GAO

United States General Accounting Office

Exposure Draft

July 2001 EXECUTIVE GUIDE

Best Practices in 

Achieving Consistent, 

Accurate Physical 

Counts of Inventory 

and Related Property

GAO-01-763G
1 GAO-01-763G Best Practices in Inventory Counts

Preface

Creating an effective and cost-efficient government has long been a public expectation. Achieving

this goal will require federal agencies to produce useful, reliable, and timely information that can be

used daily by the Congress, federal managers, and other decisionmakers. Inventory is one of the

major areas in the federal government where useful, reliable, and prompt data are still generally not

available.

To provide a framework and guide that federal managers can use to improve the accuracy and

reliability of the governmentís inventory and related property data, we studied the inventory count

processes and procedures of seven leading-edge private sector companies to identify the key factors

and practices they use to achieve accurate and reliable physical counts. Physical counts of inventory

are only one aspect of inventory control that contribute to accurate and reliable inventory records.

This draft Executive Guide, while intended to assist federal agencies in achieving the objectives of

the Chief Financial Officers (CFO) Act of 1990 and subsequent related legislation, is also applicable

to any governmental and nongovernmental entity holding inventory or property and equipment. This

draft Executive Guide describes the fundamental practices and procedures used in the private sector

to achieve consistent and accurate physical counts. It summarizes the fundamental principles that

have been successfully implemented by companies recognized for their outstanding record of

inventory management. Also, it explains and describes leading practices from which the federal

government may be able to draw lessons and ideas. This guide applies to most forms of federal

inventory, but certain of the discussed practices may not be applicable to various types of bulk,

natural resource, and nonturning inventories, such as the Department of Energyís strategic petroleum

reserve. Many of the concepts and controls for conducting physical counts discussed in this guide

could also be applied to property, plant, and equipment, an area in which many federal agencies also

face data reliability challenges.

We invite you to review and comment on the practices contained in this guide. This draft document

will be available for comment for 60 days, until October 1, 2001. Please address any questions or

comments to me at (202) 512-2600, steinhoffj@gao.gov, or Paul D. Kinney, Assistant Director, at

the following:

Mail: Paul D. Kinney, Assistant Director

U.S. General Accounting Office

1244 Speer Blvd., Suite 800

Denver, CO 80204

Phone: (303) 572-7388

Email: kinneyp@gao.gov

This guide was prepared under the direction of Gregory D. Kutz, Director, Financial Management

and Assurance. Other GAO contacts and key contributors are listed in appendix V.

Jeffrey C. Steinhoff

Managing Director, Financial Management and Assurance
2 GAO-01-763G Best Practices in Inventory Counts

Background

Accurate and reliable data are essential to an efficient and effective operating environment in the

private sector as well as in the federal government. Inventory represents a significant portion of

assets in the federal government and private sector. Therefore, managers and other decisionmakers

need to know how much inventory there is and where it is located in order to make effective

budgeting, operating, and financial decisions and to create a government that works better and costs

less.

In the 1990s the Congress passed the Chief Financial Officers Act of 1990 which has been expanded

by the Government Management Reform Act of 1994, the Government Performance and Results Act

of 1993, and the Federal Financial Management Improvement Act of 1996. The intent of these acts is

to (1) improve financial management, (2) promote accountability and reduce costs, and (3) emphasize

results-oriented management. For the governmentís major departments and agencies, these laws (1)

established chief financial officer positions, (2) required annual audited financial statements, and (3)

set expectations for agencies to develop and deploy modern financial management systems, produce

sound cost and operating performance information, and design results-oriented reports on the

governmentís financial position by integrating budget, accounting, and program information. Federal

departments and agencies work hard to address the requirements of these laws, but are challenged by

providing useful, reliable, and timely inventory data which is still not available for daily management

needs.

Managing the acquisition, production, storage, and distribution of inventory is critical to controlling

cost, operational efficiency, and mission readiness. Proper inventory accountability requires that

detailed records of produced or acquired inventory be maintained, and that this inventory be properly

reported in the entityís financial management records and reports. For example, detailed asset

records are necessary to help provide for the physical accountability of inventory and the efficiency

and effectiveness of operations. Additionally, the cost of inventory items should be charged to

operations during the period in which they are used. Physical controls and accountability reduce the

risk of (1) undetected theft and loss, (2) unexpected shortages of critical items, and (3) unnecessary

purchases of items already on hand. These controls improve visibility and accountability over the

inventory, which help ensure continuation of operations, increased productivity, and improved

storage and control of excess or obsolete stock.

Producing and maintaining accurate inventory data is a multifaceted issue. The ability to accurately

count physical inventories is only one factor that must be considered in improving the reliability of

inventory records. The ability to accurately count physical inventories is critical in verifying that

inventory actually exists and that on-hand balances agree with financial and logistical records. This

Executive Guide is intended to assist federal agencies and other governmental and nongovernmental

entities in establishing and implementing inventory counting procedures that will contribute to the

accuracy and reliability of inventory data.

In the private sector, the term inventory generally refers to items of property that are (1) held for sale

as finished goods, (2) in the process of being produced or assembled for sale (i.e., work in process),

or (3) raw materials and supplies used in producing goods, offering services, and accomplishing

operational missions. The practices discussed in this guide are based on private sector inventories

that are comparable in type, activity, and volume to inventories in the federal government, as listed in

the following table.
3 GAO-01-763G Best Practices in Inventory Counts

Examples of Inventory Types Common to the Private Sector

and the Federal Government

• Aircraft engines and turbines

• Aircraft repair parts

• Nuts and bolts

• Electronics

• Industrial tapes, adhesives, textiles, and fabrics

• Medical supplies, equipment, and cosmetics

• Office products

• Packaging

• Refrigerators, dishwashers, ovens

• Sparkplugs, oil filters, fuels, and oils

• Hydrofluoric acid, dyes, and gases

• Insecticides and chemicals

• Vehicle assembly parts

• Aviation and vehicle electronic components and infrared devices

The federal government reported $185 billion in inventory and related property at the beginning of

fiscal year 2001 consisting of a variety of finished goods, work in process, stockpile materials,

commodities, seized and forfeited property, and other operating materials and supplies.

GAO and other auditors have repeatedly found that the federal government lacks complete and

reliable information for reported inventory and other property and equipment, and can not determine

that all assets are reported, verify the existence of inventory, or substantiate the amount of reported

inventory and property. These longstanding problems with visibility and accountability are a major

impediment to the federal government achieving the goals of legislation for financial reporting and

accountability. Furthermore, the lack of reliable information impairs the governmentís ability to (1)

know the quantity, location, condition, and value of assets it owns; (2) safeguard its assets from

physical deterioration, theft, loss, or mismanagement; (3) prevent unnecessary storage and

maintenance costs or purchase of assets already on hand; and (4) determine the full costs of

government programs that use these assets. Consequently, the risk is high that the Congress,

managers of federal agencies, and other decisionmakers are not receiving accurate information for

making informed decisions about future funding, oversight of federal programs involving inventory,

and operational readiness.

An improved physical count process is only one of many corrective actions that will be required to

resolve all of these deficiencies. Although conducting a physical inventory, comparing the count

results to recorded quantities, conducting research on differences, and determining and posting an

accurate adjustment to the on-hand balance seems like a fairly simple, straight forward exercise, in

reality it is not. There are many factors that can cause the record of on hand inventory to differ from

the physical quantity counted, including omission of items from the count, incorrect counts, errors in

cut-off, and improper recording or reconciliation of count results.

This Executive Guide presents processes and controls used by private sector companies recognized as

excelling in their ability to manage inventory and achieve consistent and accurate counts of physical

inventories. Federal government agencies effectively implementing these practices can resolve
4 GAO-01-763G Best Practices in Inventory Counts

significant weaknesses in the federal governmentís property and inventory accountability and

financial reporting by improving the accuracy of data being used for budgeting, financial, and

logistical and operational management decision-making purposes. The conceptual issues discussed in

this guide are focused on inventory and related property, and under certain circumstances may be

applied to property, plant, and equipment.
5 GAO-01-763G Best Practices in Inventory Counts

Identification and Characteristics of Leading-edge Companies

To help improve the accuracy and reliability of the federal governmentís inventory and related

property data, we studied seven companies having leading edge inventory count process and

procedures to identify the key factors and practices in achieving consistent and accurate physical

counts. The seven companies we studied were recognized by leading professional service experts,

consultants, and academic and business/trade publications as having best practices in inventory

management. For more information on the criteria we used to select these companies, see

appendix II.

Leading-edge Companies

Boeing

Daimler Chrysler

DuPont

FedEx

General Electric

Honeywell

3M

Some of the seven leading-edge companies used more than one counting approach and allowed us to

review their practices and processes at more than one operating location. A total of 12 separate

locations (from the seven companies) were reviewed.

All 12 locations used one or both of the two primary approaches to counting inventory ñ cycle

counting, in which a portion of the inventory is counted either daily, weekly, or monthly until the

entire inventory has been counted over a period of time, and wall to wall counting, in which the entire

inventory is counted at a point in time. Further discussion of these approaches may be found on page

14, key factor 3. In just one location, and for only a very small portion of its inventory, was sampling

(in which merely a portion rather than the whole of the inventory was subject to count) used as a

counting approach. At this location, only after management had proven a strong control environment

evidenced by multiple years of highly accurate cycle counts, was sampling considered to be a reliable

and efficient means of counting inventory and validating records. However, because sampling was

not predominately used by this or the other leading-edge companies, the key factors contained in this

report are discussed as they relate to cycle and wall to wall methodologies.

This Executive Guide discusses common characteristics and practices used by leading-edge

companies to ensure that the development, execution, completion, and evaluation of a physical count

of their inventories provides management with useful, reliable, and timely information for decision

making and financial reporting. Specifically, we have identified 12 key factors common to these

leading-edge companies ñ regardless of the inventory count methodology or combination of practices

they used ñ which collectively ensure consistent and accurate count results. In addition, this guide

presents comparative summaries of the goals, practices, and results of certain key factors, and

provides case studies of leading-edge companies.
6 GAO-01-763G Best Practices in Inventory Counts

Twelve Key Factors and Managementís Commitment

The 12 key factors, presented in the following table are essential to leading-edge companies

achieving consistent and accurate counts of physical inventories. Overarching all of these factors is

top managementís commitment to an environment that promotes sound inventory control.

The inventory count process is an integral component of an organizationís internal control

environment and procedures over inventory. Managementís commitment is critical to establishing

effective and reliable internal controls. We observed demonstration of managementís commitment at

every leading-edge company with its attitude and leadership creating unique corporate cultures. A

disciplined and structured culture, which fosters integrity, corporate values, and commitment to

competence, begins with top management and is seeded throughout the organization at all levels of

staff and supervisory personnel. Characteristics of strong management commitment include:

• Top management advocates change and empowers employees to make changes

• Performance measures are aligned with corporate goals

• Investment in, and realized return on, technology and systems

• Development and retention of human capital

• Communication of goals and results

These characteristics were not words in the mission statements of the leading-edge companies, but

were in fact tools and practices employed by each of the companies to strategically manage change to

enhance quality and profitability. In fact, few, if any, business practices remain static, including

inventory count procedures. Senior representatives of each of the leading-edge companies discussed

the need for and drive to improve cycle times, reduce costs, and reduce capital requirements by

systematically reviewing their operational and process methods. All seven leading-edge companies

used fundamental methodologies to review their practices: three were active participants in Six

Sigma1

 and five developed other internal initiatives, including participative management

improvement groups, benchmarking of practices to industry standards, and ìaccelerated work groupsî

to develop, test, and implement process improvements. As a result, the 12 key factors are an

accumulation of continuously improved practices and controls for counting inventory and related

property.

 1

 Six Sigma and Breakthrough Strategy are copywritten methods of Six Sigma Academy to provide companies

the tactics and tools for rapid, total business transformation.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
7 GAO-01-763G Best Practices in Inventory Counts

Key Factor 1: Establish Accountability

Characteristics

• Set inventory record accuracy goals at 95 percent or better

• Set other performance expectations

• Establish accountability and responsibility for the overall physical count

One of the key factors in developing and implementing an accurate physical count process is to

establish accountability. Establishing accountability for the inventory physical count process requires

setting performance goals and holding the appropriate level of personnel responsible for the overall

physical inventory process.

Performance Goals

Performance goals establish targets for achieving managementís objectives and contribute to the

overall mission of the organization. Leading-edge companies set performance goals for the physical

count process either through the establishment of inventory record accuracy goals (i.e., to measure the

degree to which the physical on-hand balance agrees with inventory records), or other measurable,

results-oriented performance expectations.

