Rescinded [2017-04-01] - Policy on Accounting for Inventories

Provides the accounting requirements for inventories of material and equipment.
Date modified: 1996-10-01

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1. Accounting for inventories

  1. Inventories of materiel and equipment may be regarded as expenditures in suspense and, accordingly, accounting and control techniques applicable to them are described in this chapter.
  2. Accounting and control procedures are basically the same for the purchase of inventories and for regular transactions, but because inventories have continuing and often significant value for some time after their purchase, additional procedures are required to account for and control them until they have been consumed in operations or have otherwise been disposed of. Appropriate accounting and control techniques will vary between departments depending on such factors as the quantities, dollar values, and attractiveness of inventory items, and the need for accurate cost information. In selecting appropriate techniques, departments should consider the general requirements of management for visibility, accountability, and control in all financial matters. Through proper accounting for inventories, financial reports can be significantly improved, custodians can be held accountable for the assets under their control, and decision-making on the acquisition and utilization of assets can be facilitated.
  3. In this section the need for accounting control of inventories is discussed; techniques for controlling inventories of materiel and equipment through accounting records and physical counts are explained; and some considerations on the financial reporting of inventories are presented.

1.1 Need for accounting control over inventories

  1. Responsibility and accountability for the custody and use of an asset extend over its useful life, especially when the useful life exceeds the fiscal year and thus the bounds of normal parliamentary financial control. Financial officers should recognize that effective management of cash resources cannot be achieved without equally effective management of assets after they are acquired for cash. Although financial officers should not assume functional responsibilities that have been assigned to other functional disciplines, such as materiel management, or to operating managers, they should ensure that significant information relating to the custody and use of assets is expressed in financial terms and is integrated with the principal budgetary, accounting, and reporting systems of their departments.
  2. Within a department, the extent to which financial control of assets is appropriate will vary according to the circumstances of each responsibility centre. Financial control should be established when it is cost-effective to do so, or when there is a use for additional financial information or additional internal control. For example, financial control of stationery supplies would rarely be useful for most responsibility centres, although it would be expected of printing and publishing units or materiel-handling and central-storage areas.
  3. Financial officers in each department should ensure that requirements for accounting and financial control over inventories of materiel and equipment, including clear identification of inventories that must be controlled, are communicated to line and functional managers responsible for custody of inventories.
  4. Inventories of materiel and equipment are recorded at nominal value on the Statement of Assets and Liabilities of the Government of Canada, and there is no statutory requirement for them to be recorded in total in the central accounting system of the government, nor is there any regulatory requirement for detailed departmental accounts, except when they are financed by means of a revolving fund. However, a number of reasons why departmental management should consider establishing accounting control over such assets are stated below.

1.1.1 Independent control over custodians

Each department should have systems to ensure that all physical assets are in safe custody to protect against the loss of assets through theft or misuse. The management of assets is normally the responsibility of operational or specialized functional managers, and these individuals will often operate independent systems to record the costs of assets on hand. When detailed inventory records are maintained either at operating or at functional responsibility centres, internal control will be strengthened if the duties of the custodians are clearly separated from those of the record-keepers. In addition, and in accordance with the principles established earlier in this chapter, these record systems should be considered as subsidiary accounting systems and should be integrated with the principal accounting system of the department. Operation of a control account in the principal accounting system provides independent control over those operating the subsidiary system, ensuring that they do not write off or otherwise dispose of assets without appropriate authority. The attractiveness of assets and the opportunities for misuse should be taken into account in determining the need for independent control.

1.1.2 Effect on budgetary control

Investments in inventories of materiel and equipment are more readily managed than most other expenditures. As such, opportunities are provided to cushion the effect of budgetary constraints by depleting inventories or to use up otherwise lapsing funds by building up inventory levels. This may be good management of financial resources, but it should be done only with the full knowledge and approval of senior departmental management and the appropriate program officer of Treasury Board, since current-year appropriations are granted to satisfy current-year operational expenditures. When inventory movements distort the true operating results of a responsibility centre or the cost of an activity, senior management may be misled and may lose control over the operational performance of their subordinates. In addition, since there are substantial costs involved in carrying inventories, including the risk of obsolescence, it is important that the total investment in inventories be known from year to year.

