Controls for Obsolete Inventory Determination and Handling
There is inevitably a certain amount of inventory that will not be used, due to excessive purchasing of raw materials beyond a company’s needs, customers not buying certain items, or assembly requirements no longer calling for particular parts. The most common approach is inattention: letting obsolete inventory pile up until external auditors force the company to devalue and dispose of it, resulting in large and unexpected losses. A proper obsolete inventory recognition system with accompanying controls results in a much more organized approach.
The primary risks associated with obsolete inventory are that the inventory will not be promptly recognized as obsolete, that inventory will be improperly designated as obsolete, that dispositioned inventory will be accidentally reordered, and that disposition of such items will be for substantially less money than originally estimated. The next controls deal with these risks.
- Regularly complete an obsolete inventory review. The best way to ensure that obsolescence is recognized promptly is to conduct a regularly scheduled obsolescence review of the entire inventory, typically using an obsolescence report such as the one shown in Exhibit 4.11, which lists items for which there appear to be excessive quantities on hand. This review should be conducted by the Materials Review Board (MRB), which is comprised of representatives from the warehouse, purchasing, sales, and production scheduling departments (thereby ensuring a broad range of opinions regarding the need to eliminate something from stock).
- Draw down impacted inventory before implementing engineering change orders. Whenever the engineering department issues a change order for a product, there is a risk that the new product configuration will no longer require in-stock raw materials for which there is no other use, rendering the materials obsolete. Accordingly, a standard part of the change order issuance procedure should be an examination of on-hand inventory balances, so that existing stocks can be drawn down prior to the change order going into effect.
- Implement reorder flag shut-off procedure for inventory being eliminated. There is nothing more frustrating than to deliberately reduce the quantity of a particular item in stock, only to have the reduced quantity trigger an automatic reorder transaction by the computer system, resulting in more stock on hand. To prevent this, there should be an inventory reduction procedure that includes a requirement to turn off the inventory reorder flag in the item master file.
- Move obsolete inventory to segregated area. It is much easier to review and leave as-is obsolete inventory if it is congregated in a single area rather than scattered throughout the warehouse.
- Match obsolescence authorization to tagged obsolete inventory. It is possible that warehouse employees will deliberately tag inventory as being obsolete, so they can remove it from the warehouse or acquire it at a low price from the company. To avoid this problem, periodically compare the meeting notes from the MRB (see the obsolete inventory review procedure in Exhibit 4.10) to tagged obsolete inventory, to ensure that only authorized items are tagged. Any other items marked as obsolete should immediately be brought to the attention of the warehouse manager and internal audit manager as being a possible case of fraud.
- Record cash receipts from obsolete inventory dispositions in a separate account. Part of the obsolete inventory review procedure is to revise the recorded cost of obsolete inventory downward to its estimated disposition value. To determine if this disposition value actually was achieved, it is best to record the cash receipt in a separate general ledger account, with supporting detail, so that receipts can be reconciled to initial estimated values more easily.
[tags]determination and handling, obsolete invetory[/tags]