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A Financial Accounting Standards Board (FASB) proposal would modify the accounting rules for disclosing taxes paid in the United States and overseas. The result, it says, would enhance transparency about companies’ exposure to changes in tax legislation and the global tax risk they may face.

But public and private business leaders are joining the U.S. Chamber of Commerce to voice their opposition. Stakeholders have 75 days to provide public comments.

Changes to the rate reconciliation table

The most significant items in Proposed Accounting Standards Update (ASU) No. 2023-ED100, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures,” are changes to disclosures related to amounts paid for tax and the rate reconciliation. If finalized, companies will be required to break out amounts paid for taxes between federal, state and foreign taxing jurisdictions, rather than just disclose a lump sum amount.

The rate reconciliation will require disaggregation into the following eight categories:

1. State and local income tax, net of federal (national) income tax effect
2. Foreign tax effects
3. Enactment of new tax laws
4. Effect of cross-border tax laws
5. Tax credits
6. Valuation allowances
7. Nontaxable or nondeductible items
8. Changes in unrecognized tax benefits

Under the proposal, these categories would be further disaggregated by jurisdiction and for amounts exceeding 5% of their domestic tax rate. The rate reconciliation table would need to disclose both dollar amounts and percentages. Currently, companies can disclose either the dollar amounts or the percentages.

To categorize reconciling items, the state and local income tax category would reflect income taxes imposed at the state or local level within the jurisdiction (country) of domicile. The foreign tax effects category would reflect income taxes imposed by foreign jurisdictions. The remaining categories would reflect federal (national) income taxes imposed by the jurisdiction (country) of domicile.

Additionally, for the state and local category, a public company would be required to provide a qualitative description of the state and local jurisdictions that contribute to most of the effect of the state and local income tax category. The company would provide an explanation, if not otherwise evident, of the individual reconciling items disclosed, such as the nature, effect and significant year-over-year changes of the reconciling items. On an interim basis, public companies would provide a description of any reconciling items that result in significant changes in the estimated annual effective tax rate from the effective tax rate of the prior annual reporting period.

Private companies would be required to provide qualitative disclosure about specific categories of items and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate. The FASB contends that the enhancements to the current rate reconciliation table will enable investors to better assess a company’s worldwide operations, related tax risks, tax planning and operational opportunities, all of which affect its tax rate and prospects for future cash flows.

Other changes

Under pressure from U.S. Senate Democrats in 2019, the FASB previously issued a proposal to require more robust tax disclosures. However, Proposed ASU No. 2019-500, “Income Taxes (Topic 740): Disclosure Framework — Changes to the Disclosure Requirements for Income Taxes,” stalled due to pushback from stakeholders during the comment period.

The current proposal retains some aspects of the previous version. Specifically, Proposed ASU 2023-ED100 would add disclosures of pretax income (or loss) and income tax expense (or benefit) to be consistent with Securities and Exchange Commission Regulation S-X 210.4-08(h), “Rules of General Application — General Notes to Financial Statements: Income Tax Expense.” The proposal would also remove disclosures that no longer are considered cost beneficial or relevant.

Opposition letter

The FASB contends that the proposed changes wouldn’t be costly to apply because the information is already available in IRS filings. However, there’s substantial opposition from public and private companies, and a month before the proposal was issued, the FASB received a letter from U.S. Chamber of Commerce expressing the group’s concerns.

The Chamber said it believes that the FASB proposal is politically motivated, not investor driven, and oversteps the FASB’s authority. They argue it would require companies to disclose too much information, which in turn could be used politically “to vilify firms and deter investments.” Namely, the enhanced disclosures could be manipulated to show that corporations don’t “pay their fair share.”

The Chamber wants the FASB to disclose those with whom it has consulted on the project and meet with the business community to discuss the proposal before it’s approved.

Comments wanted

Companies have until May 30 to submit comments on the income tax disclosure proposal.

“We encourage all stakeholders to review and share their views on the proposed changes and whether they believe those proposed changes would improve this important area of financial reporting,” FASB Chair Richard Jones said.

If finalized, the proposal will become part of U.S. Generally Accepted Accounting Rules by the end of 2023, meaning that it would be applied retrospectively.

© 2023 KraftCPAs PLLC

Learning new software can be a major challenge. You have to learn the basic lay of the land before you can work with it. How do I do this? How does the menu system work? How can I enter data without making a mistake?

The learning process for financial software for your small business can be especially unnerving. A mistake in an invoice you create is more serious than using incorrect grammar or punctuation in a letter.