Setting high goals for inventory record accuracy rates is one way of establishing accountability for the

physical inventory count. High goals ìstretchî the organization and personnel to perform inventory

counts with increasingly superior precision. Experts agree that inventory record accuracy goals should

be set at 95 percent or higher.2

 Six of the eight leading-edge locations performing cycle counts set

performance goals by establishing inventory record accuracy goals that ranged from 95 percent to 98

percent.

The other two locations performing cycle counts and all four locations performing wall to wall

counting did not establish inventory record accuracy goals, but instead established other measurable

performance expectations. Other performance expectations, as set forth by management, can also be

used to establish high levels of accountability and measure the results of the physical count without

explicitly setting inventory record accuracy goals. These other performance expectations measure

 2

Brooks and Wilson, p. 22.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
8 GAO-01-763G Best Practices in Inventory Counts

aspects of the count, such as adjustments and the number of accurate counts. Targets for these other

performance expectations are established by management and are typically based on impact to

operations including financial significance, effect on production or services, and compliance with

policies and procedures. The four leading-edge locations performing wall to wall physical counts and

the two cycle count locations that were not setting goals for inventory record accuracy established

accountability through other performance expectations, such as dollar value and quantity of

adjustments and number of accurate counts. For example, one leading-edge location set an

expectation that net adjustments resulting from the count would not exceed 2 percent of the dollar

value of the items counted.

Additionally, many of these expectations were also used by the locations that set goals for inventory

record accuracy. Table 1 illustrates the range of performance goals and expectations used by the 12

leading-edge locations in establishing accountability.

Table 1: Performance Goals Used

Inventory record Cycle count locations Wall to wall count locations

accuracy

1 2 3 4 5 6 7 8 9 10 11 12

Goals 98% 95% 98% 95% 95% 98% A A A A A A

Other goals

Dollar value of

adjustments ! ! ! ! ! ! ! ! ! ! !

Quantity of

adjustments ! ! ! ! !

Number of accurate

counts

! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected.

A These locations did not establish inventory record accuracy goals.

Level of Accountability

Holding the appropriate level of management responsible and answerable for the overall inventory

process establishes accountability for the physical inventory and is essential to achieving consistently

accurate counts. Accountability within an organization should exist from the top of the organization to

the lowest level. However, primary responsibility for the overall physical inventory counts should be

specifically designated and assigned. Accountability should be established in job descriptions and

expectations for achieving performance goals and enforced through periodic performance evaluations

and a reward system that measures the achievement of performance goals.

Direct accountability for the overall physical inventory count process was established by the leadingedge companies at the level responsible for managing the physical count process. The person or

persons at this level were typically supervisors or managers of an inventory group that performed all

counts and research, or a materials area supervisor/manager responsible for the inventory within

his/her area. These individuals had specific responsibility for (1) planning the count, (2) organizing

the count teams, (3) reviewing counts, (4) reviewing research, and (5) approving adjustments within

established tolerances. The accountable person(s) were held responsible for achieving the companyís

performance goals, including inventory record accuracy, through personnel performance expectations

and evaluations, which affected bonus and pay decisions.
9 GAO-01-763G Best Practices in Inventory Counts

Case Study

One of the leading-edge locations, a 700,000 square foot distribution facility, used a separate

inventory group that performed all physical counts and researched all variances. The group consisted

of a supervisor, inventory group leads, and counters/researchers. The supervisor of the inventory

group was responsible for the overall physical count process including organizing and supervising the

count, performing research, reviewing and approving adjustments, and evaluating the results of the

counts. The company had established accountability and responsibility for the overall physical count

with the inventory group supervisor. The inventory group supervisor and inventory shipping and

receiving managers were jointly held accountable for achieving the companyís established inventory

record accuracy goal of 98 percent. This goal was included as part of the supervisorís and managerís

expectations and evaluations and was a tool used in determining his/her merit raises and bonuses.

In addition to holding appropriate management levels responsible and answerable for the quality of the

inventory count process, leading-edge locations often push accountability to the floor-level personnel

performing the count. For example, when a subsequent recount (discussed in key factor 10) revealed

an error in the first count results, one leading-edge location used this information as an indicator that

the first count team may have had performance problems or may have needed additional training.
10 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To establish accountability for the physical count process, senior executives could consider the

following:

• Establish performance goals for the physical count that are aligned with the organizationís

mission and strategic goals and objectives

• Establish high measurement goals and continuously assess the organizationís progress in

achieving and maintaining those goals

• Identify the line of authority and responsibility from top management to the level of the

organization responsible for accomplishing a consistent, accurate physical count of inventory and

related property

• Develop employee/supervisor performance measurement systems to hold appropriate personnel

accountable for achieving the organizationís performance goals
11 GAO-01-763G Best Practices in Inventory Counts

Key Factor 2: Establish Written Policies

Characteristics

• Document policies and procedures for entire physical count process

• Regularly review and update established policies and procedures

Establishing and documenting policies and procedures are essential to an effective and reliable

physical count. Policies and procedures demonstrate managementís commitment to the inventory

physical count process and provide to all personnel clear communication and comprehensive

instructions and guidelines for the count. Establishing written policies and procedures helps ensure

consistent and accurate compliance and application needed to achieve high levels of integrity and

accuracy in the physical count process. Policies and procedures also become the basis for training

and informing employees.

Well-documented physical count policies and procedures typically pertain to all aspects of the

physical count process, including the activities or tasks that take place before, during, and after the

physical count. Documented policies and procedures generally include everything an employee

needs to know to complete the requirements of a specific task for the physical count.

Leading-edge locations established written policies and procedures addressing their physical

inventory process. These policies and procedures include all aspects of the physical count including

the objectives of the count, the types and timing of counts, instructions for counting and recording,

and researching and adjusting variances. The policies and procedures at the leading-edge locations

were written in sufficient yet succinct detail to explain the specific procedures and tasks to be

performed. A table of contents from one leading-edge locationís written policies and procedures

manual, presented in figure 1, demonstrates the breadth of the locationís policies and procedures.

Detailed written, specific instructions on all the tasks involved in the physical count process were

included within each of its sections.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
12 GAO-01-763G Best Practices in Inventory Counts

Figure 1: Table of Contents for Sample Policies and Procedures

I. Why

 A. Objective of the Physical Inventory Process

II. Planning

 A. Inventory Methods

 B. Record Definitions

 C. Timing of Inventory

 D. Review of Inventory Procedures

 E. Physical Location Preparation

 F. Cut-Off Data Arrangements

 G. Use of Specialists

 H. Planning Meetings

III. Observing/Taking

 A. Segregation of Duties

 B. Forms

 C. Recording Information

 D. Inventory Movement During Taking

 E. Obsolete, Damaged, and Slow-Moving Items

 F. Inventories in Off-Site Locations

 G. Preliminary Inventories

 H. Review and Accountability

 I. Bar Coding System

IV. Reconciliation

 A. Summarization

 B. Reconciliation

 C. Timing and Approval of Adjustments

 D. Recording of Inventory Adjustments

V. Computer Access and Security

 A. System Security

 B. Segregation of Duties

 C. Processing Controls

 D. Disaster Recovery

 E. Documentation

 F. Master File Changes

VI. Special Situations

 A. Consigned Stock, Company Owned

 B. Consigned Stock, Vendor Owned

 C. Theft Sensitivity

 D. Returnable Items

 E. Special Materials

VII. Frequency

 A. Inventory Type

 B. Period

Appendix A Cycle Counts

 A. Inventory Classification

 B. Inventory Count Process

 C. Inventory Accuracy

 D. Inventory Tolerance

 E. Cycle Count Inventory Adjustments

 F. Management Reporting

 G. Certification

 H. Definitions

 I. Checklist
13 GAO-01-763G Best Practices in Inventory Counts

Once policies and procedures have been established and documented they must be regularly reviewed

and updated. Policies and procedures that are regularly reviewed and revised to reflect changes in the

process and tasks of the physical count reinforce managementís commitment. Up-to-date policies

and procedures provide a reliable and credible resource to employees, encourage compliance with

managementís directions, and form the basis for a reliable physical count process.

All the leading-edge locations regularly reviewed and updated their policies and procedures. The

majority of the locations reviewed and revised their policies every 1 to 2 years, while others revised

their policies any time there was a change in the process or specific tasks of the physical count.
14 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To establish effective written policies and procedures for the physical count process, senior

executives should consider the following:

• Develop broad policies affecting inventories that are designed to attain managementís goals

• Develop written procedures for all aspects of the physical count processes including:

• defining the current process and the individual tasks associated with the process

• procedures for and examples of filing and completing required paper work

• Regularly review and revise policies and procedures for changes in the process and individual

tasks
15 GAO-01-763G Best Practices in Inventory Counts

Key Factor 3: Select an Approach

Characteristics

• Cycle counting is used to support operational and financial needs of the organization

• A wall to wall physical count is primarily used to support financial reporting at a point in time

• Management considerations in selecting the best physical count approach include

1) the objective or purpose of the count and the timing issues involved

2) the capabilities of the inventory system

3) the existing control environment over the inventory system and processes

4) the characteristics of the inventory

The process of counting physical inventory is an essential control for operational efficiency and

financial reporting. A physical count, when properly executed, verifies the existence of physical

assets and the completeness and accuracy of records. Accurate inventory records are key to

managementís confidence in financial and other information used in decision-making.

The two predominant approaches used by the leading-edge companies to physically count inventory

are cycle counting and wall to wall. Each approach offers distinct advantages and serves some

purposes better than others. As a result, organizations may choose to use only one approach or a

combination of approaches.

Cycle counting is a method by which a portion of the inventory is counted either daily, weekly, or

monthly until the entire inventory has been counted over a period of time. Cycle counting serves two

purposes: (1) it supports the reliability of the on-hand inventory quantities used in management

decisions and financial reporting and (2) it normally results in increased operational efficiency. Cycle

counts are used as a control mechanism to reduce the risk that the inventory process and systems are

functioning incorrectly.

In the wall to wall approach the entire inventory is counted at a point in time, usually as of the end of

an annual or interim period. This method is primarily used for financial reporting purposes in order

to validate the amount of reported inventory.

Determining which approach or combination of approaches is the most appropriate for an

organization is a key management decision. When selecting an approach, management should

consider the objective and timing of the count, capabilities of the inventory system, the existing

control environment, and the characteristics of the inventory.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
16 GAO-01-763G Best Practices in Inventory Counts

The type of count performed is determined by management based on the reason for the count.

Physical counts can be used to establish a balance on or as of a certain date for financial reporting, to

monitor the accuracy of records in an inventory system, and to ensure that the proper inventory is

available for operational needs. In determining the objective of the count, management should

consider the time and resources available or needed to conduct and complete the count. We found

that cycle counts were used to ensure that the balances in the inventory system were continuously

correct for management decisions and financial reporting and to determine that recorded items were

present to meet operational needs for production or distribution. We found that wall to wall counts

were primarily used to establish a balance on or as of a certain date for financial reporting. In one

instance, the wall to wall approach was used monthly to monitor the inventory system and meet

operational needs.

Another primary consideration is the capability of the inventory system. There are two general types

of inventory systems -- perpetual and periodic. A perpetual inventory system maintains current item

balances by recording receipts and shipments. In contrast, a periodic inventory system tracks receipts

and shipments in a purchases account, and infrequently updates item balances. For cycle counting, a

perpetual system is needed to provide current balances for reconciliation of the system and physical

count quantities. We found that all of the leading-edge companies had perpetual inventory systems.

Additionally, we found that five of the seven leading-edge companies used a perpetual inventory

system with locator capability, commonly referred to as a locator system, which identifies the specific

physical location of each individual item in inventory.

The existing control environment over the inventory system and related processes is also a

consideration in selecting the type of count to conduct. Internal controls over the inventory system

and processes should be effective in providing reliable information for conducting the physical count.

Controls must exist to provide reasonable assurance that all transactions affecting the inventory

balances are properly executed and recorded in the inventory system. Unless this is the case,

balances in the inventory system do not provide a reasonable basis to compare to the physical count

quantities. Inventory record accuracy rates, based on results of prior counts, may be an indicator of

the strength of the control environment. A pattern of low accuracy rates or known control

weaknesses may suggest that (1) the recorded balances in the inventory system are not reliable for

conducting cycle counts and (2) that a wall to wall count may be more appropriate to reestablish

accurate inventory balances.

