storm, the manufacturer may face supply chain disruptions, extended lead times, force majeure declarations, and increased costs. For instance, when Hurricane Harvey landed in southern Texas and the Gulf Coast in 2017, it caused severe disruption to many chemical and plastic factories located in that area. Manufacturers were unable to obtain goods from these companies, and many factories made force majeure declarations because of their limited abilities to produce. Later that year, Hurricane Irma struck southern Florida. The impact of the two storms led costs of raw materials including lumber, steel, and plastics to increase by double-digit percentages.

    In addition, oil and gas costs often rise after a hurricane. Hurricane Katrina, a category 5 hurricane that hit the Gulf Coast in 2005, severely hurt refinery and production capacity in the United States. According to the U.S. Senate’s Joint Economic Committee Report on the impact of Hurricanes Katrina and Rita on oil prices and the economy, capacity concerns caused the federal government and some European countries to release oil from their emergency stockpiles. Despite these actions, the average weekly gas price increased 41.6% compared to the same period the previous year. As a result, manufacturers using material derived from oil experienced significant cost increases because of these storms. Further, freight costs increased substantially, impacting many manufacturers and businesses across the nation.

    Because hurricanes and other major weather events are inevitable, manufacturers who may be impacted by severe weather should take time to consider their vulnerabilities. Manufacturers may take the following actions to help mitigate the effects of hurricanes and other severe storms:

    1. Create a disaster recovery plan.

      A disaster recovery plan is a written document that includes actions to take in the case of a disaster, including a severe weather event. Typical plans may include reviews of resources, budgets, data, suppliers, and compliance requirements that may be impaired as the result of a disaster. Businesses without a plan should consider the risks and impacts of a disaster, and the steps to follow in the case a disaster occurs. Businesses with a current plan may consider reviewing it periodically as well as if business conditions change or a disaster occurs, to ensure the plan’s effectiveness.


    2. Revisit your insurance coverages.

      Businesses should review their insurance coverages at least annually. This review should not just focus on the coverage and its financial limits. It should also include changes made by the insurance carrier to the plans, trends in manufacturing as well as in the insurance industry, and needs of the business that may not be addressed in the current plans. For instance, manufacturers located in a hurricane-prone geography should be aware that typical flood or property insurance may not cover devastation due to a hurricane unless proper riders are implemented. Similarly, goods damaged in transit due to severe weather may not be covered by general policies, without similar riders. It is important to understand the limitations of your insurance coverage.


    3. Evaluate your supply chain.

      Do you have suppliers located in high-risk areas? If so, do you have plans in place to obtain critical goods in the case of a disruption? Know alternative ways to obtain critical materials. Also, stay abreast of major storms and their anticipated paths. Some suppliers may be able to supply extra goods on short notice or expedite future deliveries if a storm may be approaching.


    4. Consider your inventory metrics.

      Many manufacturers work actively to maintain certain inventory metrics, such as inventory turnover ratios or days sales of inventory on hand. However, there may be good reasons to forgo the metric in the case of potential supplier disruption. During times of severe weather, consider changing your metrics – therefore allowing higher inventory levels – to ensure your ability to supply in the case of a storm.


    5. Think about your IT infrastructure.

      If you are in an area that often experiences severe weather, thinking about your IT infrastructure and the preservation of data is especially critical. Physical storage can become damaged, heightening the importance of offsite storage or other cloud-based storage options. If you are not located in these geographic areas, you may not think about a storm’s potential impact on your IT infrastructure. The frequency of scams, phishing attempts, and other cybersecurity attacks often heightens during and after a natural disaster. Ensure you have proper training, protection, and other protocols in place to protect from an attack. .


    To discuss the impacts of severe weather on your manufacturing business, contact a member of HBK Manufacturing Solutions or your HBK Advisor.

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    When is it time to leave LIFO behind?

    Date June 23, 2021
    Categories

    The last in, first-out (LIFO) method of accounting for inventory is widely used by many manufacturing companies. The question is often posed, “Should we continue to use LIFO, or should we discontinue using LIFO?” Simply stated, it is time to quit using LIFO when there is no longer a benefit that outweighs the cost.

    To determine whether there is a benefit, a business must first understand LIFO, which is an inventory valuation method that can result in tax savings for businesses in the United States that use Generally Accepted Accounting Principles (often referred to as “GAAP”). LIFO is not permitted under International Financial Reporting Standards. LIFO is used to closely match current costs against current revenues because of the assumption that recent purchases cost more than previously purchased items and will be sold first resulting in a higher cost of sales. The difference between the current inventory purchase price and previously purchased items are reported in a balance sheet reserve account.