Here are five ways to get your feet wet and be on your way to mastering QuickBooks.

Familiarize yourself with lists

You’ll consult and use lists a lot in QuickBooks. Transaction forms offer access to data you’ve already created and will use later. When you need to select a customer, for example, you can just open a drop-down list and click on one.

QuickBooks also provides free-standing lists that you might need to use outside of transactions, though they’re often available there, too. Open the Lists menu to see them. They include Item List, Sales Tax Code List, and Class List. Click on one to open it, and you’ll see a series of menus running across the bottom of the window. They allow you to add or edit items, take actions like entering a sales receipt, and run related reports.

Troubleshoot transactions

What do you do when you know you’ve entered a transaction but you can’t find it? QuickBooks has good search tools, but sometimes you don’t have enough details to hunt effectively for the missing item. There are two reports that can help.

It’s possible that the transaction you’re seeking was accidentally voided or deleted. Open the Reports menu and select Accountant & Taxes | Voided/Deleted Transactions Summary or Detail. If you have an idea of when the original transaction was entered, change the date range at the top of the screen. You really shouldn’t have many of these. If you do, let us help you determine why this is happening so frequently. You can get into trouble if you void or delete transactions to solve a problem that should be resolved another way.

While you’re in the Accountant & Taxes report list, open the Audit Trail. This is a listing of transactions that have been entered or modified, when, and by whom. If you have multiple users accessing and working with QuickBooks data, you should get to know this report.

Work with windows

Every time you open a window in QuickBooks, it stays open. You can always close it by clicking the X in the upper right corner of the window – not the program X in the farthest upper right corner. If you have a lot of windows open, all that clicking can become tiresome.

Open the Window menu to see your options there. You’ll see a list of all the windows that are open. Click on one to go there. You can also “tile” the windows vertically or horizontally (so they overlap each other on the screen) or “cascade” them (which places them on top of each other with only the window label showing). And you can close all of them at once by clicking Close All.

Use local menus

Most QuickBooks windows provide ways for you to take a related action. But most also offer “local” menus, or right-click menus. Open an invoice form to see how this works (Customers | Customer Center | Transactions | Invoices). Right click in the header of the invoice. Your menu options here include:

• Duplicate invoice
• Memorize invoice
• Transaction history
• Receive payments

You’ll also find these commands and more in the toolbar at the top of the window.

Practice with a QuickBooks sample file

Before you start entering real data in QuickBooks, or if you’ve already done so and you want to try out a new feature without risking an error, use one of QuickBooks’ sample files. That’s why they were created.

You can open one of these when you load QuickBooks. You’ll see a window labeled No Company Open. Click the arrow in the box on the lower right that says Open a sample file. You can choose between a product- and service-based business.

Once you’re in QuickBooks, you can switch back and forth between your company file and a sample file by opening the File menu. Click Open Previous Company and select from the list. It should be obvious, but be sure you’re in the correct QuickBooks file before doing anything.

© 2023 KraftCPAs PLLC

Every type of business needs at least a few insurance policies. Construction companies, however, tend to need many of them. After all, there are so many risks to guard against.

Precisely which types of coverage your company needs will depend on factors such as its size, structure and specialty, as well as the geographic area in which you operate. To help you assess what you have and what you might need, here’s a brief glossary of key policy types for contractors:

Bonding. Some project owners require construction businesses to procure certain types of bonds from a surety as insurance against incomplete or faulty services. Being bonded means the surety is assuring the owner that your business is qualified and financially stable enough to perform the work.

Builder’s risk. This coverage provides financial protection against damage done to a structure still under construction — including costs resulting from fire, vandalism, weather and on-site tool or equipment theft.

Commercial auto. Commercial vehicles require separate insurance coverage because they’re exposed to more risk than personal vehicles. This coverage provides both liability and physical damage protection for fleet vehicles including cars, trucks and vans. Some policies cover legal fees and the medical costs of others if an employee is at fault in an accident.

Commercial property. This type of policy safeguards your construction company’s physical property — including tools, computers, signage and furniture — in the event of fire, broken pipes, bad weather, theft or vandalism. If you don’t need property insurance but want your equipment protected, a contractor’s tools and equipment (sometimes called inland marine) policy may be suitable.

Cyber insurance. Online attacks, such as ransomware, are a growing threat to construction businesses. At minimum, this type of policy covers liability for a data breach involving sensitive customer information — credit card numbers, driver’s license numbers and so forth — that results in fraud or might reasonably be expected to cause it.

