Inventory Count Discrepancy in a Going-Concern Valuation
You are valuing the inventory and equipment of a specialty food manufacturer for a buy-sell agreement. The company's perpetual inventory system reports $2.8 million at cost. A physical count you observed 10 days before the valuation date found $2.55 million at cost, with the shortfall concentrated in perishable raw materials. Between the count and the valuation date, the company shipped $180,000 (at cost) and received $95,000 in new raw materials. The controller says the perpetual system is 'usually right' and asks you to use the $2.8 million book figure because 'that's what the buyer will see on the balance sheet.' About $300,000 of finished goods are near their expiration date and would likely sell at a 40% discount.
1. Roll the physical count forward to the valuation date and determine the inventory quantity to rely on.
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Roll-forward from the count (10 days before valuation date):
- Physical count at cost: $2,550,000
- Less shipments after count: −$180,000 → $2,370,000
- Plus receipts after count: +$95,000 → $2,465,000
So the count-based inventory at the valuation date is approximately $2,465,000, versus the $2.8 million book figure-a gap of about $335,000. The physical count (properly rolled forward) is the more reliable evidence because it is direct observation; the perpetual system's discrepancy is exactly the kind of shrinkage/error a physical count is designed to catch. Use the rolled-forward count as the quantity basis and disclose the book-to-count variance.
2. How should the $300,000 of near-expiration finished goods be treated, and does it affect the equipment value?
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Near-expiration goods: These are not worth cost. Apply a market/utility adjustment: $300,000 × 40% discount = $120,000 reduction, so they contribute about $180,000. This is a form of economic/functional obsolescence in the inventory (loss of utility due to condition/timing), not a physical count issue-so it is a separate adjustment layered on the $2,465,000 quantity figure.
Adjusted inventory ≈ $2,465,000 − $120,000 = $2,345,000.
Effect on equipment: Indirectly yes. If the plant is valued as a going concern, the equipment's earning capacity depends on throughput of saleable product. Persistent perishable spoilage may signal overproduction, poor demand forecasting, or inadequate cold storage-any of which can imply economic obsolescence in the equipment or a need for additional capital investment. Flag it and test whether the equipment's value should reflect that operating inefficiency; do not automatically assume the equipment is unimpaired.
3. The controller wants the book figure. How do you respond, and how do you present inventory in the report?
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Response: Explain that book value is an accounting convention, not evidence of market value or even of physical quantity. The physical count is direct evidence and it contradicts the book figure by roughly $335,000 before the expiration adjustment. Using book value would overstate the asset and mislead the buy-sell parties. Offer to reconcile the difference with the controller so the discrepancy is understood (shrinkage, timing, data-entry error), but the value conclusion follows the evidence.
Report presentation: Show the roll-forward transparently (count → shipments → receipts → expiration adjustment), state the book-to-count variance and its cause if known, and disclose that the count was observed 10 days before the valuation date with the roll-forward assumptions. Present inventory by category (raw materials, WIP, finished goods) since each carries different marketability. If the buy-sell agreement defines 'inventory' by a formula or book basis, note that the agreed definition may differ from market value and value accordingly-but label it clearly.