Characteristics of the inventory should be considered in selecting an approach. Management should

consider if there are identifiable and distinct segments of the inventory that may lend themselves

better to cycle counting, wall to wall counting, or a combination of both. Identification of distinct

segments should include considerations of the size, dollar value, turnover, criticality to operations,

and susceptibility to misappropriation, including theft, of the inventory.

All of the leading-edge companies use cycle counting or wall to wall or both to count inventory. A

majority of these companies used the cycle count approach. However, some companies used a

combination of wall to wall and cycle for separate identifiable segments of their inventory. Three

companies varied their approach for separate segments of their inventory based on either the type of

material (raw material, work in process, or finished goods), or by a divisionís or locationís operations

(distribution, warehousing, and manufacturing). For example, one company conducted wall to wall

counts until such time as the accuracy of the balances was sufficient to support cycle counting.
17 GAO-01-763G Best Practices in Inventory Counts

Another leading-edge company conducted cycle counts on work in process materials that were

critical to operations and conducted monthly wall to wall counts on finished products that were a

material portion of the plantís inventory and were subject to strong logistical and process controls.

Case Study

One leading-edge company had approximately 80 different facilities within the United States and

manufactured and distributed a wide range of products from small units to large reels and bundles.

This company used a combination of cycle counting and wall to wall counts based on the existing

control environment and historical accuracy rates at its facilities. Facilities were allowed to move to

cycle counting once the location had completed a wall to wall annual physical count and had

demonstrated the ability to perform cycle counts by maintaining record accuracy rates above 95

percent and good inventory process controls for receiving, manufacturing, movement, and shipment

of items. The facility also had to demonstrate adequate training procedures, processes, and a good

system that would support cycle counts before a cycle count program would be approved. The

facility would begin by cycling through its entire inventory four times per year. As the facility

demonstrated its ability to maintain accurate inventory records by achieving high record accuracy

rates and reliable systems and processes, it could reduce the number of cycles down to one per year.

However, the reduction from four cycles to one cycle per year took approximately 6 years.

Additionally, if the facilityís inventory record accuracy fell below 95 percent it was required to

submit a corrective action plan to address the causes of the low accuracy and conduct an annual wall

to wall physical count, in addition to the regular cycle counts, until a 95 percent accuracy rate was

once again achieved and maintained.
18 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To select a physical inventory counting approach, senior executives should consider the following:

• Determine the objectives of performing the physical count:

• to establish a balance as of a specific date for financial reporting

• to monitor the accuracy of the inventory records for financial reporting and management

decisions

• to ensure the availability of inventory to meet operational needs including mission readiness

• to identify excess or obsolete inventory

• Assess the resources and timing needed to conduct the count

• Evaluate the capability of the inventory system to:

• maintain item balances on a current or periodic basis

• maintain balances by item location

• Evaluate the existing control environment over the inventory system and processes:

• to ensure transactions are properly executed and recorded in the inventory system

• to determine that the inventory system provides reasonable basis for comparison to the

physical count

• considering existing or historical accuracy rates to support the assessment
19 GAO-01-763G Best Practices in Inventory Counts

Key Factor 4: Determine Frequency of Counts

Characteristics

• Determine which items to count and how frequently

• Choose a method of selecting individual items or locations for count

Counting an appropriate amount of the total inventory at a point in time or over a period of time with

regular frequency helps to provide accurate inventory records for operational decisions and financial

reporting. Management should count an appropriate amount of the total inventory by determining the

desired frequency of counts and selecting a method of choosing individual items or locations to

count.

Frequency of Counts

In order to count an appropriate amount of the total inventory, management must decide which

inventory items to count and how frequently those items should be counted. The most desirable goal

would be to count all of the inventory items at least once a year. However, maintaining accurate

inventory records by counting items takes time and costs money. Since there are typically limits on

these resources, the best way to balance control of the inventory and cost of the count is to focus on

the items determined to be more important or higher risk to the organization. Accordingly, it is not

always practical to give the same treatment to each item; it may be desirable to segment the inventory

into identifiable classes and assess the risk for each segment or class to determine the frequency of

counts. For instance, management may determine that items critical to the production process,

resulting in a high risk to the organization, should be counted every day, week, or month. In other

instances, a segment of inventory that has little or no movement and does not represent a significant

portion of the inventory, and thus has low risk, may be counted less frequently. The purpose of

classifying items into groups or segments is to establish an appropriate degree of control over each

item. Management should exert the highest degree of control (frequent counts) on the most important

items, and the least control on less important items. Management may determine that there are many

degrees of control and importance depending upon the organizationís needs and inventory

characteristics. Management should consider the dollar amount, criticality to operations, and

susceptibility to theft or fraud when segmenting the inventory and determining the frequency of

counts for each segment.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
20 GAO-01-763G Best Practices in Inventory Counts

Leading-edge locations used a variety of frequencies for various segments of their inventory.

Locations performing cycle counts segmented their inventory by dollar value, activity or turnover,

sensitivity or criticality, historical accuracy rates, or a combination of these elements in determining

how often they would count. The frequency ranged from segments that were not counted at all, or

less than once a year, to segments that were counted daily, monthly, quarterly, semi-annually, or

annually, as shown in table 2. Locations that segmented their inventory by dollar value counted

higher dollar value items more frequently than lower value items. In other instances, locations used a

combination of dollar value and activity or turnover of items to segment their inventory, in which the

higher dollar items by activity were counted more frequently, usually four times per year, than those

that had low dollar value by activity, which were counted once a year. On the other hand, we found

that locations performing wall to wall physical counts typically counted their entire inventory at least

once a year at a point in time. However, we did note that one location performed a wall to wall

physical inventory on one segment of its inventory every month, due to the dollar value significance

of these items to the companyís total inventory. Table 2 illustrates the frequency of counts for

separate inventory segments at the 12 leading-edge locations.

Table 2: Frequency of Counts by Inventory Segments

Cycle counts locations Wall to wall count

locations Frequencies

1 2 3 4 5 6 7 8 9 10 11 12

More than 4 times per year ! ! !

!

3-4 times per year ! ! ! !

2-3 times per year ! !

1-2 times per year ! ! ! ! ! ! ! !

Less than once a year ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected. For example location 1 segments its

inventory by dollar value and counts one segment with items over $250 once per year and another segment with items less than $250

less than once a year.

Case Study

One leading-edge location (location 8 in table 2), manufacturing over 11 million electronic

components each year, segmented its work in process inventory and varied the frequency of counts

for each segment in order to achieve greater coverage of the material segments of the inventory. The

work in process inventory was segmented based on the dollar value multiplied by activity or turnover,

and placed in one of four separate segments. Segment A represented those items that were in the top

10 percent, segment B were items in the next 20 percent, segment C were items in the next 30

percent, and segment D was the remaining 40 percent. Each segment was counted with either greater

or lesser frequency to achieve more coverage of the higher dollar activity items and less coverage of

the lower dollar activity items each year. Segment A was counted four times, segment B was counted

three times, segment C was counted two times, and segment D was counted once per year.
21 GAO-01-763G Best Practices in Inventory Counts

Method of Selecting Items

Once management has determined which items to count and how frequently, a method of choosing

individual items or locations must be determined. The method should ensure that all items within the

identified segments are chosen to achieve the desired frequency and an accurate count. Leading-edge

locations used various methods to select items for count within an identified inventory segment. The

most common method among leading-edge locations performing cycle counts was to select items

sequentially by rows or geographic area within the warehouse or plant and work their way through

the facility over a period of time. For example, one of the leading-edge locations divided its

warehouse into geographic areas (shipping, receiving, warehouse rows) and then selected an area to

count each day.

Other methods used by the leading-edge locations to select individual items or locations for count

included a random selection, weighted selection toward higher dollar volume or value items, and

selection based on managementís discretion. One of the leading-edge locations used a random

method by which the inventory system tracked which items had been counted and which items still

needed to be counted in order to ensure that all items were counted each year. The inventory

supervisor manually entered how many items to select for count each month and the inventory system

randomly selected the desired number of items from those not counted. In another instance, one of

the leading-edge locations selected the top 25 items by dollar value each day from a list of items that

had not been counted. Locations performing wall to wall physical counts counted all inventory at a

point in time by splitting the warehouse or facility into geographic areas and assigning count teams to

each area to ensure that all inventory was counted.
22 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To determine the frequency of the physical counts, senior executives should consider the following:

• Assess the resources and timing needed to conduct the count

• Identify segments or classes of the inventory and assess each segments risk to determine the

degree of control needed based on:

• activity or turnover

• dollar value

• sensitive or classified items

• items critical to production or mission readiness

• items susceptible to misappropriation, including theft

• Select a frequency to count each segment based on the assessed risk and degree of control needed

such as:

• daily

• weekly

• monthly

• semi-annually

• annually

• Determine a method of selecting individual items for count such as:

• sequentially by row or area within the warehouse or facility

• random selection

• weighted selection towards higher dollar, higher activity items
23 GAO-01-763G Best Practices in Inventory Counts

Key Factor 5: Maintain Segregation of Duties

Characteristics

Segregation of duties

• Physical custody of assets

• Processing and recording of assets

• Approval of transactions

Mitigating controls

• Blind counts (see key factor 8)

• Increased supervision (see key

factor 7)

• Two-member count teams

Segregation of duties, a commonly used and widely accepted internal control and business practice,

entails dividing or segregating key duties and responsibilities among different people. Implemented

effectively, this type of control reduces risk of error and fraud so that no single individual can

adversely affect the accuracy and integrity of the count.

The key areas of segregation are (1) physical custody of assets, (2) processing and recording of

transactions, and (3) approval of transactions. Ideally personnel performing any one of the above

functions would not also have responsibilities in either of the other two functions. Thus, where

practical, adequate segregation of duties for the physical count process includes using personnel who

do not have overlapping responsibilities in (1) custody or access to the inventory items for count,

(2) recording transactions resulting from the count, and (3) authority for approving adjustments

resulting from the count. In situations where segregation of duties is not practical or cost effective,

other controls should be employed to mitigate the recognized risk. Such mitigating control

procedures include blind counts, (meaning that the counter does not know how many items are

supposed to be there before or during the count process), increased supervision, and applying dual

control by having activities performed by two or more people.

Physical Custody of Assets

To best accomplish segregation of duties, the normal job activities of the person performing the

physical count should not include custodial activities such as receiving, shipping, and storing physical

assets. We found that the strongest control employed by leading-edge locations was to exclude those

with asset custody from the counting activity. Five out of the eight leading-edge locations

performing cycle counts accomplished segregation of duties by using a separate inventory group of

dedicated counters with no other warehouse responsibilities to perform the physical count. The other

three locations use warehouse personnel with normal warehouse responsibilities, such as shipping,

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
24 GAO-01-763G Best Practices in Inventory Counts

receiving, and storing, to perform the count. These three locations implemented mitigating controls

to reduce the risk of using warehouse personnel by performing counts in which the counter did not

have knowledge of or access to the on-hand quantity. This is referred to as a blind count.

The leading-edge locations performing wall to wall physical counts used warehouse personnel or a

combination of warehouse and nonwarehouse personnel to perform the physical count. This is

normal procedure for companies performing wall to wall inventories, since it is usually an enormous

task to count the entire inventory in a short time, such as a weekend. All four of these locations had

implemented mitigating or dual controls to ensure proper counts and to reduce the risk caused by the

lack of segregation of duties. These mitigating and dual controls included (1) performing blind

counts, (2) increasing supervision, and (3) using two member count teams.

Table 3: Segregation of Duties

Cycle count locations Wall to wall count

locations

1 2 3 4 5 6 7 8 9 10 11 12

Personnel performing counts

Inventory group of dedicated

counters not having custodial

duties

! ! ! ! !

Warehouse personnel having

custodial duties !A ! ! ! ! ! !

Mitigating controls

Blind counts ! ! ! ! ! ! ! ! ! !

Increased supervision ! ! ! !

Two member count teams ! ! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected. A 

This location used warehouse personnel to perform 1st and 2nd counts and utilized a separate inventory group to perform

any necessary 3rd counts and research variances.