General liability. Often called commercial general liability, this policy type covers damages and legal costs associated with third-party injuries (not to employees) and property damage claims caused by your company or a faulty product you installed. It won’t pay to repair faulty work but can cover the resulting damage.

Professional liability. This is also called an errors and omissions policy. It covers legal costs when a contractor is sued over a mistake, such as using the wrong materials.

Umbrella. This type of policy provides supplementary coverage that absorbs costs exceeding the liability limits of another policy. Say you take on a project for which you’re contracted to carry $3 million of general liability insurance, but your insurance provides only $1 million of coverage. You could buy umbrella coverage for the remaining $2 million. Doing so may cost less than increasing the limit of your primary policy.

Workers’ compensation. A strong workers’ comp policy is essential, and often mandatory, for any business with employees. But it’s especially important for construction companies because workers face high injury risk. Coverage provides wage compensation and assistance with medical bills for on-the-job injuries or illnesses while protecting the employer from related lawsuits.

© 2023 KraftCPAs PLLC

The construction industry continues to face supply chain slowdowns, labor shortages and inflation — though the latter of the three has generally moderated a bit as of late. To monitor and optimally respond to rising contract costs and market changes, contractors need a plan. Here are eight ways you can insulate your company against the higher cost of doing business in today’s environment:

1. Double-down on accurate estimates and timely financial reporting. Generating precise estimates and tracking project expenses in real time are key to staying within budget. Make sure estimated costs have been updated to reflect inflation, wage increases, and other factors.

From there, leverage the right software tools and your company’s historical data to create feasible project budgets and forecast future costs. Use the latest job cost accounting and reporting methods to help identify cost increases before they become problematic.

It’s also important to regularly compare estimated costs to actual costs, as well as to review the likelihood of profitability for all jobs at least once a month. Include both direct and indirect cost allocations and, as appropriate, use the percentage of completion accounting method to recognize revenue.

2. Include a contingency reserve in project budgets. Setting aside a portion of the job budget for unforeseen expenses can cushion the financial blow that all too often comes from surprise cost increases or project delays. Don’t overlook risk management. Identify and assess potential threats early-on and have a plan in place to mitigate them.

3. Build flexibility into contracts. Consider price-acceleration clauses or cost-plus contracts that allow you to adjust the contract price and pass unexpected costs on to the owner. Also, when negotiating a contract, look into the possibility of asking for a deposit to buy and store materials before construction starts.

In addition, clearly integrate change order terms and procedures into the contract. Don’t wait until a job ends to pursue this additional compensation. Process change orders immediately so you can get approval and bill for added costs as soon as possible. Timely cost allocation and revenue recognition, along with supporting documentation, will also make it easier to make a claim under a price-acceleration clause — or defend against a customer’s refusal to pay.

4. Negotiate with suppliers. Let suppliers know you’re comparison shopping to encourage them to offer the best deal possible. If feasible, take advantage of bulk purchasing or just-in-time delivery options to reduce the cost of materials and minimize the risk of price fluctuations. Unless you receive a steep discount for payment in full, use manageable financing for your purchases. Although you’ll likely incur interest charges, spreading out payments should help free up cash flow.

5. Incentivize project managers to meet profitability goals. Whether through compensation or bonuses, when project managers have a clear stake in meeting profitability goals, they tend to be more proactive in managing job costs.

That includes tracking labor hours, staying on schedule, double-checking shipments of materials, and making sure subcontractors arrive on time and fully prepared to work. Project managers should also closely review job-specific financial reports and be empowered to make adjustments as needed. That said, put controls in place to minimize the risk of project managers taking unwanted shortcuts, such as shifting costs from one job to another.

6. Bill and collect proactively. When drafting contracts, include payment amounts and stipulate:

• When they’re due
• How to submit payments
• What penalties may be triggered by late payments

Include any other pertinent information related to paying invoices as well. From there, ensure invoices are detailed and include all supporting documentation showing proof of work. Diligently follow the invoice schedule outlined in the contract and regularly follow up about unpaid invoices.

If you’re not already using it, accounts receivable software such as QuickBooks can greatly help ensure that invoices are accurate and sent out in a timely manner. Set up automated reminders to bill owners, remind them of due dates and, again, don’t hesitate to inquire about past-due invoices.

7. Explore tax credits. In the hustle and bustle of winning and performing work, contractors often overlook tax credits. These are particularly valuable because they lower your tax liability dollar for dollar, freeing up that money to cover costs or build a cash reserve.