    If the inventory prices are subject to significant price fluctuations, the benefit of LIFO may diminish causing a decrease in the cost of sales and an increase in taxable income and, therefore, taxes. A few items that tend to have volatile prices are aluminum, lumber, steel, plastics, and oil. Businesses with inventory items that have significant price fluctuations that are not temporary will need to evaluate the continued benefit of using LIFO. For example, if newer inventory purchases cost less than older inventory or the commodity index for the item is declining, over time, this may result in a decrease in the inventory reserve and an increase in taxable income and taxes. This would indicate there is no longer a benefit if it is not a temporary price change. When there is no longer a tax benefit to using LIFO, the business will need to consider a change to another acceptable accounting method such as first-in, first-out (FIFO) or average cost. For financial statement purposes, the change would be retrospectively applied to prior financial statements.

    While LIFO has benefits, an annual evaluation of price fluctuations is needed to determine the continued use of LIFO versus another acceptable method of accounting for inventory. In the existing economy, some of the aforementioned inventory items have seen significant price increases, however, it bears watching, since they do tend to fluctuate significantly. For assistance or questions regarding inventory valuation methods, please contact your HBK Advisor.

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    Cash Basis Options

    Date February 23, 2021
    Authors James Dascenzo
    Categories

    As we enter a new tax season, manufacturers should consider options that may benefit their business. While this topic has been discussed in past Manufacturing Insights articles, the cash basis method of accounting remains an important concept for many manufacturing companies to consider.

    TCJA: A Recap
    The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting.

    Pros & Cons of Cash Basis Accounting
    Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred. The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

    Who is Eligible?
    The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

    Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for the cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of the inventory for tax purposes. Combining these opportunities could yield considerable benefits.

    The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. Likely, many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

    For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK Manufacturing Industry Group at 330-758-8613 or manufacturing@hbkcpa.com.

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    Inventory Essentials, Part 2

    Date June 16, 2020
    Authors Amy M. Reynallt
    Categories

    Inventory Essentials is a two-part series. The first article focused on the basics of inventory and counting systems. This article addresses concerns you may have after completing a physical inventory or cycle count.

    Your manufacturing business has completed its physical inventory or cycle count and reconciled the count to your accounting system inventory. The reconciliation may reveal that you have some issues to resolve. If this is the case, it is critical that you address these issues and prevent future reoccurrence.

    Tackling Errors
    Despite best efforts to ensure an accurate inventory, errors will likely occur, especially in systems that are not highly automated. First, inventory errors should be corrected in the accounting and/or inventory tracking system. The process for completing this task will be dependent on the software your company uses.

    Next, determine the root cause, especially for significant errors. Consider how to prevent the issues from reoccurring. Further, think ahead to other ways that you may be able to reduce future or ongoing errors. Considerations include:

    • Process improvements as your inventory flows through your system. This may include improvements to your warehouse management or production reporting system.
    • Checks and balances to ensure accurate transactions. Internal controls go beyond taking an inventory count.
    • Whether your physical or perpetual inventory system is right or sufficient for your inventory. There are advantages and disadvantages to both physical inventories and cycle counts.
    • Possible fraud. While we do not recommend hasty accusations of fraud, it is important to rule out this potential cause of inventory discrepancies and ensure you have the controls in place to prevent it.

    Obsolete or Excess Inventory
    Manufacturers should consider when inventory items lose their usefulness. This may occur if inventory is damaged, beyond its shelf life, obsolete, or considered excessive. Excess inventory occurs when on hand quantities are greater than the expected usage or sales for a given period, which may vary based on your business.

    Companies that face these issues on a regular basis may consider implementing a reserve to offset future write offs. Manufacturers should develop processes to help them address both financial and physical changes in inventory. It is good practice to review slow moving or obsolete inventory during your physical inventory process, if applicable, or at least once per year.

    For questions or to discuss your company’s inventory, contact a member of the HBK Manufacturing Industry Group at 330-758-8613.

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    Inventory Essentials, Part 1

    Date March 13, 2020
    Authors Amy M. Reynallt
    Categories

    Inventory Essentials is a two-part series. This article will focus on a basic understanding of inventory and counting systems, while the second article will focus on error resolution and prevention.

    Inventory is a critical asset. It can help manufacturers fulfill demand, reduce costs through quantity discounts, or increase profitability by improving production efficiencies. However, holding too much inventory can harm a business by depleting cash, wasting labor resources, or reducing stated profit when write offs are needed. As a result, a manufacturer must manage its inventory levels.

    Types of Inventory
    For most manufacturers, inventory includes:

    • Raw Materials: materials or parts used to manufacture a sellable product. You likely purchase raw materials from suppliers. Think of raw materials as the “ingredients” in the product you will sell to customers.
    • Work in Process (or WIP): products that are partially made or “in process”. Some but not all production processes are complete. Some companies do not have WIP inventory.
    • Finished Goods: products that are complete. All manufacturing processes are finished, and these products are ready to sell to customers.

    Physical Inventory vs. Cycle Counts
    Verifying inventory levels is a fundamental internal control practice. For financial statement or tax purposes, you may be required to take a physical inventory even if you maintain a perpetual counting system. It is recommended that all businesses, whether required or not, confirm their inventory counts regularly. Some manufacturers perform both physical and perpetual counts. Choosing the best inventory validation process is dependent on your business, your inventory, and the processes and controls you have in place.

