Period-End Procedures: Physical Counts, Cutoff, and Reconciliation

What “period-end inventory procedures” are trying to achieve

At period end, you need a defensible inventory number that matches (1) what you physically own and (2) what your accounting records say you own as of the cutoff date/time. The process combines three controls: a physical count (quantity), cutoff testing (ownership and timing), and reconciliation (turning differences into documented adjustments).

Key idea: ownership drives inclusion in inventory

Inventory should include items you own at the cutoff, even if they are not physically on-site (for example, goods in transit you own). Likewise, items physically on-site may not be yours (for example, consignment inventory from a supplier) and should be excluded.

Checklist: Plan the physical count

• Set the cutoff date and time (e.g., 12/31 at 11:59 p.m.). If you count earlier, you must “roll forward” or “roll back” for movements between count time and cutoff.
• Freeze or control inventory movement: pause shipping/receiving during the count window, or use controlled “count in progress” procedures (separate staging areas, special forms, supervisor approval).
• Assign roles: count teams (two-person teams reduce error), supervisors, data entry, and an independent reviewer.
• Define count areas: map the warehouse/store into zones; label aisles/bins; identify high-value and high-risk items for extra attention.
• Prepare the item master references: unit of measure (each, case, kg), standard pack sizes, and SKU descriptions. Mismatched units are a common source of errors.
• Decide on count method:
  • Count sheets (preprinted SKU list by location) reduce missed items but can bias counts if quantities are visible.
  • Blind tags (no expected quantity shown) reduce bias and are common for stronger control.
• Plan recount thresholds: for example, recount if variance > 2% or > $500 for a SKU, or for any high-value item.
• Identify special categories: damaged/obsolete, returns, work-in-process, consignment, customer-owned items, and items held at third-party locations.

Checklist: Tagging and count sheets (how to capture quantities correctly)

Tag controls (if using tags)

• Use sequentially numbered tags and account for all tags issued/voided/unused.
• Two-part tags (or duplicate copies): one stays with inventory, one goes to data entry.
• Write clearly: SKU, description, location, unit of measure, quantity, and condition (good/damaged).
• Mark counted items (e.g., sticker or tag attached) to prevent double counting.
• Void procedure: voided tags should be retained and approved to prevent “missing tag” issues.

Count sheet controls (if using sheets or scanners)

• Location-first counting: complete one zone at a time; sign off by team and supervisor.
• Blind counts where possible: do not show expected quantities to the counter.
• Exception reporting: flag negative quantities, unusual units, or items found in the wrong location.
• Independent review: supervisor spot-checks a sample of items and recounts discrepancies.

Checklist: Cutoff testing (purchases and sales in the right period)

Cutoff testing ensures transactions around period end are recorded in the correct period based on when ownership transfers and when goods are shipped/received. The goal is to prevent inventory and profit from being overstated or understated.

What to gather for cutoff testing

• Last receiving reports before cutoff and first receiving reports after cutoff.
• Last shipping documents (bill of lading/packing slips) before cutoff and first after cutoff.
• Vendor invoices and customer invoices around cutoff.
• Open purchase orders and open sales orders near cutoff.
• Goods-in-transit listing (inbound and outbound) with shipping terms.

Common cutoff issues and how to think about them

• Goods in transit (inbound): items shipped by the supplier but not yet received. Whether they belong in your inventory depends on when ownership transfers (often driven by shipping terms).
• Goods in transit (outbound): items shipped to customers but not yet received by them. Whether they remain in your inventory depends on when ownership transfers.
• Mis-timed receiving: goods received before cutoff but recorded after cutoff (inventory understated; payables understated).
• Mis-timed shipping: goods shipped before cutoff but recorded after cutoff (inventory overstated; sales/COGS understated).
• “Bill-and-hold” or staged shipments: invoiced but not shipped; may not qualify as a sale depending on the facts. For period-end inventory, focus on whether goods actually left your control and whether ownership transferred.
• Consignment: goods held at your site but owned by a supplier should be excluded; your goods held at a customer site may still be yours until sold.

FOB shipping point vs. FOB destination (ownership timing)

Practical rule: do not decide based on “where the goods are.” Decide based on who owns them at the cutoff, supported by shipping terms and shipping/receiving evidence.

Simple cutoff test steps (purchase side)

• Step 1: Select samples from receiving reports just before and just after cutoff.
• Step 2: Match to documents: receiving report ↔ vendor invoice ↔ purchase order ↔ bill of lading (if applicable).
• Step 3: Determine ownership at cutoff using shipping terms and shipment/delivery dates.
• Step 4: Verify recording period: if received (or owned) before cutoff, it should be included in ending inventory and recorded as a purchase/payable in the correct period.