For example, though the pandemic-related employee retention tax credit expired in 2021, eligible employers that haven’t yet claimed it may still do so for up to three years retroactively. Eligible companies can claim up to $7,000 per employee per quarter for the first three quarters of 2021, and up to $5,000 per employee for all of 2020. We can help you determine whether your construction company qualifies for this tax credit or other tax breaks.

8. Improve your overall accounting function. Having personnel who truly understand construction accounting and job costing is critical. You may need to invest in additional training or upskilling to ensure that both your in-office and on-site employees are up to the task of optimally managing costs. You can also count on us to help you assess your financial reporting and cost management processes and technology — and identify difference-making improvements.

Depending on your company’s specific situation, we can work with you to streamline your processes and get closer to meeting your goals. Reach out to a member of our construction industry team to get the conversation started.

© 2023 KraftCPAs PLLC

KraftCPAs has been chosen for two new lists — America’s Best Tax Firms 2023 and America’s Best Accounting Firms 2023 — announced by Forbes.

Kraft was one of just six firms in Tennessee to be picked for both lists, which were compiled by market research company Statista through surveys of approximately 30,000 chief financial officers, tax attorneys, accountants, and enrolled agents.

Survey participants who worked for a tax or accounting firm could name up to 10 firms for tax and 10 firms for accounting that they would recommend if their company were not able to take on a client. Survey participants who worked in a company on the client side were asked to name up to 10 firms each in tax and accounting that they would recommend based on their professional experience during the last three years.

Almost 4,500 nominees were considered, with 200 firms chosen for the best tax firms list and 200 chosen for the best accounting firms list. Click here for the full list.

© 2023 KraftCPAs PLLC

Business owners would usually agree that the best way to minimize fraud at any company, including a construction business, is to take a holistic approach. As the owner, you must set the tone at the top regarding a zero-tolerance, fully vigilant attitude toward criminal or unethical acts. And you need to create an organizational culture that features strong values, ethics and internal controls.

Understand your risks

The first significant challenge is understanding where and how you’re at risk for fraud. Be specific and realistic. Your vulnerabilities aren’t necessarily the same as those of similarly sized businesses or even your close competitors in construction. It all depends on how proactively you’ve addressed fraud prevention in the past and what new threats may have arisen.

Examine your risks objectively. The question isn’t whether your long-time bookkeeper might embezzle funds; the question is whether anyone in that job or another could steal from you. When assessing threats, consider both internal and external opportunities for malfeasance and how employees at any level of seniority could work alone or in concert to exploit them.

Once you’ve performed a thorough review of your construction company’s existing practices, consider the overall costs of your primary risks — including the consequences and long-term impact of letting them go unaddressed. Recognize that risk management is more than buying insurance; it’s working to ensure that you don’t need insurance because you’re taking steps to close gaps that fraudsters could exploit.

How you can protect yourself

Next, turn your attention to preventive strategies. If you don’t have a written code of ethics and an updated employee manual, now’s the time to work on both. As mentioned, fraud prevention begins at the top — with a clearly communicated commitment on the part of ownership and management. It isn’t enough that you have a code of ethics; you must be seen following it.

Then look at your internal controls. Did you consider fraud prevention when you designed them? If not, re-evaluate the controls with an eye on closing possible loopholes. Policies to consider implementing or reviewing for efficacy include:

• Separating financial and accounting duties among two or more employees
• Duplicating sensitive tasks, such as double-signing checks over a certain amount
• Reconciling bank accounts
• Performing internal audits
• Engaging an impartial external auditor to review your financial statements

You don’t have to do it all yourself. Train trusted in-office supervisors or staff to spot fraud and do the same for on-site project managers. At the same time, don’t allow employees to create and manage their own fraud prevention policies. For instance, if your IT staff devises its own security measures, someone outside the department should determine whether the measures are appropriate and being followed adequately.

The proper resources

Once you’ve determined your areas of risk and ways to address them, you might discover that you can’t do everything at once. If so, set priorities so you can allocate resources optimally.

Remember, every risk isn’t created equal. Some threats have the potential to cause damage that could cripple the company. But, viewed objectively, these types of threats are unlikely to occur as long as internal controls are in place. Fraudulent financial reporting, for example, can ruin a construction business. However, if financial statements are properly generated and regularly audited by a third party, malfeasance is usually difficult to hide.

Other potential problems may do less damage, but there’s a much better chance that they’ll happen. For instance, an overworked bookkeeper with a heavy mortgage could, with relative ease, exploit operational loopholes to embezzle money. In deciding how best to allocate your fraud prevention resources, assess the probability of different risks rather than simply their severity.

