Insights Featured Articles Simplifying Inventory Reconciliations

       

Simplifying Inventory Reconciliations

By: Eric M. Marschke, Manager – Inventory Valuation, AccuVal Associates, Inc.

A good inventory reconciliation eases the entire inventory appraisal process. They illustrate the source of the information received, clarify the project scope, identify excluded inventory and provide general clarity about the appraisal.

A solid reconciliation often increases the overall credibility of the valuation as well. It clearly shows an understanding of the source documentation and allows a client who might not routinely use the detailed inventory reports to get comfortable with how the appraised assets relate to more common financial reports. It's in the best interest of all parties to make that process as seamless as possible.

What sources can be used in the reconciliation?

In most inventory appraisals, reconciliations tie out the inventory reports that form the basis of the appraisal to some other information source – most commonly, a company's general ledger, balance sheet or a borrowing base certificate.

Inventory appraisals involve analysis that's usually based on the most detailed reports that are readily available. Perpetual inventory reports, physical inventory listings or detailed categorical reports are common types of source documents.

What happens if the reconciliation doesn't tie out?

A good reconciliation is especially helpful when the submitted inventory reports don't match or come close to the inventory amount reported on a company's general ledger or balance sheet. When differences exist between the reports, the reconciliation proves vital because it illustrates and quantifies the differences. These are a few common reasons:

• Inventory reserves
• Report-timing variances
• Manual adjustments made by the company
• Currency variances
• Inventory not reported in detail and tracked separately
• Inventory not reported to the appraisal firm, either purposefully or accidently
• Last-minute inventory receipts and shipments

Additionally, appraisers are commonly provided with numerous inventory reports in different formats. In that case, the reconciliation will help illustrate the grand total from the sum of these various files.

Why are reconciliations so important for lenders?

A reconciliation of the submitted inventory reports to a company's borrowing base certificate (BBC), if one has been prepared, is common in appraisals done for asset-based lending purposes. A BBC reconciliation can be highly informative to a secured lender, as it demonstrates how the appraisal compares to what is reported on the BBC. In this case, the reconciliation focuses on what inventory amounts are reported to the lender versus the appraiser, as well as appraisal scope variances. BBC reconciliations show not only what was submitted, but also inventory that was considered ineligible and removed from the valuation. By illustrating the submitted and ineligible inventory, the BBC reconciliation, by default, also reconciles the eligible inventory amount that serves as the foundation for the appraisal.

The submitted inventory cost, as initially reported to the appraiser, offers the starting point for this process and sets the stage for the success of the reconciliation. When the inventory amount from the source documents provided to the appraiser equals the amount reported on the BBC, there's a level playing field and no variance. However, when the reported values are different, a staggered starting point creates an instant discrepancy that should be understood. Common reasons for different reported values include:

• General ledger-related variances, such as those mentioned earlier
• Inventory excluded in the reports provided to the appraiser (such as if the company knows the inventory is ineligible or outside the scope)
• Inventory excluded in the reported BBC totals
• Classification- and terminology-related issues
• General Reserves Identified in a company or BBC reserve versus a specific reserve identified at the item level by the appraiser

Beyond the submitted amount, if there is ineligible inventory excluded from the appraisal, additional inconsistencies can result. Whether ineligible differences arise depends on what's ineligible and how it's calculated. To illustrate, it's common for a BBC to consider "high-level" ineligible amounts that cannot be replicated in a detailed appraisal. Examples include: blanket reserves, static ineligible amounts for location-based or other reasons and general slow-moving or obsolete adjustments, among others. Certainly, in some cases allocations can be performed to "push" an overall adjustment down to the detailed reports, but in many cases this cannot be done reliably.

In other situations, calculation differences relative to how the company calculated an ineligible amount versus the appraisal firm's calculation can occur. If there are several ineligible inventory types, the overall ineligible calculation can become somewhat order-of-operation sensitive. As an example, if slow-moving inventory and work-in-process (WIP) are both considered ineligible, then how should a slow-moving WIP item be classified? Solutions exist for these issues and others, but it takes time and effort from the company and the appraiser, and, in some cases, the client.

Ultimately, the cleanliness and usefulness of the completed BBC reconciliation comes down to how many of these factors, or others, occurred. Expect appraisers to reach out to the company or the client to understand the structure of the borrowing base, how it was calculated and what source documents were used in order to prepare the BBC reconciliation. Lenders should be aware that the appraisers' ability to truly match the BBC varies based on all of these factors.

How do appraisers perform reconciliations?

The analysis needed to complete the reconciliation can vary substantially and depends largely on the information provided. In some instances, the inventory reports equal the general ledger, balance sheet or BBC amount exactly, or they equal the exact amount when one or two known adjustments are considered. This simplistic scenario is not the norm, however. More often, especially with larger and more complex inventories, appraisers use multiple perpetual reports, each with an assortment of variances and adjustments.

With these challenging reconciliations, discussions with a business' management team are helpful to reconcile the reports and totals. For appraisals that require inspections, it's ideal to complete this exercise while onsite. Although an onsite reconciliation might be best, it's frequently impossible, especially when the company has multiple operating divisions, inventory in several countries, a decentralized reporting system or even missing files. In these cases, the appraiser is taking time away from valuation and investing time to "crack the code" – to understand how the reports link together and reconcile out. Incomplete files, or files that are inaccurate and resubmitted later, naturally impact the process.

Although the reconciliation is critical, and appraisers try to understand significant variances, it isn't the appraiser's goal to audit the company's records, trace variances to the dollar or attempt to correct a situation that might be un-reconcilable within the short timeframe of an inventory valuation. Instead, the appraiser is retained specifically to value the inventory. That means that, to a certain extent, it's logical for the appraiser (after exhausting all options) to note the un-reconciled variance and proceed with valuing the inventory accurately.

How to streamline the process (and save time and money)

For more complex reconciliations, companies can assist the appraiser and expedite the valuation by pre-reconciling inventory reports before submitting them to the appraisal firm. This initial work is not always practical or feasible, but simply noting how the files fit together and relate to the general ledger, balance sheet or BBC is helpful. Clients can help by being clear about any reconciliation-related goals and presentation preferences, as well as understanding the inherent difficulties that can accompany the process. Lastly, appraisers should communicate any major issues and, in the case of very complex reconciliations, should consider sending a preliminary reconciliation to the client for review prior to the final report's issuance.

As mentioned, the cleanliness of the reconciliation depends heavily on both the clarity of a company's records and the overall scope of the appraisal. An appraiser's ability to quickly and accurately discover discrepancies and present usable information also drives the success of this process. This is where the experience of the appraiser comes into play. Appraisers, by necessity, must focus their time to achieve quality valuation results in a timely fashion. Although reconciliations are part of the process and useful to the client, judgment should be used in determining where to draw the line during this process. Likewise, clients must be aware that an appraiser can only go so far with these steps, and ultimately, some variances might be beyond the appraiser's direct control.

This article is based on a technical white paper by Eric Marschke.

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About AccuVal
AccuVal provides a broad range of valuation, advisory and asset management solutions that contribute to growth or help ensure survival. We appraise the business enterprise and shareholder equity; bonds; intangibles and intellectual property; machinery and equipment; inventory; real estate and accounts receivables in over 100 industries worldwide. Learn more at www.accuval.net.