Transaction Processing and Recording

Personnel recording transactions that affect the on-hand quantities should not be responsible for the

physical custody of the inventory or approval of adjustments. Segregation between the duties of

recording transactions that result from the physical count and duties of custody or approval is

essential to provide for the integrity of the physical count process. Personnel recording inventory

adjustments to the on-hand balances at leading-edge locations did not have custodial responsibilities,

such as shipping, receiving, and storing, and did not have approve significant adjustments to the

records.
25 GAO-01-763G Best Practices in Inventory Counts

Approval of Transactions

Personnel approving transactions that affect on-hand inventory balances should not be responsible for

the physical custody of the inventory or recording of transactions. Leading-edge locations have

controls in place to manage and limit who has the authority to approve adjustments resulting from the

count. Most locations assigned approval limits to different levels of management. As the dollarvalue of the adjustment increased, the approval level moved up the management chain to a higher

level of management.

Case Study

One leading-edge company, a distributor of prepackaged parts, accomplished segregation of duties by

using a separate inventory group to conduct physical counts of inventory. In building this group and

assigning responsibilities, management implemented the key areas of segregation, separating the

duties of personnel responsible for the custody of the inventory (warehouse personnel), counting of

the inventory (cycle counters), and posting of adjustments to the records (cycle count leads). The

inventory group consisted of an inventory control supervisor, six cycle counters and one cycle count

lead for the first shift, four cycle counters and one cycle count lead on the second shift, and three

cycle counters and one cycle count lead on the third shift. Each counter was responsible for

performing approximately 200 inventory item location counts per day and any necessary recounts.

Responsibilities of the cycle count leads included preparing daily workload assignments for the

counters, posting and monitoring adjustments to the record on-hand balances, and researching

variances. The inventory control supervisor along with the leads determined the cause of variances

between counted quantities and record on-hand quantities and implemented solutions to rectify

underlying problems causing the variances.
26 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To implement and maintain effective segregation of duties in the physical count process, senior

executives should consider:

• Available resources to conduct the count and their knowledge and experience with the inventory

and counting

• Analyze the normal job duties of personnel performing activities of the physical count,

considering who has responsibility for:

• custody or physical control of the inventory

• processing and recording of inventory transactions

• approval of transactions and adjustments

• Determine whether controls may be impaired if any one person has been given responsibility for

more than one activity noted in the previous strategy

• Perform a risk versus cost analysis of any apparent control risks, and determine whether:

• duties may be reassigned or

• mitigating controls can be implemented or

• risk is at an acceptable tolerance
27 GAO-01-763G Best Practices in Inventory Counts

Key Factor 6: Enlist Knowledgeable Staff

Characteristics

• Counters are knowledgeable about the inventory items

• Counters are knowledgeable about the count process

• Count personnel are well-trained

Inventory counters who are knowledgeable about the inventory items being counted and the inventory

counting procedures are critical to performing effective and accurate physical counts. It is important

for inventory counters to be adequately trained; experienced, knowledgeable inventory counters

increase the accuracy and efficiency of the physical count. In addition, counters most familiar with

the plant layout and daily operations are more likely to conduct the counts quickly and resolve count

discrepancies without having to conduct excessive research.

Counters are Knowledgeable about the Inventory Items

Leading-edge companies normally use in-house personnel -- whether a dedicated group or warehouse

personnel -- who have been chosen expressly because of their prior experience with and knowledge

of the inventory items. One major advantage of this approach is that experienced warehouse

personnel are better able to distinguish between items that look similar but have different technical

specifications. They are also more likely to correctly identify the items they are counting and provide

accurate item descriptions and count quantities, decreasing the likelihood of needing second or third

counts.

Additionally, experienced personnel are more familiar with the layout of plant and warehouse

facilities and the movement of items within and between these facilities. They are aware of areas

where items may be placed, either intentionally or unintentionally, and thus can more easily locate all

the items that should be counted and potentially reduce misstatements in the quantities counted. They

are knowledgeable about how items are packaged and stored as well as how items are used in a

production line, so they can quickly and accurately count assigned items.

Eleven of the twelve leading-edge locations use personnel who have prior work experience and

knowledge about the inventory items being counted. A promotion from the warehouse to the position

of cycle counter within a dedicated count team of one organization was one way in which a leadingKey factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
28 GAO-01-763G Best Practices in Inventory Counts

edge location trained, developed, and retained high-performing counters. Another location, which

experienced high turnover and used personnel with varying degrees of experience, provided on-thejob training and teamed new counters with experienced counters.

Counters are Knowledgeable about the Count Process

Inventory counters should be knowledgeable about the count process to perform efficient and

accurate physical counts. Leading-edge locations performing cycle counts typically use individuals

whose sole function is conducting physical inventories. These dedicated counters, often designated

as the inventory audit group, usually have considerable experience working in the warehouse before

being promoted to an inventory counter position. Cycle counters normally have significant prior

inventory experience, are well trained, are dedicated to only counting inventory, and perform counts

routinely. Leading-edge locations performing wall to wall counts typically use warehouse personnel

to perform the counts using effective mitigating procedures for lack of segregation of duties, such as

blind counts and two member count teams. Warehouse personnel may be less experienced in the

count process because wall to wall counts are often performed only once a year. If personnel with

lesser knowledge of the inventory perform the count, then increased supervision, training, and

instructions are commonly required. One leading-edge location used administrative or other staff to

supplement its count teams, teaming these employees with experienced warehouse inventory

personnel.

Count Personnel are Well-Trained

Training all counters and supervisors involved in the physical count reduces the risk of error in

performing the count and communicates a consistent way to perform counts. Counters, supervisors,

and individuals involved in research and adjustment of variances in the leading edge locations all

received appropriate training. At leading-edge locations this is typically accomplished through

formal classroom training, on-the-job training, or a mix of the two.

The scope of training is generally dependent on the type of counts conducted, wall to wall and/or

cycle counts. Leading-edge locations typically train counters on types of inventory, warehouse

layout, unit of measure, recording of counts, computer systems, and use of radio frequency devices, if

applicable. Leading-edge locations that use a separate inventory group to perform research and/or

record adjustments typically provide training on researching variances, posting adjustments, and

operating computerized inventory systems.
29 GAO-01-763G Best Practices in Inventory Counts

Case Study

The dedicated inventory counter occupation in the inventory audit group of one leading-edge location

is a well-paid, prestigious position. Candidates for this position are selected primarily from

warehouse personnel with years of experience and an in-depth knowledge of the inventory item. The

inventory audit groupís commitment to excellence is such that newly recruited counters receive

several weeks of formalized on-the-job training. New counters shadow experienced counters, who

supervise hands-on training in specific areas, in accordance with a formal list of tasks and functions.

The progress of each new counter is monitored by the groupís supervisor and, before being allowed

to conduct counts on their own, they must demonstrate mastery of the required tasks and functions.

Once the new counter is on his/her own, their work is subject to increased supervisory review,

including follow-up test counts by more experienced counters, until the employee meets required

performance standards.
30 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To enlist knowledgeable staff in the physical count process, senior executives should consider:

• The amount of resources available to conduct the count

• Experience and knowledge of the inventory and count process of the count team

• Frequency of counts or time necessary to complete the count

• Establishing a separate inventory group of dedicated counters

• Assigning or promote personnel with prior experience in the warehouse and knowledge of the

inventory a counting position

• Providing on-the-job and classroom training of the count process to counters, supervisors, and

personnel researching variances on aspects such as:

• types of inventory

• warehouse layout

• unit of measure

• RF devices

• computer system

• research (if applicable)

• supervision (if applicable)
31 GAO-01-763G Best Practices in Inventory Counts

Key Factor 7: Provide Adequate Supervision

Characteristics

• Providing instructions and training

• Assigning count team and responsibilities

• Reviewing count sheets

• Ensuring that all items are counted

Supervision, a key factor of the count process, includes directing the efforts of personnel and

determining that the objectives of the inventory count have been accomplished. Elements of

supervision include providing instructions and training, solving problems, and reviewing the work

performed. Adequate supervision increases the likelihood of accurate and consistent counts and

reduces the overall risk of incorrect or unreliable counts. Supervisor responsibilities include:

(1) ensuring that counters are available to count, (2) selecting count team members, (3) assigning

count team responsibilities, and (4) ensuring that the count is completed on time. Counters also make

sure that needed supplies and equipment, such as count sheets, calculators, tape measures, scales for

weighing, and forklifts are available. Supervision includes providing instructions and guidance to

counters prior to and during the count and making sure that counters are following instructions.

Supervisors also ensure that all inventory items are counted and that counters record counts on count

sheets or other control devices.

Supervision can be applied at different levels and degrees depending upon the experience of the

inventory counters and other controls that are in place. The level of supervision is typically either

direct, on-the-floor supervision during the count, or indirect supervision in which the supervisor is not

on the floor during the count, but instead uses controls that are in place to monitor count performance.

Increased supervision in the form of direct supervision may be used as a mitigating control in

instances where (1) the counts are infrequent, (2) there is a lack of segregation of duties, and/or (3)

the counters are less experienced and knowledgeable about the inventory or count process.

The use of direct or indirect supervision at the leading-edge locations was generally dependent upon

managementís determination of the adequacy of segregation of duties - see key factor 5. All leadingedge locations performing wall to wall physical counts used direct, on-the-floor supervision as one of

their controls to reduce the risks discussed above. On the other hand, all leading-edge locations

performing cycle counts used indirect supervision, some also using additional control mechanisms to

monitor performance.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
32 GAO-01-763G Best Practices in Inventory Counts

For example, as discussed in key factor 5, the strongest of controls for segregation of duties, found at

five locations, was accomplished by using a separate inventory group of dedicated counters. These

separate, dedicated counters were highly specialized and independent of routine inventory

responsibilities. Because of their years of experience and knowledge of counting their performance

was not directly monitored by the supervisors. Supervisors monitored the number of counts being

performed and the number of variances. They also concentrated on identifying the causes of

variances between the counts and recorded on-hand quantities in order to identify solutions to correct

the causes of the errors. The remaining three locations performing cycle counts used warehouse

personnel to perform cycle counts without direct supervision. These locations reduced their risk of

impaired segregation of duties by using personnel who were experienced and knowledgeable about

the inventory and count process and performing blind counts.

Case Study

One leading-edge location, an electronic component manufacturer producing 49,000 units per

day with two warehouses totaling over 1 million square feet, performed daily cycle counts on the

raw materials used on the production line and performed monthly wall to wall counts on the

finished goods. The location used a dedicated inventory group to conduct its daily cycle counts,

which included an inventory group supervisor and 14 dedicated counters. These dedicated

counters attained their position through prior warehouse experience and as a result, were highly

knowledgeable about the inventory and count process. Because of the experience and

knowledge of these counters, the inventory group supervisor did not directly supervise the

performance of the counts, but instead monitored the cycle counts by reviewing count cards for

accuracy and completeness, to ensure that all items were counted.

Once a month the location performed a wall to wall count on its entire inventory of finished

goods. The location used the dedicated inventory group that performs cycle counts as well as

warehouse employees to conduct the wall to wall count. There were a total of 24 counters and

each warehouse person was teamed with one of the dedicated cycle counters. There were three

supervisors on the floor during the wall to wall physical count to directly monitor the count to

ensure that the count teams were following instructions and that all items were properly and

promptly counted. The degree of supervision was significantly increased for the monthly wall to

wall counts because of the increase in the number of counters and to mitigate segregation of

duties problems due to the use of warehouse personnel as members of the count team.
33 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To provide adequate supervision over the physical count process, senior executives should consider

the following:

• The number of resources or teams performing the physical count

• Frequency of the counts or the time necessary to complete the count

• Knowledge and experience of the personnel performing the count

• Whether there is adequate segregation of duties from responsibilities of asset custody

• The assigned responsibilities of the supervisor such as:

• the availability of count personnel

• selection of count team members

• assignment of count responsibilities

• monitoring of performance

• ensuring counters are following procedure and complete counts in a timely manner

• Size of the warehouse or area subject to count

• The number and complexity of items to be counted

• Other controls that may be in place during the count, such as the performance of blind counts
34 GAO-01-763G Best Practices in Inventory Counts

Key Factor 8: Perform Blind Counts

Characteristics

• No prior knowledge of on-hand balances

• Limited or no access to inventory system

A blind count refers to the performance of a physical inventory count without the knowledge of, or

access to, the on-hand quantity balance in the inventory records. Counters are provided the part

number, description, location, and other information necessary to perform the count but not the item

quantity information. Inventory items are counted and compared to the on-hand balance in the

inventory records. If the blind count agrees with the record on-hand balance, there is a high level of

confidence that both the count and the record on-hand balance are accurate.