1.1.3 Need for accurate cost information

By integrating inventory systems with the principal accounting system, the effect of changing asset levels on costs is eliminated from reports produced. Materiality will determine needs in this area. In this respect, consideration should be given to the effect of inventories on the program as a whole and on the evaluation of performance of an individual responsibility centre.

1.2 Description of materiel and equipment

  1. Inventories of materiel include consumable operating supplies and raw materials, goods in process of production, and goods held for sale or reissue.
  2. Inventories of equipment include items that are not expendable except through depreciation and normal wear and tear, and that normally need maintenance. Examples are mechanical and electrical machinery or equipment, motor vehicles, and furniture. Practices for the financial control of equipment may also be applied to minor capital items, small buildings, and holdings of real estate that may be the property of departments.
  3. The Material, Risk and Common Services volume of the Treasury Board Manual is a guide for use by departments when reviewing their materiel management systems and procedures.
  4. Techniques for accounting for inventories are described in Appendix A.

1.3 Financial reporting of inventories

  1. The principal financial reporting system of a department should report totals of significant values of materiel and equipment on hand at the end of each accounting period, by category and by responsibility centre, with accumulated totals being reported at higher levels of responsibility when appropriate. The totals reported are useful as absolute values, particularly at lower levels of responsibility, where, for example, it may be desirable to ensure that minimum inventory levels are being maintained. The totals, when compared with budgeted levels and previous experience, are also a convenient basis for identifying the effect of changing asset levels on the system of budgetary control over cash appropriations.
  2. In the principal departmental accounting system, it may also be desirable to report major exceptions either as an analysis of the total balance or as charges to responsibility centres for such items as obsolete, slow-moving, or damaged inventories, or for under-utilization of equipment or real estate.

2. Enquiries

Enquiries concerning this policy should be directed to your departmental headquarters. For interpretation of this policy, departmental headquarters should contact:

Financial and Contract Management Sector
Comptroller General Branch
Treasury Board Secretariat
L'Esplanade Laurier
300 Laurier Ave West
Ottawa, Ontario
K1A 0R5
Telephone: (613) 957-7233
Facsimile: (613) 952-9613

Appendix A -Techniques for accounting for inventories

1. Introduction

  1. This appendix describes alternative accounting methods to effect financial control over inventories of materiel and equipment when circumstances indicate the need for such control.
  2. The choice of method used to exercise financial control over inventories will depend upon the benefits to be attained relative to the cost.
  3. The actual form of the inventory records can vary from handwritten working papers or ledgers to sophisticated mechanical or electronic inventory control systems.

2. Recording of inventories of materiel

The following variations are considered:
  • use of subsidiary and control accounting records;
  • use of control accounting records only; and
  • inventory accounting in the absence of formal records by periodic stocktaking.

3. Subsidiary and control accounting records

In this method all entries in the departmental subsidiary system are recorded individually or in total in a control account in the principal departmental accounting system. These entries include the costs of all receipts and issues; quantity shortages or overages identified through physical stock counts; and deletions of obsolete, damaged, or excess stock. The subsidiary system should be regularly reconciled with the control account.

4. Control accounting records only

For economy and simplicity, a subsidiary system may record quantities of inventory only, but in these circumstances each receipt or issue transaction should be assigned a value for entry in a control account in the principal accounting system. Periodically, the quantity balances shown on the subsidiary system should be priced and reconciled in total with the control account.

5. Periodic stocktaking system

A system for accounting for inventories based on physical stock counts may be suitable only when it is uneconomic or very difficult to record each receipt and issue in the accounting system. In these circumstances, the amount of inventory used in a month or fiscal year may be determined by physical stock count on the basis that the opening inventories, plus purchases during the period, less closing physical inventories valued at unit cost prices, represent the net cost of inventories consumed in the period. The purchases in the period should be determined directly from the departmental accounting system, using line objects to obtain the necessary detail. The computed net cost of inventories consumed in the period is allocated in the accounting records on an appropriate and equitable basis, depending upon requirements for financial reporting. A degree of financial control over such inventories can be obtained through analysis of variances between actual and budgeted costs to ensure that the rate of consumption of inventories and total stock levels are in line with the level of operating activity.

