Controls for Receiving (#7)
/In this episode, we discuss the controls associated with the receiving function. This is a key area, since received goods need to be logged into the system properly in order to notify everyone that they are available for use. In addition, proper receiving assists the payables department in processing payments to suppliers. Key points in the podcast are noted below.
The Segregation of Duties
The first order of business is to make sure that the purchasing and receiving functions are segregated. Otherwise, someone in purchasing can order something, run down to the receiving dock to pick it up, and then take it home – which means that the company pays for it, and no one realizes that fraud has just been committed. So, by having a different person receive goods, the company can be sure that the received items are properly stored or dispositioned within the company – and not taken home.
The Receiving Process Flow
Besides the splitting of duties, there’s also a strict process flow used by the receiving function to ensure that there is a proper level of control. The first step in the process is when the purchasing department sends a copy of each issued purchase order to the receiving department. The receiving staff files all unreceived purchase orders by supplier name, which makes them easier to locate later on.
When a delivery arrives at the receiving dock, the staff uses the purchase order number marked on the shipment to reference the purchase order document. The staff then uses a standard receiving inspection checklist to review the delivery. This checklist can include such items as inspecting the shipping container for damage, proper labeling, product quality, quantity, and the date and time of delivery. They should initial each item on the checklist as they complete it, and make note of any problems. If there are problems, they usually contact the buyer who issued the purchase order for further instructions, which may involve storing the goods to one side for further review.
If the shipment has not been authorized by a purchase order, then the receiving staff should be authorized to reject the delivery. However, since this may cause all kinds of problems with rush deliveries that were authorized with a verbal purchase order, the receiving manager may spend some time trying to track down the recipient before rejecting the delivery.
In any case, the receiving department should always charge the buyer’s department a stiff inter-departmental charge for this service, since buying without a purchase order is a clear control breach, and is also a pain for the receiving staff to deal with.
If the shipment is acceptable, the receiving staff must identify and tag every item received with the correct part number, and then enter the part number and quantity received into the computer system. From the perspective of the materials manager, who needs to know what materials are in stock for production, this is the single most important control in the receiving process. It’s just not acceptable to put items on the shelf without first identifying and recording them. Even if the receiving manager claims that there’s too much material clogging the receiving area and he or she has got to move it into warehouse storage, the answer is always the same – tagging and logging come before storage. If necessary, the receiving staff can be supplemented with more employees to eliminate the work backlog. Under no circumstances can unrecorded inventory be stored in the warehouse, since it’s extremely difficult to locate it again. There. I think I’ve beaten that control point to death.
To continue a bit further with this concept, a key control is to make sure that all data entry happens as soon as possible. The best approach is to have suppliers attach bar coded identification tags to all deliveries, so the receiving staff simply scans the bar codes into the computer system and their data entry work is done.
If the receiving system is still paper based and there’s no computer in sight, then a different approach is needed. Receiving employees are not always hired for their data entry skills, so it may make sense to have a data entry clerk whose primary task is logging in receipts. This may call for manual entries to inventory card files, which – though primitive – are still in use. If so, the clerk should also complete a receiving log, which is a daily summary of all receipts. This log should include the date, the name of the supplier, third party delivery firm (if there is one), and the contents of each delivery at a summary level. If the receiving department enters this information into a computer system, then there is no need to maintain a separate receiving log, since the computer can automatically generate the report.
Why bother with a receiving log? It provides a good summary of daily receipts, which can be used by the accounts payable staff at month-end when it is trying to determine if there are any receipts in inventory for which it has not yet received a supplier invoice. If there are, then it uses the receiving log to assist in creating an expense accrual for the missing invoices. Of course, a fully integrated enterprise resources planning system will automatically locate any receipts for which there are no supplier invoices, and take the additional step of figuring out the price of these items from the related purchase order – this gives the accounts payable staff all the information they need to create a month-end expense accrual without ever bothering to look at the receiving log. Unfortunately, ERP systems cost a few million dollars, so most of us use other approaches to calculate the month-end payables accrual.
The final step in the receiving process is for the receiving staff to make a copy of the bill of lading, keep the copy for future reference, and forward the original to the accounts payable staff, who will match it to the supplier’s invoice and an authorizing purchase order before paying the invoice.
That’s it for the basic receiving process. However, receiving is also subject to a number of variations that are common enough to address as well.