Blind counts offer the greatest degree of assurance of accurate and reliable counts. If the record onhand quantity is provided to the counters, there is a risk that the counters will not actually perform

the count. They may visually look at the inventory, conclude that it agrees with the record on-hand

quantity, and record the on-hand balance amount as the physical count. The counters may be

influenced by the record on-hand quantity provided to them and make assumptions that are incorrect.

For example, if there is a box of 20 items and the record on-hand shows the quantity as 1, the

counters may be influenced to record the count as 1 instead of recording the correct unit measure

count as 20.

We found that blind counts were one of the strongest control measures used at leading-edge

locations. Counters did not have access to record quantity during the count at 10 of the 12 leadingedge locations. Specifically, six of the eight locations performing cycle counts and all four of the

locations performing wall to wall counts performed blind counts.

An important consideration in deciding whether or not to perform blind counts is the strength of

control provided by segregation of duties, as discussed in key factor 5. Counts at all locations

performing wall to wall inventory were completed by warehouse personnel having potentially

conflicting custodial duties. However, management at these locations mitigated that increased risk

by using blind counts and other controls. Conversely, the two locations performing cycle counts, in

which the quantity was provided to the counters before or during the count, used a dedicated count

team whose members had no other conflicting custodial duties. Management at these two locations

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
35 GAO-01-763G Best Practices in Inventory Counts

asserted that this approach added to their efficiency by allowing counters the opportunity to solve

variances often while they were at the inventory item location. They stressed, however, that the

combination of segregated duties along with other control measures, such as maintaining a history of

who performed counts by item and location and supervisory review, balanced the increased risk of

providing the counters with quantity information.

Table 4: Blind Counts

Cycle count locations Wall to wall count

locations

1 2 3 4 5 6 7 8 9 10 11 12

Blind counts

Record quantity not accessed

during the count ! ! ! ! ! ! ! ! ! !

Personnel performing counts

Inventory group of dedicated

counters not having custodial

duties

! ! ! ! !

Warehouse personnel having

custodial duties count ! ! ! ! ! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected.

Case Study

One leading edge company with over 700 warehouse and distribution centers performed daily cycle

counts. The company used warehouse personnel with normal warehouse responsibilities, including

asset custody, to perform all first and second counts. A separate inventory control group was

responsible for coordinating and overseeing their physical count(s), performing any third counts, and

researching and reconciling variances. To reduce the risk of error or fraud increased by the counters

having asset custody responsibilities, the company strengthened controls by using blind counts,

restricting access to on-hand balances prior to and during the count.
36 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To effectively use blind counts during the physical count, senior executives should consider the

following:

• Tools used to perform the count (count cards, count sheets, or RF Guns)

• Capability of the inventory system to not provide quantities on count cards or sheets, and restrict

access to on-hand balances prior to and during the performance of the count, except for

authorized personnel

• Personnel performing the physical count and whether there is segregation of duties between the

responsibilities of asset custody and physical counts

• Personnelís experience and knowledge of the inventory items and the count process
37 GAO-01-763G Best Practices in Inventory Counts

Key Factor 9: Ensure Completeness of the Count

Characteristics

• Cutoff procedures

• Pre-Inventory count activities

• Control methods for count completion

A complete count requires that (1) the inventory being counted include all the items that should be

present and not include items that are not part of the inventory and (2) control of the count process is

maintained so that all inventory items that should get counted do in fact get counted. To facilitate the

inventory being completely accounted for and accurately counted, there are a number of

considerations that need to be made before the actual count begins. These considerations fall into

three major categories:

• Cutoff procedures

• Pre-inventory count activities

• Control methods for count completion

Cutoff Procedures

Cutoff is the process of (1) controlling the movement of items between locations, such as in shipping,

receiving, production, and rewarehousing and (2) coordinating the timing and verifying the

movement of items with the related quantity changes in the inventory system. Cutoff is an essential

procedure to ensure the existence and ownership of inventory. Cutoff can be achieved in a variety of

ways, but the easiest way, in addition to verifying and coordinating the movement of items and the

inventory records, is to conduct the count when operations are shut down or during a period when

there is limited movement of inventory, such as the graveyard shift or weekends. All leading-edge

locations performing wall to wall counts shut down their warehouse operations during the physical

count.

One of the advantages of performing cycle counts is that companies do not have to shut down their

entire operation, as is normally the case for wall to wall physical counts. The leading-edge locations

performing cycle counts typically do not stop the movement of inventory but instead use other

controls to ensure that items are not erroneously omitted, included, or counted twice. These controls

include (1) counting during a slow period of operations when there is little movement, (2) preventing

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
38 GAO-01-763G Best Practices in Inventory Counts

any movement of the inventory items to be counted on the day the items are selected for counting,

and (3) using system-generated transaction histories to trace the movement of items and reconcile the

count.

Case Study

One leading-edge location addressed cutoff issues in its distribution center inventory by using a

perpetual inventory system with locator capability. The difficulties of getting an accurate location

count without shutting down operations were significantly reduced by stopping movement into and

out of locations for the specific items selected for count that day. When the inventory system

selected the items for that dayís count, a HOLD indicator was placed by the system in the record for

those items. Warehouse personnel are thus notified that, with certain exceptions, they are not to pick

items from or store items in those locations until the HOLD is released. Inventory counters are

required to complete all counts on the day scheduled and release HOLDs as the counts are completed,

including any necessary recounts and research for variances between the quantity counted and record

on-hand balances.

Pre-Inventory Activities

Pre-inventory activities, primarily physical location preparation, are accomplished prior to the

physical count in order to increase the efficiency and effectiveness of the count. Physical location

preparation typically includes (1) organizing work areas and storage locations, (2) identifying and

segregating items, (3) ensuring that all inventory items have labels or identification, (4) verifying that

items are in the correct location, (5) precounting slow moving items, and (6) identifying

excess/obsolete inventories. In the well run warehouses of the leading-edge locations we visited,

most of these activities were part of their daily routine. Other pre-inventory activities needing

consideration include the timing of the inventory, staffing and equipment requirements, review of

inventory procedures, and instructions to and training of counters.

Control Methods for Count Completion

There should be a system to ensure that all inventory items are considered for count, including items

on the receiving dock, in the warehouse, in the shipping area, in tractor-trailers, and at outside

locations, such as owned or leased warehouses, public storage, or any other locations having

inventory owned by the organization. For inventory outside the direct control of the organization,

management may consider making arrangements to have the inventory counted by its own employees

or by the people responsible for safeguarding the inventory. If their own employees are not used to

count the inventory, management should consider making arrangements to have their personnel at the

site to observe and verify that the count is preformed accurately and completely. Leading-edge

locations used three primary methods for determining the quantities of inventory items stored at

outside locations: (1) they count the inventory as part of their physical count program, (2) they obtain

written confirmation and/or monthly statements from the parties responsible for storing the inventory,

or (3) they send representatives to observe the physical counting of the inventory.
39 GAO-01-763G Best Practices in Inventory Counts

Case Study

One leading-edge location with 20 distribution centers and 80 manufacturing facilities maintained

inventory items in several different locations. Raw materials, work in process, and finished goods

were stored in tank cars, trucks, pipelines, drums, bins, and racks. Additionally, inventory was stored

at off-site locations controlled by the company and public warehouses outside the control of the

company. To maintain the integrity of the inventory records, this location counted all inventory items

within the companyís control at least twice a year, and all inventory outside of its control was

physically verified once per year. To verify completeness, inventory items within the companyís

manufacturing, distribution, and offsite locations were physically counted through regular cycle

counts using prenumbered count sheets that were reviewed by supervisors. Additionally, a company

representative was sent to observe and verify the annual physical count of inventory items outside the

control of the company held at public warehouses.

As shown in table 5, control tools are used to determine that every inventory item gets counted. A

manual system, such as count tags or count sheets, or a computerized inventory locator system that

tracks an itemís location, may be used to verify that every inventory item gets counted once and only

once. Operations without inventory locator systems commonly use prenumbered count tags, sheets,

or cards to ensure that all items are counted. For example, during a typical wall to wall physical

inventory, personnel count the inventory item, record the count on the upper and lower part of the tag,

and attach one part of the tag to the inventory item and give the other part to the control desk. The

control desk accounts for all the prenumbered tags and compares the count to the record on-hand

quantities. At the end of and during the inventory count process, the supervisor walks through the

warehouse and visually inspects that a count tag is attached to every inventory item, which offers

some assurance that all inventory items have been counted. The count tags attached to the inventory

items also ensure that the inventory is not counted twice. A second check is done by the control desk

crosschecking that all the inventory items recorded on the books have a physical inventory count

recorded. Operations with inventory locator systems rely heavily on their systems to report any

inventory items not counted and where the items are located.

Leading-edge locations rely on their computerized inventory systems to ensure that all recorded

inventory items are counted. Those performing cycle counts generally have their computer systems

generate a list of items (count sheets) to be counted each day. The system keeps track of all items

counted and entered into the system. If an item is not counted, the system carries the item forward

and repeatedly lists the item until it is counted. Supervisors can generate a report (aging list) to list

all items scheduled for a count but not counted. Some companies have their systems generate

locations to be counted, and again the system tracks all locations that have not been counted. Nine of

the twelve leading-edge locations also test the completeness of their systems by performing location

counts3

 in addition to their regular cycle and wall to wall counts. In other words, they test for the

possibility of inventory items existing on the floor that are not reflected in the records. They perform

these procedures by selecting inventory items in the warehouse and tracing those items back to the

record on-hand balances in the system.

 3

 Location counts are physical counts used by the leading edge locations to check the accuracy of their “floor to

record” quantities, whereby all items in a location or area in the warehouse are counted and compared to the

inventory records to ensure the proper recorded quantity and location of an item.
40 GAO-01-763G Best Practices in Inventory Counts

Table 5: Control Methods to Ensure Completeness of Count

Cycle count locations Wall to wall count

locations

1 2 3 4 5 6 7 8 9 10 11 12

Controls to monitor count completeness

System tracks inventory items

and/or locations counted ! ! ! ! ! ! ! ! ! ! ! !

Location counts from floor to

record ! ! ! ! ! ! ! ! !

Counted areas are physically

marked and walkthroughs are

performed

! !

Supervisors account for all count

sheets and/or count tags ! ! ! ! ! ! ! ! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected.
41 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To ensure completeness of the physical count, senior executives should consider:

• The organizationís operating environment, time of operations, and itís ability to:

• suspend operations during the physical count

• perform counts when there is limited movement of the inventory, such as nights or weekends,

and

• prevent movement of items subject to count on the day of count only

• Reliability of the inventory system to accurately capture and track transactions affecting the onhand balances

• Existence of slow moving or excess obsolete inventory items that could be segregated and

precounted

• Existence of inventory stored at outside locations and the personnel or organization responsible

for verifying itís physical existence

• Use of prenumbered count sheets or tags and reconciliation of the numbers issued to the numbers

returned

• Reconciliation of items selected for count to actual items counted

• Performance of additional counts where items are selected from the floor and compared to the

inventory system
42 GAO-01-763G Best Practices in Inventory Counts

Key Factor 10: Execute Physical Count

Characteristics

• Communicate information to the counter

• Verify item data and quantity

• Capture and compare the physical count

• Perform requisite number of counts

• Complete counts in timely manner

Practices discussed in earlier key factors lay the foundation for completion of physical count

procedures. Properly executing the count provides accurate results for comparison of the count to the

recorded balances, and the posting of adjustments to the inventory records for financial and

operational decision-making. There are five key areas of consideration when executing the physical

count including (1) communication of proper information to the counters, (2) verification of correct

item information, (3) appropriate method to capture and compare the physical count to the inventory

records, (4) determination of the number of requisite counts to perform before a count is accepted as

final, and (5) timely completion of the count.

Communicate Information to the Counter

Communication of appropriate information ensures that counters have the necessary information to

perform the count (i.e., items to be counted). Leading-edge locationís communication to counters is

usually in the form of a list of items to count, such as count sheets, or assigned zones to count, usually

including stock location, stock number, description, and unit of measure. In instances where

nonblind counts are being performed, the quantity to be counted would also be included. This

information is normally provided to the counters on count lists, sheets, cards, or on RF Guns (radio

frequency devices).4

 4

 RF Guns are handheld units that receive and transmit information to and from the inventory system. The

counter usually scans a bar code for the item or location for count and the RF Gun displays the information for

the item or location (i.e., unit of measure, stock number, location). The counter then enters the physical count

quantity directly into the RF Gun and the count is automatically transmitted and captured in the inventory

system for comparison to the on-hand balance.