Simple cutoff test steps (sales/shipping side)

• Step 1: Select samples from shipping documents just before and just after cutoff.
• Step 2: Match to documents: bill of lading/packing slip ↔ customer invoice ↔ sales order.
• Step 3: Determine ownership transfer using shipping terms and shipment/delivery dates.
• Step 4: Verify recording period: if ownership transferred before cutoff, inventory should be reduced and the sale recorded in the correct period; if not, inventory should remain.

Checklist: Reconcile physical count to accounting records

Reconciliation converts the count into the final inventory quantity/value by explaining differences between (a) the physical count and (b) the book (recorded) inventory, including documented cutoff items and other known adjustments.

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Reconciliation steps

• Step 1: Compile the physical count results by SKU and location; separate good vs. damaged/unsellable if tracked separately.
• Step 2: Obtain the book inventory listing as of the cutoff (or as of count time, then adjust for movements to cutoff).
• Step 3: Compare and compute variances (quantity and value). Investigate large or unusual variances.
• Step 4: Layer in cutoff findings: add items owned but not counted (in transit you own), remove items counted but not owned, and correct mis-timed shipments/receipts.
• Step 5: Identify root causes: receiving not entered, shipping not entered, unit-of-measure errors, mispicks, theft/shrink, damaged goods not segregated.
• Step 6: Prepare adjustment entries supported by documentation and approvals.
• Step 7: Retain an audit trail: count instructions, tag control log, recount notes, cutoff test samples, and final reconciliation schedule.

Typical adjustment patterns (conceptual)

• Physical < book: indicates shrink, unrecorded shipments, damage not written off, or book overstatement.
• Physical > book: indicates unrecorded receipts, data entry errors, or book understatement.
• Cutoff corrections: often explain differences without implying shrink (e.g., goods shipped/received around cutoff recorded in the wrong period).

Reconciliation exercise (short, numbers-based)

Scenario: Your book inventory at 12/31 shows $50,000. A physical count performed at 12/31 finds $48,700 of goods on hand (at cost). During cutoff testing, you identify the following documented items:

• Item A (inbound, FOB shipping point): Supplier shipped goods on 12/30 for $2,500. They were received on 1/2 and therefore were not on the warehouse floor during the count. Because it is FOB shipping point, you owned them at 12/31.
• Item B (inbound, FOB destination): Supplier shipped goods on 12/30 for $1,200, received on 1/3. Because it is FOB destination, you did not own them at 12/31.
• Item C (outbound, FOB shipping point): You shipped goods to a customer on 12/31 costing $1,800. The shipment was not recorded in the books until 1/2. Because it is FOB shipping point, the customer owned them once shipped; they should not be in your 12/31 inventory.
• Item D (outbound, FOB destination): You shipped goods on 12/31 costing $900, terms FOB destination, delivered 1/2. You still owned them at 12/31, so they should remain in 12/31 inventory (they may be “in transit” but still yours).

Step 1: Start with the physical count

Physical count (on hand) at cost: $48,700

Step 2: Adjust physical count for items you owned but did not count (add) and items you did not own but did count (subtract)

• Add Item A (owned at 12/31 but not on-site): + $2,500
• Do nothing for Item B (not owned at 12/31): + $0
• Subtract Item C if it was still included in the physical areas counted (common if staged for pickup or not segregated): - $1,800
• Add Item D if it was not on-site during the count but still owned (in transit): + $900

Adjusted physical inventory (should equal corrected book inventory):

Adjusted physical = 48,700 + 2,500 - 1,800 + 900 = 50,300

Step 3: Compare to book inventory and compute the required adjustment

Book inventory (per records): $50,000

Correct inventory (per adjusted physical): $50,300

Difference: $50,300 - $50,000 = $300 increase

Step 4: Translate the difference into an adjustment (conceptual entry)

If the corrected inventory is higher than the book amount, you need to increase inventory by $300 (with the offset typically to an inventory variance/shrink account or cost of sales, depending on your policy and system). The cutoff items (A, C, D) should also be fixed by ensuring the related receiving/shipping transactions are recorded in the correct period according to ownership.

Quick self-check questions

• Which items were not on-site but still belonged in inventory at 12/31? (Look for “owned at cutoff” even if received later.)
• Which items were on-site or counted but should be excluded because ownership transferred before cutoff?
• Did any item depend on FOB terms to decide ownership?