This article talks about the seasonal business of inventory counting from a Polish perspective. It is also broadly true, with variations in the details, for most countries in the region.
It’s that time of the year again. Already some businesses with financial years corresponding to the calendar year (which is still the vast majority of businesses in this country) will count their inventories at the end of November just to avoid interrupting their employees Christmas breaks, some however will be pulling in the warehouse staff and others around Christmas and New Year to do their yearly duty. Some businesses, even with material amounts of stocks, will however not be stock-taking at all, as they believe that they can take advantage of article 26 paragraph 3 point 2 of the Ustawa o Rachunkowosci and only perform this task every two years, and among those who will be doing it this year, a surprising number will not be taking it too seriously.
The point of this article is to remind you that the stocktake is one of the most important things that need to be done in order to be sure that the annual report is right, and to urge Quoracy.com readers to think again and invest some time and energy into this process if it has not been given adequate attention in your Company in the past.
For many businesses – at least half of the manufacturing ones and also a number of service enterprise performing long-term contract work-in-progress, the figure for stock is the largest asset and the largest item on the balance sheet. It is also one of the more complex to account for, as unlike the monetary items such as debtors and cash, which are simply denominated in value, you need to keep volume and value information and to that end most businesses with sizeable stocks run special warehouse programs to keep track of stocks and manage such matters as goods received notes and goods issued notes, reordering, and these systems often interface with the main accounting system showing the amount of stocks purchased against creditors for the given period and sold against debtors also.
For stock accounting an evidential or standard cost is often used, enabling the system to concentrate on the issue of volumes, and a system for allocation of deviations between actual cost and the standard costs.
In my experience the area is found difficult to get right by businesses, and where issues do occur in audits or errors appear which are of a size that could entirely upset the usefulness of the financial statement, more often than not it is precisely in the area of stocks, and a properly conducted stock-take could have helped avoid the problem. In many cases, years of sloppy stocktakes failed to spot a problem until it became critical.
International Accounting Standards, in particular IAS 2 “Inventories” talk in detail about the principals for the value to be shown for each individual item of stock, but there is no help in IAS for the question of how often and in what way to go about establishing the volume of the stock items actually present. There is no mention of inventory counting or stocktake methodology or frequenct, and there is not even a definition given for these in the glossary to IFRS. This is extremely disappointing, given the importance and centrality of this item for so many businesses, and one is driven to wonder about the practicality of IFRS when one sees a regular “taniec godowy” being made in IFRS about the question of derivatives (instrumenty pochodne) which effects only a minority of businesses and is non-routine in nature for many of them, and then total silence on a matter which actually creates more practical hicoughs in accountancy for more businesses than most others do.
So we are thrown back on national law for any kind of realistic guidance in the matter – the requirements of Polish law for businesses accounting under the “Ustawa o Rachunkowosci”. There have been queries coming across my desk from businesses which are accounting under IFRS asking what they should do when they are “not under the UoR, but the IFRS are silent in the matter” – it seems to me that they must also abide by the tenets of Polish law in matters not regulated in IFRS, but is the Polish law actually strict enough?
As you can see from the text of the Ustawa, almost all classes of asset must be counted from life (spisem z natury) on the last day of each accounting year. That’s the basic rule from 26.1 and 26.2. And a very fine rule it is. But then we come on the 3rd paragraph, which is where certain relaxations from the main rule are allowed, and we see that on the basis of these rules people are performing stock-takes of very material amounts of inventory where there are systems that do historically allow in errors and where there is rapid movement of stocks, anywhere between 3 months before and 15 days after their financial year end, and also these cases where whole years are skipped (which is only supposed to happen where warehouses are properly guarded and there is a proper stock system, but people take a very subjective interpretation of what that means). And this is where the law as it stands is rather deficient, and we have to rely on the good practice of well trained business managers, such as the people reading this magazine, to make sure they do the right thing anyway.
Here then is my advice about stocktaking for this fine magazine’s readership
DO give more attention to the stocktake if your stock is:
- A major asset in the balance sheet
- Controlled by special laws such as explosives and pharmaceuticals
- Easily removable and able to be used by employees or sold onwards
- Not tracked over the reporting period by volume and value (some businesses in Poland whose owners come from countries which have a relaxed system forget the implications of the monthly tax system in Poland and do not realise that if they do not have a full volume-and-value system, they actually need proper stock takes every month in this country)
- Difficult to count because of being “materialy sypkie” which need special mathematical algorithms to apply depending on the shape of the prism
- Obsolescent, or partly aging or damaged
- In numerous locations or needs at least several man days to count
- Extremely varied
- Known in the past to show up errors at stock take
(If you have any of the conditions in this list, then you have high risk stock, and shouldn’t in my view be taking advantage of biennial stock taking even if the Ustawa allows you to. If you have several then you should be ensuring that you have the time and resources allocated to take this exercise seriously, as failure to do so could upset the smooth-running of your business at some stage)
In planning the stocktake DO
- Start planning early, don’t leave it till the last minute
- Ensure auditors are informed and can attend. (Auditors are well within their rights to qualify your accounts if they are not enabled to attend the stocktake)
- Consider your stocks held at other locations and stocks at your location that belong to third parties.Certificates may be requested/issued for these items.