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
43 GAO-01-763G Best Practices in Inventory Counts

Verify Item Data and Quantity

Verification of data supplied to the counter ensures that the significant information in the inventory

record is consistent with the physical information about the item. The data verified by counters at

leading-edge locations typically included stock location, stock number, description, and quantity in

instances where nonblind counts are being performed.

Capture and Compare the Count

The physical count includes the instrument or method used by the counter to record the results of the

physical count for comparison to the on-hand balance in the inventory system. The leading-edge

locations used a number of techniques to record the results of the physical count ñ some used

traditional methods, such as manual count sheets or cards, while others used technical tools, such as

RF Guns. When count sheets or cards are used, the actual physical count is recorded on the sheet or

card and is then manually input into the computer system for comparison to the inventory record.

When RF Guns are used, information is automatically uploaded into the computer system to capture

the count for comparison to the inventory record on-hand quantities. The comparison of the actual

count to the record on-hand balance determines the variance between the two and the need for

recounts or research. The inventory record on-hand balances are typically not adjusted until recounts

and research are complete. See key factor 11 for a discussion of adjustments to the record on-hand

balance. The majority of the locations (cycle and wall to wall) used count sheets to record the

physical count.

Perform Requisite Number of Counts

Number of counts refers to the number of times an item will be counted before a final count is

accepted. The number of counts by leading-edge locations ranged from as few as one to any number

determined by management to be appropriate. Counts performed past the first count can be based on

any of the following: a difference between the count and record on-hand balance (variance), judgment

of supervisors or management, variances exceeding established tolerances, and until two counts

agree. There was no minimum number of counts required past the first count by the leading-edge

companies. The maximum number of required counts varied from two counts up to the necessary

number of counts until two counts agreed. Typically, two or three counts were performed.

If there is a variance between the count and the record on-hand balance, a second count is required.

Segregation of duties should be reconsidered in assigning the personnel performing any additional

counts. One of the leading-edge locations used a different count team to perform the second count.

In this leading-edge location, the second count was accepted as the final, accurate count, after which

personnel responsible for recording transactions research variances and adjust the record on-hand

quantity with the appropriate approval. Some leading-edge locations perform multiple, subsequent

counts until such time as two counts conclude with the same quantities.

Complete Counts in a Timely Manner

Timely counts are important due to managementís reliance on the information in the inventory

system for making operational decisions. Whether completing a single count or multiple counts, the

leading-edge locations expected their count teams to complete their assignments as quickly as

possible. The majority of the leading-edge locations expected the initial count and any necessary

recounts to be completed within 24 hours.
44 GAO-01-763G Best Practices in Inventory Counts

Case Study

One leading-edge location, a 710,000 square foot distribution facility maintaining over 20

million finished products, performed its counting procedures with the precision of a well-trained

military exercise. Its ìarmyî of over a dozen dedicated counters cycled through the warehouse

performing counts daily. Warehouse locations are mapped on an Excel spreadsheet, and the

inventory group supervisor assigns zones (warehouse aisles) to each counter. Counters are

provided via RF Gun (radio frequency device) data of individual items in his/her zone including

stock location, part number, and unit of measure and description. The itemís quantity is not

obtainable by the counter. By scanning the bar-coded location number contained on a

preprinted location marker, and entering the item number from the container, the counter verifies

the accuracy of item data contained in the perpetual record. Once the counter verifies that the

description is correct, he/she performs the count and enters the quantity into the RF Gun. These

data are automatically uploaded into the inventory system to capture the count, at which realtime comparison of the counted quantity and the system balance is made. Any variance is

reported to the supervisor via an on-screen or printed variance report. For inventory items

having variances, second counts are required to be performed within 8 hours by a different

inventory counter. If after the second count, the variance remains greater than $400, then all

locations in the warehouse containing that inventory item are counted on the next shift to ensure

location and total item quantity accuracy.
45 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To effectively execute the physical count, senior executives should:

• Determine the data to provide to the counter to verify during the count by considering:

• knowledge and experience of the personnel performing the count

• the item data maintained in the inventory system or on location labels

• whether blind counts are to be performed, requiring the restriction of access to on-hand

balances

• Determine the method to be used to capture and compare the count, such as count cards, sheets, or

RF Guns, by considering:

• the capability of the inventory system

• ability to use RF devices

• Determine number of counts to perform by considering:

• resources necessary to perform additional counts

• personnel performing additional counts and their segregation of duties from asset custody and

their knowledge and experience of the inventory and count process

• time necessary to complete additional counts promptly

• characteristics of the inventory (unit of measure, size, dollar value, classification, and size of

variance in quantity and dollar value) to establish tolerances for additional counts
46 GAO-01-763G Best Practices in Inventory Counts

Key Factor 11: Perform Research

Characteristics

• Perform required research

• Complete research in a timely manner

• Refer variances to management and security for approval and investigation

Even with a strong control environment and sound physical count procedures, it is not unusual for

there to be differences in quantities between the physical count and the record. Research of the cause,

sometimes referred to as ìroot cause analysis,î and reconciliation of the difference is an essential

element of an effective physical count process. Research, when properly conducted, provides support

for adjustment to the inventory records, identifies the causes of variances between the physical count

and the inventory records, and provides management with information with which to implement

corrective actions. The process of research includes performing the required analysis, promptly

completing research, and referring variances to management for approval and/or security for

investigation.

Required Research

Research is the process of investigating a discrepancy, often referred to as a variance, between the

physical count and the on-hand balance. Variances may indicate that something is wrong with the

inventory system or the warehouse operations that affect inventory balances. In order to reduce the

potential for future errors in the inventory records, it is important to identify and correct the cause of

the variance. Management determines which variances to research and the extent of research

necessary to identify the causes of the variances.

Managementís determination of which variances to research includes consideration of dollar value,

type of item, and the effect of the variance on the operations of the organization. As the impact of

variances on the financial records or on the operations of the organization increases, it becomes more

important to conduct extensive research. Management may also determine that the impact of certain

variances is insignificant, by establishing a low dollar or quantity tolerance and allowing adjustment

to the on-hand balance in the inventory system without requiring research. Leading-edge locations

researched variances based on criteria established by management. The criteria established by

management usually included setting quantity or dollar value tolerances. Tolerances ranged from

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
47 GAO-01-763G Best Practices in Inventory Counts

zero, in which all variances were researched, to 5 percent, in which only those variances exceeding

the established dollar value or quantity tolerance were researched. Others relied on the judgment of

the researcher. Some locations used a combination of tolerances and researcher judgment depending

upon the type of inventory or its impact to operations. Three of the eight leading-edge locations

performing cycle counts had a zero of error for all inventory items and researched all variances. The

remaining five locations performed research on variances that exceeded established dollar value or

quantity variances by type of item, and/or on the basis of the researcherís assessment of the impact to

ongoing operations. Two of these five locations had established tolerances ranging from zero to five

percent based on product type. Locations performing wall to wall physical counts researched

variances based on established dollar and quantity tolerances, as well as the judgement of the

researcher. If a variance did not meet managementís criteria for research, the on-hand balance in the

inventory system was usually adjusted to reflect the actual physical count. Table 6 shows the

established criteria for researching variances at leading-edge locations.

Table 6: Criteria For Variances Researched

Cycle count locations Wall to wall count

locations

Established criteria

1 2 3 4 5 6 7 8 9 10 11 12

Zero tolerance (all variances

researched) ! ! ! ! !

Variances > $100 ! !

Variances > $1000 !

Variances > 3-5 percent quantity

variance ! ! !

Judgment of researcher (based

on impact on operations) ! ! ! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected.

Once management determines which variances to research, it is essential to (1) correctly adjust the

change in inventory balances to accurately reflect the physical on-hand quantity and (2) identify the

cause of the variance. The extent of research may include reviewing (1) transaction histories, (2)

shipping and receiving records, and (3) production usage records. We found that all of the leadingedge locations researched transaction histories, movement of items during the count, and shipping

and receiving documents to ensure proper adjustment of the inventory records and identify causes of

variances. After research was completed on the selected variances, an adjustment was posted to the

on-hand balance in the inventory system to reflect the actual physical count.

Identifying the causes of variances is useful in detecting weaknesses in the underlying controls and

individual processes that affect the inventory system record. Grouping and tracking the nature or

type of errors into assigned codes is an effective tool for analyzing causes of variances and

implementing corrective actions to reduce future errors. For example, a leading edge locationís

assignment of error codes enabled the company to implement corrective actions and process

improvements, which increased the locationís inventory record accuracy and decreased operating

costs. We found that four of the locations performing cycle counts assigned and tracked error codes.
48 GAO-01-763G Best Practices in Inventory Counts

The number of error codes used by the leading-edge locations to identify causes of variances

averaged 22 and included codes for incorrect entries, leaks or spills, wrong location, receipt error,

stock picking error, and shipping error.

Case Study

One leading-edge location with over 113,000 stock numbers and approximately $222 million in

inventory, used a separate inventory group to research variances. Its research included reviewing

transaction histories, shipping and receiving records, and documentation of in-transit items to identify

causes of the variances. Also, management at the location had established criteria to determine what

level of research was required for each type of item. The inventory was segmented into two primary

types of items ñ type ìAî and ìB.î A zero tolerance was established for type ìAî items, for which all

variances were researched. A 3-percent quantity tolerance for type ìBî items was established for

which only quantity variances in excess of 3 percent of the record on-hand balance were researched.

Timely Research

Prompt completion of required research is key to identifying and correcting the causes of variances.

As the amount of time between the discovery of an error in the inventory records and research

increases, the more difficult it is to identify the cause of the error. Adjustments posted promptly to

the inventory and financial records provide reliable information for use by management. We found

that the majority of the leading-edge locations performed and completed research either the same day

as the original count or by the end of the following day. This allowed for timely adjustments to the

inventory records and immediate corrective action to prevent future errors.

Approval and Referral of Adjustments

Approval of adjustments by management and referral of potential fraud or theft to investigators helps

ensure reliable counts and research. We found that all of the leading-edge locations routinely referred

adjustments to management for approval. As the dollar amount of the adjustment increased, the

approval level within the company increased. The approval levels progressed from the lead or

supervisor of the researcher up to the location or plant manager. Although the leading-edge locations

indicated that they did not have significant problems with fraud or theft, some locations regularly

reviewed adjustments and trends on items susceptible to fraud or theft in case referral to security or

law enforcement was necessary.
49 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To effectively research variances arising from the physical count, senior executives should:

• Establish tolerances or criteria for selection of variances to research such as:

• effect on operations or mission readiness

• quantity and dollar value of the variance

• characteristics of the items with the variance, such as sensitive, classified, or items susceptible

to fraud or theft

• Develop processes for how to perform research, such as procedures for reviewing movement of

items during the count, transaction histories, and shipping and receiving documents, by

considering:

• reliability of the inventory system to accurately capture transactions affecting the on-hand

balance

• time necessary to complete the research promptly

• knowledge of the personnel performing the research

• Establish error codes that would identify the cause of variances

• Set approval levels for adjustments that move up the chain of management as the dollar value

increases or the nature of the item requires a higher level of approval

• Define responsibility for reviewing adjustments and trends on sensitive and classified items, and

items susceptible to fraud or theft, and notify security or law enforcement
50 GAO-01-763G Best Practices in Inventory Counts

Key Factor 12: Evaluate Count Results

Characteristics

• Measure the results of the physical count using performance measures

• Communicate the results of the physical count to counters, management, and warehouse

personnel

• Modify policies and procedures to address necessary changes in the physical count process

Evaluating the results of the physical count is essential to an accurate and effective physical count

process. The evaluation of the results gives management the necessary information for measuring the

effectiveness of (1) the physical count and (2) corrective actions or improvements to the inventory

process and system. Evaluation includes measuring the results of the count, communicating the

results, and modifying existing policies and procedures.

Performance Measures

The results of the physical count can be measured several ways. Calculating an inventory record

accuracy rate, summarizing the number and dollar value of adjustments, errors, or items counted, and

tracking and analyzing error code frequencies are three ways to measure results.