Customer-Owned Inventory
One special case arises when a shipment contains customer-owned inventory. This happens when customers want to have some of their parts included in a custom-designed product. It can also happen when suppliers send consignment goods to the company that are to be sold by the company. In either case, the company does not own the goods, and should not record them as company-owned inventory, since this would greatly inflate the value of its inventory, thereby also falsely increasing its reported profit.
The best fix for this issue is to have the purchasing staff assign a special purchase order number to each incoming item that the company is not actually purchasing – perhaps it begins with an unusual letter, such as “Q”, that tells the receiving staff not to assign a part number to the order that is also used by a company-owned part, thereby avoiding the accidental assignment of a cost to the item. In addition, the unique purchase order code tells the receiving staff to put the inventory away in an area assigned to customer-owned or consignment goods, which is another way to ensure that this inventory is properly segregated and therefore not counted as company-owned inventory.
Yet another control over this issue is to put a special identification tag on each item, perhaps color coded, so there is no way an inventory counter will later identify it as being company-owned.
Customer Returns
Here is another special case, and one that’s even more common. What if customers return goods to the company? How does the receiving department accept it, or should it accept these returns?
The answer is that it should not accept returns without a formal authorization from the customer service department. I have had an interesting experience in this area where unrestricted returns almost bankrupted a software company that I worked for early in my career. Our sales were to large retailers, who realized that we had no returns policy, and immediately commenced shipping back massive quantities of a few poor-selling products. We hired a CFO who soon realized that this was a make-or-break problem. He had the receiving department reject all product returns unless they included a return authorization number – each of which was issued by him – personally. And I can assure you that he did not issue very many. The sales agreement with the retailers did not allow them to return unsold products, so he solved the problem with this control.
Returning from the example, the receiving staff obviously needs to have an up-to-date list of all return authorization numbers that have been granted, including – and this is important – the exact quantity and types of items for which a return is being granted. Otherwise, customers have a bad habit of returning more than was authorized, and may continue to do so for some time.
Cross-Docking
Let’s cover another common receiving situation, which is cross-docking. This is when items are delivered into a warehouse receiving bay and immediately shifted to another outbound truck, where they are shipped out again. Cross-docking almost certainly involves a high-volume environment where the materials handling staff has no time for transaction data entry. If materials handlers are still required to do data entry, they will almost certainly make mistakes. To avoid this issue, there are three possible controls for keeping data entry out of their hands.
One solution is to require complete bar coding of all incoming loads, so each pallet can be scanned as it leaves one trailer and enters another.
This approach requires a great deal of coordination with suppliers, but is certainly a common approach.
A second option is to have suppliers send an advance shipping notice to the company, detailing the exact contents of each truckload. As long as this information is accurate, the receiving staff simply logs in the identifying trailer number, the computer matches the trailer number to the advance shipping notice, and presto! The entire truckload is automatically entered into the company’s warehouse management system. This is very nice, but it does require accurate advance shipping notices from the supplier.
A third option is more old-fashioned, which is to have the materials handlers do nothing but handle materials, and assign full-time warehouse clerks to the entry of all incoming and outgoing transactions. This approach tends to result in the most errors, but also requires minimal automation.
Deliveries to the Production Line
And finally, here is one more special case – what if the company has no receiving function at all, and instead allows suppliers to deliver goods directly to the production line? This scenario almost never arises unless a company is using a just-in-time manufacturing process where inventory levels are kept so low that all arriving deliveries are used immediately in the production process. The key control is for the company’s engineering staff to visit each supplier location and certify the accuracy of their deliveries. If they pass, then they are allowed to make deliveries without going through the receiving process. A secondary control that is built into the system is that the company’s production process will shut down if parts are NOT delivered, while excess deliveries will be immediately obvious, because they will be piled up on the shop floor. A third control is to have an ongoing supplier report card system set up that tracks on-time delivery, as well as the quality and quantity of deliveries. If a supplier’s score drops too low, then they receive a re-certification visit from the engineering staff.
Parting Thoughts
Here is my interpretation of receiving: Inspections tend to be haphazard when a large number of deliveries are received at once, since the receiving manager is more concerned with getting deliveries properly identified and stored as soon as possible. Consequently, it’s better to rely upon other means of determining delivery problems, such as supplier pre-certification, than to rely upon the receiving staff to do inspections. Also, there can be a real problem with the transfer of receiving information to the accounts payable staff, with some paperwork never reaching the payables department at all, or very late. When I eventually reach the payables control lecture, I’ll talk about methods for automating and even eliminating this transfer of information.