Finally, set up a continuous monitoring system that will allow you to track and adjust controls as changing circumstances require.

Help is available

Fraud risk management can’t be a one-time or even once-in-a-while activity. Construction business owners must constantly evaluate their existing controls — comparing them with legal, regulatory and industry standards. Reach out to a member of our construction industry team for help establishing strong internal controls and develoingp effective processes for monitoring your financials.

© 2023 KraftCPAs PLLC

KraftCPAs PLLC is pleased to announce that Spencer Mercer has been named member-in-charge for the firm’s Chattanooga office. He succeeds Tim Stees, who will retire in late 2023.

Stees was a founding partner of Matheney Stees & Associates PC, which was acquired by KraftCPAs in 2020.

“Tim has been an incredible mentor and leader, and we’ll be working closely together to make the transition as smooth as possible,” said Mercer, who joined KraftCPAs in 2009. “The next few months will be a great opportunity to learn more about his clients and make sure everything’s in place.”

Mercer, a CPA and University of Tennessee graduate, will supervise a staff of almost 20 people and manage client relationships for the Chattanooga region. He has extensive experience in tax planning, consulting, and compliance at both the corporate and individual level.

The cost of goods sold (COGS) can account for 70% of a company’s expenses, according to recent discussions by the Financial Accounting Standards Board’s Investor Advisory Committee. However, some companies skimp on details around the costs they incur to produce goods. To help rectify this situation, the FASB has launched a project to study the disaggregation of income statement expenses.

Identifying the problem

In recent years, investors have clamored for enhanced disclosure of COGS items. The current guidance allows companies to lump expenses into catch-all cost buckets. Plus, significant variances in gross margins can make it difficult to compare financial statements from company to company.

For instance, say investors would like to know how much of the COGS is tied to raw materials and employee compensation — and how much of employee compensation is cash vs. stock-based compensation. Plus, they may want to understand how much of COGS items are fixed versus variable.

Working on a solution

In October 2022, the FASB refined the scope of its disaggregation of income statement project to focus beyond “cost of tangible goods sold; cost of services and other cost of revenues; and selling, general, and administrative (SG&A) to include any relevant expense line (excluding taxes).”

The project aims to address investors’ concerns that companies combine (or “aggregate”) too many expense details under one caption in the income statement. Some investors have argued that overly aggregated expenses can blur the view of what drives profits and hinder an understanding of a company’s future cash flows.

Members of the FASB’s investor advisory committee suggested that disclosures around certain types of residual costs — anything beyond employee costs and depreciation and amortization — would help investors better evaluate financial performance. Of particular interest are discretionary expense items, such as advertising and R&D, that can be material for most companies but can vary substantially by industry.

One suggestion calls for disclosures of expense items at the COGS level by nature and at the SG&A level by function. However, companies vary in the types of expenses they incur. Another suggestion involves using a “hurdle” to determine whether a line item should be disaggregated and disclosed. For example, some members support using a qualitative threshold of 10% of COGS or SG&A expenses — any residual item that exceeds that threshold would need to be disclosed in the financial statements.

Stay tuned

As your company prepares its financial statements, consider what you’re currently disclosing about the components of COGS and SG&A expenses. Are you being transparent about the details? Companies that voluntarily share disaggregated cost data on financial statements can engender trust with investors and lenders. Contact your KraftCPAs advisor to determine the appropriate level of disclosure for your company.

© 2023 KraftCPAs PLLC

 

Every business can be an innovator, and the research tax credit is a way to reward that innovation. If you own a small business or start-up, the tax break has an intriguing feature related to payroll taxes.

Essentially, this tax break allows a business to reduce its federal and state income taxes by a percentage of eligible expenses incurred for qualified R&D activities. The rules are complex and the administrative burden substantial, but the result can be worth the effort.

What’s more, if yours is a smaller business or a start-up, you have an additional reason to consider the research credit. Subject to limits, you may be able to elect to apply all or some of any research tax credits that you earn against your payroll taxes instead of your income taxes.

Who needs it?

Newer companies might take a few years to turn a profit. Even established smaller ones can hit tough years when they finish at a loss and, thus, don’t incur income taxes. In those cases, there’s no amount against which business tax credits, such as the research credit, can be applied.

On the other hand, a wage-paying business — even a new or struggling one — has payroll tax liabilities. The payroll tax election is thereby an opportunity to immediately use the research credit. Since every dollar of credit-eligible expenditure may result in as much as a 10-cent tax credit, the election offers big help to companies that might need relief on the payroll side of taxes rather than the income side.