    Manufacturers may take physical inventory counts annually, semi-annually, quarterly, or even monthly. Operations are halted, and all items – raw materials, WIP, and finished goods – are counted. Counts are reconciled with the accounting system inventory. Physical inventory counts provide a “clean slate”, which can be beneficial as you enter a new year or fiscal period. Depending on your inventory size, physical inventories can be time-consuming and costly. However, physical inventory and planned operational shutdowns can be scheduled simultaneously to reduce the impact of downtime.

    With cycle counting, a sample of inventory is counted at specific times and in specific frequencies. The sample may be random or determined by other methods, such as the ABC or 80/20 method. Manufacturers should consider their business, inventory, and the support their inventory management software offers when selecting a cycle count method. Cycle counts cause less disruption than a physical inventory because a complete operational shutdown is not required. They may also improve the accuracy of inventory during the year. This may help purchasing agents make better decisions since they can better predict replenishment needs.

    For questions or to discuss your company’s inventory, contact a member of the HBK Manufacturing Solutions Group at 330-758-8613.

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    Cash Basis Options

    Date February 3, 2020
    Authors James Dascenzo
    Categories

    As we enter a new tax season, manufacturers should consider options that may benefit their business. While this topic has been discussed in past Manufacturing Insights articles, the cash basis method of accounting remains an important concept for many manufacturing companies to consider.

    TCJA: A Recap
    The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting.

    Pros & Cons of Cash Basis Accounting
    Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred. The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

    Who is Eligible?
    The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

    Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for the cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of the inventory for tax purposes. Combining these opportunities could yield considerable benefits.

    The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. Likely, many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

    For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK Manufacturing Industry Group at 330-758-8613 or manufacturing@hbkcpa.com.

    Speak to one of our professionals about your organizational needs

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    That Time of Year: The Annual Physical Parts Inventory

    Date December 4, 2019
    Authors
    Categories

    While the holiday season is filled with events we all look forward to, one tradition that doesn’t typically generate much enthusiasm is the annual physical parts inventory. It is usually a daunting, dreaded task, disruptive to your business and employees’ personal lives, and fraught with potential drama.

    Of course, the annual rite is a necessary one, a fundamental internal control practice. And whether it’s a third party vendor conducting the process or the parts manager overseeing departmental employees, there are only two possible outcomes: one, physical inventory is greater than that what is indicated in general ledger; or two, the GL balance is greater than what’s actually there.

    The first is usually received with great relief, although it shouldn’t be. Inaccuracy is a problem. The cause of the disparity should be determined, so that it can be fixed or at least explained and doesn’t become the source of a bigger problem. But it’s when the GL balance is greater than the physical inventory that the commotion begins. Is someone stealing? Or just sloppy? One is more serious than the other, but both can cost the dealership a lot of money.

    We’ve worked with dealers since 1984 and conducted hundreds of inventories, and in the vast majority of cases we’ve found the causes of deficient physical inventories are honest mistakes, most often parts provided for a repair job that aren’t recorded on the job order.

    The easiest way to eliminate much of the hassle and most of the fuss associated with annual inventories is to reconcile more frequently than once a year. We recommend monthly. Deviations that occur within a period of 30 days are far easier to identify, and tracking inventory throughout the year makes the final annual reconciliation much simpler, more accurate and far less of a disruption. It can take as little as an hour a month using an Excel-based tool that identifies errors and helps pinpoint whether they are in the parts or accounting department. (We’ll send you a tool we’ve developed to assist the process. See contact information below.)

    One common approach to monthly inventories is the process of cycle counts. Separate parts into 12 sections and count one each month. In addition to the month’s parts sector, spot-check other bins randomly. Most importantly, check high sales volume and high cost parts; high sales volume parts are typically those that don’t get listed on a repair order, and high-priced as well as easily marketed parts are more likely to be stolen. Obsolete parts, for both reasons, are rarely an issue.

    We advise dealers finding disparities not to be hasty in accusing anyone of theft. The consequences of a false accusation can be devastating to both employee and dealership. If theft is expected, we recommend bringing in an outside party for an independent, objective inventory investigation. As well, install a better process, which starts with two practices: no one other than parts personnel should be allowed access to the parts shelves, and no part should ever be handed across the counter without being charged to a ticket.

    Good communications between parts and accounting departments is also vital. If a parts manager buys parts from vendors other than the manufacturer, good communication ensures the parts are bought and sold at proper prices.

    Dealers have hundreds of thousands, if not millions, of dollars invested in parts inventories. A parts manager’s number one job is to see that the dealership gets a proper return on that investment. Without monitoring controls and physical inventories, all the good work of a parts department can be for naught.

    The Dealership Industry Group is happy to send you our Excel-based parts inventory program. Just call us at 317-886-1624, or email Rex Collins at rcollins@hbkcpa.com.

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