How to reconcile inventory

• Quantities: the stock records against a physical count. business.gov.au's glossary describes stocktaking as a physical count of goods and supplies, done to check both the stock records and the accounts.
• Value: the inventory account in the general ledger against the stock records priced at cost.

The second comparison matters most where stock is tracked perpetually, with the records updated at every purchase and sale. With periodic tracking, the counted stock is what brings the ledger up to date, and your accountant can say how that is done in your accounts.

Count often enough that differences can still be traced, and with perpetual records, reconcile the value every month whether or not you count. business.gov.au's inventory guidance suggests regular stocktakes and notes that monthly or quarterly counts are common. Its stocktake guidance warns against counting more often than you need to, because a full count takes staff time, risks damage to stock from handling and can take time away from selling.

Splitting the work lets you do both. A routine for a small shop with perpetual records might look like this:

With periodic tracking the ledger only catches up at a count, so the counting interval is also how often the books have a reliable stock value. Match it to how often you need one, for example for monthly reports. business.gov.au also lists getting ready for a sale, an audit or a move, and supporting an insurance claim, among the reasons to count.

A count describes one moment, and the books have to describe the same moment. Before the count, deal with the movements that cluster around it:

• Goods received but not yet billed: update the stock record when they arrive, and note the missing bill.
• Bills entered for goods not yet received: note them, because the ledger includes them and the shelves don't.
• Goods set aside for customers but not yet collected or dispatched: identify them separately. Confirm with your accountant whether they belong in inventory at the count date before excluding them, rather than relying only on an order, payment or invoice.
• Returns from customers and to suppliers: record each one before the count.

business.gov.au stresses capturing every sale and return in your stock records, and suggests planning a stocktake ahead, with count sheets ready and everyone knowing what to count. Which period a delivery near the count date belongs to can depend on the supplier's terms; ask your accountant if you aren't sure.

Count the stock, then set each item's counted quantity against its record. Value each difference at the item's cost, so you can see which ones matter.

• Recount the items with differences before anything else.
• Look for sales, returns or deliveries recorded against the wrong item or the wrong day.
• Check for damaged or expired stock removed without a record.
• Where nothing explains a difference, record it as an unexplained shortage or overage, with the count sheet as support.

Among the benefits business.gov.au gives for a stocktake are finding missing or stolen items early and spotting stock that can no longer be sold. A shortage on the same item at every count deserves more attention than a one-off.

Check the paperwork before you accept any difference as lost stock, because a recording slip and a real loss look the same on a count sheet. Here is how one month's differences at a craft supplies shop were traced:

Only the last line is a real, unexplained loss. Differences that come in pairs, one item short and a similar one over by the same amount, usually point to a mix-up between the two. Mismatched units, such as boxes against single items, give large differences that are easy to trace once you look for them.

Other causes worth checking are stock moved between locations without a transfer, customer returns restocked without being entered, and items taken for use in the business with no note. If the same lines keep coming up short with no cause, our guide to reducing stock shrinkage covers where losses tend to happen and how to tighten controls.

With the stock records corrected to the count, total them at cost and compare the result with the inventory account in the ledger at the same date.

The shortage is recorded in the ledger with a stock adjustment dated at the count, using the count sheets as support; which account it goes to is a question for your accountant. The bill for goods still on their way is a cut-off question: whether those goods count as stock at 30 June depends on when the business took them over under the supplier's terms, which your accountant can help you settle.

Set the month's movements in the ledger beside the same movements in the stock records, starting from a balance that agreed, and the line that differs shows where to look. The inventory account in the general ledger holds one total for all stock. The stock records, sometimes called the inventory subledger, hold the same total item by item. With perpetual tracking, both should move with every purchase, sale and adjustment.

Two lines explain the 320.00 gap. Purchases are 580.00 apart because a delivery was received into the stock records on 29 August and its bill hadn't arrived, so the ledger has no entry for it yet. Adjustments are 260.00 apart because damaged stock was taken off the records mid-month and the matching ledger entry was never made. Together they leave the records 320.00 above the ledger.

Write each explained difference on the reconciliation with what will clear it: the bill for the delivery, which is also a cut-off question for your accountant, and a ledger entry for the adjustment. Carry anything you can't explain forward as its own line, so next month's reconciliation doesn't absorb an older problem.

• A stock purchase coded to an expense account instead of inventory, so the records rose and the ledger didn't.
• Cost of goods sold not recorded for some sales, so the ledger still holds stock that has gone.
• A stock adjustment made in the records but never posted to the ledger.
• A supplier credit note entered in the ledger without taking the units out of the records, or the reverse.
• A wrong unit cost in the stock records, which misstates the value without changing the count.

Overstated closing stock makes the period's cost of goods sold too low and its profit too high; understated stock does the reverse. The reason is the calculation behind cost of goods sold: the stock available in the period, less what is left at the end, is what was sold. Too high a closing figure leaves too little cost in the period.

The error carries forward. The overstated figure becomes next quarter's opening stock, so if the next count is right, next quarter's cost of goods sold is 3,000.00 too high and its profit too low. The two quarters together come out right, but each one on its own is wrong, and so is the balance sheet between them.

Overstatement can come from counting goods held for someone else, or damaged stock at full cost. Goods set aside for customers are a cut-off question, covered above. Understatement can come from an area missed in the count, or from stock on its way that already belonged to the business under the supplier's terms.

A write-down lowers the value the books carry for stock that is still on hand, because it is worth less than it cost: damaged, out of date or no longer selling. It differs from a shortage. Missing stock comes out of the records entirely, as units and value; written-down stock stays in the count at a lower value.

Mark damaged, out-of-date and unsaleable items on the count sheet as you go, apart from saleable stock, so they can be valued separately. Whether to write stock down, by how much, and which account the entry goes to are questions for your accountant. For what to do with stock that has stopped selling, see our guide to managing dead stock.

Give each item one row, with its recorded and counted quantities and its unit cost, and let formulas work out the differences. The columns that make it work:

• Item code, description and location, in the order the count sheets run.
• Unit of measure, so a box is never compared with a single item.
• Quantity in the records at the cut-off, pasted in as fixed values rather than linked to a live system, so it can't change while you work. If your stock is kept in software, export its stock on hand report as at the cut-off date.
• Counted quantity, from the signed count sheets.
• Difference, as counted less recorded, so shortages show as negative numbers.
• Unit cost, and the value of each difference: the difference times the unit cost.
• Cause and action, filled in as you investigate.

Total the shortages and the overages separately as well as the net figure. A small net difference can hide large ones that cancel each other out, like the two yarn colours above. When the reconciliation is finished, save a copy as it stands with the count sheets, and start the next count from a fresh copy.

business.gov.au also suggests setting this stocktake's figures beside the last one's and beside sales records, to see what moves fast and what hasn't moved at all, and updating the records after any changes so the next count starts from the right place. Stock that is damaged or no longer sells raises a question about its value in the accounts, which is one for your accountant.

Keep the count sheets, both reconciliations and the adjustments together. They support your stock figures, and business.gov.au's general period for keeping business records is 5 years.