- Ensure that the count sheets do not contain any info on the expected volume of the stocks. This would compromise the count being a proper “count from life”. Counters will blindly accept any suggestion on the sheet about values and save on counting if they can. Count sheets should clearly identify the stock number, description, location and unit of measurement, and should be signed off by the counter and double-checked at least on a sample basis by another team)
- Ensure BHP training for each participant, especially those not normally working in the warehouse, and proper protective clothing on the day if needed.
- Ensure that there is an adequate number of teams to do the job in the available time – which ought to be the time over which the business can afford to avoid moving the stock around. Where stocks must be moved during the count, it is necessary to devise some marking system so that all items are counted, and once only.
- Ensure that the wareouse people who are responsible are all there, and that they are teamed up with people independent, such as bookeepers or other administrative people.
- Ensure that enough forklift drivers will be on hand if access to stock depends on that
- Take advantage of sensible techniques, such as digital photography, weighing homogenous stocks and the use of dipsticks for liquid tanks.
- Do try to arrange a stock-take at the time when the company’s stocks are at their annual low. The counting then is at its most accurate, and it is worth doing even if it is not the main stock count of the year. This is the probable origin of why the inwentaryzacja is sometimes known in informal language in Polish as the “remanent” – it refers to checking the ‘remnant’, the small amount left over at the end of a season.
Some DON’Ts of stock taking:
- Don’t cut corners – especially if the stock is risky stock as identified in the first list above. All year round you are paying good money to the accounts department to get a good set of financial statements, but if you don’t get this bit right, what chance do they have?
- Ignore likely weather or lighting conditions in planning. Last year alone I had to abort one count because it was planned after sundown in a poorly lit location and in another case the outside guages were frozen over so the apple juice concentrate involved would not flow over them. In another case it was hard to tell where the snow stopped and the coal started on one prism.
- Don’t try to measure a hałda or prism at a distance or use photography without a proper measurement. For complex shapes of materialy sypkie, don’t try to measure them unless you have specialist resources – get a surveyor in (geodeta).
- Don’t allow the people who are materially responsible for the stock to be responsible for the count of it, although they should be there at the time to answer questions.
- Don’t let the counters go from books to life, only from life to the books. Don’t give them access to the volume the system thinks is there
- Don’t delay in turning the results of the count into an adjustment to the books. You also need to analyse the possible reasons behind any surprising divergences between expacted volumes and actual volumes. This is a cue to check controls, especially access controls to avoid theft and also the correct functioning of the guages and scales that measure the inflow and outflow of stock – have they been checked for accuracy and maintained properly by the producer?
- Don’t forget to reward the count people with some kind of special thank-you, especially if they have been pulled out of their homes at Christmas time. This job is worth doing well, so it’s worth motivating people to take it seriously. Let it become one of your Company’s traditions that people actually might even start to enjoy and look forward to!
I would like to close this article with a story from my casebook about a company who had failed to get their stocktaking right – and this was a company in the heating sector which burned coal. They had had a problem with their weighing apparatus and for some time had been getting very good calorific results for each ton of coal they put into their furnaces, or so they thought. What had actually been happening was that they were reading 1 tonne of coal but putting in in fact 15% more.
Of course they suddenly ran out of coal in the depths of winter when the system was telling them that they had enough to go easily to the end of the season. They then assumed that the coal had been stolen and asked me to do a forensic accounting exercise to discover what had happened. This analysis led to the broken rolling scale and the both good and bad news that no-one had in fact stolen their coal, they had simply been overusing it for the previous six months. This would have showed up on their stock take (and saved them a lot of money not least in not needing to employ a top consultant) had they used the correct manner of measuring the coal, and not relied on two inexperienced children fresh from university sent in by their auditor, one of the largest companies in the world, who later needed to withdraw their audit opinion and redraft it with the correct figures in. When I asked what procedures these kids had applied at the stocktake attendance, I was told that they had looked at the coal pile from the third floor (about 300 metres away) as it was rather cold that day and they were young ladies and didn’t want to go outside. Please take your stocktakes a bit more seriously than that!
