ProQua

COMMUNITIES OF PRACTICE

Focus on Supply Chain Management: SOX and Inventory Reconciliation
Getting the Numbers Right

No matter how much information about the Sarbanes-Oxley Act (SOX) of 2002 is disseminated, the role company executives play bears repeating time and time again to ensure compliance.

When SOX was signed into law on July 30, 2002, it changed the way executives at nearly every publicly traded company thought about their business. Summarized in one sentence, the key tenet of SOX is that publicly traded companies must now provide financial transparency when preparing their financial reports. Both the chief executive officer (CEO) and the chief financial officer (CFO) must certify the accuracy of this financial transparency quarterly. Keeping this in mind, let�s explore how this basic tenet is applicable in one very important area of supply chain management activities�inventory reconciliation.

There are three basic issues involved with inventory reconciliation. It may not be apparent at first blush, but let�s examine why SOX demands accurately and timely review of materials to ensure inventory numbers.

1. The materials are physically present.

Because CEOs and CFOs must validate financials quarterly, the law significantly raises the importance of inventory reconciliation, as well as the pressure on executives to accurately account for their inventory. Traditionally, inventory reconciliation has been done on a periodic basis and generally annually.

Under today�s compliance laws, however, processes must be in place to confirm what a company says it owns each quarter is truly in its possession. For example, if a company says it has $40 million in inventory but can only definitively account for $35 million, it will have to make an adjustment and write off $5 million for the quarter. If the materials are not in the company�s possession, reconciliation must take place quarterly to ensure the financials are accurately depicted.

2. The inventory value is correct.

Not only must the inventory be physically accounted for, but through SOX the inventory values must correctly reflect market conditions. As we all have experienced, the market value of purchased inventory may be different from the value at time of purchase. Therefore, if an inventory item is purchased for $100/unit, this value must be reviewed quarterly for SOX purposes. If the market value of this $100 item is now $75, are we systematically reviewing the values to ensure the inventory account has been revalued to reflect the market price?

Why is this necessary? The CEO and the CFO must certify the financials of the company and the inventory values are certainly very visible in the financial statements. If the book value is still listed at $100 and not revalued to $75, then the financials are overstated and they violate the basic tenets of SOX�the ability of stockholders to see the true value of the inventory and financial condition of the company.

3. Inventory values are accurately represented within the accounting system.

When organizations operate in a lean environment, inventory control often takes a back seat. Too often material transfers are not processed on time and a true �inventory to accounting records� situation is difficult to achieve. With SOX, it is imperative that all movements of inventory or fixed assets be recorded in a timely manner given their definitive financial impact. So, if a company�s systems and processes are such that transactions are not recorded on time, the company may be subject to SOX violations. With quarterly certification by both the CEO and CFO, timely recording is a necessity.

Use SOX as your �calling card� to the CEO, CFO, or department head to improve processes, obtain additional resources, or implement new systems to meet the demands of SOX and inventory reconciliation. Traditionally, the budget for either people or systems is difficult to obtain in the inventory world. However, knowledge of SOX and the profound implications that exist with these inventory reconciliation issues should certainly open the door for discussion of and consideration for personnel and systems needs.

�Bob Engel, C.P.M., national director of client service, Resources Global Professionals, can be reached at (713) 401-1979 or via e-mail at bob.engel@resources-us.com.