A common method of measuring the results of the physical count is the calculation of an inventory

record accuracy rate. Inventory record accuracy rates measure the degree of agreement between the

balance in the inventory records and the physical count. When calculating inventory record accuracy,

it is necessary to define what will be considered an error. An error can be defined in various ways,

including (1) any error in the item record, such as location, description, and quantity or (2) quantity

errors exceeding established tolerances. Tolerance is a range within which an actual value or quantity

can disagree with the inventory record and still be considered accurate for the purposes of calculating

inventory record accuracy. Tolerances are typically based on an itemís or segment of itemís usage or

volume, dollar value, lead-time, and criticality to production or operations. The range of tolerance

may be as low as zero, in which all quantity differences are considered errors, upward to ìXî

percent, in which quantity differences only in excess of that amount are considered errors. Once the

definition of what constitutes an error has been established, the inventory record accuracy rate can be

calculated. There are multiple ways of calculating inventory record accuracy; however, the common

method is:

Number of accurate items or records x 100% = record accuracy rate

 Number of items or records counted

Key factors in

achieving

consistent and

accurate counts

of physical

inventories1. Establish Accountability

2. Establish Written Policies

3. Select an Approach

4. Determine Frequency of Counts

5. Maintain Segregation of Duties

6. Enlist Knowledgeable Staff

7. Provide Adequate Supervision

8. Perform Blind Counts

9. Ensure Completeness of Count

10. Execute Physical Count

11. Perform Research

12. Evaluate Count Results

Management Commitment
51 GAO-01-763G Best Practices in Inventory Counts

Leading-edge locations evaluated the results of a physical count using various performance measures,

including inventory record accuracy calculations and other measures. Six of the eight leading-edge

locations performing cycle counts measured inventory record accuracy. Locations measuring

inventory record accuracy defined an error as either (1) any error in the inventory record (quantity

and location) or (2) any quantity error exceeding established tolerances. Established tolerances

ranged from zero to 5 percent; however, four of the six locations had a zero quantity tolerance for all

items or segments of items. Three locations performing cycle counts had established separate

tolerances for identifiable segments of their inventory based on type of item, dollar value, activity, or

criticality of an item to operations. For example, one location (shown as location 3 in table 7)

segmented its inventory by type of items (type ìAî and ìBî). It established a zero tolerance for the

ìAî segment, in which any difference in the inventory record counted as an error. It established a

3-percent tolerance for any quantity differences exceeding 3 percent of the on-hand balance for the

ìBî segment of inventory. Table 7 illustrates leading-edge locationsí measuring inventory record

accuracy, defining errors, and the tolerance established by management for use in calculating

inventory record accuracy.

Table 7: Performance Measures

Cycle count locations Wall to wall count

locations

Performance measures

1 2 3 4 5 6 7 8 9 10 11 12

Inventory record accuracy ! ! ! ! ! !

Other performance measures ! ! ! ! ! ! ! ! ! ! ! !

Error definition

Any error in the inventory record

(location, quantity, stock number) ! !

Quantity errors

 Zero tolerance (all quantity

differences are errors) ! ! ! !

 Greater than 0 but less than 5-

percent tolerance (quantity

differences exceeding the

tolerance are errors)

! ! !

! Indicates applicability to the individual 12 locations studied from the 7 companies selected.

The leading-edge locations performing wall to wall counts and two of the companies performing

cycle counts did not calculate inventory record accuracy rates but instead measured the results of the

physical count using other methods. These other methods included (1) total quantity adjustments,

(2) total dollar value of adjustments, and (3) number of errors by error code. Quantity and dollar

values of adjustments were measured in both gross (sum of the absolute value of adjustments) and net

(mathematical sum of the adjustments). These other performance measures were also used by

locations calculating inventory record accuracy rates in evaluating their physical count, as shown in

table 7.
52 GAO-01-763G Best Practices in Inventory Counts

Communication of Results

Communicating the results of each physical count is essential to achieving and maintaining accurate,

reliable counts and records and improving the results of future physical counts. The results of a count

should be communicated to the people doing the work, including counters and warehouse employees,

and to management supporting the effort. Communication of results to the counters reinforces the

results of their work and the importance of reliable counts. Likewise, communication to warehouse

employees makes them aware of the effect they have on the results of the count as they perform their

daily activities and the importance of doing their jobs correctly. Communicating the results of the

count conveys the importance of accurate records to all personnel and enforces managementís

dependence on personnel to achieve accurate records. Communicating the results to management

ensures that management is informed and can then assess the impact on operations and implement

corrective action.

All of the leading-edge locations communicated the results of the physical counts to management,

counters, and/or warehouse personnel. Management was forwarded the results of the physical count

in the form of reports containing inventory record accuracy, amount of adjustments, and trend

analysis of error codes. Weekly and monthly meetings were held with the managers responsible for

the physical count, warehouse operations, and other areas affecting the inventory. The meetings were

used to discuss the results of the count, including inventory record accuracy, amount of adjustments,

and the trends or error codes in order to identify the impact to the companyís operations and address

identified problems. The results of the physical counts were communicated to counters and

warehouse employees in the form of display boards or scorecards published for areas of the

warehouse, which were displayed around the warehouse in highly visible locations. At one of the

leading-edge companies, the results of the physical count and the impact each employee had on the

accuracy of inventory records was discussed during a quarterly meeting with all employees.

Modification of Policies and Procedures

Once the results of the physical count have been evaluated and communicated, it is useful to ìclose

the loopî of the physical count by considering indicated changes to the inventory count and

management process and making appropriate modifications to policies and procedures.

Managementís assessment of the results of the physical count and employee feedback is useful in

determining the effectiveness of the physical count. The results may indicate the need to count a

particular item more frequently due to high errors. Conversely, an item that has not had any errors

and little activity may be counted less frequently. In other instances, the makeup of the inventory or

the operations of the organization may have changed, in which case management may need to

reconsider the significance of items and the frequency with which they should be counted. It is

important that lessons learned from each physical count result in changes that improve the physical

count process and inventory management process. We found that the leading-edge locations routinely

updated policies and procedures for the physical count process as a result of changes to processes or

systems, and at a minimum reviewed the adequacy of documented and performed procedures every

one to two years.
53 GAO-01-763G Best Practices in Inventory Counts

Case Study

One leading-edge location, a 710,000-square foot distribution center with over 380 employees, used a

variety of methods to evaluate and communicate the results of its physical count. Results were

measured with a combination of an inventory record accuracy rate, dollar value and quantity of

adjustments, number of accurate counts, and analysis of error codes assigned to variances. A daily

report was sent to the inventory managers and supervisors summarizing the number of items counted,

accuracy rate, and dollar value of adjustments. Once a week the results of the count were published

and posted in the warehouse summarizing the current accuracy rate and trends, as well as successes

and problem areas. The location also held weekly and biweekly meetings with operation managers,

the inventory group supervisor, inventory managers for material returns and receiving, quality

control, engineering, and the director of operations to discuss the results of the count and causes of

the variances ñ the purpose of which was to correct problems and improve operations on a ìrealtimeî basis.
54 GAO-01-763G Best Practices in Inventory Counts

Strategies to Consider

To evaluate the results of the physical count process, senior executives should consider the following:

• Establish performance measures that are aligned with organizational objectives and strategies and

that are useful in evaluating the results of the physical count

• Determine the methods to be used to measure performance of the count:

• Define an error for purposes of measuring performance

• Establish tolerances based on characteristics of the inventory and the quantity or dollar value

of the variances to be considered in error

• Establish mechanisms to communicate results and performance measures to counters, warehouse

personnel, and managers

• Establish routine meetings with managers from all aspects of the inventory process including the

physical count, receiving, shipping, ordering, stocking, and production, to discuss results and

measures and evaluate the causes of the errors to identify corrective actions and assign

responsibility for those actions

• Use results and performance measures as a basis to make changes to the process and modify

existing policies and procedures to reflect changes in the processes
55 GAO-01-763G Best Practices in Inventory Counts

Appendix I: Implementation Checklist

Planning, Conducting, Researching, and Evaluating a Count of Physical

Inventory

(AN IMPLEMENTATION CHECKLIST)

This checklist is provided as an aid to making and documenting decisions in the planning,

conducting, and/or auditing of the inventory count process and researching and evaluating its

results. It is presented in the chronological order of the major steps of the process. References

are provided to the 12 key factors in the body of the report, which provide guidance in

considering the issues and factors involved in the decision-making processes.

The checklist is segregated into the following four major sections, with eleven steps to consider

categorized in each of the numbered subtitles, as follows:

PLANNING 1) Select an approach to the count

2) Determine count frequency

3) Organize the count team(s)

COUNTING 1) Accomplish appropriate cutoff

2) Perform pre-inventory activities

3) Count the inventory

RESEARCH AND

ADJUSTMENTS

1) Perform research

2) Adjust the record

EVALUATION OF

RESULTS

1) Determine the record accuracy rate

2) Consider other performance measures

3) Communicate the results of the count
56 GAO-01-763G Best Practices in Inventory Counts

PLANNING

1) Select an approach to the count

2) Determine count frequency

3) Organize the count team(s)

1) Select an approach – The two basic approaches most used by leading-edge companies to count inventory

are (a) cycle counting a portion of items over time or (b) a physical wall to wall count. Which approach or

combination of approaches is best for your inventory will depend on specific circumstances. Management

should consider the following major issues when making this decision.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) the guidance provided in

existing policies and

procedures?

Establish written

policies

b) what approach(es) your

inventory system will support? Select an approach

c) the amount of time available

and/or deadline issues

involved?

Select an approach

d) the primary objectives in

conducting a physical count? Select an approach

e) whether existing system

accuracy supports reliance on

it?

Select an approach

f) natural or logical segments of

your inventory? Select an approach

Document your final conclusions for selecting an approach below. (e.g. The cycle counting approach is selected for the (ABC)

segment(s) and/or the wall to wall counting approach is selected for (XYZ) segment(s).)

2) Determine count frequency – Selecting how many, how often, and which items to count may not be as

straightforward as it seems. Risk factors of mission and operational criticality, dollar values, quantity

significance, rate of turn-over and pilferability, along with the following, should play a part in management’s

decisions.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) the frequency with which all or

certain items or segments

should be counted?

Determine frequency of

counts
57 GAO-01-763G Best Practices in Inventory Counts

b) if the frequency of counts

should be weighted to certain

items or segments?

Determine frequency of

counts

c) if items to be counted should

be selected randomly or

otherwise?

Determine frequency of

counts

Document your conclusions for determining count frequency below. (e.g. Items in inventory segment(s) (ABC) will be randomly

selected from a diminishing pool and counted, or cycled through, 4 times a year; segment(s) (XYZ) will all be counted once a month

during the midnight shift.)

3) Organize the count team(s) – The selection and organization of appropriate count team(s) is critical to

controlling the count process and achieving accurate results. Considerations of who is going to perform,

supervise, record, evaluate, and analyze the results of the count should be made by management after

considering the following issues.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) whether adequate segregation

of duties can be accomplished?

Maintain segregation of

duties

b) whether the degree and level of

supervision is appropriate?

Provide adequate

supervision

c) whether blind counts should be

required?

Maintain segregation of

duties & perform blind

counts

d) who should do counts

subsequent to the first count? Execute physical count

e) how many people should be on

a count team?

Maintain segregation of

duties

f) how many count teams are

needed? Execute physical count

g) whether count team members

are knowledgeable of the

inventory and count process?

Enlist knowledgeable

staff

h) whether the necessary training

has been provided to team

members?

Enlist knowledgeable

staff
58 GAO-01-763G Best Practices in Inventory Counts

Document your conclusions for organizing the count teams below. (e.g. All cycle counting of the (ABC) and wall to wall counting of

the (XYZ) segment(s) will be accomplished and/or supervised by individual members of the independent inventory audit group. Six

two-man wall to wall count teams will be supplemented by shift warehousemen. All counts will be blind counts.)
59 GAO-01-763G Best Practices in Inventory Counts

COUNTING

1) Accomplish appropriate cutoff

2) Perform pre-inventory activities

3) Count the inventory

1) Accomplish appropriate cutoff – The difficulties in achieving an accurate physical count of quantities

on hand increase when items are moving into and out of, as well as between warehouse locations during the

count. The risks to be concerned about include (1) not counting items that are moving, (2) counting items more

than once that have moved, (3) counting items not yet recorded in the inventory records, or (4) counting items

that have been removed from the inventory records. These risks exist for inventory movement at primary

inventory locations, off-site storage, contract warehouses, consignment, and other locations. Management

should weigh these risks and consider the following issues when deciding how to control them.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) suspending shipping, receiving,

production, etc., during the

count?

Ensure completeness of

the count

b) the risk of relying on your

system for control of cutoff

issues?

Ensure completeness of

the count

c) other methods of reducing the

risk of improper cutoff?

Ensure completeness of

the count

d) the risk of cutoff at the

contractor warehouse and

other inventory locations?

