Making the important connection between tech-enabled inventory management and the Generally Accepted Accounting Principles (GAAP).
Established to make the financial reporting process transparent, the Generally Accepted Accounting Principles (GAAP) standardizes the assumptions, terminology, definitions and methods that companies use to report their financial performance(opens in new tab).
This standardization helps external parties (e.g., investors, lenders, etc.) easily compare financial statements issued by GAAP-compliant entities and safely assume consistency, while also enabling quick and accurate cross-company comparisons.
Without GAAP, organizations wouldn’t be able to provide uniform, accurate financial data to their investors, stakeholders and creditors. “The purpose of GAAP is to create a uniform standard for financial reporting,” Motley Fool(opens in new tab) points out.
“When financial information is made available to the public,” it continues, “it should serve the purpose of helping investors make informed decisions as to where to put their money. Similarly, it should enable lenders to properly assess the financial condition of companies looking to borrow money.”
The Inventory Management-GAAP Connection
Good inventory management is a vital aspect of GAAP compliance because it can help limit the overstating of profits and/or value associated with inventory, which is recorded as the lesser of cost or “market value.”
According to the Financial Accounting Standards Board (FASB)(opens in new tab), market value is defined as the current replacement cost as limited by net realizable value. Put simply, it’s the amount of money that an item can be sold for in a given market.
For example, GAAP states that all inventory reserves be stated(opens in new tab) and valued using either the cost or the market value method, whichever is lower. An inventory reserve is money that is taken out of earnings for the purpose of paying cash or non-cash anticipated [as] future costs associated with inventory.
What Counts as Inventory?
According to FASB code section ASC 330 (Inventory), inventory has financial significance because revenues may be obtained from its sale, or from the sale of goods or services in the production of which that inventory is used. Thus, the inventory at any given date is the balance of costs applicable to goods on hand remaining after the matching of absorbed costs (which account for all direct and indirect costs associated with manufacturing a product) with concurrent revenues.
This balance is appropriately carried to future periods provided it does not exceed an amount properly chargeable against the revenues expected to be obtained from ultimate disposition of the goods carried forward, according to FASB. In practice, this balance is determined by the process of pricing the articles included in the inventory.
In What are the Generally Accepted Accounting Principles Relating to the Inventory Method?(opens in new tab), David Ingram points out that all tangible personal property intended for sale can be considered inventory. “Raw materials—items that will be included in final products—and work in process inventory—goods on which work has begun but not yet finished,” he writes, “[all] count as inventory, in addition to finished goods ready for sale.”
Minding the GAAP
Under GAAP, companies must count their complete inventory on an annual basis or implement a perpetual counting (“cycle counting”) system. Using an inventory system, companies can improve the accuracy of their inventory records, make good stocking choices, analyze missed sales opportunities, reduce turnover and use capital more efficiently.
NetSuite offers a number of native tools and features to help companies ensure GAAP compliance, including tracking inventory in multiple locations, safety stock, reorder points, cycle counts, demand planning and distribution requirements planning.
For example, NetSuite’s Inventory Count feature improves inventory tracking, gives organizations more control over their assets and provides the accurate information those companies need to stay GAAP-compliant. They can also categorize inventory based on volume of transactions and/or value, and enter regular periodic counts of on-hand item quantities to maintain inventory accuracy.
Ultimately, a company’s main goal should be to maintain inventory accuracy, enter all accounts payable into the inventory system as soon as that payable has been accrued, and ensure that all payments and credits are posted in a timely fashion. By implementing an inventory system, organizations can not only improve their accounting efficiencies, but they can also more readily comply with GAAP and any other operational/financial standards that they’re expected to adhere to.
Ready to learn more about inventory management systems and how they can help your organization stay GAAP-compliant? Contact us today or download this informative paper(opens in new tab) to learn more about how NetSuite can help you streamline your inventory management processes, improve tracking and maintain compliance.