6. Physical counts

  1. Whatever the accounting system, there is a need to perform physical counts to prove that there have been no serious lapses in either physical custody or accounting controls over inventories.
  2. Physical counts should be performed, summarized, and verified with inventory records by persons who are independent of the inventory custodians. Financial officers should participate directly in the planning, performance, and review of physical counts to ensure independence in the determination of quantities, physical condition, and values of inventories.

7. Valuation of inventories of materiel

  1. Inventories of materiel may be accounted for at cost by the following methods:
    • Establishing what direct and indirect expenses are to be included in or excluded from cost. For example, the cost of goods in a warehouse may be recorded at the price paid to the supplier or may include shipping, handling, and warehousing costs.
    • Establishing how costs are to be allocated to individual items in inventory. For example, costs may be recorded on a specific, average, or standard basis.
  2. A standard costing system is recommended for most applications because it provides a good basis for financial control; serves the needs of those responsible for the materiel management function; and does not require complex accounting methods.
  3. In this system, materiel acquisitions are recorded in the control account and subsidiary system at standard cost, with any resulting differences in the purchase price and shipping costs being recorded in a separate account. The balance in this separate account will represent accumulated price variances for each category of item, an analysis of which may disclose unrealistic standards, or favourable or unfavourable purchasing arrangements in the period. Issues from inventory to operations are also recorded at standard cost. At any point in time the total standard cost of all physical inventories on hand should be equal to the balances in the subsidiary accounting system and to the total in the control account. When standard costing is used, the standards should be realistically determined. Established standards should be reassessed on a systematic basis once each year or, if appropriate, on an exception basis during the year. When a new standard is introduced, existing inventories should be revalued and the applicable adjustment should be recorded in the accounts.

8. Work in process

A work-in-process system should be used to determine the costs of manufacturing or processing operations. In such a system labour and raw-material costs are identified in relation to individual operations or projects, and other costs are allocated on an appropriate basis. Separate control accounts are operated for each cost component. These act as clearing accounts for inventories of work in process; they are charged with raw materials, labour, and other costs as they are entered into the productive process and are relieved of these costs as products are completed and transferred to finished-product inventories. Separate control accounts are also maintained for raw materials and finished products. This enables accurate costs to be determined on a period-by-period basis and permits the investment in raw materials, work in process, and finished goods to be controlled.

9. Inventories of equipment

The following sets out certain accounting principles with respect to equipment that should be adhered to by all departments:

  1. "While in inventory, equipment should be accounted for in the same manner as other items. Once issued for use, central records should be maintained to reflect distribution either geographically or by individual operating units.
  2. "To preserve the continuity of responsibility for equipment in use, operating units should maintain records of the internal distribution of equipment."
  3. There should be adequate accounting controls over the equipment records to ensure that they are complete and accurate. This includes maintaining a direct link with the principal departmental accounting system to ensure that all assets acquired and processed through the cash records are also included in the equipment records. For example, the total-dollar values of purchases as recorded in the equipment records should be reconciled with appropriate line-object totals created for that purpose in the classification of accounts and shown in financial reports. This would require a minimum of extra work, since computer reports that summarize the data in a useful way could be developed easily. As a minimum standard, when it is not practical to maintain dollar values in the detailed equipment records, no cheque requisition with respect to equipment should be processed unless it bears evidence that the item has been entered into the equipment records.
  4. It should not always be necessary to integrate equipment records fully into the departmental accounting system, but information with respect to the total cost of equipment on hand at a responsibility centre should be available on request. There are circumstances, however, when it would be useful to report information on equipment by memorandum in departmental financial reporting systems. This may include a monthly or annual depreciation charge to allocate the cost of each item of equipment over its useful life and to provide an estimate of the current depreciated value of each item or of the total equipment on hand. Such depreciation charges should be equitably computed and consistently applied for each individual item or for each class of item, based on usage statistics or on a straight time consideration.
  5. When it is desired to integrate equipment records with the principal accounting system, this can be done through the use of contra accounts.

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