How can you qualify?

To qualify for the payroll tax election, a taxpayer must have gross receipts for the election year of less than $5 million and be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer may take into account are those from the business. Items such as salary, investment income, or other income aren’t taken into account. Also, note that neither an entity nor an individual can make the election for more than six years in a row.

What are the limits?

Research credits for which a taxpayer makes the payroll tax election can be applied only against the employer’s Old Age, Survivors and Disability Insurance liability — the “OASDI” or Social Security portion of FICA taxes. That means you can’t use the election to lower:

• Your company’s liability for the Medicare portion of FICA taxes
• Any FICA taxes that you withhold and remit to the government on behalf of employees

The amount of research credit for which the election can be made can’t annually exceed $250,000. Also note that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for research credits that the taxpayer can use to reduce current or past income tax liabilities.

Who can help?

As you can see, opting for the payroll tax election — not to mention claiming the research credit itself — isn’t exactly a simple affair. For savvy business owners looking to expertly manage their payroll and income taxes, it’s an opportunity well worth exploring. Contact your tax advisor at KraftCPAs to help assess whether you qualify for the research credit and payroll tax election and, if so, identify and substantiate the expenses eligible for the tax break.

© 2023 KraftCPAs PLLC

Is the amount of inventory on your company’s balance sheet accurate? Depending on the nature of a company’s operations, its balance sheet may include inventory consisting of raw materials, work in progress, and/or finished goods. Inventory items are recorded at the lower of cost or market value under U.S. Generally Accepted Accounting Principles (GAAP).

Estimating the market value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. The value of work-in-progress inventory can be especially hard to objectively assess. That’s because it includes overhead allocations and, in some cases, may require percentage of completion assessments.

Why does accuracy matter?

It’s important to get the inventory count right for many reasons. First, you want a reliable estimate of ending inventory so that the profits you record this year are accurate. Your cost of sales — a major expense on the income statement — is a function of the value of beginning and ending inventories.

At the most basic level, the cost of sales equals beginning inventory plus purchases during the year minus ending inventory. If the inventory balance is incorrect at the beginning or end of the year, management won’t know how profitable the company truly is.

In addition, inventory is a major line item on your company’s balance sheet. Lenders rely on inventory as a form of loan collateral. Stockholders look to inventory-based ratios (such as the current ratio or days-in-inventory ratio) to evaluate financial strength. And if disaster strikes, your insurance coverage (which is based on asset values on your balance sheet) should be adequate to cover any inventory losses.

Most companies track the value of inventory through a computerized perpetual inventory system. In this system, the value increases when purchases are made (or as raw materials are processed into finished goods) and decreases when goods are sold. But a count taken from a perpetual inventory system may not always be accurate. That’s why periodic physical counts are part of a strong internal control system.

Why do discrepancies happen?

Possible reasons for differences between the perpetual inventory system and the physical count include:

• Data entry errors
• Inaccurate bin or part numbers
• Shipping errors
• Inventory in the authorized possession of employees
• Theft
• Intentional financial misstatement

Companies that conduct a year-end physical inventory count send a message to would-be fraudsters: We’re watching our assets and taking steps to catch fraud.

Benefits of a physical count

A physical inventory count gives management a snapshot of how much inventory the company has on hand as of a specific date. For example, a manufacturing plant might need to count what’s on its warehouse shelves, on the shop floor and shipping dock, on consignment, at the repair shop, at remote or public warehouses, and in transit from suppliers and between company locations.

Well-executed physical inventory counts have benefits beyond accounting compliance and fraud prevention. They provide opportunities for management to evaluate how to stock items more efficiently, reduce carrying costs and identify actual fraud losses. In turn, more efficient inventory management can lead to improved customer satisfaction and higher sales.

For example, when conducting counts, management should evaluate how the warehouse is laid out. The most commonly used items should also be the most accessible. Employees should navigate the warehouse with familiarity and find items off the inventory listing with ease. Bin and aisle labels should be easy to read quickly. High-value items should be locked away during off hours and counted on a regular basis to reduce pilferage. And plant managers should know how to systematically compute the optimal reorder point and buffer stock levels for key inventory items (rather than just relying on gut instinct) to avoid manufacturing and shipping delays.

We can help

When it comes to physical inventory counts, we’ve seen the best and worst practices over the years, and we can advise you on how to manage your inventory more efficiently. Reach out to a KraftCPAs advisor for details.