What Is Physical Inventory?


Merchandise businesses and manufacturing businesses focus on physical inventory. The inventory represents one of the largest assets owned by these types of companies. For merchandise businesses, physical inventory consists of the items the company will sell in its retail locations. For manufacturing businesses, physical inventory consists of raw materials the company purchases and the finished goods into which those materials are converted.

Tangible Goods

  • Physical inventory requires the items to be tangible and exist in a physical space. Tangible goods require the company to plan for adequate storage space. The company must plan and design the warehouse facility so that the inventory is organized and easily accessible. Every item contained in a company’s physical inventory occupies a specific amount of space, which the company must consider when planning out the location.

Cycle Count

  • Many companies use cycle counting to manage inventory quantities. Cycle counting refers to the process of selecting some inventory items to count each month. The company counts the selected items and compares these counts to the quantities recorded in the accounting system. The company records an adjustment in the inventory system to make the system quantity equal the actual quantity on hand. Each month the company rotates the items to be counted so that the selected inventory items change regularly. High value items might be included in the cycle count every month.

Physical Inventory Count

  • At least once per year, the company performs a physical inventory count of every item contained in inventory. This count requires the company to create several teams of counters and assigns different warehouse locations to each team. Half of the teams go through the warehouse and count each item in their assigned location. Then the remaining teams go through and recount the items. This creates a duplicate count that allows the company to compare counts. Any discrepancies are investigated.

Physical Inventory Audit

  • Most companies include an annual physical inventory audit in their inventory control procedures. During a physical inventory audit, internal company representatives as well as external auditors select specific inventory items to count. They choose these items based on dollar value, quantities and total transactions. The auditors recount the selected items and compare their numbers to quantities counted by the original counting teams.

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