Some businesses holding large amounts of stock in their balance sheets are going to be audited and so they automatically will get an auditor to look (hopefully more closely than the above mentioned case) at their stock count, but even if your business is too small to fall under obligatory audit, but has relatively a large figure of stock or difficulties with control of stock, remember you can ask an auditor to make an audit style stock-take attendance without doing a full audit, and just report to you on the quality of the stocktake with recommendations for improvements. This shouldn’t cost more than a thousand Euro or two, and has a chance of giving you a good proportion of the value back that you would have had from a much more expensive full audit, if it’s a stock intensive business you are in. This comes under “agreed upon procedures” and auditors will be very pleased to help you with just what you need without making a full audit or review assignment out of it. Many people in business would find it useful, but just haven’t thought of asking an auditor in just for their view on the inventory count.
David J. James
(Photos by the author)
Sale and Leaseback or “leasing zwrotny” is becoming more popular in the Polish market and many of the readers of this fine new blog will find themselves tempted to enter into a sales and leaseback transaction at some time. Your decision whether or not to accept the deal will mainly be taken on the basis of comparing it to other deals to see who will put up most money at the best rate and fees, but two aspects you should still consider are firstly the tax treatment of sale and leaseback and secondly the treatment of the leased-back asset in your balance sheet. These issues may seem secondary, but where the choice is marginal you should certainly include these considerations in the calculation, and they are things you should be aware of.
- 1. Taxation of sale and leaseback.
You know the “leasing zwrotny” is one contact, the finance provider knows it’s one contract, but the tax office still treats this as two separate matters, the sale on the one hand, and a normal lease of an asset on the other. So, if the sale of the asset less the tax written-down value of that asset gives a profit, you will have a CIT charge. You may also be freezing money in the VAT system, as VAT will fall due on the sale element just the same as any other sale. (The best way to minimise the burden from this is to plan so that the lease is definitely classified as a finance lease, and make sure that both sides take place within the same month. Input VAT on operating leases is not all taken up front, and so you could end up with a surplus of output VAT to pay to the tax office with the inputs only coming back in future years if you structure the tax side of the deal as an operating lease). The ongoing depreciation of the asset will be either in the lessor’s books (operating lease) or the lessee’s books (finance lease) depending on the terms of the contract, and that can certainly make a difference between one deal and another being the best all-round option or not.
- 2 Accounting treatment of sale and leaseback
This all depends on whether your organisation is one of those organisations (part of any group that is an EU listed stock) which must report in IFRS on not. If you don’t need to report on IFRS, then whether the leaseback is a finance lease or an operating lease depends on the terms of Polish Accounting Law (Ustawa o Rachunkowości). Under UoR, it is also possible to treat what is formally an operating lease (where the asset is held and depreciated in the lessor’s tax accounting books) as a finance lease, if the risks and rewards of ownership are transferred to the lessee in terms of substance over form, (which they almost always are with sale and leaseback), but many business reporting under UoR still keep their tax and commercial accounts the same, and since that is fine with the tax office, if it’s fine with the owners, then who else is going to complain about it? For financial statements produced only under Polish accounting law, you can also get away with recognising the profit on the sale of the asset in the profit and loss for the year, in the same way as you will for the corporate income tax computation, although in fact it is more prudent, accurate and legal under UoR to follow the IFRS policy as below, as long as you make the correct adjustments to get back to your tax computation.
But if you do need to report under IFRS, then sale and leaseback transactions are to be treated in the commercial books as outlined in IAS 17:58-66, which specifically deal with “leasingi zwrotne”. That means that the lease will fall to be treated as a finance lease – regardless of tax treatment – if the risks and rewards incidental to ownership are substantially passed to the lessee. This is, incidentally, so in almost all cases of sale and leaseback that we can see on the market, by the way. The details of what indicates whether these risks and rewards have passed to the lessee can be checked against IAS 17 paragraphs 7 to 12, but basically it is up to you to convince your auditor. If it truly is an operating lease, then the good news under IAS 17 is that you can take the profit on the sale of the asset to the profit and loss account immediately. The bad news is that you won’t have the asset on the balance sheet any more, but then you won’t have the lease financing either, so that might be a good thing if you are still on the look out for more financing. If it is a finance lease in substance, then you have the asset and the new lease credit both on the balance sheet, but you have to take the profit on the sale of the asset and apply it over the course of the finance lease. This is because sale and leaseback is defined in IFRS as “usually interdependent, because they are negotiated as part of a package”, and therefore, just like you and the lender, but unlike the tax office, the IFRS sees the whole thing as a single deal. The asset going out and coming back is like a single throw of the boomerang.
The moral of the story is that it could look worse for your balance sheet to do sale and leaseback if you are reporting under IFRS than under UoR.
David J. James (first published in Polish in Finance Director magazine, 2006. Updated, translated and adapted for Quoracy.com)