Ensure completeness of

the count

Document your conclusions for accomplishing cutoff below. (e.g. Temporary HOLDS, restricting movement into and out of item

locations, will be placed on the daily cycle count items. Holds will be released as counts are completed, no later than the end of the

day. All movement of all wall to wall count items will be suspended during the count.)

2) Pre-inventory preparation – Prior preparation of the inventory, and the warehouse area housing it, can

greatly increase the efficiency and accuracy of accomplishing the physical count of inventory on hand.

Management should include the following in its consideration of pre-inventory issues.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) organizing the inventory and

warehouse to facilitate the

count process?

Ensure completeness of

the count
60 GAO-01-763G Best Practices in Inventory Counts

b) identifying and segregating

certain slow moving, excess,

obsolete, and reserved items

from other items?

Ensure completeness of

the count

c) doing pre-counts and

increasing control of

segregated slow moving,

excess, obsolete, and reserved

items?

Ensure completeness of

the count

Document your conclusion for pre-inventory preparation below (e.g. Warehouse routine is expected to maintain (ABC) inventory

segments in a count-ready condition. The day prior to wall to wall counts, warehouse personnel will be detailed, under the

supervision of the inventory audit group, to label, straighten, and pre-count as necessary.)

3) Count the inventory – Actually counting the inventory is a critical step and deserves an appropriate level

of attention and control. There are a number of options available in the process of the count and decisions in

one area will affect decisions in another area. The following are issues that management should include in

making those decisions.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) how information about the

item to be counted will be

communicated to the counter?

Execute physical count

b) what record data elements

(e.g., quantities, description,

location) should be provided to

the counter?

Execute physical count

c) the pros and cons of requiring

blind counts? Perform blind counts

d) what record data elements the

counter(s) are to verify? Execute physical count

e) the total lapse of time

allowable to complete counting

(including appropriate

research) before requiring an

adjustment?

Execute physical count

& perform research

f) when to require recounts (e.g.,

if first count does not equal

record amount)?

Execute physical count
61 GAO-01-763G Best Practices in Inventory Counts

g) how many recounts to require

(e.g., until two counts equal)? Execute physical count

h) how the count supervisor will

verify that the count is

complete?

Provide adequate

supervision & ensure

completeness of the

count

i) how data elements verified for

each item will be captured

during the count (e.g., count

sheets)?

Execute physical count

& perform research

j) how and by whom will the

count’s actual results be posted

to the inventory system?

Execute physical count

& maintain segregation

of duties

k) who should conduct recounts

or verification of completed

counts (e.g., someone other

than the first counter)?

Execute physical count

l) how to verify that all items

selected for counting have

been counted?

Ensure completeness of

the count

Document your conclusions for counting the inventory below. (e.g. Item description, number, and location only will be provided to

and verified by cycle and wall to wall counters on sheets generated by the inventory locator system. Quantities counted will be

recorded on the count sheet and compared to record on-hand balances maintained by the inventory audit group supervisor.

Recounts, until two counts agree, will be conducted by an inventory audit group individual other than the original counter. The

original counter will conduct and document research and propose needed adjustments to the group supervisor.)
62 GAO-01-763G Best Practices in Inventory Counts

RESEARCH AND

ADJUSTMENTS

1) Perform research

2) Adjust the record

1) Perform research – In the event of a discrepancy between the actual physical count and the recorded data

element, appropriate research designed to determine the reason for the difference should be performed. The

following are issues management should include in its considerations when making decisions of when to and

who should conduct such an investigation.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) when and where it may be

appropriate to establish

acceptable variances not

requiring research?

Perform research

b) the extent to which research

should be performed? Perform research

c) using error codes to track the

trends and frequency of the

causes of discrepancies?

Perform research

d) the required documentation

and retention period for the

research performed and

adjustment of the records?

Perform research

e) when discrepancies should be

referred to management and/or

security for investigation?

Perform research

f) whether there should be a limit

on the amount of time allowed

to research a discrepancy

before requiring an

adjustment?

Perform research

g) whether persons performing

root cause analysis have

responsibilities in areas of

conflicting interest?

Perform research &

segregation of duties

Document your final conclusions for research and adjustments below (e.g. All variances between physical count and record

amounts are to be researched, or variances of less than X percent are to be adjusted without research, etc. ).
63 GAO-01-763G Best Practices in Inventory Counts

2) Adjust the record – Adjustments to the record are most critical when they affect on-hand quantities. Such

adjustments will likely directly affect information used to make managerial decisions. They will also establish

new quantity levels for effective internal controls designed to safeguard assets from unauthorized use or

disposition. The following are issues management should include in its consideration when making decisions on

who should make and how adjustments to on-hand quantities should be made.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) what levels of authorization to

require for adjustments to onhand balances?

Perform research

b) how to allow for and control

exceptions to authorization

requirements?

Perform research

c) whether there should be a limit

on the amount of time allowed

to elapse before an adjustment

is required?

Perform research

d) whether persons making

adjustments to on-hand

balances have responsibilities

in areas of conflicting interest?

Maintain segregation of

duties

Document your conclusions for adjusting the records below (e.g. Adjustments to on-hand balances exceeding $XXX required

documented approval by (middle management position), those exceeding $XX,XXX require documented approval by (senior

management position), etc.).
64 GAO-01-763G Best Practices in Inventory Counts

EVALUATION OF

RESULTS

1) Determine the record accuracy rate

2) Consider other performance measures

3) Communicate the results of the count

1) Determine the record accuracy rate – Inventory systems usually provide management information

upon which potentially critical mission readiness and financial resource decisions are based. An appropriately

calculated record accuracy rate is a telling measure of how dependable your inventory system is at maintaining

accurate information. The following are issues management should include in its considerations when making

decisions for calculating an inventory accuracy rate.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) what discrepancies in the

record will be considered

errors in the accuracy rate

calculation?

Evaluate count results

b) the actual mathematical

calculation to be used in

determining the accuracy rate?

Evaluate count results

c) how you will use the results of

the accuracy rate calculation?

Evaluate count results

& establish

accountability

Document your conclusions for evaluation of results below. (e.g. Discrepancies between any elements (e.g., number, description,

location, quantity) verified by counters are considered errors. Or, quantity differences exceeding established tolerances are

considered errors, etc.)

2) Consider other performance measures – The results of physical inventory counts may be measured

by methods other than record accuracy rates. The following are issues management should include in its

considerations when making decisions for calculating an inventory accuracy rate.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) what other

results/measurements are

appropriate to your needs?

Evaluate count results

b) how other measures can be

expressed in relevant terms? Evaluate count results

c) how other measures can be

expressed in relevant terms? Evaluate count results
65 GAO-01-763G Best Practices in Inventory Counts

Document your conclusions for consideration of other performance measures below (e.g. Total net and total gross (quantity and/or

value) adjustments to inventory over a period of time shall be considered to determine the effectiveness of the count and root

cause analysis process, etc.).

3) Communicate the results of the count – To maximize the usefulness of the physical inventory count,

the results should be communicated to management and lessons learned should be incorporated in planning for

subsequent physical counts. The following are issues management should include in its considerations when

making decisions in communicating the results of the physical count.

HAVE YOU CONSIDERED

REPORT SECTION

PROVIDING GUIDANCE

(Y)ES,

(N)O,

N/A

NOTES/COMMENTS

a) how and what results you will

communicate to management?

Evaluate results and

perform research

b) how and what results you will

communicate to counters? Evaluate count results

c) how and what results you will

communicate to employees

who are responsible in areas

giving rise to record accuracy

errors.

Evaluate count results

d) changes indicated to existing

policies and procedures by the

results and considerations

made above?

Evaluate count results

& establish written

policies

Document your conclusions for communicating the results of the count below (e.g. Monthly written reports summarizing quantity

and dollar amounts counted, adjustments made, results of root cause analysis, and frequency and trends in error codes will be

prepared for management review, etc.).
66 GAO-01-763G Best Practices in Inventory Counts

Appendix II

Objectives, Scope, and Methodology

To determine the principles fundamental to achieving consistent, accurate counts of physical

inventories, our objectives were to (1) identify inventory counting procedures that have been

successfully implemented by private sector companies recognized as leaders in inventory accuracy

and (2) provide examples (case studies) of counting procedures used by these companies that might

help federal agencies improve the accuracy and reliability of their inventory and property records.

To fulfill our objectives, we identified 80 companies, 77 of which were Fortune 500 companies, with

large inventories that are considered to be leaders in inventory management. In order to identify

these companies, we consulted with experts in the field of inventory management. Our contacts

included professionals from the major accounting firms of KPMG Peat Marwick and Ernst and

Young, LLP, and professors at the Massachusetts Institute of Technology and Ohio State University.

We also researched publications issued by CIO 100, Industry Week, and the American Productivity

and Quality Center (APQC), and we considered companies that were winners of the prestigious

Malcolm Baldridge National Quality Award.

From these 80 companies, we identified 22 companies having best practices in inventory

management. Our selection was based on the company receiving recognition for outstanding

inventory management practices by at least three of the above named sources. In order to confirm

our selections as a best practice company, we sent a survey to each company to obtain information on

inventory record accuracy rates, policies and procedures, physical count methods, research, training,

and willingness to participate in our study.

Eleven of the twenty-two companies returned the survey; from the pool of eleven we selected seven

companies willing to participate in our study. Our selection was based on (1) reported accuracy rates,

(2) size and types of inventory, and (3) existing count procedures and controls. Based on these

criteria, we selected the following companies:

Leading-edge Companies

Boeing

Daimler Chrysler

DuPont

FedEx

General Electric

Honeywell

3M

Some of the selected companies employed more than one counting methodology and allowed us to

review their practices and processes at more than one operating location. A total of 12 separate

locations from the seven companies were studied.
67 GAO-01-763G Best Practices in Inventory Counts

To gather the data needed from each company we developed a structured interview checklist to cover

the following areas: planning, execution, research, evaluation, training, and policies and procedures

for the physical inventory count process. We consulted professional guidance issued by the

American Institute of Certified Public Accountants and an accounting firm in designing the structured

interview.

During each site visit, we completed our structured interview checklist through interviews with

officials responsible for inventory management and record accuracy. We also toured the companiesí

warehouses, distribution centers, and production and assembly plants to obtain an understanding of

how inventory counting procedures were implemented at these locations. We relied on company

officials to describe their processes to us. We did not verify the accuracy of their statements or any

information provided to us, but, wherever possible, we obtained and reviewed company documents

describing the inventory counting and verification processes. The documentation we obtained was

consistent with the information we reported. Based on the information we obtained from each of our

site visits, we consolidated and refined the inventory counting principles and practices to those

presented in this guide. We asked officials at each of the seven private sector companies we studied

to confirm the accuracy and completeness of the information presented in the report and incorporated

their comments as appropriate. However, we did not independently verify the accuracy of the

information the officials provided.
68 GAO-01-763G Best Practices in Inventory Counts

Appendix III

Acknowledgement of Best Practice Participants and Advisors

We would like to acknowledge and thank the following companies whose management and staff

provided advice and assistance throughout this project.

 ______

Leading-edge Companies

The Boeing Company

Seattle, Washington

DaimlerChrysler AG

Stuttgart, Germany

E. I. DuPont De Nemours and Company

Wilmington, Delaware

FedEx Corporation

Memphis, Tennessee

General Electric Company

Fairfield, Connecticut

Honeywell International Inc.

Morristown, New Jersey

Minnesota Mining & Manufacturing Company

St. Paul, Minnesota

 

Project Advisors

The Gillette Company

Boston, Massachusetts

Private Sector Council

Washington, DC

Raytheon Company

Lexington, Massachusetts

Samsonite Corporation

Denver, Colorado
69 GAO-01-763G Best Practices in Inventory Counts

Appendix IV

Bibliography

Brooks, Roger B., and Wilson, Larry W. Inventory Record Accuracy: Unleashing the Power of

Cycle Counting. Oliver Wight Publications, Inc., 1993.

Edwards, Douglas J. ìThe Best 100.î Industry Week. August 16, 1999.

Taninecz, George. ìIWís Ninth-Annual Honor Roll.î Industry Week. October 19, 1998.

ìPracticing Judgment.î CIO Magazine. August 1, 1995.
70 GAO-01-763G Best Practices in Inventory Counts

Appendix V

GAO Contacts and Staff Acknowledgements

 

GAO Contacts

Paul D. Kinney (303) 572-7388

Stephen W. Lipscomb (303) 572-7328

 

Acknowledgements

In addition to those named above, Letha C. Angelo and Robert A. Sharpe made key contributions to

this report.

(192001)