Financial statements for Langley distributors and stock-holding businesses

Why inventory is the number that decides the statements

Closing inventory sits on the balance sheet as an asset and simultaneously determines cost of sales on the income statement. Overstate it and gross margin improves while working capital looks stronger; understate it and both fall. No other figure on a distributor’s year end moves two statements at once, which is why every reader looks at it.

It is also the figure most often produced by estimate. A warehouse count taken three weeks early and rolled forward on a spreadsheet is not a count at the date, and the gap is where a quiet margin distortion lives.

Cost, net realizable value and slow-moving stock

Inventory is measured at the lower of cost and net realizable value. Cost includes purchase price plus the costs of getting the goods to their present location and condition — freight in, duty, brokerage — which many small distributors expense instead of capitalizing, understating both inventory and margin. Net realizable value is what the stock will actually fetch less the cost to sell it.

That second test is where slow-moving and obsolete stock has to be confronted. Product that has sat for three seasons is not worth what was paid for it, and carrying it at cost inflates the asset base a lender is lending against. Writing it down is uncomfortable and is also the honest answer. The inventory accounting guide covers the mechanics.

Cost formulas, and staying on one

Whether cost is tracked on a first-in-first-out basis, a weighted average, or specific identification for serialized goods, the choice has to be applied consistently to similar items and disclosed. In a period of moving supplier prices the formula alone can shift reported margin materially, which is exactly why changing it mid-stream without disclosure destroys the comparability of two years of statements.

Landed-cost allocation deserves the same discipline. A container carrying twenty product lines has one freight and duty bill, and how that bill is spread across the lines determines the per-unit margin the business thinks it is earning. An allocation that is convenient rather than reasoned tends to flatter the fastest movers.

Cut-off: goods in transit and unshipped orders

Cut-off testing asks a simple question with awkward answers: on the last day of the fiscal year, who owned what. Goods on the water under FOB shipping-point terms are already the buyer’s inventory and already a payable, even though nothing has arrived. Goods picked and staged for a customer but not shipped are still inventory, not revenue. Consignment stock at a retailer usually remains on the distributor’s books.

Each of these is easy to state and easy to get wrong when the warehouse and the accounting system are not looking at the same date. A supplier invoice recorded in the wrong period without the matching inventory is a double hit to margin, and it is one of the most common findings when a stock-heavy year end is reworked.

What an inventory-secured lender wants to see

A distributor borrowing on an operating line usually has that line secured against receivables and inventory, with an advance rate applied to each. The lender is reconciling the borrowing-base reporting submitted through the year against the audited or compiled year-end figures, and gaps between the two are taken seriously. Aged inventory and aged receivables are typically excluded from the base entirely.

Statements that show inventory as one undifferentiated line, with no note on the basis of measurement and no write-down policy, invite exactly the questions a distributor does not want at renewal. Statements that disclose the measurement basis and show the write-down as a stated policy make the file legible.

A compilation does not verify the count

This point matters more for an inventory business than for almost anyone else. A compilation engagement under CSRS 4200 presents information management supplies. The accountant does not attend the stock count, does not test the valuation, and expresses no opinion or conclusion. It is not an audit and it is not a review. If a lender wants independent comfort that the inventory exists and is worth what the balance sheet says, that is a review or an audit, and it is a different engagement with a different cost and timetable.

Most owner-managed Langley distributors run on compiled statements without difficulty. But an inventory-secured facility above a certain size, a new lender, or a pending sale of the business are all common reasons a higher level gets requested — and an audit cannot be performed retroactively on a count nobody observed. If assurance may be needed, decide before the year end, not after.

Working with a remote CPA on a Langley year end

EverStone is a sole practitioner CPA firm operating from a single Abbotsford office, and there is no Langley location. Statements, the corporate return and the supporting schedules are prepared remotely through a secure portal, with video calls when something needs discussing. Nothing requires leaving the warehouse.

The work suits incorporated wholesalers, importers, equipment and parts distributors, building-supply businesses and light manufacturers holding raw materials. Related reading: the Langley small-business CPA page and accounting for Langley inventory businesses.

For conversion cycle and margin by line, see fractional CFO support for Langley distributors.